**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

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**FORM 10-Q**

**x     QUARTERLY REPORT PURSUANT TO SECTION 13 OR15 (d) OF THESECURITIES EXCHANGE ACT OF 1934**

**Forthe Quarterly Period ended September 30, 2006**

**CommissionFile Number: 0-19972**

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**HF FINANCIAL CORP.**

(Exact name of registrantas specified in its charter.)

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

 

**(605)   333-7556**

(Registrant’s telephone number, including area code)

Indicate by checkmark whether the registrant  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  YES x    NO o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated fileror a non-accelerated filer.  Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.
| LARGE ACCELERATED FILER o |   | ACCELERATED FILER o |   | NON-ACCELERATED  FILER x |
|--------------------------------|--------|--------------------------|--------|-------------------------------|

 

Indicate by check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Exchange Act.)   YES o    NO x

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

Asof November 10, 2006 there were 3,965,479 issued and outstanding shares of theRegistrant’s Common Stock, with $.01 par value per share.

 

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**HF FINANCIAL CORP.**

**Form 10-Q**

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

 

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**PART I  – FINANCIALINFORMATION**

**Item1.             Financial Statements**

**HF FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION(Dollars in Thousands)**

 
| ** **                                                                                                                                                | ** ** | **September 30, 2006**                                | ** ** | **June 30, 2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                | ** ** | **    (Unaudited)    ** | ** ** | **(Audited)**               | ** ** |
| **ASSETS**                                                                                                                                                |       |                                                            |       |                        |       |
| Cash and cash  equivalents                                                                                                                                |       | $                                                               | 14,919     |                        | $          | 27,037 |   |
| Securities available  for sale                                                                                                                            |       | 153,167                                                         |       | 145,518                     |       |
| Federal Home Loan Bank  stock                                                                                                                             |       | 7,300                                                           |       | 5,647                       |       |
| Loans held for sale                                                                                                                                       |       | 9,311                                                           |       | 7,623                       |       |
| Loans and leases  receivable                                                                                                                              |       | 747,189                                                         |       | 727,260                     |       |
| Allowance for loan and  lease losses                                                                                                                      |       | (5,631                                                          | )          | (5,657                      | )          |
| Net loans and  leases receivable                                                                                                                          |       | 741,558                                                         |       | 721,603                     |       |
|                                                                                                                                                      |       |                                                            |       |                        |       |
| Accrued interest  receivable                                                                                                                              |       | 8,496                                                           |       | 6,880                       |       |
| Office properties and  equipment, net of accumulated depreciation                                                                                         |       | 15,043                                                          |       | 14,459                      |       |
| Foreclosed real estate  and other properties                                                                                                              |       | 2,055                                                           |       | 1,889                       |       |
| Cash value of life  insurance                                                                                                                             |       | 13,140                                                          |       | 13,013                      |       |
| Servicing rights                                                                                                                                          |       | 10,742                                                          |       | 5,648                       |       |
| Goodwill, net                                                                                                                                             |       | 4,951                                                           |       | 4,951                       |       |
| Other assets                                                                                                                                              |       | 6,513                                                           |       | 7,026                       |       |
| Total assets                                                                                                                                              |       | $                                                               | 987,195    |                        | $          | 961,294 |   |
|                                                                                                                                                      |       |                                                            |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                            | ** ** | ** **                                                      | ** ** | ** **                  | ** ** |
| **LIABILITIES**                                                                                                                                           | ** ** | ** **                                                      | ** ** | ** **                  | ** ** |
| Deposits                                                                                                                                                  |       | $                                                               | 741,801    |                        | $          | 769,002 |   |
| Advances from Federal  Home Loan Bank and other borrowings                                                                                                |       | 131,975                                                         |       | 91,620                      |       |
| Subordinated debentures  payable to trusts                                                                                                                |       | 27,837                                                          |       | 27,837                      |       |
| Advances by borrowers  for taxes and insurance                                                                                                            |       | 13,687                                                          |       | 6,969                       |       |
| Accrued expenses and  other liabilities                                                                                                                   |       | 13,572                                                          |       | 9,808                       |       |
| Total  liabilities                                                                                                                                        |       | 928,872                                                         |       | 905,236                     |       |
|                                                                                                                                                      |       |                                                            |       |                        |       |
| **STOCKHOLDERS’ EQUITY**                                                                                                                             | ** ** | ** **                                                      | ** ** | ** **                  | ** ** |
| Preferred stock, $.01  par value, 500,000 shares authorized, none outstanding                                                                             |       | —                                                          |       | —                      |       |
| Series A Junior  Participating Preferred Stock, $1.00 stated value, 50,000 shares authorized,  none outstanding                                           |       | —                                                          |       | —                      |       |
| Common stock, $.01 par  value, 10,000,000 shares authorized, 5,943,315 and 5,926,496 shares issued at  September 30, 2006 and June 30, 2006, respectively |       | 59                                                              |       | 59                          |       |
| Common stock subscribed  for but not issued, 4,078 shares at June 30, 2006                                                                                |       | —                                                          |       | 65                          |       |
| Additional paid-in capital                                                                                                                                |       | 19,788                                                          |       | 19,384                      |       |
| Retained earnings,  substantially restricted                                                                                                              |       | 68,870                                                          |       | 68,179                      |       |
| Accumulated other  comprehensive income (loss), net of related deferred tax effect                                                                        |       | (1,227                                                          | )          | (2,462                      | )          |
| Less cost of treasury  stock, 1,977,836 and 1,977,836 shares at September 30, 2006 and June 30,  2006, respectively                                  |       | (29,167                                                         | )          | (29,167                     | )          |
| Total  stockholders’ equity                                                                                                                          |       | 58,323                                                          |       | 56,058                      |       |
| Total liabilities and  stockholders’ equity                                                                                                          |       | $                                                               | 987,195    |                        | $          | 961,294 |   |

 

*See accompanying notes to unaudited consolidated financialstatements.*

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**HFFINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME(Dollars in Thousands, Except Per Share Data)(Unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                              | ** ** | **September 30,**           | ** ** |
| ** **                                                              | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Interest, dividend and  loan fee income:                                |       |                             |       |   |   |
| Loans and leases  receivable                                            |       | $                                | 13,240     |   | $ | 11,121 |   |
| Investment  securities and interest-earning deposits                    |       | 1,838                            |       | 1,351 |   |
|                                                                    |       | 15,078                           |       | 12,472 |   |
| Interest expense:                                                       |       |                             |       |   |   |
| Deposits                                                                |       | 6,541                            |       | 4,296 |   |
| Advances from  Federal Home Loan Bank and other borrowings              |       | 2,119                            |       | 1,841 |   |
|                                                                    |       | 8,660                            |       | 6,137 |   |
| **Net interest  income**                                                |       | 6,418                            |       | 6,335 |   |
| ** **                                                              |       |                             |       |   |   |
| Provision for losses on  loans and leases                               |       | 291                              |       | 462 |   |
|                                                                    |       |                             |       |   |   |
| **Net  interest income after provision for losses on loans and leases** |       | 6,127                            |       | 5,873 |   |
|                                                                    |       |                             |       |   |   |
| Noninterest income:                                                     |       |                             |       |   |   |
| Fees on deposits                                                        |       | 1,193                            |       | 1,176 |   |
| Loan servicing  income                                                  |       | 329                              |       | 268 |   |
| Gain on sale of  loans, net                                             |       | 196                              |       | 299 |   |
| Trust income                                                            |       | 216                              |       | 195 |   |
| Other                                                                   |       | 410                              |       | 447 |   |
|                                                                    |       | 2,344                            |       | 2,385 |   |
| Noninterest expense:                                                    |       |                             |       |   |   |
| Compensation and  employee benefits                                     |       | 4,156                            |       | 4,303 |   |
| Occupancy and  equipment                                                |       | 938                              |       | 780 |   |
| Other                                                                   |       | 1,815                            |       | 1,591 |   |
|                                                                    |       | 6,909                            |       | 6,674 |   |
|                                                                    |       |                             |       |   |   |
| **Income  before income taxes**                                         |       | 1,562                            |       | 1,584 |   |
| ** **                                                              |       |                             |       |   |   |
| Income tax expense                                                      |       | 465                              |       | 561 |   |
| **Net  income**                                                         |       | $                                | 1,097      |   | $ | 1,023 |   |
| **Comprehensive income**                                                |       | $                                | 2,332      |   | $ | 861 |   |
| **Cash dividends declared per  share**                                  |       | $                                | 0.1050     |   | $ | 0.1023 |   |
|                                                                    |       |                             |       |   |   |
| **Earnings per share:(1)**                                              |       |                             |       |   |   |
| Basic                                                                   |       | $                                | 0.28       |   | $ | 0.26 |   |
| Diluted                                                                 |       | $                                | 0.27       |   | $ | 0.26 |   |

 

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(1) Retroactively adjusted for the 10% stock dividendpaid on April 24, 2006 to stockholders of record as of April 10, 2006

 

*See accompanying notes to unaudited consolidated financialstatements.*

2

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**HF FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Dollars in Thousands)(Unaudited)**

 
| ** **                                                                                     | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| **Cash flows from operating  activities**                                                      |       |                                                     |       |   |   |
| Net income                                                                                     |       | $                                                        | 1,097      |   | $ | 1,023 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities:   |       |                                                     |       |   |   |
| Provision for  losses on loans and leases                                                      |       | 291                                                      |       | 462 |   |
| Depreciation                                                                                   |       | 242                                                      |       | 361 |   |
| Amortization of  discounts and premiums on securities and other                                |       | 269                                                      |       | 516 |   |
| Stock based compensation                                                                       |       | 259                                                      |       | 184 |   |
| Deferred income  taxes (credits)                                                               |       | (12                                                      | )          | (4 | ) |
| Loans originated  for resale                                                                   |       | (19,680                                                  | )          | (32,772 | ) |
| Proceeds from  the sale of loans                                                               |       | 18,188                                                   |       | 27,172 |   |
| (Gain) on sale  of loans, net                                                                  |       | (196                                                     | )          | (255 | ) |
| Losses and  provision for losses on sales of foreclosed real estate and other properties,  net |       | 19                                                       |       | 14 |   |
| (Gain) loss on  disposal of office properties and equipment, net                               |       | 2                                                        |       | (2 | ) |
| Change in other  assets and liabilities                                                        |       | 1,931                                                    |       | 1,156 |   |
| Net cash  provided by (used in) operating activities                                           |       | 2,410                                                    |       | (2,145 | ) |
|                                                                                           |       |                                                     |       |   |   |
| **Cash flows from investing  activities**                                                      |       |                                                     |       |   |   |
| Loan  participations purchased                                                                 |       | (6,010                                                   | )          | — |   |
| Loans and leases  originated and held                                                          |       | (54,940                                                  | )          | (85,281 | ) |
| Principal  collected on loans and leases                                                       |       | 40,383                                                   |       | 81,191 |   |
| Securities  available for sale:                                                                |       |                                                     |       |   |   |
| Sales and  maturities and repayments                                                           |       | 11,329                                                   |       | 10,535 |   |
| Purchases                                                                                      |       | (17,114                                                  | )          | (18,655 | ) |
| Purchase of  Federal Home Loan Bank stock                                                      |       | (2,505                                                   | )          | (1,342 | ) |
| Redemption of  Federal Home Loan Bank stock                                                    |       | 852                                                      |       | 1,805 |   |
| Proceeds from  sale of office properties and equipment                                         |       | —                                                   |       | 2 |   |
| Purchase of  office properties and equipment                                                   |       | (981                                                     | )          | (834 | ) |
| Purchase of  servicing rights                                                                  |       | (5,224                                                   | )          | (284 | ) |
| Proceeds from  sale of foreclosed real estate and other properties, net                        |       | 136                                                      |       | 121 |   |
| Net cash (used in)  investing activities                                                       |       | (34,074                                                  | )          | (12,742 | ) |
|                                                                                                |            |                                                          |            |  |  |  |  |

 

*See accompanying notes to unaudited consolidated financialstatements.*

3

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**HF FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)(Dollars in Thousands)(Unaudited)**

 
| ** **                                                             | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
|                                                                   |       |                                                     |       |   |   |
| **Cash flows from financing  activities**                              |       |                                                     |       |   |   |
| Net (decrease)  in deposit accounts                                    |       | $                                                        | (27,201    | ) | $ | (3,925 | ) |
| Proceeds of  advances from Federal Home Loan Bank and other borrowings |       | 382,486                                                  |       | 145,678 |   |
| Payments on  advances from Federal Home Loan Bank and other borrowings |       | (342,131                                                 | )          | (130,116 | ) |
| Increase in  advances by borrowers                                     |       | 6,718                                                    |       | 4,301 |   |
| Proceeds from  issuance of common stock                                |       | 80                                                       |       | 178 |   |
| Cash dividends  paid                                                   |       | (406                                                     | )          | (384 | ) |
| Net cash  provided by financing activities                             |       | 19,546                                                   |       | 15,732 |   |
|                                                                   |       |                                                     |       |   |   |
| Increase (decrease)  in cash and cash equivalents                      |       | (12,118                                                  | )          | 845 |   |
|                                                                   |       |                                                     |       |   |   |
| Cash and cash  equivalents                                             |       |                                                     |       |   |   |
| Beginning                                                              |       | 27,037                                                   |       | 18,248 |   |
| Ending                                                                 |       | $                                                        | 14,919     |   | $ | 19,093 |   |
|                                                                   |       |                                                     |       |   |   |
| Supplemental  Disclosures of Cash Flows Information                    |       |                                                     |       |   |   |
| Cash payments  for interest                                            |       | $                                                        | 7,999      |   | $ | 5,420 |   |
| Cash payments for  income and franchise taxes, net                     |       | 27                                                       |       | 919 |   |

 

*See accompanying notes to unaudited consolidated financialstatements.*

4

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**HF FINANCIAL CORP. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIALSTATEMENTS**For The Three Months Ended September 30, 2006 and 2005(Unaudited)

**NOTE1.          SELECTED ACCOUNTING POLICIES**

*Basis ofpresentation:*

Theconsolidated financial information of HF Financial Corp. (the “Company”) andits wholly-owned subsidiaries included in this Quarterly Report on Form 10-Q isunaudited.  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 Form10-K for the fiscal year ended June 30, 2006 (“Fiscal 2006”), filed with theSecurities and Exchange Commission.  Theaccounting and reporting policies of the Company and its subsidiaries conformto accounting principles generally accepted in the United States of America (“GAAP”)and to general practice within the industry.

Theinterim consolidated financial statements include the accounts of the Company,its wholly-owned subsidiaries, Home Federal Bank (the “Bank”), HF FinancialGroup, Inc. (“HF Group”) and HomeFirst Mortgage Corp. (the “Mortgage Corp.”),and the Bank’s wholly-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 financialstatements reflect the deconsolidation of the subsidiary trusts of the Company,HF Financial Capital Trust I (“Trust I”), HF Financial Capital Trust II (“TrustII”), HF Financial Capital Trust III (“Trust III”) and HF Financial CapitalTrust IV (“Trust IV”).  All intercompanybalances and transaction have been eliminated in consolidation.

Stock-basedcompensation:  InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 123R, *“Share-Based Payment,”* which requires all companies tomeasure compensation cost for all share-based payments (including stockoptions) at fair value and to record such expense in their consolidatedfinancial statements.  SFAS No. 123R is arevision of SFAS No. 123, *“Accounting forStock-Based Compensation,”*and supersedes Accounting PrinciplesBoard (“APB”) Opinion No. 25, *“Accountingfor Stock Issued to Employees”*.

The Company adopted SFAS No. 123R effective as of July1, 2005, using the Black-Scholes option-pricing model and the modifiedprospective method in which compensation cost is recognized for all awardsgranted subsequent to the Company’s adoption of this statement as well as forthe unvested portion of awards outstanding as of the Company’s adoption of thisstatement.  Prior to July 1, 2005, theCompany accounted for stock-based compensation in accordance with APB No. 25and related interpretations. As such, no stock-based employee compensation costwas recognized for grants under the Company’s stock option and incentive plans,as all options granted under those plans had an exercise price equal to themarket value of the underlying common stock on the date of grant.  These stock option and incentive plans are describedmore fully in Part II, Item 8 “Financial Statements and Supplementary Data” ofthe Company’s Annual Report on Form 10-K for Fiscal 2006, under Note 17 of “Notesto Consolidated Financial Statements.”

5

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 **NOTE 2.         REGULATORYCAPITAL**

Thefollowing table sets forth the Bank’s compliance with its minimum capitalrequirements for a well-capitalized institution at September 30, 2006:
|                                                    | ** ** | **Amount**                 | ** ** | **Percent** | ** ** |
|----------------------------------------------------|------------|----------------------------|------------|-------------|------------|
| ** **                                         | ** ** | **(Dollars in Thousands)** | ** ** |
| Tier I (core)  capital (to adjusted total assets): |       |                       |       |        |       |
| Required                                           |       | $                          | 39,298     |        | 5.00       | % |
| Actual                                             |       | 79,444                     |       | 8.09        |       |
| Excess over required                               |       | 40,146                     |       | 3.09        |       |
|                                               |       |                       |       |        |       |
| Risk-based  capital (to risk-weighted assets):     |       |                       |       |        |       |
| Required                                           |       | $                          | 63,939     |        | 10.00      | % |
| Actual                                             |       | 85,075                     |       | 10.64       |       |
| Excess over  required                              |       | 21,136                     |       | 0.64        |       |

 

**NOTE 3.          EARNINGS PER SHARE**

Basicearnings per share is computed by dividing income available to commonstockholders (the numerator) by the weighted-average number of common sharesoutstanding  (the denominator) during theperiod.  Shares issued during the periodand shares reacquired during the period are weighted for the portion of theperiod that they were outstanding. The weighted average number of basic commonshares outstanding for the three months ended September 30, 2006 and 2005 was3,959,622 and 3,847,016, respectively.

Dilutiveearnings per share is similar to the computation of basic earnings per shareexcept that the denominator is increased to include the number of additionalcommon shares that would have been outstanding if the dilutive optionsoutstanding had been exercised. The weighted average number of common anddilutive potential common shares outstanding for the three months endedSeptember 30, 2006 and 2005 was 4,035,493 and 3,940,277, respectively.

Allearnings per share data and number of common shares outstanding have beenretroactively adjusted for the 10% stock dividend paid on April 24, 2006 tostockholders of record as of April 10, 2006.

6

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**NOTE 4.                INVESTMENTSIN SECURITIES**

The amortized cost and fair values of investments insecurities, all of which are classified as available for sale according tomanagement’s intent, are as follows:

|                             | ** ** | **September 30, 2006**     | ** ** |
|-----------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | ** **                           | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Amortized**                        | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                  | ** ** | **Cost**                             | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Value** | ** ** |
| ** **                  | ** ** | **(Dollars in Thousands)** | ** ** |
|                        |       |                                 |       |   |   |   |   |   |   |
| Debt securities:            |       |                                 |       |   |   |   |   |   |   |
| U.S. government  agencies   |       | $                                    | 12,043     |   | $ | 32 |   | $ | (79 | ) | $ | 11,996 |   |
| Federal Home  Loan Bank     |       | 13,426                               |       | 18 |   | (89 | ) | 13,355 |   |
| Municipal bonds             |       | 7,604                                |       | 25 |   | (84 | ) | 7,545 |   |
| Preferred Term  Securities  |       | 11,019                               |       | 68 |   | (81 | ) | 11,006 |   |
| Other  Investments          |       | 5,423                                |       | 103 |   | — |   | 5,526 |   |
|                        |       | 49,515                               |       | 246 |   | (333 | ) | 49,428 |   |
|                        |       |                                 |       |   |   |   |   |   |   |
| Equity securities:          |       |                                 |       |   |   |   |   |   |   |
| FNMA                        |       | 8                                    |       | 14 |   | — |   | 22 |   |
| Federal Ag  Mortgage        |       | 7                                    |       | 3 |   | — |   | 10 |   |
| Other  Investments          |       | 66                                   |       | — |   | — |   | 66 |   |
|                        |       | 81                                   |       | 17 |   | — |   | 98 |   |
|                        |       |                                 |       |   |   |   |   |   |   |
| Mortgage-backed  securities |       | 105,551                              |       | 110 |   | (2,020 | ) | 103,641 |   |
|                        |       | $                                    | 155,147    |   | $ | 373 |   | $ | (2,353 | ) | $ | 153,167 |   |

 

7

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|                             | ** ** | **September 30, 2005**     | ** ** |
|-----------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | ** **                           | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Amortized**                        | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                  | ** ** | **Cost**                             | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Value** | ** ** |
| ** **                  | ** ** | **(Dollars in Thousands)** | ** ** |
|                        |       |                                 |       |   |   |   |   |   |   |
| Debt securities:            |       |                                 |       |   |   |   |   |   |   |
| U.S. government  agencies   |       | $                                    | 5,000      |   | $ | — |   | $ | (28 | ) | $ | 4,972 |   |
| Federal Home  Loan Bank     |       | 6,390                                |       | 31 |   | (12 | ) | 6,409 |   |
| Municipal bonds             |       | 2,698                                |       | 1 |   | (17 | ) | 2,682 |   |
| Preferred Term  Securities  |       | 11,019                               |       | 68 |   | — |   | 11,087 |   |
|                        |       | 25,107                               |       | 100 |   | (57 | ) | 25,150 |   |
|                        |       |                                 |       |   |   |   |   |   |   |
| Equity securities:          |       |                                 |       |   |   |   |   |   |   |
| FNMA                        |       | 8                                    |       | 10 |   | — |   | 18 |   |
| Federal Ag  Mortgage        |       | 7                                    |       | 2 |   | — |   | 9 |   |
| Other  Investments          |       | 38                                   |       | — |   | — |   | 38 |   |
|                        |       | 53                                   |       | 12 |   | — |   | 65 |   |
|                        |       |                                 |       |   |   |   |   |   |   |
| Mortgage-backed  securities |       | 126,424                              |       | 6 |   | (1,685 | ) | 124,745 |   |
|                        |       | $                                    | 151,584    |   | $ | 118 |   | $ | (1,742 | ) | $ | 149,960 |   |

 

The following table presentsthe fair value and age of gross unrealized losses by investment category atSeptember 30, 2006 in accordance with FASB Staff Position (FSP) No. FAS 115-1, *The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments,*which supersedes EmergingIssues Task Force Issue No. 03-1:
| ** **                  | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                  | ** ** | ** **                             | ** ** | **Gross**                            | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                  | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                  | ** ** | **Value**                              | ** ** | **(Losses)**                         | ** ** | **Value** | ** ** | **(Losses)** | ** ** | **Value** | ** ** | **(Losses)** | ** ** |
| ** **                  | ** ** | **(Dollars in Thousands)**   | ** ** |
| Debt securities:            |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S. government  agencies   |       | $                                      | 5,515      |                                 | $          | (32       | )          | $ | 3,953 |   | $ | (47 | ) | $ | 9,468 |   | $ | (79 | ) |
| Federal Home  Loan Bank     |       | 7,427                                  |       | (71                                  | )          | 1,482     |       | (18 | ) | 8,909 |   | (89 | ) |
| Municipal bonds             |       | 3,981                                  |       | (77                                  | )          | 768       |       | (7 | ) | 4,749 |   | (84 | ) |
| Preferred term  securities  |       | 1,938                                  |       | (81                                  | )          | —    |       | — |   | 1,938 |   | (81 | ) |
| Mortgage-backed  securities |       | 16,357                                 |       | (156                                 | )          | 70,590    |       | (1,864 | ) | 86,947 |   | (2,020 | ) |
|                        |       | $                                      | 35,218     |                                 | $          | (417      | )          | $ | 76,793 |   | $ | (1,936 | ) | $ | 112,011 |   | $ | (2,353 | ) |

 

8

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Management does not believeany individual unrealized losses as of September 30, 2006 represent another-than-temporary impairment.  Theunrealized losses reported for mortgage-backed securities relate to securitiesissued by the Federal National Mortgage Association (“FNMA”), the GovernmentNational Mortgage Association and the Federal Home Loan Mortgage Corporation(“FHLMC”).  These unrealized losses in totalare primarily attributable to changes in interest rates and the contractualcashflows of those investments are guaranteed by an agency of the U.S.government.  As a group, the unrealizedlosses were less than 2.1% of its respective amortized cost basis at September30, 2006.  Because the decline in marketvalue is attributable to changes in interest rates and not credit quality andbecause the Company has the ability and intent to hold those investments untila recovery of fair value, which may be at maturity, the Company does notconsider those investments to be other-than-temporarily impaired at September30, 2006.

9

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**NOTE5.                SEGMENT REPORTING**

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

Themanagement approach is used as the conceptual basis for identifying reportablesegments and is based on the way that management organizes the segments withinthe enterprise for making operating decisions, allocating resources andmonitoring performance, which is primarily based on products.
| **Three Months Ended September 30, 2006** | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                         | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                               |       |                                 |       |      |       |      |       |
| Net interest income                                                |       | $                                    | 7,279      |      | $          | (861      | )          | $ | 6,418 |   |
| Intersegment interest  income                                      |       | (247                                 | )          | 247       |       | —    |       |
| Provision for losses on  loans and leases                          |       | (291                                 | )          | —    |       | (291      | )          |
| Noninterest income                                                 |       | 2,426                                |       | (82       | )          | 2,344     |       |
| Intersegment  noninterest income                                   |       | (7                                   | )          | 7         |       | —    |       |
| Noninterest expense                                                |       | (6,716                               | )          | (193      | )          | (6,909    | )          |
| Intersegment  noninterest expense                                  |       | 1                                    |       | (1        | )          | —    |       |
| Income before  income taxes                                        |       | $                                    | 2,445      |      | $          | (883      | )          | $ | 1,562 |   |
|                                                               |       |                                 |       |      |       |      |       |
| Total assets at September 30, 2006                                 |       | $                                    | 985,464    |      | $          | 1,731     |       | $ | 987,195 |   |

 
| **Three Months Ended September 30, 2005** | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                         | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                               |       |                                 |       |      |       |      |       |
| Net interest income                                                |       | $                                    | 7,142      |      | $          | (807      | )          | $ | 6,335 |   |
| Intersegment interest  income                                      |       | (298                                 | )          | 298       |       | —    |       |
| Provision for losses on  loans and leases                          |       | (462                                 | )          | —    |       | (462      | )          |
| Noninterest income                                                 |       | 2,436                                |       | (51       | )          | 2,385     |       |
| Intersegment  noninterest income                                   |       | (52                                  | )          | 52        |       | —    |       |
| Noninterest expense                                                |       | (6,480                               | )          | (194      | )          | (6,674    | )          |
| Intersegment  noninterest expense                                  |       | 1                                    |       | (1        | )          | —    |       |
| Income  (loss) before income taxes                                 |       | $                                    | 2,287      |      | $          | (703      | )          | $ | 1,584 |   |
|                                                               |       |                                 |       |      |       |      |       |
| Total assets at  September 30, 2005                                |       | $                                    | 916,639    |      | $          | 1,279     |       | $ | 917,918 |   |

 

10

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**NOTE6.                DEFINED BENEFIT PLAN**

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

|                                    | ** ** | **Three Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|
| ** **                         | ** ** | **September 30,**           | ** ** |
| ** **                         | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                               |       |                             |       |   |   |
| Service cost                       |       | $                                | 116,521    |   | $ | 116,367 |   |
| Interest cost                      |       | 97,748                           |       | 91,238 |   |
| Expected return  on plan assets    |       | (109,101                         | )          | (93,185 | ) |
| Amortization of  prior losses      |       | —                           |       | — |   |
| Accretion of  prior service cost   |       | —                           |       | — |   |
| Amortization of  transition asset  |       | —                           |       | 2,908 |   |
| Total costs  recognized in expense |       | $                                | 105,168    |   | $ | 117,328 |   |

 

TheCompany previously disclosed in its consolidated financial statements forFiscal 2006, which are included in Part II, Item 8 “Financial Statements andSupplementary Data” of the Company’s Annual Report on Form 10-K for Fiscal2006, that it contributed $610,000 to fund its qualified pension plan.  During the first quarter ended September 30,2006, the Company made contributions of $621,000 to fund its qualified pensionplan.  The Company anticipates noadditional contributions for the fiscal year ending June 30, 2007 (“Fiscal2007”).

**NOTE7.                SELF-INSURED HEALTHCAREPLAN**

TheCompany has had a self-insured health plan for its employees, subject tocertain limits, since January 1994.  TheBank is named the plan administrator for this plan and has retained theservices of an independent third party administrator to process claims andhandle other duties for this plan.  Thethird party administrator does not assume liability for benefits payable underthis plan.

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

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Totalnet healthcare costs are inclusive of health claims expenses and administrationfees offset by stop loss and employee reimbursement.  Reported below is a summary of net healthcarecosts by quarter for the fiscal years ended June 30, 2006 and 2007.

|                             | ** ** | **Fiscal Years Ended June 30,** | ** ** |
|-----------------------------|------------|-----------------------------------------------------|------------|
| ** **                  | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| ** **                  | ** ** | **(Dollars in Thousands)**                | ** ** |
|                        |       |                                                |       |   |   |
| Quarter ended  September 30 |       | $                                                   | 436        |   | $ | 419 |   |
| Quarter ended  December 31  |       | —                                              |       | 409 |   |
| Quarter ended  March 31     |       | —                                              |       | 382 |   |
| Quarter ended  June 30      |       | —                                              |       | 285 |   |
| Net healthcare  costs       |       | $                                                   | 436        |   | $ | 1,495 |   |

 

**NOTE8.                FASB STATEMENT NO. 140**

During the thirdquarter of Fiscal 2006, the Company completed a line item change ofits income recorded on originated mortgage servicing rights for loans soldto South Dakota Housing Development Authority.  This process was doneupon a fuller interpretation of Statement No. 140, *“Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities”*as issued by theFASB.   All periods presented have been revised in presentation toreflect this line item and there was no change to netincome, earnings per share, or recorded value of servicing rights asa result of this line item change. The following table reflects the effects of the line item change onthe Company’s consolidated statements of income for the three monthsended September 30, 2006 and 2005.

|                             | ** ** | **Three Months Ended**     | ** ** |
|-----------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | **September 30,**               | ** ** |
| ** **                  | ** ** | **2006**                             | ** ** | **2005** | ** ** |
| ** **                  | ** ** | **(Dollars in Thousands)** | ** ** |
|                        |       |                                 |       |   |   |
| Loan servicing income       |       | $                                    | —     |   | $ | (44 | ) |
| Gain on sale of loans,  net |       | —                               |       | 44 |   |
| Net income change           |       | $                                    | —     |   | $ | — |   |

 

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**NOTE9.                STOCK-BASED COMPENSATIONPLANS**

Thefair value of each incentive stock option grant and stock appreciation right isestimated at the grant date using the Black-Scholes option-pricing model.  The following weighted average assumptionswere used for grants in the three months ended September 30, 2006 and 2005:

|                           | ** ** | **For the Three Months Ended**                                           | ** ** |
|---------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                | ** ** | **September 30,**                                                                       | ** ** |
| ** **                | ** ** | **       2006       ** | ** ** | **       2005       ** | ** ** |
| Expected  volatility      |       | 23.00                                                                                        | %          | 24.00 | % |
| Expected  dividend yield  |       | 2.56                                                                                         | %          | 2.75 | % |
| Risk-free  interest rate  |       | 4.61                                                                                         | %          | 4.09 | % |
| Expected term (in  years) |       | 4                                                                                            |       | 7 |   |

 

Stockoption and stock appreciation right activity for the three months endedSeptember 30 follows:

|                               | ** ** | **2006**   | ** ** |
|-------------------------------|------------|------------|------------|
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Remaining** | ** ** | **Aggregate** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Average** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Term** | ** ** | **Value** | ** ** |
| ** **                    | ** ** | **Shares** | ** ** | **Price** | ** ** | **(in years)** | ** ** | **(In thousands)** | ** ** |
| Balance,  beginning July 1    |       | 318,977    |       | $ | 12.77 |   |   |   |   |   |
| Granted                       |       | 20,953     |       | 16.00 |   |   |   |   |   |
| Forfeited                     |       | (6,731     | )          | 16.49 |   |   |   |   |   |
| Exercised                     |       | (6,484     | )          | 10.66 |   |   |   |   |   |
| Balance, ending  September 30 |       | 326,715    |       | $ | 12.94 |   | 5.83 |   | $ | 1,080 |   |
|                          |       |       |       |   |   |   |   |   |   |
| Exercisable at  September 30  |       | 260,425    |       | $ | 12.20 |   | 5.06 |   | $ | 1,041 |   |

 

|                               | ** ** | **2005**   | ** ** |
|-------------------------------|------------|------------|------------|
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Remaining** | ** ** | **Aggregate** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Average** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Term** | ** ** | **Value** | ** ** |
| ** **                    | ** ** | **Shares** | ** ** | **Price** | ** ** | **(in years)** | ** ** | **(In thousands)** | ** ** |
| Balance,  beginning July 1    |       | 325,422    |       | $ | 12.22 |   |   |   |   |   |
| Granted                       |       | 30,769     |       | 17.27 |   |   |   |   |   |
| Forfeited                     |       | —     |       | — |   |   |   |   |   |
| Exercised                     |       | (11,025    | )          | 12.08 |   |   |   |   |   |
| Balance, ending  September 30 |       | 345,166    |       | $ | 12.68 |   | 6.50 |   | $ | 1,586 |   |
|                          |       |       |       |   |   |   |   |   |   |
| Exercisable at  September 30  |       | 248,135    |       | $ | 11.52 |   | 5.43 |   | $ | 1,427 |   |

 

13

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Theweighted-average grant date fair value of options and appreciation rightsgranted during the three months ended September 30, 2006 and 2005 was $3.11 and$3.83, respectively.  The total intrinsicvalue of options exercised during the three months ended September 30, 2006 and2005 was $36 and $57, respectively.  Asof September 30, 2006, there was $69 of total unrecognized compensation costrelated to nonvested stock option awards. The cost is expected to be recognized over a period of two years.  Cash received from the exercise of options forthe three months ended September 30, 2006 and 2005 was $55 and $133, respectively.  The tax benefit realized for the taxdeductions from cashless option exercises totaled $11 and $6 for the threemonths ended September 30, 2006 and 2005, respectively.  The Company generally uses treasury shares tosatisfy stock option exercises.

Restrictedshare activity for the three months ended September 30 follows:

|                               | ** ** | **2006**   | ** ** | **2005**     | ** ** |
|-------------------------------|------------|------------|------------|--------------|------------|
| ** **                    | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Grant**    | ** ** | ** ** | ** ** | **Grant** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Date**     | ** ** | ** ** | ** ** | **Date** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Fair**     | ** ** | ** ** | ** ** | **Fair** | ** ** |
| ** **                    | ** ** | **Shares** | ** ** | **Value**    | ** ** | **Shares** | ** ** | **Value** | ** ** |
| Nonvested  Balance, beginning |       | 158,159    |       | $            | 15.85      |   | 91,888 |   | $ | 13.62 |   |
| Granted                       |       | 10,335     |       | 16.67        |       | 85,572 |   | 17.42 |   |
| Vested                        |       | (15,004    | )          | 14.08        |       | (13,500 | ) | 11.79 |   |
| Forfeited                     |       | (805       | )          | 19.86        |       | — |   | — |   |
| Nonvested Balance,  ending    |       | 152,685    |       | $            | 15.95      |   | 163,960 |   | $ | 15.65 |   |

 

Pretaxcompensation expense recognized for restricted shares for the three monthsended September 30, 2006 and 2005 was $118 and $87, respectively.  The tax benefit for the three months endedSeptember 30, 2006 and 2005 was $40 and $30, respectively.  As of September 30, 2006, there was $1,746 oftotal unrecognized compensation cost related to restricted shares granted underthe Plan.  That cost is expected to berecognized over a weighted-average period of five years.  The total fair value of shares vested duringthe three months ended September 30, 2006 and 2005 was $132 and $70,respectively.

TheCompany has a Director Restricted Stock Plan which provides that awards ofrestricted shares of the Company’s common stock be made to outside directors ofthe Company.  The plan is designed toallow for payment of the annual retainer fee in shares of the Company’s commonstock, with the inclusion of an annual cost of living adjustment based on theConsumer Price Index.  Each outsidedirector is entitled to all voting, dividend and distribution rights during therestriction period.  The effective dateof the plan was July 1, 1997.  The planhas 90,750 shares allocated to it and is in effect for a period of tenyears.  During the three months endedSeptember 30, 2006 and 2005, 4,824 and 6,571 shares were awarded and $25 and$24 of expense was incurred under the plan, respectively, as the annualretainer for the Company’s Board of Directors.

Thesestock option and 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 2006, under Note 17 of “Notes to Consolidated Financial Statements.”

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**Item2.  Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

**Forward-Looking Statements**

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

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

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

·      Forecasts of future economic performance.

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

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

Forward-looking statements about the Company’sexpected financial results and other plans are subject to certain risks,uncertainties and assumptions.  Theseinclude, but are not limited to, the risks discussed in Part I, Item 1A “RiskFactors” in the Company’s Annual Report on Form 10-K for Fiscal 2006 and thefollowing: possible legislative changes and adverse economic, business andcompetitive conditions and developments (such as shrinking interest margins andcontinued short-term rate environments); deposit outflows; reduced demand forfinancial services and loan products; changes in accounting policies orguidelines, or in monetary and fiscal policies of the federal government;changes in credit and other risks posed by the Company’s loan portfolios; theability or inability of the Company to manage interest rate and other risks;unexpected or continuing claims against the Company’s self-insured health plan;the Company’s use of trust preferred securities; the ability or inability ofthe Company to successfully enter into a definitive agreement for and closeanticipated transactions; technological, computer-related or operationaldifficulties; adverse changes in securities markets; results of litigation; orother significant uncertainties.

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

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**ExecutiveSummary**

TheCompany’s net income for the first quarter of Fiscal 2007 was $1.1 million, or$0.27 per diluted share, compared to $1.0 million, or $0.26 per diluted sharefor the first quarter of Fiscal 2006. Return on average equity was 7.67% at September 30, 2006 compared with7.59% at September 30, 2005.

Netinterest income for the three months ended September 30, 2006 was $6.4 million,an increase of $83,000, or 1.3%, over the same period a year ago.  For the three months ended September 30,2006, average interest-earning assets and average interest-bearing liabilitieseach increased 7.3%, compared to the same quarter a year ago.  Yields on earning assets increased to 6.62%in the first quarter, compared to 5.88% a year ago.  For the same time period, cost of fundsincreased to 4.25%, compared to 3.23%.

Thenet interest margin on a fully taxable equivalent basis for the three monthsended September 30, 2006 was 2.86%, compared to 3.02% for the same period ayear ago, a decline of 16 basis points. During the quarter, $724,000 in loans were placed into nonaccrualresulting in a reversal of $114,000 in interest income.  This action had the effect of lowering thenet interest margin by five basis points. The increase in interest rates for the Company’s variable priced trustpreferred securities tied to LIBOR, caused a decrease in margin of six basispoints.

Netinterest margin ratio may vary due to many factors, including Federal Reservepolicies for short-term interest rates, competitive and economic factors andcustomer preferences for various products and services.  From September 30, 2005 to June 30, 2006, theFederal Reserve increased short-term interest rates six times at 25 basispoints each, for a total increase of 150 basis points, however, there has beenno change since June 2006.  Theflattening of the treasury yield curve caused by increasing short-term ratesand lagging long-term rates continued to affect the Company’s net interestmargin ratio during the quarter.  Thisinverted yield curve is evidenced by the interest rate spread of 79 basispoints between the 3-month Treasury and the 10-year Treasury at September 30,2005, decreasing to a negative 28 basis points at September 30, 2006.

Totaldeposits at September 30, 2006 were $741.8 million, an increase of $64.5million, or 9.5%, from September 30, 2005. Interest expense on these deposits was $6.5 million for the quarterended September 30, 2006, an increase of $2.2 million, or 52.3%, over the sameperiod a year ago.  In-market depositsincreased from $631.5 million at September 30, 2005 to $670.5 million atSeptember 30, 2006, an increase of $39.0 million, or 6.2%.  For the same period, out-of-market depositsincreased from $41.3 million to $71.3 million, respectively.  Public funds have remained stable, decreasingfrom $88.2 million at September 30, 2005 to $87.0 million at September 30,2006.  The primary factor affectinginterest expense was the increase in volume of certificates of deposits by$72.3 million, or 25.4%, from September 30, 2005, to September 30, 2006.  Out-of-market certificates of depositsaccounted for $30.6 million of this increase. Interest expense for certificates of deposits increased by $1.4 millionor 60.5% in the first quarter, compared to the same period in the prior fiscalyear, driving its cost of funds to 4.31% from 3.20%.

Theallowance for loan and lease losses increased to $5.6 million at September 30,2006, compared to $5.3 million at September 30, 2005, an increase of $310,000or 5.8%.  The ratio of allowance for loanand lease losses to total loans and leases was 0.74% as of September 30, 2006 comparedto 0.77% at September 30, 2005.  Totalnonperforming assets at September 30, 2006 were $4.3 million as compared to$8.7 million at September 30, 2005.  Theratio of nonperforming assets to total assets decreased to 0.43% at September30, 2006, compared to 0.94% at September 30, 2005.  The decrease in nonperforming assets wasprimarily attributable to a decrease of $4.6 million in nonaccruing loans andleases, from $5.9 million at September 30, 2005 to $1.3 million at September30, 2006.  The allowance for loan andlease losses is calculated based on loan and lease levels, loan and lease losshistory, credit quality of the loan and lease portfolio, and environmentalfactors such as economic health of the region and management experience.  This risk rating analysis is designed to givethe Company a consistent and systematic methodology to determine proper levelsfor the allowance at a given time.

16

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Thetotal risk-based capital ratio was 10.64% at September 30, 2006, compared to10.66% at September 30, 2005, a decrease of 2 basis points.  This continues to place the Bank in the “wellcapitalized” category within OTS regulation at September 30, 2006 and isconsistent within the “well capitalized” OTS category in which the Companyplans to operate.  The Companyhistorically has been able to manage the size of its assets through secondarymarket loan sales of single-family mortgages and student loans and a loansecuritization.

Noninterestincome was $2.3 million for the quarter ended September 30, 2006 compared to$2.4 million at September 30, 2005, a decrease of 1.7%.  The primary factor affecting noninterestincome was a decrease of $103,000 in net gain on sale of loans as a result offewer loans being sold into the secondary market, offset by an increase of$61,000 in loan servicing income.

Noninterestexpense was $6.9 million for the quarter ended September 30, 2005 compared to$6.7 million at September 30, 2005, an increase of 3.5%.  The primary factors affecting noninterestexpense include an increase of $264,000 in marketing expenses associated withseveral targeted product promotions and an increase of $158,000 in occupancyand equipment costs relating to three new branch openings that occurredsubsequent to the end of the first quarter. Partially offsetting these increases was a decrease of $147,000 incompensation and employee benefits.

TheCompany focuses on balancing operating costs with operating revenue levels inorder to provide better efficiency ratios over time and continues to review itsoperations for ways to reduce its cost structure while continuing to supportlong-term revenue enhancements.  Theoperating efficiency ratio at September 30, 2006 was 73.59%, compared to 72.41%for the same time period a year ago, an increase of 118 basis points.  The operating efficiency ratio excludes theimpact of net interest expense on the variable priced trust preferredsecurities.  The Company has issued trustpreferred securities primarily to provide funding for stock repurchases and torepay other borrowings.  Net interestexpense on the $27.8 million of trust preferred securities outstandingincreased to $626,000 for the first quarter ended September 30, 2006, comparedto $497,000 for the same period a year ago, an increase of $129,000 or26.0%.  The average rate paid on thesesecurities increased 189 basis points, from 7.30% at September 30, 2005 to9.19% at September 30, 2006.  The totalefficiency ratio was 78.85% at September 30, 2006, compared to 76.54% for thesame period a year ago, an increase of 231 basis points.  The primary factor contributing to thisincrease in the efficiency ratio from a year ago was a $235,000 increase innoninterest expenses.  It is theCompany’s goal to move the operating efficiency ratio towards the 50% levelover the long term.  Management believesthat this can be accomplished through steady growth of the balance sheet andthe containment of incremental operating expenses.

17

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**General**

The Company is a financial servicesprovider and, as such, has inherent risks that must be managed in order toachieve net income.  Primary risks thataffect net income include credit risk, liquidity risk, operational risk,regulatory compliance risk and reputation risk. The Company’s net income is derived by managing net interest margin, theability to collect fees from services provided, by controlling the costs ofdelivering services and the management of loan and lease losses.  The primary source of revenues comes from thenet interest margin, which represents the difference between income oninterest-earning assets (i.e. loans and investment securities) and expense oninterest-bearing liabilities (i.e. deposits and borrowed funding).  The net interest margin is affected byregulatory, economic and competitive factors that influence interest rates,loan demand and deposit flows.  Feesearned include charges for deposit services, trust services and loanservices.  Personnel costs are theprimary expenses required to deliver the services to customers.  Other costs include occupancy and equipmentand general and administrative expenses.

**Financial Condition Data**

At September 30, 2006,the Company had total assets of $987.2 million, an increase of $25.9 millionfrom the level at June 30, 2006.  Theincrease in assets was due primarily to increases in net loans and leases receivableof $20.0 million, securities available for sale of $7.6 million and loanservicing rights of $5.1 million offset by a decrease in cash and cashequivalents of $12.1 million.  Theincrease in liabilities of $23.6 million from June 30, 2006 to September 30,2006 was primarily due to increases in advances from the FHLB and otherborrowings of $40.4 million and advances by borrowers for taxes and insuranceof $6.7 million offset by a decrease in deposits of $27.2 million.  In addition, stockholders’ equity increased$2.3 million to $58.3 million at September 30, 2006 from $56.1 million at June30, 2006, primarily due to net income of $1.1 million.

The increase in net loansand leases receivable of $20.0 million was due primarily to an increase inpurchases and originations over sales, amortization and repayments of principal**.** Inaddition, net deferred (fees), costs and discounts decreased $54,000 from thelevels at June 30, 2006 to $829,000 at September 30, 2006.

Theincrease in securities available for sale of $7.6 million was primarily theresult of purchases of $17.1 million exceeding sales, maturities and repaymentsof $11.3 million.  The purchases of $17.1million included fixed-rate, mortgage-backed securities of $11.1 million.

Loanservicing rights increased $5.1 million primarily due to the purchase of $4.9million in mortgage servicing rights from Great Western Bank.

Cashand cash equivalents decreased $12.1 million, which was primarily due to thepurchase of $4.9 million in mortgage servicing rights and a decrease indeposits of $27.2 million resulting primarily from seasonal fluctuation inpublic fund deposits.

Advancesfrom the FHLB and other borrowings increased $40.4 million, which was primarilydue to new borrowings of $382.5 million exceeding paydowns of FHLB borrowingsof $342.1 million.  The overall increasein FHLB borrowings was primarily the result of a $27.2 million decrease indeposits.

Advancesby borrowers for taxes and insurance increased $6.7 million primarily due tothe purchase of $4.9 million in mortgage servicing rights which resulted in anincrease in escrow accounts for taxes and insurance of $3.7 million.

18

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The $27.2 million decrease in deposits was due todecreases in savings accounts of $45.2 million, money market accounts of $14.9million and noninterest-bearing checking accounts of $4.0 million offset byincreases in in-market certificates of deposit of $23.6 million, out-of-marketcertificates of deposit of $12.9 million and interest-bearing checking accountsof $435,000.  The $45.2 million decreasein savings accounts was primarily due to temporary fluctuations experiencedwith one public fund entity, while the increase in certificates of deposit wasprimarily driven by commercial business accounts.

During the time period offiscal years 2002 through 2004, the Company issued a total of $27.8 million insubordinated debentures payable to trusts at various times through its trustsubsidiaries.  Each of the issuancesincluded an option  to shorten thematurity date at a specific time as stated in the contract.  The issuance of $10.0 million of CompanyObligated Mandatorily Redeemable Preferred Securities of Trust I on November28, 2001 included an option to shorten the maturity date to December 8, 2006.  The Company has exercised this option toredeem $10.0 million of trust preferred securities.  Also during the second quarter of Fiscal2007, the Company will issue $10.0 million of Company Obligated MandatorilyRedeemable Preferred Securities of Trust IV. The new funding is calculated at a rate based on three-month LIBOR plus1.83%, compared to the original issuance which is based on six-month LIBOR plus3.75%.  The unamortized amount of$290,000 deferred debt issuance costs related to the original issuance will bewritten off.

19

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The following tables show the compositionof the Company’s loan and lease portfolio and deposit accounts:
| ** **                                   | ** ** | **At September 30, 2006** | ** ** | **At June 30, 2006** | ** ** |
|----------------------------------------------|------------|------------------------------------------|------------|-------------------------------------|------------|
| ** **                                   | ** ** | **Amount**                               | ** ** | **Percent**                         | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                                   | ** ** | **(Dollars in Thousands)**     | ** ** |
| One-to  four-family (1)                      |       | $                                        | 102,325    |                                | 13.69      | % | $ | 100,585 |   | 13.83 | % |
| Commercial  business and real estate (2) (3) |       | 257,670                                  |       | 34.49                               | %          | 247,643 |   | 34.05 | % |
| Multi-family  real estate                    |       | 33,963                                   |       | 4.55                                | %          | 34,066 |   | 4.69 | % |
| Equipment  finance leases                    |       | 28,193                                   |       | 3.77                                | %          | 29,406 |   | 4.04 | % |
| Consumer Direct  (4) (5)                     |       | 110,943                                  |       | 14.85                               | %          | 110,493 |   | 15.19 | % |
| Consumer  Indirect                           |       | 91,173                                   |       | 12.20                               | %          | 91,601 |   | 12.60 | % |
| Agricultural                                 |       | 94,257                                   |       | 12.61                               | %          | 89,437 |   | 12.30 | % |
| Construction and  development                |       | 28,665                                   |       | 3.84                                | %          | 24,029 |   | 3.30 | % |
| Total Loans and  Leases Receivable (6)       |       | $                                        | 747,189    |                                | 100.00     | % | $ | 727,260 |   | 100.00 | % |

 

----

(1) Excludes $7,442 and$6,980 loans held for sale at September 30, 2006 and June 30, 2006,respectively.

(2) Includes $3,388 and$3,388 tax exempt leases at September 30, 2006 and June 30, 2006, respectively.

(3) Excludes $223 commercialloans held for sale at September 30, 2006 and June 30, 2006.

(4) Includes mobile home loans.

(5) Excludes $1,646 and $420student loans held for sale at September 30, 2006 and June 30, 2006,respectively.

(6) Includes deferred loan fees and discounts and undisbursed portion ofloans in process.
| ** **                             | ** ** | **At September 30, 2006** | ** ** | **At June 30, 2006** | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|-------------------------------------|------------|
| ** **                             | ** ** | **Amount**                               | ** ** | **Percent**                         | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)**     | ** ** |
|                                   |       |                                     |       |                                |       |   |   |   |   |
| Noninterest  bearing checking accounts |       | $                                        | 80,741     |                                | 10.88      | % | $ | 84,757 |   | 11.02 | % |
| Interest bearing  accounts             |       | 55,297                                   |       | 7.45                                | %          | 54,862 |   | 7.14 | % |
| Money market  accounts                 |       | 217,575                                  |       | 29.33                               | %          | 232,471 |   | 30.23 | % |
| Savings accounts                       |       | 31,494                                   |       | 4.25                                | %          | 76,695 |   | 9.97 | % |
| Certificates of  deposit               |       | 356,694                                  |       | 48.09                               | %          | 320,217 |   | 41.64 | % |
| Total Deposits                         |       | $                                        | 741,801    |                                | 100.00     | % | $ | 769,002 |   | 100.00 | % |

 

20

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**Analysisof Net Interest Income**

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

*Average Balances, Interest Rates and Yields.*  The following table presents for the periodsindicated, the total dollar amount of interest income from average interest-earningassets and the resulting yields, as well as the interest expense on averageinterest-bearing liabilities, expressed both in dollars and rates, and the netinterest margin.  The table does notreflect any effect of income taxes. Average balances consist of daily average balances for the Bank withsimple average balances for all other subsidiaries of the Company.  The average balances include nonaccruingloans and leases.  The yields on loansand leases include origination fees, net of costs, which are consideredadjustments to yield.
| ** **                                     | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **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)            |       | $                                                        | 744,497    |   | $ | 13,240 |   | 7.06 | % | $ | 689,195 |   | $ | 11,121 |   | 6.40 | % |
| Investment securities (2) (3)                  |       | 151,566                                                  |       | 1,759 |   | 4.60 | % | 145,600 |   | 1,343 |   | 3.66 | % |
| FHLB stock                                     |       | 6,974                                                    |       | 79 |   | 4.49 | % | 6,976 |   | 8 |   | 0.45 | % |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 903,037                                                  |       | $ | 15,078 |   | 6.62 | % | 841,771 |   | $ | 12,472 |   | 5.88 | % |
| Noninterest-earning assets                     |       | 62,233                                                   |       |   |   |   |   | 59,630 |   |   |   |   |   |
| Total assets                                   |       | $                                                        | 965,270    |   |   |   |   |   | $ | 901,401 |   |   |   |   |   |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Checking and money market                      |       | $                                                        | 280,114    |   | $ | 2,638 |   | 3.74 | % | $ | 268,858 |   | $ | 1,787 |   | 2.64 | % |
| Savings                                        |       | 43,755                                                   |       | 261 |   | 2.37 | % | 51,284 |   | 240 |   | 1.86 | % |
| Certificates of deposit                        |       | 335,059                                                  |       | 3,642 |   | 4.31 | % | 281,467 |   | 2,269 |   | 3.20 | % |
| Total interest-bearing deposits                |       | 658,928                                                  |       | 6,541 |   | 3.94 | % | 601,609 |   | 4,296 |   | 2.83 | % |
| FHLB advances  and other borrowings            |       | 121,867                                                  |       | 1,474 |   | 4.80 | % | 124,328 |   | 1,329 |   | 4.24 | % |
| Subordinated  debentures payable to trusts     |       | 27,837                                                   |       | 645 |   | 9.19 | % | 27,837 |   | 512 |   | 7.30 | % |
| Total  interest-bearing liabilities            |       | 808,632                                                  |       | 8,660 |   | 4.25 | % | 753,774 |   | 6,137 |   | 3.23 | % |
| Noninterest-bearing deposits                   |       | 79,497                                                   |       |   |   |   |   | 75,257 |   |   |   |   |   |
| Other liabilities                              |       | 19,939                                                   |       |   |   |   |   | 18,460 |   |   |   |   |   |
| Total  liabilities                             |       | 908,068                                                  |       |   |   |   |   | 847,491 |   |   |   |   |   |
| Equity                                         |       | 57,202                                                   |       |   |   |   |   | 53,910 |   |   |   |   |   |
| Total liabilities  and equity                  |       | $                                                        | 965,270    |   |   |   |   |   | $ | 901,401 |   |   |   |   |   |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income; interest rate spread (4) |       |                                                     |       | $ | 6,418 |   | 2.37 | % |   |   | $ | 6,335 |   | 2.65 | % |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (4) (5)                   |       |                                                     |       |   |   | 2.82 | % |   |   |   |   | 2.99 | % |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest margin, TE  (6)                   |       |                                                     |       |   |   | 2.86 | % |   |   |   |   | 3.02 | % |

 

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

(2)  Includes federal funds sold.

(3)  Yields do not reflect thetax-exempt nature of loans, equipment leases and municipal securities.

(4)  Percentages for the threemonths ended September 30, 2006 and September 30, 2005 have been annualized.

(5)  Net interest margin is netinterest income divided by average interest-earning assets.

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

21

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**Rate/VolumeAnalysis of Net Interest Income**

Thefollowing schedule presents the dollar amount of changes in interest income andinterest expense for major components of interest-earning assets andinterest-bearing liabilities.  Itdistinguishes between the increases and decreases due to fluctuatingoutstanding balances that are due to the levels and volatility of interestrates.  For each category ofinterest-earning assets and interest-bearing liabilities, information isprovided on changes attributable to (i) changes in volume (i.e., changes involume multiplied by old rate) and (ii) changes in rate (i.e., changes in ratemultiplied by old volume).  For purposesof this table, changes attributable to both rate and volume, which cannot be segregated,have been allocated proportionately to the change due to volume and the changedue to rate.

|                                            | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                 | ** ** | **2006 vs 2005**                               | ** ** |
| ** **                                 | ** ** | **Increase**                                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **(Decrease)**                                           | ** ** | **Increase** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Due to**                                          | ** ** | **Due to** | ** ** | **Total** | ** ** |
| ** **                                 | ** ** | **Volume**                                               | ** ** | **Rate** | ** ** | **Increase** | ** ** |
|                                       |       |                                                     |       |   |   |   |   |
| Interest-earning  assets:                  |       |                                                     |       |   |   |   |   |
| Loans and leases receivable (1)            |       | $                                                        | 892        |   | $ | 1,227 |   | $ | 2,119 |   |
| Investment securities (2)                  |       | 55                                                       |       | 361 |   | 416 |   |
| FHLB stock                                 |       | —                                                   |       | 71 |   | 71 |   |
|                                       |       |                                                     |       |   |   |   |   |
| Total  interest-earning assets             |       | $                                                        | 947        |   | $ | 1,659 |   | $ | 2,606 |   |
|                                       |       |                                                     |       |   |   |   |   |
| Interest-bearing  liabilities:             |       |                                                     |       |   |   |   |   |
| Deposits:                                  |       |                                                     |       |   |   |   |   |
| Checking and money market                  |       | $                                                        | 75         |   | $ | 776 |   | $ | 851 |   |
| Savings                                    |       | (35                                                      | )          | 56 |   | 21 |   |
| Certificates of deposit                    |       | 432                                                      |       | 941 |   | 1,373 |   |
| Total interest-bearing deposits            |       | 472                                                      |       | 1,773 |   | 2,245 |   |
| FHLB advances  and other borrowings        |       | (26                                                      | )          | 171 |   | 145 |   |
| Subordinated  debentures payable to trusts |       | —                                                   |       | 133 |   | 133 |   |
|                                       |       |                                                     |       |   |   |   |   |
| Total  interest-bearing liabilities        |       | $                                                        | 446        |   | $ | 2,077 |   | $ | 2,523 |   |
|                                       |       |                                                     |       |   |   |   |   |
| Net interest income  increase              |       |                                                     |       |   |   | $ | 83 |   |

 

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

(2)  Includes federal funds sold.

22

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**Applicationof Critical Accounting Policies**

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

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

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

*Mortgage Servicing Rights (“MSR”)* –The Company records a servicing asset for contractually separated servicingfrom the underlying mortgage loans.   Theasset is initially recorded at fair value and represents an intangible assetbacked by an income stream from the serviced assets.  The asset is amortized in proportion to andover the period of estimated net servicing income.

Ateach balance sheet date, the MSRs are analyzed for impairment, which occurswhen the fair value of the MSRs is lower than the amortized book value. TheCompany’s MSRs are primarily servicing rights acquired on South Dakota HousingDevelopment Authority first time home buyers program.  Due to the lack of quoted markets for theCompany’s servicing portfolio, the Company estimates the fair value of the MSRsusing present value of future cash flow analysis.  If the analysis produces a fair value that isgreater than or equal to the amortized book value of the MSRs, no impairment isrecognized.  If the fair value is lessthan the book value, an expense for the difference is charged to earnings byinitiating a MSR valuation account.  Ifthe Company determines this impairment is temporary, any future changes in fairvalue are recorded as a change in earnings and the valuation.  If the Company determines the impairment tobe permanent, the valuation is written off against the MSRs, which results in anew amortized balance.

TheCompany has included MSRs as a critical accounting policy because the use ofestimates for determining fair value using present value concepts may produceresults which may significantly differ from other fair value analysis perhapseven to the point of recording impairment. The risk to earnings is when the underlying mortgages payoff significantlyfaster than the 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 atSeptember 30, 2006.

23

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*Self-Insurance*- The Company has a self-insured health plan for itsemployees up to certain limits.  Tomitigate a portion of these risks, the Company has a stop-loss insurance policythrough a commercial insurance carrier for coverage in excess of $65,000 perindividual occurrence with a maximum aggregate limitation of $2.0 million.  The estimate of self-insurance liability isbased upon known claims and an estimate of incurred, but not reported (“IBNR”)claims.  IBNR claims are estimated usinghistorical claims lag information received by a third party claimsadministrator.  Due to the uncertainty ofhealth claims, the approach includes a process that may differ significantlyfrom other methodologies and still produce an estimate that is in accordancewith GAAP.  Although management believesthat it uses the best information available to determine the accrual,unforeseen health claims could result in adjustments to the accrual.  These adjustments could significantly affectnet earnings if circumstances differ substantially from the assumptions used inestimating the accrual.

**AssetQuality and Potential Problem Loans and Leases**

Nonperformingassets (nonaccrual loans and leases, accruing loans and leases delinquent morethan 90 days and foreclosed assets) increased to $4.3 million at September 30,2006 from $3.9 million at June 30, 2006, an increase of $366,000, or 9.4%.  Nonaccruing loans and leases increased$265,000 to $1.3 million at September 30, 2006 from $1.0 million at June 30,2006.  In addition, the ratio ofnonperforming assets to total assets, which is one indicator of credit riskexposure, increased to 0.43% at September 30, 2006 from 0.40% at June 30, 2006.

Nonaccruingloans and leases increased 25.6%, or $265,000, to $1.3 million at September 30,2006 compared to $1.0 million at June 30, 2006. Included in nonaccruing loans and leases at September 30, 2006 were twoloans totaling $39,000 secured by one- to four-family real estate, seven loanstotaling $816,000 secured by commercial business, three leases totaling$225,000, 26 consumer loans totaling $200,000 and one agriculture loan totaling$20,000.

Therisk rating system in place is designed to identify and manage thenonperforming loans and leases. Commercial and agricultural loans and equipment finance leases will havespecific reserve allocations based on collateral values or based on the presentvalue of expected cash flows if the loans and leases are deemed impaired.  Loans and leases that are not performing donot necessarily result in a loss.

Asof September 30, 2006, the Company had $845,000 of foreclosed assets.  The balance of foreclosed assets at September 30,2006 consisted of $492,000 of single-family collateral owned, $207,000 ofequipment finance leases and $146,000 of consumer collateral owned.

AtSeptember 30, 2006, the Company haddesignated $12.0 million of its assets as special mention and classified $3.7million of its assets that management has determined need to be closelymonitored because of possible credit problems of the borrowers or the cashflows of the secured properties.  AtSeptember 30, 2006 the Company had $20.8 million in multi-family, commercialbusiness, commercial real estate and agricultural participation loanspurchased, of which $243,000 were classified as of September 30, 2006.  These loans and leases were considered indetermining the adequacy of the allowance for loan and lease losses.  The allowance for loan and lease losses isestablished based on management’s evaluation of the risks probable in the loanand lease portfolio and changes in the nature and volume of loan and leaseactivity.  Such evaluation, whichincludes a review of all loans and leases for which full collectibility may notbe reasonably assured, considers the estimated fair market value of theunderlying collateral, present value of expected principal and interestpayments, economic conditions, historical loss experience and other factorsthat warrant recognition in providing for an adequate loan and lease lossallowance.

Althoughthe Company’s management believes that the September 30, 2006 recordedallowance for loan and lease losses was adequate to provide for probable losseson the related loans and leases, there can be no assurance that the allowanceexisting at September 30, 2006 will be adequate in the future.

24

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Inaccordance with the Company’s internal classification of assets policy,management evaluates the loan and lease portfolio on a monthly basis toidentify loss potential and determines the adequacy of the allowance for loanand lease losses quarterly.  Loans andleases are placed on nonaccrual status when the collection of principal and/orinterest become doubtful.  Foreclosedassets include assets acquired in settlement of loans and leases.  The following table sets forth the amountsand categories of the Company’s nonperforming assets for the periods indicated.
|                                                                           | ** ** | **Nonperforming Assets As Of** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                | ** ** | **September 30,**                        | ** ** | **June 30,** | ** ** |
| ** **                                                                | ** ** | **2006**                                      | ** ** | **2006** | ** ** |
| ** **                                                                | ** ** | **(Dollars in Thousands)**          | ** ** |
| Nonaccruing  loans and leases:                                            |       |                                          |       |   |   |
| One- to four-family                                                       |       | $                                             | 39         |   | $ | 371 |   |
| Commercial real estate                                                    |       | —                                        |       | — |   |
| Commercial business                                                       |       | 816                                           |       | 341 |   |
| Equipment finance leases                                                  |       | 225                                           |       | 36 |   |
| Consumer (1)                                                              |       | 200                                           |       | 287 |   |
| Agricultural                                                              |       | 20                                            |       | — |   |
| Total                                                                     |       | 1,300                                         |       | 1,035 |   |
|                                                                      |       |                                          |       |   |   |
| Accruing loans  and leases delinquent more than 90 days:                  |       |                                          |       |   |   |
| One- to four-family                                                       |       | 215                                           |       | 358 |   |
| Commercial real estate                                                    |       | 217                                           |       | 308 |   |
| Commercial business                                                       |       | 158                                           |       | 814 |   |
| Equipment finance leases                                                  |       | 478                                           |       | 302 |   |
| Consumer (1)                                                              |       | 11                                            |       | 7 |   |
| Agricultural                                                              |       | 1,034                                         |       | 541 |   |
| Total                                                                     |       | 2,113                                         |       | 2,330 |   |
|                                                                      |       |                                          |       |   |   |
| Foreclosed  assets: (2)                                                   |       |                                          |       |   |   |
| One- to four-family                                                       |       | 492                                           |       | 96 |   |
| Equipment finance leases                                                  |       | 207                                           |       | 254 |   |
| Consumer (1)                                                              |       | 146                                           |       | 177 |   |
| Total                                                                     |       | 845                                           |       | 527 |   |
|                                                                      |       |                                          |       |   |   |
| Total  nonperforming assets                                               |       | $                                             | 4,258      |   | $ | 3,892 |   |
|                                                                      |       |                                          |       |   |   |
| Ratio of  nonperforming assets to total assets                            |       | 0.43                                          | %          | 0.40 | % |
|                                                                      |       |                                          |       |   |   |
| Ratio of nonperforming  loans and leases to total loans and leases (3)(4) |       | 0.45                                          | %          | 0.46 | % |

 

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(1)  Includes mobile home loans.

(2)  Totalforeclosed assets do not include land or other real estate owned held for sale.

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

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

25

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The following table sets forth information with respectto activity in the Company’s allowance for loan and lease losses during theperiods indicated.  
|                                                                                                           | ** ** | **Three Months Ended September 30,**                                                             | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                | ** ** | **         2006         ** | ** ** | **         2005         ** | ** ** |
| ** **                                                                                                | ** ** | **(Dollars in Thousands)**                                                                                 | ** ** |
|                                                                                                      |       |                                                                                                                 |       |   |   |
| Balance at  beginning of period                                                                           |       | $                                                                                                                    | 5,657      |   | $ | 5,076 |   |
| Charge-offs:                                                                                              |       |                                                                                                                 |       |   |   |
| One- to four-family                                                                                       |       | —                                                                                                               |       | (1 | ) |
| Commercial real estate                                                                                    |       | —                                                                                                               |       | — |   |
| Commercial business                                                                                       |       | (164                                                                                                                 | )          | (2 | ) |
| Equipment finance leases                                                                                  |       | (50                                                                                                                  | )          | (6 | ) |
| Consumer (1)                                                                                              |       | (214                                                                                                                 | )          | (267 | ) |
| Agriculture                                                                                               |       | —                                                                                                               |       | — |   |
| Total charge-offs                                                                                         |       | (428                                                                                                                 | )          | (276 | ) |
|                                                                                                      |       |                                                                                                                 |       |   |   |
| Recoveries:                                                                                               |       |                                                                                                                 |       |   |   |
| One- to four-family                                                                                       |       | 3                                                                                                                    |       | 1 |   |
| Commercial real estate                                                                                    |       | —                                                                                                               |       | — |   |
| Commercial business                                                                                       |       | —                                                                                                               |       | — |   |
| Equipment finance leases                                                                                  |       | —                                                                                                               |       | 6 |   |
| Consumer (1)                                                                                              |       | 51                                                                                                                   |       | 52 |   |
| Agriculture                                                                                               |       | 57                                                                                                                   |       | — |   |
| Total recoveries                                                                                          |       | 111                                                                                                                  |       | 59 |   |
|                                                                                                      |       |                                                                                                                 |       |   |   |
| Net (charge-offs)                                                                                         |       | (317                                                                                                                 | )          | (217 | ) |
|                                                                                                      |       |                                                                                                                 |       |   |   |
| Additions  charged to operations                                                                          |       | 291                                                                                                                  |       | 462 |   |
|                                                                                                      |       |                                                                                                                 |       |   |   |
| Balance at end  of period                                                                                 |       | $                                                                                                                    | 5,631      |   | $ | 5,321 |   |
|                                                                                                      |       |                                                                                                                 |       |   |   |
| Ratio of net  (charge-offs) during the period to average loans and leases outstanding  during the period  |       | (0.04                                                                                                                | )%         | (0.03 | )% |
|                                                                                                      |       |                                                                                                                 |       |   |   |
| Ratio of  allowance for loan and lease losses to total loans and leases at end of  period (2)        |       | 0.74                                                                                                                 | %          | 0.77 | % |
|                                                                                                      |       |                                                                                                                 |       |   |   |
| Ratio of allowance for  loan and lease losses to nonperforming loans and leases at end of period (3) |       | 164.99                                                                                                               | %          | 62.42 | % |

 

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(1)  Includes mobile home loans.

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

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

26

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Thedistribution of the Company’s allowance for loan and lease losses and impairedloss summary as required by FASB Statement No. 114, “Accounting by Creditorsfor Impairment of a Loan” are summarized in the following tables.  The combination of FASB Statement No. 5“Accounting for Contingencies” and FASB Statement No. 114 calculations comprisethe 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, 2006** | ** ** | **At June 30, 2006** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)**               | ** ** |
| One- to  four-family                   |       | $                                        | 205        |                                | $          | —                     |       | $                      | 193        |   | $ | — |   |
| Commercial real  estate                |       | 334                                      |       | —                              |       | 317                        |       | —                 |       |
| Multi-family  real estate              |       | 84                                       |       | —                              |       | 79                         |       | —                 |       |
| Commercial  business                   |       | 2,669                                    |       | —                              |       | 2,563                      |       | —                 |       |
| Equipment  finance leases              |       | 531                                      |       | —                              |       | 570                        |       | —                 |       |
| Consumer (1)                           |       | 1,337                                    |       | —                              |       | 1,432                      |       | —                 |       |
| Agricultural                           |       | 471                                      |       | —                              |       | 503                        |       | —                 |       |
|                                   |       |                                     |       |                                |       |                       |       |                   |       |
| Total                                  |       | $                                        | 5,631      |                                | $          | —                     |       | $                      | 5,657      |   | $ | — |   |

 

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(1)  Includesmobile home loans.

**ImpairedLoan 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, 2006** | ** ** | **At June 30, 2006**  | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)**     | ** ** | **(Dollars in Thousands)** | ** ** |
| Commercial  business                   |       | 5                                        |       | $                                    | 797        |          | —     |             | 4          |        | $          | 325           |       | — |   |
| Total                                  |       | 5                                        |       | $                                    | 797        |          | $          | —           |       | 4           |       | $             | 325        |   | $ | — |   |
|                                        |            |                                          |            |                                      |            |               |            |                  |            |             |            |               |            |  |  |  |  |

 

27

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Theallowance for loan and lease losses was $5.6 million at September 30, 2006 ascompared to $5.3 million at September 30, 2005. The ratio of the allowance for loan and lease losses to total loans andleases was 0.74% at September 30, 2006 compared to 0.77% at September 30,2005.  The Company’s management hasconsidered nonperforming loans and leases and potential problem loans andleases in establishing the allowance for loan and lease losses.  The Company continues to monitor itsallowance for probable loan and lease losses and make future additions orreductions in light of the level of loans and leases in its portfolio and aseconomic conditions dictate.  The currentlevel of the allowance for loan and lease losses is a result of management’sassessment of the risks within the portfolio based on the information revealedin credit reporting processes. The Company utilizes a risk-rating system on allcommercial business, agricultural, construction and multi-family and commercialreal estate loans, including purchased loans and leases.  A periodic credit review is performed on alltypes of loans and leases to establish the necessary reserve based on theestimated risk within the portfolio. This assessment of risk takes into accountthe composition of the loan and lease portfolio, historical loss experience foreach loan and lease category, previous loan and lease experience,concentrations of credit, current economic conditions and other factors that inmanagement’s judgment deserve recognition.

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

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

28

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**Comparison of the Three Months Ended September 30,2006 and September 30, 2005**

*General*.  The Company’s net income was $1.1 million, or$0.28 for basic and $0.27 for diluted earnings per share for the three monthsended September 30, 2006, a $74,000 increase in earnings compared to $1.0million, or $0.26 for basic and $0.26 for diluted earnings per share for thesame period in the prior fiscal year. For the three months ended September 30, 2006, the return on averageequity was 7.67%, a 1.1% increase compared to 7.59% for the same period in theprior fiscal year.  For the three monthsended September 30, 2006, the return on average assets was 0.45%, no changecompared to 0.45% for the same period in the prior fiscal year.  As discussed in more detail below, theincreases were due to a variety of key factors, including an increase in netinterest income of $83,000 and a decrease in provision for losses on loans andleases of $171,000 offset by a decrease in noninterest income of $41,000 and anincrease in noninterest expense of $235,000.

 

*Interest,Dividend and Loan Fee Income.* Interest, dividend and loan fee income was $15.1 million for the threemonths ended September 30, 2006 as compared to $12.5 million for the sameperiod in the prior fiscal year, an increase of $2.6 million or 20.9%.  A $1.2 million increase in interest, dividendand loan fee income was the result of an increase in the average yield on loansand leases receivable from 6.40% for the three months ended September 30, 2005to 7.06% for the three months ended September 30, 2006 and a $892,000 increasein interest, dividend and loan fee income was due to a 8.0% increase in theaverage volume of loans and leases receivable. The average yield on totalinterest-earning assets was 6.62% for the three months ended September 30, 2006as compared to 5.88% for the same period in the prior fiscal year.

 

*Interest Expense.*  Interest expense was $8.7 million for thethree months ended September 30, 2006 as compared to $6.1 million for thesame period in the prior fiscal year, an increase of $2.5 million or41.1%.  A $1.8 million increase ininterest expense was the result of an increase in average rate paid oninterest-bearing deposits from 2.83% for the three months ended September 30,2005 to 3.94% for the three months ended September 30, 2006.  A $171,000 increase in interest expense wasthe result of an increase in the average rate paid on FHLB advances and otherborrowings increasing from 4.24% for the three months ended September 30, 2005to 4.80% for the three months ended September 30, 2006.  An increase of $2.1 million in interestexpense was the result of an increase in the average rate paid on totalinterest-bearing liabilities from 3.23% for the three months ended September30, 2005 to 4.25% for the three months ended September 30, 2006.

*Net Interest Income.* TheCompany’s net interest income for the three months ended September 30, 2006increased $83,000, or 1.3%, to $6.4 million compared to $6.3 million for thesame period in the prior fiscal year. The increase in net interest income was due primarily to increases inthe average yield on interest-earning assets and in the average balance ofinterest-earning assets for the three months ended September 30, 2006 comparedto the same period in the prior fiscal year offset by an increase in theaverage rate paid on interest-bearing liabilities for the three months endedSeptember 30, 2006 compared to the same period in the prior fiscal year.  The Company’s net interest margin was 2.82%for the first quarter of Fiscal 2007 as compared to 2.99% for the same periodin the prior fiscal year.

*Provision for Losses on Loans and Leases.*The allowance for loan and leaselosses is maintained at a level which is considered by management to beadequate to absorb probable losses on existing loans and leases that may becomeuncollectible, based on an evaluation of the collectibility of loans and leasesand prior loan and lease loss experience. The evaluation takes into consideration such factors as changes in the natureand volume of the loan and lease portfolio, overall portfolio quality, reviewof specific problem loans and leases, and current economic conditions that mayaffect the borrower’s ability to pay. The allowance for loan and lease losses is established through aprovision for losses on loans and leases charged to expense.

During the three monthsended September 30, 2006, the Company recorded a provision for losses on loansand leases of $291,000 compared to $462,000 for the three months endedSeptember 30, 2005, a decrease of $171,000. See “Asset Quality” for further discussion.

29

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*Noninterest Income.*  Noninterest income was $2.3 million for thethree months ended September 30, 2006 as compared to $2.4 million for the sameperiod in the prior fiscal year, a decrease of $41,000, or 1.7%.  The decrease in noninterest income wasprimarily due to a decrease in gain on sale of loans of $103,000 offset by anincrease in loan servicing income of $61,000.

Gainon sale of loans decreased $103,000 from $299,000 for the three months ended September 30, 2005 to $196,000 forthe three months ended September 30, 2006 primarily due to a decrease in thenumber of loans being sold into the secondary market.

Loan servicing incomeincreased $61,000 from $268,000 for the three months ended September 30, 2005to $329,000 for the three months ended September 30, 2006 primarily due to anincrease of $46.3 million in the balances of loans serviced by the Bank from$533.4 million at September 30, 2005 to $579.7 million at September 30, 2006.

*Noninterest Expense.*  Noninterest expense was $6.9 million for thethree months ended September 30, 2006 as compared to $6.7 million for the threemonths ended September 30, 2005, an increase of $235,000, or 3.5%.  The increase in noninterest expense wasprimarily due to increases in occupancy and equipment of $158,000 and othernoninterest expense of $224,000 offset by a decrease in compensation andemployee benefits of $147,000.

Occupancyand equipment expense increased $158,000 for the three months ended September30, 2006 compared to the same period in the prior fiscal year primarily due toincreases in rent expense of $60,000, depreciation expense of  $37,000 and building and property maintenanceof $23,000.

Othernoninterest expense increased $224,000 for the three months ended September 30,2006 compared to the same period in the prior fiscal year primarily due to anincrease in advertising expense of $264,000 offset by a decrease in communitycontributions for reinvestment in the communities we serve of $68,000.

Compensation and employeebenefits decreased $147,000, or 3.4%, to $4.2 million for the three monthsended September 30, 2006 as compared to $4.3 million for the three months endedSeptember 30, 2005.  Net healthcarecosts, inclusive of health claims and administration fees offset by stop lossand employee reimbursement under the Company’s self-insured health plan were$436,000 for the three months ended September 30, 2006, an increase of $17,000compared to the same period in the prior fiscal year.  The remainder of the decrease in compensationand employee benefits was primarily due a $93,000 decrease in employeecompensation as a result of a decrease in staffing over the prior year.

*Income tax expense.*  The Company’s income tax expense for thethree months ended September 30, 2006 decreased $96,000 or 17.1% to $465,000compared to $561,000 for the same period in the prior fiscal year.  The effective tax rate was 29.7% and 35.4%for the three months ended September 30, 2006 and September 30, 2005,respectively.  The decrease in theeffective tax rate for the quarter was the result of an increase inpermanent tax differences primarily due to increases in tax-exemptinterest income.

30

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**Liquidity and Capital Resources**

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

Liquiditymanagement is both a daily and long-term responsibility of management.  The Bank adjusts its investments in liquidassets based upon management’s assessment of (i) expected loan demand, (ii)projected loan 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.

TheBank anticipates that it will have sufficient funds available to meet currentloan commitments.  At September 30, 2006,the Bank had outstanding commitments to originate residential mortgage loans of$20.5 million and commercial business loans of $8.5 million.  In addition, the Bank had outstandingcommitments to sell residential mortgage loans of $7.4 million, commercialbusiness loans of $223,000 and consumer student loans of $1.6 million.  Commitments by the Bank to originate loansare not necessarily executed by the customer. The Bank monitors the ratio of commitments to funding for use inliquidity management.  At September 30,2006, the Bank had no commitments to purchase securities available for sale andno commitments to sell securities available for sale.

Althoughin-market deposits are the Bank’s primary source of funds, the Bank’s policyhas been to utilize borrowings where the funds can be invested in either loansor securities at a positive rate of return or to use the funds for short-termliquidity purposes.  The Bank currentlyhas an unsecured line of federal funds totaling $15.0 million with acorrespondent bank.  In addition, theCompany has a line of credit totaling $6.0 million with a correspondent bank.  There were no funds drawn on either line ofcredit at September 30, 2006. Additionally, as of September 30, 2006, the Bank had $70.3 million inout-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.

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

OnSeptember 30, 2006, the Company had in effect a stock buyback program in whichup to 10% of the common stock of the Company outstanding on May 1, 2006 couldbe acquired through April 30, 2007.  Asof September 30, 2006, no shares of common stock had been purchased pursuant tothe program.  See Part II, Item 2 “UnregisteredSales of Equity Securities and Use of Proceeds” of this Form 10-Q.

Savingsinstitutions insured by the Federal Deposit Insurance Corporation are requiredby the Financial Institutions Reform, Recovery and Enforcement Act of 1989 tomeet three regulatory capital requirements. If a requirement is not met, regulatory authorities may take legal oradministrative actions, including restrictions on growth or operations or, inextreme cases, seizure.  Institutions notin compliance may apply for an exemption from the requirements and submit arecapitalization plan.  At September 30,2006, the Bank met all current regulatory capital requirements.

Theminimum OTS Tier 1 (core) capital requirement for well-capitalized institutionsis 5.00% of total adjusted assets for thrifts. The Bank had Tier 1 (core) capital of 8.09% at September 30, 2006.  The minimum OTS total risk-based capitalrequirement for well-capitalized institutions is 10.00% of risk-weightedassets.  The Bank had total risk-basedcapital of 10.64% at September 30, 2006.

31

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**Impact ofInflation and Changing Prices**

Theunaudited consolidated financial statements and notes thereto presented in thisQuarterly Report on Form 10-Q have been prepared in accordance with GAAP, whichrequire the measurement of financial position and operating results in terms ofhistorical dollars without considering the change in the relative purchasingpower of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Bank’soperations. Unlike most industrial companies, nearly all the assets andliabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on the Bank’sperformance than do the effects of general levels of inflation.  Interest rates do not necessarily move in thesame direction or to the same extent as the prices of goods and services.

**Recent Accounting Pronouncements**

In December 2004, FASBissued SFAS No. 123R, “Share-Based Payment”, which requires all companies tomeasure compensation costs for all share-based payments (including stockoptions) at fair value.  SFAS No. 123Rprovides two alternatives for adoption: (1) a “modified prospective” method inwhich compensation cost is recognized for all awards granted subsequent to theeffective date of this statement as well as for the unvested portion of awardsoutstanding as of the effective date, and (2) a “modified retrospective” methodwhich follows the approach in the “modified prospective” method, but alsopermits entities to restate prior periods to reflect compensation costcalculated under SFAS No. 123 for pro forma amounts disclosure.  The Company adopted SFAS No. 123R, using theBlack-Scholes option-pricing model and the modified prospective methodeffective as of July 1, 2005.

In May 2005, FASB issuedSFAS No. 154, “Accounting Changes and Error Corrections”, which replaces APBOpinion No. 20 and SFAS No. 3.  SFAS No.154 requires that a voluntary change in accounting principle be appliedretrospectively with all prior period financial statements presented, unless itis impracticable to do so.  The newstandard is effective for accounting changes and correction of errors made infiscal years beginning after December 15, 2005. The Company adopted SFAS No. 154 as of July 1, 2006.

In November 2005, theFASB issued FASB Staff Position (FSP) No. FAS 115-1,**“The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments”,**whichsupersedes EITF No. 03-1.  This FSPprovides additional guidance when an investment in a debt or equity securityshould be considered impaired and when that impairment should be consideredother-than-temporary and recognized as a loss in earnings. Specifically, theguidance clarifies that an investor should recognize an impairment loss nolater than when the impairment is deemed other-than-temporary, even if adecision to sell has not been made. The FSP also requires certain disclosuresabout unrealized losses that have not been recognized as other-than-temporaryimpairments. The Company adopted the guidance in  FSP No. FAS 115-1 as of April 1, 2006.

In March 2006, FASBissued SFAS No. 156, “Accounting for Servicing of Financial Assets”, whichamends SFAS No. 140.  SFAS No. 156requires the recognition of all separately recognized servicing assets andservicing liabilities to be initially measured at fair value utilizing theamortization method or fair market value method. SFAS 156 is effective thebeginning of the first fiscal year that begins after September 15, 2006.  Under the amortization method, an entityshall amortize the value of servicing assets or liabilities in proportion toand over the period of estimated net servicing income or net servicing loss andassess servicing assets or liabilities for impairment or increased obligationbased on fair value at each reporting date. Under the fair value method, anentity shall measure servicing assets or liabilities at fair value at eachreporting date and report changes in fair value in earnings in the period inwhich the changes occur.  The Company hasnot determined the effect the adoption of SFAS No. 156 will have on itsfinancial statements.

32

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In September 2006, FASBissued SFAS No. 157, “Fair Value Measurements,” which defines fair value,establishes guidelines for measuring fair value and expands disclosuresregarding fair value measurements.  SFASNo. 157 does not require any new fair value measurements but rather eliminatesinconsistencies in guidance found in various prior accountingpronouncements.  SFAS No. 157 iseffective for fiscal years beginning after November 15, 2007. The Company hasnot determined the effect the adoption of SFAS No. 157 will have on itsconsolidated financial statements.

In September 2006, FASBissued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension andOther Postretirement Plans,” which amends several prior FASB statements.  SFAS No. 158 requires the measurement andrecognition of an overfunded or underfunded status of a defined benefitpostretirement plan as an asset or liability. SFAS No. 158 is effective for the end of the fiscal year ending afterDecember 15, 2006.  The Company has notdetermined the effect the adoption of SFAS No. 158 will have on itsconsolidated financial statements.

33

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

TheCompany’s net income is largely dependent on its net interest income.  Net interest income is susceptible tointerest rate risk to the degree that interest-bearing liabilities with short-and medium-term maturities mature or reprice more rapidly than its interest-earningassets.  When interest-bearing liabilitiesmature or reprice more quickly than interest-earning assets in a given period,a significant increase in market rates of interest could adversely affect netinterest income.  Similarly, wheninterest-earning assets mature or reprice more quickly than interest-bearingliabilities, falling interest rates could result in a decrease in net income.

Inan attempt to manage its exposure to change in interest rates, managementmonitors the Company’s interest rate risk. The Company’s Asset-Liability Committee meets periodically to review theCompany’s interest rate risk position and profitability, and to recommendadjustments for consideration by executive management. Management also reviewsthe Bank’s securities portfolio, formulates investment strategies, and overseesthe timing and implementation of transactions to assure attainment of theBoard’s objectives in the most effective manner.  In managing market risk and theasset/liability mix, the Bank has placed its emphasis on developing a portfolioin which, to the extent practicable, assets and liabilities reprice withinsimilar periods.  Notwithstanding theCompany’s interest rate risk management activities, the potential for changinginterest rates is an uncertainty that can have an adverse effect on netincome.  The Company does not currentlyengage in trading activities or use derivative instruments to control interestrate risk although it may in the future, if necessary, to manage interest raterisk.

Inadjusting the Company’s asset/liability position, management attempts to managethe Company’s interest rate risk while enhancing net interest margins.  At times, depending on the level of generalinterest rates, the relationship between long and short-term interest rates,market conditions and competitive factors, management may determine to increasethe Company’s interest rate risk position somewhat in order to increase its netinterest margin.

As set forth below, depending upon the volatility ofthe rate change, the change in asset or liability mix of the Company or otherfactors may produce a decrease in net interest margin in an upward moving rateenvironment even as the net portfolio value (“NPV”) estimate indicates anincrease in net value.  The conversesituation can also be expected.  Oneapproach used to quantify interest rate risk is the NPV analysis.  In essence, this analysis calculates thedifference between the present value of the liabilities and the present valueof expected cash flows from assets and off-balance sheet contracts.  The following tables set forth, at June 30,2006 (the most recent report available) and September 30, 2005, an analysis ofthe Company’s interest rate risk as measured by the estimated changes in NPVresulting from instantaneous and sustained parallel shifts in the yield curve(+300 or -200 basis points, measured in 100 basis point increments).  Management does not believe that the Companyhas experienced any material changes in its market risk position from thatdisclosed in the Company’s Annual Report on Form 10-K for Fiscal 2006 or thatthe Company’s primary market risk exposures and how those exposures weremanaged during the three months ended September 30, 2006 changed significantlywhen compared to June 30, 2006.

Thedata in the following tables is based on assumptions utilized by the OTS inassessing interest rate risk of thrift institutions and published in “SelectedAsset and Liability Price Tables as of June 30, 2006” and “Selected Asset andLiability Price Tables as of September 30, 2005”.  Even if interest rates change in the designatedamounts, there can be no assurance that the Company’s assets and liabilitieswould perform as set forth below.

34

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June 30, 2006

|                                         | ** ** | ** **                           | ** ** | **Estimated Increase  (Decrease) in NPV** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|----------------------------------------------------------|------------|
| **Change in  Interest Rates** | ** ** | **Estimated  NPV  Amount**           | ** ** | **Amount**                                               | ** ** | **Percent** | ** ** |
| **Basis Points**                   | ** ** | **(Dollars in thousands)** | ** ** | ** **                                               | ** ** |
|                                    |       |                                 |       |                                                     |       |   |   |
| +300                                    |       | $                                    | 87,096     |                                                     | $          | (24,868 | ) | (22 | )% |
| +200                                    |       | 95,152                               |       | (16,812                                                  | )          | (15 | ) |
| +100                                    |       | 103,741                              |       | (8,223                                                   | )          | (7 | ) |
| —                                  |       | 111,964                              |       | —                                                   |       | — |   |
| -100                                    |       | 119,214                              |       | 7,250                                                    |       | 6 |   |
| -200                                    |       | 121,611                              |       | 9,647                                                    |       | 9 |   |
|                                         |            |                                      |            |                                                          |            |  |  |  |  |

 

September 30, 2005

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

 

Inmanaging market risk and the asset/liability mix, the Bank has placed itsemphasis on developing a portfolio in which, to the extent practicable, assetsand liabilities reprice within similar periods. The effect of this policy willgenerally be to reduce the Bank’s sensitivity to interest rate changes.  The goal of this policy is to provide arelatively consistent level of net interest income in varying interest ratecycles and to minimize the potential for significant fluctuations from periodto period.

**Item4.  Controls and Procedures**

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 the periodcovered 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 identifiedin the above referenced evaluation that materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.

35

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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 Daniel A. 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.  Legalproceedings are currently pending in the Second Judicial Circuit Court,Minnehaha County, South Dakota.

In addition, the Company, the Bank and each of their subsidiaries are, from time totime, involved as plaintiff or defendant in various legal actions arising inthe normal course of their businesses. While the ultimate outcome of any such proceedings cannot be predictedwith certainty, it is generally the opinion of management, after consultationwith counsel representing the Bank and the Company in any such proceedings,that the resolution of any such proceedings should not have a material effecton the Company’s consolidated 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 no material changes from the risk factors disclosed inPart 1, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K forFiscal 2006.

 

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

Thefollowing table sets forth the purchases by the Company of its common stockduring the quarterly period ended September 30, 2006.  
| ** **              | ** ** | **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,  2006      |       | 0                  |       | $                   | 0.00       |                                   | 0          |                                   | 394,035    |   |
| August 1 - 31,  2006    |       | 0                  |       | $                   | 0.00       |                                   | 0          |                                   | 394,035    |   |
| September 1 -  30, 2006 |       | 0                  |       | $                   | 0.00       |                                   | 0          |                                   | 394,035    |   |
|                    |       |               |       |                |       |                                   |       |                                   |       |
| 1st Quarter  Total      |       | 0                  |       | $                   | 0.00       |                                   | 0          |                                   |       |   |

 

TheCompany currently has in effect a stock buyback program, which was publiclyannounced on April 24, 2006 and pursuant to which up to 10% of the common stockof the Company that was outstanding on May 1, 2006, which equals 394,035shares, may be acquired through April 30, 2007. As of September 30, 2006, no shares of common stock have been purchasedpursuant to the program.

36

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**Item 6.    Exhibits**
| Regulation S-K  Exhibit Number | ** ** | **Document**                                                                                                                                 |
|--------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                           |       | Notice of redemption to the holders of HF Financial  Capital Trust I securities                                                              |
| 31.1                           |       | Certification of Chairman, President and Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                  |
| 31.2                           |       | Certification of Executive Vice President, Chief  Financial Officer and Treasurer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |
| 32.1                           |       | Certification of Chairman, President and Chief  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                  |
| 32.2                           |       | Certification of Executive Vice President, Chief  Financial Officer and Treasurer Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |

 

37

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**HF FINANCIAL CORP.**

**FORM 10-QSIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
|        |                                           | HF Financial  Corp. |   |
|--------|------------------------------------------------|---------------------|--------|
|   | (Registrant)                                   |
|   |                                           |
| Date:  | November 13,  2006                             |                | By:    |     /s/ Curtis L. Hage |   |
|   | Curtis L. Hage,  Chairman, President           |
|   | And Chief  Executive Officer                   |
|   | (Principal  Executive Officer)                 |
|   |                                           |
| Date:  | November 13,  2006                             |                |   | By: |     /s/ Darrel L. Posegate |   |
|   | Darrel L.  Posegate, Executive Vice President, |
|   | Chief Financial  Officer and Treasurer         |
|   | (Principal Financial  and Accounting Officer)  |
|        |                                                |                     |        |  |  |  |  |  |

 

 

38

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**Indexto Exhibits**
| Exhibit Number | ** ** | ** **                                                                                                                                   |
|----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|
| ** **     | ** ** | ** **                                                                                                                                   |
| 10.1           |       | Notice of redemption to the holders of HF Financial  Capital Trust I securities                                                              |
| 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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