** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

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**FORM 10-Q**

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

 

**For the Quarterly Period ended March 31, 2008**

** **

**Commission File Number: 0-19972**

 

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**HF FINANCIAL CORP.**

(Exact name of registrant as specified inits 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 theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  YES  x    NO  o

 

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

 

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

 

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

 

Indicate the number of shares outstandingof each of the issuer’s classes of common stock, as of the latest practicabledate.

 

As of May 12,2008 there were 3,946,680 issued and outstanding shares of the Registrant’sCommon Stock, with $.01 par value per share.

 

 

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**HF FINANCIAL CORP.**

 

**Form 10-Q**

 

**Table of Contents**

 
| ** **                                    | ** ** | ** **                                                                                        | **Page Number** |
|-----------------------------------------------|------------|---------------------------------------------------------------------------------------------------|----------------------|
|                                          |       |                                                                                              |                 |
| **PART I –  FINANCIAL INFORMATION** |       |
|                                          |       |                                                                                              |                 |
| Item 1.                                       |       | Financial Statements (Unaudited):                                                                 |                 |
|                                          |       |                                                                                              |                 |
|                                          |       | Consolidated  Statements of Financial Condition As of March 31, 2008 and June 30,  2007 | 1                    |
|                                          |       |                                                                                              |                 |
|                                          |       | Consolidated  Statements of Income for the Nine Months Ended March 31, 2008 and 2007         | 2                    |
|                                          |       |                                                                                              |                 |
|                                          |       | Consolidated  Statements of Cash Flows for the Nine Months Ended March 31, 2008 and  2007    | 3                    |
|                                          |       |                                                                                              |                 |
|                                          |       | Notes to Consolidated Financial Statements                                                        | 5                    |
|                                          |       |                                                                                              |                 |
| Item 2.                                       |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations       | 14                   |
|                                          |       |                                                                                              |                 |
| Item 3.                                       |       | Quantitative  and Qualitative Disclosures about Market Risk                                       | 34                   |
|                                          |       |                                                                                              |                 |
| Item 4.                                       |       | Controls and Procedures                                                                           | 36                   |
|                                          |       |                                                                                              |                 |
| **PART II  – OTHER INFORMATION**    |       |
|                                          |       |                                                                                              |                 |
| Item 1.                                       |       | Legal Proceedings                                                                                 | 36                   |
|                                          |       |                                                                                              |                 |
| Item 1A.                                      |       | Risk Factors                                                                                      | 37                   |
|                                          |       |                                                                                              |                 |
| Item 2.                                       |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                      | 37                   |
|                                          |       |                                                                                              |                 |
| Item 6.                                       |       | Exhibits                                                                                          | 38                   |
|                                          |       |                                                                                              |                 |
| Form 10-Q                                |       | Signature Page                                                                                    | 39                   |

 

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**PART I - FINANCIAL INFORMATION**

 

**Item 1.                    FinancialStatements**

** **

**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF FINANCIALCONDITION**

**(Dollars in Thousands)**

 
| ** **                                                                                                                                                      | ** ** | **March 31, 2008** | ** ** | **June 30, 2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                      | ** ** | **(Unaudited)**              | ** ** | **(Audited)**               | ** ** |
| **ASSETS**                                                                                                                                                      |       |                         |       |                        |       |   |   |
| Cash and cash  equivalents                                                                                                                                      |       | $                            | 18,781     |                        | $          | 22,476 |   |
| Securities  available for sale                                                                                                                                  |       | 215,993                      |       | 142,223                     |       |
| Federal Home  Loan Bank stock                                                                                                                                   |       | 10,551                       |       | 5,058                       |       |
| Loans held for  sale                                                                                                                                            |       | 9,927                        |       | 8,776                       |       |
| Loans and leases  receivable                                                                                                                                    |       | 759,624                      |       | 767,471                     |       |
| Allowance for  loan and lease losses                                                                                                                            |       | (5,570                       | )          | (5,872                      | )          |
| Net loans and  leases receivable                                                                                                                                |       | 754,054                      |       | 761,599                     |       |
|                                                                                                                                                            |       |                         |       |                        |       |
| Accrued interest  receivable                                                                                                                                    |       | 8,477                        |       | 8,495                       |       |
| Office  properties and equipment, net of accumulated depreciation                                                                                               |       | 14,335                       |       | 15,830                      |       |
| Foreclosed real  estate and other properties                                                                                                                    |       | 442                          |       | 508                         |       |
| Cash value of  life insurance                                                                                                                                   |       | 13,916                       |       | 13,519                      |       |
| Servicing rights                                                                                                                                                |       | 11,249                       |       | 10,871                      |       |
| Goodwill, net                                                                                                                                                   |       | 4,951                        |       | 4,951                       |       |
| Other assets                                                                                                                                                    |       | 5,213                        |       | 7,148                       |       |
| Total assets                                                                                                                                                    |       | $                            | 1,067,889  |                        | $          | 1,001,454 |   |
|                                                                                                                                                            |       |                         |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                  |       |                         |       |                        |       |
| **LIABILITIES**                                                                                                                                                 |       |                         |       |                        |       |
| Deposits                                                                                                                                                        |       | $                            | 744,219    |                        | $          | 815,864 |   |
| Advances from  Federal Home Loan Bank and other borrowings                                                                                                      |       | 200,255                      |       | 68,600                      |       |
| Subordinated  debentures payable to trusts                                                                                                                      |       | 27,837                       |       | 27,837                      |       |
| Advances by  borrowers for taxes and insurance                                                                                                                  |       | 15,424                       |       | 10,337                      |       |
| Accrued expenses  and other liabilities                                                                                                                         |       | 14,622                       |       | 16,546                      |       |
| Total  liabilities                                                                                                                                              |       | 1,002,357                    |       | 939,184                     |       |
|                                                                                                                                                            |       |                         |       |                        |       |
| **STOCKHOLDERS’  EQUITY**                                                                                                                                  |       |                         |       |                        |       |
| Preferred stock,  $.01 par value, 500,000 shares authorized, none outstanding                                                                                   |       | —                       |       | —                      |       |
| Series A  Junior Participating Preferred Stock, $1.00 stated value, 50,000 shares  authorized, none outstanding                                            |       | —                       |       | —                      |       |
| Common stock,  $.01 par value, 10,000,000 shares authorized, 6,029,360 and 5,991,200 shares  issued at March 31, 2008 and June 30, 2007, respectively |       | 60                           |       | 60                          |       |
| Common stock  subscribed for but not issued, 5,146 shares at June 30, 2007                                                                                 |       | —                       |       | 81                          |       |
| Additional  paid-in capital                                                                                                                                     |       | 21,851                       |       | 20,898                      |       |
| Retained  earnings, substantially restricted                                                                                                                    |       | 74,845                       |       | 71,900                      |       |
| Accumulated  other comprehensive income (loss), net of related deferred tax effect                                                                              |       | (439                         | )          | (1,502                      | )          |
| Less cost of  treasury stock, 2,071,928 and 1,977,836 shares at March 31, 2008 and  June 30, 2007, respectively                                       |       | (30,785                      | )          | (29,167                     | )          |
| Total  stockholders’ equity                                                                                                                                |       | 65,532                       |       | 62,270                      |       |
| Total  liabilities and stockholders’ equity                                                                                                                |       | $                            | 1,067,889  |                        | $          | 1,001,454 |   |

 

*See accompanying notes to unauditedconsolidated financial statements.*

 

1

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

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

**(Unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                              | ** ** | **March 31,**               | ** ** | **March 31,**              | ** ** |
| ** **                                                              | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest,  dividend and loan fee income:                                |       |                             |       |                            |       |   |   |   |   |
| Loans and leases  receivable                                            |       | $                                | 13,188     |                            | $          | 13,435 |   | $ | 41,187 |   | $ | 40,403 |   |
| Investment  securities and interest-earning deposits                    |       | 2,354                            |       | 1,925                           |       | 6,425 |   | 5,698 |   |
|                                                                    |       | 15,542                           |       | 15,360                          |       | 47,612 |   | 46,101 |   |
| Interest  expense:                                                      |       |                             |       |                            |       |   |   |   |   |
| Deposits                                                                |       | 5,693                            |       | 7,268                           |       | 20,104 |   | 21,168 |   |
| Advances from  Federal Home Loan Bank and other borrowings              |       | 2,154                            |       | 1,689                           |       | 6,149 |   | 6,052 |   |
|                                                                    |       | 7,847                            |       | 8,957                           |       | 26,253 |   | 27,220 |   |
| **Net  interest income**                                                |       | 7,695                            |       | 6,403                           |       | 21,359 |   | 18,881 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| Provision for  losses on loans and leases                               |       | 551                              |       | 34                              |       | 1,171 |   | 786 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| **Net  interest income after provision for losses on loans and leases** |       | 7,144                            |       | 6,369                           |       | 20,188 |   | 18,095 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| Noninterest  income:                                                    |       |                             |       |                            |       |   |   |   |   |
| Gain on sale of  branches, net                                          |       | —                           |       | —                          |       | — |   | 2,763 |   |
| Fees on deposits                                                        |       | 1,290                            |       | 1,232                           |       | 4,058 |   | 3,740 |   |
| Loan servicing  income                                                  |       | 589                              |       | 525                             |       | 1,636 |   | 1,295 |   |
| Gain on sale of  loans, net                                             |       | 257                              |       | 223                             |       | 955 |   | 679 |   |
| Trust income                                                            |       | 229                              |       | 238                             |       | 727 |   | 684 |   |
| Other                                                                   |       | 442                              |       | 395                             |       | 1,212 |   | 1,218 |   |
|                                                                    |       | 2,807                            |       | 2,613                           |       | 8,588 |   | 10,379 |   |
| Noninterest  expense:                                                   |       |                             |       |                            |       |   |   |   |   |
| Compensation and  employee benefits                                     |       | 4,987                            |       | 4,768                           |       | 14,218 |   | 13,402 |   |
| Occupancy and  equipment                                                |       | 941                              |       | 962                             |       | 2,859 |   | 2,858 |   |
| Marketing                                                               |       | 221                              |       | 217                             |       | 783 |   | 1,364 |   |
| Check and data  processing expense                                      |       | 594                              |       | 578                             |       | 1,815 |   | 1,697 |   |
| Other                                                                   |       | 811                              |       | 946                             |       | 2,731 |   | 2,750 |   |
|                                                                    |       | 7,554                            |       | 7,471                           |       | 22,406 |   | 22,071 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| **Income  before income taxes**                                         |       | 2,397                            |       | 1,511                           |       | 6,370 |   | 6,403 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| Income tax  expense                                                     |       | 774                              |       | 477                             |       | 2,149 |   | 2,161 |   |
| **Net  income**                                                         |       | $                                | 1,623      |                            | $          | 1,034 |   | $ | 4,221 |   | $ | 4,242 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| **Comprehensive  income**                                               |       | $                                | 1,681      |                            | $          | 1,306 |   | $ | 5,284 |   | $ | 5,892 |   |
| **Cash  dividends declared per share**                                  |       | $                                | 0.1075     |                            | $          | 0.1050 |   | $ | 0.3225 |   | $ | 0.3125 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| **Earnings  per share:**                                                |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                   |       | $                                | 0.41       |                            | $          | 0.26 |   | $ | 1.06 |   | $ | 1.07 |   |
| Diluted                                                                 |       | $                                | 0.40       |                            | $          | 0.25 |   | $ | 1.05 |   | $ | 1.05 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

2

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollars in Thousands)**

**(Unaudited) **

 
| ** **                                                                                     | ** ** | **Nine Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Cash  flows from operating activities**                                                      |       |                                                |       |   |   |
| Net income                                                                                     |       | $                                                   | 4,221      |   | $ | 4,242 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities:   |       |                                                |       |   |   |
| Provision for  losses on loans and leases                                                      |       | 1,171                                               |       | 786 |   |
| Depreciation                                                                                   |       | 1,241                                               |       | 1,221 |   |
| Amortization of  discounts and premiums on securities and other                                |       | 1,177                                               |       | 1,406 |   |
| Stock based  compensation                                                                      |       | 483                                                 |       | 715 |   |
| Deferred income  taxes (credits)                                                               |       | —                                              |       | (534 | ) |
| Net change in  loans held for resale                                                           |       | (196                                                | )          | (5,164 | ) |
| (Gain) on sale  of loans, net                                                                  |       | (955                                                | )          | (679 | ) |
| Realized (gain)  on sale of securities, net                                                    |       | (219                                                | )          | — |   |
| (Gain) on sale  of branches                                                                    |       | —                                              |       | (2,763 | ) |
| Losses and  provision for losses on sales of foreclosed real estate and other properties,  net |       | 31                                                  |       | 48 |   |
| (Gain) loss on  disposal of office properties and equipment, net                               |       | —                                              |       | (9 | ) |
| Change in other  assets and liabilities                                                        |       | (1,504                                              | )          | 6,072 |   |
| Net cash  provided by operating activities                                                     |       | 5,450                                               |       | 5,341 |   |
|                                                                                           |       |                                                |       |   |   |
| **Cash  flows from investing activities**                                                      |       |                                                |       |   |   |
| Loan  participations purchased                                                                 |       | (5,477                                              | )          | (19,329 | ) |
| Net change in  loans outstanding                                                               |       | 10,832                                              |       | (10,859 | ) |
| Proceeds from  sale of loans associated with branch sales                                      |       | —                                              |       | 4,256 |   |
| Securities  available for sale:                                                                |       |                                                |       |   |   |
| Sales and  maturities and repayments                                                           |       | 52,206                                              |       | 27,781 |   |
| Purchases                                                                                      |       | (123,419                                            | )          | (18,564 | ) |
| Purchase of  Federal Home Loan Bank stock                                                      |       | (7,365                                              | )          | (3,844 | ) |
| Redemption of  Federal Home Loan Bank stock                                                    |       | 1,871                                               |       | 3,110 |   |
| Proceeds from  sale of office properties and equipment                                         |       | 1,274                                               |       | 9 |   |
| Proceeds from  sale of office properties and equipment associated with branch sales            |       | —                                              |       | 341 |   |
| Purchase of  office properties and equipment                                                   |       | (1,020                                              | )          | (2,913 | ) |
| Purchase of  servicing rights                                                                  |       | (1,170                                              | )          | (5,858 | ) |
| Proceeds from  sale of foreclosed real estate and other properties, net                        |       | 449                                                 |       | 703 |   |
| Net cash (used  in) investing activities                                                       |       | (71,819                                             | )          | (25,167 | ) |
|                                                                                                |            |                                                     |            |  |  |  |  |

 

*See accompanying notes tounaudited consolidated financial statements.*

 

3

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

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

**(Dollars in Thousands)**

**(Unaudited) **

 
| ** **                                                             | ** ** | **Nine Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                             | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
|                                                                   |       |                                                |       |   |   |
| **Cash  flows from financing activities**                              |       |                                                |       |   |   |
| Net increase  (decrease) in deposit accounts                           |       | $                                                   | (71,645    | ) | $ | 51,675 |   |
| Proceeds of  advances from Federal Home Loan Bank and other borrowings |       | 1,311,434                                           |       | 529,615 |   |
| Payments on  advances from Federal Home Loan Bank and other borrowings |       | (1,179,779                                          | )          | (530,735 | ) |
| Proceeds from  issuance of subordinated debentures                     |       | 5,000                                               |       | 10,000 |   |
| Deposit account  disbursements associated with branch sales            |       | —                                              |       | (33,563 | ) |
| Redemption of  subordinated debentures                                 |       | (5,000                                              | )          | (10,000 | ) |
| Increase  (decrease) in advances by borrowers                          |       | 5,087                                               |       | 7,165 |   |
| Purchase of  treasury stock                                            |       | (1,618                                              | )          | — |   |
| Proceeds from  issuance of common stock                                |       | 470                                                 |       | 337 |   |
| Cash dividends  paid                                                   |       | (1,275                                              | )          | (1,240 | ) |
| Net cash  provided by financing activities                             |       | 62,674                                              |       | 23,254 |   |
|                                                                   |       |                                                |       |   |   |
| Increase  (decrease) in cash and cash equivalents                      |       | (3,695                                              | )          | 3,428 |   |
|                                                                   |       |                                                |       |   |   |
| Cash and cash  equivalents                                             |       |                                                |       |   |   |
| Beginning                                                              |       | 22,476                                              |       | 27,037 |   |
| Ending                                                                 |       | $                                                   | 18,781     |   | $ | 30,465 |   |
|                                                                   |       |                                                |       |   |   |
| Supplemental  Disclosures of Cash Flows Information                    |       |                                                |       |   |   |
| Cash payments  for interest                                            |       | $                                                   | 25,999     |   | $ | 26,085 |   |
| Cash payments  for income and franchise taxes, net                     |       | 2,638                                               |       | 647 |   |

 

*See accompanying notes tounaudited consolidated financial statements.*

 

4

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

For The Nine MonthsEnded March 31, 2008 and 2007

(Unaudited)

 

**NOTE 1.                SELECTED ACCOUNTING POLICIES**

 

*Basis ofpresentation:*

 

The consolidated financial information of HF Financial Corp. (the “Company”)and its wholly-owned subsidiaries included in this Quarterly Report on Form 10-Qis unaudited.  However, in the opinion ofmanagement, adjustments (consisting of normal recurring adjustments) necessaryfor a fair presentation for the interim periods have been included.  Results for any interim period are notnecessarily indicative of results to be expected for the fiscal year.  Interim consolidated financial statements andthe notes thereto should be read in conjunction with the consolidated financialstatements and notes thereto included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended June 30, 2007 (“Fiscal 2007”), filed with theSecurities and Exchange Commission.  Theaccounting and reporting policies of the Company and its subsidiaries conformto accounting principles generally accepted in the United States of America (“GAAP”)and to general practice within the industry.

 

The interim consolidated financial statements include the accounts ofthe Company, its wholly-owned subsidiaries, Home Federal Bank (the “Bank”), HFFinancial Group, Inc. (“HF Group”) and HomeFirst Mortgage Corp. (the “MortgageCorp.”), and the Bank’s wholly-owned subsidiaries, Mid America Capital Services, Inc.(“Mid America Capital”), Hometown Insurors, Inc. (“Hometown”), HomeFederal Securitization Corp. (“HFSC”), Mid-America Service Corporation and PMD, Inc.  All intercompany balances and transactionshave been eliminated in consolidation.

 

**NOTE 2.                REGULATORY CAPITAL**

 

The following table setsforth the Bank’s compliance with its minimum capital requirements for awell-capitalized institution at March 31, 2008:

 
| ** **                                           | ** ** | **Amount**                           | ** ** | **Percent** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                                           | ** ** | **(Dollars in Thousands)** | ** ** |
| Tier I (core)  capital (to adjusted total assets):   |       |                                 |       |        |       |
| Required                                             |       | $                                    | 53,066     |        | 5.00       | % |
| Actual                                               |       | 85,295                               |       | 8.04        |       |
| Excess over  required                                |       | 32,229                               |       | 3.04        |       |
|                                                 |       |                                 |       |        |       |
| Total risk-based  capital (to risk-weighted assets): |       |                                 |       |        |       |
| Required                                             |       | $                                    | 82,159     |        | 10.00      | % |
| Actual                                               |       | 90,502                               |       | 11.02       |       |
| Excess over  required                                |       | 8,343                                |       | 1.02        |       |

 

5

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**NOTE 3.                EARNINGS PER SHARE**

 

Basic earnings per shareis computed by dividing income available to common stockholders (the numerator)by the weighted-average number of common shares outstanding (the denominator)during the period.  Shares issued duringthe period and shares reacquired during the period are weighted for the portionof the period they were outstanding. The weighted average number of basiccommon shares outstanding for the three months ended March 31, 2008 and2007 was 3,960,315 and 3,982,096, respectively. The weighted average number of basic common shares outstanding for thenine months ended March 31, 2008 and 2007 was 3,976,414 and 3,970,119,respectively.

 

Dilutive earnings per share is similar to the computationof basic earnings per share except the denominator is increased to include thenumber of additional common shares that would have been outstanding if thedilutive options outstanding had been exercised. The weighted average number ofcommon and dilutive potential common shares outstanding for the three monthsended March 31, 2008 and 2007 was 4,014,770 and 4,065,310,respectively.  The weighted averagenumber of common and dilutive potential common shares outstanding for the ninemonths ended March 31, 2008 and 2007 was 4,035,416 and 4,048,119,respectively.

 

**NOTE 4.                INVESTMENTSIN SECURITIES**

 

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

 
| ** **                  | ** ** | **March 31, 2008**         | ** ** |
|-----------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | ** **                           | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Amortized**                        | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                  | ** ** | **Cost**                             | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Value** | ** ** |
| ** **                  | ** ** | **(Dollars in Thousands)** | ** ** |
|                        |       |                                 |       |   |   |   |   |   |   |
| Debt securities:            |       |                                 |       |   |   |   |   |   |   |
| U.S. government  agencies   |       | $                                    | 8,593      |   | $ | 336 |   | $ | — |   | $ | 8,929 |   |
| Federal Home  Loan Bank     |       | 4,911                                |       | 166 |   | — |   | 5,077 |   |
| Municipal bonds             |       | 11,505                               |       | 198 |   | (44 | ) | 11,659 |   |
| Preferred Term  Securities  |       | 12,371                               |       | — |   | (1,055 | ) | 11,316 |   |
|                        |       | 37,380                               |       | 700 |   | (1,099 | ) | 36,981 |   |
|                        |       |                                 |       |   |   |   |   |   |   |
| Equity  securities:         |       |                                 |       |   |   |   |   |   |   |
| FNMA                        |       | 8                                    |       | 2 |   | — |   | 10 |   |
| Federal Ag  Mortgage        |       | 7                                    |       | 3 |   | — |   | 10 |   |
| Other  Investments          |       | 232                                  |       | — |   | — |   | 232 |   |
|                        |       | 247                                  |       | 5 |   | — |   | 252 |   |
|                        |       |                                 |       |   |   |   |   |   |   |
| Mortgage-backed  securities |       | 178,251                              |       | 1,425 |   | (916 | ) | 178,760 |   |
|                        |       | $                                    | 215,878    |   | $ | 2,130 |   | $ | (2,015 | ) | $ | 215,993 |   |

 

6

----

 
| ** **                 | ** ** | **March 31, 2007**         | ** ** |
|----------------------------|------------|--------------------------------------|------------|
| ** **                 | ** ** | **Amortized  Cost**                  | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** |
| ** **                 | ** ** | **(Dollars in Thousands)** | ** ** |
|                       |       |                                 |       |   |   |   |   |   |   |
| Debt securities:           |       |                                 |       |   |   |   |   |   |   |
| U.S. government  agencies  |       | $                                    | 12,079     |   | $ | 40 |   | $ | (57 | ) | $ | 12,062 |   |
| Federal Home  Loan Bank    |       | 13,474                               |       | 34 |   | (46 | ) | 13,462 |   |
| Municipal bonds            |       | 7,671                                |       | 30 |   | (72 | ) | 7,629 |   |
| Preferred Term  Securities |       | 11,018                               |       | 28 |   | (76 | ) | 10,970 |   |
| Other  Investments         |       | 5,072                                |       | 70 |   | — |   | 5,142 |   |
|                       |       | 49,314                               |       | 202 |   | (251 | ) | 49,265 |   |
|                       |       |                                 |       |   |   |   |   |   |   |
| Common Stock:              |       |                                 |       |   |   |   |   |   |   |
| FNMA                       |       | 8                                    |       | 14 |   | — |   | 22 |   |
| Federal Ag  Mortgage       |       | 7                                    |       | 3 |   | — |   | 10 |   |
| Other  Investments         |       | 134                                  |       | — |   | — |   | 134 |   |
|                       |       | 149                                  |       | 17 |   | — |   | 166 |   |
|                       |       |                                 |       |   |   |   |   |   |   |
| Mortgage-backed securities |       | 90,522                               |       | 154 |   | (1,432 | ) | 89,244 |   |
|                       |       | $                                    | 139,985    |   | $ | 373 |   | $ | (1,683 | ) | $ | 138,675 |   |

 

The following table presentsthe fair value and age of gross unrealized losses by investment category at March 31,2008 in accordance with FASB Staff Position (“FSP”) No. FAS 115-1, The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments:

 
|                       |   | **Less than 12 Months** |   | **12 Months or More** |   | **Total**       |   |
|----------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|-----------------|--------|
|                       |   | **Fair  Value**                        |   | **Gross  Unrealized  (Losses)**      |   | **Fair  Value** |   | **Gross  Unrealized  (Losses)** |   | **Fair  Value** |   | **Gross  Unrealized  (Losses)** |   |
|                       |   | **(Dollars in Thousands)**   |   |
|                       |   |                                   |   |                                 |   |            |   |   |   |   |   |   |   |
| Municipal bonds            |   | 1,376                                  |   | (24                                  | )      | 1,293           |   | (20 | ) | 2,669 |   | (44 | ) |
| Preferred term securities  |   | 9,423                                  |   | (930                                 | )      | 1,893           |   | (125 | ) | 11,316 |   | (1,055 | ) |
| Mortgage-backed securities |   | 62,876                                 |   | (283                                 | )      | 27,265          |   | (633 | ) | 90,141 |   | (916 | ) |
|                       |   | $                                      | 73,675 |                                 | $      | (1,237          | )      | $ | 30,451 |   | $ | (778 | ) | $ | 104,126 |   | $ | (2,015 | ) |
|                            |        |                                        |        |                                      |        |                 |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

Managementdoes not believe any individual unrealized losses as of March 31, 2008represent an other-than-temporary impairment. The unrealized losses reported for mortgage-backed securities relate tosecurities issued primarily by the Federal National Mortgage Association (“FNMA”),the Government National Mortgage Association (“GNMA”), and the Federal HomeLoan Mortgage Corporation (“FHLMC”). These unrealized losses in total are primarily attributable to changesin interest rates and the contractual cashflows of those investments are primarilyguaranteed by an agency of the U.S. government. As a group, the unrealized losses were less than 2.0% of theirrespective amortized cost basis at March 31, 2008.  Because the decline in market value isattributable primarily 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 March 31,2008.

 

7

----

 

**NOTE 5.                SEGMENT REPORTING**

 

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

 

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

 
| **Three Months Ended March 31, 2008** | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                     | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                           |       |                                 |       |      |       |      |       |
| Net interest  income                                           |       | $                                    | 8,165      |      | $          | (470      | )          | $ | 7,695 |   |
| Provision for  losses on loans and leases                      |       | (551                                 | )          | —    |       | (551      | )          |
| Noninterest  income                                            |       | 2,717                                |       | 90        |       | 2,807     |       |
| Intersegment  noninterest income                               |       | (28                                  | )          | (16       | )          | (44       | )          |
| Noninterest  expense                                           |       | (7,394                               | )          | (160      | )          | (7,554    | )          |
| Intersegment  noninterest expense                              |       | —                               |       | 44        |       | 44        |       |
| Income (loss)  before income taxes                             |       | $                                    | 2,909      |      | $          | (512      | )          | $ | 2,397 |   |
|                                                           |       |                                 |       |      |       |      |       |
| Total assets at  March 31, 2008                           |       | $                                    | 1,064,393  |      | $          | 3,496     |       | $ | 1,067,889 |   |

 
| **Three Months Ended March 31, 2007** | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                     | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                           |       |                                 |       |      |       |      |       |
| Net interest  income                                           |       | $                                    | 7,140      |      | $          | (737      | )          | $ | 6,403 |   |
| Intersegment  interest income                                  |       | (211                                 | )          | 211       |       | —    |       |
| Provision for  losses on loans and leases                      |       | (34                                  | )          | —    |       | (34       | )          |
| Noninterest  income                                            |       | 2,665                                |       | (52       | )          | 2,613     |       |
| Intersegment  noninterest income                               |       | (108                                 | )          | 108       |       | —    |       |
| Noninterest  expense                                           |       | (7,266                               | )          | (205      | )          | (7,471    | )          |
| Intersegment  noninterest expense                              |       | 3                                    |       | (3        | )          | —    |       |
| Income (loss)  before income taxes                             |       | $                                    | 2,189      |      | $          | (678      | )          | $ | 1,511 |   |
|                                                           |       |                                 |       |      |       |      |       |
| Total assets at  March 31, 2007                           |       | $                                    | 994,613    |      | $          | 1,511     |       | $ | 996,124 |   |

 

8

----

 
| **Nine Months Ended March 31, 2008** | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                    | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                          |       |                                 |       |      |       |      |       |
| Net interest  income                                          |       | $                                    | 22,962     |      | $          | (1,603    | )          | $ | 21,359 |   |
| Provision for  losses on loans and leases                     |       | (1,171                               | )          | —    |       | (1,171    | )          |
| Noninterest  income                                           |       | 8,409                                |       | 179       |       | 8,588     |       |
| Intersegment  noninterest income                              |       | (82                                  | )          | (50       | )          | (132      | )          |
| Noninterest  expense                                          |       | (21,707                              | )          | (699      | )          | (22,406   | )          |
| Intersegment  noninterest expense                             |       | —                               |       | 132       |       | 132       |       |
| Income (loss)  before income taxes                            |       | $                                    | 8,411      |      | $          | (2,041    | )          | $ | 6,370 |   |
|                                                          |       |                                 |       |      |       |      |       |
| Total assets at  March 31, 2008                          |       | $                                    | 1,064,393  |      | $          | 3,496     |       | $ | 1,067,889 |   |

 
| **Nine  Months Ended March 31, 2007** | ** ** | **Banking**                 | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|-----------|------------|-----------|------------|
| ** **                                 | ** ** | **(Dollars  in Thousands)** | ** ** |
|                                       |       |                        |       |      |       |      |       |
| Net interest  income                       |       | $                           | 21,593     |      | $          | (2,712    | )          | $ | 18,881 |   |
| Intersegment  interest income              |       | (688                        | )          | 688       |       | —    |       |
| Provision for  losses on loans and leases  |       | (786                        | )          | —    |       | (786      | )          |
| Noninterest  income                        |       | 10,566                      |       | (187      | )          | 10,379    |       |
| Intersegment  noninterest income           |       | (316                        | )          | 316       |       | —    |       |
| Noninterest  expense                       |       | (21,445                     | )          | (626      | )          | (22,071   | )          |
| Intersegment  noninterest expense          |       | 7                           |       | (7        | )          | —    |       |
| Income (loss)  before income taxes         |       | $                           | 8,931      |      | $          | (2,528    | )          | $ | 6,403 |   |
|                                       |       |                        |       |      |       |      |       |
| Total assets at  March 31, 2007       |       | $                           | 994,613    |      | $          | 1,511     |       | $ | 996,124 |   |

 

**NOTE 6.                DEFINED BENEFIT PLAN**

 

The Company has a noncontributory (cash balance) defined benefitpension plan covering all employees of the Company and its wholly-ownedsubsidiaries who have attained the age of 21 and have completed 1,000 hours ofservice in a plan year.  The benefits arebased on 6% of each eligible participant’s annual compensation, plus incomeearned in the accounts at a rate determined annually based on 30-year treasurynote rates.  The Company’s funding policyis to make the minimum annual required contribution plus such amounts as theCompany may determine to be appropriate from time to time.  Participants are 100% vested after five yearsof service with a retirement age of the later of age 65 or five years ofparticipation.  Information relative tothe components of net periodic benefit cost for the Company’s defined benefitplan is presented below:

 
| ** **                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **March 31,**               | ** ** | **March 31,**              | ** ** |
| ** **                         | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                               |       |                             |       |                            |       |   |   |   |   |
| Service cost                       |       | $                                | 111,830    |                            | $          | 116,521 |   | $ | 335,490 |   | $ | 349,563 |   |
| Interest cost                      |       | 109,260                          |       | 97,748                          |       | $ | 327,780 |   | $ | 293,244 |   |
| Expected return  on plan assets    |       | (121,791                         | )          | (109,101                        | )          | $ | (365,373 | ) | $ | (327,303 | ) |
| Total costs  recognized in expense |       | $                                | 99,299     |                            | $          | 105,168 |   | $ | 297,897 |   | $ | 315,504 |   |

 

9

----

 

The Company previously disclosed in its consolidated financialstatements for Fiscal 2007, which are included in Part II, Item 8 “FinancialStatements and Supplementary Data” of the Company’s Annual Report on Form 10-Kfor Fiscal 2007, that it contributed $621,000 to fund its qualified pensionplan.  During the first quarter of thefiscal year ending June 30, 2008 (“Fiscal 2008”), the Company madecontributions of $532,000 to fund its qualified pension plan.  The Company anticipates no additionalcontributions for Fiscal 2008.

 

**NOTE 7.                SELF-INSURED HEALTHCARE PLAN**

 

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

 

The Company assumes the responsibility for funding the plan benefitsout of general assets; however, employees cover some of the costs of coveredbenefits through contributions, deductibles, co-pays and participationamounts.  An employee is eligible forcoverage upon completion of 30 calendar days of regular employment.  The plan, which is on a calendar year basis,is intended to comply with, and be governed by, the Employee Retirement IncomeSecurity Act of 1974, as amended.

 

Total net healthcarecosts are inclusive of health claims expenses and administration fees offset bystop loss and employee reimbursement. Reported below is a summary of net healthcare costs by quarter for thefiscal years ended June 30, 2008 and 2007:

 
| ** **                       | ** ** | **Fiscal Years Ended June 30,** | ** ** |
|----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **                       | ** ** | **(Dollars in Thousands)**                | ** ** |
|                             |       |                                                |       |   |   |
| Quarter ended  September 30 |       | $                                                   | 221        |   | $ | 436 |   |
| Quarter ended  December 31  |       | 409                                                 |       | 357 |   |
| Quarter ended  March 31     |       | 328                                                 |       | 760 |   |
| Quarter ended  June 30      |       | —                                              |       | 596 |   |
| Net healthcare  costs            |       | $                                                   | 958        |   | $ | 2,149 |   |

 

**NOTE 8.                STOCK-BASED COMPENSATION PLANS**

 

The fair value of each incentive stock option grantand stock appreciation right is estimated at the grant date using theBlack-Scholes option-pricing model.  Thefollowing weighted average assumptions were used for grants in the nine monthsended March 31, 2008 and 2007:

 
| ** **                | ** ** | **For the Nine Months Ended** | ** ** |
|---------------------------|------------|---------------------------------------------------|------------|
| ** **                | ** ** | **March 31,**                                | ** ** |
| ** **                | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
|                      |       |                                              |       |   |   |
| Expected  volatility      |       | 22.00                                             | %          | 23.00 | % |
| Expected  dividend yield  |       | 2.61                                              | %          | 2.63 | % |
| Risk-free  interest rate  |       | 4.10                                              | %          | 4.61 | % |
| Expected term  (in years) |       | 4                                                 |       | 4 |   |

 

10

----

 

Stock option and stock appreciation right activity for the nine monthsended March 31 follow:

 
| ** **         | ** ** | **Stock Options** | ** ** |
|--------------------|------------|------------------------|------------|
| ** **         | ** ** | **2008**               | ** ** | **2007** | ** ** |
| ** **         | ** ** | ** **             | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **         | ** ** | ** **             | ** ** | **Weighted** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **         | ** ** | ** **             | ** ** | **Average** | ** ** | **Remaining** | ** ** | **Aggregate** | ** ** | ** ** | ** ** | **Average** | ** ** | **Remaining** | ** ** | **Aggregate** | ** ** |
| ** **         | ** ** | ** **             | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **         | ** ** | **Shares**             | ** ** | **Price** | ** ** | **Term** | ** ** | **Value** | ** ** | **Shares** | ** ** | **Price** | ** ** | **Term** | ** ** | **Value** | ** ** |
|               |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning  Balance |       | 244,602                |       | $ | 12.75 |   |   |   |   |   | 318,977 |   | $ | 12.77 |   |   |   |   |   |
| Granted            |       | —                 |       | — |   |   |   |   |   | — |   | — |   |   |   |   |   |
| Forfeited          |       | (5,608                 | )          | 17.27 |   |   |   |   |   | (12,743 | ) | 16.58 |   |   |   |   |   |
| Exercised          |       | (34,090                | )          | 11.65 |   |   |   |   |   | (32,968 | ) | 12.90 |   |   |   |   |   |
|               |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Ending Balance     |       | 204,904                |       | $ | 12.81 |   | 5.84 |   | $ | 636 |   | 273,266 |   | $ | 12.81 |   | 5.46 |   | $ | 1,483 |   |
|                    |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **         | ** ** | **Stock Appreciation Rights** | ** ** |
|--------------------|------------|-----------------------------------------|------------|
| ** **         | ** ** | **2008**                                | ** ** | **2007** | ** ** |
| ** **         | ** ** | ** **                              | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **         | ** ** | ** **                              | ** ** | **Weighted** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **         | ** ** | ** **                              | ** ** | **Average** | ** ** | **Remaining** | ** ** | **Aggregate** | ** ** | ** ** | ** ** | **Average** | ** ** | **Remaining** | ** ** | **Aggregate** | ** ** |
| ** **         | ** ** | ** **                              | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **         | ** ** | **SARs**                                | ** ** | **Price** | ** ** | **Term** | ** ** | **Value** | ** ** | **SARs** | ** ** | **Price** | ** ** | **Term** | ** ** | **Value** | ** ** |
|               |       |                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning  Balance |       | 19,899                                  |       | $ | 12.75 |   |   |   |   |   | — |   | $ | — |   |   |   |   |   |
| Granted            |       | 29,204                                  |       | 16.10 |   |   |   |   |   | 20,953 |   | 16.00 |   |   |   |   |   |
| Forfeited          |       | (3,954                                  | )          | 16.05 |   |   |   |   |   | (1,054 | ) | 16.00 |   |   |   |   |   |
| Exercised          |       | —                                  |       | — |   |   |   |   |   | — |   | — |   |   |   |   |   |
|               |       |                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Ending Balance     |       | 45,149                                  |       | $ | 14.63 |   | 3.08 |   | $ | 103 |   | 19,899 |   | $ | 16.00 |   | 3.50 |   | $ | 112 |   |
|                    |            |                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The weighted-average grant date fair value of optionsand stock appreciation rights (SARs) granted during the nine months ended March 31,2008 and 2007 was $2.89 and $3.11, respectively.  The total intrinsic value of optionsexercised during the nine months ended March 31, 2008 and 2007 was$148,000 and $176,000, respectively.  Asof March 31, 2008, there was $1,600 of total unrecognized compensationcost related to nonvested stock option awards. The cost is expected to be recognized over the remaining period of threemonths for stock option awards and over a weighted average period of four yearsfor SARs awards.  Cash received from theexercise of options for the nine months ended March 31, 2008 and 2007 was$397,000 and $425,000, respectively.  Thetax benefit realized for the tax deductions from cashless option exercisestotaled $5,500 and $42,000 for the nine months ended March 31, 2008 and2007, respectively.

 

11

----

 

Restricted share activityfor the nine months ended March 31 follows:

 
| ** **                    | ** ** | **2008**   | ** ** | **2007**            | ** ** |
|-------------------------------|------------|------------|------------|---------------------|------------|
| ** **                    | ** ** | ** ** | ** ** | **Weighted**        | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Average**         | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Grant Date** | ** ** | ** ** | ** ** | **Grant Date** | ** ** |
| ** **                    | ** ** | **Shares** | ** ** | **Fair Value** | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
|                          |       |       |       |                |       |   |   |   |   |
| Nonvested  Balance, beginning |       | 144,711    |       | $                   | 16.10      |   | 158,159 |   | $ | 15.85 |   |
| Granted                       |       | 14,955     |       | 16.78               |       | 11,603 |   | 16.75 |   |
| Vested                        |       | (31,236    | )          | 14.50               |       | (17,467 | ) | 13.63 |   |
| Forfeited                     |       | (10,894    | )          | 16.46               |       | (5,417 | ) | 15.32 |   |
| ** **                    | ** ** | ** ** | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nonvested  Balance, ending    |       | 117,536    |       | $                   | 16.58      |   | 146,878 |   | $ | 16.08 |   |

 

Pretax compensation expense recognized for restricted shares for thenine months ended March 31, 2008 and 2007 was $314,000 and $344,000,respectively.  The tax benefit for thenine months ended March 31, 2008 and 2007 was $107,000 and $117,000,respectively.  As of March 31 2008,there was $947,000 of total unrecognized compensation cost related torestricted shares granted under the Company’s 2002 Stock Option and IncentivePlan, as amended (“the Plan”).  The costis expected to be recognized over a weighted-average period of four years.  The total fair value of shares vested duringthe nine months ended March 31, 2008 and 2007 was $453,000 and $238,000,respectively.

 

Awards to directors of restricted shares of the Company’s common stockare made to outside directors from the Company’s 2002 Stock Option andIncentive Plan (2002 Option Plan).  Thisplan was effective for directors as of January 1, 2007, when the priorplan, the “Director Restricted Stock Plan” expired on December 31,2006.  The Director Restricted Stock Planprovided awards of restricted shares of the Company’s common stock and was ineffect for a period of ten years.

 

These stock option and incentive plans are described more fully in Part II,Item 8 “Financial Statements and Supplementary Data” of the Company’s AnnualReport on Form 10-K for Fiscal 2007, under Note 16 of “Notes toConsolidated Financial Statements.”

 

**NOTE 9.                SUBORDINATED DEBENTURES PAYABLETO TRUSTS**

 

On July 5, 2007, the Company issued 5,000 shares totaling $5.0million of Company Obligated Mandatorily Redeemable Preferred Securities ofTrust VI.  Trust VI was established andexists for the sole purpose of issuing trust preferred securities and investingthe proceeds in subordinated debentures of the Company.  These subordinated debentures constitute thesole asset of Trust VI.  The securitiesprovide for cumulative cash distributions calculated at a rate based on three-monthLIBOR plus 1.65%, adjusted quarterly. Refer to Note 11 in regards to the interest rate swap agreement, whichconverted the variable-rate Trust Preferred VI security into a fixed-ratesecurity for a term of five years.  TheCompany may, at one or more times, defer interest payments on the capitalsecurities for up to 20 consecutive quarterly periods, but not beyond October 1,2037.  At the end of the deferral period,all accumulated and unpaid distributions must be paid.  The capital securities must be redeemed on October 1,2037; however, the Company has the option to shorten the maturity date to adate not earlier than October 1, 2012. Holders of the capital securities have no voting rights, are unsecured,and rank junior in priority of the payment to all of the Company’s indebtednessand senior to the Company’s capital stock.

 

On July 5, 2007, the Company exercised its option to redeem $5.0million of Company Obligated Mandatorily Redeemable Preferred Securities ofTrust II.

 

12

----

** **

**NOTE 10.              SALE OF BRANCHES**

** **

During the second quarter of Fiscal 2007, the Bankclosed on the sale of three branches and their associated book of business,along with one physical location.  TheBank recognized a gain on sale of $2.8 million that resulted in the sale of$4.2 million in loans and $33.6 million in deposits.

 

**NOTE 11.              INTEREST RATE CONTRACTS**

 

During the first quarter of Fiscal 2008, the Company entered into aninterest rate swap agreement with a $5.0 million notional amount to convert thevariable-rate Trust Preferred VI security into a fixed-rate security for a termof five years at a fixed rate of 6.69%. This rate swap is designated as a cash flow hedge.  For the nine months ended March 31,2008, the Company recognized net interest income of $4,700 and this was used tooffset the interest expense for the subordinated debentures.

 

The Company is exposed to losses if the counterparty fails to make itspayments under a contract in which the Company is in a receiving status.  The Company minimizes its risk by monitoringthe credit standing of the counterparty. The Company anticipates the counterparty will be able to fully satisfyits obligations under the remaining agreement.

 

**NOTE 12.              COMPREHENSIVE INCOME**

 

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

 
| ** **                                                                                     | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                     | ** ** | **March 31,**                   | ** ** | **March 31,**              | ** ** |
| ** **                                                                                     | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                     | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Net Income                                                                                     |       | $                                    | 1,623      |                            | $          | 1,034 |   | $ | 4,221 |   | $ | 4,242 |   |
| Other  comprehensive income:                                                                   |       |                                 |       |                            |       |   |   |   |   |
| Net change in  unrealized gain (loss) on securities available for sale, net of deferred  taxes |       | 295                                  |       | 272                             |       | 1,476 |   | 1,650 |   |
| Net change in  interest rate swap fair value                                                   |       | (237                                 | )          | —                          |       | (413 | ) | — |   |
| Total other  comprehensive income                                                              |       | 58                                   |       | 272                             |       | 1,063 |   | 1,650 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Total  comprehensive income                                                                    |       | $                                    | 1,681      |                            | $          | 1,306 |   | $ | 5,284 |   | $ | 5,892 |   |

 

13

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

 

**Forward-Looking Statements**

 

This Quarterly Report on Form 10-Q and otherreports issued by the Company, including reports filed with the Securities andExchange Commission, contain “forward-looking statements” that deal with futureresults, expectations, plans and performance. In addition, the Company’s management may make forward-lookingstatements orally to the media, securities analysts, investors or others.  These forward-looking statements might includeone or more of the following:

 

·                  Projections of income, loss, revenues, earnings orlosses per share, dividends, capital expenditures, capital structure, taxbenefit or other financial items.

·                  Descriptions of plans or objectives of management for futureoperations, products or services, transactions, investments and use ofsubordinated debentures payable to trusts.

·      Forecastsof future economic performance.

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

 

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

 

Forward-lookingstatements about the Company’s expected financial results and other plans aresubject to certain risks, uncertainties and assumptions.  These include, but are not limited to, therisks discussed in Part I, Item 1A “Risk Factors” in the Company’s AnnualReport on Form 10-K for Fiscal 2007 and the following: possiblelegislative changes and adverse economic, business and competitive conditionsand developments (such as shrinking interest margins and continued short-termrate environments); deposit outflows; reduced demand for financial services andloan products; changes in accounting policies or guidelines, or in monetary andfiscal policies of the federal government; changes in credit and other risksposed by the Company’s loan and lease portfolios; the ability or inability ofthe Company to manage interest rate and other risks; unexpected, continuing orexcessive claims against the Company’s self-insured health plan; the Company’suse of trust preferred securities; the ability or inability of the Company tosuccessfully enter into a definitive agreement for and close anticipatedtransactions; technological, computer-related or operational difficulties;adverse changes in securities markets; results of litigation; or othersignificant uncertainties.

 

 Forward-looking statements speak only as of the date they aremade.  The Company does not undertake toupdate forward-looking statements to reflect circumstances or events that occurafter the date the forward-looking statements are made.  Although the Company believes itsexpectations are reasonable, it can give no assurance that such expectationswill prove to be correct.  Based uponchanging conditions, should any one or more of these risks or uncertaintiesmaterialize, or should any underlying assumptions prove incorrect, actualresults may vary materially from those described in any forward-lookingstatements.

 

14

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**ExecutiveSummary**

 

The Company’s net incomefor the third quarter of Fiscal 2008 was $1.6 million, or $0.40 in dilutedearnings per share, compared to $1.0 million, or $0.25 in diluted earnings pershare, for the third quarter of Fiscal 2007. For the first nine months of Fiscal 2008, net income was $4.2 million,or $1.05 in diluted earnings per share, compared to $4.2 million, or $1.05 indiluted earnings per share, for the first nine months of Fiscal 2007.  Fiscal year 2007 second quarter net incomeincluded a non-recurring after-tax gain on sale of branches of $1.7 million,which represented $0.42 of diluted earnings per share.  Return on average equity was 8.80% at March 31,2008 compared to 9.59% at March 31, 2007.

 

The net interestmargin on a fully taxable equivalent basis for the nine months ended March 31,2008 was 3.08%, compared to 2.80% for the same period a year ago, an increaseof 28 basis points.  The increase overthe same period last year is primarily attributable to a higher volume ofearning assets and lower costs on liabilities.  During the first quarter of Fiscal 2008, there was $125,000 expense ofunamortized debt issue costs related to the early redemption of the Trust IITrust Preferred Securities.  This causeda decrease of two basis points to the net interest margin on a fully taxableequivalent basis for the nine months ended March 31, 2008.  During the second quarter of Fiscal 2007, theCompany expensed $290,000 of unamortized debt issuance costs relating to theredemption of the Trust I Trust Preferred Securities.  This caused a decrease of four basis pointsto the net interest margin on a fully taxable equivalent basis for the ninemonths ended March 31, 2007.

 

Net interestincome for the first nine months of Fiscal 2008 was $21.4 million, an increaseof $2.5 million, or 13.1%, over the same period a year ago.  Net interest income increased $1.3 million,or 20.2%, to $7.7 million for the three months ended March 31, 2008 from$6.4 million for the same period in the prior fiscal year.  For the nine months ended March 31,2008, average interest-earning assets and average interest-bearing liabilitiesincreased 2.6% and 1.9%, respectively, compared to the same period a yearago.  Yields on earning assets increasedto 6.74% in the first nine months of Fiscal 2008, compared to 6.70% a year ago,an increase of four basis points.  Forthe same period, cost of funds decreased to 4.16%, compared to 4.40%, adecrease of 24 basis points.

 

Net interest marginratio may vary due to many factors, including Federal Reserve policies forshort-term interest rates, competitive and economic factors and customerpreferences for various products and services. On September 18, 2007 the Federal Reserve decreased the Fed FundsTarget Rate by 50 basis points, the first decrease in short-term interest ratessince June 25, 2003.  This actionwas followed by further Fed Funds rate cuts of 250 basis points through thesecond and third quarters of the fiscal year.

 

The Company hadpreviously issued trust preferred securities primarily to provide funding forstock repurchases and to repay other borrowings.  Interest expense on the $27.8 million oftrust preferred securities outstanding decreased to $1.7 million for the ninemonths ended March 31, 2008, compared to $2.1 million for the same perioda year ago, a decrease of $421,000 or 19.9%. The average rate paid on these securities decreased 203 basis points,from 10.12% at March 31, 2007 to 8.09% at March 31, 2008.  In July 2007, the Company refinanced$5.0 million of trust preferred securities, originally issued in July 2002.  This new funding was calculated at a ratebased on three-month LIBOR plus 1.65%. This compares to the original issuance which was based on three-month LIBORplus 3.65%.  In December 2006, theCompany refinanced $10.0 million of trust preferred securities, originallyissued in November 2001.  The newfunding was calculated at a rate based on three-month LIBOR plus 1.83%, fixedfor five years and adjusted quarterly thereafter, compared to the originalissuance of six-month LIBOR plus 3.75%. The Company will evaluate the suitability to refinance additional trustpreferred securities outstanding over the next year depending upon yield curvespreads which exist at the time of refinancing.

 

The allowance forloan and lease losses decreased to $5.6 million at March 31, 2008,compared to $5.8 million at March 31, 2007, a decrease of $208,000 or3.6%.  The ratio of allowance for loanand lease losses to total loans and leases was 0.72% as of March 31, 2008compared to 0.76% at March 31, 2007. Total nonperforming assets at March 31, 2008 were $4.3 million ascompared to $4.1 million a year ago, an increase of $195,000 or 4.7%.  The ratio of nonperforming assets to totalassets decreased to 0.40% at March 31, 2008, compared to 0.41% at March 31,2007.  The allowance for loan and leaselosses 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.

 

15

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The Company made astrategic decision during the first quarter of Fiscal 2008 to stop originatingindirect automobile loans, and will continue to service the existingportfolio.  As of March 31, 2008,the Consumer Indirect loan portfolio balance was $52.8 million, a decrease of$30.3 million from June 30, 2007. The Company entered this line of business in the 1990’s as part of aninterest rate risk reduction strategy, as well as for further diversificationof the balance sheet.

 

The Company addedto its investment portfolio, increasing to $216.0 million from $142.2 millionsince June 30, 2007.  A widening ofspreads over the treasury market in the third quarter provided an opportunityto add AAA-rated Agency mortgage-backed securities, and an occasion to leveragecapital from the discontinued origination and reduction of indirect autoportfolio balances.  The increase insecurities available for sale was primarily funded by advances from the FHLB.

 

Total deposits at March 31,2008 were $744.2 million, a decrease of $71.6 million, or 8.8%, from June 30,2007.  In-market deposits decreased from$744.3 million at June 30, 2007 to $733.2 million at March 31, 2008,a decrease of $11.2 million, or 1.5%. For the same period, out-of-market deposits decreased from $71.5 millionto $11.0 million, respectively.  Publicfunds have decreased, from $167.4 million at June 30, 2007 to $135.5million at March 31, 2008.  Interestexpense on deposits was $20.1 million for the nine months ended March 31,2008, a decrease of $1.1 million, or 5.0%, over the same period a yearago.  The primary factors affectinginterest expense on deposits was the decrease in the average rate paid onchecking and money market deposits, from 3.77% at March 31, 2007 to 3.02%at March 31, 2008, offset by an increase in the average rate paid oncertificates of deposits, from 4.57% at March 31, 2007 to 4.82% at March 31,2008.

 

In October 2007,the Company announced an increase in its quarterly cash dividend, from 10.50cents per share to 10.75 cents per share, resulting in an annualized increaseof 2.4%.

 

The totalrisk-based capital ratio of 11.02% at March 31, 2008 is slightly below the11.05% at June 30, 2007, with a decrease of three basis points.  This continues to place the Bank in the “wellcapitalized” category within OTS regulation at March 31, 2008 and isconsistent with the “well capitalized” OTS category in which the Company plansto operate.  The Company historically hasbeen able to manage the size of its assets through secondary market loan salesof single-family mortgages and student loans.

 

On March 31,2008, the Company had in effect a stock buyback program in which up to 10% ofthe common stock of the Company outstanding on May 1, 2007 could beacquired through April 30, 2008. The Company utilized its stock buyback program during the third quarter,repurchasing 23,092 shares.  For fiscal year 2008, the Company hasrepurchased a total of 99,092 shares. Under the current program, the Company is authorized to repurchase up to300,049 additional shares of common stock through April 30, 2008.  In addition, the Company approved a new stockbuyback program in which up to 10% of the common stock of the Companyoutstanding on May 1, 2008 may be acquired through April 30,2009.  See Part II, Item 2 “UnregisteredSales of Equity Securities and Use of Proceeds” of this Form 10-Q for moredetails.

 

Non-interestincome was $2.8 million for the quarter ended March 31, 2008 compared to$2.6 million at March 31, 2007, an increase of $194,000 or 7.4%.  The primary factors affecting non-interestincome were increases of $64,000 in loan servicing income and $58,000 in feeson deposits.  Non-interest income for thenine months ended March 31, 2008 was $8.6 million compared to $10.4million at March 31, 2007, a decrease of $1.8 million or 17.3%.  The primary factors affecting non-interestincome were a one-time gain on sale of branches of $2.8 million in Fiscal2007.  In addition, there were increasesin loan servicing income of $341,000, fees on deposits of $318,000 and net gainon sale of loans of $276,000 for the nine months ended March 31, 2008 ascompared to the same period in the prior fiscal year.

 

A component ofother non-interest income includes tax-free earnings from general account BOLI,“Bank-Owned Life Insurance,” which stem from growth in policy values fromvarious carriers.  The Company haspurchased general account BOLI through insurance companies with “Excellent” or “VeryStrong” ratings from Moody’s, S&P, A.M. Best or Fitch.

 

16

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Non-interestexpense was $7.6 million for the quarter ended March 31, 2008 compared to$7.5 million at March 31, 2007, an increase of $83,000 or 1.1%.  Compensation and employee benefit expenseincreased $219,000, offset by a decrease in other non-interest expense of$135,000.  The increase in compensationand employee benefit expense was primarily due to increases in regular employeecompensation of $499,000 and variable pay relating to employee incentives of$45,000, offset by a decrease in net healthcare costs of $432,000.  The decrease in other non-interest expensewas primarily due to a decrease in legal expenses of $85,000.  Non-interest expense for the nine monthsended March 31, 2008 was $22.4 million compared to $22.1 million at March 31,2007, an increase of $335,000 or 1.5%. Compensation and employee benefits increased $816,000, primarily due toincreases in regular employee compensation of $1.0 million, variable pay relatingto employee incentives of $171,000 and recruiting costs of $109,000, offset bya decrease in net healthcare costs of $595,000. Check and data processing expenses increased $118,000, offset by adecrease in marketing of $581,000.

 

**General**

 

The Company is afinancial services provider and, as such, has inherent risks that must bemanaged in order to achieve net income. Primary risks that affect net income include credit risk, liquidityrisk, operational risk, regulatory compliance risk and reputation risk.  The Company’s net income is derived bymanaging net interest margin, the ability to collect fees from servicesprovided, by controlling the costs of delivering services and the management ofloan and lease losses.  The primary sourceof revenues comes from the net interest margin, which represents the differencebetween income on interest-earning assets (i.e. loans and investmentsecurities) and expense on interest-bearing liabilities (i.e. deposits andborrowed funding).  The net interestmargin is affected by regulatory, economic and competitive factors thatinfluence interest rates, loan demand and deposit flows.  Fees earned include charges for depositservices, trust services and loan services. Personnel costs are the primary expenses required to deliver theservices to customers.  Other costsinclude occupancy and equipment and general and administrative expenses.

 

**FinancialCondition Data**

 

At March 31,2008, the Company had total assets of $1.1 billion, an increase of $66.4million from the level at June 30, 2007. The increase in assets was due primarily to increases in securitiesavailable for sale of $73.8 million, and FHLB stock of $5.5 million, offset bydecreases in loans and leases receivable of $7.8 million and cash and cashequivalents of $3.7 million.  Theincrease in liabilities of $63.2 million from June 30, 2007 to March 31,2008 was primarily due to increases in advances from the FHLB and otherborrowings of $131.7 million, offset by a decrease in out-of-market deposits of$60.5 million.  In addition, stockholders’equity increased $3.3 million to $65.5 million at March 31, 2008 from$62.3 million at June 30, 2007, primarily due to net income of $4.2million.

 

The increase in securities available for sale of $73.8million was primarily the result of purchases of $123.4 million exceedingsales, maturities and repayments of $52.2 million.  The $123.4 million of purchases includedfixed-rate, mortgage-backed securities of $87.4 million. The increase in FHLBstock of $5.5 million was the result of higher outstanding balances ofadvances.

 

The decrease innet loans and leases receivable of $7.8 million was due primarily to theprevious announcement on the decision to stop indirect automobile loanorigination.  The balances on consumerindirect loans decreased $30.3 million from June 30, 2007 to March 31,2008.  This was offset by the increase inother loan and lease receivables of $22.4 million for the same period.**** Inaddition, net deferred costs decreased $605,000 from the levels at June 30,2007, moving to a net deferred fees position of $23,000 at March 31, 2008.

 

Advances from the FHLB and other borrowings increased $131.7 million.The overall increase in FHLB borrowings was primarily the result of a decreasein out-of-market certificates of deposit of $60.5 million and increasedpurchases of securities available for sale of $123.4 million.

 

17

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The $71.6 million decrease in deposits was due to decreases inout-of-market certificates of deposit of $60.5 million, money market accountsof $39.6 million, savings accounts of $5.3 million and non-interest bearingchecking accounts of $3.4 million. The decrease in out-of-market certificatesof deposit is attributed to a decision to pursue other sources of lower costwholesale funds in the period.  Thesedecreases were offset by increases within in-market certificates of deposit of$35.4 million and interest-bearing checking accounts of $1.6 million.  Public fund deposits decreased $31.9 millionduring the first nine months of Fiscal 2008 due to seasonal fluctuationstypical for these accounts, primarily affecting the certificate of deposit andchecking account balances.

 

During the 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 the maturity date at a specific time as stated inthe contract.  The issuance of $5.0million of Company Obligated Mandatorily Redeemable Preferred Securities ofTrust II on July 11, 2002 included an option to shorten the maturity dateto July 5, 2007.  The Companyexercised this option to redeem $5.0 million of trust preferredsecurities.  Also during the firstquarter of Fiscal 2008, the Company issued $5.0 million of Company ObligatedMandatorily Redeemable Preferred Securities of Trust VI.  The new funding is calculated at a rate basedon three-month LIBOR plus 1.65%, compared to the original issuance which wasbased on three-month LIBOR plus 3.65%. The unamortized amount of $125,000 deferred debt issuance costs relatedto the original issuance was expensed.

 

18

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The following tables show the composition of theCompany’s loan and lease portfolio and deposit accounts:

 

**Loan and Lease Portfolio Composition**

 
| ** **                                        | ** ** | **At March 31, 2008** | ** ** | **At June 30, 2007** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                        | ** ** | **Amount**                           | ** ** | **Percent**                         | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                                        | ** ** | **(Dollars in Thousands)** | ** ** |
|                                              |       |                                 |       |                                |       |   |   |   |   |
| One-to  four-family (1)                           |       | $                                    | 102,274    |                                | 13.46      | % | $ | 116,544 |   | 15.18 | % |
| Commercial  business and real estate (2) (3) |       | 300,728                              |       | 39.59                               | %          | 275,646 |   | 35.92 | % |
| Multi-family  real estate                         |       | 42,057                               |       | 5.54                                | %          | 34,047 |   | 4.44 | % |
| Equipment  finance leases                         |       | 20,914                               |       | 2.75                                | %          | 22,307 |   | 2.91 | % |
| Consumer Direct  (4)                              |       | 101,001                              |       | 13.30                               | %          | 104,647 |   | 13.63 | % |
| Consumer  Indirect (5)                            |       | 52,832                               |       | 6.96                                | %          | 83,094 |   | 10.83 | % |
| Agricultural                                      |       | 133,944                              |       | 17.63                               | %          | 116,710 |   | 15.21 | % |
| Construction and  development                     |       | 5,874                                |       | 0.77                                | %          | 14,476 |   | 1.88 | % |
| Total Loans and  Leases Receivable (6)            |       | $                                    | 759,624    |                                | 100.00     | % | $ | 767,471 |   | 100.00 | % |

 

----

(1) Excludes $7,060and $8,290 loans held for sale at March 31, 2008 and June 30, 2007,respectively.

(2) Includes $3,109and $3,297 tax exempt leases at March 31, 2008 and June 30, 2007,respectively.

(3) Excludes $223commercial loans held for sale at March 31, 2008 and June 30, 2007.

(4) Excludes $2,644and $263 student loans held for sale at March 31, 2008 and June 30,2007, respectively.

(5) The Companyannounced Consumer Indirect originations ceased during the first quarter ofFiscal 2008.

(6) Includesdeferred loan fees and discounts and undisbursed portion of loans in process.

 

**Deposit Composition**

 
| ** **                             | ** ** | **At March 31, 2008** | ** ** | **At June 30, 2007** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                             | ** ** | **Amount**                           | ** ** | **Percent**                         | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
|                                   |       |                                 |       |                                |       |   |   |   |   |
| Noninterest  bearing checking accounts |       | $                                    | 83,316     |                                | 11.20      | % | $ | 86,679 |   | 10.62 | % |
| Interest bearing  checking accounts    |       | 88,655                               |       | 11.91                               | %          | 87,030 |   | 10.67 | % |
| Money market  accounts                 |       | 172,970                              |       | 23.24                               | %          | 212,546 |   | 26.05 | % |
| Savings accounts                       |       | 60,930                               |       | 8.19                                | %          | 66,235 |   | 8.12 | % |
| In-Market  Certificates of deposit     |       | 327,299                              |       | 43.98                               | %          | 291,858 |   | 35.77 | % |
| Out-of-Market  Certificates of deposit |       | 11,049                               |       | 1.48                                | %          | 71,516 |   | 8.77 | % |
| Total Deposits                         |       | $                                    | 744,219    |                                | 100.00     | % | $ | 815,864 |   | 100.00 | % |

 

19

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**Analysisof Net Interest Income**

 

Net interest incomerepresents the difference between income on interest-earning assets and expenseon interest-bearing liabilities.  Netinterest income depends upon the volume of interest-earning assets andinterest-bearing liabilities and the interest rates earned or paid on them.

 

*Average Balances, Interest Rates and Yields.* The following table presents for the periods indicated, the total dollaramount of interest income from average interest-earning assets and theresulting yields, as well as the interest expense on average interest-bearingliabilities, expressed both in dollars and rates, and the net interestmargin.  The table does not reflect anyeffect of income taxes, except where noted. 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 March 31,** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                     | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **Average**                                          | ** ** | **Interest** | ** ** | ** ** | ** ** | **Average** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Outstanding**                                      | ** ** | **Earned/** | ** ** | **Yield/** | ** ** | **Outstanding** | ** ** | **Earned/** | ** ** | **Yield/** | ** ** |
| ** **                                     | ** ** | **Balance**                                          | ** ** | **Paid** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Paid** | ** ** | **Rate** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)**                 | ** ** |
| Interest-earning  assets:                      |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans and leases  receivable (1) (3)      |       | $                                                    | 766,960    |   | $ | 13,188 |   | 6.92 | % | $ | 758,370 |   | $ | 13,435 |   | 7.18 | % |
| Investment  securities (2) (3)            |       | 173,835                                              |       | 2,253 |   | 5.21 | % | 156,671 |   | 1,869 |   | 4.84 | % |
| FHLB stock                                     |       | 8,889                                                |       | 101 |   | 4.56 | % | 5,768 |   | 56 |   | 3.94 | % |
|                                           |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 949,684                                              |       | $ | 15,542 |   | 6.58 | % | 920,809 |   | $ | 15,360 |   | 6.77 | % |
| Noninterest-earning  assets                    |       | 70,917                                               |       |   |   |   |   | 70,682 |   |   |   |   |   |
| Total assets                                   |       | $                                                    | 1,020,601  |   |   |   |   |   | $ | 991,491 |   |   |   |   |   |
|                                           |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Checking and  money market                     |       | $                                                    | 262,518    |   | $ | 1,495 |   | 2.29 | % | $ | 286,371 |   | $ | 2,639 |   | 3.74 | % |
| Savings                                        |       | 54,391                                               |       | 256 |   | 1.89 | % | 48,029 |   | 344 |   | 2.90 | % |
| Certificates of  deposit                       |       | 343,517                                              |       | 3,942 |   | 4.61 | % | 367,374 |   | 4,285 |   | 4.73 | % |
| Total  interest-bearing deposits               |       | 660,426                                              |       | 5,693 |   | 3.47 | % | 701,774 |   | 7,268 |   | 4.20 | % |
| FHLB advances  and other borrowings            |       | 159,773                                              |       | 1,660 |   | 4.18 | % | 99,139 |   | 1,132 |   | 4.63 | % |
| Subordinated  debentures payable to trusts     |       | 27,837                                               |       | 494 |   | 7.14 | % | 27,837 |   | 557 |   | 8.11 | % |
|                                           |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities            |       | 848,036                                              |       | 7,847 |   | 3.72 | % | 828,750 |   | 8,957 |   | 4.38 | % |
| Noninterest-bearing  deposits                  |       | 79,186                                               |       |   |   |   |   | 74,017 |   |   |   |   |   |
| Other  liabilities                             |       | 28,217                                               |       |   |   |   |   | 27,685 |   |   |   |   |   |
| Total  liabilities                             |       | 955,439                                              |       |   |   |   |   | 930,452 |   |   |   |   |   |
| Equity                                         |       | 65,162                                               |       |   |   |   |   | 61,039 |   |   |   |   |   |
| Total  liabilities and equity                  |       | $                                                    | 1,020,601  |   |   |   |   |   | $ | 991,491 |   |   |   |   |   |
|                                           |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income; interest rate spread (4) |       |                                                 |       | $ | 7,695 |   | 2.86 | % |   |   | $ | 6,403 |   | 2.39 | % |
|                                           |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (4) (5)              |       |                                                 |       |   |   | 3.26 | % |   |   |   |   | 2.82 | % |
|                                           |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin, TE (6)                   |       |                                                 |       |   |   | 3.32 | % |   |   |   |   | 2.87 | % |

 

----

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

(2)  Includesfederal funds sold.

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

(4)  Percentages forthe three months ended March 31, 2008 and March 31, 2007 have beenannualized.

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

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

 

20

----

 
| ** **                                     | ** ** | **Nine Months Ended March 31,** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **Average**                                         | ** ** | **Interest** | ** ** | ** ** | ** ** | **Average** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Outstanding**                                     | ** ** | **Earned/** | ** ** | **Yield/** | ** ** | **Outstanding** | ** ** | **Earned/** | ** ** | **Yield/** | ** ** |
| ** **                                     | ** ** | **Balance**                                         | ** ** | **Paid** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Paid** | ** ** | **Rate** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)**                | ** ** |
| Interest-earning  assets:                      |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Loans and leases  receivable (1) (3)      |       | $                                                   | 772,732    |   | $ | 41,187 |   | 7.09 | % | $ | 755,079 |   | $ | 40,403 |   | 7.13 | % |
| Investment  securities (2) (3)            |       | 160,577                                             |       | 6,176 |   | 5.12 | % | 155,158 |   | 5,488 |   | 4.71 | % |
| FHLB stock                                     |       | 7,403                                               |       | 249 |   | 4.47 | % | 6,466 |   | 210 |   | 4.33 | % |
|                                           |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 940,712                                             |       | $ | 47,612 |   | 6.74 | % | 916,703 |   | $ | 46,101 |   | 6.70 | % |
| Noninterest-earning  assets                    |       | 70,653                                              |       |   |   |   |   | 68,177 |   |   |   |   |   |
| Total assets                                   |       | $                                                   | 1,011,365  |   |   |   |   |   | $ | 984,880 |   |   |   |   |   |
|                                           |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Checking and  money market                     |       | $                                                   | 271,388    |   | $ | 6,153 |   | 3.02 | % | $ | 281,144 |   | $ | 7,953 |   | 3.77 | % |
| Savings                                        |       | 52,195                                              |       | 940 |   | 2.40 | % | 43,302 |   | 812 |   | 2.50 | % |
| Certificates of  deposit                       |       | 359,620                                             |       | 13,011 |   | 4.82 | % | 361,828 |   | 12,403 |   | 4.57 | % |
| Total  interest-bearing deposits               |       | 683,203                                             |       | 20,104 |   | 3.92 | % | 686,274 |   | 21,168 |   | 4.11 | % |
| FHLB advances  and other borrowings            |       | 129,295                                             |       | 4,456 |   | 4.59 | % | 110,696 |   | 3,938 |   | 4.74 | % |
| Subordinated  debentures payable to trusts (4) |       | 27,837                                              |       | 1,693 |   | 8.09 | % | 27,837 |   | 2,114 |   | 10.12 | % |
|                                           |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities            |       | 840,335                                             |       | 26,253 |   | 4.16 | % | 824,807 |   | 27,220 |   | 4.40 | % |
| Noninterest-bearing  deposits                  |       | 79,544                                              |       |   |   |   |   | 77,069 |   |   |   |   |   |
| Other  liabilities                             |       | 27,650                                              |       |   |   |   |   | 23,998 |   |   |   |   |   |
| Total  liabilities                             |       | 947,529                                             |       |   |   |   |   | 925,874 |   |   |   |   |   |
| Equity                                         |       | 63,836                                              |       |   |   |   |   | 59,006 |   |   |   |   |   |
| Total  liabilities and equity                  |       | $                                                   | 1,011,365  |   |   |   |   |   | $ | 984,880 |   |   |   |   |   |
|                                           |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income; interest rate spread (5) |       |                                                |       | $ | 21,359 |   | 2.58 | % |   |   | $ | 18,881 |   | 2.30 | % |
|                                           |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (5) (6)              |       |                                                |       |   |   | 3.02 | % |   |   |   |   | 2.74 | % |
|                                           |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin, TE (7)                   |       |                                                |       |   |   | 3.08 | % |   |   |   |   | 2.80 | % |

 

----

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

(2)  Includesfederal funds sold.

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

(4)  Includes $125and $290 expense in July 2007 and December 2006, respectively, forunamortized debt issuance costs.

(5)  Percentages forthe nine months ended March 31, 2008 and March 31, 2007 have beenannualized.

(6)  Net interestmargin is net interest income divided by average interest-earning assets.

(7)  Net interestmargin expressed on a fully taxable equivalent basis.

 

21

----

 

**Rate/VolumeAnalysis of Net Interest Income**

 

The following schedule presents the dollar amount ofchanges in interest income and interest expense for major components ofinterest-earning assets and interest-bearing liabilities.  It distinguishes between the increases anddecreases due to fluctuating outstanding balances due to the levels andvolatility of interest rates.  For eachcategory of interest-earning assets and interest-bearing liabilities,information is provided on changes attributable to (i) changes in volume(i.e., changes in volume multiplied by old rate) and (ii) changes in rate(i.e., changes in rate multiplied by old volume).  For purposes of this table, changesattributable to both rate and volume, which cannot be segregated, have beenallocated proportionately to the change due to volume and the change due torate.

 
| ** **                                 | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                 | ** ** | **2008 vs 2007**                           | ** ** | **2008 vs 2007**                          | ** ** |
| ** **                                 | ** ** | **Increase**                                         | ** ** | **Increase**                                        | ** ** | ** ** | ** ** | **Increase** | ** ** | **Increase** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **(Decrease)**                                       | ** ** | **(Decrease)**                                      | ** ** | **Total** | ** ** | **(Decrease)** | ** ** | **(Decrease)** | ** ** | **Total** | ** ** |
| ** **                                 | ** ** | **Due to**                                      | ** ** | **Due to**                                     | ** ** | **Increase** | ** ** | **Due to** | ** ** | **Due to** | ** ** | **Increase** | ** ** |
| ** **                                 | ** ** | **Volume**                                           | ** ** | **Rate**                                            | ** ** | **(Decrease)** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| ** **                                 | ** ** | **(Dollars in Thousands)**                 | ** ** |
| Interest-earning  assets:                  |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Loans and leases  receivable (1)           |       | $                                                    | 209        |                                                | $          | (456 | ) | $ | (247 | ) | $ | 964 |   | $ | (180 | ) | $ | 784 |   |
| Investment  securities (2)                 |       | 214                                                  |       | 170                                                 |       | 384 |   | 195 |   | 493 |   | 688 |   |
| FHLB stock                                 |       | 31                                                   |       | 14                                                  |       | 45 |   | 31 |   | 8 |   | 39 |   |
|                                       |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Total  interest-earning assets             |       | $                                                    | 454        |                                                | $          | (272 | ) | $ | 182 |   | $ | 1,190 |   | $ | 321 |   | $ | 1,511 |   |
|                                       |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:             |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Deposits:                                  |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Checking and  money market                 |       | $                                                    | (211       | )                                                   | $          | (933 | ) | $ | (1,144 | ) | $ | (273 | ) | $ | (1,527 | ) | $ | (1,800 | ) |
| Savings                                    |       | 48                                                   |       | (136                                                | )          | (88 | ) | 168 |   | (40 | ) | 128 |   |
| Certificates of  deposit                   |       | (262                                                 | )          | (81                                                 | )          | (343 | ) | (70 | ) | 678 |   | 608 |   |
| Total  interest-bearing deposits           |       | (425                                                 | )          | (1,150                                              | )          | (1,575 | ) | (175 | ) | (889 | ) | (1,064 | ) |
| FHLB advances  and other borrowings        |       | 703                                                  |       | (175                                                | )          | 528 |   | 664 |   | (146 | ) | 518 |   |
| Subordinated  debentures payable to trusts |       | —                                               |       | (63                                                 | )          | (63 | ) | — |   | (421 | ) | (421 | ) |
|                                       |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities        |       | $                                                    | 278        |                                                | $          | (1,388 | ) | $ | (1,110 | ) | $ | 489 |   | $ | (1,456 | ) | $ | (967 | ) |
|                                       |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Net interest  income increase              |       |                                                 |       |                                                |       | $ | 1,292 |   |   |   |   |   | $ | 2,478 |   |

 

----

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

(2)  Includesfederal funds sold.

 

22

----

 

**Applicationof Critical Accounting Policies**

 

GAAP requires management to utilize estimates when reporting financialresults.  The Company has identified thepolicies discussed below as Critical Accounting Policies because the accountingestimates require management to make certain assumptions about matters whichmay be uncertain at the time the estimate was made and a different method ofestimating could have been reasonably made which could have a material impacton the 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 asidereserves or maintain an allowance against probable loan and lease losses in theloan and lease portfolio.  Managementmust develop a consistent and systematic approach to estimate the appropriatebalances to cover the probable losses. Due to the uncertainty of future events, the approach includes a processthat may differ significantly from other methodologies and still produce anestimate in accordance with GAAP.

 

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

 

*MortgageServicing Rights (“MSR”)* – The Company records a servicing asset forcontractually separated servicing from the underlying mortgage loans.   The asset is initially recorded at fairvalue and represents an intangible asset backed by an income stream from theserviced assets.  The asset is amortizedin proportion to and over the period of estimated net servicing income.

 

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

 

The Company hasincluded MSRs as a critical accounting policy because the use of estimates fordetermining fair value using present value concepts may produce results whichmay significantly differ from other fair value analysis perhaps even to thepoint of recording impairment.  The riskto earnings is when the underlying mortgages pay off significantly faster thanthe assumptions used in the previously recorded amortization.  Estimating future cash flows on theunderlying mortgages is a difficult analysis and requires judgment based on thebest information available.  The Companylooks at alternative assumptions and projections when preparing a reasonableand supportable analysis.  Based on theCompany’s quarterly analysis of MSRs, there was no impairment to the MSRs at March 31,2008.

 

*Self-Insurance*- The Companyhas a self-insured healthcare plan for its employees up to certain limits.  To mitigate a portion of these risks, theCompany has a stop-loss insurance policy through a commercial insurance carrierfor coverage in excess of $65,000 per individual occurrence with a maximumaggregate limitation of $2.0 million. The estimate of self-insurance liability is based upon known claims andan estimate of incurred, but not reported (“IBNR”) claims.  IBNR claims are estimated using historicalclaims lag information received by a third party claims administrator.  Due to the uncertainty of health claims, theapproach includes a process which may differ significantly from othermethodologies and still produce an estimate in accordance with GAAP.  Although management believes it uses the bestinformation available to determine the accrual, unforeseen health claims couldresult in adjustments to the accrual. These adjustments could significantly affect net earnings ifcircumstances differ substantially from the assumptions used in estimating theaccrual.

 

23

----

 

**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 March 31,2008 from $4.0 million at June 30, 2007, an increase of $299,000, or7.5%.  Accruing loans and leasesdelinquent more than 90 days increased $549,000 to $1.9 million at March 31,2008 from $1.3 million at June 30, 2007. Nonaccruing loans and leases decreased $184,000 to $2.0 million at March 31,2008 from $2.2 million at June 30, 2007. In addition, the ratio of nonperforming assets to total assets, which isone indicator of credit risk exposure, was 0.40% at March 31, 2008,remaining the same as the 0.40% reported at June 30, 2007.

 

Nonaccruing loansand leases decreased 8.4%, or $184,000, to $2.0 million at March 31, 2008compared to $2.2 million at June 30, 2007. Included in nonaccruing loans and leases at March 31, 2008 wereeight loans totaling $335,000 secured by one- to four-family real estate, oneloan totaling $153,000 secured by commercial real estate, 11 loans totaling$555,000 secured by commercial business, four loans totaling $260,000 securedby agriculture, four leases totaling $134,000 and 38 consumer loans totaling$569,000.

 

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

 

As of March 31,2008, the Company had $442,000 of foreclosed assets.  The balance of foreclosed assets at March 31,2008 consisted of $234,000 of single-family collateral owned, $28,000 ofequipment finance leases and $180,000 of consumer collateral owned.

 

At March 31,2008, the Company had designated $12.6million of its assets as special mention and classified $8.2 million of itsassets that management has determined need to be closely monitoredbecause of possible credit problems of the borrowers or the cash flows of thesecured properties.  At March 31,2008 the Company had $22.3 million in multi-family, commercial business,commercial real estate and agricultural participation loans purchased, of which$243,000 were classified as of March 31, 2008.  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 collectability may notbe reasonably assured, considers the estimated fair market value of theunderlying collateral, present value of expected principal and interestpayments, economic conditions, historical loss experience and other factorsthat warrant recognition in providing for an adequate loan and lease lossallowance.

 

Although the Company’s management believes the March 31, 2008recorded allowance for loan and lease losses was adequate to provide for probablelosses on the related loans and leases, there can be no assurance the allowanceexisting at March 31, 2008 will be adequate in the future.

 

24

----

 

In accordance with the Company’s internal classification of assetspolicy, management evaluates the loan and lease portfolio on a monthly basis toidentify loss potential and determine the adequacy of the allowance for loanand lease losses quarterly.  Loans andleases are placed on nonaccrual status when the collection of principal and/orinterest becomes 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** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                     | ** ** | **March 31,**                            | ** ** | **June 30,** | ** ** |
| ** **                                                                     | ** ** | **2008**                                      | ** ** | **2007** | ** ** |
| ** **                                                                     | ** ** | **(Dollars in Thousands)**          | ** ** |
| Nonaccruing  loans and leases:                                                 |       |                                          |       |   |   |
| One- to  four-family                                                           |       | $                                             | 335        |   | $ | 228 |   |
| Commercial real  estate                                                        |       | 153                                           |       | 25 |   |
| Commercial  business                                                           |       | 555                                           |       | 1,441 |   |
| Equipment finance  leases                                                      |       | 134                                           |       | 118 |   |
| Consumer                                                                       |       | 569                                           |       | 378 |   |
| Agricultural                                                                   |       | 260                                           |       | — |   |
| Total                                                                          |       | 2,006                                         |       | 2,190 |   |
|                                                                           |       |                                          |       |   |   |
| Accruing loans  and leases delinquent more than 90 days:                       |       |                                          |       |   |   |
| One- to  four-family                                                           |       | 306                                           |       | 470 |   |
| Commercial real  estate                                                        |       | 262                                           |       | 178 |   |
| Commercial business                                                            |       | 790                                           |       | 213 |   |
| Equipment  finance leases                                                      |       | 309                                           |       | 88 |   |
| Consumer                                                                       |       | 23                                            |       | 1 |   |
| Agricultural                                                                   |       | 167                                           |       | 358 |   |
| Total                                                                          |       | 1,857                                         |       | 1,308 |   |
|                                                                           |       |                                          |       |   |   |
| Foreclosed  assets: (1)                                                        |       |                                          |       |   |   |
| One- to  four-family                                                           |       | 234                                           |       | 158 |   |
| Equipment  finance leases                                                      |       | 28                                            |       | 180 |   |
| Consumer                                                                       |       | 180                                           |       | 170 |   |
| Total                                                                          |       | 442                                           |       | 508 |   |
|                                                                           |       |                                          |       |   |   |
| Total  nonperforming assets                                                    |       | $                                             | 4,305      |   | $ | 4,006 |   |
|                                                                           |       |                                          |       |   |   |
| Ratio of  nonperforming assets to total assets                                 |       | 0.40                                          | %          | 0.40 | % |
|                                                                           |       |                                          |       |   |   |
| Ratio of  nonperforming loans and leasesto total loans and leases (2) (3) |       | 0.50                                          | %          | 0.45 | % |

 

----

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

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

(3)  Totalloans and leases include loans held for sale.

 

25

----

 

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

 
| ** **                                                                                               | ** ** | **Nine Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **                                                                                               | ** ** | **(Dollars in Thousands)**                | ** ** |
|                                                                                                     |       |                                                |       |   |   |
| Balance at  beginning of period                                                                          |       | $                                                   | 5,872      |   | $ | 5,657 |   |
| Charge-offs:                                                                                             |       |                                                |       |   |   |
| One- to  four-family                                                                                     |       | (3                                                  | )          | (12 | ) |
| Commercial  business                                                                                     |       | (873                                                | )          | (216 | ) |
| Equipment  finance leases                                                                                |       | (198                                                | )          | (133 | ) |
| Consumer                                                                                                 |       | (626                                                | )          | (527 | ) |
| Agricultural                                                                                             |       | —                                              |       | (31 | ) |
| Total  charge-offs                                                                                       |       | (1,700                                              | )          | (919 | ) |
|                                                                                                     |       |                                                |       |   |   |
| Recoveries:                                                                                              |       |                                                |       |   |   |
| One- to  four-family                                                                                     |       | 2                                                   |       | 3 |   |
| Commercial  business                                                                                     |       | 9                                                   |       | — |   |
| Equipment  finance leases                                                                                |       | 18                                                  |       | — |   |
| Consumer                                                                                                 |       | 193                                                 |       | 171 |   |
| Agricultural                                                                                             |       | 5                                                   |       | 80 |   |
| Total recoveries                                                                                         |       | 227                                                 |       | 254 |   |
|                                                                                                     |       |                                                |       |   |   |
| Net  (charge-offs)                                                                                       |       | (1,473                                              | )          | (665 | ) |
|                                                                                                     |       |                                                |       |   |   |
| Additions  charged to operations                                                                         |       | 1,171                                               |       | 786 |   |
|                                                                                                     |       |                                                |       |   |   |
| Balance at end  of period                                                                                |       | $                                                   | 5,570      |   | $ | 5,778 |   |
|                                                                                                     |       |                                                |       |   |   |
| Ratio of net  (charge-offs) during the period to average loans and leases outstanding  during the period |       | (0.19                                               | )%         | (0.09 | )% |
|                                                                                                     |       |                                                |       |   |   |
| Ratio of  allowance for loan and lease losses to total loans and leases at end of  period (1)            |       | 0.72                                                | %          | 0.76 | % |
|                                                                                                     |       |                                                |       |   |   |
| Ratio of  allowance for loan and lease losses to nonperforming loans and leases at end  of period (2)    |       | 144.19                                              | %          | 163.22 | % |

 

----

(1)  Totalloans and leases include loans held for sale.

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

 

26

----

 

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

 
| ** **                             | ** ** | **Allowance**                        | ** ** | **Impaired Loan**              | ** ** | **Allowance**              | ** ** | **Impaired Loan** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **for Loan and**           | ** ** | **Valuation**                       | ** ** | **for Loan and** | ** ** | **Valuation**          | ** ** |
| ** **                             | ** ** | **Lease Losses**                | ** ** | **Allowance**                       | ** ** | **Lease Losses**      | ** ** | **Allowance**          | ** ** |
| **Loan and Lease Type** | ** ** | **At March 31, 2008** | ** ** | **At June 30, 2007** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
|                                   |       |                                 |       |                                |       |                       |       |                   |       |
| One- to  four-family                   |       | $                                    | 318        |                                | $          | —                     |       | $                      | 342        |   | $ | — |   |
| Commercial real  estate                |       | 738                                  |       | —                              |       | 524                        |       | —                 |       |
| Multi-family  real estate              |       | 129                                  |       | —                              |       | 123                        |       | —                 |       |
| Commercial  business                   |       | 1,355                                |       | 90                                  |       | 1,974                      |       | 335                    |       |
| Equipment  finance leases              |       | 542                                  |       | —                              |       | 486                        |       | —                 |       |
| Consumer                               |       | 1,234                                |       | —                              |       | 1,178                      |       | —                 |       |
| Agricultural                           |       | 1,034                                |       | 130                                 |       | 860                        |       | 50                     |       |
| Total                                  |       | $                                    | 5,350      |                                | 220        |                       | $          | 5,487                  |       | 385 |   |
|                                        |            |                                      |            |                                     |            |                            |            |                        |            |  |  |  |  |

 

**Impaired Loan Summary**

 
| ** **                             | ** ** | ** **                           | ** ** | ** **                          | ** ** | **Impaired**  | ** ** | ** **       | ** ** | ** **  | ** ** | **Impaired**  | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|---------------|------------|------------------|------------|-------------|------------|---------------|------------|
| ** **                             | ** ** | **Number**                           | ** ** | ** **                          | ** ** | **Loan**      | ** ** | **Number**       | ** ** | ** **  | ** ** | **Loan**      | ** ** |
| ** **                             | ** ** | **of Loan**                     | ** ** | **Loan**                            | ** ** | **Valuation** | ** ** | **of Loan** | ** ** | **Loan**    | ** ** | **Valuation** | ** ** |
| ** **                             | ** ** | **Customers**                        | ** ** | **Balance**                         | ** ** | **Allowance** | ** ** | **Customers**    | ** ** | **Balance** | ** ** | **Allowance** | ** ** |
| **Loan and Lease Type** | ** ** | **At March 31, 2008** | ** ** | **At June 30, 2007** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
|                                   |       |                                 |       |                                |       |          |       |             |       |        |       |          |       |
| Commercial  business                   |       | 4                                    |       | $                                   | 390        |          | 90         |             | 7          |        | $          | 1,360         |       | 335 |   |
| Agricultural                           |       | 2                                    |       | 341                                 |       | 130           |       | 1                |       | 121         |       | 50            |       |
| Total                                  |       | 6                                    |       | $                                   | 731        |          | 220        |             | 8          |        | $          | 1,481         |       | 385 |   |

 

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The allowance forloan and lease losses was $5.6 million at March 31, 2008 as compared to$5.8 million at March 31, 2007.  Theratio of the allowance for loan and lease losses to total loans and leases was0.72% at March 31, 2008 compared to 0.76% at March 31, 2007.  The Company’s management has considerednonperforming loans and leases and potential problem loans and leases inestablishing the allowance for loan and lease losses.  The Company continues to monitor itsallowance for probable loan and lease losses and make future additions orreductions in light of the level of loans and leases in its portfolio and aseconomic conditions dictate.  Thecurrent level of the allowance for loan and lease losses is a result ofmanagement’s assessment of the risks within the portfolio based on theinformation revealed in credit reporting processes. The Company utilizes arisk-rating system on all commercial business, agricultural, construction andmulti-family and commercial real estate loans, including purchased loans andleases.  A periodic credit review isperformed on all types of loans and leases to establish the necessary reservebased on the estimated risk within the portfolio. This assessment of risk takesinto account the composition of the loan and lease portfolio, historical lossexperience for each loan and lease category, previous loan and leaseexperience, concentrations of credit, current economic conditions and otherfactors that in management’s judgment deserve recognition.

 

Real estate 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.

 

Although management believes it uses the best informationavailable to determine the allowances, unforeseen market conditions couldresult in adjustments and net earnings being significantly affected ifcircumstances differ substantially from the assumptions used in making thefinal determinations.  Future additionsto the Company’s allowances may result from periodic loan, property orcollateral reviews which cannot be predicted at this time.

 

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** **

**Comparison of the Three MonthsEnded March 31, 2008 and March 31, 2007**

 

*General*.  The Company’s net income was $1.6 million, or$0.41 in basic and $0.40 in diluted earnings per share for the three monthsended March 31, 2008, a $589,000 increase in earnings compared to $1.0million, or $0.26 in basic and $0.25 in diluted earnings per share for the sameperiod in the prior fiscal year.  For thethree months ended March 31, 2008, the return on average equity was 10.02%compared to 6.78% for the same period in the prior fiscal year.  For the three months ended March 31,2008, the return on average assets was 0.64% compared to 0.42% for the sameperiod in the prior fiscal year.  Asdiscussed in more detail below, the increases were due to a variety of keyfactors, including increases in interest income of $182,000 and non-interestincome of $194,000 and a decrease in interest expense of $1.1 million offset byan increase in provision for losses on loans and leases of $517,000 and anincrease in non-interest expense of $83,000.

 

*Interest, Dividend and Loan Fee Income.*  Interest, dividend and loan fee income was$15.5 million for the three months ended March 31, 2008 as compared to$15.4 million for the same period in the prior fiscal year, an increase of$182,000 or 1.2%.  A $209,000 increase ininterest, dividend and loan fee income was due to a 1.1% increase in theaverage volume of loans and leases receivable, a $214,000 increase in interest,dividend and loan fee income was the result of an 11.0% increase in the averagevolume of investment securities and a $170,000 increase in interest, dividendand loan fee income was due to an increase in the average yield on investmentsecurities from 4.84% for the three months ended March 31, 2007 to 5.21%for the three months ended March 31, 2008. This was offset by a $456,000 decrease in the average yield on loans andleases receivable from 7.18% at March 31, 2007 to 6.92% at March 31,2008.  The average yield on totalinterest-earning assets was 6.58% for the three months ended March 31,2008 as compared to 6.77% for the same period in the prior fiscal year.

 

*InterestExpense.*  Interestexpense was $7.8 million for the three months ended March 31, 2008 ascompared to $9.0 million for the same period in the prior fiscal year, adecrease of $1.1 million or 12.4%.  A$1.2 million decrease in interest expense was the result of a decrease in theaverage rate paid on interest-bearing deposits from 4.20% for the three monthsended March 31, 2007 to 3.47% for the three months ended March 31,2008.  A $425,000 interest expensedecrease was due to a 5.9% decrease in the average volume on interest-bearingdeposits.  An interest expense increaseof $703,000 was due to a 61.2% increase in the average volume of FHLB advancesand other borrowings.  The average ratepaid on total interest-bearing liabilities was 3.72% for the three months endedMarch 31, 2008 as compared to 4.38% for the same period in the priorfiscal year.

 

*NetInterest Income.* The Company’s net interest income for the threemonths ended March 31, 2008 increased $1.3 million, or 20.2%, to $7.7million compared to $6.4 million for the same period in the prior fiscalyear.  The increase in net interestincome was due primarily to decreases in the average rate paid on interest-bearingliabilities and increases in the average volume of interest-earning assets forthe three months ended March 31, 2008 compared to the same period in theprior fiscal year.  The Company’s netinterest margin on a fully taxable equivalent basis was 3.32% for the threemonths ended March 31, 2008 as compared to 2.87% for the same period inthe prior fiscal year.

 

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

 

During the threemonths ended March 31, 2008, the Company recorded a provision for losseson loans and leases of $551,000 compared to $34,000 for the three months ended March 31,2007, an increase of $517,000.  See “AssetQuality” for further discussion.

 

*Non-interestIncome.*  Non-interestincome was $2.8 million for the three months ended March 31, 2008 ascompared to $2.6 million for the same period in the prior fiscal year, anincrease of $194,000, or 7.4%.  Theincrease in non-interest income was attributable to increases of $64,000 inloan servicing income, $58,000 in fees on deposits and $47,000 in othernon-interest income for the three months ended March 31, 2008 as comparedto the same period in the prior fiscal year.

 

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Loan servicing income increased $64,000 from $525,000for the three months ended March 31, 2007 to $589,000 for the three monthsended March 31, 2008 primarily due to an increase of $64.4 million in thebalances of loans serviced by the Bank from $962.7 million at March 31,2007 to $1.027 billion at March 31, 2008.

 

Fees on deposits increased $58,000, for the threemonths ended March 31, 2008 as compared to the same period in the priorfiscal year, primarily due to increased point-of-sale interchange revenue.

 

Other non-interest income increased $47,000 for thethree months ended March 31, 2008 as compared to the same period in theprior fiscal year, primarily due to a gain of $77,000 due to the mandatorypartial redemption of VISA Inc. class B common stock.

 

*Non-interestExpense.*  Non-interestexpense was $7.6 million for the three months ended March 31, 2008 ascompared to $7.5 million for the three months ended March 31, 2007, anincrease of $83,000, or 1.1%.  Theincrease in non-interest expense was primarily due to increases in compensationand employee benefits of $219,000 offset by a decrease in other non-interestexpense of $135,000.

 

Compensation and employeebenefits increased $219,000, or 4.6%, from $4.8 million for the three monthsended March 31, 2007 to $5.0 million for the three months ended March 31,2008.  Regular employee compensationincreased $499,000 and variable pay related to employee incentives increased$45,000, offset by a decrease in net healthcare costs of $432,000.

 

Other non-interestexpense decreased $135,000, or 14.3%, from $946,000 for the three months ended March 31,2007 to $811,000 for the three months ended March 31, 2008, primarily dueto a decrease in legal expenses of $85,000.

 

*Income tax expense.*  The Company’s income tax expense for thethree months ended March 31, 2008 increased $297,000 or 62.3% to $774,000compared to $477,000 for the same period in the prior fiscal year.  The effective tax rate was 32.29% and 31.57%for the three months ended March 31, 2008 and 2007, respectively.

 

**Comparison of the Nine MonthsEnded March 31, 2008 and March 31, 2007**

 

*General*.  The Company’s net income was $4.2 million, or$1.06 in basic and $1.05 in diluted earnings per share for the nine monthsended March 31, 2008, a $21,000 decrease in earnings compared to $4.2million, or $1.07 in basic and $1.05 in diluted earnings per share for the sameperiod in the prior fiscal year.  For thenine months ended March 31, 2008, the return on average equity was 8.80%compared to 9.59% for the same period in the prior fiscal year.  For the nine months ended March 31,2008, the return on average assets was 0.56% compared to 0.57% for the sameperiod in the prior fiscal year.  Asdiscussed in more detail below, the decrease was due to a variety of keyfactors, including an increase in interest income of $1.5 million and adecrease in interest expense of $967,000 offset by a decrease in non-interestincome of $1.8 million, an increase in provision for losses on loans and leasesof $385,000 and an increase in non-interest expense of $335,000.

 

*Interest, Dividend and Loan Fee Income.*  Interest, dividend and loan fee income was$47.6 million for the nine months ended March 31, 2008 as compared to$46.1 million for the same period in the prior fiscal year, an increase of $1.5million or 3.3%.  A $964,000 increase ininterest, dividend and loan fee income was due to a 2.3% increase in theaverage volume of loans and leases receivable. A $493,000 increase in interest, dividend and loan fee income was theresult of an increase in the average yield on investment securities from 4.71%for the nine months ended March 31, 2007 to 5.12% for the nine monthsended March 31, 2008.  The averageyield on total interest-earning assets was 6.74% for the nine months ended March 31,2008 as compared to 6.70% for the same period in the prior fiscal year.

 

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*InterestExpense.*  Interestexpense was $26.3 million for the nine months ended March 31, 2008 ascompared to $27.2 million for the same period in the prior fiscal year, adecrease of $967,000 or 3.6%.  An$889,000 decrease in interest expense was the result of a decrease in theaverage rate paid on interest-bearing deposits from 4.11% for the nine monthsended March 31, 2007 to 3.92% for the nine months ended March 31,2008, and a $664,000 increase in interest expense was the result of an increasein the average volume of FHLB advances and other borrowings of 16.8%.  A net interest expense decrease of $165,000was due to the unamortized debt issuance costs relating to the early redemptionof two Trust Preferred Securities and $256,000 in interest expense was theresult of a decrease in the average rate paid on subordinated debenturespayable to trusts moving from 10.12% for the nine months ended March 31,2007 to 8.09% for the nine months ended March 31, 2008,  The average rate paid on total interest-bearingliabilities was 4.16% for the nine months ended March 31, 2008 as comparedto 4.40% for the same period in the prior fiscal year.

 

*NetInterest Income.* The Company’s net interest income for thenine months ended March 31, 2008 increased $2.5 million, or 13.1%, to$21.4 million compared to $18.9 million for the same period in the prior fiscalyear.  The increase in net interestincome was due primarily to increases in the average volume of interest-earningassets and average yield on interest-earning assets and by decreases in theaverage rate paid on interest-bearing deposits and subordinated debenturespayable to trusts offset by an increase in the average volume of FHLB advancesand other borrowings for the nine months ended March 31, 2008 compared tothe same period in the prior fiscal year. The Company’s net interest margin on a fully taxable equivalent basiswas 3.08% for the nine months ended March 31, 2008 as compared to 2.80%for the same period in the prior fiscal year.

 

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

 

During the ninemonths ended March 31, 2008, the Company recorded a provision for losseson loans and leases of $1.2 million compared to $786,000 for the nine monthsended March 31, 2007, an increase of $385,000.  See “Asset Quality” for further discussion.

 

*Non-interestIncome.*  Non-interestincome was $8.6 million for the nine months ended March 31, 2008 ascompared to $10.4 million for the same period in the prior fiscal year, adecrease of $1.8 million, or 17.3%.  Thedecrease in non-interest income was primarily attributable to a one-time gainon sale of branches of $2.8 million in Fiscal 2007.  In addition, there were increases in loanservicing income of $341,000, fees on deposits of $318,000 and net gain on saleof loans of $276,000 for the nine months ended March 31, 2008 as comparedto the same period in the prior fiscal year.

 

Loan servicingincome increased $341,000 from $1.3 million for the nine months ended March 31,2007 to $1.6 million for the nine months ended March 31, 2008 primarilydue to an increase of $64.4 million in the balances of loans serviced by theBank from $962.7 million at March 31, 2007 to $1.027 billion at March 31,2008.

 

Fees on depositsincreased $318,000 to $4.1 million for the nine months ended March 31,2008 from $3.7 million the same period in the prior fiscal year primarily dueto an increase in higher activity and increased service pricing.

 

Net gain on sale of loans increased $276,000 from$679,000 for the nine months ended March 31, 2007 to $955,000 for the ninemonths ended March 31, 2008 primarily due to an increase in the amount ofloans sold.

 

*Non-interestExpense.*  Non-interestexpense was $22.4 million for the nine months ended March 31, 2008 ascompared to $22.1 million for the nine months ended March 31, 2007, anincrease of $335,000, or 1.5%.  The increasein non-interest expense was primarily due to increases in compensation andemployee benefits of $816,000 and check and data processing expenses of$118,000 offset by a decrease in marketing of $581,000.

 

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Compensation and employeebenefits increased $816,000, or 6.1%, from $13.4 million for the nine monthsended March 31, 2007 to $14.2 million for the nine months ended March 31,2008.

 

Check and dataprocessing expenses increased $118,000 for the nine months ended March 31,2008 compared to the same period in the prior fiscal year, primarily due toincreases in data processing expenses of $126,000 for the nine months ended March 31,2008 compared to the nine months ended March 31, 2007.

 

Marketing expensedecreased $581,000, or 42.6%, from $1.4 million for the nine months ended March 31,2007 to $783,000 for the nine months ended March 31, 2008 primarily due toseveral deposit packages introduced during Fiscal 2007.

 

*Incometax expense.*  TheCompany’s income tax expense for the nine months ended March 31, 2008decreased $12,000, or 0.6%, to $2.1 million compared to $2.2 million for thesame period in the prior fiscal year. The effective tax rate was 33.74% and 33.75% for the nine months ended March 31,2008 and 2007, respectively.

 

**Liquidity and Capital Resources**

 

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

 

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

 

The Bankanticipates it will have sufficient funds available to meet current loancommitments.  At March 31, 2008, theBank had outstanding commitments to originate mortgage loans of $22.2 millionand non-mortgage loans of $15.6 million. In addition, the Bank had outstanding commitments to sell residentialmortgage loans of $13.6 million, commercial business loans of $223,000 andconsumer student loans of $2.6 million. Commitments by the Bank to originate loans are not necessarily executedby the customer.  The Bank monitors theratio of commitments to funding for use in liquidity management.  At March 31, 2008, the Bank hadcommitments to purchase securities available for sale of $10.8 million and nocommitments to sell securities available for sale.

 

Although in-market deposits are the Bank’s primarysource of funds, the Bank’s policy has been to utilize borrowings where thefunds can be invested in either loans or securities at a positive rate ofreturn or to use the funds for short-term liquidity purposes.  The Bank has unsecured federal fundsaccommodations totaling $25.0 million with correspondent banks.  In addition, the Company has a revolving lineof credit totaling $6.0 million with a correspondent bank.  There were no funds drawn on either line ofcredit at March 31, 2008. Additionally, as of March 31, 2008, the Bank had $11.0 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.

 

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

 

On March 31, 2008, the Company had in effect a stock buybackprogram in which up to 10% of the common stock of the Company outstanding on May 1,2007 could be acquired through April 30, 2008.  As of March 31, 2008, 99,092 shares ofcommon stock had been purchased pursuant to the program.  In addition, the Company approved a new stockbuyback program in which up to 10% of the common stock of the Companyoutstanding on May 1, 2008 may be acquired through April 30,2009.  See Part II, Item 2 “UnregisteredSales of Equity Securities and Use of Proceeds” of this Form 10-Q.

 

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Savings institutions insured by the Federal DepositInsurance Corporation are required by the Financial Institutions Reform,Recovery and Enforcement Act of 1989 to meet three regulatory capitalrequirements.  If a requirement is notmet, regulatory authorities may take legal or administrative actions, includingrestrictions on growth or operations or, in extreme cases, seizure.  Institutions not in compliance may apply foran exemption from the requirements and submit a recapitalization plan.  At March 31, 2008, the Bank met allcurrent regulatory capital requirements.

 

The minimum OTS Tier 1(core) capital requirement for well-capitalized institutions is 5.00% of totaladjusted assets for thrifts.  The Bankhad Tier 1 (core) capital of 8.04% at March 31, 2008.  The minimum OTS total risk-based capitalrequirement for well-capitalized institutions is 10.00% of risk-weightedassets.  The Bank had total risk-basedcapital of 11.02% at March 31, 2008.

 

**Impact ofInflation and Changing Prices**

 

The unaudited consolidated financial statements andnotes thereto presented in this Quarterly Report on Form 10-Q have beenprepared in accordance with GAAP, which require the measurement of financialposition and operating results in terms of historical dollars withoutconsidering the change in the relative purchasing power of money over time dueto inflation.  The impact of inflation isreflected in the increased cost of the Bank’s operations. Unlike mostindustrial companies, nearly all the assets and liabilities of the Bank are monetaryin nature.  As a result, interest rateshave a greater impact on the Bank’s performance than do the effects of generallevels of inflation.  Interest rates donot necessarily move in the same direction or to the same extent as the pricesof goods and services.

 

**RecentAccounting Pronouncements**

 

  In March 2006, FASB issued SFAS No. 156,“Accounting for Servicing of Financial Assets,” which amends SFAS No. 140.  SFAS No. 156 requires the recognition ofall separately recognized servicing assets and servicing liabilities to beinitially measured at fair value utilizing the amortization method or fairmarket value method. SFAS 156 is effective the beginning of the first fiscalyear that begins after September 15, 2006. The Company adopted this new accounting standard effective July 1,2007.  Under the amortization method, anentity shall amortize the value of servicing assets or liabilities inproportion to and over the period of estimated net servicing income or netservicing loss and assess servicing assets or liabilities for impairment orincreased obligation based on fair value at each reporting date. Under the fairvalue method, an entity shall measure servicing assets or liabilities at fairvalue at each reporting date and report changes in fair value in earnings inthe period in which the changes occur. The adoption of SFAS No. 156 hasnot had a material affect on the Company’s financial statements.

 

  In June 2006, FASB issued FIN 48, “Accountingfor Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109”to create a single model to address accounting for uncertainty in taxpositions.  FIN 48 clarifies that a taxposition must be more likely than not of being sustained before beingrecognized in the financial statements. As required, the Company adopted FIN 48 effective July 1,2007.  The adoption of FIN 48 did nothave a material impact on the Company’s financial statements.

 

In September 2006,FASB issued Statement of Financial Accounting Standards No. 157 (SFAS157), “Fair Value Measurements” and is effective for financial statementsissued for fiscal years beginning after November 15, 2007.  SFAS 157 provides a common definition of fairvalue and a framework for measuring assets and liabilities at fair values whena particular standard prescribes it.  Inaddition, the Statement expands disclosures about fair value measurements.  As required by SFAS 157, the Company willadopt this new accounting standard effective July 1, 2008.  Management is currently reviewing the impactof SFAS 157 on the Company’s financial statements.

 

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In September 2006, FASB issued Statement ofFinancial Accounting Standards No. 158 (SFAS 158), “Employers’ Accountingfor Defined Benefit Pension and Other Postretirement Plans – an amendment ofFASB Statements No. 87, 88, 106 and 132R.” SFAS 158 requires recognition of the overfunded or underfunded status ofpension and other postretirement benefit plans on the balance sheet.  Under SFAS 158, gains and losses, priorservice costs and credits and any remaining transition amounts under SFAS 87and SFAS 106 that have not yet been recognized through net periodic benefitcost will be recognized in accumulated other comprehensive income, net of taxeffects, until they are amortized as a component of net periodic cost. Also,the measurement date – the date at which the benefit obligation and plan assetsare measured – is required to be the company’s fiscal year-end.  As required by SFAS 158, the Company adoptedthe balance sheet recognition provisions at June 30, 2007 and will adoptthe year-end measurement date in 2009.

 

InFebruary 2007, FASB issued Statement of Financial Accounting Standards No. 159(SFAS 159), “The Fair Value Option for Financial Assets and FinancialLiabilities – Including an Amendment of FASB Statement No. 115.”  SFAS 159 is effective as of the beginning ofan entity’s first fiscal year after November 15, 2007.  SFAS 159 allows companies the choice tomeasure many financial instruments and certain other items at fair value.  This gives a company the opportunity tomitigate volatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accountingprovisions. The Company will adopt this new accounting standard effective July 1,2008.  Management is currently reviewingthe impact of SFAS 159 on the Company’s financial statements.

 

In December 2007,FASB issued Statement of Financial Accounting Standards No. 141R (SFAS141R), “Business Combinations.”  SFAS141R is effective for fiscal years beginning after December 15, 2008.  SFAS 141R improves reporting by creatinggreater consistency in the accounting and financial reporting of businesscombinations, resulting in more complete, comparable, and relevant informationfor investors and other users of financial statements.  Management has reviewed SFAS 141R and doesnot expect the adoption of this statement to have a material impact on theCompany’s consolidated financial condition, results of operations or cash flow.

 

In December 2007,FASB issued Statement of Financial Accounting Standards No. 160 (SFAS160), “Noncontrolling Interests in Consolidated Financial Statements – anamendment of ARB No. 51.”  SFAS 160is effective for fiscal years beginning after December 15, 2008.  SFAS 160 improves the relevance,comparability, and transparency of financial information provided to investorsby requiring all entities to report noncontrolling (minority) interest insubsidiaries in the same way – as equity in the consolidated financialstatements.  The Company does notcurrently have any noncontrolling interest in the consolidated financialstatements.

 

In March 2008,FASB issued Statement of Financial Accounting Standards No. 161 (SFAS161), “Disclosures about Derivative Instruments and Hedging Activities.”  SFAS 161 is effective for fiscal years andinterim periods beginning after November 15, 2008.  SFAS 161 is intended to improve financialreporting about derivative instruments and hedging activities by requiringenhanced disclosures to enable investors to better understand their effects onan entity’s financial position, financial performance, and cash flows.  Management is currently reviewing the impactof SFAS 161 on the Company’s financial statements.

 

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

 

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

 

In an attempt to manage its exposure to change in interest rates,management monitors the Company’s interest rate risk.  The Company’s Asset/Liability Committee meetsperiodically to review the Company’s interest rate risk position andprofitability, and to recommend adjustments for consideration by executivemanagement. Management also reviews the Bank’s securities portfolio, formulatesinvestment strategies, and oversees the timing and implementation oftransactions to assure attainment of the Board’s objectives in the most effectivemanner.  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 which may have an adverse effect on netincome.

 

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

 

As set forth below, the volatility of a rate change, the change in assetor liability mix of the Company or other factors may produce a decrease in netinterest margin in an upward moving rate environment even as the net portfoliovalue (“NPV”) estimate indicates an increase in net value.  The inverse situation may also occur.  One approach used by the Company to quantifyinterest rate risk is an NPV analysis. This analysis calculates the difference between the present value of theliabilities and the present value of expected cash flows from assets andoff-balance sheet contracts.  Thefollowing tables set forth, at December 31, 2007 (the most recent reportavailable) and March 31, 2007, an analysis of the Company’s interest raterisk as measured by the estimated changes in NPV resulting from instantaneousand sustained parallel shifts in the yield curve (+300 or –200 basis points,measured in 100 basis point increments). Management does not believe that the Company has experienced anymaterial changes in its market risk position from that disclosed in the Company’sAnnual Report on Form 10-K for Fiscal 2007 or that the Company’s primarymarket risk exposures and how those exposures were managed during the ninemonths ended March 31, 2008 changed significantly when compared to June 30,2007.

 

The data in the following tables is based on assumptions utilized bythe OTS in assessing interest rate risk of thrift institutions and published in“Selected Asset and Liability Price Tables as of December 31, 2007” and “SelectedAsset and Liability Price Tables as of March 31, 2007.”  Even if interest rates change in thedesignated amounts, there can be no assurance that the Company’s assets andliabilities would perform as set forth below.

 

**December 31, 2007**

 
| ** **              | ** ** | **Estimated**               | ** ** | **Estimated Increase**     | ** ** |
|-------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| **Change in**      | ** ** | **NPV**                     | ** ** | **(Decrease) in NPV** | ** ** |
| **Interest Rates** | ** ** | **Amount**                  | ** ** | **Amount**                      | ** ** | **Percent** | ** ** |
| **Basis  Points**       | ** ** | **(Dollars  in Thousands)** | ** ** | ** **                      | ** ** |
|                    |       |                        |       |                            |       |   |   |
| +300                    |       | $                           | 102,405    |                            | $          | (18,334 | ) | (15 | )% |
| +200                    |       | 110,505                     |       | (10,234                         | )          | (8 | ) |
| +100                    |       | 116,905                     |       | (3,833                          | )          | (3 | ) |
| —                  |       | 120,739                     |       | —                          |       | — |   |
| -100                    |       | 121,147                     |       | 409                             |       | — |   |
| -200                    |       | 118,967                     |       | (1,772                          | )          | (1 | ) |
|                         |            |                             |            |                                 |            |  |  |  |  |

 

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**March 31, 2007**

 
| ** **         | ** ** | **Estimated**               | ** ** | **Estimated Increase**     | ** ** |
|--------------------|------------|-----------------------------|------------|---------------------------------|------------|
| **Change  in**     | ** ** | **NPV**                     | ** ** | **(Decrease) in NPV** | ** ** |
| **Interest Rates** | ** ** | **Amount**                  | ** ** | **Amount**                      | ** ** | **Percent** | ** ** |
| **Basis Points**   | ** ** | **(Dollars  in Thousands)** |       |                            |       |
|               |       |                        |       |                            |       |   |   |
| +300               |       | $                           | 99,108     |                            | $          | (24,523 | ) | (20 | )% |
| +200               |       | 107,335                     |       | (16,295                         | )          | (13 | ) |
| +100               |       | 115,942                     |       | (7,688                          | )          | (6 | ) |
| —             |       | 123,630                     |       | —                          |       | — |   |
| -100               |       | 124,127                     |       | 496                             |       | — |   |
| -200               |       | 122,411                     |       | (1,220                          | )          | (1 | ) |
|               |       |                        |       |                            |       |   |   |
|                    |            |                             |            |                                 |            |  |  |  |  |

 

In managing market risk and the asset/liability mix,the Bank has placed an emphasis on developing a portfolio in which, to the extentpracticable, assets and liabilities reprice within similar periods.  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.

 

**Item 4.                    Controlsand Procedures**

 

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

 

**PART II - OTHER INFORMATION**

 

**Item 1.                    Legal Proceedings**

 

On June 26,2006, the Company filed a $3.8 million lawsuit against MetaBank and two individuals, J. Tyler Haahr and DanielA. Nelson, for their role in aparticipation loan, alleging fraud, breach of fiduciary duty, conspiracyand negligent misrepresentation.  These damages were the result of afailure by the lead bank to make disclosures regarding an investigation of thecommercial customer by the Iowa Attorney General at the time the Bank agreed toan extension of loan participation agreements. Legal proceedings are currently pending in the Second Judicial CircuitCourt, 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, theresolution of any such proceedings should not have a material effect on theCompany’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.

 

36

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**Item 1A.                 Risk Factors**

 

There have been nomaterial changes from the risk factors disclosed in Part 1, Item 1A “RiskFactors” in the Company’s Annual Report on Form 10-K for Fiscal 2007.

 

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

 

The followingtable sets forth the purchases by the Company of its common stock during thequarterly period ended March 31, 2008:

 
| ** **                  | ** ** | **Total**          | ** ** | ** **          | ** ** | **Total Number**                  | ** ** | **Maximum Number of**        | ** ** |
|-----------------------------|------------|--------------------|------------|---------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| ** **                  | ** ** | **Number**         | ** ** | **Average**         | ** ** | **of Shares Purchased**      | ** ** | **Shares that May Yet** | ** ** |
| ** **                  | ** ** | **of Shares** | ** ** | **Price Paid** | ** ** | **as Part of Publicly** | ** ** | **Be Purchased Under**       | ** ** |
| **Period**                  | ** ** | **Purchased**      | ** ** | **per Share**  | ** ** | **Announced Programs**            | ** ** | **the Current Program**      | ** ** |
| January 1 -  31, 2008  |       | —             |       | $                   | 0.00       |                                   | —     |                                   | 323,141    |   |
| February 1  - 29, 2008 |       | 11,600             |       | $                   | 16.15      |                                   | 11,600     |                                   | 311,541    |   |
| March 1 -  31, 2008    |       | 11,492             |       | $                   | 16.33      |                                   | 11,492     |                                   | 300,049    |   |
| 3rd Quarter  Total          |       | 23,092             |       | $                   | 16.24      |                                   | 23,092     |                                   |       |   |

 

The Companycurrently has in effect a stock buyback program, which was publicly announcedon April 30, 2007 and pursuant to which up to 10% of the common stock ofthe Company that was outstanding on May 1, 2007, which equals 399,141shares, may be acquired through April 30, 2008.  As of March 31, 2008, 99,092 shares ofcommon stock have been purchased pursuant to this program.

 

The Companyapproved a new stock buyback program effective as of May 1, 2008, whichwas publicly announced on April 28, 2008, in which up to 10% of the commonstock of the Company outstanding on May 1, 2008, which equals 395,321shares, may be acquired through April 30, 2009.

 

37

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**Item 6.                    Exhibits**

 
| **Regulation S-K   Exhibit Number****** | ** ** | **Document**                                                                                                                                                                                                                                                                         |
|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.25                                        |       | Form of Employment Agreement by and between Home  Federal Bank and Jon M. Gadberry (incorporated herein by reference to  Exhibit 10.2 from the Company’s Current Report on Form 8-K dated  July 2, 2007 and filed with the SEC on July 9, 2007)        |
| 10.26                                        |       | Form of Change-in-Control Agreement by and between  Home Federal Bank and Jon M. Gadberry (incorporated herein by reference to  Exhibit 10.4 from the Company’s Current Report on Form 8-K dated  July 2, 2007 and filed with the SEC on July 9, 2007) |
| 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                                                                                                                                    |

 

38

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**HF FINANCIAL CORP.**

 

**FORM 10-Q**

**SIGNATURES**

 

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

 
|   |              |   |                                           |
|--------|-------------------|--------|------------------------------------------------|
|   |              |   | HF  Financial Corp.                            |
|   |              |   | (Registrant)                                   |
|   |              |   |                                           |
|   |              |   |                                           |
| Date:  | May 15, 2008 | By:    | /s/  Curtis L. Hage                            |
|   |              |   | Curtis L. Hage, Chairman,  President           |
|   |              |   | And Chief Executive  Officer                   |
|   |              |   | (Principal Executive  Officer)                 |
|   |              |   |                                           |
| Date:  | May 15, 2008 | By:    | /s/  Darrel L. Posegate                        |
|   |              |   | Darrel L. Posegate,  Executive Vice President, |
|   |              |   | Chief Financial Officer  and Treasurer         |
|   |              |   | (Principal Financial  and Accounting Officer)  |

 

39

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**Index to Exhibits**

 
| **Exhibit Number** | ** ** | ** **                                                                                                                                                                                                                                                                           |
|-------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **              | ** ** | ** **                                                                                                                                                                                                                                                                           |
| 10.25                   |       | Form of Employment Agreement by and between Home  Federal Bank and Jon M. Gadberry (incorporated herein by reference to  Exhibit 10.2 from the Company’s Current Report on Form 8-K dated  July 2, 2007 and filed with the SEC on July 9, 2007)        |
| 10.26                   |       | Form of Change-in-Control Agreement by and between  Home Federal Bank and Jon M. Gadberry (incorporated herein by reference to  Exhibit 10.4 from the Company’s Current Report on Form 8-K dated  July 2, 2007 and filed with the SEC on July 9, 2007) |
| 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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