Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**x****      QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the quarterly period ended March 31, 2009**

 

**OR**

 

**o****         TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**

##  

**For the transition period from                          to                        **

 

**Commission File Number 0-28312**

 

**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

(Exact name of registrant as specified in its charter)

 

| **Texas**                                                       | ** ** | **71-0785261**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or other jurisdiction of incorporation  or organization) |       | (I.R.S. Employer  Identification Number) |

 

| **1401 Highway 62-65 North  Harrison, Arkansas** | ** ** | **72601**  |
|--------------------------------------------------|------------|------------|
| (Address of principal executive office)          |       | (Zip Code) |

 

**(870) 741-7641**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes x  No o

 

Indicate by check mark whetherthe registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and postedpursuant to Rule 405 of Regulation S-T during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).  Yes o  No o

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, a non-accelerated filer, ora smaller reporting company.  See thedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting 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 |

 

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 thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date:  As ofMay 1, 2009, there were issued and outstanding 4,846,785 shares of theRegistrant’s Common Stock, par value $.01 per share.

 

 

 

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Tableof Contents

 

**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**TABLE OF CONTENTS**

 
| ** **        | ** **                                                                                                                                                                 | **Page**   |
|-------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Part I.**  | **Financial Information**                                                                                                                                                  | ** ** |
| ** **        | ** **                                                                                                                                                                 | ** ** |
|              |                                                                                                                                                                       |       |
| Item 1.           | Consolidated Financial Statements                                                                                                                                          |       |
|              |                                                                                                                                                                       |       |
|              | Consolidated  Statements of Financial Condition as of March 31, 2009 and  December 31, 2008 (unaudited)                                                          | 1          |
|              |                                                                                                                                                                       |       |
|              | Consolidated  Statements of Operations for the three months ended March 31, 2009 and  2008 (unaudited)                                                                | 2          |
|              |                                                                                                                                                                       |       |
|              | Consolidated Statement of Stockholders’ Equity for the  three months ended March 31, 2009 (unaudited)                                                            | 3          |
|              |                                                                                                                                                                       |       |
|              | Consolidated  Statements of Cash Flows for the three months ended March 31, 2009 and  2008 (unaudited)                                                                | 4          |
|              |                                                                                                                                                                       |       |
|              | Notes  to Unaudited Consolidated Financial Statements                                                                                                                      | 6          |
|              |                                                                                                                                                                       |       |
| Item  2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                | 10         |
|              |                                                                                                                                                                       |       |
| Item  3.          | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                | 23         |
|              |                                                                                                                                                                       |       |
| Item 4.           | Controls and  Procedures                                                                                                                                                   | 23         |
|              |                                                                                                                                                                       |       |
| **Part II.** | **Other Information**                                                                                                                                                      | ** ** |
|              |                                                                                                                                                                       |       |
| Item 1.           | Legal  Proceedings                                                                                                                                                         | 24         |
| Item 1A.          | Risk Factors                                                                                                                                                               | 24         |
| Item  2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                               | 24         |
| Item  3.          | Defaults  Upon Senior Securities                                                                                                                                           | 24         |
| Item  4.          | Submission  of Matters to a Vote of Security Holders                                                                                                                       | 24         |
| Item 5.           | Other  Information                                                                                                                                                         | 24         |
| Item 6.           | Exhibits                                                                                                                                                                   | 24         |
|              |                                                                                                                                                                       |       |
| **Signatures**    | ** **                                                                                                                                                                 | ** ** |
|              |                                                                                                                                                                       |       |
| **Exhibits**      | ** **                                                                                                                                                                 | ** ** |
| 31.1              | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a) of Exchange Act, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |       |
| 31.2              | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) of Exchange Act, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |       |
| 32.1              | Section 906 Certification of the CEO                                                                                                                                  |       |
| 32.2              | Section 906 Certification of the CFO                                                                                                                                  |       |

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

**CONSOLIDATEDSTATEMENTS OF FINANCIAL CONDITION**

(In thousands, except share data)

(Unaudited)

 
| ** **                                                                                                                                                                                                                                                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                            | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| ASSETS                                                                                                                                                                                                                                                                |       |               |       |                  |       |
|                                                                                                                                                                                                                                                                  |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                                             |       | $                  | 32,578     |                  | $          | 9,367 |   |
| Investment securities held  to maturity                                                                                                                                                                                                                               |       | 131,990            |       | 136,412               |       |
| Federal Home Loan Bank  stock                                                                                                                                                                                                                                         |       | 4,363              |       | 4,825                 |       |
| Loans receivable, net                                                                                                                                                                                                                                                 |       | 555,181            |       | 568,123               |       |
| Accrued interest  receivable                                                                                                                                                                                                                                          |       | 5,026              |       | 6,701                 |       |
| Real estate acquired in  settlement of loans, net                                                                                                                                                                                                                     |       | 25,133             |       | 22,385                |       |
| Office properties and  equipment, net                                                                                                                                                                                                                                 |       | 24,413             |       | 24,694                |       |
| Cash surrender value of  life insurance                                                                                                                                                                                                                               |       | 20,609             |       | 20,412                |       |
| Prepaid expenses and other  assets                                                                                                                                                                                                                                    |       | 4,100              |       | 2,253                 |       |
|                                                                                                                                                                                                                                                                  |       |               |       |                  |       |
| TOTAL ASSETS                                                                                                                                                                                                                                                          |       | $                  | 803,393    |                  | $          | 795,172 |   |
|                                                                                                                                                                                                                                                                  |       |               |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                            |       |               |       |                  |       |
|                                                                                                                                                                                                                                                                  |       |               |       |                  |       |
| LIABILITIES:                                                                                                                                                                                                                                                          |       |               |       |                  |       |
| Deposits                                                                                                                                                                                                                                                              |       | $                  | 633,720    |                  | $          | 618,003 |   |
| Other borrowings                                                                                                                                                                                                                                                      |       | 72,366             |       | 92,212                |       |
| Advance payments by  borrowers for taxes and insurance                                                                                                                                                                                                                |       | 1,024              |       | 810                   |       |
| Other liabilities                                                                                                                                                                                                                                                     |       | 8,274              |       | 11,030                |       |
| Total liabilities                                                                                                                                                                                                                                                     |       | 715,384            |       | 722,055               |       |
|                                                                                                                                                                                                                                                                  |       |               |       |                  |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                            |       |               |       |                  |       |
| Preferred stock, no par  value, 5,000,000 shares authorized; Series A fixed rate cumulative  perpetual; liquidation preference of $1,000 per share; 16,500 shares issued  and outstanding at March 31, 2009 and none outstanding at  December 31, 2008 |       | 16,147             |       | —                |       |
| Common stock, $.01 par  value, 20,000,000 shares authorized, 10,307,502 shares issued, 4,846,785  shares outstanding at March 31, 2009 and December 31, 2008                                                                                                |       | 103                |       | 103                   |       |
| Additional paid-in capital                                                                                                                                                                                                                                            |       | 56,985             |       | 56,627                |       |
| Retained  earnings-substantially restricted                                                                                                                                                                                                                           |       | 85,392             |       | 87,005                |       |
|                                                                                                                                                                                                                                                                  |       | 158,627            |       | 143,735               |       |
| Treasury stock, at cost,  5,460,717 shares at March 31, 2009 and December 31, 2008                                                                                                                                                                          |       | (70,618            | )          | (70,618               | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                       |       | 88,009             |       | 73,117                |       |
|                                                                                                                                                                                                                                                                  |       |               |       |                  |       |
| TOTAL LIABILITIES ANDSTOCKHOLDERS’ EQUITY                                                                                                                                                                                                                        |       | $                  | 803,393    |                  | $          | 795,172 |   |

 

See notes to unaudited consolidated financialstatements.

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(In thousands, except share data)

(Unaudited)

 
| ** **                                                           | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                           | ** ** | **March 31,**     | ** ** | **March 31,** | ** ** |
| ** **                                                           | ** ** | **2009**               | ** ** | **2008** | ** ** |
| INTEREST INCOME:                                                     |       |                   |       |   |   |
| Loans receivable                                                     |       | $                      | 7,555      |   | $ | 9,975 |   |
| Investment securities:                                               |       |                   |       |   |   |
| Taxable                                                              |       | 1,348                  |       | 1,207 |   |
| Nontaxable                                                           |       | 216                    |       | 186 |   |
| Other                                                                |       | 3                      |       | 168 |   |
| Total interest income                                                |       | 9,122                  |       | 11,536 |   |
|                                                                 |       |                   |       |   |   |
| INTEREST EXPENSE:                                                    |       |                   |       |   |   |
| Deposits                                                             |       | 3,781                  |       | 5,568 |   |
| Other borrowings                                                     |       | 645                    |       | 903 |   |
| Total interest expense                                               |       | 4,426                  |       | 6,471 |   |
|                                                                 |       |                   |       |   |   |
| NET INTEREST INCOME                                                  |       | 4,696                  |       | 5,065 |   |
|                                                                 |       |                   |       |   |   |
| PROVISION FOR LOAN LOSSES                                            |       | 3,521                  |       | 1,528 |   |
|                                                                 |       |                   |       |   |   |
| NET INTEREST INCOME AFTER  PROVISION FOR LOAN LOSSES                 |       | 1,175                  |       | 3,537 |   |
|                                                                 |       |                   |       |   |   |
| NONINTEREST INCOME:                                                  |       |                   |       |   |   |
| Deposit fee income                                                   |       | 1,192                  |       | 1,211 |   |
| Earnings on life insurance  policies                                 |       | 197                    |       | 1,371 |   |
| Gain on sale of loans                                                |       | 148                    |       | 175 |   |
| Other                                                                |       | 370                    |       | 447 |   |
| Total noninterest income                                             |       | 1,907                  |       | 3,204 |   |
|                                                                 |       |                   |       |   |   |
| NONINTEREST EXPENSES:                                                |       |                   |       |   |   |
| Salaries and employee  benefits                                      |       | 2,967                  |       | 3,387 |   |
| Net occupancy expense                                                |       | 677                    |       | 639 |   |
| Real estate owned, net                                               |       | 395                    |       | 430 |   |
| Data processing                                                      |       | 408                    |       | 318 |   |
| Professional fees                                                    |       | 291                    |       | 130 |   |
| Advertising and public  relations                                    |       | 111                    |       | 342 |   |
| Postage and supplies                                                 |       | 240                    |       | 239 |   |
| Other                                                                |       | 760                    |       | 586 |   |
| Total noninterest expenses                                           |       | 5,849                  |       | 6,071 |   |
|                                                                 |       |                   |       |   |   |
| INCOME (LOSS) BEFORE  INCOME TAXES                                   |       | (2,767                 | )          | 670 |   |
| INCOME TAX BENEFIT                                                   |       | (1,264                 | )          | (417 | ) |
| NET INCOME (LOSS)                                                    |       | (1,503                 | )          | 1,087 |   |
| PREFERRED STOCK DIVIDENDS  AND ACCRETION OF PREFERRED STOCK DISCOUNT |       | 62                     |       | — |   |
| NET INCOME (LOSS)  AVAILABLE TO COMMON SHAREHOLDERS                  |       | $                      | (1,565     | ) | $ | 1,087 |   |
|                                                                 |       |                   |       |   |   |
| EARNINGS (LOSS) PER COMMON  SHARE:                                   |       |                   |       |   |   |
| Basic                                                                |       | $                      | (0.32      | ) | $ | 0.22 |   |
|                                                                 |       |                   |       |   |   |
| Diluted                                                              |       | $                      | (0.32      | ) | $ | 0.22 |   |
|                                                                 |       |                   |       |   |   |
| Cash Dividends Declared                                              |       | $                      | 0.01       |   | $ | 0.16 |   |

 

See notes to unaudited consolidated financial statements.

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

**CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY**

**FOR THETHREE MONTHS ENDED MARCH 31, 2009**

(In thousands, except share data)

(Unaudited)

 
| ** **                                                                                             | ** ** | ** **          | ** ** | ** **               | ** ** | ** **              | **Retained** | ** **                   | ** ** | ** **         | ** ** | ** **                    |
|--------------------------------------------------------------------------------------------------------|------------|---------------------|------------|--------------------------|------------|-------------------------|--------------|------------------------------|------------|--------------------|------------|-------------------------------|
| ** **                                                                                             | ** ** | **Preferred Stock** | ** ** | **Issued  Common Stock** | ** ** | **Additional  Paid-In** | ** **   | **Earnings  (Substantially** | ** ** | **Treasury Stock** | ** ** | **Total  Stockholders’** | ** ** |
| ** **                                                                                             | ** ** | **Shares**          | ** ** | **Amount**               | ** ** | **Shares**              | ** **   | **Amount**                   | ** ** | **Capital**        | ** ** | **Restricted)**               | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Equity** | ** ** |
|                                                                                                   |       |                |       |                     |       |                    |         |                         |       |               |       |                          |   |   |   |   |   |   |   |
| Balance, January 1,  2009                                                                         |       | —              |       | $                        | —     |                    | 10,307,502   |                         | $          | 103                |       | $                             | 56,627 |   | $ | 87,005 |   | 5,460,717 |   | $ | (70,618 | ) | $ | 73,117 |   |
| Net loss                                                                                               |       |                |       |                     |       |                    |         |                         |       |               |       | (1,503                        | ) |   |   |   |   | (1,503 | ) |
| Issuance of 16,500 shares  of preferred stock and a warrant to purchase 321,847 shares of common stock |       | 16,500              |       | 16,142                   |       |                    |         |                         |       | 358                |       |                          |   |   |   |   |   | 16,500 |   |
| Preferred stock dividends                                                                              |       |                |       |                     |       |                    |         |                         |       |               |       | (57                           | ) |   |   |   |   | (57 | ) |
| Accretion of preferred  stock discount                                                                 |       |                |       | 5                        |       |                    |         |                         |       |               |       | (5                            | ) |   |   |   |   | — |   |
| Dividends declared, $0.01  per common share                                                            |       |                |       |                     |       |                    |         |                         |       |               |       | (48                           | ) |   |   |   |   | (48 | ) |
|                                                                                                   |       |                |       |                     |       |                    |         |                         |       |               |       |                          |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance, March 31,  2009                                                                          |       | 16,500              |       | $                        | 16,147     |                    | 10,307,502   |                         | $          | 103                |       | $                             | 56,985 |   | $ | 85,392 |   | 5,460,717 |   | $ | (70,618 | ) | $ | 88,009 |   |

 

See notes to unaudited consolidated financial statements.

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In Thousands)

(Unaudited)

 
| ** **                                                                                | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| OPERATING ACTIVITIES:                                                                     |       |                                  |       |   |   |
| Net income (loss)                                                                         |       | $                                     | (1,503     | ) | $ | 1,087 |   |
| Adjustments to reconcile  net income (loss) to net cash provided by operating activities: |       |                                  |       |   |   |
| Provision for loan losses                                                                 |       | 3,521                                 |       | 1,528 |   |
| Provision for real estate  losses                                                         |       | 164                                   |       | 229 |   |
| Deferred tax benefit                                                                      |       | (1,919                                | )          | (331 | ) |
| Accretion of discounts on  investment securities, net                                     |       | (23                                   | )          | (35 | ) |
| Federal Home Loan Bank  stock dividends                                                   |       | (6                                    | )          | (49 | ) |
| Gain on disposition of  office properties and equipment, net                              |       | —                                |       | (18 | ) |
| Loss (gain) on sale of  repossessed assets, net                                           |       | (22                                   | )          | 53 |   |
| Originations of loans held  for sale                                                      |       | (10,797                               | )          | (10,950 | ) |
| Proceeds from sales of  loans held for sale                                               |       | 11,310                                |       | 12,110 |   |
| Gain on sale of loans  originated to sell                                                 |       | (148                                  | )          | (175 | ) |
| Depreciation                                                                              |       | 377                                   |       | 358 |   |
| Amortization of deferred  loan costs, net                                                 |       | 98                                    |       | 74 |   |
| Stock compensation expense                                                                |       | —                                |       | 6 |   |
| Earnings on life insurance  policies                                                      |       | (197                                  | )          | (1,371 | ) |
| Changes in operating  assets and liabilities:                                             |       |                                  |       |   |   |
| Accrued interest  receivable                                                              |       | 1,675                                 |       | 1,238 |   |
| Prepaid expenses and other  assets                                                        |       | 68                                    |       | (561 | ) |
| Other liabilities                                                                         |       | 564                                   |       | 218 |   |
| Net cash provided by  operating activities                                                |       | 3,162                                 |       | 3,411 |   |
|                                                                                      |       |                                  |       |   |   |
| INVESTING ACTIVITIES:                                                                     |       |                                  |       |   |   |
| Purchases of investment  securities held to maturity                                      |       | (68,571                               | )          | (60,638 | ) |
| Proceeds from  maturities/calls of investment securities held to maturity                 |       | 69,591                                |       | 39,701 |   |
| Federal Home Loan Bank  stock redeemed                                                    |       | 468                                   |       | — |   |
| Loan participations  purchased                                                            |       | (485                                  | )          | (451 | ) |
| Net loan repayments                                                                       |       | 6,364                                 |       | 10,621 |   |
| Proceeds from sales of  repossessed assets                                                |       | 205                                   |       | 355 |   |
| Improvements to real  estate owned                                                        |       | (12                                   | )          | (196 | ) |
| Proceeds from sales of  office properties and equipment                                   |       | —                                |       | 30 |   |
| Purchases of office  properties and equipment                                             |       | (96                                   | )          | (985 | ) |
| Net cash provided by (used  in) investing activities                                      |       | 7,464                                 |       | (11,563 | ) |
|                                                                                      |       |                                  |       |   |   |
| FINANCING ACTIVITIES:                                                                     |       |                                  |       |   |   |
| Net increase in deposits                                                                  |       | 15,717                                |       | 26,499 |   |
| Advances from FHLB                                                                        |       | —                                |       | 15,000 |   |
| Repayment of advances from  FHLB                                                          |       | (9,816                                | )          | (9,453 | ) |
| Net repayments to Federal  Reserve Bank                                                   |       | (10,030                               | )          | — |   |
| Net increase in advance  paymentsby borrowers for taxes and  insurance                    |       | 214                                   |       | 148 |   |
| Proceeds from issuance of  preferred stock and related common stock warrant               |       | 16,500                                |       | — |   |
| Reissued treasury stock                                                                   |       | —                                |       | 46 |   |
| Dividends paid                                                                            |       | —                                |       | (775 | ) |
| Net cash provided by  financing activities                                                |       | 12,585                                |       | 31,465 |   |
|                                                                                      |       |                                  |       |   |   |
| Net increase in cash and  cash equivalents                                                |       | 23,211                                |       | 23,313 |   |
|                                                                                           |            |                                       |            |  |  |  |  |

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In Thousands)

(Unaudited)

 
| ** **                                                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                     | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| CASH AND CASH EQUIVALENTS:                                                     |       |                                  |       |   |   |
| Beginning of period                                                            |       | $                                     | 9,367      |   | $ | 27,387 |   |
| End of period                                                                  |       | $                                     | 32,578     |   | $ | 50,700 |   |
|                                                                           |       |                                  |       |   |   |
| SUPPLEMENTAL DISCLOSURES  OF CASH FLOW INFORMATION:                            |       |                                  |       |   |   |
| Cash paid for:                                                                 |       |                                  |       |   |   |
| Interest                                                                       |       | $                                     | 4,480      |   | $ | 6,416 |   |
| Income taxes                                                                   |       | $                                     | 568        |   | $ | — |   |
|                                                                           |       |                                  |       |   |   |
| SUPPLEMENTAL SCHEDULE OF  NONCASH INVESTING ACTIVITIES:                        |       |                                  |       |   |   |
| Real estate and other  assets acquired in settlement of loans                  |       | $                                     | 5,425      |   | $ | 5,323 |   |
| Loans to facilitate sales  of real estate owned                                |       | $                                     | 2,346      |   | $ | 1,808 |   |
| Investment securities  traded, recorded in investments not yet settled in cash |       | $                                     | 5,570      |   | $ | 7,492 |   |
|                                                                           |       |                                  |       |   |   |
|                                                                           |       |                                  |       | (Concluded) |   |

 

See notes to unaudited consolidated financial statements.

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

** **

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

# **Note1 - Basis of Presentation and Principles of Consolidation**

# ** **

First Federal Bancshares of Arkansas, Inc. (the “Company”) is aunitary holding company which owns all of the stock of First Federal Bank (the“Bank”).  The Bank provides a broad lineof financial products to individuals and small- to medium-sized businesses.  The unaudited consolidated financialstatements also include the accounts of the Bank’s wholly-owned subsidiary,First Harrison Service Corporation (“FHSC”), which is inactive.

 

The accompanying unaudited consolidated financial statements of theCompany have been prepared in accordance with instructions to Form 10-Q.  Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements. However, such information reflects all adjustments which are, in theopinion of management, necessary for a fair statement of results for theinterim periods.

 

The accompanying unaudited consolidated financial statements includethe accounts of the Company and the Bank. All material intercompany transactions have been eliminated inconsolidation.

 

The results of operations for the threemonths ended March 31, 2009, are not necessarily indicative of the resultsto be expected for the year ending December 31, 2009.  The unaudited consolidated financialstatements and notes thereto should be read in conjunction with the auditedfinancial statements and notes thereto for the year ended December 31,2008, contained in the Company’s 2008 Annual Report to Stockholders.

 

**Note 2 – Recently AdoptedAccounting Standards**

 

We adopted FinancialAccounting Standards Board (“FASB”) Statement of Financial Accounting Standards(“SFAS”) No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities*, as of January 1,2009. The objective of this statement is to provide enhanced disclosuresabout derivative instruments and related hedging items. This Statement did nothave an impact on the Company’s financial statements.

 

We adopted SFAS No. 141R, *BusinessCombinations,* as of January 1, 2009. The objective of this Statementis to improve the relevance, representational faithfulness, and comparabilityof the information that a reporting entity provides in its financial reportsabout a business combination and its effects. To accomplish that, thisStatement establishes principles and requirements for how the acquirer:

 

a.               Recognizes and measures inits financial statements the identifiable assets acquired, the liabilitiesassumed, and any noncontrolling interest in the acquiree

 

b.              Recognizes and measures thegoodwill acquired in the business combination or a gain from a bargain purchase

 

c.               Determines what informationto disclose to enable users of the financial statements to evaluate the natureand financial effects of the business combination.

 

This Statement appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008.  Based on our current activities, the adoption of this Statement didnot have a material effect on the financial statements of the Company.

 

**Note 3 – Accounting Standards Issued Not Yet Effective**

 

On April 9, 2009, theFASB issued FSP FAS No. 107-1 and APB 28-1, *Interim Disclosures about Fair Value of Financial Instruments,*which will amend FASB No. 107,Disclosures about Fair Value of Financial Instruments and be effective forfinancial statements issued for interim periods ending after June 15,2009. * *The statement was amended torequire that the existing annual fair value disclosure requirements under FAS107 be expanded to interim periods.  Wewill adopt this Statement in the second quarter of 2009.

 

On April 9, 2009, theFASB issued FSP FAS No. 115-2 and FAS No. 124-2, *Recognition and Presentation of Other-Than-TemporaryImpairments,*effective forfinancial statements issued for interim periods ending after June 15,2009. * *The statement was amended to makesignificant changes to the Other Than Temporary Impairment (OTTI) assertionsmade related to debt securities. The FAS will also provide for additionalinterim disclosures related to OTTI on debt securities.  We do not anticipate that the adoptionof these Statements will have a material effect on the financial statements ofthe Company.

 

On April 9, 2009, theFASB issued FSP FAS 157-4, *Determining FairValue When the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly*(FSPFAS 157-4), effective for financialstatements issued for interim periods ending after June 15, 2009. * *TheFSP provides 

 

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additional guidance ondetermining fair value in inactive markets for financial assets under FASBStatement No. 157, *Fair ValueMeasurements.** *Wedo not anticipate that the adoption of this Statement will have a materialeffect on the financial statements of the Company.

 

**Note 4 – Preferred Stock**

** **

OnMarch 6, 2009, as part of the Troubled Asset Relief Program (“TARP”)Capital Purchase Program, the Company entered into a Securities PurchaseAgreement (the “Purchase Agreement”) with the United States Department of theTreasury (“Treasury”), pursuant to which the Company, for a purchase price of$16.5 million in cash, (i) sold 16,500 shares of the Company’s Fixed RateCumulative Perpetual Preferred Stock, Series A (the “Series APreferred Stock”) and (ii) issued a warrant (the “Warrant”) to purchase321,847 shares of the Company’s common stock, par value $1.00 per share (the“Common Stock”), at an exercise price of $7.69 per share.  The Series A Preferred Stock qualifiesas Tier 1 capital and is entitled to cumulative dividends. The preferred stockdividend reduces earnings available to common shareholders and is computed atan annual rate of 5% per annum for the first five years, and 9% per annumthereafter. The Series A Preferred Stock is non-voting, other than classvoting rights on certain matters that could adversely affect the Series APreferred Stock. The Series A Preferred Stock may be redeemed by theCompany with regulatory approval and when such preferred shares are redeemed,the Treasury shall liquidate the Warrant associated with such preferredshares.  The Warrant has a 10-year termand was immediately exercisable upon its issuance, with an exercise price,subject to anti-dilution adjustments, equal to $7.69 per share of the CommonStock.   Treasury has agreed not toexercise voting power with respect to any shares of Common Stock issued uponexercise of the Warrant that it holds.

 

Uponreceipt of the aggregate consideration from the Treasury on March 6, 2009,the Company allocated the $16.5 million proceeds on a pro rata basis to the Series APreferred Stock and the Warrant based on relative fair values. In estimatingthe fair value of the Warrant, the Company utilized an option pricing modelwhich includes assumptions regarding the Company’s common stock prices, stockprice volatility, dividend yield, the risk free interest rate and the estimatedlife of the Warrant. The fair value of the Series A Preferred Stock wasdetermined using a discounted cash flow methodology and a discount rate of 12%.As a result, the Company assigned $358,000 of the aggregate proceeds to theWarrant and $16.1 million to the Series A Preferred Stock. The valueassigned to the Series A Preferred Stock will be accreted up to the $16.5million liquidation value of such preferred stock, with the cost of suchaccretion being reported as additional preferred stock dividends. This resultsin a total dividend with a constant effective yield of 5.50% over a five-yearperiod, which is the expected life of the Series A Preferred Stock. Inaddition, the Purchase Agreement (i) grants the holders of the Series APreferred Stock, the Warrant and the Warrant Common Stock certain registrationrights, (ii) subjects the Company to certain of the executive compensationlimitations included in the EESA (which are discussed below) and (iii) allowsthe Treasury to unilaterally amend any of the terms of the Purchase Agreementto the extent required to comply with any changes after March 6, 2009 inapplicable federal statutes. On April 2, 2009, the Company filed a “shelf”registration statement on Form S-3 with the Securities and ExchangeCommission (the “Commission”) for the purpose of registering the Warrant andthe Warrant Common Stock in order to permit the sale of such securities by theU.S. Treasury at any time after effectiveness of the registration statement. OnApril 28, 2009, the Company was notified by the Commission that the“shelf” registration statement was deemed effective.

 

Immediatelyprior to the execution of the Purchase Agreement, the Company amended itscompensation, bonus, incentive and other benefit plans, arrangements andagreements to the extent necessary to comply with the executive compensationand corporate governance requirements of Section 111(b) of the EESAand applicable guidance or regulations issued by the Treasury on or prior to March 6,2009. The applicable executive compensation requirements apply to thecompensation of the Company’s chief executive officer, chief financial officerand three other most highly compensated executive officers (collectively, the“senior executive officers”). In addition, in connection with the closing ofthe Treasury’s purchase of the Series A Preferred Stock each of the seniorexecutive officers was required to execute a waiver of any claim against theUnited States or the Company for any changes to his or her compensation orbenefits that are required in order to comply with the regulation issued by theTreasury as published in the Federal Register on October 20, 2008.

 

TheCompany’s ability to repurchase its shares is restricted. Consent of theTreasury generally is required for the Company to make any stock repurchaseuntil the third anniversary of the investment by Treasury unless all of the Series APreferred Stock has been redeemed or transferred to a third party. Further,common, junior preferred or *pari passu* preferredshares may not be repurchased if the Company is in arrears on the Series APreferred Stock dividends. Under the terms of the Purchase Agreement, theCompany’s ability to declare or pay dividends on any of its shares isrestricted.  Specifically, the Companymay not declare dividend payments on common, junior preferred or *pari passu* preferred shares if it is in arrears on thedividends on the Series A Preferred Stock. In addition, the Company may not increase the dividends on its Common Stockabove the amount of the last quarter cash dividend per share declared prior to October 14,2008, which was $0.16 per share, without the Treasury’s approval until thethird anniversary of the investment unless all of the Series A PreferredStock has been redeemed or transferred to a third party.  Further, until the Series A PreferredStock is redeemed, the Company may not pay a quarterly cash dividend in excessof $0.01 per share without approval of its primary regulator, the Office ofThrift Supervision.

 

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**Note 5 - Earnings per CommonShare**

** **

The weighted average number of common shares used to calculate earningsper share for the periods ended March 31, 2009 and 2008 were as follows:

 
| ** **                                | ** ** | **Three months ended March 31,** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|
| ** **                                | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Basic weighted - average  common shares   |       | 4,846,785                             |       | 4,848,297 |   |
| Effect of dilutive  securities            |       | —                                |       | 2,338 |   |
| Diluted weighted - average  common shares |       | 4,846,785                             |       | 4,850,635 |   |

 

The incremental sharesfor the assumed exercise of the outstanding options were determined byapplication of the treasury stock method. The calculation of diluted earningsper share excludes 17,242 options outstanding for the three months ended March31, 2009, which were antidilutive. In addition, the calculation excludes theWarrant to purchase 321,847 shares of common stock outstanding for the threemonth period ending March 31, 2009, which were antidilutive.

 

**Note 6 – Allowances for Loanand Real Estate Losses**

** **

A summary of the activity in the allowances for loan and real estatelosses is as follows for the quarters ended March 31 (in thousands):

 
| ** **                        | ** ** | **Three Months Ended  March 31,****2009** | ** ** | **Three Months Ended  March 31,****2008** | ** ** |
|-----------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                        | ** ** | **Loans**                                      | ** ** | **Real Estate**                                | ** ** | **Loans** | ** ** | **Real Estate** | ** ** |
|                              |       |                                           |       |                                           |       |   |   |   |   |
| Balance–beginning of  period |       | $                                              | 6,441      |                                           | $          | — |   | $ | 5,162 |   | $ | — |   |
|                              |       |                                           |       |                                           |       |   |   |   |   |
| Provisions for estimated  losses  |       | 3,521                                          |       | 164                                            |       | 1,528 |   | 229 |   |
| Recoveries                        |       | 60                                             |       | —                                         |       | 136 |   | — |   |
| Losses charged off                |       | (464                                           | )          | (164                                           | )          | (719 | ) | (229 | ) |
|                              |       |                                           |       |                                           |       |   |   |   |   |
| Balance–end of period        |       | $                                              | 9,558      |                                           | $          | — |   | $ | 6,107 |   | $ | — |   |

 

The provision for loanlosses increased between the periods listed above primarily due to increases intotal nonaccrual loans and in the loss factors used in certain allowancecategories, as well as an increase in specific loan loss allowances, in eachrespect due to deteriorating economic conditions.

 

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**Note 7 – Fair Value Measurement**

 

Effective January 1, 2008, the Bank adopted SFAS 157, whichprovides a framework for measuring fair value. SFAS 157 defines fair value asthe exchange price that would be received for an asset or paid to transfer aliability (an exit price) in the principal or most advantageous market for theasset or liability in an orderly transaction between market participants on themeasurement date. SFAS 157 also establishes a fair value hierarchy whichrequires an entity to maximize the use of observable inputs and minimize theuse of unobservable inputs when measuring fair value. The standard describesthree levels of inputs that may be used to measure fair value:

 
| Level 1 | Unadjusted, quoted prices in active markets for identical assets or  liabilities at the measurement date.                                                                                                                                                                                                                          |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |                                                                                                                                                                                                                                                                                                                               |
| Level 2 | Observable inputs other than Level 1 prices, such as quoted prices for  similar assets or liabilities; quoted prices in markets that are not active;  or other inputs that are observable or can be corroborated by observable  market data at the measurement date for substantially the full term of the  assets or liabilities. |
|         |                                                                                                                                                                                                                                                                                                                               |
| Level 3 | Unobservable inputs that reflect management’s best estimate of what  market participants would use in pricing the asset or liability at the  measurement date.                                                                                                                                                                |

 

The assets presented at fair value on the Bank’s financial statementsare related to real estate owned, net, and impaired loans, both of which arevalued based on Level 3 inputs. Management utilizes appraisals, listing prices,market information from local realtors and market research reports to base thefair value measurement.

 

The table below presents a reconciliation for all assets and liabilitiesmeasured at fair value on a recurring basis using significant unobservableinputs (Level 3):

 
| ** **             | ** ** | **December 31,  2008** | ** ** | **Additions** | ** ** | **Fair Value  Adjustments** | ** ** | **Transfers  Out** | ** ** | **Gain  (Loss)** | ** ** | **March 31,  2009** | ** ** |
|------------------------|------------|-----------------------------|------------|---------------|------------|-----------------------------|------------|--------------------|------------|------------------|------------|--------------------------|------------|
| ** **             | ** ** | **(in thousands)**          | ** ** |
| Real estate owned, net |       | $                           | 22,385     |          | $          | 5,657                       |       | $                  | (348       | )                | $          | (2,582                   | )          | $ | 21 |   | $ | 25,133 |   |
| Impaired loans         |       | $                           | 8,344      |          | $          | 21,702                      |       | $                  | (1,463     | )                | $          | (2,911                   | )          | $ | — |   | $ | 25,672 |   |

# ** **

# **Realized and unrealized gainsand losses on real estate owned are recognized in noninterest expenses in theconsolidated statements of income under the caption “Real estate owned,net.”  Gains on sales of real estateowned which are financed by the Bank are deferred in certain circumstances andrecognized as the borrower pays down the related loan.  Fair value adjustments to impaired loans arerecorded through the allowance for loan losses.**

 

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# **MANAGEMENT’S DISCUSSION AND ANALYSIS**

# **OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

### **CRITICAL ACCOUNTING POLICIES**

### ** **

Various elements of ouraccounting policies, by their nature, are inherently subject to estimationtechniques, valuation assumptions and other subjective assessments.  In particular, valuation of real estate ownedand the methodology for the determination of our allowance for loan losses, dueto the judgments, estimates and assumptions inherent in those policies arecritical to preparation of our financial statements.  These policies and the judgments, estimatesand assumptions are described in greater detail in subsequent sections ofManagement’s Discussion and Analysis and in the notes to the unauditedfinancial statements included herein.  Webelieve that the judgments, estimates and assumptions used in the preparationof our financial statements are appropriate given the factual circumstances atthe time.  However, given the sensitivityof our financial statements to these critical accounting policies, the use ofother judgments, estimates and assumptions could result in material differencesin our financial condition or results of operations.

 

In estimating the amount ofcredit losses inherent in our loan portfolio, various judgments and assumptionsare made.  For example, when assessingthe condition of the overall economic environment, assumptions are maderegarding future market conditions and their impact on the loan portfolio.  In the event the economy were to sustain aprolonged downturn, the loss factors applied to our portfolios may need to berevised, which may significantly impact the measurement of the allowance forloan losses.  For impaired loans that arecollateral-dependent, and for real estate owned, the estimated fair value of thecollateral may deviate significantly from the proceeds received when thecollateral is sold.

 

## **CHANGES IN FINANCIAL CONDITION**

##  

Changes in financialcondition between March 31, 2009 and December 31, 2008 are presentedin the following table (dollars in thousands). Material changes between the periods are discussed in the sections whichfollow the table.

 
| ** **                                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **Percentage** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|-----------------------|------------|----------------|------------|----------------|------------|
| ** **                                    | ** ** | **2009**           | ** ** | **2008**              | ** ** | **(Decrease)** | ** ** | **Change**     | ** ** |
| **ASSETS**                                    |       |               |       |                  |       |           |       |           |       |
| Cash and cash equivalents                     |       | $                  | 32,578     |                  | $          | 9,367          |       | $              | 23,211     |   | 247.8 | % |
| Investment securities held  to maturity       |       | 131,990            |       | 136,412               |       | (4,422         | )          | (3.2           | )          |
| Federal Home Loan Bank  stock                 |       | 4,363              |       | 4,825                 |       | (462           | )          | (9.6           | )          |
| Loans receivable, net                         |       | 555,181            |       | 568,123               |       | (12,942        | )          | (2.3           | )          |
| Accrued interest  receivable                  |       | 5,026              |       | 6,701                 |       | (1,675         | )          | (25.0          | )          |
| Real estate owned, net                        |       | 25,133             |       | 22,385                |       | 2,748          |       | 12.3           |       |
| Office properties and  equipment, net         |       | 24,413             |       | 24,694                |       | (281           | )          | (1.1           | )          |
| Prepaid expenses and other  assets            |       | 24,709             |       | 22,665                |       | 2,044          |       | 9.0            |       |
|                                          |       |               |       |                  |       |           |       |           |       |
| TOTAL                                         |       | $                  | 803,393    |                  | $          | 795,172        |       | $              | 8,221      |   | 1.0 | % |
|                                          |       |               |       |                  |       |           |       |           |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY** |       |               |       |                  |       |           |       |           |       |
| LIABILITIES:                                  |       |               |       |                  |       |           |       |           |       |
| Deposits                                      |       | $                  | 633,720    |                  | $          | 618,003        |       | $              | 15,717     |   | 2.5 | % |
| Other borrowings                              |       | 72,366             |       | 92,212                |       | (19,846        | )          | (21.5          | )          |
| Other liabilities                             |       | 9,298              |       | 11,840                |       | (2,542         | )          | (21.5          | )          |
|                                          |       |               |       |                  |       |           |       |           |       |
| Total liabilities                             |       | 715,384            |       | 722,055               |       | (6,671         | )          | (0.9           | )          |
|                                          |       |               |       |                  |       |           |       |           |       |
| STOCKHOLDERS’ EQUITY                     |       | 88,009             |       | 73,117                |       | 14,892         |       | 20.4           |       |
|                                          |       |               |       |                  |       |           |       |           |       |
| TOTAL                                         |       | $                  | 803,393    |                  | $          | 795,172        |       | $              | 8,221      |   | 1.0 | % |
|                                          |       |               |       |                  |       |           |       |           |       |
| BOOK VALUE PER COMMON  SHARE                  |       | $                  | 14.83      |                  | $          | 15.09          |       |           |       |   |   |
|                                          |       |               |       |                  |       |           |       |           |       |
| COMMON EQUITY TO ASSETS                       |       | 8.9                | %          | 9.2                   | %          |           |       |           |       |

 

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**LoansReceivable. **Changes in loan composition between March 31,2009 and December 31, 2008 are presented in the following table (dollarsin thousands).

 
| ** **                                       | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | ** **   | ** ** |
|--------------------------------------------------|------------|--------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|
| ** **                                       | ** ** | **2009**           | ** ** | **2008**              | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
|                                             |       |               |       |                  |       |           |       |         |       |
| One- to four-family  residences                  |       | $                  | 242,543    |                  | $          | 243,321        |       | $            | (778       | ) | (0.3 | )% |
| Home equity lines of  credit and second mortgage |       | 30,233             |       | 31,712                |       | (1,479         | )          | (4.7         | )          |
| Multifamily                                      |       | 25,662             |       | 24,147                |       | 1,515          |       | 6.3          |       |
| Commercial real estate                           |       | 112,680            |       | 115,935               |       | (3,255         | )          | (2.8         | )          |
| Land                                             |       | 51,229             |       | 50,510                |       | 719            |       | 1.4          |       |
| Construction:                                    |       |               |       |                  |       |           |       |         |       |
| One- to four-family  residences                  |       | 7,421              |       | 8,450                 |       | (1,029         | )          | (12.2        | )          |
| Speculative one-to four-family  residences       |       | 15,278             |       | 17,096                |       | (1,818         | )          | (10.6        | )          |
| Multifamily                                      |       | 14,894             |       | 15,016                |       | (122           | )          | (0.8         | )          |
| Commercial real estate                           |       | 18,168             |       | 18,297                |       | (129           | )          | (0.7         | )          |
| Land development                                 |       | 16,032             |       | 18,457                |       | (2,425         | )          | (13.1        | )          |
| Total construction loans                         |       | 71,793             |       | 77,316                |       | (5,523         | )          | (7.1         | )          |
| Total mortgage loans                             |       | 534,140            |       | 542,941               |       | (8,801         | )          | (1.6         | )          |
|                                             |       |               |       |                  |       |           |       |         |       |
| Commercial                                       |       | 20,224             |       | 21,922                |       | (1,698         | )          | (7.7         | )          |
|                                             |       |               |       |                  |       |           |       |         |       |
| Automobile                                       |       | 7,979              |       | 8,631                 |       | (652           | )          | (7.6         | )          |
| Other                                            |       | 11,574             |       | 12,291                |       | (717           | )          | (5.8         | )          |
| Total consumer                                   |       | 19,553             |       | 20,922                |       | (1,369         | )          | (6.5         | )          |
|                                             |       |               |       |                  |       |           |       |         |       |
| Total loans receivable                           |       | 573,917            |       | 585,785               |       | (11,868        | )          | (2.0         | )          |
|                                             |       |               |       |                  |       |           |       |         |       |
| Undisbursed loan funds                           |       | (9,675             | )          | (11,750               | )          | 2,075          |       | (17.7        | )          |
| Deferred loan costs – net                   |       | 497                |       | 529                   |       | (32            | )          | (6.0         | )          |
| Allowance for loan losses                        |       | (9,558             | )          | (6,441                | )          | (3,117         | )          | 48.4         |       |
|                                             |       |               |       |                  |       |           |       |         |       |
| Loans receivable, net                            |       | $                  | 555,181    |                  | $          | 568,123        |       | $            | (12,942    | ) | (2.3 | )% |

 

The decrease in the Bank’s loanportfolio was primarily due to a decrease in loan originations due to continuedsoftening of the housing market in the Bank’s market area.  Market data indicates an overall decrease inhome sales in Benton and Washington counties in 2008 and 2007 as well as thefirst quarter of 2009.  Although theNorthwest Arkansas region continues to have a relatively strong job market,ranking number 4 on Forbes’ magazine’s latest ranking of best metropolitanareas for business and careers, the supply of new residential lots and newspeculative homes for sale continues to outpace demand.  We expect this trend to continue for theforeseeable future given the level of oversupply in the market.

 

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**AssetQuality. **The following table sets forth the amounts andcategories of the Bank’s nonperforming assets at the dates indicated.

 
| ** **                                                                                               | ** ** | **March 31,  2009**   | ** ** | **December 31,  2008** | ** ** | **Increase  (Decrease)** | ** ** | **Percentage  Change** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|--------------------------|------------|------------------------|------------|
| ** **                                                                                               | ** ** | **(Dollars in Thousands)** | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Nonaccrual loans:                                                                                        |       |                       |       |                        |       |                     |       |                   |       |
| One- to four-family  residential                                                                         |       | $                          | 8,577      |                        | $          | 8,471                    |       | $                      | 106        |   | 1.3 | % |
| Home equity and second  mortgage                                                                         |       | 1,390                      |       | 927                         |       | 463                      |       | 49.9                   |       |
| Speculative one- to  four-family construction                                                            |       | 2,518                      |       | 1,466                       |       | 1,052                    |       | 71.8                   |       |
| Multifamily residential                                                                                  |       | 237                        |       | 441                         |       | (204                     | )          | (46.3                  | )          |
| Land development                                                                                         |       | 8,354                      |       | 2,577                       |       | 5,777                    |       | 224.2                  |       |
| Land                                                                                                     |       | 18,541                     |       | 2,537                       |       | 16,004                   |       | 630.8                  |       |
| Commercial real estate                                                                                   |       | 3,545                      |       | 6,702                       |       | (3,157                   | )          | (47.1                  | )          |
| Commercial loans                                                                                         |       | 2,106                      |       | 2,128                       |       | (22                      | )          | (1.0                   | )          |
| Consumer loans                                                                                           |       | 149                        |       | 170                         |       | (21                      | )          | (12.4                  | )          |
| Total nonaccrual loans                                                                                   |       | 45,417                     |       | 25,419                      |       | 19,998                   |       | 78.7                   |       |
|                                                                                                     |       |                       |       |                        |       |                     |       |                   |       |
| Accruing loans 90 days or  more past due                                                                 |       | 1,177                      |       | 8,961                       |       | (7,784                   | )          | (86.9                  | )          |
| Real estate owned                                                                                        |       | 25,133                     |       | 22,385                      |       | 2,748                    |       | 12.3                   |       |
|                                                                                                     |       |                       |       |                        |       |                     |       |                   |       |
| Total nonperforming assets                                                                               |       | $                          | 71,727     |                        | $          | 56,765                   |       | $                      | 14,962     |   | 26.4 | % |
|                                                                                                     |       |                       |       |                        |       |                     |       |                   |       |
| Total nonaccrual and  accruing loans 90 days or more past due as a percentage of total loans  receivable |       | 8.12                       | %          | 5.87                        | %          |                     |       |                   |       |
|                                                                                                     |       |                       |       |                        |       |                     |       |                   |       |
| Total nonperforming assets  as a percentage of total assets                                              |       | 8.93                       | %          | 7.14                        | %          |                     |       |                   |       |

 

The increase in nonaccrual loans isprimarily related to increases in nonaccrual land development loans, nonaccrualspeculative single family construction loans and nonaccrual land loans, offsetby transfers of $5.7 million to real estate owned.  The increase in nonaccrual land loans isprimarily due to six loans, four of which are to the entities related to thesame borrower totaling $9.1 million discussed in the first relationshipbelow.  The fifth loan of $3.3 million isdiscussed in the second relationship below. The sixth loan contributing to the increase, totaling $2.8 million, isdiscussed in the third relationship below. The increase in land development loans is primarily due to thesubdivision discussed in the second relationship below.

 

We expect a significant amount of thenonaccrual real estate loans to eventually migrate to real estate owned as$15.7 million of the nonaccrual real estate loans reported above are in somestage of the foreclosure process as of March 31, 2009.  Therefore, we expect real estate owned andassociated expenses to continue to increase in future periods as such loansmigrate from loans to real estate owned.

 

The level of nonaccrual speculativeone- to four-family residential loans, commercial real estate loans, landloans, land development loans and commercial loans is attributable primarily tosix loan relationships totaling $26.8 million, or 59% of nonaccrual loans.  These relationships are described in moredetail in the paragraphs that follow.

 

The first relationship totaled $9.1million with a specific loan loss allowance of $861,000 at March 31, 2009,and is comprised of 29 acres of land acquired for future development inSpringdale, Arkansas, 80 acres acquired for future development in Fayetteville,Arkansas, and 24 acres of raw land located in Lowell, Arkansas.  The borrower has passed away and the estateis currently addressing how the obligations of the borrower will be satisfied.Based on the nature of these loans and the possibility of continued adversechanges in the market conditions, we may incur losses in the future in excessof the specific allowance recorded as of March 31, 2009.

 

The second relationship totaled $9.1million with a specific loan loss allowance of $500,000 at March 31, 2009,and is comprised of a 207 lot subdivision and a 60 acre parcel of land, alllocated in Fayetteville, Arkansas.  Thesubdivision is comprised of three phases, 52 lots of which are complete, 64lots which lack final paving, and 91 additional lots which areundeveloped.  Based on the nature ofthese loans and the possibility of continued adverse changes in the marketconditions, we may incur losses in the future in excess of the specificallowance recorded as of March 31, 2009.

 

The third relationship consisted of a$2.8 million first mortgage loan secured by the Belclaire subdivision locatedin Fayetteville, Arkansas.  Bonds weresold on this property by the Belclaire Improvement District without satisfyingthe first mortgage with our Bank.  Theloan is in default and we have filed foreclosure.  This property is also the subject of 

 

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litigation.  We believe our first mortgage will prevailand absent that, believe the guarantors will satisfy the obligation. At March 31,2009, based on the estimated fair value of the collateral, the Bank estimatesit will incur no loss.

 

The fourth relationship totaled $2.2million with a specific loan loss allowance of $981,000 at March 31, 2009,and is comprised of a completed 42 lot subdivision located in Cave Springs, Arkansas.  The borrowers have been attempting to find abuyer for the subdivision since it matured in July 2007.  We are exercising forbearance with thisborrower due to their cooperation and maintenance of the subdivision while theytry to find a buyer.  The Bank obtainedan updated valuation on the subdivision using discounted cash flowanalysis.  Due to the market conditionsand the oversupply of lots in Northwest Arkansas, the valuation indicated lowerlot prices and an extended marketing time over that in the original appraisalobtained when the loan was originated. Based on the nature of this loan and the possibility of continuedadverse changes in the market conditions, we may incur losses in the future inexcess of the specific allowance recorded as of March 31, 2009.

 

The fifth relationship totaled $2.0million at March 31, 2009, and consists of a $1.3 million commercial loansecured by commercial real estate and franchise rights, a $650,000 loan on theborrower’s primary residence, and a $20,000 unsecured loan.  The loans in this relationship are currentlyin foreclosure and a specific loan loss allowance of $621,000 has been recordedas of March 31, 2009.

 

The sixth relationship totaled $1.6million at March 31, 2009, and consists of a $677,000 commercial realestate loan secured by an office building located in Pea Ridge, Arkansas, fiveloans totaling $671,000 secured by single family rental properties located inPea Ridge, Arkansas and Washburn, Missouri, and a $237,000 loan secured by anapartment building located in Pea Ridge, Arkansas.  The borrower has filed for bankruptcyprotection.  At March 31, 2009,based on the estimated fair value of the collateral, the Bank has recorded a$116,000 specific loan loss allowance related to this relationship.

 

At March 31, 2009, the Bank had a$1.2 million loan that was over 90 days past due and not designated asnonaccrual compared to $9.0 million of such loans at December 31, 2008.This loan is secured by a church building and the related property located in Fayetteville,Arkansas.  The church has the propertyunder contract with a buyer and is waiting for the sale to close. This loan wasmaintained on accrual status and not classified or judged to be impaired at March 31,2009, based on our assessment of facts and circumstances existing at thattime.  If any of the facts orcircumstances change, our treatment of this loan might be different in futurereporting periods.

 

The following table sets forth theamounts and categories of the Bank’s real estate owned at the dates indicated.

 
| ** **                                       | ** ** | **March 31,  2009**   | ** ** | **December 31,  2008** | ** ** | **Increase** | ** ** | **Percentage Change** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|--------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **(Dollars in Thousands)** | ** ** | ** **                  | ** ** | ** **   | ** ** |
| Real estate owned                                |       |                       |       |                        |       |         |       |                  |       |
| One- to four-family residential                  |       | $                          | 4,775      |                        | $          | 3,436        |       | $                     | 1,339      |   | 39.0 | % |
| Speculative one- to  four-family construction(1) |       | 4,526                      |       | 4,310                       |       | 216          |       | 5.0                   |       |
| Multifamily                                      |       | 546                        |       | —                      |       | 546          |       | —                |       |
| Land(2)                                          |       | 13,323                     |       | 13,314                      |       | 9            |       | 0.1                   |       |
| Commercial real estate                           |       | 1,963                      |       | 1,325                       |       | 638          |       | 48.2                  |       |
| Total real estate owned                          |       | $                          | 25,133     |                        | $          | 22,385       |       | $                     | 2,748      |   | 12.3 | % |

 

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(1)                        At March 31, 2009, $4.1 million of these properties were 100%complete.  The remainder range from 85%to 88% complete.

 

(2)                        At March 31, 2009, $10.0 million of the land balance represented273 developed subdivision lots.  Theremainder consisted of raw land.

 

The increase in real estate owned fromDecember 31, 2008 to March 31, 2009 is primarily related to sevensingle family residential properties totaling $1.7 million, three commercialreal estate properties totaling $647,000, and two multifamily propertiestotaling $546,000 that were transferred to real estate owned during the firstquarter of 2009.

 

The Bank is diligently working todispose of its REO and has dedicated an experienced special assets officer whois working full-time to liquidate the Bank’s properties in the NorthwestArkansas market. Each property is evaluated on a case-by-case basis todetermine the best course of action with respect to liquidation. Properties are marketed directly by the Bank or listed with local real estateagents utilizing appraisals, market information from realtors, market researchreports, and our own market evaluations to make pricing and sellingdecisions.   The Bank’s Chief Lending Officer, loan officers, creditmanager, special assets officer, and team members in the collections departmentall work together in this endeavor.   The Bank’s goal is to liquidatethese properties in an orderly and efficient manner without incurringextraordinary losses due to quick sale pricing. During 2008, the Bank sold real estate owned totaling $10.0 million andoriginated loans to facilitate such sales totaling $6.9 million.  During the first three months of 2009, theBank sold real estate owned totaling $2.5 million and originated loans tofacilitate such sales totaling $2.3 million.

 

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Another $2.9 million of real estateowned is under contract and anticipated to close during the second quarter. TheBank offers attractive rates and financing options to prospective buyers ofreal estate owned to help facilitate sales. During the second quarter of 2009, the Bank also settled litigationrelated to a subdivision property held in real estate owned and expects torecord a recovery of previous chargeoffs to the allowance for loan losses. Thisrecovery will increase the allowance for loan losses, which may reduce theprovision for loan losses required in future quarters when compared to what theprovision might have been absent such a recovery.

 

**Classified Assets.**  Federal regulations require that each insuredsavings association classify its assets on a regular basis.  In addition, in connection with examinationsof insured institutions, federal examiners have authority to identify problemassets and, if appropriate, classify them. There are three classifications for problem assets: “substandard,”“doubtful” and “loss.”  Substandardassets have one or more defined weaknesses and are characterized by thedistinct possibility that the insured institution will sustain some loss if thedeficiencies are not corrected.  Doubtfulassets have the weaknesses of substandard assets with the additionalcharacteristic that the weaknesses make collection or liquidation in full onthe basis of currently existing facts, conditions and values questionable, andthere is a high possibility of loss.  Anasset classified loss is considered uncollectible and of such little value thatcontinuance as an asset of the institution is not warranted.  At March 31, 2009, the Bank had $79.2 millionof classified assets, $74.4 million of which were classified as substandard and$4.8 million of which were classified as loss, including $45.4 million ofnonaccrual loans, $25.1 million of real estate owned, and $1.2 million of loans90 days or more past due and still accruing. In addition, at such date, theBank had $35.6 million of assets designated as special mention. Special mentionassets have potential weaknesses that deserve management’s closeattention.  If left uncorrected, thesepotential weaknesses may result in deterioration of the repayment prospects forthe asset or the institution’s credit position at some future date.  The Bank has engaged a third party toindependently review all of its assets designated as either watch or specialmention and anticipates receipt of the results of such review no later than thethird quarter of 2009. The Bank will use the results of this review to helpdetermine the effectiveness of existing policies and procedures.  To the extent the third party review producesresults in classifications different from those of the Bank, additional loansmay be adversely classified that could result in additional charges to theprovision for loan losses and have a corresponding adverse impact on earnings.

 

**Potential Problem Loans.**  Based on the oversupply of lots in NorthwestArkansas, our land development portfolio poses a higher risk of default.  These loans are typically structured withinterest due at maturity and lot sales as the source of repayment.  Since lot sales in the Northwest Arkansasmarket are significantly slower than when these loans were originated, ourborrowers typically must rely on a secondary source of funds to pay theinterest as it becomes due.  Due to therelatively large balances of these types of loans, the interest due at maturityis usually significant.  At March 31,2009, gross land development loans totaled $16.0 million with $1.0 million ofaccrued interest.  Of this total, $8.4million is on nonaccrual status with $892,000 in nonaccrual interest, $5.5million with $69,000 in accrued interest is classified as special mention, and$2.0 million with $28,000 in accrued interest is on our watch list.

 

**Allowancefor Loan Losses**.  A summary of theactivity in the allowance for loan losses is as follows (in thousands):

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| Balance at beginning of  period  |       | $                                     | 6,441      |   | $ | 5,162 |   |
| Provisions for estimated  losses |       | 3,521                                 |       | 1,528 |   |
| Recoveries                       |       | 60                                    |       | 136 |   |
| Losses charged off               |       | (464                                  | )          | (719 | ) |
| Balance at end of period         |       | $                                     | 9,558      |   | $ | 6,107 |   |

# ** **

Changes in the composition ofthe allowance for loan losses between March 31, 2009 and December 31,2008 are presented in the following table (in thousands):

 
| ** ** | ** ** | **March 31,** | ** **  | **December 31,** | ** ** | ** **   | ** ** |
|------------|------------|--------------------|-------------|-----------------------|------------|--------------|------------|
| ** ** | ** ** | **2009**           | ** **  | **2008**              | ** ** | **Increase** | ** ** |
| General    |       | $                  | 4,703       |                  | $          | 3,525        |       | $ | 1,178 |   |
| Specific   |       | 4,855              |        | 2,916                 |       | 1,939        |       |
|       |       | $                  |  9,558 |                  | $          | 6,441        |       | $ | 3,117 |   |

 

The general component of the allowance for loan losses increasedprimarily due to increases in the loss factors applied to land loans, homeequity loans, consumer loans, speculative single family loans, and multifamilyloans, partially offset by decreases in certain of the related loanbalances.  These loss factors wereincreased due to the recent loss history on these types of loans as well asdelinquency trends and economic factors such as unemployment, bankruptcy trendsand home sale data.  The specificcomponent of the allowance for loan losses increased primarily due toallowances established this quarter on land and land development loans.  See “Asset Quality.”

 

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The allowance for loan losses is established as losses are estimated tohave occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowancewhen management believes it is likely that a loan balance isuncollectible.  Subsequent recoveries, ifany, are credited to the allowance.

 

The allowance for loan losses represents management’s estimate ofincurred credit losses inherent in the Company’s loan portfolio as of thebalance sheet date.  The estimation ofthe allowance is based on a variety of factors, including past loan lossexperience, the current credit profile of the Company’s borrowers, adversesituations that have occurred that may affect the borrowers’ ability to repay,the estimated value of underlying collateral, and general economicconditions.  Losses are recognized whenavailable information indicates that it is probable that a loss has beenincurred and the amount of the loss can be reasonably estimated. Thisevaluation is inherently subjective as it requires estimates that aresusceptible to significant revision as more information becomes available orconditions change.

 

In determining the allowance for loan losses, the Company allocates aportion of the allowance to its various loan categories based on an analysis ofindividual loans and pools of loans. However, the entire allowance is available to absorb credit lossesinherent in the total loan portfolio as of the balance sheet date.

 

A loan is considered impaired when, based on current information andevents, it is probable that the Bank will be unable to collect the scheduledpayments of principal or interest when due according to the contractual termsof the loan agreement. Factors considered by management in determiningimpairment include payment status, collateral value, and the probability ofcollecting scheduled principal and interest payments when due. Loans thatexperience insignificant payment delays and payment shortfalls generally arenot classified as impaired. Management determines the significance of paymentdelays and payment shortfalls on a case-by-case basis, taking intoconsideration all of the circumstances surrounding the loan and the borrower,including the length of the delay, the reasons for the delay, the borrower’sprior payment record, and the amount of the short fall in relation to theprincipal and interest owed. Impairment is measured on a loan by loan basis byeither the present value of expected future cash flows discounted at the loan’seffective interest rate, the loan’s obtainable market price, or the fair valueof the collateral if the loan is collateral dependent.  Multifamily residential, commercial realestate, land and land development, and commercial loans that are delinquent orwhere the borrower’s total loan relationship exceeds $1 million are evaluatedon a loan by loan basis at least annually.

 

Large groups of smaller balance homogeneous loans are collectivelyevaluated for impairment. Accordingly, the Bank does not separately identifyindividual consumer and residential loans for impairment disclosures.  Homogeneous loans are those that areconsidered to have common characteristics that provide for evaluation on anaggregate or pool basis. The Bank considers the characteristics of (1) one-to four-family residential first mortgage loans; (2) unsecured consumerloans; and (3) collateralized consumer loans to permit consideration ofthe appropriateness of the allowance for losses of each group of loans on apool basis. The primary methodology used to determine the appropriateness ofthe allowance for losses includes segregating certain specific, poorlyperforming loans based on their performance characteristics from the pools ofloans as to type, valuing these loans, and then applying a loss factor to theremaining pool balance based on several factors including past loss experience,inherent risks, and economic conditions in the primary market areas.

 

In estimating theamount of credit losses inherent in our loan portfolio, various judgments andassumptions are made.  For example, whenassessing the condition of the overall economic environment, assumptions aremade regarding future market conditions and their impact on the loanportfolio.  For impaired loans that arecollateral dependent, the estimated fair value of the collateral may deviatesignificantly from the proceeds received when the collateral is sold in theevent that the Bank has to foreclose or repossess the collateral.

 

Although we consider theallowance for loan losses of approximately $9.6 million adequate to coverlosses inherent in our loan portfolio at March 31, 2009, no assurance canbe given that we will not sustain loan losses that are significantly differentfrom the amount recorded, or that subsequent evaluations of the loan portfolio,in light of factors then prevailing, would not result in a significant changein the allowance for loan losses.

 

**Investment Securities. **Changes in the compositionof investment securities held to maturity between March 31, 2009 and December 31,2008 are presented in the following table (in thousands).

 
| ** **                              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** |
|-----------------------------------------|------------|--------------------|------------|-----------------------|------------|----------------|------------|
| ** **                              | ** ** | **2009**           | ** ** | **2008**              | ** ** | **(Decrease)** | ** ** |
|                                    |       |               |       |                  |       |           |       |
| U.S. Government and agency  obligations |       | $                  | 111,033    |                  | $          | 116,847        |       | $ | (5,814 | ) |
| Municipal securities                    |       | 20,957             |       | 19,565                |       | 1,392          |       |
| Total                                   |       | $                  | 131,990    |                  | $          | 136,412        |       | $ | (4,422 | ) |

 

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During the first three months of 2009,investment securities totaling $65.1 million with an average tax equivalentyield of 5.44% were purchased and $69.6 million with an average tax equivalentyield of 5.99% matured or were called.

 

At March 31, 2009, estimated fair values of investmentsecurities held to maturity were as follows (in thousands):

** **
| ** **                             | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------|------------|
|                                   |       |                |       |            |       |
| U.S. Government and agency obligations |       | $                   | 111,033    |            | $          | 110,047 |   |
| Municipal securities                   |       | 20,957              |       | 20,612          |       |
| Total                                  |       | $                   | 131,990    |            | $          | 130,659 |   |

 

**AccruedInterest Receivable. ** The decrease in accrued interestreceivable was primarily due to an increase in nonaccrual loans, a decrease inthe loans receivable balance, and a decrease in the loan yield at March 31,2009 compared to December 31, 2008.

 

**Real Estate Owned, net.**  Changesin the composition of real estate owned between March 31, 2009 and December 31, 2008 arepresented in the following table (dollars in thousands).

 
| ** **                      | ** ** | **December 31,  2008** | ** **   | **Additions** | ** ** | **Fair Value  Adjustments** | ** ** | **Net Sales  Proceeds(1)** | ** ** | **Gain (Loss)** | ** ** | **March 31,  2009** | ** ** |
|---------------------------------|------------|-----------------------------|--------------|---------------|------------|----------------------------------|------------|---------------------------------|------------|----------------------|------------|--------------------------|------------|
| One- to four-family residential |       | $                           | 3,436        |          | $          | 1,653                            |       | $                               | (131       | )                    | $          | (182                     | )          | $ | (1 | ) | $ | 4,775 |   |
| Speculative one- to four-family |       | 4,310                       |         | 457           |       | (49                              | )          | (214                            | )          | 22                   |       | 4,526                    |       |
| Multifamily                     |       | —                      |         | 591           |       | (45                              | )          | —                          |       | —               |       | 546                      |       |
| Land                            |       | 13,314                      |         | 148           |       | (97                              | )          | (42                             | )          | —               |       | 13,323                   |       |
| Commercial real estate          |       | 1,325                       |         | 2,808         |       | (26                              | )          | (2,144                          | )          | —               |       | 1,963                    |       |
|                            |       | $                           |  22,385 |          | $          | 5,657                            |       | $                               | (348       | )                    | $          | (2,582                   | )          | $ | 21 |   | $ | 25,133 |   |

 

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(1) Net sales proceedsinclude $2.3 million of loans made by the Bank to facilitate the sale of realestate owned.

 

**Deposits. **Changes in the composition of depositsbetween March 31, 2009and December 31, 2008 are presented in the following table (dollars inthousands).

 
| ** **              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **Percentage** | ** ** |
|-------------------------|------------|--------------------|------------|-----------------------|------------|----------------|------------|----------------|------------|
| ** **              | ** ** | **2009**           | ** ** | **2008**              | ** ** | **(Decrease)** | ** ** | **Change**     | ** ** |
| ** **              | ** ** | ** **         | ** ** | ** **            | ** ** | ** **     | ** ** | ** **     | ** ** |
| Checking accounts       |       | $                  | 162,125    |                  | $          | 163,468        |       | $              | (1,343     | ) | (0.8 | )% |
| Money Market accounts   |       | 46,094             |       | 45,022                |       | 1,072          |       | 2.4            |       |
| Savings accounts        |       | 25,474             |       | 23,019                |       | 2,455          |       | 10.7           |       |
| Certificates of deposit |       | 400,027            |       | 386,494               |       | 13,533         |       | 3.5            |       |
|                    |       |               |       |                  |       |           |       |           |       |
| Total deposits          |       | $                  | 633,720    |                  | $          | 618,003        |       | $              | 15,717     |   | 2.5 | % |

 

Deposits increased in the comparison period, primarily due to anincrease in certificate of deposits. TheBank views checking accounts as an attractive source of funds and will continueto promote such accounts as they offer overall low-interest deposits, feeincome potential, and the opportunity to cross-sell other financial services.

 

**Other Borrowings.**  The Bank experienced a $19.8 million or 21.5%decrease in other borrowings during the quarter primarily due to a decrease inFederal Reserve Bank borrowings of $10.0 million and a $9.8 million decrease inFHLB advances since December 31, 2008.

 

**Other Liabilities.**  Other liabilities decreased primarily due toa decrease in investment security purchases which settled after period end from$9.0 million at December 31, 2008, to $5.6 million at March 31, 2009.

 

**Stockholders’ Equity. **Stockholders’equity increased approximately $14.9 million from December 31, 2008 to March 31,2009.  The increase in stockholders’ equity wasprimarily due to the issuance of 16,500 shares of preferred stock totaling$16.5 million offset by a net loss totaling $1.5 million during the first threemonths of 2009.  In addition, during the threemonths ended March 31, 2009, dividends on common shares of approximately $48,000 were declaredand preferred dividends of approximately $57,000 were accrued.  See the Unaudited Consolidated Statement ofStockholders’ Equity for the three months ended March 31, 2009 for more detail.

 

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### **Average Balance Sheets**

### ** **

The following table sets forth certain information relating to the Company’saverage balance sheets and reflects the average yield on assets and averagecost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by theaverage balance of assets or liabilities, respectively, for the periodspresented.  Average balances are based ondaily balances during the period.

 
| ** **                                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| ** **                                                       | ** ** | **Average**                                          | ** ** | ** ** | ** ** | **Average  Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average  Yield/** | ** ** |
| ** **                                                       | ** ** | **Balance**                                          | ** ** | **Interest** | ** ** | **Cost** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Cost** | ** ** |
|                                                             |       | **(Dollars in Thousands)**                 |       |
| Interest-earning assets:                                         |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans receivable(1)                                              |       | $                                                    | 567,745    |   | $ | 7,555 |   | 5.32 | % | $ | 601,996 |   | $ | 9,975 |   | 6.63 | % |
| Investment securities(2)                                         |       | 126,240                                              |       | 1,564 |   | 4.96 |   | 105,254 |   | 1,393 |   | 5.29 |   |
| Other interest-earning assets                                    |       | 14,740                                               |       | 3 |   | 0.10 |   | 21,159 |   | 168 |   | 3.18 |   |
| Total interest-earning assets                                    |       | 708,725                                              |       | 9,122 |   | 5.15 |   | 728,409 |   | 11,536 |   | 6.34 |   |
| Noninterest-earning assets                                       |       | 84,406                                               |       |   |   |   |   | 72,425 |   |   |   |   |   |
| Total assets                                                     |       | $                                                    | 793,131    |   |   |   |   |   | $ | 800,834 |   |   |   |   |   |
| Interest-bearing liabilities:                                    |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                         |       | $                                                    | 628,829    |   | 3,781 |   | 2.41 |   | $ | 632,954 |   | 5,568 |   | 3.52 |   |
| Other borrowings                                                 |       | 78,382                                               |       | 645 |   | 3.29 |   | 84,870 |   | 903 |   | 4.25 |   |
| Total interest-bearing liabilities                               |       | 707,211                                              |       | 4,426 |   | 2.50 |   | 717,824 |   | 6,471 |   | 3.61 |   |
| Noninterest-bearing liabilities                                  |       | 7,822                                                |       |   |   |   |   | 8,856 |   |   |   |   |   |
| Total liabilities                                                |       | 715,033                                              |       |   |   |   |   | 726,680 |   |   |   |   |   |
| Stockholders’ equity                                        |       | 78,098                                               |       |   |   |   |   | 74,154 |   |   |   |   |   |
| Total liabilities and stockholders’ equity                  |       | $                                                    | 793,131    |   |   |   |   |   | $ | 800,834 |   |   |   |   |   |
|                                                             |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                              |       |                                                 |       | $ | 4,696 |   |   |   |   |   | $ | 5,065 |   |   |   |
| Net earning assets                                               |       | $                                                    | 1,514      |   |   |   |   |   | $ | 10,585 |   |   |   |   |   |
| Interest rate spread                                             |       |                                                 |       |   |   | 2.65 | % |   |   |   |   | 2.73 | % |
| Net interest margin                                              |       |                                                 |       |   |   | 2.65 | % |   |   |   |   | 2.78 | % |
| Ratio of interest-earning assets to interest-bearing liabilities |       |                                                 |       |   |   | 100.21 | % |   |   |   |   | 101.47 | % |

 

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(1)  Includes nonaccrual loans.

(2)  Includes FHLB of Dallas stock.

 

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## **Rate/Volume Analysis**

##  

The table below sets forth certaininformation regarding changes in interest income and interest expense of the Companyfor the periods indicated.  For eachcategory of interest-earning assets and interest-bearing liabilities,information is provided on changes attributable to (i) changes in volume(changes in average volume multiplied by prior rate); (ii) changes in rate(change in rate multiplied by prior average volume); (iii) changes inrate-volume (changes in rate multiplied by the change in average volume); and (iv) thenet change.

 
| ** **                         | ** ** | **Three Months Ended March 31,  2009 vs. 2008** | ** ** |
|------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                         | ** ** | **Increase (Decrease)**                                                  | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Due to**                                                               | ** ** | **Total** | ** ** |
| ** **                         | ** ** | **Volume**                                                                    | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Increase  (Decrease)** | ** ** |
| ** **                         | ** ** | **(In Thousands)**                                                            | ** ** |
| Interest income:                   |       |                                                                          |       |   |   |   |   |   |   |
| Loans receivable                   |       | $                                                                             | (568       | ) | $ | (1,964 | ) | $ | 112 |   | $ | (2,420 | ) |
| Investment securities              |       | 278                                                                           |       | (89 | ) | (18 | ) | 171 |   |
| Other interest-earning assets      |       | (51                                                                           | )          | (163 | ) | 49 |   | (165 | ) |
| Total interest-earning assets      |       | (341                                                                          | )          | (2,216 | ) | 143 |   | (2,414 | ) |
|                               |       |                                                                          |       |   |   |   |   |   |   |
| Interest expense:                  |       |                                                                          |       |   |   |   |   |   |   |
| Deposits                           |       | (36                                                                           | )          | (1,762 | ) | 11 |   | (1,787 | ) |
| Other borrowings                   |       | (70                                                                           | )          | (204 | ) | 16 |   | (258 | ) |
| Total interest-bearing liabilities |       | (106                                                                          | )          | (1,966 | ) | 27 |   | (2,045 | ) |
| Net change in net interest income  |       | $                                                                             | (235       | ) | $ | (250 | ) | $ | 116 |   | $ | (369 | ) |

 

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**CHANGES IN RESULTS OF OPERATIONS**

 

The table below presents acomparison of results of operations for the three months ended March 31,2009 and 2008 (dollars in thousands). Specific changes in captions are discussed in the sections which followthe table.

 
| ** **                                                           | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase  (Decrease)** | ** ** | **Percentage  Change** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------|------------|------------------------|------------|
| ** **                                                           | ** ** | **2009**                               | ** ** | **2008**                 | ** ** | **2009 vs 2008**       | ** ** | **2009 vs 2008** | ** ** |
| Interest income:                                                     |       |                                   |       |                     |       |                   |       |   |   |
| Loans receivable                                                     |       | $                                      | 7,555      |                     | $          | 9,975                  |       | $ | (2,420 | ) | (24.3 | )% |
| Investment securities                                                |       | 1,564                                  |       | 1,393                    |       | 171                    |       | 12.3 |   |
| Other                                                                |       | 3                                      |       | 168                      |       | (165                   | )          | (98.2 | ) |
| Total interest income                                                |       | 9,122                                  |       | 11,536                   |       | (2,414                 | )          | (20.9 | ) |
| Interest expense:                                                    |       |                                   |       |                     |       |                   |       |   |   |
| Deposits                                                             |       | 3,781                                  |       | 5,568                    |       | (1,787                 | )          | (32.1 | ) |
| FHLB advances                                                        |       | 645                                    |       | 903                      |       | (258                   | )          | (28.6 | ) |
| Total interest expense                                               |       | 4,426                                  |       | 6,471                    |       | (2,045                 | )          | (31.6 | ) |
| Net interest income beforeprovision for loan losses                  |       | 4,696                                  |       | 5,065                    |       | (369                   | )          | (7.3 | ) |
| Provision for loan losses                                            |       | 3,521                                  |       | 1,528                    |       | 1,993                  |       | 130.4 |   |
| Net interest income afterprovision for loan losses                   |       | 1,175                                  |       | 3,537                    |       | (2,362                 | )          | (66.8 | ) |
| Noninterest income:                                                  |       |                                   |       |                     |       |                   |       |   |   |
| Deposit fee income                                                   |       | 1,192                                  |       | 1,211                    |       | (19                    | )          | (1.6 | ) |
| Earnings on life insurance  policies                                 |       | 197                                    |       | 1,371                    |       | (1,174                 | )          | (85.6 | ) |
| Gain on sale of loans                                                |       | 148                                    |       | 175                      |       | (27                    | )          | (15.4 | ) |
| Other                                                                |       | 370                                    |       | 447                      |       | (77                    | )          | (17.2 | ) |
| Total noninterest income                                             |       | 1,907                                  |       | 3,204                    |       | (1,297                 | )          | (40.4 | ) |
| Noninterest expenses:                                                |       |                                   |       |                     |       |                   |       |   |   |
| Salaries and employee  benefits                                      |       | 2,967                                  |       | 3,387                    |       | (420                   | )          | (12.4 | ) |
| Real estate owned, net                                               |       | 395                                    |       | 430                      |       | (35                    | )          | (6.0 | ) |
| Data processing                                                      |       | 408                                    |       | 318                      |       | 90                     |       | 28.3 |   |
| Advertising and public  relations                                    |       | 111                                    |       | 342                      |       | (231                   | )          | (67.5 | ) |
| Other                                                                |       | 1,968                                  |       | 1,594                    |       | 374                    |       | 23.5 |   |
| Total noninterest expenses                                           |       | 5,849                                  |       | 6,071                    |       | (222                   | )          | (3.7 | ) |
| Income (loss) before  income taxes                                   |       | (2,767                                 | )          | 670                      |       | (3,437                 | )          | (513.0 | ) |
| Income tax provision  (benefit)                                      |       | (1,264                                 | )          | (417                     | )          | (847                   | )          | 203.1 |   |
| Net income (loss)                                                    |       | (1,503                                 | )          | 1,087                    |       | (2,590                 | )          | (238.3 | ) |
| Preferred stock dividends and accretion of preferred  stock discount |       | 62                                     |       | —                   |       | 62                     |       | — |   |
| Net income (loss) available to common shareholders                   |       | $                                      | (1,565     | )                        | $          | 1,087                  |       | $ | (2,652 | ) | (244.0 | )% |
|                                                                 |       |                                   |       |                     |       |                   |       |   |   |
| Basic earnings per common  share                                     |       | $                                      | (0.32      | )                        | $          | 0.22                   |       | $ | (0.54 | ) | (245.5 | )% |
| Diluted earnings per  common share                                   |       | $                                      | (0.32      | )                        | $          | 0.22                   |       | $ | (0.54 | ) | (245.5 | )% |
|                                                                 |       |                                   |       |                     |       |                   |       |   |   |
| Interest rate spread                                                 |       | 2.65                                   | %          | 2.73                     | %          |                   |       |   |   |
| Net interest margin                                                  |       | 2.65                                   | %          | 2.78                     | %          |                   |       |   |   |
|                                                                 |       |                                   |       |                     |       |                   |       |   |   |
| Average full-time  equivalents                                       |       | 291                                    |       | 306                      |       |                   |       |   |   |
|                                                                 |       |                                   |       |                     |       |                   |       |   |   |
| Full-service offices                                                 |       | 20                                     |       | 19                       |       |                   |       |   |   |

 

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**Net Interest Income. **Net interest income is determined by the Company’s interest rate spread(i.e., the difference between the yields earned on its interest-earning assetsand the rates paid on its interest-bearing liabilities) and the relativeamounts of interest-earning assets and interest-bearing liabilities.

 

### **INTEREST INCOME AND INTEREST EXPENSE**

### ** **

Dollar changes in interest income and interest expense for thecomparison periods are presented in the Rate/Volume Analysis table whichappears on a previous page.

 

**Interest Income. **The decrease in interest income for the three month comparative periodwas primarily due to a decrease in the average yield earned on loansreceivable, as well as a decrease in the average balance of loansreceivable.  These decreases were offsetby an increase in the average balance of investment securities.  The decrease in the average yield earned onloans receivable was due to decreases in market interest rates and an increasein the level of nonaccrual loans.  Theaverage balance of loans receivable decreased due to repayments and maturitiesas well as a decrease in loan originations.

 

**Interest Expense. **The decrease in interest expense for the three month comparative periodwas primarily due to a decrease in the average rates paid on deposits and otherborrowings.  The decrease in the average rates paid on depositaccounts and other borrowings reflects decreases in market interest rates.

 

**Provision for Loan Losses.**  The provision for loan losses includescharges to maintain an allowance for loan losses adequate to cover probablecredit losses related to specifically identified loans as well as probablecredit losses inherent in the remainder of the loan portfolio that have beenincurred as of the balance sheet date. Such provision and the adequacy of the allowance for loan losses isevaluated quarterly by management of the Bank based on the Bank’s past loanloss experience, known and inherent risks in the portfolio, adverse situationsthat may affect the borrower’s ability to repay, the estimated value of anyunderlying collateral and current economic conditions.

 

The provision for loan losses increased $2.0 million to $3.5 millionfor the quarter ended March 31, 2009 compared to $1.5 million for thequarter ended March 31, 2008.  Theincrease in the provision for loan losses was primarily due to increases intotal nonaccrual loans and in the loss factors used in certain allowancecategories and an increase in specific loan loss allowances recorded during thequarter, in each respect due to deteriorating economic conditions.

 

**Noninterest Income. **The decrease in other noninterest income for the three monthcomparative period in 2009 was primarily due to $1.2 million in nonrecurringearnings on life insurance policies due to a death benefit claim recordedduring the quarter ended March 31, 2008.

 

**NoninterestExpense**

 

**Salaries and Employee Benefits. **The changes in thecomposition of this line item are presented below (in thousands):

 
| ** **                         | ** ** | **Three Months Ended  March 31,** | ** ** | **Decrease** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|--------------|------------|
| ** **                         | ** ** | **2009**                               | ** ** | **2008**     | ** ** | **2009 vs 2008** | ** ** |
| Salaries                           |       | $                                      | 2,467      |         | $          | 2,642 |   | $ | (175 | ) |
| Payroll taxes                      |       | 230                                    |       | 256          |       | (26 | ) |
| Insurance                          |       | 158                                    |       | 171          |       | (13 | ) |
| 401(k) (1)                    |       | 37                                     |       | 78           |       | (41 | ) |
| Defined benefit plan  contribution |       | 39                                     |       | 196          |       | (157 | ) |
| Other                              |       | 36                                     |       | 44           |       | (8 | ) |
| Total                              |       | $                                      | 2,967      |         | $          | 3,387 |   | $ | (420 | ) |

 

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(1)          Represents Company matching contributions on the 401(k) plan.  Effective February 16, 2009, the Companydiscontinued its matching contributions to the 401(k) plan.

 

The decrease in salaries and benefits was primarily due to a reduction infull time equivalents as well as a change in the benefit formula related to thedefined benefit plan.

 

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**Realestate owned, net.  **The changes in the composition of thisline item are presented below (in thousands):

 
| ** **               | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase****(Decrease)** | ** ** |
|--------------------------|------------|----------------------------------------|------------|----------------------------|------------|
| ** **               | ** ** | **2009**                               | ** ** | **2008**                   | ** ** | **2009 vs 2008** | ** ** |
| Loss provisions          |       | $                                      | 164        |                       | $          | 229 |   | $ | (65 | ) |
| Net loss (gain) on sales |       | (22                                    | )          | 53                         |       | (75 | ) |
| Taxes and insurance      |       | 184                                    |       | 111                        |       | 73 |   |
| Other                    |       | 69                                     |       | 37                         |       | 32 |   |
| Total                    |       | $                                      | 395        |                       | $          | 430 |   | $ | (35 | ) |

 

Expensesassociated with real estate owned have decreased due to the gain recognized onone property during the quarter. However, real estate owned is expected to increase in the foreseeablefuture and real estate owned expenses associated with maintaining theproperties are expected to increase accordingly.  Future levels of loss provisions and netgains or losses on sales of real estate owned will be dependent on market conditions.

 

**Data Processing.**  The increase in the three month comparativeperiod in 2009 was primarily due to credits received in 2008 associated withupgrading our computer system in the first quarter of 2007.

 

**Advertising and Public Relations.**  The decrease in 2009 is primarily related toa decrease in direct mail advertising as well as a decrease in expenses relatedto the “Thank You” gift program that was discontinued in September 2008.

 

**Other Expenses.**  Otherexpenses increased primarily due to a $223,000 increase in FDIC insurancepremiums to $241,000 for the first quarter of 2009 compared to $18,000 for thefirst quarter of 2008.  This increase wasdue to assessment credits which were available to partially offset FDIC premiumexpense in the first quarter of 2008 as well as an increase in the premium ratefor 2009.  FDIC premium expense isexpected to continue to increase, particularly in light of the proposed specialassessment to be effective June 30, 2009. We anticipate that FDIC premiums for the second, third, and fourthquarters of 2009 will be approximately $850,000, $225,000 and $225,000 higherthan the same periods in 2008, respectively, due to the special assessment inthe second quarter of 2009 and an increase in premium rates compared to thesame periods in 2008.  The estimatedincrease for the second quarter of 2009 assumes a 10 basis point specialassessment, which is estimated to be approximately $630,000.

 

**IncomeTaxes. **The income tax benefit increased primarily due to thenet taxable loss position for the quarter ended March 31, 2009.

 

# **OFF-BALANCE SHEET ARRANGEMENTS**

# ** **

The Company, in the normal course ofbusiness, makes commitments to buy or sell assets or to incur or fundliabilities.  Commitments include, butare not limited to:

 

·                  theorigination, purchase or sale of loans;

 

·                  thefulfillment of commitments under letters-of-credit, extensions of credit onhome equity lines of credit, construction loans, and predetermined overdraftprotection limits; and

 

·                  thecommitment to fund withdrawals of certificates of deposit at maturity.

 

At March 31, 2009, the Bank’soff-balance sheet arrangements principally included lending commitments, whichare described below.  At March 31,2009, the Company had no interests in non-consolidated special purposeentities.

 

At March 31, 2009, commitments included:

 

·                  totalapproved commitments to originate or purchase loans amounting to $4.3 million;

 

·                  ratelock agreements with customers of $8.5 million, all of which have been lockedwith an investor;

 

·                  fundedmortgage loans committed to sell of $1.2 million;

 

·                  unadvancedportion of construction loans of $9.7 million;

 

·                  unusedlines of credit of $18.4 million;

 

·                  outstandingstandby letters of credit of approximately $3.8 million;

 

·                  totalpredetermined overdraft protection limits of $15.8 million; and

 

·                  certificatesof deposit scheduled to mature in one year or less totaling $308.2 million.

 

Total unfunded commitments to originate loans for sale and the relatedcommitments to sell of $8.5 million meet the definition of a derivativefinancial instrument.  The related assetand liability are considered immaterial at March 31, 2009.

 

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Historically, a very small percentage of predetermined overdraft limitshave been used.  At March 31, 2009,overdrafts of accounts with Bounce ProtectionTM represented usage of 3.3% of the limit.  We expect utilization of these overdraftlimits to remain at comparable levels in the future.

 

Based on historical experience, management believes that a significantportion of maturing deposits will remain with the Bank.  We anticipate that we will continue to havesufficient funds, through repayments, deposits and borrowings, to meet ourcurrent commitments.

 

### **LIQUIDITY ANDCAPITAL RESOURCES**

### ** **

The Bank’s liquidity, represented bycash and cash equivalents and eligible investment securities, is a product ofits operating, investing and financing activities.  The Bank’s primary sources of funds aredeposits, borrowings, payments on outstanding loans, maturities and calls ofinvestment securities and other short-term investments and funds provided fromoperations.  While scheduled loanamortization and maturing investment securities and short-term investments arerelatively predictable sources of funds, deposit flows and loan prepayments aregreatly influenced by general interest rates, economic conditions andcompetition.  Calls of investmentsecurities are determined by the issuer and are generally influenced by thelevel of market interest rates at the bond’s call date compared to the couponrate of the bond.  The Bank manages thepricing of its deposits to maintain deposit balances at levels commensuratewith the operating, investing and financing activities of the Bank.  In addition, the Bank invests excess funds inovernight deposits and other short-term interest-earning assets that provideliquidity to meet lending requirements and pay deposit withdrawals. When fundsfrom the retail deposit market are inadequate for the liquidity needs of theBank or the pricing of deposits is not as favorable as other sources, the Bankhas borrowed from the FHLB of Dallas and the Federal Reserve Bank of St. Louis(“FRB”).  During the first quarter of2009, the use of FHLB and FRB borrowings decreased by $19.8 million or21.5%.  The Bank uses U.S. governmentagency investment securities and eligible one- to four-family loans ascollateral for FHLB advances and commercial real estate and U.S. governmentagency investment securities as collateral for FRB borrowings.  The Bank’s borrowing capacity is based on theamount of securities and loans pledged to the FHLB and FRB.  The Bank may transfer additional collateralto provide additional borrowing capacity if needed.  Currently, the Bank may borrow onlyshort-term FHLB advances with maturities up to thirty days.  At March 31, 2009, the Bank hadshort-term funds availability of approximately $136.8 million or 17% of assetsconsisting of borrowing capacity at the FRB and FHLB, unpledged investmentsecurities, and overnight funds.  TheBank anticipates it will continue to rely primarily on deposits, loanrepayments and repayments of its investment securities to provide liquidity.  As necessary, the sources of borrowed fundsdescribed above will be used to augment the Bank’s funding sources.

 

Liquidity management is both a dailyand long-term function of business management. Excess liquidity is generally invested in short-term investments such asovernight deposits and certificates of deposit. On a longer-term basis, the Bank maintains a strategy of investing invarious lending products and investment securities.  The Bank uses its sources of funds primarilyto meet its ongoing commitments, to pay maturing savings certificates and savingswithdrawals, to repay maturing borrowings, to fund loan commitments, and topurchase investment securities.

 

For the quarters ended March 31,2009 and 2008, the Company declared dividends of $0.01 and $0.16 per share,respectively.  The determination offuture dividends on the Company’s common stock will depend on conditionsexisting at that time with consideration given to the Company’s earnings,capital, and liquidity needs.  See Note 4to the unaudited consolidated financial statements for further informationregarding dividend restrictions.

 

As of March 31, 2009, the Bank’s regulatory capital was in excess of all applicableregulatory requirements and the Bank was considered well-capitalized under theregulatory framework for prompt corrective action.  At March 31, 2009, the Bank’s tangible, core and risk-based capital ratios amounted to10.69%, 10.69% and 16.51%, respectively, compared to regulatory requirements of1.5%, 4.0% and 8.0%, respectively.  As a result of the current difficult economic environmentand the uncertainties surrounding the timing of an economic recovery, theBank has agreed to maintain a core capital ratio of at least fivepercent and a risk-based capital ratio of at least ten percent.

 

### **IMPACT OF INFLATION AND CHANGING PRICES**

### ** **

The financial statements and related financial data presented hereinhave been prepared in accordance with generally accepted accounting principles,which require the measurement of financial position and operating results interms of historical dollars, without considering changes in relative purchasingpower over time due to inflation.

 

Unlike most industrial companies,virtually all of the Bank’s assets and liabilities are monetary in nature.  As a result, interest rates generally have amore significant impact on a financial institution’s performance than does theeffect of inflation.

 

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### **FORWARD-LOOKING STATEMENTS**

### ** **

The Company’s Quarterly Report on Form 10-Qcontains certain forward-looking statements and information relating to theCompany that are based on the beliefs of management as well as assumptions madeby and information currently available to management.  In addition, in this document, thewords “anticipate”, “believe,” “estimate,”****“expect,”“intend,” “should” and similar expressions, or the negative thereof, as theyrelate to the Company or the Company’s management, are intended to identifyforward-looking statements.  Suchstatements reflect the current views of the Company with respect to futurelooking events and are subject to certain risks, uncertainties andassumptions.  Should one or more of theserisks or uncertainties materialize or should underlying assumptions proveincorrect, actual results may vary materially from those described herein asanticipated, believed, estimated, expected or intended.  The Company does not intend to update theseforward-looking statements.

 

**QUANTITATIVE AND QUALITATIVE DISCLOSURES**

**ABOUT MARKET RISK**

 

There has been no material change in the market value of the Bank’sportfolio equity since December 31, 2008. Similarly, while there has been no material change in the Company’sasset and liability position since such time, the Bank’s increased level ofnonperforming assets continued to impact the level of net interest incomeduring the three months ended March 31, 2009.  Correspondingly, the Bank’s net interestmargin decreased from 3.19% for the three months ended December 31, 2008to 2.65% for the three months ended March 31, 2009.  Based on the level of nonperforming assetsand competitive pressures on loan and deposit rates, management anticipatescontinued pressure on the Bank’s interest rate spread and interest margin forthe second quarter of 2009 although the level of maturing certificates ofdeposits repricing to lower rates will somewhat offset the pressure on theinterest rate spread and margin.

 

**CONTROLS AND PROCEDURES**

 

Our management evaluated, with the participationof our Chief Executive Officer and Chief Financial Officer, the effectivenessof the design and operation of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934) as of the end of the period covered by this report.  Based on such evaluation, our Chief ExecutiveOfficer and Chief Financial Officer have concluded that our disclosure controlsand procedures are operating effectively.

 

No change in the Company’s internal controlover financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) underthe Securities Exchange Act) occurred during the most recent fiscal quarterthat has materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**Part II**

 

Item1.                                  LegalProceedings

 

Neither the Company nor the Bank is involved in any pending legalproceedings other than non-material legal proceedings occurring in the ordinarycourse of business.

 

Item1A.                        Risk Factors

 

There have been no material changes in the Company’s risk factors from thosepreviously disclosed in the Company’s Form 10-K for the year ended December 31,2008.

 

Item2.                                  UnregisteredSales of Equity Securities and Use of Proceeds

 

The Company did not repurchase any securities duringthe first quarter of 2009.  The Company isin its 19th announced repurchase program, which was approved by the board ofdirectors on July 25, 2006, and publicly announced on November 8,2006.  Total shares approved to bepurchased in this program are 245,197 of which 214,587 have been purchased asof March 31, 2009.  All treasurystock purchases are made under publicly announced repurchase programs.  The repurchase program is currentlysuspended.

 

Item3.                                  Defaults UponSenior Securities

 

Not applicable.

 

Item4.                                  Submission ofMatters to a Vote of Security Holders

 

Not applicable.

 

Item5.                                  OtherInformation

 

None.

 

Item6.                                  Exhibits

 

Exhibit 31.1 — Certification of Chief Executive Officer, Pursuantto Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

Exhibit 31.2 — Certification of Chief Financial Officer, Pursuantto Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

Exhibit 32.1 — Certification of Chief Executive Officer, Pursuantto Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

Exhibit 32.2 — Certification of Chief Financial Officer, Pursuantto Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 

**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

 

 
| Date: May 14, 2009 | By:    | /s/ Larry J. Brandt                                  |
|-------------------------|--------|------------------------------------------------------|
|                    |   | Larry J. Brandt                                      |
|                    |   | Chief Executive Officer                              |
|                    |   |                                                 |
|                    |   |                                                 |
| Date: May 14, 2009 | By:    | /s/ Sherri R. Billings                               |
|                    |   | Sherri R. Billings                                   |
|                    |   | Chief Financial Officer and Chief Accounting Officer |

 

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