**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 
| **ý** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE   SECURITIES EXCHANGE ACT OF 1934**                                                                                     |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                         |
|       | **For  the quarterly period ended June 30, 2005**                                                                                                                                       |
|       |                                                                                                                                                                                         |
| **OR**     |
|       |                                                                                                                                                                                         |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE   SECURITIES EXCHANGE ACT OF 1934**                                                                                    |
|       |                                                                                                                                                                                         |
|       | **For  the transition period from                          to** |

 

**CommissionFile Number 0-28312**

 

**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

(Exactname 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’stelephone number, including area code)

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

Yes    ý   No   o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

Yes    ý   No   o

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practicabledate:  As of July 19, 2005, therewere issued and outstanding 5,053,708 shares of the Registrant’s Common Stock,par value $.01 per share.

 

 

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

 

**TABLE OF CONTENTS**

 
| **Part I.**  | **Financial  Information**                                                                                                                                                  | ** ** |
|-------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|              |                                                                                                                                                                        |       |
| Item  1.          | Consolidated  Financial Statements                                                                                                                                          |       |
|              |                                                                                                                                                                        |       |
|              | Consolidated Statements of  Financial Condition as of June 30,  2005 and December 31, 2004 (unaudited)                                                       |       |
|              |                                                                                                                                                                        |       |
|              | Consolidated Statements of  Income for the three and six months ended June 30, 2005 and 2004 (unaudited)                                                          |       |
|              |                                                                                                                                                                        |       |
|              | Consolidated Statement of  Stockholders’ Equity for the six months ended June 30, 2005 (unaudited)                                                           |       |
|              |                                                                                                                                                                        |       |
|              | Consolidated Statements of  Cash Flows for the six months ended June 30,  2005 and 2004 (unaudited)                                                               |       |
|              |                                                                                                                                                                        |       |
|              | Notes to Unaudited  Consolidated Financial Statements                                                                                                                       |       |
|              |                                                                                                                                                                        |       |
| Item  2.          | Management’s  Discussion and Analysis of Financial Condition  and Results of Operations                                                                           |       |
|              |                                                                                                                                                                        |       |
| Item  3.          | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                 |       |
|              |                                                                                                                                                                        |       |
| Item  4.          | Controls  and Procedures                                                                                                                                                    |       |
|              |                                                                                                                                                                        |       |
| **Part II.** | **Other Information**                                                                                                                                                       | ** ** |
|              |                                                                                                                                                                        |       |
| Item 1.           | Legal Proceedings                                                                                                                                                           |       |
| Item 2.           | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                                                                |       |
| Item 3.           | Defaults Upon Senior Securities                                                                                                                                             |       |
| Item 4.           | Submission of Matters to a Vote of Security Holders                                                                                                                         |       |
| Item 5.           | Other Information                                                                                                                                                           |       |
| Item 6.           | Exhibits                                                                                                                                                                    |       |
|              |                                                                                                                                                                        |       |
| **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.**

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

(In thousands, except share data)

(Unaudited)

 
| ** **                                                                                                                                                                                   | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                   | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ASSETS:                                                                                                                                                                                      |       |              |       |                  |       |
|                                                                                                                                                                                         |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                    |       | $                 | 14,047     |                  | $          | 16,003 |   |
| Investment securities held to maturity                                                                                                                                                       |       | 55,885            |       | 56,660                |       |
| Federal Home Loan Bank stock                                                                                                                                                                 |       | 7,124             |       | 4,876                 |       |
| Loans receivable, net                                                                                                                                                                        |       | 685,939           |       | 634,217               |       |
| Accrued interest receivable                                                                                                                                                                  |       | 5,425             |       | 4,427                 |       |
| Real estate acquired in settlement of  loans, net                                                                                                                                            |       | 316               |       | 563                   |       |
| Office properties and equipment, net                                                                                                                                                         |       | 16,707            |       | 15,295                |       |
| Cash surrender value of life insurance                                                                                                                                                       |       | 18,286            |       | 17,897                |       |
| Prepaid expenses and other assets                                                                                                                                                            |       | 1,642             |       | 1,727                 |       |
|                                                                                                                                                                                         |       |              |       |                  |       |
| TOTAL ASSETS                                                                                                                                                                                 |       | $                 | 805,371    |                  | $          | 751,665 |   |
|                                                                                                                                                                                         |       |              |       |                  |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                    |       |              |       |                  |       |
|                                                                                                                                                                                         |       |              |       |                  |       |
| LIABILITIES:                                                                                                                                                                                 |       |              |       |                  |       |
| Deposits                                                                                                                                                                                     |       | $                 | 585,018    |                  | $          | 582,424 |   |
| Federal Home Loan Bank advances                                                                                                                                                              |       | 140,051           |       | 89,756                |       |
| Advance payments by borrowers for taxes and  insurance                                                                                                                                       |       | 519               |       | 757                   |       |
| Other liabilities                                                                                                                                                                            |       | 3,847             |       | 3,427                 |       |
| Total liabilities                                                                                                                                                                            |       | 729,435           |       | 676,364               |       |
|                                                                                                                                                                                         |       |              |       |                  |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                   |       |              |       |                  |       |
| Preferred stock, no par value, 5,000,000  shares authorized, none issued                                                                                                                     |       |              |       |                  |       |
| Common stock, $.01 par value, 20,000,000  shares authorized, 10,307,502 shares issued, 5,053,208 and 5,094,020 shares  outstanding at June 30, 2005 and December 31, 2004, respectively |       | 103               |       | 103                   |       |
| Additional paid-in capital                                                                                                                                                                   |       | 55,440            |       | 54,427                |       |
| Employee stock benefit plans                                                                                                                                                                 |       | (361              | )          | (582                  | )          |
| Retained earnings-substantially restricted                                                                                                                                                   |       | 80,959            |       | 78,261                |       |
|                                                                                                                                                                                         |       | 136,141           |       | 132,209               |       |
| Treasury stock, at cost, 5,254,294 and  5,213,482 shares at June 30, 2005 and December 31, 2004,  respectively                                                                     |       | (60,205           | )          | (56,908               | )          |
| Total stockholders’ equity                                                                                                                                                              |       | 75,936            |       | 75,301                |       |
|                                                                                                                                                                                         |       |              |       |                  |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                              |       | $                 | 805,371    |                  | $          | 751,665 |   |

 

See notes to unaudited consolidated financial statements.

 

1

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

**CONSOLIDATED STATEMENTS OF INCOME**

(In thousands, except share data)

(Unaudited)

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                           | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                           | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| INTEREST INCOME:                                     |       |                   |       |                 |       |   |   |   |   |
| Loans receivable                                     |       | $                      | 10,266     |                 | $          | 8,745 |   | $ | 20,150 |   | $ | 17,074 |   |
| Investment securities:                               |       |                   |       |                 |       |   |   |   |   |
| Taxable                                              |       | 532                    |       | 778                  |       | 1,050 |   | 1,572 |   |
| Nontaxable                                           |       | 178                    |       | 172                  |       | 358 |   | 338 |   |
| Other                                                |       | 25                     |       | 18                   |       | 39 |   | 110 |   |
| Total interest income                                |       | 11,001                 |       | 9,713                |       | 21,597 |   | 19,094 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| INTEREST EXPENSE:                                    |       |                   |       |                 |       |   |   |   |   |
| Deposits                                             |       | 3,480                  |       | 3,107                |       | 6,764 |   | 6,295 |   |
| Other borrowings                                     |       | 1,108                  |       | 326                  |       | 1,952 |   | 645 |   |
| Total interest expense                               |       | 4,588                  |       | 3,433                |       | 8,716 |   | 6,940 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| NET INTEREST INCOME                                  |       | 6,413                  |       | 6,280                |       | 12,881 |   | 12,154 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| PROVISION FOR LOAN LOSSES                            |       | 287                    |       | 202                  |       | 536 |   | 461 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| NET INTEREST INCOME AFTER PROVISION FOR  LOAN LOSSES |       | 6,126                  |       | 6,078                |       | 12,345 |   | 11,693 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| NONINTEREST INCOME:                                  |       |                   |       |                 |       |   |   |   |   |
| Deposit fee income                                   |       | 1,105                  |       | 896                  |       | 2,114 |   | 1,667 |   |
| Earnings on life insurance policies                  |       | 191                    |       | 197                  |       | 389 |   | 407 |   |
| Gain on sale of loans                                |       | 182                    |       | 196                  |       | 316 |   | 322 |   |
| Other                                                |       | 246                    |       | 296                  |       | 475 |   | 620 |   |
| Total noninterest income                             |       | 1,724                  |       | 1,585                |       | 3,294 |   | 3,016 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| NONINTEREST EXPENSES:                                |       |                   |       |                 |       |   |   |   |   |
| Salaries and employee benefits                       |       | 3,013                  |       | 2,758                |       | 6,016 |   | 5,437 |   |
| Net occupancy expense                                |       | 506                    |       | 510                  |       | 1,005 |   | 1,002 |   |
| Data processing                                      |       | 412                    |       | 387                  |       | 752 |   | 795 |   |
| Professional fees                                    |       | 105                    |       | 121                  |       | 220 |   | 229 |   |
| Advertising and public relations                     |       | 241                    |       | 304                  |       | 482 |   | 431 |   |
| Postage and supplies                                 |       | 190                    |       | 173                  |       | 380 |   | 353 |   |
| Other                                                |       | 512                    |       | 571                  |       | 1,021 |   | 1,051 |   |
| Total noninterest expenses                           |       | 4,979                  |       | 4,824                |       | 9,876 |   | 9,298 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| INCOME BEFORE INCOME TAXES                           |       | 2,871                  |       | 2,839                |       | 5,763 |   | 5,411 |   |
| INCOME TAX PROVISION                                 |       | 922                    |       | 908                  |       | 1,850 |   | 1,720 |   |
| NET INCOME                                           |       | $                      | 1,949      |                 | $          | 1,931 |   | $ | 3,913 |   | $ | 3,691 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| EARNINGS PER SHARE:                                  |       |                   |       |                 |       |   |   |   |   |
| Basic                                                |       | $                      | 0.39       |                 | $          | 0.38 |   | $ | 0.79 |   | $ | 0.72 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| Diluted                                              |       | $                      | 0.37       |                 | $          | 0.36 |   | $ | 0.75 |   | $ | 0.68 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| Cash Dividends Declared                              |       | $                      | 0.12       |                 | $          | 0.10 |   | $ | 0.24 |   | $ | 0.20 |   |

 

See notes to unaudited consolidated financial statements.

 

2

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

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

**FOR THE SIX MONTHS ENDED JUNE 30, 2005**

(In thousands, except share data)

(Unaudited)

 
| ** **                                                 | ** ** | ** **       | ** ** | ** **     | ** ** | ** **  | ** ** | **Employee** | ** ** | ** **   | ** ** |
|------------------------------------------------------------|------------|------------------|------------|----------------|------------|-------------|------------|--------------|------------|--------------|------------|
| ** **                                                 | ** ** | **Issued**       | ** ** | **Additional** | ** ** | **Stock**   | ** ** | ** **   | ** ** |
| ** **                                                 | ** ** | **Common Stock** | ** ** | **Paid-In**    | ** ** | **Benefit** | ** ** | **Retained** | ** ** |
| ** **                                                 | ** ** | **Shares**       | ** ** | **Amount**     | ** ** | **Capital** | ** ** | **Plans**    | ** ** | **Earnings** | ** ** |
|                                                       |       |             |       |           |       |        |       |         |       |         |       |
| Balance, January 1, 2005                              |       | 10,307,502       |       | $              | 103        |        | $          | 54,427       |       | $            | (582       | ) | $ | 78,261 |   |
| Net income                                                 |       |             |       |           |       |        |       |         |       | 3,913        |       |
| Release of ESOP shares                                     |       |             |       |           |       | 792         |       | 208          |       |         |       |
| Tax effect of stock compensation plan                      |       |             |       |           |       | 472         |       |         |       |         |       |
| Treasury shares reissued due to exercise of  stock options |       |             |       |           |       | (251        | )          |         |       |         |       |
| Purchase of treasury stock, at cost                        |       |             |       |           |       |        |       |         |       |         |       |
| Vesting of MRP shares                                      |       |             |       |           |       |        |       | 13           |       |         |       |
| Dividends paid                                             |       |             |       |           |       |        |       |         |       | (1,215       | )          |
|                                                       |       |             |       |           |       |        |       |         |       |         |       |
| Balance, June 30, 2005                                |       | 10,307,502       |       | $              | 103        |        | $          | 55,440       |       | $            | (361       | ) | $ | 80,959 |   |

 
| ** **                                                 | ** ** | ** **         | ** ** | ** **             | ** ** | **Total**  | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                 | ** ** | **Treasury Stock** | ** ** | **Stockholders’** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                 | ** ** | **Shares**         | ** ** | **Amount**             | ** ** | **Equity** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                       |       |               |       |                   |       |       |       |       |       |       |       |
| Balance, January 1, 2005                              |       | 5,213,482          |       | $                      | (56,908    | )          | $          | 75,301     |       |       |       |   |   |
| Net income                                                 |       |               |       |                   |       | 3,913      |       |       |       |       |       |
| Release of ESOP shares                                     |       |               |       |                   |       | 1,000      |       |       |       |       |       |
| Tax effect of stock compensation plan                      |       |               |       |                   |       | 472        |       |       |       |       |       |
| Treasury shares reissued due to exercise of  stock options |       | (172,188           | )          | 1,918                  |       | 1,667      |       |       |       |       |       |
| Purchase of treasury stock, at cost                        |       | 213,000            |       | (5,215                 | )          | (5,215     | )          |       |       |       |       |
| Vesting of MRP shares                                      |       |               |       |                   |       | 13         |       |       |       |       |       |
| Dividends paid                                             |       |               |       |                   |       | (1,215     | )          |       |       |       |       |
|                                                       |       |               |       |                   |       |       |       |       |       |       |       |
| Balance, June 30, 2005                                |       | 5,254,294          |       | $                      | (60,205    | )          | $          | 75,936     |       |       |       |   |   |

 

Seenotes to unaudited consolidated financial statements.

 

3

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In Thousands)

(Unaudited)

 
| ** **                                                                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                                                               |       |                               |       |   |   |
| OPERATING ACTIVITIES:                                                              |       |                               |       |   |   |
| Net income                                                                         |       | $                                  | 3,913      |   | $ | 3,691 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                               |       |   |   |
| Provision for loan losses                                                          |       | 536                                |       | 461 |   |
| Provision for real estate losses                                                   |       | 24                                 |       | 32 |   |
| Deferred tax benefit                                                               |       | (91                                | )          | (105 | ) |
| Accretion of discounts on investment  securities, net                              |       | (1                                 | )          | (34 | ) |
| Federal Home Loan Bank stock dividends                                             |       | (95                                | )          | (26 | ) |
| Gain (loss) on disposition of office  properties and equipment                     |       | 3                                  |       | (37 | ) |
| Gain (loss) on sale of repossessed assets,  net                                    |       | (15                                | )          | 2 |   |
| Originations of loans held for sale                                                |       | (24,087                            | )          | (26,196 | ) |
| Proceeds from sales of loans                                                       |       | 23,559                             |       | 26,876 |   |
| Gain on sale of loans originated to sell                                           |       | (316                               | )          | (322 | ) |
| Depreciation                                                                       |       | 585                                |       | 594 |   |
| Amortization of deferred loan fees, net                                            |       | 80                                 |       | 26 |   |
| Release of ESOP shares                                                             |       | 1,000                              |       | 842 |   |
| MRP compensation expense                                                           |       | 13                                 |       | 13 |   |
| Earnings on life insurance policies                                                |       | (389                               | )          | (407 | ) |
| Changes in operating assets and  liabilities:                                      |       |                               |       |   |   |
| Accrued interest receivable                                                        |       | (998                               | )          | (180 | ) |
| Prepaid expenses and other assets                                                  |       | 85                                 |       | 455 |   |
| Other liabilities                                                                  |       | (17                                | )          | 125 |   |
| Net cash provided by operating activities                                          |       | 3,789                              |       | 5,810 |   |
|                                                                               |       |                               |       |   |   |
| INVESTING ACTIVITIES:                                                              |       |                               |       |   |   |
| Purchases of investment securities held to  maturity                               |       | (1,640                             | )          | (83,019 | ) |
| Proceeds from maturities/calls of  investment securities held to maturity          |       | 3,416                              |       | 86,479 |   |
| Purchases of FHLB stock                                                            |       | (2,153                             | )          | (225 | ) |
| Redemptions of FHLB stock                                                          |       | —                             |       | 678 |   |
| Loan participations sold                                                           |       | 1,787                              |       | 2,709 |   |
| Loan originations, net of repayments                                               |       | (53,514                            | )          | (69,613 | ) |
| Proceeds from sales of repossessed assets                                          |       | 471                                |       | 426 |   |
| Proceeds from sales of office properties  and equipment                            |       | —                             |       | 576 |   |
| Purchases of office properties and  equipment                                      |       | (2,000                             | )          | (1,160 | ) |
| Net cash used in investing activities                                              |       | (53,633                            | )          | (63,149 | ) |
|                                                                               |       |                               |       |   |   |
| FINANCING ACTIVITIES:                                                              |       |                               |       |   |   |
| Net increase in deposits                                                           |       | 2,594                              |       | 8,061 |   |
| Advances from FHLB                                                                 |       | 88,423                             |       | 21,233 |   |
| Repayment of advances from FHLB                                                    |       | (38,128                            | )          | (7,298 | ) |
| Net decrease in advance payments by  borrowers for taxes and insurance             |       | (238                               | )          | (134 | ) |
| Purchase of treasury stock                                                         |       | (5,215                             | )          | (5,242 | ) |
| Reissued treasury stock                                                            |       | 1,667                              |       | 1,079 |   |
| Dividends paid                                                                     |       | (1,215                             | )          | (1,052 | ) |
| Net cash provided by financing activities                                          |       | 47,888                             |       | 16,647 |   |
|                                                                               |       |                               |       |   |   |
| Net decrease in cash and cash equivalents                                          |       | (1,956                             | )          | (40,692 | ) |
|                                                                                    |            |                                    |            |  |  |  |  |

 

(Continued)

 

4

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In Thousands)

(Unaudited)

 
| ** **                                                                     | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                     | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                                                           |       |                               |       |   |   |
| CASH AND CASH EQUIVALENTS:                                                     |       |                               |       |   |   |
| Beginning of period                                                            |       | $                                  | 16,003     |   | $ | 56,201 |   |
| End of period                                                                  |       | $                                  | 14,047     |   | $ | 15,509 |   |
|                                                                           |       |                               |       |   |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:                            |       |                               |       |   |   |
| Cash paid for:                                                                 |       |                               |       |   |   |
| Interest                                                                       |       | $                                  | 8,467      |   | $ | 6,939 |   |
| Income taxes                                                                   |       | $                                  | 1,132      |   | $ | 1,469 |   |
|                                                                           |       |                               |       |   |   |
| SUPPLEMENTAL SCHEDULE OF NONCASH  INVESTING ACTIVITIES:                   |       |                               |       |   |   |
| Real estate and other assets acquired in  settlement of loans                  |       | $                                  | 233        |   | $ | 330 |   |
| Loans to facilitate sales of real estate  owned                                |       | $                                  | —     |   | $ | 197 |   |
| Investment securities traded, recorded in  investments not yet settled in cash |       | $                                  | 1,000      |   | $ | 425 |   |

 

(Concluded)

 

See notes to unaudited consolidated financial statements.

 

5

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

 

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

# **Note 1 -Basis of Presentation and Principles of Consolidation**

#  

FirstFederal Bancshares of Arkansas, Inc. (the “Company”) is a unitary holdingcompany which owns all of the stock of First Federal Bank of Arkansas, FA (the “Bank”).  The Bank provides a broad line of financialproducts to individuals and small- to medium-sized businesses in Northwest andNorthcentral Arkansas.  The unauditedconsolidated financial statements also include the accounts of the Bank’swholly-owned subsidiary, First Harrison Service Corporation (“FHSC”), which isinactive.

 

Theaccompanying unaudited consolidated financial statements of the Company havebeen 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.

 

Theaccompanying unaudited consolidated financial statements include the accounts ofthe Company and the Bank.  All materialintercompany transactions have been eliminated in consolidation.

 

Theresults of operations for the six months ended June 30, 2005, are notnecessarily indicative of the results to be expected for the year ending December 31,2005.  The unaudited consolidatedfinancial statements and notes thereto should be read in conjunction with theaudited financial statements and notes thereto for the year ended December 31,2004, contained in the Company’s 2004 Annual Report to Stockholders.

 

Certainamounts in the June 30, 2004, unaudited consolidated financial statementshave been reclassified to conform to the classifications adopted for reportingin 2005.

 

**Note 2 - Earnings per Share**

 

Theweighted average number of common shares used to calculate earnings per sharefor the periods ended June 30, 2005 and 2004 were as follows:

 
| ** **                        | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                        | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Basic weighted - average shares   |       | 4,975,893                            |       | 5,113,191                          |       | 4,981,529 |   | 5,129,969 |   |
| Effect of dilutive securities     |       | 250,552                              |       | 313,711                            |       | 265,657 |   | 329,339 |   |
| Diluted weighted - average shares |       | 5,226,445                            |       | 5,426,902                          |       | 5,247,186 |   | 5,459,308 |   |

 

6

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# **MANAGEMENT’S DISCUSSION AND ANALYSIS**

**OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

### **CRITICALACCOUNTING POLICIES**

###  

Various elements of our accounting policies,by their nature, are inherently subject to estimation techniques, valuationassumptions and other subjective assessments. In particular, the methodology for the determination of our allowancefor loan losses, due to the judgments, estimates and assumptions inherent inthat policy, is critical to preparation of our financial statements.  This policy and the judgments, estimates andassumptions 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 this critical accounting policy, the use ofother judgments, estimates and assumptions could result in material differencesin our financial condition or results of operations.

 

Inestimating the amount of credit losses inherent in our loan portfolio, variousjudgments and assumptions are made.  Forexample, when assessing the condition of the overall economic environment,assumptions are made regarding future market conditions and their impact on theloan portfolio.  In the event thenational economy were to sustain a prolonged downturn, the loss factors appliedto our portfolios may need to be revised, which may significantly impact themeasurement of the allowance for loan losses. For impaired loans that are collateral-dependent, the estimated fairvalue of the collateral may deviate significantly from the proceeds receivedwhen the collateral is sold.

 

## **CHANGES INFINANCIAL CONDITION**

##  

Changesin financial condition between June 30, 2005 and December 31, 2004are presented in the following table (dollars in thousands).  Material changes between the periods arediscussed in the sections which follow the table.

 
| ** **                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **Percentage** | ** ** |
|-----------------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|----------------|------------|
| ** **                                    | ** ** | **2005**          | ** ** | **2004**              | ** ** | **(Decrease)** | ** ** | **Change**     | ** ** |
| **ASSETS**                                    |       |              |       |                  |       |           |       |           |       |
| Cash and cash equivalents                     |       | $                 | 14,047     |                  | $          | 16,003         |       | $              | (1,956     | ) | (12.2% | ) |
| Investment securities held to maturity        |       | 55,885            |       | 56,660                |       | (775           | )          | (1.4%          | )          |
| Loans receivable, net                         |       | 685,939           |       | 634,217               |       | 51,722         |       | 8.2            | %          |
| Federal Home Loan Bank stock                  |       | 7,124             |       | 4,876                 |       | 2,248          |       | 46.1           | %          |
| Office properties and equipment, net          |       | 16,707            |       | 15,295                |       | 1,412          |       | 9.2            | %          |
| Prepaid expenses and other assets             |       | 25,669            |       | 24,614                |       | 1,055          |       | 4.3            | %          |
|                                          |       |              |       |                  |       |           |       |           |       |
| TOTAL                                         |       | $                 | 805,371    |                  | $          | 751,665        |       | $              | 53,706     |   | 7.1 | % |
|                                          |       |              |       |                  |       |           |       |           |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY** |       |              |       |                  |       |           |       |           |       |
| LIABILITIES:                                  |       |              |       |                  |       |           |       |           |       |
| Deposits                                      |       | $                 | 585,018    |                  | $          | 582,424        |       | $              | 2,594      |   | 0.4 | % |
| Federal Home Loan Bank advances               |       | 140,051           |       | 89,756                |       | 50,295         |       | 56.0           | %          |
| Other liabilities                             |       | 4,366             |       | 4,184                 |       | 182            |       | 4.3            | %          |
|                                          |       |              |       |                  |       |           |       |           |       |
| Total liabilities                             |       | 729,435           |       | 676,364               |       | 53,071         |       | 7.9            | %          |
|                                          |       |              |       |                  |       |           |       |           |       |
| STOCKHOLDERS’ EQUITY                     |       | 75,936            |       | 75,301                |       | 635            |       | 0.8            | %          |
|                                          |       |              |       |                  |       |           |       |           |       |
| TOTAL                                         |       | $                 | 805,371    |                  | $          | 751,665        |       | $              | 53,706     |   | 7.1 | % |
|                                          |       |              |       |                  |       |           |       |           |       |
| BOOK VALUE PER SHARE                          |       | $                 | 15.03      |                  | $          | 14.78          |       |           |       |   |   |
|                                          |       |              |       |                  |       |           |       |           |       |
| EQUITY TO ASSETS                              |       | 9.4               | %          | 10.0                  | %          |           |       |           |       |

 

7

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**Loans Receivable. **Changes in loan composition between June 30,2005 and December 31, 2004 are presented in the following table (dollarsin thousands).

 
| ** **                                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **Percentage** | ** ** |
|------------------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|----------------|------------|
| ** **                                     | ** ** | **2005**          | ** ** | **2004**              | ** ** | **(Decrease)** | ** ** | **Change**     | ** ** |
|                                           |       |              |       |                  |       |           |       |           |       |
| One- to four- family residential               |       | $                 | 281,100    |                  | $          | 282,144        |       | $              | (1,044     | ) |   |   |
| Multi-family residential                       |       | 12,759            |       | 9,454                 |       | 3,305          |       |           |       |
| Commercial real estate                         |       | 147,503           |       | 145,909               |       | 1,594          |       |           |       |
| Construction                                   |       | 218,471           |       | 159,111               |       | 59,360         |       |           |       |
| Total first mortgage loans                     |       | 659,833           |       | 596,618               |       | 63,215         |       | 10.6           | %          |
|                                           |       |              |       |                  |       |           |       |           |       |
| Commercial                                     |       | 31,284            |       | 27,545                |       | 3,739          |       | 13.6           | %          |
|                                           |       |              |       |                  |       |           |       |           |       |
| Home equity and second mortgage                |       | 49,365            |       | 45,256                |       | 4,109          |       |           |       |
| Automobile                                     |       | 17,638            |       | 19,101                |       | (1,463         | )          |           |       |
| Other                                          |       | 12,127            |       | 10,685                |       | 1,442          |       |           |       |
| Total consumer                                 |       | 79,130            |       | 75,042                |       | 4,088          |       | 5.4            | %          |
|                                           |       |              |       |                  |       |           |       |           |       |
| Total loans receivable                         |       | 770,247           |       | 699,205               |       | 71,042         |       | 10.2           | %          |
| Less:                                          |       |              |       |                  |       |           |       |           |       |
| Undisbursed loan funds                         |       | (82,009           | )          | (62,661               | )          | (19,348        | )          |           |       |
| Unearned discounts and net deferred loan  fees |       | (277              | )          | (481                  | )          | 204            |       |           |       |
| Allowance for loan losses                      |       | (2,022            | )          | (1,846                | )          | (176           | )          |           |       |
|                                           |       |              |       |                  |       |           |       |           |       |
| Total loans receivable, net                    |       | $                 | 685,939    |                  | $          | 634,217        |       | $              | 51,722     |   | 8.2 | % |

 

TheBank continued to experience demand for multi-family loans, commercial realestate loans, construction loans, commercial loans, and consumer loans.  Generally, the Bank’s construction loans werefor the purpose of constructing single-family residential properties.  The interest rate environment and robusteconomy of our market area provided continued demand and opportunity for our otherloan products as well.  In recent years,the Bank has placed an increased emphasis on commercial real estate lending,construction lending, and commercial lending to diversify its loan portfolio,take advantage of market opportunities in these types of loans, and help theBank transition to a more full-service community bank, as well as to provideopportunities to cross-sell its other banking products.  The growth in the consumer loan category wasprimarily within home equity loans.

 

8

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**Asset Quality. **The following table sets forth the amountsand categories of the Bank’s nonperforming assets at the dates indicated.

 
| ** **                                                                         | ** ** | **June 30, 2005**     | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                                                         | ** ** | **(Dollars in Thousands)** | ** ** |
| Nonaccrual loans:                                                                  |       |                       |       |                       |       |
| One- to four-family residential                                                    |       | $                          | 4,475      |                       | $          | 2,619 |   |
| Construction loans                                                                 |       | 845                        |       | 634                        |       |
| Commercial real estate                                                             |       | 744                        |       | —                     |       |
| Commercial loans                                                                   |       | 1,125                      |       | 186                        |       |
| Consumer loans                                                                     |       | 583                        |       | 723                        |       |
| Total nonaccrual loans                                                             |       | 7,772                      |       | 4,162                      |       |
|                                                                               |       |                       |       |                       |       |
| Restructured loans (1)                                                             |       | 3,700                      |       | 3,790                      |       |
| Real estate owned                                                                  |       | 316                        |       | 563                        |       |
|                                                                               |       |                       |       |                       |       |
| Nonperforming assets                                                               |       | $                          | 11,788     |                       | $          | 8,515 |   |
|                                                                               |       |                       |       |                       |       |
| Total nonaccrual and restructured loans as  a percentage of total loans receivable |       | 1.49                       | %          | 1.14                       | %          |
|                                                                               |       |                       |       |                       |       |
| Total nonperforming assets as a percentage  of total assets                        |       | 1.46                       | %          | 1.13                       | %          |

 

----

(1)       At June 30, 2005 and December 31, 2004,restructured loans consisted of a group of commercial loans and commercial realestate loans to a single borrower. Although the loans were not past due more than 90 days at either date,the borrower has used overdraft privileges with the Bank to maintain paymentson the loans.  At June 30, 2005 andDecember 31, 2004, the borrower was overdrawn $234,000 and $151,000,respectively.  It is unlikely that theborrower would be able to keep their loans current without the overdraftprivilege and the Bank is currently working with the borrower while they seekalternative financing arrangements.

 

The increase in one- to four- familyresidential, commercial real estate, and commercial nonaccrual loans between December 31,2004 and June 30, 2005 was primarily due to two lending relationshipsdiscussed below.  At June 30, 2005,each of the loans in these relationships was reviewed and the value ofunderlying collateral was estimated, primarily based on appraisals.  For the relationship totaling $1.5 million,the Bank estimates that it will incur no loss. For the relationship totaling $4.0 million, the Bank has estimated itsloss exposure as of June 30, 2005 at approximately $175,000.  This estimated loss is included in theallowance for loan losses as of June 30, 2005.

 

Thefirst relationship consists of five loans totaling $1.54 million, consisting of$800,000 of one- to four- family residential loans secured by two residentialproperties and $700,000 of commercial real estate loans secured by an officebuilding.  The Bank has initiatedforeclosure proceedings on all three properties as of June 30, 2005.  The Bank is currently in negotiations with apotential buyer who has made a verbal offer to buy the loans for $1.5 million.Negotiations are ongoing and the Bank believes that it will negotiate anagreement to sell these notes for a minimal loss to the Bank.

 

Thesecond relationship includes 24 loans totaling $4.0 million, consisting of 15loans or $1.7 million classified as substandard, which are listed in the tableabove, four loans or $1.5 million classified as special mention, and five loansor $800,000 classified as watch.  Theseloans include approximately $130,000 in unsecured loans and a collateral shortfallof approximately $45,000 on one of the properties when loan balances werecompared to appraised amounts.  The Bank,through its attorney, has sent demand letters to the borrower with a deadlineof the end of August to pay the loans in full.  The Bank has received correspondence from theborrower’s attorney that the borrower intends to refinance the loans or sellassets to satisfy all loans with the Bank.

 

9

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**Allowance for Loan Losses**.  Asummary of the activity in the allowance for loan losses is as follows (inthousands):

 
| ** **                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                      | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Balance at beginning of period  |       | $                                    | 1,950      |                               | $          | 1,703 |   | $ | 1,846 |   | $ | 1,621 |   |
| Provisions for estimated losses |       | 287                                  |       | 202                                |       | 536 |   | 461 |   |
| Recoveries                      |       | 25                                   |       | 25                                 |       | 51 |   | 49 |   |
| Losses charged off              |       | (240                                 | )          | (240                               | )          | (411 | ) | (441 | ) |
| Balance at end of period        |       | $                                    | 2,022      |                               | $          | 1,690 |   | $ | 2,022 |   | $ | 1,690 |   |

#  

Changesin the composition of the allowance for loan losses between June 30, 2005and December 31, 2004 are presented in the following table (in thousands):

 
| ** **  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** |
|-------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|
| ** **  | ** ** | **2005**          | ** ** | **2004**              | ** ** | **(Decrease)** | ** ** |
| General     |       | $                 | 1,527      |                  | $          | 1,476          |       | $ | 51 |   |
| Specific    |       | 319               |       | 318                   |       | 1              |       |
| Unallocated |       | 176               |       | 52                    |       | 124            |       |
|        |       | $                 | 2,022      |                  | $          | 1,846          |       | $ | 176 |   |

 

Theallowance for loan losses is evaluated on a regular basis by management and isbased upon management’s periodic review of the collectibility of the loans inlight of historical experience, the nature and volume of the loan portfolio,adverse situations that may affect the borrower’s ability to repay, theestimated value of any underlying collateral and prevailing economicconditions.  This evaluation isinherently subjective as it requires estimates that are susceptible tosignificant revision as conditions change and more information becomesavailable.

 

Theallowance consists of specific, general and unallocated components. Thespecific component relates to loans that are classified as loss, doubtful,substandard or special mention. For such loans that are also classified asimpaired, an allowance is established when the discounted cash flows (orcollateral value or observable market price) of the impaired loan is lower thanthe carrying value of that loan. The general component covers non-classifiedloans and is based primarily on historical loss experience. An unallocatedcomponent is maintained to cover uncertainties that could affect management’sestimate of probable losses. The unallocated component of the allowancereflects the margin of imprecision inherent in the underlying assumptions usedin the methodologies for estimating specific and general losses in theportfolio.

 

TheBank reviews its non-homogeneous loans for impairment on a quarterlybasis.  The Bank considers commercialreal estate, construction, multi-family, and commercial loans to benon-homogeneous loans.  A loan isconsidered impaired when, based on current information and events, it isprobable that the Bank will be unable to collect the scheduled payments of principalor interest when due according to the contractual terms of the loanagreement.  Factors considered bymanagement in determining impairment include payment status, collateral value,and the probability of collecting scheduled principal and interest paymentswhen due.  Loans that experienceinsignificant payment delays and payment shortfalls generally are notclassified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record, and the amount ofthe shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loanbasis by either the present value of expected future cash flows discounted atthe loan’s effective interest rate, the loan’s obtainable market price, or thefair value of the collateral if the loan is collateral dependent.

 

10

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Largegroups of smaller balance homogeneous loans are collectively evaluated forimpairment.  Accordingly, the Bank doesnot separately identify individual consumer and residential loans for impairmentdisclosures.  Homogeneous loans are thosethat are considered to have common characteristics that provide for evaluationon an aggregate or pool basis.  The Bankconsiders the characteristics of (1) one- to- four family residentialfirst mortgage loans; (2) unsecured consumer loans; and (3) collateralizedconsumer loans to permit consideration of the appropriateness of the allowancefor losses of each group of loans on a pool basis.  The primary methodology used to determine theappropriateness of the allowance for losses includes segregating certainspecific, poorly performing loans based on their performance characteristicsfrom the pools of loans as to type, valuing these loans, and then applying aloss factor to the remaining pool balance based on several factors, includingpast loss experience, inherent risks, and economic conditions in the primarymarket areas.

 

Inestimating the amount of credit losses inherent in our loan portfolio, variousjudgments and assumptions are made.  Forexample, when assessing the condition of the overall economic environment,assumptions are made regarding future market conditions and their impact on theloan portfolio.  In the event thenational economy were to sustain a prolonged downturn, the loss factors appliedto our portfolios may need to be revised, which may significantly impact themeasurement of the allowance for loan losses. For impaired loans that are collateral-dependent, the estimated fairvalue of the collateral may deviate significantly from the proceeds receivedwhen the collateral is sold.

 

Althoughwe consider the allowance for loan losses of approximately $2.0 millionappropriate and adequate to cover losses inherent in our loan portfolio at June 30,2005, no assurance can be given that we will not sustain loan losses that aresignificantly different from the amount provided, or that subsequentevaluations of the loan portfolio, in light of factors then prevailing, wouldnot result in a significant change in the allowance for loan losses.

 

**Investment Securities. **Changes in thecomposition of investment securities held to maturity between June 30,2005 and December 31, 2004 are presented in the following table (inthousands).

 
| ** **                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** |
|----------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|
| ** **                             | ** ** | **2005**          | ** ** | **2004**              | ** ** | **(Decrease)** | ** ** |
| Certificates of deposit                |       | $                 | —     |                  | $          | 3,000          |       | $ | (3,000 | ) |
| U.S. Government and agency obligations |       | 40,042            |       | 37,821                |       | 2,221          |       |
| Municipal securities                   |       | 15,843            |       | 15,839                |       | 4              |       |
| Total                                  |       | $                 | 55,885     |                  | $          | 56,660         |       | $ | (775 | ) |

 

Duringthe first six months of 2005, investment securities totaling $2.6 million werepurchased and $3.4 million matured or were called.   The increase in U.S. Government and agencyobligations was due to purchases in excess of calls and maturities.

 

AtJune 30, 2005, estimated fair values of investment securities held tomaturity were as follows (in thousands):

** **
| ** **                             | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------|------------|------------|------------|
|                                   |       |                |       |            |       |       |       |
| U.S. Government and agency obligations |       | $                   | 40,042     |            | $          | 39,803     |       |   |   |
| Municipal securities                   |       | 15,843              |       | 16,105          |       |       |       |
| Total                                  |       | $                   | 55,885     |            | $          | 55,908     |       |   |   |

 

**Federal Home Loan Bank Stock. ** Federal Home Loan Bank (“FHLB”) stockincreased by approximately $2.2 million due to required purchases related tothe increase in FHLB advances.

 

**Office properties and equipment. **The increase in office properties and equipment is due to land purchasedfor branch expansion, construction costs for new branches in Mountain Home andSpringdale, and remodeling of existing branch locations.

 

11

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**Deposits. **Changes in the composition of depositsbetween June 30, 2005 and December 31, 2004 are presented in thefollowing table (dollars in thousands).

 
| ** **              | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **Percentage** | ** ** |
|-------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|----------------|------------|
| ** **              | ** ** | **2005**          | ** ** | **2004**              | ** ** | **(Decrease)** | ** ** | **Change**     | ** ** |
|                    |       |              |       |                  |       |           |       |           |       |
| DDA and NOW accounts    |       | $                 | 114,689    |                  | $          | 109,772        |       | $              | 4,917      |   | 4.5 | % |
| Money Market accounts   |       | 81,057            |       | 106,063               |       | (25,006        | )          | (23.6          | )%         |
| Savings accounts        |       | 32,631            |       | 31,611                |       | 1,020          |       | 3.2            | %          |
| Certificates of deposit |       | 356,641           |       | 334,978               |       | 21,663         |       | 6.5            | %          |
|                    |       |              |       |                  |       |           |       |           |       |
| Total deposits          |       | $                 | 585,018    |                  | $          | 582,424        |       | $              | 2,594      |   | 0.4 | % |

 

TheBank experienced a shift in the mix of deposits from money market accounts tocertificates of deposit during the six month period ended June 30,2005.  Certificates of deposit increasedas interest rates began to rise. Further, the Bank has advertised several CD products with special ratesand terms ranging from 7 to 40 months. The cost of deposit funds increased from 2.26% at December 31, 2004to 2.46% at June 30, 2005.  The Bankwill continue to aggressively promote checking accounts and expand its promotionof checking accounts by targeting small- and medium-sized business accountswith its direct mail campaign and “thank you” gifts which began in the secondquarter of 2005.  Checking accounts arean attractive source of funds for the Bank as they offer low-interest deposits,fee income potential, and the opportunity to cross-sell other financialservices.

 

**Federal Home Loan Bank Advances. ** The Bank experienced growth of$50.3 million or 56.0% in FHLB of Dallas advances during the first six monthsof 2005.  The advances were used to fundloan growth during the year.  The balanceof advances at June 30, 2005 of $140.1 million consisted of $91.9 millionof fixed rate advances with an average cost of 3.8% and $48.2 million offloating rate advances with an average cost of 3.3%.

 

**Other Liabilities.**  Other liabilities increasedprimarily due to an increase in accrued interest payable on FHLB advancesrelated to an increase in the balance of FHLB advances.

 

**Stockholders’ Equity. **Stockholders’ equity increased $635,000 from December 31,2004 to June 30, 2005.  The increasein stockholders’ equity was primarily due to net income of $3.9 million and theissuance of treasury stock due to proceeds received from the exercise of stockoptions of $1.7 million offset by the purchase of treasury stock totaling $5.2million during the first six months of 2005. In addition, during the six months ended June 30, 2005, cashdividends of $1.2 million were paid.  Seethe Unaudited Consolidated Statement of Stockholders’ Equity for the six monthsended June 30, 2005 for more detail.

 

12

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### **AverageBalance Sheets**

###  

Thefollowing 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 and the yields earned and ratespaid at June 30, 2005.  Such yieldsand costs are derived by dividing income or expense by the average balance ofassets or liabilities, respectively, for the periods presented and outstandingbalances at June 30, 2005.  Averagebalances are based on daily balances during the period.

 
| ** **                                                        | ** ** | ** **                  | ** ** | **Three  Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------------|------------|
| ** **                                                        | ** ** | ** **                  | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | **June 30,**           | ** ** | ** **                            | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                        | ** ** | **2005**                    | ** ** | **Average**                           | ** ** | ** ** | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** |
| ** **                                                        | ** ** | **Yield/Cost**              | ** ** | **Balance**                           | ** ** | **Interest** | ** ** | **Cost** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Cost** | ** ** |
| ** **                                                        | ** ** | **(Dollars  in Thousands)** | ** ** |
| Interest-earning  assets:                                         |       |                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Loans  receivable(1)                                              |       | 6.24                        | %          | $                                     | 678,547    |   | $ | 10,266 |   | 6.05 | % | $ | 558,359 |   | $ | 8,745 |   | 6.26 | % |
| Investment  securities(2)                                         |       | 4.57                        |       | 61,237                                |       | 710 |   | 4.64 |   | 87,979 |   | 950 |   | 4.32 |   |
| Other  interest-earning assets                                    |       | 3.27                        |       | 3,529                                 |       | 25 |   | 2.86 |   | 8,294 |   | 18 |   | 0.89 |   |
| Total  interest-earning assets                                    |       | 6.10                        |       | 743,313                               |       | 11,001 |   | 5.92 |   | 654,632 |   | 9,713 |   | 5.94 |   |
| Noninterest-earning  assets                                       |       |                        |       | 52,997                                |       |   |   |   |   | 48,107 |   |   |   |   |   |
| Total assets                                                      |       |                        |       | $                                     | 796,310    |   |   |   |   |   | $ | 702,739 |   |   |   |   |   |
| Interest-bearing  liabilities:                                    |       |                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                          |       | 2.46                        |       | 589,009                               |       | 3,480 |   | 2.36 |   | 580,472 |   | 3,107 |   | 2.14 |   |
| FHLB advances                                                     |       | 3.58                        |       | 126,229                               |       | 1,108 |   | 3.51 |   | 41,727 |   | 326 |   | 3.13 |   |
| Total  interest-bearing liabilities                               |       | 2.67                        |       | 715,238                               |       | 4,588 |   | 2.57 |   | 622,199 |   | 3,433 |   | 2.21 |   |
| Noninterest-bearing  liabilities                                  |       |                        |       | 5,155                                 |       |   |   |   |   | 4,867 |   |   |   |   |   |
| Total liabilities                                                 |       |                        |       | 720,393                               |       |   |   |   |   | 627,066 |   |   |   |   |   |
| Stockholders’  equity                                        |       |                        |       | 75,917                                |       |   |   |   |   | 75,673 |   |   |   |   |   |
| Total liabilities  and stockholders’ equity                  |       |                        |       | $                                     | 796,310    |   |   |   |   |   | $ | 702,739 |   |   |   |   |   |
|                                                              |       |                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income                                              |       |                        |       |                                  |       | $ | 6,413 |   |   |   |   |   | $ | 6,280 |   |   |   |
| Net earning  assets                                               |       |                        |       | $                                     | 28,075     |   |   |   |   |   | $ | 32,433 |   |   |   |   |   |
| Interest rate  spread                                             |       | 3.43                        | %          |                                  |       |   |   | 3.35 | % |   |   |   |   | 3.73 | % |
| Net interest  margin                                              |       |                        |       |                                  |       |   |   | 3.45 | % |   |   |   |   | 3.84 | % |
| Ratio of  interest-earning assets to interest-bearing liabilities |       |                        |       |                                  |       |   |   | 103.93 | % |   |   |   |   | 105.21 | % |

 
| ** **                                                        | ** ** | **Six  Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                        | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | **Average  Balance**                | ** ** | **Interest** | ** ** | **Average   Yield/ Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average   Yield/ Cost** | ** ** |
| ** **                                                        | ** ** | **(Dollars  in Thousands)**         | ** ** |
| Interest-earning  assets:                                         |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Loans  receivable(1)                                              |       | $                                   | 665,064    |   | $ | 20,150 |   | 6.06 | % | $ | 539,633 |   | $ | 17,074 |   | 6.33 | % |
| Investment  securities(2)                                         |       | 61,510                              |       | 1,408 |   | 4.58 |   | 88,015 |   | 1,910 |   | 4.34 |   |
| Other  interest-earning assets                                    |       | 2,939                               |       | 39 |   | 2.64 |   | 24,676 |   | 110 |   | 0.89 |   |
| Total  interest-earning assets                                    |       | 729,513                             |       | 21,597 |   | 5.92 |   | 652,324 |   | 19,094 |   | 5.85 |   |
| Noninterest-earning  assets                                       |       | 51,956                              |       |   |   |   |   | 47,534 |   |   |   |   |   |
| Total assets                                                      |       | $                                   | 781,469    |   |   |   |   |   | $ | 699,858 |   |   |   |   |   |
| Interest-bearing  liabilities:                                    |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                          |       | 585,715                             |       | 6,764 |   | 2.31 |   | 579,150 |   | 6,295 |   | 2.17 |   |
| FHLB advances                                                     |       | 114,886                             |       | 1,952 |   | 3.40 |   | 40,109 |   | 645 |   | 3.22 |   |
| Total  interest-bearing liabilities                               |       | 700,601                             |       | 8,716 |   | 2.49 |   | 619,259 |   | 6,940 |   | 2.24 |   |
| Noninterest-bearing  liabilities                                  |       | 5,164                               |       |   |   |   |   | 5,030 |   |   |   |   |   |
| Total liabilities                                                 |       | 705,765                             |       |   |   |   |   | 624,289 |   |   |   |   |   |
| Stockholders’  equity                                        |       | 75,704                              |       |   |   |   |   | 75,569 |   |   |   |   |   |
| Total liabilities  and stockholders’ equity                  |       | $                                   | 781,469    |   |   |   |   |   | $ | 699,858 |   |   |   |   |   |
|                                                              |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income                                              |       |                                |       | $ | 12,881 |   |   |   |   |   | $ | 12,154 |   |   |   |
| Net earning  assets                                               |       | $                                   | 28,912     |   |   |   |   |   | $ | 33,065 |   |   |   |   |   |
| Interest rate  spread                                             |       |                                |       |   |   | 3.43 | % |   |   |   |   | 3.61 | % |
| Net interest  margin                                              |       |                                |       |   |   | 3.53 | % |   |   |   |   | 3.73 | % |
| Ratio of  interest-earning assets to interest-bearing liabilities |       |                                |       |   |   | 104.13 | % |   |   |   |   | 105.34 | % |

 

----

(1) Includes nonaccrual loans.

(2) Includes FHLB of Dallas stock.

 

13

----

 

## **Rate/VolumeAnalysis**

##  

Thetable below sets forth certain information regarding changes in interest incomeand interest expense of the Company for the periods indicated.  For each category of interest-earning assetsand interest-bearing liabilities, information is provided on changesattributable to (i) changes in volume (changes in average volumemultiplied by prior rate); (ii) changes in rate (change in rate multipliedby prior average volume); (iii) changes in rate-volume (changes in ratemultiplied by the change in average volume); and (iv) the net change.

 
| ** **                         | ** ** | **Three Months Ended June 30,  2005 vs. 2004** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | **Increase (Decrease)   Due to**                    | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Volume**                                          | ** ** | **Rate** | ** ** | **Rate/   Volume** | ** ** | **Total   Increase  (Decrease)** | ** ** |
| ** **                         | ** ** | **(In Thousands)**                                  | ** ** |
| Interest income:                   |       |                                                |       |   |   |   |   |   |   |
| Loans receivable                   |       | $                                                   | 1,882      |   | $ | (297 | ) | $ | (64 | ) | $ | 1,521 |   |
| Investment securities              |       | (289                                                | )          | 70 |   | (21 | ) | (240 | ) |
| Other interest-earning assets      |       | (11                                                 | )          | 41 |   | (23 | ) | 7 |   |
| Total interest-earning assets      |       | 1,582                                               |       | (186 | ) | (108 | ) | 1288 |   |
|                               |       |                                                |       |   |   |   |   |   |   |
| Interest expense:                  |       |                                                |       |   |   |   |   |   |   |
| Deposits                           |       | 46                                                  |       | 323 |   | 4 |   | 373 |   |
| FHLB advances                      |       | 661                                                 |       | 40 |   | 81 |   | 782 |   |
| Total interest-bearing liabilities |       | 707                                                 |       | 363 |   | 85 |   | 1,155 |   |
| Net change in net interest income  |       | $                                                   | 875        |   | $ | (549 | ) | $ | (193 | ) | $ | 133 |   |

 
| ** **                         | ** ** | **Six Months Ended June 30,  2005 vs. 2004** | ** ** |
|------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **Increase (Decrease)   Due to**                  | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Volume**                                        | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Total   Increase (Decrease)** | ** ** |
| ** **                         | ** ** | **(In Thousands)**                                | ** ** |
| Interest income:                   |       |                                              |       |   |   |   |   |   |   |
| Loans receivable                   |       | $                                                 | 3,968      |   | $ | (724 | ) | $ | (168 | ) | $ | 3,076 |   |
| Investment securities              |       | (575                                              | )          | 105 |   | (32 | ) | (502 | ) |
| Other interest-earning assets      |       | (97                                               | )          | 216 |   | (190 | ) | (71 | ) |
| Total interest-earning assets      |       | 3,296                                             |       | (403 | ) | (390 | ) | 2,503 |   |
|                               |       |                                              |       |   |   |   |   |   |   |
| Interest expense:                  |       |                                              |       |   |   |   |   |   |   |
| Deposits                           |       | 71                                                |       | 394 |   | 4 |   | 469 |   |
| FHLB advances                      |       | 1,203                                             |       | 36 |   | 68 |   | 1,307 |   |
| Total interest-bearing liabilities |       | 1,274                                             |       | 430 |   | 72 |   | 1,776 |   |
| Net change in net interest income  |       | $                                                 | 2,022      |   | $ | (833 | ) | $ | (462 | ) | $ | 727 |   |

 

14

----

 

**CHANGES IN RESULTS OF OPERATIONS**

 

Thetable below presents a comparison of results of operations for the three monthsended June 30, 2005 and 2004 (dollars in thousands).  Specific changes in captions are discussed inthe sections which follow the table.

 
| ** **                                             | ** ** | **Three Months Ended   June 30,** | ** ** | **Increase (Decrease)** | ** ** | **Percentage  Change** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|------------------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **2005**                               | ** ** | **2004**                     | ** ** | **2005 vs 2004**       | ** ** | **2005 vs 2004** | ** ** |
| Interest  income:                                      | ** ** | ** **                             | ** ** | ** **                   | ** ** | ** **             | ** ** | ** ** | ** ** |
| Loans receivable                                       |       | $                                      | 10,266     |                         | $          | 8,745                  |       | $ | 1,521 |   |   |   |
| Investment securities                                  |       | 710                                    |       | 950                          |       | (240                   | )          |   |   |
| Other                                                  |       | 25                                     |       | 18                           |       | 7                      |       |   |   |
| Total interest income                                  |       | 11,001                                 |       | 9,713                        |       | 1,288                  |       | 13.3 | % |
| Interest expense:                                      |       |                                   |       |                         |       |                   |       |   |   |
| Deposits                                               |       | 3,480                                  |       | 3,107                        |       | 373                    |       |   |   |
| Other borrowings                                       |       | 1,108                                  |       | 326                          |       | 782                    |       |   |   |
| Total interest expense                                 |       | 4,588                                  |       | 3,433                        |       | 1,155                  |       | 33.6 | % |
| Net interest income before   provision for loan losses |       | 6,413                                  |       | 6,280                        |       | 133                    |       |   |   |
| Provision for loan losses                              |       | 287                                    |       | 202                          |       | 85                     |       | 42.1 | % |
| Net interest income after   provision for loan losses  |       | 6,126                                  |       | 6,078                        |       | 48                     |       | 0.8 | % |
| Noninterest income:                                    |       |                                   |       |                         |       |                   |       |   |   |
| Deposit fee income                                     |       | 1,105                                  |       | 896                          |       | 209                    |       |   |   |
| Gain on sale of loans                                  |       | 182                                    |       | 196                          |       | (14                    | )          |   |   |
| Other                                                  |       | 437                                    |       | 493                          |       | (56                    | )          |   |   |
| Total noninterest income                               |       | 1,724                                  |       | 1,585                        |       | 139                    |       | 8.8 | % |
| Noninterest expenses:                                  |       |                                   |       |                         |       |                   |       |   |   |
| Salaries and employee benefits                         |       | 3,013                                  |       | 2,758                        |       | 255                    |       |   |   |
| Net occupancy expense                                  |       | 506                                    |       | 510                          |       | (4                     | )          |   |   |
| Advertising and public relations                       |       | 241                                    |       | 304                          |       | (63                    | )          |   |   |
| Other                                                  |       | 1,219                                  |       | 1,252                        |       | (33                    | )          |   |   |
| Total noninterest expenses                             |       | 4,979                                  |       | 4,824                        |       | 155                    |       | 3.2 | % |
| Income before income taxes                             |       | 2,871                                  |       | 2,839                        |       | 32                     |       |   |   |
| Provision for income taxes                             |       | 922                                    |       | 908                          |       | 14                     |       |   |   |
| Net income                                             |       | 1,949                                  |       | 1,931                        |       | 18                     |       | 0.9 | % |
|                                                   |       |                                   |       |                         |       |                   |       |   |   |
| Basic earnings per share                               |       | $                                      | 0.39       |                         | $          | 0.38                   |       | $ | 0.01 |   | 2.6 | % |
| Diluted earnings per share                             |       | $                                      | 0.37       |                         | $          | 0.36                   |       | $ | 0.01 |   | 2.8 | % |
|                                                   |       |                                   |       |                         |       |                   |       |   |   |
| Interest rate spread                                   |       | 3.35                                   | %          | 3.73                         | %          |                   |       |   |   |
| Net interest margin                                    |       | 3.45                                   | %          | 3.84                         | %          |                   |       |   |   |
|                                                   |       |                                   |       |                         |       |                   |       |   |   |
| Full-time equivalents                                  |       | 261.5                                  |       | 246.3                        |       |                   |       |   |   |
|                                                   |       |                                   |       |                         |       |                   |       |   |   |
| Full-service offices                                   |       | 15                                     |       | 15                           |       |                   |       |   |   |

 

15

----

 

Thetable below presents a comparison of results of operations for the six monthsended June 30, 2005 and 2004 (dollars in thousands).  Specific changes in captions are discussed inthe sections which follow the table.

 
| ** **                                             | ** ** | **Six Months Ended   June 30,** | ** ** | **Increase  (Decrease)** | ** ** | **Percentage  Change** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|--------------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **2005**                             | ** ** | **2004**                 | ** ** | **2005 vs 2004**       | ** ** | **2005 vs 2004** | ** ** |
| Interest income:                                       |       |                                 |       |                     |       |                   |       |   |   |
| Loans receivable                                       |       | $                                    | 20,150     |                     | $          | 17,074                 |       | $ | 3,076 |   |   |   |
| Investment securities                                  |       | 1,408                                |       | 1,910                    |       | (502                   | )          |   |   |
| Other                                                  |       | 39                                   |       | 110                      |       | (71                    | )          |   |   |
| Total interest income                                  |       | 21,597                               |       | 19,094                   |       | 2,503                  |       | 13.1 | % |
| Interest expense:                                      |       |                                 |       |                     |       |                   |       |   |   |
| Deposits                                               |       | 6,764                                |       | 6,295                    |       | 469                    |       |   |   |
| Other borrowings                                       |       | 1,952                                |       | 645                      |       | 1,307                  |       |   |   |
| Total interest expense                                 |       | 8,716                                |       | 6,940                    |       | 1,776                  |       | 25.6 | % |
| Net interest income before   provision for loan losses |       | 12,881                               |       | 12,154                   |       | 727                    |       |   |   |
| Provision for loan losses                              |       | 536                                  |       | 461                      |       | 75                     |       | 16.3 | % |
| Net interest income after   provision for loan losses  |       | 12,345                               |       | 11,693                   |       | 652                    |       | 5.6 | % |
| Noninterest income:                                    |       |                                 |       |                     |       |                   |       |   |   |
| Deposit fee income                                     |       | 2,114                                |       | 1,667                    |       | 447                    |       |   |   |
| Gain on sale of loans                                  |       | 316                                  |       | 322                      |       | (6                     | )          |   |   |
| Other                                                  |       | 864                                  |       | 1,027                    |       | (163                   | )          |   |   |
| Total noninterest income                               |       | 3,294                                |       | 3,016                    |       | 278                    |       | 9.2 | % |
| Noninterest expenses:                                  |       |                                 |       |                     |       |                   |       |   |   |
| Salaries and employee benefits                         |       | 6,016                                |       | 5,437                    |       | 579                    |       |   |   |
| Net occupancy expense                                  |       | 1,005                                |       | 1,002                    |       | 3                      |       |   |   |
| Advertising and public relations                       |       | 482                                  |       | 431                      |       | 51                     |       |   |   |
| Other                                                  |       | 2,373                                |       | 2,428                    |       | (55                    | )          |   |   |
| Total noninterest expenses                             |       | 9,876                                |       | 9,298                    |       | 578                    |       | 6.2 | % |
| Income before income taxes                             |       | 5,763                                |       | 5,411                    |       | 352                    |       |   |   |
| Provision for income taxes                             |       | 1,850                                |       | 1,720                    |       | 130                    |       |   |   |
| Net income                                             |       | 3,913                                |       | 3,691                    |       | 222                    |       | 6.0 | % |
|                                                   |       |                                 |       |                     |       |                   |       |   |   |
| Basic earnings per share                               |       | $                                    | 0.79       |                     | $          | 0.72                   |       | $ | 0.07 |   | 9.7 | % |
| Diluted earnings per share                             |       | $                                    | 0.75       |                     | $          | 0.68                   |       | $ | 0.07 |   | 10.3 | % |
|                                                   |       |                                 |       |                     |       |                   |       |   |   |
| Interest rate spread                                   |       | 3.43                                 | %          | 3.61                     | %          |                   |       |   |   |
| Net interest margin                                    |       | 3.53                                 | %          | 3.73                     | %          |                   |       |   |   |
|                                                   |       |                                 |       |                     |       |                   |       |   |   |
| Full-time equivalents                                  |       | 254.4                                |       | 248.9                    |       |                   |       |   |   |
|                                                   |       |                                 |       |                     |       |                   |       |   |   |
| Full-service offices                                   |       | 15                                   |       | 15                       |       |                   |       |   |   |

 

16

----

 

**Net Interest Income. **Net interest income is determined by theCompany’s interest rate spread (i.e., the difference between the yields earnedon its interest-earning assets and the rates paid on its interest-bearingliabilities) and the relative amounts of interest-earning assets andinterest-bearing liabilities.

 

### **INTERESTINCOME AND INTEREST EXPENSE**

###  

Dollarchanges in interest income and interest expense for the comparison periods arepresented in the rate/volume analysis table which appears on page 14.

 

**Interest Income. **The increases in interest income for both thethree and six month comparative periods were primarily due to an increase inthe average balance of loans, partially offset by a decrease in the averageyield earned on loans and a decrease in the average balance of investmentsecurities.  The decrease in the averageyield earned on loans was primarily due to an increase in nonaccrual loans andan increase in construction loans, which typically have lower rates atorigination than those charged for permanent loans due to their shorter-termnature.  The average balance of loansincreased primarily due to increased construction loan originationactivity.  The average balance ofinvestment securities decreased due to calls and maturities.

 

**Interest Expense.  **The increases in interest expense for boththe three and six month comparative periods were primarily due to an increasein the average balance of FHLB advances and an increase in the average ratepaid on deposits.  The average balance ofFHLB advances increased due to advances being used to fund loan growth.

 

**Provision for Loan Losses.**  Theprovision for loan losses includes charges to maintain an allowance for loanlosses adequate to cover probable credit losses related to specificallyidentified loans as well as probable credit losses inherent in the remainder ofthe loan portfolio that have been incurred as of the balance sheet date.  Such provision and the adequacy of theallowance for loan losses is evaluated quarterly by management of the Bankbased on the Bank’s past loan loss experience, known and inherent risks in theportfolio, adverse situations that may affect the borrower’s ability to repay,the estimated value of any underlying collateral and current economicconditions.

 

Theincrease in the provision for loan losses in both the three and six monthcomparative periods was due primarily to the increase in nonperforming loansand, to a lesser degree, growth in the loan portfolio.

 

**Noninterest Income. **Deposit fee income increased for both thethree and six month comparative periods as a result of the Bank’s continuedpromotion of Bounce ProtectionTM overdraft service as well as anincrease in the number of checking accounts. The number of checking accounts increased approximately 6.6% from June 30,2004 to June 30, 2005.  The Bankplans to continue to aggressively promote checking accounts in 2005 throughdirect mail campaigns to expand its checking accounts and increase deposit feeincome.

 

Thedecreases in other noninterest income for both the three and six monthcomparative periods were primarily due to a decrease in loan fees collected.

 

17

----

 

**Noninterest Expense**

 

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

 
| ** **                        | ** ** | **Three Months Ended June 30,** | ** ** | **Increase   (Decrease)** | ** ** | **Six Months Ended June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|---------------------------|------------|------------------------------------|------------|--------------------------|------------|
| ** **                        | ** ** | **2005**                             | ** ** | **2004**                  | ** ** | **2005 vs 2004**                   | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2005 vs 2004** | ** ** |
| Salaries                          |       | $                                    | 2,027      |                      | $          | 1,894                              |       | $                        | 133        |   | $ | 4,005 |   | $ | 3,762 |   | $ | 243 |   |
| Payroll taxes                     |       | 174                                  |       | 158                       |       | 16                                 |       | 408                      |       | 379 |   | 29 |   |
| Insurance                         |       | 153                                  |       | 148                       |       | 5                                  |       | 300                      |       | 292 |   | 8 |   |
| ESOP expense (1)                  |       | 495                                  |       | 394                       |       | 101                                |       | 975                      |       | 804 |   | 171 |   |
| MRP expense (2)                   |       | 7                                    |       | 7                         |       | —                             |       | 13                       |       | 13 |   | — |   |
| Defined benefit plan contribution |       | 122                                  |       | 122                       |       | —                             |       | 245                      |       | 113 |   | 132 |   |
| Other                             |       | 35                                   |       | 35                        |       | —                             |       | 70                       |       | 74 |   | (4 | ) |
| Total                             |       | $                                    | 3,013      |                      | $          | 2,758                              |       | $                        | 255        |   | $ | 6,016 |   | $ | 5,437 |   | $ | 579 |   |

 

----

(1)   Employee Stock Ownership Plan

(2)   Management Recognition and Retention Plan

 

Theincrease in salaries for the three and six months ended June 30 was dueprimarily to an increase in the number of employees and normal salary and meritincreases.  Payroll taxes increasedduring both periods due to the increase in salaries.  The increase in employee stock ownership planexpense during both comparison periods was due to an increase in the Company’saverage stock price in 2005 compared to the same periods in 2004.  Defined benefit plan expense increased in thesix month comparative period due to the unusual credit during the first quarterof 2004.

 

Theloan to the ESOP matures on March 31, 2006 and will be repaid in full atsuch time. Absent further leveraged purchases by the ESOP, expenses related tothe ESOP will decrease subsequent to March 31, 2006.

 

**Advertising and public relations.** Advertising and public relations decreased for the second quarter of2005 compared to the same period in 2004 primarily due to costs associated withthe start-up of the checking account marketing program in the 2004 quarter.

 

Advertisingand public relations increased for the six months ended June 30, 2005,compared to the same period in 2004, primarily due to a full six months ofcosts in 2005 associated with the new checking account marketing program,including direct mail, “thank you” gifts, marketing brochures, posters andbillboards, compared to only three months in the previous year.  The marketing program began in April 2004.

 

**Other expenses.**  The changes in the compositionof this line item are presented below (in thousands):

 
| ** **                     | ** ** | **Three Months Ended June 30,** | ** ** | **Increase  (Decrease)** | ** ** | **Six Months Ended June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|--------------------------------|------------|--------------------------------------|------------|--------------------------|------------|------------------------------------|------------|--------------------------|------------|
| ** **                     | ** ** | **2005**                             | ** ** | **2004**                 | ** ** | **2005 vs 2004**                   | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2005 vs 2004** | ** ** |
| Consultant and management fees |       | $                                    | 44         |                     | $          | 109                                |       | $                        | (65        | ) | $ | 70 |   | $ | 201 |   | $ | (131 | ) |
| Other                          |       | 1,175                                |       | 1,143                    |       | 32                                 |       | 2,303                    |       | 2,227 |   | 76 |   |
| Total                          |       | $                                    | 1,219      |                     | $          | 1,252                              |       | $                        | (33        | ) | $ | 2,373 |   | $ | 2,428 |   | $ | (55 | ) |

 

Otherexpenses decreased in the three and six month comparative periods primarily dueto a decrease in consultant and management fees.  These fees decreased primarily due to feespaid to a consulting firm for assistance in promotion of checking accounts in2004.

 

18

----

 

**Income Taxes.**

 

Theincrease in income tax expense for the three and six month comparable periodsended June 30 was primarily due to an increase in taxable income and, to alesser extent, an increase in the effective tax rate.

 

# **OFF-BALANCESHEET ARRANGEMENTS**

#  

TheCompany, in the normal course of business, makes commitments to buy or sellassets or to incur or fund liabilities. Commitments include, but are not limited to:

 

•      the origination, purchase or sale of loans;

•      the fulfillment of commitments underletters-of-credit, extensions of credit on home equity lines of credit,construction loans, and predetermined overdraft protection limits; and

•      the commitment to fund withdrawals ofcertificates of deposit at maturity.

 

AtJune 30, 2005, the Bank’s off-balance sheet arrangements principally includedlending commitments, which are described below. At June 30, 2005, the Company had no interests in non-consolidatedspecial purpose entities.

 

AtJune 30, 2005, commitments included:

 

•      total approved commitments to originate loansamounting to $9.6 million, including $1.2 million of loans committed to sell;

•      rate lock agreements with customers of $6.7million, all of which have been locked with an investor;

•      funded mortgage loans committed to sell of$2.5 million;

•      unadvanced portion of construction loans of$82.0 million;

•      unused lines of credit of $27.1 million;

•      outstanding standby letters of credit of$960,000;

•      total predetermined overdraft protectionlimits of $10.5 million; and

•      certificates of deposit scheduled to maturein one year or less totaling $159.0 million.

 

Totalunfunded commitments to originate loans for sale and the related commitments tosell of $6.7 million meet the definition of a derivative financialinstrument.  The related asset andliability are considered immaterial at June 30, 2005.

 

Historically,a very small percentage of predetermined overdraft limits have been used.  At June 30, 2005, overdrafts of accountswith Bounce ProtectionTM represented usage of 2.9% of thelimit.  We expect utilization of theseoverdraft limits to remain at comparable levels in the future.

 

Basedon historical experience, management believes that a significant portion ofmaturing deposits will remain with the Bank. We anticipate that we will continue to have sufficient funds, throughrepayments, deposits and borrowings, to meet our current commitments.

 

### **LIQUIDITYAND CAPITAL RESOURCES**

###  

TheBank’s liquidity, represented by cash and cash equivalents and eligibleinvestment securities, is a product of its operating, investing and financingactivities.  The Bank’s primary sourcesof funds are deposits, borrowings, collections on outstanding loans, maturitiesand calls of investment securities and other short-term investments and fundsprovided from operations.  While scheduledloan amortization and maturing investment securities and short-term investmentsare relatively predictable sources of funds, deposit flows and loan prepaymentsare greatly influenced by general interest rates, economic conditions andcompetition.  The Bank manages thepricing of its deposits to maintain a steady deposit balance.  In addition, the Bank invests excess funds inovernight deposits and other short-term interest-earning assets which provideliquidity to meet lending requirements. During 2005, the use of FHLB advances increased due to increased demandfor the Bank’s loan products.  At June 30,2005, available borrowing capacity with the FHLB was in excess of $135 million.

 

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Liquiditymanagement is both a daily and long-term function of business management.  Excess liquidity is generally invested inshort-term investments such as overnight deposits and certificates ofdeposit.  On a longer-term basis, theBank maintains a strategy of investing in various lending products.  The Bank uses its sources of funds primarilyto meet its ongoing commitments, to pay maturing savings certificates andsavings withdrawals, to repay maturing FHLB of Dallas advances, and to fundloan commitments.

 

Asof June 30, 2005, the Bank’s regulatory capital was in excess of allapplicable regulatory requirements.  At June 30,2005, the Bank’s tangible, core and risk-based capital ratios amounted to9.15%, 9.15% and 12.67%, respectively, compared to regulatory requirements of1.5%, 4.0% and 8.0%, respectively.

 

### **IMPACT OFINFLATION AND CHANGING PRICES**

###  

Thefinancial statements and related financial data presented herein have beenprepared in accordance with generally accepted accounting principles, whichrequire the measurement of financial position and operating results in terms ofhistorical dollars, without considering changes in relative purchasing powerover time due to inflation.

 

Unlikemost industrial companies, virtually all of the Bank’s assets and liabilitiesare monetary in nature.  As a result,interest rates generally have a more significant impact on a financialinstitution’s performance than does the effect of inflation.

 

### **FORWARD-LOOKINGSTATEMENTS**

###  

TheCompany’s Quarterly Report on Form 10-Q contains certain forward-lookingstatements and information relating to the Company that are based on thebeliefs of management as well as assumptions made by and information currentlyavailable to management.  In addition, inthis document, the words “anticipate”, “believe,” “estimate,”****“expect,” “intend,” “should” and similarexpressions, or the negative thereof, as they relate to the Company or theCompany’s management, are intended to identify forward-looking statements.  Such statements reflect the current views ofthe Company with respect to future looking events and are subject to certainrisks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize or shouldunderlying assumptions prove incorrect, actual results may vary materially fromthose described herein as anticipated, believed, estimated, expected orintended.  The Company does not intend toupdate these forward-looking statements.

 

**QUANTITATIVE AND QUALITATIVE DISCLOSURES**

**ABOUT MARKET RISK**

 

Fora discussion of the Company’s asset and liability management policies as wellas the potential impact of interest rate changes upon the market value of theBank’s portfolio equity, see “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” in the Company’s 2004 Annual Report toStockholders.  There has been no materialchange in the Company’s asset and liability position or the market value of theBank’s portfolio equity since December 31, 2004.

 

**CONTROLS AND PROCEDURES**

 

Ourmanagement evaluated, with the participation of our Chief Executive Officer andChief Financial Officer, the effectiveness of the design and operation of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e)) under the Securities Exchange Act of 1934) as of the end of the periodcovered by this report.  Based on suchevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures are designed to ensurethat information required to be disclosed by us in the reports that we file orsubmit under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andregulations and are operating in an effective manner.

 

Nochange in the Company’s internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f)) under the Securities Exchange Act)occurred during the most recent fiscal quarter that has materially affected, oris reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

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

 

**Part II**

 

Item 1.            Legal Proceedings

 

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

 

Item 2.            Unregistered Sales of Equity Securities andUse of Proceeds

 
| ISSUER  PURCHASES OF EQUITY SECURITIES | ** ** |
|----------------------------------------|------------|
|                                   | ** ** |
| ** **                             | ** ** | **(a) Total   Number of   Shares Purchased** | ** ** | **(b) Average  Price Paid   per Share** | ** ** | **(c) Total Number of  Shares Purchased as  Part of Publicly   Announced Plans or   Programs** | ** ** | **(d) Maximum Number   of Shares that May Yet   Be Purchased Under the  Plans or Programs** | ** ** |
| ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| April 1, to April 30, 2005   |       | — |   | — |   | — |   | — |   |
| May 1, to May 31, 2005       |       | 55,000 |   | $ | 24.93 |   | 55,000 |   | 109,792 |   |
| June 1, to June 30, 2005     |       | 22,000 |   | $ | 25.16 |   | 22,000 |   | 87,792 |   |

 

The Company is in its 17thannounced repurchase program, which was approved by the board of directors on November 30,2004, and publicly announced on February 8, 2005.  Total shares approved to be purchased in thisprogram are 251,801, of which 164,009 have been purchased as of June 30,2005.  All treasury stock purchases aremade under publicly announced repurchase programs.

 

Item 3.            Defaults Upon Senior Securities

 

Not applicable.

 

Item 4.            Submission of Matters to a Vote of SecurityHolders

 

On April 27, 2005, theCorporation held an annual meeting of stockholders for the following purposes:

 

(1)           To elect one director for a term of threeyears; and

 

(2)           To ratify the appointment by the Board ofDirectors of Deloitte and Touche LLP as the Corporation’s independent auditorsfor the year ending December 31, 2005.

 

The results of the votingare set forth below:

 

Proposal One (Election of Director):

 
| **NAME**            | ** ** | **FOR**   | ** ** | **AGAINST/   WITHHELD** | ** ** | **NOT VOTED** | ** ** |
|---------------------|------------|-----------|------------|-------------------------|------------|---------------|------------|
| Kenneth C.  Savells |       | 4,547,793 |       | 3,600                   |       | 522,015       |       |

 

Proposal Two (Ratificationof Auditors):

 
| **FOR**   | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** | **NOT VOTED** | ** ** |
|-----------|------------|-------------|------------|-------------|------------|---------------|------------|
| 4,535,910 |       | 1,548       |       | 13,935      |       | 522,015       |       |

 

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Item 5.            Other Information

 

None.

 

Item 6.            Exhibits 

 

Exhibit 31.1 –Certification of Chief Executive Officer,

Pursuant to Section 302of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

Exhibit 31.2 –Certification of Chief Financial Officer,

Pursuant to Section 302of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

Exhibit 32.1 –Certification of Chief Executive Officer,

Pursuant to Section 906of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

Exhibit 32.2 –Certification of Chief Financial Officer,

Pursuant to Section 906of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 

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

 

 
| Date: July 28, 2005 | By:    | /s/Larry J. Brandt       |   |
|--------------------------|--------|--------------------------|--------|
|                     |   |  Larry J. Brandt    |
|                     |   |  President/CEO      |
|                     |   |                     |
|                     |   |                     |
| Date: July 28, 2005 | By:    | /s/Sherri R. Billings    |   |
|                     |   |  Sherri R. Billings |
|                     |   |  EVP/CFO            |

 

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