**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **x**      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                                                              |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** |
|       |       |                                                                                                                                                                                                                                                                                                 |
| ** ** | ** ** | **For the quarterly period ended  March 31, 2008**                                                                                                                                                                                                                                              |
|       |       |                                                                                                                                                                                                                                                                                                 |
| **OR**     |
|       |       |                                                                                                                                                                                                                                                                                                 |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                                                             |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                           |
| ** ** | ** ** | **For the transition period from                              to                ** |

 

**Commission File Number 0-28312**

 

**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

(Exact name of registrant as specified in itscharter)

 
| **Texas**                                                        | **71-0785261**                           |
|------------------------------------------------------------------|------------------------------------------|
| (State or other jurisdiction of  incorporation

or organization) | (I.R.S. Employer

Identification Number) |
|                                                             |                                     |
| **1401 Highway 62-65 North**

**Harrison, Arkansas**             | **72601**                                |
| (Address of principal executive office)                          | (Zip Code)                               |

 

**(870) 741-7641**

(Registrant’s telephone number, includingarea 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 x   No o

 

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

 

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

 

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

Yes  o          No  x

 

Indicate the number of shares outstandingof each of the issuer’s classes of common stock, as of the latest practicabledate:  As of April 21, 2008, therewere issued and outstanding 4,848,385 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**

 
| ** **        | ** ** | ** **                                                                                                                                                                 | ** ** | **Page**   |
|-------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| **Part I.**       |       | **Financial Information**                                                                                                                                                  |       |       |
|              |       |                                                                                                                                                                       |       |       |
| Item 1.           |       | Consolidated Financial Statements                                                                                                                                          |       |       |
|              |       |                                                                                                                                                                       |       |       |
|              |       | Consolidated Statements of Financial  Condition as of March 31, 2008 and December 31, 2007 (unaudited)                                                           |       | 1          |
|              |       |                                                                                                                                                                       |       |       |
|              |       | Consolidated Statements of Income for the  three months ended March 31, 2008 and 2007 (unaudited)                                                                     |       | 2          |
|              |       |                                                                                                                                                                       |       |       |
|              |       | Consolidated  Statement of Stockholders’ Equity for the three months ended March 31,  2008 (unaudited)                                                           |       | 3          |
|              |       |                                                                                                                                                                       |       |       |
|              |       | Consolidated  Statements of Cash Flows for the three months ended March 31, 2008 and  2007 (unaudited)                                                                |       | 4          |
|              |       |                                                                                                                                                                       |       |       |
|              |       | Notes to  Unaudited Consolidated Financial Statements                                                                                                                      |       | 6          |
|              |       |                                                                                                                                                                       |       |       |
| Item 2.           |       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                                                |       | 9          |
|              |       |                                                                                                                                                                       |       |       |
| Item 3.           |       | Quantitative and Qualitative Disclosures  About Market Risk                                                                                                                |       | 21         |
|              |       |                                                                                                                                                                       |       |       |
| Item 4.           |       | Controls and Procedures                                                                                                                                                    |       | 22         |
|              |       |                                                                                                                                                                       |       |       |
| **Part II.** |       | **Other  Information**                                                                                                                                                     |       |       |
|              |       |                                                                                                                                                                       |       |       |
| Item 1.           |       | Legal Proceedings                                                                                                                                                          |       | 23         |
| Item 1A.          |       | Risk Factors                                                                                                                                                               |       | 23         |
| Item 2.           |       | Unregistered Sales of Equity Securities and  Use of Proceeds                                                                                                               |       | 23         |
| Item 3.           |       | Defaults Upon Senior Securities                                                                                                                                            |       | 23         |
| Item 4.           |       | Submission of Matters to a Vote of Security  Holders                                                                                                                       |       | 23         |
| Item 5.           |       | Other Information                                                                                                                                                          |       | 23         |
| Item 6.           |       | Exhibits                                                                                                                                                                   |       | 23         |
|              |       |                                                                                                                                                                       |       |       |
| **Signatures**    | ** ** | ** **                                                                                                                                                                 | ** ** | ** ** |
|              |       |                                                                                                                                                                       |       |       |
| **Exhibits**      | ** ** | ** **                                                                                                                                                                 | ** ** | ** ** |
| 31.1              |       | Certification of Chief Executive Officer  pursuant to Rule 13a-14(a) of Exchange Act, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |       |       |
| 31.2              |       | Certification of Chief Financial Officer  pursuant to Rule 13a-14(a) of Exchange Act, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |       |       |
| 32.1              |       | Section 906 Certification of the CEO                                                                                                                                  |       |       |
| 32.2              |       | Section 906 Certification of the CFO                                                                                                                                  |       |       |

 

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

**CONSOLIDATEDSTATEMENTS OF FINANCIAL CONDITION**

(In thousands, except share data)

(Unaudited)

 
| ** **                                                                                                                                                                                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                          | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| ASSETS                                                                                                                                                                                              |       |               |       |                  |       |
|                                                                                                                                                                                                |       |               |       |                  |       |
| Cash and  cash equivalents                                                                                                                                                                          |       | $                  | 50,700     |                  | $          | 27,387 |   |
| Investment  securities held to maturity                                                                                                                                                             |       | 120,864            |       | 95,590                |       |
| Federal Home  Loan Bank stock                                                                                                                                                                       |       | 4,482              |       | 4,433                 |       |
| Loans  receivable, net                                                                                                                                                                              |       | 584,984            |       | 601,256               |       |
| Accrued  interest receivable                                                                                                                                                                        |       | 7,804              |       | 9,042                 |       |
| Real estate  acquired in settlement of loans, net                                                                                                                                                   |       | 11,234             |       | 8,120                 |       |
| Office  properties and equipment, net                                                                                                                                                               |       | 24,878             |       | 24,263                |       |
| Cash  surrender value of life insurance                                                                                                                                                             |       | 19,821             |       | 20,159                |       |
| Prepaid  expenses and other assets                                                                                                                                                                  |       | 4,291              |       | 1,728                 |       |
|                                                                                                                                                                                                |       |               |       |                  |       |
| TOTAL ASSETS                                                                                                                                                                                        |       | $                  | 829,058    |                  | $          | 791,978 |   |
|                                                                                                                                                                                                |       |               |       |                  |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                                                                          |       |               |       |                  |       |
|                                                                                                                                                                                                |       |               |       |                  |       |
| LIABILITIES:                                                                                                                                                                                        |       |               |       |                  |       |
| Deposits                                                                                                                                                                                            |       | $                  | 656,913    |                  | $          | 630,414 |   |
| Federal Home  Loan Bank advances                                                                                                                                                                    |       | 87,634             |       | 82,087                |       |
| Advance  payments by borrowers for taxes and insurance                                                                                                                                              |       | 723                |       | 575                   |       |
| Other  liabilities                                                                                                                                                                                  |       | 9,763              |       | 5,239                 |       |
| Total  liabilities                                                                                                                                                                                  |       | 755,033            |       | 718,315               |       |
|                                                                                                                                                                                                |       |               |       |                  |       |
| 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, 4,848,385 and 4,844,385 shares outstanding at March 31, 2008 and  December 31, 2007, respectively |       | 103                |       | 103                   |       |
| Additional  paid-in capital                                                                                                                                                                         |       | 56,646             |       | 56,653                |       |
| Employee  stock benefit plans                                                                                                                                                                       |       | (37                | )          | (42                   | )          |
| Retained  earnings-substantially restricted                                                                                                                                                         |       | 87,912             |       | 87,600                |       |
|                                                                                                                                                                                                |       | 144,624            |       | 144,314               |       |
| Treasury  stock, at cost, 5,459,117 and 5,463,117 shares at March 31, 2008 and  December 31, 2007, respectively                                                                           |       | (70,599            | )          | (70,651               | )          |
| Total  stockholders’ equity                                                                                                                                                                    |       | 74,025             |       | 73,663                |       |
|                                                                                                                                                                                                |       |               |       |                  |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                    |       | $                  | 829,058    |                  | $          | 791,978 |   |

 

See notes to unaudited consolidated financial statements.

 

1

----

 

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

**CONSOLIDATEDSTATEMENTS OF INCOME**

(In thousands, except share data)

(Unaudited)

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **March 31,**               | ** ** | **March 31,** | ** ** |
| ** **                                           | ** ** | **2008**                         | ** ** | **2007** | ** ** |
|                                                 |       |                             |       |   |   |
| INTEREST  INCOME:                                    |       |                             |       |   |   |
| Loans  receivable                                    |       | $                                | 9,975      |   | $ | 12,201 |   |
| Investment  securities:                              |       |                             |       |   |   |
| Taxable                                              |       | 1,207                            |       | 656 |   |
| Nontaxable                                           |       | 186                              |       | 182 |   |
| Other                                                |       | 168                              |       | 188 |   |
| Total  interest income                               |       | 11,536                           |       | 13,227 |   |
|                                                 |       |                             |       |   |   |
| INTEREST  EXPENSE:                                   |       |                             |       |   |   |
| Deposits                                             |       | 5,568                            |       | 5,848 |   |
| Other  borrowings                                    |       | 903                              |       | 1,260 |   |
| Total  interest expense                              |       | 6,471                            |       | 7,108 |   |
|                                                 |       |                             |       |   |   |
| NET INTEREST  INCOME                                 |       | 5,065                            |       | 6,119 |   |
|                                                 |       |                             |       |   |   |
| PROVISION  FOR LOAN LOSSES                           |       | 1,528                            |       | 1,961 |   |
|                                                 |       |                             |       |   |   |
| NET INTEREST  INCOME AFTER PROVISION FOR LOAN LOSSES |       | 3,537                            |       | 4,158 |   |
|                                                 |       |                             |       |   |   |
| NONINTEREST  INCOME:                                 |       |                             |       |   |   |
| Deposit fee  income                                  |       | 1,211                            |       | 1,157 |   |
| Earnings on  life insurance policies                 |       | 1,371                            |       | 189 |   |
| Gain on sale  of loans                               |       | 175                              |       | 226 |   |
| Other                                                |       | 447                              |       | 286 |   |
| Total  noninterest income                            |       | 3,204                            |       | 1,858 |   |
|                                                 |       |                             |       |   |   |
| NONINTEREST  EXPENSES:                               |       |                             |       |   |   |
| Salaries and  employee benefits                      |       | 3,387                            |       | 3,443 |   |
| Net  occupancy expense                               |       | 639                              |       | 623 |   |
| Real estate  owned, net                              |       | 430                              |       | 162 |   |
| Data  processing                                     |       | 318                              |       | 454 |   |
| Professional  fees                                   |       | 130                              |       | 141 |   |
| Advertising  and public relations                    |       | 342                              |       | 359 |   |
| Postage and  supplies                                |       | 239                              |       | 275 |   |
| Other                                                |       | 586                              |       | 609 |   |
| Total  noninterest expenses                          |       | 6,071                            |       | 6,066 |   |
|                                                 |       |                             |       |   |   |
| INCOME  (LOSS) BEFORE INCOME TAXES                   |       | 670                              |       | (50 | ) |
| INCOME TAX  BENEFIT                                  |       | (417                             | )          | (209 | ) |
| NET INCOME                                           |       | $                                | 1,087      |   | $ | 159 |   |
|                                                 |       |                             |       |   |   |
| EARNINGS PER  SHARE:                                 |       |                             |       |   |   |
| Basic                                                |       | $                                | 0.22       |   | $ | 0.03 |   |
|                                                 |       |                             |       |   |   |
| Diluted                                              |       | $                                | 0.22       |   | $ | 0.03 |   |
|                                                 |       |                             |       |   |   |
| Cash  Dividends Declared                             |       | $                                | 0.16       |   | $ | 0.16 |   |

 

See notes to unaudited consolidated financialstatements.

 

2

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

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’EQUITY**

**FOR THE THREE MONTHS ENDED MARCH 31,2008**

(In thousands, except share data)

(Unaudited)

 
| ** **                                                 | ** ** | **Issued  Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Employee  Stock  Benefit** | ** ** | **Retained  Earnings  (Substantially** | ** ** |
|------------------------------------------------------------|------------|-------------------------------|------------|-------------------------|------------|------------------------------|------------|----------------------------------------|------------|
| ** **                                                 | ** ** | **Shares**                    | ** ** | **Amount**              | ** ** | **Capital**                  | ** ** | **Plans**                              | ** ** | **Restricted)** | ** ** |
|                                                       |       |                          |       |                    |       |                         |       |                                   |       |   |   |
| Balance,  January 1, 2008                             |       | 10,307,502                    |       | $                       | 103        |                         | $          | 56,653                                 |       | $ | (42 | ) | $ | 87,600 |   |
| Net income                                                 |       |                          |       |                    |       |                         |       |                                   |       | 1,087 |   |
| Tax effect  of stock compensation plan                     |       |                          |       |                    |       | (2                           | )          |                                   |       |   |   |
| Treasury  shares reissued due to exercise of stock options |       |                          |       |                    |       | (6                           | )          |                                   |       |   |   |
| Stock  compensation expense                                |       |                          |       |                    |       | 1                            |       | 5                                      |       |   |   |
| Dividends  paid                                            |       |                          |       |                    |       |                         |       |                                   |       | (775 | ) |
|                                                       |       |                          |       |                    |       |                         |       |                                   |       |   |   |
| Balance,  March 31, 2008                              |       | 10,307,502                    |       | $                       | 103        |                         | $          | 56,646                                 |       | $ | (37 | ) | $ | 87,912 |   |

 
| ** **                                                 | ** ** | **Treasury Stock** | ** ** | **Total  Stockholders’** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|-------------------------------|------------|------------|------------|------------|------------|
| ** **                                                 | ** ** | **Shares**              | ** ** | **Amount**                    | ** ** | **Equity** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                       |       |                    |       |                          |       |       |       |       |       |   |   |
| Balance,  January 1, 2008                             |       | 5,463,117               |       | $                             | (70,651    | )          | $          | 73,663     |       |   |   |   |   |
| Net income                                                 |       |                    |       |                          |       | 1,087      |       |       |       |   |   |
| Tax effect  of stock compensation plan                     |       |                    |       |                          |       | (2         | )          |       |       |   |   |
| Treasury  shares reissued due to exercise of stock options |       | (4,000                  | )          | 52                            |       | 46         |       |       |       |   |   |
| Stock  compensation expense                                |       |                    |       |                          |       | 6          |       |       |       |   |   |
| Dividends  paid                                            |       |                    |       |                          |       | (775       | )          |       |       |   |   |
|                                                       |       |                    |       |                          |       |       |       |       |       |   |   |
| Balance,  March 31, 2008                              |       | 5,459,117               |       | $                             | (70,599    | )          | $          | 74,025     |       |   |   |   |   |

 

See notes to unaudited consolidated financialstatements.

 

3

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In Thousands)

(Unaudited)

 
| ** **                                                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
|                                                                               |       |                                                 |       |   |   |
| OPERATING  ACTIVITIES:                                                             |       |                                                 |       |   |   |
| Net income                                                                         |       | $                                                    | 1,087      |   | $ | 159 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                                 |       |   |   |
| Provision  for loan losses                                                         |       | 1,528                                                |       | 1,961 |   |
| Provision  for real estate losses                                                  |       | 229                                                  |       | 74 |   |
| Deferred tax  benefit                                                              |       | (331                                                 | )          | (788 | ) |
| Accretion of  discounts on investment securities, net                              |       | (35                                                  | )          | (9 | ) |
| Federal Home  Loan Bank stock dividends                                            |       | (49                                                  | )          | (98 | ) |
| Gain on  disposition of office properties and equipment, net                       |       | (18                                                  | )          | (2 | ) |
| Loss on sale  of repossessed assets, net                                           |       | 53                                                   |       | 43 |   |
| Originations  of loans held for sale                                               |       | (10,950                                              | )          | (16,100 | ) |
| Proceeds  from sales of loans held for sale                                        |       | 12,110                                               |       | 16,076 |   |
| Gain on sale  of loans originated to sell                                          |       | (175                                                 | )          | (226 | ) |
| Depreciation                                                                       |       | 358                                                  |       | 354 |   |
| Amortization  of deferred loan fees, net                                           |       | 74                                                   |       | 91 |   |
| Stock  compensation expense                                                        |       | 6                                                    |       | 14 |   |
| Earnings on  life insurance policies                                               |       | (1,371                                               | )          | (189 | ) |
| Changes in  operating assets and liabilities:                                      |       |                                                 |       |   |   |
| Accrued  interest receivable                                                       |       | 1,238                                                |       | (286 | ) |
| Prepaid  expenses and other assets                                                 |       | (561                                                 | )          | 191 |   |
| Other  liabilities                                                                 |       | 218                                                  |       | 236 |   |
| Net cash  provided by operating activities                                         |       | 3,411                                                |       | 1,501 |   |
|                                                                               |       |                                                 |       |   |   |
| INVESTING  ACTIVITIES:                                                             |       |                                                 |       |   |   |
| Purchases of  investment securities held to maturity                               |       | (60,638                                              | )          | (6,299 | ) |
| Proceeds  from maturities/calls of investment securities held to maturity          |       | 39,701                                               |       | 4,320 |   |
| Federal Home  Loan Bank stock redeemed                                             |       | —                                               |       | 1,315 |   |
| Loan  participations sold                                                          |       | —                                               |       | 4,907 |   |
| Loan  participations purchased                                                     |       | (451                                                 | )          | — |   |
| Net loan  repayments                                                               |       | 10,621                                               |       | 16,090 |   |
| Proceeds  from sales of repossessed assets                                         |       | 355                                                  |       | 1,165 |   |
| Improvements  to real estate owned                                                 |       | (196                                                 | )          | (148 | ) |
| Proceeds  from sales of office properties and equipment                            |       | 30                                                   |       | 6 |   |
| Purchases of  office properties and equipment                                      |       | (985                                                 | )          | (651 | ) |
| Net cash  provided by (used in) investing activities                               |       | (11,563                                              | )          | 20,705 |   |
|                                                                               |       |                                                 |       |   |   |
| FINANCING  ACTIVITIES:                                                             |       |                                                 |       |   |   |
| Net increase  in deposits                                                          |       | 26,499                                               |       | 2,128 |   |
| Advances  from FHLB                                                                |       | 15,000                                               |       | 4,000 |   |
| Repayment of  advances from FHLB                                                   |       | (9,453                                               | )          | (21,751 | ) |
| Net decrease  in advance payments by borrowers for taxes and insurance             |       | 148                                                  |       | 202 |   |
| Purchase of  treasury stock                                                        |       | —                                               |       | (1,389 | ) |
| Reissued  treasury stock                                                           |       | 46                                                   |       | 265 |   |
| Dividends  paid                                                                    |       | (775                                                 | )          | (779 | ) |
| Net cash  provided by (used in) financing activities                               |       | 31,465                                               |       | (17,324 | ) |
|                                                                               |       |                                                 |       |   |   |
| Net increase  in cash and cash equivalents                                         |       | 23,313                                               |       | 4,882 |   |
|                                                                               |       |                                                 |       | (Continued) |   |
|                                                                                    |            |                                                      |            |  |  |  |  |

 

4

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| ** **                                                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
|                                                                           |       |                                                 |       |   |   |
| CASH AND CASH EQUIVALENTS:                                                     | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Beginning of  period                                                           |       | $                                                    | 27,387     |   | $ | 35,518 |   |
| End of  period                                                                 |       | $                                                    | 50,700     |   | $ | 40,400 |   |
|                                                                           |       |                                                 |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                            |       |                                                 |       |   |   |
| Cash paid  for:                                                                |       |                                                 |       |   |   |
| Interest                                                                       |       | $                                                    | 6,416      |   | $ | 7,253 |   |
| Income taxes                                                                   |       | $                                                    | —     |   | $ | 2 |   |
|                                                                           |       |                                                 |       |   |   |
| SUPPLEMENTAL  SCHEDULE OF NONCASH INVESTING ACTIVITIES:                        |       |                                                 |       |   |   |
| Real estate  and other assets acquired in settlement of loans                  |       | $                                                    | 5,323      |   | $ | 150 |   |
| Loans to  facilitate sales of real estate owned                                |       | $                                                    | 1,808      |   | $ | — |   |
| Investment  securities traded, recorded in investments not yet settled in cash |       | $                                                    | 7,492      |   | $ | — |   |
|                                                                           |       |                                                 |       |   |   |   |   |
|                                                                           |       |                                                 |       |   |   | (Concluded) |   |

 

See notes tounaudited consolidated financial statements.

 

5

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

 

**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

First Federal Bancshares of Arkansas, Inc.(the “Company”) is a unitary holding company which owns all of the stock ofFirst Federal Bank (the “Bank”). The Bank provides a broad line of financialproducts to individuals and small- to medium-sized businesses. The unauditedconsolidated financial statements also include the accounts of the Bank’s wholly-ownedsubsidiary, First Harrison Service Corporation (“FHSC”), which is inactive.

 

The accompanying unaudited consolidatedfinancial statements of the Company have been prepared in accordance withinstructions 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 alladjustments which are, in the opinion of management, necessary for a fairstatement of results for the interim periods.

 

The accompanying unaudited consolidatedfinancial statements include the accounts of the Company and the Bank. Allmaterial intercompany transactions have been eliminated in consolidation.

 

The results of operations for thethree months ended March 31, 2008, are not necessarily indicative of theresults to be expected for the year ending December 31, 2008. Theunaudited consolidated financial statements and notes thereto should be read inconjunction with the audited financial statements and notes thereto for theyear ended December 31, 2007, contained in the Company’s 2007 AnnualReport to Stockholders.

 

**Note 2 – Recently Adopted AccountingStandards**

 

We adopted Financial AccountingStandards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 157,*Fair Value Measurements*, as of January 1,2008. See Note 6.

 

We adopted SFAS No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities,*, as of January 1, 2008 and have electednot to measure any of our current eligible financial assets or liabilities atfair value upon adoption; however, we may elect to measure future eligiblefinancial assets or liabilities at fair value.

 

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

** **

In December 2007, the FASB issued SFAS No. 141R,*Business Combinations.*The objective of this Statement is to improvethe relevance, representational faithfulness, and comparability of theinformation that a reporting entity provides in its financial reports about a businesscombination and its effects. To accomplish that, this Statement establishesprinciples and requirements for how the acquirer:

 

a.               Recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed, and any noncontrolling interest in the acquiree

 

b.              Recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase

 

c.               Determineswhat information to disclose to enable users of the financial statements toevaluate the nature and financialeffects of the business combination.

 

This Statement applies prospectively to business combinations for whichthe acquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008. An entity may not apply itbefore that date. The effective date of this Statement is the same as that ofthe related FASB Statement No. 160, *NoncontrollingInterests in Consolidated Financial Statements.*Based on ourcurrent activities, we estimate that the adoption of this Statement will nothave a material effect on the financial statements of the Company.

 

In March 2008, the FASB issued SFAS 161,*Disclosures about Derivative Instruments andHedging Activities*, effective for financial statements issued forfiscal years beginning after November 15, 2008. The objective of thisstatement is to provide enhanced disclosures about derivative instruments andrelated hedging items. Based on the Bank’s current activities, we estimate thatthe adoption of this statement will not have a material effect on the financialstatements of the Company.

 

6

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**Note 4 - Earnings per Share**

** **

The weighted average number of common sharesused to calculate earnings per share for the periods ended March 31, 2008and 2007 were as follows:

 
| ** **                         | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Basic  weighted - average shares   |       | 4,848,297                                            |       | 4,869,855 |   |
| Effect of  dilutive securities     |       | 2,338                                                |       | 38,509 |   |
| Diluted  weighted - average shares |       | 4,850,635                                            |       | 4,908,364 |   |

 

**Note 5 – Allowances for Loan and Real Estate Losses**

** **

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

 
| ** **                        | ** ** | **Three Months Ended  March 31,****2008** | ** ** | **Three Months Ended  March 31,****2007** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                        | ** ** | **Loans**                                                | ** ** | **Real Estate**                           | ** ** | **Loans** | ** ** | **Real Estate** | ** ** |
|                              |       |                                                     |       |                                           |       |   |   |   |   |
| Balance—beginning  of period |       | $                                                        | 5,162      |                                           | $          | — |   | $ | 2,572 |   | $ | — |   |
|                              |       |                                                     |       |                                           |       |   |   |   |   |
| Provisions  for estimated losses  |       | 1,528                                                    |       | 229                                            |       | 1,961 |   | 74 |   |
| Recoveries                        |       | 136                                                      |       | —                                         |       | 49 |   | — |   |
| Losses  charged off               |       | (719                                                     | )          | (229                                           | )          | (288 | ) | (74 | ) |
|                              |       |                                                     |       |                                           |       |   |   |   |   |
| Balance—end  of period       |       | $                                                        | 6,107      |                                           | $          | — |   | $ | 4,294 |   | $ | — |   |

 

The provision for loan losses decreasedbetween the periods listed above primarily due to a $1.4 million specific loanloss allowance on two phases of a subdivision recorded at March 31, 2007,compared to an increase in specific loan loss allowances for the quarter ended March 31,2008 of approximately $666,000.

 

7

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**Note 6 – Fair Value Measurement**

 

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

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

 

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

 

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

 
| ** **              | ** ** | **December 31,  2007** | ** ** | **Additions** | ** ** | **Fair Value  Adjustments** | ** ** | **Transfers  Out** | ** ** | **Gain  (Loss)** | ** ** | **March 31,  2008** | ** ** |
|-------------------------|------------|-----------------------------|------------|---------------|------------|----------------------------------|------------|--------------------|------------|------------------|------------|--------------------------|------------|
| ** **              | ** ** | **(in thousands)**     | ** ** |
| Real estate  owned, net |       | $                           | 8,120      |          | $          | 5,500                            |       | $                  | (229       | )                | $          | (2,111                   | )          | $ | (46 | ) | $ | 11,234 |   |
| Impaired  loans         |       | 14,894                      |       | 1,128         |       | (378                             | )          | **—**         | ** ** | **—**       |       | 15,644                   |       |
|                         |            |                             |            |               |            |                                  |            |                    |            |                  |            |                          |            |  |  |  |  |  |  |

 

Realized and unrealized gains and losses onreal estate owned are recognized in noninterest expenses in the consolidatedstatements of income under the caption “Real estate owned, net.”  Gains on sales of real estate owned which arefinanced by the Bank are deferred in certain circumstances and recognized asthe borrower pays down the related loan. Fair value adjustments to impairedloans are recorded through the allowance for loan losses.

 

8

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**MANAGEMENT’SDISCUSSION AND ANALYSIS**

**OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

** **

### **CRITICAL ACCOUNTING POLICIES**

### ** **

Variouselements of our accounting policies, by their nature, are inherently subject toestimation techniques, valuation assumptions and other subjective assessments. Inparticular, the methodology for the determination of our allowance for loanlosses, due to the judgments, estimates and assumptions inherent in thatpolicy, is critical to preparation of our financial statements. This policy andthe judgments, estimates and assumptions are described in greater detail insubsequent sections of Management’s Discussion and Analysis and in the notes tothe unaudited financial statements included herein. We believe that thejudgments, estimates and assumptions used in the preparation of our financialstatements are appropriate given the factual circumstances at the time. However,given the sensitivity of our financial statements to this critical accountingpolicy, the use of other judgments, estimates and assumptions could result inmaterial differences in our financial condition or results of operations.

 

Inestimating the amount of credit losses inherent in our loan portfolio, variousjudgments and assumptions are made. For example, when assessing the conditionof the overall economic environment, assumptions are made regarding futuremarket conditions and their impact on the loan portfolio. In the event thelocal or national economy were to sustain a prolonged downturn, the lossfactors applied to our portfolios may need to be revised, which maysignificantly impact the measurement of the allowance for loan losses. Forimpaired loans that are collateral-dependent, the estimated fair value of thecollateral may deviate significantly from the proceeds received when thecollateral is sold.

 

## **CHANGESIN FINANCIAL CONDITION**

##  

Changesin financial condition between March 31, 2008 and December 31, 2007are presented in the following table (dollars in thousands). Material changesbetween the periods are discussed in the sections which follow the table.

 
| ** **                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **Percentage** | ** ** |
|------------------------------------------------|------------|--------------------|------------|-----------------------|------------|----------------|------------|----------------|------------|
| ** **                                     | ** ** | **2008**           | ** ** | **2007**              | ** ** | **(Decrease)** | ** ** | **Change**     | ** ** |
| **ASSETS**                                     |       |               |       |                  |       |           |       |           |       |
| Cash and  cash equivalents                     |       | $                  | 50,700     |                  | $          | 27,387         |       | $              | 23,313     |   | 85.1 | % |
| Investment  securities held to maturity        |       | 120,864            |       | 95,590                |       | 25,274         |       | 26.4           |       |
| Federal Home  Loan Bank stock                  |       | 4,482              |       | 4,433                 |       | 49             |       | 1.1            |       |
| Loans  receivable, net                         |       | 584,984            |       | 601,256               |       | (16,272        | )          | (2.7           | )          |
| Accrued  interest receivable                   |       | 7,804              |       | 9,042                 |       | (1,238         | )          | (13.7          | )          |
| Real estate  owned, net                        |       | 11,234             |       | 8,120                 |       | 3,114          |       | 38.4           |       |
| Office  properties and equipment, net          |       | 24,878             |       | 24,263                |       | 615            |       | 2.5            |       |
| Prepaid  expenses and other assets             |       | 24,112             |       | 21,887                |       | 2,225          |       | 10.2           |       |
|                                           |       |               |       |                  |       |           |       |           |       |
| TOTAL                                          |       | $                  | 829,058    |                  | $          | 791,978        |       | $              | 37,080     |   | 4.7 | % |
|                                           |       |               |       |                  |       |           |       |           |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY** |       |               |       |                  |       |           |       |           |       |
| LIABILITIES:                                   |       |               |       |                  |       |           |       |           |       |
| Deposits                                       |       | $                  | 656,913    |                  | $          | 630,414        |       | $              | 26,499     |   | 4.2 | % |
| Federal Home  Loan Bank advances               |       | 87,634             |       | 82,087                |       | 5,547          |       | 6.8            |       |
| Other  liabilities                             |       | 10,486             |       | 5,814                 |       | 4,672          |       | 80.4           |       |
|                                           |       |               |       |                  |       |           |       |           |       |
| Total  liabilities                             |       | 755,033            |       | 718,315               |       | 36,718         |       | 5.1            |       |
|                                           |       |               |       |                  |       |           |       |           |       |
| STOCKHOLDERS’  EQUITY                     |       | 74,025             |       | 73,663                |       | 362            |       | 0.5            |       |
|                                           |       |               |       |                  |       |           |       |           |       |
| TOTAL                                          |       | $                  | 829,058    |                  | $          | 791,978        |       | $              | 37,080     |   | 4.7 | % |
|                                           |       |               |       |                  |       |           |       |           |       |
| BOOK VALUE  PER SHARE                          |       | $                  | 15.27      |                  | $          | 15.21          |       |           |       |   |   |
|                                           |       |               |       |                  |       |           |       |           |       |
| EQUITY TO ASSETS                               |       | 8.9                | %          | 9.3                   | %          |           |       |           |       |

 

9

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**Loans Receivable.**Changes in loan composition between March 31,2008 and December 31, 2007 are presented in the following table (dollarsin thousands).

 
| ** **                                       | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | ** **        | ** ** |
|--------------------------------------------------|------------|--------------------|------------|-----------------------|------------|----------------|------------|-------------------|------------|
| ** **                                       | ** ** | **2008**           | ** ** | **2007**              | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
|                                             |       |               |       |                  |       |           |       |              |       |
| One- to  four-family residences                  |       | $                  | 228,803    |                  | $          | 230,005        |       | $                 | (1,202     | ) | (0.5 | )% |
| Home equity  lines of credit and second mortgage |       | 35,240             |       | 34,315                |       | 925            |       | 2.7               |       |
| Multi-family                                     |       | 18,011             |       | 15,616                |       | 2,395          |       | 15.3              |       |
| Commercial  real estate                          |       | 118,115            |       | 117,548               |       | 567            |       | 0.5               |       |
| Land                                             |       | 44,369             |       | 42,843                |       | 1,526          |       | 3.6               |       |
| Construction:                                    |       |               |       |                  |       |           |       |              |       |
| One- to  four-family residences                  |       | 17,858             |       | 20,815                |       | (2,957         | )          | (14.2             | )          |
| Speculative  one-to four-family residences       |       | 29,345             |       | 40,893                |       | (11,548        | )          | (28.2             | )          |
| Multi-family                                     |       | 18,904             |       | 18,632                |       | 272            |       | 1.5               |       |
| Commercial  real estate                          |       | 16,773             |       | 31,239                |       | (14,466        | )          | (46.3             | )          |
| Land development                                 |       | 39,232             |       | 42,145                |       | (2,913         | )          | (6.9              | )          |
| Total  construction loans                        |       | 122,112            |       | 153,724               |       | (31,612        | )          | (20.6             | )          |
| Total  mortgage loans                            |       | 566,650            |       | 594,051               |       | (27,401        | )          | (4.6              | )          |
|                                             |       |               |       |                  |       |           |       |              |       |
| Commercial                                       |       | 24,344             |       | 24,846                |       | (502           | )          | (2.0              | )          |
|                                             |       |               |       |                  |       |           |       |              |       |
| Automobile                                       |       | 9,153              |       | 9,531                 |       | (378           | )          | (4.0              | )          |
| Other                                            |       | 13,902             |       | 14,537                |       | (635           | )          | (4.4              | )          |
| Total  consumer                                  |       | 23,055             |       | 24,068                |       | (1,013         | )          | (4.2              | )          |
|                                             |       |               |       |                  |       |           |       |              |       |
| Total loans  receivable                          |       | 614,049            |       | 642,965               |       | (28,916        | )          | (4.5              | )          |
|                                             |       |               |       |                  |       |           |       |              |       |
| Undisbursed  loan funds                          |       | (23,344            | )          | (36,868               | )          | 13,524         |       | (36.7             | )          |
| Deferred  loan costs – net                  |       | 386                |       | 321                   |       | 65             |       | 20.2              |       |
| Allowance  for loan losses                       |       | (6,107             | )          | (5,162                | )          | (945           | )          | 18.3              |       |
|                                             |       |               |       |                  |       |           |       |              |       |
| Loans  receivable, net                           |       | $                  | 584,984    |                  | $          | 601,256        |       | $                 | (16,272    | ) | (2.7 | )% |

 

The decrease in the Bank’s loanportfolio was primarily due to continued softening of the housing market in theBank’s market area. Market data indicates an overall decrease in home sales inBenton and Washington counties in 2008 and 2007. The Bank’s loan originationswere down 21.8% for the quarter ended March 31, 2008, compared to thefirst quarter of 2007. Although the Northwest Arkansas region continues toexperience a strong job market and population growth, the supply of newresidential lots and new speculative homes for sale has outpaced demand duringthe past several years. We expect this trend to continue for the foreseeablefuture given the level of oversupply in the market.

 

10

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**Asset Quality.**Thefollowing table sets forth the amounts and categories of the Bank’snonperforming assets at the dates indicated.

 
| ** **                                                                                                                   | ** ** | **March 31,  2008**             | ** ** | **December 31,  2007** | ** ** | **Increase  (Decrease)** | ** ** | **Percentage  Change** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|--------------------------|------------|------------------------|------------|
| ** **                                                                                                                   | ** ** | **(Dollars in Thousands)** | ** ** | ** **                  | ** ** | ** **               | ** ** |
| Nonaccrual  loans:                                                                                                           |       |                                 |       |                        |       |                     |       |                   |       |
| One- to  four-family residential                                                                                             |       | $                                    | 6,845      |                        | $          | 6,800                    |       | $                      | 45         |   | 0.7 | % |
| Home equity  and second mortgage                                                                                             | ** ** | 1,329                                |       | 1,194                       |       | 135                      |       | 11.3                   |       |
| Speculative  one- to four-family construction                                                                                | ** ** | 2,347                                |       | 4,934                       |       | (2,587                   | )          | (52.4                  | )          |
| Land  development                                                                                                            | ** ** | 11,460                               |       | 11,428                      |       | 32                       |       | 0.3                    |       |
| Land                                                                                                                         | ** ** | 2,505                                |       | 1,311                       |       | 1,194                    |       | 91.1                   |       |
| Commercial  real estate                                                                                                      |       | 4,472                                |       | 4,027                       |       | 445                      |       | 11.1                   |       |
| Commercial  loans                                                                                                            |       | 2,617                                |       | 3,367                       |       | (750                     | )          | (22.3                  | )          |
| Consumer loans                                                                                                               |       | 267                                  |       | 268                         |       | (1                       | )          | (0.4                   | )          |
| Total  nonaccrual loans                                                                                                      |       | 31,842                               |       | 33,329                      |       | (1,487                   | )          | (4.5                   | )          |
|                                                                                                                         |       |                                 |       |                        |       |                     |       |                   |       |
| Accruing  loans 90 days or more past due                                                                                     |       | 2,878                                |       | 2,412                       |       | 466                      |       | 19.3                   |       |
| Real estate  owned                                                                                                           |       | 11,234                               |       | 8,120                       |       | 3,114                    |       | 38.3                   |       |
|                                                                                                                         |       |                                 |       |                        |       |                     |       |                   |       |
| Total  nonperforming assets                                                                                                  |       | $                                    | 45,954     |                        | $          | 43,861                   |       | $                      | 2,093      |   | 4.8 | % |
|                                                                                                                         |       |                                 |       |                        |       |                     |       |                   |       |
| Total  nonaccrual, accruing loans 90 days or more past due and restructured loans as  a percentage of total loans receivable |       | 5.65                                 | %          | 5.56                        | %          |                     |       |                   |       |
|                                                                                                                         |       |                                 |       |                        |       |                     |       |                   |       |
| Total  nonperforming assets as a percentage of total assets                                                                  |       | 5.54                                 | %          | 5.54                        | %          |                     |       |                   |       |

 

The decrease in nonaccrualloans is primarily related to the transfer of nonaccrual speculative singlefamily construction loans to real estate owned, which was offset somewhat by anincrease in nonaccrual land loans. The Northwest Arkansas market continues toexperience an oversupply of lots and speculative homes. Certain of the Bank’shomebuilders are experiencing extended marketing times for the sale of theirhomes which has resulted in inadequate cash flow to service the interest carryon their loans. The specific loan loss allowance related to loans to buildersand developers was approximately $2.9 million at March 31, 2008.

 

We expect a significantamount of the nonaccrual real estate loans to eventually migrate to real estateowned as $17.6 million of the nonaccrual real estate loans reported above arein some stage of the foreclosure process as of March 31, 2008. Thereforewe expect real estate owned and associated expenses to continue to increase infuture periods as such loans migrate from loans to real estate owned.

 

The level of nonaccrual speculativeconstruction loans, land development loans and commercial real estate loans isattributable primarily to six loan relationships totaling $18.9 million, or 59%of nonaccrual loans. These relationships are described in more detail in theparagraphs that follow.

 

The first relationship totaled $5.9 millionat March 31,2008, and is comprised of two subdivision loans totaling $5.4 millionand the borrower’s primary residence totaling approximately $520,000. Foreclosureproceedings have begun on the subdivision and the borrower has filed forbankruptcy protection. The subdivision loans represent two phases of the samesubdivision located in Lowell, Arkansas, one of which is complete and the otheris approximately 10% complete. Since the time the loans were originated, marketconditions have deteriorated and a subdivision across the street from thissubdivision has gone into default. We are aware that the financial institutionthat obtained those lots liquidated them in bulk at a substantial discount,which had an adverse effect on the value of the lots in the subdivisionsecuring the Bank’s loan. As a result, we ordered appraisals in the firstquarter of 2007 on both phases of the subdivision which used discounted cashflow analysis for the complete phase, given the extended selling period thatwould be necessary under current market conditions, and a land only valuationon the incomplete phase given the decreasing likelihood that these lots wouldbe developed. These appraisals resulted in a specific loan loss allowancetotaling $1.4 million on this subdivision initially recorded in the firstquarter of 2007. These subdivision loans are also the subject of litigationalleging fraud and negligence, among other complaints, that the Bank has filedagainst various parties to the loan. The Bank may be able to recover some ofits loss through this litigation, although at this time the Bank cannot giveany assurances as to the amount of a recovery, if any. Due to the nature ofthese loans, the uncertain nature of the legal process, and the possibility ofcontinued adverse changes in market conditions, we may incur losses in thefuture in excess of the amount estimated as of March 31, 2008.

 

The second relationship totaled $2.2 millionat March 31,2008, and is comprised of a subdivision located in Cave Springs,Arkansas. The subdivision is 100% complete. The Bank obtained an updatedvaluation on the subdivision 

 

11

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using discounted cash flow analysis. Due tothe market conditions and the oversupply of lots in Northwest Arkansas, thevaluation indicated lower lot prices and an extended marketing time over thatin the original appraisal obtained when the loan was originated. Based on theestimated fair value of the collateral, a specific loan loss allowance totaling$885,000 was recorded during the third quarter of 2007. Based on the nature ofthis loan and the possibility of continued adverse changes in the marketconditions, we may incur losses in the future in excess of the amount estimatedas of March 31,2008.

 

The third relationship totaled $2.8 million, which consisted of a $2.1commercial loan secured by commercial real estate, franchise rights, inventoryand equipment, a $650,000 loan on the borrower’s primary residence, and a$20,000 unsecured loan. The loans in this relationship became over 90 days pastdue during the third quarter of 2007. Based on the borrower’s workout plans,these loans were maintained on accrual status at that time. However, due to thepassage of time with no progress on the workout plan, we placed the loans onnonaccrual status during the fourth quarter of 2007. The borrower is sellingall of the collateral securing his loans and has entered into sales contractson some of the franchises. During the first quarter of 2008 one of thefranchise sales closed and the Bank received proceeds from this sale. However,the Bank agreed to accept less than the full amount of proceeds as part of theworkout. Based on this and other valuation changes during the first quarter,the Bank recorded an additional $350,000 in specific loan loss allowances,bringing the total specific allowance to $373,000 with respect to thisrelationship as of March 31, 2008.

 

The fourth relationship totaled $2.1 million and represents a singlecommercial real estate loan secured by a convenience store, car wash, andretail space. This loan became over 90 days past due during the third quarterof 2007. Based on our expectation that the guarantors would cooperate with uson a workout plan and our assessment of their financial strength, these loanswere maintained on accrual status at that time. However, due to the passage oftime with no progress on a workout plan, we placed this loan on nonaccrualstatus during the fourth quarter of 2007. In the event of a foreclosure and apossible deficiency judgment, we believe sufficient net worth exists among theguarantors to satisfy their obligation. As of March 31, 2008, based on the then current estimated fairvalue of the collateral, the Bank estimates it will incur no loss.

 

The fifth relationship totaled $4.8 million at March 31, 2008, and is comprised primarily of $3.8 millionin land development loans for a 110 lot subdivision in Springdale, Arkansas, aswell as seven loans totaling approximately $950,000 for a speculativesingle-family residence, a pre-sold custom home, a single family residence, arental property, and land. This borrower has filed for bankruptcy protection.We have estimated losses of $15,000 at March 31, 2008.However, based on factors such as the potential adverse changes in marketconditions, we may incur losses greater than that amount.

 

The sixth relationship totaled $1.1 million at March 31, 2008, andis comprised primarily of loans totaling $1.0 million for 35 completed lots ina subdivision located in Pea Ridge, Arkansas, and a $96,000 loan on acompleted speculative home. As ofMarch 31, 2008, based on the then current estimated fairvalue of the collateral, the Bank estimates it will incur no loss. Basedon the nature of this loan and the possibility of continued adverse changes inthe market conditions, we may incur losses in the future.

 

Accruing loans 90 days or more past due at March 31, 2008, primarilyconsisted of one loan whose past due interest is expected to be paid after March 31, 2008.

 

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

 
| ** **                                       | ** ** | **March 31,  2008**             | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **(Dollars in Thousands)** | ** ** |
| Real estate  owned                               |       |                                 |       |                        |       |
| One- to  four-family residential                 |       | $                                    | 2,175      |                        | $          | 1,566 |   |
| Speculative  one- to four-family construction(1) |       | 7,199                                |       | 5,956                       |       |
| Land                                             |       | 1,032                                |       | 598                         |       |
| Commercial  real estate                          |       | 828                                  |       | —                      |       |
| Total real  estate owned                         |       | $                                    | 11,234     |                        | $          | 8,120 |   |

 

----

(1)                        At March 31,2008 $5.5 million of these properties are 100% complete. The remainder rangefrom 85% to 97% complete.

 

The Bank is diligently working to dispose of its REO and has dedicatedan experienced special assets officer who is working full-time to liquidate theBank’s properties in the Northwest Arkansas market. Each property is evaluatedon a case-by-case basis to determine the best course of action with respect toliquidation.  Properties are marketed directly by the Bank or listed withlocal real estate agents utilizing appraisals, market information fromrealtors, market research reports, and our own market evaluations to makepricing and selling decisions.   The Bank’s Chief Lending Officer,loan officer, credit manager, special assets officer, and team members in thecollections department all work 

 

12

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together in this endeavor.   The Bank’s goal is to liquidatethese properties as soon as possible without incurring extraordinary losses dueto quick sale pricing. During the quarter ended March 31, 2008, the Bankoriginated loans to facilitate the sales of real estate owned totaling $1.8million. The Bank offers attractive rates and financing options to prospectivebuyers of real estate owned to help facilitate sales.

 

**Allowancefor Loan Losses**. A summary of the activity in the allowance for loan lossesis as follows (in thousands):

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Balance at  beginning of period  |       | $                                                    | 5,162      |   | $ | 2,572 |   |
| Provisions  for estimated losses |       | 1,528                                                |       | 1,961 |   |
| Recoveries                       |       | 136                                                  |       | 49 |   |
| Losses  charged off              |       | (719                                                 | )          | (288 | ) |
| Balance at  end of period        |       | $                                                    | 6,107      |   | $ | 4,294 |   |

 

Changesin the composition of the allowance for loan losses between March 31, 2007and December 31, 2006 are presented in the following table (in thousands):

 
| ** ** | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | ** **   | ** ** |
|------------|------------|--------------------|------------|-----------------------|------------|--------------|------------|
| ** ** | ** ** | **2008**           | ** ** | **2007**              | ** ** | **Increase** | ** ** |
| General    |       | $                  | 2,546      |                  | $          | 2,267        |       | $ | 279 |   |
| Specific   |       | 3,561              |       | 2,895                 |       | 666          |       |
|       |       | $                  | 6,107      |                  | $          | 5,162        |       | $ | 945 |   |

 

The general component of the allowance forloan losses increased primarily due to increases in the loss factors applied tosingle family residential loans, speculative single family construction loansand land development loans, partially offset by decreases in the related loanbalances. These loss factors were increased due to the recent loss history onthese types of loans. The specific component of the allowance for loan lossesincreased primarily due to specific allowances on one borrower. See “AssetQuality.”

 

The allowance for loan losses is establishedas losses are estimated to have occurred through a provision for loan lossescharged to earnings. Loan losses are charged against the allowance whenmanagement believes it is likely that a loan balance is uncollectible. Subsequentrecoveries, if any, are credited to the allowance.

 

The allowance for loan losses representsmanagement’s estimate of incurred credit losses inherent in the Company’s loanportfolio as of the balance sheet date. The estimation of the allowance isbased on a variety of factors, including past loan loss experience, the currentcredit profile of the Company’s borrowers, adverse situations that haveoccurred that may affect the borrowers’ ability to repay, the estimated value ofunderlying collateral, and general economic conditions. Losses are recognizedwhen available information indicates that it is probable that a loss has beenincurred and the amount of the loss can be reasonably estimated. Thisevaluation is inherently subjective as it requires estimates that aresusceptible to significant revision as more information becomes available orconditions change.

 

In determining the allowance for loan losses,the Company allocates a portion of the allowance to its various loan categoriesbased on an analysis of individual loans and pools of loans. However, theentire allowance is available to absorb credit losses inherent in the totalloan portfolio as of the balance sheet date.

 

A loan is considered impaired when, based oncurrent information and events, it is probable that the Bank will be unable tocollect the scheduled payments of principal or interest when due according tothe contractual terms of the loan agreement. Factors considered by managementin determining impairment include payment status, collateral value, and theprobability of collecting scheduled principal and interest payments when due.Loans that experience insignificant payment delays and payment shortfallsgenerally are not classified as impaired. Management determines thesignificance of payment delays and payment shortfalls on a case-by-case basis,taking into consideration all of the circumstances surrounding the loan and theborrower, including the length of the delay, the reasons for the delay, theborrower’s prior payment record, and the amount of the short fall in relationto 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. Multi-familyresidential, commercial real estate, land and land development, and commercialloans that are delinquent or where the borrower’s total loan relationshipexceeds $1 million are evaluated on a loan by loan basis at least annually.

 

Large groups of smaller balance homogeneousloans are collectively evaluated for impairment. Accordingly, the Bank does notseparately identify individual consumer and residential loans for impairmentdisclosures. Homogeneous loans are those that are considered to have commoncharacteristics that provide for evaluation on an aggregate or 

 

13

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pool basis. The Bank considers thecharacteristics of (1) one- to four-family residential first mortgageloans; (2) unsecured consumer loans; and (3) collateralized consumerloans to permit consideration of the appropriateness of the allowance forlosses of each group of loans on a pool basis. The primary methodology used todetermine the appropriateness of the allowance for losses includes segregatingcertain specific, poorly performing loans based on their performancecharacteristics from the pools of loans as to type, valuing these loans, andthen applying a loss factor to the remaining pool balance based on severalfactors including past loss experience, inherent risks, and economic conditionsin the primary market areas.

 

In estimating theamount of credit losses inherent in our loan portfolio, various judgments andassumptions are made. For example, when assessing the condition of the overalleconomic environment, assumptions are made regarding future market conditionsand their impact on the loan portfolio. In the event the national or localeconomy were to sustain a prolonged downturn, the loss factors applied to ourportfolios may need to be revised, which may significantly impact themeasurement of the allowance for loan losses. For impaired loans that arecollateral dependent, the estimated fair value of the collateral may deviatesignificantly from the proceeds received when the collateral is sold in theevent that the Bank has to foreclose or repossess the collateral.

 

Although we considerthe allowance for loan losses of approximately $6.1 million adequate to coverlosses inherent in our loan portfolio at March 31, 2008, no assurance canbe given that we will not sustain loan losses that are significantly differentfrom the amount recorded, or that subsequent evaluations of the loan portfolio,in light of factors then prevailing, would not result in a significant changein the allowance for loan losses.

 

**Investment Securities.**Changes in the composition ofinvestment securities held to maturity between March 31, 2008 and December 31,2007 are presented in the following table (in thousands).

 
| ** **                              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | ** **   | ** ** |
|-----------------------------------------|------------|--------------------|------------|-----------------------|------------|--------------|------------|
| ** **                              | ** ** | **2008**           | ** ** | **2007**              | ** ** | **Increase** | ** ** |
| U.S.  Government and agency obligations |       | $                  | 103,174    |                  | $          | 78,501       |       | $ | 24,673 |   |
| Municipal  securities                   |       | 17,690             |       | 17,089                |       | 601          |       |
| Total                                   |       | $                  | 120,864    |                  | $          | 95,590       |       | $ | 25,274 |   |

 

During the first three monthsof 2008, investment securities totaling $64.9 million with an average taxequivalent yield of 6.07% were purchased and $39.7 million matured or werecalled.

 

At March 31,2008, estimated fair values of investment securities held to maturitywere as follows (in thousands):

 
| ** **                             | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------|------------|
|                                   |       |                |       |            |       |
| U.S. Government and agency obligations |       | $                   | 103,174    |            | $          | 103,708 |   |
| Municipal securities                   |       | 17,690              |       | 17,646          |       |
| Total                                  |       | $                   | 120,864    |            | $          | 121,354 |   |

 

**Accrued Interest Receivable.**Thedecrease in accrued interest receivable was primarily due to a decrease in theloans receivable balance as well as a decrease in the loan yield at March 31,2008 compared to December 31, 2007.

 

**Real EstateOwned, net.**Changesin the composition of real estate owned between March 31, 2008 and December 31, 2007 arepresented in the following table (dollars in thousands).

 
| ** **                      | ** ** | **December 31,  2007** | ** ** | **Additions** | ** ** | **Fair Value  Adjustments** | ** ** | **Net Sales  Proceeds(1)** | ** ** | **Gain (Loss)** | ** ** | **March 31,  2008** | ** ** |
|---------------------------------|------------|-----------------------------|------------|---------------|------------|----------------------------------|------------|---------------------------------|------------|----------------------|------------|--------------------------|------------|
| One- to four-family residential |       | $                           | 1,566      |          | $          | 763                              |       | $                               | (65        | )                    | $          | (65                      | )          | $ | (24 | ) | $ | 2,175 |   |
| Speculative one- to four-family |       | 5,956                       |       | 3,392         |       | (146                             | )          | (1,981                          | )          | (22                  | )          | 7,199                    |       |
| Land                            |       | 598                         |       | 517           |       | (18                              | )          | (65                             | )          | —               |       | 1,032                    |       |
| Commercial real estate          |       | —                      |       | 828           |       | —                           |       | —                          |       | —               |       | 828                      |       |
|                            |       | $                           | 8,120      |          | $          | 5,500                            |       | $                               | (229       | )                    | $          | (2,111                   | )          | (46 | ) | $ | 11,234 |   |
|                                 |            |                             |            |               |            |                                  |            |                                 |            |                      |            |                          |            |  |  |  |  |  |  |

 

----

(1) Net sales proceeds include $1.8million of loans made by the Bank to facilitate the sale of real estate owned.

 

**Prepaid Expenses and Other Assets.**Prepaid expenses and other assetsincreased by $2.2 million from December 31, 2007 to March 31, 2008primarily due to a $1.7 million receivable for a death benefit claim on ourlife insurance policies recorded in the first quarter of 2008.

 

14

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**Deposits. **Changes in the composition of depositsbetween March 31, 2008and December 31, 2007 are presented in the following table (dollars inthousands).

 
| ** **              | ** ** | **March 31,****2008** | ** ** | **December 31,****2007** | ** ** | **Increase  (Decrease)** | ** ** | **Percentage  Change** | ** ** |
|-------------------------|------------|----------------------------|------------|-------------------------------|------------|--------------------------|------------|------------------------|------------|
|                    |       |                       | ** ** | ** **                    | ** ** | ** **               | ** ** | ** **             | ** ** |
| Checking accounts       |       | $                          | 161,315    |                          | $          | 127,491                  |       | $                      | 33,824     |   | 26.5 | % |
| Money Market accounts   |       | 51,713                     |       | 51,424                        |       | 289                      |       | 0.6                    |       |
| Savings accounts        |       | 25,073                     |       | 25,088                        |       | (15                      | )          | (0.1                   | )          |
| Certificates of deposit |       | 418,812                    |       | 426,411                       |       | (7,599                   | )          | (1.8                   | )          |
|                    |       |                       |       |                          |       |                     |       |                   |       |
| Total deposits          |       | $                          | 656,913    |                          | $          | 630,414                  |       | $                      | 26,499     |   | 4.2 | % |

 

Deposits increased in the comparison period, primarily due to anincrease in checking accounts related to public unit deposits and focusedmarketing efforts to increase checking accounts with a checking product whichhas a higher interest rate than the Bank’s other checking accountproducts.  To earn the maximum rate underthe new product, customers must qualify based on usage of electronic bankingservices such as debit card transactions, e-statements, and direct deposits orautomatic payments. The Bank willcontinue to promote checking accounts by targeting households and small- andmedium-sized business accounts with its direct mail campaign and “thank you”gifts.   Checking accounts are an attractive source offunds for the Bank as they offer overall low-interest deposits, fee incomepotential, and the opportunity to cross-sell other financial services.

 

**Other Liabilities.**  Other liabilities increased primarily due toan increase in investment security purchases which settled after period endfrom $3.2 million at December 31, 2007, to $7.5 million at March 31,2008.

 

**Stockholders’ Equity. **Stockholders’equity increased approximately $362,000 from December 31, 2007 to March 31,2008.  The increase in stockholders’ equity wasprimarily due to net income totaling $1.1 million during the first three monthsof 2008.  In addition, during the threemonths ended March 31, 2008, cash dividends of approximately $775,000 were paid.  See the Unaudited Consolidated Statement of Stockholders’Equity for the three months ended March 31, 2008 for more detail.

 

15

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### **Average Balance Sheets**

### ** **

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

 
| ** **                                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| ** **                                                       | ** ** | **Average  Balance**                                 | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** |
| ** **                                                       | ** ** | **(Dollars in Thousands)**                 | ** ** |
| Interest-earning assets:                                         |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans receivable(1)                                              |       | $                                                    | 601,996    |   | $ | 9,975 |   | 6.63 | % | $ | 686,419 |   | $ | 12,201 |   | 7.11 | % |
| Investment securities(2)                                         |       | 105,254                                              |       | 1,393 |   | 5.29 |   | 66,961 |   | 838 |   | 5.00 |   |
| Other interest-earning assets                                    |       | 21,159                                               |       | 168 |   | 3.18 |   | 14,650 |   | 188 |   | 5.13 |   |
| Total interest-earning assets                                    |       | 728,409                                              |       | 11,536 |   | 6.34 |   | 768,030 |   | 13,227 |   | 6.89 |   |
| Noninterest-earning assets                                       |       | 72,425                                               |       |   |   |   |   | 66,206 |   |   |   |   |   |
| Total assets                                                     |       | $                                                    | 800,834    |   |   |   |   |   | $ | 834,236 |   |   |   |   |   |
| Interest-bearing liabilities:                                    |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                         |       | $                                                    | 632,954    |   | 5,568 |   | 3.52 |   | $ | 641,633 |   | 5,848 |   | 3.65 |   |
| FHLB advances                                                    |       | 84,870                                               |       | 903 |   | 4.25 |   | 110,491 |   | 1,260 |   | 4.56 |   |
| Total interest-bearing liabilities                               |       | 717,824                                              |       | 6,471 |   | 3.61 |   | 752,124 |   | 7,108 |   | 3.78 |   |
| Noninterest-bearing liabilities                                  |       | 8,856                                                |       |   |   |   |   | 6,201 |   |   |   |   |   |
| Total liabilities                                                |       | 726,680                                              |       |   |   |   |   | 758,325 |   |   |   |   |   |
| Stockholders’ equity                                        |       | 74,154                                               |       |   |   |   |   | 75,911 |   |   |   |   |   |
| Total liabilities and stockholders’ equity                  |       | $                                                    | 800,834    |   |   |   |   |   | $ | 834,236 |   |   |   |   |   |
|                                                             |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                              |       |                                                 |       | $ | 5,065 |   |   |   |   |   | $ | 6,119 |   |   |   |
| Net earning assets                                               |       | $                                                    | 10,585     |   |   |   |   |   | $ | 15,906 |   |   |   |   |   |
| Interest rate spread                                             |       |                                                 |       |   |   | 2.73 | % |   |   |   |   | 3.11 | % |
| Net interest margin                                              |       |                                                 |       |   |   | 2.78 | % |   |   |   |   | 3.19 | % |
| Ratio of interest-earning assets to interest-bearing liabilities |       |                                                 |       |   |   | 101.47 | % |   |   |   |   | 102.11 | % |

 

----

(1) Includes nonaccrual loans.

(2) Includes FHLB of Dallas stock.

 

16

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## **Rate/Volume Analysis**

##  

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

 
| ** **                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2008 vs. 2007**                          | ** ** |
| ** **                         | ** ** | **Increase (Decrease)  Due to**            | ** ** | **Total** | ** ** |
| ** **                         | ** ** | **Volume**                                           | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Increase  (Decrease)** | ** ** |
| ** **                         | ** ** | **(In Thousands)**                                   | ** ** |
| ** **                         |       |                                                 |       |   |   |   |   |   |   |
| Interest income:                   |       |                                                 |       |   |   |   |   |   |   |
| Loans receivable                   |       | $                                                    | (1,501     | ) | $ | (827 | ) | $ | 102 |   | $ | (2,226 | ) |
| Investment securities              |       | 478                                                  |       | 49 |   | 28 |   | 555 |   |
| Other interest-earning assets      |       | 83                                                   |       | (71 | ) | (32 | ) | (20 | ) |
| Total interest-earning assets      |       | (940                                                 | )          | (849 | ) | 98 |   | (1,691 | ) |
|                               |       |                                                 |       |   |   |   |   |   |   |
| Interest expense:                  |       |                                                 |       |   |   |   |   |   |   |
| Deposits                           |       | (80                                                  | )          | (203 | ) | 3 |   | (280 | ) |
| FHLB advances                      |       | (292                                                 | )          | (85 | ) | 20 |   | (357 | ) |
| Total interest-bearing liabilities |       | (372                                                 | )          | (288 | ) | 23 |   | (637 | ) |
| Net change in net interest income  |       | $                                                    | (568       | ) | $ | (561 | ) | $ | 75 |   | $ | (1,054 | ) |

 

17

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**CHANGES IN RESULTS OF OPERATIONS**

 

The table below presents acomparison of results of operations for the three months ended March 31,2008 and 2007 (dollars in thousands). Specific changes in captions are discussed in the sections which followthe table.

 
| ** **                                            | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase  (Decrease)** | ** ** | **Percentage  Change**     | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                            | ** ** | **2008**                                         | ** ** | **2007**                 | ** ** | **2008 vs 2007** | ** ** | **2008 vs 2007** | ** ** |
| Interest income:                                      |       |                                             |       |                     |       |                       |       |   |   |
| Loans receivable                                      |       | $                                                | 9,975      |                     | $          | 12,201                     |       | $ | (2,226 | ) | (18.2 | )% |
| Investment securities                                 |       | 1,393                                            |       | 838                      |       | 555                        |       | 66.2 |   |
| Other                                                 |       | 168                                              |       | 188                      |       | (20                        | )          | (10.6 | ) |
| Total interest income                                 |       | 11,536                                           |       | 13,227                   |       | (1,691                     | )          | (12.8 | ) |
| Interest expense:                                     |       |                                             |       |                     |       |                       |       |   |   |
| Deposits                                              |       | 5,568                                            |       | 5,848                    |       | (280                       | )          | (4.8 | ) |
| FHLB advances                                         |       | 903                                              |       | 1,260                    |       | (357                       | )          | (28.3 | ) |
| Total interest expense                                |       | 6,471                                            |       | 7,108                    |       | (637                       | )          | (9.0 | ) |
| Net interest income before  provision for loan losses |       | 5,065                                            |       | 6,119                    |       | (1,054                     | )          | (17.2 | ) |
| Provision for loan losses                             |       | 1,528                                            |       | 1,961                    |       | (433                       | )          | (22.1 | ) |
| Net interest income afterprovision for loan losses    |       | 3,537                                            |       | 4,158                    |       | (621                       | )          | (14.9 | ) |
| Noninterest income:                                   |       |                                             |       |                     |       |                       |       |   |   |
| Deposit fee income                                    |       | 1,211                                            |       | 1,157                    |       | 54                         |       | 4.7 |   |
| Earnings on life insurance  policies                  |       | 1,371                                            |       | 189                      |       | 1,182                      |       | 625.4 |   |
| Gain on sale of loans                                 |       | 175                                              |       | 226                      |       | (51                        | )          | (22.6 | ) |
| Other                                                 |       | 447                                              |       | 286                      |       | 161                        |       | 56.3 |   |
| Total noninterest income                              |       | 3,204                                            |       | 1,858                    |       | 1,346                      |       | 72.4 |   |
| Noninterest expenses:                                 |       |                                             |       |                     |       |                       |       |   |   |
| Salaries and employee  benefits                       |       | 3,387                                            |       | 3,443                    |       | (56                        | )          | (1.6 | ) |
| Real estate owned, net                                |       | 430                                              |       | 162                      |       | 268                        |       | 165.4 |   |
| Data processing                                       |       | 318                                              |       | 454                      |       | (136                       | )          | (30.0 | ) |
| Other                                                 |       | 1,936                                            |       | 2,007                    |       | (71                        | )          | (3.5 | ) |
| Total noninterest expenses                            |       | 6,071                                            |       | 6,066                    |       | 5                          |       | 0.1 |   |
| Income before income taxes                            |       | 670                                              |       | (50                      | )          | 720                        |       | 1,440.0 |   |
| Income tax provision  (benefit)                       |       | (417                                             | )          | (209                     | )          | (208                       | )          | 99.5 |   |
| Net income                                            |       | $                                                | 1,087      |                     | $          | 159                        |       | $ | 928 |   | 583.7 | % |
|                                                  |       |                                             |       |                     |       |                       |       |   |   |
| Basic earnings per share                              |       | $                                                | 0.22       |                     | $          | 0.03                       |       | $ | 0.19 |   | 633.3 | % |
| Diluted earnings per share                            |       | $                                                | 0.22       |                     | $          | 0.03                       |       | $ | 0.19 |   | 633.3 | % |
|                                                  |       |                                             |       |                     |       |                       |       |   |   |
| Interest rate spread                                  |       | 2.73                                             | %          | 3.11                     | %          |                       |       |   |   |
| Net interest margin                                   |       | 2.78                                             | %          | 3.19                     | %          |                       |       |   |   |
|                                                  |       |                                             |       |                     |       |                       |       |   |   |
| Average full-time  equivalents                        |       | 306                                              |       | 306                      |       |                       |       |   |   |
|                                                  |       |                                             |       |                     |       |                       |       |   |   |
| Full-service offices                                  |       | 19                                               |       | 18                       |       |                       |       |   |   |

 

18

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**Net Interest Income. **Net interest income is determined by the Company’s interest rate spread(i.e., the difference between the yields earned on its interest-earning assetsand the rates paid on its interest-bearing liabilities) and the relativeamounts of interest-earning assets and interest-bearing liabilities.  The decrease in net interest income wasprimarily due to the level of nonperforming loans.

 

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

### ** **

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

 

**Interest Income. **The decrease in interest income for the three month comparative periodwas primarily due to a decrease in the average balance of loans receivable andan increase in the level of deferred interest on nonperforming loans, as wellas a decrease in the average yield earned on loans receivable.  These decreases were offset by an increase inthe average balance of investment securities. The decrease in average yields earned was due to decreases in marketinterest rates.  The average balance ofloans receivable decreased due to repayments and maturities as well as adecrease in loan originations.

 

**Interest Expense.  **The decrease in interest expense for the three month comparative periodwas primarily due to a decrease in the average rates paid on deposits and FHLBadvances and decreases in the average balances of deposits and FHLB advances.  The decrease in the average rates paid on depositaccounts reflects the recent decreases in market interest rates.

 

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

 

The provision for loan losses decreased $433,000 to $1.5 million forthe quarter ended March 31, 2008 compared to $2.0 million for the quarterended March 31, 2007.  The decreasein the provision for loan losses was primarily due to a large specific loanloss allowance recorded in the first quarter of 2007.

 

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

 

**NoninterestExpense**

 

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

 
| ** **                         | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase****(Decrease)** | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|----------------------------|------------|
| ** **                         | ** ** | **2008**                                         | ** ** | **2007**                   | ** ** | **2008 vs 2007** | ** ** |
| Salaries                           |       | $                                                | 2,642      |                       | $          | 2,665 |   | $ | (23 | ) |
| Payroll taxes                      |       | 256                                              |       | 263                        |       | (7 | ) |
| Insurance                          |       | 171                                              |       | 170                        |       | 1 |   |
| 401(k)                             |       | 78                                               |       | 80                         |       | (2 | ) |
| Stock compensation (1)             |       | 6                                                |       | 14                         |       | (8 | ) |
| Defined benefit plan  contribution |       | 196                                              |       | 210                        |       | (14 | ) |
| Other                              |       | 38                                               |       | 41                         |       | (3 | ) |
| Total                              |       | $                                                | 3,387      |                       | $          | 3,443 |   | $ | (56 | ) |

 

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(1)   Includes stock options and ManagementRecognition and Retention Plan (“MRP”) expense.

 

19

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

 
| ** **               | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase****(Decrease)** | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|----------------------------|------------|
| ** **               | ** ** | **2008**                                         | ** ** | **2007**                   | ** ** | **2008 vs 2007** | ** ** |
| Loss provisions          |       | $                                                | 229        |                       | $          | 74 |   | $ | 155 |   |
| Net loss (gain) on sales |       | 53                                               |       | 43                         |       | 10 |   |
| Taxes and insurance      |       | 111                                              |       | 5                          |       | 106 |   |
| Other                    |       | 37                                               |       | 40                         |       | (3 | ) |
| Total                    |       | $                                                | 430        |                       | $          | 162 |   | $ | 268 |   |

 

Expensesassociated with real estate owned have increased due to the increase in realestate owned balances as discussed in “Asset Quality.”   Real estate owned is expected to continue toincrease in the foreseeable future and real estate owned expenses associatedwith maintaining the properties are expected to increase accordingly.  Future levels of loss provisions and netgains or losses on sales of real estate owned will be dependent on marketconditions.

 

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

 

**IncomeTaxes. **The income tax benefit increased primarily due to anincrease in nontaxable life insurance earnings.

 

# **OFF-BALANCE SHEET ARRANGEMENTS**

 

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

 

·      theorigination, purchase or sale of loans;

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

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

 

At March 31, 2008, the Bank’soff-balance sheet arrangements principally included lending commitments, whichare described below.  At March 31,2008, the Company had no interests in non-consolidated special purposeentities.

 

At March 31, 2008, commitments included:

 

·      totalapproved commitments to originate or purchase loans amounting to $3.8 million,including $842,000 of loans committed to sell;

·      ratelock agreements with customers of $4.4 million, all of which have been lockedwith an investor;

·      fundedmortgage loans committed to sell of $1.8 million;

·      unadvancedportion of construction loans of $23.3 million;

·      unusedlines of credit of $21.5 million;

·      outstandingstandby letters of credit of approximately $135,000;

·      totalpredetermined overdraft protection limits of $14.1 million; and

·      certificatesof deposit scheduled to mature in one year or less totaling $330.1 million.

 

Total unfunded commitments to originate loans for sale and the relatedcommitments to sell of $4.4 million meet the definition of a derivativefinancial instrument.  The related assetand liability are considered immaterial at March 31, 2008.

 

Historically, a very small percentage of predetermined overdraft limitshave been used.  At March 31, 2008,overdrafts of accounts with Bounce ProtectionTM represented usage of 4.5% of the limit.  We expect utilization of these overdraftlimits to remain at comparable levels in the future.

 

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

 

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### **LIQUIDITY AND CAPITAL RESOURCES**

### ** **

The Bank’s liquidity, represented bycash and cash equivalents and eligible investment securities, is a product ofits operating, investing and financing activities.  The Bank’s primary sources of funds aredeposits, borrowings, payments on outstanding loans, maturities and calls ofinvestment securities and other short-term investments and funds provided fromoperations.  While scheduled loanamortization and maturing investment securities and short-term investments arerelatively predictable sources of funds, deposit flows and loan prepayments aregreatly influenced by general interest rates, economic conditions andcompetition.  Calls of investmentsecurities are determined by the issuer and are generally influenced by thelevel of market interest rates at the bond’s call date compared to the couponrate of the bond.  The Bank manages thepricing of its deposits to maintain a steady deposit balance.  In addition, the Bank invests excess funds inovernight deposits and other short-term interest-earning assets that provideliquidity to meet lending requirements.  TheBank has generally been able to generate enough cash through the retail depositmarket, its traditional funding source, to offset the cash utilized ininvesting activities.  As an additionalsource of funds, the Bank has borrowed from the FHLB of Dallas.    Duringthe first quarter of 2008, the use of FHLB advances increased by $5.5 millionor 6.8%.  The Bank uses investmentsecurities and eligible loans as collateral for FHLB advances.  In addition, brokered deposits may be used toaugment the Bank’s primary funding sources. At March 31, 2008, the Bank had outstanding brokered deposits of$2.1 million.

 

For each of the quarters ended March 31,2008 and 2007, the Company paid dividends of $0.16 per share.  The determination of future dividends on theCompany’s common stock will depend on conditions existing at that time withconsideration given to the Company’s earnings, capital, and liquidity needs.

 

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

 

As of March 31, 2008, the Bank’s regulatory capital was in excess of all applicableregulatory requirements.  At March 31,2008, the Bank’s tangible, core andrisk-based capital ratios amounted to 8.65%, 8.65% and 13.00%, respectively,compared to regulatory requirements of 1.5%, 4.0% and 8.0%, respectively.

 

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

### ** **

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

 

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

 

### **FORWARD-LOOKINGSTATEMENTS**

### ** **

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

 

**QUANTITATIVE AND QUALITATIVE DISCLOSURES**

 

**ABOUT MARKET RISK**

 

There has been no material change in the market value of the Bank’sportfolio equity since December 31, 2007. Similarly, while there has been no material change in the Company’sasset and liability position since such time, the Bank’s increased level ofnonperforming assets continued to impact the level of net interest incomeduring the three months ended March 31, 2008.  Correspondingly, the Bank’s net interestmargin decreased from 3.19% for the three months ended March 31, 2007 to2.78% for the same period in 2008.  Based on the level of nonperforming assets 

 

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and competitive pressures on loan and deposit rates, managementanticipates continued pressure on the Bank’s interest rate spread and interestmargin for the second quarter of 2008.

 

**CONTROLS AND PROCEDURES**

 

Our management evaluated, with theparticipation of our Chief Executive Officer and Chief Financial Officer, theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934) as of the end of the period covered bythis report.  Based on such evaluation,our Chief Executive Officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures are designed to ensure that informationrequired to be disclosed by us in the reports that we file or submit under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and regulations andare operating in an effective manner.

 

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

 

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

 

**Part II**

 

Item 1.             Legal Proceedings

 

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

 

Item 1A.         Risk Factors

 

There have been no material changes in theCompany’s risk factors from those previously disclosed in the Company’s Form 10-Kfor the year ended December 31, 2007.

 

Item 2.             Unregistered Sales of Equity Securitiesand Use 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** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | ** **                                                              | ** ** | ** **                                                    | ** ** | ** **                                                                                                                                                        | ** ** | ** **                                                                                                                                                           | ** ** |
| January 1 to January 31, 2008   |       | —                                                                  |       | —                                                        |       | —                                                                                                                                                            |       | —                                                                                                                                                               |       |
| February 1 to February 29, 2008 |       | —                                                                  |       | —                                                        |       | —                                                                                                                                                            |       | —                                                                                                                                                               |       |
| March 1 to March 31, 2008       |       | —                                                                  |       | —                                                        |       | —                                                                                                                                                            |       | —                                                                                                                                                               |       |

 

The Company is in its 19th announcedrepurchase program, which was approved by the board of directors on July 25,2006, and publicly announced on November 8, 2006.  Total shares approved to be purchased in thisprogram are 245,197 of which 214,587 have been purchased as of March 31,2008.  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 ofSecurity Holders

 

Not applicable.

 

Item 5.             Other Information

 

None.

 

Item 6.             Exhibits

 

Exhibit 31.1 – Certification of ChiefExecutive Officer,

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

Exhibit 31.2 – Certification of ChiefFinancial Officer,

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

Exhibit 32.1 – Certification of ChiefExecutive Officer,

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

Exhibit 32.2 – Certification of ChiefFinancial Officer,

Pursuant to Section 906 of theSarbanes-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.

 

 

**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

 

 
| Date:  | April 30, 2008 | By:    | /s/ Larry J. Brandt     |
|--------|---------------------|--------|-------------------------|
|   |                |   | Larry J. Brandt         |
|   |                |   | Chief Executive Officer |

 

 
| Date:  | April 30, 2008 | By:    | /s/ Sherri R. Billings                               |
|--------|---------------------|--------|------------------------------------------------------|
|   |                |   | Sherri R. Billings                                   |
|   |                |   | Chief Financial Officer and Chief Accounting Officer |

 

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