Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND 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 June 30, 2009**

 

**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**

 

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

(Exact name ofregistrant as specified in its charter)

 

| **Texas**                                                       | ** ** | **71-0785261**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or other jurisdiction of incorporation  or organization) |       | (I.R.S. Employer  Identification Number) |
|                                                            |       |                                     |
| **1401 Highway 62-65 North  Harrison, Arkansas**                | ** ** | **72601**                                |
| (Address of principal executive office)                         |       | (Zip Code)                               |

 

**(870) 741-7641**

(Registrant’s telephone number, including area code)

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.  Yes x No o

 

Indicate bycheck mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files).  Yes o 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 the definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 

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

 

Indicate by check mark whether the registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date:  As ofAugust 3, 2009, there were issued and outstanding 4,846,785 shares of theRegistrant’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  June 30, 2009 and December 31, 2008 (unaudited)                                                            | 1          |
|              |                                                                                                                                                                       |       |
|              | Consolidated Statements of Operations for the three  and six months ended June 30, 2009 and 2008 (unaudited)                                                          | 2          |
|              |                                                                                                                                                                       |       |
|              | Consolidated Statement of Stockholders’ Equity for the  six months ended June 30, 2009 (unaudited)                                                               | 3          |
|              |                                                                                                                                                                       |       |
|              | Consolidated Statements of Cash Flows for the six  months ended June 30, 2009 and 2008 (unaudited)                                                                    | 4          |
|              |                                                                                                                                                                       |       |
|              | Notes to Unaudited Consolidated Financial Statements                                                                                                                       | 6          |
|              |                                                                                                                                                                       |       |
| Item  2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                | 14         |
|              |                                                                                                                                                                       |       |
| Item  3.          | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                | 30         |
|              |                                                                                                                                                                       |       |
| Item 4.           | Controls and  Procedures                                                                                                                                                   | 30         |
|              |                                                                                                                                                                       |       |
| **Part II.** | **Other  Information**                                                                                                                                                     | ** ** |
|              |                                                                                                                                                                       |       |
| Item 1.           | Legal  Proceedings                                                                                                                                                         | 31         |
| Item 1A.          | Risk Factors                                                                                                                                                               | 31         |
| Item  2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                               | 31         |
| Item  3.          | Defaults  Upon Senior Securities                                                                                                                                           | 31         |
| Item  4.          | Submission  of Matters to a Vote of Security Holders                                                                                                                       | 32         |
| Item 5.           | Other  Information                                                                                                                                                         | 32         |
| Item 6.           | Exhibits                                                                                                                                                                   | 32         |
|              |                                                                                                                                                                       |       |
| **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)

 
| ** **                                                                                                                                                                                                                                                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                           | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ASSETS                                                                                                                                                                                                                                                               |       |              |       |                  |       |
|                                                                                                                                                                                                                                                                 |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                                            |       | $                 | 10,541     |                  | $          | 9,367 |   |
| Investment securities held  to maturity                                                                                                                                                                                                                              |       | 141,688           |       | 136,412               |       |
| Federal Home Loan Bank  stock                                                                                                                                                                                                                                        |       | 3,656             |       | 4,825                 |       |
| Loans receivable, net of  allowance of $11,924 and $6,441                                                                                                                                                                                                            |       | 548,329           |       | 566,537               |       |
| Loans held for sale                                                                                                                                                                                                                                                  |       | 3,517             |       | 1,586                 |       |
| Accrued interest  receivable                                                                                                                                                                                                                                         |       | 5,324             |       | 6,701                 |       |
| Real estate owned, net                                                                                                                                                                                                                                               |       | 23,473            |       | 22,385                |       |
| Office properties and  equipment, net                                                                                                                                                                                                                                |       | 24,151            |       | 24,694                |       |
| Cash surrender value of  life insurance                                                                                                                                                                                                                              |       | 20,810            |       | 20,412                |       |
| Deferred tax asset                                                                                                                                                                                                                                                   |       | 4,087             |       | 1,105                 |       |
| Prepaid expenses and other  assets                                                                                                                                                                                                                                   |       | 1,121             |       | 1,148                 |       |
|                                                                                                                                                                                                                                                                 |       |              |       |                  |       |
| TOTAL ASSETS                                                                                                                                                                                                                                                         |       | $                 | 786,697    |                  | $          | 795,172 |   |
|                                                                                                                                                                                                                                                                 |       |              |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                           |       |              |       |                  |       |
|                                                                                                                                                                                                                                                                 |       |              |       |                  |       |
| LIABILITIES:                                                                                                                                                                                                                                                         |       |              |       |                  |       |
| Deposits                                                                                                                                                                                                                                                             |       | $                 | 620,180    |                  | $          | 618,003 |   |
| Other borrowings                                                                                                                                                                                                                                                     |       | 73,783            |       | 92,212                |       |
| Advance payments by  borrowers for taxes and insurance                                                                                                                                                                                                               |       | 410               |       | 810                   |       |
| Other liabilities                                                                                                                                                                                                                                                    |       | 5,506             |       | 11,030                |       |
| Total liabilities                                                                                                                                                                                                                                                    |       | 699,879           |       | 722,055               |       |
|                                                                                                                                                                                                                                                                 |       |              |       |                  |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                           |       |              |       |                  |       |
| Preferred stock, no par  value, 5,000,000 shares authorized; Series A fixed rate cumulative  perpetual; liquidation preference of $1,000 per share; 16,500 shares issued  and outstanding at June 30, 2009 and none outstanding at  December 31, 2008 |       | 16,162            |       | —                |       |
| Common stock, $.01 par  value, 20,000,000 shares authorized, 10,307,502 shares issued, 4,846,785  shares outstanding at June 30, 2009 and December 31, 2008                                                                                                |       | 103               |       | 103                   |       |
| Additional paid-in capital                                                                                                                                                                                                                                           |       | 56,986            |       | 56,627                |       |
| Retained  earnings-substantially restricted                                                                                                                                                                                                                          |       | 84,185            |       | 87,005                |       |
|                                                                                                                                                                                                                                                                 |       | 157,436           |       | 143,735               |       |
| Treasury stock, at cost,  5,460,717 shares at June 30, 2009 and December 31, 2008                                                                                                                                                                          |       | (70,618           | )          | (70,618               | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                      |       | 86,818            |       | 73,117                |       |
|                                                                                                                                                                                                                                                                 |       |              |       |                  |       |
| TOTAL LIABILITIES ANDSTOCKHOLDERS’ EQUITY                                                                                                                                                                                                                       |       | $                 | 786,697    |                  | $          | 795,172 |   |

 

See notes to unauditedconsolidated financial statements.

 

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

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(In thousands, except share data)

(Unaudited)

 
| ** **                                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                           | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                           | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| INTEREST INCOME:                                                     |       |                   |       |                 |       |   |   |   |   |
| Loans receivable                                                     |       | $                      | 7,565      |                 | $          | 9,520 |   | $ | 15,120 |   | $ | 19,495 |   |
| Investment securities:                                               |       |                   |       |                 |       |   |   |   |   |
| Taxable                                                              |       | 1,373                  |       | 1,645                |       | 2,721 |   | 2,852 |   |
| Nontaxable                                                           |       | 243                    |       | 190                  |       | 459 |   | 376 |   |
| Other                                                                |       | 12                     |       | 112                  |       | 16 |   | 280 |   |
| Total interest income                                                |       | 9,193                  |       | 11,467               |       | 18,316 |   | 23,003 |   |
|                                                                 |       |                   |       |                 |       |   |   |   |   |
| INTEREST EXPENSE:                                                    |       |                   |       |                 |       |   |   |   |   |
| Deposits                                                             |       | 3,513                  |       | 4,779                |       | 7,293 |   | 10,347 |   |
| Other borrowings                                                     |       | 547                    |       | 879                  |       | 1,192 |   | 1,782 |   |
| Total interest expense                                               |       | 4,060                  |       | 5,658                |       | 8,485 |   | 12,129 |   |
|                                                                 |       |                   |       |                 |       |   |   |   |   |
| NET INTEREST INCOME                                                  |       | 5,133                  |       | 5,809                |       | 9,831 |   | 10,874 |   |
|                                                                 |       |                   |       |                 |       |   |   |   |   |
| PROVISION FOR LOAN LOSSES                                            |       | 2,445                  |       | 971                  |       | 5,966 |   | 2,499 |   |
|                                                                 |       |                   |       |                 |       |   |   |   |   |
| NET INTEREST INCOME AFTER  PROVISION FOR LOAN LOSSES                 |       | 2,688                  |       | 4,838                |       | 3,865 |   | 8,375 |   |
|                                                                 |       |                   |       |                 |       |   |   |   |   |
| NONINTEREST INCOME:                                                  |       |                   |       |                 |       |   |   |   |   |
| Deposit fee income                                                   |       | 1,328                  |       | 1,344                |       | 2,520 |   | 2,555 |   |
| Earnings on life insurance  policies                                 |       | 200                    |       | 191                  |       | 398 |   | 1,562 |   |
| Gain on sale of loans                                                |       | 152                    |       | 91                   |       | 300 |   | 266 |   |
| Other                                                                |       | 359                    |       | 422                  |       | 728 |   | 870 |   |
| Total noninterest income                                             |       | 2,039                  |       | 2,048                |       | 3,946 |   | 5,253 |   |
|                                                                 |       |                   |       |                 |       |   |   |   |   |
| NONINTEREST EXPENSES:                                                |       |                   |       |                 |       |   |   |   |   |
| Salaries and employee  benefits                                      |       | 2,845                  |       | 3,244                |       | 5,813 |   | 6,632 |   |
| Net occupancy expense                                                |       | 663                    |       | 645                  |       | 1,340 |   | 1,285 |   |
| Real estate owned, net                                               |       | 1,085                  |       | 269                  |       | 1,480 |   | 698 |   |
| FDIC insurance premium                                               |       | 687                    |       | 108                  |       | 928 |   | 127 |   |
| Data processing                                                      |       | 338                    |       | 370                  |       | 746 |   | 688 |   |
| Professional fees                                                    |       | 185                    |       | 142                  |       | 476 |   | 272 |   |
| Advertising and public  relations                                    |       | 91                     |       | 218                  |       | 202 |   | 560 |   |
| Postage and supplies                                                 |       | 144                    |       | 182                  |       | 384 |   | 421 |   |
| Other                                                                |       | 518                    |       | 470                  |       | 1,037 |   | 1,037 |   |
| Total noninterest expenses                                           |       | 6,556                  |       | 5,648                |       | 12,406 |   | 11,720 |   |
|                                                                 |       |                   |       |                 |       |   |   |   |   |
| INCOME (LOSS) BEFORE  INCOME TAXES                                   |       | (1,829                 | )          | 1,238                |       | (4,595 | ) | 1,908 |   |
| INCOME TAX PROVISION  (BENEFIT)                                      |       | (892                   | )          | 229                  |       | (2,156 | ) | (188 | ) |
| NET INCOME (LOSS)                                                    |       | $                      | (937       | )                    | $          | 1,009 |   | (2,439 | ) | $ | 2,096 |   |
| PREFERRED STOCK DIVIDENDS  AND ACCRETION OF PREFERRED STOCK DISCOUNT |       | 222                    |       | —               |       | 284 |   | — |   |
| NET INCOME (LOSS)  AVAILABLE TO COMMON SHAREHOLDERS                  |       | $                      | (1,159     | )                    | $          | 1,009 |   | $ | (2,723 | ) | $ | 2,096 |   |
|                                                                 |       |                   |       |                 |       |   |   |   |   |
| EARNINGS (LOSS) PER COMMON  SHARE:                                   |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                |       | $                      | (0.24      | )                    | $          | 0.21 |   | $ | (0.56 | ) | $ | 0.43 |   |
|                                                                 |       |                   |       |                 |       |   |   |   |   |
| Diluted                                                              |       | $                      | (0.24      | )                    | $          | 0.21 |   | $ | (0.56 | ) | $ | 0.43 |   |
|                                                                 |       |                   |       |                 |       |   |   |   |   |
| Cash Dividends Declared                                              |       | $                      | (0.01      | )                    | $          | 0.16 |   | $ | (0.02 | ) | $ | 0.32 |   |

 

Seenotes to unaudited consolidated financial statements.

 

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

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

**FOR THE SIX MONTHS ENDED JUNE 30, 2009**

(In thousands, except share data)

(Unaudited)

 
| ** **                                                                                             | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Retained  Earnings  (Substantially** | ** ** | **Treasury Stock** | ** ** | **Total  Stockholders’** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------|------------|-------------------------|------------|----------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| ** **                                                                                             | ** ** | **Shares**          | ** ** | **Amount**       | ** ** | **Shares**              | ** ** | **Amount**                             | ** ** | **Capital**        | ** ** | **Restricted)**               | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Equity** | ** ** |
| Balance, January 1,  2009                                                                         |       | —              |       | $                | —     |                    | 10,307,502 |                                   | $          | 103                |       | $                             | 56,627     |   | $ | 87,005 |   | 5,460,717 |   | $ | (70,618 | ) | $ | 73,117 |   |
| Net loss                                                                                               |       |                |       |             |       |                    |       |                                   |       |               |       | (2,439                        | )          |   |   |   |   | (2,439 | ) |
| Issuance of 16,500 shares  of preferred stock and a warrant to purchase 321,847 shares of common stock |       | 16,500              |       | 16,142           |       |                    |       |                                   |       | 358                |       |                          |       |   |   |   |   | 16,500 |   |
| Preferred stock dividends                                                                              |       |                |       |             |       |                    |       |                                   |       |               |       | (264                          | )          |   |   |   |   | (264 | ) |
| Accretion of preferred  stock discount                                                                 |       |                |       | 20               |       |                    |       |                                   |       |               |       | (20                           | )          |   |   |   |   | — |   |
| Stock compensation                                                                                     |       |                |       |             |       |                    |       |                                   |       | 1                  |       |                          |       |   |   |   |   | 1 |   |
| Dividends declared, $0.02  per common share                                                            |       |                |       |             |       |                    |       |                                   |       |               |       | (97                           | )          |   |   |   |   | (97 | ) |
|                                                                                                   |       |                |       |             |       |                    |       |                                   |       |               |       |                          |       |   |   |   |   |   |   |
| Balance, June 30,  2009                                                                           |       | 16,500              |       | $                | 16,162     |                    | 10,307,502 |                                   | $          | 103                |       | $                             | 56,986     |   | $ | 84,185 |   | 5,460,717 |   | $ | (70,618 | ) | $ | 86,818 |   |

 

See notes to unaudited consolidated financial statements.

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In Thousands)

(Unaudited)

 
| ** **                                                                                | ** ** | **Six Months Ended June 30,** | ** **   |
|-------------------------------------------------------------------------------------------|------------|------------------------------------|--------------|
| ** **                                                                                | ** ** | **2009**                           | ** **   | **2008** | ** ** |
|                                                                                      |       |                               |         |   |   |
| OPERATING ACTIVITIES:                                                                     |       |                               |         |   |   |
| Net income (loss)                                                                         |       | $                                  |  (2,439 | ) | $ |  2,096 |   |
| Adjustments to reconcile  net income (loss) to net cash provided by operating activities: |       |                               |         |   |   |
| Provision for loan losses                                                                 |       | 5,966                              |         | 2,499 |   |
| Provision for real estate  losses                                                         |       | 715                                |         | 316 |   |
| Deferred tax benefit                                                                      |       | (2,982                             | )            | (83 | ) |
| Accretion of discounts on  investment securities, net                                     |       | (58                                | )            | (50 | ) |
| Federal Home Loan Bank  stock dividends                                                   |       | (8                                 | )            | (85 | ) |
| Gain on disposition of  office properties and equipment, net                              |       | —                             |         | (19 | ) |
| Loss on sale of  repossessed assets, net                                                  |       | 233                                |         | 28 |   |
| Originations of loans held  for sale                                                      |       | (24,680                            | )            | (17,335 | ) |
| Proceeds from sales of  loans held for sale                                               |       | 23,049                             |         | 19,069 |   |
| Gain on sale of loans  originated to sell                                                 |       | (300                               | )            | (266 | ) |
| Depreciation                                                                              |       | 749                                |         | 726 |   |
| Amortization of deferred  loan costs, net                                                 |       | 197                                |         | 179 |   |
| Stock compensation expense                                                                |       | 1                                  |         | 12 |   |
| Earnings on life insurance  policies                                                      |       | (398                               | )            | (382 | ) |
| Changes in operating  assets and liabilities:                                             |       |                               |         |   |   |
| Accrued interest  receivable                                                              |       | 1,377                              |         | 1,119 |   |
| Prepaid expenses and other  assets                                                        |       | 20                                 |         | 333 |   |
| Other liabilities                                                                         |       | 591                                |         | 351 |   |
| Net cash provided by  operating activities                                                |       | 2,033                              |         | 8,508 |   |
|                                                                                      |       |                               |         |   |   |
| INVESTING ACTIVITIES:                                                                     |       |                               |         |   |   |
| Purchases of investment  securities held to maturity                                      |       | (117,512                           | )            | (96,693 | ) |
| Proceeds from  maturities/calls of investment securities held to maturity                 |       | 106,074                            |         | 62,474 |   |
| Federal Home Loan Bank  stock redeemed                                                    |       | 1,177                              |         | — |   |
| Federal Home Loan Bank  Stock purchased                                                   |       | —                             |         | (261 | ) |
| Loan participations sold                                                                  |       | —                             |         | 4,045 |   |
| Loan participations  purchased                                                            |       | (937                               | )            | (1,147 | ) |
| Net loan repayments                                                                       |       | 9,582                              |         | 10,672 |   |
| Proceeds from sales of  repossessed assets                                                |       | 1,429                              |         | 1,001 |   |
| Improvements to real  estate owned                                                        |       | (58                                | )            | (261 | ) |
| Proceeds from sales of  office properties and equipment                                   |       | —                             |         | 30 |   |
| Purchases of office  properties and equipment                                             |       | (206                               | )            | (1,427 | ) |
| Net cash used in investing  activities                                                    |       | (451                               | )            | (21,567 | ) |
|                                                                                      |       |                               |         |   |   |
| FINANCING ACTIVITIES:                                                                     |       |                               |         |   |   |
| Net increase in deposits                                                                  |       | 2,177                              |         | 7,676 |   |
| Advances from FHLB                                                                        |       | 22,225                             |         | 51,500 |   |
| Repayment of advances from  FHLB                                                          |       | (31,159                            | )            | (29,487 | ) |
| Net repayments to Federal  Reserve Bank                                                   |       | (9,495                             | )            | — |   |
| Net decrease in advance  payments by borrowers for taxes and insurance                    |       | (400                               | )            | (142 | ) |
| Proceeds from issuance of  preferred stock and related common stock warrant               |       | 16,500                             |         | — |   |
| Reissued treasury stock                                                                   |       | —                             |         | 46 |   |
| Preferred dividends paid                                                                  |       | (159                               | )            | — |   |
| Dividends paid, common shares                                                             |       | (97                                | )            | (1,551 | ) |
| Net cash provided by (used  in) financing activities                                      |       | (408                               | )            | 28,042 |   |
|                                                                                      |       |                               |         |   |   |
| Net increase in cash and  cash equivalents                                                |       | 1,174                              |         | 14,983 |   |
|                                                                                           |            |                                    |              |  |  |  |  |

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(In Thousands)

(Unaudited)

 
| ** **                                                                     | ** ** | **Six Months Ended June 30,** | ** **   |
|--------------------------------------------------------------------------------|------------|------------------------------------|--------------|
| ** **                                                                     | ** ** | **2009**                           | ** **   | **2008** | ** ** |
|                                                                           |       |                               |         |   |   |
| CASH AND CASH EQUIVALENTS:                                                     |       |                               |         |   |   |
| Beginning of period                                                            |       | $                                  |  9,367  |   | $ |  27,387 |   |
| End of period                                                                  |       | $                                  |  10,541 |   | $ |  42,370 |   |
|                                                                           |       |                               |         |   |   |
| SUPPLEMENTAL DISCLOSURES  OF CASH FLOW INFORMATION:                            |       |                               |         |   |   |
| Cash paid for:                                                                 |       |                               |         |   |   |
| Interest                                                                       |       | $                                  |  8,793  |   | $ |  12,244 |   |
| Income taxes                                                                   |       | $                                  |  864    |   | $ |  — |   |
|                                                                           |       |                               |         |   |   |
| SUPPLEMENTAL SCHEDULE OF  NONCASH INVESTING AND FINANCING ACTIVITIES:          |       |                               |         |   |   |
| Real estate and other  assets acquired in settlement of loans                  |       | $                                  |  8,860  |   | $ |  16,369 |   |
| Loans to facilitate sales  of real estate owned                                |       | $                                  |  5,460  |   | $ |  2,964 |   |
| Investment securities  traded, recorded in investments not yet settled in cash |       | $                                  |  2,775  |   | $ |  1,195 |   |
| Preferred stock dividends  accrued, not paid                                   |       | $                                  |  105    |   | $ |  — |   |
|                                                                           |       |                               |         |   |   |
|                                                                           |       |                               |         | (Concluded) |   |

 

See notes to unauditedconsolidated financial statements.

 

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

 

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

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

# ** **

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

 

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

 

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

 

The results of operations for the three andsix months ended June 30, 2009, are not necessarily indicative of theresults to be expected for the year ending December 31, 2009.  The unaudited consolidated financialstatements and notes thereto should be read in conjunction with the auditedfinancial statements and notes thereto for the year ended December 31,2008, contained in the Company’s 2008 Annual Report to Stockholders.

 

**Note 2 — Recently AdoptedAccounting Standards**

 

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

 

We adopted SFAS No. 141R, *BusinessCombinations,* as of January 1, 2009. The objective of thisStatement is to improve the relevance, representational faithfulness, andcomparability of the information that a reporting entity provides in itsfinancial reports about a business combination and its effects. To accomplishthat, this Statement establishes principles and requirements for how theacquirer:
| a. | Recognizes and measures in  its financial statements the identifiable assets acquired, the liabilities  assumed, and any noncontrolling interest in the acquiree |
|----|------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| b. | Recognizes and measures the  goodwill acquired in the business combination or a gain from a bargain  purchase                                                    |
| c. | Determines what information  to disclose to enable users of the financial statements to evaluate the  nature and financial effects of the business combination.  |

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

 

We adopted FASB Statement165, *Subsequent Events*, effective forfinancial statements issued for periods ending after June 15, 2009.  This statement addresses events that occurafter the balance sheet date but before the issuance of the financialstatements, distinguishes which subsequent events that should be recognized inthe financial statements, which nonrecognized events require disclosure andrequires the disclosure of the date through which subsequent events wereevaluated.  See note 10 for disclosure.

 

On April 9, 2009, theFASB issued FSP FAS No. 107-1 and APB 28-1, *Interim Disclosures about Fair Value of Financial Instruments,*which amended FASB No. 107, Disclosuresabout Fair Value of Financial Instruments and was effective for financialstatements issued for interim periods ending after June 15, 2009. * *Thestatement was amended to require that the existing annual fair value disclosurerequirements under FAS 107 be expanded to interim periods.  This statement was adopted in thesecond quarter of 2009. See note 9 for disclosure.

 

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On April 9, 2009, theFASB issued FSP FAS No. 115-2 and FAS No. 124-2, *Recognition and Presentation of Other-Than-TemporaryImpairments,*effective forfinancial statements issued for interim periods ending after June 15,2009. * *The statement was amended to makesignificant changes to the Other Than Temporary Impairment (OTTI) assertionsmade related to debt securities. The FSP also provided for additional interimdisclosures related to OTTI on debt securities. These Statements did not have a material effect on the financialstatements of the Company.

 

On April 9, 2009, theFASB issued FSP FAS 157-4, *Determining FairValue When the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly*(FSPFAS 157-4), effective for financialstatements issued for interim periods ending after June 15, 2009. * *TheFSP provides additional guidance on determining fair value in inactive marketsfor financial assets under FASB Statement No. 157, *Fair Value Measurements.** *This Statement did not havea material effect on the financial statements of the Company.

 

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

 

OnJune 12, 2009, the FASB issued SFAS No. 166, *Accounting for Transfers of Financial Assets*(“FAS166”). FAS 166 is a revision to FAS 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities*, and will require more information about transfers offinancial assets, including securitization transactions, and where companieshave continuing exposure to the risks related to transferred financial assets.FAS 166 also eliminates the concept of a “qualifying special-purpose entity”,changes the requirements for derecognizing financial assets and requiresadditional disclosures. FAS 166 will be effective for financial statementsissued for interim and annual periods ending after November 15, 2009.  Earlier application is prohibited. Therecognition and measurement provisions of FAS 166 shall be applied to transfersthat occur on or after the effective date. The Bank will adopt FAS 166 on January 1,2010, as required. Management has not determined the impact adoption may haveon the Bank’s consolidated financial statements.

 

OnJune 12, 2009, the FASB issued SFAS No.167, *Amendments to FASB Interpretation No. 46(R) *(“FAS167”), which will change the way entities account for securitizations andspecial-purpose entities. FAS 167 is a revision to FASB Interpretation No. 46(R),*Consolidation of Variable Interest Entities*,and changes how a company determines when an entity that is insufficientlycapitalized or is not controlled through voting (or similar rights) should beconsolidated. The determination of whether a company is required to consolidatean entity is based on, among other things, an entity’s purpose and design and acompany’s ability to direct the activities of the entity that mostsignificantly impact the entity’s economic performance. FAS 167 will beeffective for financial statements issued for interim and annual periods endingafter November 15, 2009.  Earlierapplication is prohibited. The Bank will adopt FAS 167 on January 1, 2010,as required. Management has not determined the impact adoption may have on theBank’s consolidated financial statements.

 

OnJune 29, 2009, the FASB issued SFAS No. 168 (“FAS 168”) *Accounting Standards Codification**and the Hierarchy of Generally Accepted Accounting Principles — areplacement of FASB Statement No. 162*. FAS 168 establishes the *FASB Accounting Standards Codification* asthe source of authoritative accounting principles recognized by the FASB to beapplied by nongovernmental entities in the preparation of financial statementsin conformity with US GAAP. FAS 168 will be effective for financial statementsissued for interim and annual periods ending after September 15, 2009, formost entities. On the effective date, all non-SEC accounting and reportingstandards will be superseded. The Bank will adopt FAS 168 for the quarterlyperiod ending September 30, 2009, as required, and adoption is notexpected to have a material impact on the Bank’s consolidated financialstatements.

 

**Note 4 — Preferred Stock**

** **

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

 

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

 

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

 

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

 

**Note 5 - Earnings per CommonShare**

** **

The weighted average number of common shares used to calculate earningsper share for the periods ended June 30, 2009 and 2008 were as follows:

 
| ** **                                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Basic weighted - average  common shares   |       | 4,846,785                            |       | 4,848,385                          |       | 4,846,785 |   | 4,848,341 |   |
| Effect of dilutive  securities            |       | —                               |       | 1,091                              |       | — |   | 1,748 |   |
| Diluted weighted - average  common shares |       | 4,846,785                            |       | 4,849,476                          |       | 4,846,785 |   | 4,850,089 |   |

 

The incremental shares for the assumed exercise of the outstandingoptions were determined by application of the treasury stock method. Thecalculation of diluted earnings per share excludes 17,242 options outstandingfor the three and six months ended June 30, 2009, which were antidilutive.In addition, the calculation excludes the Warrant to purchase 321,847 shares ofcommon stock outstanding for the three and six month periods endedJune 30, 2009, which was antidilutive.

 

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**Note 6 —Investment Securities**

 

Investment securities consisted of the following (in thousands):

 
| ** **                              | ** ** | **June 30, 2009** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | ** **             | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Amortized**          | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Held To  Maturity**                   | ** ** | **Cost**               | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                    |       |                   |       |   |   |   |   |   |   |
| Municipal securities                    |       | $                      | 24,272     |   | $ | 111 |   | $ | (420 | ) | $ | 23,963 |   |
| U.S. Government and Agency  obligations |       | 117,416                |       | 142 |   | (1,774 | ) | 115,784 |   |
|                                    |       |                   |       |   |   |   |   |   |   |
| Total                                   |       | $                      | 141,688    |   | $ | 253 |   | $ | (2,194 | ) | $ | 139,747 |   |

 
| ** **                              | ** ** | **December 31, 2008** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|
| ** **                              | ** ** | ** **                 | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Amortized**              | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Held To  Maturity**                   | ** ** | **Cost**                   | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                    |       |                       |       |   |   |   |   |   |   |
| Municipal securities                    |       | $                          | 19,565     |   | $ | 75 |   | $ | (599 | ) | $ | 19,041 |   |
| U.S. Government and Agency  obligations |       | 116,847                    |       | 233 |   | (66 | ) | 117,014 |   |
|                                    |       |                       |       |   |   |   |   |   |   |
| Total                                   |       | $                          | 136,412    |   | $ | 308 |   | $ | (665 | ) | $ | 136,055 |   |

 

The following tables summarize the gross unrealized losses and fairvalue of the Company’s investments with unrealized losses that are not deemedto be other-than-temporarily impaired (in thousands), aggregated by investmentcategory and length of time that individual securities have been in acontinuous unrealized loss position:

 
| ** **                              | ** ** | **June 30, 2009**  | ** ** |
|-----------------------------------------|------------|-------------------------|------------|
| ** **                              | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **Fair**                | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                              | ** ** | **Value**               | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                                    |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Municipal securities                    |       | $                       | 4,157      |   | $ | 98 |   | $ | 5,922 |   | $ | 322 |   | $ | 10,079 |   | $ | 420 |   |
| U.S. Government and Agency  obligations |       | 80,744                  |       | 1,754 |   | 5,378 |   | 20 |   | 86,122 |   | 1,774 |   |
|                                    |       |                    |       |   |   |   |   |   |   |   |   |   |   |
|                                    |       | $                       | 84,901     |   | $ | 1,852 |   | $ | 11,300 |   | $ | 342 |   | $ | 96,201 |   | $ | 2,194 |   |

 
| ** **                              | ** ** | **December 31, 2008** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|
| ** **                              | ** ** | **Less than 12 Months**    | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **Fair**                   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                              | ** ** | **Value**                  | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                                    |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Municipal securities                    |       | $                          | 5,493      |   | $ | 171 |   | $ | 3,926 |   | $ | 428 |   | $ | 9,419 |   | $ | 599 |   |
| U.S. Government and Agency  obligations |       | 15,503                     |       | 66 |   | — |   | — |   | 15,503 |   | 66 |   |
|                                    |       |                       |       |   |   |   |   |   |   |   |   |   |   |
|                                    |       | $                          | 20,996     |   | $ | 237 |   | $ | 3,926 |   | $ | 428 |   | $ | 24,922 |   | $ | 665 |   |

 

On a quarterly basis, management conducts a formal review of securitiesfor the presence of OTTI.  Management assesses whether an OTTI ispresent when the fair value of a security is less than its amortized cost basisat the balance sheet date.  For such securities, OTTI is consideredto have occurred if the Company intends to sell the security, if it is morelikely than not the Company will be required to sell the security beforerecovery of its amortized cost basis or if the present values of expected cashflows is not sufficient to recover the entire amortized cost.

 

The unrealized losses are primarily a result of increases in marketyields from the time of purchase.  In general, as market yields rise,the fair value of securities will decrease; as market yields fall, the fairvalue of securities will increase. Management generally views changes in fairvalue caused by changes in interest rates as temporary; therefore, thesesecurities have not been classified as other-than-temporarilyimpaired.  Additionally, the impairment is also considered temporarybecause scheduled coupon payments have been made, it is anticipated that theentire principal balance will be collected as scheduled, and management neitherintends to sell the securities and it is not 

 

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more likely than not that the Company will be required to sell thesecurities before the recovery of the remaining amortized cost amount.

 

The Company has pledged investment securities held to maturity withcarrying values of approximately $62.2 million at June 30, 2009, and $76.4million at December 31, 2008 as collateral for certain deposits in excessof $250,000.

 

The scheduled maturities of debt securities at June 30, 2009, bycontractual maturity are shown below (in thousands). Expected maturities maydiffer from contractual maturities because borrowers may have the right to callor prepay obligations with or without call or prepayment penalties.

 
| ** **                        | ** ** | **June 30, 2009** | ** ** |
|-----------------------------------|------------|------------------------|------------|
| ** **                        | ** ** | **Amortized**          | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**               | ** ** | **Value** | ** ** |
|                              |       |                   |       |   |   |
| Within one year                   |       | $                      | 425        |   | $ | 433 |   |
| Due from one year to five  years  |       | 2,580                  |       | 2,523 |   |
| Due from five years to ten  years |       | 11,956                 |       | 11,816 |   |
| Due after ten years               |       | 126,727                |       | 124,975 |   |
|                              |       |                   |       |   |   |
| Total                             |       | $                      | 141,688    |   | $ | 139,747 |   |

 

As of June 30, 2009 and December 31, 2008, investments withcarrying values of approximately $134.4 million and $135.8 million,respectively, have call options held by the issuer, of which approximately$108.6 million and $124.8 million, respectively, are or were callable withinone year.

 

**Note 7 —Allowances for Loan and Real Estate Losses**

 

A summary of the activity in the allowances for loan and real estatelosses is as follows for the three and six months ended June 30 (inthousands):

 
| ** **                       | ** ** | **Three Months Ended  June 30,****2009** | ** ** | **Three Months Ended  June 30,****2008** | ** ** |
|----------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                       | ** ** | **Loans**                                     | ** ** | **Real Estate**                               | ** ** | **Loans** | ** ** | **Real Estate** | ** ** |
|                             |       |                                          |       |                                          |       |   |   |   |   |
| Balance—beginning of period |       | $                                             | 9,558      |                                          | $          | — |   | $ | 6,107 |   | $ | — |   |
|                             |       |                                          |       |                                          |       |   |   |   |   |
| Provisions for estimated losses  |       | 2,445                                         |       | 552                                           |       | 971 |   | 87 |   |
| Recoveries                       |       | 693                                           |       | —                                        |       | 58 |   | — |   |
| Losses charged off               |       | (772                                          | )          | (552                                          | )          | (1,921 | ) | (87 | ) |
|                             |       |                                          |       |                                          |       |   |   |   |   |
| Balance—end of period       |       | $                                             | 11,924     |                                          | $          | — |   | $ | 5,215 |   | $ | — |   |

 
| ** **                       | ** ** | **Six Months Ended  June 30,****2009** | ** ** | **Six Months Ended  June 30,****2008** | ** ** |
|----------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                       | ** ** | **Loans**                                   | ** ** | **Real Estate**                             | ** ** | **Loans** | ** ** | **Real Estate** | ** ** |
|                             |       |                                        |       |                                        |       |   |   |   |   |
| Balance—beginning of period |       | $                                           | 6,441      |                                        | $          | — |   | $ | 5,162 |   | $ | — |   |
|                             |       |                                        |       |                                        |       |   |   |   |   |
| Provisions for estimated losses  |       | 5,966                                       |       | 715                                         |       | 2,499 |   | 316 |   |
| Recoveries                       |       | 754                                         |       | —                                      |       | 194 |   | — |   |
| Losses charged off               |       | (1,237                                      | )          | (715                                        | )          | (2,640 | ) | (316 | ) |
|                             |       |                                        |       |                                        |       |   |   |   |   |
| Balance—end of period       |       | $                                           | 11,924     |                                        | $          | — |   | $ | 5,215 |   | $ | — |   |

 

The provision for loan losses increased between the periods listedabove primarily due to increases in total nonaccrual loans and in the lossfactors used in certain allowance categories, as well as an increase inspecific loan loss allowances, in each respect due to deteriorating economicconditions.

 

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**Note 8 —Income Taxes**

 

The provisions (benefits) for income taxes are summarized as follows (inthousands):

 
| ** **                       | ** ** | **Six Months Ended**    | ** ** |
|----------------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **June 30,  2009** | ** ** | **June 30,  2008** | ** ** |
|                             |       |                    |       |   |   |
| Income tax provision  (benefit): |       |                    |       |   |   |
| Current:                         |       |                    |       |   |   |
| Federal                          |       | $                       | 816        |   | $ | 79 |   |
| State                            |       | 10                      |       | (184 | ) |
| Total current                    |       | 826                     |       | (105 | ) |
|                             |       |                    |       |   |   |
| Deferred:                        |       |                    |       |   |   |
| Federal                          |       | (2,490                  | )          | (71 | ) |
| State                            |       | (492                    | )          | (12 | ) |
| Total deferred                   |       | (2,982                  | )          | (83 | ) |
|                             |       |                    |       |   |   |
| Total                            |       | $                       | (2,156     | ) | $ | (188 | ) |

 

The reasons for the differences between the statutory federal income taxrates and the effective tax rates are summarized as follows (in thousands):

 
| ** **                           | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|
| ** **                           | ** ** | **2009**                           | ** ** | **2008** | ** ** |
|                                 |       |                               |       |   |   |   |   |   |   |
| Taxes at statutory rate              |       | $                                  | (1,563     | ) | 34.0 | % | $ | 649 |   | 34.0 | % |
| Increase (decrease)  resulting from: |       |                               |       |   |   |   |   |   |   |
| State income tax—net            |       | (292                               | )          | 6.4 |   | (129 | ) | (6.7 | ) |
| Earnings on life insurance  policies |       | (135                               | )          | 2.9 |   | (531 | ) | (27.8 | ) |
| Nontaxable investments               |       | (147                               | )          | 3.2 |   | (114 | ) | (6.0 | ) |
| Other—net                       |       | (19                                | )          | 0.4 |   | (63 | ) | (3.3 | ) |
|                                 |       |                               |       |   |   |   |   |   |   |
| Total                                |       | $                                  | (2,156     | ) | 46.9 | % | $ | (188 | ) | (9.8 | )% |

 

The Company’s net deferred tax asset account was comprised of thefollowing (in thousands):

 
| ** **                      | ** ** | **June 30,********2009** | ** ** | **December 31, 2008** | ** ** |
|---------------------------------|------------|-------------------------------|------------|----------------------------|------------|
|                            |       |                          |       |                       |       |
| Deferred tax assets:            |       |                          |       |                       |       |
| Allowance for loan losses       |       | $                             | 4,566      |                       | $          | 2,466 |   |
| Real estate owned               |       | 870                           |       | 360                        |       |
| Other                           |       | 212                           |       | 14                         |       |
|                            |       |                          |       |                       |       |
| Total deferred tax assets       |       | 5,648                         |       | 2,840                      |       |
|                            |       |                          |       |                       |       |
| Deferred tax liabilities:       |       |                          |       |                       |       |
| Office properties               |       | (903                          | )          | (919                       | )          |
| Federal Home Loan Bank  stock   |       | (425                          | )          | (559                       | )          |
| Pension plan contribution       |       | (94                           | )          | (106                       | )          |
| Prepaid expenses                |       | (139                          | )          | (151                       | )          |
|                            |       |                          |       |                       |       |
| Total deferred tax  liabilities |       | (1,561                        | )          | (1,735                     | )          |
|                            |       |                          |       |                       |       |
| Net deferred tax asset          |       | $                             | 4,087      |                       | $          | 1,105 |   |

 

Specifically exempted from deferred tax recognition requirements are baddebt reserves for tax purposes of U.S. savings and loans in the institution’sbase year, as defined. Base year reserves totaled approximately $4.2 million.Consequently, a deferred tax liability of approximately $1.6 million related tosuch reserves was not provided for in the consolidated statements of financialcondition at June 30, 2009 and 2008. Payment of dividends to shareholdersout of retained earnings deemed to have been made out of earnings previouslyset aside as bad debt reserves may 

 

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create taxable income to the Bank. No provision has been made for incometax on such a distribution as the Bank does not anticipate making suchdistributions.

 

The Company files income tax returns in the U.S. federal jurisdictionand the state of Arkansas. The Company is subject to U.S. federal and stateincome tax examinations by tax authorities for tax years ended December 31,2006 and forward.  The Company’s 2007federal income tax return was subject to examination by the Internal RevenueService during the first quarter of 2009. As a result of the examination, the Company was assessed approximately$45,000, including interest, for the 2007 tax year.

 

**Note 9 — 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 following is a description of valuation methodologies used forsignificant assets measured at fair value on a non-recurring basis.

 

*Loans Receivable*

Loans which meet certain criteria are evaluated individually forimpairment. A loan is considered impaired when, based upon current informationand events, it is probable the Bank will be unable to collect all amounts due,including principal and interest, according to the contractual terms of theloan agreement.  Substantially all of the Bank’s impaired loans at June 30,2009 are secured by real estate.  These impaired loans areindividually assessed to determine that the carrying value of the loan is notin excess of the fair value of the collateral, less estimated selling costs.Fair value is estimated through current appraisals, real estate brokers orlisting prices.  Fair values may be adjusted by management to reflectcurrent economic and market conditions and, as such, are classified as Level3.  Impaired loans at June 30, 2009 were $42.3 million. Based onthis evaluation, the Company maintains an allowance for loan losses of $3.7million at June 30, 2009 for such impaired loans.

 

*REO, net*

REO represents real estate acquired as a result of foreclosure or bydeed in lieu of foreclosure and is carried at the lower of cost or fair valueless estimated selling costs.  Fair value is estimated throughcurrent appraisals, real estate brokers or listing prices.  As theseproperties are actively marketed, estimated fair values may be adjusted bymanagement to reflect current economic and market conditions and, as such, areclassified as Level 3.  REO at June 30, 2009 was $23.5million. During the three and six months ended June 30, 2009, charge-offsto the allowance for loan losses related to loans that were transferred toREO were $440,000 and $618,000, respectively, on transfers to REO of$5.6 million and $9.4 million, respectively. Write downs related to REO that were charged to other expense were$552,000 and $715,000 for the three and six months ended June 30,2009.

 

The following table provides the level of valuation assumption used todetermine the carrying value of the Company’s assets measured at fair value ona non-recurring basis at June 30, 2009:

 
| ** **     | ** ** | **Carrying Value** | ** ** | **Quoted Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Significant********Other Observable  Inputs********(Level 2)** | ** ** | **Significant********Unobservable********Inputs********(Level 3)** | ** ** |
|----------------|------------|--------------------|------------|-----------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| Impaired loans |       | $                  | 38,646     |                                                                  | $          | —                                                           |       | $                                                                  | —     |   | $ | 38,646 |   |
| REO, net       |       | 23,473             |       | —                                                                |       | —                                                           |       | 23,473                                                             |       |
|           |       | $                  | 62,119     |                                                                  | $          | —                                                           |       | $                                                                  | —     |   | $ | 62,119 |   |

 

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FAIRVALUE OF FINANCIAL INSTRUMENTS

 

The estimated fair value amounts have been determinedby the Company using available market information and appropriate valuationmethodologies. However, considerable judgment is required to interpret marketdata to develop the estimates of fair value. Accordingly, the estimatespresented herein are not necessarily indicative of the amounts the Companycould realize in a current market exchange. The use of different marketassumptions and/or estimation methodologies may have a material effect on theestimated fair value amounts. The estimated fair values of financialinstruments are as follows (in thousands):

 
| ** **                                             | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | ** **              | ** ** | **Estimated**               | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                             | ** ** | **Carrying**            | ** ** | **Fair**                    | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                             | ** ** | **Value**               | ** ** | **Value**                   | ** ** | **Value** | ** ** | **Value** | ** ** |
| ASSETS:                                                |       |                    |       |                        |       |   |   |   |   |
| Cash and cash equivalents                              |       | $                       | 10,541     |                        | $          | 10,541 |   | $ | 9,367 |   | $ | 9,367 |   |
| Investment securities—held  to maturity           |       | 141,688                 |       | 139,747                     |       | 136,412 |   | 136,055 |   |
| Federal Home Loan Bank  stock                          |       | 3,656                   |       | 3,656                       |       | 4,825 |   | 4,825 |   |
| Loans receivable—net                              |       | 548,329                 |       | 555,393                     |       | 566,537 |   | 579,627 |   |
| Loans held for sale                                    |       | 3,517                   |       | 3,517                       |       | 1,586 |   | 1,586 |   |
| Cash surrender value of  life insurance                |       | 20,810                  |       | 20,810                      |       | 20,412 |   | 20,412 |   |
| Accrued interest receivable                            |       | 5,324                   |       | 5,324                       |       | 6,701 |   | 6,701 |   |
| Commitments                                            |       | 142                     |       | 142                         |       | 14 |   | 14 |   |
|                                                   |       |                    |       |                        |       |   |   |   |   |
| LIABILITIES:                                           |       |                    |       |                        |       |   |   |   |   |
| Deposits:                                              |       |                    |       |                        |       |   |   |   |   |
| Checking, money market and  savings accounts           |       | 236,621                 |       | 236,621                     |       | 231,509 |   | 231,509 |   |
| Certificates of deposit                                |       | 383,559                 |       | 388,283                     |       | 386,494 |   | 390,638 |   |
| Other borrowings                                       |       | 73,783                  |       | 74,804                      |       | 92,212 |   | 94,114 |   |
| Accrued interest payable                               |       |                    |       |                        |       |   |   |   |   |
| Advance payments by  borrowers for taxes and insurance |       | 410                     |       | 410                         |       | 810 |   | 810 |   |
| Commitments                                            |       | 142                     |       | 142                         |       | 14 |   | 14 |   |
|                                                        |            |                         |            |                             |            |  |  |  |  |  |  |  |  |

 

For cash and cash equivalents, Federal Home Loan Bankstock, cash surrender value of life insurance and accrued interest receivable,the carrying value is a reasonable estimate of fair value, primarily because ofthe short-term nature of the instruments or, as to Federal Home Loan Bankstock, the ability to sell the stock back to the Federal Home Loan Bank atcost. The fair value of investment securities is based on quoted market prices,dealer quotes and prices obtained from independent pricing services. The fairvalue of variable rate loans is based on repricing dates. Fixed rate loans werevalued using discounted cash flows. The discount rates used to determine thepresent value of these loans were based on interest rates currently beingcharged by the Bank on comparable loans as to credit risk and term.

 

The fair value of checking accounts, savings accountsand money market deposits is the amount payable on demand at the reportingdate. The fair value of fixed-maturity certificates of deposit and Federal HomeLoan Bank advances is estimated using the rates currently offered for depositsof similar terms and advances of similar remaining maturities at the reportingdate. For advance payments by borrowers, for taxes and insurance, accruedinterest payable and Federal Reserve Bank advances, the carrying value is areasonable estimate of fair value, primarily because of the short-term natureof the instruments.

 

The fair value estimates presented herein are basedon pertinent information available to management as of June 30, 2009 and December 31,2008. Although management is not aware of any factors that would significantlyaffect the estimated fair value amounts, such amounts have not beencomprehensively revalued for purposes of these financial statements since thereporting date and, therefore, current estimates of fair value may differsignificantly from the amounts presented herein.

 

**Note 10 —Subsequent Events**

 

Subsequentevents have been evaluated through August 7, 2009, which is the date thefinancial statements were issued.

 

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**MANAGEMENT’S DISCUSSION AND ANALYSIS**

**OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**EXECUTIVE SUMMARY**

 

Management’s discussion and analysis offinancial condition and results of operations is intended to assist a reader inunderstanding the consolidated financial condition and results ofoperations of the Company for the periods presented.  The information contained in this sectionshould be read in conjunction with the unaudited consolidated financialstatements and the notes to such financial statements found in this reportunder “Part I, Item 1, Consolidated Financial Statements”.

 

The Bank is a federally chartered stocksavings and loan association that was formed in 1934.  First Federal conducts business from its mainoffice and nineteen full-service branch offices, all of which are located in asix county area in Northcentral and Northwest Arkansas comprised of Benton,Marion, Washington, Carroll, Baxter and Boone counties. The Bank will continueto focus its growth and expansion efforts in this six county area, especiallyin Benton and Washington counties, one of the fastest growing areas of thestate.  The Bank is a community-oriented financialinstitution offering a wide range of retail and commercial deposit accounts,including noninterest bearing and interest bearing checking, savings and moneymarket accounts, certificates of deposit, and individual retirementaccounts.  Loan products offered by theBank include residential real estate, consumer, construction, lines of credit,commercial real estate and commercial business loans. Other financial servicesinclude investment products offered through First Federal Investment Services, Inc.;automated teller machines; 24-hour telephone banking; internet banking,including account access, e-statements, bill payment and online loanapplications; Bounce ProtectionTM overdraft service; debitcards; and safe deposit boxes.

 

The Company’s results of operationsdepend primarily on its net interest income, which is the difference betweeninterest income on interest earning assets, such as loans and investments, andinterest expense on interest bearing liabilities, such as deposits andborrowings.  Net interest income isaffected by the level of nonperforming assets as they provide no interestearnings to the Bank.  The Company’sresults of operations are also affected by the provision for loan losses, thelevel of its noninterest income and expenses, and income tax expense.

 

The Companyrecorded a net loss of $937,000 for the second quarter of 2009 compared to netincome of $1.0 million during the second quarter of 2008.  For the six months ended June 30, 2009,net loss totaled $2.4 million compared to net income of $2.1 million for thefirst six months of 2008.  The decreasesin net income for both the three month and six month comparative periods wereprimarily due to an increase in the provision for loan losses and increases inreal estate owned expenses and FDIC insurance premiums.  The Company’s net loss available to commonshareholders was $0.24 per common share for the quarter ended June 30,2009 compared to net income of $0.21 per common share for the quarter ended June 30,2008.  The Company’s net loss availableto common shareholders was $0.56 per common share for the six months ended June 30,2009 compared to net income of $0.43 per common share for the six months ended June 30,2008.

 

The Company’s business activities and credit exposures are concentratedin Northwest Arkansas and the surrounding region which is subject to a weakhousing market and an oversupply of residential real estate, includingdeveloped and undeveloped land and residential development projects.  The continued recessionary forces in theCompany’s market area have had a negative impact on the Company’s financialcondition and results of operations. Nonaccrual loans have increased from $25.4 million at December 31,2008 to $54.8 million at June 30, 2009 and, over the same period, totalnonperforming assets have increased from $56.8 million or 7.1% of total assetsto $79.8 million or 10.1% of the total assets. The level of nonperforming assets has and will continue to have anadverse effect on interest income, the provision for loan losses, noninterestexpenses and net income as well as the Company’s interest rate spread and netinterest margin.  The Company has devotedsubstantial resources toward the resolution of delinquent and nonperformingassets and, with respect to its REO properties, has committed an experiencedspecial assets officer who is working full-time to liquidate the Bank’sproperties in the Northwest Arkansas market. The Company will continue to be proactive in taking steps to contain andreduce its nonperforming assets and minimize the negative impact on itsfinancial condition and results of operations in future periods.

 

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### **CRITICALACCOUNTING POLICIES**

### ** **

Variouselements of our accounting policies, by their nature, are inherently subject toestimation techniques, valuation assumptions and other subjectiveassessments.  In particular, valuation ofreal estate owned and the methodology for the determination of our allowancefor loan losses, due to the judgments, estimates and assumptions inherent inthose policies are critical to preparation of our financial statements.  These policies and the judgments, estimatesand assumptions are described in greater detail in subsequent sections ofManagement’s Discussion and Analysis and in the notes to the unauditedfinancial statements included herein.  Webelieve that the judgments, estimates and assumptions used in the preparationof our financial statements are appropriate given the factual circumstances atthe time.  However, given the sensitivityof our financial statements to these critical accounting policies, the use ofother judgments, estimates and assumptions could result in material differencesin our financial condition or results of operations.

 

Inestimating the amount of credit losses inherent in our loan portfolio, variousjudgments and assumptions are made.  Forexample, when assessing the condition of the overall economic environment,assumptions are made regarding future market conditions and their impact on theloan portfolio.  In the event the economywere 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 are collateral-dependent, and for real estateowned, the estimated fair value of the collateral may deviate significantlyfrom the proceeds received when the collateral is sold.

 

## **CHANGES IN FINANCIAL CONDITION**

##  

Changes in financialcondition between June 30, 2009 and December 31, 2008 are presentedin the following table (dollars in thousands). Material changes between the periods are discussed in the sections whichfollow the table.

 
| ** **                                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **Percentage** | ** ** |
|------------------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|----------------|------------|
| ** **                                     | ** ** | **2009**          | ** ** | **2008**              | ** ** | **(Decrease)** | ** ** | **Change**     | ** ** |
| **ASSETS**                                     |       |              |       |                  |       |           |       |           |       |
| Cash and cash equivalents                      |       | $                 | 10,541     |                  | $          | 9,367          |       | $              | 1,174      |   | 12.5 | % |
| Investment securities held to maturity         |       | 141,688           |       | 136,412               |       | 5,276          |       | 3.9            |       |
| Federal Home Loan Bank stock                   |       | 3,656             |       | 4,825                 |       | (1,169         | )          | (24.2          | )          |
| Loans receivable, net                          |       | 548,329           |       | 566,537               |       | (18,208        | )          | (3.2           | )          |
| Loans held for sale                            |       | 3,517             |       | 1,586                 |       | 1,931          |       | 121.8          |       |
| Accrued interest receivable                    |       | 5,324             |       | 6,701                 |       | (1,377         | )          | (20.6          | )          |
| Real estate owned, net                         |       | 23,473            |       | 22,385                |       | 1,088          |       | 4.9            |       |
| Office properties and equipment, net           |       | 24,151            |       | 24,694                |       | (543           | )          | (2.2           | )          |
| Prepaid expenses and other assets              |       | 26,018            |       | 22,665                |       | 3,353          |       | 14.8           |       |
|                                           |       |              |       |                  |       |           |       |           |       |
| TOTAL                                          |       | $                 | 786,697    |                  | $          | 795,172        |       | $              | (8,475     | ) | (1.1 | ) |
|                                           |       |              |       |                  |       |           |       |           |       |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY** |       |              |       |                  |       |           |       |           |       |
| LIABILITIES:                                   |       |              |       |                  |       |           |       |           |       |
| Deposits                                       |       | $                 | 620,180    |                  | $          | 618,003        |       | $              | 2,177      |   | 0.4 |   |
| Other borrowings                               |       | 73,783            |       | 92,212                |       | (18,429        | )          | (20.0          | )          |
| Other liabilities                              |       | 5,916             |       | 11,840                |       | (5,924         | )          | (50.0          | )          |
|                                           |       |              |       |                  |       |           |       |           |       |
| Total liabilities                              |       | 699,879           |       | 722,055               |       | (22,176        | )          | (3.1           | )          |
|                                           |       |              |       |                  |       |           |       |           |       |
| STOCKHOLDERS’ EQUITY                      |       | 86,818            |       | 73,117                |       | 13,701         |       | 18.7           |       |
|                                           |       |              |       |                  |       |           |       |           |       |
| TOTAL                                          |       | $                 | 786,697    |                  | $          | 795,172        |       | $              | (8,475     | ) | (1.1 | )% |
|                                           |       |              |       |                  |       |           |       |           |       |
| BOOK VALUE PER COMMON SHARE                    |       | $                 | 14.58      |                  | $          | 15.09          |       |           |       |   |   |
|                                           |       |              |       |                  |       |           |       |           |       |
| COMMON EQUITY TO ASSETS                        |       | 9.0               | %          | 9.2                   | %          |           |       |           |       |
|                                           |       |              |       |                  |       |           |       |           |       |
| TOTAL EQUITY TO ASSETS                         |       | 11.0              | %          | 9.2                   | %          |           |       |           |       |

 

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**LoansReceivable. **Changes in loan composition between June 30,2009 and December 31, 2008 are presented in the following table (dollarsin thousands).

 
| ** **                                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | ** **   | ** ** |
|-------------------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|
| ** **                                      | ** ** | **2009**          | ** ** | **2008**              | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
|                                            |       |              |       |                  |       |           |       |         |       |
| One- to four-family residences                  |       | $                 | 244,104    |                  | $          | 241,735        |       | $            | 2,369      |   | 1.0 | % |
| Home equity lines of credit and second mortgage |       | 29,017            |       | 31,712                |       | (2,695         | )          | (8.5         | )          |
| Multifamily                                     |       | 24,347            |       | 24,147                |       | 200            |       | 0.8          |       |
| Commercial real estate                          |       | 111,768           |       | 115,935               |       | (4,167         | )          | (3.6         | )          |
| Land                                            |       | 50,386            |       | 50,510                |       | (124           | )          | (0.2         | )          |
| Construction:                                   |       |              |       |                  |       |           |       |         |       |
| One- to four-family residences                  |       | 8,804             |       | 8,450                 |       | 354            |       | 4.2          |       |
| Speculative one-to four-family residences       |       | 14,040            |       | 17,096                |       | (3,056         | )          | (17.9        | )          |
| Multifamily                                     |       | 14,766            |       | 15,016                |       | (250           | )          | (1.7         | )          |
| Commercial real estate                          |       | 17,612            |       | 18,297                |       | (685           | )          | (3.7         | )          |
| Land  development                               |       | 15,918            |       | 18,457                |       | (2,539         | )          | (13.8        | )          |
| Total construction loans                        |       | 71,140            |       | 77,316                |       | (6,176         | )          | (8.0         | )          |
| Total mortgage loans                            |       | 530,762           |       | 541,355               |       | (10,593        | )          | (2.0         | )          |
|                                            |       |              |       |                  |       |           |       |         |       |
| Commercial                                      |       | 19,468            |       | 21,922                |       | (2,454         | )          | (11.2        | )          |
|                                            |       |              |       |                  |       |           |       |         |       |
| Automobile                                      |       | 7,579             |       | 8,631                 |       | (1,052         | )          | (12.2        | )          |
| Other                                           |       | 11,550            |       | 12,291                |       | (741           | )          | (6.0         | )          |
| Total consumer                                  |       | 19,129            |       | 20,922                |       | (1,793         | )          | (8.6         | )          |
|                                            |       |              |       |                  |       |           |       |         |       |
| Total loans receivable                          |       | 569,359           |       | 584,199               |       | (14,840        | )          | (2.5         | )          |
|                                            |       |              |       |                  |       |           |       |         |       |
| Undisbursed loan funds                          |       | (9,559            | )          | (11,750               | )          | 2,191          |       | (18.6        | )          |
| Deferred loan costs — net                  |       | 453               |       | 529                   |       | (76            | )          | (14.4        | )          |
| Allowance for loan losses                       |       | (11,924           | )          | (6,441                | )          | (5,483         | )          | 85.1         |       |
|                                            |       |              |       |                  |       |           |       |         |       |
| Loans receivable, net                           |       | $                 | 548,329    |                  | $          | 566,537        |       | $            | (18,208    | ) | (3.2 | ) |

 

The decrease in the Bank’s loanportfolio was primarily due to a decrease in loan originations due to continuedsoftening of the housing market in the Bank’s market area and transfers ofnonperforming loans to REO, net of loans to facilitate sales of REO. Marketdata indicates an overall decrease in home sales in Benton and Washingtoncounties in 2008 and 2007 as well as the first two quarters of 2009.  Although the Northwest Arkansas region’seconomy continues to experience population growth and a relatively good jobmarket, ranking number 4 on Forbes’ magazine’s latest ranking of bestmetropolitan areas for business and careers and ranking number 2 on Forbes’best cities for recession recovery, the supply of new residential lots and newspeculative homes for sale continues to outpace demand.  We expect this trend to continue for theforeseeable future given the level of oversupply in the market.

 

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

 
| ** **                                                                                              | ** ** | **June 30,  2009**    | ** ** | **December 31, 2008** | ** ** | **Increase********(Decrease)** | ** ** | **Percentage Change** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|--------------------------------|------------|-----------------------|------------|
|                                                                                                    |       | **(Dollars in Thousands)** |       |                       |       |                           |       |
| Nonaccrual loans:                                                                                       |       |                       |       |                       |       |                           |       |                  |       |
| One- to four-family residential                                                                         |       | $                          | 12,302     |                       | $          | 8,471                          |       | $                     | 3,831      |   | 45.2 | % |
| Home equity and second mortgage                                                                         |       | 1,201                      |       | 927                        |       | 274                            |       | 29.6                  |       |
| Speculative one- to four-family construction                                                            |       | 3,431                      |       | 1,466                      |       | 1,965                          |       | 134.0                 |       |
| Multifamily residential                                                                                 |       | —                     |       | 441                        |       | (441                           | )          | (100.0                | )          |
| Land development                                                                                        |       | 8,416                      |       | 2,577                      |       | 5,839                          |       | 226.6                 |       |
| Land                                                                                                    |       | 21,436                     |       | 2,537                      |       | 18,899                         |       | 744.9                 |       |
| Commercial real estate                                                                                  |       | 5,233                      |       | 6,702                      |       | (1,469                         | )          | (21.9                 | )          |
| Commercial loans                                                                                        |       | 2,658                      |       | 2,128                      |       | 530                            |       | 24.9                  |       |
| Consumer loans                                                                                          |       | 154                        |       | 170                        |       | (16                            | )          | (9.4                  | )          |
| Total nonaccrual loans                                                                                  |       | 54,831                     |       | 25,419                     |       | 29,412                         |       | 115.7                 |       |
|                                                                                                    |       |                       |       |                       |       |                           |       |                  |       |
| Accruing loans 90 days or more past due                                                                 |       | 1,489                      |       | 8,961                      |       | (7,472                         | )          | (83.4                 | )          |
| Real estate owned                                                                                       |       | 23,473                     |       | 22,385                     |       | 1,088                          |       | 4.9                   |       |
|                                                                                                    |       |                       |       |                       |       |                           |       |                  |       |
| Total nonperforming assets                                                                              |       | $                          | 79,793     |                       | $          | 56,765                         |       | $                     | 23,028     |   | 40.6 | % |
|                                                                                                    |       |                       |       |                       |       |                           |       |                  |       |
| Total nonaccrual and accruing loans 90 days or more  past due as a percentage of total loans receivable |       | 9.83                       | %          | 5.87                       | %          |                           |       |                  |       |
|                                                                                                    |       |                       |       |                       |       |                           |       |                  |       |
| Total nonperforming assets  as a percentage of total assets                                             |       | 10.14                      | %          | 7.14                       | %          |                           |       |                  |       |

 

The increase in nonaccrual loans isprimarily related to increases in nonaccrual land development loans, nonaccrualland loans and nonaccrual single family loans. The increase in nonaccrual land loans is primarily due to seven loans,four of which are to the entities related to the same borrower totaling $9.1million discussed in the first relationship below.  The fifth loan of $3.3 million is discussedin the second relationship below.  Thesixth loan contributing to the increase, totaling $2.8 million, is discussed inthe fourth relationship below.  Theseventh loan is discussed in the third relationship below and totaled $2.8million.  The increase in nonaccrual landdevelopment loans is primarily due to the subdivision discussed in the secondrelationship below.

 

We expect a significant amount of thenonaccrual real estate loans to eventually migrate to real estate owned as$18.9 million of the nonaccrual real estate loans reported above are inbankruptcy or some stage of the foreclosure process as of June 30,2009.  Therefore, we expect real estateowned and associated expenses to continue to increase in future periods as suchloans migrate from loans to real estate owned.

 

The level of nonaccrual one- tofour-family residential loans, commercial real estate loans, land loans, landdevelopment loans and commercial loans is attributable primarily to eight loanrelationships totaling $34.8 million, or 63.5% of nonaccrual loans.  These relationships are described in moredetail in the paragraphs that follow.

 

The first relationship totaled $9.1million with a specific loan loss allowance of $861,000 at June 30, 2009,and is comprised of 29 acres of land acquired for future development inSpringdale, Arkansas, 80 acres acquired for future development in Fayetteville,Arkansas, and 24 acres of raw land located in Lowell, Arkansas.  The borrower has passed away and the estateis currently addressing how the obligations of the borrower will be satisfied.Based on the nature of these loans and the possibility of continued adversechanges in the market conditions, we may incur losses in the future in excessof the specific allowance recorded as of June 30, 2009.

 

The second relationship totaled $9.1million with a specific loan loss allowance of $559,000 at June 30, 2009,and is comprised of a 212 lot subdivision and a 60 acre parcel of land, alllocated in Fayetteville, Arkansas.  Thesubdivision is comprised of three phases, 52 lots of which are complete, 69lots which lack final paving, and 91 additional lots which areundeveloped.  Based on the nature ofthese loans and the possibility of continued adverse changes in the marketconditions, we may incur losses in the future in excess of the specificallowance recorded as of June 30, 2009.

 

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The third relationship totaled $5.1million with a specific loan loss allowance of $103,000 at June 30, 2009.The loans are secured by 2.5 acres of commercial land located in Rogers,Arkansas and three vacant commercial lots and two commercial properties locatedin Springdale, Arkansas. Based on the nature of these loans and the changes inmarket conditions, we may incur losses in the future in excess of the specificallowance as of June 30, 2009.

 

The fourth relationship consisted of a$2.8 million first mortgage loan secured by the Belclaire subdivision locatedin Fayetteville, Arkansas.  Bonds weresold on this property by the Belclaire Improvement District without satisfyingthe first mortgage with our Bank.  Theloan is in default and we have filed foreclosure.  This property is also the subject oflitigation.  We believe our firstmortgage will prevail and absent that, believe the guarantors will satisfy theobligation. At June 30, 2009, based on the estimated fair value of thecollateral, the Bank estimates it will incur no loss.

 

The fifth relationship totaled $2.5million and the collateral consists of the borrower’s residence, sixspeculative single family houses in various stages of construction and sevenlots in Fayetteville, Arkansas. The loans in this relationship are currently inforeclosure and a specific loan loss allowance of $388,000 has been recorded asof June 30, 2009.   Based on thenature of these loans and the possibility of continued adverse changes in themarket conditions, we may incur losses in the future in excess of the specificallowance recorded as of June 30, 2009.

 

The sixth relationship totaled $2.2million with a specific loan loss allowance of $981,000 at June 30, 2009,and is comprised of a completed 42 lot subdivision located in Cave Springs,Arkansas.  The borrowers have beenattempting to find a buyer for the subdivision since the loan matured in July 2007.  We are exercising forbearance with thisborrower due to their cooperation and maintenance of the subdivision while theytry to find a buyer.  The Bank obtainedan updated valuation on the subdivision using discounted cash flow analysis.  Due to the market conditions and the oversupplyof lots in Northwest Arkansas, the valuation indicated lower lot prices and anextended marketing time over that in the original appraisal obtained when theloan was originated.  Based on the natureof this loan and the possibility of continued adverse changes in the marketconditions, we may incur losses in the future in excess of the specificallowance recorded as of June 30, 2009.

 

The seventh relationship totaled $2.0million at June 30, 2009, and consists of a $1.3 million commercial loansecured by commercial real estate and franchise rights, a $657,000 loan on theborrower’s primary residence, and a $22,000 unsecured loan.  The loans in this relationship are currentlyin foreclosure and a specific loan loss allowance of $632,000 has been recordedas of June 30, 2009.  Based on thenature of these loans and the possibility of continued adverse changes in themarket conditions, we may incur losses in the future in excess of the specificallowance recorded as of June 30, 2009.

 

The eighth relationship totaled $2.0million and the collateral consists of sixteen single family rental propertiesin Fayetteville and Springdale, Arkansas. The borrower has filed bankruptcy anda specific loan loss reserve of $137,000 has been recorded as of June 30,2009.

 

At June 30, 2009, the Bank had$1.5 million that was over 90 days past due and not designated as nonaccrualcompared to $9.0 million of such loans at December 31, 2008. One loantotaling $1.2 million is secured by a church building and the related propertylocated in Fayetteville, Arkansas.  Thechurch has the property under contract with a buyer and is waiting for the saleto close. The second loan of $310,000 is a commercial line of credit and ispending an extension to be processed in August. These loans were maintained on accrual status and not classified orjudged to be impaired at June 30, 2009, based on our assessment of factsand circumstances existing at that time. If any of the facts or circumstances change, our treatment of theseloans might be different in future reporting periods.

 

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

 
| ** **                                      | ** ** | **June 30,  2009**    | ** ** | **December 31,  2008** | ** ** | **Increase  (Decrease)** | ** ** | **Percentage Change** | ** ** |
|-------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|--------------------------|------------|-----------------------|------------|
|                                            |       | **(Dollars in Thousands)** |       |                        |       |                     |       |
| Real estate owned                               |       |                       |       |                        |       |                     |       |                  |       |
| One- to four-family residential                 |       | $                          | 3,683      |                        | $          | 3,436                    |       | $                     | 247        |   | 7.2 | % |
| Speculative one- to four-family construction(1) |       | 3,013                      |       | 4,310                       |       | (1,297                   | )          | (30.1                 | )          |
| Multifamily                                     |       | 615                        |       | —                      |       | 615                      |       | —                |       |
| Land(2)                                         |       | 13,220                     |       | 13,314                      |       | (94                      | )          | (0.7                  | )          |
| Commercial real estate                          |       | 2,942                      |       | 1,325                       |       | 1,617                    |       | 122.0                 |       |
| Total real estate owned                         |       | $                          | 23,473     |                        | $          | 22,385                   |       | $                     | 1,088      |   | 4.9 | % |

 

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(1)                        At June 30, 2009, $2.9 million of these properties were 100%complete.  The remaining property is 99%complete.

(2)                        At June 30, 2009, $9.9 million of the land balance represented270 developed subdivision lots.  Theremainder consisted of unimproved land originally intended to be future phasesof two of the subdivisions.

 

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The increase in real estate owned fromDecember 31, 2008 to June 30, 2009 is primarily related to fivecommercial real estate properties totaling $2.0 million and three multifamilyproperties totaling $615,000 that were transferred to real estate owned duringthe first six months of 2009, offset by the sale of six speculative singlefamily properties totaling $1.5 million.

 

The Bank is diligently working todispose of its REO and has dedicated an experienced special assets officer whois working full-time to liquidate the Bank’s properties in the NorthwestArkansas market. Each property is evaluated on a case-by-case basis todetermine the best course of action with respect to liquidation. Properties are marketed directly by the Bank or listed with local real estateagents utilizing appraisals, market information from realtors, market researchreports, and our own market evaluations to make pricing and sellingdecisions.   The Bank’s Chief Lending Officer, loan officers, creditmanager, special assets officer, and team members in the collections departmentall work together in this endeavor.   The Bank’s goal is to liquidatethese properties in an orderly and efficient manner without incurringextraordinary losses due to quick sale pricing. During 2008, the Bank sold real estate owned totaling $10.0 million andoriginated loans to facilitate such sales totaling $6.9 million.  During the first six months of 2009, the Banksold real estate owned totaling $7.0 million and originated loans to facilitatesuch sales totaling $5.5 million. Another $1.7 million of real estate owned isunder contract. The Bank offers attractive rates and financing options toprospective buyers of real estate owned to help facilitate sales.  During the second quarter of 2009, the Bankalso settled litigation related to a subdivision property held in real estateowned and recorded a recovery of previous chargeoffs to the allowance for loanlosses. This recovery increased the allowance for loan losses, which reducedthe provision for loan losses required during the quarter when compared to whatthe provision might have been absent such a recovery.

 

**Classified Assets. **Federal regulations require that each insured savings associationclassify its assets on a regular basis. In addition, in connection with examinations of insured institutions,federal examiners have authority to identify problem assets and, ifappropriate, classify them.  There arethree classifications for problem assets: “substandard,” “doubtful” and “loss.”  Substandard assets have one or more definedweaknesses and are characterized by the distinct possibility that the insuredinstitution will sustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses ofsubstandard assets with the additional characteristic that the weaknesses makecollection or liquidation in full on the basis of currently existing facts,conditions and values questionable, and there is a high possibility ofloss.  An asset classified loss isconsidered uncollectible and of such little value that continuance as an assetof the institution is not warranted.  At June 30,2009, the Bank had $98.2 million of classified assets, $92.3 million of whichwere classified as substandard and $5.9 million of which were classified asloss, including $54.8 million of nonaccrual loans, $23.5 million of real estateowned, and $1.5 million of loans 90 days or more past due and still accruing.  Substandard loans include $18.5 million ofloans not included in the nonperforming assets table.  Such loans have been reviewed and determinednot to be impaired or if impaired, were estimated to have no loss.  As a result, such loans remained on accrualstatus at June 30, 2009.

 

In addition, at such date, the Bank had $68.4 million of assetsdesignated as special mention. Special mention assets have potential weaknessesthat deserve management’s close attention. If left uncorrected, these potential weaknesses may result indeterioration of the repayment prospects for the asset or the institution’scredit position at some future date.

 

The Bank engaged a third party to independently review all of its assetsdesignated as either watch or special mention and received the results of suchreview in July 2009. The third party review did not revealany significant differences between our classifications and their recommendedclassifications.  The Bank has thereforedetermined that its loan review and asset classification procedures areeffective in identifying loans which should be classified.  In connection with this review, the Bankconducted its annual loan review procedures primarily in the second quarter of2009.  The loan review proceduresindicated an overall deterioration in the credit quality of our portfolio withtotal substandard and special mention assets totaling $160.7 million at June 30,2009, compared to $110.0 million at March 31, 2009, and $86.3 million at December 31,2008.  The level of substandard andspecial mention loans and the trend thereof was taken into consideration whenestablishing the allowance for loan losses. Based on our comprehensive review of the loan portfolio during thesecond quarter of 2009, we believe that we have identified potential problemloans/relationships and, assuming no further deterioration in local andnational economic trends, do not expect a significant increase in classifiedassets in future periods.

 

**PotentialProblem Loans.** Based on the oversupply of lots in Northwest Arkansas, our land developmentportfolio poses a higher risk of default. These loans are typically structured with interest due at maturity andlot sales as the source of repayment. Since lot sales in the Northwest Arkansas market are significantlyslower than when these loans were originated, our borrowers typically must relyon a secondary source of funds to pay the interest as it becomes due.  Due to the relatively large balances of thesetypes of loans, the interest due at maturity is usually significant.  At June 30, 2009, gross land developmentloans totaled $15.9 million with $1.2 million of accrued interest.  Of this total, $8.4 million is on nonaccrualstatus with $1.0 million in nonaccrual interest, $4.0 million with $124,000 inaccrued interest is classified as special mention, and $3.1 million with$42,000 in accrued interest is on our watch list.

 

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

 
| ** **                       | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Balance at beginning of  period  |       | $                                    | 9,558      |                               | $          | 6,107 |   | $ | 6,441 |   | $ | 5,162 |   |
| Provisions for estimated  losses |       | 2,445                                |       | 971                                |       | 5,966 |   | 2,499 |   |
| Recoveries                       |       | 693                                  |       | 58                                 |       | 754 |   | 194 |   |
| Losses charged off               |       | (772                                 | )          | (1,921                             | )          | (1,237 | ) | (2,640 | ) |
| Balance at end of period         |       | $                                    | 11,924     |                               | $          | 5,215 |   | $ | 11,924 |   | $ | 5,215 |   |

# ** **

Changes in the composition ofthe allowance for loan losses between June 30, 2009 and December 31,2008 are presented in the following table (in thousands):

 
| ** ** | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | ** **   | ** ** |
|------------|------------|-------------------|------------|-----------------------|------------|--------------|------------|
| ** ** | ** ** | **2009**          | ** ** | **2008**              | ** ** | **Increase** | ** ** |
| General    |       | $                 | 5,989      |                  | $          | 3,525        |       | $ | 2,464 |   |
| Specific   |       | 5,935             |       | 2,916                 |       | 3,019        |       |
|       |       | $                 | 11,924     |                  | $          | 6,441        |       | $ | 5,483 |   |

 

The general component of the allowance for loan losses increasedprimarily due to increases in the loss factors applied to single family loans,home equity loans, speculative single family loans, and land development loans,partially offset by decreases in certain of the related loan balances.  These loss factors were increased due to therecent loss history on these types of loans as well as delinquency trends, thelevel of classified assets and economic factors such as unemployment,bankruptcy trends and home sale data. The specific component of the allowance for loan losses increasedprimarily due to allowances established since December 31, 2008 on landloans, land development loans, single family loans, and speculative singlefamily loans.  See “Asset Quality.”

 

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

 

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

 

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

 

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

 

Large groups of smaller balance homogeneous loans are collectivelyevaluated for impairment. Accordingly, the Bank does not separately identifyindividual consumer and residential loans for impairment disclosures.  Homogeneous loans are those that areconsidered to have common characteristics that provide for evaluation on anaggregate or pool basis. The Bank considers the characteristics of (1) one-to four-family residential first mortgage loans; (2) unsecured consumerloans; and (3) collateralized consumer loans to permit consideration ofthe appropriateness 

 

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of the allowance for losses of each group of loans on a pool basis. Theprimary methodology used to determine the appropriateness of the allowance forlosses includes segregating certain specific, poorly performing loans based ontheir performance characteristics from the pools of loans as to type, valuingthese loans, and then applying a loss factor to the remaining pool balancebased on several factors including past loss experience, inherent risks, andeconomic conditions in the primary market areas.

 

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

 

Although we consider theallowance for loan losses of approximately $11.9 million adequate to coverlosses inherent in our loan portfolio at June 30, 2009, no assurance canbe given that we will not sustain loan losses that are significantly differentfrom the amount recorded, or that subsequent evaluations of the loan portfolio,in light of factors then prevailing, would not result in a significant changein the allowance for loan losses.

 

**Investment Securities. **Changes in the compositionof investment securities held to maturity between June 30, 2009 and December 31,2008 are presented in the following table (in thousands).

 
| ** **                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | ** **   | ** ** |
|----------------------------------------|------------|-------------------|------------|-----------------------|------------|--------------|------------|
|                                   |       | **2009**          | ** ** | **2008**              | ** ** | **Increase** | ** ** |
| U.S. Government and agency obligations |       | $                 | 117,416    |                  | $          | 116,847      |       | $ | 569 |   |
| Municipal securities                   |       | 24,272            |       | 19,565                |       | 4,707        |       |
| Total                                  |       | $                 | 141,688    |                  | $          | 136,412      |       | $ | 5,276 |   |

 

During the first six months of 2009,investment securities totaling $111.3 million with an average tax equivalentyield of 5.45% were purchased and $106.1 million with an average tax equivalentyield of 5.93% matured or were called.

 

At June 30, 2009, estimated fair values of investmentsecurities held to maturity were as follows (in thousands):

** **
| ** **                             | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------|------------|
|                                   |       |                |       |            |       |
| U.S. Government and agency obligations |       | $                   | 117,416    |            | $          | 115,784 |   |
| Municipal securities                   |       | 24,272              |       | 23,963          |       |
| Total                                  |       | $                   | 141,688    |            | $          | 139,747 |   |

 

**AccruedInterest Receivable. ** The decrease in accrued interestreceivable was primarily due to an increase in nonaccrual loans, a decrease inthe loans receivable balance, and a decrease in the loan yield at June 30,2009 compared to December 31, 2008.

 

**Real Estate Owned, net.**  Changesin the composition of real estate owned between June 30, 2009 and December 31, 2008 arepresented in the following table (dollars in thousands).

 
| ** **                      | ** ** | **December 31,  2008** | ** ** | **Additions** | ** ** | **Fair Value  Adjustments** | ** ** | **Net Sales  Proceeds(1)** | ** ** | **Gain (Loss)** | ** ** | **June 30,  2009** | ** ** |
|---------------------------------|------------|-----------------------------|------------|---------------|------------|-----------------------------|------------|----------------------------|------------|-----------------|------------|-------------------------|------------|
| One- to four-family residential |       | $                           | 3,436      |          | $          | 2,902                       |       | $                          | (179       | )               | $          | (2,342                  | )          | $ | (134 | ) | $ | 3,683 |   |
| Speculative one- to four-family |       | 4,310                       |       | 473           |       | (238                        | )          | (1,464                     | )          | (68             | )          | 3,013                   |       |
| Multifamily                     |       | —                      |       | 1,007         |       | (12                         | )          | (370                       | )          | (10             | )          | 615                     |       |
| Land                            |       | 13,314                      |       | 162           |       | (135                        | )          | (121                       | )          | —          |       | 13,220                  |       |
| Commercial real estate          |       | 1,325                       |       | 4,459         |       | (151                        | )          | (2,674                     | )          | (17             | )          | 2,942                   |       |
|                            |       | $                           | 22,385     |          | $          | 9,003                       |       | $                          | (715       | )               | $          | (6,971                  | )          | $ | (229 | ) | $ | 23,473 |   |

 

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(1) Net sales proceedsinclude $5.5 million of loans made by the Bank to facilitate the sale of realestate owned.

 

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**Deposits. **Changes in the composition of depositsbetween June 30, 2009and December 31, 2008 are presented in the following table (dollars inthousands).

 
| ** **              | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** | **Increase  (Decrease)** | ** ** | **Percentage  Change** | ** ** |
|-------------------------|------------|-------------------------|------------|-----------------------------|------------|--------------------------|------------|------------------------|------------|
|                    |       |                    |       |                        |       |                     |       |                   |       |
| Checking accounts       |       | $                       | 166,129    |                        | $          | 163,468                  |       | $                      | 2,661      |   | 1.6 | % |
| Money Market accounts   |       | 44,568                  |       | 45,022                      |       | (454                     | )          | (1.0                   | )          |
| Savings accounts        |       | 25,924                  |       | 23,019                      |       | 2,905                    |       | 12.6                   |       |
| Certificates of deposit |       | 383,559                 |       | 386,494                     |       | (2,935                   | )          | (0.8                   | )          |
|                    |       |                    |       |                        |       |                     |       |                   |       |
| Total deposits          |       | $                       | 620,180    |                        | $          | 618,003                  |       | $                      | 2,177      |   | 0.4 |   |

 

Deposits increased in the comparison period, primarily due to anincrease in checking and savings accounts, offset by a decrease in certificatesof deposit. The Bank viewschecking accounts as an attractive source of funds and will continue to promotesuch accounts as they offer overall low-interest deposits, fee incomepotential, and the opportunity to cross-sell other financial services.

 

**Other Borrowings.**  The Bank experienced a $18.4 million or 20.0%decrease in other borrowings during the quarter primarily due to a decrease inFederal Reserve Bank borrowings of $9.5 million and a $8.9 million decrease inFHLB advances since December 31, 2008.

 

**Other Liabilities.**  Other liabilities decreased primarily due toa decrease in investment security purchases which settled after period end from$9.0 million at December 31, 2008, to $2.8 million at June 30, 2009.

 

**Stockholders’ Equity. **Stockholders’equity increased approximately $13.7 million from December 31, 2008 to June 30,2009.  The increase in stockholders’ equity wasprimarily due to the issuance of 16,500 shares of preferred stock totaling$16.5 million offset by a net loss of $2.4 million during the first six monthsof 2009.  In addition, during the sixmonths ended June 30, 2009,dividends on common shares of approximately $97,000 and preferred dividends ofapproximately $264,000 were paid or accrued. See the Unaudited Consolidated Statement of Stockholders’ Equity for thesix months ended June 30, 2009for more detail.

 

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### **Average Balance Sheets**

### ** **

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

 
| ** **                                                       | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                       | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| ** **                                                       | ** ** | **Average  Balance**                 | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** |
| ** **                                                       | ** ** | **(Dollars in Thousands)**           | ** ** |
| Interest-earning assets:                                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans receivable(1)                                              |       | $                                    | 563,088    |   | $ | 7,565 |   | 5.37 | % | $ | 582,318 |   | $ | 9,520 |   | 6.54 | % |
| Investment securities(2)                                         |       | 139,734                              |       | 1,616 |   | 4.63 |   | 135,380 |   | 1,835 |   | 5.42 |   |
| Other interest-earning assets                                    |       | 16,109                               |       | 12 |   | 0.30 |   | 20,149 |   | 112 |   | 2.22 |   |
| Total interest-earning assets                                    |       | 718,931                              |       | 9,193 |   | 5.12 |   | 737,847 |   | 11,467 |   | 6.22 |   |
| Noninterest-earning assets                                       |       | 77,128                               |       |   |   |   |   | 77,659 |   |   |   |   |   |
| Total assets                                                     |       | $                                    | 796,059    |   |   |   |   |   | $ | 815,506 |   |   |   |   |   |
| Interest-bearing liabilities:                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                         |       | $                                    | 630,382    |   | 3,513 |   | 2.23 |   | $ | 645,999 |   | 4,779 |   | 2.96 |   |
| Other borrowings                                                 |       | 67,231                               |       | 547 |   | 3.26 |   | 90,106 |   | 879 |   | 3.90 |   |
| Total interest-bearing liabilities                               |       | 697,613                              |       | 4,060 |   | 2.33 |   | 736,105 |   | 5,658 |   | 3.08 |   |
| Noninterest-bearing liabilities                                  |       | 10,191                               |       |   |   |   |   | 5,167 |   |   |   |   |   |
| Total liabilities                                                |       | 707,804                              |       |   |   |   |   | 741,272 |   |   |   |   |   |
| Stockholders’ equity                                        |       | 88,255                               |       |   |   |   |   | 74,234 |   |   |   |   |   |
| Total liabilities andstockholders’  equity                  |       | $                                    | 796,059    |   |   |   |   |   | $ | 815,506 |   |   |   |   |   |
|                                                             |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                              |       |                                 |       | $ | 5,133 |   |   |   |   |   | $ | 5,809 |   |   |   |
| Net earning assets                                               |       | $                                    | 21,318     |   |   |   |   |   | $ | 1,742 |   |   |   |   |   |
| Interest rate spread                                             |       |                                 |       |   |   | 2.79 | % |   |   |   |   | 3.14 | % |
| Net interest margin                                              |       |                                 |       |   |   | 2.86 | % |   |   |   |   | 3.15 | % |
| Ratio of interest-earning assets tointerest-bearing  liabilities |       |                                 |       |   |   | 103.06 | % |   |   |   |   | 100.24 | % |

 
| ** **                                                       | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                       | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| ** **                                                       | ** ** | **Average  Balance**               | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** |
|                                                             |       | **(Dollars in Thousands)**         |       |
| Interest-earning assets:                                         |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Loans receivable(1)                                              |       | $                                  | 565,417    |   | $ | 15,120 |   | 5.35 | % | $ | 592,157 |   | $ | 19,495 |   | 6.58 | % |
| Investment securities(2)                                         |       | 132,987                            |       | 3,180 |   | 4.78 |   | 120,317 |   | 3,228 |   | 5.37 |   |
| Other interest-earning assets                                    |       | 15,424                             |       | 16 |   | 0.20 |   | 20,654 |   | 280 |   | 2.71 |   |
| Total interest-earning assets                                    |       | 713,828                            |       | 18,316 |   | 5.13 |   | 733,128 |   | 23,003 |   | 6.28 |   |
| Noninterest-earning assets                                       |       | 80,767                             |       |   |   |   |   | 75,042 |   |   |   |   |   |
| Total assets                                                     |       | $                                  | 794,595    |   |   |   |   |   | $ | 808,170 |   |   |   |   |   |
| Interest-bearing liabilities:                                    |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                         |       | $                                  | 629,606    |   | 7,293 |   | 2.32 |   | $ | 639,476 |   | 10,347 |   | 3.24 |   |
| Other borrowings                                                 |       | 72,806                             |       | 1,192 |   | 3.28 |   | 87,488 |   | 1,782 |   | 4.07 |   |
| Total interest-bearing liabilities                               |       | 702,412                            |       | 8,485 |   | 2.42 |   | 726,964 |   | 12,129 |   | 3.34 |   |
| Noninterest-bearing liabilities                                  |       | 9,006                              |       |   |   |   |   | 7,012 |   |   |   |   |   |
| Total liabilities                                                |       | 711,418                            |       |   |   |   |   | 733,976 |   |   |   |   |   |
| Stockholders’ equity                                        |       | 83,177                             |       |   |   |   |   | 74,194 |   |   |   |   |   |
| Total liabilities andstockholders’  equity                  |       | $                                  | 794,595    |   |   |   |   |   | $ | 808,170 |   |   |   |   |   |
|                                                             |       |                               |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                              |       |                               |       | $ | 9,831 |   |   |   |   |   | $ | 10,874 |   |   |   |
| Net earning assets                                               |       | $                                  | 11,416     |   |   |   |   |   | $ | 6,164 |   |   |   |   |   |
| Interest rate spread                                             |       |                               |       |   |   | 2.71 | % |   |   |   |   | 2.94 | % |
| Net interest margin                                              |       |                               |       |   |   | 2.75 | % |   |   |   |   | 2.97 | % |
| Ratio of interest-earning assets tointerest-bearing  liabilities |       |                               |       |   |   | 101.63 | % |   |   |   |   | 100.85 | % |

 

----

(1)  Includes nonaccrual loans.

(2)  Includes FHLB of Dallasstock.

 

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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 June 30,********2009 vs. 2008** |       |
|------------------------------------|--------|-----------------------------------------------------------|------------|
|                               |   | **Increase (Decrease)********Due to**                     |       | **Total** |   |
|                               |   | **Volume**                                                | ** ** | **Rate** | ** ** | **Rate/********Volume** | ** ** | **Increase (Decrease)** | ** ** |
|                               |   | **(In Thousands)**                                        |       |
| Interest income:                   |   |                                                      |       |   |   |   |   |   |   |
| Loans receivable                   |   | $                                                         | (314       | ) | $ | (1,697 | ) | $ | 56 |   | $ | (1,955 | ) |
| Investment securities              |   | 59                                                        |       | (269 | ) | (9 | ) | (219 | ) |
| Other interest-earning assets      |   | (23                                                       | )          | (96 | ) | 19 |   | (100 | ) |
| Total interest-earning assets      |   | (278                                                      | )          | (2,062 | ) | 66 |   | (2,274 | ) |
|                               |   |                                                      |       |   |   |   |   |   |   |
| Interest expense:                  |   |                                                      |       |   |   |   |   |   |   |
| Deposits                           |   | (116                                                      | )          | (1,179 | ) | 29 |   | (1,266 | ) |
| Other borrowings                   |   | (223                                                      | )          | (146 | ) | 37 |   | (332 | ) |
| Total interest-bearing liabilities |   | (339                                                      | )          | (1,325 | ) | 66 |   | (1,598 | ) |
| Net change in net interest income  |   | $                                                         | 61         |   | $ | (737 | ) | $ | — |   | $ | (676 | ) |

 
| ** **                         | ** ** | **Six Months Ended June 30,  2009 vs. 2008** | ** ** |
|------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **Increase (Decrease)   Due to**                  | ** ** | **Total** | ** ** |
| ** **                         | ** ** | **Volume**                                        | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Increase  (Decrease)** | ** ** |
| ** **                         | ** ** | **(In Thousands)**                                | ** ** |
| Interest income:                   |       |                                              |       |   |   |   |   |   |   |
| Loans receivable                   |       | $                                                 | (880       | ) | $ | (3,660 | ) | $ | 165 |   | $ | (4,375 | ) |
| Investment securities              |       | 340                                               |       | (351 | ) | (37 | ) | (48 | ) |
| Other interest-earning assets      |       | (71                                               | )          | (259 | ) | 66 |   | (264 | ) |
| Total interest-earning assets      |       | (611                                              | )          | (4,270 | ) | 194 |   | (4,687 | ) |
|                               |       |                                              |       |   |   |   |   |   |   |
| Interest expense:                  |       |                                              |       |   |   |   |   |   |   |
| Deposits                           |       | (159                                              | )          | (2,940 | ) | 45 |   | (3,054 | ) |
| Other borrowings                   |       | (299                                              | )          | (349 | ) | 58 |   | (590 | ) |
| Total interest-bearing liabilities |       | (458                                              | )          | (3,289 | ) | 103 |   | (3,644 | ) |
| Net change in net interest income  |       | $                                                 | (153       | ) | $ | (981 | ) | $ | 91 |   | $ | (1,043 | ) |

 

24

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**CHANGES IN RESULTS OF OPERATIONS**

 

The table below presents acomparison of results of operations for the three months ended June 30,2009 and 2008 (dollars in thousands). Specific changes in captions are discussed in the sections which followthe table.

 
| ** **                                                           | ** ** | **Three Months Ended********June 30,** | ** ** | **Increase********(Decrease)** | ** ** | **Percentage  Change** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **                                                           | ** ** | **2009**                                    | ** ** | **2008**                       | ** ** | **2009 vs 2008**       | ** ** | **2009 vs 2008** | ** ** |
| Interest income:                                                     |       |                                        |       |                           |       |                   |       |   |   |
| Loans receivable                                                     |       | $                                           | 7,565      |                           | $          | 9,520                  |       | $ | (1,955 | ) | (20.5 | )% |
| Investment securities                                                |       | 1,616                                       |       | 1,835                          |       | (219                   | )          | (11.9 | ) |
| Other                                                                |       | 12                                          |       | 112                            |       | (100                   | )          | (89.3 | ) |
| Total interest income                                                |       | 9,193                                       |       | 11,467                         |       | (2,274                 | )          | (19.8 | ) |
| Interest expense:                                                    |       |                                        |       |                           |       |                   |       |   |   |
| Deposits                                                             |       | 3,513                                       |       | 4,779                          |       | (1,266                 | )          | (26.5 | ) |
| Other borrowings                                                     |       | 547                                         |       | 879                            |       | (332                   | )          | (37.8 | ) |
| Total interest expense                                               |       | 4,060                                       |       | 5,658                          |       | (1,598                 | )          | (28.2 | ) |
| Net interest income before provision for loan losses                 |       | 5,133                                       |       | 5,809                          |       | (676                   | )          | (11.6 | ) |
| Provision for loan losses                                            |       | 2,445                                       |       | 971                            |       | 1,474                  |       | 151.8 |   |
| Net interest income afterprovision for loan losses                   |       | 2,688                                       |       | 4,838                          |       | (2,150                 | )          | (44.4 | ) |
| Noninterest income:                                                  |       |                                        |       |                           |       |                   |       |   |   |
| Deposit fee income                                                   |       | 1,328                                       |       | 1,344                          |       | (16                    | )          | (1.2 | ) |
| Earnings on life insurance policies                                  |       | 200                                         |       | 191                            |       | 9                      |       | 4.7 |   |
| Gain on sale of loans                                                |       | 152                                         |       | 91                             |       | 61                     |       | 67.0 |   |
| Other                                                                |       | 359                                         |       | 422                            |       | (63                    | )          | (14.9 | ) |
| Total noninterest income                                             |       | 2,039                                       |       | 2,048                          |       | (9                     | )          | (0.4 | ) |
| Noninterest expenses:                                                |       |                                        |       |                           |       |                   |       |   |   |
| Salaries and employee benefits                                       |       | 2,845                                       |       | 3,244                          |       | (399                   | )          | (12.3 | ) |
| Real estate owned, net                                               |       | 1,085                                       |       | 269                            |       | 816                    |       | 303.4 |   |
| FDIC insurance premium                                               |       | 687                                         |       | 108                            |       | 579                    |       | 536.1 |   |
| Advertising and public relations                                     |       | 91                                          |       | 218                            |       | (127                   | )          | (58.3 | ) |
| Other                                                                |       | 1,848                                       |       | 1,809                          |       | 39                     |       | 2.2 |   |
| Total noninterest expenses                                           |       | 6,556                                       |       | 5,648                          |       | 908                    |       | 16.1 |   |
| Income (loss) before income taxes                                    |       | (1,829                                      | )          | 1,238                          |       | (3,067                 | )          | (247.7 | ) |
| Income tax provision (benefit)                                       |       | (892                                        | )          | 229                            |       | (1,121                 | )          | (489.5 | ) |
| Net income (loss)                                                    |       | (937                                        | )          | 1,009                          |       | (1,946                 | )          | (192.9 | ) |
| Preferred  stock dividends and accretion of preferred stock discount |       | 222                                         |       | —                         |       | 222                    |       | — |   |
| Net  income (loss) available to common shareholders                  |       | $                                           | (1,159     | )                              | $          | 1,009                  |       | $ | (2,168 | ) | (214.9 | )% |
|                                                                 |       |                                        |       |                           |       |                   |       |   |   |
| Basic earnings (loss) per common share                               |       | $                                           | (0.24      | )                              | $          | 0.21                   |       | $ | (0.45 | ) | (214.3 | )% |
| Diluted earnings (loss) per common share                             |       | $                                           | (0.24      | )                              | $          | 0.21                   |       | $ | (0.45 | ) | (214.3 | )% |
|                                                                 |       |                                        |       |                           |       |                   |       |   |   |
| Interest rate spread                                                 |       | 2.79                                        | %          | 3.14                           | %          |                   |       |   |   |
| Net interest margin                                                  |       | 2.86                                        | %          | 3.15                           | %          |                   |       |   |   |
|                                                                 |       |                                        |       |                           |       |                   |       |   |   |
| Average full-time equivalents                                        |       | 280                                         |       | 303                            |       |                   |       |   |   |
|                                                                 |       |                                        |       |                           |       |                   |       |   |   |
| Full-service offices                                                 |       | 20                                          |       | 19                             |       |                   |       |   |   |

 

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The table below presents a comparison ofresults of operations for the six months ended June 30, 2009 and 2008(dollars in thousands). Specific changes in captions are discussed in thesections which follow the table.

 
| ** **                                                           | ** ** | **Six Months Ended********June 30,** | ** ** | **Increase********(Decrease)** | ** ** | **Percentage  Change** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **                                                           | ** ** | **2009**                                  | ** ** | **2008**                       | ** ** | **2009 vs 2008**       | ** ** | **2009 vs 2008** | ** ** |
| Interest income:                                                     |       |                                      |       |                           |       |                   |       |   |   |
| Loans receivable                                                     |       | $                                         | 15,120     |                           | $          | 19,495                 |       | $ | (4,375 | ) | (22.4 | ) |
| Investment securities                                                |       | 3,180                                     |       | 3,228                          |       | (48                    | )          | (1.5 | ) |
| Other                                                                |       | 16                                        |       | 280                            |       | (264                   | )          | (94.3 | ) |
| Total interest income                                                |       | 18,316                                    |       | 23,003                         |       | (4,687                 | )          | (20.4 | ) |
| Interest expense:                                                    |       |                                      |       |                           |       |                   |       |   |   |
| Deposits                                                             |       | 7,293                                     |       | 10,347                         |       | (3,054                 | )          | (29.5 | ) |
| Other borrowings                                                     |       | 1,192                                     |       | 1,782                          |       | (590                   | )          | (33.1 | ) |
| Total interest expense                                               |       | 8,485                                     |       | 12,129                         |       | (3,644                 | )          | (30.0 | ) |
| Net interest income before provision for loan losses                 |       | 9,831                                     |       | 10,874                         |       | (1,043                 | )          | (9.6 | ) |
| Provision for loan losses                                            |       | 5,966                                     |       | 2,499                          |       | 3,467                  |       | 138.7 |   |
| Net interest income afterprovision for loan losses                   |       | 3,865                                     |       | 8,375                          |       | (4,510                 | )          | (53.9 | ) |
| Noninterest income:                                                  |       |                                      |       |                           |       |                   |       |   |   |
| Deposit fee income                                                   |       | 2,520                                     |       | 2,555                          |       | (35                    | )          | (1.4 | ) |
| Earnings on life insurance policies                                  |       | 398                                       |       | 1,562                          |       | (1,164                 | )          | (74.5 | ) |
| Gain on sale of loans                                                |       | 300                                       |       | 266                            |       | 34                     |       | 12.8 |   |
| Other                                                                |       | 728                                       |       | 870                            |       | (142                   | )          | (16.3 | ) |
| Total noninterest income                                             |       | 3,946                                     |       | 5,253                          |       | (1,307                 | )          | (24.9 | ) |
| Noninterest expenses:                                                |       |                                      |       |                           |       |                   |       |   |   |
| Salaries and employee benefits                                       |       | 5,813                                     |       | 6,632                          |       | (819                   | )          | (12.4 | ) |
| Real estate owned, net                                               |       | 1,480                                     |       | 698                            |       | 782                    |       | 112.0 |   |
| FDIC insurance premium                                               |       | 928                                       |       | 127                            |       | 801                    |       | 630.7 |   |
| Advertising and public relations                                     |       | 202                                       |       | 560                            |       | (358                   | )          | (63.9 | ) |
| Other                                                                |       | 3,983                                     |       | 3,703                          |       | 280                    |       | 7.6 |   |
| Total noninterest expenses                                           |       | 12,406                                    |       | 11,720                         |       | 686                    |       | 5.9 |   |
| Income before income taxes                                           |       | (4,595                                    | )          | 1,908                          |       | (6,503                 | )          | (340.8 | ) |
| Income tax provision (benefit)                                       |       | (2,156                                    | )          | (188                           | )          | (1,968                 | )          | (1,046.8 | ) |
| Net income (loss)                                                    |       | (2,439                                    | )          | 2,096                          |       | (4,535                 | )          | (216.4 | ) |
| Preferred  stock dividends and accretion of preferred stock discount |       | 284                                       |       | —                         |       | 284                    |       | — |   |
| Net  income (loss) available to common shareholders                  |       | $                                         | (2,723     | )                              | $          | 2,096                  |       | $ | (4,819 | ) | (229.9 | )% |
|                                                                 |       |                                      |       |                           |       |                   |       |   |   |
| Basic  earnings per share                                            |       | $                                         | (0.56      | )                              | $          | 0.43                   |       | $ | (0.99 | ) | (230.2 | )% |
| Diluted  earnings per share                                          |       | $                                         | (0.56      | )                              | $          | 0.43                   |       | $ | (0.99 | ) | (230.2 | )% |
|                                                                 |       |                                      |       |                           |       |                   |       |   |   |
| Interest rate spread                                                 |       | 2.71                                      | %          | 2.94                           | %          |                   |       |   |   |
| Net interest margin                                                  |       | 2.75                                      | %          | 2.97                           | %          |                   |       |   |   |
|                                                                 |       |                                      |       |                           |       |                   |       |   |   |
| Average full-time equivalents                                        |       | 285                                       |       | 304                            |       |                   |       |   |   |
|                                                                 |       |                                      |       |                           |       |                   |       |   |   |
| Full-service offices                                                 |       | 20                                        |       | 19                             |       |                   |       |   |   |

 

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

 

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

 

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

 

**Interest Income. **The decrease in interest income for the three and six month comparativeperiods was primarily due to a decrease in the average yield earned on loansreceivable, as well as a decrease in the average balance of loansreceivable.  These decreases wereslightly offset by an increase in the average balance of investment securities.  The decrease in the average yield earned onloans receivable was due to decreases in market interest rates and an increasein the level of nonaccrual loans.  Thelevel of nonaccrual loans and other nonperforming assets will continue tonegatively impact interest income, interest rate spread, and net interestmargin.  The average balance of loansreceivable decreased due to repayments and maturities as well as a decrease inloan originations.

 

**Interest Expense.  **The decrease in interest expense for the three and six monthcomparative periods was primarily due to a decrease in the average rates paidon deposits and other borrowings as well as a decrease in the related averagebalances.  The decrease in the average rates paid on depositaccounts and other borrowings reflects decreases in market interest rates.

 

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

 

The provision for loan losses increased $1.5 million to $2.4 millionfor the quarter ended June 30, 2009 compared to $971,000 for the quarterended June 30, 2008 and increased $3.5 million to $6.0 million for the sixmonths ended June 30, 2009 compared to $2.5 million for the same periodended June 30, 2008.  The increasein the provision for loan losses was primarily due to increases in totalnonaccrual loans and in the loss factors used in certain allowance categoriesand an increase in specific loan loss allowances recorded during the three andsix months ended June 30, 2009, in each respect due to deterioratingeconomic conditions.

 

**Noninterest Income. **The decrease in other noninterest income for the six month comparativeperiod in 2009 was primarily due to $1.2 million in nonrecurring earnings onlife insurance policies due to a death benefit claim recorded during thequarter ended March 31, 2008.

 

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**NONINTERESTEXPENSE**

 

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

 
| ** **                        | ** ** | **Three Months Ended June 30,** | ** ** | **Increase****(Decrease)** | ** ** | **Six Months Ended June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|--------------------------|------------|
| ** **                        | ** ** | **2009**                                            | ** ** | **2008**                   | ** ** | **2009 vs 2008**                        | ** ** | **2009**                 | ** ** | **2008** | ** ** | **2009 vs 2008** | ** ** |
| Salaries                          |       | $                                                   | 2,404      |                       | $          | 2,539                                             |       | $                        | (135       | ) | $ | 4,871 |   | $ | 5,181 |   | $ | (310 | ) |
| Payroll taxes                     |       | 210                                                 |       | 217                        |       | (7                                                | )          | 439                      |       | 472 |   | (33 | ) |
| Insurance                         |       | 156                                                 |       | 167                        |       | (11                                               | )          | 314                      |       | 338 |   | (24 | ) |
| 401(k)(1)                         |       | —                                              |       | 79                         |       | (79                                               | )          | 38                       |       | 157 |   | (119 | ) |
| Defined benefit plan contribution |       | 39                                                  |       | 196                        |       | (157                                              | )          | 77                       |       | 391 |   | (314 | ) |
| Other                             |       | 36                                                  |       | 46                         |       | (10                                               | )          | 74                       |       | 93 |   | (19 | ) |
| Total                             |       | $                                                   | 2,845      |                       | $          | 3,244                                             |       | $                        | (399       | ) | $ | 5,813 |   | $ | 6,632 |   | $ | (819 | ) |

 

----

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

 

The decrease in salaries and benefits was primarily due to a reduction infull time equivalents as well as a change in the benefit formula related to thedefined benefit plan and cessation of the Company’s 401(k) matchingcontribution in February 2009.

 

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

 
| ** **               | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase****(Decrease)** | ** ** | **Six Months Ended June 30,** | ** ** | **Increase  (Decrease)** | ** ** |
|--------------------------|------------|---------------------------------------|------------|----------------------------|------------|------------------------------------|------------|--------------------------|------------|
| ** **               | ** ** | **2009**                              | ** ** | **2008**                   | ** ** | **2009 vs 2008**                   | ** ** | **2009**                 | ** ** | **2008** | ** ** | **2009 vs 2008** | ** ** |
| Loss provisions          |       | $                                     | 552        |                       | $          | 87                                 |       | $                        | 465        |   | $ | 715 |   | $ | 316 |   | $ | 399 |   |
| Net loss (gain) on sales |       | 254                                   |       | (25                        | )          | 279                                |       | 233                      |       | 28 |   | 205 |   |
| Taxes and insurance      |       | 138                                   |       | 169                        |       | (31                                | )          | 322                      |       | 279 |   | 43 |   |
| Other                    |       | 141                                   |       | 38                         |       | 103                                |       | 210                      |       | 75 |   | 135 |   |
| Total                    |       | $                                     | 1,085      |                       | $          | 269                                |       | $                        | 816        |   | $ | 1,480 |   | $ | 698 |   | $ | 782 |   |

 

Real estate ownedis expected to increase in the foreseeable future and real estate ownedexpenses associated with maintaining the properties are expected to increaseaccordingly.  Future levels of lossprovisions and net gains or losses on sales of real estate owned will bedependent on market conditions.

 

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

 

**FDIC Insurance Premium.**  FDIC insurance increased during the three andsix month comparison periods due to assessment credits which were available topartially offset FDIC premium expense in the first quarter of 2008 as well asdue to an increase in the premium rate for 2009.  Further, in the second quarter of 2009, theFDIC imposed a five basis point special assessment, which resulted inadditional expense of $350,000 in that period. FDIC premium expense is expected to continue to increase.  We anticipate that FDIC premiums for thethird and fourth quarters of 2009 will be approximately $225,000 and $225,000higher than the same periods in 2008, respectively, due to an increase inpremium rates compared to the same periods in 2008.

 

**IncomeTaxes. **The income tax benefit increased primarily due to thenet taxable loss position for the six months ended June 30, 2009.

 

# **OFF-BALANCE SHEET ARRANGEMENTS**

 

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

 

·      the origination, purchase orsale of loans;

·      the fulfillment ofcommitments under letters-of-credit, extensions of credit on home equity linesof credit, construction loans, and predetermined overdraft protection limits;and

·      the commitment to fund withdrawalsof certificates of deposit at maturity.

 

At June 30, 2009, the Bank’s off-balancesheet arrangements principally included lending commitments, which aredescribed below.  At June 30, 2009,the Company had no interests in non-consolidated special purpose entities.

 

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At June 30, 2009, commitments included:

 

·      total approved commitmentsto originate or purchase loans amounting to $3.7 million;

·      rate lock agreements withcustomers of $9.1 million, all of which have been locked with an investor;

·      funded mortgage loanscommitted to sell of $3.5 million;

·      unadvanced portion ofconstruction loans of $9.6 million;

·      unused lines of credit of$18.7 million;

·      outstanding standby lettersof credit of approximately $3.7 million;

·      total predeterminedoverdraft protection limits of $15.0 million; and

·      certificates of depositscheduled to mature in one year or less totaling $292.8 million.

 

Total unfunded commitments to originate loans for sale and the relatedcommitments to sell of $9.1 million meet the definition of a derivativefinancial instrument.  The related assetand liability are considered immaterial at June 30, 2009.

 

Historically, a very small percentage of predetermined overdraft limitshave been used.  At June 30, 2009,overdrafts of accounts with Bounce ProtectionTM represented usage of 3.2% of the limit.  We expect utilization of these overdraftlimits to remain at comparable levels in the future.

 

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

 

### **LIQUIDITY 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 deposit balances at levels commensuratewith the operating, investing and financing activities of the Bank.  In addition, the Bank invests excess funds inovernight deposits and other short-term interest-earning assets that provideliquidity to meet lending requirements and pay deposit withdrawals. When fundsfrom the retail deposit market are inadequate for the liquidity needs of theBank or the pricing of deposits is not as favorable as other sources, the Bankhas borrowed from the FHLB of Dallas and the Federal Reserve Bank of St. Louis(“FRB”).    During the first six months of 2009, the useof FHLB and FRB borrowings decreased by $18.4 million or 20.0%.  The Bank uses U.S. government agencyinvestment securities and eligible one- to four-family loans as collateral forFHLB advances and commercial real estate and U.S. government agency investmentsecurities as collateral for FRB borrowings. The Bank’s borrowing capacity is based on the amount of securities andloans pledged to the FHLB and FRB.  TheBank may transfer additional collateral to provide additional borrowingcapacity if needed.  Currently, the Bankmay borrow only short-term FHLB advances with maturities up to thirtydays.   At June 30, 2009, the Bankhad short-term funds availability of approximately $108.6 million or 13.8% ofassets consisting of borrowing capacity at the FRB and FHLB, unpledgedinvestment securities, and overnight funds. The Bank anticipates it will continue to rely primarily on deposits,loan repayments and repayments of its investment securities to provideliquidity.  As necessary, the sources ofborrowed funds described above will be used to augment the Bank’s fundingsources.

 

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 borrowings, to fund loan commitments,and to purchase investment securities.

 

For the quarters ended June 30,2009 and 2008, the Company declared dividends of $0.01 and $0.16 per share,respectively.  The determination offuture dividends on the Company’s common stock will depend on conditionsexisting at that time with consideration given to the Company’s earnings,capital, and liquidity needs.  See Note 4to the unaudited consolidated financial statements for further informationregarding dividend restrictions.

 

As of June 30, 2009, the Bank’s regulatory capital was in excess of all applicableregulatory requirements and the Bank was considered well-capitalized under theregulatory framework for prompt corrective action.  At June 30, 2009, the Bank’s tangible, core and risk-based capital ratios amounted to10.80%, 10.80% and 16.60%, respectively. As a result of the currentdifficult economic environment and the uncertainties surrounding the timing ofan economic 

 

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recovery, the Bank has agreed with itsprimary regulator, the Office of Thrift Supervision, to maintain a corecapital ratio of at least five percent and a risk-based capital ratio of atleast ten percent.

 

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

 

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

 

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

 

### **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 nomaterial change in the market value of the Bank’s portfolio equity since December 31,2008.  Similarly, while there has been no material change in the Company’sasset and liability position since such time, the Bank’s increased level ofnonperforming assets continued to impact the level of net interest incomeduring both the three months ended March 31, 2009 and June 30, 2009. Correspondingly, the Bank’s net interest margin decreased from 3.19% forthe three months ended December 31, 2008 to 2.65% for the three monthsended March 31, 2009.  The margin for the three months ended June 30,2009 was 2.86% which represents an improvement over the first quarter’s netinterest margin. Both the first and second quarter’s net interest margin wasnegatively impacted by the deferral of previous period accrued interest ofapproximately $400,000 in the first quarter and approximately $220,000 in thesecond quarter.  With the level of maturing certificates of depositsrepricing to lower rates in the third quarter, management anticipates animprovement in the net interest margin in the third quarter of 2009.  Although management does not anticipate a significant increase innonaccrual loans, further deferrals of current and previous period interest onany new nonaccrual loans could offset any improvement in the net interestmargin gained from lower deposit costs.

 

**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 operating effectively.

 

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

 

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

 

**Part II**

 

Item 1.             Legal Proceedings

 

On June 22, 2009, a lawsuit was filed inthe Circuit Court of Benton County, Arkansas, Civil Division, Docket No. CIV2009-1936-3styled Pinnacle Hills Hotel Group, LLC, Landsite Acquisitions, LLC, Basic Construction, Inc.,and Gary Combs vs. First Federal Bank of Harrison.  The limited liability plaintiffs are director indirect affiliates of Gary Combs, a commercial and residential developerwho is a resident of Washington County, Arkansas.  According to the complaint, the plaintiffsare borrowers and/or guarantors of certain loans made to the various borrowersand secured by a mortgage on property in Washington County, Arkansas and amortgage secured by property in Benton County, Arkansas.  The complaint alleges that the Bank hasbreached its agreement with Combs to provide financing, wrongfully shareddetails of a project with a third party, disseminated proprietary information,among other allegations.  The plaintiffsseek damages under the complaint in the amount of $16 million.  The Company believes that the allegations ofthe complaint are wholly without merit.

 

Neither the Company nor the Bank is involved in any other 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 the Company’s risk factors fromthose previously disclosed in the Company’s Form 10-K for the year ended December 31,2008.

 

Item 2.             Unregistered Sales of EquitySecurities and Use of Proceeds

 

The Company did not repurchase any securities duringthe second quarter of 2009.  The Companyis in its 19th announced repurchase program, which was approved by the board ofdirectors on July 25, 2006, and publicly announced on November 8,2006.  Total shares approved to bepurchased in this program are 245,197 of which 214,587 have been purchased asof June 30,2009.  All treasury stock purchases aremade under publicly announced repurchase programs.  The repurchase program is currentlysuspended.

 

Item 3.             Defaults Upon SeniorSecurities

 

Not applicable.

 

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Item 4.             Submission of Matters to aVote of Security Holders

 

On April 28, 2009, the Corporation held an annual meeting ofstockholders for the following purposes:

 

(1)         To elect two directors for aterm of three years; and

 

(2)         To ratify the appointment bythe Board of Directors of Deloitte & Touche LLP as the Corporation’sindependent auditors for the year ending December 31, 2009.

 

(3)         To approve on a non-bindingadvisory basis the compensation of the Company’s named executive officers

 

The results of the voting are set forth below:

 

Proposal One (Election of Directors):

 
| **NAME**              | ** ** | **FOR**   | ** ** | **AGAINST/********WITHHELD** | ** ** | **NOT VOTED** | ** ** |
|-----------------------|------------|-----------|------------|------------------------------|------------|---------------|------------|
| Jeffrey L. Brandt     |       | 4,030,091 |       | 187,106                      |       | 629,588       |       |
| John P. Hammerschmidt |       | 4,194,639 |       | 22,558                       |       | 629,588       |       |

 

Proposal Two (Ratification of Auditors):

 
| **FOR**   | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** | **NOT VOTED** |   |
|-----------|------------|-------------|------------|-------------|------------|---------------|--------|
| 4,201,630 |       | 13,247      |       | 2,320       |       | 629,588       |   |

 

Proposal Three (Compensation Approval):

 
| **FOR**   | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** | **NOT VOTED** |   |
|-----------|------------|-------------|------------|-------------|------------|---------------|--------|
| 4,036,079 |       | 160,641     |       | 20,477      |       | 629,588       |   |

 

Item 5.             Other Information

 

None.

 

Item 6.             Exhibits

 
| Exhibit 31.1 — Certification of Chief  Executive Officer, Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 (18 U.S.C. 1350) |
|------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 31.2 — Certification of Chief  Financial Officer, Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 (18 U.S.C. 1350) |
| Exhibit 32.1 — Certification of Chief Executive  Officer, Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18  U.S.C. 1350) |
| Exhibit 32.2 — Certification of Chief  Financial Officer, Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 (18 U.S.C. 1350) |

 

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**SIGNATURES**

 

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

 

 

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

 

 
| Date:   August 7,  2009 | By:    | /s/ Larry J. Brandt                                   |
|---------------------------------------------|--------|-------------------------------------------------------|
|                                        |   | Larry J. Brandt                                       |
|                                        |   | Chief Executive Officer                               |
|                                        |   |                                                  |
|                                        |   |                                                  |
| Date:   August 7,  2009 | By:    | /s/ Sherri R. Billings                                |
|                                        |   | Sherri R. Billings                                    |
|                                        |   | Chief Financial Officer  and Chief Accounting Officer |

 

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