UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-Q




(mark
one)




ý QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934




For
the quarterly period ended September 30, 2008




or




 ̈TRANSITION REPORT UNDER
SECTION 13 OR 15(d)


OF
THE EXCHANGE ACT




For the
transition period from _______to_______




Commission
File Number 000-51123




ROYAL
FINANCIAL, INC.


(Exact name of registrant specified in
its charter)




Delaware
              (State
      or other jurisdiction of incorporation or organization)
            20-1636029
              (I.R.S.
      Employer Identification Number)9226
      S. Commercial Avenue
              Chicago,
      Illinois 60617
              (Address
      of principal executive offices)(773)
      768-4800
              (Issuer’s
      telephone number)Not
      Applicable
              (Former
      name, former address and former fiscal year,
              if
      changes since last report)





Check
whether the issuer (1) filed all reports required to be filed by Section 13 or
15(d) of the Exchange Act during the past 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.  Yes ý No  ̈




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




Large accelerated filer  ̈                                                                          Accelerated
filer  ̈


Non-accelerated filer  ̈                                                                           
Smaller reporting company ý




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




State the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date:




Class
            Outstanding
      as of November 13, 2008Common
      Stock, $0.01 par value
            2,556,490











ROYAL
FINANCIAL, INC. AND SUBSIDIARY




FORM
10-Q




For
the quarterly period ended September 30, 2008




TABLE OF CONTENTS







PagePART I – FINANCIAL INFORMATIONItem 1.      Financial
      StatementsConsolidated Statements of Financial
      Condition as of September 30, 2008 and June 30, 2008
                  1Consolidated Statements of Operations
      for the three months ended September 30, 2008 and 2007
                  2Consolidated Statements of
      Stockholders’ Equity for the three months ended September 30, 2008 and
      2007
                  3Consolidated Statements of Cash Flows for the
      three months ended September 30, 2008 and 2007
                  5Notes to Unaudited Financial
    Statements
                  6Item 2.      Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                  11Item 3.      Quantitative and
      Qualitative Disclosures about Market Risk
                  20Item 4T.    Controls and
      Procedures
                  20PART II – OTHER INFORMATIONItem 1.       Legal
      Proceedings
                  21 Item 1A.  Risk Factors
                      21
 Item
      2.      Unregistered Sales of Equity
      Securities and Use of Proceeds
                    22Item 3.      Defaults
      Upon Senior Securities
                    22Item 4.      Submission
      of Matters to a Vote of Security Holders
                    22Item 5.      Other
      Information
                    22Item 6.     
      Exhibits
                    22SIGNATURESEXHIBIT INDEX








i





PART I. – FINANCIAL INFORMATION




Item 1.  Financial Statements.




ROYAL
FINANCIAL, INC. AND SUBSIDIARY


CONSOLIDATED STATEMENTS OF FINANCIAL
CONDITION


September
30, 2008 and June 30, 2008 (Unaudited)




September 30,
      2008
              
              
              June
      30, 2008ASSETSCash
      and non-interest-bearing balances in financial
institutions
              
              $
              3,435,714
              
              
              $
              3,692,777Interest-bearing
      balances in financial institutions
              
              
              67,967
              
              
              
              68,126Federal
      funds sold
              
              
              392,555
              
              
              
              2,163,946Total
      cash and cash equivalents
              
              
              3,896,236
              
              
              
              5,924,849Securities
      available-for-sale
              
              
              4,925,161
              
              
              
              7,747,047Loans
      receivable, net of allowance for loan losses of $1,757,269 at
      September 30, 2008 and $2,060,000 at June 30,
    2008
              
              
              93,087,498
              
              
              
              90,775,183Federal
      Home Loan Bank stock, at cost
              
              
              381,300
              
              
              
              381,300Cash
      surrender value of life insurance
              
              
              4,982,697
              
              
              
              4,933,722Premises
      and equipment, net
              
              
              5,440,930
              
              
              
              5,534,815Accrued
      interest receivable
              
              
              420,151
              
              
              
              454,922Other
      assets
              
              
              364,947
              
              
              
              376,277Total
      assets
              
              $
              113,498,920
              
              
              $
              116,128,115LIABILITIES
      AND STOCKHOLDERS’ EQUITYLiabilitiesDeposits
              
              $
              75,676,330
              
              
              $
              83,875,204Advances
      from borrowers for taxes and insurance
              
              
              744,641
              
              
              
              545,518Federal
      Home Loan Bank advances
              
              
              6,000,000
              
              
              
              -Accrued
      interest payable and other liabilities
              
              
              538,851
              
              
              
              1,167,569Common
      stock in ESOP subject to contingent repurchase obligation
              
              
              593,538
              
              
              
              643,264Total
      Liabilities
              
              
              83,553,360
              
              
              
              86,231,555Stockholders’
      equityPreferred
      stock, $.01 par value per share, authorized 1,000,000 shares; no
      issues are outstanding
              
              
              —
              
              
              
              —Common
      stock, $.01 par value per share, authorized 5,000,000 and 2,645,000 shares
      issued at September 30, 2008 and June 30, 2008
              
              
              26,450
              
              
              
              26,450Additional
      paid-in capital
              
              
              24,706,708
              
              
              
              24,672,588Retained
      earnings
              
              
              8,639,254
              
              
              
              8,759,470Treasury
      stock,  88,510  and 89,568 shares, at
    cost
              
              
              (1,310,575
              )
              
              
              (1,326,286
              )Accumulated
      other comprehensive income, net of tax
              
              
              15,182
              
              
              
              12,376Unearned
      ESOP shares
              
              
              (1,537,921
              )
              
              
              (1,604,774
              )Reclassification
      of ESOP shares
              
              
              (593,538
              )
              
              
              (643,264
              )Total
      stockholders’ equity
              
              
              29,945,560
              
              
              
              29,896,560Total
      liabilities and stockholders’ equity
              
              $
              113,498,920
              
              
              $
              116,128,115





See
accompanying notes to these unaudited consolidated financial
statements.







1
 Table of Contents





ROYAL
FINANCIAL, INC. AND SUBSIDIARY


CONSOLIDATED STATEMENTS OF
OPERATIONS


Three
months ended September 30, 2008 and 2007


(Unaudited)




Three
      Months Ended
                  September
      30,2008
              
              
              2007Interest
      incomeLoans
              
              $
              1,520,463
              
              
              $
              1,620,592Securities,
      taxable
              
              
              61,991
              
              
              
              161,209Federal
      funds sold and other
              
              
              8,767
              
              
              
              179,525Total
      interest income
              
              
              1,591,221
              
              
              
              1,961,326Interest
      expenseDeposits
              
              
              371,865
              
              
              
              768,096Federal
      Home Loan Bank advances and other borrowings
              
              
              8,648
              
              
              
              105Total
      interest expense
              
              
              380,513
              
              
              
              768,201Net
      interest income
              
              
              1,210,708
              
              
              
              1,193,125Provision
      for loan losses
              
              
              150,000
              
              
              
              23,777Net
      interest income after provision for loan losses
              
              
              1,060,708
              
              
              
              1,169,348Non-interest
      incomeService
      charges on deposit accounts
              
              
              84,423
              
              
              
              63,529Earnings
      on cash surrender value of life insurance
              
              
              48,976
              
              
              
              47,581Other
      income
              
              
              12,714
              
              
              
              12,547Total
      non-interest income
              
              
              146,113
              
              
              
              123,657Non-interest
      expenseSalaries
      and employee benefits
              
              
              630,289
              
              
              
              717,641Occupancy
      and equipment
              
              
              239,109
              
              
              
              315,674Data
      processing
              
              
              105,201
              
              
              
              106,282Professional
      services
              
              
              184,588
              
              
              
              194,888Investigation
      costs
              
              
              —
              
              
              
              301,180Director
      fees
              
              
              36,700
              
              
              
              30,800Supplies
              
              
              10,029
              
              
              
              14,536Advertising
              
              
              3,429
              
              
              
              34,404Insurance
      premiums
              
              
              19,438
              
              
              
              22,035Other
              
              
              98,254
              
              
              
              102,351Total
      non-interest expense
              
              
              1,327,037
              
              
              
              1,839,791Net
      loss
              
              $
              (120,216
              )
              
              $
              (546,786
              )Basic
      and diluted loss per share
              
              $
              (0.05
              )
              
              $
              (0.23
              )Comprehensive
      loss
              
              $
              (117,410
              )
              
              $
              (463,001
              )





See
accompanying notes to these unaudited consolidated financial
statements.







2
 Table of Contents





ROYAL
FINANCIAL, INC. AND SUBSIDIARY


CONSOLIDATED STATEMENTS OF STOCKHOLDERS’
EQUITY


Three
months ended September 30, 2008 and 2007


(Unaudited)




2007
              
              Common
      Stock
              
              
              Additional
      Paid-In Capital
              
              
              Retained
      Earnings
              
              
              Accumulated
      Other Comprehensive Income (Loss)
              
              
              Unearned
      ESOP Shares
              
              
              Amount
      Reclassified on ESOP Shares
              
              
              Treasury
      Stock
              
              
              TotalBalance
      at July 1, 2007
              
              $
              26,450
              
              
              $
              24,169,282
              
              
              $
              11,510,299
              
              
              $
              (143,372
              )
              
              $
              (1,874,859
              )
              
              $
              (968,070
              )
              
              $
              (1,057,698
              )
              
              $
              31,662,032Comprehensive
      income (loss)Net
      loss
              
              
              —
              
              
              
              —
              
              
              
              (546,786
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (546,786
              )Change
      in fair value of securities available-for-sale, net
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              83,785
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              83,785Total
      comprehensive loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (463,001
              )Reclassification
      due to release and change in fair value of common stock in ESOP subject to
      contingent repurchase obligation of ESOP shares
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (29,095
              )
              
              
              —
              
              
              
              (29,095
              )Release
      of 5,290 of unearned ESOP shares
              
              
              —
              
              
              
              7,369
              
              
              
              —
              
              
              
              —
              
              
              
              66,853
              
              
              
              —
              
              
              
              —
              
              
              
              74,222Issuance
      of 5,290 shares to RRP plan
              
              
              —
              
              
              
              (78,556
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              78,556
              
              
              
              —Forfeiture
      of  21,160 shares from the RRP plan
              
              
              —
              
              
              
              309,994
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (309,994
              )
              
              
              —Stock-based
      compensation
              
              
              —
              
              
              
              51,303
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              51,303Balance
      at September 30, 2007
              
              $
              26,450
              
              
              $
              24,459,392
              
              
              $
              10,963,513
              
              
              $
              (59,587
              )
              
              $
              (1,808,006
              )
              
              $
              (997,165
              )
              
              $
              (1,289,136
              )
              
              $
              31,295,461








3
 Table of Contents





ROYAL
FINANCIAL, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY (Cont’d)


Three
months ended September 30, 2008 and 2007


(Unaudited)




2008
              
              Common
      Stock
              
              
              Additional
      Paid-In Capital
              
              
              Retained
      Earnings
              
              
              Accumulated
      Other Comprehensive Income (Loss)
              
              
              Unearned
      ESOP Shares
              
              
              Amount
      Reclassified on ESOP Shares
              
              
              Treasury
      Stock
              
              
              TotalBalance
      at July 1, 2008
              
              $
              26,450
              
              
              $
              24,672,588
              
              
              $
              8,759,470
              
              
              $
              12,376
              
              
              $
              (1,604,774
              )
              
              $
              (643,264
              )
              
              $
              (1,326,286
              )
              
              $
              29,896,560Comprehensive
      income (loss)Net
      loss
              
              
              —
              
              
              
              —
              
              
              
              (120,216
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (120,216
              )Change
      in fair value of securities available-for-sale, net
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              2,806
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              2,806Total
      comprehensive loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (117,410
              )Reclassification
      due to change in fair value of common stock in ESOP subject to contingent
      repurchase obligation
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              49,726
              
              
              
              —
              
              
              
              49,726Release
      of 5,290 of unearned ESOP shares
              
              
              —
              
              
              
              (25,697
              )
              
              
              —
              
              
              
              —
              
              
              
              66,853
              
              
              
              —
              
              
              
              —
              
              
              
              41,156Issuance
      of 1,058 shares to RRP plan
              
              
              —
              
              
              
              (15,711
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              15,711
              
              
              
              —Stock-based
      compensation
              
              
              —
              
              
              
              75,528
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              75,528Balance
      at September 30, 2008
              
              $
              26,450
              
              
              $
              24,706,708
              
              
              $
              8,639,254
              
              
              $
              15,182
              
              
              $
              (1,537,921
              )
              
              $
              (593,538
              )
              
              $
              (1,310,575
              )
              
              $
              29,945,560







See
accompanying notes to these unaudited consolidated financial
statements.







4
 Table of Contents





ROYAL
FINANCIAL, INC. AND SUBSIDIARY


CONSOLIDATED STATEMENTS OF CASH FLOWS


Three
months ended September 30, 2008 and 2007


(Unaudited)




2008
              
              
              2007Cash
      flows from operating activitiesNet
      loss
              
              $
              (120,216
              )
              
              $
              (546,786
              )Adjustments
      to reconcile net loss to net cash from operating
      activities:Depreciation
              
              
              93,885
              
              
              
              117,711Provision
      for loan losses
              
              
              150,000
              
              
              
              23,777Earnings
      on bank-owned life insurance
              
              
              (48,976
              )
              
              
              (47,581
              )ESOP
      expense
              
              
              41,156
              
              
              
              74,222Stock-based
      compensation
              
              
              75,528
              
              
              
              51,303Change
      in accrued interest receivable and other assets
              
              
              47,298
              
              
              
              148,578Change
      in other accrued interest payable and liabilities
              
              
              (628,718
              )
              
              
              136,323Net
      cash from operating activities
              
              
              (390,043
              )
              
              
              (42,453
              )Cash
      flows from investing activitiesProceeds
      from sales, maturities, calls, and paydowns of available for sale
      securities
              
              
              2,823,496
              
              
              
              1,660,998Change
      in loans receivable
              
              
              (2,462,315
              )
              
              
              (3,179,464
              )Purchase
      of loan participations
              
              
              —
              
              
              
              (3,000,000
              )Purchase
      of premises and equipment
              
              
              —
              
              
              
              (8,093
              )Net
      cash from investing activities
              
              
              361,181
              
              
              
              (4,526,559
              )Cash
      flows from financing activitiesNet
      decrease in deposits
              
              
              (8,198,874
              )
              
              
              (7,232,209
              )Net
      change in Federal Home Loan Bank advances
              
              
              6,000,000Change
      in advances from borrowers for taxes and insurance
              
              
              199,123
              
              
              
              188,646Net
      cash used in financing activities
              
              
              (1,999,751
              )
              
              
              (7,043,563
              )Net
      change in cash and cash equivalents
              
              
              (2,028,613
              )
              
              
              (11,612,575
              )Cash
      and cash equivalentsBeginning
      of the period
              
              
              5,924,849
              
              
              
              21,395,954End
      of period
              
              $
              3,896,236
              
              
              $
              9,783,379





See
accompanying notes to these unaudited consolidated financial
statements.







5
 Table of Contents





ROYAL
FINANCIAL, INC. AND SUBSIDIARY


NOTES TO UNAUDITED FINANCIAL STATEMENTS




Note
1 - Nature of Business




Royal
Financial, Inc. was incorporated under the laws of Delaware on September 15,
2004, for the purpose of serving as the holding company of Royal Savings Bank
(the “Bank”) as part of the Bank’s conversion from a mutual to stock form of
organization.




Note
2 - Basis of Presentation




The
accompanying unaudited consolidated financial statements include the accounts of
Royal Financial, Inc. (the “Company”) and its wholly owned subsidiary, the Bank,
as of and for the three month periods ended September 30, 2008 and
2007.  Significant intercompany accounts and transactions have been
eliminated in consolidation.




The
accompanying unaudited interim consolidated financial statements have been
prepared pursuant to the rules and regulations for reporting on Form
10-Q.  Accordingly, certain disclosures required by U.S. generally
accepted accounting principles (GAAP) are not included herein.  These
interim financial statements should be read in conjunction with the audited
financial statements and accompanying notes of the Company for the fiscal years
ended June 30, 2008 and 2007.  The results of the Company’s operations
for any interim period are not necessarily indicative of the results of the
Company’s operations for any other interim period or for a full fiscal
year.




Interim
statements are subject to possible adjustment in connection with the annual
audit of the Company’s financial statements for the fiscal year ending June 30,
2009.  In the opinion of management of the Company, the accompanying
unaudited interim consolidated financial statements reflect all adjustments
(consisting of normal recurring adjustments) necessary for a fair presentation
of the consolidated financial position and consolidated results of operations
for the periods presented.




Note
3 - Use of Estimates and Significant Accounting Policies




The
preparation of the consolidated financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect amounts
reported in the consolidated financial statements.  Changes in these
estimates and assumptions are considered reasonably possible and may have a
material impact on the consolidated financial statements and thus actual results
could differ from the amounts reported and disclosed herein.  The
Company considers the allowance for loan losses and valuation allowance on
deferred tax assets to be critical accounting estimates.




Note
4 - Significant Accounting Policies




Significant
accounting policies we follow are presented in Note 1 to the consolidated
financial statements included in our Annual Report on Form 10-KSB for the fiscal
year ended June 30, 2008. Effective July 1, 2008, we have adopted Financial
Accounting Standards Boards (“FASB”) No. 157 and No. 159 as described
below.




In
September 2006, the FASB issued Statement No. 157, Fair Value
Measurements.   This statement defines fair value,
establishes a framework for measuring fair value, and expands disclosures about
fair value measurements. This statement establishes a fair value hierarchy about
the assumptions used to measure fair value and clarifies assumptions about risk
and the effect of a restriction on the sale or use of an asset. The standard is
effective for fiscal years beginning after November 15, 2007. In
February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date
of FASB Statement No. 157.   This FSP delays the effective date of FAS
157 for all non-financial assets and non-financial liabilities,





6
 Table of Contents




except those
that are recognized or disclosed at fair value on a recurring basis (at least
annually) to fiscal years beginning after November 15, 2008, and interim periods
within those fiscal years. We have adopted FAS 157 effective July 1, 2008. The
adoption had no effect on our financial condition or results of
operations.  In
February 2007, the FASB issued Statement No. 159, The
Fair Value Option for Financial Assets and Financial
Liabilities.  The standard provides companies with an option to
report selected financial assets and liabilities at fair value and establishes
presentation and disclosure requirements designed to facilitate comparisons
between companies that choose different measurement attributes for similar types
of assets and liabilities.  The Company did not elect the fair value
option for any financial assets or financial liabilities as of July 1,
2008.
  Note
5 – Loans
  At
September 30, 2008 and June 30, 2008, loans receivable consisted of the
following:
  September
      30,
                    2008
                
                
                June
      30,
                    2008Real
      estate loansOne-to-four
      family
                
                $
                34,807,239
                
                
                $
                36,362,454Commercial
                
                
                44,645,254
                
                
                
                43,337,424Multi-family
                
                
                3,661,558
                
                
                
                3,688,999Total
      real estate loans
                
                
                83,114,051
                
                
                
                83,388,877Commercial
      loans
                
                
                11,042,308
                
                
                
                8,738,738Consumer
      loansHome
      equity loans
                
                
                577,524
                
                
                
                591,347Other
                
                
                101,257
                
                
                
                119,067Total
      consumer loans
                
                
                678,781
                
                
                
                710,414Less:Net
      deferred loan fees
                
                
                (9,627
                )
                
                
                2,846Allowance
      for loan losses
                
                
                1,757,269
                
                
                
                2,060,000Loans,
      net
                
                $
                93,087,498
                
                
                $
                90,775,183
 
 A summary
of changes in the allowance for loan losses for the three months ended September
30, 2008 and 2007 is as follows:
  2008
                
                
                2007Balance
      at beginning of period
                
                $
                2,060,000
                
                
                $
                667,105Provision
      for loan loss
                
                
                150,000
                
                
                
                23,777Charge
      offs
                
                
                (452,731
                )
                
                
                —Balance
      at end of period
                
                $
                1,757,269
                
                
                $
                690,822
   7
 Table of Contents
 The
following is a summary of information pertaining to impaired and nonperforming
loans at:
  September 30,
                    2008
                
                
                June
      30,
                    2008Loans
      with allocated allowance for loan loss at period end
                
                $
                3,614,723
                
                
                $
                3,745,680Loans
      with no allocated allowance for loan loss at period
    end
                
                
                3,306,844
                
                
                
                1,519,334Total
      impaired and non-performing loans
                
                $
                6,921,567
                
                
                $
                5,265,014Amount
      of the allowance for loan losses allocated to impaired loans at period
      end
                
                $
                928,000
                
                
                $
                1,285,000Interest
      income recognized during impairment
                
                
                —
                
                
                
                —Cash
      basis interest income recognized
                
                
                —
                
                
                
                —
 
 Non-performing
loans were as follows at September 30, 2008 and June 30, 2008:
  Septembeer 30,
                    2008
                
                
                June
      30,
                    2008Loans
      past due over 90 days still on accrual
                
                
                —
                
                
                
                —Nonaccrual
      loans
                
                $
                6,921,567
                
                
                $
                5,265,014
 
 8
 Table of Contents


Note
6 - Loss Per Share




The
following table presents a reconciliation of the components used to compute
basic and diluted loss per share for the three month periods ended September 30,
2008 and 2007.  ESOP shares and restricted stock are considered
outstanding for the calculations unless unearned.




Three
      Months Ended
                  September 30,
      2008
              
              
              Three
      Months Ended
                  September
      30, 2007Basic
      and diluted loss per shareNet
      loss as reported
              
              $
              (120,216
              )
              
              $
              (546,786
              )Weighted
      average common shares outstanding
              
              
              2,390,955
              
              
              
              2,363,949Basic
      and diluted loss per share
              
              $
              (0.05
              )
              
              $
              (0.23
              )





The
effect of stock option and stock awards was not included in the calculation of
diluted loss per share because to do so would have been anti-dilutive for all
shares given the Company’s losses for each period.




Note
7 - Fair Value




FASB
Statement 157 defines fair value as the exchange price that would be received
for an asset or paid to transfer a liability (an exit price) in the principal or
most advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date.  Statement 157
also establishes a fair value hierarchy which requires an entity to maximize the
use of observable inputs and minimize the use of unobservable inputs when
measuring fair value.  The standard describes three levels of inputs
that may be used to measure fair value:




Level
1:  Quoted prices (unadjusted) for identical assets or liabilities in
active markets that the entity has the ability to access as of the measurement
date.




Level
2:  Significant other 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.




Level
3:  Significant unobservable inputs that reflect a reporting entity’s
own assumptions about the assumptions that market participants would use in
pricing an asset or liability.




Assets and Liabilities
Measured on a Recurring Basis




The fair
values of securities available-for-sale are determined by matrix pricing, which
is a mathematical technique widely used in the industry to value debt securities
without relying exclusively on quoted prices for the specific securities but
rather by relying on the securities’ relationship to other benchmark quoted
securities (Level 2 inputs).






9
 Table of Contents


Assets
and liabilities measured at fair value on a recurring basis are summarized
below:




Fair
      Value Measurements at September 30, 2008 UsingSeptember 30,
      2008
              
              
              Quoted
      Prices in Active Markets for Identical Assets
                  (Level
      1)
              
              
              Significant
      Other Observable Inputs
                  (Level
      2)Assets:Securities
      available-for-sale
              
              $
              4,925,161
              
              
              $
              —
              
              
              $
              4,925,161





Assets
and liabilities measured at fair value on a non-recurring basis are summarized
below:




Fair
      Value Measurements at September 30, 2008 UsingSeptember
      30, 2008
              
              
              Quoted
      Prices in Active Markets for Identical Assets
                  (Level
      1)
              
              
              Significant
      Other Observable Inputs
                  (Level
      2)
              
              
              Significant
      Unobservable Inputs
                  (Level
      3)Assets:Impaired
      loans
              
              $
              3,614,723
              
              
              
              —
              
              
              
              —
              
              
              $
              3,614,723





Impaired
loans are evaluated and valued at the time the loan is identified as impaired,
at the lower of cost or fair value.  Fair value is measured based on
the value of the collateral securing these loans and is classified at a level 3
in the fair value hierarchy.  Collateral may be real estate and/or
business assets including equipment, inventory and/or accounts receivable and is
determined based on appraisals by qualified licensed appraisers hired by the
Company.   Appraised and reported values may be discounted based
on management’s historical knowledge, changes in market conditions from the time
of valuation, and/or management’s expertise and knowledge of the client and
client’s business.  Impaired loans are reviewed and evaluated on at
least a quarterly basis for additional impairment and adjusted accordingly,
based on the same factors identified above.




The
following represent impairment charges recognized during the
period:




Impaired
loans, which are measured for impairment using the fair value of the collateral
for collateral dependent loans, had a carrying amount of $3,614,723, with a
valuation allowance of $928,000 resulting in an additional provision for loan
losses of $95,731 for the period.




Note
8 - Effect of Newly Issued But Not Yet Effective Accounting
Standards




In
December 2007, the FASB issued Statement 141R, Business Combinations
(Revised). Statement 141R replaces the current standard on business
combinations and will significantly change the accounting for and reporting of
business combinations in financial statements. This Statement requires an entity
to measure the business acquired at fair value and to recognize goodwill
attributable to any noncontrolling interests (previously referred to as minority
interests) rather than just the portion attributable to the
acquirer.  The Statement will also result in fewer exceptions to the
principle of measuring assets acquired and liabilities assumed in a business
combination at fair value.  In addition, the Statement will result in
payments to third parties for consulting, legal, audit, and similar services
associated with an acquisition to be recognized as expenses when incurred rather
than capitalized as part of the business combination.  Statement 141R
is effective for fiscal years beginning on or after December 15,
2008.  The Statement will not impact the Bank’s financial position or
results of operations, unless the Bank enters into a business
combination.






10
 Table of Contents




Item2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations.
  Forward-Looking
Information
  This
report includes forward-looking statements, including statements regarding our
strategy, effectiveness of investment programs, evaluations of future interest
rate trends and liquidity, expectations as to growth in assets, deposits and
results of operations, future operations, market position, financial position,
and prospects, plans and objectives of management.  These
forward-looking statements, which are based on certain assumptions and describe
our future plans, strategies and expectations, can generally be identified by
use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,”
“project,” or similar expressions.  Our ability to predict results or
the actual effect of future plans or strategies is inherently uncertain and
actual results may differ materially from those predicted in such
forward-looking statements.  Factors that could have a material
adverse effect on the operations and future prospects of the Company and the
Bank include, but are not limited to, changes in interest rates; the economic
health of the local real estate market; general economic conditions; credit
deterioration in our loan portfolio that would cause us to further increase our
allowance for loan losses; legislative/regulatory changes; monetary and fiscal
policies of the U.S. government, including policies of the U.S. Treasury and the
Federal Reserve Board; the quality or composition of the loan and securities
portfolios; demand for loan products in our market areas; deposit flows;
competition; demand for financial services in the Company’s market area; and
changes in accounting principles, policies, and guidelines.  These
risks and uncertainties should be considered in evaluating forward-looking
statements, and undue reliance should not be placed on such
statements.
  Comparison
of Financial Condition at September 30, 2008  and June 30,
2008
  The
Company’s total assets decreased $2.6 million, or 2.26%, to $113.5 million at
September 30, 2008, from $116.1 million at June 30, 2008.
  Cash and
cash equivalents decreased $2.0 million to $3.9 million at September 30, 2008
from $5.9 million at June 30, 2008, as a result of the Company using the excess
liquidity from federal funds sold to fund maturing certificate of
deposits.
  Securities
available for sale decreased $2.8 million, or 36.43%, to $4.9 million at
September 30, 2008 from $7.7 million at June 30, 2008.  The decrease
is the result of securities maturing or being repaid during the three months
ended September 30, 2008.  The proceeds received as a result of these
maturities or repayments were used to fund loan growth rather than to purchase
additional investment securities.
  Loans
increased $2.3 million, or 2.55%, to $93.1 million at September 30, 2008, from
$90.8 million at June 30, 2008.  The increase in loans was solely
due to two existing commercial loan customers utilizing their revolving
lines of credit during the quarter.
  Total
deposits decreased $8.2 million, or 9.78%, to $75.7 million at September 30,
2008 from $83.9 million at June 30, 2008 as a result of a deliberate attempt by
the Bank to manage its interest costs and, accordingly, not renew certain
maturing certificates of deposit at above market interest rates. A large portion
of these certificates were originally issued during the promotion of the Bank’s
opening of its Frankfort, Illinois and Schererville, Indiana branch locations
during fiscal 2007.
  
 11
 Table of Contents
  Deposits are
detailed as below:
  September
      30,
                        2008
                    
                    
                    June
      30,
                        2008Savings
                    
                    $
                    25,536,926
                    
                    
                    $
                    25,944,633NOW
      accounts
                    
                    
                    4,349,675
                    
                    
                    
                    4,804,409Non-interest
      bearing checking
                    
                    
                    6,029,605
                    
                    
                    
                    5,157,209Money
      market
                    
                    
                    3,509,992
                    
                    
                    
                    3,364,53839,426,198
                    
                    
                    
                    39,270,789Certificates
      of deposit
                    
                    
                    29,580,325
                    
                    
                    
                    38,010,315IRAs
                    
                    
                    6,669,807
                    
                    
                    
                    6,594,10036,250,132
                    
                    
                    
                    44,604,415Total
      Deposits
                    
                    $
                    75,676,330
                    
                    
                    $
                    83,875,204
 
 Federal
Home Loan Bank advances increased to $6.0 million at September 30, 2008 from $0
at June 30, 2008, as a result of the need to fund loan demand and replace the
maturing of certain certificates of deposit as a source of
liquidity.
  Total
stockholders’ equity remained steady at $29.9 million at September 30, 2008
compared to $29.9 million at June 30, 2008, with a slight decrease of
$49,000.
  Comparison
of Results of Operation for the Three Months Ended September 30, 2008 and
2007
  General.  The net loss for the three
months ended September 30, 2008 was $120,000, a decrease in net loss of
$427,000, from the same period in 2007.  The decrease in the net loss
for the three months ended September 30, 2008 resulted primarily from a decrease
in non interest expense of $513,000.
  Net Interest Income.  Net interest
income increased $18,000 to $1.2 million for the three months ended September
30, 2008, from $1.19 million for the same period in 2007.  The net
interest rate spread increased to 4.24% for the three months ended September 30,
2008, from 3.32% for the same period in 2007. The net interest margin increased
to 4.74% for the three months ended September 30, 2008, from 4.08% for the same
period in 2007. The reduction in deposits related to the promotional
certificates of deposit offered with the opening of two branch locations,
slightly offset by a decline in the loan yield, was the primary cause for the
increase in spread and margin.
  Interest Income.  Total interest
income was $1.6 million for the three months ended September 30, 2008, a
decrease of $370,000 from the same period in 2007.  For the three
months ended September 30, 2008, average interest-earning assets decreased to
$102.0 million from $116.6 million for the same period in 2007.  The
decrease in interest income was primarily the result of decreases in the average
balances of the securities portfolio and federal funds sold for the respective
periods and a decrease in the loan yield due to interest rate declines. The
yield on interest-earning assets was 6.23% for the three months ended September
30, 2008 compared to 6.71% for the same period in 2007.
  Interest Expense.  Total interest
expense decreased $388,000 to $381,000 for the three months ended September 30,
2008 as compared to $768,000 for the three months ended September 30, 2007. The
average cost of funds decreased to 1.99% for the three months ended September
30, 2008 from 3.39% for the same period in 2007 as a result of the decreasing
rate environment and a reduction of promotional certificates of
deposit.
  The following table shows average
balances with corresponding interest income and interest expense as well as
average yield and cost information for the three months ending September 30,
2008 and 2007. Average balances are derived from daily balances, and nonaccrual
loans are included as interest-bearing loans for purposes of these
tables.
  
 12
 Table of Contents
  Three-month
      period ended September 30,2008
                  
                  
                  2007Average
      Balance
                  
                  
                  Interest
                  
                  
                  Average
      Yield/Rate(1)
                  
                  
                  Average
      Balance
                  
                  
                  Interest
                  
                  
                  Average
      Yield/Rate(1)Interest-
      earning assets:Loans
      receivable, net(2)
                  
                  $
                  94,311,611
                  
                  
                  $
                  1,520,463
                  
                  
                  
                  6.45
                  %
                  
                  $
                  87,567,174
                  
                  
                  $
                  1,620,592
                  
                  
                  
                  7.40
                  %Securities
      available-for-sale(3)
                  
                  
                  5,680,657
                  
                  
                  
                  61,992
                  
                  
                  
                  4.38
                  %
                  
                  
                  15,233,123
                  
                  
                  
                  161,209
                  
                  
                  
                  4.20
                  %Interest-bearing
      balances in  financial institutions(4)
                  
                  
                  68,103
                  
                  
                  
                  331
                  
                  
                  
                  1.95
                  %
                  
                  
                  3,385,023
                  
                  
                  
                  44,343
                  
                  
                  
                  5.24
                  %Federal
      funds sold and other
                  
                  
                  2,050,639
                  
                  
                  
                  8,435
                  
                  
                  
                  1.65
                  %
                  
                  
                  10,647,217
                  
                  
                  
                  2,364
                  
                  
                  
                  5.08
                  %Total
      interest earning assets
                  
                  
                  102,111,010
                  
                  
                  
                  1,591,221
                  
                  
                  
                  6.23
                  %
                  
                  
                  116,832,537
                  
                  
                  
                  1,961,326
                  
                  
                  
                  6.71
                  %Non-interest-earning
      assets
                  
                  
                  12,591,346
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  14,099,144Total
      assets
                  
                  $
                  114,702,356
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  130,931,681Interest-bearing
      liabilities:Interest-bearing
      deposits
                  
                  $
                  74,805,574
                  
                  
                  
                  371,865
                  
                  
                  
                  1.99
                  %
                  
                  $
                  90,645,217
                  
                  
                  
                  768,096
                  
                  
                  
                  3.39
                  %FHLB
      advances
                  
                  
                  1,418,478
                  
                  
                  
                  8,073
                  
                  
                  
                  2.28
                  %
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Federal
      funds purchased
                  
                  
                  92,090
                  
                  
                  
                  575
                  
                  
                  
                  2.50
                  %
                  
                  
                  7,609
                  
                  
                  
                  105
                  
                  
                  
                  5.54
                  %Total
      interest-bearing liabilities
                  
                  
                  76,316,142
                  
                  
                  
                  380,513
                  
                  
                  
                  1.99
                  %
                  
                  
                  90,652,826
                  
                  
                  
                  768,201
                  
                  
                  
                  3.39
                  %Non-interest-bearing
      liabilities
                  
                  
                  8,337,963
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  8,611,422Total
      equity capital(5)
                  
                  
                  30,048,251
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  31,667,433Total
      liabilities and equity capital
                  
                  $
                  114,702,356
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  114,702,356Net
      average interest-earning assetsNet
      interest income; interest rate spread(6)
                  
                  
                  
                  
                  
                  $
                  1,210,708
                  
                  
                  
                  4.24
                  %
                  
                  
                  
                  
                  
                  $
                  1,193,125
                  
                  
                  
                  3.32
                  %Net
      interest margin(7)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  4.74
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  4.08
                  %
 _______________
 (1)
              Yields
      and rates have been annualized where
  appropriate.
 (2)
              Includes
      nonaccruing loans.
 (3)
              Tax
      effective yield, assuming a 34%
rate.
 (4)
              Includes
      interest-bearing demand deposits, repurchase agreements, and federal funds
      sold.
 (5)
              Includes
      retained earnings.
 (6)
              Interest
      rate spread represents the difference between the weighted average yield
      on interest-earning assets and the weighted average rate on
      interest-bearing liabilities.
 (7)
              Net
      interest margin is net interest income divided by average interest-earning
      assets.
  Provision for Loan
Losses.  Provisions for loan losses are charged to earnings to
bring the total allowance for loan losses to a level considered adequate by
management to cover probable incurred credit losses in the loan
portfolio.  In evaluating the level of the allowance for loan losses,
management considers historical loss experience, the types of loans and the
amount of loans in the loan portfolio, overall portfolio mix, the level of
past-due or classified loans, the status of past-due principal and interest
payments, loan-to-value ratios, adverse situations that may affect the
borrower’s ability to repay, estimated value of any underlying collateral, and
prevailing economic conditions and other factors related to the collectibility
of the loan portfolio.  Groups of smaller balance homogenous loans,
such as residential real estate, small commercial real estate, and home equity
and consumer loans, are evaluated in the aggregate using historical loss factors
and peer group data adjusted for current economic conditions.  Large,
more complex loans, such as multi-family and larger commercial real estate
loans, are evaluated individually for impairment.
   13
 Table of Contents
  Management
assesses the allowance for loan losses quarterly.  While management
uses available information to recognize losses on loans, future loan loss
provisions may be necessary based on changes in economic
conditions.  In addition, regulatory agencies, as an integral part of
their examination process,periodically review the allowance for loan
losses and may require us to recognize additional provisions based on their
judgment of information available to them at the time of their
examination.
  This
evaluation is inherently subjective, as it requires estimates that are
susceptible to significant revision, as more information becomes available or as
projected events change.  The allowance for loan losses as a
percentage of gross loans outstanding decreased to 1.85% at September 30, 2008,
from 2.22% at June 30, 2008.  The decrease is the result of a $453,000
loan charged off during the period. There was a $440,000 reserve for this
specific loan as of June 30, 2008.
  The Bank
recorded a provision of $150,000 during the three months ended September 30,
2008 based on management’s estimate of probable incurred losses in the
portfolio, which was reflective of an increase in classified credits, impaired
credits, changing economic conditions in the Bank’s market areas and the growth
and continued change in the composition of the loan portfolio as management
continues to emphasize growth in commercial and commercial real estate
loans.
  As of September 30,
2008, all loans considered impaired were on nonaccrual status.
 
 Non-accrual
loans for the period ending September 30, 2008 were $6.9 million; compared to
$5.3 million for the year ended June 30, 2008.  Foregone interest
on non-accrual loans was approximately $109,000 for the period ended September
30, 2008 compared to zero for the period ended September 30, 2007.
 
 During
the quarter ending September 30, 2008 two additional loan relationships were
identified as impaired.  Both of these relationships were previously
disclosed at June 30, 2008 as credits with heightened concerns.  The
first, a loan participation involving a commercial property in the Chicagoland
area with an approximate balance of $450,000 is experiencing negative operating
results attributed directly to the weak economy.  Current legal and
potential workout options are being considered, which may include forbearance
arrangements intended to provide short term cash flow
relief.   The property securing this loan is in the process of
being reappraised which will provide a current analysis of our collateral
position.  Management has not established a specific reserve for this
credit based on information available to us at this time.  At the
present time management believes this loan remains adequately
secured.
 
 The
second relationship involves a single family residential home builder also
located in the Chicagoland area. The total relationship consists of approximate
balances of $2.2 million as of September 30, 2008 involving two separate
loans.  The larger credit consists of a construction loan with an
approximate balance of $2.1 million secured by a newly constructed single family
home.  The property is currently listed for sale.  The
borrower has been unable to remedy certain loan covenants required by the loan
agreement.  The Bank recognizes that the current weak housing market
and the uncertainty of continuing declining real estate values warrant obvious
concerns.  The second credit involving this borrower is a commercial
real estate secured loan with an approximate balance of
$148,000.  Management did not establish a specific reserve for either
of these loans based on our analysis.  At the present time management
believes each loan remains adequately secured.
  A credit,
also disclosed at June 30, 2008, with heightened credit concerns involving a
commercial property located in the state of Michigan with an approximate balance
of $3.0 million is presently performing in a satisfactory manner.  We
continue to closely monitor this credit.
 
 14
 Table of Contents
  As
previously disclosed, another existing impaired loan, a commercial and
industrial loan secured by receivables also continues to perform in a
satisfactory manner.  The balance of the loan at June 30, 2008 was
approximately $590,000.  At September 30 2008, the loan balance was
approximately$530,000.  The specific reserve on this loan
has been reduced from $442,000 as of June 30, 2008 to $412,000 at September 30,
2008.  We continue to closely monitor this credit.
 Management
made the decision to charge off a previously disclosed impaired loan involving a
construction and development loan located in the Chicagoland
area.  After receiving a principal reduction of $501,000 on August 20,
2008, the bank was unable to obtain additional agreed-upon collateral to secure
a potential loan extension for the remaining balance.  As property
values continued to decline in the residential housing markets, our collateral
position deteriorated.  A charge-off of $452,731 was approved as of
September 30, 2008.  We have initiated legal collection efforts in our
attempt to seek recovery.  We presently remain secured by a first lien
position on a remaining improved residential lot with an estimated value of
approximately $50,000.
 
 On
October 28, 2008, the bank agreed to and received a principal reduction in the
amount of $403,987 on a previously disclosed impaired commercial real estate
loan participation in Florida that had been impacted by current economic and
housing conditions.  The loan had an approximate outstanding balance
of $425,120 at September 30, 2008.  The principal reduction received
was obtained after the unanimous consensus of participating banks agreeing to
accept a discounted principal payment equal to 95% of the total outstanding
which allowed this takeout financing to occur.  The Bank incurred a
$21,132 charge off based on this negotiated reduced payment.  Based on
a previous stressed market valuation of the subject collateral, the bank had
established a $72,000 specific reserve for this loan.
 
 The following tables
present information concerning impaired loans, nonaccrual
loans, OREO and accruing loans which are contractually past due 90
days or more, as to interest or principal
payments:
   Dollar
      amounts in thousandsSeptember
      30, 2008
                
                
                June
      30, 2008
                
                
                September
      30, 2007Geographical
      Location
                
                Total 
      Loans
                
                
                Impaired
      Loans
                
                
                %
                
                
                Total
      Loans
                
                
                Impaired
      Loans
                
                
                %
                
                
                Total 
      Loans
                
                
                Impaired
      Loans
                
                
                %Illinois
                
                $
                68,176
                
                
                $
                4,365
                
                
                
                63.06
                %
                
                $
                65,872
                
                
                $
                2,735
                
                
                
                51.95
                %
                
                $
                65,562
                
                
                $
                242
                
                
                
                34.13
                %Indiana
                
                
                15,003
                
                
                
                —
                
                
                
                —
                
                
                
                14,755
                
                
                
                —
                
                
                
                —
                
                
                
                13,355
                
                
                
                —
                
                
                
                —Michigan
                
                
                3,437
                
                
                
                —
                
                
                
                —
                
                
                
                3,441
                
                
                
                —
                
                
                
                —
                
                
                
                3,000
                
                
                
                —
                
                
                
                —Florida
                
                
                3,009
                
                
                
                2,557
                
                
                
                36.94
                %
                
                
                2,989
                
                
                
                2,530
                
                
                
                48.05
                %
                
                
                2,635
                
                
                
                467
                
                
                
                65.87
                %Wisconsin
                
                
                1,700
                
                
                
                —
                
                
                
                —
                
                
                
                1,700
                
                
                
                —
                
                
                
                —
                
                
                
                1,648
                
                
                
                —
                
                
                
                —Other
      states combined
                
                
                3,520
                
                
                
                —
                
                
                
                —
                
                
                
                4,078
                
                
                
                —
                
                
                
                —
                
                
                
                4,145
                
                
                
                —
                
                
                
                —Total Loans
                
                $
                94,845
                
                
                $
                6,922
                
                
                
                100.00
                %
                
                $
                92,835
                
                
                $
                5,265
                
                
                
                100.00
                %
                
                $
                90,345
                
                
                $
                709
                
                
                
                100.00
                %
 Dollar
      amounts in thousandsSeptember
      30, 2008
                  
                  
                  June
      30, 2008
                  
                  
                  September
      30, 2007Loan
      Category
                  
                  Amount
                  
                  
                  Percent
                  
                  
                  Amount
                  
                  
                  Percent
                  
                  
                  Amount
                  
                  
                  PercentOne-to-four family
      loans
                  
                  $
                  2,649
                  
                  
                  
                  38.27
                  %
                  
                  $
                  1,358
                  
                  
                  
                  25.79
                  %
                  
                  $
                  —
                  
                  
                  
                  —Commercial
      real estate loans
                  
                  
                  3,595
                  
                  
                  
                  51.94
                  %
                  
                  
                  2,873
                  
                  
                  
                  54.57
                  %
                  
                  
                  467
                  
                  
                  
                  65.87
                  %Multi-family
      loans
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Commercial
      loans
                  
                  
                  678
                  
                  
                  
                  9.79
                  %
                  
                  
                  1,034
                  
                  
                  
                  19.64
                  %
                  
                  
                  242
                  
                  
                  
                  34.13
                  %Home
      Equity loans
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Other
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Total Impaired
      Loans By Category
                  
                  $
                  6,922
                  
                  
                  
                  100.00
                  %
                  
                  $
                  5,265
                  
                  
                  
                  100.00
                  %
                  
                  $
                  709
                  
                  
                  
                  100.00
                  %
   15
 Table of Contents
  Management
recognizes that the current economic environment continues to present an
extremely difficult challenge for many of our borrowers.  With the
housing and credit markets dramatically impacted by the current state of the
economy, management remains committed to taking an aggressive and proactive
approach in continuing to closely monitor our asset quality.   We
remain cognizant of the importance of building strong reserve levels in an
appropriate and prudent manner given the current unstable
financial environment.  We continue to review our methodology with the
adequacy in which we estimate probable losses in our loan portfolio given all
the recent market disruptions being experienced.
 
 As the
preceding tables indicate, our nonperforming assets have steadily risen over the
past three quarters illustrated, as a result of the continued weakening of the
credit and housing markets.  Like many community banks, we relied on
real estate secured lending as a primary type of lending.  Management
has responded to this challenge by imposing and adhering to loan policy
geographic concentration and construction lending restrictions as well as
continuing to enforce stricter underwriting and loan structuring
covenants.
 
 Management
identifies nonperforming loans proactively and
aggressively.   These loans include nonaccrual loans and accruing
loans that are 90 days or more delinquent.  Loans in this category
include those with risk characteristics such as past maturity more than 90 days,
those that have payments past due more than 90 days, those that have recent
adverse operating cash flow or balance sheet trends, or loans that have general
risk characteristics that management believes might jeopardize the future timely
collection of principal and interest payments.  Management does not
consider extension or renewals of credits with these characteristics in an
attempt to avoid proper nonperforming classification.
 
 Delinquent Loans.  We continue
to monitor the performance of our loan portfolio through regular contact with
our borrowers, continuous management portfolio review and careful monitoring of
delinquency reports and internal watch list and risk rating
reports.  As the delinquent status of a loan may determine its risk
rating, the allowance for loan losses may be directly affected by loans that are
performing despite past due status.
 
 The following table summarizes our delinquent loans that are past due and still
accruing interest; all loans
less than 90 days delinquent as of September 30, 2008 consist of Illinois and
Indiana market area loans.  Management has determined that the
increase in delinquencies at September 30, 2008, compared to the two disclosed
periods, are a direct result of the rising unemployment
levels.
  (Dollar
      amounts in thousands)September
      30, 2008
                  
                  
                  June
      30, 2008
                  
                  
                  September
      30, 200730-59
      Days
                  
                  
                  60-89
      Days
                  
                  
                  30-59
      Days
                  
                  
                  60-89
      Days
                  
                  
                  30-59
      Days
                  
                  
                  60-89
      DaysOne-to-four
      family loans
                  
                  $
                  697
                  
                  
                  $
                  56
                  
                  
                  $
                  136
                  
                  
                  $
                  56
                  
                  
                  $
                  582
                  
                  
                  $
                  57Commercial
      Real Estate loans
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Multi-family
      loans
                  
                  
                  94
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Commercial
      loans
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  60
                  
                  
                  
                  —
                  
                  
                  
                  23
                  
                  
                  
                  242Home
      Equity loans
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Share
      Loans
                  
                  
                  
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1Total
      Loan Delinquencies
                  
                  $
                  791
                  
                  
                  $
                  56
                  
                  
                  $
                  196
                  
                  
                  $
                  56
                  
                  
                  $
                  605
                  
                  
                  $
                  300
   16
 Table of Contents
  Allowance for Loan Losses.  At
September 30, 2008, the allowance for loan losses was $1,757,000, or 1.85% of
the total loan portfolio.  The loss allowance is maintained by
management at a level considered adequate to cover probable incurred losses
inherent in the existing portfolio based on prior loan loss experience, known
and probable risks in the portfolio, adverse situations that may affect the
borrower’s ability to repay, the estimated value of any underlying collateral,
general economic conditions, and other factors and estimates that are subject to
change over time.
 
 The Bank
relies, among other things, on its experienced senior management in determining
the appropriate allowance for loan losses on the commercial and commercial real
estate loan portfolio, as the Bank does not have a seasoned portfolio of
commercial and commercial real estate loans. Management reviews the composition
of the commercial and commercial real estate loan portfolio on a quarterly
basis. This includes reviewing delinquency trends, impaired loans, loan-to-value
ratios, and types of collateral. Management then compares this ratio to peer
group data and the FDIC state profile for Illinois banks as a means of
additional analysis. Based on these factors, we determined that the allocation
of the allowance for loan losses for these types of loans was appropriate at
September 30, 2008.
 
 While
management believes that it determines the amount of the allowance based on the
best information available at the time, the allowance will need to be adjusted
as circumstances change and assumptions are updated. Future adjustments to the
allowance could significantly affect net income.
 
 Specific Component of the Allowance for Loan
Losses.  For loans where management deems either the timing or
the repayment to be significantly impaired, there are specific reserve
allocations established.  The specific reserve is established based on
a loan’s current value compared to the present value of its projected future
cash flows, collateral value or market value, as is relevant for the particular
loan pursuant to SFAS 114, Accounting by
Creditors for Impairment of a Loan.  At September 30, 2008, the
specific component of the allowance for loan losses was $928,000, a decrease of
$357,000 from $1,285,000 at June 30, 2008. The decrease was due to a $453,000
charge-off offset by a provision for loan losses of $96,000 for impaired
loans.
 
 The following table shows our allocation for the specific component of the
allowance for loan losses as of September 30, 2008:
  (Dollar
      amounts in thousands)Number
      of loans
                    
                    
                    Specific
      Reserve Allocation (in thousands)Florida
                    
                    
                    5
                    
                    
                    $
                    378Illinois
                    
                    
                    9
                    
                    
                    
                    550Total
                    
                    
                    14
                    
                    
                    $
                    928
  Potential
Problem Loans.  In
determining the adequacy of the allowance for loan losses the Bank regularly
evaluates potential problem loans as to the ability of the borrower to comply
with the present loan repayment terms.  The Bank has not identified any
potential problem loans, excluding loans already disclosed in the Provision for
Loan Loss Section as impaired, nonaccrual, and past due 90 days and still
accruing interest as of September 30, 2008, that would cause management to have
serious doubts as to the ability of such borrowers to comply with the present
loan repayment terms.
 
 Non-interest Income.  Non-interest
income increased $22,000 to $146,000 for the three-month period ended September
30, 2008 from the same period in 2007.  The increase in the
three-month period was primarily related to the restructuring of deposit fees in
January 2008 coupled with an increased level of overdraft activity.
  Non-interest Expense.  Non-interest
expense decreased $513,000 to $1.3 million for the three months ended September
30, 2008 from $1.8 million for the same period in 2007.
   17
 Table of Contents
  As
previously disclosed, we closed the bank’s branch located at 17130 Torrence
Avenue, in Lansing, Illinois effective June 30, 2008.  The decision to
close the branch was due primarily to a shrinking customer base in that location
given our customers’ clear preference to bank at our other, recently established
locations in Frankfort, Illinois and Schererville, Indiana.  The
Bank’s operating expenses have decreased approximately $35,000 per month as a
result of the branch closing. As a result of management’s cost-cutting efforts,
salary and benefits and advertising expenses have been significantly reduced
resulting in a decrease in expense of approximately $118,327 in the period.
Additionally, the investigation originating in fiscal year 2007 was concluded in
January 2008; therefore, no investigation costs were incurred for the
three-month period ended September 30, 2008 compared to $301,000 for the same
period in 2007.
  Provision for Income Taxes.  The
Company recognized no income tax benefit for the three months ended September
30, 2008 and 2007. The Company ceased recording an income tax benefit until net
income is recorded to offset these benefits.
  Liquidity
and Capital Resources
  Liquidity.  Liquidity management is
measured and monitored on both a short- and long-term basis, allowing management
to better understand and react to emerging balance sheet
trends.  After assessing actual and projected cash flow needs,
management seeks to obtain funding at the most economical cost.  Our
primary sources of funds are deposits, principal and interest payments on loans,
proceeds from maturities and calls of securities and FHLB advances, and funds
provided from operations.  While maturities and scheduled amortization
of loans and securities are relatively predictable sources of funds, deposit
flows and loan repayments are greatly influenced by general interest rates,
economic conditions, and competition.  We invest excess funds in
short-term interest-earning assets, which enable us to meet lending
requirements.  FHLB advances are borrowed when in need of
liquidity.  Recently, the FHLB implemented a risk rating process which
could have impact on the available credit to member banks.  As of the
most recent risk analysis of the bank there were no additional restrictions on
our credit availability or additional lending and reporting requirements imposed
by the FHLB. At September 30, 2008, there were $6.0 million of FHLB advances
outstanding.  As of September 30, 2008, the Bank had $1.6 million of
available credit from the FHLB, which may be increased based on parameters set
by the FHLB.
  The
Company’s cash flows are comprised of three primary
classifications:  cash flows from operating activities, investing
activities, and financing activities.  Net cash used in operating
activities were $(390,000) and $(42,000) for September 30, 2008 and 2007,
respectively.  Net cash from (used in) investing activities consisted
primarily of disbursements for loan originations, maturing agency securities and
paydowns on mortgage backed securities.  Net cash from (used in)
investing activities were $361,000 and $(4.5) million for September 30, 2008 and
2007, respectively.  Net cash used in financing activities consisted
primarily of the activity in deposit accounts, FHLB advances, and advances from
borrowers for taxes and insurance.  The net cash used in financing
activities was $(2.0) million and $(7.0) million at September 30, 2008 and
2007.
  From June
30, 2008 through September 30, 2008, the Company received proceeds of $2.8
million from sales, maturities, calls, and paydowns of available-for-sale
securities.  These proceeds were primarily used to fund new
loans.
  At
September 30, 2008, the Company had outstanding commitments to originate
$205,000 in loan originations, $11.0 million in unfunded lines, and letters of
credit outstanding of $513,000.  In addition, as of September 30,
2008, the total amount of certificates of deposit that were scheduled to mature
in the next 12 months equaled $36.3 million.  The Company believes
that it has adequate resources to fund all of
  18
 Table of Contents
  its
commitments and that it can adjust the rates paid on certificates of deposit to
retain deposits in changing interest rate environments.  If the
Company requires funds beyond its internal funding capabilities,
advances from the FHLB are available as an additional source of
funds.
  Capital.  The Bank is required to
maintain regulatory capital sufficient to meet Tier 1 leverage, Tier 1
risk-based and total risk-based capital ratios of at least 4.0%, 4.0%, and 8.0%,
respectively.  At September 30, 2008, the Bank exceeded each of its
capital requirements with ratios of 19.67%, 23.69%, and 24.95%,
respectively.
  Participation in the Treasury Capital Purchase
Program.  On October 3, 2008, Congress passed the Emergency
Economic Stabilization Act of 2008 (the “Act”), which provides the U. S.
Secretary of the Treasury with broad authority to implement certain actions to
help restore stability and liquidity to U.S. markets.  One of the
provisions resulting from the Act is the Treasury Capital Purchase Program
(“CPP”), which provides direct equity investment of perpetual preferred stock by
the Treasury in qualified financial institutions.  The program is
voluntary and requires an institution to comply with a number of restrictions
and provisions, including limits on the payment of executive compensation, stock
repurchase, and the declaration of dividends.  Applications must be
submitted by November 14, 2008 and are subject to approval by the
Treasury.  The CPP provides for a minimum investment of 1% of
Risk-Weighted Assets, with a maximum investment equal to the lesser of 3% of
Total Risk-Weighted Assets or $25 billion.  The perpetual preferred
stock will have a dividend rate of 5% per year, until the fifth anniversary
of the Treasury investment, and a dividend of 9%, thereafter.  The CPP
also requires the Treasury to receive warrants to purchase shares of common
stock equal to 15% of the capital invested by the Treasury.  The
Company is currently evaluating it’s participation in the
CPP.  Participation in the program is not automatic and subject to
approval by the Treasury.
  Critical Accounting Policies and Estimates
  The
accounting and reporting policies of the Company are in accordance with U.S.
generally accepted accounting principles and conform to general practices within
the banking industry.  Accounting and reporting policies for the
allowance for loan losses and income tax are deemed critical because they
involve the use of estimates and require significant management
judgments.
  Allowance for Loan Losses.  The
allowance for loan losses is an amount that management believes will be adequate
to absorb probable incurred losses in existing loans, taking into consideration
such factors as past loss experience, changes in the nature and volume of the
portfolio, overall portfolio quality, loan concentrations, specific problem
loans, and current economic conditions that affect the borrower’s ability to
pay.  Determination of the allowance is inherently subjective due to
the above mentioned reasons.  Loan losses are charged off against the
allowance when management believes that the full collectibility of the loan is
unlikely.  Recoveries of amounts previously charged off are credited
to the allowance.  Allowances established to provide for losses under
commitments to extend credit, or recourse provisions under loan sales agreements
or servicing agreements are classified with other liabilities.
  A loan is
considered impaired when it is probable that not all principal and interest
amounts will be collected according to the loan contract.  Residential
mortgage, installment and other consumer loans are collectively evaluated for
impairment.  Individual commercial loans are evaluated for
impairment.  Impaired loans are recorded at the loan’s fair value by
the establishment of a specific allowance where necessary.  The fair
value of collateral-dependent loans is determined by the fair value of the
underlying collateral.  The fair value of noncollateral-dependent
loans is determined by discounting expected future interest and principal
payments at the loan’s effective interest rate.
   19
 Table of Contents
 The
Company maintains the allowance for loan losses at a level adequate to absorb
management’s estimate of probable losses inherent in the loan
portfolio.  Management believes that it uses the best information
available to determine the adequacy of the allowance for loan
losses.  However, future adjustments to the allowance may be necessary
and the results of operations could be significantly and adversely affected if
circumstances differ substantially from the assumptions used in making the
determinations.
  Income Taxes.  Accounting for income
taxes is a critical accounting policy due to the subjective nature of certain
estimates that are involved in the calculation.  The Company uses an
asset/liability method of accounting for income taxes in which deferred tax
assets and liabilities are established for temporary differences between the
financial reporting basis and the tax basis of the Company’s assets and
liabilities.  The Company must assess the realization of the deferred
tax asset quarterly, and to the extent that management believes that recovery is
not likely, a valuation allowance is established.  This assessment is
impacted by various factors, including taxable income and the composition of the
investment securities portfolio.  Material changes to these items can
cause an adjustment to the valuation allowance.  An adjustment to
increase or decrease the valuation allowance is charged or credited,
respectively, to income tax expense.
  Item 3. Quantitative
and Qualitative Disclosure About Market Risk
  Not
applicable
  Item 4T.    Controls
and Procedures.
  As of the
end of the period covered by this report, we carried out an evaluation, under
the supervision, and with the participation of our management, including our
Chief Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures as contemplated
by Exchange Act Rule 13a-15.  Based upon, and as of the date of that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company’s disclosure controls and procedures are effective, in all
material respects, in timely alerting them to material information relating to
the Company (and its consolidated subsidiary) required to be included in the
periodic reports the Company is required to file and submit to the SEC under the
Exchange Act.
  There
have been no changes in the Company’s internal controls over financial reporting
during the quarter ended September 30, 2008, that have materially affected or
are reasonably likely to materially affect, the Company’s internal control over
financial reporting.
   20
 Table of Contents
 PART II. – OTHER INFORMATION
  Item 1. Legal
Proceedings
  The
Company is not involved in any pending legal proceedings other than routine
legal proceedings occurring in the ordinary course of business that in the
aggregate, are believed by management to be immaterial to the Company’s
business, financial condition, results of operations, and cash
flows.
  Item 1A.  
Risk Factors
  The
continuation of adverse market conditions in the U.S economy and the markets in
which we operate could adversely impact us.
  A
continued deterioration of overall market conditions, a continued economic
downturn or prolonged economic stagnation in our markets or adverse changes in
laws and regulations that impact the banking industry may have a negative impact
on our business. If the strength of the U.S. economy in general and the strength
of the economy in areas where we lend (or previously provided real estate
financing) continue to decline, this could result in, among other things, a
further deterioration in credit quality or loans. Negative conditions in the
real estate markets where we operate could adversely affect our borrowers’
ability to repay their loans and the value of the underlying collateral. Real
estate values are affected by various factors, including general economic
conditions, governmental rules or policies and natural
disasters.  These factors may adversely impact our borrowers’ ability
to make required payments, which in turn, may negatively impact our financial
results.
 
 Current and further deterioration in the housing market could cause further
increases in delinquencies and non-performing assets, including loan
charge-offs, and depress our income and growth.
 
 The volume of our one-to-four family
residential mortgages and home equity loans may decrease during economic
downturns as a result of, among other things, a decrease in real estate values,
an increase in unemployment, a slowdown in housing price appreciation or
increases in interest rates. These factors could reduce our earnings and
consequently our financial condition because:
  ·
              The
      borrowers may not be able to repay their
loans
 ·
              The
      value of the collateral securing our loans to borrowers may decline
      further
 ·
              The
      quality of our loan portfolio may decline
  further
 ·
              Customers
      may not want or need our products and
services
 
 Any of
these scenarios could cause an increase in delinquencies and non-performing
assets, require us to charge off a higher percentage of our loans, increase
substantially our provision for losses on loans, or make fewer loans, which
would reduce income.
   21
 Table of Contents
 Recent developments affecting the financial markets presently have an unknown
effect on our business.
 
 In response to recent crises affecting
the financial markets, the federal government has taken unprecedented steps in
an attempt to stabilize and provide liquidity to the U.S. financial
markets.
 
 Under the Emergency Economic
Stabilization Act of 2008 (“EESA”) and the  Capital Purchase Program
(“CPP”), the U.S. Treasury will make $250 million of capital available to U.S.
financial institutions by purchasing preferred stock in these institutions. In
conjunction with the purchase of preferred stock, the U.S. Treasury will receive
warrants to purchase common stock having an aggregate market price equal to 15%
of the preferred stock purchased. Participating financial institutions will be
required to adopt the Treasury’s standards for executive compensation and
corporate governance for the period during which the Treasury holds the
securities issued under the CPP.
 
 In addition, the Federal Deposit
Insurance Corporation will temporarily provide a 100% guarantee of the senior
unsecured debt of all FDIC-insured institutions and their holding companies, as
well as deposits in non-interest bearing transaction deposit accounts under the
Temporary Liquidity Guarantee Program. Coverage under the Temporary Liquidity
Guarantee Program is available for 30 days without a charge and thereafter at a
cost of 75 basis points per annum for senior unsecured debt and 10 basis points
per annum for non-interest bearing transactions deposits. We are assessing our
participation in the CPP and the Temporary Liquidity Guarantee Program but have
not made a definitive decision whether or not to participate in either or both
programs. It is not clear at this time whether our decision to participate
or not to participate in either the CPP or the Temporary Liquidity Guarantee
Program will have an effect on our business.
  Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds.
  None
  Item 3. Defaults
Upon Senior Securities.
  None
  Item 4. Submission
of Matters to a Vote of Security Holders.  None
  Item 5. Other
Information.
  None
  Item 6. Exhibits.
  (a) The exhibits filed as
part of this Form 10-Q are listed in the Exhibit Index, which is incorporated
herein by reference.
   22
 Table of Contents
 SIGNATURES
  Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
  Date: 
      November 14, 2008
                ROYAL FINANCIAL,
      INC.By:
                /s/
      Leonard Szwajkowski
 Leonard
  Szwajkowski
 Chief Executive Officer
      and President
 Date: 
      November 14, 2008
                  By:
                  /s/
      Jodi A. Ojeda Jodi A.
  Ojeda
 Senior Vice
      President and Chief Financial
Officer
  23
 Table of Contents
  EXHIBIT INDEX
  31.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.32.1
              Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.
 
  24