BV Financial, Inc. 10-K

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES BV Financial’s common stock is traded on the OTC Electronic Bulletin Board under the symbol “BVFL.OB.” As of September 19, 2008, the Company had approximately 133 holders of record. The following table sets forth, for the quarters indicated, the daily high and low sales price for and dividends declared on the common stock for fiscal 2008 and 2007. The prices do not necessarily reflect inter-dealer prices without retail markup, markdown or commission and may not reflect actual transactions. High Low Dividends Fiscal 2008: Fourth Quarter $ 7.15 $ 5.50 $ 0.05 Third Quarter 7.90 6.50 0.05 Second Quarter 8.50 7.00 0.05 First Quarter 8.75 7.65 0.05 Fiscal 2007: Fourth Quarter $ 8.80 $ 8.50 $ 0.05 Third Quarter 9.25 8.41 0.05 Second Quarter 9.45 8.70 0.05 First Quarter 9.47 8.60 — BV Financial is not subject to Office of Thrift Supervision regulatory restrictions on the payment of dividends. However, BV Financial’s ability to pay dividends may depend, in part, upon its receipt of dividends from Bay-Vanguard Federal because BV Financial has no source of income other than earnings from the investment of the net proceeds from the offering that it retained. Payment of cash dividends on capital stock by a savings institution is limited by OTS regulations. No insured depository institution may make a capital distribution if, after making the distribution, the institution would be undercapitalized. See “Regulation and Supervision—Regulation of Federal Savings Associations—Limitations on Capital Distribution.” As of June 30, 2008, BV Financial satisfied all prescribed capital requirements. Future dividend payments will depend on the Company’s profitability, approval by its Board of Directors and prevailing OTS regulations. The Board of Directors of Bay-Vanguard, M.H.C. determines whether Bay-Vanguard, M.H.C. will waive or receive dividends declared by the Company each time the Company declares a dividend, which is expected to be on a quarterly basis. Bay-Vanguard, M.H.C. may elect to receive dividends and utilize such funds to pay general corporate expenses. The OTS has indicated that: (1) Bay-Vanguard, M.H.C. shall provide the OTS annually with written notice of its intent to waive its dividends before the proposed date of the dividend and the OTS shall have the authority to approve or deny any dividend waiver request; and (2) if a waiver is granted, dividends waived by Bay-Vanguard, M.H.C. will be excluded from the Company’s capital accounts for calculating dividend payments to minority shareholders. Through June 30, 2008, Bay-Vanguard, M.H.C. waived the right to receive its portion of the cash dividends paid, which totaled $509,000 on a cumulative basis. 20 The following table provides certain information with regard to shares repurchased by the Company in the fourth quarter of fiscal 2008. Period Total Number of Shares Purchased (1) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs April 1, 2008 through April 30, 2008 — $ — — 97,830 May 1, 2008 through May 31, 2008 — — — 97,830 June 1, 2008 through June 30, 2008 50,000 6.50 50,000 47,830 Total 50,000 6.50 50,000 (1) On March 20, 2008, BV Financial announced the adoption of a stock repurchase program to acquire up to 97,830 shares, or 10%, of BV Financial’s outstanding shares of common stock, excluding shares held by Bay-Vanguard M.H.C. The program will continue until it is completed or terminated by the Board of Directors. ITEM 6. SELECTED FINANCIAL DATA Not applicable as BV Financial is a smaller reporting company. ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The objective of this section is to help potential investors understand our views on our results of operations and financial condition. You should read this discussion in conjunction with the financial statements and notes to the financial statements included in this annual report on Form 10-K. Overview Income . Our primary source of income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. To a much lesser extent, we also recognize income from service charge income—mostly from service charges on deposit accounts and fees for late loan payments—and from the increase in surrender value of our bank-owned life insurance. Allowance for Loan Losses . The allowance for loan losses is a valuation allowance for losses inherent in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings. Expenses. The expenses we incur in operating our business consist of compensation and related expenses, occupancy expenses, data processing expenses, telephone and postage expenses, advertising expenses, professional fees, equipment expenses and other miscellaneous expenses. Compensation and related expenses consist primarily of the salaries and wages paid to our employees, payroll taxes and expenses for health insurance, retirement plans and other employee benefits, including the employee stock ownership plan. Expense for the employee stock ownership plan is based on the average market value of the shares committed to be released. An equal number of shares will be released each year over the 15-year term of the loan. Expense for shares of restricted stock awards and stock options is based on the fair market value of the shares on the date of grant. Compensation and related expenses is recognized on a straight-line basis over the vesting period. 21 Occupancy expenses, which are the fixed and variable costs of land and building, consist primarily of lease payments, real estate taxes, depreciation charges, maintenance and costs of utilities. Depreciation of premises is computed using the straight-line method based on the useful lives of the related assets, which range from 15 to 40 years. Leasehold improvements are amortized over the shorter of the useful life of the asset or term of the lease. Data processing expenses include fees paid for third-party data processing service. Telephone and postage expenses include our communication lines between branch offices, our Internet access and our mailing expenses, including certain deposit statements. Advertising expenses include expenses for print advertisements, promotions and premium items. Professional fees primarily include fees paid to our independent registered public accountants, as well as our attorneys, predominantly in relation to problem assets and due to the costs of operating a public company. Equipment expense includes expenses and depreciation charges related to office and banking equipment. Depreciation of equipment is computed using the straight-line method based on the useful lives of the related assets, which range from three to ten years. Other expenses include federal insurance deposit premiums, charitable contributions, regulatory assessments, office supplies and other miscellaneous operating expenses. Critical Accounting Policies We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider the allowance for loan losses and the determination of other than temporary impairment to be critical accounting policies. Allowance for Loan Losses . The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impaired loans; the value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. However, historically, our estimates and assumptions have provided results that did not differ materially from actual results. For example, we recorded a loss of $21,000 and a loss of $13,000 in relation to repossessed assets in fiscal 2008 and 2007, respectively. Additionally, we had net charge-offs to average loans of 0.02% for fiscal 2008 compared to net charge offs to average loans of 0.01% for fiscal 2007. Management reviews the level of the allowance on a quarterly basis, at a minimum, and establishes the provision for loan losses based on an evaluation of the portfolio, past loss experience, economic conditions and business conditions affecting our primary market area, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, the duration of the current business cycle and other factors related to the collectibility of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary if certain future events occur that cause actual results to differ from the assumptions used in making the evaluation. For example, a downturn in the local economy could cause increases in non-performing loans. Additionally, a decline in real estate values could cause some of our loans to become inadequately collateralized. In either case, this may require us to increase our provision for loan losses, which would negatively impact earnings. Further, the Office of Thrift Supervision, as an integral part of its examination process, periodically reviews our allowance for loan losses. Such agency may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. An increase to the allowance required to be made by the Office of Thrift Supervision would negatively impact our earnings. Additionally, a large loss could deplete the allowance and require increased 22 provisions to replenish the allowance, which would negatively affect earnings. See note 1 to the notes to consolidated financial statements included in this Form 10-K. At each of June 30, 2008 and 2007, over 89.9% of the loan portfolio consisted of real estate loans. However, over 19.2% of the real estate loans consisted of multi-family and commercial real estate and construction loans, which carry a higher risk of default than one-to four-family residential real estate loans. The level of the allowance for loan losses has changed primarily due to an increase in nonperforming loans due to the addition of a $1.2 million residential construction loan to non-accrual status, and, to a lesser extent, changes in the composition of the loan portfolio and the growth of the loan portfolio, which has increased by 6.2% and 2.7% for fiscal 2008 and 2007, respectively. Other-than-Temporary Impairment of Investment Securities. There are certain securities in an unrealized loss position that management believes at this time are temporarily impaired. If the fair value of these securities does not recover in a reasonable period of time or management can no longer demonstrate the ability and intend to hold them until recovery, a write-down through the consolidated statements of income would be necessary. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value or until maturity. In analyzing the issuer’s financial condition, management considers industry analysts’ reports, financial performance and project target prices of investment analysts. During the quarter ended June 30, 2008, the Company identified the Shay AMF Ultra Short Mortgage Fund equity securities it holds as being an other-than-temporary impaired asset and realized an impairment loss of $274,000 on these securities. See note 1 to the notes to consolidated financial statements included in this Form 10-K. Intangible Asset Impairment. The Company has goodwill and core deposit intangible assets arising from a branch purchase. The goodwill is evaluated regularly for impairment while the core deposit intangible is being amortized over seven years. Deferred Tax Asset Valuation Allowance. Management determined that no valuation allowance was warranted based on a history of taxable income, the expectation of taxable income going forward and the availability of tax planning strategies to generate future income, including capital gains if necessary to offset capital losses on the impaired mutual fund security. Operating Strategy Our mission is to operate and grow a profitable community-oriented financial institution. We plan to achieve this by executing our strategy of: • aggressively attracting core deposits; • continuing to emphasize the origination of one- to four-family residential real estate loans; • pursuing opportunities to increase multi-family and commercial real estate lending in our market area; • continuing to use conservative underwriting practices to maintain the high quality of our loan portfolio; and • providing exceptional service to attract and retain customers. 23 Aggressively attract core deposits Core deposits (accounts other than certificates of deposit) comprised 55.5% of our total deposits at June 30, 2008. We value core deposits because they represent longer-term customer relationships and a lower cost of funding compared to certificates of deposit. We aggressively seek core deposits through competitive pricing and targeted advertising. Continue to emphasize the origination of one- to four-family residential real estate loans Our primary lending activity is the origination of residential mortgage loans secured by homes in our market area. We intend to continue emphasizing the origination of residential mortgage loans going forward. At June 30, 2008, 70.7% of our total loans were one- to four-family residential real estate loans. We believe that our emphasis on residential lending, which carries a lower credit risk, contributes to our high asset quality. Pursue opportunities to increase multi-family and commercial real estate lending in our market area Multi-family and commercial real estate loans provide us with the opportunity to earn more income because they tend to have higher interest rates than residential mortgage loans. Additionally, we offer adjustable-rate multi-family and commercial real estate loans. Adjustable-rate loans, which reprice periodically, help to offset the adverse effects of an increase in interest rates, which improves our interest rate risk management. Multi-family and commercial real estate loans increased $2.1 million for the year ended June 30, 2008 and comprised approximately 10.6% of total loans. There are many multi-family and commercial properties located in our market area, and we will continue to pursue these opportunities, while continuing to originate any such loans in accordance with what we believe are our conservative underwriting guidelines. Continue to use conservative underwriting practices to maintain the high quality of our loan portfolio We believe that high asset quality is a key to long-term financial success. We have sought to maintain a high level of asset quality and moderate credit risk by using underwriting standards which we believe are conservative. While our non-performing loans (loans that are 90 or more days delinquent) at June 30, 2008 increased to 2.2% of our total loan portfolio and 1.6% of our total assets, the increase was attributable to two residential construction loans totaling $2.2 million being placed on non-accrual status. We intend to continue our efforts to originate multi-family and commercial real estate loans and our philosophy of managing large loan exposures through our conservative approach to lending. Provide exceptional service to attract and retain customers As a community-oriented financial institution, we emphasize providing exceptional customer service as a means to attract and retain customers. We deliver personalized service and respond with flexibility to customer needs. We believe that our community orientation is attractive to our customers and distinguishes us from the large banks that operate in our market area. We have also provided Internet banking since 1997. Balance Sheet Analysis Loans . Our primary lending activity is the origination of loans secured by real estate. We originate real estate loans secured by one- to four-family residential real estate, and to a much lesser extent, secured by multi-family and commercial real estate. At June 30, 2008, real estate loans totaled $115.1 million, or 89.9% of total loans, compared to $108.6 million, or 90.1%, of total loans at June 30, 2007. The largest segment of our real estate loans is one- to four-family residential real estate loans. At June 30, 2008, one- to four-family residential real estate loans totaled $90.5 million, which represented 78.6% of real estate loans and 70.7% of total loans compared to $86.5 million at June 30, 2007, which represented 79.6% of real estate loans and 71.8% of total loans. One- to four-family residential real estate loans increased $4.0 million, or 4.6%, in the year ended June 30, 2008 due to the continuing low interest rate environment, competitive pricing and increased marketing efforts. 24 Multi-family and commercial real estate loans totaled $13.6 million at June 30, 2008, which represented 11.8% of real estate loans and 10.6% of total loans, compared to $11.4 million at June 30, 2007, which represented 10.5% of real estate loans and 9.5% of total loans. Multi-family and commercial real estate loans increased $2.1 million, or 18.8%, for the year ended June 30, 2008 due to the continued emphasis of this type of lending. We purchase and originate loans secured by mobile homes. Mobile home loans totaled $11.8 million at June 30, 2008, which represented 9.2% of total loans, compared to $11.0 million at June 30, 2007, which represented 9.1% of total loans. To mitigate our exposure to this type of lending, we have limited the amount of mobile home loans to 15% of our loan portfolio. Mobile home loans increased in fiscal 2008 due to additional purchases from Forward National and Mainland Financial. A further discussion of our mobile home loans is contained in “Business—Lending Activities—Mobile Home Loans.” We also originate construction loans secured by residential and multi-family and commercial real estate and loans to individuals to acquire land upon which they intend to build a residence. This portfolio totaled $11.1 million at June 30, 2008, which represented 8.7% of total loans, compared to $10.7 million at June 30, 2007, which represented 9.0% of total loans. Construction loans increased $396,000, or 3.7%, for the year ended June 30, 2008 primarily because of an increase in non-residential and construction loans due to successful sales efforts. We also originate a variety of consumer loans, including loans secured by passbook or certificate accounts. Consumer loans totaled $824,000 and represented 0.7% of total loans at June 30, 2008, compared to $812,000, or 0.7% of total loans, at June 30, 2007. 25 The following table sets forth the composition of our loan portfolio at the dates indicated. At June 30, 2008 2007 Amount Percent Amount Percent (Dollars in thousands) Real estate loans: One- to four-family (1) $ 90,494 70.66 % $ 86,485 71.75 % Multi-family and commercial 13,572 10.60 11,421 9.48 Construction 11,125 8.68 10,729 8.90 Total real estate loans 115,191 89.94 108,635 90.13 Mobile home loans 11,810 9.22 10,981 9.11 Other consumer loans 824 0.65 812 0.67 Total consumer loans 12,634 9.87 11,793 9.78 Commercial 244 0.19 108 0.09 Total gross loans 128,069 100.00 % 120,536 100.00 % Loans in process (2,533 ) (4,107 ) Deferred loan costs, net 16 24 Allowance for loan losses (709 ) (402 ) Total loans receivable, net $ 124,843 $ 116,051 (1) Includes second mortgage loans, home equity loans and home equity lines of credit. The following table sets forth certain information at June 30, 2008 regarding the dollar amount of loans maturing during the periods indicated. The table does not include any estimate of prepayments, which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. One- to Four- Family Multi-Family and Commercial Construction Mobile Home Other Consumer Commercial Total Loans (In thousands) Amounts due in: One year or less $ 2,494 $ 406 $ 9,275 $ 5 $ 6 $ 132 $ 12,318 More than one year to five years 9,948 76 1,850 228 511 112 12,725 More than five years 78,052 13,090 — 11,577 307 — 103,026 Total amount due $ 90,494 $ 13,572 $ 11,125 $ 11,810 $ 824 $ 244 $ 128,069 The following table sets forth the dollar amount of all loans at June 30, 2008 that are due after June 30, 2009 and have either fixed interest rates or floating or adjustable interest rates. Due After June 30, 2009 Fixed- Rates Floating or Adjustable- Rates Total (In thousands) One- to four-family $ 83,290 $ 4,710 $ 88,000 Multi-family and commercial 2,453 10,713 13,166 Construction 449 1,401 1,850 Mobile home 11,805 — 11,805 Other consumer loans 818 — 818 Commercial 107 5 112 Total loans $ 98,922 $ 16,829 $ 115,751 26 The following table shows loan activity during the periods indicated. Year Ended June 30, 2008 2007 (In thousands) Total loans at beginning of period $ 116,051 $ 113,026 Loans originated: One- to four-family 10,795 10,831 Multi-family and commercial 2,936 1,880 Construction 3,048 3,211 Mobile home 545 1,154 Other consumer 311 482 Total loans originated 17,635 17,558 Loans and participations purchased 5,250 2,797 Deduct: Principal loan repayments 13,049 17,195 Loans and participations sold 890 — Transfer to foreclosed real estate/repossessed assets 42 13 Other 112 122 Net loan activity 8,792 3,025 Total loans at end of period $ 124,843 $ 116,051 Securities. Our securities portfolio consists primarily of U.S. Treasury and U.S. government agency securities, mortgage-backed securities and a mutual fund that invests in adjustable-rate loans. Securities increased approximately $12.7 million, or 212.7%, in the year ended June 30, 2008 primarily due to the purchase of $6.0 million in medium-term Federal Home Loan Bank notes, $10.2 million in mortgage-backed securities, and $1.0 million in Federal Farm Credit Bank notes. All of our mortgage-backed securities were issued by Ginnie Mae, Fannie Mae or Freddie Mac. The following table sets forth the carrying amounts and fair values of our securities portfolio at the dates indicated. At June 30, 2008 2007 Amortized Cost Fair Value Amortized Cost Fair Value (In thousands) Held-to-maturity securities: Obligations of the U.S. Treasury and U.S. Government agencies $ 2,000 $ 2,013 $ 2,500 $ 2,443 Mortgage-backed securities 7,788 7,648 156 158 Total held-to-maturity securities 9,788 9,661 2,656 2,601 Available-for-sale securities: Obligations of the U.S. Treasury and U.S. Government agencies 5,000 4,947 — — Marketable equity securities 2,547 2,547 2,945 2,859 Mortgage-backed securities 1,351 1,344 443 441 Total available-for-sale securities 8,898 8,838 3,388 3,300 Total securities $ 18,686 $ 18,499 $ 6,044 $ 5,901 At June 30, 2008, marketable equity securities consisted of an investment in a variable-rate mortgage mutual fund offered by American Funds, with an amortized cost of $2.5 million and a fair value of $2.5 million. We also had a Ginnie Mae mortgage-backed security with an amortized cost of $1.7 million and a fair value of $1.7 million. We had no other investments that had an aggregate book value in excess of 10% of our equity at June 30, 2008. Management analyzed its exposure to U.S. federal agencies securities and mortgage-backed securities held and found no impairment at June 30, 2008. The above-mentioned mutual fund was written down by $274,000 in the 2008 fiscal year when it became evident that the impairment was not temporary. 27 The following table sets forth the maturities and weighted average yields of securities at June 30, 2008. Weighted average yields are not presented on a tax-equivalent basis as the investment portfolio does not include any tax-exempt obligations. One Year or Less More than One Year to Five Years More than Five Years to Ten Years More than Ten Years Total Carrying Amount Weighted Average Yield Carrying Amount Weighted Average Yield Carrying Amount Weighted Average Yield Carrying Amount Weighted Average Yield Carrying Amount Weighted Average Yield (Dollars in thousands) Held-to-maturity securities: Obligations of the U.S. Treasury and U.S. Government agencies $ — — % $ 2,000 5.00 % $ — — % $ — — % $ 2,000 5.00 % Mortgage-backed securities — — 895 4.50 3,025 5.06 3,868 5.66 7,788 5.29 Total held-to-maturity securities $ — — $ 2,895 4.85 $ 3,025 5.06 $ 3,868 5.66 $ 9,788 5.23 Available-for-sale securities: Obligations of the U.S. Treasury and U.S. Government agencies $ — — % $ 3,976 4.24 % $ 971 4.25 % $ — — % $ 4,947 4.25 % Marketable equity securities 2,547 4.13 — — — — — — 2,547 4.13 Mortgage-backed securities — — 54 6.50 153 5.50 1,137 5.14 1,344 5.24 Total available-for-sale securities $ 2,547 4.13 $ 4,030 4.27 $ 1,124 4.42 $ 1,137 5.14 $ 8,838 4.36 28 Deposits . Our primary source of funds is our deposit accounts, which are comprised of demand deposits, savings accounts and time deposits. These deposits are provided primarily by individuals within our market area. We do not use brokered deposits as a source of funding. Deposits increased $38.5 million, or 39.1%, for the year ended June 30, 2008. The Bank acquired $51.5 million in deposits, comprised mostly of $27.5 million in certificates of deposit and $20.2 million in NOW and money market accounts, in connection with a branch office purchase in August 2007. During the year ended June 30, 2008, certificates of deposit experienced a $9.5 million runoff. The following table sets forth the balances of our deposit products at the dates indicated. At June 30, 2008 2007 (In thousands) Non-interest bearing accounts $ 6,040 $ 3,571 NOW and money market accounts 52,630 32,978 Savings accounts 17,344 18,924 Certificates of deposit 61,018 43,019 Total $ 137,032 $ 98,492 The following table indicates the amount of jumbo certificates of deposit by time remaining until maturity as of June 30, 2008. Jumbo certificates of deposit require minimum deposits of $100,000. Maturity Period Amount (In thousands) Three months or less $ 7,879 Over three through six months 1,143 Over six through twelve months 3,321 Over twelve months 9,301 Total $ 21,644 The following table sets forth time deposits classified by rates at the dates indicated. At June 30, 2008 2007 (In thousands) 1.00 - 1.99% $ — $ — 2.00 - 2.99% 6,019 26 3.00 - 3.99% 8,579 2,935 4.00 - 4.99% 29,662 16,559 5.00 - 5.99% 16,395 23,012 6.00 - 6.99% 363 487 Total $ 61,018 $ 43,019 29 The following table sets forth the amount and maturities of time deposits at June 30, 2008. Amount Due Total Percent of Total Certificate Accounts Less Than One Year More Than One Year to Two Years More Than Two Years to Three Years More Than Three Years to Four Years More Than Four Years (Dollars in thousands) 2.00 - 2.99% $ 4,892 $ 1,127 $ — $ — $ — $ 6,019 9.86 % 3.00 - 3.99% 4,198 3,646 405 72 258 8,579 14.06 4.00 - 4.99% 22,223 3,327 2,244 973 895 29,662 48.61 5.00 - 5.99% 4,174 840 10,847 534 — 16,395 26.87 6.00 - 6.99% 263 100 — — — 363 0.60 Total $ 35,750 $ 9,040 $ 13,496 $ 1,579 $ 1,153 $ 61,018 100.00 % The following table sets forth the deposit activity for the periods indicated. Year Ended June 30, 2008 2007 (In thousands) Beginning balance $ 98,492 $ 97,095 Decrease before branch acquisition and interest credited (17,655 ) (2,249 ) Increase due to branch acquisition 51,521 — Interest credited 4,674 3,646 Net increase in deposits 38,540 1,397 Ending balance $ 137,032 $ 98,492 Borrowings . We use advances from the Federal Home Loan Bank to supplement our supply of lendable funds or to meet deposit withdrawal requirements. The following tables present certain information regarding our advances with the Federal Home Loan Bank during the periods and at the dates indicated. For the Years Ended June 30, 2008 2007 (Dollars in thousands) Maximum amount of advances outstanding at any month end $ 16,000 $ 16,000 Average advances outstanding 9,605 14,321 Weighted average rate paid on advances 4.86 % 4.49 % At June 30, 2008 2007 (Dollars in thousands) Balance outstanding at end of year $ 7,500 $ 13,500 Weighted average rate on advances at end of year 4.68 % 4.95 % 30 Results of Operations for the Years Ended June 30, 2008 and 2007 Overview. 2008 2007 % Change 2008/2007 (Dollars in thousands) Net (loss) income $ (330 ) $ 91 (462.6 )% Return on average assets (0.20 )% 0.07 % (385.7 ) Return on average equity (2.44 )% 0.68 % (458.8 ) Average equity to average assets 8.15 % 10.01 % (18.6 ) Dividend payout ratio (56 )% 179 % (131.3 ) Net income decreased $421,000, or 462.6%, for fiscal 2008 due primarily to an increase in the provision for loan losses and an increase in non-interest expense due to an impairment charge of $274,000 on a mutual fund, offset by an increase in net interest income. Net Interest Income. Net interest income increased $353,000, or 10.5%, to $3.7 million for fiscal 2008. The increase in net interest income for fiscal 2008 was primarily attributable to an increase in the volume of interest-earning assets, offset by a higher volume of interest-bearing liabilities. Our net interest margin decreased from 2.67% for fiscal 2007 to 2.48% for fiscal 2008 and our interest rate spread decreased from 2.16% for fiscal 2007 to 2.13% for fiscal 2008. Total interest income increased $1.2 million, or 15.8%, to $8.8 million for fiscal 2008, resulting from an increase in the volume of interest-earning assets. During fiscal 2008, average interest-earning assets increased by $23.8 million, or 19.0%, to $149.4 million, while the average yield decreased 16 basis points to 5.92%. The composition of interest-earning assets consists of loans, securities and interest-bearing deposits. Interest on loans increased $469,000, or 6.6%, to $7.5 million for fiscal 2008 due to a $6.6 million, or 5.8%, increase in the average balance of loans, plus an increase in the average yield from 6.21% to 6.26%. During fiscal 2008, other interest income increased $599,000, or 608.7%, due to an increase in overnight federal funds interest earned. Interest on securities increased 69.5% due to an increase in the average balance of securities, offset by the decrease in the average yield from 5.12% to 5.03%. Total interest expense increased $852,000, or 19.9%, to $5.1 million for fiscal 2008 primarily due to increases in interest on deposits, offset by a decrease in the average balance of Federal Home Loan Bank advances with the funds obtained in the branch acquisition. The average interest rate paid on deposits decreased 13 basis points to 3.70%. The average balance of Federal Home Loan Bank advances decreased from $14.3 million for fiscal 2007 to $9.6 million for fiscal 2008. Average Balances and Yields. The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. For purposes of this table, average balances have been calculated using daily average balances. 31 Year Ended June 30, 2008 2007 Average Balance Interest and Dividends Average Yield/ Rate Average Balance Interest and Dividends Average Yield/ Rate (Dollars in thousands) Assets: Interest-earning assets: Loans (1) $ 120,324 $ 7,533 6.26 % $ 113,720 $ 7,064 6.21 % Securities taxable 12,164 612 5.03 7,048 361 5.12 Interest-bearing deposits 537 23 4.28 2,717 116 4.23 Federal Funds 16,411 675 4.11 2,127 97 4.56 Total interest-earning assets 149,436 8,843 5.92 125,612 7,638 6.08 Non-interest-earning assets 16,792 7,905 Total assets $ 166,228 $ 133,517 Interest-bearing liabilities: Interest-bearing deposits: Passbook accounts $ 5,172 $ 42 0.81 % $ 6,107 $ 62 1.02 % Statement savings 12,210 268 2.19 14,074 370 2.63 Money market accounts 40,578 1,423 3.51 27,989 1,138 4.07 NOW accounts 8,079 47 0.58 5,156 44 0.85 Certificates of deposit 60,140 2,894 4.81 41,778 2,032 4.86 Total interest-bearing deposits 126,179 4,674 3.70 95,104 3,646 3.83 FHLB advances 9,605 467 4.86 14,321 643 4.49 Total interest-bearing liabilities 135,784 5,141 3.79 109,425 4,289 3.92 Non-interest-bearing deposits 5,518 3,330 Other non-interest-bearing liabilities 11,383 7,396 Total liabilities 152,685 120,151 Total stockholders’ equity 13,543 13,366 Total liabilities and stockholders’ equity $ 166,228 $ 133,517 Net interest income $ 3,702 $ 3,349 Interest rate spread (2) 2.13 % 2.16 % Net interest margin (3) 2.48 % 2.67 % Interest-earning assets as a percentage of interest-bearing liabilities 110.05 % 114.79 % (1) Amount is net of deferred loan origination costs, undisbursed proceeds of loans in process, allowance for loan losses and includes non-accrual loans. (2) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. (3) Net interest margin represents net interest income as a percentage of average interest-earning assets. 32 Rate/Volume Analysis . The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume. 2008 Compared to 2007 Increase (Decrease) Due to Volume Rate Net (In thousands) Interest income: Loans receivable $ 413 $ 56 $ 469 Securities 258 (7 ) 251 Interest-earning deposits (93 ) 1 (92 ) Federal Funds 588 (10 ) 578 Total interest income 1,166 40 1,206 Interest expense: Deposit: Passbook accounts (9 ) (11 ) (20 ) Savings accounts (45 ) (57 ) (102 ) Money market accounts 458 (173 ) 285 NOW accounts 20 (17 ) 3 Certificates of deposit 884 (22 ) 862 Total deposits 1,308 (280 ) 1,028 Borrowings (226 ) 50 (176 ) Total interest expense 1,082 (230 ) 852 Net interest income $ 84 $ 270 $ 354 Provision for Loan Losses. The provision for loan losses increased $323,000, from $5,000 for fiscal 2007 to $328,000 for fiscal 2008. This was a result of an increase in non-accrual loans primarily due to the addition of $2.6 million in residential construction loans to non-accrual status and a related $284,000 provision for loan losses. An analysis of the changes in the allowance for loan losses, non-performing loans and classified loans is presented under “Risk Management—Analysis of Non-Performing and Classified Assets” and “Risk Management—Analysis and Determination of the Allowance for Loan Losses.” Non-Interest Income . The following table shows the components of other income and the percentage changes from year to year. 2008 2007 % Change (Dollars in thousands) Service fees on deposits $ 119 $ 120 (0.8 )% Service fees on loans 31 29 6.9 Income from investment in life insurance 76 89 (13.5 ) Other income 81 50 60.0 Total $ 307 $ 288 6.6 Service fees on loans increased due to an increase in income from participation loans that we service. Income from investment in life insurance policy decreased due to the lower performance of the life insurance policies because of the lower interest rate environment. Other income increased $30,000 or 60.0% primarily due to a $15,000 increase in debit card income as the Bank went through its first full year with the debit card product, an $8,000 increase in ATM fees due to the addition of an ATM at the new branch and increased usage of the existing ATMs. 33 Non-Interest Expenses. The following table shows the components of non-interest expenses and the percentage changes from year to year. 2008 2007 % Change (Dollars in thousands) Compensation and related expenses $ 2,250 $ 2,035 10.6 % Occupancy 257 174 47.7 Data processing 375 288 30.2 Advertising 115 104 10.6 Professional fees 213 242 (12.0 ) Equipment 175 142 23.2 Impairment write-down of investment securities 274 — 100.0 Net amortization of intangible assets 112 — 100.0 Loss on sale of securities available for sale 19 — 100.0 Other 475 490 (3.1 ) Total $ 4,265 $ 3,475 22.7 Efficiency ratio (1) 106.4 % 95.6 % 11.3 (1) Computed as non-interest expenses divided by the sum of net interest income and other income. Compensation and related expenses increased due to increased staff in connection with the branch acquisition and an increase in salaries and medical benefit expense. Occupancy expense increased primarily due to the rental expense related to the new branch. Data processing costs increased due to additional charges related to the branch acquisition. Advertising increased as we increased the advertising of our loan products. Equipment expense increased due to increased depreciation costs and building maintenance. A non-cash charge to earnings of $274,000, as a result of an other-than-temporary impairment in the value of the AMF Ultra Short Mortgage Fund held in our investment portfolio also contributed to an increase in the non-interest expenses for 2008. Other expense increased due to the amortization of the core deposit premium that resulted from the branch acquisition, offset by a decrease in debit card expense due to start up costs in 2007 and the settlement costs of a lawsuit in 2007. Professional fees decreased due primarily to the legal fees in connection with the branch acquisition being expensed during fiscal year 2007. Income Taxes. The provision for income taxes decreased $320,000, or 484.8%, from $66,000 for fiscal year 2007 to a benefit of $254,000 for fiscal year 2008 due primarily to the decrease in pre-tax income. The Company’s effective tax rate was (43.49%) for fiscal year 2008 compared to 42.04% for fiscal year 2007. Risk Management Overview . Managing risk is an essential part of successfully managing a financial institution. Our most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available-for-sale securities that are accounted for on a mark-to-market basis. Other risks that we encounter are operational risks, liquidity risks and reputation risk. Operational risks include risks related to fraud, regulatory compliance, processing errors, technology and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue. 34 Credit Risk Management . Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. Our strategy also emphasizes the origination of one- to four-family residential real estate loans, which typically have lower default rates than other types of loans and are secured by collateral that generally tends to appreciate in value. When a borrower fails to make a required loan payment, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status. We make initial contact with the borrower when the loan becomes 15 days past due. If payment is not received by the 35 th day of delinquency, a letter from our President and Chief Executive Officer is sent. Typically, when the loan becomes 60 days past due, a letter is sent from our attorney notifying the borrower that we will commence foreclosure proceedings if the loan is not paid in full within 30 days. Generally, loan workout arrangements are made with the borrower at this time; however, if an arrangement cannot be structured before the loan becomes 90 days past due, we will commence foreclosure proceedings against any real property that secures the loan or attempt to repossess any personal property that secures a consumer loan. If a foreclosure action is instituted and the loan is not brought current, paid in full or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. Management informs the board of directors monthly of the amount of loans delinquent more than 30 days. Analysis of Non-Performing and Classified Assets. We consider repossessed assets and loans that are 90 days or more past due to be non-performing assets. When a loan becomes 90 days delinquent, the loan is placed on non-accrual status at which time the accrual of interest ceases and an allowance for any uncollectible accrued interest is established and charged against operations. Typically, payments received on a non-accrual loan are applied to the outstanding principal and interest as determined at the time of collection of the loan. Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired, it is recorded at fair value, net of estimated selling costs, at the date of foreclosure. Holding costs and declines in fair value after acquisition of the property result in charges against income. Non-performing assets totaled $2.7 million, or 1.7% of total assets, at June 30, 2008, which is an increase of $2.5 million, or 966.2%, from June 30, 2007. The increase in non-performing assets was due primarily to three residential construction loans totaling $2.6 million being placed on non-accrual status. There is a specific allowance for loan loss valuation of $284,000 for these three loans. Two loans were to be repaid by the sale of the properties securing the loan. One of the two construction loans has been refinanced. In refinancing the loan, the Bank split the original loan amount between the two primary borrowers. Two of the properties were only 85% complete. The borrower who took this part of the refinancing provided additional properties for collateral so that there would be enough equity to finish the last 15% of the project. Once complete, the two units will be rented to improve cash flows for repayment. The borrower who refinanced the other properties is repaying a term loan that is secured by the two completed units, which are rented and producing income. The borrower is adding personal cash to help make the payments. The other impaired construction loan is non-performing. The borrowers have stipulated that they will deed the two properties securing this loan in lieu of foreclosure. One of the two properties is complete, while the other unit is nearly complete. Once deeded to the Bank, the Bank will use the funds in escrow to finish the incomplete unit and either lease or sell the properties as market conditions dictate. Non-accrual loans accounted for 96.9% of total non-performing assets at June 30, 2008. 35 The following table provides information with respect to our non-performing assets at the dates indicated. At June 30, 2008 2007 (Dollars in thousands) Non-accruing loans: Construction $ 2,623 $ 149 Other consumer 62 3 Total 2,685 152 Accruing loans past due 90 days or more — — Troubled debt restructuring (1) 46 64 Foreclosed real estate — — Other repossessed assets 41 44 Total non-performing assets $ 2,772 $ 260 Total non-performing loans to total loans 2.10 % 0.13 % Total non-performing loans to total assets 1.64 0.11 Total non-performing assets to total assets 1.69 0.15 (1) As defined in Statement of Financial Accounting Standards No. 15. Other than disclosed in the above table, there are no other loans at June 30, 2008 that management has serious doubts about the ability of the borrowers to comply with the present repayment terms. Interest income that would have been recorded for the year ended June 30, 2008 had nonaccruing loans been current according to their original terms amounted to $194,000. The amount of interest related to these loans included in interest income was $138,000 for the year ended June 30, 2008. Federal regulations require us to review and classify our assets on a regular basis. In addition, the Office of Thrift Supervision has the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. “Doubtful assets” have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable and there is a high possibility of loss. An asset classified “loss” is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations also provide for a “special mention” category, described as assets that do not currently expose us to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving our close attention. When we classify an asset as substandard or doubtful, we establish a specific allowance for loan losses. If we classify an asset as loss, we charge off an amount equal to 100% of the portion of the asset classified as loss. The following table shows the aggregate amounts of our classified assets at the dates indicated. At June 30, 2008 2007 (In thousands) Special mention assets $ — $ 425 Substandard assets 2,603 64 Doubtful assets — — Loss assets — — Total classified assets $ 2,603 $ 489 36 There were four loans at June 30, 2008 with an aggregate balance of $2.6 million that are classified as substandard and are considered non-performing. There was one residential loan at June 30, 2007 with a principal balance of $63,677 that was classified as substandard and was considered non-performing. Delinquencies. The following table provides information about delinquencies in our loan portfolio at the dates indicated. At June 30, 2008 2007 60-89 Days 90 Days or More 60-89 Days 90 Days or More Number of Loans Principal Balance of Loans Number of Loans Principal Balance of Loans Number of Loans Principal Balance of Loans Number of Loans Principal Balance of Loans (Dollars in thousands) Construction 2 $ 411 6 $ 2,623 1 $ 1 6 $ 148 Multi-family and commercial real estate — — — — — — — — Mobile home 4 163 2 62 — — — — Other consumer — — — — — — 1 3 Total 6 $ 574 8 $ 2,685 1 $ 1 7 $ 151 Analysis and Determination of the Allowance for Loan Losses . The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish provisions against losses on loans on a quarterly basis. When additions to the allowance are necessary, a provision for loan losses is charged to earnings. Our methodology for assessing the appropriateness of the allowance for loan losses consists of three key elements: (1) specific allowances for identified problem loans; (2) a general valuation allowance on certain identified problem loans; and (3) a general valuation allowance on the remainder of the loan portfolio. Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available for the entire portfolio. Specific Allowance Required for Identified Problem Loans. We establish an allowance on certain identified problem loans based on such factors as: (1) the strength of the customer’s personal or business cash flows; (2) the availability of other sources of repayment; (3) the amount due or past due; (4) the type and value of collateral; (5) the strength of our collateral position; (6) the estimated cost to sell the collateral; and (7) the borrower’s effort to cure the delinquency. General Valuation Allowance on Certain Identified Problem Loans. We also establish a general allowance for classified loans that do not have an individual allowance. We segregate these loans by loan category and assign allowances to each category based on inherent losses associated with each type of lending and consideration that these loans, in the aggregate, represent an above-average credit risk and that more of these loans will prove to be uncollectible compared to loans in the general portfolio. General Valuation Allowance on the Remainder of the Loan Portfolio. We establish another general allowance for loans that are not classified to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, has not been allocated to particular problem assets. This general valuation allowance is determined by segregating the loans by loan category and assigning allowances based on our historical loss experience, delinquency trends and management’s evaluation of the collectibility of the loan portfolio. The allowance may be adjusted for significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary market area, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are re-evaluated quarterly to ensure their relevance in the current real estate environment. 37 The Office of Thrift Supervision, as an integral part of its examination process, periodically reviews our allowance for loan losses. The Office of Thrift Supervision may require us to make additional provisions for loan losses based on judgments different from ours. At June 30, 2008, our allowance for loan losses represented 0.57% of total loans and 26.82% of non-performing loans. The allowance for loan losses increased to $709,000 at June 30, 2008 from $402,000 at June 30, 2007, due to a provision for loan losses of $328,000 and charge-offs of $21,000. The provision reflects an increase in non-accrual loans as well as increasing levels of loan growth compared to 2007. In the first quarter of fiscal 2008, the Bank increased its allowance factor for mobile home loans as there is no additional dealer reserve account to assist in offsetting losses. In addition, a higher general reserve was established for the few unsecured loans the Bank originated. The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated. At June 30, 2008 2007 Amount % of Allowance to Total Allowance % of Loans in Each Category to Total Loans Amount % of Allowance to Total Allowance % of Loans in Each Category to Total Loans (Dollars in thousands) One- to four-family $ 178 25.11 % 70.66 % $ 172 42.79 % 71.75 % Multi-family and Commercial 73 10.30 10.60 57 14.18 9.48 Construction 329 46.40 8.69 54 13.43 8.90 Mobile home 118 16.64 9.22 110 27.36 9.11 Other consumer 8 1.13 0.64 8 1.99 0.67 Commercial 3 0.42 0.19 1 0.25 0.09 Total allowance for loan losses $ 709 100.00 % 100.00 % $ 402 100.00 % 100.00 % Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that regulators, in reviewing our loan portfolio, will not request us to increase our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations. 38 Analysis of Loan Loss Experience. The following table sets forth an analysis of the allowance for loan losses for the periods indicated. Where specific loan loss allowances have been established, any difference between the loss allowance and the amount of loss realized has been charged or credited to current income. Year Ended June 30, 2008 2007 (Dollars in thousands) Allowance for loan losses, at beginning of year $ 402 $ 410 Provision for loan losses 328 5 Charge-offs: Mobile home 7 — Other consumer 14 13 Total charge-offs 21 13 Recoveries: Total recoveries — — Net charge-offs 21 13 Allowance for loan losses, end of period $ 709 $ 402 Allowance to non-performing loans(1) 26.40 % 264.47 % Allowance to total loans outstanding at end of period 0.57 0.35 Net charge-offs to average loans outstanding during the period 0.02 0.01 (1) The difference between fiscal 2008 and 2007 amounts were due primarily to a change in non-performing loan balances. Interest Rate Risk Management. We manage the interest rate sensitivity of our interest-bearing liabilities and interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Deposit accounts typically react more quickly to changes in market interest rates than mortgage loans because of the shorter maturities of deposits. As a result, sharp increases in interest rates may adversely affect our earnings while decreases in interest rates may beneficially affect our earnings. To reduce the potential volatility of our earnings, we have sought to improve the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Also, we attempt to manage our interest rate risk through: the origination of adjustable-rate one- to four-family residential real estate loans; an investment in a mutual fund that invests in adjustable-rate mortgage loans; an increased focus on multi-family and commercial real estate lending, which emphasizes the origination of shorter-term adjustable-rate loans; and efforts to originate fixed-rate mortgage loans with maturities of fifteen years or less. We currently do not participate in hedging programs, interest rate swaps or other activities involving the use of off-balance sheet derivative financial instruments. Our board of directors serves as our Asset/Liability Committee to communicate, coordinate and control all aspects involving asset/liability management. The committee monitors the volume and mix of assets and funding sources with the objective of managing assets and funding sources. Net Portfolio Value Simulation Analysis. We use an interest rate sensitivity analysis prepared by the Office of Thrift Supervision to review our level of interest rate risk. This analysis measures interest rate risk by computing changes in net portfolio value of our cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. Net portfolio value represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 300 basis point increase or 100 and 200 basis point decrease in market interest rates. We measure interest rate risk by modeling the changes in net portfolio value over a variety of interest rate scenarios. The following table, which is based on information that we provide to the Office of Thrift Supervision, presents the change in our net portfolio value at June 30, 2008 that would occur in the event of an immediate change in interest rates based on Office of Thrift Supervision assumptions, with no effect given to any steps that we might take to counteract that change. 39 Net Portfolio Value (Dollars in thousands) Net Portfolio Value as % of Portfolio Value of Assets Basis Point (“bp”) Change in Rates $ Amount $ Change % Change NPV Ratio Change 300 $ 4,746 $ (7,324 ) (61 )% 3.05 % (423 )bp 200 7,593 (4,477 ) (37 ) 4.77 (252 ) 100 10,137 (1,932 ) (16 ) 6.23 (106 ) 50 11,226 (843 ) (7 ) 6.83 (45 ) Static 12,069 — — 7.28 — (50) 12,617 548 5 7.57 28 (100) 12,961 892 7 7.73 45 The Office of Thrift Supervision uses certain assumptions in assessing the interest rate risk of savings associations. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others. As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table. Liquidity Management . Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments and maturities and sales of investment securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits, federal funds sold and short- and intermediate-term U.S. Treasury and federal agency securities. Our most liquid assets are cash and cash equivalents and interest-bearing deposits. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At June 30, 2008, cash and cash equivalents totaled $8.9 million, including interest-bearing deposits of $580,000. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $8.8 million at June 30, 2008. In addition, at June 30, 2008, we had the ability to borrow an additional $32.5 million from the Federal Home Loan Bank of Atlanta. On that date, we had $7.5 million outstanding. At June 30, 2008, we had $2.8 million in loan commitments outstanding. In addition to commitments to originate loans, we had $2.3 million in unused lines of credit and $2.4 million in undisbursed construction loans in process. Certificates of deposit due within one year of June 30, 2008 totaled $35.8 million, or 26.1% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and lines of credit. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before June 30, 2009. We believe, however, based on past experience, that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered. Our primary investing activities are the origination of loans and the purchase of securities. Our primary financing activities consist of activity in deposit accounts. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive and to increase core deposits. Occasionally, we offer promotional rates to attract certain deposit products. 40 The following table presents our primary investing and financing activities during the periods indicated. Year Ended June 30, 2008 2007 (In thousands) Investing activities: Loan originations $ 17,635 $ 17,558 Loan participation purchases 5,250 2,797 Securities purchases 17,360 140 Loan participation sales (890 ) — Financing activities: Increase (decrease) in deposits (8,402 ) $ 1,397 FHLB borrowings net (6,000 ) (1,000 ) Capital Management. We have managed our capital to maintain strong protection for depositors and creditors. We are subject to various regulatory capital requirements administered by the Office of Thrift Supervision, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At June 30, 2008, we exceeded all of our regulatory capital requirements. We are considered “well capitalized” under regulatory guidelines. See “Regulation and Supervision—Regulation of Federal Savings Associations—Capital Requirements” and “Regulatory Capital Compliance” and note 12 of the notes to the consolidated financial statements. We also will manage our capital for maximum shareholder benefit. We may use capital management tools such as cash dividends and share repurchases. Off-Balance Sheet Arrangements . In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. A presentation of our outstanding loan commitments and unused lines of credit at June 30, 2008 and their effect on our liquidity is presented at note 3 of the notes to the consolidated financial statements included in this Form 10-K and under “—Risk Management—Liquidity Management.” For the year ended June 30, 2008, we did not engage in any off-balance-sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows. Recent Accounting Pronouncements In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that companies recognize in their financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The Company adopted the provisions of FIN 48 in the fiscal year ended June 30, 2008 and determined that upon adoption, it had no impact on its financial statements. In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141 (R) “Business Combinations” (“SFAS No. 141 (R)”). This Statement establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interests in the acquiree. The Statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The guidance will become effective as of the beginning of a company’s fiscal year beginning after December 15, 2008. This new pronouncement will impact the Company’s accounting for business combinations completed beginning July 1, 2009. 41 In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“SFAS No. 160”). This Statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The guidance will become effective as of the beginning of a company’s fiscal year beginning after December 15, 2008 and is not expected to have a significant impact on its financial statements. Staff Accounting Bulletin No. 110 (SAB 110) amends and replaces Question 6 of Section D.2 of Topic 14, “Share-Based Payment,” of the Staff Accounting Bulleting series. Question 6 of Section D.2 of Topic 14 expresses the views of the staff regarding the use of the “simplified” method in developing an estimate of expected term of “plain vanilla” share options and allows usage of the “simplified” method for share option grants prior to December 31, 2007. SAB 110 allows public companies which do not have historically sufficient experience to provide a reasonable estimate to continue use of the “simplified” method for estimating the expected term of “plain vanilla” share option grants after December 31, 2007. SAB 110 was effective January 1, 2008 and did not have a significant impact on the Company’s financial statements. In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. FASB Statement No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective beginning July 1, 2008 and did not have a significant impact on the Company’s financial statements. In February 2008, the FASB issued FASB Staff Position (“FSP”) 157-2, “Effective Date of FASB Statement No. 157,” that permits a one-year deferral in applying the measurement provisions of Statement No. 157 to non-financial assets and non-financial liabilities (non-financial items) that are not recognized or disclosed at fair value in an entity’s financial statements on a recurring basis (at least annually). Therefore, if the change in fair value of a non-financial item is not required to be recognized or disclosed in the financial statements on an annual basis or more frequently, the effective date of application of Statement 157 to that item is deferred until fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. The Company is currently evaluating the impact, if any, of the adoption of FSP 157-2 on its financial statements. In September 2006, the FASB’s Emerging Issues Task Force (EITF) issued EITF Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements” (“EITF 06-4”). EITF 06-4 requires the recognition of a liability related to the postretirement benefits covered by an endorsement split-dollar life insurance arrangement. The consensus highlights that the employer (who is also the policyholder) has a liability for the benefit it is providing to its employee. As such, if the policyholder has agreed to maintain the insurance policy in force for the employee’s benefit during his or her retirement, then the liability recognized during the employee’s active service period should be based on the future cost of insurance to be incurred during the employee’s retirement. Alternatively, if the policyholder has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized by following the guidance in SFAS No. 106 or Accounting Principles Board (APB) Opinion No. 12, as appropriate. For transition, an entity can choose to apply the guidance using either of the following approaches: (a) a change in accounting principle through retrospective application to all periods presented or (b) a change in accounting principle through a cumulative-effect adjustment to the balance in retained earnings at the beginning of the year of adoption. The Company adopted this EITF effective July 1, 2007 and recorded a cumulative-effect adjustment of $(221,000). In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for the Company July 1, 2008. The Company has elected to account for the Shay AMF Ultra Short Mortgage Fund mutual fund it holds at fair value and there was no impairment recognized with this adoption as the investment had been written down to fair value at June 30, 2008. Future gains and losses will be reflected through earnings. 42 In June 2007, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards” (“EITF 06-11”). EITF 06-11 states that an entity should recognize a realized tax benefit associated with dividends on nonvested equity shares, nonvested equity share units and outstanding equity share options charged to retained earnings as an increase in additional paid in capital. The amount recognized in additional paid in capital should be included in the pool of excess tax benefits available to absorb potential future tax deficiencies on share-based payment awards. EITF 06-11 should be applied prospectively to income tax benefits of dividends on equity-classified share-based payment awards that are declared in fiscal years beginning after December 15, 2007. Adoption is not expected to have a significant impact on the Company’s financial statements. In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This Statement identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements. This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements. In April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of the Useful Life of Intangible Assets.” This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141R, and other GAAP. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements. Effect of Inflation and Changing Prices The financial statements and related financial data presented in this annual report on Form 10-K have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this item is incorporated by reference to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Risk Management—Interest Rate Risk Management” and “—Net Portfolio Value Simulation Analysis.”