SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the period ended June 30, 2007

- or -

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                     to

Commission file number:  0-24168

TF FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

 

Registrant’s telephone number, including area code:  (215) 579-4000

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 x  NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer o

Non-accelerated filer x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 Exchange Act). YES o  NO x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:             August 1, 2007

 

CONTENTS

PART I-CONSOLIDATED FINANCIAL INFORMATION
Item 1.		Consolidated Financial Statements		3
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		13
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		20
Item 4.		Controls and Procedures		20
PART II-OTHER INFORMATION
Item 1.		Legal Proceedings		22
Item 1A.		Risk Factors		22
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		22
Item 3.		Defaults Upon Senior Securities		22
Item 4.		Submission of Matters to a Vote of Security Holders		22
Item 5.		Other Information		22
Item 6.		Exhibits		22
Signatures				23
Exhibits
31. Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32. Certification pursuant of Section 906 of the Sarbanes-Oxley Act of 2002

 

2

TF Financial Corporation and Subsidiaries

CONSOLIDATED BALANCE SHEETS

 

		Unaudited June 30, 2007			Audited December 31, 2006
		(in thousands)
ASSETS
Cash and cash equivalents		$	5,826		$	12,364
Certificates of deposit in other financial institutions		—			40
Investment securities available for sale—at fair value		28,296			34,524
Investment securities held to maturity (fair value of $685 and $681, respectively)		678			677
Mortgage-backed securities available for sale—at fair value		82,410			74,338
Mortgage-backed securities held to maturity (fair value of $6,771 and $7,788, respectively)		6,729			7,697
Loans receivable, net		499,245			483,570
Loans receivable held for sale		783			969
Federal Home Loan Bank stock—at cost		6,875			7,130
Accrued interest receivable		2,938			3,030
Premises and equipment, net		6,481			6,544
Goodwill		4,324			4,324
Bank-owned life insurance		15,575			15,274
Other assets		3,872			2,122
TOTAL ASSETS		$	664,032		$	652,603
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits		$	489,578		$	478,087
Borrowings from the Federal Home Loan Bank		100,110			101,701
Advances from borrowers for taxes and insurance		2,734			1,866
Accrued interest payable		3,322			3,177
Other liabilities		2,089			2,133
Total liabilities		597,833			586,964
Stockholders’ equity
Preferred stock, no par value; 2,000,000 shares authorized at June 30, 2007 and December 31, 2006, none issued		—			—
Common stock, $0.10 par value; 10,000,000 shares authorized, 5,290,000 shares issued, 2,718,748 and 2,702,845 shares outstanding at June 30, 2007 and December 31, 2006, respectively, net of shares in treasury 2,405,417 and 2,415,766, respectively		529			529
Retained earnings		66,408			65,075
Additional paid-in capital		53,141			52,700
Unearned ESOP shares		(1,648		)	(1,703		)
Treasury stock—at cost		(49,708		)	(48,980		)
Accumulated other comprehensive loss		(2,523		)	(1,982		)
Total stockholders’ equity		66,199			65,639
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	664,032		$	652,603

 

The accompanying notes are an integral part of these statements

3

---

TF Financial Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

		For the three months ended June 30,						For the six months ended June 30,
		2007			2006			2007			2006
		(in thousands, except per share data)
Interest income
Loans, including fees		$	7,986		$	8,167		$	15,765		$	15,838
Mortgage-backed securities		1,006			957			1,939			1,969
Investment securities		404			489			838			901
Interest-bearing deposits and other		19			14			86			22
TOTAL INTEREST INCOME		9,415			9,627			18,628			18,730
Interest expense
Deposits		3,416			2,560			6,646			4,808
Borrowings		1,056			1,388			2,035			2,736
TOTAL INTEREST EXPENSE		4,472			3,948			8,681			7,544
NET INTEREST INCOME		4,943			5,679			9,947			11,186
Provision for loan losses		—			60			—			150
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		4,943			5,619			9,947			11,036
Non-interest income
Service fees, charges and other operating income		514			521			1,061			1,071
Bank-owned life insurance		153			126			301			248
Gain on sale of loans		63			29			117			38
Loss on sale of mortgage-backed securities available for sale		—			(51		)	—			(51		)
Other income		—			—			777			—
TOTAL NON-INTEREST INCOME		730			625			2,256			1,306
Non-interest expense
Compensation and benefits		2,680			2,683			5,348			5,322
Occupancy and equipment		712			694			1,404			1,398
Professional fees		133			135			357			347
Marketing and advertising		163			175			326			352
Other operating		580			614			1,423			1,252
TOTAL NON-INTEREST EXPENSE		4,268			4,301			8,858			8,671
INCOME BEFORE INCOME TAXES		1,405			1,943			3,345			3,671
Income taxes		368			551			910			1,024
NET INCOME		$	1,037		$	1,392		$	2,435		$	2,647
Earnings per share—basic		$	0.38		$	0.52		$	0.89		$	0.98
Earnings per share—diluted		$	0.38		$	0.51		$	0.89		$	0.98
Dividends paid		$	0.20		$	0.19		$	0.40		$	0.38

 

The accompanying notes are an integral part of these statements

4

---

TF Financial Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		For the six months ended
		June 30,
		2007			2006
		(in thousands)
OPERATING ACTIVITIES
Net income		$	2,435		$	2,647
Adjustments to reconcile net income to net cash provided by operating activities
Amortization of
Mortgage loan servicing rights		22			11
Deferred loan origination fees		(53		)	(43		)
Premiums and discounts on investment securities, net		46			33
Premiums and discounts on mortgage-backed securities, net		45			149
Premiums and discounts on loans, net		67			85
Discount on wholesale deposits		12			5
Core deposit intangibles		—			56
Provision for loan losses		—			150
Provision for decrease in fair value of mortgage servicing rights		1			—
Depreciation of premises and equipment		442			472
Increase in value of bank-owned life insurance		(301		)	(248		)
Stock grant expense		180			181
Stock option expense		195			189
Stock-based benefit programs: ESOP		168			282
Proceeds from sale of loans originated for sale		10,523			4,855
Origination of loans held for sale		(10,370		)	(5,473		)
Tax benefit arising from stock compensation		363			102
(Gain) loss on sale of
Mortgage loans available for sale		(117		)	(38		)
Mortgage-backed securities available for sale		—			51
Real estate acquired through foreclosure		—			(26		)
(Income) expense from mortgage loan derivatives		(9		)	13
(Income) expense associated with forward loan sales		1			(13		)
(Increase) decrease in
Accrued interest receivable		92			211
Other assets		(1,284		)	(641		)
Increase (decrease) in
Accrued interest payable		145			969
Other liabilities		(44		)	682
NET CASH PROVIDED BY OPERATING ACTIVITIES		2,559			4,661
INVESTING ACTIVITIES
Loan originations		(75,392		)	(84,115		)
Loan principal payments		58,950			55,153
Principal repayments on mortgage-backed securities held to maturity		964			1,583
Principal repayments on mortgage-backed securities available for sale		5,310			8,320
Proceeds from sale of loan participations		753			2,452
Purchase of investment securities available for sale		(771		)	(1,917		)
Purchase of mortgage-backed securities available for sale		(13,798		)	—
Proceeds from the sale of mortgaged-backed securities available for sale		—			4,971
Proceeds from maturities of investment securities held to maturity		6,455			2,673
Redemption (purchases) of Federal Home Loan Bank stock, net		255			(738		)
Purchase of premises and equipment		(379		)	(741		)
Proceeds from the sale of real estate acquired through foreclosure		—			726
Maturities of certificates of deposit in other financial institutions		40			—
NET CASH USED IN INVESTING ACTIVITIES		(17,613		)	(11,633		)

 

5

---

 

		For the six months ended
		June 30,
		2007			2006
		(in thousands)
FINANCING ACTIVITIES
Net increase in demand deposit/NOW accounts, passbook savings accounts and certificates of deposit		11,479			9,203
Net increase (decrease) in short-term borrowings from the Federal Home Loan Bank		8,366			(4,655		)
Proceeds of long-term Federal Home Loan Bank borrowings		—			15,535
Repayment of long-term Federal Home Loan Bank borrowings		(9,957		)	(9,127		)
Net increase in advances from borrowers for taxes and insurance		868			356
Treasury stock acquired		(2,909		)	(1,421		)
Exercise of stock options		1,771			298
Common stock dividends paid		(1,102		)	(1,025		)
NET CASH PROVIDED BY FINANCING ACTIVITIES		8,516			9,164
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(6,538		)	2,192
Cash and cash equivalents at beginning of period		12,364			3,821
Cash and cash equivalents at end of period		$	5,826		$	6,013
Supplemental disclosure of cash flow information
Cash paid for
Interest on deposits and borrowings from Federal Home Loan Bank		$	8,536		$	6,575
Income taxes		$	180		$	1,015

 

The accompanying notes are an integral part of these statements

6

TF FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - PRINCIPLES OF CONSOLIDATION

The consolidated financial statements as of June 30, 2007 (unaudited) and December 31, 2006 and for the three and six-month periods ended June 30, 2007 and 2006 (unaudited) include the accounts of TF Financial Corporation (the “Company”) and its wholly owned subsidiaries Third Federal Bank (the “Bank”), TF Investments Corporation and Penns Trail Development Corporation. The Company’s business is conducted principally through the Bank. All significant intercompany accounts and transactions have been eliminated in consolidation.

NOTE 2 - BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all of the disclosures or footnotes required by accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for fair presentation of the consolidated financial statements have been included. The results of operations for the period ended June 30, 2007 are not necessarily indicative of the results which may be expected for the entire fiscal year or any other period. For further information, refer to consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

NOTE 3 — CONTINGENCIES

The Company, from time to time, is a party to routine litigation that arises in the normal course of business. In the opinion of management, the resolution of this litigation, if any, would not have a material adverse effect on the Company’s consolidated financial position or results of operations.

NOTE 4 - OTHER COMPREHENSIVE INCOME

The Company follows SFAS No. 130, “Reporting Comprehensive Income.” SFAS No. 130 establishes standards to provide prominent disclosure of comprehensive income items. Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The components of other comprehensive loss are as follows for the three months ended:

		June 30, 2007
		Before tax amount			Tax (expense) benefit			Net of tax amount
		(in thousands)
Unrealized losses on securities
Unrealized holding losses arising during period		$	(1,122	)	$	381		$	(741	)
Pension plan benefit adjustment related to prior service costs and losses		55			(19		)	36
Other comprehensive loss, net		$	(1,067	)	$	362		$	(705	)

 

		June 30, 2006
		Before tax amount			Tax (expense) benefit			Net of tax amount
		(in thousands)
Unrealized losses on securities
Unrealized holding losses arising during period		$	(401	)	$	137		$	(264	)
Reclassification adjustment for losses realized		51			(18		)	33
Other comprehensive loss, net		$	(350	)	$	119		$	(231	)

 

7

---

The components of other comprehensive loss are as follows for the six months ended:

 

		June 30, 2007
		Before tax amount			Tax (expense) benefit			Net of tax amount
		(in thousands)
Unrealized losses on securities
Unrealized holding losses arising during period		$	(872	)	$	295		$	(577	)
Pension plan benefit adjustment related to prior service costs and losses		55			(19		)	36
Other comprehensive loss, net		$	(817	)	$	276		$	(541	)

 

		June 30, 2006
		Before tax amount			Tax (expense) benefit			Net of tax amount
		(in thousands)
Unrealized losses on securities
Unrealized holding losses arising during period		$	(1,456	)	$	497		$	(959	)
Reclassification adjustment for losses realized		51			(18		)	33
Other comprehensive loss, net		$	(1,405	)	$	479		$	(926	)

 

NOTE 5—EARNINGS PER SHARE

The following tables illustrate the reconciliation of the numerators and denominators of the basic and diluted earnings per share computations (dollars in thousands, except per share data):

		Three months ended June 30, 2007
		Income (numerator)			Weighted average shares (denominator)		Per share Amount
Basic earnings per share
Income available to common stockholders		$	1,037		2,727,121		$	0.38
Effect of dilutive securities
Stock options and grants		—			4,610		—
Diluted earnings per share
Income available to common stockholders plus effect of dilutive securities		$	1,037		2,731,731		$	0.38

 

8

---

 

		Six months ended June 30, 2007
		Income (numerator)			Weighted average shares (denominator)		Per share Amount
Basic earnings per share
Income available to common stockholders		$	2,435		2,732,964		$	0.89
Effect of dilutive securities
Stock options and grants		—			3,502		—
Diluted earnings per share
Income available to common stockholders plus effect of dilutive securities		$	2,435		2,736,466		$	0.89

 

There were 20,128 options to purchase shares of common stock at a price of $34.14 per share which were outstanding during the first six months of 2007 that were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares.

 

		Three months ended June 30, 2006
		Income (numerator)			Weighted average shares (denominator)		Per share Amount
Basic earnings per share
Income available to common stockholders		1,392			2,694,988		$	0.52
Effect of dilutive securities
Stock options and grants		—			19,108		(0.01		)
Diluted earnings per share
Income available to common stockholders plus effect of dilutive securities		$	1,392		2,714,096		$	0.51

 

		Six months ended June 30, 2006
		Income (numerator)			Weighted average shares (denominator)		Per share Amount
Basic earnings per share
Income available to common stockholders		2,647			2,696,758		$	0.98
Effect of dilutive securities
Stock options and grants		—			16,055		—
Diluted earnings per share
Income available to common stockholders plus effect of dilutive securities		$	2,647		2,712,813		$	0.98

 

There were 21,018 options to purchase shares of common stock at a price of $34.14 per share which were outstanding during the six months ended June 30, 2006 that were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares.

9

---

NOTE 6- STOCK BASED COMPENSATION

The Company has stock benefit plans that allow the Company to grant options and stock to employees and directors. The awards, which have a term of up to 10 years when issued, vest over a three to five year period. The exercise price of each award equals the market price of the Company’s stock on the date of the grant. There was $613,000 and $927,000 of total unrecognized compensation cost, net of estimated forfeitures, related to non-vested awards under the Plan at June 30, 2007 and 2006, respectively. That cost is expected to be recognized over a weighted average period of 19.3 months and 29.8 months at June 30, 2007 and 2006, respectively.

Stock-based compensation expense included in net income related to stock options was $96,000 and $94,000, resulting in a tax benefit of $30,000 and $28,000, for the three months ended June 30, 2007 and 2006, respectively. Stock-based compensation expense included in net income related to stock options was $195,000 and $189,000, resulting in a tax benefit of $60,000 and $57,000, for the six months ended June 30, 2007 and 2006, respectively.

Option activity under the Company’s stock option plan as of June 30, 2007 and 2006 is as follows:

		2007
		Number of shares		Weighted average exercise price per share			Weighted average remaining contractual term (in years)		Aggregate intrinsic value ($000)
Outstanding at January 1, 2007		365,734		$	23.62
Options granted		—		—
Options exercised		(106,908	)	16.56
Options forfeited		(730	)	31.49
Options expired		—		—
Outstanding at June 30, 2007		258,096		$	26.49		4.11		$	960
Options exercisable at June 30, 2007		128,554		$	24.35		3.92		$	758

 

		2006
		Number of shares		Weighted average exercise price per share		Weighted average remaining contractual term (in years)		Aggregate intrinsic value ($000)
Outstanding at January 1, 2006		384,848		$23.18
Options granted		—		—
Options exercised		(19,832	)	15.01
Options forfeited		(8,094	)	29.66
Options expired		—		—
Outstanding at June 30, 2006		356,922		$23.49		3.72		$1,913
Options exercisable at June 30, 2006		175,494		$18.21		3.20		$1,867

 

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the second quarter and the exercise price, multiplied by the number of in-the money options).

The aggregate intrinsic value of options exercised during the six months ended June 30, 2007 and 2006 was $1,084,000 and $299,000, respectively. Exercise of stock options during the six months ended June 30, 2007 and 2006 resulted in cash receipts of $1,771,000 and $298,000, respectively.

Stock-based compensation expense included in net income related to stock grants was $90,000 for each of the quarters ended June 30, 2007 and 2006. Stock-based compensation expense included in net income related to the Company’s employee stock ownership plan totaled $77,000 and $108,000 for the three-month periods ended June 30, 2007 and 2006, respectively.

Stock-based compensation expense included in net income related to stock grants was $180,000 and $181,000 the six months ended June 30, 2007 and 2006, respectively. Stock-based compensation expense included in net income related to the Company’s employee stock ownership plan totaled $137,000 and $215,000 for the six-month periods ended June 30, 2007 and 2006, respectively.

10

---

NOTE 7- EMPLOYEE BENEFIT PLANS

Net periodic defined benefit pension cost included the following (in thousands):

		Three months ended June 30
		2007			2006
Components of net periodic benefit cost
Service cost		$	84		$	77
Interest cost		53			52
Expected return on plan assets		(100		)	(80		)
Amortization of prior service cost		16			15
Recognized net actuarial (gain) loss		13			13
Net periodic benefit cost		$	66		$	77

 

		Six months ended June 30
		2007			2006
Components of net periodic benefit cost
Service cost		$	168		$	154
Interest cost		106			105
Expected return on plan assets		(200		)	(161		)
Amortization of prior service cost		30			31
Recognized net actuarial (gain) loss		25			26
Net periodic benefit cost		$	129		$	155

 

The employer contribution made for the six months ended June 30, 2007 and 2006 was $1,107,000 and $620,000, respectively.

11

---

NOTE 8- NEW ACCOUNTING PRONOUNCEMENTS

In September 2006,  the Financial Accounting Standards Board (FASB) Issued Statement No. 157 (SFAS 157), “Fair Value Measurements” which is effective for fiscal years beginning after November 15, 2007 and for interim periods within those years. This statement defines fair value, establishes a framework for measuring fair value and expands the related disclosure requirements. The Company is currently evaluating the impact the adoption of SFAS No. 157 will have on its consolidated financial statements.

In September 2006, the Emerging Issues Task Force (EITF) finalized Issue No. 06-5, “Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life Insurance)”. This issue requires that a policyholder consider contractual terms of a life insurance policy in determining the amount that could be realized under the insurance contract. It also requires that if the contract provides for a greater surrender value if all individual policies in a group are surrendered at the same time, that the surrender value be determined based on the assumption that policies will be surrendered on an individual basis. Lastly, the issue discusses whether the cash surrender value should be discounted when the policyholder is contractually limited in its ability to surrender a policy. This issue is effective for fiscal years beginning after December 15, 2006. Application of this issue has not made a material impact on the financial statements.

The Company adopted the provisions of FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes”, on January 1, 2007. Previously, the Company had accounted for tax contingencies in accordance with SFAS 5, “Accounting for Contingencies”. As required by FIN 48, which clarifies SFAS 109, “Accounting for Income Taxes”, the Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.  The Company is subject to income taxes in the U.S. federal jurisdiction, and the states of Pennsylvania and New Jersey. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply.  The Company applied Interpretation 48 to all tax positions for which the statute of limitations remained open. The adoption of FIN 48 did not have a material impact on the results operations or financial condition of the Company.

In February 2007, FASB issued Statement No. 159 (SFAS 159), “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115”. The statement permits entities to choose to measure many financial instruments and certain other items at fair value.  SFAS 159 provides an opportunity to mitigate volatility in reporting earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007.  Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of FASB Statement No. 157 (SFAS 157), “Fair Value Measurements”.  Although the Company has decided against early adoption, the Company will adopt SFAS No. 159 and does not anticipate any material impact on its consolidated financial statements.

NOTE 9- RECLASSIFICATIONS

Certain prior period amounts have been reclassified to conform to the current period presentation.

12

TF FINANCIAL CORPORATION AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL POSITION AND RESULTS OF OPERATIONS

GENERAL

The Company may from time to time make written or oral “forward-looking statements”, including statements contained in the Company’s filings with the Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the exhibits thereto), in its reports to stockholders and in other communications by the Company, which are made in good faith by the Company pursuant to the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve risks and uncertainties, such as statements of the Company’s plans, objectives, expectations, estimates and intentions that are subject to change based on various important factors (some of which are beyond the Company’s control). The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System, inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services; the willingness of users to substitute competitors’ products and services for the Company’s products and services; the success of the Company in gaining regulatory approval of its products and services, when required; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes, acquisitions; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing.

The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

Financial Position

The Company’s total assets at June 30, 2007 and December 31, 2006 were $664.0 million and $652.6 million, respectively, an increase of $11.4 million, or 1.8%, during the six-month period. Cash and cash equivalents decreased by $6.5 million. Investment securities available for sale decreased by $6.2 million due to maturities of agency and corporate notes totaling $6.5 million and a $0.5 million decrease in the market value of these securities, offset by purchases of $0.8 million of tax-exempt municipal bonds. Mortgage-backed securities available for sale increased by $8.1 million due to $13.8 million of purchases reduced by $5.3 million in principal repayments received and a decrease in the market value of the securities of $0.4 million. Mortgage-backed securities held to maturity decreased by $1.0 million as a result of principal repayments.

Loans receivable increased by $15.5 million during the first six months of 2007. Consumer and single-family residential mortgage loans of $41.1 million and commercial loans of $34.3 million were originated during the first six months of 2007. Principal repayments of loans receivable were $59.0 million. Loans originated for sale during the first six months of 2007 totaled $10.4 million, and there were $10.5 million in proceeds from the sale of loans in the secondary market during this period.

13

---

Total liabilities increased by $10.9 million. Deposit balances increased by $11.5 million during the first six months of 2007. Non-interest checking, savings, and money market accounts increased by a combined $13.3 million while interest-bearing checking accounts decreased $2.0 million during the period. Retail certificates of deposit increased $5.4 million which offset maturities of broker originated certificates of deposit of $5.2 million, a net increase of $0.2 million during the first six months of 2007. Borrowings from the Federal Home Loan Bank decreased by $1.6 million, a result of an $8.4 million increase of short-term borrowings, less scheduled amortization payments of $10.0 million.

Total consolidated stockholders’ equity of the Company was $66.2 million or 10.0% of total assets at June 30, 2007. During the first six months of 2007 the Company repurchased 96,559 shares of its common stock and issued 106,908 shares pursuant to the exercise of stock options. As of June 30, 2007, there were approximately 31,000 shares available for repurchase under the previously announced share repurchase plan.

Asset Quality

During the six months of 2007 and 2006, the Company’s provision for loan losses was $0 and $150,000, respectively. The increase in non-performing loans during the first six months of 2007 is largely due to the addition of two real estate secured credits. Subsequent to June 30, 2007, both of the credits totaling $2.3 million resumed performing status. The Company is diligently working on each of the remaining non-performing loans, all of which are real estate secured to resolve the individual situations.

The following table sets forth information regarding the Company’s asset quality (dollars in thousands):

		June 30,			December 31,			June 30,
		2007			2006			2006
Non-performing loans		$	4,965		$	2,110		$	1,314
Ratio of non-performing loans to gross loans		0.99		%	0.43		%	0.25		%
Ratio of non-performing loans to total assets		0.75		%	0.32		%	0.19		%
Ratio of total non-performing assets to total assets		0.75		%	0.32		%	0.19		%
Ratio of allowance for loan losses to total loans		0.57		%	0.59		%	0.54		%
Ratio of allowance for loan losses to non-performing loans		57.40		%	135.78		%	212.18		%

 

Management maintains an allowance for loan losses at levels that are believed to be adequate; however, there can be no assurances that further additions will not be necessary or that losses inherent in the existing loan portfolio will not exceed the allowance. The following table sets forth the activity in the allowance for loan losses during the periods indicated (in thousands):

		2007			2006
Beginning balance, January 1,		$	2,865		$	2,641
Provision		—			150
Less: charge-off’s (recoveries), net		15			3
Ending balance, June 30,		2,850			2,788

 

14

---

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2007 AND 2006

Net Income. The Company recorded net income of $1,037,000, or $0.38 per diluted share, for the three months ended June 30, 2007 as compared to net income of $1,392,000, or $0.51 per diluted share, for the three months ended June 30, 2006.

Average Balance Sheet

The following table sets forth information (dollars in thousands) relating to the Company’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated. Yield and cost are computed by dividing income or expense by the average daily balance of interest-earning assets or interest-bearing liabilities, respectively, for the three-month periods indicated.

		June 30,
		2007								2006
		Average balance			Interest			Average yld/cost		Average balance			Interest			Average yld/cost
ASSETS
Interest-earning assets:
Loans receivable(1)		$	498,321		$	7,986		6.43	%	$	512,542		$	8,167		6.39	%
Mortgage-backed securities		86,619			1,006			4.66	%	82,311			957			4.66	%
Investment securities(2)		37,474			512			5.48	%	41,703			583			5.61	%
Other interest-earning assets(3)		1,195			19			6.38	%	1,375			14			4.08	%
Total interest-earning assets		623,609			9,523			6.13	%	637,931			9,721			6.11	%
Non interest-earning assets		34,032								35,381
Total assets		$	657,641							$	673,312
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Deposits		481,084			3,416			2.85	%	467,570			2,560			2.20	%
Borrowings from the FHLB		103,182			1,056			4.10	%	135,399			1,388			4.11	%
Total interest-bearing liabilities		584,266			4,472			3.07	%	602,969			3,948			2.63	%
Non interest-bearing liabilities		8,260								7,963
Total liabilities		592,526								610,932
Stockholders’ equity		65,115								62,380
Total liabilities and stockholders’ equity		$	657,641							$	673,312
Net interest income					$	5,051							$	5,773
Interest rate spread(4)								3.06	%							3.49	%
Net yield on interest-earning assets(5)								3.25	%							3.63	%
Ratio of average interest-earning assets to average interest- bearing liabilities								107	%							106	%

 

(1)		Nonaccrual loans have been included in the appropriate average loan balance category, but interest on nonaccrual loans has not been included for purposes of determining interest income.
(2)		Tax equivalent adjustments to interest on investment securities were $108,000 and $94,000 for the quarter ended June 30, 2007 and 2006, respectively. Tax equivalent interest income is based upon a marginal effective tax rate of 34%.
(3)		Includes interest-bearing deposits in other banks.
(4)		Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(5)		Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.

 

15

---

Rate/Volume Analysis

The following table presents, for the periods indicated, the change in interest income and interest expense (in thousands) attributed to (i) changes in volume (changes in the weighted average balance of the total interest earning asset and interest bearing liability portfolios multiplied by the prior year rate), and (ii) changes in rate (changes in rate multiplied by prior year volume). Changes attributable to the combined impact of volume and rate have been allocated proportionately based on the absolute value of changes due to volume and changes due to rate.

		Three months ended June 30,
		2007 vs 2006 Increase (decrease) due to
		Volume			Rate			Net
Interest income:
Loans receivable, net		$	(462	)	$	281		$	(181	)
Mortgage-backed securities		56			(7		)	49
Investment securities (1)		(58		)	(13		)	(71		)
Other interest-earning assets		(11		)	16			5
Total interest-earning assets		(475		)	277			(198		)
Interest expense:
Deposits		76			780			856
Borrowings from the FHLB		(330		)	(2		)	(332		)
Total interest-bearing liabilities		(254		)	778			524
Net change in net interest income		$	(221	)	$	(501	)	$	(722	)

 

(1)

Tax equivalent adjustments to interest on investment securities were $108,000 and $94,000 for the quarters ended June 30, 2007 and 2006, respectively. Tax equivalent interest income is based upon a marginal effective tax rate of 34%.

 

Total Interest Income. Total interest income, on a taxable equivalent basis, decreased by $198,000 or 2.0% to $9.5 million for the quarter ended June 30, 2007 compared with the second quarter of 2006. The average balance of loans outstanding decreased between the two periods largely because of the sale of $16.3 million of previously purchased loans during the third quarter of 2006. However, the average yield on loans increased 4 basis points, reflecting a rise in the yield on new loans added to the portfolio during the intervening period. During the quarter ended June 30, 2007, the Bank reduced interest income by $111,000 for interest on non-accrual loans while there was no such adjustment in the prior year period.  Interest income from mortgage-backed securities was higher in the second quarter of 2007 in comparison to the same period of 2006 due to purchases of $23.9 million of these securities during the intervening period. Interest income from investment securities decreased as a result of maturities of $6.8 million in excess of purchases of $2.5 million during the intervening period.

Total Interest Expense. Total interest expense increased by $524,000 to $4.5 million during the three-month period ended June 30, 2007 as compared with the second quarter of 2006. During 2006 and the first half of 2007, the Bank raised the interest rates paid on many of its deposit products due to the competitive pricing environment in the Bank’s deposit market. Additionally during the intervening period, the Bank offered new products with higher rates which also contributed to deposit growth and a shift in the deposit mix. Accordingly, the interest rate paid on deposits increased by 65 basis points. Interest on borrowings from the Federal Home Loan Bank decreased by $0.3 million during the second quarter of 2007 versus the same quarter of 2006 as a result of a $32.2 million decrease in the average balance of borrowings.

Non-interest income. Total non-interest income was $730,000 for the three-month period ended June 30, 2007 compared with $625,000 for the same period in 2006. The increase is mainly attributable to the loss on the sale of mortgage-backed securities in the second quarter of 2006 of $51,000 while there was no such loss in the second quarter of 2007. Additionally, net gain on the sale of loans totaled $63,000 during the second quarter of 2007, while the gain during the second quarter of 2006 totaled $29,000 due to an increase between the two quarters in the dollar amount of loans sold. The increase in the value of the bank-owned life insurance of $27,000 during the second quarter of 2007 versus 2006 is largely due to an additional $2.0 million purchase during November of 2006.

Non-interest expense. Total non-interest expense decreased by $33,000 to $4.3 million for the three months ended June 30, 2007 compared to the same period in 2006. In 2006, other non-interest expense included core deposit intangible amortization expense totaling $28,000 and as the asset is fully amortized there was no such charge during the second quarter of 2007.

16

---

RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006

Net Income. The Company recorded net income of $2,435,000, or $0.89 per diluted share, for the six months ended June 30, 2007 as compared to net income of $2,647,000, or $0.98 per diluted share, for the six months ended June 30, 2006.

Average Balance Sheet

The following table sets forth information (dollars in thousands) relating to the Company’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated. Yield and cost are computed by dividing income or expense by the average daily balance of interest-earning assets or interest-bearing liabilities, respectively, for the six-month periods indicated.

		June 30,
		2007								2006
		Average balance			Interest			Average yld/cost		Average balance			Interest			Average yld/cost
ASSETS
Interest-earning assets:
Loans receivable(1)		$	493,038		$	15,765		6.47	%	$	505,475		$	15,838		6.32	%
Mortgage-backed securities		83,644			1,939			4.69	%	86,868			1,969			4.57	%
Investment securities(2)		39,368			1,056			5.42	%	41,670			1,089			5.27	%
Other interest-earning assets(3)		3,571			86			4.87	%	1,017			22			4.36	%
Total interest-earning assets		619,621			18,846			6.15	%	635,030			18,918			6.01	%
Non interest-earning assets		34,091								34,470
Total assets		$	653,712							$	669,500
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Deposits		478,742			6,646			2.81	%	464,156			4,808			2.09	%
Borrowings from the FHLB		101,237			2,035			4.06	%	135,656			2,736			4.07	%
Total interest-bearing liabilities		579,979			8,681			3.03	%	599,812			7,544			2.54	%
Non interest-bearing liabilities		8,103								7,256
Total liabilities		588,082								607,068
Stockholders’ equity		65,630								62,432
Total liabilities and stockholders’ equity		$	653,712							$	669,500
Net interest income					$	10,165							$	11,374
Interest rate spread(4)								3.12	%							3.47	%
Net yield on interest-earning assets(5)								3.32	%							3.61	%
Ratio of average interest-earning assets to average interest- bearing liabilities								107	%							106	%

 

(1)		Nonaccrual loans have been included in the appropriate average loan balance category, but interest on nonaccrual loans has not been included for purposes of determining interest income.
(2)		Tax equivalent adjustments to interest on investment securities were $218,000 and $188,000 for the six months ended June 30, 2007 and 2006, respectively. Tax equivalent interest income is based upon a marginal effective tax rate of 34%.
(3)		Includes interest-bearing deposits in other banks.
(4)		Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(5)		Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.

 

17