Edgar Filing: HOPFED BANCORP INC

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company filer

Form 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2012

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

Commission File Number: 000-23667

HOPFED BANCORP, INC.

(Exact name of registrant as specified in its charter)


Delaware		61-1322555
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

4155 Lafayette Road, Hopkinsville, Kentucky		42240
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (270) 885-1171

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 ninety days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated file or a non-accelerated filer. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule12b-2 of the Exchange Act: (Check one)

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

As of November 13, 2012, the Registrant had outstanding 7,502,812 shares of the Registrant’s Common stock.

CONTENTS

HOPFED BANCORP, INC.


		PAGE
PART I.	FINANCIAL INFORMATION
The unaudited consolidated condensed financial statements of the Registrant and its wholly owned subsidiaries are as follows:
Item 1.	Financial Statements

	Consolidated Condensed Statements of Financial Condition as of September 30, 2012 (unaudited) and December 31, 2011		2

	Consolidated Condensed Statements of Income (Loss) for the Three and Nine-Month Periods Ended September 30, 2012, and September 30, 2011 (unaudited)		4

	Consolidated Condensed Statements of Comprehensive Income for the Three-Month and Nine-Month Periods Ended September 30, 2012 and September 30, 2011 (unaudited)		6

	Consolidated Condensed Statement of Stockholders’ Equity for the Nine-Month Period Ended September 30, 2012 (unaudited)		7

	Consolidated Condensed Statements of Cash Flows for the Nine-Month Periods Ended September 30, 2012, and September 30, 2011 (unaudited)		8

	Notes to Unaudited Consolidated Condensed Financial Statements		9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		40

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		53

Item 4.	Controls and Procedures		54

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings		55

Item 1A.	Risk Factors		55

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		55

Item 3.	Defaults Upon Senior Securities		55

Item 4.	Mine Safety Disclosure		55

Item 5.	Other Information		55

Item 6.	Exhibits		56

SIGNATURES			57

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

HOPFED BANCORP, INC.

Consolidated Condensed Statements of Financial Condition

(Dollars in Thousands)


	September 30, 2012		December 31, 2011
	(Unaudited )
Assets
Cash and due from banks	$	50,042		44,389
Interest-earning deposits		7,661		4,371

Cash and cash equivalents		57,703		48,760
Federal Home Loan Bank stock		4,428		4,428
Securities available for sale		348,877		383,782
Commerical real estate loans held for sale		2,763		—
Loans receivable, net of allowance for loan losses of $10,490 at September 30, 2012, and $11,262 at December 31, 2011		539,503		556,360
Accrued interest receivable		5,333		6,183
Real estate and other assets owned		681		2,267
Bank owned life insurance		9,373		9,135
Premises and equipment, net		22,750		23,431
Deferred tax assets		—		1,132
Intangible asset		341		519
Other assets		4,981		4,823

Total assets	$	996,733		1,040,820

Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Non-interest-bearing accounts	$	88,451		79,550
Interest-bearing accounts:
Interest bearing checking accounts		131,952		130,114
Savings and money market accounts		74,314		70,443
Other time deposits		474,539		519,988

Total deposits		769,256		800,095

Advances from Federal Home Loan Bank		44,222		63,319
Repurchase agreements		42,799		43,080
Subordinated debentures		10,310		10,310
Advances from borrowers for taxes and insurance		639		153
Dividends payable		179		176
Deferred tax liability		628		—
Accrued expenses and other liabilities		5,439		5,204

Total liabilities		873,472		922,337

See accompanying Notes to Unaudited Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Consolidated Condensed Statements of Financial Condition, Continued

(Dollars in Thousands)


	September 30, 2012			December 31, 2011
	(Unaudited)
Stockholders’ equity
Preferred stock, par value $0.01 per share; authorized - 500,000 shares; 18,400 shares issued and outstanding with a liquidation preference of $18,400,000 at September 30, 2012, and December 31, 2011		—			—
Common stock, par value $.01 per share; authorized 15,000,000 shares; 7,905,728 issued and 7,502,812 outstanding at September 30, 2012, and 7,895,336 issued and 7,492,420 outstanding at December 31, 2011		79			79
Common stock warrants (253,666 issued and outstanding)		556			556
Additional paid-in-capital		76,127			75,967
Retained earnings-substantially restricted		41,330			39,591
Treasury stock (at cost, 402,916 shares at September 30, 2012, and December 31, 2011)		(5,076	)		(5,076	)
Accumulated other comprehensive income, net of taxes		10,245			7,366

Total stockholders’ equity		123,261			118,483

Total liabilities and stockholders’ equity	$	996,733			1,040,820

The consolidated condensed statement of financial condition at December 31, 2011, has been derived from the audited financial statements as of that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying Notes to Unaudited Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Consolidated Condensed Statements of Income (Loss)

(Dollars in Thousands)

(Unaudited)


	For the Three Month Periods Ended September 30,				For the Nine Month Periods Ended September 30,
	2012		2011		2012		2011
Interest and dividend income:
Loans receivable	$	7,403		8,332		22,617		25,254
Investment in securities, taxable		2,014		2,581		6,823		8,003
Nontaxable securities available for sale		573		532		1,695		1,733
Interest-earning deposits		6		5		20		13

Total interest and dividend income		9,996		11,450		31,155		35,003

Interest expense:
Deposits		2,640		3,543		8,279		11,179
Advances from Federal Home Loan Bank		1,017		625		2,155		1,946
Repurchase agreements		236		238		721		668
Subordinated debentures		185		186		553		551

Total interest expense		4,078		4,592		11,708		14,344

Net interest income		5,918		6,858		19,447		20,659
Provision for loan losses		506		475		1,775		5,445

Net interest income after provision for loan losses		5,412		6,383		17,672		15,214

Non-interest income:
Service charges		963		1,020		2,874		2,828
Merchant card income		212		194		620		571
Mortgage origination revenue		218		295		684		425
Gain on sale of securities		944		1,247		1,618		2,297
Other than temporarily impairment on available for sale securities		—		—		—		(14	)
Income from bank owned life insurance		80		84		238		249
Financial services commission		280		272		778		691
Other operating income		200		169		641		717

Total non-interest income		2,897		3,281		7,453		7,764

See accompanying Notes to Unaudited Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Consolidated Condensed Statements of Income (Loss), Continued

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)


	For the Three Month Periods Ended September 30,				For the Nine Month Periods Ended September 30,
	2012		2011		2012		2011
Non-interest expenses:
Salaries and benefits	$	3,447		3,309		10,515		9,987
Occupancy expense		875		867		2,614		2,452
Data processing expense		610		653		1,863		2,056
State deposit tax		161		151		485		476
Intangible amortization expense		48		65		178		227
Professional services expense		435		293		1,320		986
Deposit insurance and examination expense		419		445		1,272		1,604
Advertising expense		324		324		952		931
Postage and communications expense		146		140		444		421
Supplies expense		64		96		280		294
Loss on disposal of equipment		5		5		13		145
Loss on sale of real estate owned		68		570		287		1,642
Real estate owned expenses		19		16		90		216
Other operating expenses		350		193		1,196		575

Total non-interest expense		6,971		7,127		21,509		22,012

Income before income tax expense		1,338		2,537		3,616		966
Income tax expense		263		909		652		375

Net income		1,075		1,628		2,964		591

Less:
Dividend on preferred shares		229		232		689		688
Accretion dividend on preferred shares		27		28		83		83

Net income (loss) available (attributable) to common shareholders	$	819	$	1,368	$	2,192	($	180	)

Net income (loss) available (attributable) to common shareholders
Per share, basic	$	0.11	$	0.18	$	0.29	($	0.02	)

Per share, diluted	$	0.11	$	0.18	$	0.29	($	0.02	)

Dividend per share	$	0.02	$	0.02	$	0.06	$	0.18

Weighted average shares outstanding - basic		7,487,283		7,481,448		7,485,571		7,456,750

Weighted average shares outstanding - diluted		7,487,283		7,481,448		7,485,571		7,456,750

See accompanying Notes to Unaudited Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Consolidated Condensed Statements of Comprehensive Income

(Dollars in Thousands)

(Unaudited)


	For the Three Month Periods Ended September 30,						For the Nine Month Periods Ended September 30,
	2012			2011			2012			2011
Net income	$	1,075			1,628			2,964			591
Other comprehensive income, net of tax:
Unrealized gain on investment securities available for sale, net of tax effect of ($1,180) and ($2,218) for the three month periods ended September 30, 2012, and September 30, 2011, respectively; and ($2,008) and ($3,801) for the nine month periods ended September 30, 2012, and September 30, 2011, respectively		1,770			4,306			3,897			7,378
Unrealized gain on derivatives, net of tax effect of ($5) and $77 for the three month periods ending September 30, 2012, and September 30, 2011, respectively; and ($26) and $97 for the nine month periods ended September 30, 2012, and September 30, 2011, respectively.		10			(149	)		50			(188	)
Reclassification adjustment for gains included in net income (loss), net of tax effect of $321 and $424 for the three month periods ended September 30, 2012, and September 30, 2011, respectively: and $550 and $781 for the nine month periods ended September 30, 2012, and September 30, 2011, respectively.		(623	)		(823	)		(1,068	)		(1,516	)

Comprehensive income	$	2,232			4,962			5,843			6,265

See accompanying Notes to Unaudited Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Consolidated Condensed Statement of Stockholders’ Equity

For the Nine Month Period Ended September 30, 2012

(Dollars in Thousands, Except Share Amounts)

(Unaudited)


																	Accumulated
	Shares						Common		Additional								Other		Total
	Common Stock		Preferred Stock		Common Stock		Stock Warrants		Capital Surplus		Retained Earnings			Treasury Stock			Comprehensive Income		Stockholders Equity
Balance at December 31, 2011		7,492,420		18,400	$	79		556		75,967		39,591			(5,076	)		7,366		118,483
Restricted stock awards		10,392		—		—		—		—		—			—			—		—
Consolidated net income		—		—		—		—		—		2,964			—			—		2,964
Compensation expense, restricted stock awards		—		—		—		—		77		—			—			—		77
Net change in unrealized gain on securities available for sale, net of income taxes of $1,457		—		—		—		—		—		—			—			2,829		2,829
Net change in unrealized loss on derivatives, net of income taxes of $26		—		—		—		—		—		—			—			50		50
Cash dividend to preferred stockholder		—		—		—		—		—		(690	)		—			—		(690	)
Accretion of preferred stock discount		—		—		—		—		83		(83	)		—			—		—
Cash dividend to common stockholders		—		—		—		—		—		(452	)		—			—		(452	)

Balance September 30, 2012		7,502,812		18,400	$	79		556		76,127		41,330			(5,076	)		10,245		123,261

See accompanying Notes to Unaudited Consolidated Condensed Financial Statements

HOPFED BANCORP, INC.

Consolidated Condensed Statements of Cash Flows

(Dollars in Thousands)

(Unaudited)


	For the Nine Month Periods Ended September 30,
	2012			2011
Cash flows from operating activities:
Net cash provided by operating activities	$	5,716			7,893

Cash flows from investing activities
Proceeds from sales, calls and maturities of securities available for sale		140,001			143,369
Purchase of securities available for sale		(101,768	)		(158,954	)
Net decrease in loans		13,978			23,228
Purchase of Federal Home Loan Bank stock		—			(50	)
Proceeds from sale of foreclosed assets		2,403			7,124
Purchase of premises and equipment		(517	)		(665	)

Net cash provided by investing activities		54,097			14,052

Cash flows from financing activities:
Net increase in non-interest bearing deposits		8,901			8,631
Net decrease in time and other deposits		(39,740	)		(24,044	)
Increase in advances from borrowers for taxes and insurance		486			384
Advances from Federal Home Loan Bank		8,000			30,000
Repayment of advances from Federal Home Loan Bank		(27,097	)		(42,708	)
Net increase (decrease) in repurchase agreements		(281	)		(1,696	)
Dividend paid on preferred stock		(690	)		(690	)
Dividends paid on common stock		(449	)		(1,758	)

Net cash used in financing activities		(50,870	)		(31,881	)

Increase (decrease) in cash and cash equivalents		8,943			(9,936	)
Cash and cash equivalents, beginning of period		48,760			60,984

Cash and cash equivalents, end of period	$	57,703			51,048

Supplemental disclosures of cash flow information:
Interest paid	$	6,279			7,447

Income taxes paid	$	1,545			1,445

Supplemental disclosures of non-cash investing and financing activities:
Loans charged off	$	3,086			2,069

Foreclosures and in substance foreclosures of loans during period	$	1,104			3,515

Net unrealized gains on investment securities classified as available for sale	$	4,286			8,882

Increase in deferred tax liability related to unrealized gains on investments	$	1,457			(2,923	)

Dividends declared and payable	$	150			176

Issue of unearned restricted stock	$	74			87

See accompanying Notes to Unaudited Consolidated Condensed Financial Statements

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(1) BASIS OF PRESENTATION

HopFed Bancorp, Inc. (the “Company”) was formed at the direction of Heritage Bank, formerly Hopkinsville Federal Savings Bank (the “Bank”), to become the holding company of the Bank upon the conversion of the Bank from a federally chartered mutual savings bank to a federally chartered stock savings bank. The conversion was consummated on February 6, 1998. The Company’s primary assets are the outstanding capital stock of the converted Bank, and its sole business is that of the converted Bank. The Bank owns 100% of the stock of Fall and Fall Insurance Agency (“Fall & Fall”) of Fulton, Kentucky. Fall & Fall sells life and casualty insurance to both individuals and businesses. The majority of Fall & Fall’s customer base is within the geographic footprint of the Bank.

The Bank operates a mortgage division, Heritage Mortgage Services, in Clarksville, Tennessee with agents located in several of its markets. The Bank has a financial services division, Heritage Solutions, with offices in Murray, Kentucky, Kingston Springs, Tennessee and Pleasant View, Tennessee. Heritage Solutions agents travel throughout western Kentucky and middle Tennessee offering fixed and variable annuities, mutual funds and brokerage services.

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted (“GAAP”) in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of only normal recurring accruals) necessary for fair representation have been included. The results of operations and other data for the three and nine month periods ended September 30, 2012, are not necessarily indicative of results that may be expected for the entire fiscal year ending December 31, 2012.

The accompanying unaudited financial statements should be read in conjunction with the Consolidated Financial Statements and the Notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The accounting policies followed by the Company are set forth in the Summary of Significant Accounting Policies in the Company’s December 31, 2011, Consolidated Financial Statements.

(2) INCOME (LOSS) PER SHARE

The following schedule reconciles the numerators and denominators of the basic and diluted income (loss) per share (“IPS”) computations for the three and nine month periods ended September 30, 2012, and September 30, 2011. Diluted common shares arise from the potentially dilutive effect of the Company’s stock options and warrants outstanding.


	Three Month Periods Ended
	September 30,
	2012		2011
Basic IPS:
Net income available to common stockholders	$	819,000	$	1,368,000
Average common shares outstanding		7,487,283		7,481,448

Net income per share available to common shareholders, basic	$	0.11	$	0.18

Diluted IPS:
Net income available to common stockholders	$	819,000	$	1,368,000
Average common shares outstanding		7,487,283		7,481,448
Dilutive effect of stock options		—		—

Average diluted shares outstanding		7,487,283		7,481,448

Net income per share available to common shareholders, diluted	$	0.11	$	0.18


	Nine Month Periods Ended
	September 30,
	2012		2011
Basic IPS:
Net income (loss) available (attributable) to common stockholders	$	2,192,000	($	180,000	)
Average common shares outstanding		7,485,571		7,456,750

Net income (loss) per share available (attributable) to common shareholders, basic	$	0.29	($	0.02	)

Diluted IPS:
Net income (loss) available (attributable) to common stockholders	$	2,192,000	($	180,000	)
Average common shares outstanding		7,485,571		7,456,750
Dilutive effect of stock options		—		—

Average diluted shares outstanding		7,485,571		7,456,750

Net income (loss) per share available (attributable) to common shareholders, diluted	$	0.29	($	0.02	)

(3) STOCK COMPENSATION

The Company incurred compensation cost related to the HopFed Bancorp, Inc. 2004 Long Term Incentive Plan of $22,700 and $76,700 for the three and nine month periods ended September 30, 2012, respectively, and $29,000 and $90,000 for the three and nine month period ended September 30, 2011, respectively. The Company issued 10,392 and 10,972 shares of restricted stock during the nine month periods ended September 30, 2012, and September 30, 2011, respectively. The Company did not issue any restricted stock during the three month period ended September 30, 2012. The table below provides a detail of the Company’s future compensation expense related to restricted stock vesting at September 30, 2012:


Year ending December 31,	Future Expense
2012	$	22,001
2013		73,739
2014		45,760
2015		27,575
2016		7,797

Total	$	176,872

The compensation committee may make additional awards of restricted stock, thereby increasing the future expense related to this plan. In addition, award vesting may be accelerated due to certain events as outlined in the restricted stock award agreement. Any acceleration of vesting will change the timing of, but not the aggregate amount of, compensation expense incurred.

(4) SECURITIES

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluations. 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.

At September 30, 2012, the Company has nine securities with unrealized losses. The amortized cost of securities and their estimated fair values at September 30, 2012, were as follows:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Restricted:
FHLB stock	$	4,428		—		—			4,428

Unrestricted:
U.S. government and agency securities:
Agency debt securities	$	148,554		5,052		(15	)		153,591
Tax free municipal bonds		62,930		5,958		—			68,888
Taxable municipal bonds		11,647		1,348		(11	)		12,984
Trust preferred securities		2,000		—		(578	)		1,422
Mortgage-backed securities:
GNMA		20,459		1,436		(3	)		21,892
FNMA		60,060		2,809		—			62,869
FHLMC		5,115		202		—			5,317
NON-AGENCY CMOs		5,419		69		—			5,488
AGENCY CMOs		15,950		488		(12	)		16,426

	$	332,134		17,362		(619	)		348,877

The amortized cost of securities and their estimated fair values at December 31, 2011, was as follows:


	December 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
			(Dollars in Thousands)
Restricted:
FHLB stock	$	4,428		—		—			4,428

Unrestricted:
U.S. government and agency securities:	$	171,141		3,511		(65	)		174,587
Tax free municipal bonds		60,432		4,623		—			65,055
Taxable municipal bonds		12,846		1,059		—			13,905
Trust preferred securities		2,000		—		(1,007	)		993
Mortgage-backed securities:
GNMA		30,427		1,413		(19	)		31,821
FNMA		59,195		2,101		(1	)		61,295
FHLMC		15,108		491		—			15,599
NON-AGENCY CMOs		2,012		7		(223	)		1,796
AGENCY CMOs		18,163		568		—			18,731

	$	371,324		13,773		(1,315	)		383,782

The scheduled maturities of debt securities available for sale at September 30, 2012, were as follows:


September 30, 2012	Amortized Cost		Estimated Fair Value
	(Dollars in Thousands)
Due within one year	$	535	$	538
Due in one to five years		10,095		10,311
Due in five to ten years		23,790		26,033
Due in more than ten years		52,381		56,826

		86,801		93,708
Amortizing agency bonds		138,330		143,177
Mortgage-backed securities		107,003		111,992

Total debt securities available for sale	$	332,134	$	348,877

The scheduled maturities of debt securities available for sale at December 31, 2011, were as follows:


December 31, 2011	Amortized Cost		Estimated Fair Value
	(Dollars in Thousands)
Due within one year	$	461		464
Due in one to five years		6,844		6,929
Due in five to ten years		24,471		26,153
Due after ten years		72,460		75,804

		104,236		109,350
Amortizing agency bonds		142,183		145,190
Mortgage-backed securities		124,905		129,242

Total debt securities available for sale	$	371,324		383,782

The estimated fair value and unrealized loss amounts of temporarily impaired investments as of September 30, 2012, are as follows:


	Less than 12 months					12 months or longer					Total
	Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses
	(Dollars in Thousands)
Available for sale
U.S. government and agency securities:
Agency debt securities	$	6,674		(15	)		—		—			6,674		(15	)
Taxable municipals		862		(11	)		—		—			862		(11	)
Tax free municipals		—		—			—		—			—		—
Trust preferred securities		—		—			1,422		(578	)		1,422		(578	)
Mortgage-backed securities:
GNMA		—		—			1,565		(3	)		1,565		(3	)
FNMA		—		—			—		—			—		—
FHLMC		—		—			—		—			—		—
NON-AGENCY CMOs		—		—			—		—			—		—
AGENCY CMOs		1,860		(12	)		—		—			1,860		(12	)

Total Available for Sale	$	9,396		(38	)		2,987		(581	)		12,383		(619	)

The estimated fair value and unrealized loss amounts of temporarily impaired investments as of December 31, 2011, were as follows:


	Less than 12 months					12 months or longer					Total
	Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses
	(Dollars in Thousands)
Available for sale
U.S. government and agency securities:
Agency debt securities	$	20,422		(54	)		2,007		(11	)		22,429		(65	)
Taxable municipal bonds		—		—			—		—			—		—
Tax free municipal bonds		—		—			—		—			—		—
Trust preferred securities		—		—			993		(1,007	)		993		(1,007	)
Mortgage-backed securities:
GNMA		1,925		(19	)		—		—			1,925		(19	)
FNMA		—		—			81		(1	)		81		(1	)
FHLMC		—		—			—		—			—		—
NON-AGENCY CMOs		—		—			1,494		(223	)		1,494		(223	)
AGENCY CMOs		—		—			—		—			—		—

Total Available for Sale	$	22,347		(73	)		4,575		(1,242	)		26,922		(1,315	)

At September 30, 2012, securities with a book value of approximately $122.6 million and a market value of approximately $132.6 million were pledged to various municipalities for deposits in excess of FDIC limits as required by law. The Federal Home Loan Bank of Cincinnati has issued letters of credit in the Bank’s name totaling $15.5 million secured by the Bank’s loan portfolio to secure additional municipal deposits.

At September 30, 2012, securities with a book and market value of approximately $26.8 million were sold under agreements to repurchase from various customers. Furthermore, the Company has two wholesale repurchase agreements with third parties secured by investments with a combined book value of $21.2 million and a market value of $22.0 million. One repurchase agreement is in the amount of $6.0 million and has a maturity of September 18, 2016 and is currently callable on a quarterly basis and has a fixed rate of interest of 4.36%. The second repurchase agreement, in the amount of $10.0 million, has a maturity of September 5, 2014, is currently callable quarterly and has a fixed rate of interest of 4.28%.

(5) LOANS

Set forth below is selected data relating to the composition of the loan portfolio by type of loan at September 30, 2012 and December 31, 2011. At September 30, 2012 and December 31, 2011, there were no concentrations of loans exceeding 10% of total loans other than as disclosed below:


	September 30, 2012		September 30, 2012			December 31, 2011		December 31, 2011
	Amount		Percent			Amount		Percent
	(Dollars in Thousands)
Real estate loans:
One-to-four family (closed end) first mortgages	$	165,439		30.1	%	$	171,192		30.2	%
Second mortgages (closed end)		5,382		1.0	%		6,209		1.1	%
Home equity lines of credit		37,962		6.9	%		38,694		6.8	%
Multi-family		33,243		6.0	%		33,739		5.9	%
Construction		15,694		2.8	%		11,931		2.1	%
Land for development		47,189		8.6	%		52,338		9.2	%
Farmland		38,821		7.1	%		34,841		6.1	%
Non-residential real estate		133,747		24.3	%		148,644		26.2	%

Total mortgage loans		477,477		86.8	%		497,588		87.6	%

Consumer loans		13,094		2.4	%		15,110		2.7	%
Commercial loans		59,252		10.8	%		54,673		9.7	%

Total other loans		72,346		13.2	%		69,783		12.4	%

Total loans, gross		549,823		100.0	%		567,371		100.0	%

Deferred loan cost, net of income		170					251

Less allowance for loan losses		10,490					11,262

Total loans	$	539,503				$	556,360

The Bank assigns an industry standard NAICS code to each loan in the Bank’s portfolio. By assigning a standard code to each type of loan, management can more readily determine concentrations in risk by industry, location and loan type. This information is most useful when analyzing the Bank’s non-residential real estate loan portfolio. At September 30, 2012, and December 31, 2011, the Bank’s non-residential real estate, land for development and farmland loan portfolio was made up of the following loan types:


	Balance		Balance
	September 30, 2012		December 31, 2011
	(Dollars in Thousands)
Land & development	$	47,189		52,338
Construction		5,933		6,151
Manufacturing		3,861		4,172
Professional and Technical		2,051		2,300
Retail Trade		10,771		12,019
Other Services		17,199		17,767
Finance & Insurance		375		141
Agricultural, Forestry, Fishing & Hunting		38,821		33,473
Real Estate and Rental and Leasing		45,771		50,770
Wholesale Trade		8,569		6,235
Arts, Entertainment & Recreation		3,526		5,309
Accomodations / Food Service		23,025		25,255
Healthcare and Social Assistance		4,614		10,140
Educational Services		25		30
Transportation & Warehousing		1,325		1,638
Information		2,568		2,646
Non-industry		1,089		3,219
Admin Support / Waste Mgmt		3,045		2,220

Total	$	219,757		235,823

The allowance for loan losses totaled $10.5 million at September 30, 2012, $11.3 million at December 31, 2011, and $13.5 million at September 30, 2011. The ratio of the allowance for loan losses to total loans was 1.91% at September 30, 2012, 1.98% at December 31, 2011, and 2.33% at September 30, 2011. The following table indicates the type and level of non-accrual loans at the periods indicated below:


	September 30, 2012		December 31, 2011		September 30, 2011
	(Dollars in Thousands)
One-to-four family mortgages	$	2,795		2,074		1,857
Home equity line of credit		24		134		137
Junior lien		—		101		—
Multi-family		190		—		—
Construction		—		—		—
Land		3,279		1,330		1,331
Non-residential real estate		1,268		2,231		639
Farmland		49		—		—
Consumer loans		59		9		9
Commercial loans		2,160		254		278

Total non-accrual loans	$	9,824		6,133		4,251

The following table provides a detail of the Company’s activity in the allowance for loan loss account by loan type for the year ended September 30, 2012:


Nine month period ended September 30, 2012	Balance December 31, 2011		Charge off 2012			Recovery 2012		General Provision 2012			Specific Provision 2012			Ending Balance Period Ending September 30, 2012
	(Table in Thousands)
One-to-four family mortgages	$	2,640		(282	)		77		237			(323	)		2,349
Home equity line of credit		408		(65	)		5		(15	)		1			334
Junior liens		277		(1	)		3		(34	)		(87	)		158
Multi-family		1,201		(416	)		—		(648	)		576			713
Construction		139		—			—		(11	)		279			407
Land		1,332		(1,033	)		234		491			930			1,954
Non-residential real estate		3,671		(799	)		100		63			638			3,673
Consumer loans		262		(284	)		110		151			23			262
Commercial loans		1,332		(206	)		10		(68	)		(428	)		640

	$	11,262		(3,086	)		539		166			1,609			10,490


The following table provides a detail of the Company’s activity in the allowance for loan loss account by loan type for the year ended December 31, 2011:

Year Ended December 31, 2011	Balance December 31, 2010		Charge off 2011			Recovery 2011		General Provision 2011			Specific Provision 2011			Ending Balance Year Ending December 31, 2011
	(Table in Thousands)
One-to-four family mortgages	$	1,097		(758	)		139		1,687			475			2,640
Home equity line of credit		212		(123	)		—		245			74			408
Junior liens		146		(27	)		1		79			78			277
Multi-family		2,022		(89	)		—		26			(758	)		1,201
Construction		657		(353	)		—		(91	)		(74	)		139
Land		865		(308	)		30		353			392			1,332
Non-residential real estate		4,025		(2,645	)		84		1,114			1,093			3,671
Consumer loans		108		(371	)		112		425			(12	)		262
Commercial loans		698		(201	)		20		305			510			1,332

	$	9,830		(4,875	)		386		4,143			1,778			11,262

The Company’s general provisions represent the current eight quarter loss history of the Company by loan type. The loss history is weighted using the sum of the quarter digit method, placing more emphasis on the most recent quarterly result and may be further adjusted for any adverse trends in the local or national markets. A negative general provision indicates that the Company’s recent loss history has improved over prior periods or has been specifically reserved for and that lower amounts of general provisions are necessary.

The table below presents past due and non-accrual balances at September 30, 2012, and December 31, 2011, by loan classification allocated between performing and non-performing:


	Currently		30 - 89 Days		Non-accrual		Special		Impaired Loans Currently Performing
September 30, 2012	Performing		Past Due		Loans		Mention		Substandard		Doubful		Total
					(Dollars in Thousands)
One-to-four family mortgages	$	154,241		2,240		2,795		1,940		4,223		—		165,439
Home equity line of credit		35,454		55		24		1,202		1,227		—		37,962
Junior liens		4,722		10		—		73		577		—		5,382
Multi-family		20,297		—		190		6,192		6,564		—		33,243
Construction		11,606		—		—		—		4,088		—		15,694
Land		17,540		—		3,279		9,069		17,301		—		47,189
Non-residential real estate		142,193		575		1,317		3,732		24,751		—		172,568
Consumer loans		12,541		86		59		2		406		—		13,094
Commercial loans		49,873		19		2,160		837		6,363		—		59,252

	$	448,467		2,985		9,824		23,047		65,500		—		549,823


	Currently Performing		30 - 89 Days Past Due		Non-accrual Loans		Special Mention		Impaired Loans Currently Performing
December 31, 2011	Currently Performing		30 - 89 Days Past Due		Non-accrual Loans		Special Mention		Substandard		Doubtful		Total
					(Dollars in Thousands)
One-to-four family mortgages	$	153,375		628		2,074		9,163		5,722		230		171,192
Home equity line of credit		36,528		5		134		1,664		134		229		38,694
Junior liens		4,778		312		101		521		497		—		6,209
Multi-family		20,715		—		—		7,073		5,951		—		33,739
Construction		9,943		107		—		213		1,668		—		11,931
Land		17,570		237		1,330		24,714		7,488		999		52,338
Non-residential real estate		142,190		487		2,231		24,782		13,678		117		183,485
Consumer loans		14,399		28		9		268		386		20		15,110
Commercial loans		45,509		506		254		4,003		4,385		16		54,673

Total	$	445,007		2,310		6,133		72,401		39,909		1,611		567,371

All loans listed as 30 – 89 days past due are not performing as agreed. Loans listed as non-accrual may or may not be performing as agreed but have significant weaknesses that makes it doubtful as to whether the loan will continue to perform as agreed. Loans listed as special mention, substandard and doubtful are paying as agreed. However, the customer’s financial statements may indicate weaknesses in their current cash flow, the customer’s industry may be in decline due to current economic conditions, collateral values used to secure the loan may be declining, or the Company may be concerned about the customer’s future business prospects. At September 30, 2012, loans held for sale totaling $2,763,000 were previously classified as non-accrual. Included in loans held for sale is a $760,000 land development loan and a $2.0 million Commercial real estate loan. The sale of both loans settled November 5, 2012.

The Bank does not originate loans it considers sub-prime and is not aware of any exposure to the additional credit concerns associated with sub-prime lending in either the Company’s loan or investment portfolios. The Company does have a significant amount of construction and land development loans. Management reports to the Company’s Board of Directors on the status of the Company’s specific construction and development loans as well as the market trends in those markets in which the Company actively participates.

The Company’s annualized net charge off ratios for the nine month periods ended September 30, 2012, September 30, 2011, and the year ended December 31, 2011, were 0.61%, 0.39% and 0.76%, respectively. The ratios of allowance for loan losses to non-accrual loans at September 30, 2012, September 30, 2011, and December 31, 2011, were 106.78%, 318.49%, and 183.62% respectively. The following table sets forth an analysis of the Bank’s allowance for loan losses for the periods ended:


	September 30, 2012			December 31, 2011			September 30, 2011
	(Dollars in Thousands, Except Percentages)
Beginning balance, allowance for loan loss	$	11,262			9,830			9,830
Charge offs
One-to-four family mortgages		(282	)		(758	)		(441	)
Home equity line of credit		(65	)		(123	)		(57	)
Junior liens		(1	)		(27	)		—
Multi-family		(416	)		(89	)		(89	)
Construction		—			(353	)		(353	)
Land		(1,033	)		(308	)		(198	)
Non-residential real estate		(799	)		(2,645	)		(572	)
Consumer loans		(284	)		(371	)		(326	)
Commercial loans		(206	)		(201	)		(33	)

Total charge offs		(3,086	)		(4,875	)		(2,069	)

Recoveries
One-to-four family mortgages		77			139			136
Home equity line of credit		5			—			—
Junior liens		3			1			1
Multi-family		—			—			—
Construction		—			—			—
Land		234			30			30
Non-residential real estate		100			84			84
Consumer loans		110			112			82
Commercial loans		10			20			2

Total recoveries		539			386			335

Net Charge offs		(2,547	)		(4,489	)		(1,734	)

Provision for loan losses		1,775			5,921			5,445

Ending balance	$	10,490			11,262			13,541

Average loan balance, gross	$	556,332			575,133			592,417

Ratio of net charge offs to average outstanding loans during the period		0.61	%		0.76	%		0.39	%

The determination of the allowance for loan losses is based on management’s analysis, performed on a quarterly basis. Various factors are considered, including the market value of the underlying collateral, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans, historical loss experience, delinquency trends and prevailing economic conditions. Although management believes its allowance for loan losses is adequate, there can be no assurance that additional allowances will not be required or that losses on loans will not be incurred.

The Company conducts annual reviews on all loan relationships above one million to ascertain the borrowers continued ability to service their debt as agreed. In addition to the credit relationships mentioned above, management may classify any credit relationship once it becomes aware of adverse credit trends for that customer. Typically, the annual review consists of updated financial statements for borrowers and any guarantors, a review of the borrower’s credit history with the Company and other creditors, and current income tax information.

As a result of this review, management will classify loans based on their credit risk. Additionally, the Company provides a risk grade for all loans past due more than sixty days. The Company uses the following risk definitions for risk grades:

Satisfactory loans of average strength may have some deficiency or vulnerability to changing economic or industry conditions. These customers should have reasonable amount of capital and operating ratios. Secured loans may lack in margin or liquidity. Loans to individuals, perhaps supported in dollars of net worth, but with supporting assets may be difficult to liquidate.

Watch loans are acceptable credits: (1) that need continual monitoring, such as out-of territory or asset-based loans (since the Bank does not have an asset-based lending department), or (2) with a marginal risk level to business concerns and individuals that; (a) have exhibited favorable performance in the past, though currently experiencing negative trends; (b) are in an industry that is experiencing volatility or is declining, and their performance is less than industry norms; and (c) are experiencing unfavorable trends in their financial position, such as one-time net losses or declines in asset values. These marginal borrowers may have early warning signs of problems such as occasional overdrafts and minor delinquency. If considered marginal, a loan would be a “watch” until financial data demonstrated improved performance or further deterioration to a “substandard” grade usually within a 12-month period. In the table on page 23, Watch loans are included with satisfactory loans and classified as Pass.

Loans classified as Other Loans Especially Mentioned are considered currently protected but are potentially weak. These loans constitute an undue and unwarranted credit risk but not to the point of justifying a substandard classification. The credit risk may be relatively minor yet constitutes an unwarranted risk in light of the circumstances surrounding a specific loan. These credit weaknesses, if not checked or corrected, will weaken the loan or inadequately protect the Bank’s credit position at some future date.

A Substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. The loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. This does not imply ultimate loss of the principal, but may involve burdensome administrative expenses and the accompanying cost to carry the credit. Examples of substandard loans include those to borrowers with insufficient or negative cash flow, negative net worth coupled with inadequate guarantor support, inadequate working capital, and/or significantly past-due loans and overdrafts.

A loan classified Doubtful has all the weaknesses inherent in a substandard credit except that the weaknesses make collection or liquidation in full (on the basis of currently existing facts, conditions, and values) highly questionable and improbable. The possibility of loss is extremely high, but because of certain pending factors charge-off is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans. The doubtful classification is applied to that portion of the credit in which the full collection of principal and interest is questionable.

A loan is considered to be classified when management determines that it is probable that the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. The value of individually classified loans is measured based on the present value of expected payments using the fair value of the collateral if the loan is collateral dependent. Currently, it is management’s practice to classify all substandard or doubtful loans as classified. At September 30, 2012, December 31, 2011, and September 30, 2011, the Company’s classified loans totaled $75.8 million, $49.3 million and $56.8 million, respectively. At September 30, 2012, December 31, 2011, and September 30, 2011, the Company’s specific reserve for impaired loans totaled $3.6 million, $4.1 million and $6.0 million, respectively.

A summary of the Company’s loans, including their respective regulatory classification and their respective specific reserve at September 30, 2012, is as follows:


			Special		Impaired Loans						Specific Reserve for		Reserve for Performing
September 30, 2012	Pass		Mention		Substandard		Doubful		Total		Impairment		Loans
	(Dollars in Thousands)
One-to-four family mortgages	$	156,358		1,940		7,025		116		165,439		509		1,840
Home equity line of credit		35,510		1,201		1,251		—		37,962		14		320
Junior liens		4,727		74		581		—		5,382		104		54
Multi-family		20,298		6,191		6,754		—		33,243		356		357
Construction		11,606		—		4,088		—		15,694		294		113
Land		17,539		9,070		20,580		—		47,189		888		1,066
Non-residential real estate		142,397		3,809		26,362		—		172,568		1,228		2,445
Consumer loans		12,577		12		505		—		13,094		102		160
Commercial loans		49,892		837		8,523		—		59,252		86		554

Total	$	450,904		23,134		75,669		116		549,823		3,581		6,909

A summary of the Company’s impaired loans, including their respective regulatory classification and their respective specific reserve at December 31, 2011, is as follows:


			Special		Impaired Loans						Specific Reserve for		Allowance for Performing
December 31, 2011	Pass		Mention		Substandard		Doubful		Total		Impairment		Loans
	(Dollars in Thousands)
One-to-four family mortgages	$	153,375		9,434		8,153		230		171,192		728		1,912
Home equity line of credit		36,528		1,694		233		239		38,694		131		277
Junior liens		4,778		622		809		—		6,209		180		97
Multi-family		20,715		7,073		5,951		—		33,739		26		1,175
Construction		9,943		213		1,775		—		11,931		14		125
Land		17,570		24,714		9,055		999		52,338		924		408
Non-residential real estate		142,190		25,077		16,101		117		183,485		1,374		2,297
Consumer loans		14,399		268		423		20		15,110		80		182
Commercial loans		45,509		4,009		5,034		121		54,673		623		709

Total	$	445,007		73,104		47,534		1,726		567,371		4,080		7,182

Impaired loans by classification type and the related valuation allowance amounts at September 30, 2012, were as follows:


	At September 30, 2012						For the nine month period ended September 30, 2012
Impaired loans with no recorded allowance:	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
One-to-four family mortgages	$	4,618		4,618		—		6,538		171
Home equity line of credit		976		976		—		787		32
Junior liens		477		477		—		375		22
Multi-family		3,025		3,025		—		3,394		78
Construction		—		—		—		2,562		—
Land		16,967		16,967		—		19,971		289
Non-residential real estate		21,066		21,066		—		21,495		1,038
Consumer loans		115		115		—		62		5
Commercial loans		2,444		2,444		—		2,895		207

Total	$	49,688		49,688		—		58,079		1,842


	At September 30, 2012						For the nine month period ended September 30, 2012
Impaired loans with recorded allowance:	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
One-to-four family mortgages	$	2,523		2,523		509		3,149		108
Home equity line of credit		275		275		14		176		8
Junior liens		104		104		104		331		10
Multi-family		3,729		3,729		356		3,590		178
Construction		4,088		4,088		294		1,460		83
Land		3,613		3,613		888		5,274		145
Non-residential real estate		5,296		5,296		1,228		6,708		271
Consumer loans		390		390		102		217		1
Commercial loans		6,079		6,079		86		4,552		42

Total	$	26,097		26,097		3,581		25,457		846

Total impaired loans	$	75,785		75,785		3,581		83,536		2,688

On a periodic basis, the Bank may modify the terms of certain loans. In evaluating whether a restructuring constitutes a troubled debt restructuring (TDR), Financial Accounting Standards Board has issued Accounting Standards Update 310 (ASU 310); A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. In evaluating whether a restructuring constitutes a TDR, the Bank must separately conclude that both of the following exist:

•

The restructuring constitutes a concession

•

The debtor is experiencing financial difficulties

ASU 310 provides the following guidance for the Bank’s evaluation of whether it has granted a concession as follows:

•

If a debtor does not otherwise have access to funds at a market interest rate for debt with similar risk characteristics as the restructured debt, the restructured debt would be considered a below market rate, which may indicate that the Bank may have granted a concession. In that circumstance, the Bank should consider all aspects of the restructuring in determining whether it has granted a concession, the creditor must make a separate assessment about whether the debtor is experiencing financial difficulties to determine whether the restructuring constitutes a TDR.

•

A temporary or permanent increase in the interest rate on a loan as a result of a restructuring does not eliminate the possibility of the restructuring from being considered a concession if the new interest rate on the loan is below the market interest rate for loans of similar risk characteristics.

•

A restructuring that results in a delay in payment that is insignificant is not a concession. However, the Bank must consider a variety of factors in assessing whether a restructuring resulting in a delay in payment is insignificant.

Troubled Debt Restructuring

Due to challenges in the local and national economy that persisted into 2012, the Company has had more of its customers incur financial problems. These customers may request temporary or permanent modification of loans in an effort to avoid foreclosure. The Company analyzes each request separately and grants loan modifications based on the customer’s ability to eventually repay the loan and return to the original loan terms, the customer’s current loan status and the current and projected future value of the Bank’s collateral. Loans that are modified as a result of a customer’s financial distress are classified as Troubled Debt Restructuring (TDR). The classification of a loan as TDR is important in that it indicates that a particular customer may not be past due but represents a credit weakness due to the Bank’s willingness to modify loan terms based on the financial weakness of the borrower. The classification of a loan as a TDR may represent the Company’s “last best chance” to work with a distressed customer before foreclosure proceedings begin.

A summary of the Company’s loans classified as Troubled Debt Restructurings (TDR’s) that are reported as performing at September 30, 2012 and December 31, 2011, is below:


	September 30, 2012			December 31, 2011
TDR by Loan Type:	(Dollars in Thousands)
One-to-four family mortgages	$	2,001			2,521
Home equity line of credit		204			—
Junior lien		—			857
Multi-family		236			—
Construction		3,145			—
Land		4,801			941
Non-residential real estate		2,490			3,367
Farmland		956			—
Consumer loans		8			33
Commercial loans		371			125

Total TDR		14,212			7,844

Less:
TDR in non-accrual status
One-to-four family mortgages		(1,449	)		(1,410	)
Home equity line of credit		—			—
Junior lien		—			(100	)
Multi-family		—			—
Construction		—			—
Land		(2,490	)		—
Non-residential real estate		(956	)		(1	)
Consumer loans		—			(1	)
Commercial loans		—			(105	)

Total performing TDR	$	9,317			6,227

At September 30, 2012, the Company’s level of performing Troubled Debt Restructurings (“TDRs”) was $9.3 million, as compared to $6.2 million at December 31, 2011. A summary of the activity in loans classified as performing TDRs for the nine month period ended September 30, 2012, is as follows:


	Balance at December 31, 2011		New TDR		Loss or Foreclosure		Removed due to performance		Balance at September 30, 2012
	(Dollars in Thousands)
One-to-four family mortgages		1,111		146		—		705		552
Home equity line of credit		—		244		—		40		204
Junior Lien		757		—		—		757		—
Multi-family		—		239		—		3		236
Construction		—		3,145		—		—		3,145
Land		941		4,850		233		757		4,801
Farmland		—		956		—		956		—
Non-residential real estate		3,366		—		453		2,913		—
Consumer loans		32		75		2		97		8
Commercial loans		20		931		10		570		371

Total performing TDR		6,227		10,586		698		6,798		9,317

The following is a summary of the activity in loans classified as performing TDR’s for the twelve month period ended December 31, 2011:


	Balance at December 31, 2010		New TDR		Loss or Foreclosure		Removed due to performance		Balance at December 31, 2011
One-to-four family mortgages		2,751		1,163		401		2,402		1,111
Home equity line of credit		114		—		—		114		—
Junior Lien		—		757		—		—		757
Multi-family		246		—		5		241		—
Construction		203		1,438		1,641		—		—
Land		—		1,475		534		—		941
Farmland		—		—		—		—		—
Non-residential real estate		3,915		1,540		1,228		861		3,366
Consumer loans		69		27		9		55		32
Commercial loans		700		102		235		547		20

Total performing TDR		7,998		6,502		4,053		4,220		6,227

(6) REAL ESTATE AND OTHER ASSETS OWNED

The Company’s real estate and other assets owned represent properties and personal collateral acquired through customer loan defaults. The property is recorded at the lower of cost or fair value less estimated cost to sell and carrying cost at the date acquired. Any difference between the book value and estimated market value is recognized as a charge off through the allowance for loan loss account. Additional real estate owned and other asset losses may be determined on individual properties at specific intervals or at the time of disposal. In general, the Company will obtain a new appraisal on all real estate owned with a book balance in excess of $100,000 on an annual basis. Additional losses are recognized as a non-interest expense.

At September 30, 2012, December 31, 2011, and September 30, 2011, the Company had balances in other real estate assets owned and problem loans consisting of the following:


	September 30, 2012			December 31, 2011			September 30, 2011
	(Dollars in Thousands)
One-to-four family mortgages	$	147			480			218
Multi-family		—			905			2,507
Construction		216			465			535
Land		275			248			665
Non-residential real estate		43			160			635
Consumer loans		—			9			1

Total other assets owned	$	681			2,267			4,561

Total non-accrual loans	$	9,824			6,133			4,251

Total non-performing assets	$	10,505			8,400			8,812

Non-performing asset / Total assets		1.05	%		0.81	%		0.83	%

The following is a summary of the activity in the Company’s real estate and other assets owned for the nine month period ending September 30, 2012:


	Balance		Activity During 2012					Reduction			Gain (Loss)			Balance
	12/31/2011		Foreclosures		Sales			in Values			on Sale			9/30/2012
	(Dollars in Thousands)
One-to-four family mortgages	$	480		658		(855	)		(107	)		(29	)		147
Multi-family		905		—		(875	)		—			(30	)		—
Construction		465		—		(235	)		—			(14	)		216
Land		248		383		(269	)		(68	)		(19	)		275
Non-residential real estate		160		63		(160	)		(20	)		—			43
Consumer assets		9		—		(9	)		—			—			—

Total	$	2,267		1,104		(2,403	)		(195	)		(92	)		681

(7) INVESTMENTS IN AFFILIATED COMPANIES

Investments in affiliated companies accounted for under the equity method consist of 100% of the common stock of HopFed Capital Trust 1 (“Trust”), a wholly-owned statutory business trust. The Trust was formed on September 25, 2003. Summary financial information for the Trust follows (dollars in thousands):

Summary Statements of Financial Condition


	At September 30, 2012		At December 31, 2011
Asset - investment in subordinated debentures issued by HopFed Bancorp, Inc.	$	10,310		10,310

Liabilities		—		—

Stockholder’s equity – trust preferred securities		10,000		10,000
Common stock (100% Owned by HopFed Bancorp, Inc.)		310		310

Total stockholders’ equity	$	10,310		10,310

Summary Statement of Income


	Three Month Periods Ended September 30,				Nine Month Period Ended September 30,
	2012		2011		2012		2011
Income – interest income from subordinated debenturesissued by HopFed Bancorp, Inc.	$	93		91	$	282		265

Net income	$	93		91	$	282		265

Summary Statement of Stockholders’ Equity


	Trust Preferred Securities		Common Stock		Retained Earnings			Total Stockholders’ Equity
Beginning balances, December 31, 2011	$	10,000		310		—			10,310
Net income		—		—		282			282
Dividends:
Trust preferred securities		—		—		(274	)		(274	)
Common paid to HopFed Bancorp, Inc.		—		—		(8	)		(8	)

Ending balances, September 30, 2012	$	10,000		310		—			10,310

(8) FAIR VALUE OF ASSETS AND LIABILITIES

In September 2006, the FASB issued ASC 820-10, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosure about fair value. The statement establishes a fair value hierarchy which requires an entity to maximize the use of observable input and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value.

•

Level 1 is for assets and liabilities that management has obtained quoted prices (unadjusted for transaction cost) or identical assets or liabilities in active markets that the Company has the ability to access as of the measurement date.

•

Level 2 is for assets and liabilities in which significant unobservable inputs other than Level 1 prices such as quoted prices for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

•

Level 3 is for assets and liabilities in which significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair values of securities available for sale are determined by a matrix pricing, which is a mathematical technique that is widely used in the industry to value debt securities without exclusively using quoted prices for the individual securities in the Company’s portfolio but rather by relying on the securities relationship to other benchmark quoted securities. Impaired loans are valued at the net present value of expected payments using the fair value of any assigned collateral. The values for bank owned life insurance are obtained from stated values from the respective insurance companies. The liability associated with the Company’s derivative is obtained from a quoted value supplied by our correspondent banker. The value of real estate owned is obtained from appraisals completed on properties at the time of acquisition and annually thereafter.

Assets and Liabilities Measured on a Recurring Basis

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


September 30, 2012	Total carrying Value in the Consolidated Balance sheet at		Quoted Prices In Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	September 30, 2012		(Level 1)		(Level 2)		(Level 3)
Assets
Available for sale securities	$	348,877		—		347,455		1,422
Bank owned life insurance		9,373		—		9,373		—

Liabilities
Interest rate swap		1,220		—		1,220		—


December 31, 2011	Total carrying Value in the Consolidated Balance sheet at		Quoted Prices In Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	December 31, 2011		(Level 1)		(Level 2)		(Level 3)

Assets
Available for sale securities	$	383,782		—		382,789		993
Bank owned life insurance		9,135		—		9,135		—

Liabilities
Interest rate swap		1,297		—		1,297		—

The assets measured at fair value on a non-recurring basis are summarized below for September 30, 2012:


September 30, 2012	Total carrying Value in the Consolidated Balance sheet at		Quoted Prices In Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	September 30, 2012		(Level 1)		(Level 2)		(Level 3)
Assets
Other real estate owned	$	681		—		—	$	681

Impaired loans, net of reserve of $3,581	$	72,204		—		—	$	72,204

The assets measured at fair value on a non-recurring basis are summarized below for December 31, 2011:


December 31, 2011	Total carrying value in the consolidated balance sheet		Quoted Prices In Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	at December 31, 2011		(Level 1)		(Level 2)		(Level 3)
Assets
Other real estate owned	$	2,258		—		—	$	2,258
Other assets owned		9		—		—		9
Impaired loans, net of reserve of $4,080		45,180		—		—		45,180

The table below includes a roll-forward of the consolidated condensed statement of financial condition items for the nine month periods ended September 30, 2012, and September 30, 2011, (including the change in fair value) for assets and liabilities classified by HopFed Bancorp, Inc. within level 3 of the valuation hierarchy for assets and liabilities measured at fair value on a recurring basis. When a determination is made to classify an asset or liability within level 3 of the valuation hierarchy, the determination is based upon the significance of the unobservable factors to the overall fair value measurement. However, since level 3 assets and liabilities typically include, in addition to the unobservable or level 3 components, observable components (that is components that are actively quoted and can be validated to external sources), the gains and losses in the table below include changes in fair value due in part to observable factors that are part of the valuation methodology.


	2012				2011
Nine month period ended September 30,	Available for Sale Securities		Liabilities		Available for Sale Securities			Liabilities
			(Dollars in Thousands)
Fair value, January 1,	$	993		—	$	1,277			—
Change in unrealized gains (losses) included in other comprehensive income for assets and liabilities still held at September 30,		429		—		(231	)		—
Purchases, issuances and settlements, net		—		—		—			—
Transfers in and/or out of Level 3		—		—		—			—

Fair value, September 30,	$	1,422		—	$	1,046			—

The estimated fair values of financial instruments were as follows at September 30, 2012:


					Estimated Fair Value Measurement at September 30, 2012 Using
	Carrying Amount		Estimated Fair Value		Quoted Prices In Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3
	(Dollars in Thousands)
Financial Assets:
Cash and due from banks	$	50,042		50,042	$	50,042		—		—
Interest-earning deposits		7,661		7,661		7,661		—		—
Securities available for sale		348,877		348,877		—		347,455		1,422
Federal Home Loan Bank stock		4,428		4,428		—		4,428		—
Commercial real estate held for sale		2,763		2,763		—		2,763		—
Loans receivable		539,503		573,132		—		—		573,132
Accrued interest receivable		5,333		5,333		—		5,333		—
Bank owned life insurance		9,373		9,373		—		9,373		—
Financial liabilities:
Deposits		769,256		780,206		298,496		481,710		—
Advances from borrowers for taxes and insurance		639		639		—		—		633
Advances from Federal Home Loan Bank		44,222		48,655		—		48,655		—
Repurchase agreements		42,799		44,252		26,799		17,453		—
Subordinated debentures		10,310		10,099		—		—		10,099
Off-balance-sheet liabilities:
Commitments to extend credit		—		—		—		—		—
Commercial letters of credit		—		—		—		—		—
Market value of interest rate swap		1,220		1,220		—		1,220		—

The estimated fair values of financial instruments were as follows at December 31, 2011:


					Estimated Fair Value Measurement at December 31, 2011 Using
	Carrying Amount		Estimated Fair Value		Quoted Prices In Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3
	(Dollars in Thousands)
Financial Assets:
Cash and due from banks	$	44,389		44,389	$	44,389		—		—
Interest-earning deposits		4,371		4,371		4,371		—		—
Securities available for sale		383,782		383,782		—		382,789		993
Federal Home Loan Bank stock		4,428		4,428		—		4,428		—
Loans receivable		556,360		585,734		—		—		585,734
Accrued interest receivable		6,183		6,183		—		6,183		—
Bank owned life insurance		9,135		9,135		—		9,135		—
Financial liabilities:
Deposits		800,095		811,415		280,107		531,308		—
Advances from borrowers for taxes and insurance		153		153		—		—		153
Advances from Federal Home Loan Bank		63,319		69,206		3,000		66,287		—
Repurchase agreements		43,080		44,969		27,080		17,889		—
Subordinated debentures		10,310		10,099		—		—		10,099
Off-balance-sheet liabilities:
Commitments to extend credit		—		—		—		—		—
Commercial letters of credit		—		—		—		—		—
Market value of interest rate swap		1,297		1,297		—		1,297		—

(9) ISSUANCE OF SHARES

On December 12, 2008, HopFed Bancorp issued and sold 18,400 shares of preferred stock to the United States Treasury (Treasury) for $18,400,000 pursuant to the Capital Purchase Program. The Company also issued 243,816 common stock warrants to the Treasury as a condition to its participation in the Capital Purchase Program. The warrants have an exercise price of $11.32 each and are immediately exercisable. The warrants expire in ten years from the date of issuance. The preferred stock has no stated maturity and is non-voting, other than having class voting rights on certain matters, and pays cumulative dividends quarterly at a rate of 5% per year for the first five years and 9% thereafter.

On September 22, 2010, and September 21, 2011, the Board of Directors declared a 2% common stock dividend to be paid to shareholders of record on September 30, 2010 and October 3, 2011, respectively. As a result of the common stock dividends, total shares outstanding increased by 143,458 at September 30, 2010, and 146,485 on October 3, 2011. In addition, the Company is obligated to adjust the number and strike price of warrants issued to the United States Treasury under the Capital Purchase Program. At November 10, 2012, the warrant balance is 253,666 shares and the warrant strike price is $10.88.

(10) STOCK OPTIONS

At September 30, 2012, all stock options outstanding were issued under the HopFed Bancorp, Inc. 1999 Stock Option Plan. At September 30, 2012, the Company can no longer issue options under this plan. The remaining 20,808 options are fully vested and outstanding until June 1, 2014, with an exercise price of $16.67 per share.

(11) DERIVATIVE INSTRUMENTS

Under guidelines of Financial Accounting Standards Board (“FASB”) ASC 815, Derivative and Hedging Activities, as amended, all derivative instruments are required to be carried at fair value on the consolidated statement of financial position. ASC 815 provides special hedge accounting provisions, which permit the change in fair value of the hedge item related to the risk being hedged to be recognized in earnings in the same period and in the same income statement line as the change in the fair value of the derivative.

A derivative instrument designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges under ASC 815. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Cash value hedges are accounted for by recording the fair value of the derivative instrument and the fair value related to the risk being hedged of the hedged asset or liability on the consolidated statement of financial position with corresponding offsets recorded in the consolidated statement of financial position.

The adjustment to the hedged asset or liability is included in the basis of the hedged item, while the fair value of the derivative is recorded as a freestanding asset or liability. Actual cash receipts or payments and related amounts accrued during the period on derivatives included in a fair value hedge relationship are recorded as adjustments to the income or expense recorded on the hedged asset or liability.

Under both the fair value and cash flow hedge methods, derivative gains and losses not effective in hedging the change in fair value or expected cash flows of the hedged item are recognized immediately in the income statement. At the hedge’s inception and at least quarterly thereafter, a formal assessment is performed to determine whether changes in the fair values or cash flows of the derivative instrument has been highly effective in offsetting changes in the fair values or cash flows of the hedged items and whether they are expected to be highly effective in the future. If it is determined a derivative instrument has not been, or will not continue to be highly effective as a hedge, hedged accounting is discontinued. ASC 815 basis adjustments recorded on hedged assets and liabilities are amortized over the remaining life of the hedged item beginning no later than when hedge accounting ceases. There were no fair value hedging gains or losses, as a result of hedge ineffectiveness, recognized for the three and nine month periods ended September 30, 2012, or the year ended December 31, 2011.

In October of 2008, the Bank entered into an interest rate swap agreement for a term of seven years and an amount of $10.0 million. The Bank will pay a fixed rate of 7.27% for seven years and receive an amount equal to the three-month London Interbank Lending Rate (LIBOR) plus 3.10%. The interest rate swap is classified as a cash flow hedge by the Bank and will be tested quarterly for effectiveness. At September 30, 2012, and December 31, 2011, the cost of the Bank to terminate the cash flow hedge was approximately $1,220,000 and $1,297,000, respectively.

(12) REGULATORY AGREEMENT

On April 30, 2010, the Company and the Bank each entered into an informal Memorandum of Understanding (MOU) with its primary regulator at that time, the Office of Thrift Supervision (OTS). On October 11, 2012, the Office of the Comptroller of the Currency terminated the MOU with the Bank. At this time, the MOU between the Company and the Federal Reserve Bank remains in effect.

The Company’s MOU requires us to obtain prior written approval prior to the declaration of a common stock dividend, borrow money from any source and pay a cash dividend to the Bank. The Company may continue to pay other normal operating expenses, and may pay interest on HopFed Capital Trust 1 and dividends on preferred stock held by the United States Department of Treasury without regulatory approval if the Bank maintains a Tier 1 Capital Ratio of 8.00% and a Total Risk Based Capital Ratio of 12.00%. At September 30, 2012, the Company’s Tier 1 Ratio was 12.33% and its Total Risk Based Capital was 22.31%.

The Board of Directors and management of the Company have taken various actions to comply with the terms and conditions of the MOU, and will continue to take all actions believed to be necessary for compliance. The Board and management will continue to work closely with the Federal Reserve in order to comply with the terms and conditions of the MOU.

(13) REGULATORY CHANGES

Effective July 21, 2011, pursuant to Section 312 of Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) (i) the regulatory functions and rulemaking authority of the OTS with regard to federally chartered savings and loans associations (including the Company’s wholly owned bank subsidiary) were transferred to the Office of the Comptroller of the Currency (“OCC”) and the (ii) regulatory functions and rulemaking authority of the OTS in regards to saving and loan companies, including HopFed Bancorp, Inc., were transferred to the Board of Governors of the Federal Reserve System (“FRB”). Beginning on July 21, 2011, the OCC became the primary regulator of the Bank and is vested with the authority to enforce the Bank’s MOU. Also beginning July 21, 2011, the Company became subject to the regulation of the FRB, which is vested with authority to enforce the Company’s MOU.

The Bank is subject to various regulatory capital requirements now administered by the Office of the Comptroller of the Currency as successor to the OTS (see discussion above regarding “Regulatory Changes”). Failure to meet minimum capital requirements can result in certain mandatory—and possible additional discretionary—actions by regulators that, if undertaken, could have a direct and material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Federal Reserve Notices of Proposed Rulemaking

On June 7, 2012, the Board of Governors of the Federal Reserve System issued three related notices of proposed rulemaking (the “NPRs”) relating to implementation of revised capital rules reflecting requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Base III international capital standards. Among other things, if adopted as currently proposed, the NPRs would result in a new capital standard consisting of common equity tier 1 capital; would increase capital ratios required for certain existing capital categories and add a requirement for a capital conservation buffer (failure to meet these standards would result in limitations on capital distributions, as well as executive bonuses); and would add more conservative standards for securities included in regulatory capital, which would phase-out trust preferred securities as a component of tier 1 capital commencing January 1, 2013. In addition, the NPRs would deduct more assets from regulatory capital and revise methodologies for determining risk-weighted assets, including applying a more risk-sensitive treatment to residential mortgage exposures and to past due or nonaccrual loans. The NPRs provide for various phase-in periods over the next several years. The final regulations applicable to the Company and the Bank may be substantially different from those proposed in the NPRs. Management will continue to evaluate the potential impact of the NPRs to ensure the capital levels of both the Company and the Bank exceed the amounts required to be deemed “well capitalized.” The Company and the Bank will be subject to many provisions in the NPRs, but until final rules are issued we cannot predict the actual effect.

(14) EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS

In January 2011, the FASB issued ASU 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in ASU 2010-20 which temporarily delayed the effective date of the disclosures about troubled debt restructuring in ASU 2010-20. This delay was intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring.

In April 2011, the FASB issued ASU 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. The provisions of ASU 2011-02 provide additional guidance related to determining whether a creditor has granted a concession, including factors and examples for creditors to consider in evaluating when a credit restructuring results in a delay in payment that is insignificant, prohibits creditors from using the borrowers interest cost as a factor in determining whether the lender has granted a concession to the borrower, and added factors for creditors to use in determining whether a borrower is experiencing financial difficulties. A provision in ASU 2011-02 ends the FASB’s deferral of additional disclosures about troubled debt restructuring as required by ASU 2010-20. The provisions of ASU 2011-02 were effective for the Company’s reporting period ending September 30, 2011. The adoption of ASU 2011-02 did not have a material impact on the Company’s consolidated financial statements of income, condition and cash flow.

In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in United States of America generally accepted accounting principles (U.S. GAAP) and international Financial Reporting Standards (Topic 820) – Fair Value Measurement (ASU 2011-04), to provide consistent definition of the fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 was effective for reporting periods ending after March 30, 2012, and was applied prospectively. The implementation of ASU 2011-04 did not have a material impact on the Company’s consolidated financial statements of income, condition and cash flows.

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income, new disclosure guidance related to the presentation of the Statement of Comprehensive Income. This guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity and requires presentation of reclassification adjustments on the face of the income statement. The effective date of this pronouncement is December 15, 2011. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements of income, condition, and cash flow.

In September 2011, the FASB issued ASU No. 2011-8, Intangibles – Goodwill and other, regarding testing goodwill for impairment. The new guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting until is less than its carrying amount. If an entity determines that this is the case, it is required to perform the currently prescribed two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill reporting unit is more than its carrying amount, the two-step goodwill impairment test is not required. The new guidance was effective on January 1, 2012. The implementation of ASU 2011-8 did not have a material impact on the Company’s consolidated financial statements of income, condition and cash flow.

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards update No. 2011-05. This update to Comprehensive Income (Topic 220) defers the requirement to present items that are reclassified from accumulated other comprehensive income to net income separately with their respective components of net income and other comprehensive income. The deferral supersedes only the paragraphs pertaining to how and where reclassification adjustments are presented. The amendments in this update were effective for public entities for reporting periods beginning after December 15, 2011.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies

The consolidated condensed financial statements as of September 30, 2012, and December 31, 2011, and for the three and nine month periods ended September 30, 2012, and September 30, 2011, included herein have been prepared by the Company, without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in interim financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the financial statements and notes thereon included in the Company’s 2011 Annual Report to Stockholders on Form 10-K.

Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances, which could affect these material judgments, include, but without limitation, changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses, determining the fair value of securities and other financial instruments, and assessing other than temporary impairments of securities.

Comparison of Financial Condition at September 30, 2012, and December 31, 2011

At September 30, 2012, total assets decreased $44.1 million, to $996.7 million, as compared to December 31, 2011, due to lower levels of available for sale investments. Management has liquidated investments to fund the reduction in higher costing borrowings, retail time deposits and brokered deposits. Securities available for sale declined from $383.8 million at December 31, 2011, to $348.9 million at September 30, 2012. At September 30, 2012, and December 31, 2011, securities classified as “available for sale” had an amortized cost of $332.2 million and $371.3 million, respectively.

The Company ownership of Federal Home Loan Bank of Cincinnati (“FHLB”) stock, at cost totaled $4.4 million at December 31, 2011, and September 30, 2012. Total Federal Home Loan Bank “FHLB” borrowings decreased $19.1 million, from $63.3 million at December 31, 2011, to $44.2 million at September 30, 2012. The reduction in FHLB advances were funded by the liquidation of investment securities, many of which were experiencing increased prepayment speeds due to the Federal Reserve Bank’s decision to utilize quantitative easing (“QE 3”) in an attempt to stimulate economic activity. Total repurchase balances decreased from $43.1 million at December 31, 2011, to $42.8 million at September 30, 2012.

Net loans totaled $539.5 million and $556.4 million at September 30, 2012, and December 31, 2011, respectively. Loan demand remains tepid. Given the current weakness in the economy, the Company remains highly selective in both its underwriting standards and types of loans being originated.

At September 30, 2012, deposits decreased to $769.3 million from $800.1 million at December 31, 2011, due to a $45.4 million reduction in time deposits. At September 30, 2012, non-interest checking account balances increased to $88.5 million, or 11.5% of total deposits. The average cost of all deposits during the three and nine month periods ended September 30, 2012, was 1.36% and 1.38%, respectively, as compared to 1.71% and 1.79% for the three and nine month periods ended September 30, 2011, respectively, and 1.72% for the year ended December 31, 2011. Management continually evaluates the investment alternatives available to customers and adjusts the pricing on its deposit products to more actively manage its funding costs while remaining competitive in its market area. Given weak loan demand and poor investment alternatives, the Company has chosen to reduce its balances of higher costing time deposits.

Comparison of Operating Results for the Nine Month Periods Ended September 30, 2012 and 2011.

Net Income. The Company’s net income available to common shareholders was $2.2 million for the nine month period ended September 30, 2012, as compared to a net loss attributable to common shareholders of $180,000 for the nine month period ended September 30, 2011. The Company’s results for the nine month period ended September 30, 2011, were negatively affected by a $5.4 million provision for loan loss expense, as compared to a $1.8 million provision expense for the nine month period ended September 30, 2012.

Net Interest Income. Net interest income for the nine month period ended September 30, 2012, was $19.4 million, as compared to $20.7 million for the nine month period ended September 30, 2011. The decline in net interest income for the nine months ended September 30, 2012, as compared to September 30, 2011, was due to a $34.4 million decline in the average balance of loans outstanding and $480,000 in FHLB prepayment penalties. The decline in loans outstanding was partially offset by both lower deposit rates, a decrease in the average balance of FHLB advances and an increased level of non-interest bearing deposit balances.

For the nine months ended September 30, 2012, the average yield on loans was 5.53%, as compared to 5.81% for the nine month period ended September 30, 2011. For the nine month period ended September 30, 2012, income on taxable securities declined to $6.8 million, from $8.0 million for the nine month period ended September 30, 2011. For the nine month period ended September 30, 2012, the average balance of taxable securities increased by $25.0 million as compared to the nine month period ended September 30, 2011, while the average balance of tax free municipal securities increased by $837,000.

For the nine month period ended September 30, 2012, the yield on taxable securities was 2.82%, compared to 3.59% for the nine-month period ended September 30, 2011. The decline in yields on taxable securities is the result of lower available yields on currently available investments as well as a decision by management to increase the portfolio’s allocation of adjustable rate securities. In addition, the investment portfolio has experienced an increase in prepayments on amortizing loans. The increased level of cash flow acts to reduce both current yields as well as increasing the amount of premium amortization on bonds.

For the nine month period ended September 30, 2012, the tax equivalent yield on tax free securities was 4.91%, compared to 5.07% for the nine-month period ended September 30, 2011. The yield on tax free securities has held relatively constant due to the relative stability in both the size and composition of the portfolio. Furthermore, lower yields on new purchases can be partially offset by a lower cost of funds, reducing the Company’s TEFRA tax effect.

For the nine month periods ended September 30, 2012, and September 30, 2011, the Company’s cost of interest bearing liabilities was 1.88% and 2.17%, respectively. The Company’s decision to incur $480,000 in FHLB prepayment fees increased our cost of interest bearing liabilities by 0.07%. The lower cost of interest bearing liabilities was the result of lower short term interest rates. At September 30, 2012, and September 30, 2011, the Company’s net interest margin was 2.84% and 3.01%, respectively.

Average Balances, Yields and Interest Expenses. The table below summarizes the overall effect of changes in both interest rates and the average balances of interest earning assets and liabilities for the nine-month periods ended September 30, 2012, and September 30, 2011. Yields on assets and cost of liabilities are derived by dividing income or expense by the average daily balances of interest earning assets and liabilities for the appropriate nine-month periods.

Average balances for loans include loans classified as non-accrual, net of the allowance for loan losses. The table adjusts tax-free investment income by $798,000 for September 30, 2012, and $810,000 for September 30, 2011, for a tax equivalent rate using a cost of funds rate of 2.00% for September 30, 2012, and 2.20% for September 30, 2011. The table adjusts tax-free loan income by $7,000 for September 30, 2012, and $27,000 for September 30, 2011, for a tax equivalent rate using the same cost of funds rate:


	Average		Income and			Average			Average		Income and			Average
	Balance		Expense			Rates			Balance		Expense			Rates
	9/30/2012		9/30/2012			9/30/2012			9/30/2011		9/30/2011			9/30/2011
	(Dollars in Thousands, Except Percentages)
Loans	$	545,464	$	22,624			5.53	%	$	579,888	$	25,281			5.81	%
Investments AFS taxable		322,091		6,823			2.82	%		297,112		8,003			3.59	%
Investment AFS tax free		67,714		2,493			4.91	%		66,877		2,543			5.07	%
Interest earning deposits		14,918		20			0.18	%		8,666		13			0.15	%

Total interest earning assets		950,187		31,960			4.48	%		952,543		35,840			5.02	%

Other assets		87,878								121,080

Total assets	$	1,038,065							$	1,073,623

Retail time deposits	$	444,553		6,538			1.96	%	$	470,894		8,608			2.44	%
Brokered deposits		52,558		754			1.91	%		84,139		1,222			1.94	%
Now accounts		145,015		888			0.82	%		137,961		1,256			1.21	%
MMDA and savings accounts		73,983		99			0.18	%		67,369		93			0.18	%
FHLB borrowings		61,336		2,155			4.68	%		72,557		1,946			3.58	%
Repurchase agreements		40,968		721			2.35	%		39,676		668			2.24	%
Subordinated debentures		10,310		553			7.15	%		10,310		551			7.13	%

Total interest bearing liabilities		828,723		11,708			1.88	%		882,906		14,344			2.17	%

Non-interest bearing deposits		82,800								72,216
Other liabilities		5,717								4,905
Shareholders equity		120,825								113,596

Total liabilities and shareholder equity	$	1,038,065							$	1,073,623

Net interest income			$	20,252							$	21,496

Interest rate spread							2.60	%							2.85	%

Net interest margin				2.84	%							3.01	%

Interest Income. For the nine month periods ended September 30, 2012, and September 30, 2011, the Company’s total interest income was $31.2 million and $35.0 million, respectively. As our loan demand has slowed down, the Company continues to have a greater dependency on investment income. The average balance of loans receivable declined from $579.9 million for the nine months ended September 30, 2011, to $545.5 million for the nine month period ended September 30, 2012. The ratio of average interest-earning assets to average interest-bearing liabilities increased from 107.89% for the nine month period ended September 30, 2011, to 114.66% for the nine month period ended September 30, 2012.

Interest Expense. Interest expense declined approximately $2.6 million for the nine month period ended September 30, 2012, as compared to September 30, 2011. The decline was attributable to lower market interest rates, the re-pricing of higher costing deposits, and a reduction in the average balance of FHLB borrowings. The average cost of interest-bearing retail time deposits declined from 2.44% for the nine month period ended September 30, 2011, to 1.96% for the nine months ended September 30, 2012. Over the same period, the average balance of interest bearing retail time deposits declined $26.3 million, from $470.9 million for the nine months ended September 30, 2011, to $444.6 million for the nine months ended September 30, 2012.

The average cost of brokered deposits remained relatively stable during the nine month period ended September 30, 2012, at 1.91% as compared to 1.94% for the nine month period ended September 30, 2011. Over the same period, the average balance of brokered deposits declined $31.5 million to $52.6 million for the nine month period ended September 30, 2012. For the nine month period ended September 30, 2012, the Company’s total cost of deposits was 1.38% as compared to 1.79% for the nine month period ended September 30, 2011.

The average balance of funds borrowed from the FHLB declined $11.3 million, from $72.6 million for the nine months ended September 30, 2011, to $61.3 million for the nine month period ended September 30, 2012. The average cost of borrowed funds from the FHLB was 3.58% for the nine months ended September 30, 2011, and 4.68% for the nine months ended September 30, 2012, as prepayment penalties added 1.04% to FHLB borrowings for the nine months ended September 30, 2012. The average balance of repurchase agreements increased from $39.7 million for the nine months ended September 30, 2011, to $41.0 million for the nine months ended September 30, 2012. The average cost of repurchase agreements increased from 2.24% for the nine months ended September 30, 2011, to 2.35% for the nine months ended September 30, 2012.

Provision for Loan Losses. The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the risk inherent in its loan portfolio and the general economy. Such evaluation considers numerous factors including general economic conditions, loan portfolio composition and prior loss experience, the estimated fair value of the underlying collateral and other factors that warrant recognition in providing for an adequate loan loss allowance. The Company determined that an additional $1.8 million in provision for loan loss was required for the nine months ended September 30, 2012, compared to a $5.4 million in provision for loan loss expense for the nine months ended September 30, 2011.

Non-Interest Income. There was a $311,000 decrease in non-interest income in the nine month period ended September 30, 2012, as compared to the same period in 2011. The decline in non-interest income was largely the result of a $679,000 decline in gains realized on the sale of investments. For the nine month period ended September 30, 2012, the Company earned $684,000 in mortgage origination income, as compared to $425,000 during the nine month period ended September 30, 2011, as lower mortgage rates spurred refinancing activity. For the nine month period ended September 30, 2012, the Company earned $778,000 in financial services commission, as compared to $691,000 in income for the nine month period ended September 30, 2011.

For the nine month period ended September 30, 2012, income from service charges and merchant card income increased by $95,000 as compared to the nine month period ended September 30, 2011, due to a higher number of checking accounts opened which offset the loss of income due to regulatory changes.

Non-Interest Expenses. There was a $503,000 decline in total non-interest expenses in the nine-month period ended September 30, 2012, as compared to the same period in 2011. The most significant change in non-interest expenses for the nine month period ended September 30, 2012, was a $1.4 million decline in losses incurred on the sale of other real estate owned as compared to the same nine month period in 2011. This expense has declined due to the Company’s continued success in reducing the balance of other real estate owned.

For the nine months ended September 30, 2012, salaries and benefits expense increased by $528,000 over the nine month period ended September 30, 2011. For the nine month period ended September 30, 2012, other expenses increasing more than $200,000 as compared to the same period in 2011 including professional services which increased by $334,000 and other operating expenses which increased by $621,000 as compared to the same period in 2011. The most significant reason for the increases in non-interest expenses was the increased regulatory requirements placed on the Company.

Income Taxes. The effective tax rate for the nine-month period ended September 30, 2012, was 18.0%, compared to an effective tax rate of 38.8% for the nine-month period ended September 30, 2011. The Company’s income tax rate remains low due to the amount of tax free income as well as a relatively low level of pre-tax income.

Comparison of Operating Results for the Three Month Periods Ended September 30, 2012 and 2011.

Net Income. The Company’s net income available to common shareholders was $819,000 for the three month period ended September 30, 2012, as compared to net income available to common shareholders of $1,368,000 for the three month period ended September 30, 2011.

Net Interest Income. Net interest income for the three month period ended September 30, 2012, was $5.9 million, as compared to $6.9 million for the three month period ended September 30, 2011. The decline in net interest income for the three month period ended September 30, 2012, compared to September 30, 2011, was primarily due to a $27.8 million decline in the average balance of loans outstanding and $480,000 of FHLB prepayment penalties incurred. As a result of the changes in deposits, the Company’s average cost of all deposits declined from 1.71% for the three month period ended September 30, 2011, to 1.36% for the three month period ended September 30, 2012, resulting in a $903,000 decline in interest expense on deposits.

For the three months ended September 30, 2012, the average yield on loans was 5.48%, as compared to 5.87% for the three month period ended September 30, 2011. For the three month period ended September 30, 2012, income on taxable securities declined to $2.0 million, from $2.6 million for the three month period ended September 30, 2011. For the three month period ended September 30, 2012, the average balance of taxable securities increased by $5.2 million as compared to the three month period ended September 30, 2011 while the average balance of tax free securities increased by $4.7 million over the same period.

For the three month period ending September 30, 2012, the yield on taxable securities was 2.61%, as compared to 3.40% for the three-month period ended September 30, 2011. The decline in yields on taxable securities is the result of lower available yields on currently available investments, a decision by management to increase the portfolio’s allocation of adjustable rate securities and an increase in the prepayments on securities, resulting in high premium amortizations and lower reinvestment rates.

For the three month period ended September 30, 2012, the tax equivalent yield on tax free securities was 4.87%, compared to 4.83% for the three-month period ended September 30, 2011. The yield on tax free securities has held relatively constant due to the relative stability in both the size and composition of the portfolio. Furthermore, lower yields on new purchases can be partially offset by a lower cost of funds, reducing the Company’s TEFRA tax effect.

For the three month periods ended September 30, 2012 and September 30, 2011, the Company’s cost of interest bearing liabilities was 2.03% and 2.10%, respectively. At September 30, 2012, and September 30, 2011, the Company’s net interest margin was 2.67% and 3.00%, respectively. For the three month period ended September 30, 2012, the Company’s cost of interest bearing liabilities was 0.24% higher and its net interest margin 0.24% lower due to the presence of $480,000 in FHLB prepayment penalties.

Average Balances, Yields and Interest Expenses. The table below summarizes the overall effect of changes in both interest rates and the average balances of interest earning assets and liabilities for the three-month periods ended September 30, 2012, and September 30, 2011. Yields on assets and cost of liabilities are derived by dividing income or expense by the average daily balances of interest earning assets and liabilities for the appropriate three-month periods.

Average balances for loans include loans classified as non-accrual, net of the allowance for loan losses. The table adjusts tax-free investment income by $273,000 for September 30, 2012, and $250,000 for September 30, 2011, for a tax equivalent rate using a cost of funds rate of 2.00% for September 30, 2012, and 2.00% for September 30, 2011. The table adjusts tax-free loan income by $2,000 for September 30, 2012, and $7,000 for September 30, 2011, for a tax equivalent rate using the same cost of funds rate:


	Average Balance 9/30/2012		Income & Expense 9/30/2012			Average Rates 9/30/2012			Average Balance 9/30/2011		Income & Expense 9/30/2011			Average Rates 9/30/2011
	(Dollars in Thousands, Except Percentages)
Loans	$	540,811	$	7,405			5.48	%	$	568,600	$	8,339			5.87	%
Investments AFS taxable		308,578		2,014			2.61	%		303,384		2,581			3.40	%
Investment AFS tax free		69,420		846			4.87	%		64,712		782			4.83	%
Interest earning deposits		10,555		6			0.23	%		12,720		5			0.16	%

Total interest earning assets		929,364		10,271			4.42	%		949,416		11,707			4.93	%

Other assets		87,537								118,896

Total assets	$	1,016,901							$	1,068,312

Retail time deposits	$	430,568		2,064			1.92	%	$	475,287		2,773			2.33	%
Brokered deposits		49,181		258			2.10	%		76,557		374			1.95	%
Now accounts		140,424		285			0.81	%		133,022		358			1.08	%
MMDA and savings accounts		75,031		33			0.18	%		68,913		38			0.22	%
FHLB borrowings		58,962		1,017			6.90	%		70,575		625			3.54	%
Repurchase agreements		39,093		236			2.41	%		39,323		238			2.42	%
Subordinated debentures		10,310		185			7.18	%		10,310		186			7.22	%

Total interest bearing liabilities		803,569		4,078			2.03	%		873,987		4,592			2.10	%

Non-interest bearing deposits		84,079								74,077
Other liabilities		6,284								4,983
Stockholders’ equity		122,969								115,265

Total liabilities and stockholders’ equity	$	1,016,901							$	1,068,312

Net interest income			$	6,193							$	7,115

Interest rate spread							2.39	%							2.83	%

Net yield on interest earning assets				2.67	%							3.00	%

Interest Income. For the three month periods ended September 30, 2012, and September 30, 2011, the Company’s total interest income was $10.0 million and $11.5 million, respectively. Loan demand remains weak and the Company has reduced the amount of investments available for sale to fund the decline in both FHLB loan balances and time deposits. The average balance of loans receivable declined from $568.6 million for the three months ended September 30, 2011, to $540.8 million for the three month period ended September 30, 2012. The ratio of average interest-earning assets to average interest-bearing liabilities increased from 108.63% for the three months ended September 30, 2011, to 115.65% for the three months ended September 30, 2012 as the Company reduced the average size of its balance sheet.

Interest Expense. Interest expense declined approximately $500,000 for the three months ended September 30, 2012, as compared to September 30, 2011. The decline was attributable to lower market interest rates, the re-pricing of higher costing deposits, and a reduction in the average balance of time deposits but was partially offset by the $480,000 in FHLB prepayment penalties. The average cost of interest-bearing retail time deposits declined from 2.33% for the three month period ended September 30, 2011, to 1.92% for the three months ended September 30, 2012. Over the same period, the average balance of interest bearing retail time deposits declined $44.7 million, from $475.3 million for the three months ended September 30, 2011, to $430.6 million for the three months ended September 30, 2012. In the three month period ended December 31, 2012, the Company has $96.8 million in time deposits scheduled to mature with a weighted average cost of approximately 2.00%.

The average cost of brokered deposits increased from 1.95% for the three months ended September 30, 2011, to 2.10% for the three months ended September 30, 2012, as lower costing deposits have matured and not been renewed. Over the same period, the average balance of brokered deposits declined $27.4 million to $49.2 million for the three month period ended September 30, 2012. For the three month period ended September 30, 2012, the Company’s total cost of deposits was 1.36%, as compared to 1.71% for the three month period ended September 30, 2011.

The average balance of funds borrowed from the FHLB declined $11.6 million, from $70.6 million for the three months ended September 30, 2011, to $59.0 million for the three month period ended September 30, 2012. The average cost of borrowed funds from the FHLB was 3.54% for the three months ended September 30, 2011, and 6.90% for the three months ended September 30, 2012. For the three month period ended September 30, 2012, borrowing cost would have been 3.64% excluding FHLB prepayment penalties. The average balance of repurchase agreements decreased from $39.3 million for the three months ended September 30, 2011, to $39.1 million for the three months ended September 30, 2012. The average cost of repurchase agreements decreased from 2.42% for the three months ended September 30, 2011, to 2.41% for the three months ended September 30, 2012.

Provision for Loan Losses. The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the risk inherent in its loan portfolio and the general economy. Such evaluation considers numerous factors, including general economic conditions, loan portfolio composition and prior loss experience, the estimated fair value of the underlying collateral and other factors that warrant recognition in providing for an adequate loan loss allowance. The Company determined that an additional $506,000 in provision for loan loss was required for the three months ended September 30, 2012, compared to a $475,000 in provision for loan loss expense for the three months ended September 30, 2011.

Non-Interest Income. There was a $384,000 decrease in non-interest income in the three months ended September 30, 2012, as compared to the same period in 2011. The decrease in non-interest income was largely the result of a $303,000 reduction in gains realized on the sale of available for sale securities as management sold selective securities to fund liquidations in FHLB advances, brokered and higher cost time deposits. For the three month period ended September 30, 2012, the Company earned $218,000 in mortgage origination income as compared to $295,000 during the three month period ended September 30, 2011. For the three month periods ended September 30, 2012 and 2011, income from service charges and merchant card income was $1.2 million, respectively as the presence of higher checking account balances was offset by the negative effects of increased regulations on service charge income.

Non-Interest Expenses. For the three-month period ended September 30, 2012, and September 30, 2011, total non-interest expenses declined by $156,000. For the three months ended September 30, 2012, salaries and benefits expense increased by $138,000, professional services expenses increased by $142,000 and other operating expenses increased by $157,000 over the three month period ended September 30, 2011. For the three month period ended September 30, 2012, no other operating expenses increased by more than $100,000 as compared to the three month period ended September 30, 2011. The most significant reduction non-interest expenses for the three month period ended September 30, 2012, as compared to the three month period ended September 30, 2011, is a $502,000 reduction in losses on the sale of other real estate owned.

Income Taxes. The effective tax rate for the three-month period ending September 30, 2012, was 19.7% as compared to 35.8% for the three month period ended September 30, 2011.

Liquidity and Capital Resources. The Company has no business other than that of the Bank. Management believes that dividends that may be paid by the Bank to the Company will provide sufficient funds for its current needs. However, no assurance can be given that the Company will not have a need for additional funds in the future. The Bank is subject to certain regulatory limitations with respect to the payment of dividends to the Company. In the past, the Company was required to seek approval from the Office of Thrift Supervision prior to the declaration of a dividend to common shareholders. Currently, we are required to seek approval for each cash common dividend payment from the Federal Reserve Bank.

At September 30, 2012, the company brokered deposits consisted of the following:


Date Issued	Interest Rate			Current Balance		Maturity Date			Call Option
10/16/2009		2.30	%	$	3,011,000		10/16/2012
3/3/2010		1.75	%		2,032,000		3/4/2013
1/22/2010		2.20	%		3,092,000		7/22/2013
3/2/2010		2.00	%		3,204,000		9/2/2013
9/22/2010		1.15	%		2,144,000		3/22/2014
7/1/2011		1.00	%		3,000,000		5/1/2014
8/11/2009		3.00	%		5,095,000		8/11/2014
7/9/2012		0.54	%		3,159,000		1/9/2015
7/27/2012		0.70	%		3,590,000		7/27/2015	¹
12/21/2010		1.70	%		805,000		12/21/2015
1/3/2011		1.00	%		1,874,000		1/3/2016	¹
9/21/2012		0.60	%		2,500,000		1/21/2016
7/9/2012		0.70	%		2,309,000		3/9/2016
3/17/2011		2.25	%		1,500,000		3/17/2016
10/13/2011		1.35	%		2,086,000		10/13/2016	¹
3/9/2012		1.00	%		3,044,000		12/9/2016	¹
7/9/2012		0.98	%		1,446,000		1/9/2017
7/27/2012		0.50	%		1,496,000		7/27/2017
9/22/2011		1.00	%		2,127,000		9/22/2017	¹
10/6/2010		1.25	%		540,000		10/6/2020	¹

		1.44	%	$	48,054,000

⁽¹⁾	Denotes brokered deposit with rising rate feature in which the company has an option to call the deposit at specific intervals.

The Bank must satisfy three capital standards: a ratio of core capital to adjusted total assets of 4.0%, a tangible capital standard expressed as 1.5% of total adjusted assets, and a combination of core and “supplementary” capital equal to 8.0% of risk-weighted assets. At September 30, 2012, the Bank exceeded all regulatory capital requirements.

The table below presents certain information relating to the Company’s and Bank’s capital compliance at September 30, 2012:


	Company					Bank
	Amount		Percent			Amount		Percent
	(Dollars in Thousands)
Tier 1 Leverage	$	122,826		12.33	%	$	106,947		10.91	%
Tier 1 Risk based	$	122,826		21.09	%	$	106,947		18.46	%
Total Risk Based Capital	$	130,115		22.31	%	$	114,229		19.72	%

At September 30, 2012, the Bank had outstanding commitments to originate loans totaling $15.0 million and undisbursed commitments on loans outstanding of $67.9 million. Management believes that the Bank’s sources of funds are sufficient to fund all of its outstanding commitments. Certificates of deposits scheduled to mature in one year or less from September 30, 2012, totaled $268.5 million. Management believes that a significant percentage of such deposits will remain with the Bank.

The Bank’s FHLB borrowings are secured by a blanket security agreement pledging the Bank’s 1-4 family first mortgage loans and non-residential real estate loans. At September 30, 2012, the Bank has pledged all eligible 1-4 family first mortgages and non-residential real estate loans that may be pledged under this agreement.

At September 30, 2012, the Company has outstanding borrowings of $44.2 million from the FHLB with maturities ranging from March 2016 to January 2019. In the three month period ended September 30, 2012, the Company liquidated $20.0 million in FHLB advances and recognized prepayment penalties of approximately $480,000. A schedule of FHLB borrowings at September 30, 2012, is provided below:


Outstanding Balance		Rate			Maturity		Note
		(Dollars in thousands)
	$ 4,000		5.34	%		03/17/16
	7,000		4.25	%		05/01/17	Quarterly callable
	10,000		4.56	%		06/28/17	Quarterly callable
	10,000		4.26	%		08/17/17	Quarterly callable
	13,222		3.13	%		01/01/19	Monthly principal payments

	$44,222		4.09	%		5.1 years	Weighted average life

At September 30, 2012, the Company had $65.5 million in additional borrowing capacity with the FHLB which includes an overnight line of credit of $30.0 million and $8 million in overnight borrowing capacity from the Company’s correspondent bank.

The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making these commitments and conditional obligations as it does for on-balance-sheet instruments.

At September 30, 2012, the Company had the following off-balance sheet commitments (in thousands):


Standby letters of credit	$	762
Unused home equity lines of credit	$	28,383
Unused commercial lines of credit	$	39,535
Commitments to originate loans	$	14,987

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements. Additional written or oral forward-looking statements may be made by the Company from time to time in filings with the Securities and Exchange Commission or otherwise. The words “believe,” “expect,” “seek,” and “intend” and similar expressions identify forward-looking statements, which speak only as of the date the statement is made. Such forward-looking statements are within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements may include, but are not limited to, projections of income or loss, expenditures, acquisitions, plans for future operations, financing needs or plans relating to services of the Company, as well as assumptions relating to the foregoing.

Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. The Company does not undertake, and specifically disclaims, any obligation to publicly release the results of revisions, which may be made to forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

The actual results of the Company’s asset liability management analysis are highly dependent on the prepayment speed of mortgage backed securities and collateralized mortgage obligations. The United States Treasury’s policy of purchasing longer dated Treasury bonds has the result of lowering mortgage loan rates, allowing more consumers to refinance their mortgages and pay-off their current mortgage, resulting in higher prepayment speeds on mortgage investment products.

The effects of rising interest rates are discussed throughout Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Actual results for the year ending December 31, 2012, will differ from simulations due to timing, magnitude, and the frequency or interest rate changes, market conditions, management strategies, and the timing of the Company’s cash receipts and disbursements.

The Company’s analysis at September 30, 2012, indicates that changes in interest rates are less likely to result in significant changes in the Company’s annual net interest income. A summary of the Company’s net interest income analysis at September 30, 2012, for the twelve month period ending September 30, 2013, is as follows:


	Down 1.00%		No change		Up 1.00%		Up 2.00%		Up 3.00%
	(Dollars in Thousands)
Net interest income	$	26,169	$	26,834	$	27,213	$	27,643	$	28,160

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

In accordance with Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), an evaluation was carried out with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the quarter ended September 30, 2012.

Based upon their evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of the nine month period ended September 30, 2012, to ensure that material information relating to the Company, including its consolidated subsidiaries, was made known to them by others within those entities, particularly during the period in which this quarterly report on Form 10-Q was being prepared.

Any control system, no matter how well conceived and operated, can provide only reasonable assurance that its objectives are achieved. The design of a control system inherently has limitations, including the controls cost relative to their benefits. Additionally, controls can be circumvented. No cost-effective control system can provide absolute assurance that all control issues and instances of fraud will be detected.

The Company is subject to Section 404 of The Sarbanes-Oxley Act of 2002. Section 404 requires management to assess and report on the effectiveness of the Company’s internal controls over financial reporting.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the Company’s fiscal quarter ended September 30, 2012, that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

The Company currently has no material pending legal proceedings. An individual has filed a lawsuit against Heritage Bank, our thrift subsidiary, in a Tennessee court. The lawsuit alleges that Heritage Bank did not provide adequate disclosures as to fees assessed for a non-customer using Heritage Bank’s automated teller machines (“ATM’s). The plaintiff is seeking unspecified damages, pre-judgment cost and attorney fees. The Company and the Bank are aggressively contesting the allegations made in the lawsuit. Based on our current knowledge, neither the Company nor the Bank believe that any liability arising from this matter will have a material adverse effect on the Company’s consolidated financial condition, operating results or cash flows.

Item 1A.

Risk Factors

There have been no material changes to our risk factors as previously disclosed in Part 1, Item 1A of our annual report on Form 10K for the fiscal year ended December 31, 2011.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

(a)

None

(b)

None

(c)

None

Item 3.

Defaults Upon Senior Securities

None

Item 4.

Mine Safety Disclosure

Not Applicable

Item 5.

Other Information

None

Item 6.

Exhibits



31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for John E. Peck, Chief Executive Officer.

31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for Billy C. Duvall, Chief Financial Officer.

32.1		Certification Pursuant to Section 18 U.S.C. Section 1350 for John E. Peck, Chief Executive Officer.

32.2		Certification Pursuant to Section 18 U.S.C. Section 1350 for Billy C. Duvall, Chief Financial Officer.

101		The following materials from the Company’s quarterly report on Form 10-Q for the three and nine month periods ended September 30, 2012, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Statement of Financial Condition as of September 30, 2012 (unaudited) and December 31, 2011, (ii) Condensed Consolidated Statements of Income (Loss) for the three and nine month periods ended September 30, 2012 and 2011 (unaudited), (iii) Condensed Consolidated Statements of Comprehensive Income for the three and nine month periods ended September 31, 2012 and 2011 (unaudited), (iv) Condensed Consolidated Statements of Cash Flows, for the nine month periods ended September 30, 2012 and 2011 (unaudited), (v) Consolidated Condensed Statement of Stockholders’ Equity for the nine month period ended September 30, 2012 (unaudited) and (vi) Notes to Condensed Consolidated Financial Statements (unaudited), tagged as blocks of text.

SIGNATURES

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


						HOPFED BANCORP, INC.

Date: November 14, 2012						/s/ John E. Peck
						John E. Peck
						President and Chief Executive Officer

Date: November 14, 2012						/s/ Billy C. Duvall
						Billy C. Duvall
						Senior Vice President, Chief Financial
						Officer and Treasurer