Form 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-Q
(Mark One)

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

For the quarterly period ended
September 30, 2006
  

OR

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

For the transition period from ____________ to _______________

Commission File No. 0-23433

WAYNE SAVINGS BANCSHARES, INC.
(Exact name of registrant as specified in its charter)

         Delaware
  
31-1557791
(State or other jurisdiction of
  
(I.R.S. Employer
incorporation or organization)
  
Identification Number)
     
151 North Market Street
    
Wooster, Ohio     
  
44691
(Address of principal
  
(Zip Code)
executive office)
    

Registrant’s telephone number, including area code: (330) 264-5767

Indicate by check market whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes   ý
No ¨    


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

Large accelerated filer ¨           
Accelerated filer ¨
         Non-accelerated filer ý

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

As of October 27, 2006, the latest practicable date, 3,304,052 shares of the registrant’s common stock, $.10 par value, were issued and outstanding.


1
 


Wayne Savings Bancshares, Inc.

INDEX

   
Page
     
PART I -
  
     
Item 1
3
 
4
 
5
 
6
 
8
     
Item 2
  
 
13
     
Item 3
23
 
    
Item 4
23
     
     
PART II -
  
     
Item 1
24
     
Item 1A
24
     
Item 2
24
     
Item 3
24
     
Item 4
24
     
Item 5
25
     
Item 6
25
     
 
26





2
 


Wayne Savings Bancshares, Inc.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(In thousands, except share data)

   
September 30,
  
March 31,
  
ASSETS  
  
2006
  
2006
  
   
(Unaudited)
      
           
Cash and due from banks
 
$
2,539
  
$
2,952
  
Interest-bearing deposits in other financial institutions 
    
9,487
    
11,171
  
Cash and cash equivalents
    
12,026
    
14,123
  
               
Investment securities available for sale - at market
   
62,610
    
67,505
  
Investment securities held to maturity - at amortized cost, approximate market value
              
of $686 and $5,796 as of September 30, 2006 and March 31, 2006, respectively
   
629
    
5,802
  
Mortgage-backed securities available for sale - at market
   
67,018
    
53,932
  
Mortgage-backed securities held to maturity - at cost, approximate market value of
             
$1,497 and $1,805 as of September 30, 2006 and March 31, 2006, respectively
   
1,489
    
1,799
  
Loans receivable - net 
    
236,299
    
235,312
  
Office premises and equipment - net
    
8,388
    
8,557
  
Real estate acquired through foreclosure
    
97
    
156
  
Federal Home Loan Bank stock - at cost
   
4,758
    
4,623
  
Cash surrender value of life insurance
    
5,922
    
5,811
  
Accrued interest receivable on loans
   
1,160
    
1,075
  
Accrued interest receivable on mortgage-backed securities
   
310
    
250
  
Accrued interest receivable on investments and interest-bearing deposits
   
766
    
700
  
Prepaid expenses and other assets
   
1,594
    
1,526
  
Goodwill and other intangible assets
    
2,455
    
2,508
  
Prepaid federal income taxes
    
280
    
-
  
               
Total assets
  
$
405,801
  
$
403,679
  
               
 LIABILITIES AND STOCKHOLDERS’ EQUITY
              
               
Deposits
  
$
327,476
  
$
332,570
  
Advances from the Federal Home Loan Bank
   
38,900
    
32,750
  
Advances by borrowers for taxes and insurance
   
530
    
521
  
Accrued interest payable 
    
338
    
263
  
Accounts payable on mortgage loans serviced for others  
    
221
    
225
  
Other liabilities  
    
1,600
    
1,118
  
Accrued federal income taxes
   
-
    
51
  
Deferred federal income taxes
    
1,023
    
665
  
Total liabilities 
    
370,088
    
368,163
  
               
Commitments 
    
-
    
-
  
               
Stockholders’ equity
              
Preferred stock (500,000 shares of $.10 par value authorized;
              
no preferred stock issued)
    
-
    
-
  
Common stock (9,000,000 shares of $.10 par value authorized; 3,954,874 and 3,934,874
              
shares issued at September 30, 2006 and March 31, 2006, respectively)  
    
395
    
393
  
Additional paid-in capital 
    
35,881
    
35,604
  
Retained earnings - substantially restricted
   
11,672
    
11,394
  
Less required contributions for shares acquired by Employee Stock Ownership Plan
    
(1,199
)
  
(1,239
)
Less 650,822 and 595,322 shares of treasury stock at September 30, 2006 and
             
March 31, 2006, respectively - at cost
   
(10,461
)
  
(9,625
)
Accumulated other comprehensive loss - unrealized losses on securities designated
              
as available for sale, net of tax effects
   
(575
)
  
(1,011
)
Total stockholders’ equity
   
35,713
    
35,516
  
               
Total liabilities and stockholders’ equity
  
$
405,801
  
$
403,679
  

See accompanying notes to consolidated financial statements.
 
3
 


Wayne Savings Bancshares, Inc.

CONSOLIDATED STATEMENTS OF EARNINGS

(In thousands, except share data)
(Unaudited)

 
  
Six months
  
Three months
  
 
  
ended
  
ended
  
 
  
September 30,
  
September 30,
  
 
  
2006
  
2005
  
2006
  
2005
  
Interest income
                          
Loans
  
$
7,876
  
$
6,725
  
$
3,985
  
$
3,441
  
Mortgage-backed securities
   
1,481
    
979
    
782
    
467
  
Investment securities
   
1,455
    
1,533
    
712
    
774
  
Interest-bearing deposits and other
   
202
    
242
    
99
    
116
  
Total interest income
   
11,014
    
9,479
    
5,578
    
4,798
  
                           
Interest expense
                          
Deposits
    
4,649
    
3,346
    
2,417
    
1,728
  
Borrowings
    
628
    
502
    
345
    
238
  
Total interest expense
   
5,277
    
3,848
    
2,762
    
1,966
  
                           
Net interest income
   
5,737
    
5,631
    
2,816
    
2,832
  
Provision for losses on loans
   
60
    
-
    
30
    
-
  
Net interest income after provision for losses on loans
   
5,677
    
5,631
    
2,786
    
2,832
  
                           
Other income
                          
Gain on sale of loans
   
-
    
69
    
-
    
44
  
Increase in cash surrender value of life insurance
   
110
    
125
    
55
    
63
  
Service fees, charges and other operating
   
747
    
660
    
376
    
339
  
Total other income
   
857
    
854
    
431
    
446
  
                           
General, administrative and other expense
                          
Employee compensation and benefits
   
2,847
    
3,113
    
1,449
    
1,544
  
Occupancy and equipment
   
935
    
901
    
477
    
476
  
Federal deposit insurance premiums
   
20
    
22
    
10
    
11
  
Franchise taxes
   
198
    
261
    
80
    
132
  
Other operating
    
1,025
    
974
    
522
    
489
  
Total general, administrative and other expense
   
5,025
    
5,271
    
2,538
    
2,652
  
                           
Earnings before income taxes
   
1,509
    
1,214
    
679
    
626
  
                           
Federal incomes taxes
                          
Current
    
298
    
229
    
90
    
81
  
Deferred
   
134
    
78
    
105
    
78
  
Total federal income taxes
   
432
    
307
    
195
    
159
  
                           
NET EARNINGS
 
$
1,077
  
$
907
  
$
484
  
$
467
  
                           
EARNINGS PER SHARE
                          
Basic
 
$
0.33
  
$
0.27
  
$
0.15
  
$
0.14
  
Diluted
 
$
0.33
  
$
0.27
  
$
0.15
  
$
0.14
  
                           
DIVIDENDS PER SHARE
 
$
0.24
  
$
0.24
  
$
0.12
  
$
0.12
  

See accompanying notes to consolidated financial statements.

4
 


Wayne Savings Bancshares, Inc.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)
(Unaudited)


   
Six months
  
Three months
  
   
ended
  
ended
  
   
September 30,
  
September 30,
  
   
2006
  
2005
  
2006
  
2005
  
                   
Net earnings
  
$
1,077
  
$
907
  
$
484
  
$
467
  
                           
Other comprehensive income:
                          
Unrealized holding gains (losses) on securities, net of related
                          
taxes (benefits) of $225, $211, $485 and $(156) during the
                          
respective periods
    
436
    
410
    
941
    
(302
)
                           
Comprehensive income
  
$
1,513
  
$
1,317
  
$
1,425
  
$
165
  
                           
Accumulated comprehensive loss
  
$
(575
)
$
(382
)
$
(575
)
$
(382
)


See accompanying notes to consolidated financial statements.

5
 


Wayne Savings Bancshares, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the six months ended September 30,
(In thousands)
(Unaudited)


   
2006
  
2005
  
           
Cash flows from operating activities:
              
Net earnings for the period
  
$
1,077
  
$
907
  
Adjustments to reconcile net earnings to net cash
              
provided by operating activities:
              
Amortization of discounts and premiums on loans,
             
investments and mortgage-backed securities - net
    
(52
)
  
281
  
Amortization of deferred loan origination fees
    
(30
)
  
(74
)
Depreciation and amortization
    
348
    
319
  
Amortization of expense related to ESOP
    
40
    
24
  
Gain on sale of loans
    
-
    
(17
)
Proceeds from sale of loans in the secondary market
    
-
    
5,669
  
Loans originated for sale in the secondary market
    
-
    
(5,654
)
Provision for losses on loans
    
60
    
-
  
Federal Home Loan Bank stock dividends
    
(135
)
  
(108
)
Increase (decrease) in cash due to changes in:
              
Accrued interest receivable on loans
    
(85
)
  
(216
)
Accrued interest receivable on mortgage-backed securities
    
(60
)
  
229
  
Accrued interest receivable on investments and interest-bearing deposits
    
(66
)
  
(47
)
Prepaid expenses and other assets
    
(68
)
  
(237
)
Amortization of expense related to amortization of intangibles
    
53
    
53
  
Accrued interest payable
    
75
    
41
  
Accounts payable on mortgage loans serviced for others
    
(4
)
  
(37
)
Other liabilities
    
482
    
(477
)
Federal income taxes
              
Current
    
(331
)
  
363
  
Deferred
    
134
    
78
  
Net cash provided by operating activities
    
1,438
    
1,097
  
               
Cash flows provided by (used in) investing activities:
              
Purchase of investment securities designated as available for sale
    
(1,101
)
  
(5,344
)
Proceeds from maturity of investment securities designated as held to maturity
    
2,681
    
89
  
Proceeds from sale of investment securities designated as held to maturity
    
2,512
    
-
  
Proceeds from maturity of investment securities designated as available for sale
    
6,430
    
1,051
  
Purchase of mortgage-backed securities designated as available for sale
    
(15,584
)
  
(5,706
)
Principal repayments on mortgage-backed securities designated as held to maturity
    
305
    
530
  
Principal repayments and sales of mortgage-backed securities designated as available for sale
    
2,761
    
13,309
  
Proceeds from sale of mortgage-backed securities designated as available for sale
    
-
    
2,860
  
Loan principal repayments
    
30,932
    
18,325
  
Loan disbursements
    
(31,949
)
  
(30,449
)
Purchase of office premises and equipment - net
    
(179
)
  
(135
)
Proceeds from sale of real estate acquired through foreclosure
    
59
    
115
  
Increase in cash surrender value of life insurance
    
(111
)
  
(125
)
Net cash used in investing activities
    
(3,244
)
  
(5,480
)
 
              
Net cash used in operating and investing activities
              
(balance carried forward)
    
(1,806
)
  
(4,383
)


6
 


Wayne Savings Bancshares, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

For the six months ended September 30,
(In thousands)
(Unaudited)


   
2006
  
2005
  
           
Net cash used in operating and investing activities
              
(balance brought forward)
  
$
(1,806
)
$
(4,383
)
               
Cash flows provided by (used in) financing activities:
              
Net increase (decrease) in deposit accounts
    
(5,094
)
  
5,232
  
Proceeds from Federal Home Loan Bank advances
    
71,400
    
17,500
  
Repayments of Federal Home Loan Bank advances
    
(65,250
)
  
(29,000
)
Advances by borrowers for taxes and insurance
    
9
    
(20
)
Dividends paid on common stock
    
(799
)
  
(815
)
Proceeds from exercise of stock options
    
279
    
367
  
Tax benefits from exercise of stock options
    
-
    
27
  
Purchase of treasury shares
    
(836
)
  
(4,656
)
Net cash used in financing activities
    
(291
)
  
(11,365
)
               
Net decrease in cash and cash equivalents
    
(2,097
)
  
(15,748
)
               
Cash and cash equivalents at beginning of period
    
14,123
    
29,942
  
               
Cash and cash equivalents at end of period
  
$
12,026
  
$
14,194
  
               
               
Supplemental disclosure of cash flow information:
              
Cash paid during the period for:
              
Federal income taxes
  
$
630
  
$
325
  
               
Interest on deposits and borrowings
  
$
5,202
  
$
3,807
  
               
               
Supplemental disclosure of noncash investing activities:
              
Transfers from loans to real estate acquired through foreclosure
  
$
-
  
$
129
  
               
Unrealized gains on securities designated as available for sale,
              
net of related tax effects
  
$
436
  
$
410
  
               
Recognition of mortgage servicing rights in accordance
              
with SFAS No. 140
  
$
-
  
$
52
  
 
              
Dividends payable
  
$
396
  
$
404
  
               
 
See accompanying notes to consolidated financial statements.

7
 


Wayne Savings Bancshares, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the six and three month periods ended September 30, 2006 and 2005


1.             
Basis of Presentation

 
The accompanying unaudited consolidated financial statements for the six and three months ended September 30, 2006 and 2005 were prepared in accordance with instructions for Form 10-Q and Article 10 of Regulation S-X and, therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. Accordingly, these financial statements should be read in conjunction with the consolidated financial statements and notes thereto of Wayne Savings Bancshares, Inc. (the “Company”) included in the Annual Report on Form 10-K for the year ended March 31, 2006.

 
In the opinion of management, all adjustments (consisting only of normal recurring accruals) which are necessary for a fair presentation of the unaudited financial statements have been included. The results of operations for the six and three month periods ended September 30, 2006 are not necessarily indicative of the results which may be expected for the entire fiscal year.

 
Critical Accounting Policy - The Company’s critical accounting policy relates to the allowance for loan losses. The Company has established a systematic method of periodically reviewing the credit quality of the loan portfolio in order to establish a sufficient allowance for loan losses. The allowance for loan losses is based on management’s current judgments about the credit quality of individual loans and segments of the loan portfolio. The allowance for loan losses is established through a provision, and considers all known internal and external factors that affect loan collectability as of the reporting date. Such evaluation, which included a review of all loans on which full collectability may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience, management’s knowledge of inherent risks in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance. Management has discussed the development and selection of this critical accounting policy with the audit committee of the Board of Directors.

 
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

2.
Principles of Consolidation

 
The accompanying consolidated financial statements include Wayne Savings Bancshares, Inc. and the Company’s wholly-owned subsidiary, Wayne Savings Community Bank (“Wayne Savings” or the “Bank”).

 
Wayne Savings has eleven banking locations in Wayne, Holmes, Ashland, Medina and Stark counties. All significant intercompany transactions and balances have been eliminated in the consolidation.


8
 


Wayne Savings Bancshares, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the six and three month periods ended September 30, 2006 and 2005


3.
Earnings Per Share

 
Basic earnings per common share are computed based upon the weighted-average number of common shares outstanding during the period, less shares in the Company’s Employee Stock Ownership Plan (“ESOP”) that are unallocated and not committed to be released. Diluted earnings per common share include the dilutive effect of all additional potential common shares issuable under the Company’s stock option plan. The computations are as follows:
           
   
For the six months ended
  
For the three months ended
  
   
September 30,
  
September 30,
  
   
2006
  
2005
  
2006
  
2005
  
                   
Weighted-average common shares
                          
outstanding (basic)
    
3,230,084
    
3,365,102
    
3,225,249
    
3,273,901
  
Dilutive effect of assumed exercise
                          
of stock options
    
12,135
    
18,808
    
11,333
    
14,354
  
Weighted-average common shares
                          
outstanding (diluted)
    
3,242,219
    
3,383,910
    
3,236,582
    
3,288,255
  

All outstanding options were included in the diluted earnings per share calculation for the three and six month periods ending September 30, 2006 and 2005.

4.             
Stock Option Plan

The Company maintains a 1993 incentive Stock Option Plan that provided for the issuance of 196,390 shares of authorized common stock, as adjusted, with 2,567 options outstanding at September 30, 2006. In fiscal 2004, the Company adopted a new Stock Option Plan that provided for the issuance of 142,857 incentive options and 61,224 non-incentive options of authorized common stock. As of September 30, 2006, all options under the 2004 Plan have been granted and (excluding forfeited options), are subject to exercise at the discretion of the grantees, and will expire in fiscal 2014 unless otherwise exercised or forfeited.

In the fourth quarter of fiscal 2005, the Company adopted the provisions of SFAS No. 123(R), “Share Based Payment.” SFAS No. 123(R) requires the recognition of compensation expense related to stock option awards based on the fair value of the option award at the grant date. Compensation cost is then recognized over the vesting period. Subsequent to the adoption of SFAS No. 123(R), the Company modified 163,265 stock option awards under the 2004 Stock Option Plan, eliminating the reload options contained therein and immediately vesting these awards. Pursuant to SFAS No. 123(R), the modification represented a new grant. Accordingly, in accordance with the modified prospective application method under SFAS No. 123(R), the Company recognized compensation costs representing the fair value of the option awards at the date of modification.

There were no options granted during each of the six months ended September 30, 2006 and 2005.



9
 


Wayne Savings Bancshares, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the six and three month periods ended September 30, 2006 and 2005


4.             
Stock Option Plan (continued)

A summary of the status of the Company’s stock option plans as of and for the years ended March 31, 2006 and 2005, and the six months ended September 30, 2006 is presented below:
 
   
Six months ended
  
Year ended
  
   
September 30,
  
March 31,
  
   
2006
  
2006
    2005  
       
Weighted-
      
Weighted-
      
Weighted-
  
       
average
      
average
      
average
  
       
exercise
      
exercise
      
exercise
  
   
Shares
  
price
  
Shares
  
price
  
Shares
  
price
  
                           
Outstanding at beginning of period
    
179,148
  
$
13.92
    
214,204
  
$
13.84
    
214,204
  
$
13.84
  
Granted
    
-
    
-
    
-
    
-
    
163,265
    
13.95
  
Exercised
    
(20,000
)
  
13.95
    
(27,556
)
  
13.32
    
-
    
-
  
Forfeited
    
-
    
-
    
(7,500
)
  
13.95
    
(163,265
)
  
13.95
  
                                       
Outstanding at end of period
    
159,148
  
$
13.91
    
179,148
  
$
13.92
    
214,204
  
$
13.84
  
                                       
Options exercisable at period-end
    
159,148
  
$
13.91
    
179,148
  
$
13.92
    
214,204
  
$
13.84
  
                                       
Fair value of options granted
        
$
-
        
$
-
        
$
4.07
  
                                       
The following information applies to options outstanding at September 30, 2006:

Number outstanding
  
159,148
Range of exercise prices
 
$11.67 - $13.95
Weighted-average exercise price
  
$13.91
Weighted-average remaining contractual life
  
7.5 years
 
The fair value of options granted in fiscal 2005 has been based on the Black Scholes options pricing model using a dividend yield of 4.5% and an expected volatility of 27.3%. All options granted in fiscal 2005 have expected lives of nine years.

5.             
Recent Accounting Developments

In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155, “Accounting for Certain Hybrid Instruments - an amendment of FASB Statements No. 133 and 140,” to simplify and make more consistent the accounting for certain financial instruments. Specifically, SFAS No. 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to permit fair value remeasurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided that the whole instrument is accounted for on a fair value basis. SFAS No. 155 amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,” to allow a qualifying special purpose entity to hold a derivative instrument that pertains to a beneficial interest other than another derivative financial instrument.

SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006, or April 1, 2007 as to the Corporation, with earlier application allowed. The Corporation is currently evaluating SFAS No. 155, but does not expect it to have a material effect on the Corporation’s financial position or results of operations.


10
 


Wayne Savings Bancshares, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the six and three month periods ended September 30, 2006 and 2005
 


5.             
Recent Accounting Developments (continued)

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of SFAS No. 140,” to simplify the accounting for separately recognized servicing assets and servicing liabilities. Specifically, SFAS No. 156 amends SFAS No. 140 to require an entity to take the following steps:

 
·
Separately recognize financial assets as servicing assets or servicing liabilities, each time it undertakes an obligation to service a financial asset by entering into certain kinds of servicing contracts;
 
·
Initially measure all separately recognized servicing assets and liabilities at fair value, if practicable; and
 
·
Separately present servicing assets and liabilities subsequently measured at fair value in the statement of financial condition and additional disclosures for all separately recognized servicing assets and servicing liabilities.

Additionally, SFAS No. 156 permits, but does not require, an entity to choose either the amortization method or the fair value measurement method for measuring each class of separately recognized servicing assets and servicing liabilities. SFAS No. 156 also permits a servicer that uses derivative financial instruments to offset risks on servicing to use fair value measurement when reporting both the derivative financial instrument and related servicing asset or liability.

SFAS No. 156 applies to all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006, or April 1, 2007 as to the Company. The Company is currently evaluating SFAS No. 156, but does not expect it to have a material effect on the Company’s financial condition or results of operations.

In September 2006, the FASB issued SFAS No. 158, “Employers Accounting for Defined Benefit Pension and Other Postretirement Plans: An Amendment of FASB Statements No. 87, 88, 106 and 132R.” The Statement requires recognition of the funded status of postretirement benefit plans in the consolidated statement of financial condition. An employer must recognize an asset or liability in its statement of financial condition for the difference between the fair value of the plan assets and the projected benefit obligations. Changes in the plan’s funded status must be recognized, in the year of change, in comprehensive income.

Additionally, the Statement will require entities to measure the funded status of the plan as of the date of the year-end statement of financial condition, with a few exceptions.

The recognition provisions of this Statement are effective for fiscal years ending after December 31, 2006, or March 31, 2007, as to the Company. The Statement is to be applied as of the end of the year adopted. Retrospective application is prohibited.

The provisions that may require an entity to change the plan measurement date are effective for fiscal years ending after December 31, 2008, or March 31, 2009, as to the Company.

Management is currently evaluating the requirements of SFAS No. 158 but does not expect it to have a material effect on its consolidated statement of financial condition and results of operations.


11
 


Wayne Savings Bancshares, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the six and three month periods ended September 30, 2006 and 2005


5.             
Recent Accounting Developments (continued)

In September 2006, the SEC staff issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.”  SAB 108 was issued to provide consistency between how registrants quantify financial statement misstatements.

Historically, there have been two widely-used methods for quantifying the effects of financial statement misstatements.  These methods are referred to as the “roll-over” and “iron curtain” method.  The roll-over method quantifies the amount by which the current year income statement is misstated.  Exclusive reliance on an income statement approach can result in the accumulation of errors on the balance sheet that may not have been material to any individual income statement, but which may misstate one or more balance sheet accounts.  The iron curtain method quantifies the error as the cumulative amount by which the current year balance sheet is misstated.   Exclusive reliance on a balance sheet approach can result in disregarding the effects of errors in the current year income statement that results from the correction of an error existing in previously issued financial statements. We currently use the roll-over method for quantifying identified financial statement misstatements.

SAB 108 established an approach that requires quantification of financial statement misstatements based on the effects of the misstatement on each of the company’s financial statements and the related financial statement disclosures.  This approach is commonly referred to as the “dual approach” because it requires quantification of errors under both the roll-over and iron curtain methods. 

SAB 108 allows registrants to initially apply the dual approach either by (1) retroactively adjusting prior financial statements as if the dual approach had always been used, or by (2) recording the cumulative effect of initially applying the dual approach as adjustments to the carrying values of assets and liabilities as of April 1, 2006, with an offsetting adjustment recorded to the opening balance of retained earnings. Use of this “cumulative effect” transition method requires detailed disclosure of the nature and amount of each individual error being corrected through the cumulative adjustment and how and when it arose.

Management is currently evaluating the requirements of SAB 108 but does not expect it to have a material adverse effect on the Company’s consolidated statement of financial position or results of operations.

In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes.” The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” Specifically, FIN 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax provision taken or expected to be taken on a tax return. FIN 48 also provides guidance on the related derecognition, classification, interest and penalties, accounting for interim periods, disclosure, and transition of uncertain tax positions. FIN 48 is effective for fiscal years beginning after December 15, 2006, or April 1, 2007 as to the Company. The Company is currently evaluating the requirements of FIN 48 but does not expect it to have a material adverse effect on the Company’s consolidated statement of financial position or results of operations.



12
 


Wayne Savings Bancshares, Inc.

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

 
Average Balance Sheet

The following tables set forth certain information relating to the Company’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields earned and rates paid. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented.

   
For the six months ended September 30,
  
       
2006
          
2005
      
   
Average
      
Average Yield/
  
Average
      
Average Yield/
  
   
Balance
  
Interest
  
Rate
  
Balance
  
Interest
  
Rate
  
   
(Dollars in thousands)
  
Interest-earning assets:
                                      
Loans receivable, net1
  
$
236,034
  
$
7,876
    
6.67
%
$
215,902
  
$
6,725
    
6.23
%
Mortgage-backed
                                     
securities2
    
60,714
    
1,481
    
4.88
    
55,971
    
979
    
3.50
  
Investment securities
    
69,376
    
1,455
    
4.19
    
77,412
    
1,533
    
3.96
  
Interest-bearing deposits3
    
10,427
    
202
    
3.87
    
16,335
    
242
    
2.96
  
Total interest-
                                      
earning assets
    
376,551
    
11,014
    
5.85
    
365,620
    
9,479
    
5.19
  
Non-interest-earning assets
    
22,782
                
25,169
              
Total assets
  
$
399,333
              
$
390,789
              
                                       
Interest-bearing liabilities:
                                      
Deposits
  
$
332,611
    
4,649
    
2.80
  
$
323,406
    
3,346
    
2.07
  
Borrowings
    
28,078
    
628
    
4.47
    
27,234
    
502
    
3.69
  
Total interest-
                                      
bearing liabilities
    
360,689
    
5,277
    
2.93
    
350,640
    
3,848
    
2.19
  
Non-interest bearing
                                      
liabilities
    
2,913
                
1,692
              
Total liabilities
    
363,602
                
352,332
              
Stockholders’ equity
    
35,731
                
38,457
              
Total liabilities and
                                      
stockholders’ equity
  
$
399,333
              
$
390,789
              
Net interest income
        
$
5,737
              
$
5,631
        
Interest rate spread4
                
2.92
%
              
3.00
%
Net yield on interest-
                                      
earning assets5
                
3.05
%
              
3.08
%
Ratio of average interest-
                                      
earning assets to average
                                      
interest-bearing liabilities
                
104.40
%
              
104.27
%

__________________________________
1 Includes non-accrual loan balances.
2 Includes mortgage-backed securities designated as available for sale.
3 Includes federal funds sold and interest-bearing deposits in other financial institutions.
4 Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities
5 Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.


13
 


Wayne Savings Bancshares, Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Average Balance Sheet - (continued)

   
For the three months ended September 30,
  
       
2006
          
2005
      
   
Average
      
Average Yield/
  
Average
      
Average Yield/
  
   
Balance
  
Interest
  
Rate
  
Balance
  
Interest
  
Rate
  
   
(Dollars in thousands)
  
Interest-earning assets:
                                      
Loans receivable, net1
  
$
236,649
  
$
3,985
    
6.74
%
$
218,695
  
$
3,441
    
6.29
%
Mortgage-backed
                                     
securities2
    
62,906
    
782
    
4.97
    
53,284
    
467
    
3.51
  
Investment securities
    
67,751
    
712
    
4.20
    
78,075
    
774
    
3.97
  
Interest-bearing deposits3
    
10,186
    
99
    
3.88
    
15,053
    
116
    
3.08
  
Total interest-
                                      
earning assets
    
377,492
    
5,578
    
5.91
    
365,107
    
4,798
    
5.26
  
Non-interest-earning assets
    
22,706
                
24,609
              
Total assets
  
$
400,198
              
$
389,716
              
                                       
Interest-bearing liabilities:
                                      
Deposits
  
$
331,448
    
2,417
    
2.92
  
$
325,465
    
1,728
    
2.12
  
Borrowings
    
30,158
    
345
    
4.58
    
25,076
    
238
    
3.80
  
Total interest-
                                      
bearing liabilities
    
361,606
    
2,762
    
3.06
    
350,541
    
1,966
    
2.24
  
Non-interest bearing
                                      
liabilities
    
2,767
                
2,018
              
Total liabilities
    
364,373
                
352,559
              
Stockholders’ equity
    
35,825
                
37,157
              
Total liabilities and
                                      
stockholders’ equity
  
$
400,198
              
$
389,716
              
Net interest income
        
$
2,816
              
$
2,832
        
Interest rate spread4
                
2.85
%
              
3.02
%
Net yield on interest-
                                      
earning assets5
                
2.98
%
              
3.10
%
Ratio of average interest-
                                      
earning assets to average
                                      
interest-bearing liabilities
                
104.40
%
              
104.16
%

_____________________________________________
1 Includes non-accrual loan balances.
2 Includes mortgage-backed securities designated as available for sale.
3 Includes federal funds sold and interest-bearing deposits in other financial institutions.
4 Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities
5 Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.


14
 


Wayne Savings Bancshares, Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Discussion of Financial Condition Changes from March 31, 2006 to September 30, 2006

At September 30, 2006, we had total assets of $405.8 million, an increase of $2.1 million, or .5%, from March 31, 2006 levels.

Liquid assets, consisting of cash, interest-bearing deposits and investment securities, decreased by $12.2 million, or 13.9%, to $75.3 million at September 30, 2006, due primarily to sales and maturities of $11.6 million of investment securities. In addition to maturities of available for sale investment securities totaling $6.4 million, investment securities held to maturity decreased $5.2 million due to the maturity of a $2.5 million corporate bond, coupled with management’s decision to sell another $2.5 million corporate bond due to deterioration of the credit rating to sub-investment level. Additionally, the interest-bearing deposits in other financial institutions decreased $1.7 million.

Mortgage-backed securities increased by $12.8 million, or 22.9%, during the six months ended September 30, 2006. Due to a decline in loan demand, management elected to use proceeds from sales and maturities of investment securities to fund purchases of mortgage-backed securities.

At September 30, 2006 loans receivable increased by $987,000, compared to March 31, 2006, as the Bank originated and retained $31.9 million of loans and received payments of $30.9 million. Rather than reinvest funds from repayments on loans in long-term, fixed-rate residential loans, the lending division has originated shorter-term and adjustable-rate commercial loans. The Company believes that investing in shorter-term and adjustable-rate commercial loans positions the Company favorably in an increasing interest rate environment. The composition of the loan portfolio has changed during the six months ended September 30, 2006, due to a net decrease of $4.3 million in residential and construction mortgage loans, offset by increases in nonresidential real estate loans of $3.8 million and a net increase in commercial loans of $1.1 million in connection with the Bank’s increased emphasis on commercial lending.

   
September 30, 2006
  
March 31, 2006
  
   
(Dollars in thousands)
  
Mortgage loans:
                          
One-to four-family residential(1)
  
$
146,758
    
61.14
%
$
149,134
    
62.40
%
Residential construction loans
    
2,844
    
1.18
    
4,675
    
1.96
  
Multi-family residential
    
7,729
    
3.22
    
7,930
    
3.32
  
Non-residential real estate/land(2)
    
54,599
    
22.74
    
50,778
    
21.25
  
Total mortgage loans
    
211,930
    
88.28
    
212,517
    
88.93
  
Other loans:
                          
Consumer loans(3)
    
5,464
    
2.28
    
4,901
    
2.05
  
Commercial business loans
    
22,683
    
9.44
    
21,550
    
9.02
  
Total other loans
    
28,147
    
11.72
    
26,451
    
11.07
  
Total loans before net items
    
240,077
    
100.00
%
  
238,968
    
100.00
%
Less:
                          
Loans in process
    
1,804
          
1,729
        
Deferred loan origination fees
    
486
          
443
        
Allowance for loan losses
    
1,488
          
1,484
        
Total loans receivable, net
  
$
236,299
        
$
235,312
        
Mortgage-backed securities, net(4)
  
$
68,507
        
$
55,731
        
_________________________
(1)
Includes equity loans collateralized by second mortgages in the aggregate amount of $20.3 million and $20.9 million as of September 30, 2006 and March 31, 2006, respectively. Such loans have been underwritten on substantially the same basis as the Company’s first mortgage loans.
(2)
Includes land loans of $258,000 and $674,000 as of September 30, 2006 and March 31, 2006, respectively.
(3)
Includes second mortgage loans of $550,000 and $783,000 as of September 30, 2006 and March 31, 2006, respectively.
(4) Includes mortgage-backed securities designated as available for sale.


15
 


Wayne Savings Bancshares, Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Discussion of Financial Condition Changes from March 31, 2006 to September 30, 2006 (continued)

Non-performing loans amounted to $872,000 at September 30, 2006, as compared with $772,000 in non-performing loans at March 31, 2006. Such loans consisted, on both dates, of primarily residential mortgage loans. Historically, the Company generally has not recognized significant losses on non-performing loans secured by residential mortgages. The following table sets forth information regarding our past due, nonaccrual and impaired loans and real estate acquired through foreclosure as of September 30, 2006 and March 31, 2006.

   
September 30,
  
March 31,
  
   
2006
  
2006
  
   
(Dollars in thousands)
  
Past due loans 30-89 days:
              
Mortgage loans:
              
One- to four-family residential
  
$
487
  
$
553
  
Nonresidential
    
-
    
-
  
Land
    
-
    
-
  
Non-mortgage loans:
              
Commercial business loans
    
25
    
72
  
Consumer loans
    
21
    
1
  
     
533
    
626
  
               
Non-performing loans:
              
Mortgage loans:
              
One- to four-family residential
    
860
    
725
  
All other mortgage loans
    
-
    
-
  
Non-mortgage loans:
              
Commercial business loans
    
-
    
47
  
Consumer
    
12
    
-
  
Total non-performing loans
    
872
    
772
  
Total real estate acquired through foreclosure
    
97
    
156
  
Total non-performing assets
  
$
969
  
$
928
  
               
Total non-performing loans to net
              
loans receivable
    
0.37
%
  
0.33
%
Total non-performing loans to total assets
    
0.21
%
  
0.19
%
Total non-performing assets to total assets
    
0.24
%
  
0.23
%

 


16
 


Wayne Savings Bancshares, Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Discussion of Financial Condition Changes from March 31, 2006 to September 30, 2006 (continued)

The following table sets forth the analysis of the allowance for loan losses for the periods indicated.

 
 For the six months ended
 For the year ended
 
 September 30, 2006
  
March 31, 2006
  
   
(Dollars in thousands)
  
             
Loans receivable, net
  
$
236,299
    
$
235,312
  
Average loans receivable, net
  
$
236,034
    
$
222,944
  
Allowance balance (at beginning of period)
  
$
1,484
    
$
1,374
  
Charge-offs:
                
Mortgage loans:
                
One- to four-family
    
(46
)
    
(73
)
Residential construction
    
-
      
-
  
Multi-family residential
    
-
      
-
  
Non-residential real estate and land
    
(15
)
    
-
  
Other loans:
                
Consumer
    
(6
)
    
(75
)
Commercial
    
-
      
(10
)
Gross charge-offs
    
(67
)
    
(158
)
Recoveries:
                
Mortgage loans:
                
One- to four-family
    
-
      
14
  
Residential construction
    
-
      
-
  
Multi-family residential
    
-
      
-
  
Non-residential real estate and land
    
-
      
-
  
Other loans:
                
Consumer
    
11
      
35
  
Commercial
    
-
      
8
  
Gross recoveries
    
11
      
57
  
Net charge-offs
    
(56
)
    
(101
)
Provision charged to operations
    
60
      
211
  
Allowance for loans losses balance (at end
                
of period)
 
$
1,488
    
$
1,484
  
Allowance for loan losses as a percent of loans
                
receivable, net at end of period
    
0.63
%
    
0.63
%
Net loans charged off as a percent of average
               
loans receivable, net
    
0.02
%
    
0.05
%
Ratio of allowance for loan losses to non-
                
performing loans at end of period
    
170.64
%
    
192.23
%


Deposits totaled $327.5 million at September 30, 2006, a decrease of $5.1 million, or 1.5%, from $332.6 million at March 31, 2006, due primarily to general market competition. Savings deposits decreased by $12.7 million and Commercial Repurchase Agreements decreased by $1.1 million. These decreases were offset by an increase in NOW accounts of $5.9 million, money market growth of $1.7 million and certificates of deposit growth of $1.0 million.

Borrowings totaled $38.9 million at September 30, 2006 as compared with $32.8 million at March 31, 2006. The Company increased borrowings due to funding requirements to offset the decrease in deposits during the September 30, 2006 six month period.


17
 


Wayne Savings Bancshares, Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Discussion of Financial Condition Changes from March 31, 2006 to September 30, 2006 (continued)

Stockholders’ equity increased by $197,000, or 0.6%, during the six months ended September 30, 2006, due mainly to earnings of $1.1 million, a decrease in the unrealized losses on available for sale securities of $436,000 and proceeds from stock options exercised of $279,000, offset by the treasury stock purchase of $836,000 and dividends paid of $799,000.


Comparison of Operating Results for the Six Month Periods Ended September 30, 2006 and 2005

General

Net earnings totaled $1.1 million for the six months ended September 30, 2006, an increase of $170,000, or 18.7%, compared to the net earnings of $907,000 for the six months ended September 30, 2005. The increase in net earnings was primarily attributable to a decrease in general, administrative and other expense of $246,000, or 4.7%, and an increase in net interest income after provision for losses on loans of $46,000, or 0.8%, which were partially offset by an increase in federal income taxes of $125,000, or 40.7%.

Interest Income

Interest income increased by $1.5 million, or 16.2%, to $11.0 million for the six months ended September 30, 2006, compared to the same period in 2005. This increase was mainly due to an increase in the weighted-average yield on interest-earning assets to 5.85% from 5.19% for the six-month period ended September 30, 2005. Additionally, the average balance of interest-earning assets outstanding increased by $10.9 million to $376.6 million for the six months ended September 30, 2006, from $365.6 million for the comparable period ended September 30, 2005. The yield increase is primarily due to the Federal Reserve raising the prime rate by 2.0% over the past year and the corresponding impact on the Company’s interest-earning assets, particularly investment securities and interest-bearing deposits.

Interest income on loans increased by $1.2 million, or 17.1%, for the six months ended September 30, 2006, compared to the same period in 2005, due primarily an increase in the average balance of loans outstanding period to period of $20.1 million, or 9.3%, to $236.0 million for the 2006 period, coupled with an increase in the weighted-average yield of 44 basis points to 6.67% for the six months ended September 30, 2006.

Interest income on mortgage-backed securities increased by $502,000, or 51.3%, during the six months ended September 30, 2006, compared to the same period in 2005, due primarily to an increase of 138 basis points in the weighted-average yield to 4.88% in the 2006 period as compared to 3.50% for the comparable 2005 period. The slowdown of prepayments caused premium amortization to decrease, resulting in an increase in interest income on mortgage-backed securities. In addition to the increased weighted-average rate, the average balance increased by $4.7 million, or 8.5% over the six months ended September 30, 2006 compared to the same period in 2005.

Interest income on investment securities decreased by $78,000, or 5.1%, during the six-months ended September 30, 2006, compared to the same period in 2005, reflecting a decrease in the average balance of $8.0 million, or 10.4%, to $69.4 million from $77.4 million during the comparable 2005 period, offset by an increase in the weighted-average yield to 4.19% from 3.96% for the six month period in 2005.

Interest income on interest-bearing deposits decreased by $40,000, or 16.5%, for the six months ended September 30, 2006, compared to the same period in 2005, due primarily to a decrease in the average balance outstanding of $5.9 million, or 36.2%, offset by an increase in the weighted-average yield of 91 basis points to 3.87% for the 2006 period from 2.96% for the six months ended September 30, 2005.

18
 


 
Wayne Savings Bancshares, Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Comparison of Operating Results for the Six Month Periods Ended September 30, 2006 and 2005 (continued)

Interest Expense

Interest expense totaled $5.3 million for the six months ended September 30, 2006, an increase of $1.4 million, or 37.1%, over the six months ended September 30, 2005. The increase resulted from a 74 basis point increase in the weighted-average cost of funds to 2.93% for the 2006 period, coupled with an increase in the average balance of deposits and borrowings outstanding of $10.0 million, or 2.9%, to $360.7 million for the six-month period ended September 30, 2006.

Interest expense on deposits totaled $4.6 million for the six months ended September 30, 2006, an increase of $1.3 million, or 38.9%, compared to the six months ended September 30, 2005, as a result of a 73 basis point increase in the weighted-average cost of deposits to 2.80% for the 2006 period, coupled with an increase in the average balance outstanding of $9.2 million, or 2.8%, to $332.6 million for the 2006 period.
 
Interest expense on borrowings totaled $628,000 for the six months ended September 30, 2006, an increase of $126,000, or 25.1%, over the 2005 period, primarily due to an increase in the weighted-average yield of 78 basis points to 4.47% for the six months ended September 30, 2006, coupled with an increase in the average balance outstanding of $844,000, or 3.1%.

Net Interest Income

Net interest income totaled $5.7 million for the six months ended September 30, 2006, an increase of $106,000, or 1.9%, over the six month period ended September 30, 2005. The average interest rate spread decreased to 2.92% for the six months ended September 30, 2006 from 3.00% for the six months ended September 30, 2005. The net interest margin decreased to 3.05% for the six months ended September 30, 2006 from 3.08% for the six months ended September 30, 2005.

Provision for Losses on Loans

Management recorded a $60,000 provision for losses on loans for the six-month period ended September 30, 2006. The Company did not record any provision for losses on loans for the six month period ended September 30, 2005. This increase was primarily due to the shift in the composition of the loan portfolio discussed above. To the best of management’s knowledge, all known and inherent losses that are probable and which can be reasonably estimated have been recorded as of September 30, 2006.

Other Income

Other income, consisting primarily of the cash surrender value of life insurance, gain on sale of loans, service fees and charges on deposit accounts increased by $3,000, or 0.4%, for the six months ended September 30, 2006, as compared with the six months ending September 30, 2005. Gain on sale of loans was down $69,000 due to management’s decision to retain mortgage loans originated in the portfolio instead of selling them into the secondary market. The decrease in cash surrender value of life insurance of $15,000, or 12.0%, was due to a decrease in the average balance on these policies. These decreases were offset by an increase of $87,000, or 13.2%, in service fees, charges and other operating income which was mainly comprised of general depositor service charges and an increase in trust income.


19
 


Wayne Savings Bancshares, Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Comparison of Operating Results for the Six Month Periods Ended September 30, 2006 and 2005 (continued)

General, Administrative and Other Expense

General, administrative and other expense decreased by $246,000, or 4.7%, to $5.0 million for the six months ended September 30, 2006 compared to the six months ended September 30, 2005. Employee compensation and benefits expense decreased by $266,000, or 8.5%, due primarily to management’s successful efforts to reduce the number of full time equivalent employees from 128 at September 30, 2005 to 114 at September 30, 2006. The majority of this reduction occurred through attrition. Additionally, during the six-month period ended September 30, 2006, management undertook an initiative to enhance the Bank’s sales culture at the branch manager level. In connection with this initiative several employees left the Bank and the Bank incurred approximately $84,000 in severance costs. Franchise taxes were reduced by $63,000, or 24.1%, due primarily to the effects of the treasury stock repurchase programs from prior years. These decreases were offset by an increase of $51,000, or 5.2%, in other operating expense mainly due to an increase in internet banking expenses, and a $34,000, or 3.8%, increase in occupancy and equipment expense which was due primarily to data processing expenses needed to facilitate growth in internet banking, the implementation of check imaging technology and increased building maintenance, insurance and taxes at our branches.

Federal Income Taxes

Federal income tax expense was $432,000 for the six months ended September 30, 2006, an increase of $125,000, or 40.7%, compared to the same period in 2005, primarily due to the $295,000, or 24.3%, increase in earnings before taxes. The difference in the effective tax rate from the 34% statutory rate was mainly due to the beneficial effects of income from the cash surrender value on life insurance and other tax-exempt obligations.


Comparison of Operating Results for the Three Month Periods Ended September 30, 2006 and 2005

General

Net earnings totaled $484,000 for the quarter ended September 30, 2006, an increase of $17,000, or 3.6%, compared to the net earnings of $467,000 for the quarter ended September 30, 2005. The increase in net earnings was primarily attributable to a decrease in general, administrative and other expense of $114,000, or 4.3%, offset by a decrease in net interest income after provision for losses on loans of $46,000, or 1.6%, an increase in federal income taxes of $36,000, or 22.6% and a decrease in other operating income of $15,000, or 3.4%.

Interest Income

Interest income increased by $780,000, or 16.3%, to $5.6 million for the three months ended September 30, 2006, compared to the same period in 2005. This increase was mainly due to an increase in the weighted-average yield on interest-earning assets to 5.91% for the 2006 period from 5.26% for the three-month period ended September 30, 2005. The increase in yield was primarily due to the Federal Reserve raising the prime rate by 2.0% over the past year and the corresponding impact on the Company’s interest-earning assets, particularly investment securities and interest-bearing deposits.

Interest income on loans increased by $544,000, or 15.8%, for the three months ended September 30, 2006, compared to the same period in 2005, due primarily to an increase in the average balance of loans outstanding period to period of $18.0 million, or 8.2%, to $236.6 million for the 2006 period, coupled with an increase in the weighted-average yield of 45 basis points to 6.74%.


20
 


Wayne Savings Bancshares, Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Comparison of Operating Results for the Three Month Periods Ended September 30, 2006 and 2005 (continued)

Interest Income (continued)

Interest income on mortgage-backed securities increased by $315,000, or 67.5%, during the three months ended September 30, 2006, compared to the same period in 2005, due primarily to an increase of 146 basis points in the weighted-average yield to 4.97% for the 2006 period as compared to 3.51% for the comparable 2005 period. The slowdown of prepayments caused premium amortization to decrease, resulting in an increase in interest income on mortgage-backed securities. In addition to the increased weighted-average rate, the average balance outstanding increased by $9.6 million, or 18.1%.
 
Interest income on investment securities decreased by $62,000, or 8.0%, during the three months ended September 30, 2006, compared to the same period in 2005, reflecting a decrease in the average balance outstanding of $10.3 million, or 13.2%, to $67.8 million in the 2006 period from $78.1 million during the comparable 2005 period, offset by an increase in the weighted-average yield of 23 basis points to 4.20%.

Interest income on interest-bearing deposits decreased by $17,000, or 14.7%, for the three months ended September 30, 2006, due primarily to a decrease in the average balance outstanding of $4.9 million, or 32.3%, offset by an increase in the weighted-average yield of 80 basis points to 3.88% from 3.08% for the quarter ended September 30, 2005.

Interest Expense

Interest expense totaled $2.8 million for the three months ended September 30, 2006, an increase of $796,000, or 40.5%, compared to the three months ended September 30, 2005. The increase resulted from an 82 basis point increase in the average cost of funds to 3.06% for the 2006 period, coupled with an increase in the average balance of deposits and borrowings outstanding of $11.1 million, or 3.2%, to $361.6 million for the three-month period ended September 30, 2006.

Interest expense on deposits totaled $2.4 million for the three months ended September 30, 2006, an increase of $689,000, or 39.9%, compared to the three months ended September 30, 2005, as a result of an increase in the weighted-average cost of deposits of 80 basis points to 2.92% for the 2006 period, coupled with an increase in the average balance outstanding of $6.0 million, or 1.8%, to $331.4 million for the 2006 period.
 
Interest expense on borrowings totaled $345,000 for the three months ended September 30, 2006, an increase of $107,000, or 45.0%, over the 2005 period, primarily due to an increase in the weighted-average yield of 78 basis points to 4.58% for the three months ended September 30, 2006, and an increase in the average balance outstanding of $5.1 million, or 20.3%.

Net Interest Income

Net interest income totaled $2.8 million for the three months ended September 30, 2006, a decrease of $16,000, or 0.6%, from the three month period ended September 30, 2005. The average interest rate spread decreased to 2.85% for the three months ended September 30, 2006 from 3.02% for the three months ended September 30, 2005. The net interest margin decreased to 2.98% for the three months ended September 30, 2006 from 3.10% for the three months ended September 30, 2005. The interest rate spread decrease was primarily a result of the Bank’s cost of funds increasing at a higher rate, due to competition for deposits in our local market area and changes in consumer preferences toward higher yielding certificates of deposit, than the loan portfolio’s adjustable rates repricing upward and higher yielding new loans being added.


21
 


Wayne Savings Bancshares, Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Comparison of Operating Results for the Three Month Periods Ended September 30, 2006 and 2005 (continued)

Provision for Losses on Loans 

Management recorded a $30,000 provision for losses on loans for the three-month period ended September 30, 2006. The Company did not record any provision for losses on loans for the three month period ending September 30, 2005. This increase was primarily due to the shift in the composition of the loan portfolio discussed above. To the best of management’s knowledge, all known and inherent losses that are probable and which can be reasonably estimated have been recorded as of September 30, 2006.

Other Income

Other income, consisting primarily of the cash surrender value of life insurance, gain on sale of loans, service fees, and charges on deposit accounts decreased by $15,000, or 3.4%, for the three months ended September 30, 2006 as compared with the quarter ended September 30, 2005. Gain on sale of loans was down $44,000 due to management’s decision to retain mortgage loans originated in the portfolio instead of selling them in the secondary market. The cash surrender value of life insurance decreased by $8,000, or 12.7%, due to a decrease in average balance on these policies. These decreases were offset by an increase of $37,000, or 10.9%, in service fees, charges and other operating income, which was mainly comprised of general depositor service charges coupled with an increase in trust income.

General, Administrative and Other Expense

General, administrative and other expense decreased by $114,000, or 4.3%, to $2.5 million for the three months ended September 30, 2006 compared to the three months ended September 30, 2005. Employee compensation and benefits expense decreased by $95,000, or 6.2%, mainly due to management’s successful efforts to reduce the number of full time equivalent employees from 128 at September 30, 2005 to 114 at September 30, 2006. The majority of this reduction occurred through attrition. Additionally, during the three-month period ended September 30, 2006, management undertook an initiative to enhance the Bank’s sales culture at the branch manager level. In connection with this initiative several employees left the Bank and the Bank incurred approximately $84,000 in severance costs. Franchise taxes were reduced by $52,000, or 39.4%, as a result of the treasury stock repurchase programs from prior years. These decrease were offset by an increase of $33,000, or 6.8%, in other operating expense due primarily to data processing expenses needed to facilitate growth in internet banking, the implementation of check imaging technology and increased building maintenance, insurance and taxes at our branches.

Federal Income Taxes

Federal income tax expense was $195,000 for the three months ended September 30, 2006, an increase of $36,000, or 22.6%, compared to the same period in 2005, primarily due to the $53,000, or 8.5%, increase in earnings before taxes. The difference in the effective tax rate from the 34% statutory rate is mainly due to the beneficial effects of income from the cash surrender value on life insurance and other tax-exempt obligations.



22
 


Wayne Savings Bancshares, Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)


Forward-Looking Statements

This document contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar expressions. These forward-looking statements include: statements of goals, intentions and expectations, statements regarding prospects and business strategy, statements regarding asset quality and market risk, and estimates of future costs, benefits and results.

These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following: (1) general economic conditions, (2) competitive pressure among financial services companies, (3) changes in interest rates, (4) deposit flows, (5) loan demand, (6) changes in legislation or regulation, (7) changes in accounting principles, policies and guidelines, (8) litigation liabilities, including costs, expenses, settlements and judgments, and (9) other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services.

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. We have no obligation to update or revise any forward-looking statements to reflect any changed assumptions, any unanticipated events or any changes in the future.


ITEM 3      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Management believes there has been no material change in the Company’s market risk since the Company’s Form 10-K filed with the Securities and Exchange Commission for the year ended March 31, 2006.


ITEM 4            CONTROLS AND PROCEDURES

(a)     Evaluation of disclosure controls and procedures.

Under the supervision and with the participation of the Company’s management, including our Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of its 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 period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective in timely alerting them to the material information relating to the Company (or our consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.

(b)     Changes in internal controls.

There has been no change made in the Company’s internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.


23
 


Wayne Savings Bancshares, Inc. 

PART II

ITEM 1.         Legal Proceedings

Not applicable

ITEM 1A.  Risk Factors

Not applicable

ITEM 2.         Unregistered Sales of Equity Securities and Use of Proceeds

 
(a)
Not applicable
 
(b)
Not applicable
 
(c)
The following table sets forth certain information regarding repurchases by the Company for the quarter ended September 30, 2006.

                 
Total # of
  
Maximum # of shares
     
Total
  
Average
  
shares purchased
  
which may still be
     
# of shares
  
price paid
  
as part of the
  
purchased as part
 
Period
  
purchased
  
per share
  
announced plan
  
of the announced plan
                           
 
July 1-31, 2006
    
-
   
$
-
      
-
     
140,105
  
 
August 1-31, 2006
    
39,500
    
$
15.14
      
39,500
      
100,605
  
 
September 1-30, 2006
    
16,000
    
$
14.86
      
16,000
      
84,605
  

Notes to the Table:

On June 6, 2005, the Company announced the completion of the repurchase program and the authorization by the Board of Directors of a new program for the repurchase of 352,433 shares, or 10% of the Company’s outstanding shares.

ITEM 3.          Defaults Upon Senior Securities

Not applicable

ITEM 4.          Submission of Matters to a Vote of Security Holders

The Company held its Annual Meeting of Stockholders on July 27, 2006. Two matters were presented to the shareholders for a vote: The stockholders elected two directors for terms expiring in 2009 by the following votes:

 
For
Withheld
     
Kenneth R. Lehman
2,329,236
197,721
James C. Morgan
2,329,440
197,516

The following directors terms continued after the meeting: Phillip E. Becker, Daniel R. Buehler, Terry A. Gardner, Russell L. Harpster and Frederick J. Krum.

The stockholders ratified the selection of Grant Thornton LLP as the Company’s auditors for the fiscal year ending March 31, 2007, by the following vote:

For: 2,485,350
Against: 27,593
Abstain: 14,013



24
 


Wayne Savings Bancshares, Inc. 

PART II (CONTINUED)


ITEM 5.                  Other Information
 
Not applicable

ITEM 6.                  Exhibits


 
 
EX-31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
   
EX-31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
   
EX-32
Written Statement of Chief Executive Officer and Chief Financial Officer furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350

 

25
 


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.





Date:     November 7, 2006
   By: 
 /s/ Phillip E. Becker
     
Phillip E. Becker
     
President and Chief Executive Officer
       
       
       
Date:     November 7, 2006
   By: 
 /s/ H. Stewart Fitz Gibbon III
     
H. Stewart Fitz Gibbon III
     
Executive Vice President and
     
Chief Financial Officer

Index
26