1.	BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

Prudential Bancorp, Inc. of Pennsylvania (the “Company”) is a Pennsylvania corporation, which was organized to be the mid-tier holding company for Prudential Savings Bank (the “Bank”), which is a Pennsylvania-chartered, FDIC-insured savings bank with six full service branches in the Philadelphia area. The Company was organized in conjunction with the Bank’s reorganization from a mutual savings bank to the mutual holding company structure in March 2005. The Bank is principally in the business of attracting deposits from its community through its branch offices and investing those deposits, together with funds from borrowings and operations, primarily in single-family residential loans and construction loans.

 

Prudential Mutual Holding Company, a Pennsylvania corporation, is the mutual holding company parent of the Company. Prudential Mutual Holding Company owns 59.5% (6,910,062 shares) of the Company’s outstanding common stock as of June 30, 2007 and must always own at least a majority of the voting stock of the Company. In addition to the shares of the Company, Prudential Mutual Holding Company was capitalized with $100,000 in cash from the Bank in connection with the completion of the reorganization. The consolidated financial statements of the Company include the accounts of the Company and the Bank. In addition, Prudential Mutual Holding Company receives dividends on the common stock of the Company that it holds, and has incurred legal expenses related to the legal proceedings described in Part II, Item 1. All significant intercompany balances and transactions have been eliminated.

Prior to the reorganization described above, the Board of Directors approved a plan of charter conversion in May 2004 pursuant to which the Bank would convert its charter from a Pennsylvania-chartered mutual savings and loan association to a Pennsylvania-chartered mutual savings bank. The conversion to a Pennsylvania-chartered mutual savings bank was completed on August 20, 2004. As a result of the charter conversion, the Bank’s primary federal banking regulator changed from the Office of Thrift Supervision to the Federal Deposit Insurance Corporation. The Pennsylvania Department of Banking remains as the Bank’s state banking regulator.

In November 2005, the Bank formed PSB Delaware, Inc., a Delaware Corporation, as a subsidiary of the Bank. In March 2006, all mortgage-backed securities owned by the Company were transferred to PSB Delaware, Inc. The activity of PSB Delaware, Inc. is included as part of the consolidated financial statements.

The accompanying unaudited consolidated financial statements were prepared in accordance with the instructions to Form 10-Q, and therefore do not include all the information or footnotes necessary for complete financial statements in conformity with accounting principles generally accepted in the United States of America. However, all normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the financial statements have been included. The results for the three months and nine months ended June 30, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2007, or any other period. These financial statements should be read in conjunction with the audited consolidated financial statements of the Company and the accompanying notes thereto for the year ended September 30, 2006 included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2006.

Use of Estimates in the Preparation of Financial Statements—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 the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. The most significant estimates and assumptions in the Company’s consolidated financial statements are recorded in the allowance for loan losses and deferred income taxes. Actual results could differ from those estimates.

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Dividend Payable - On June 20, 2007, the Company’s Board of Directors declared a quarterly cash dividend of $.05 on the common stock of the Company payable on July 27, 2007 to the shareholders of record at the close of business on July 13, 2007 which resulted in a payable of $556,000 at June 30, 2007. The portion of the cash dividend payable to Prudential Mutual Holding Company due to its ownership of shares of the Company’s common stock totaled $346,000.

Employee Stock Ownership Plan - In fiscal 2005, the Company established an employee stock ownership plan (“ESOP”) for substantially all of its full-time employees.  The ESOP purchased 452,295 shares of the Company’s common stock for an aggregate cost of approximately $4.5 million. Shares of the Company’s common stock purchased by the ESOP are held in a suspense account until released for allocation to participants. Shares are allocated to each eligible participant based on the ratio of each such participant’s compensation, as defined in the ESOP, to the total compensation of all eligible plan participants. As the unearned shares are released from the suspense account, the Company recognizes compensation expense equal to the fair value of the ESOP shares during the periods in which they become committed to be released. To the extent that the fair value of the ESOP shares released differs from the cost of such shares, the difference is charged or credited to equity as adjustments to additional paid-in capital. As of June 30, 2007, the Company had allocated a total of 39,585 shares from the suspense account to participants and committed to release an additional 11,310 shares. For the nine months ended June 30, 2007, the Company recognized $231,000 in compensation expense.

Treasury Stock - Stock held in treasury by the Company is accounted for using the cost method, which treats stock held in treasury as a reduction to total stockholders’ equity.

Comprehensive Income—The Company presents in the unaudited consolidated statement of changes in stockholders’ equity and comprehensive income those amounts from transactions and other events which currently are excluded from the statement of income and are recorded directly to stockholders’ equity. For the nine months ended June 30, 2007 and 2006, the only components of comprehensive income were net income and unrealized holding losses, net of income tax benefit, on available for sale securities. Comprehensive income totaled $2,537,000 and $2,735,000 for the nine months ended June 30, 2007 and 2006, respectively.

Recent Accounting Pronouncements - On July 13, 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"), which is effective for fiscal years beginning after December 15, 2006. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." This Interpretation prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. The Company is currently assessing the impact of FIN 48 on its financial statements.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently assessing the impact of SFAS No. 157 on its financial statements.

 

In September 2006, the Securities and Exchange Commission (“SEC”) issued SAB No. 108 expressing the SEC staff’s views regarding the process of quantifying financial statement misstatements and the build up of improper amounts on the balance sheet. SAB No. 108 requires that registrants quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a misstated amount that, when all relevant quantitative and qualitative factors are considered, is material. The built up misstatements, while not considered material in the individual years in which the misstatements were built up, may be considered material in a subsequent year if a company were to correct those misstatements through current period earnings. Initial application of SAB No. 108 allows registrants to elect not to restate prior periods but to reflect the initial application in their annual financial statements covering the first fiscal year ending after November 15, 2006. The cumulative effect of the initial application should be reported in the carrying amounts of assets and liabilities as of the beginning of that fiscal year and the offsetting adjustment, net of tax, should be made to the opening balance of retained earnings for that year.

 

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The Company implemented SAB No. 108 on October 1, 2006 which resulted in an increase in mortgage-backed securities held to maturity of approximately $321,000, an increase in income tax liabilities of approximately $149,000 and a cumulative adjustment to increase retained earnings as of that date by approximately $172,000. The adjustment relates to two separate accounting entries. The first entry pertains to the method of accounting that was utilized in past years for the recognition of investment income on mortgage-backed securities. Prior to fiscal 2006, the Company used the straight line method over the contractual life of the securities rather than using the effective yield method prescribed by SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases”. The impact of this entry was the correction of an understatement of mortgage-backed securities by approximately $321,000 and a corresponding understatement of income tax payable of $109,000. The second entry relates to a write off of a deferred tax asset of approximately $40,000 that was incorrectly accounted for in prior periods.

In prior periods, management performed a quantitative and qualitative analysis of the differences between these two methods of accounting and concluded that there was not a material impact on any past individual quarter or annual reporting periods.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. The statement provides companies with an option to report selected financial assets and liabilities at fair value. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted under certain circumstances. The Company is currently assessing the impact of SFAS No. 159 on its financial statements.

 

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2.	EARNINGS PER SHARE

 

Basic earnings per common share is computed based on the weighted average number of shares outstanding. Diluted earnings per share is computed based on the weighted average number of shares outstanding and common share equivalents ("CSEs") that would arise from the exercise of dilutive securities. As of June 30, 2007, the Company did not have outstanding any CSEs.

The calculated basic and diluted earnings per share are as follows:

		For the Quarter Ended June 30, 2007						For the Quarter Ended June 30, 2006
		Basic			Diluted			Basic			Diluted
		(Dollars in thousands except per share data)
Net income		$	977		$	977		$	882		$	882
Weighted average shares outstanding used in
basic earnings per share computation			11,325,265			11,325,265			11,866,046			11,866,046
Effect of CSEs			-			-			-			-
Adjusted weighted average shares used in
diluted earnings per share computation			11,325,265			11,325,265			11,866,046			11,866,046
Earnings per share - basic and diluted		$	0.09		$	0.09		$	0.07		$	0.07

 

		For the Nine Months Ended June 30, 2007						For the Nine Months Ended June 30, 2006
		Basic			Diluted			Basic			Diluted
		(Dollars in thousands except per share data)
Net income		$	2,838		$	2,838		$	2,924		$	2,924
Weighted average shares outstanding used in
basic earnings per share computation			11,498,527			11,498,527			11,984,754			11,984,754
Effect of CSEs			-			-			-			-
Adjusted weighted average shares used in
diluted earnings per share computation			11,498,527			11,498,527			11,984,754			11,984,754
Earnings per share - basic and diluted		$	0.25		$	0.25		$	0.24		$	0.24

 

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3.	INVESTMENT SECURITIES

 

The amortized cost and fair value of securities, with gross unrealized gains and losses, are as follows:

 

		June 30, 2007
					Gross			Gross			Estimated
		Amortized			Unrealized			Unrealized			Fair
		Cost			Gains			Losses			Value
		(Dollars in thousands)
Securities held to maturity:
Debt securities - U.S. Treasury securities
and securities of U.S. Government agencies		$	132,330		$	6		$	(3,352	)	$	128,984
Debt securities - Municipal bonds			2,885			-			(74	)		2,811
Total securities held to maturity		$	135,215		$	6		$	(3,426	)	$	131,795
Securities available for sale:
Debt securities - U.S. Treasury securities
and securities of U.S. Government agencies		$	2,999		$	-		$	(81	)	$	2,918
FNMA stock			-			8			-			8
Mutual fund			34,982			-			(1,141	)		33,841
FHLMC preferred stock			26			1,579			-			1,605
Total securities available for sale		$	38,007		$	1,587		$	(1,222	)	$	38,372

		September 30, 2006
					Gross			Gross			Estimated
		Amortized			Unrealized			Unrealized			Fair
		Cost			Gains			Losses			Value
		(Dollars in thousands)
Securities held to maturity:
Debt securities - U.S. Treasury securities
and securities of U.S. Government agencies		$	129,199		$	-		$	(2,459	)	$	126,740
Debt securities - Municipal bonds			2,885			6			(38	)		2,853
Total securities held to maturity		$	132,084		$	6		$	(2,497	)	$	129,593
Securities available for sale:
Debt securities - U.S. Treasury securities
and securities of U.S. Government agencies		$	2,999		$	-		$	(64	)	$	2,935
FNMA stock			-			6			-			6
Mutual fund			34,982			-			(930	)		34,052
FHLMC preferred stock			26			1,728			-			1,754
Total securities available for sale		$	38,007		$	1,734		$	(994	)	$	38,747

 

 

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The following table shows the gross unrealized losses and related estimated fair values of the Company’s investment securities, aggregated by investment category and length of time that individual securities have been in a continuous loss position at June 30, 2007:

 

		Less than 12 months						More than 12 months
		Gross			Estimated			Gross			Estimated
		Unrealized			Fair			Unrealized			Fair
		Losses			Value			Losses			Value
		(Dollars in thousands)
Securities held to maturity:
U.S. Treasury and Government agencies		$	379		$	23,612		$	2,973		$	103,364
Municipal bonds			-			-			74			1,566
Total securities held to maturity			379			23,612			3,047			104,930
Securities available for sale:
U.S. Treasury and Government agencies			-			-			81			2,918
Mutual fund			-			-			1,141			33,841
Total securities available for sale			-			-			1,222			36,759
Total		$	379		$	23,612		$	4,269		$	141,689

 

 

The following table shows the gross unrealized losses and related estimated fair values of the Company’s investment securities, aggregated by investment category and length of time that individual securities have been in a continuous loss position at September 30, 2006:

 

		Less than 12 months						More than 12 months
		Gross			Estimated			Gross			Estimated
		Unrealized			Fair			Unrealized			Fair
		Losses			Value			Losses			Value
		(Dollars in thousands)
Securities held to maturity:
U.S. Treasury and Government agencies		$	76		$	8,919		$	2,383		$	114,821
Municipal bonds			-			-			38			1,601
Total securities held to maturity			76			8,919			2,421			116,422
Securities available for sale:
U.S. Treasury and Government agencies			-			-			64			2,935
Mutual fund			-			-			930			34,052
Total securities available for sale			-			-			994			36,987
Total		$	76		$	8,919		$	3,415		$	153,409

 

 

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.  For all securities that are in an unrealized loss position for an extended period of time and for all securities whose fair value is significantly below amortized cost, the Company performs an evaluation of the specific events attributable to the market decline of the security. The Company considers the length of time and extent to which the security’s market value has been below cost as well as the general market conditions, industry characteristics, and the fundamental operating results of the issuer to determine if the decline is other-than-temporary. The Company also considers as part of the evaluation its intent and ability to hold the security until its market value has recovered to a level at least equal to the amortized cost. When the Company determines that a security’s unrealized loss is other-than-temporary, a realized loss is recognized in the period in which the decline in value is determined to be other-than-temporary. The write-downs are measured based on public market prices of the security at the time the Company determines the decline in value was other-than temporary.

 

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At June 30, 2007, securities in a gross unrealized loss position for twelve months or longer consisted of 113 securities having an aggregate depreciation of 2.9% from the Company’s amortized cost basis as of June 30, 2007. As of June 30, 2007, securities in a gross unrealized loss position for less than twelve months consisted of 23 securities having an aggregate depreciation of 1.6% from the Company’s amortized cost basis. The unrealized losses disclosed above are primarily related to movement in market interest rates. Although the fair value will fluctuate as the market interest rates move, the majority of the Company’s investment portfolio consists of low risk securities from U.S. government agencies or government sponsored enterprises. If held to maturity, the contractual principal and interest payments of such securities are expected to be received in full. As such, no loss in value is expected over the lives of the securities. Although not all of the securities are classified as held to maturity, the Company has the ability to hold these securities until they mature and does not intend to sell the securities at a loss. The Company also has a significant investment in a mutual fund that invests in adjustable-rate mortgage-backed securities. Management believes that the estimated fair value of the mutual fund is also primarily dependent upon the movement in market interest rates. Although the investment in the mutual fund is classified as available for sale, the Company has the intent and ability to hold the mutual fund until the fair value increases and does not intend to sell it at a loss. Based on the above, management believes that the unrealized losses are temporary. The determination of whether a decline in market value is temporary is necessarily a matter of subjective judgment. The timing and amount of any realized losses reported in the Company’s financial statements could vary if conclusions other than those made by management were to determine whether an other-than-temporary impairment exists.

 

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The amortized cost and estimated fair value of debt securities, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

		June 30, 2007
		Held to Maturity						Available for Sale
					Estimated						Estimated
		Amortized			Fair			Amortized			Fair
		Cost			Value			Cost			Value
		(Dollars in thousands)
Due within one year		$	6,000		$	5,961		$	-		$	-
Due after one through five years			26,001			25,634			-			-
Due after five through ten years			39,292			38,431			1,000			993
Due after ten years			63,922			61,769			1,999			1,925
Total		$	135,215		$	131,795		$	2,999		$	2,918

 

 

		September 30, 2006
		Held to Maturity						Available for Sale
					Estimated						Estimated
		Amortized			Fair			Amortized			Fair
		Cost			Value			Cost			Value
		(Dollars in thousands)
Due within one year		$	13,085		$	13,034		$	-		$	-
Due after one through five years			33,084			32,601			-			-
Due after five through ten years			39,986			39,356			1,000			985
Due after ten years			45,929			44,602			1,999			1,950
Total		$	132,084		$	129,593		$	2,999		$	2,935

 

4.	MORTGAGE-BACKED SECURITIES

 

Mortgage-backed securities are summarized as follows:

 

		June 30, 2007
					Gross			Gross			Estimated
		Amortized			Unrealized			Unrealized			Fair
		Cost			Gains			Losses			Value
		(Dollars in thousands)
Securities held to maturity
GNMA pass-through certificates		$	44,015		$	8		$	(2,015	)	$	42,008
FNMA pass-through certificates			1,425			-			(83	)		1,342
FHLMC pass-through certificates			1,724						(28	)		1,696
Total securities held to maturity		$	47,164		$	8		$	(2,126	)	$	45,046
Securities available for sale
FNMA pass-through certificates		$	5,929		$	16		$	(28	)	$	5,917
Total securities available for sale		$	5,929		$	16		$	(28	)	$	5,917

 

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		September 30, 2006
					Gross			Gross			Estimated
		Amortized			Unrealized			Unrealized			Fair
		Cost			Gains			Losses			Value
		(Dollars in thousands)
Securities held to maturity
GNMA pass-through certificates		$	46,992		$	157		$	(896	)	$	46,253
FNMA pass-through certificates			1,448			-			(53	)		1,395
FHLMC pass-through certificates			1,920						(42	)		1,878
Total securities held to maturity		$	50,360		$	157		$	(991	)	$	49,526
Securities available for sale
FNMA pass-through certificates		$	4,535		$	80		$	-		$	4,615
Total securities available for sale		$	4,535		$	80		$	-		$	4,615

 

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The following table shows the gross unrealized losses and related estimated fair values of the Company’s mortgage-backed securities and length of time that individual securities have been in a continuous loss position at June 30, 2007:

 

		Less than 12 months						More than 12 months
		Gross			Estimated			Gross			Estimated
		Unrealized			Fair			Unrealized			Fair
		Losses			Value			Losses			Value
		(Dollars in thousands)
Securities held to maturity:
GNMA pass-through certificates		$	271		$	9,188		$	1,744		$	31,614
FNMA pass-through certificates									83			1,342
FHLMC pass-through certificates			-			-			28			1,695
Total securities held to maturity			271			9,188			1,855			34,651
Securities available for sale:
FNMA pass-through certificates			28			1,853			-			-
Total securities available for sale			28			1,853			-			-
Total		$	299		$	11,041		$	1,855		$	34,651

 

 

The following table shows the gross unrealized losses and related estimated fair values of the Company’s mortgage-backed securities, and length of time that individual securities have been in a continuous loss position at September 30, 2006:

 

		Less than 12 months						More than 12 months
		Gross			Estimated			Gross			Estimated
		Unrealized			Fair			Unrealized			Fair
		Losses			Value			Losses			Value
		(Dollars in thousands)
Securities held to maturity:
GNMA pass-through certificates		$	526		$	25,602		$	370		$	11,200
FNMA pass-through certificates			52			1,395			1
FHLMC pass-through certificates			42			1,877			-			-
Total		$	620		$	28,874		$	371		$	11,200

 

At September 30, 2006, all mortgage-backed securities available-for-sale were in an unrealized gain position.

 

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Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. For all securities that are in an unrealized loss position for an extended period of time and for all securities whose fair value is significantly below amortized cost, the Company performs an evaluation of the specific events attributable to the market decline of the security. The Company considers the length of time and extent to which the security’s market value has been below cost as well as the general market conditions, industry characteristics, and the fundamental operating results of the issuer to determine if the decline is other-than-temporary. The Company also considers as part of the evaluation its intent and ability to hold the security until its market value has recovered to a level at least equal to the amortized cost. When the Company determines that a security’s unrealized loss is other-than-temporary, a realized loss is recognized in the period in which the decline in value is determined to be other-than-temporary. The write-downs are measured based on public market prices of the security at the time the Company determines the decline in value was other-than-temporary.

 

At June 30, 2007, mortgage-backed securities in a gross unrealized loss position for twelve months or longer consisted of 31 securities having an aggregate depreciation of 5.1% from the Company’s amortized cost basis. Mortgage-backed securities in a gross unrealized loss position for less than twelve months consist of 15 securities having an aggregate depreciation of 2.6% from the Company’s amortized cost basis. The unrealized losses disclosed above are primarily related to movement in market interest rates. Although the fair value will fluctuate as the market interest rates move, the Company’s entire mortgage-backed securities portfolio consists of low-risk securities issued by U.S. government sponsored enterprises. If held to maturity, the contractual principal and interest payments of such securities are expected to be received in full. As such, no loss in value is expected over the lives of the securities. The Company has the ability to hold these securities until they mature and does not intend to sell the securities at a loss. Based on the above, management believes that the unrealized losses are temporary. The determination of whether a decline in market value is temporary is necessarily a matter of subjective judgment. The timing and amount of any realized losses reported in the Company’s financial statements could vary if conclusions other than those made by management were to determine whether an other-than-temporary impairment exists.

 

5.	LOANS RECEIVABLE

 

Loans receivable consist of the following:

 

		June 30,			September 30,
		2007			2006
		(Dollars in thousands)
One-to-four family residential		$	159,484		$	155,454
Multi-family residential			4,651			5,074
Commercial real estate			15,956			11,339
Construction and land development			61,200			82,801
Commercial business			990			234
Consumer			807			1,239
Total loans			243,088			256,141
Undisbursed portion of loans-in-process			(19,193	)		(36,258	)
Deferred loan fees			302			153
Allowance for loan losses			(671	)		(618	)
Net		$	223,526		$	219,418

 

 

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The following schedule summarizes the changes in the allowance for loan losses:

		Nine Months Ended June 30,
		2007			2006
		(Dollars in thousands)
Balance, beginning of period		$	618		$	558
Provision for loan losses			55			30
Charge-offs			(2	)		-
Recoveries			-			-
Balance, end of period		$	671		$	588

 

Nonperforming loans (which consist of nonaccrual loans and loans in excess of 90 days delinquent and still accruing interest) at June 30, 2007 and September 30, 2006 amounted to approximately $497,000 and $151,000, respectively.

 

6.

DEPOSITS

 

Deposits consist of the following major classifications:

		June 30,						September 30,
		2007						2006
		(Dollars in thousands)
		Amount			Percent			Amount			Percent
Money market deposit accounts		$	64,813			18.3	%	$	64,498			18.6	%
NOW accounts			30,060			8.5			34,203			9.8
Passbook, club and statement savings			72,441			20.5			76,989			22.2
Certificates maturing in six months or less			111,716			31.5			77,904			22.4
Certificates maturing in more than six months			75,022			21.2			93,698			27.0
Total		$	354,052			100.0	%	$	347,292			100.0	%

 

At June 30, 2007 and September 30, 2006, the weighted average cost of funds was 3.8% and 3.5%, respectively.

 

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7.	INCOME TAXES

 

    Items that gave rise to significant portions of deferred income taxes are as follows:

 

		June 30,			September 30,
		2007			2006
Deferred tax assets:			(Dollars in thousands)
Deposit premium		$	277		$	314
Allowance for loan losses			249			247
Employee stock ownership plan			70			-
Other			-			40
Total			596			601
Deferred tax liabilities:
Unrealized gain on available for sale securities			120			286
Property			443			407
Mortgage servicing rights			8			10
Deferred loan fees			102			51
Total			673			754
Net deferred tax liability		$	(77	)	$	(153	)

 

8.	COMMITMENTS AND CONTINGENT LIABILITIES

 

At June 30, 2007, the Company had $6,094,000 in outstanding commitments to originate fixed and variable- rate loans with market interest rates ranging from 5.38% to 9.25%. At September 30, 2006, the Company had $4,933,000 in outstanding commitments to originate fixed and variable-rate loans with market interest rates ranging from 6.00% to 9.25%.

 

The Company also had commitments under unused lines of credit of $7,364,000 and $6,706,000 at June 30, 2007 and September 30, 2006, respectively. There were no letters of credit outstanding at June 30, 2007 while there were letters of credit outstanding of $110,000 at September 30, 2006.

 

Among the Company’s contingent liabilities are exposures to limited recourse arrangements with respect to the Company’s sales of whole loans and participation interests. At June 30, 2007, the exposure, which represents a portion of credit risk associated with the interests sold, amounted to $64,451. This exposure is for the life of the related loans and payables, on our proportionate share, as actual losses are incurred.

 

The Company is involved in various legal proceedings occurring in the ordinary course of business. Management of the Company, based on discussions with litigation counsel, believes that such proceedings will not have a material adverse effect on the financial condition or operations of the Company. There can be no assurance that any of the outstanding legal proceedings to which the Company is a party will not be decided adversely to the Company's interests and have a material adverse effect on the financial condition and operations of the Company.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview. Prudential Bancorp, Inc. of Pennsylvania (the “Company”) was formed by Prudential Savings Bank (the “Bank”) in connection with the Bank’s reorganization into the mutual holding company form. The Company’s results of operations are primarily dependent on the results of the Bank, which is a wholly owned subsidiary of the Company. The Company’s results of operations depend to a large extent on net interest income, which is the difference between the income earned on its loan and securities portfolios and the cost of funds, which is the interest paid on deposits and borrowings.  Results of operations are also affected by our provisions for loan losses, non-interest income and non-interest expense. Non-interest expense principally consists of salaries and employee benefits, office occupancy, depreciation, data processing expense, payroll taxes and other expense. Our results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially impact our financial condition and results of operations. The Bank is subject to regulation by the Federal Deposit Insurance Corporation (“FDIC”) and the Pennsylvania Department of Banking. The Bank’s main office is in Philadelphia, Pennsylvania, with five additional banking offices located in Philadelphia and Delaware Counties in Pennsylvania. The Bank’s primary business consists of attracting deposits from the general public and using those funds together with borrowings to originate loans and to invest primarily in U.S. Government and agency securities and mortgage-backed securities. In November 2005, the Bank formed PSB Delaware, Inc., a Delaware Corporation, as a subsidiary of the Bank. In March 2006, all mortgage-backed securities owned by the Bank were transferred to PSB Delaware, Inc. The activity of PSB Delaware, Inc. is included as part of the consolidated financial statements.

Critical Accounting Policies. In reviewing and understanding financial information for the Company, you are encouraged to read and understand the significant accounting policies used in preparing our financial statements. These policies are described in Note 2 of the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended September 30, 2006. The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The preparation of the Company’s consolidated financial statements 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 income and expenses during the reporting period. Management evaluates these estimates and assumptions on an ongoing basis. The following accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require numerous estimates or economic assumptions that may prove inaccurate or may be subject to variations which may significantly affect our reported results and financial condition for the period or in future periods.

Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that management believes will cover known and inherent losses in the loan portfolio that are both probable and reasonable to estimate, based on evaluations of the collectibility of loans. The evaluations take into consideration such factors as changes in the types and amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, estimated losses relating to specifically identified loans, and current economic conditions. This evaluation is inherently subjective as it requires material estimates including, among others, exposure at default, the amount and timing of expected future cash flows on affected loans, value of collateral, estimated losses on our commercial, construction and residential loan portfolios and general amounts for historical loss experience. All of these estimates may be susceptible to significant change.

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While management uses the best information available to make loan loss allowance evaluations, adjustments to the allowance may be necessary based on changes in economic and other conditions or changes in accounting guidance. Historically, our estimates of the allowance for loan loss have not required significant adjustments from management’s initial estimates. In addition, the Pennsylvania Department of Banking and the FDIC, as an integral part of their examination processes, periodically review our allowance for loan losses. The Pennsylvania Department of Banking and the FDIC may require the recognition of adjustments to the allowance for loan losses based on their judgment of information available to them at the time of their examinations. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance for loan losses may be required that would adversely impact earnings in future periods.

Income Taxes. We make estimates and judgments to calculate some of our tax liabilities and determine the recoverability of some of our deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We also estimate a reserve for deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective. In the past, our estimates and judgments to calculate our deferred tax amounts have not required significant revision to our initial estimates.

In evaluating our ability to recover deferred tax assets, we consider all available positive and negative evidence, including our past operating results and our forecast of future taxable income. In determining future taxable income, we make assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business. Any reduction in estimated future taxable income may require us to record an additional valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.

Forward-looking Statements. In addition to historical information, this Quarterly Report on Form 10-Q includes certain "forward-looking statements" based on management's current expectations. The Company's actual results could differ materially, as such term is defined in the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, from management's expectations. Such forward-looking statements include statements regarding management's current intentions, beliefs or expectations as well as the assumptions on which such statements are based. These forward-looking statements are subject to significant business, economic and competitive uncertainties and contingencies, many of which are not subject to the Company's control. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Factors that could cause future results to vary from current management expectations include, but are not limited to, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal, state and local tax authorities, changes in interest rates, deposit flows, the cost of funds, demand for loan products, demand for financial services, competition, changes in the quality or composition of the Company's loan and investment portfolios, changes in accounting principles, policies or guidelines and other economic, competitive, governmental and technological factors affecting the Company's operations, markets, products, services and fees.

The Company undertakes no obligation to update or revise any forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results that occur subsequent to the date such forward-looking statements are made.

COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2007 AND SEPTEMBER 30, 2006

At June 30, 2007, the Company’s total assets were $477.4 million, an increase of $5.0 million from $472.4 million at September 30, 2006. The increase was primarily attributable to an increase in loans of $4.1 million. In particular, increases occurred in the one-to-four family residential and commercial real estate loan portfolios which were partially offset by decreases in construction and land development loans.

 

Total liabilities increased $9.8 million to $394.8 million at June 30, 2007 from $384.9 million at September 30, 2006. The increase was primarily attributable to a $6.8 million increase in deposits, primarily in certificates of deposit.

 

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Stockholders’ equity decreased by $4.8 million to $82.7 million at June 30, 2007 as compared to $87.4 million at September 30, 2006 primarily as a result of the cost of stock repurchased during the nine month period ended June 30, 2007 of $6.1 million and the declaration of cash dividends totaling $1.6 million offset, in part, by net income during the nine month period ended June 30, 2007 of $2.8 million.

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

Net income. Net income was $977,000 for the quarter ended June 30, 2007 as compared to $882,000 for the same period in 2006. The increase was primarily due to a decrease in non-interest expense and an increase non-interest income partially offset by a decrease in net interest income and an increase in income tax.

For the nine month period ended June 30, 2007, net income was $2.8 million compared to $2.9 for the comparable period in 2006. The decrease was primarily due to a decrease in net interest income and an increase in non-interest expense, partially offset by a decrease in income tax expense and an increase in non-interest income.

Net interest income. Net interest income decreased $121,000 or 3.9% to $3.0 million for the three months ended June 30, 2007 as compared to $3.1 million for the same period in 2006. The decrease was due to a $632,000 or 20.3% increase in interest expense partially offset by a $511,000 or 8.2% increase in interest income. The increase in interest expense resulted primarily from a 52 basis point increase to 3.96% in the weighted average rate paid on interest-bearing liabilities, reflecting the effects of increases in market rates of interest during the past year. Also contributing to the increase in interest expense was a $16.9 million or 4.7% increase in the average balance of interest-bearing liabilities for the three months ended June 30, 2007, as compared to the same period in 2006. The increase in interest income resulted primarily from a 29 basis point increase in the weighted average yield earned on such assets to 5.93% for the quarter ended June 30, 2007 from the comparable period in 2006 combined with a $13.2 million or 3.0% increase in the average balance of interest-earning assets for the three months ended June 30, 2007, as compared to the same period in 2006.

For the nine months ended June 30, 2007, net interest income decreased $248,000 or 2.6% to $9.2 million as compared to $9.4 million for the same period in 2006. The decrease was due to a $2.4 million or 28.6% increase in interest expense partially offset by a $2.2 million or 12.1% increase in interest income. The increase in interest expense resulted primarily from a 68 basis point increase to 3.88% in the weighted average rate paid on interest-bearing liabilities, reflecting the increase in market rates of interest during the past year. Also contributing to the increase in interest expense was a $21.1 million or 6.0% increase in the average balance of interest-bearing liabilities for the nine months ended June 30, 2007 as compared to the same period in 2006. The increase in interest income resulted primarily from a 43 basis point increase in the weighted average yield earned on such assets to 5.92% for the nine month period ended June 30, 2007 from the comparable period in 2006 combined with a $17.5 million or 4.0% increase in the average balance of interest-earning assets for the nine months ended June 30, 2007 as compared to the same period in 2006.

For the quarter ended June 30, 2007, the net interest margin was 2.64% as compared to 2.83% for the same period in 2006. For the nine months ended June 30, 2007, the net interest margin was 2.71%, as compared to 2.89% for the comparable period in 2006. The compression in the net interest margin reflected the more rapid increase in the weighted average rate paid on interest-bearing liabilities due to their greater interest rate sensitivity, partially offset by an increase in the weighted average yield on interest-earning assets combined with an increase in the volume of interest-earning assets.

Average Balances, Net Interest Income, and Yields Earned and Rates Paid. The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the total dollar amount of interest expense on average interest-bearing liabilities and the resulting rates, and the net interest margin. Tax-exempt income and yields have not been adjusted to a tax-equivalent basis. All average balances are based on monthly balances. Management does not believe that the monthly averages differ significantly from what the daily averages would be.

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		Three Months
		Ended June 30,
		2007									2006
		Average						Average			Average						Average
		Balance			Interest			Yield/Rate			Balance			Interest			Yield/Rate
		(Dollars in Thousands)
Interest-earning assets:
Investment securities		$	175,293		$	2,231			5.09	%	$	175,118		$	2,043			4.67	%
Mortgage-backed securities			53,318			692			5.19			59,188			769			5.20
Loans receivable(1)			222,409			3,792			6.82			204,260			3,380			6.62
Other interest-earning assets			4,246			31			2.92			3,452			43			4.98
Total interest-earning assets			455,266			6,746			5.93			442,018			6,235			5.64
Cash and non-interest-bearing balances			3,936									4,848
Other non-interest-earning assets			11,520									11,436
Total assets		$	470,722								$	458,302
Interest-bearing liabilities:
Savings accounts		$	70,847			469			2.65		$	81,167			635			3.13
Money market deposit and NOW accounts			92,993			832			3.58			95,008			781			3.29
Certificates of deposit			184,617			2,052			4.45			161,944			1,398			3.45
Total deposits			348,457			3,353			3.85			338,119			2,814			3.33
Advances from Federal Home Loan Bank			28,043			387			5.52			21,544			294			5.46
Advances from borrowers for taxes and
insurance			1,553			2			0.52			1,451			2			0.55
Total interest-bearing liabilities			378,053			3,742			3.96			361,114			3,110			3.44
Non-interest-bearing liabilities:
Non-interest-bearing demand accounts			4,895									4,146
Other liabilities			3,267									3,370
Total liabilities			386,215									368,630
Stockholders' equity			84,507									89,672
Total liabilities and stockholders' equity		$	470,722								$	458,302
Net interest-earning assets		$	77,213								$	80,904
Net interest income; interest rate spread					$	3,004			1.97	%				$	3,125			2.20	%
Net interest margin(2)									2.64	%								2.83	%
Average interest-earning assets to average
interest-bearing liabilities						120.42	%								122.40	%

_____________________________________

(1)	Includes non-accrual loans. Calculated net of unamortized deferred fees, undisbursed portion of loans-in-process and allowance for loan losses.

(2)	Equals net interest income divided by average interest-earning assets.

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		Nine Months
		Ended June 30,
		2007									2006
		Average						Average			Average						Average
		Balance			Interest			Yield/Rate			Balance			Interest			Yield/Rate
		(Dollars in Thousands)
Interest-earning assets:
Investment securities		$	173,228		$	6,490			5.00	%	$	174,001		$	5,928			4.54	%
Mortgage-backed securities			53,796			2,105			5.22	%		62,314			2,421			5.18	%
Loans receivable(1)			221,238			11,402			6.87	%		191,090			9,335			6.51	%
Other interest-earning assets			5,102			123			3.21	%		8,461			259			4.08	%
Total interest-earning assets			453,364			20,120			5.92	%		435,866			17,943			5.49	%
Cash and non-interest-bearing balances			4,403									4,696
Other non-interest-earning assets			11,419									10,011
Total assets		$	469,186								$	450,573
Interest-bearing liabilities:
Savings accounts		$	72,727			1,582			2.90	%	$	83,065			1,834			2.94	%
Money market deposit and NOW accounts			94,371			2,505			3.54	%		99,412			2,259			3.03	%
Certificates of deposit			179,202			5,714			4.25	%		152,973			3,704			3.23	%
Total deposits			346,300			9,801			3.77	%		335,450			7,797			3.10	%
Advances from Federal Home Loan Bank			26,542			1,102			5.54	%		16,389			680			5.53	%
Advances from borrowers for taxes and
insurance			1,595			6			0.50	%		1,513			7			0.62	%
Total interest-bearing liabilities			374,437			10,909			3.88	%		353,352			8,484			3.20	%
Non-interest-bearing liabilities:
Non-interest-bearing demand accounts			5,099									3,369
Other liabilities			3,181									3,127
Total liabilities			382,717									359,848
Stockholders' equity			86,469									90,725
Total liabilities and stockholders' equity		$	469,186								$	450,573
Net interest-earning assets		$	78,927								$	82,514
Net interest income; interest rate spread					$	9,211			2.04	%				$	9,459			2.29	%
Net interest margin(2)									2.71	%								2.89	%
Average interest-earning assets to average
interest-bearing liabilities						121.08	%								123.35	%

_____________________________________

(1)	Includes non-accrual loans. Calculated net of unamortized deferred fees, undisbursed portion of loans-in-process and allowance for loan losses.

(2)	Equals net interest income divided by average interest-earning assets.

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Provision for loan losses. Provisions for loan losses are charged to earnings to maintain the total allowance for loan losses at a level believed by management to cover all known and inherent losses in the loan portfolio which are both probable and reasonably estimable. Management's analysis includes consideration of the Company's historical experience, the volume and type of lending conducted by the Company, the amount of the Company's classified assets, the status of past due principal and interest payments, general economic conditions, particularly as they relate to the Company's primary market area, and other factors related to the collectibility of the Company’s loan portfolio. The Company reduced the provision for loan losses by $20,000 for the quarter ended June 30, 2007 and incurred a $55,000 expense for the nine month period ended June 30, 2007. Provision expense was $30,000 for three and nine month periods ended June 30, 2006. The provision for the nine month period ended June 30, 2007 was established due to growth in the loan portfolio over the past year. The provision reduction in the current quarter was due to a reduction in the Company’s exposure in construction and land development loans including loan in process.

At June 30, 2007, the Company’s non-performing assets totaled $497,000 or 0.1% of total assets and consisted of five single-family residential real estate loans and two commercial real estate loans. The allowance for loan losses totaled $671,000, or 0.3% of total loans and 135.01% of non-performing loans at such date.

The secondary mortgage market has been adversely impacted during the third quarter of fiscal 2007 and through the filing date of this Form 10-Q by deteriorating investor demand for mortgage loan products, particularly with regard to subprime products, as investors are tightening credit standards and offering less favorable pricing.  For the three and nine month periods ended June 30, 2007 and through the date of this filing, the Company has not experienced a decline in credit quality based on trends in net charge-offs, delinquencies, and nonperforming assets.  At both June 30, 2007 and September 30, 2006, the Company had no real estate loans that would be considered subprime loans, which are defined as mortgage loans advanced to borrowers who do not qualify for loans bearing market interest rates because of problems with their credit history.  The Company does not originate subprime loans.  The Company's lending standards are discussed in Item 1 of its Annual Report on Form 10-K for the year ended September 30, 2006. 

Management continues to review its loan portfolio to determine the extent, if any, to which further additional loss provisions may be deemed necessary. There can be no assurance that the allowance for losses will be adequate to cover losses which may in fact be realized in the future or that additional provisions for losses will not be required.

Non-interest income. Non-interest income increased $53,000 for the quarter ended June 30, 2007, as compared to the same period in 2006 and increased $115,000 for the nine months ended June 30, 2007 as compared to the same period in 2006. The increase for the nine months ended June 30, 2007 was primarily due a successful recovery of $88,000 in the first fiscal quarter of 2007, which represented a portion of our losses and legal fees related to a previously disclosed lawsuit which was settled in 2004. Also contributing to the increase in both the three and nine month periods in 2007 were credits paid by a new “Official Check” service provider for the amount of checks issued but not yet paid totaling $22,000 and $59,000, respectively, which were not applicable in the comparable periods in 2006. Additionally, there was an increase in income from bank owned life insurance (“BOLI”) of $46,000 for the nine months ended June 30, 2007 compared to the comparable period in 2006. Income from BOLI was minimal during the first quarter of the 2006 period as the BOLI was purchased near the end of the first quarter of fiscal 2006. The 2006 period was beneficially affected by a $100,000 gain on sale of real estate owned recognized in 2006 which was not applicable in the 2007 period.

 

Non-interest expenses. For the quarter ended June 30, 2007, non-interest expense decreased $155,000 compared to the same quarter in 2006. This was primarily due to a decrease in professional fees of $157,000. The preponderance of the decrease in professional fees was related to a reimbursement from our insurance carrier for legal expenses associated with the defense of a previously disclosed lawsuit commenced in October 2006 by a shareholder, Stilwell Value Partners I, L.P. For the nine month period ended June 30, 2007, non-interest expense increased $156,000 compared to the same period in 2006 primarily due to an increase in salaries and employee benefits of $108,000, the majority of which related to normal merit pay rate increases. Also contributing to the increase was a $59,000 increase in professional fees primarily related to increased expenses associated with audit and accounting services.

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Income tax expense. Income tax expense for the quarter and nine months ended June 30, 2007 amounted to $456,000 and $1.1 million, respectively, compared to $414,000 and $1.3 million, respectively, for the quarter and nine months ended June 30, 2006. The effective income tax rate decreased slightly to 31.8% for the quarter ended June 30, 2007 compared to 31.9% for the quarter ended June 30, 2006. For the nine month period ended June 30, 2007, the effective tax rate decreased to 28.2% from 31.5% from the same period in 2006. The lower effective tax rate in the 2007 period was primarily attributable to certain tax benefits the Company realized as a result of the adjustment of a valuation allowance that had previously been established for accrued liabilities related to prior period tax accruals and the implementation of various tax strategies.

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LIQUIDITY AND CAPITAL RESOURCES

The Company’s liquidity, represented by cash and cash equivalents, is a product of its operating, investing and financing activities. Our primary sources of funds are from deposits, scheduled principal and interest payments on loans, loan prepayments and the maturity of loans, mortgage-backed securities and other investments, and other funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities are relatively predictable sources of funds, deposit flows and loan and securities prepayments can be greatly influenced by market rates of interest, economic conditions and competition. We also maintain excess funds in short-term, interest-bearing assets that provide additional liquidity. At June 30, 2007, our cash and cash equivalents amounted to $11.0 million. In addition, our available for sale investment and mortgage-backed securities amounted to an aggregate of $44.3 million at such date.

We use our liquidity to fund existing and future loan commitments, to fund maturing certificates of deposit and demand deposit withdrawals, to invest in other interest-earning assets, and to meet operating expenses. At June 30, 2007, the Company had $6.1 million in outstanding commitments to originate fixed and variable-rate loans, not including loans in process. The Company also had commitments under unused lines of credit of $7.4 million at June 30, 2007. Certificates of deposit at June 30, 2007 maturing in one year or less totaled $146.2 million. Based upon historical experience, we anticipate that a significant portion of the maturing certificates of deposit will be redeposited with us.

In addition to cash flow from loan and securities payments and prepayments as well as from sales of available for sale securities, we have significant borrowing capacity available to fund liquidity needs should the need arise. Our borrowings consist solely of advances from the Federal Home Loan Bank of Pittsburgh, of which we are a member. Under terms of the collateral agreement with the Federal Home Loan Bank, we pledge residential mortgage loans and mortgage-backed securities as well as our stock in the Federal Home Loan Bank as collateral for such advances. However, use of FHLB advances has been relatively limited and the amount outstanding has remained relatively constant during the past several years, only fluctuating materially since fiscal year 2006 in order to fund loan growth. At June 30, 2007, we had $32.8 million in outstanding FHLB advances and we had the ability to borrow an additional $252.3 million in FHLB advances.

We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.

The Company had no collateral underlying mortgage-backed securities that would be considered subprime loans, which are defined as mortgage loans advanced to borrowers who do not qualify for loans bearing market interest rates because of problems with their credit history.  All mortgage-backed securities owned by the Company as of June 30, 2007 possessed the highest possible investment credit rating.

 

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The following table summarizes the Company and Bank’s regulatory capital ratios as of June 30, 2007 and September 30, 2006 and compares them to current regulatory guidelines.

 

								To Be
								Well Capitalized
					Required for			Under Prompt
					Capital Adequacy			Corrective Action
		Actual Ratio			Purposes			Provisions
June 30, 2007:
Tier 1 capital (to average assets)
The Company			17.51	%		4.0	%		N/A
The Bank			15.35	%		4.0	%		5.0	%
Tier 1 capital (to risk weighted assets)
The Company			37.26	%		4.0	%		N/A
The Bank			32.66	%		4.0	%		6.0	%
Total capital (to risk weighted assets)
The Company			37.66	%		8.0	%		N/A
The Bank			33.05	%		8.0	%		10.0	%
September 30, 2006:
Tier 1 capital (to average assets)
The Company			18.64	%		4.0	%		N/A
The Bank			14.74	%		4.0	%		5.0	%
Tier 1 capital (to risk weighted assets)
The Company			39.23	%		4.0	%		N/A
The Bank			31.12	%		4.0	%		6.0	%
Total capital (to risk weighted assets)
The Company			39.68	%		8.0	%		N/A
The Bank			31.56	%		8.0	%		10.0	%

IMPACT OF INFLATION AND CHANGING PRICES

The financial statements, accompanying notes, and related financial data of the Company presented herein have been prepared in accordance with generally accepted accounting principles which requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.

Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services, since such prices are affected by inflation to a larger extent than interest rates. In the current interest rate environment, liquidity and the maturity structure of the Company's assets and liabilities are critical to the maintenance of acceptable performance levels.

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·	we have increased our originations of shorter term loans and/or loans with adjustable rates of interest, particularly construction and land development loans;

·	we have invested in securities with “step-up” rate features providing for increased interest rates prior to maturity according to a pre-determined schedule and formula; and

·	we have maintained moderate levels of short-term liquid assets.

(a)	Not applicable

(b)	Not applicable

(c)	Purchases of Equity Securities

(1)	On January 17, 2007, the Company announced its third stock repurchase program to repurchase up to 255,384 shares or approximately 5% of the Company’s outstanding common stock held by shareholders other than Prudential Mutual Holding Company. The program was completed during May 2007.

(2)

On March 21, 2007, the Company announced its fourth stock repurchase program to repurchase up to 242,000 shares or approximately 5% of the Company’s outstanding common stock held by shareholders other than Prudential Mutual Holding Company, commencing after the completion of third repurchase plan in May 2007. The program will expire one year after it commences, unless extended, as necessary, to complete such buyback program.