t69751_10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
Washington, DC  20549
 
FORM 10-Q
 
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended December 31, 2010
 
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                     to                         
 
Commission file number: 000-51214
 
Prudential Bancorp, Inc. of Pennsylvania
 
(Exact Name of Registrant as Specified in Its Charter)
 
Pennsylvania
 
68-0593604
 
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
1834 Oregon Avenue
Philadelphia, Pennsylvania
 
19145
Zip Code
 
(Address of Principal Executive Offices)
     
(215) 755-1500
 
(Registrant’s Telephone Number, Including Area Code)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x   No o      
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
  o Yes   o No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company.  See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large accelerated filer o Accelerated filer o
Non-accelerated filer o  (Do not check if a smaller reporting company) Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes   x No
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practical date: as of February 1, 2011, 10,023,495 shares were issued and outstanding.

 
 

 

PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA
 
TABLE OF CONTENTS
 
       
PAGE
         
PART I
FINANCIAL INFORMATION:
   
         
 
Item 1.
Consolidated Financial Statements
   
         
   
Unaudited Consolidated Statements of Financial Condition December 31, 2010 and September 30, 2010
 
2
         
   
Unaudited Consolidated Statements of Operations for the Three Months Ended December 31, 2010 and 2009
 
3
         
   
Unaudited Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the Three Months Ended December 31, 2010 and 2009
 
4
         
   
Unaudited Consolidated Statements of Cash Flows for the Three Months Ended December 31, 2010 and 2009
 
5
         
   
Notes to Unaudited Consolidated Financial Statements
 
6
         
 
Item 2.
Managements Discussion and Analysis of Financial Condition and Results of Operations
 
26
         
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
38
         
 
Item 4.
Controls and Procedures
 
38
         
PART II
OTHER INFORMATION
   
         
 
Item 1.
Legal Proceedings
 
39
         
 
Item 1A.
Risk Factors
 
39
         
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
39
         
 
Item 3.
Defaults Upon Senior Securities
 
39
         
 
Item 4.
(Removed and Reserved)
 
39
         
 
Item 5.
Other Information
 
39
         
 
Item 6.
Exhibits
 
39
         
 
SIGNATURES
 
40
 
 
1

 
 
PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA AND SUBSIDIARIES
 
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

 
   
December 31,
   
September 30,
 
   
2010
   
2010
 
   
(Dollars in Thousands)
 
ASSETS
           
             
Cash and amounts due from depository institutions
  $ 3,278     $ 3,649  
Interest-bearing deposits
    47,026       62,875  
                 
           Total cash and cash equivalents
    50,304       66,524  
                 
Investment and mortgage-backed securities held to maturity (estimated fair value—December 31, 2010, $126,822; September 30, 2010, $116,594)
    125,230       112,673  
Investment and mortgage-backed securities available for sale (amortized cost—December 31, 2010, $72,935; September 30, 2010, $69,891)
    74,445       72,425  
Loans receivable—net of allowance for loan losses (December 31, 2010, $3,731; September 30, 2010, $3,151)
    252,719       255,091  
Accrued interest receivable
    2,751       2,669  
Real estate owned
    2,034       3,197  
Federal Home Loan Bank stock—at cost
    3,368       3,545  
Office properties and equipment—net
    2,011       2,069  
Bank owned life insurance
    6,040       5,990  
Prepaid expenses and other assets
    2,919       3,135  
Deferred tax asset-net
    1,800       1,762  
TOTAL ASSETS
  $ 523,621     $ 529,080  
                 
LIABILITIES AND STOCKHOLDERS EQUITY
               
                 
LIABILITIES:
               
  Deposits:
               
     Noninterest-bearing
  $ 2,976     $ 2,570  
     Interest-bearing
    461,058       461,885  
           Total deposits
    464,034       464,455  
  Advances from Federal Home Loan Bank
    604       615  
  Accrued interest payable
    89       3,361  
  Advances from borrowers for taxes and insurance
    1,765       1,115  
  Accounts payable and accrued expenses
    686       2,033  
  Accrued dividend payable
    501       502  
 
               
           Total liabilities
    467,679       472,081  
                 
COMMITMENTS AND CONTINGENCIES (Note 8)
               
                 
STOCKHOLDERS EQUITY:
               
   Preferred stock, $.01 par value, 10,000,000 shares authorized, none issued
    -       -  
   Common stock, $.01 par value, 40,000,000 shares authorized, issued 12,563,750; outstanding - 10,031,472 at December 31, 2010 and September 30, 2010
    126       126  
   Additional paid-in capital
    53,666       53,528  
   Unearned ESOP shares
    (3,178 )     (3,234 )
   Treasury stock, at cost: 2,532,278 shares at December 31, 2010 and September 30, 2010
    (31,576 )     (31,576 )
   Retained earnings
    35,907       36,483  
   Accumulated other comprehensive income
    997       1,672  
                 
           Total stockholders’ equity
    55,942       56,999  
                 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 523,621     $ 529,080  
                 
See notes to unaudited consolidated financial statements.
               

 
2

 
 
PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA AND SUBSIDIARIES
 
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

 
   
Three Months Ended
December 31,
 
   
2010
   
2009
 
       
   
(Dollars in Thousands Except Per Share Amounts)
 
INTEREST INCOME:
           
  Interest on loans
  $ 3,623     $ 3,751  
  Interest on mortgage-backed securities
    1,065       1,223  
  Interest and dividends on investments
    965       1,492  
                 
          Total interest income
    5,653       6,466  
                 
INTEREST EXPENSE:
               
  Interest on deposits
    2,020       2,272  
  Interest on borrowings
    2       217  
                 
          Total interest expense
    2,022       2,489  
                 
NET INTEREST INCOME
    3,631       3,977  
                 
PROVISION FOR LOAN LOSSES
    580       135  
                 
NET INTEREST  INCOME AFTER PROVISION FOR LOAN LOSSES
    3,051       3,842  
                 
NON-INTEREST INCOME:
               
  Fees and other service charges
    118       125  
                 
     Total other-than-temporary impairment losses
    (127 )     (294 )
     Portion of losses recognized in other comprehensive income, before taxes
    32       90  
     Net impairment losses recognized in earnings
    (95 )     (204 )
                 
  Other
    111       98  
                 
          Total non-interest income
    134       19  
                 
NON-INTEREST EXPENSE:
               
  Salaries and employee benefits
    1,431       1,361  
  Data processing
    119       138  
  Professional services
    77       141  
  Office occupancy
    89       93  
  Depreciation
    88       87  
  Payroll taxes
    65       67  
  Director compensation
    82       62  
  Real estate owned expenses
    145       20  
  Federal Deposit Insurance Corporation insurance
    265       182  
  Other
    502       402  
                 
           Total non-interest expense
    2,863       2,553  
                 
INCOME BEFORE INCOME TAXES
    322       1,308  
                 
INCOME TAXES:
               
  Current expense
    106       594  
  Deferred expense
    310       28  
                 
          Total income tax expense
    416       622  
                 
NET (LOSS) INCOME
  $ (94 )   $ 686  
                 
BASIC (LOSS) INCOME PER SHARE
  $ (0.01 )   $ 0.07  
                 
DILUTED (LOSS) INCOME PER SHARE
  $ (0.01 )   $ 0.07  
 

See notes to unaudited consolidated financial statements.
 
 
3

 
 
 PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA AND SUBSIDIARIES
 
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)


                           
 
   
Accumulated
             
         
Additional
   
Unearned
         
 
   
Other
   
Total
       
   
Common
   
Paid-In
   
ESOP
   
Treasury
   
Retained
   
Comprehensive
   
Stockholders
   
Comprehensive
 
   
Stock
   
Capital
   
Shares
   
Stock
   
Earnings
   
Income (Loss)
   
Equity
   
Income (Loss)
 
   
(Dollars in Thousands except per share amounts)
 
BALANCE, OCTOBER 1, 2010
  $ 126     $ 53,528     $ (3,234 )   $ (31,576 )   $ 36,483     $ 1,672     $ 56,999        
                                                               
Comprehensive loss:
                                                             
                                                               
Net loss
                                    (94 )             (94 )     (94 )
              
                                                               
Net unrealized holding loss on available for sale securities arising during the period, net of income tax benefit of $380
                                            (738 )     (738 )     (738 )
                                                                 
Reclassification adjustment for other than temporary impairment recognized in earnings net of tax of $32
                                            63       63       63  
Comprehensive loss
                                                          $ (769 )
                                                                 
Cash dividend declared
                                                               
($ 0.05 per share)
                                    (482 )             (482 )        
                                                                 
Excess tax benefit from stock compensation
          39                                       39          
                                                                 
Stock option expense
            55                                       55          
                                                                 
Recognition and Retention Plan expense
          64                                       64          
                                                                 
ESOP shares committed to
                                                               
be released (5,655 shares)
    -       (20 )     56       -       -       -       36          
                                                                 
BALANCE, December 31, 2010
  $ 126     $ 53,666     $ (3,178 )   $ (31,576 )   $ 35,907     $ 997     $ 55,942          
 
                           
 
   
Accumulated
             
         
Additional
   
Unearned
         
 
   
Other
   
Total
       
   
Common
   
Paid-In
   
ESOP
   
Treasury
   
Retained
   
Comprehensive
   
Stockholders’
   
Comprehensive
 
   
Stock
   
Capital
   
Shares
   
Stock
   
Earnings
   
Income (Loss)
   
Equity
   
Income (Loss)
 
   
(Dollars in Thousands except per share amounts)
 
BALANCE, OCTOBER 1, 2009
  $ 126     $ 52,938     $ (3,457 )   $ (28,652 )   $ 35,293     $ (391 )   $ 55,857        
                                                               
Comprehensive income:
                                                             
                                                               
Net income
                                    686               686       686  
                                                                 
Net unrealized holding loss on available for sale securities arising during the period, net of income tax benefit of $229
                                          (445 )     (445 )     (445 )
                                                                 
Reclassification adjustment for other than temporary impairment recognized in earnings net of tax of $69
                                            135       135       135  
Comprehensive income
                                                          $ 376  
                                                                 
Cash dividend declared
                                                               
 ($ 0.05 per share)
                                    (497 )             (497 )        
                                                                 
Excess tax benefit from stock compensation
          37                                       37          
                                                                 
Stock option expense
            53                                       53          
                                                                 
Recognition and Retention Plan expense
          63                                       63          
                                                                 
ESOP shares committed to
                                                               
be released (5,655 shares)
    -       -       56       -       -       -       56          
                                                                 
BALANCE, December 31, 2009
  $ 126     $ 53,091     $ (3,401 )   $ (28,652 )   $ 35,482     $ (701 )   $ 55,945          
 
See notes to unaudited consolidated financial statements

 
4

 

PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA AND SUBSIDIARIES
 
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS 

 
   
Three Months Ended December 31,
 
   
2010
   
2009
 
OPERATING ACTIVITIES:
 
(Dollars in Thousands)
 
  Net (loss) income
  $ (94 )   $ 686  
  
               
  Adjustments to reconcile net (loss) income to net cash used in operating activities:
               
    Provision for loan losses
    580       135  
    Depreciation
    88       87  
    Net accretion of premiums/discounts
    (83 )     (81 )
    Net accretion of deferred loan fees and costs
    (18 )     (13 )
    Impairment charge on investment securities
    95       204  
    Loss on sale of real estate owned
    135       -  
    Share-based compensation expense
    158       153  
    Compensation expense of ESOP
    36       56  
    Income from bank owned life insurance
    (50 )     (53 )
    Deferred income tax expense
    310       28  
    Excess tax benefit related to stock compensation
    (39 )     (37 )
    Changes in assets and liabilities which used cash:
               
      Accrued interest receivable
    (82 )     81  
      Prepaid expenses and other assets
    216       (2,611 )
      Accrued interest payable
    (3,272 )     (2,708 )
      Accounts payable and accrued expenses
    (1,347 )     (285 )
               Net cash used in operating activities
    (3,367 )     (4,358 )
INVESTING ACTIVITIES:
               
  Purchase of investment and mortgage-backed securities held to maturity
    (25,000 )     (2,994 )
  Purchase of investment and mortgage-backed securities available for sale
    (14,777 )     (5,935 )
  Loans originated or acquired
    (13,656 )     (11,167 )
  Principal collected on loans
    15,466       11,300  
  Principal payments received on investment and mortgage-backed securities:
               
     held-to-maturity
    12,455       15,861  
     available-for-sale
    11,710       2,656  
  Proceeds from redemption of FHLB stock
    177       -  
  Proceeds from sale of real estate owned
    1,028       -  
  Purchases of equipment
    (30 )     (61 )
               Net cash (used in) provided by investing activities
    (12,627 )     9,660  
FINANCING ACTIVITIES:
               
  Net increase in demand deposits, NOW accounts, and savings accounts
    2,690       7,561  
  Net decrease in certificates of deposit
    (3,111 )     (18,807 )
  Repayment of advances from Federal Home Loan Bank
    (11 )     -  
  Borrowings of advances from Federal Home Loan Bank
    -       3,989  
  Increase in advances from borrowers for taxes and insurance
    650       596  
  Excess tax benefit related to stock compensation
    39       37  
  Cash dividend paid
    (483 )     (472 )
               Net cash used in financing activities
    (226 )     (7,096 )
                 
NET DECREASE IN CASH AND CASH EQUIVALENTS
    (16,220 )     (1,794 )
                 
CASH AND CASH EQUIVALENTS—Beginning of period
    66,524       13,669  
                 
CASH AND CASH EQUIVALENTS—End of period
  $ 50,304     $ 11,875  
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
               
  INFORMATION:
               
  Interest paid on deposits and advances from Federal
               
     Home Loan Bank
  $ 5,294     $ 5,197  
                 
  Income taxes paid
  $ 550     $ 753  
                 
SUPPLEMENTAL DISCLOSURES OF NONCASH ITEMS:
               
  Real estate acquired in settlement of loans
  $ -     $ 437  
                 
See notes to unaudited consolidated financial statements.
               
 
 
5

 

PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA AND SUBSIDIARIES
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 
1.
SIGNIFICANT ACCOUNTING POLICIES
 
Basis of presentation –The accompanying unaudited consolidated financial statements were prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”) for interim information and therefore do not include all the information or footnotes necessary for a complete presentation of financial condition, results of operations, changes in equity and cash flows in conformity with accounting principles generally accepted in the United States of America (“GAAP”).  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 ended December 31, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2011, or any other period. These financial statements should be read in conjunction with the audited consolidated financial statements of Prudential Bancorp, Inc. of Pennsylvania (the “Company”) and the accompanying notes thereto for the year ended September 30, 2010 included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2010.
 
Use of Estimates in the Preparation of Financial StatementsThe preparation of financial statements in conformity with GAAP 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, deferred income taxes, other than temporary impairment, and the fair value measurement for financial instruments. Actual results could differ from those estimates.
 
Dividend Payable – On December 15, 2010, the Company’s Board of Directors declared a quarterly cash dividend of $ 0.05 on the common stock of the Company payable on January 28, 2011 to the shareholders of record at the close of business on January 14, 2011 which resulted in a payable of $501,000 at December 31, 2010.  A portion of the cash dividend was payable to Prudential Mutual Holding Company (the “MHC”) due to its ownership of shares of the Company’s common stock and totaled $374,000.
 
Employee Stock Ownership Plan – The Company maintains 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 in fiscal 2005.  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 additional paid-in capital.  As of December 31, 2010, the Company had allocated a total of 130,065 shares from the suspense account to participants.  In addition, at such date the total number of shares of Company common stock held by the ESOP was 449,492.  For the three months ended December 31, 2010, the Company recognized $30,000 in compensation expense.
 
Share-Based Compensation – The Company accounts for stock-based compensation issued to employees, and where appropriate non-employees, with fair value.  Under fair value provisions, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the appropriate vesting period using the straight-line method.  The amount of stock-based compensation recognized at any date must at least equal the portion of the grant date fair value of the award that is vested at that date and as a result it may be necessary to recognize the expense using a ratable method.  Determining the fair value of stock-based awards at the date of grant requires judgment, including estimating the expected term of the stock options and the expected volatility of the Company’s stock. In addition, judgment is required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates or different key assumptions were used, it could have a material effect on the Company’s consolidated financial statements.
 
 
6

 
 
Dividends with respect to non-vested share awards are held by the Company’s Recognition and Retention Plan (“Plan”) Trust (the “Trust”) for the benefit of the recipients and are paid out proportionately by the Trust to the recipients of stock awards granted pursuant to the Plan as soon as practicable after the stock awards are earned.
 
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.  The average cost per share of the approximately 2.5 million shares which have been repurchased by the Company was $12.47 for purchases through December 31, 2010.  As of December 31, 2010, the MHC had purchased 568,000 shares at an average cost of $10.30 per share. The repurchased shares are available for general corporate purposes.  As of December 31, 2010, 7,478,062 shares were owned by the MHC, 2,532,278 shares had been purchased by the Company and held as treasury stock which results in 2,553,410 shares owned by public shareholders.
 
Comprehensive Income (Loss) —The Company presents in the unaudited consolidated statement of changes in stockholders’ equity and comprehensive income those amounts arising from transactions and other events which currently are excluded from the statements of operations and are recorded directly to stockholders’ equity.  For the three months ended December 31, 2010 and 2009, the only components of comprehensive income were net income (loss), unrealized holding gains and losses, net of income tax expense and benefit, on available for sale securities and reclassifications related to realized losses due to other than temporary impairment, net of tax.
 
FHLB Stock – Federal Home Loan Bank (“FHLB”) stock is classified as a restricted equity security because ownership is restricted and there is not an established market for its resale.  FHLB stock is carried at cost and is evaluated for impairment when certain conditions warrant further consideration.  While the FHLB has recognized losses in recent periods, it is currently not probable that the Company will not realize its cost basis as the FHLB has maintained capital levels in excess of regulatory requirements.  Management concluded that no impairment existed as of December 31, 2010.
 
Recent Accounting Pronouncements – In July 2010, FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.  ASU 2010-20 is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.  The amendments in ASU 2010-20 encourage, but do not require, comparative disclosures for earlier reporting periods that ended before initial adoption. However, an entity should provide comparative disclosures for those reporting periods ending after initial adoption.  The required disclosures have been incorporated in note 4.
 
In September, 2010, the FASB issued ASU No. 2010-25, Plan Accounting – Defined Contribution Pension Plans.  The amendments in this ASU require that participant loans be classified as notes receivable from participants, which are segregated from plan investments and measured at their unpaid principal balance plus any accrued but unpaid interest.  The amendments in this update are effective for fiscal years ending after December 15, 2010 and are not expected to have a significant impact on the Company’s consolidated financial statements.
 
 
7

 
 
In October, 2010, the FASB issued No. ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts.  This ASU addresses the diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral, The amendments are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2011 and are not expected to have a significant impact on the Company’s consolidated financial statements.
 
In December, 2010, the FASB issued ASU No. 2010-28, When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.  This ASU modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists.  In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating an impairment may exist.  The qualitative factors are consistent with the existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.  For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010.  Early adoption is not permitted.  For nonpublic entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  Nonpublic entities may early adopt the amendments using the effective date for public entities.  This ASU is not expected to have a significant impact on the Company’s consolidated financial statements.
 
In December 2010, the FASB issued ASU No. 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations.  The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only.  The amendments also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings.   The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted.  This ASU is not expected to have a significant impact on the Company’s consolidated financial statements.
 
 
8

 
 
2.         EARNINGS PER SHARE
 
Basic earnings per common share is computed  by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding, net of any treasury shares, during the period.  Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding, net of any treasury shares, after consideration of the potential dilutive effect of common stock equivalents (“CSEs”), based upon the treasury stock method using an average market price for the period.
 
The calculated basic and diluted earnings per share are as follows:
 
   
Quarter Ended December 31,
 
             
   
2010
   
2009
 
   
Basic
   
Diluted
   
Basic
   
Diluted
 
   
(Dollars in Thousands Except Per Share Data)
 
                         
Net (loss) income
  $ (94 )   $ (94 )   $ 686     $ 686  
Weighted average shares outstanding
    9,514,031       9,514,031       9,873,428       9,873,428  
Effect of common stock equivalents
    -       -       -       187,566  
 
                               
Adjusted weighted average shares used in earnings per share computation
  $ 9,514,031     $ 9,514,031     $ 9,873,428     $ 10,060,994  
(Loss) income per share - basic and diluted
  $ (0.01 )   $ (0.01 )   $ 0.07     $ 0.07  
 
Due to the net loss recognized for the quarter ended December 31, 2010, the inclusion of any CSEs would decrease the amount of net loss per share for the quarter and be antidilutive.  Consequently, basic and diluted weighted average shares outstanding are equal for the quarter ended December 31, 2010.  Had net income been recognized for the quarter ended December 31, 2010, there would have been an additional 92,503 shares used in the  diluted earnings per share calculation.
 
 
9

 
 
3.
INVESTMENT AND MORTGAGE-BACKED SECURITIES
 
The amortized cost and fair value of investment and mortgage-backed securities, with gross unrealized gains and losses, are as follows:
 
   
December 31, 2010
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
Securities held to maturity:
 
(Dollars in Thousands)
 
                         
  U.S. Government agency obligations
  $ 100,703     $ 783     $ (1,043 )   $ 100,443  
  Mortgage-backed securities - U.S.
                               
   Government agencies
    24,527       1,852       -       26,379  
                                 
           Total securities held to maturity
  $ 125,230     $ 2,635     $ (1,043 )   $ 126,822  
                                 
Securities available for sale:
                               
  U.S. Government agency obligations
  $ 6,998     $ 91     $ (69 )   $ 7,020  
  Mortgage-backed securities - U.S.
                               
   Government agencies
    58,427       2,416       (236 )     60,607  
  Mortgage-backed securities - Non-agency
    7,502       200       (892 )     6,810  
                                 
           Total debt securities
    72,927       2,707       (1,197 )     74,437  
                                 
  FHLMC preferred stock
    8       -       -       8  
                                 
           Total securities available for sale
  $ 72,935     $ 2,707     $ (1,197 )   $ 74,445  
 
   
September 30, 2010
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
   
(Dollars in Thousands)
 
Securities held to maturity:
                       
  U.S. Government agency obligations
  $ 85,983     $ 1,831     $ (12 )   $ 87,802  
  Municipal obligations
    475       -       -       475  
  Mortgage-backed securities - U.S.
                               
   Government agencies
    26,215       2,102       -       28,317  
                                 
           Total securities held to maturity
  $ 112,673     $ 3,933     $ (12 )   $ 116,594  
                                 
Securities available for sale:
                               
  U.S. Government agency obligations
  $ 9,995     $ 198     $ -     $ 10,193  
  Mortgage-backed securities - U.S.
                               
   Government agencies
    51,821       3,204       -       55,025  
  Mortgage-backed securities - Non-agency
    8,067       178       (1,046 )     7,199  
           Total debt securities
    69,883       3,580       (1,046 )     72,417  
                                 
  FHLMC preferred stock
    8       -       -       8  
                                 
           Total securities available for sale
  $ 69,891     $ 3,580     $ (1,046 )   $ 72,425  
                                 
 
 
10

 
 
The following table shows the gross unrealized losses and related fair values of the Company’s investment securities, aggregated by investment category and length of time that individual securities had been in a continuous loss position at December 31, 2010:
 
   
Less than 12 months
   
More than 12 months
   
Total
 
   
Gross
         
Gross
         
Gross
       
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
 
   
Losses
   
Value
   
Losses
   
Value
   
Losses
   
Value
 
   
(Dollars in Thousands)
 
Securities held to maturity:
                                   
   U.S. Government agency obligations
  $ (1,043 )   $ 53,669     $ -     $ -     $ (1,043 )   $ 53,669  
                                                 
           Total securities held to maturity
    (1,043 )     53,669       -       -       (1,043 )     53,669  
                                                 
Securities available for sale:
                                               
   U.S. Government agency obligations
    (69 )     1,931       -       -       (69 )     1,931  
   Mortgage-backed securities - U.S.
                                               
     Government agencies
    (236 )     7,429       -       -       (236 )     7,429  
   Mortgage-backed securities - Non-agency
    (15 )     737       (877 )     3,149       (892 )     3,886  
                                                 
           Total securities available for sale
    (320 )     10,097       (877 )     3,149       (1,197 )     13,246  
                                                 
Total
  $ (1,363 )   $ 63,766     $ (877 )   $ 3,149     $ (2,240 )   $ 66,915  
 
The following table shows the gross unrealized losses and related fair values of the Company’s investment securities, aggregated by investment category and length of time that individual securities had been in a continuous loss position at September 30, 2010:
 
   
Less than 12 months
   
More than 12 months
   
Total
 
   
Gross
         
Gross
         
Gross
       
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
 
   
Losses
   
Value
   
Losses
   
Value
   
Losses
   
Value
 
   
(Dollars in Thousands)
 
Securities held to maturity:
                                   
   U.S. Government and agency obligations
  $ (12 )   $ 5,988     $ -     $ -     $ (12 )   $ 5,988  
                                                 
           Total securities held to maturity
    (12 )     5,988                       (12 )     5,988  
                                                 
Securities available for sale:
                                               
   Mortgage-backed securities - Non-agency
    (9 )     225       (1,037 )     3,311       (1,046 )     3,536  
                                                 
           Total securities available for sale
    (9 )     225       (1,037 )     3,311       (1,046 )     3,536  
                                                 
Total
  $ (21 )   $ 6,213     $ (1,037 )   $ 3,311     $ (1,058 )   $ 9,524  
 
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least once each quarter, and more frequently when economic or market concerns warrant such evaluation.  The Company determines whether the unrealized losses are temporary.  The evaluation is based upon factors such as the creditworthiness of the issuers/guarantors, the underlying collateral, if applicable, and the continuing performance of the securities.  Management also evaluates other facts and circumstances that may be indicative of an OTTI condition. This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost, and near-term prospects of the issuer.
 
 
11

 
 
The Company assesses whether the credit loss existed by considering whether (1) the Company has the intent to sell the security, (2) it is more likely than not that it will be required to sell the security before recovery, or (3) it does not expect to recover the entire amortized cost basis of the security. The Company bifurcates the OTTI impact on impaired securities where impairment in value was deemed to be other than temporary between the component representing credit loss and the component representing loss related to other factors. The portion of the fair value decline attributable to credit loss must be recognized through a charge to earnings. Credit component is determined by comparing the present value of the cash flows expected to be collected, discounted at the rate in effect before recognizing any OTTI with the amortized cost basis of the debt security.  The Company uses the cash flow expected to be realized from the security, which includes assumptions about interest rates, timing and severity of defaults, estimates of potential recoveries, the cash flow distribution from the bond indenture and other factors, then applies a discount rate equal to the effective yield of the security.  The difference between the present value of the expected cash flows and the amortized book value is considered a credit loss.  The fair market value of the security is determined using the same expected cash flows; the discount rate is a rate the Company determines from open market and other sources as appropriate for the security.  The difference between the fair market value and the security’s remaining amortized cost  is recognized in other comprehensive income.  
 
The following is a rollforward for the three months ended December 31, 2010 of the amounts recognized in earnings related to credit losses on securities which the Company has recorded OTTI charges through earnings and other comprehensive income.
 
   
(Dollars in thousands)
 
Credit component of OTTI as of October 1, 2010
  $ 3,087  
         
Additions for credit-related OTTI charges on previously unimpaired securities
    -  
         
Additional increases as a result of impairment charges recognized on investments for which an OTTI was previously recognized
    95  
         
Credit component of OTTI as of December 31, 2010
  $ 3,182  
 
U.S. Government Agency Obligations - The Company’s investments in the preceding table in United States Government sponsored enterprise notes consist of debt obligations of the Federal Home Loan Bank (“FHLB”), Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”), and Federal Farm Credit System (“FFCS”).  FHLB debt securities are rated by both Moody’s and Standard & Poor’s. All long-term debt issued by the FHLB banks is rated Aaa by Moody’s and AAA by Standard and Poor’s. All short-term debt is rated “Prime-1” by Moody’s and A-1+ by Standard & Poor’s.  FNMA and FHLMC  senior debt securities are also currently rated  “Aaa” by Moody’s , short-term debt is rated “Prime-1”, subordinated debt  is rated “Aa2” and preferred stock ratings are currently “Aa3”  with “Stable” outlooks. Farm Credit Designated Bonds are high credit quality, liquid and callable securities.  The securities are Aaa rated by Moody’s, AAA by Standard & Poor’s, and AAA by Fitch.  At December 31, 2010, securities in a gross unrealized loss for less than twelve months consist of 33 securities having an aggregate depreciation of 1.0% from the Company’s amortized cost basis.  There were no securities in a gross unrealized loss for more than twelve months.  The unrealized losses on these debt securities relates principally to the changes in market interest rates and a lack of liquidity currently in the financial markets and are not as a result of projected shortfall of cash flows.  In addition, the Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell the securities.  As such, the Company anticipates it will recover the entire amortized cost basis of the securities.  As a result, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2010.
 
 
12

 
 
US Agency Issued Mortgage-Backed SecuritiesAt December 31, 2010, the gross unrealized loss in U.S. agency issued mortgage-backed securities in the category of less than 12 months was $236,000 or 3.1% from the Company’s amortized cost basis and consisted of six securities.  There were no securities in a gross unrealized loss in the category of more than 12 months.  These securities represent asset-backed issues that are issued or guaranteed by a U.S. Government sponsored agency or carry the full faith and credit of the United States through a government agency and are currently rated AAA by at least one bond credit rating agency. In September 2008, the U.S. Department of the Treasury announced the establishment of the Government-Sponsored Enterprise Credit Facility to ensure credit availability to Fannie Mae and Freddie Mac. The Treasury also entered into senior preferred stock purchase agreements, which ensure that each entity maintains a positive net worth and effectively support the holders of debt and mortgage-backed securities (“MBS”) issued or guaranteed by Fannie Mae and Freddie Mac. The Agreements enhance market stability by providing additional security to debt holders, senior and subordinated, thereby alleviating the concern of the credit driven impairment of the securities.  The unrealized loss on these debt securities relates principally to the changes in market interest rates and a lack of liquidity currently in the financial markets and are not as a result of projected shortfall in cash flows.  In addition, the Company does not intend to sell the securities and it is more likely than not that the Company will not be required to sell the securities.  As such, the Company expects to recover the entire amortized cost basis of the securities.  As a result, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2010.
 
Non-Agency Issued Mortgage-Backed Securities and Collateralized Mortgage Obligations - This portfolio was acquired through the redemption-in-kind during 2008 of an investment in a mutual fund and includes 68 collateralized mortgage obligations (“CMO”) and mortgage-backed securities issued by large commercial financial institutions. For the quarter ended December 31, 2010, management recognized an OTTI charge related to a portion of the portfolio securities in the amount of $127,000 on a pre-tax basis due to the fact that, in management’s judgment, the credit quality of the collateral pool underlying such securities had deteriorated during recent periods to the point that full recovery of the entire amortized cost of the investment was considered to be uncertain. This portfolio consists primarily of securities collateralized by Alt-A loans, home equity lines of credit and other receivables as well as whole loans with more significant exposure to declining real estate markets.  For the overall portfolio of the securities, there was exposure to the declining real estate markets such as California, Nevada, Arizona and Florida and consequently, an additional OTTI charge was deemed to be warranted as of December 31, 2010. Of the recorded charge, a total of $95,000 was concluded to be credit related and recognized currently in earnings and $32,000 was concluded to be attributable to other factors and recognized in other accumulated comprehensive income.
 
As of December 31, 2010, with the exception of securities discussed above, there are no securities for which the Company currently believes it is not probable that it will collect all amounts due according to the contractual terms of the investment. Management concluded that an other-than-temporary impairment did not exist and the decline in value was attributed to the illiquidity in the financial markets.  With respect to the $892,000 in gross unrealized losses related to this portfolio, 26 securities had been in a loss position for longer than 12 months while 11 securities had been in a loss position for less than 12 months.  In addition, the Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities.
 
 
13

 
 
The amortized cost and 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.
 
   
December 31, 2010
 
   
Held to Maturity
   
Available for Sale
 
                         
   
Amortized
   
Fair
   
Amortized
   
Fair
 
   
Cost
   
Value
   
Cost
   
Value
 
   
(Dollars in Thousands)
 
Due within one year
  $ -     $ -     $ -     $ -  
Due after one through five years
    13,000       12,869       -       -  
Due after five through ten years
    29,994       30,337       2,999       3,081  
Due after ten years
    57,709       57,237       3,999       3,939  
                                 
Total
  $ 100,703     $ 100,443     $ 6,998     $ 7,020  
 
The maturity table above excludes mortgage-backed securities because the contractual maturities are not indicative of actual maturities due to significant prepayments.
 
4.        LOANS RECEIVABLE
 
Loans receivable consist of the following:
 
   
December 31,
   
September 30,
 
   
2010
   
2010
 
   
(Dollars in Thousands)
 
One-to-four family residential
  $ 198,345     $ 197,164  
Multi-family residential
    3,950       4,006  
Commercial real estate
    21,214       19,710  
Construction and land development
    35,620       40,650  
Commercial business
    882       893  
Consumer
    720       595  
                 
           Total loans
    260,731       263,018  
                 
  Undisbursed portion of loans-in-process
    (4,847 )     (5,366 )
  Deferred loan costs, net
    566       590  
  Allowance for loan losses
    (3,731 )     (3,151 )
                 
Net
  $ 252,719     $ 255,091  
 
 
14

 
 
The following table summarizes the loans individually evaluated for impairment by loan segment at December 31, 2010:
 
    One- to four-
family
residential
     
Multi-family
residential
     
Commercial
real estate
    Construction
and land
development
     
Commercial
business
     
Consumer
     
Total
 
      (Dollars in Thousands)  
Total loans
  $ 198,345     $ 3,950     $ 21,214     $ 35,620     $ 882     $ 720     $ 260,731  
Individually evaluated for impairment
  $ 2,824     $ -     $ -     $ 5,816     $ -     $ -     $ 8,640  
Collectively evaluated for impairment
    195,521       3,950       21,214       29,804       882       720       252,091  
    
The loan portfolio is segmented at a level that allows management to monitor risk and performance.  Management evaluates all construction loans and 90 plus day delinquent commercial loans for potential impairment.  Loans are considered to be impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.
 
Once the determination is made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is generally measured by comparing the recorded investment in the loan to the fair value of the loan using one of the following three methods:  (a) the present value of the expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. Management primarily utilizes the fair value of collateral method as a practically expedient alternative.
 
The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of December 31, 2010:
 
               
Impaired
             
               
Loans with
             
    Impaired Loans with    
No Specific
             
    Specific Allowance    
Allowance
      Total Impaired Loans  
      (Dollars in Thousands)  
                             
Unpaid
 
   
Recorded
   
Related
   
Recorded
   
Recorded
   
Principal
 
   
Investment
   
Allowance
   
Investment
   
Investment
   
Balance
 
One-to-four family residential
  $ 2,824     $ 16     $
-
    $ 2,824     $ 2,824  
Multi-family residential
 
-
   
-
     
-
   
-
   
-
 
Commercial real estate
 
-
   
-
     
-
   
-
   
-
 
Construction and land development
    5,191       1,166       625       5,816       5,816  
Commercial business
 
-
   
-
     
-
   
-
   
-
 
Consumer
 
-
   
-
     
-
   
-
   
-
 
Total Loans
  $ 8,015     $ 1,182     $ 625     $ 8,640     $ 8,640  
 
 
15

 
 
The following table presents the average recorded investment in impaired loans and related interest income recognized for the periods indicated:
 
  Three months ended  
    December 31,  
  (Dollars in Thousands)  
   
2010
      2009  
Average recorded investment in impaired loans
  $ 6,850     $ 1,665  
Interest income recognized on an accrual basis on impaired loans
    68    
-
 
Interest income recognized on a cash basis on impaired loans
    15       8  
 
Federal regulations and our policies require that we utilize an internal asset classification system as a means of reporting problem and potential problem assets.  We have incorporated an internal asset classification system, consistent with Federal banking regulations, as a part of our credit monitoring system.  We currently classify problem and potential problem assets as “substandard,” “doubtful” or “loss” assets.  An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected.  Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.  Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “special mention.”
 
The following table presents the classes of the loan portfolio summarized by the aggregate “Pass” and the criticized categories of “special mention”, “substandard” and “doubtful” within the Company’s risk rating system as of December 31, 2010:
 
         
Special
               
Total
 
   
Pass
   
Mention
   
Substandard
   
Doubtful
   
Loans
 
     (Dollars in Thousands)  
One-to-four family residential
  $ 191,735     $ -     $ 6,610     $ -     $ 198,345  
Multi-family residential
    3,950       -       -       -       3,950  
Commercial real estate
    20,319       -       895       -       21,214  
Construction and land development
    20,538       4,331       10,751       -       35,620  
Commercial business
    882       -       -       -       882  
Consumer
    720       -       -       -       720  
Total Loans
  $ 238,144     $ 4,331     $ 18,256     $ -     $ 260,731  
 
 
16

 
 
Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is due.  The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of December 31, 2010:
 
                   
Total
             
         
30-89 Days
  90 Days+   Past Due    
Non-
   
Total
 
   
Current
    Past Due  
Past Due
  and accruing    
Accrual
   
Loans
 
      (Dollars in Thousands)  
One-to-four family residential
  $ 190,399     $ 1,618     $ 3,197     $ 4,815     $ 3,131     $ 198,345  
Multi-family residential
    3,950       -       -       -       -       3,950  
Commercial real estate
    20,319       -       485       485       410       21,214  
Construction and land development
    35,414       -       -       -       206       35,620  
Commercial business
    882       -       -       -       -       882  
Consumer
    720       -       -       -       -       720  
Total Loans
  $ 251,684     $ 1,618     $ 3,682     $ 5,300     $ 3,747     $ 260,731  
 
The allowance for loan losses is established through a provision for loan losses.  We maintain the allowance at a level believed, to the best of management’s knowledge, to cover all known and inherent losses in the portfolio that are both probable and reasonable to estimate at each reporting date.  Management reviews the allowance for loan losses on no less than a quarterly basis in order to identify those inherent losses and to assess the overall collection probability for the loan portfolio.  For each primary type of loan, we establish a loss factor reflecting our estimate of the known and inherent losses in such loan type using both a quantitative analysis as well as consideration of qualitative factors.  Our evaluation process includes, among other things, an analysis of delinquency trends, non-performing loan trends, the level of charge-offs and recoveries, prior loss experience, total loans outstanding, the volume of loan originations, the type, size and geographic concentration of our loans, the value of collateral securing the loan, the borrower’s ability to repay and repayment performance, the number of loans requiring heightened management oversight, local economic conditions and industry experience.
 
We consider commercial real estate loans, commercial business loans, and land acquisition, development and construction loans to be riskier than one- to four-family residential mortgage loans. Commercial real estate loans entail significant additional credit risks compared to one- to four-family residential mortgage loans, as they involve large loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related real estate project and/or business operation of the borrower who is also the primary occupant, and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. Commercial business loans involve a higher risk of default than residential loans of like duration since their repayment is generally dependent on the successful operation of the borrower’s business and the sufficiency of collateral, if any. Land acquisition, development and construction lending exposes us to greater credit risk than permanent mortgage financing. The repayment of land acquisition, development and construction loans depends upon the sale of the property to third parties or the availability of permanent financing upon completion of all improvements. In the event we make an acquisition loan on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. These events may adversely affect the borrower and the collateral value of the property. Development and construction loans also expose us to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the property may not occur as anticipated. All of these factors are considered as part of the underwriting, structuring and pricing of the loan.
 
 
17

 
 
 The following schedule summarizes the changes in the allowance for loan losses:
 
   
Three Months Ended December 31,
 
   
2010
   
2009
 
   
(Dollars in Thousands)
 
             
Balance, beginning of period
  $ 3,151     $ 2,732  
Provision for loan losses
    580       135  
Charge-offs
    -       -  
Recoveries
    -       -  
                 
Balance, end of period
  $ 3,731     $ 2,867  
 
We will continue to monitor and modify our allowance for loan losses as conditions dictate.  No assurances can be given that our level of allowance for loan losses will cover all of the inherent losses on our loans or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses.
 
5.        DEPOSITS
 
Deposits consist of the following major classifications:
 
   
December 31,
   
September 30,
 
   
2010
   
2010
 
                         
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(Dollars in Thousands)
 
Money market deposit accounts
  $ 75,378       16.2 %   $ 75,822       16.3 %
Checking accounts (1)
    31,676       6.8       28,642       6.2  
Passbook, club and statement savings
    70,001       15.1       69,901       15.1  
Certificates maturing in six months or less
    154,092       33.3       111,180       23.9  
Certificates maturing in more than six months
    132,887       28.6       178,910       38.5  
                                 
  Total
  $ 464,034       100.0 %   $ 464,455       100.0 %
 
            (1)  
Includes interest and non-interest bearing checking accounts.
 
Certificates of $100,000 and over totaled $113.9 million as of December 31, 2010 and $113.0 million as of September 30, 2010.
 
 
18

 
 
6.
  INCOME TAXES
 
  Items that gave rise to significant portions of deferred income taxes are as follows:
 
   
December 31,
   
September 30,
 
   
2010
   
2010
 
Deferred tax assets:
 
(Dollars in Thousands)
 
  Deposit premium
  $ 106     $ 118  
  Allowance for loan losses
    1,333       1,114  
  Real estate owned expenses
    2       291  
  Nonaccrual interest
    17       -  
  Accrued vacation
    63       59  
  Capital loss carryforward
    1,873       1,873  
  Impairment loss
    1,585       1,553  
  Split dollar life insurance
    32       33  
  Post-retirement benefits
    171       173  
  Employee benefit plans
    342       298  
   Total deferred tax assets
    5,524       5,512  
   Valuation allowance
    (2,538 )     (2,209 )
Total deferred tax assets, net of valuation allowance
    2,986       3,303  
                 
Deferred tax liabilities:
               
  Unrealized gain on available for sale securities
    514       861  
  Property
    478       478  
  Mortgage servicing rights
    2       2  
  Deferred loan fees
    192       200  
Total deferred tax liabilities
    1,186       1,541  
                 
Net deferred tax asset
  $ 1,800     $ 1,762  
 
The Company establishes a valuation allowance for deferred tax assets when management believes that the deferred tax assets are not likely to be realized either through a carry back to taxable income in prior years, future reversals of existing taxable temporary differences, and, to a lesser extent, future taxable income.  The tax deduction generated by the redemption of the shares of the mutual fund and the subsequent impairment charge on the assets acquired through the redemption in kind are considered a capital loss and can only be utilized to the extent of capital gains over a five year period, resulting in the establishment of a valuation allowance for the carryforward period which expires beginning in 2013.  The valuation allowance totaled $2.5 million at December 31, 2010.  The gross deferred asset related to impairment losses increased by $32,000 during the three months ended December 31, 2010 while the corresponding valuation allowance increased by $329,000, resulting in additional income tax expense of $297,000 corresponding to the decrease in value of available for sale mortgage-backed securities which may be sold in the future to generate capital gains.
 
There is currently no liability for uncertain tax positions and no known unrecognized tax benefits. The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the Unaudited Consolidated Statement of Operations. During 2009, the Internal Revenue Service concluded an audit of the Company’s tax returns for the year ended September 30, 2007 in which there was no change necessary to the Company’s tax liability.  The Company’s federal and state income tax returns for taxable years through September 30, 2006 have been closed for purposes of examination by the Internal Revenue Service and the Pennsylvania Department of Revenue.
 
 
19

 
 
7.             STOCK COMPENSATION PLANS
 
The Company maintains a Recognition and Retention Plan (“RRP”) which is administered by a committee of the Board of Directors.  The RRP provides for the grant of shares of common stock of the Company to certain officers, employees and directors of the Company.  In order to fund the grant of shares under the RRP, the RRP Trust purchased 226,148 shares of the Company’s common stock in the open market for approximately $2.5 million, at an average price per share of $10.85.  The Company made sufficient contributions to the RRP Trust to fund these purchases.  No additional purchases are expected to be made by the RRP Trust under this plan.  As of December 31, 2010, grants covering 178,882 shares had been awarded as part of the RRP.  The remaining 47,266 shares in the RRP Trust are available for future awards.  Shares subject to awards under the RRP generally vest at the rate of 20% per year over five years.  As of December 31, 2010, 34,656 shares had become fully vested and no shares were forfeited.
 
Compensation expense related to the shares subject to awards granted is recognized ratably over the five-year vesting period in an amount which totals the share price at the grant date.  During the three months ended December 31, 2010, approximately $97,000 was recognized in compensation expense for the RRP.  A tax benefit of $33,000 was recognized during the three months ended December 31, 2010.   During the three months ended December 31, 2009, approximately $95,000 was recognized in compensation expense for the RRP.  A tax benefit of $32,000 was recognized during the three months ended December 31, 2009.  At December 31, 2010, approximately $1.2 million in additional compensation expense for the shares awarded related to the RRP remained unrecognized.  
 
A summary of the Company’s non-vested stock award activity for the three months ended December 31, 2010 is presented in the following table:
 
     Three Months Ended
December 31, 2010
 
     
Number of
Shares
    Weighted Average
Grant Date Fair
Value
 
                 
Nonvested stock awards at October 1, 2010
    144,236     $ 11.11  
   Issued
    -       -  
   Vested
    -       -  
Nonvested stock awards at the December 31, 2010
    144,236     $ 11.11  
 
The Company also maintains a Stock Option Plan.  The Stock Option Plan authorizes the grant of stock options to officers, employees and directors of the Company to acquire shares of common stock with an exercise price at least equal to the market value of the common stock on the grant date.  Options will generally become vested and exercisable at the rate of 20% per year over five years and are generally exercisable for a period of ten years after the grant date.   A total of 565,369 shares of common stock are available for future issuance pursuant to the Stock Option Plan.  As of December 31, 2010, 315,194 incentive stock options and 127,206 non-qualified stock options had been awarded under the plan.  As of December 31, 2010, 85,653 options were vested while none had been forfeited.  
 
 
20

 
 
A summary of the status of the Company’ stock options under the Stock Option Plan as of December 31, 2010 and changes during the three month period ended December 31, 2010 are presented below:
 
     
Three Months Ended
December 31, 2010
 
    Number of
Shares
   
  Weighted Average
Exercise Price
 
                 
Outstanding at October 1, 2010
    442,400     $ 11.12  
Granted
    -       -  
Exercised
    -       -  
Forfeited
    -       -  
Outstanding at December 31, 2010
    442,400     $ 11.12  
Exercisable at December 31, 2010
    85,653     $ 11.17  
 
The weighted average remaining contractual term was approximately 8 years for options outstanding as of December 31, 2010.
 
The estimated fair value of options granted during fiscal 2009 was $2.81 per share, while options granted during fiscal 2010 were estimated to have a fair value of $2.76.  The fair value was estimated on the date of grant in accordance with FASB ASC Topic 718 using the Black-Scholes pricing model with the following weighted average assumptions used:
 
   
Granted Fiscal Year Ended
 
   
2009
   
2010
 
Dividend yield
    1.79 %     2.10 %
Expected volatility
    27.94 %     28.95 %
Risk-free interest rate
    1.96 %     3.10 %
Expected life of options
 
6.5 years
   
6.5 years
 
 
During the three months ended December 31, 2010, $61,000 was recognized in compensation expense for the Stock Option Plan.  A tax benefit of $6,000 was recognized during the three months ended December 31, 2010.  During the three months ended December 31, 2009, $59,000 was recognized in compensation expense for the Stock Option Plan.  A tax benefit of $6,000 was recognized during the three months ended December 31, 2009.  At December 31, 2010, approximately $741,000 in additional compensation expense for awarded options remained unrecognized.  The weighted average period over which this expense will be recognized is approximately 3 years.
 
8.
COMMITMENTS AND CONTINGENT LIABILITIES
 
At December 31, 2010, the Company had $5.9 million in outstanding commitments to originate fixed and variable-rate loans with market interest rates ranging from 4.875% to 6.75%.  At September 30, 2010, the Company had $6.1 million in outstanding commitments to originate fixed and variable-rate loans with market interest rates ranging from 4.875% to 6.75%.
 
The aggregate undisbursed portion of loans-in-process amounted to $4.8 million and $5.4 million, respectively, at December 31, 2010 and September 30, 2010.
 
 
21

 
 
The Company also had commitments under unused lines of credit of $6.9 million at both December 31, 2010 and September 30, 2010, and letters of credit outstanding of $676,000 at both December 31, 2010 and September 30, 2010.
 
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 December 31, 2010, the exposure, which represents a portion of credit risk associated with the interests sold, amounted to $64,000. 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, operations or cash flows 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.
 
9.
FAIR VALUE OF FINANCIAL INSTRUMENTS
 
The fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value.
 
Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
             
   
December 31,
   
September 30
 
   
2010
   
2010
 
                         
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
   
(Dollars in Thousands)
 
Assets:
                       
  Cash and cash equivalents
  $ 50,304     $ 50,304     $ 66,524     $ 66,524  
  Investment and mortgage-backed
                               
    securities held to maturity
    125,230       126,822       112,673       116,594  
  Investment and mortgage-backed
                               
    securities available for sale
    74,445       74,445       72,425       72,425  
  Loans receivable, net
    252,719       258,866       255,091       262,777  
  Accrued interest receivable
    2,751       2,751       2,669       2,669  
  Federal Home Loan Bank stock
    3,368       3,368       3,545       3,545  
  Bank owned life insurance
    6,040       6,040       5,990       5,990  
                                 
Liabilities:
                               
  Checking accounts
    31,676       31,676       28,642       28,642  
  Money market deposit accounts
    75,378       75,378       75,822       75,822  
  Passbook, club and statement
                               
    savings accounts
    70,001       70,001       69,901       69,901  
  Certificates of deposit
    286,979       292,625       290,090       296,087  
  Advances from Federal Home
                               
    Loan Bank
    604       602       615       614  
  Accrued interest payable
    89       89       3,361       3,361  
                                 
 
 
22

 
 
Cash and Cash Equivalents—For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.
 
Investments and Mortgage-Backed SecuritiesThe fair value of investment securities and mortgage-backed securities is based on quoted market prices, dealer quotes, and prices obtained from independent pricing services that may be derivable from observable and unobservable market inputs.
 
Loans ReceivableThe fair value of loans is estimated based on present value using the current market rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
 
Accrued Interest Receivable – For accrued interest receivable, the carrying amount is a reasonable estimate of fair value.
 
Federal Home Loan Bank (FHLB) StockAlthough FHLB stock is an equity interest in an FHLB, it is carried at cost because it does not have a readily determinable fair value as its ownership is restricted and it lacks a market. The estimated fair value approximates the carrying amount.
 
Bank Owned Life InsuranceThe fair value of bank owned life insurance is based on the cash surrender value obtained from an independent advisor that may be derivable from observable and unobservable market inputs.
 
Checking Accounts, Money Market Deposit Accounts, Passbook Accounts, Club Accounts, Statement Savings Accounts, and Certificates of DepositThe fair value of passbook accounts, club accounts, statement savings accounts, checking accounts, and money market deposit accounts is the amount reported in the financial statements. The fair value of certificates of deposit is based on a present value estimate using market rates currently offered for deposits of similar remaining maturity.
 
Advances from Federal Home Loan BankThe fair value of advances from FHLB is the amount payable on demand at the reporting date.
 
Accrued Interest Payable – For accrued interest payable, the carrying amount is a reasonable estimate of fair value.
 
Commitments to Extend Credit and Letters of CreditThe majority of the Bank’s commitments to extend credit and letters of credit carry current market interest rates if converted to loans. Because commitments to extend credit and letters of credit are generally unassignable by either the Bank or the borrower, they only have value to the Bank and the borrower. The estimated fair value approximates the recorded deferred fee amounts, which are not significant.
 
10.
FAIR VALUE MEASUREMENT
 
The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2010 and September 30, 2010, respectively. Although management is not aware of any factors that would significantly affect the fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
 
Generally accepted accounting principles used in the United States establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value.
 
 
23

 
 
The three broad levels of hierarchy are as follows:
 
Level 1
Quoted prices in active markets for identical assets or liabilities.
Level 2
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. 
 
Those assets which will continue to be measured at fair value on a recurring basis as of December 31, 2010 are as follows:
 
   
Category Used for Fair Value Measurement
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(Dollars in Thousands)
 
                         
Assets:
                       
Securities available for sale:
                       
  U.S. Government and agency obligations
  $ -     $ 7,020     $ -     $ 7,020  
  Mortgage-backed securities - U.S. Government agencies
    -       60,607       -       60,607  
  Mortgage-backed securities - Non-agency
    -       6,810       -       6,810  
  FHLMC preferred stock
    8       -       -       8  
           Total
  $ 8     $ 74,437     $ -     $ 74,445  
 
Those assets which will continue to be measured at fair value on a recurring basis as of September 30, 2010 are as follows:
 
   
Category Used for Fair Value Measurement
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(Dollars in Thousands)
 
                         
Assets:
                       
Securities available for sale:
                       
  U.S. Government and agency obligations
  $ -     $ 10,193     $ -     $ 10,193  
  Mortgage-backed securities - U.S. Government agencies
    -       55,025       -       55,025  
  Mortgage-backed securities - Non-agency
    -       7,199       -       7,199  
  FHLMC preferred stock
    8       -       -       8  
           Total
  $ 8     $ 72,417     $ -     $ 72,425  
 
Certain assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).  The Company measures impaired loans and loans or properties collateralizing loans transferred into real estate owned at fair value on a non-recurring basis.
 
 
24

 
 
Impaired Loans
 
The Company considers loans to be impaired when it becomes probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement. Under ASC No. 310-10-35, Receivables-Subsequent Measurement, collateral dependent impaired loans are based on the fair value of the collateral which is based on appraisals.  In some cases, adjustments are made to the appraised values for various factors including age of the appraisal, age of the comparables included in the appraisal, and known changes in the market and in the collateral  These adjustments are based upon observable inputs, and therefore, the fair value measurement has been categorized as a Level 2 measurement. Specific reserves were calculated for impaired loans with carrying amounts totaling $8.6 million at December 31, 2010. The collateral underlying these loans had a fair value of $7.5 million, resulting in specific reserves in the allowance for loan losses of $1.2 million.  
 
Transfer of Impaired Loans into Real Estate Owned
 
Once an asset is determined to be uncollectible, the underlying collateral is repossessed and reclassified to foreclosed real estate and repossessed assets. These assets are carried at lower of cost or fair value of the collateral, less cost to sell. In some cases, adjustments are made to the appraised values for various factors including age of the appraisal, age of the comparables included in the appraisal, and known changes in the market and in the collateral  These adjustments are based upon observable inputs, and therefore, the fair value measurement has been categorized as a Level 2 measurement.
 
 Summary of Non-Recurring Fair Value Measurements
 
   
At December 31, 2010
 
   
(Dollars in Thousands)
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Impaired Loans
  $ -     $ 7,458     $ -     $ 7,458  
Real estate owned
    -       2,034       -     $ 2,034  
Total
  $ -     $ 9,492     $ -     $ 9,492  

   
At September 30, 2010
 
   
(Dollars in Thousands)
 
                         
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Impaired Loans
  $ -     $ 4,249     $ -       4,249  
Real estate owned
    -       3,197       -       3,197  
Total
  $ -     $ 7,446     $ -     $ 7,446  

 
25

 
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion should be read in conjunction with our unaudited consolidated financial statements included elsewhere in this Form 10-Q and with our Annual Report on Form 10-K for the year ended September 30, 2010 (the “Form 10-K”).
 
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 of organization in 2005.  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 primarily 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 (which includes impairment charges) 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 “Department”). The Bank’s main office is in Philadelphia, Pennsylvania, with six 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 Company were transferred to PSB Delaware, Inc.  PSB Delaware, Inc.’s. activities are 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 Form 10-K .  The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) 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 for loan losses is maintained at a level that management considers adequate to provide for estimated losses and impairment based upon an evaluation of known and inherent risk in the loan portfolio. Loan impairment is evaluated based on the fair value of collateral or estimated net realizable value. It is the policy of management to provide for losses on unidentified loans in its portfolio in addition to classified loans.
 
 
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Management monitors its allowance for loan losses at least quarterly and makes adjustments to the allowance through the provision for loan losses as economic conditions and other pertinent factors indicate. The quarterly review and adjustment of the qualitative factors employed in the allowance methodology and the updating of historic loss experience allow for timely reaction to emerging conditions and trends.  In this context, a series of qualitative factors are used in a methodology as a measurement of how current circumstances are affecting the loan portfolio. Included in these qualitative factors are:
 
Levels of past due, classified and non-accrual loans, troubled debt restructurings and modifications
Nature and volume of loans
Changes in lending policies and procedures, underwriting standards, collections, charge-offs and recoveries and for commercial loans, the level of loans being approved with exceptions to lending policy
Experience, ability and depth of management and staff
National and local economic and business conditions, including various market segments
Quality of the Company’s loan review system and degree of Board oversight
Concentrations of credit and changes in levels of such concentrations
Effect of external factors on the level of estimated credit losses in the current portfolio
 
In determining the allowance for loan losses, management has established both specific and general pooled allowances. Values assigned to the qualitative factors and those developed from historic loss experience provide a dynamic basis for the calculation of reserve factors for both pass-rated loans (general pooled allowance) and those criticized and classified loans. The amount of the specific allowance is determined through a loan-by-loan analysis of certain large dollar commercial loans. Loans not individually reviewed are evaluated as a group using reserve factor percentages based on historic loss experience and the qualitative factors described above. In determining the appropriate level of the general pooled allowance, management makes estimates based on internal risk ratings, which take into account such factors as debt service coverage, loan-to-value ratios, and external factors. Estimates are periodically measured against actual loss experience.
 
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 impaired loans, value of collateral, estimated losses on our commercial, construction and residential loan portfolios and historical loss experience.  All of these estimates may be susceptible to significant change.
 
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 Department and the FDIC, as an integral part of their examination processes, periodically review our allowance for loan losses. The Department 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.
 
Investment and mortgage-backed securities available for sale.  Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated using quoted prices of securities with similar characteristics or discounted cash flows and are classified within Level 2 of the fair value hierarchy. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. 
 
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.  The Company determines whether the unrealized losses are temporary in accordance with  GAAP.  The evaluation is based upon factors such as the creditworthiness of the issuers/guarantors, the underlying collateral, if applicable, and the continuing performance of the securities.  In addition the Company also considers the likelihood that the security will be required to be sold by a regulatory agency, our internal intent not to dispose of the security prior to maturity and whether the entire cost basis of the security is expected to be recovered.  In determining whether the cost basis will be recovered, management evaluates other facts and circumstances that may be indicative of an other-than-temporary impairment condition. This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost, and near-term prospects of the issuer.
 
 
27

 
 
In addition, certain assets are measured at fair value on a non-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The Company measures impaired loans, FHLB stock and loans or  properties collateralizing loans transferred into real estate owned at fair value on a non-recurring basis.  

Valuation techniques and models utilized for measuring financial assets and liabilities are reviewed and validated by the Company at least quarterly.

Income Taxes.  The Company records deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. 

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.
 
The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the consolidated income statement.  Assessment of uncertain tax positions requires careful consideration of the technical merits of a position based on management’s analysis of tax regulations and interpretations.  Significant judgment may be involved in the assessment of the tax position.

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 unless required by law or regulations.
 
 
28

 

Market Overview.  The market dislocations experienced in the financial market beginning in 2007 have continued through 2010.  One of the primary sources for the difficulties in the market is the significant declines experienced in the housing market throughout the country.  While the Philadelphia area has not suffered wholesale declines in the value of residential real estate as have other areas of the country, this downturn has rippled through many parts of the economy, especially condominium sales, construction lending and lending to contractors.  The Company continues to focus on the credit quality of its customers – closely monitoring the financial status of borrowers throughout the Company’s markets, gathering information, working on early detection of potential problems, taking pre-emptive steps where necessary and performing the analysis required to maintain adequate reserves for loan losses. 

Despite the current market and economic conditions, the Company continues to maintain a strong capital position.
 
The following discussion provides further details on the financial condition and results of operations of the Company at and for the periods ended December 31, 2010.

COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2010 AND SEPTEMBER 30, 2010

At December 31, 2010, the Company had total assets of $523.6 million, a decrease of $5.5 million from $529.1 million at September 30, 2010.  The decrease was primarily attributable to decreases during the first quarter of fiscal 2010 of $16.2 million in cash and cash equivalents and $2.4 million in net loans.  These decreases were partially offset by a $14.6 million increase in the investment and mortgage-backed securities portfolio as we re-invested a portion of our cash and cash equivalents in such higher yielding assets.

Total liabilities decreased $4.4 million to $467.7 million at December 31, 2010 from $472.1 million at September 30, 2010.  The decrease was primarily the result of a $3.3 million decrease in accrued interest related to certificates of deposit that is generally distributed at the end of the calendar year.

Stockholders’ equity decreased by $1.1 million to $55.9 million at December 31, 2010.  The decrease reflected the payment of dividends totaling $482,000 combined with a $738,000 decrease in the unrealized gain on available for sale securities.  The decrease in the amount of the unrealized gain reflected the decline in fair value of available for sale securities as a result of increases in market rates of interest as compared to September 30, 2010.

COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2010 AND 2009

Net income.  The Company reported a net loss of $94,000 for the quarter ended December 31, 2010 as compared to net income of $686,000 for the quarter ended December 31, 2009.  The loss incurred for the first quarter of fiscal 2011 reflected the combined effects of increases in the provision for loan losses, non-interest expense and the valuation allowance on deferred tax assets as well as a decrease in net interest income.

Net interest income.  Net interest income decreased $346,000 or 8.7% to $3.6 million for the three months ended December 31, 2010 as compared to $4.0 million for the same period in 2009. The decrease was due to an $813,000 or 12.6% decrease in interest income partially offset by a $467,000, or 18.8% decrease in interest expense.  The decrease in interest income resulted from an 89 basis point decrease to 4.47% in the weighted average yield earned on interest-earning assets partially offset by a $23.8 million or 4.9% increase in the average balance of interest-earning assets for the three months ended December 31, 2010, as compared to the same period in 2009.  The decrease in the weighted average yield earned was primarily due to the increased amount of cash and cash equivalents as the result of the receipt of the receipt of proceeds from the repayment of investment securities.  The yield on cash and cash equivalents is less than the weighted average yield on the investment securities which repaid during the 2010 period.  The decrease in interest expense resulted primarily from an 50 basis point decrease to 1.75% in the weighted average rate paid on interest-bearing liabilities, reflecting the repricing downward of interest-bearing liabilities during the year, partially offset by a $19.8 million or 4.5% increase in the average balance of interest-bearing liabilities, primarily in certificates of deposit, for the three months ended December 31, 2010, as compared to the same period in 2009.  The decline in the weighted average rate paid reflected the continued effect of the low interest rate environment on the Bank’s cost of funds as deposits, in particular, certificates of deposit, repriced downward.
 
29

 

For the quarter ended December 31, 2010, the net interest margin was 2.87%, as compared to 3.30% for the same period in 2009.  The decrease in the net interest margin was primarily due to the shift in the relative composition of interest-earning assets to increased amounts of cash and cash equivalents as higher yielding investment securities were called and repaid during the later part of fiscal 2010 and first quarter of fiscal 2011.
 
 
30

 

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 interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin.  Average yields and rates have been annualized.  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.
                                     
   
Three Months
Ended December 31,
 
   
2010
    2009  
   
Average
Balance
   
Interest
   
Average
Yield/Rate
   
Average
Balance
   
Interest
   
Average
Yield/Rate
 
       
   
(Dollars in Thousands)
 
Interest-earning assets:
                                   
Investment securities
  $ 99,371     $ 932       3.75 %   $ 126,535     $ 1,490       4.71 %
Mortgage-backed securities
    88,339       1,065       4.82       94,671       1,223       5.17  
Loans receivable(1)
    255,129       3,623       5.68       256,079       3,751       5.86  
Other interest-earning assets
    63,362       33       0.21       5,100       2       0.16  
Total interest-earning assets
    506,201       5,653       4.47       482,385       6,466       5.36  
Cash and non-interest-bearing balances
    3,160                       8,010                  
Other non-interest-earning assets
    18,620                       18,180                  
Total assets
  $ 527,981                     $ 508,575                  
Interest-bearing liabilities:
                                               
Savings accounts
  $ 69,391       229       1.32     $ 67,997       327       1.92  
Money market deposit and NOW accounts
    103,262       202       0.78       106,462       293       1.10  
Certificates of deposit
    287,327       1,588       2.21       246,200       1,650       2.68  
Total deposits
    459,980       2,019       1.76       420,659       2,270       2.16  
Advances from Federal Home Loan Bank
    608       2       1.32       20,043       217       4.33  
Advances from borrowers for taxes and insurance
    1,429       1       0.28       1,476       2       0.54  
Total interest-bearing liabilities
    462,017       2,022       1.75       442,178       2,489       2.25  
Non-interest-bearing liabilities:
                                               
Non-interest-bearing demand accounts
    2,768                       3,047                  
Other liabilities
    6,725                       7,449                  
Total liabilities
    471,510                       452,674                  
Stockholders equity
    56,471                       55,901                  
      Total liabilities and stockholders equity
  $ 527,981                     $ 508,575                  
Net interest-earning assets
  $ 44,184                     $ 40,207                  
Net interest income; interest rate spread
          $ 3,631       2.72 %           $ 3,977       3.11 %
Net interest margin(2)
                    2.87 %                     3.30 %
                                                 
Average interest-earning assets to average interest-bearing liabilities
            109.56                     109.09 %        
 

(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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Provisions for loan losses.  The allowance is maintained at a level sufficient to provide for estimated probable losses in the loan portfolio at each reporting date.  At least quarterly, management performs an analysis to identify the inherent risk of loss in the Company’s loan portfolio. This analysis includes a qualitative evaluation of concentrations of credit, past loss experience, current economic conditions, amount and composition of the loan portfolio (including loans being specifically monitored by management), estimated fair value of underlying collateral, delinquencies, and other factors.

Our methodology for assessing the adequacy of the allowance establishes both specific and general pooled allocations of the allowance. To determine the adequacy of the allowance and the need for potential changes to the allowance, we conduct a formal analysis at least quarterly to assess the risk within the loan portfolio.  This assessment includes analyses of historical performance, past due trends, the level of nonperforming loans, reviews of certain impaired loans, loan activity since the last quarter, consideration of current economic conditions, and other pertinent information.  Loans are assigned ratings, either individually for larger credits or in homogeneous pools, based on an internally developed grading system.  The resulting conclusions are reviewed and approved by senior management.

The Company established a provision for loan losses of $580,000 for the quarter ended December 31, 2010, compared to $135,000 for the same quarter in 2009.  The increased provision for the 2010 period primarily related to an additional specific reserve of $315,000 established with respect to an 18-unit condominium project located in Philadelphia in which the estimated net realizable value of the collateral has been determined to be less than the $4.2 million loan balance based on a recent appraisal.  Although the loan is impaired, the loan is not considered non-performing as the loan is not delinquent or in non-accrual status.   At December 31, 2010, the Company’s non-performing assets totaled $9.5 million or 1.8% of total assets as compared to $6.7 million or 1.4% at September 30, 2010.  The non-performing assets consisted of one construction loan totaling $206,000, three commercial real estate loans to two borrowers totaling $898,000, 24 one-to four-family residential mortgage loans totaling $6.3 million and five real estate owned properties totaling $2.0 million.  Four of the properties represent the entirety of one townhouse project totaling $1.7 million while the fifth property is a condominium unit which is part of an existing construction project.  With respect to the project, the outstanding principle balance of the loan, which is impaired, at December 31, 2010 was $1.0 million.  The allowance for loan losses totaled $3.7 million, or 1.4% of total loans and 50.2% of non-performing loans at December 31, 2010.

Non-interest income.  Non-interest income amounted to $134,000 for the three months ended December 31, 2010, compared with $19,000 for the same period in 2009.  The improvement compared to the 2009 period was due to the reduced level of other than temporary impairment (“OTTI”) charges arising from the Company’s redemption in kind in June 2008 of its entire investment in a mutual fund. The decline in the amount of losses recognized between the 2009 and 2010 periods reflected the decline in the amount of the OTTI charges from $204,000 for the three months ended December 31, 2009 to $95,000 for the three months ended December 31, 2010 related to the non-agency mortgage-backed securities acquired as part of the redemption in kind of such investment.

Non-interest expenses.  For the quarter ended December 31, 2010, non-interest expense increased $310,000 compared to the same period in 2009.  The most significant component of the increase in the period related to a loss of $135,000 recognized on the previously disclosed sale of a $1.2 million real estate owned property during the quarter ended December 31, 2010.

Income tax expense.  The Company recognized income tax expense for the quarter ended December 31, 2010 of $416,000 compared to income tax expense of $622,000 for the three months ended December 31, 2009.  The decrease in income tax expense was primarily attributable to the lower level of taxable net income before taxes during the three months ended December 31, 2010 as compared to the comparable period in 2009.  Partially offsetting the decrease was a $297,000 increase in the valuation allowance related to the $3.5 million aggregate deferred tax asset capital loss carryforward and the related impairment loss created in connection with the June 2008 redemption in kind referenced above.   As a result, the Company’s effective tax rate exceeded 100% for the 2010 period.
 
 
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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 December 31, 2010, our cash and cash equivalents amounted to $50.3 million.  In addition, our available for sale investment and mortgage-backed securities amounted to an aggregate of $74.4 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 December 31, 2010, the Company had $5.9 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 $6.9 million and letters of credit outstanding of $676,000 at December 31, 2010.  Certificates of deposit at December 31, 2010 maturing in one year or less totaled $205.3 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 flows 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 (“FHLB”), of which we are a member.  Under terms of the collateral agreement with the FHLB, we pledge residential mortgage loans as well as our stock in the Federal Home Loan Bank as collateral for such advances.  However, use of FHLB advances has been modest.  At December 31, 2010, we had $604,000 in outstanding FHLB advances and had the ability to obtain an additional $157.9 million in FHLB advances.  Additional borrowing capacity with the FHLB could be obtained with the pledging of certain investment securities.  The Company has also obtained approval to borrow from the Federal Reserve Bank discount window.

We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.
 
 
33

 
 
The following table summarizes the Company’s and Bank’s regulatory capital ratios as of December 31, 2010 and September 30, 2010 and compares them to current regulatory guidelines.
 
               
To Be
 
               
Well Capitalized
 
         
Required for
   
Under Prompt
 
         
Capital Adequacy
   
Corrective Action
 
   
Actual Ratio
   
Purposes
   
Provisions
 
December 31, 2010:
                 
Tier 1 capital (to average assets)
                 
The Company
    10.41 %     4.0 %     N/A  
The Bank
    9.48 %     4.0 %     5.0 %
                         
Tier 1 capital (to risk weighted assets)
                       
The Company
    23.15 %     4.0 %     N/A  
The Bank
    21.09 %     4.0 %     6.0 %
                         
Total capital (to risk weighted assets)
                       
The Company
    24.41 %     8.0 %     N/A  
The Bank
    22.35 %     8.0 %     10.0 %
                         
September 30, 2010:
                       
Tier 1 capital (to average assets)
                       
Company
    10.27 %     4.0 %     N/A  
Bank
    9.46 %     4.0 %     5.0 %
                         
Tier 1 capital (to risk-weighted assets)
                       
Company
    23.12 %     4.0 %     N/A  
Bank
    21.28 %     4.0 %     6.0 %
                         
Total capital (to risk-weighted assets)
                       
Company
    24.37 %     8.0 %     N/A  
Bank
    22.53 %     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 require 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 institutions 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 Companys assets and liabilities are critical to the maintenance of acceptable performance levels.
 
 
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How We Manage Market Risk.  Market risk is the risk of loss from adverse changes in market prices and rates.  Our market risk arises primarily from the interest rate risk which is inherent in our lending, investment and deposit gathering activities.  To that end, management actively monitors and manages interest rate risk exposure.  In addition to market risk, our primary risk is credit risk on our loan portfolio.  We attempt to manage credit risk through our loan underwriting and oversight policies.
 
The principal objective of our interest rate risk management function is to evaluate the interest rate risk embedded in certain balance sheet accounts, determine the level of risk appropriate given our business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with approved guidelines. We seek to manage our exposure to risks from changes in interest rates while at the same time trying to improve our net interest spread.  We monitor interest rate risk as such risk relates to our operating strategies.   We have established an Asset/Liability Committee which is comprised of our President and Chief Executive Officer, Chief Financial Officer, Chief Lending Officer, Treasurer and Controller.  The Asset/Liability Committee meets on a regular basis and is responsible for reviewing our asset/liability policies and interest rate risk position. Both the extent and direction of shifts in interest rates are uncertainties that could have a negative impact on future earnings.
 
In recent years, we primarily have reduced our exposure in callable agency bonds and increased our portfolio of agency issued mortgage-backed securities.  However, notwithstanding the foregoing steps, we remain subject to a significant level of interest rate risk in a low interest rate environment due to the high proportion of our loan portfolio that consists of fixed-rate loans as well as our decision to invest a significant amount of our assets in long-term, fixed-rate investment and mortgage-backed securities.
 
Gap Analysis.  The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring a Company’s interest rate sensitivity “gap.”  An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period.  The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period.  A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities.  A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets.  During a period of rising interest rates, a negative gap would tend to affect adversely net interest income while a positive gap would tend to result in an increase in net interest income.  Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to affect adversely net interest income.
 
The following table sets forth the amounts of our interest-earning assets and interest-bearing liabilities outstanding at December 31, 2010, which we expect, based upon certain assumptions, to reprice or mature in each of the future time periods shown (the “GAP Table”).  Except as stated below, the amounts of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability.  The table sets forth an approximation of the projected repricing of assets and liabilities at December 31, 2010, on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three-month period and subsequent selected time intervals.  The loan amounts in the table reflect principal balances expected to be redeployed and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans.  Annual prepayment rates for variable-rate and fixed-rate single-family and multi-family residential and commercial mortgage loans are assumed to range from 5.9% to 25.5%.  The annual prepayment rate for mortgage-backed securities is assumed to range from 0.4% to 39.0%.   For savings accounts, checking accounts and money markets, the decay rates vary on annual basis over a ten year period.
 
 
35

 
 
         
More than
   
More than
   
More than
             
   
3 Months
   
3 Months
   
1 Year
   
3 Years
   
More than
   
Total
 
   
or Less
   
to 1 Year
   
to 3 Years
   
to 5 Years
   
5 Years
   
Amount
 
                                     
    (Dollars in Thousands)  
Interest-earning assets(1):
                                   
Investment and mortgage-backed securities(2)
  $ 11,845     $ 20,119     $ 29,295     $ 23,871     $ 113,035     $ 198,165  
Loans receivable(3)
    34,991       54,458       83,443       40,187       42,805       255,884  
Other interest-earning assets(4)
    50,394                                       50,394  
Total interest-earning assets
  $ 97,230     $ 74,577     $ 112,738     $ 64,058     $ 155,840     $ 504,443  
                                                 
Interest-bearing liabilities:
                                               
Savings accounts
  $ 1,709     $ 4,894     $ 9,497     $ 8,715     $ 45,640     $ 70,455  
Money market deposit and NOW accounts
    4,076       12,230       24,363       18,116       44,839       103,624  
Certificates of deposit
    70,559       134,774       56,734       24,912               286,979  
Advances from Federal Home Loan Bank
    38       115       111       340               604  
Advances from borrowers for taxes and insurance
    1,765       -       -       -       -       1,765  
Total interest-bearing liabilities
  $ 78,147     $ 152,013     $ 90,705     $ 52,083     $ 90,479     $ 463,427  
                                                 
Interest-earning assets
                                               
less interest-bearing liabilities
  $ 19,083     $ (77,436 )   $ 22,033     $ 11,975     $ 65,361     $ 41,016  
                                                 
Cumulative interest-rate sensitivity gap (5)
  $ 19,083     $ (58,353 )   $ (36,320 )   $ (24,345 )   $ 41,016          
                                                 
Cumulative interest-rate gap as a percentage of total assets at December 31, 2010
    3.64 %     -11.14 %     -6.94 %     -4.65 %     7.83 %        
                                                 
Cumulative interest-earning assets as a percentage of cumulative interest-bearing liabilities at December 31, 2010
    124.42 %     74.65 %     88.68 %     93.47 %     108.85 %        
 
(1)
Interest-earning assets are included in the period in which the balances are expected to be redeployed and/or repriced as a result of anticipated prepayments, scheduled rate adjustments and contractual maturities.
 
(2)
For purposes of the gap analysis, investment securities are stated at amortized cost.
 
(3)
For purposes of the gap analysis, loans receivable includes non-performing loans and is gross of the allowance for loan losses and unamortized deferred loan fees, but net of the undisbursed portion of loans-in-process.
 
(4)
Includes FHLB stock.
 
(5)
Cumulative interest-rate sensitivity gap represents the difference between interest-earning assets and interest-bearing liabilities.
 
Certain shortcomings are inherent in the method of analysis presented in the foregoing table.  For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates.  Additionally, certain assets, such as variable-rate loans, have features which restrict changes in interest rates both on a short-term basis and over the life of the asset.  Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table.  Finally, the ability of many borrowers to service their variable-rate loans may be adversely affected in the event of an interest rate increase.
 
 
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Net Portfolio Value Analysis.  Our interest rate sensitivity also is monitored by management through the use of a model which generates estimates of the changes in our net portfolio value (“NPV”) over a range of interest rate scenarios.  NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts.  The NPV ratio, under any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario.  The “Sensitivity Measure” is the decline in the NPV ratio, in basis points, caused by a 2% increase or decrease in rates, whichever produces a larger decline.  The following table sets forth our NPV as of December 31, 2010 and reflects the changes to NPV as a result of immediate and sustained changes in interest rates as indicated.
                                 
Change in
                     
NPV as % of Portfolio
 
Interest Rates
    Net Portfolio Value    
Value of Assets
 
In Basis Points
                               
(Rate Shock)
   
Amount
   
$ Change
   
% Change
   
NPV Ratio
   
Change
 
                                 
      (Dollars in Thousands)  
                                 
  300     $ 39,186     $ (42,721 )     (52.16 )%     8.45 %     (6.98 )%
  200       52,789       (29,118 )     (35.55 )%     10.83 %     (4.60 )%
  100       66,873       (15,034 )     (18.35 )%     13.18 %     (2.25 )%
 
Static
      81,907       -       -       15.43 %     -  
  (100)       82,435       528       0.64 %     15.26 %     (0.17 )%
  (200)       80,614       (1,293 )     (1.58 )%     14.79 %     (0.64 )%
  (300)       80,705       (1,202 )     (1.47 )%     14.63 %     (0.80 )%
 
At December 31, 2010, the Company’s NPV was $81.9 million or 15.43% of the market value of assets.  Following a 200 basis point increase in interest rates, the Company’s “post shock” NPV would be $52.8 million or 10.83% of the market value of assets.  The change in the NPV ratio or Company’s sensitivity measure was a decline of 460 basis points.
 
At September 30, 2010, the Company’s NPV was $80.3 million or 14.86% of the market value of assets.  Following a 200 basis point increase in interest rates, the Company’s “post shock” NPV would be $62.0 million or 12.28% of the market value of assets.  The change in the NPV ratio or Company’s sensitivity measure was a decline of 258 basis points.
 
As is the case with the GAP Table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements.  Modeling changes in NPV requires the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates.  In this regard, the models presented assume that the composition of our interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities.  Accordingly, although the NPV model provides an indication of interest rate risk exposure at a particular point in time, such model is not intended to and does not provide a precise forecast of the effect of changes in market interest rates on net interest income and will differ from actual results.
 
 
37

 
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of the end of period covered by this report, our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SECs rules and regulations and are operating in an effective manner.

No change in our internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934) occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
38

 
 
PART II

Item 1. Legal Proceedings

No material changes in the matters previously disclosed in Item 3 of the Company’s Annual Report on Form 10-K for the year ended September 30, 2010 has occurred.

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, does not believe that such proceedings will 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.

Item 1A. Risk Factors

Not applicable

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

 
(a)
Not applicable

 
(b)
Not applicable

 
(c)
There were no repurchases of common stock by the Company or purchases of common stock by the MHC during the quarter ended December 31, 2010.

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. (Removed and Reserved)

Item 5. Other Information

Not applicable

Item 6. Exhibits
 
Exhibit No.   Description  
31.1
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2  
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.0
 
Section 1350 Certifications
 
 
39

 
 
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.

PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA
         
  Date: February 14, 2011        By: /s/ Thomas A. Vento
        Thomas A. Vento
        President and Chief Executive Officer
         
  Date: February 14, 2011        By: /s/ Joseph R. Corrato
        Joseph R. Corrato
        Executive Vice President and Chief Financial Officer
 
40