PATAPSCO BANCORP INC - FORM 10-Q

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EX-32 - EXHIBIT 32 -- SECTION 906 CEO AND CFO CERTIFICATION - PATAPSCO BANCORP INC	dex32.htm
EX-31.1 - EXHIBIT 31.1 -- SECTION 302 CEO CERTIFICATION - PATAPSCO BANCORP INC	dex311.htm
EX-31.2 - EXHIBIT 31.2 -- SECTION 302 CFO CERTIFICATION - PATAPSCO BANCORP INC	dex312.htm

United States

Securities and Exchange Commission

Washington, D. C. 20549

FORM 10 - Q

(Mark One)

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended December 31, 2010

¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number: 0-28032

PATAPSCO BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland

52-1951797

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

1301 Merritt Boulevard, Dundalk, Maryland 21222-2194

(Address of Principal Executive Offices)

(410) 285-1010

Registrant’s Telephone Number, Including Area Code

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 ¨

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 (Section 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). Yes ¨ No ¨

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

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

As of February 10, 2011, the issuer had 1,939,593 shares of Common Stock issued and outstanding.


	TABLE OF CONTENTS

		PAGE

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Statements of Financial Condition at December 31, 2010 and June 30, 2010 (Unaudited)		3

	Consolidated Statements of Operations for the Six and Three Month Periods Ended December 31, 2010 and 2009 (Unaudited)		4

	Consolidated Statements of Comprehensive Income/(Loss) for the Six and Three Month Periods Ended December 31, 2010 and 2009 (Unaudited)		5

	Consolidated Statements of Cash Flows for the Six Month Periods Ended December 31, 2010 and 2009 (Unaudited)		6

	Notes to Consolidated Financial Statements (Unaudited)		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		22

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		31

Item 4.	Controls and Procedures		31

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings		32

Item 1A.	Risk Factors		32

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		32

Item 3.	Defaults upon Senior Securities		32

Item 4.	Removed and Reserved		32

Item 5.	Other Information		32

Item 6.	Exhibits		32

Signatures			33

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Patapsco Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(unaudited)

($ in thousands except for share data)


	December 31, 2010			June 30, 2010
Assets:
Cash and cash equivalents:
Cash on hand and due from banks	$	4,687		$	6,811
Interest bearing deposits in other banks		22,454			21,232

Total cash and cash equivalents		27,141			28,043
Securities available for sale		36,571			25,482
Loans receivable, net of allowance for loan losses of $4,405 and $3,527, respectively		192,656			197,169
Investment in securities required by law, at cost		2,654			2,848
Repossessed real estate and other assets, net of allowance for losses of $0 and $19, respectively		1,885			2,875
Property and equipment, net		3,692			3,759
Core deposit intangible		168			193
Accrued interest and other assets		8,366			9,354

Total assets	$	273,133		$	269,723


Liabilities and Stockholders’ Equity

Liabilities:
Deposits:
Non-interest bearing deposits	$	9,045		$	11,554
Interest bearing deposits		228,432			217,235

Total deposits		237,477			228,789
Accrued expenses and other liabilities		1,723			1,464
Long-term debt		12,000			17,100
Junior subordinated debentures		5,000			5,000

Total liabilities		256,200			252,353


Stockholders’ equity:
Preferred Stock – Series A Cumulative perpetual; $0.01 par value; authorized 1,000,000 shares with a liquidation preference of $1,000 per share; 6,000 shares outstanding		5,800			5,766
Warrant Preferred stock – Series B Cumulative perpetual; $0.01 par value; authorized 1,000,000 shares with a liquidation preference of $1,000 per share; 300 shares outstanding		323			326
Common stock - $0.01 par value; authorized 4,000,000 shares; issued and outstanding 1,939,593 and 1,930,317 shares, respectively		19			19
Additional paid in capital		7,872			7,847
Retained income, substantially restricted		2,941			3,212
Accumulated other comprehensive (loss)/income, net of income taxes		(22	)		200

Total stockholders’ equity		16,933			17,370

Total liabilities and stockholders’ equity	$	273,133		$	269,723

See accompanying notes to consolidated financial statements.

Patapsco Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)


($ in thousands except for per share data)	For Six Months Ended December 31,						For Three Months Ended December 31,
	2010			2009			2010			2009
Interest income:
Loans receivable, including fees	$	6,073		$	6,913		$	2,990		$	3,357
Securities, including securities required by law		411			325			205			163
Federal funds sold and other investments		30			15			16			5

Total interest income		6,514			7,253			3,211			3,525


Interest expense:
Deposits		1,837			2,247			888			1,039
Short-term debt		—			6			—			—
Long-term debt and subordinated debentures		481			634			217			304

Total interest expense		2,318			2,887			1,105			1,343

Net interest income		4,196			4,366			2,106			2,182

Provision for loan losses		1,298			792			994			398

Net interest income after provision for loan losses		2,898			3,574			1,112			1,784


Non-interest income:
Fees and service charges		330			357			176			169
Net gain on sale of securities available for sale		67			—			—			—
Gain on sale of repossessed real estate and other assets		10			—			6			—
Loss on sale of other assets		(22	)		—			(22	)
Other		40			48			21			22

Total non-interest income		425			405			181			191

Non-interest expense:
Compensation and employee benefits		1,942			2,127			953			1,046
Professional fees		296			261			157			145
Federal deposit insurance assessments		270			254			133			122
Equipment expense		109			107			56			51
Net occupancy expense		273			283			133			138
Advertising		20			22			10			7
Data processing		190			201			93			102
Amortization of core deposit intangible		26			26			13			13
Telephone, postage & delivery		136			141			70			69
Provision for losses on and cost of repossessed real estate and other assets		96			42			62			34
Other		375			354			192			173

Total non-interest expense		3,733			3,818			1,872			1,900

Income/(loss) before provision/(benefit) for income taxes		(410	)		161			(579	)		75

Provision/(benefit) for income taxes		(169	)		56			(231	)		26

Net Income/(loss)	$	(241	)	$	105		$	(348	)	$	49

Preferred stock dividends		194			163			97			82

Net loss available for common shareholders	$	(435	)	$	(58	)	$	(445	)	$	(33	)

Basic loss per common share	$	(0.22	)	$	(0.03	)	$	(0.23	)	$	(0.02	)

Diluted loss per common share	$	(0.22	)	$	(0.03	)	$	(0.23	)	$	(0.02	)

Cash dividends declared per common share	$	—		$	—		$	—		$	—

See accompanying notes to consolidated financial statements.

Patapsco Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)

(unaudited)

($ in thousands)


	For Six Months Ended December 31,					For Three Months Ended December 31,
	2010			2009		2010			2009

Net income/(loss)	$	(241	)	$	105	$	(348	)	$	49
Other comprehensive income/(loss), net of income taxes/(benefit):
Reclassification adjustments for gains realized in income		(67	)		—		—			—
Unrealized net holding gain/(loss) on securities available-for-sale		(300	)		130		(267	)		(170	)

Subtotal		(608	)		235		(715	)		(121	)
Tax effect		(145	)		51		(105	)		(67	)

Comprehensive income/(loss)	$	(463	)	$	184	$	(510	)	$	(54	)

See accompanying notes to consolidated financial statements.

Patapsco Bancorp, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


($ in thousands)	For the Six Months Ended December 31,
	2010			2009
Cash flows from operating activities:
Net income/(loss)	$	(241	)	$	105
Adjustments to reconcile net income/(loss) to net cash provided by/(used in) operating activities:
Amortization of premiums and discounts, net		124			144
Gain on sale of securities available for sale		(67	)		—
Amortization of deferred loan origination costs		2			3
Provision for loan losses		1,298			792
Net gain on sale of repossessed real estate and other assets		(10	)		—
Depreciation		137			140
Amortization of core deposit intangible		26			26
Increase in cash surrender value of bank owned life insurance		(33	)		(33	)
Loss on sale of other assets		22			—
Decrease/(increase) in accrued interest receivable and other assets		1,153			(1,075	)
Non-cash compensation under stock-based benefit plan		3			30
Increase/(decrease) in accrued expenses and other liabilities		258			(227	)

Net cash provided by/(used in) operating activities		2,672			(95	)


Cash flows from investing activities:
Proceeds from maturity of investments and principal repayments on mortgage-backed securities		15,989			6,137
Purchase of securities available for sale		(29,017	)		(7,139	)
Proceeds from sale of securities available for sale		1,526			—
Net change in loans		2,937			555
Funds received in sale of repossessed real estate and other assets		1,279			—
Net change in investments required by law		194			(30	)
Purchase of property and equipment		(70	)		(10	)

Net cash used in investing activities		(7,162	)		(487	)


Cash flows from financing activities:
Net increase in deposits		9,770			6,175
Decrease in advance payments by borrowers		(1,082	)		(1,142	)
Payments on long-term borrowings		(5,100	)		(12,200	)
Dividends paid		—			(163	)

Net cash provided by/(used in) financing activities		3,588			(7,330	)


Net decrease in cash and cash equivalents		(902	)		(7,912	)
Cash and cash equivalents at beginning of period		28,043			19,794

Cash and cash equivalents at end of period	$	27,141		$	11,882


Supplemental cash flow information:
Interest paid on deposits and borrowed funds	$	2,238		$	2,996
Income taxes paid		—			173

Non-cash disclosures:
Loans transferred to repossessed real estate and other assets, net	$	265		$	3,112

See accompanying notes to consolidated financial statements.

Patapsco Bancorp, Inc. and Subsidiary

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Principles of Consolidation

The consolidated financial statements include the accounts of Patapsco Bancorp, Inc. (the “Company” or “Patapsco Bancorp”) and its wholly owned subsidiary, The Patapsco Bank (the “Bank”), and the Bank’s wholly owned subsidiaries Prime Business Leasing and Patapsco Financial Services, Inc. All inter-company accounts and transactions have been eliminated in the accompanying consolidated financial statements.

Note 2: The Patapsco Bank

The Bank, the primary operating unit of the Company, is regulated by The Federal Reserve Bank of Richmond (the “Federal Reserve Bank”) and The State of Maryland. The primary business of the Bank is to attract deposits from individual and corporate customers and to originate residential and commercial mortgage loans, consumer loans and commercial business loans. The Bank competes with other financial and mortgage institutions in attracting and retaining deposits and originating loans.

Note 3: Basis of Presentation

The accompanying consolidated statement of financial condition at June 30, 2010, which has been derived from audited financial statements, and the unaudited interim consolidated financial statements have been prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures necessary for a complete presentation of the financial statements in conformity with Accounting Principles Generally Accepted in the United States of America (“GAAP”). However, all adjustments and disclosures that are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. Such adjustments were of a normal recurring nature. The results of operations for the six months ended December 31, 2010 are not necessarily indicative of the results that may be expected for the entire year. For additional information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual report on Form 10-K for the fiscal year ended June 30, 2010.

Note 4: Subsequent Events

In accordance with ASC Topic 855, “Subsequent Events,” management has evaluated potential subsequent events through the date the financial statements were issued for potential recognition or disclosure in the consolidated financial statements.

Note 5: Recent Accounting Pronouncements

ASC Topic 860

In October 2009, the FASB issued Topic 860, “Accounting for Transfers of Financial Assets.” The amendments in this Update improve financial reporting by eliminating the exceptions for qualifying special-purpose entities from the consolidation guidance and the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. In addition, the amendments require enhanced disclosures about the risks that a transferor continues to be exposed to because of its continuing involvement in transferred financial assets. Comparability and consistency in accounting for transferred financial assets will also be improved through clarifications of the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting.

This Update is effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009. Early application is not permitted. Adoption of this ASC did not have a material impact on the Company’s financial condition or results of operations.

ASC Topic 810

In October 2009, the FASB issued Topic 810, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.” This Update amends the Codification for the issuance of FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R). The amendments in this Update replace the quantitative-based risks and rewards calculation for determining which reporting entity, if any, has a controlling financial interest in a

variable interest entity with an approach focused on identifying which reporting entity has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. An approach that is expected to be primarily qualitative will be more effective for identifying which reporting entity has a controlling financial interest in a variable interest entity. The amendments in this Update also require additional disclosures about a reporting entity’s involvement in variable interest entities, which will enhance the information provided to users of financial statements.

ASC Topic 820

The FASB has issued Topic 820, “Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements.” This ASC requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting. Specifically, ASC 820 amends

Codification Subtopic 820-10 to now require:

•

A reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and

•

In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.

In addition, Topic 820 clarifies the requirements of the following existing disclosures:

•

For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and

•

A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.

Topic 820 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early adoption is permitted. Adoption of this ASC did not have a material impact on the Company’s financial condition or results of operations.

ASU 2010-18

Topic 310, “Receivables”, codifies the consensus reached in EITF Issue No. 09-I, “Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset.” The amendments to the Codification provide that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. ASU 2010-18 does not affect the accounting for loans under the scope of Subtopic 310-30 that are not accounted for within pools. Loans accounted for individually under Subtopic 310-30 continue to be subject to the troubled debt restructuring accounting provisions within Subtopic 310-40.

Topic 310 is effective prospectively for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. Early application is permitted. Upon initial adoption of Topic 310, an entity may make a one-time election to terminate accounting for loans as a pool under Subtopic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration. Adoption of this ASC will not have a material impact on the Company’s financial condition or results of operations.

ASU 2011-01

The amendments in this Update temporarily delay the effective date of the disclosures about troubled debt restructurings in ASU 2010-20 for public entities. Under the existing effective date in Update 2010-20, public-entity creditors would have provided disclosures about troubled debt restructurings for periods beginning on or after December 15, 2010. The delay is intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011. The deferral in this amendment is effective upon issuance.

International Financial Reporting Standards

In November 2008, the SEC released a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (“IASB”). Under the proposed roadmap, the Company may be required to prepare financial statements in accordance with IFRS as early as 2014. The SEC will make a determination in 2011 regarding the mandatory adoption of IFRS. The Company is currently assessing the impact that this potential change would have on its consolidated financial statements, and it will continue to monitor the development of the potential implementation of IFRS.

Note 6: Securities Available for Sale

Investment securities, classified as available for sale, are summarized as follows as of:


	December 31, 2010
(In thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value

Corporate bonds	$	3,000	$	16	($	13	)	$	3,003
U.S. Government agencies		15,056		4		(120	)		14,940
Mortgage-backed securities, residential		6,684		162		(14	)		6,832
Collateralized mortgage obligations		11,867		—		(71	)		11,796

	$	36,607	$	182	($	218	)	$	36,571


	June 30, 2010
(In thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value

Corporate bonds	$	1,500	$	11	$	—		$	1,511
U.S. Government agencies		13,600		40		(3	)		13,637
Mortgage-backed securities, residential		6,737		291		(4	)		7,024
Collateralized mortgage obligations		3,314		—		(4	)		3,310

	$	25,151	$	342	($	11	)	$	25,482

The scheduled maturities of securities available for sale at December 31, 2010 are as follows:


(In thousands)	Amortized Cost		Fair Value
Due in less than one year	$	4,000	$	3,997
Due in one to five years		1,500		1,498
Due after five through ten years		4,000		3,993
Due after ten years		8,556		8,455
Mortgage-backed securities, residential		6,684		6,832
Collateralized mortgage obligations		11,867		11,796

	$	36,607	$	36,571

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


	December 31, 2010
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
(In thousands)

Corporate bonds	$	987	$	(13	)	$	—	$	—		$	987	$	(13	)
U.S. Government agencies		13,379		(120	)		—		—			13,379		(120	)
Mortgage-backed securities, residential		976		(11	)		492		(3	)		1,468		(14	)
Collateralized mortgage obligations		11,796		(71	)		—		—			11,796		(71	)

Total Temporarily Impaired Securities	$	27,138	$	(215	)	$	492	$	(3	)	$	27,630	$	(218	)


	June 30, 2010
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
(In thousands)

U.S. Government agencies	$	1,586	$	(3	)	$	—	$	—		$	1,586	$	(3	)
Mortgage-backed securities, residential		662		(4	)		—		—			662		(4	)
Collateralized mortgage Obligations		3,310		(4	)		—		—			3,310		(4	)

Total Temporarily Impaired Securities	$	5,558	$	(11	)	$	—	$	—		$	5,558	$	(11	)

All mortgage-backed securities and collateralized mortgage obligations in the portfolio were comprised of securities issued by U.S. Government agencies.

Securities, issued by agencies of the federal government, with a carrying value of $4.6 million and $5.1 million on December 31, 2010 and June 30, 2010, respectively, were pledged to secure the Bank’s federal funds accommodation.

During the six months ended December 31, 2010 and 2009, $1.5 million and $0 million in securities were sold at a gross gain of $67,000 and $0, respectively, using the specific identification method.

At December 31, 2010, the Company had twenty securities in an unrealized loss position. Unrealized losses detailed above relate to ten collateralized mortgage obligations, seven U.S. Government Agency securities, two mortgage-backed securities and one corporate bond. The declines in fair value are considered temporary and are primarily due to interest rate fluctuations. The Company does not have the intent to sell these securities, and it is more likely than not that it will not be required to sell the securities prior to their recovery. None of the individual unrealized losses are significant.

The carrying amount of Federal Reserve Bank and Federal Home Loan Bank stocks totals $2.7 million and $2.8 million at December 31, 2010 and June 30, 2010, respectively, and such securities are considered restricted as to marketability. Management evaluates the Company’s restricted stock for impairment in accordance with ASC Topic 350, “Accounting by Certain Entities (Including With Trade Receivables) That Lend to or Finance The Activities of Others.” Management’s determination of whether these investments are impaired is based on their assessment of the

ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the issuer as compared to the capital stock amount for the issuer and the length of time this situation has persisted, (2) commitments by the issuer to make payments required by law or regulation and the level of such payments in relation to the operating performance of the issuer, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the issuer. The Company has concluded that the restricted stock investment is not impaired as of December 31, 2010.

Note 7: Loans and Related Allowance for Loan Losses

The following table summarizes the primary segments of the loan portfolio as of December 31, 2010:


(in thousands)	Commercial		Commercial Real Estate		Consumer		Residential		Commercial Leases		Total
Loan receivables:
Ending balance	$	54,132	$	67,059	$	14,326	$	58,271	$	3,273	$	197,061

Ending balance: individually evaluated for impairment	$	4,449	$	8,940	$	—	$	615	$	—	$	14,004
Ending balance: collectively evaluated for impairment	$	49,683	$	58,119	$	14,326	$	57,656	$	3,273	$	183,057

Allowance for credit losses:
Ending balance	$	931	$	2,585	$	471	$	110	$	308	$	4,405

Ending balance: individually evaluated for impairment	$	592	$	1,142	$	—	$	—	$	—	$	1,734
Ending balance: collectively evaluated for impairment	$	339	$	1,443	$	471	$	110	$	308	$	2,671

The segments of the Bank’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. The commercial real estate (“CRE”) loan segment is further disaggregated into commercial mortgages and acquisition, development, and construction loans. The commercial loan segment consists of loans made for the purpose of financing the activities of commercial customers. The consumer loan segment consists primarily of installment loans (direct and indirect), home equity lines of credit, which are generally second liens, and overdraft lines of credit connected with customer deposit accounts.

At December 31, 2010 and June 30, 2010, the Company had an agreement under a blanket-floating lien with the Federal Home Loan Bank of Atlanta that provides the Company a line of credit of $61.0 million and $50.7 million, respectively, which is secured by qualified mortgage loans. Borrowings totaled $12.0 million and $17.1 million at December 31, 2010 and June 30, 2010, respectively. The Company is required to maintain as collateral for its FHLB borrowings qualified mortgage loans in an amount greater than 100% of the outstanding advances.

Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $100,000, and if the loan either is in nonaccrual status, or is risk rated Substandard. Loans are considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reason for the delay, the borrower’s primary payment record, and the amount of the shortfall in relation to the principal and interest owed. The Company does not separately evaluate individual consumer loans for impairment, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring agreement.

Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (a) the present value of the expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observed market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis, with management primarily utilizing the fair value of collateral method.

The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis. The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

The following table sets forth information with respect to the Company’s impaired loans as of December 31, 2010:


(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recorded
With no related allowance recorded:
Commercial business	$	696	$	900	$	—	$	894	$	5
Commercial real estate- construction		588		753		—		1,187		—
Commercial real estate- other		4,786		4,786		—		5,216		17
Residential- prime		615		615		—		282		—

With an allowance recorded:
Commercial business	$	3,753	$	3,853	$	592	$	3,868		—
Commercial real estate- construction		547		1,354		256		270		—
Commercial real estate- other		3,019		3,019		886		1,204		—

Total:
Commercial business	$	4,449	$	4,753	$	592	$	4,762	$	5
Commercial real estate- construction		1,135		2,107		256		1,457		—
Commercial real estate- other		7,805		7,805		886		6,420		17
Residential- prime		615		615		—		282		—

Management uses an eight point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first four categories are considered not criticized, and are aggregated as “Pass” rated. Risks Ratings One through Three are deemed “acceptable”. Four rated credits require a quarterly review, because potential weakness in some form may exist. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, may be on non-accrual, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. Loans greater than 90 days past due are considered Substandard. Loans in the Doubtful category are on non-accrual and have a definite loss of an undetermined amount. The portion of any loan that represents a specific allocation of the allowance for loan losses is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans generally are included in the Pass categories unless a specific action, such as a delinquency, bankruptcy, repossession or death occurs to raise awareness of a possible credit event. The Bank’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. Commercial Real Estate Loans, Residential Mortgage Loans, Home Equity Lines of Credit and Leases that are greater than 60 days past due; and Commercial Business Loans that are greater than 30 days past due, are individually reviewed on a monthly basis and reported to the Board of Directors. In addition, all Residential, Commercial Business, Commercial Real Estate, Consumer Loans and Leases rated Four through Eight are evaluated with a detailed review, including plans for resolution, and presented to the Watch Committee quarterly. Loans in the Special Mention, Substandard and Doubtful categories are evaluated for impairment and are given separate consideration in the determination of the allowance. The Bank engages an external consultant to conduct loan reviews on at least an annual basis. Generally, the external consultant randomly reviews relationships within the Business and Commercial Portfolios with an emphasis on loans over $500,000, concentrations, criticized assets, non-performing and Regulation O Loans.

The following table sets forth information with respect to the Company’s credit quality indicators as of December 31, 2010 and June 30, 2010:

Credit Risk Profile by Internally

Assigned Grade

(in thousands)

Commercial Credit Exposure


	Commercial				Commercial Leases				Commercial Real Estate- Construction				Commercial Real Estate- Other
	December 31, 2010		June 30, 2010		December 31, 2010		June 30, 2010		December 31, 2010		June 30, 2010		December 31, 2010		June 30, 2010
Pass	$	44,974	$	38,837	$	3,026	$	5,061	$	8,147	$	11,470	$	41,005	$	31,909
Special Mention		1,360		3,319		2		8		2,428		1,673		2,561		1,672
Substandard		7,206		8,609		245		58		2,602		3,942		9,174		13,056
Doubtful		592		546		—		—		256		131		886		209

Total	$	54,132	$	51,311	$	3,273	$	5,127	$	13,433	$	17,216	$	53,626	$	46,846


Consumer Credit Exposure
	Residential
	December 31, 2010		June 30, 2010
Pass	$	57,599	$	64,931
Special Mention		57		58
Substandard		615		117
Doubtful		—		—

Total	$	58,271	$	65,106

Consumer Credit Exposure
	Consumer
	December 31, 2010		June 30, 2010
Performing	$	13,870	$	15,035
Nonperforming		456		55

Total	$	14,326	$	15,090

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 past 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:


(in thousands)	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days and Still Accruing		Total Past Due		Current		Non- Accrual Loans		Total Loans
Residential- prime	$	—	$	680	$	—	$	680	$	56,976	$	615	$	58,271
Commercial real estate:
Construction		—		—		—		—		12,297		1,136		13,433
Other		—		1,890		—		1,890		45,992		5,744		53,626
Commercial business		430		2,687		—		3,117		46,433		4,582		54,132
Commercial leases		80		114		—		194		2,903		176		3,273
Consumer:
Consumer- HELOC		32		—		—		32		5,666		402		6,100
Consumer- other		34		99		—		133		8,039		54		8,226

Total	$	576	$	5,470	$	—	$	6,046	$	178,306	$	12,709	$	197,061

An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.

The Bank’s methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment. The total of the two components represent the Bank’s ALL.

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative factors.

The classes described above, which are based on the Federal call report code assigned to each loan, provide the starting point for the ALL analysis. Management tracks the historical net charge-off activity at the call code level. A historical charge-off factor is calculated utilizing a defined number of consecutive historical years. Consumer pools currently utilize one year, leases currently utilize two years, while Commercial pools currently utilize three to four years as all Commercial watch list loans over $100,000 are individually evaluated for impairment.

“Pass” rated credits are segregated from “criticized” credits for the application of historical and qualitative factors. Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are individually monitored by management and subject to additional qualitative factors.

Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volume, size, and terms of loans; effects of changes in lending policies; experience, ability and depth of lending staff; and risk identification methods.

The following table summarizes the primary segments of the allowance for loan losses.


	Six Months Ended December 31				Three Months Ended December 31
(in thousands)	2010		2009		2010			2009

Allowance for loan losses, beginning of period	$	3,527	$	3,023	$	3,791		$	3,220
Provision for loan losses		1,298		792		994			398
Loans Charged Off:
Consumer		216		302		126			156
Real Estate		39		3		(30	)		—
Commercial		263		110		263			110
Commercial Lease		100		158		65			55

Total Charge-Offs		618		573		424			321

Recoveries:
Consumer		42		43		11			12
Real Estate		—		—		—			—
Commercial		9		19		—			18
Commercial Lease		147		29		33			6

Total Recoveries		198		91		44			36

Allowance for loan losses, end of period	$	4,405	$	3,333	$	4,405		$	3,333

The allowance for loan losses is based on estimates, and actual losses will vary from current estimates. Management believes that the granularity of the homogenous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.

Note 8: Junior Subordinated Debentures

On October 31, 2005, Patapsco Statutory Trust I, a Connecticut statutory business trust and an unconsolidated wholly-owned subsidiary of the Company, issued $5 million of capital trust pass-through securities to investors. The interest rate is fixed for the first seven years at 6.465%. Thereafter, the interest rate adjusts on a quarterly basis at the rate of the three month LIBOR plus 1.48%. Patapsco Statutory Trust I purchased $5,155,000 of junior subordinated deferrable interest debentures from the Company. The debentures are the sole asset of the Trust. The terms of the junior subordinated debentures are the same as the terms of the capital securities. The Company has also fully and unconditionally guaranteed the obligations of the Trust under the capital securities. The capital securities are redeemable by the Company on or after October 31, 2010, at par. The capital securities must be redeemed upon final maturity of the subordinated debentures on December 31, 2035.

On May 6, 2010, the Company’s Board of Directors determined to suspend interest payments on the trust preferred securities. The Company’s Board of Directors took this action in consultation with the Federal Reserve Bank of Richmond as required by recent regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled interest payments; however, the Company believes this decision will better support the capital position of The Patapsco Bank, a wholly owned subsidiary of the Company.

Note 9: Preferred Stock

On December 19, 2008, as part of the Troubled Asset Relief Program’s (“TARP”) Capital Purchase Program, the Company entered into a Letter Agreement, and the related Securities Purchase Agreement – Standard Terms (collectively, the “Purchase Agreement”), with the United States Department of the Treasury (“Treasury”), pursuant to which the Company issued (i) 6,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation preference of $1,000 per share (“Series A preferred stock”), and (ii) a warrant for the Treasury to purchase an additional $300,000 in preferred stock (“Series B preferred stock”), for an aggregate purchase price of $6.0 million.

The Series A preferred stock qualifies as Tier 1 capital and pays cumulative dividends at a rate of 5% per annum until February 15, 2014. Beginning February 15, 2014, the dividend rate will increase to 9% per annum. Under the original terms of the Purchase Agreement, the Company is prohibited from redeeming the Series A preferred stock within the first three years unless it completed a qualified equity offering whereby it received aggregate gross proceeds of not less than $6.0 million. However, the provisions introduced by the American Recovery and

Reinvestment Act of 2009 indicate that once the Company notifies Treasury that it would like to redeem the Series A preferred stock, the Treasury must permit the Company to do so subject to consultation with the Federal Reserve Bank of Richmond. The Company will be subject to existing supervisory procedures for approving redemption requests for capital instruments. The Federal Reserve Bank of Richmond will weigh the Company’s desire to redeem the Series A preferred stock against the contribution of Treasury capital to the Company’s overall soundness, capital adequacy and ability to lend, including confirming that the Company has a comprehensive internal capital assessment process.

On December 19, 2008, Treasury exercised all of the warrants on the Series B preferred stock at the exercise price of $0.01 per share. The Series B preferred stock qualifies as Tier 1 capital and pays cumulative dividends at a rate of 9% per annum. The Series B preferred stock may not be redeemed until all the Series A preferred stock has been redeemed.

The Series A preferred stock and Series B preferred stock were issued in a transaction exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. Neither the Series A preferred stock nor the Series B preferred stock will be subject to any contractual restrictions on transfer.

On May 6, 2010, the Company’s Board of Directors determined to suspend regular quarterly cash dividends on the $6.0 million in Series A Preferred Stock and $300,000 in Series B Preferred Stock. The Company’s Board of Directors took this action in consultation with the Federal Reserve Bank of Richmond as required by recent regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled dividends on the preferred stock; however, the Company believes this decision will better support the capital position of The Patapsco Bank, a wholly owned subsidiary of the Company.

Note 10: Regulatory Capital Requirements

At December 31, 2010, the Bank met each of the three minimum regulatory capital requirements. The following table summarizes the Bank’s regulatory capital position at December 31, 2010.


	Actual					For Capital Adequacy Purposes					Well Capitalized Under Prompt Corrective Action Provision
($ in thousands)	Amount		%			Amount		%			Amount		%
Total Capital (to Risk Weighted Assets)	$	23,069		13.15	%	$	14,213		8.00	%	$	17,767		10.00	%

Tier 1 Capital (to Risk Weighted Assets)	$	20,848		11.88	%	$	7,107		4.00	%	$	10,660		6.00	%

Tier 1 Capital (to Average Assets)	$	20,848		7.66	%	$	10,883		4.00	%	$	13,603		5.00	%

The following table summarizes the Bank’s regulatory capital position at June 30, 2010.


	Actual					For Capital Adequacy Purposes					Well Capitalized Under Prompt Corrective Action Provision
($ in thousands)	Amount		%			Amount		%			Amount		%

Total Capital (to Risk Weighted Assets)	$	23,009		12.35	%	$	15,000		8.00	%	$	18,750		10.00	%

Tier 1 Capital (to Risk Weighted Assets)	$	20,663		11.09	%	$	7,500		4.00	%	$	11,250		6.00	%

Tier 1 Capital (to Average Assets)	$	20,663		7.76	%	$	10,649		4.00	%	$	13,311		5.00	%

Note 11: Loss Per Share

The following table presents a summary of per share data and amounts for the periods indicated.


	Six Months Ended December 31,						Three Months Ended December 31,
	2010			2009			2010			2009
(in thousands, except for per share data)
Net loss available for common shareholders	$	(435	)	$	(58	)	$	(445	)	$	(33	)
Basic weighted average shares outstanding		1,941			1,933			1,941			1,931
Basic loss per share	$	(0.22	)	$	(0.03	)	$	(0.23	)	$	(0.02	)
Dilutive shares		—			—			—			—
Diluted weighted average shares outstanding		1,941			1,933			1,941			1,931
Diluted loss per share	$	(0.22	)	$	(0.03	)	$	(0.23	)	$	(0.02	)

At December 31, 2010, there were 20,832 stock options outstanding all of which had exercise prices above the market price of the Company’s common stock on the same date.

Note 12: Guarantees

The Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit issued by the Bank. Standby letters of credit are conditional written commitments issued by the Bank to guarantee the performance of a customer to a third party. Generally, all letters of credit when issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Bank, generally, holds collateral and/or personal guarantees supporting these commitments. The Bank had $1,430,000 of standby letters of credit as of December 31, 2010 and $1,349,000 outstanding as of June 30, 2010. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payment required under the corresponding guarantees. The amount of the liability as of December 31, 2010 and June 30, 2010 for guarantees under standby letters of credit issued is not material.

Note 13: Core Deposit Intangible Asset

ASC Topic 350, “Intangibles - Goodwill and Other” requires that other acquired intangible assets with finite lives, such as purchased customer accounts, be amortized over their estimated lives. Other intangible assets are amortized using the straight-line method over estimated useful lives of 10 years. The Company periodically assesses whether events or changes in circumstances indicate that the carrying amounts of other intangible assets may be impaired.

Note 14: Share-Based Compensation

Stock Options

The Company’s 1996 Stock Options and Incentive Plan (Plan) was approved by the stockholders at the 1996 annual meeting. The Plan provides for the granting of options to acquire common stock to directors and key employees. Option prices are equal or greater than the estimated fair market value of the common stock at the date of the grant. In October 1996, the Company granted options to purchase 137,862 shares at $4.60 per share. There are no remaining options to be issued under this plan.

The Company’s 2000 Stock Option and Incentive Plan was approved by the stockholders at the 2000 annual meeting. The Plan provides for the granting of options to acquire common stock to directors and key employees. Option prices are equal or greater than the estimated fair market value of the common stock at the date of the grant. The Plan provides for one-fifth of the options granted to be exercisable on each of the first five anniversaries of the date of grant. Under this plan, in August 2001 the Company granted options to purchase 99,975 shares at $6.29 per share. There are 8,971 options eligible to be issued under this plan.

A summary of share option activity for the six month period ended December 31, 2010 follows:


	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term in Years		Aggregate Intrinsic Value (000s)

Outstanding at June 30, 2010		20,832	$	6.29		1.11	$	—

Granted		—		—		—

Exercised		—		—		—

Forfeited or expired		—		—		—


Outstanding at December 31, 2010		20,832	$	6.29		0.60	$	—


Exercisable at December 31, 2010		20,832	$	6.29

Stock Incentive Plan

In October 2004, the shareholders of the Company approved the 2004 Stock Incentive Plan. Under this plan, 90,000 shares of common stock are available for issuance under a variety of awards. An additional 40,146 shares were made available for issuance to settle past deferred compensation obligations. This newer plan replaced the Director’s retirement plan that became effective in September 1995. At the time of adoption, the directors had the option to reallocate their deferred compensation assets.

In May 2009, the Board of Directors voted to terminate the directors deferred compensation portion of the Plan. Accordingly, 57,255 deferred shares were distributed to the respective directors in May 2010, and are now included as issued shares. The remaining portion of the Plan continues to remain in effect. As of June 30, 2010 there are 2,250 non-vested shares outstanding under this plan.

A summary of the status of the Company’s non-vested shares as of December 31, 2010 is presented below:


	Common Shares		Weighted Average Grant-Date Fair Value

Non-vested as of June 30, 2010		2,250	$	7.10

Awards Granted		—		—
Vested		—		—
Forfeited		—		—


Non-vested at December 31, 2010		2,250	$	7.10

As of December 31, 2010 there was $3,000 of total unrecognized compensation costs related to non-vested share-based compensation. The cost is expected to be recognized over a weighted average period of 6 months. At grant date, vesting of the shares was “cliff” vesting at the end of either a two or three year period. Compensation expense totaling $1,000, $3,000, $6,000 and $20,000 has been recognized in the three and six month periods ended December 31, 2010 and 2009, respectively, as a result of these awards.

Note 15: Fair Value Measurements

ASC Topic 820, “Fair Value Measurements and Disclosures” defined the concept of fair value and established a framework for measuring fair value in accordance with GAAP. Fair value is defined as the price to sell an asset or to transfer a liability in an orderly transaction between willing market participants as of the measurement date. The statement also eliminates the use of large position discounts for financial instruments quoted in active markets. The disclosure’s emphasis is on the inputs used to measure fair value and the effect of the measurement on earnings for the period. Fair value estimates, methods, and assumptions are set forth below for the Company’s financial instruments as of December 31, 2010 and June 30, 2010.

Fair value estimates are made at a specific point in time, based on relevant market information and information about financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect estimates.

The carrying amount and estimated fair value of financial instruments is summarized as follows at:


	December 31, 2010				June 30, 2010
(In thousands)	Carrying amount		Fair value		Carrying amount		Fair value
Assets:
Cash and cash equivalents	$	27,141	$	27,141	$	28,043	$	28,043
Securities, available for sale		36,571		36,571		25,482		25,482
Loans receivable, net		192,656		200,454		197,169		205,092
Investment in securities required by law		2,654		2,654		2,848		2,848
Accrued interest receivable		1,728		1,728		1,482		1,482
Liabilities:
Deposits		237,477		238,403		228,789		228,846
Long-term debt and junior subordinated debentures		17,000		15,773		22,100		21,084
Accrued interest payable		472		472		392		392
Off balance sheet instruments:
Commitments to extend credit		—		—		—		—

Cash and Cash Equivalents - Due from Banks, Interest Bearings Deposits with Banks and Federal Funds Sold

The statement of financial condition carrying amounts for cash and due from banks, interest bearing deposits with banks and federal funds sold approximate the estimated fair values of such assets.

Securities Available for Sale

The fair value of securities available for sale (carried at fair value) are determined by obtaining quoted market prices on nationally recognized securities exchanges (level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.

Loans Receivable

Loans receivable were segmented into portfolios with similar financial characteristics. Loans were also segmented by type such as residential and nonresidential, construction and land, second mortgage loans, commercial, and consumer. Each loan category was further segmented by fixed and adjustable rate interest terms. The fair value of loans was calculated by discounting anticipated cash flows based on weighted average contractual maturity, weighted average coupon and market rates.

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. All non-accrual loans are considered impaired. The measurement of impaired loans is based on the present value of the expected cash flows discounted at the historical effective interest rate, the market price of the loan, or the fair value of the underlying collateral. Collateral values are estimated utilizing methods such as appraisals, broker price opinions and taking into consideration the timing of the valuation, the nature of the collateral and such other information as is deemed appropriate. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements. The fair value consists of the loan balances of $7.3 million and $4.0 million less their specific valuation allowances of $1.7 million and $668,000 as determined in accordance with ASC 310-10-35 (formerly SFAS 114, “Accounting by Creditors for Impairment of a Loan”) at December 31, 2010 and June 30, 2010, respectively.

Repossessed Real Estate and Other Assets (“REO”)

Repossessed real estate and other assets is initially recorded at fair value less cost to sell which is determined typically by utilizing an outside appraiser. Management evaluates the value of REO at least annually. Any declines in value are reflected by establishing an REO valuation allowance with an offsetting charge to operating expense. Any increases in the value of the property may be recognized only to the extent of the valuation allowance when the property value has recovered. The fair value consists of REO balances of $2.9 million less their specific valuation allowances of $19,000 at June 30, 2010.

Securities required by Law

The carrying amount of securities required by law approximates its fair value.

Accrued Interest Receivable

The carrying amount of accrued interest receivable approximates its fair value.

Deposits

The fair value of deposits with no stated maturity, such as non-interest bearing deposits, interest bearing NOW accounts and statement savings accounts, is equal to the carrying amounts. The fair value of certificates of deposit was based on the discounted value of contractual cash flows. The discount rate for certificates of deposit was estimated using market rates.

Long-Term Debt and Junior Subordinated Debentures

The fair value of long-term debt was based on the discounted value of contractual cash flows, using market rates.

Accrued Interest Payable

The carrying amount of accrued interest payable approximates its fair value.

Off-Balance Sheet Financial Instruments

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business, including mortgage loan commitments, undisbursed lines of credit on commercial business loans and standby letters of credit. These instruments involve, to various degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. The fair values of such commitments are immaterial.

The disclosure of fair value amounts does not include the fair values of any intangibles, including core deposit intangibles. Core deposit intangibles represent the value attributable to total deposits based on an expected duration of customer relationships.

Fair Value Disclosures

In April 2009, the FASB issued ASC 820-10-65, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” ASC 820-10-65 defines fair value as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. ASC 820-10-65 provides additional guidance in determining when the volume and level of activity for the asset or liability has significantly decreased. ASC 820-10-65 also includes guidance on identifying circumstances when a transaction may not be considered orderly.

ASC 820-10-65 provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with GAAP.

This ASC 820-10-65 clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. ASC 820-10-65 provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

The Company has an established and documented process for determining fair values. Fair value is based on quoted market prices, when available. If listed prices or quotes are not available, fair value is based on fair value models

that use market participant or independently sourced market data, which include discount rate, interest rate yield curves, prepayment speeds, bond ratings, credit risk, loss severities, default rates, and expected cash flow assumptions. In addition, valuation adjustments may be made in the determination of fair value. These fair value adjustments may include amounts to reflect counterparty credit quality, creditworthiness, liquidity, and other unobservable inputs that are applied consistently over time. These adjustments are estimates and therefore, subject to management’s judgment, and at times, may be necessary to mitigate the possibility of error or revision in the estimate of the fair value provided by the model. The Company has various controls in place to ensure that the valuations are appropriate, including review and approval of the valuation models, benchmarking, comparison to similar products, and reviews of actual cash settlements. The methods described above may produce fair value calculations that may not be indicative of the net realizable value or reflective of future fair values. While the Company believes its valuation methods are consistent with other financial institutions, the use of different methods or assumptions to determine fair values could result in different estimates of fair value.

ASC Topic 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based on the inputs used to value the particular asset or liability at the measurement date. The three levels are defined as follows:

•

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

•

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices of identical or similar assets or liabilities in markets that are not active, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

•

Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Each financial instrument’s level assignment within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement for that particular category.

For financial assets measured at fair value on a recurring and nonrecurring basis, the fair value measurements by level within the fair value hierarchy are as follows:


	At December 31, 2010
(In thousands)	Total		Level 1		Level 2		Level 3
Measured at fair value on a recurring basis:
Securities available for sale	$	36,571	$	—	$	36,571	$	—


Measured at fair value on a nonrecurring basis:
Impaired Loans	$	5,585	$	—	$	—	$	5,585


	At June 30, 2010
(In thousands)	Total		Level 1		Level 2		Level 3
Measured at fair value on a recurring basis:
Securities available for sale	$	25,482	$	—	$	25,482	$	—


Measured at fair value on a nonrecurring basis:
Impaired loans	$	3,353	$	—	$	—	$	3,353

Repossessed real estate and other assets	$	2,875	$	—	$	—	$	2,875

Note 16: Reclassification

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

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

General

The Company’s results of operations depend primarily on its level of net interest income, which is the difference between interest earned on interest-earning assets, consisting primarily of loans, investment securities, mortgage-backed securities and other investments, and the interest paid on interest-bearing liabilities, consisting primarily of deposits and advances from the Federal Home Loan Bank of Atlanta. The net interest income earned on interest-earning assets (“net interest margin”) and the ratio of interest-earning assets to interest-bearing liabilities have a significant impact on net interest income. The Company’s net interest margin is affected by regulatory, economic and competitive factors that influence interest rates, loan and deposit flows. The Company, like other financial institutions, is subject to interest rate risk to the degree that its interest-earning assets mature or reprice at different times, or on a different basis, than its interest-bearing liabilities. The Company’s results of operations are also significantly impacted by the amount of its non-interest income, including loan fees and service charges, and levels of non-interest expense, which consists principally of compensation and employee benefits, insurance premiums, professional fees, equipment expense, occupancy costs, advertising, data processing and other operating expenses.

The Company’s operating results are significantly affected by general economic and competitive conditions, in particular, changes in market interest rates, government policies and actions taken by regulatory authorities. Lending activities are influenced by general economic conditions, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, account maturities and the level of personal income and savings in the Company’s market area.

Forward-Looking Statements

When used in this Form 10-Q, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties including changes in economic conditions in the Company’s market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company’s market area, competition and the Risk Factors described in Item 1A of the Company’s Annual Report on Form 10-K for the year ended June 30, 2010, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. These estimates, assumptions and judgments are necessary when financial instruments are required to be recorded at fair value or when the decline in the value of an asset carried on the statement of financial condition at historic cost requires an impairment write-down or a valuation reserve to be established.

The allowance for loan losses (“allowance”) represents an amount, that in the judgment of management, will be adequate to absorb probable losses on outstanding loans and leases that may become uncollectible. The allowance represents an estimate made based upon two principles of accounting: (1) ASC Topic 855, “Accounting for Contingencies”, that requires losses to be accrued when their occurrence is probable and estimable, and (2) ASC

310-10-35, “Accounting by Creditors for Impairment of a Loan”, that requires losses be accrued when it is probable that the lender will not collect all principal and interest due under the original terms of the loan. The adequacy of the allowance is determined through careful evaluation of the loan portfolio. This determination is inherently subjective and requires significant estimates, including estimated losses on pools of homogeneous loans based on historical loss experience and consideration of the current economic environment that may be subject to change. Loans and leases deemed uncollectible are charged against the allowance and recoveries of previously charged-off amounts are credited to it. The level of the allowance is adjusted through the provision for loan losses that is recorded as a current period expense.

The methodology for assessing the appropriateness of the allowance includes a specific allowance, a formula allowance and a nonspecific allowance. The specific allowance is for risk rated credits on an individual basis. The formula allowance reflects historical losses by credit category. The nonspecific allowance captures losses whose impact on the portfolio have occurred but have yet to be recognized in either the specific allowance or the formula allowance. The factors used in determining the nonspecific allowance include trends in delinquencies, trends in volumes and terms of loans, the size of loans relative to the allowance, concentration of credits, the quality of the risk identification system and credit administration and local and national economic trends.

In accordance with the provisions of ASC 310-10-35, the Company determines and recognizes impairment of certain loans. A loan is determined to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan is not considered impaired during a period of delay in payment if the Company expects to collect all amounts due, including past-due interest. The Company generally considers a period of delay in payment to include delinquency up to and including 90 days. ASC Topic 310 requires that impairment in a loan be measured at the present value of its expected future cash flows discounted at the loan’s effective interest rate, or at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

ASC Topic 310 is generally applicable for all loans except large groups of smaller-balance homogeneous loans that are evaluated collectively for impairment, including residential first and second mortgage loans and consumer installment loans. Impaired loans are therefore generally comprised of commercial mortgage, real estate development, and certain restructured residential loans. In addition, impaired loans are generally loans which management has placed in non-accrual status since loans are placed in non-accrual status on the earlier of the date that management determines that the collection of principal and/or interest is in doubt or the date that principal or interest is 90 days or more past-due.

Management believes that the allowance is adequate. However, its determination requires significant judgment, and estimates of the probable losses in the loan and lease portfolio can vary significantly from amounts that actually occur.

Repossessed real estate and other assets are initially recorded at the estimated fair value, net of estimated selling costs, and subsequently at the lower of carrying cost or fair value less estimated costs to sell. Costs relating to holding such property are charged against income in the current period, while costs relating to improving such real estate are capitalized until a salable condition is reached.

Comparison of Financial Condition at December 31, 2010 and June 30, 2010

Patapsco Bancorp’s assets increased by $3.4 million, or 1.3% to $273.1 million at December 31, 2010 from $269.7 million at June 30, 2010. Net loans declined $4.5 million or 2.3% to $192.7 million at December 31, 2010 from $197.2 million at June 30, 2010. Growth in commercial mortgages of $7.9 million was more than offset by declines in residential mortgage loans of $3.7 million, construction loans of $3.8 million, commercial leases of $1.9 million, commercial business loans of $1.5 million and consumer loans of $744,000. Such decreases were due primarily to soft loan demand.

Securities available for sale increased $11.1 million to $36.6 million at December 31, 2010 from $25.5 million at June 30, 2010 as purchases of $29.0 million outpaced maturities of $13.5 million, sales of $1.5 million and pay-downs of the mortgage-backed securities of $2.5 million. The growth in the securities portfolio was a function of low loan demand and strong deposit growth.

Repossessed real estate and other assets decreased $990,000 to $1.9 million as of December 31, 2010 as four smaller properties with a value of $265,000 were added and three properties totaling $1.3 million were sold at a $10,000 total gain.

Total deposits grew $8.6 million, or 3.8%, to $237.5 million at December 31, 2010 from $228.8 million at June 30, 2010. Interest-bearing deposits increased $11.2 million, or 5.2%, to $228.4 million at December 31, 2010 from $217.2 million at June 30, 2010. Noninterest-bearing deposits declined $2.5 million to $9.0 million at December 31, 2010. Long-term debt declined $5.1 million to $12.0 million at December 31, 2010 from $17.1 million at June 30, 2010.

Stockholders’ equity decreased by $437,000 from $17.37 million at June 30, 2010 to $16.93 million at December 31, 2010 primarily reflecting the loss during the current year-to-date period.

Comparison of Operating Results for the Quarter and Six Months Ended December 31, 2010 and December 31, 2009

Net Income. Patapsco Bancorp recorded a net loss available to common shareholders of $445,000, or $0.23 per share, for the quarter ended December 31, 2010 compared to a net loss of $33,000 or $0.02 per share for the quarter ended December 31, 2009. The increased net loss available to common shareholders in the current quarter resulted from the loan loss provision being $596,000 higher than same quarter in 2009. In addition, net interest income was $76,000 lower due to a reduction in loan demand which has resulted in a shift in earning assets from loans to lower yielding investments. For the six months ended December 31, 2010, the Company recorded a net loss applicable to common shareholders of $435,000 compared to a loss of $58,000 for the same period in 2009 as the loan loss provision increased $506,000 to $1.3 million in the current period from $792,000 in the same period of the prior year.

Net Interest Income. Patapsco Bancorp’s net interest income decreased by $76,000, or 3.5%, to $2.1 million for the quarter ended December 31, 2010 compared to $2.2 million for the same quarter in 2009. The decrease in net interest income during the comparable three-month periods was due to a 15 basis point decrease in the net interest margin to 3.34% in the quarter ended December 31, 2010 from 3.49% in the quarter ended December 31, 2009. The decline in the net interest margin was driven by a 60 basis point decline in the average rate earned on interest earning assets which more than offset the 47 basis point decrease in the average rate paid on interest bearing liabilities. In addition, while the volume of interest earning assets grew $7.9 million to $255.8 million for the quarter ended December 31, 2010 versus $247.9 million for the quarter ended December 31, 2009, higher yielding average loans have decreased $20.5 million and lower yielding investments and overnight funds have grown a combined $28.4 million.

For the six months ended December 31, 2010 net interest income declined $170,000 as the net interest margin decreased 17 basis points which more than offset the $2.8 million increase in growth in interest earning assets. The decline in the net interest margin was due to the aforementioned decline in asset yields which exceeded the drop in funding costs.

Interest Income. Total interest income decreased by $314,000, or 9%, to $3.2 million for the quarter ended December 31, 2010 from $3.5 million for the quarter ended December 31, 2009. Total interest income for the six months ended December 31, 2010 decreased $739,000 to $6.5 million from $7.3 million in the comparable period of the prior year. The decreases in interest income during the comparable three and six month periods were due to lower rates of interest earned, which more than offset the higher level of earning assets. The impact of lower market interest rates in the current three and six month periods had a negative effect on the yields on earning assets. In addition, a shift in the mix of earning assets from loans to lower yielding investments and a decrease in the yield on loans negatively affected the yield on average earning assets.

Interest income on loans receivable decreased by $367,000, or 11%, to $3.0 million for the quarter ended December 31, 2010 from $3.4 million for the quarter ended December 31, 2009. For the six months ended December 31, 2010, interest income on loans declined $840,000 to $6.1 million from $6.9 million in the same period of the previous year. The decreases in interest income on loans for both the three and six months periods were due to lower yields as well as lower average loan balances. The lower yields were due to the decline in market interest rates mentioned above. In addition, the increase in the level of non-accrual loans also contributed to the declines in yields. The lower loan volumes were due to a continued low level of loan demand over the previous year.

Interest income on investment securities, including investments required by law, increased $42,000, or 26%, to $205,000 and by $86,000, or 26%, to $411,000 in the three and six month periods ended December 31, 2010, respectively as the increase in volumes for the respective periods more than offset the declines in the yield over the same periods.

Interest income on federal funds sold and other investments increased $11,000, or 220%, to $16,000, and by $15,000, or 100%, to $30,000 in the three and six month periods ended December 31, 2010, respectively due to growth in average balances.

Interest Expense. Total interest expense decreased by $238,000, or 18%, to $1.1 million for the quarter ended December 31, 2010 from $1.3 million for the quarter ended December 31, 2009. Total interest expense decreased $569,000, or 20%, to $2.3 million for the six month period ended December 31, 2010 from $2.9 million for the six month period ended December 31, 2009. The decline in interest expense during the comparable three and six month periods was due to lower rates paid on interest-bearing liabilities which more than offset the higher level of balances.

Interest expense on deposits decreased by $151,000, or 15%, to $888,000 in the current quarter from $1.0 million in the previous year’s quarter. For the six months ended December 31, 2010 interest expense on deposits decreased $410,000, or 18%, to $1.8 million. The decrease in interest expense on deposits in both the quarterly and year to date periods was due to a decline in rates paid on deposits which had a larger impact than the growth in average deposit balances. The lower rates paid on deposits reflect the lower rate environment in the current periods.

Interest expense on short-term borrowings decreased $6,000, or 100%, to $0 for the six months ended December 31, 2010 from $6,000 for the six months ended December 31, 2009 due to the complete run-off of these borrowings.

Interest expense on long-term borrowings decreased $87,000, or 29%, to $217,000 for the quarter ended December 31, 2010. For the six months ended December 31, 2010, interest expense on long-term borrowings decreased $153,000, or 24%, to $481,000. The decreases in interest expense in the comparable three and six month periods were due to lower average balances outstanding which more than offset the slightly higher rates of interest paid. The average rates paid were higher as lower rate borrowings matured and were not replaced.

Average Balance, Interest and Average Yields and Rates

The following table sets forth certain information relating to the Company’s average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and cost of liabilities for the periods and at the dates indicated. Dividing interest income or expense by the average daily balance of interest earning assets or interest bearing liabilities, respectively, derives such yields and costs for the periods presented. Average balances are derived from daily balances.

The table also presents information for the periods indicated with respect to the Company’s net interest margin, which is net interest income divided by the average balance of interest earning assets. This in an important indicator of commercial bank profitability. The net interest margin is affected by yields on interest-earning assets, the costs of interest-bearing liabilities and the relative amounts of interest earning assets and interest bearing liabilities. Another indicator of the Company’s net interest income is the interest rate spread, or the difference between the average yield on interest earning assets and the average rate paid on interest bearing liabilities.


	Six Months Ended December 31,
	2010							2009
	Average Balance		Interest		Average Rate(1)			Average Balance		Interest		Average Rate(1)
	(Dollars in thousands)
Interest-earning assets:
Loans receivable, including fees (2)	$	199,506	$	6,073		6.00	%	$	219,438	$	6,913		6.23	%
Securities, including securities required by law		29,668		411		2.77	%		18,911		325		3.43	%
Federal funds sold and other investments		24,148		30		0.25	%		12,148		15		0.24	%

Total interest earning assets		253,322		6,514		5.07	%		250,497		7,253		5.73	%
Non-interest-earning assets		17,195							15,136

Total assets	$	270,517						$	265,633


Interest-bearing liabilities:
Interest-bearing deposits	$	220,943		1,837		1.65	%	$	201,207		2,247		2.21	%
Short-term borrowings		—		—		—			2,935		6		0.43	%
Long-term borrowings		20,880		481		4.50	%		28,872		634		4.30	%

Total interest-bearing liabilities		241,823		2,318		1.90	%		233,014		2,887		2.45	%
Non-interest-bearing liabilities		10,848							12,423

Total liabilities		252,671							245,437
Stockholders’ equity		17,846							20,196

Total liabilities and stockholders’ equity	$	270,517						$	265,633


Net interest income			$	4,196						$	4,366


Interest rate spread						3.17	%						3.28	%

Net Interest margin						3.29	%						3.46	%


Ratio of average interest-earning assets to average interest-bearing liabilities						104.76	%						107.50	%

(1)	Yields and rates are annualized.

(2)	Includes nonaccrual loans.


	Three Months Ended December 31,
	2010							2009
	Average Balance		Interest		Average Rate(1)			Average Balance		Interest		Average Rate(1)
	(Dollars in thousands)
Interest-earning assets:
Loans receivable, including fees (2)	$	198,686	$	2,990		6.02	%	$	219,181	$	3,357		6.06	%
Securities, including securities required by law		31,898		205		2.57	%		19,838		163		3.28	%
Federal funds sold and other investments		25,243		16		0.26	%		8,880		5		0.22	%

Total interest earning assets		255,827		3,211		5.02	%		247,899		3,525		5.62	%
Non-interest-earning assets		18,023							15,297

Total assets	$	273,850						$	263,196


Interest-bearing liabilities:
Interest-bearing deposits	$	223,639		888		1.61	%	$	203,192		1,039		2.03	%
Short-term borrowings		—		—		—			—		—		—
Long-term borrowings		19,661		217		4.39	%		27,100		304		4.39	%

Total interest-bearing liabilities		243,300		1,105		1.84	%		230,292		1,343		2.31	%
Non-interest-bearing liabilities		10,670							13,023

Total liabilities		253,970							243,315
Stockholders’ equity		19,880							19,881

Total liabilities and stockholders’ equity	$	273,850						$	263,196


Net Interest Income			$	2,106						$	2,182

Interest rate spread						3.18	%						3.31	%

Net interest margin						3.34	%						3.49	%

Ratio of average interest-earning assets to average interest-bearing liabilities						105.15	%						107.65	%

(1)	Yields and rates are annualized.

(2)	Includes nonaccrual loans.

Provision for Loan Losses. Provisions for loan losses are charged to earnings to maintain the total allowance for loan losses at a level considered adequate by management to provide for loan losses. The components of the allowance for loan losses represent an estimation done pursuant to either ASC Topic 855 and ASC 310-10-35. The adequacy of the allowance for loan losses is determined through a continuous review of the loan and lease portfolio and considers factors such as prior loss experience, type of collateral, industry standards, amount and type of past due loans in Patapsco Bancorp’s loan portfolio, current economic conditions, both national and local, and other factors unique to particular loans and leases in the portfolio. Patapsco Bancorp’s management periodically monitors and adjusts its allowance for loan losses based upon its analysis of the loan portfolio.

The provision for loan losses was $994,000 in the quarter ended December 31, 2010, compared to $398,000 for the quarter ended December 31, 2009. The increase in the provision is primarily due to an increase in non-performing loans. In the current quarter non-performing loans increased 15%, while in the quarter ended December 31, 2009 non-performing loans decreased 2%. Non-performing loans represented 6.43% of loans at December 31, 2010 versus 4.85% at June 30, 2010 and 4.81% at December 31, 2009. Patapsco Bancorp’s allowance for loan losses as a percentage of total loans outstanding was 2.24% of total loans as of December 31, 2010 versus 1.76% at June 30, 2010 and 1.54% at December 31, 2009. Patapsco Bancorp’s allowance for loan losses as a percentage of nonperforming loans was 34.7% at December 31, 2010 as compared to 36.3% at June 30, 2010 and 32.1% at December 31, 2009. Setting the allowance at this level takes into consideration that 97% of non-performing loans are collateralized by real estate and/or guaranteed by the SBA at December 31, 2010. In consideration of the appropriate level for the allowance for loan losses, downward adjustments were made to values established by real estate appraisals, where warranted, taking into consideration the age of the appraisal and the nature of the collateral. These adjusted appraisal values, which required management’s judgment, were used to develop estimated losses and related specific loss reserves within the allowance for loan losses. Patapsco Bancorp has concluded, after a thorough analysis of the nonperforming loan portfolio, watch list loans, delinquencies and other factors, that the allowance is adequate at December 31, 2010.

The following table sets forth information with respect to the Company’s non-performing assets at the dates indicated.


($ in thousands)	December 31, 2010			June 30, 2010

Loans accounted for on a non-accrual basis (1)
Real Estate:
Residential	$	615		$	116
Commercial		5,744			2,737
Construction		1,136			1,763
Consumer		456			46
Commercial Loan		4,582			4,973
Commercial Lease		176			93

Total		12,709			9,728
Accruing loans that are contractually past due 90 days or more		—			—

Total non-performing loans		12,709			9,728
Other non-performing assets (2)		1,885			2,875

Total non-performing assets	$	14,594		$	12,603


Nonperforming loans to total loans		6.43	%		4.85	%
Nonperforming assets to total assets		5.34	%		4.67	%
Troubled debt restructurings: (3)
Accruing	$	3,328		$	3,400
Non-accruing		3,752			4,327

Total	$	7,080		$	7,727

(1)

Nonaccrual status denotes loans on which, in the opinion of management, the collection of additional interest is unlikely. Payments received on a nonaccrual loan are either applied to the outstanding principal balance or recorded as interest income, depending on management’s assessment of the collectability of the loan.

(2)	Other non-performing assets represent property acquired by Patapsco Bancorp through foreclosure or repossession.

(3)	Certain troubled debt restructurings are accounted on a non-accrual basis and included in total non-performing loans above.

The following table reflects the activity in non-performing loans for the six months ended December 31, 2010:


Balance June 30, 2010, in thousands	$	9,728
Added to non-accrual during the year		5,140
Paid off/down		(1,060	)
Brought to accrual status		(1,188	)
Transferred to repossessed real estate and other assets		(225	)
Charged-off		(227	)
Net change in non-accrual Leases, Consumer & Residential Mortgages, and all other		541

Balance December 31, 2010	$	12,709

At December 31, 2010, non-accrual construction loans totaled $1.1 million and consisted of a $450,000 condominium conversion project and $680,000 in residential construction and development loans. Non-accrual commercial real estate increased $3.0 million due to the addition of several commercial mortgages totaling $3.3 million. Other non-accrual commercial real estate loans consist of an $857,000 warehouse building loan, a $384,000 office/retail building loan and $728,000 in residential investor property loans. All commercial real estate and construction loans are considered well securitized. Commercial loans/leases include a $3.3 million loan supporting a borrower’s various business interests including commercial properties. Of the $4.6 million in non-accrual commercial loans, $700,000 have an SBA guarantee.

Noninterest Income. Patapsco Bancorp’s noninterest income consists of deposit fees, service charges, income from bank owned life insurance (“BOLI”) and gains. Total noninterest income decreased by $10,000, or 5.2%, to $181,000 for the quarter ended December 31, 2010 from $191,000 for the quarter ended December 31, 2009 due to a $22,000 loss on the sale of ground rents in the current period. For the six months ended December 31, 2010, noninterest income increased $20,000 or 4.9% due to a nonrecurring gain on sale of securities in the current year’s period.

Noninterest Expenses. Total noninterest expenses decreased by $28,000, or 1.4%, to $1.9 million for the quarter ended December 31, 2010 from $1.9 million for the quarter ended December 31, 2009. Compensation costs decreased $56,000 or 6.8% as staff salaries and incentives were lower. Offsetting this decline in part, costs associated with repossessed real estate and other assets increased $28,000 or 82.4% due to a higher level of foreclosed real estate on average for the current quarter. In addition, professional fees were $12,000, or 8.3%, higher totaling $157,000 for the current quarter due to legal costs associated with loan collection activities. For the six months ended December 31, 2010, noninterest expenses decreased $85,000 or 2.2% to $3.7 million from $3.8 million in same period of the prior year. Similar trends as in the current quarter were prevalent in the six month period.

Income Taxes. Income tax benefit was $231,000 (or 39.9% of pre-tax loss) versus an expense of $26,000 (or 34.7% of pre-tax income) for the three month periods ended December 31, 2010 and 2009, respectively. For the six months ended December 31, 2010 the Company recorded a tax benefit of $169,000 (or 41.9% of pre-tax loss) versus an expense of $56,000 (or 34.8% of pre-tax income) in the same period last year.

Liquidity and Capital Resources

An important component of the Company’s asset/liability structure is the level of liquidity available to meet the needs of customers and creditors. The Company’s Asset/Liability Management Committee has established general guidelines for the maintenance of prudent levels of liquidity. The Committee continually monitors the amount and source of available liquidity, the time to acquire it and its cost. Management of the Company seeks to maintain a relatively high level of liquidity in order to retain flexibility in terms of investment opportunities and deposit pricing. Because liquid assets generally provide lower rates of return, the Company’s relatively high liquidity will, to a certain extent, result in lower rates of return on assets.

The Company’s most liquid assets are cash on hand, interest-bearing deposits and Federal funds sold, which are short-term, highly liquid investments with original maturities of less than three months that are readily convertible to known amounts of cash. The levels of these assets are dependent on the Company’s operating, financing and investing activities during any given period. At December 31, 2010, the Company’s cash on hand and interest-bearing deposits totaled $27.1 million. In addition, the Company has approximately $36.6 million of investment securities classified as available for sale, $4.6 million of which are pledged as collateral for the Company’s federal funds line of credit.

The Company anticipates that it will have sufficient funds available to meet its current loan commitments of $15.1 million and unused lines of credit of $9.9 million. Certificates of deposit that are scheduled to mature in less than one year at December 31, 2010 totaled $43.4 million. Historically, a high percentage of maturing deposits have remained with the Company.

The Company’s primary sources of funds are deposits and proceeds from maturing investment securities and mortgage-backed securities and principal and interest payments on loans. While maturities and scheduled amortization of mortgage-backed securities and loans are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, competition and other factors.

The Company, as the holding company for the Bank, has an annual cash requirement of approximately $654,000 for the payment of preferred dividends, as well as, interest payments on the $5.0 million in junior subordinated debentures. The only source of funds for the holding company is dividends from the Bank. The amount of dividends that can be paid to the holding company from the Bank is limited by the earnings of the Bank. At December 31, 2010 the holding company had cash on hand and interest bearing deposits of $1.7 million versus $1.6 million at June 30, 2010. The balance at December 31, 2010 includes approximately $800,000 in an intercompany payable to settle income tax refunds owed to subsidiary companies. In January, 2011 $300,000 was paid to the Bank as a capital contribution.

Under the terms of its trust preferred securities and its Series A and Series B preferred stock, while it has deferred dividends on the trust preferred securities and suspended dividends on its Series A and Series B preferred stock, it generally may not declare or pay any dividends or distributions on, or repurchase, its common stock.

The Bank had $61.0 million in borrowing capacity with the Federal Home Loan Bank of Atlanta, with $12.0 million in borrowings outstanding, at December 31, 2010. These borrowings are secured by the Bank’s stock in the Federal Home Loan Bank of Atlanta and other eligible assets. In addition, the Bank has a $4.0 million line of credit, none of which was outstanding at December 31, 2010, with Pacific Coast Bankers Bank.

As discussed in Note 10 - Regulatory Capital Requirements, the Bank exceeded all regulatory minimum capital requirements.

Contingencies and Off-Balance Sheet Items

The Company is party to financial instruments with off-balance sheet risk including commitments to extend credit under both new facilities and under existing lines of credit. Commitments to fund loans typically expire after 60 days, commercial lines of credit are subject to annual reviews and home equity lines of credit are generally for a term of 20 years. These instruments contain, to varying degrees, credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.

Off-balance sheet financial instruments whose contract amounts represent credit and interest rate risk are summarized as follows:


	December 31, 2010		June 30, 2010
	($ in thousands)
Commitments to originate new loans	$	15,105	$	11,911
Undisbursed lines of credit		9,928		10,132
Financial standby letters of credit		1,430		1,349

Item 3. Quantitative and Qualitative Disclosures About Market Risk

This item is not applicable as the Company is a smaller reporting company.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

Changes to Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the six months ended December 31, 2010 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

For information regarding the Company’s risk factors, see Item 1A in the Company’s Annual Report on Form 10-K for the year ended June 30, 2010. There have been no material changes to the Risk Factors disclosed in Item 1A of the Company’s Annual Report on Form 10-K for the year ended June 30, 2010.

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

None.

Item 3. Defaults Upon Senior Securities

None

Item 4. Removed and Reserved

Not applicable.

Item 5. Other Information

None

Item 6. Exhibits

(a)

Exhibits

The following exhibits are filed herewith:


Exhibit Number		Title

31.1		Rule 13a-14(a) Certification of Chief Executive Officer

31.2		Rule 13a-14(a) Certification of Chief Financial Officer

32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to §906 of Sarbanes Oxley Act

Signatures

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


		PATAPSCO BANCORP, INC.

Date: February 10, 2011		/s/ Michael J. Dee
		Michael J. Dee
		President and Chief Executive Officer

		/s/ William C. Wiedel, Jr.
		William C. Wiedel, Jr.
		Senior Vice President and Chief Financial Officer

Large Accelerated Filer

Accelerated Filer

Non-Accelerated Filer

¨ (Do not check if a smaller reporting company)

Smaller Reporting Company