Table of Contents

 

 

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 March 31, 2011.

OR

 

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

For the transition period from              to             .

Commission File No. 0-22288

 

 

Fidelity Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania		25-1705405
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1009 Perry Highway, Pittsburgh, Pennsylvania 15237

(Address of principal executive offices)

412-367-3300

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    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.

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,062,155 shares, par value $0.01, at April 29, 2011.

 

 

 

---

Table of Contents

FIDELITY BANCORP, INC. AND SUBSIDIARIES

Index

 

				Page
Part I - Financial Information
Item 1.		Financial Statements (Unaudited)			3
		Consolidated Statements of Financial Condition as of March 31, 2011 and September 30, 2010			3
		Consolidated Statements of Income for the Three and Six Months Ended March 31, 2011 and 2010			4-5
		Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended March  31, 2011			6
		Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2011 and 2010			7-8
		Notes to Consolidated Financial Statements			9
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			35
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			46
Item 4.		Controls and Procedures			47
Part II - Other Information
Item 1.		Legal Proceedings			47
Item 1A.		Risk Factors			47
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			47
Item 3.		Defaults Upon Senior Securities			47
Item 4.		[Removed and Reserved]			47
Item 5.		Other Information			47
Item 6.		Exhibits			48-49
Signatures					50

 

2

---

Table of Contents

Part I - Financial Information

Item 1. Financial Statements

FIDELITY BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Financial Condition (Unaudited)

(in thousands, except share data)

 

		March 31, 2011				September 30, 2010
Assets
Cash and due from banks		$	5,569			$	8,414
Interest-bearing demand deposits with other institutions			46,331				20,923
Cash and Cash Equivalents			51,900				29,337
Securities available-for-sale (amortized cost of $178,382 and $176,949)			175,398				174,700
Securities held-to-maturity (fair value of $77,240 and $76,033)			76,796				74,827
Loans held for sale			172				1,970
Loans receivable, net of allowance of $6,173 and $5,821			338,356				373,072
Federal Home Loan Bank stock, at cost			9,056				10,034
Office premises and equipment, net			9,806				9,315
Accrued interest receivable			2,494				2,655
Bank owned life insurance			5,708				5,592
Goodwill			2,653				2,653
Deferred tax assets			7,422				6,853
Other assets			5,051				5,662
Total Assets		$	684,812			$	696,670
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Non-interest bearing		$	49,863			$	51,963
Interest bearing			395,366				392,485
Total Deposits			445,229				444,448
Securities sold under agreement to repurchase			95,210				108,342
Short-term borrowings			211				130
Long-term debt			80,000				80,401
Subordinated debt			7,732				7,732
Advance payments by borrowers for taxes and insurance			2,230				1,223
Other liabilities			4,303				4,808
Total Liabilities			634,915				647,084
Stockholders’ equity:
Preferred stock, $0.01 par value per share, liquidation preference $1,000; 5,000,000 shares authorized; 7,000 shares issued			6,833				6,803
Common stock, $0.01 par value per share, 10,000,000 shares authorized; 3,672,668 and 3,668,436 shares issued, respectively			37				37
Paid-in-capital			46,602				46,473
Retained earnings			8,906				8,708
Accumulated other comprehensive loss, net of tax			(2,249	)			(2,053	)
Treasury stock, at cost - 610,513 shares and 619,129 shares, respectively			(10,232	)			(10,382	)
Total Stockholders’ Equity			49,897				49,586
Total Liabilities and Stockholders’ Equity		$	684,812			$	696,670

See accompanying notes to unaudited consolidated financial statements.

 

3

---

Table of Contents

FIDELITY BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

(in thousands, except per share data)

 

		Three Months Ended March 31,								Six Months Ended March 31,
		2011				2010				2011				2010
Interest income:
Loans		$	4,880			$	5,457			$	10,028			$	11,260
Mortgage-backed securities			816				738				1,535				1,519
Investment securities-taxable			632				753				1,312				1,532
Investment securities-tax-exempt			382				442				778				888
Other			22				13				41				26
Total interest income			6,732				7,403				13,694				15,225
Interest expense:
Deposits			1,097				1,398				2,270				2,980
Securities sold under agreement to repurchase			1,184				1,248				2,454				2,525
Short-term borrowings			1				2				2				3
Long-term debt			668				1,134				1,350				2,356
Subordinated debt			100				100				204				204
Total interest expense			3,050				3,882				6,280				8,068
Net interest income			3,682				3,521				7,414				7,157
Provision for loan losses			300				300				600				600
Net interest income after provision for loan losses			3,382				3,221				6,814				6,557
Non-interest income:
Other-than-temporary impairment losses			(810	)			(1,517	)			(2,395	)			(6,012	)
Non-credit related losses recognized in other comprehensive income			531				1,221				1,039				4,482
Net impairment losses recognized in earnings			(279	)			(296	)			(1,356	)			(1,530	)
Loan service charges and fees			126				125				358				278
Realized gain on sales of securities, net			580				387				586				1,037
Gain on sales of loans			76				86				228				221
Gain (loss) on loan interest rate swaps			3				(1	)			13				5
Deposit service charges and fees			295				334				600				719
ATM fees			235				214				476				457
Non-insured investment products			54				34				106				83
Earnings on cash surrender value of life insurance policies			62				58				128				119
Other			102				64				143				100
Total non-interest income			1,254				1,005				1,282				1,489
Non-interest expense:
Compensation and benefits			2,163				2,021				4,363				4,079
Office occupancy and equipment expense			301				274				528				528
Depreciation and amortization			145				133				287				267
Advertising			100				82				200				182
Professional fees			115				130				234				270
Service bureau expense			150				145				297				307
Federal deposit insurance premiums			298				322				594				631
Other			505				651				1,102				1,195
Total non-interest expense			3,777				3,758				7,605				7,459

 

4

---

Table of Contents

FIDELITY BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited) (Cont’d.)

(in thousands, except per share data)

 

		Three Months Ended March 31,								Six Months Ended March 31,
		2011				2010				2011				2010
Income before Provision for (Benefit of) Income Taxes		$	859			$	468			$	491			$	587
Provision for (Benefit of) Income Taxes			200				(11	)			(34	)			(124	)
Net Income			659				479				525				711
Preferred stock dividend			(88	)			(88	)			(175	)			(175	)
Accretion of preferred stock discount			(15	)			(15	)			(30	)			(30	)
Net income available to common stockholders		$	556			$	376			$	320			$	506
Earnings per share
Basic earnings per common share		$	0.18			$	0.12			$	0.11			$	0.17
Diluted earnings per common share		$	0.18			$	0.12			$	0.11			$	0.17
Dividends per common share		$	0.02			$	0.02			$	0.04			$	0.04

See accompanying notes to unaudited consolidated financial statements.

 

5

---

Table of Contents

FIDELITY BANCORP, INC. AND SUBSIDIARIES

Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)

(in thousands, except share data)

 

		Number of Common Shares Issued				Preferred Stock				Common Stock				Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Treasury Stock				Total
Balance at September 30, 2010			3,668,436			$	6,803			$	37			$	46,473			$	8,708			$	(2,053	)		$	(10,382	)		$	49,586
Comprehensive income (loss):
Net income																			525												525
Comprehensive gain on cash flow hedges net of tax of $50																							97								97
Comprehensive loss on investment securities, net of tax of ($60)																							(116	)							(116	)
Reclassification adjustment on investment securities, net of tax of ($170)																							(329	)							(329	)
Comprehensive loss on securities for which other-than-temporary impairment has been recognized in earnings, net of tax of ($353)																							(686	)							(686	)
Reclassification adjustment for other-than-temporary impairment losses on debt securities, net of tax of $431																							838								838
Total comprehensive income																															329
Accretion of preferred stock discount							30												(30	)											—
Cumulative dividends on preferred stock																			(175	)											(175	)
Stock-based compensation expense															20																20
Restricted stock issued			2,969
Cash dividends declared																			(122	)											(122	)
Shares issued through Dividend Reinvestment Plan			1,263												9																9
Contribution of stock to Employee Stock Ownership Plan (ESOP) (8,616 shares)															100												150				250
Balance at March 31, 2011			3,672,668			$	6,833			$	37			$	46,602			$	8,906			$	(2,249	)		$	(10,232	)		$	49,897

See accompanying notes to unaudited consolidated financial statements.

 

 

6

---

Table of Contents

FIDELITY BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

 

		Six Months Ended March 31,
		2011				2010
Operating Activities:
Net income		$	525			$	711
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Provision for loan losses			600				600
Provision for depreciation and amortization			287				267
Deferred loan fee amortization			(88	)			(20	)
Amortization of investment and mortgage-backed securities (discounts) premiums, net			500				511
Realized gains on sales of securities, net			(586	)			(1,037	)
Impairment losses on securities			1,356				1,530
Loans originated for sale			(9,489	)			(14,221	)
Sales of loans held for sale			11,515				14,619
Net gains on sales of loans			(228	)			(221	)
Earnings on cash surrender value of life insurance policies			(128	)			(119	)
Decrease in interest receivable			161				169
Decrease in interest payable			(88	)			(176	)
Increase in accrued taxes			24				1,159
Noncash compensation expense related to stock benefit plans			20				35
Changes in other assets			855				(4,348	)
Changes in other liabilities			(25	)			(287	)
Net cash provided by (used in) operating activities			5,211				(828	)
Investing Activities:
Proceeds from sales of securities available-for-sale			22,382				16,284
Proceeds from maturities and principal repayments of securities available-for-sale			18,093				31,934
Purchases of securities available-for-sale			(42,787	)			(42,543	)
Proceeds from maturities and principal repayments of securities held-to-maturity			24,582				18,235
Purchases of securities held-to-maturity			(26,448	)			(31,612	)
Net decrease in loans			33,154				19,176
Proceeds from sales of foreclosed real estate			139				37
Additions to office premises and equipment			(789	)			(914	)
Redemptions of Federal Home Loan Bank (FHLB) stock			978				—
Net cash provided by investing activities			29,304				10,597

 

7

---

Table of Contents

FIDELITY BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited) (Cont’d.)

(in thousands)

 

		Six Months Ended March 31,
		2011				2010
Financing Activities:
Net increase in deposits		$	781			$	2,250
Net decrease in retail securities sold under agreement to repurchase			(3,132	)			(1,164	)
Repayments of wholesale structured borrowings			(10,000	)			—
Net increase in short-term borrowings			81				27
Increase in advance payments by borrowers for taxes and insurance			1,007				1,208
Repayments of long-term debt			(401	)			(25,098	)
Cash dividends paid			(297	)			(298	)
Proceeds from sale of stock through Dividend Reinvestment Plan			9				8
Net cash used in financing activities			(11,952	)			(23,067	)
Net increase (decrease) in cash and cash equivalents			22,563				(13,298	)
Cash and cash equivalents at beginning of period			29,337				42,480
Cash and cash equivalents at end of period		$	51,900			$	29,182
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for:
Interest paid on deposits and other borrowings		$	6,368			$	8,244
Income taxes paid		$	410			$	—
Supplemental Schedule of Noncash Investing and Financing Activities
Transfer of loans to foreclosed real estate		$	1,050			$	202

See accompanying notes to unaudited consolidated financial statements.

 

8

---

Table of Contents

FIDELITY BANCORP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - (Unaudited)

March 31, 2011

(1) Consolidation

The consolidated financial statements contained herein for Fidelity Bancorp, Inc. (the “Company”) include the accounts of Fidelity Bancorp, Inc. and its wholly-owned subsidiary, Fidelity Bank, PaSB (the “Bank”). All inter-company balances and transactions have been eliminated.

(2) Basis of Presentation

The accompanying consolidated financial statements were prepared in accordance with instructions to Form 10-Q, and therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles in the United States. However, all adjustments (consisting of normal recurring adjustments), which, in the opinion of management, are necessary for a fair presentation of the financial statements, have been included. These financial statements should be read in conjunction with the audited financial statements and the accompanying notes thereto included in the Company’s Annual Report for the fiscal year ended September 30, 2010. The results for the three and six month periods ended March 31, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2011 or any future interim period.

Certain amounts in the fiscal year 2010 financial statements have been reclassified to conform with the fiscal year 2011 presentation format. These reclassifications had no effect on stockholders’ equity or net income.

(3) New Accounting Standards

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for 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. The adoption of this guidance is not expected to have a significant impact on the Company’s financial statements.

In July 2010, FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The amendments in ASU 2010-20 encourage, but do not require, comparative disclosures for earlier reporting periods that ended before initial adoption. However, an entity should provide comparative disclosures for those reporting periods ending after initial adoption. The adoption of this ASU did not have a material effect on the Company’s results of operations or financial position. The Company has presented the necessary disclosures in Note (7) herein.

In October, 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. This ASU addresses the diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. The amendments are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2011 and are not expected to have a significant impact on the Company’s financial statements.

 

9

---

Table of Contents

In December, 2010, the FASB issued ASU 2010-28, When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. This ASU modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating an impairment may exist. The qualitative factors are consistent with the existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the amendments in this Update are effective for fiscal year, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. This ASU is not expected to have a significant impact on the Company’s financial statements.

In January 2011, the FASB issued ASU 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. The amendments in this Update temporarily delay the effective date of the disclosures about troubled debt restructurings in Update 2010-20, enabling public-entity creditors to provide those disclosures after the FASB clarifies the guidance for determining what constitutes a troubled debt restructuring. The deferral in this Update will result in more consistent disclosures about troubled debt restructurings. This amendment does not defer the effective date of the other disclosure requirements in Update 2010-20. In the proposed Update for determining what constitutes a troubled debt restructuring, the FASB proposed that the clarifications would be effective for interim and annual periods ending after June 15, 2011. For the new disclosures about troubled debt restructurings in Update 2010-20, those clarifications would be applied retrospectively to the beginning of the fiscal year in which the proposal is adopted. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendments in this Update provide additional guidance or clarification to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The amendments in this Update are effective for the first interim or annual reporting period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

(4) Stock Based Compensation

On March 31, 2011, the Company had five share-based compensation plans, for which stock options and restricted stock were outstanding as of March 31, 2011. However, the plan described below is the only plan for which stock options and restricted stock are available for grant. The compensation cost that has been charged against income for those plans was $20,000 and $35,000 for the six months ended March 31, 2011 and 2010, respectively.

The Company’s 2005 Stock-Based Incentive Plan (the Plan), which was shareholder-approved, permits the grant of stock options and restricted stock to its employees and non-employee directors for up to 165,000 shares of common stock, of which a maximum of 55,000 may be restricted stock. Option awards are granted with an exercise price equal to the market value of the common stock on the date of the grant, the options vest over a three-year period, and have a contractual term of seven years, although the Plan permits contractual terms of up to ten years. Option awards provide for accelerated vesting if there is a change in control, as defined in the Plan. Additionally, at December 21, 2010 and November 30, 2008, the Company awarded 2,969 and 7,100 shares, respectively, of restricted stock from the unallocated shares under the Plan having a market value of approximately $17,550 and $49,700, respectively. Compensation expense on the restricted stock awards equals the market value of the Company’s stock on the grant date and will be amortized ratably over the three-year vesting period. As of March 31, 2011, 9,881 share awards were available for grant under this program.

 

10

---

Table of Contents

As of March 31, 2011 there was approximately $34,000 of unrecognized compensation costs related to unvested share-based compensation awards granted.

Stock option transactions for the six months ended March 31, 2011 were as follows:

 

		Options				Weighted- Average Exercise Price Per Share
Outstanding at the beginning of the year			353,196			$	15.18
Granted			—				—
Exercised			—				—
Forfeited			(19,471	)			8.12
Outstanding as of March 31, 2011			333,725			$	15.59
Exercisable as of March 31, 2011			318,825			$	16.03

The options outstanding and exercisable as of March 31, 2011 have a weighted average remaining term of 2.2 years and 2.1 years, respectively.

No options were granted for the six-month period ended March 31, 2011 or 2010.

Compensation cost related to restricted stock is recognized based on the market price of the stock at the grant date over the vesting period. Compensation expense related to restricted stock was $14,000 and $18,000 for the six months ended March 31, 2011 and 2010, respectively. The following table summarizes restricted stock awards for the six months ended March 31, 2011. There were no shares issued for the six months ended March 31, 2010.

 

		Six Months Ended March 31, 2011
Number of shares awarded			2,969
Market price of stock on date of grant		$	5.91

 

11

---

Table of Contents

(5) Earnings Per Share

Basic earnings per share (EPS) excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. The following table sets forth the computation of basic and diluted earnings per share (amounts in thousands, except per share data):

 

		Three Months Ended March 31,								Six Months Ended March 31,
		2011				2010				2011				2010
Numerator:
Net income available to common stockholders		$	556			$	376			$	320			$	506
Denominator:
Denominator for basic earnings per share - weighted average shares outstanding			3,057				3,041				3,052				3,041
Effect of dilutive securities:
Common stock equivalents			11				—				5				—
Denominator for diluted earnings per share - weighted average shares and assumed conversions			3,068				3,041				3,057				3,041
Basic earnings per common share		$	0.18			$	0.12			$	0.11			$	0.17
Diluted earnings per common share		$	0.18			$	0.12			$	0.11			$	0.17

Options to purchase 289,025 shares of common stock at prices ranging from $11.06 to $22.91 per share and warrants to acquire 121,387 shares of common stock at a price of $8.65 per share were outstanding during the three months ended March 31, 2011, but were not included in the computation of diluted EPS because to do so would have been anti-dilutive. Similarly, options to purchase 354,251 shares of common stock at prices ranging from $6.23 to $22.91 per share, 5,962 shares of restricted stock at prices ranging from $7.00 to $13.06 per share, and warrants to acquire 121,387 shares of common stock at a price of $8.65 per share were outstanding during the three months ended March 31, 2010, but were not included in the computation of diluted EPS because to do so would have been anti-dilutive.

Options to purchase 289,025 shares of common stock at prices ranging from $11.06 to $22.91 per share and warrants to acquire 121,387 shares of common stock at a price of $8.65 per share were outstanding during the six months ended March 31, 2011, but were not included in the computation of diluted EPS because to do so would have been anti-dilutive. Similarly, options to purchase 354,251 shares of common stock at prices ranging from $6.23 to $22.91 per share, 5,962 shares of restricted stock at prices ranging from $7.00 to $13.06 per share, and warrants to acquire 121,387 shares of common stock at a price of $8.65 per share were outstanding during the six months ended March 31, 2010, but were not included in the computation of diluted EPS because to do so would have been anti-dilutive.

 

12

---

Table of Contents

(6) Securities

The amortized cost and fair value of securities are as follows:

 

		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
(Dollar amounts in thousands)
Available-for-sale:
As of March 31, 2011:
U.S. government and agency obligations		$	39,255			$	368			$	350			$	39,273
Municipal obligations			29,659				860				148				30,371
Corporate obligations			6,980				118				572				6,526
Equity securities in financial institutions			2,469				23				847				1,645
Other equity securities			1,000				—				40				960
Mutual funds			2,644				—				31				2,613
Trust preferred securities			15,422				38				3,393				12,067
Mortgage-backed securities:
Agency			67,566				1,125				195				68,496
Collateralized mortgage obligations:
Agency			10,582				186				61				10,707
Private-label			2,805				34				99				2,740
		$	178,382			$	2,752			$	5,736			$	175,398
Held-to-maturity:
As of March 31, 2011:
U.S. government and agency obligations		$	23,049			$	59			$	264			$	22,844
Municipal obligations			14,242				257				73				14,426
Mortgage-backed securities:
Agency			7,535				304				36				7,803
Collateralized mortgage obligations:
Agency			29,399				361				69				29,691
Private-label			2,571				14				109				2,476
		$	76,796			$	995			$	551			$	77,240

 

13

---

Table of Contents

		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
(Dollar amounts in thousands)
Available-for-sale:
As of September 30, 2010:
U.S. government and agency obligations		$	49,442			$	836			$	—			$	50,278
Municipal obligations			27,838				1,742				30				29,550
Corporate obligations			7,980				193				567				7,606
Equity securities in financial institutions			2,685				5				912				1,778
Other equity securities			1,000				—				68				932
Mutual funds			8,716				501				3				9,214
Trust preferred securities			16,695				29				5,784				10,940
Mortgage-backed securities:
Agency			43,778				1,602				3				45,377
Collateralized mortgage obligations:
Agency			15,332				329				6				15,655
Private-label			3,483				17				130				3,370
		$	176,949			$	5,254			$	7,503			$	174,700
Held-to-maturity:
As of September 30, 2010:
U.S. government and agency obligations		$	20,064			$	161			$	5			$	20,220
Municipal obligations			16,514				554				13				17,055
Mortgage-backed securities:
Agency			6,931				353				—				7,284
Collateralized mortgage obligations:
Agency			27,861				410				21				28,250
Private-label			3,457				36				269				3,224
		$	74,827			$	1,514			$	308			$	76,033

The following table presents the amortized cost and fair value of debt securities by contractual maturity dates as of March 31, 2011:

 

		Securities Available-for-Sale								Securities Held-to-Maturity
		Amortized Cost				Fair Value				Amortized Cost				Fair Value
		(In Thousands)
As of March 31, 2011:
Due in one year or less		$	8,960			$	9,014			$	—			$	—
Due after one year through five years			25,888				26,403				12,954				12,990
Due after five years through ten years			31,470				31,921				21,307				21,360
Due after ten years			105,951				102,842				42,535				42,890
		$	172,269			$	170,180			$	76,796			$	77,240

The proceeds from the sale of securities for the three months ended March 31, 2011 and 2010 were $22.2 million and $10.7 million, respectively. Gross gains of $580,000 and $407,000 were realized on sales of securities during the three months ended March 31, 2011 and 2010, respectively. Gross losses of $0 and $20,000 were realized on sales of securities during the three months ended March 31, 2011 and 2010, respectively. The proceeds from the sale of securities for the six months ended March 31, 2011 and 2010 were $22.4 million and $16.3 million, respectively. Gross gains of $586,000 and $1.1 million were realized on sales of securities during the six months ended March 31, 2011 and 2010, respectively. Gross losses of $0 and $20,000 were realized on sales of securities during the six months ended March 31, 2011 and 2010, respectively.

 

14

---

Table of Contents

The Company recognized other-than-temporary impairment losses on securities of $279,000 and $296,000 for the three-month periods ended March 31, 2011 and 2010, respectively. The impairment charges for the three-month period ended March 31, 2011 relate to the Company’s holdings of a pooled trust preferred security, a single issue trust preferred security, and a private label mortgage-backed security. The impairment charges for the three-month period ended March 31, 2010 relate to two pooled trust preferred securities. The Company recognized other-than-temporary impairment losses on securities of $1.4 million and $1.5 million for the six-month periods ended March 31, 2011 and 2010, respectively. The impairment charges for the six-month period ended March 31, 2011 relate to the Company’s holdings of five pooled trust preferred securities, a single issue trust preferred security, a private label mortgage-backed security, and common stock of a local financial institution. The impairment charges for the six-month period ended March 31, 2010 relate to six pooled trust preferred securities.

At March 31, 2011, the unrealized losses on the securities portfolio were primarily attributable to wider credit spreads, reflecting market illiquidity. The Company does not intend to sell these securities and it is not more-likely than-not that the Company will have to sell these securities.

 

15

---

Table of Contents

The following tables show the aggregate related fair value of investments with a continuous unrealized loss position for less than twelve months and those that have been in a continuous unrealized loss position for twelve months or more.

 

		Less than 12 Months												12 Months or More												Total
		# of Securities				Fair Value				Unrealized Losses				# of Securities				Fair Value				Unrealized Losses				# of Securities				Fair Value				Unrealized Losses
As of March 31, 2011:
(Dollar amounts in thousands)
Available-for-sale:
U.S. government and agency obligations			9			$	18,599			$	350				—			$	—			$	—				9			$	18,599			$	350
Municipal obligations			8				4,817				144				1				497				4				9				5,314				148
Corporate obligations			—				—				—				2				1,423				572				2				1,423				572
Equity securities in financial institutions			—				—				—				5				1,300				847				5				1,300				847
Other equity securities			—				—				—				1				960				40				1				960				40
Mutual Funds			2				2,613				31				—				—				—				2				2,613				31
Trust preferred securities			1				390				50				10				9,758				3,343				11				10,148				3,393
Mortgage-backed securities:
Agency			10				30,057				195				—				—				—				10				30,057				195
Collateralized mortgage obligations:
Agency			2				3,425				61				—				—				—				2				3,425				61
Private-label			—				—				—				2				1,550				99				2				1,550				99
Total temporarily impaired available-for-sale securities			32				59,901				831				21				15,488				4,905				53				75,389				5,736
Held-to-maturity:
U.S. government and agency obligations			7				15,736				264				—				—				—				7				15,736				264
Municipal obligations			4				2,305				73				—				—				—				4				2,305				73
Mortgage-backed securities:
Agency			2				2,105				36				—				—				—				2				2,105				36
Collateralized mortgage obligations:
Agency			4				9,108				65				1				900				4				5				10,008				69
Private-label			—				—				—				3				1,424				109				3				1,424				109
Total temporarily impaired held-to-maturity securities			17				29,254				438				4				2,324				113				21				31,578				551
Total temporarily impaired securities			49			$	89,155			$	1,269				25			$	17,812			$	5,018				74			$	106,967			$	6,287

 

16

---

Table of Contents

		Less than 12 Months												12 Months or More												Total
		# of Securities				Fair Value				Unrealized Losses				# of Securities				Fair Value				Unrealized Losses				# of Securities				Fair Value				Unrealized Losses
As of September 30, 2010:
(Dollar amounts in thousands)
Available-for-sale:
Municipal obligations			1			$	998			$	7				1			$	478			$	23				2			$	1,476			$	30
Corporate obligations			—				—				—				2				1,428				567				2				1,428				567
Equity securities in financial institutions			—				—				—				6				1,367				912				6				1,367				912
Other equity securities			—				—				—				1				933				68				1				933				68
Mutual funds			1				1,332				3				—				—				—				1				1,332				3
Trust preferred securities			—				—				—				15				9,321				5,784				15				9,321				5,784
Mortgage-backed securities:
Agency			1				161				3				—				—				—				1				161				3
Collateralized mortgage obligations:
Agency			—				—				—				1				647				6				1				647				6
Private-label			—				—				—				3				2,663				130				3				2,663				130
Total temporarily impaired available-for-sale securities			3				2,491				13				29				16,837				7,490				32				19,328				7,503
Held-to-maturity:
U.S. government and agency obligations			1			$	2,995			$	5				—			$	—			$	—				1			$	2,995			$	5
Municipal obligations			—				—				—				1				607				13				1				607				13
Collateralized mortgage obligations:
Agency			1				1,653				1				1				1,295				20				2				2,948				21
Private-label			—				—				—				4				1,773				269				4				1,773				269
Total temporarily impaired held-to-maturity securities			2				4,648				6				6				3,675				302				8				8,323				308
Total temporarily impaired securities			5			$	7,139			$	19				35			$	20,512			$	7,792				40			$	27,651			$	7,811

The Company conducts periodic reviews to identify and evaluate each investment that has an unrealized loss, in accordance with U.S. generally accepted accounting principles. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. Unrealized losses that are determined to be temporary in nature are recorded, net of tax, in Accumulated Other Comprehensive Income (AOCI) for available-for-sale securities, while such losses related to held-to-maturity securities are not recorded, as these investments are carried at their amortized cost.

Regardless of the classification of the securities as available-for-sale or held-to-maturity, the Company has assessed each position for other than temporary impairment.

 

17

---

Table of Contents

Factors considered in determining whether a loss is temporary include:

 

•

the length of time and the extent to which fair value has been below cost;

 

•

the severity of the impairment;

 

•

the cause of the impairment and the financial condition and near-term prospects of the issuer;

 

•

activity in the market of the issuer which may indicate adverse credit conditions;

 

•

if the Company intends to sell the investment;

 

•

if it’s more-likely-than-not the Company will be required to sell the investment before recovering its amortized cost basis; and

 

•

if the Company does not expect to recover the investment’s entire amortized cost basis (even if the Company does not intend to sell the security).

The Company’s review for impairment generally entails:

 

•

identification and evaluation of investments that have indications of possible impairment;

 

•

analysis of individual investments that have fair values less than amortized cost, including consideration of the length of time the investment has been in an unrealized loss position and the expected recovery period;

 

•

discussion of evidential matter, including an evaluation of factors or triggers that could cause individual investments to qualify as having other-than-temporary impairment and those that would not support other-than-temporary impairment; and

 

•

documentation of the results of these analyses, as required under business policies.

For debt securities that are not deemed to be credit impaired, management performs additional analysis to assess whether it intends to sell or would more-likely-than-not be required to sell the investment before the expected recovery of the amortized cost basis. Management has asserted that it has no intent to sell and that it believes it is more-likely-than-not that it will not be required to sell the investment before recovery of its amortized cost basis.

Similarly, for equity securities, management considers the various factors described above, including its intent and ability to hold the equity security for a period of time sufficient for recovery to amortized cost. Where management lacks that intent or ability, the security’s decline in fair value is deemed to be other-than-temporary and is recorded in earnings.

For debt securities, a critical component of the evaluation for other-than-temporary impairment is the identification of credit impaired securities, where management does not receive cash flows sufficient to recover the entire amortized cost basis of the security. The extent of the Company’s analysis regarding credit quality and the stress on assumptions used in the analysis had been refined for securities where the current fair value or other characteristics of the security warrant. The paragraphs below describe the Company’s process for identifying credit impairment in security types with the most significant unrealized losses as of March 31, 2011.

Trust Preferred Debt Securities

Included in debt securities in an unrealized loss position at March 31, 2011 were eleven different trust preferred offerings with an aggregate fair value of $10.1 million, which had floating rates based on LIBOR. The unrealized losses on these debt securities amounted to $3.4 million at March 31, 2011. Due to dislocations in the credit markets broadly, and the lack of trading and new issuances in trust preferred securities, market price indications generally reflect the lack of liquidity in the market. Prices on pooled trust preferred securities were calculated by a third party valuation company. The valuation methodology is based on the premise that the fair value of the security’s collateral should approximate the fair value of its liabilities. In general, the spreads for trust preferred collateral have widened by over 500 basis points since 2007. To determine the decline in the collateral’s value associated with this increase in credit spreads, the third party projected collateral cash flows for each pool using Intex, the commonly used modeling software for securities of this type. Once generated, the cash flows for each pool were discounted at the applicable rate to arrive at the fair value of the collateral. Any declines in the resulting fair value of the collateral below the par value represents the component of loss attributed to credit risk.

 

18

---

Table of Contents

The credit quality of each collateral pool was then analyzed for the purpose of projecting defaults and recoveries. Prepayment assumptions were also estimated. With these additional assumptions, cash flow projections for both the collateral and the debt obligation were modeled and valued. The fair value of each bond was then determined by discounting the projected cash flows by an adjusted discount rate (adjusted to capture the default risk). During the three months ended March 31, 2011, the Company recognized in earnings impairment charges of $100,000 on an investment in a pooled trust preferred security and $135,000 on a single issue trust preferred security. The impairment charges on the pooled trust preferred security resulted from several factors, including a downgrade on its credit ratings, failure to pass its principal coverage test, indications of a break in yield, and the decline in the net present value of its projected cash flows. The impairment charges on the single issue trust preferred security resulted from the financial institution being put on regulatory order after several quarters of losses and it started deferring interest payments on both its trust preferred and its TARP preferred shares outstanding. During the three months ended March 31, 2010, the Company recognized in earnings impairment charges of $296,000 on two investments in pooled trust preferred securities resulting from several factors, including a downgrade on their credit ratings, failure to pass their principal coverage tests, indications of a break in yield, and the decline in the net present value of their projected cash flows. During the six months ended March 31, 2011, the Company recognized impairment charges of $1.0 million on five investments in pooled trust preferred securities and $135,000 on a single issue trust preferred security. The impairment charges on the pooled trust preferred securities resulted from several factors, including a downgrade on their credit ratings, failure to pass their principal coverage tests, indications of a break in yield, and the decline in the net present value of their projected cash flows. The impairment charges on the single issue trust preferred security resulted from the financial institution being put on regulatory order after several quarters of losses and it started deferring interest payments on both its trust preferred and its TARP preferred shares outstanding. During the six months ended March 31, 2010, the Company recognized impairment charges of $1.5 million on six investments in pooled trust preferred securities resulting from several factors, including a downgrade on their credit ratings, failure to pass their principal coverage tests, indications of a break in yield, and the decline in the net present value of their projected cash flows. Based on cash flow forecasts for the remaining securities, management expects to recover the remaining amortized cost of these securities. Furthermore, the Company does not intend to sell these securities and it is not more-likely-than-not that the Company will be required to sell these securities before recovery of their cost basis, which may be at maturity.

Equity Securities in Financial Institutions

At March 31, 2011 the Company had $847,000 of unrealized losses on equity securities in financial institutions. These securities represent investments in common equity offerings of five financial institutions with an aggregate fair value of $1.3 million. In addition to the general factors mentioned above for determining whether the decline in market value is other than temporary, the analysis of each of these securities includes a review of the profitability of each issuer and its capital adequacy, and all data available to determine the credit quality of each issuer. During the six months ended March 31, 2011, the Company recognized in earnings impairment charges of $87,000 on one investment in common stock of a local financial institution resulting from the duration and extent to which the market value has been less than the cost and the performance of the financial institution over the past two years. There were no impairment charges taken on these securities for the three months ended March 31, 2011, three months ended March 31, 2010, and the six months ended March 31, 2010. Based on the Company’s detailed analysis, and because the Company has the ability and intent to hold the investments until a recovery of its amortized cost basis, except for the investment mentioned above, the Company does not consider these remaining assets to be other-than-temporarily impaired at March 31, 2011. However, continued price declines could result in a write down of one or more of these equity investments.

Corporate Obligations

Included in corporate obligations in an unrealized loss position at March 31, 2011 were two different securities with an aggregate fair value of $1.4 million. The unrealized loss on these securities amounted to $572,000 at March 31, 2011. These two securities represent investments in corporate obligations issued by financial institutions and have floating rates which reset monthly based on LIBOR. In addition to the general factors mentioned above for determining whether the decline in market value is other-than-temporary, the analysis of each of these securities included a review of the profitability of each issuer and its capital adequacy, and all data available to determine the credit quality of each issuer. Both issuers are well capitalized as of March 31, 2011 and the securities have an investment grade rating as rated by at least one nationally recognized credit rating agency.

 

19

---

Table of Contents

Both institutions had participated in the Treasury’s TARP Capital Purchase Program and have subsequently repaid the TARP proceeds. Based on the Company’s detailed analysis and because the Company has the ability and intent to hold these investments until a recovery of its amortized cost basis, the Company does not consider these securities to be other-than-temporarily impaired at March 31, 2011. There were no impairment charges on corporate obligations for the three and six months ended March 31, 2011 and 2010.

Private-Label Collateralized Mortgage Obligations

Included in private-label collateralized mortgage obligations in an unrealized loss position at March 31, 2011 were two different securities with an aggregate fair value of $1.6 million. The unrealized loss on these securities amounted to $99,000 at March 31, 2011. A significant amount of the unrealized losses at March 31, 2011 represents one private label mortgage-backed security. For the three months ended March 31, 2011 the Company recognized $44,000 of credit impairment losses relating to this security. For the six months ended March 31, 2011 the Company recognized $87,000 of credit impairment losses relating to this security. The impairment losses were a result of a downgrade in its credit rating, as well as independent third-party analysis of the underlying collateral for the bond. There were no impairment charges recognized for this security during the three and six-month periods ended March 31, 2010. Based on management’s analysis of the remaining securities, management determined that the price declines are strictly market and spread related and management expects to recover the remaining amortized cost of these securities. Furthermore, the Company does not intend to sell these securities and it is not more-likely-than-not that the Company will be required to sell these securities before recovery of their cost basis, which may be at maturity.

The following is a roll forward for the six months ended March 31, 2011 of the amounts recognized in earnings related to credit losses on securities which the Company has recorded other-than-temporary impairment charges through earnings and other comprehensive income:

 

		(In Thousands)
Credit component of OTTI as of October 1, 2010		$	3,586
Additions for credit-related OTTI charges on previously unimpaired securities			135
Additions for credit-related OTTI charges on previously impaired securities			1,134
Credit component of OTTI as of March 31, 2011		$	4,855

(7) Loans Receivable and Related Allowance for Loan Losses

The following table summarizes the primary segments of the loan portfolio as of March 31, 2011 and September 30, 2010 (in thousands):

 

		Individually Evaluated for Impairment				Collectively Evaluated for Impairment				Total
March 31, 2011
Residential loans		$	—			$	120,656			$	120,656
Commercial real estate loans
Non owner-occupied			6,781				60,864				67,645
All other commercial real estate			9,109				15,129				24,238
Construction loans
Residential construction loans			—				2,839				2,839
Commercial construction loans			—				16,150				16,150
Home equity loans			—				66,625				66,625
Consumer loans			—				2,720				2,720
Commercial business and lease loans			1,179				42,477				43,656
Total		$	17,069			$	327,460			$	344,529

 

20

---

Table of Contents

		Individually Evaluated for Impairment				Collectively Evaluated for Impairment				Total
September 30, 2010
Residential loans		$	93			$	127,182			$	127,275
Commercial real estate loans
Non owner-occupied			7,069				61,867				68,936
All other commercial real estate			9,924				16,732				26,656
Construction loans
Residential construction loans			—				1,762				1,762
Commercial construction loans			—				18,260				18,260
Home equity loans			—				72,008				72,008
Consumer loans			—				3,786				3,786
Commercial business and lease loans			1,060				59,150				60,210
Total		$	18,146			$	360,747			$	378,893

The segments of the Bank’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. The residential mortgage loan segment is made up of fixed rate and adjustable rate single-family amortizing term loans, which are primarily first liens. The commercial real estate (“CRE”) loan segment is further disaggregated into two classes. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than all other CRE loans, which include multifamily structures and owner-occupied commercial structures. The construction loan segment is further disaggregated into two classes. One to four family residential construction loans are generally made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are generally made to developers or investors for the purpose of acquiring, developing and constructing residential or commercial structures. Construction lending is generally considered to involve a higher degree of credit risk than long-term permanent financing. If the estimate of construction cost proves to be inaccurate, the Bank may be compelled to advance additional funds to complete the construction with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If the Bank is forced to foreclose on a project prior to completion, there is no assurance that it will be able to recover all of the unpaid portion of the loan. In addition, the Bank may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time. The commercial business and lease loan segment consists of loans made for the purpose of financing the activities of commercial customers. The installment loan segment consists primarily of home equity loans, which are generally second liens, and consumer loans. The consumer loans consist of motor vehicle loans, savings account loans, personal lines of credit, overdraft loans, other types of secured consumer loans, and unsecured personal loans.

Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $50,000 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 reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Company does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring agreement.

 

21

---

Table of Contents

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 expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by loan basis, with management primarily utilizing the fair value of collateral method, which is required for loans that are collateral dependent. 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 monthly 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 presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of March 31, 2011 and September 30, 2010 (in thousands):

 

		Impaired Loans with Specific Allowance								Impaired Loans with No Specific Allowance				Total Impaired Loans
		Recorded Investment				Related Allowance				Recorded Investment				Recorded Investment				Unpaid Principal Balance
March 31, 2011
Commercial real estate loans
Non owner-occupied		$	2,957			$	443			$	3,824			$	6,781			$	7,197
All other commercial real estate			4,933				713				4,176				9,109				9,433
Commercial business and lease loans			745				297				434				1,179				1,179
Total impaired loans		$	8,635			$	1,453			$	8,434			$	17,069			$	17,809
September 30, 2010
Residential loans		$	—			$	—			$	93			$	93			$	93
Commercial real estate loans
Non owner-occupied			3,017				542				4,052				7,069				7,351
All other commercial real estate			5,741				812				4,183				9,924				10,253
Commercial business and lease loans			723				188				337				1,060				1,060
Total impaired loans		$	9,481			$	1,542			$	8,665			$	18,146			$	18,757

There are certain impaired loans whose payments are being applied to reduce the principal balance of the loan because the recovery of interest is not determinable. The unpaid principal balance reflects the balance as if the payments were applied in accordance with the terms of the original contractual agreement whereas the recorded investment reflects the outstanding principal balance for financial reporting purposes.

 

22

---

Table of Contents

The following table presents the average recorded investment in impaired loans and related interest income recognized for the periods indicated (in thousands):

 

		Six Months Ended March 31, 2011												Six Months Ended March 31, 2010
		Average Investment in Impaired Loans				Interest Income Recognized on an Accrual Basis				Interest Income Recognized on a Cash Basis				Average Investment in Impaired Loans				Interest Income Recognized on an Accrual Basis				Interest Income Recognized on a Cash Basis
Residential loans		$	62			$	—			$	—			$	31			$	—			$	—
Commercial real estate loans
Non owner-occupied			6,959				—				124				7,481				—				202
All other commercial real estate			9,398				—				247				7,735				65				27
Commercial construction loans			—				—				—				55				—				—
Commercial business and lease loans			1,153				2				33				2,183				9				61
Total impaired loans		$	17,572			$	2			$	404			$	17,485			$	74			$	290

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. 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 orderly liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Loans in the Doubtful category have all the weaknesses found in substandard loans, with the added provision that the weaknesses make collection of debt in full highly questionable and improbable. Any portion of a loan that has been charged off 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. 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. The Credit Analysis Department confirms the appropriate risk grade at origination and monitors all subsequent changes to risk ratings. The Bank’s Classified Asset Committee approves all risk rating changes, except those made within the pass risk ratings. The Bank engages an external consultant to conduct loan reviews on a quarterly basis. Generally, the external consultant reviews commercial relationships that equal or exceed $1,000,000, 10% of the number of loans under $1,000,000, and adversely classified commercial credits in excess of $50,000. Detailed reviews, including plans for resolution, are performed on loans classified as substandard on a monthly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

 

23

---

Table of Contents

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard, and Doubtful within the internal risk rating system as of March 31, 2011 (in thousands):

 

		Pass				Special Mention				Substandard				Doubtful				Total
March 31, 2011
Commercial real estate loans
Non owner-occupied		$	57,944			$	2,920			$	6,781			$	—			$	67,645
All other commercial real estate			14,253				—				9,985				—				24,238
Construction loans
Residential construction loans			2,839				—				—				—				2,839
Commercial construction loans			14,244				—				1,906				—				16,150
Commercial business and lease loans			42,128				349				1,139				40				43,656
Total		$	131,408			$	3,269			$	19,811			$	40			$	154,528

The following table presents the classes of the loan portfolio for which loan performance is the primary credit quality indicator.

 

		Residential Loans				Home Equity Loans				Consumer Loans				Total
March 31, 2011
Performing loans		$	118,798			$	65,947			$	2,701			$	187,446
Non-performing loans			1,858				678				19				2,555
Total		$	120,656			$	66,625			$	2,720			$	190,001

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 March 31, 2011 (in thousands):

 

		Current				30 - 59 Days Past Due				60 - 89 Days Past Due				90 Days+ Past Due				Total Past Due				Non- Accrual				Total Loans
Residential loans		$	116,487			$	1,453			$	829			$	29			$	2,311			$	1,858			$	120,656
Commercial real estate loans
Non owner-occupied			55,798				1,495				983				2,559				5,037				6,810				67,645
All other commercial real estate			18,315				5,342				581				—				5,923				—				24,238
Construction loans
Residential construction loans			2,839				—				—				—				—				—				2,839
Commercial construction loans			15,631				—				519				—				519				—				16,150
Home equity loans			65,026				284				209				428				921				678				66,625
Consumer loans			2,652				35				12				2				49				19				2,720
Commercial business and lease loans			41,848				704				146				626				1,476				332				43,656
Total		$	318,596			$	9,313			$	3,279			$	3,644			$	16,236			$	9,697			$	344,529

 

24

---

Table of Contents

An allowance for loan and lease losses (“ALLL”) is maintained to absorb losses from the loan portfolio. The ALLL 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 classes described above, provide the starting point for the ALLL analysis. Management tracks the historical net charge-off activity by loan class. A historical charge-off factor is calculated and applied to each class. 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. Other qualitative factors are also considered.

“Pass” rated credits are segregated from “Criticized” credits for the application of qualitative factors. Management has identified a number of 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 qualitative factors are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources. The Bank’s qualitative factors consist of: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; levels of and trends in the Bank’s borrowers in bankruptcy; trends in volumes and terms of loans; effects of changes in lending policies and strategies; and concentrations of credit from a loan type, industry and/or geographic standpoint.

Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALLL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALLL.

The following table summarizes the primary segments of the ALLL, segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of March 31, 2011. Activity in the allowance is presented for the six months ended March 31, 2011 (in thousands):

 

		Residential Loans				Commercial Real Estate Loans				Installment Loans				Commercial Business and Lease Loans				Unallocated				Total
ALLL balance at September 30, 2010		$	236			$	3,300			$	371			$	1,914			$	—			$	5,821
Charge-offs			(13	)			(69	)			(62	)			(142	)			—				(286	)
Recoveries			—				—				9				29				—				38
Provision			201				(77	)			127				—				349				600
ALLL balance at March 31, 2011		$	424			$	3,154			$	445			$	1,801			$	349			$	6,173
Individually evaluated for impairment		$	—			$	1,156			$	—			$	297			$	—			$	1,453
Collectively evaluated for impairment		$	424			$	1,998			$	445			$	1,504			$	349			$	4,720

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

(8) Derivative Instruments

The Company accounts for its derivative instruments as either assets or liabilities on the balance sheet at fair value through adjustments to either the hedged items, accumulated other comprehensive income (loss), or current earnings, as appropriate. As part of its overall interest rate risk management activities, the Company utilizes derivative instruments to manage its exposure to various types of interest rate risk. These derivative instruments consist of interest rate swaps. There were two interest rate swap contracts outstanding as of March 31, 2011.

 

25

---

Table of Contents

Entering into interest rate derivatives potentially exposes the Company to the risk of counterparties’ failure to fulfill their legal obligations including, but not limited to, potential amounts due or payable under each derivative contract. Notional principal amounts are often used to express the volume of these transactions, but the amounts potentially subject to credit risk are much smaller.

During the second quarter of fiscal 2008, the Company entered into an interest rate swap contract involving the exchange of the Company’s floating rate interest rate payment on its $7.5 million in floating rate preferred securities for a fixed rate interest payment without the exchange of the underlying principal amount. This hedge relationship fails to qualify for the assumption of no ineffectiveness (short cut method) as defined by U.S. generally accepted accounting principles. Therefore, the Company accounts for this hedge relationship as a cash flow hedge. The cumulative change in fair value of the hedging derivative, to the extent that it is expected to be offset by the cumulative change in anticipated interest cash flows from the hedged exposure, will be deferred and reported as a component of accumulated other comprehensive income (AOCI). Any hedge ineffectiveness will be charged to current earnings. Consistent with the risk management objective and the hedge accounting designation, management measured the degree of hedge effectiveness by comparing the cumulative change in anticipated interest cash flows from the hedged exposure over the hedging period to the cumulative change in anticipated cash flows from the hedging derivative. Management utilizes the “Hypothetical Derivative Method” to compute the cumulative change in anticipated interest cash flows from the hedged exposure. To the extent that the cumulative change in anticipated cash flows from the hedging derivative offsets from 80% to 125% of the cumulative change in anticipated interest cash flows from the hedged exposure, the hedge will be deemed effective. The Company will use the Hypothetical Derivative Method to measure ineffectiveness. Under this method, the calculation of ineffectiveness will be done by using the change in fair value of the hypothetical derivative. That is, the swap will be recorded at fair value on the balance sheet and other comprehensive income will be adjusted to an amount that reflects the lesser of either the cumulative change in fair value of the swap or the cumulative change in the fair value of the hypothetical derivative instrument. Management will determine the ineffectiveness of the hedging relationship by comparing the cumulative change in anticipated interest cash flows from the hedged exposure over the hedging period to the cumulative change in anticipated cash flows from the hedging derivative. Any difference between these two measures will be deemed hedge ineffectiveness and recorded in current earnings. As of March 31, 2011, the hedge instrument was deemed to be effective, therefore, no amounts were charged to current earnings. The Company does not expect to reclassify any hedge-related amounts from accumulated other comprehensive income (loss) to earnings over the next twelve months.

The pay fixed interest rate swap contract outstanding at March 31, 2011 is being utilized to hedge $7.5 million in floating rate-preferred securities. Below is a summary of the interest rate swap contract and the terms at March 31, 2011:

 

(Dollars in thousands)		Notional				Pay				Receive				Maturity				Unrealized
		Amount				Rate				Rate(*)				Date				Gain				Loss
Cash flow hedge		$	7,500				5.32	%			1.67	%			12/15/2012			$	—			$	421

 

(*)	Variable receive rate based upon contract rates in effect at March 31, 2011.

During the first quarter of fiscal 2009, the Bank originated a $1.0 million fixed rate loan for one of its commercial mortgage loan customers and simultaneously entered into an offsetting fixed interest rate swap contract with PNC Bank, National Association (“PNC”). The Bank pays PNC interest at the same fixed rate on the same notional amount as the customer pays to the Bank on the commercial mortgage loan, and receives interest from PNC at a floating rate on the same notional amount. This interest rate hedging program helps the Bank limit its interest rate risk while at the same time helps the Bank meet the financing needs and interest rate risk management needs of its commercial customers. The Company accounts for this hedge relationship as a fair value hedge. This interest rate swap contract was recorded at fair value with any resulting gain or loss recorded in current period earnings. For the three and six months ended March 31, 2011 the Company recorded gains of $3,000 and $13,000, respectively, relating to this contract. For the three and six months ended March 31, 2010 the Company recorded a loss of $1,000 and a gain of $5,000, respectively, relating to this contract. As of March 31, 2011, the notional amount of the customer-related interest rate derivative financial instrument was $959,000, compared to $975,000 at March 31, 2010.

 

26

---

Table of Contents

(9) Comprehensive Income

The Company has developed the following table, which includes the tax effects of the components of other comprehensive income (loss). Other comprehensive income (loss) consists of net unrealized gains (losses) on securities available-for-sale, non-credit impairment charges on securities, and derivatives that qualify as cash flow hedges. Other comprehensive income (loss) and related tax effects for the indicated periods, consists of:

 

(Dollars in thousands)		Three Months Ended March 31, 2011				Three Months Ended March 31, 2010
Net income		$	659			$	479
Comprehensive gain (loss) on cash flow hedges net of tax of $23 in 2011 and ($17) in 2010			44				(33	)
Comprehensive gain on investment securities, net of tax of $479 in 2011 and $545 in 2010			931				1,057
Reclassification adjustment on investment securities, net of tax of ($197) in 2011 and ($132) in 2010			(383	)			(255	)
Comprehensive (loss) gain on securities for which other-than-temporary impairment has been recognized in earnings, net of tax of ($181) in 2011 and $54 in 2010			(350	)			106
Reclassification adjustment for other-than-temporary impairment losses on debt securities, net of tax of $95 in 2011 and $101 in 2010			184				195
Total comprehensive income		$	1,085			$	1,549
(Dollars in thousands)		Six Months Ended March 31, 2011				Six Months Ended March 31, 2010
Net income		$	525			$	711
Comprehensive gain on cash flow hedges net of tax of $50 in 2011 and $1 in 2010			97				2
Comprehensive (loss) gain on investment securities, net of tax of ($60) in 2011 and $1,737 in 2010			(116	)			3,372
Reclassification adjustment on investment securities, net of tax of ($170) in 2011 and ($353) in 2010			(329	)			(684	)
Comprehensive loss on securities for which other-than-temporary impairment has been recognized in earnings, net of tax of ($353) in 2011 and ($1,524) in 2010			(686	)			(2,958	)
Reclassification adjustment for other-than-temporary impairment losses on debt securities, net of tax of $431 in 2011 and $520 in 2010			838				1,010
Total comprehensive income		$	329			$	1,453

 

27

---

Table of Contents

(10) Disclosures About Fair Value Measurements

The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value. The three broad levels defined by U.S. generally accepted accounting principles are as follows:

 

Level I -		Quoted prices are available in the active markets for identical assets or liabilities as of the reported date.
Level II -		Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
Level III -		Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

This hierarchy requires the use of observable market data when available.

The following tables present the assets and liabilities reported on the consolidated statements of financial condition at their fair value as of March 31, 2011 and September 30, 2010 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

		Level I				Level II				Level III				Total
		(In Thousands)
As of March 31, 2011
Assets:
Available-for-sale securities:
U.S. government and agency obligations		$	—			$	39,273			$	—			$	39,273
Municipal obligations			—				30,371				—				30,371
Corporate obligations			—				6,526				—				6,526
Equity securities in financial institutions			1,645				—				—				1,645
Other equity securities			960				—				—				960
Mutual funds			2,613				—				—				2,613
Trust preferred securities			—				—				12,067				12,067
Mortgage-backed securities:
Agency			—				68,496				—				68,496
Collateralized mortgage obligations:
Agency			—				10,707				—				10,707
Private-label			—				2,740				—				2,740
		$	5,218			$	158,113			$	12,067			$	175,398
Residential loans held for sale		$	—			$	172			$	—			$	172
Liabilities:
Derivative instruments		$	—			$	493			$	—			$	493

 

28

---

Table of Contents

		Level I				Level II				Level III				Total
		(In Thousands)
As of September 30, 2010
Assets:
Available-for-sale securities:
U.S. government and agency obligations		$	—			$	50,278			$	—			$	50,278
Municipal obligations			—				29,550				—				29,550
Corporate obligations			—				7,606				—				7,606
Equity securities in financial institutions			1,778				—				—				1,778
Other equity securities			932				—				—				932
Mutual funds			9,214				—				—				9,214
Trust preferred securities			—				—				10,940				10,940
Mortgage-backed securities:
Agency			—				45,377				—				45,377
Collateralized mortgage obligations:
Agency			—				15,655				—				15,655
Private-label			—				3,370				—				3,370
		$	11,924			$	151,836			$	10,940			$	174,700
Residential loans held for sale		$	—			$	1,970			$	—			$	1,970
Liabilities:
Derivative instruments		$	—			$	736			$	—			$	736

At March 31, 2011, trust preferred securities represent investments in 20 different trust preferred offerings with an aggregate fair value of $12.1 million, which had floating rates based on LIBOR at March 31, 2011. Due to dislocations in the credit markets broadly, and the lack of trading and new issuance in trust preferred securities, market price indications generally reflect the lack of liquidity in the market. Prices on pooled trust preferred securities were calculated by a third party valuation company. The valuation methodology is based on the premise that the fair value of the security’s collateral should approximate the fair value of its liabilities. In general, the spreads for trust preferred collateral have widened by over 500 basis points since 2007. To determine the decline in the collateral’s value associated with this increase in credit spreads, the third party projected collateral cash flows for each pool using Intex, the commonly used modeling software for securities of this type. Once generated, the cash flows for each pool were discounted at the applicable rate to arrive at the fair value of the collateral. Any declines in the resulting fair value of the collateral below the par value represents the component of loss attributed to credit risk. The credit quality of each collateral pool was then analyzed for the purpose of projecting defaults and recoveries. Prepayment assumptions were also estimated. With these additional assumptions, cash flow projections for both the collateral and the debt obligation were modeled and valued. The fair value of each bond was then determined by discounting the projected cash flows by an adjusted discount rate (adjusted to capture the default risk). During the three months ended March 31, 2011 the Company recognized in earnings $100,000 of impairment charges on an investment in a pooled trust preferred security and $135,000 on a single issue trust preferred security. The impairment charges on the pooled trust preferred security resulted from several factors, including a downgrade in its credit rating, failure to pass its principal coverage test, indications of a break in yield, and the decline in the net present value of its projected cash flows. The impairment charges on the single issue trust preferred security resulted from the financial institution being put on regulatory order after several quarters of losses and it started deferring interest payments on both its trust preferred and its TARP preferred shares outstanding. During the six months ended March 31, 2011 the Company recognized in earnings $1.0 million of impairment charges on five investments in pooled trust preferred securities and $135,000 on a single issue trust preferred security. The impairment charges on the pooled trust preferred securities resulted from several factors, including a downgrade in their credit ratings, failure to pass their principal coverage tests, indications of a break in yield, and the decline in the net present value of their projected cash flows. The impairment charges on the single issue trust preferred security resulted from the financial institution being put on regulatory order after several quarters of losses and it started deferring interest payments on both its trust preferred and its TARP preferred shares outstanding.

 

29

---

Table of Contents

Management of the Company has deemed the impairment on these trust preferred securities to be other-than-temporary based upon these factors and the duration and extent to which their market values have been less than cost, the inability to forecast a recovery in market value, and other factors concerning the issuers in the securities. There were $296,000 and $1.5 million of impairment charges taken on these securities during the three and six months ending March 31, 2010. Based on cash flow forecasts for the remaining securities, management expects to recover the remaining amortized cost of these securities. Furthermore, the Company does not intend to sell these securities and it is not more-likely-than-not that the Company will be required to sell these securities before recovery of their cost basis, which may be at maturity.

The following table presents the changes in the Level III fair value category for the six months ended March 31, 2011. The Company classifies financial instruments in Level III of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to the unobservable inputs, the valuation models for Level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly.

Securities Available-For-Sale (In Thousands)

 

Beginning balance October 1, 2010		$	10,940
Impairment charge on securities			(1,182	)
Net change in unrealized loss on securities available-for-sale			2,400
Purchases, issuances, calls, and settlements			—
Other			(91	)
Transfers in and/or out of Level III			—
Ending balance March 31, 2011		$	12,067

The following tables present the assets measured on a nonrecurring basis on the consolidated statements of financial condition at their fair value as of March 31, 2011 and September 30, 2010 by level within the fair value hierarchy. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves. Techniques used to value the collateral that secure the impaired loan include: quoted market prices for identical assets classified as Level I inputs; observable inputs, employed by certified appraisers, for similar assets classified as Level II inputs. In cases where valuation techniques included inputs that are unobservable and are based on estimates and assumptions developed by management based on the best information available under each circumstance, the asset valuation is classified as Level III inputs.

 

		Level I				Level II				Level III				Total
		(In Thousands)
As of March 31, 2011
Assets Measured on a Nonrecurring Basis:
Impaired loans		$	—			$	9,656			$	5,960			$	15,616
Foreclosed real estate, net			—				1,302				—				1,302
		$	—			$	10,958			$	5,960			$	16,918
		Level I				Level II				Level III				Total
		(In Thousands)
As of September 30, 2010
Assets Measured on a Nonrecurring Basis:
Impaired loans		$	—			$	10,318			$	6,286			$	16,604
Foreclosed real estate, net			—				398				—				398
		$	—			$	10,716			$	6,286			$	17,002

 

30

---

Table of Contents

(11) Disclosures About Fair Value of Financial Instruments

Management uses its best judgment in estimating the fair value of the Company’s financial instruments, however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective periods, and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities.

Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The Company, in estimating its fair value disclosures for financial instruments, used the following methods and assumptions:

Cash and Due From Banks

The carrying amounts reported approximate those assets’ fair value.

Interest Bearing Demand Deposits with Other Institutions

The carrying amounts reported approximate those assets’ fair value.

Securities

Fair values of securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities. Prices on pooled trust preferred securities were calculated by a third party using a discounted projected cash-flow technique. Cash flows were estimated based on credit quality and prepayment assumptions. The present value of the projected cash flows was calculated using an adjusted discount rate which reflects higher credit spreads due to economic stresses in the marketplace and lower credit ratings.

Loans Receivable

The net loan portfolio has been valued using a present value discounted cash flow. The discount rate used in these calculations is based upon the treasury yield curve adjusted for non-interest operating costs, credit loss, current market prices and assumed prepayment risk.

Federal Home Loan Bank Stock

The carrying amounts reported approximate those assets’ fair value.

Accrued Interest Receivable and Payable

The carrying amounts of accrued interest receivable and payable approximate their fair value.

Deposits

Deposits with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar assets and liabilities. Deposits with no stated maturities have an estimated fair value equal to both the amount payable on demand and the recorded book balance.

 

31

---

Table of Contents

Securities Sold Under Agreements to Repurchase

The fair values for securities sold under agreement to repurchase were estimated using the interest rate currently available from the party that holds the existing debt.

Short-Term Borrowings

The carrying amounts for short-term borrowings approximate the estimated fair value of such liabilities.

Long-Term Debt

The fair values for long-term debt were estimated using the interest rate currently available from the party that holds the existing debt.

Subordinated Debt

Fair values for subordinated debt are estimated using a discounted cash flow calculation similar to that used in valuing fixed rate certificate of deposit liabilities.

Advance Payments by Borrowers for Taxes and Insurance

The fair value of the advance payments by borrowers for taxes and insurance approximates the carrying value of those commitments at those dates.

Interest Rate Swap Contracts

Estimated fair values of interest rate swap contracts are based on quoted market prices.

Off-Balance Sheet Instruments

Fair values for the Company’s off-balance sheet instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.

 

32

---

Table of Contents

The carrying amounts and fair values of the Company’s financial instruments are presented in the following table:

 

		March 31, 2011								September 30, 2010
		Carrying Amount				Fair Value				Carrying Amount				Fair Value
		(In Thousands)
Financial assets:
Cash and due from banks		$	5,569			$	5,569			$	8,414			$	8,414
Interest bearing demand deposits with other institutions			46,331				46,331				20,923				20,923
Securities available-for-sale			175,398				175,398				174,700				174,700
Securities held-to-maturity			76,796				77,240				74,827				76,033
Loans receivable, net (including loans held for sale)			338,528				337,525				375,042				379,906
Federal Home Loan Bank stock			9,056				9,056				10,034				10,034
Accrued interest receivable			2,494				2,494				2,655				2,655
Financial liabilities:
Deposits			445,229				448,461				444,448				449,467
Securities sold under agreements to repurchase			95,210				101,682				108,342				117,307
Short-term borrowings			211				211				130				130
Long-term debt			80,000				83,699				80,401				85,871
Subordinated debt			7,732				7,732				7,732				7,732
Advance payments by borrowers for taxes and insurance			2,230				2,230				1,223				1,223
Accrued interest payable			949				949				1,037				1,037
Interest rate swap contracts			493				493				736				736

(12) Federal Home Loan Bank (“FHLB”) Stock Dividends

The FHLB of Pittsburgh historically paid quarterly cash dividends, which were last paid on November 17, 2008 at an annualized rate of 2.35%. In December 2008, the FHLB announced that it was suspending dividend payments beginning with the dividend payment that would have been payable in the March 2009 quarter in an effort to retain capital. In addition, the historical practice of repurchasing excess capital stock from members of the FHLB was also suspended. However, on October 20, 2010 and again on February 22, 2011 the FHLB announced the repurchase of approximately $200 million in excess capital stock. The amount of excess stock repurchased from any member was the lesser of 5% of the member’s total capital stock outstanding or its excess capital stock outstanding. The Bank’s investment in the FHLB of Pittsburgh was $9.1 million at March 31, 2011 and is valued at the par issue amount of $100 per share.

 

33

---

Table of Contents

(13) TARP Capital Purchase Program

On December 12, 2008, the Company entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with the United States Department of the Treasury (“Treasury”) under the TARP Capital Purchase Program, pursuant to which the Company sold (i) 7,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 121,387 shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), for an aggregate purchase price of $7.0 million in cash.

The Series B Preferred Stock will qualify as Tier 1 capital and will pay cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. Pursuant to the terms of the Purchase Agreement, the ability of the Company to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its Junior Stock (as defined below) and Parity Stock (as defined below) will be subject to restrictions, including a restriction against increasing dividends from the last quarterly cash dividend per share ($0.14) declared on the Common Stock prior to December 12, 2008. The Company may redeem the Series B Preferred Stock at a price of $1,000 per share plus accrued and unpaid dividends, subject to the concurrence of the Treasury and its federal banking regulators. Prior to December 12, 2011, unless the Company has redeemed the Series B Preferred Stock or the Treasury has transferred the Series B Preferred Stock to a third party, the consent of the Treasury will be required for the Company to increase its Common Stock dividend or repurchase its Common Stock or other equity or capital securities, other than in certain circumstances specified in the Agreement.

The Warrant has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $8.65 per share of the Common Stock. Treasury has agreed not to exercise voting power with respect to any shares of Common Stock issued upon exercise of the Warrant.

The Series B Preferred Stock and the Warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. Upon the request of Treasury at any time, the Company has agreed to promptly enter into a deposit arrangement pursuant to which the Series B Preferred Stock may be deposited and depositary shares (“Depositary Shares”), representing fractional shares of Series B Preferred Stock, may be issued. The Company has agreed to register the Series B Preferred Stock, the Warrant, the shares of Common Stock underlying the Warrant (the “Warrant Shares”) and Depositary Shares, if any, as soon as practicable after the date of the issuance of the Series B Preferred Stock and the Warrant. Neither the Series B Preferred Stock nor the Warrant will be subject to any contractual restrictions on transfer, except that Treasury may only transfer or exercise an aggregate of one-half of the Warrant Shares prior to the earlier of the redemption of 100% of the shares of Series B Preferred Stock or December 31, 2009.

The fair value of the preferred stock and the common stock warrants was determined based on their relative fair values calculated as of their issuance date, December 12, 2008. Based on their relative fair values, the TARP proceeds (net of issuance costs) were allocated between preferred stock and additional paid in capital (for the warrant component). The market/discount rate used when deriving the fair value of the preferred stock was 10.00%. This rate was determined by calculating the average dividend rate of the five most recent preferred equity offerings completed by banks and thrifts. A Black-Scholes model was used to calculate the fair value of the common stock warrants. Key assumptions input into the model included: amount of common stock, $1,050,000 (based on 15% of the gross TARP proceeds); market price of the common stock on the warrant grant date, $6.75; exercise price of the warrant, $8.65 (20 day trailing average of the common stock as of the Treasury’s approval date); number of common stock warrants issued, 121,387; expected life of the warrants, 5 years; the risk free interest rate, 1.55%; the continuous annualized volatility of the change in the underlying common stock’s price, 32.00%; and the simple annual expected cash dividend yield on common stock, 8.30%. Based on the calculations, the fair value of the preferred stock represented 95.65% of the total fair value of the preferred stock and common stock warrants, while the fair value of the common stock warrants represented 4.35% of the total. The discount on the preferred stock is being amortized on a straight-line basis over five years.

 

34

---

Table of Contents

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

FIDELITY BANCORP, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words “believes,” “anticipates,” “contemplates,” “expects,” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, risks associated with the effect of integrating newly acquired businesses, the ability to control costs and expenses, and general economic conditions. The Company does not undertake to, and specifically disclaims any obligation to, update any such forward-looking statements.

Fidelity Bancorp, Inc.’s (“Fidelity” or the “Company”) business is conducted principally through its wholly-owned subsidiary, Fidelity Bank PaSB, (the “Bank”). All references to the Company refer collectively to the Company and the Bank, unless the context indicates otherwise.

Critical Accounting Policies

Note 1 on pages 60 through 67 of the Company’s 2010 Annual Report to Shareholders lists significant accounting policies used in the development and presentation of its financial statements. This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of the Company and its results of operations.

The most significant estimates in the preparation of the Company’s financial statements are for the allowance for loan losses, evaluation of investments for other-than-temporary impairment, income taxes, and accounting for stock options. Please refer to the discussion of the allowance for loan losses in Note 7, “Loans Receivable and Related Allowance for Loan Losses”, on pages 20 through 25 above. In addition, further discussion of the estimates used in determining the allowance for loan losses is contained in the discussion on “Provision for Loan Losses” on page 47 of the Company’s 2010 Annual Report to Shareholders. Please refer to the discussion of other-than-temporary impairment in Note 6, “Securities”, on pages 13 through 20 above and in Note 2, “Securities”, on pages 68 through 75 of the Company’s 2010 Annual Report to Shareholders. Please refer to the discussion of income taxes on page 45 below and in Note 11, “Income Taxes”, on pages 85 through 87 of the Company’s 2010 Annual Report to Shareholders. Stock based compensation expense is reported in net income utilizing the fair value-based method in accordance with U.S. generally accepted accounting principles. The fair value of each option award is estimated at the date of grant using the Black-Scholes option-pricing model. Please refer to the discussion of stock based compensation in Note 4, “Stock Based Compensation”, on pages 10 and 11 above. In addition, further discussion of the assumptions used in determining stock based compensation is contained in Note 14, “Stock Option Plans”, on pages 89 through 91 of the Company’s 2010 Annual Report to Shareholders.

Comparison of Financial Condition

Total assets of the Company decreased $11.9 million, or 1.7%, to $684.8 million at March 31, 2011 from $696.7 million at September 30, 2010. Significant changes in individual categories include decreases in net loans of $34.7 million and loans held-for-sale of $1.8 million, partially offset by increases in cash and cash equivalents of $22.6 million and securities held-to-maturity of $2.0 million. The decrease in net loans reflects $76.9 million of repayments, partially offset by $42.4 million in loan originations. The increase in cash and cash equivalents is a result of an increase in maturities and repayments of loans and securities.

Total liabilities of the Company decreased $12.2 million, or 1.9%, to $634.9 million at March 31, 2011 from $647.1 million at September 30, 2010. Significant changes include a decrease in securities sold under agreement to repurchase, partially offset by an increase in advance payments by borrowers for taxes and insurance. Securities sold under agreement to repurchase decreased $13.1 million at March 31, 2011 as compared to September 30, 2010 primarily due to the Company repaying a $10.0 million wholesale structured borrowing that matured during the current quarter.

 

35

---

Table of Contents

Stockholders’ equity increased slightly to $49.9 million at March 31, 2011, compared to $49.6 million at September 30, 2010. This result reflects net income for the six-month period ended March 31, 2011 of $525,000; stock issued under the Dividend Reinvestment Plan of $9,000; stock-based compensation expense of $20,000; and stock contributed to the employee stock ownership plan of $250,000. Offsetting these increases were common and preferred stock cash dividends paid of $297,000 and an increase in the accumulated other comprehensive loss of $196,000, which is a result of changes in the net unrealized losses on the available-for-sale securities, changes in non-credit losses on available-for-sale and held-to-maturity securities, and by the unrealized loss recognized on the cash flow hedge as discussed in Note 8, “Derivative Instruments”, on pages 25 and 26 above. On December 12, 2008, the Company sold $7.0 million in preferred stock to the U.S. Department of Treasury as a participant in the federal government’s TARP Capital Purchase Program. In connection with the investment, the Company also issued a ten-year warrant to the Treasury which permits the Treasury to purchase up to 121,387 shares of its common stock at an exercise price of $8.65 per share. The Series B Preferred Stock will pay dividends at the rate of 5% per annum until the fifth anniversary of issuance and, unless redeemed earlier, at the rate of 9% thereafter. Until the third anniversary of the issuance of the Series B Preferred Stock or its earlier redemption or transfer by the Treasury Department to an unaffiliated holder, the Company may not increase the dividend on the common stock or repurchase any shares of common stock. Approximately $3.4 million of the balances in retained earnings as of March 31, 2011 and September 30, 2010 represent base year bad debt deductions for tax purposes only, as they are considered restricted accumulated earnings.

Non-Performing Assets

The following table sets forth information regarding non-accrual loans and foreclosed real estate held by the Company at the dates indicated. The table does not include $3.6 million and $4.8 million in loans at March 31, 2011 and September 30, 2010, respectively, that were more than 90 days past due. Included in the $3.6 million is $3.2 million of loans, which have reached their maturity dates and are in the process of renewing. These loans represent commercial real estate loans, commercial business loans, and commercial business lines of credit.

 

		March 31, 2011				September 30, 2010
		(Dollars in Thousands)
Non-accrual residential real estate loans (one-to-four family)		$	1,858			$	1,939
Non-accrual construction, multi-family residential and commercial real estate loans			6,810				7,151
Non-accrual installment loans			697				1,212
Non-accrual commercial business loans			332				70
Total non-performing loans		$	9,697			$	10,372
Total non-performing loans as a percent of net loans receivable			2.87	%			2.78	%
Total foreclosed real estate		$	1,302			$	398
Total non-performing loans and foreclosed real estate as a percent of total assets			1.61	%			1.55	%

Included in non-performing loans at March 31, 2011 are twenty-one single-family residential real estate loans totaling $1.9 million, three commercial real estate loans totaling $6.8 million, nineteen installment loans totaling $697,000, and three commercial business loans totaling $332,000. Non-performing loans decreased $675,000 to $9.7 million at March 31, 2011 from $10.4 million at September 30, 2010. The decrease was primarily due to a decrease in non-accrual installment loans.

 

36

---

Table of Contents

At March 31, 2011, the Company had one troubled debt restructuring that had a recorded investment of $2.8 million. The Company originally agreed to a restructure of this loan at its maturity by entering into a forbearance agreement with the borrower to make reduced payments over a six-month period in an effort to give the borrower greater flexibility to restructure its operations and to improve its cash flows during this difficult economic period. The Company has never had any payment delinquency with this borrower. The borrower is making principal and interest payments in accordance with the new loan agreement and with the most recent Shared National Credit Examination this loan was removed from non-accrual status at September 30, 2010. A $140,000 specific reserve has been established against this credit.

At March 31, 2011, the Company had an allowance for loan losses of $6.2 million or 1.8% of gross loans receivable, as compared to an allowance of $5.8 million or 1.5% of gross loans receivable at September 30, 2010. The allowance for loan losses equals 63.7% of non-performing loans at March 31, 2011 compared to 56.1% at September 30, 2010. The level of the allowance for loan losses as a percentage of non-performing loans reflects the concentration of non-performing loans in the commercial real estate category, most of which are collateral-dependent loans that do not have a related allowance for loan losses as a result of applying impairment tests prescribed under U.S. generally accepted accounting principles (see Footnote 7). Management believes the balance in the allowance for loan losses is adequate based on its analysis of quantitative and qualitative factors as of March 31, 2011. Management has evaluated its entire loan portfolio, including these non-performing loans, and the overall allowance for loan losses and believes that the allowance for losses on loans at March 31, 2011 is reasonable. See also “Provision for Loan Losses” on page 42. However, there can be no assurance that the allowance for loan losses is sufficient to cover possible future loan losses.

The Company recognizes that it must maintain an Allowance for Loan and Lease Losses (“ALLL”) at a level that is adequate to absorb estimated credit losses associated with the loan and lease portfolio. The Company’s Board of Directors has adopted an ALLL policy designed to provide management with a systematic methodology for determining and documenting the ALLL each reporting period. This methodology was developed to provide a consistent process and review procedure to ensure that the ALLL is in conformity with the Company’s policies and procedures and other supervisory and regulatory guidelines.

The Company’s ALLL methodology incorporates management’s current judgments about the credit quality of the loan portfolio. The following factors are considered when analyzing the adequacy of the allowance: historical loss experience; volume; type of lending conducted by the Bank; industry standards; the level and status of past due and non-performing loans; the general economic conditions in the Bank’s lending area; and other factors affecting the collectibility of the loans in its portfolio. The primary elements of the Bank’s methodology include portfolio segmentation and impairment measurement. Management acknowledges that this is a dynamic process and consists of factors, many of which are external and out of management’s control, that can change often, rapidly and substantially. The adequacy of the ALLL is based upon estimates considering all the aforementioned factors as well as current and known circumstances and events. There is no assurance that actual portfolio losses will not be substantially different than those that were estimated.

 

37

---

Table of Contents

Comparison of Results of Operations

for the Three and Six Months Ended March 31, 2011 and 2010

Net Income

The Company recorded net income for the three months ended March 31, 2011 of $659,000 and net income available to common stockholders of $556,000 or $0.18 per diluted common share compared to net income of $479,000 and net income available to common stockholders of $376,000 or $0.12 per diluted common share for the same period in fiscal 2010. The $180,000 increase in earnings primarily reflects an increase in net interest income of $161,000, or 4.6%, an increase in non-interest income (excluding other-than-temporary impairment “OTTI” charges) of $232,000, or 17.8%, partially offset by an increase in other non-interest expense of $19,000, or 0.5% and an increase in income tax provision of $211,000. OTTI charges were $279,000 for the three months ended March 31, 2011 compared to $296,000 for the prior year period.

The Company recorded net income for the six months ended March 31, 2011 of $525,000 and net income available to common stockholders of $320,000 or $0.11 per diluted common share compared to net income of $711,000 and net income available to common stockholders of $506,000 or $0.17 per diluted common share for the same period in fiscal 2010. The $186,000 decrease in earnings primarily reflects a decrease in the gains on sales of securities of $451,000. Other factors contributing to the decrease in earnings include an increase in operating expenses of $146,000, or 2.0% and a decrease in income tax benefit of $90,000, partially offset by an increase in net interest income of $257,000, or 3.6%, a decrease in OTTI charges of $174,000, and an increase in other income (excluding OTTI charges and gains on sales of securities) of $70,000, or 3.5%. OTTI charges were $1.4 million for the six months ended March 31, 2011 compared to $1.5 million for the prior year period.

The Company’s net income available to common stockholders and diluted earnings per common share for the three and six months ended March 31, 2011 and 2010 reflects the impact of $103,000 and $205,000, respectively, of preferred stock dividends and discount accretion in each period.

 

38

---

Table of Contents

Interest Rate Spread

The Company’s interest rate spread, the difference between average yields calculated on a tax-equivalent basis on interest-earning assets and the average cost of funds, increased to 2.10% (annualized) in the three months ended March 31, 2011 from 1.94% (annualized) in the same period in 2010. The Company’s tax-equivalent interest rate spread increased to 2.12% (annualized) in the six months ended March 31, 2011 from 1.97% (annualized) in the same period in 2010. The increase for the three and six month periods ended March 31, 2011 is the result of the average rate paid on interest-bearing liabilities decreasing more than the average yield on interest-earning assets. The decrease in average rate paid on interest-bearing liabilities reflects the repayment of higher rate long-term debt and structured wholesale debt between the periods. The following table shows the average yields earned on the Company’s interest-earning assets and the average rates paid on its interest-bearing liabilities for the periods indicated, the resulting interest rate spreads, and the net yields on interest-earning assets.

 

		Three Months Ended March 31,								Six Months Ended March 31,
		2011				2010				2011				2010
Average yield on:
Mortgage loans			5.65	%			5.55	%			5.66	%			5.62	%
Mortgage-backed securities			2.82				3.07				2.80				3.25
Installment loans			5.35				5.56				5.36				5.66
Commercial business loans and leases			4.99				4.91				4.90				4.96
Interest-earning deposits with other institutions, investment securities, and FHLB stock (1)			2.64				3.02				2.71				3.02
Total interest-earning assets			4.22				4.46				4.27				4.54
Average rates paid on:
Deposits			1.13				1.42				1.16				1.50
Securities sold under agreement to repurchase			4.82				4.83				4.76				4.81
Short-term borrowings			0.18				0.23				0.20				0.25
Long-term debt			3.38				4.15				3.38				4.14
Subordinated debt			5.28				5.28				5.28				5.28
Total interest-bearing liabilities			2.12				2.52				2.15				2.57
Average interest rate spread			2.10	%			1.94	%			2.12	%			1.97	%
Net yield on interest-earning assets			2.36	%			2.18	%			2.36	%			2.20	%

 

(1)

Interest income on tax-exempt investments has been adjusted for federal income tax purposes using a rate of 34%. Interest income on tax-exempt investment securities was $382,000 and $442,000 and the yield was 4.13% and 4.19%, prior to adjusting for federal income tax for the three months ended March 31, 2011 and 2010, respectively. Interest income on tax-exempt investment securities was $778,000 and $888,000 and the yield was 4.10% and 4.22%, prior to adjusting for federal income tax for the six months ended March 31, 2011 and 2010, respectively.

 

39

---

Table of Contents

Interest Income

Interest on loans decreased $577,000 or 10.6% to $4.9 million for the three months ended March 31, 2011, compared to $5.5 million in the same period in 2010. Interest on loans decreased $1.2 million or 10.9% to $10.0 million for the six months ended March 31, 2011, compared to $11.3 million in the same period in 2010. The decrease for the three months ended March 31, 2011 reflects a decrease in the average size of the loan portfolio, partially offset by a slight increase in the average yield earned on the loan portfolio. The decrease for the six months ended March 31, 2011 reflects both a decrease in the average size of the loan portfolio and a decrease in the average yield earned on the loan portfolio. For the three-month period ended March 31, 2011, the average outstanding loan balances decreased $44.9 million or 11.2% and the average yield increased by 4 basis points from 5.46% in the prior period to 5.50% in the current period. For the six-month period ended March 31, 2011, the average outstanding loan balances decreased $41.3 million or 10.2% and the average yield decreased by 5 basis points from 5.54% in the prior period to 5.49% in the current period. The average loan balances continued to decrease primarily due to increases in principal repayments mainly caused by customers refinancing their mortgage loans. Also, due to the current low interest rate environment, for asset/liability purposes, the Bank continues to sell a portion of the fixed rate, single-family mortgage loans that it originates.

Interest on mortgage-backed securities increased $78,000 or 10.6% to $816,000 for the three-month period ended March 31, 2011, compared to $738,000 in the same period in 2010. Interest on mortgage-backed securities increased $16,000 or 1.1% to $1.5 million for the six-month period ended March 31, 2011, as compared to the same period in 2010. The increase for both periods reflects an increase in the average balance of mortgage-backed securities owned, partially offset by a decrease in the average yield earned on the portfolio. For the three-month period ended March 31, 2011, the average balance of mortgage-backed securities increased $19.5 million or 20.3% and the average yield decreased by 25 basis points from 3.07% in the prior period to 2.82% in the current period. For the six-month period ended March 31, 2011, the average balance of mortgage-backed securities increased $16.7 million or 17.9% and the average yield decreased by 45 basis points from 3.25% in the prior period to 2.80% in the current period. The yield earned on mortgage-backed securities is affected, to some degree, by the repayment rate of loans underlying the securities. Premiums or discounts on the securities, if any, are amortized to interest income over the life of the securities using the level yield method. During periods of falling interest rates, repayments of the loans underlying the securities generally increase, which shortens the average life of the securities and accelerates the amortization of the premium or discount. Falling rates, however, also tend to increase the market value of the securities.

Interest on interest-bearing demand deposits with other institutions and investment securities (non-tax equivalent) decreased $172,000 or 14.2% to $1.0 million for the three months ended March 31, 2011, as compared to $1.2 million in the same period in 2010. Interest on interest-bearing demand deposits with other institutions and investment securities (non-tax equivalent) decreased $315,000 or 12.9% to $2.1 million for the six months ended March 31, 2011, as compared to $2.4 million in the same period in 2010. The decrease for both periods reflects both a decrease in the average balance of investment securities in the portfolio and a decrease in the yield earned on these investments. For the three-month period ended March 31, 2011, the average balance of interest-bearing demand deposits with other institutions and investment securities decreased $2.9 million or 1.5% and the average tax-equivalent yield decreased by 38 basis points from 3.02% in the prior period to 2.64% in the current period. For the six-month period ended March 31, 2011, the average balance of interest-bearing demand deposits with other institutions and investment securities decreased $5.4 million or 2.8% and the average tax-equivalent yield decreased by 31 basis points from 3.02% in the prior period to 2.71% in the current period. The lower average balance was primarily related to repayments of investment securities, partially offset by higher interest-bearing demand deposits with other institutions resulting from increased maturities and repayments of loans and securities. The decrease in the yields are a result of the current lower interest rate environment.

 

40

---

Table of Contents

Interest Expense

Interest on deposits decreased $301,000 or 21.5% to $1.1 million for the three-month period ended March 31, 2011, as compared to $1.4 million during the same period in 2010. Interest on deposits decreased $710,000 or 23.8% to $2.3 million for the six-month period ended March 31, 2011, as compared to $3.0 million during the same period in 2010. The decrease for both periods reflects both a decrease in the average balance of deposits and a decrease in the average cost of the deposits. For the three-month period ended March 31, 2011, the average balance of deposits decreased $5.7 million or 1.4% and the average yield decreased by 29 basis points from 1.42% in the prior period to 1.13% in the current period. For the six-month period ended March 31, 2011, the average balance of deposits decreased $6.0 million or 1.5% and the average yield decreased by 34 basis points from 1.50% in the prior period to 1.16% in the current period. Management continues to try to attract and retain deposit accounts. The Company manages its cost of interest bearing deposit accounts by diligently monitoring the interest rates on its products as well as the rates being offered by its competition through bi-weekly interest rate committee meetings and utilizing rate surveys and subsequently adjusting rates accordingly.

Interest on securities sold under agreement to repurchase, including retail, term, and wholesale structured borrowings, decreased $64,000 or 5.1% to $1.2 million for the three-month period ended March 31, 2011, as compared to the same period in 2010. Interest on securities sold under agreement to repurchase, including retail, term, and wholesale structured borrowings, decreased $71,000 or 2.8% to $2.5 million for the six-month period ended March 31, 2011, as compared to the same period in 2010. The decrease for both periods reflects both a decrease in the cost of these funds and a lower level of average securities sold under agreement to repurchase. For the three-month period ended March 31, 2011, the average balance of securities sold under agreement to repurchase decreased $5.2 million or 5.0% and the average yield decreased by 1 basis point from 4.83% in the prior period to 4.82% in the current period. For the six-month period ended March 31, 2011, the average balance of securities sold under agreement to repurchase decreased $1.9 million or 1.8% and the average yield decreased by 5 basis points from 4.81% in the prior period to 4.76% in the current period. The Bank had $85.0 million and $95.0 million of wholesale structured borrowings outstanding at March 31, 2011 and 2010, respectively.

Interest on short-term borrowings, including advance payments by borrowers for taxes and insurance and treasury, tax, and loan notes, decreased $1,000 or 50.0% to $1,000 for the three-month period ended March 31, 2011, as compared to $2,000 in the same period in 2010. Interest on short-term borrowings, including advance payments by borrowers for taxes and insurance and treasury, tax, and loan notes, decreased $1,000 or 33.3% to $2,000 for the six-month period ended March 31, 2011, as compared to $3,000 in the same period in 2010. The decrease for both periods reflects a decrease in the average cost of these borrowings, partially offset by an increase in the average balance of these borrowings. For the three-month period ended March 31, 2011 the average balance of short-term borrowings increased $106,000 or 4.0% and the average yield decreased by 5 basis points from 0.23% in the prior period to 0.18% in the current period. For the six-month period ended March 31, 2011 the average balance of short-term borrowings increased $14,000 or 0.6% and the average yield decreased by 5 basis points from 0.25% in the prior period to 0.20% in the current period.

Interest on long-term debt, including FHLB fixed rate advances and “Convertible Select” advances, decreased $466,000 or 41.1% to $668,000 for the three-month period ended March 31, 2011, as compared to $1.1 million in the same period in 2010. Interest on long-term debt, including FHLB fixed rate advances and “Convertible Select” advances, decreased $1.0 million or 42.7% to $1.4 million for the six-month period ended March 31, 2011, as compared to $2.4 million in the same period in 2010. The decrease for both periods reflects both a decrease in the average balance of the debt and a decrease in the average cost of the debt. For the three-month period ended March 31, 2011, the average balance of long-term debt decreased $30.9 million or 27.8% and the average yield decreased by 77 basis points from 4.15% in the prior period to 3.38% in the current period. For the six-month period ended March 31, 2011, the average balance of long-term debt decreased $34.1 million or 29.9% and the average yield decreased by 76 basis points from 4.14% in the prior period to 3.38% in the current period. The decrease in the average balance and average cost reflects the Company’s decision to de-leverage the balance sheet and was accomplished by using its excess cash to pay off higher rate long-term debt that has matured between the periods. As noted above, the excess liquidity resulted from the decrease in net loan average balances resulting from increased prepayments.

 

41

---

Table of Contents

Net Interest Income

The Company’s net interest income increased $161,000 or 4.6% to $3.7 million, for the three-month period ended March 31, 2011, as compared to $3.5 million in the same period in 2010. The Company’s net interest income increased $257,000 or 3.6% to $7.4 million, for the six-month period ended March 31, 2011, as compared to $7.2 million in the same period in 2010. The increase in net interest income for the three-month period ended March 31, 2011 reflects interest expense decreasing more than interest income. Interest income decreased $671,000 or 9.1% to $6.7 million as compared to $7.4 million in the same period in 2010. The decrease reflects both a decrease in the average balance of interest earning assets and a decrease in the yields earned on these assets. Interest expense decreased $832,000 or 21.4% to $3.1 million as compared to $3.9 million in the same period in 2010. The decrease reflects both a decrease in the average balance of interest-bearing liabilities and a decrease in the interest rates paid on interest-bearing liabilities. The increase in net interest income for the six-month period ended March 31, 2011 reflects interest expense decreasing more than interest income. Interest income decreased $1.5 million or 10.1% to $13.7 million as compared to $15.2 million in the same period in 2010. The decrease reflects both a decrease in the average balance of interest earning assets and a decrease in the yields earned on these assets. Interest expense decreased $1.8 million or 22.2% to $6.3 million as compared to $8.1 million in the same period in 2010. The decrease reflects both a decrease in the average balance of interest-bearing liabilities and a decrease in the interest rates paid on interest-bearing liabilities. For the three months ended March 31, 2011 and 2010 the ratio of average interest-earning assets to average interest-bearing liabilities was 112.3% and 109.3%, respectively. For the six months ended March 31, 2011 and 2010 the ratio of average interest-earning assets to average interest-bearing liabilities was 112.3% and 109.5%, respectively.

Provision for Loan Losses

The provision for loan losses was $300,000 for the three-month periods ended March 31, 2011 and 2010. The provision for loan losses was $600,000 for the six-month periods ended March 31, 2011 and 2010. At March 31, 2011, the allowance for loan losses increased to $6.2 million from $5.8 million at September 30, 2010. Net loan charge-offs were $91,000 for the three months ended March 31, 2011 as compared to net loan charge-offs of $776,000 for the three months ended March 31, 2010. Net loan charge-offs were $248,000 for the six months ended March 31, 2011 as compared to net loan charge-offs of $815,000 for the six months ended March 31, 2010.

The provision for loan losses is charged to operations to bring the total allowance for loan losses to a level that represents management’s best estimates of the losses inherent in the portfolio based on a quarterly review by management of factors such as historical loss experience, volume, type of lending conducted by the Bank, industry standards, the level and status of past due and non-performing loans, the general economic conditions in the Bank’s lending area, and other factors affecting the collectibility of the loans in its portfolio. However, there can be no assurance that the allowance for loan losses will be adequate to cover losses which may be realized in the future and that additional provisions for losses will not be required.

Non-interest Income

Excluding OTTI charges of $279,000 and $1.4 million for the three and six months ended March 31, 2011, respectively, and $296,000 and $1.5 million for the three and six months ended March 31, 2010, respectively, total non-interest or other income increased $232,000 or 17.8% to $1.5 million and decreased $381,000 or 12.6% to $2.6 million for the three and six month periods ended March 31, 2011, respectively, as compared to $1.3 million and $3.0 million during the same periods in 2010. The increase for the three-month period ended March 31, 2011 is primarily attributed to an increase in realized gains on sales of securities, an increase in ATM fees, an increase in non-insured investment products income, and an increase in other income, partially offset by a decrease in gains on sales of loans and a decrease in deposit service charges and fees. The decrease for the six-month period ended March 31, 2011 is primarily attributed to a decrease in realized gains on sales of securities and a decrease in deposit service charges and fees, partially offset by an increase in loan service charges and fees, an increase in ATM fees, an increase in non-insured investment products income, and an increase in other income.

 

42

---

Table of Contents

Impairment charges on securities were $279,000 and $296,000 for the three months ended March 31, 2011 and 2010, respectively. The impairment charges for the current three-month period relate to the Company’s holdings of a pooled trust preferred security, a single issue trust preferred security, and one private label mortgage-backed security. The pooled trust preferred impairment charges resulted from several factors, including a downgrade in its credit rating, its failure to pass its principal coverage test, indications of a break in yield, and the decline in the net present value of its projected cash flows. The impairment charges on the single issue trust preferred security resulted from the financial institution being put on regulatory order after several quarters of losses and it started deferring interest payments on both its trust preferred and its TARP preferred shares outstanding. Management of the Company has deemed the impairment on the trust preferred securities to be other-than-temporary based upon these factors and the duration and extent to which the market value has been less than cost, the inability to forecast a recovery in market value, and other factors concerning the issuers in the pooled securities. The private label mortgage-backed security impairment charge resulted from a downgrade in its credit rating, as well as independent third-party analysis of the underlying collateral for the bond. The impairment charges for the prior three-month period relate to the Company’s investments in two pooled trust preferred securities. Impairment charges on securities were $1.4 million and $1.5 million for the six months ended March 31, 2011 and 2010, respectively. In addition to the three-month period charges, the impairment charges for the current six-month period relate to four additional pooled trust preferred securities and a common stock of a local financial institution. The common stock impairment charge resulted from the duration and extent to which the market value has been less than cost and the performance of the financial institution over the past two years. The impairment charges for the prior six-month period relate to the Company’s investments in six pooled trust preferred securities. At March 31, 2011, the Company had holdings in 20 different trust preferred offerings with a book value of $15.4 million. The unrealized loss on these securities amounted to $3.4 million at March 31, 2011. Included in the Company’s holdings of trust preferred securities are 13 pooled trust preferred securities with a book value of $11.6 million and an unrealized loss of $2.9 million as of March 31, 2011. Of the $11.6 million in pooled trust preferred securities, five securities representing $8.3 million pass their principal coverage tests, while eight pooled securities with a book value of $3.3 million do not. Those securities that fail their coverage test have a current face amount of $11.7 million for which $8.4 million in impairment charges have previously been taken.

Loan service charges and fees, which includes late charges on loans and other miscellaneous loan fees was relatively unchanged for the three months ended March 31, 2011 as compared to the same period in 2010. Loan service charges and fees increased $80,000 or 28.8% to $358,000, as compared to $278,000 during the same period in 2010. The increase for the six-month period ended March 31, 2011 is primarily attributed to an increase in miscellaneous fees collected on commercial business loans and an increase in title insurance fees, partially offset by a decrease in late charges on mortgage loans.

The Company recognized $580,000 and $586,000 in net realized gains on the sales of securities for the three and six months ended March 31, 2011, respectively, as compared to $387,000 and $1.0 million during the same periods in 2010. The current period sales were made from the available-for-sale portfolio as part of management’s asset/liability management strategies.

Gains on the sales of loans were $76,000 and $228,000 for the three and six months ended March 31, 2011, respectively, as compared to $86,000 and $221,000 during the same periods in 2010. The three-month period ended March 31, 2011 results reflect the sale of approximately $3.2 million of fixed-rate, single-family mortgage loans, compared to $5.8 million of similar loan sales during the prior year period. The six-month period ended March 31, 2011 results reflect the sale of approximately $11.5 million of fixed-rate, single-family mortgage loans, compared to $14.6 million of similar loan sales during the prior year period. Due to the low interest rate environment, the Bank continues to sell a portion of the fixed rate, single-family mortgage loans it originates.

Deposit service charges and fees were $295,000 and $600,000 for the three and six months ended March 31, 2011 as compared to $334,000 and $719,000 during the same periods in 2010. The decrease for both periods is attributed to a decrease in net volume of fees collected for returned checks.

Automated teller machine (ATM) fees were $235,000 and $476,000 for the three and six months ended March 31, 2011 as compared to $214,000 and $457,000 during the same periods in 2010. The increase for the three and six months ended March 31, 2011 is attributed to an increase in the interchange fees earned on debit card transactions.

 

43

---

Table of Contents

Included in the results for the six months ended March 31, 2010 was a one-time incentive payment of $45,000 the Bank received to convert its ATM network.

Non-insured investment product income was $54,000 and $106,000 for the three and six months ended March 31, 2011 as compared to $34,000 and $83,000 for the same periods in 2010. The increase for both periods is primarily attributed to an increase in the commissions earned on the sales of these products due to higher volumes of sales.

Other income was $102,000 and $143,000 for the three and six months ended March 31, 2011 as compared to $64,000 and $100,000 for the same periods in 2010. The increase for both periods in primarily attributable to an increase in commissions and fees earned on the sales of insurance products.

Non-interest Expense

Total non-interest expense for the three-month period ended March 31, 2011 increased $19,000, or 0.5%, to $3.8 million, as compared to the same period in 2010. Total non-interest expense for the six-month period ended March 31, 2011 increased $146,000, or 2.0%, to $7.6 million, as compared to $7.5 million for the same period in 2010. The increase for the three months ended March 31, 2011 is primarily attributed to an increase in compensation and benefits expense, an increase in office occupancy and equipment expense, an increase in depreciation and amortization expense, and an increase in advertising expense, partially offset by a decrease in professional fees, a decrease in federal deposit insurance premiums, and a decrease in other operating expenses. The increase for the six months ended March 31, 2011 is primarily attributed to an increase in compensation and benefits expense, an increase in depreciation and amortization expense, and an increase in advertising expense, partially offset by a decrease in professional fees, a decrease in federal deposit insurance premiums, and a decrease in other operating expenses.

Compensation and benefits expense was $2.2 million for the three-month period ended March 31, 2011, as compared to $2.0 million for the same period in 2010. Compensation and benefits expense was $4.4 million for the six-month period ended March 31, 2011, as compared to $4.1 million for the same period in 2010. The increase for the three and six months ended March 31, 2011 is attributed to an increase in retirement fund expense, an increase in commissions expense, an increase in unemployment compensation expense, an increase in health insurance expense, and an increase in bonus expense.

Office occupancy and equipment expense was $301,000 for the three months ended March 31, 2011 as compared to $274,000 in the same period in 2010. Office occupancy and equipment expense was $528,000 for the six months ended March 31, 2011 and 2010. The increase for the three months ended March 31, 2011 was primarily due to the Bank opening a new branch in McCandless Township, Pennsylvania on November 8, 2010.

Depreciation and amortization expense was $145,000 and $287,000 for the three and six months ended March 31, 2011 as compared to $133,000 and $267,000 for the same period in 2010. The increase for both periods is primarily attributed to an increase in depreciation expense on its information and network systems as a result of the Bank continually expanding technology and new products and services.

Advertising expense was $100,000 and $200,000 for the three and six months ended March 31, 2011, respectively, as compared to $82,000 and $182,000 for the same periods in 2010. The Company strives to market its products and services in a cost effective manner and incorporates a market segmentation strategy in its business plan to effectively manage its advertising dollars.

Professional fees were $115,000 and $234,000 for the three and six months ended March 31, 2011, respectively, as compared to $130,000 and $270,000 for the same periods in 2010. The decrease for both periods is primarily attributed to a decrease in legal fees.

Federal deposit insurance premiums were $298,000 and $594,000 for the three and six months ended March 31, 2011, respectively, as compared to $322,000 and $631,000 for the same periods in 2010. The decrease for both periods is primarily due to accrual adjustments booked in the three and six-month periods ended March 31, 2011.

 

44

---

Table of Contents

Other operating expenses were $505,000 for the three-month period ended March 31, 2011 compared to $651,000 for the same period in 2010. Other operating expenses were $1.1 million for the six-month period ended March 31, 2011 compared to $1.2 million for the same period in 2010. The decrease for the three and six-month periods ended March 31, 2011 is primarily attributed to a decrease in scorecard rewards redemption expense, teller cash over and short expense, and a decrease in ATM card expense.

Income Taxes

Total income tax provision was $200,000 for the three months ended March 31, 2011 as compared to a benefit of $11,000 for the same period in 2010. Total income tax benefit was $34,000 and $124,000 for the six months ended March 31, 2011 and 2010, respectively. The tax benefits for the periods were significantly impacted by the OTTI charges during the respective periods. The OTTI charges recorded in the current six-month period caused pre-tax income to be lower than tax-exempt income, therefore a tax benefit was recorded. Tax-exempt income includes: income earned on certain municipal investments that qualify for state and/or federal income tax exemption; income earned by the Bank’s Delaware subsidiary, which is not subject to state income tax; and earnings on Bank-owned life insurance policies, which are exempt from federal taxation. State and federal tax-exempt income for the three-month period ended March 31, 2011 was $1.7 million and $357,000, respectively, compared to $1.7 million and $445,000, respectively, for the three-month period ended March 31, 2010. State and federal tax-exempt income for the six-month period ended March 31, 2011 was $3.2 million and $729,000, respectively, compared to $3.9 million and $852,000, respectively, for the six-month period ended March 31, 2010.

Capital Requirements

The Federal Reserve Board measures capital adequacy for bank holding companies on the basis of a risk-based capital framework and a leverage ratio. The guidelines include the concept of Tier 1 capital and total capital. Tier 1 capital is essentially common equity, excluding net unrealized gains (losses) on securities available-for-sale, goodwill, and cash flow hedges, plus certain types of preferred stock, including the Series B Preferred Stock, and the Preferred Securities issued by FB Statutory Trust III in 2007. The Preferred Securities may comprise up to 25% of the Company’s Tier 1 capital. The Series B Preferred Stock constitutes Tier 1 Capital for both the risk-weighted and leverage capital requirements. Total capital includes Tier 1 capital and other forms of capital such as the allowance for loan losses, subject to limitations, and subordinated debt. The guidelines establish a minimum standard risk-based target ratio of 8%, of which at least 4% must be in the form of Tier 1 capital. At March 31, 2011, the Company had Tier 1 capital as a percentage of risk-weighted assets of 13.40% and total risk-based capital as a percentage of risk-weighted assets of 14.66%.

In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. These guidelines currently provide for a minimum ratio of Tier 1 capital as a percentage of average total assets (the “Leverage Ratio”) of 3% for bank holding companies that meet certain criteria, including that they maintain the highest regulatory rating. All other bank holding companies are required to maintain a Leverage Ratio of at least 4% or be subject to prompt corrective action by the Federal Reserve. At March 31, 2011, the Company had a leverage ratio of 7.68%.

The FDIC has issued regulations that require insured institutions, such as the Bank, to maintain minimum levels of capital. In general, current regulations require a leverage ratio of Tier 1 capital to average total assets of not less than 3% for the most highly rated institutions and an additional 1% to 2% for all other institutions. At March 31, 2011, the Bank complied with the minimum leverage ratio having Tier 1 capital of 7.29% of average total assets, as defined.

The Bank is also required to maintain a ratio of qualifying total capital to risk-weighted assets and off-balance sheet items of a minimum of 8%. At March 31, 2011, the Bank’s total capital to risk-weighted assets ratio calculated under the FDIC capital requirement was 13.89%.

 

45

---

Table of Contents

Liquidity

The Company’s primary sources of funds have historically consisted of deposits, repurchase agreements, amortization and prepayments of outstanding loans, borrowings from the FHLB of Pittsburgh and other sources, including sales of securities and, to a limited extent, loans. At March 31, 2011, the total of approved loan commitments amounted to $3.6 million. In addition, the Company had $9.5 million of undisbursed loan funds at that date. The amount of savings certificates which mature during the next twelve months totals approximately $72.8 million, a substantial portion of which management believes, on the basis of prior experience as well as its competitive pricing strategy, will remain in the Company.

Off Balance Sheet Commitments

The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.

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

A summary of the contractual amount of the Company’s financial instrument commitments is as follows:

 

		March 31,				September 30,
		2011				2010
		(in thousands)
Commitments to grant loans		$	3,563			$	9,093
Unfunded commitments under lines of credit			85,603				70,684
Financial and performance standby letters of credit			2,099				1,333

The Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit written are conditional commitments issued by the Company 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 that involved in extending other loan commitments. The Bank requires collateral supporting these letters of credit as deemed necessary. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The current amount of liability as of March 31, 2011 for guarantees under standby letters of credit issued is not material.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Not Applicable

 

46

---

Table of Contents

Item 4.

Controls and Procedures

 

The Company’s management evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures, as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

 

There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II - Other Information

 

Item 1.

Legal Proceedings

The Company is not involved in any pending legal proceedings other than non-material legal proceedings undertaken in the ordinary course of business.

 

Item 1A.

Risk Factors

Not Applicable

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Not Applicable

 

Item 3.

Defaults Upon Senior Securities

Not Applicable

 

Item 4.

[Removed and Reserved]

 

Item 5.

Other Information

(a) Not applicable

(b) Not applicable

 

47

---

Table of Contents

Item 6.

Exhibits

The following exhibits are filed as part of this Report.

 

 

48

---

Table of Contents

*	Not filed in accordance with the provisions of Item 601(b)(4)(iii) of Regulation S-K. The Company agrees to provide a copy of these documents to the Commission upon request.

(1)	Incorporated by reference from the exhibits attached to the Prospectus and Proxy Statement of the Company included in its Registration Statement on Form S-4 (SEC File No. 33-55384) filed with the SEC on December 3, 1992 (the “Registration Statement”).

(2)	Incorporated by reference from the identically numbered exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003.

(3)	Incorporated by reference from Exhibit 1 to the Company’s Registration Statement on Form 8-A filed June 30, 2003.

(4)	Incorporated by reference to Exhibit 4.2 to Amendment No. 1 to the Company’s Registration Statement on Form 8-A filed March 17, 2005.

(5)	Incorporated by reference from an exhibit to the Registration Statement on Form S-8 (SEC File No. 333-26383) filed with the SEC on May 2, 1997.

(6)	Incorporated by reference from an exhibit to the Registration Statement on Form S-8 for the year ended September 30, 1998 (SEC File No. 333-47841) filed with the SEC on March 12, 1998.

(7)	Incorporated by reference to an identically numbered exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 1998 filed with the SEC on December 29, 1998.

(8)	Incorporated by reference from Exhibit 4.1 to the Registration Statement on Form S-8 (SEC File No. 333-71145) filed with the SEC on January 25, 1999.

(9)	Incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-8 (SEC File No. 333-53934) filed with the SEC on January 19, 2001.

(10)	Incorporated by reference from Exhibit 4.1 to the Registration Statement on Form S-8 (SEC File No. 333-81572) filed with the SEC on January 29, 2002.

(11)	Incorporated by reference from Exhibit 4.1 to Registration Statement on Form S-8 (SEC File No. 333-103448) filed with the SEC on February 26, 2003.

(12)	Incorporated by reference from Exhibit 4.1 to Registration Statement on Form S-8 (SEC File No. 333-123168) filed with the SEC on March 7, 2005.

(13)	Incorporated by reference to an identically numbered exhibit in Form 10-Q filed with the SEC on February 13, 2007.

(14)	Incorporated by reference to an identically numbered exhibit to the Registrants Annual Report on Form 10-K for the fiscal year ended September 30, 2007.

(15)	Incorporated by reference to an exhibit to the Registrant’s Current Report on Form 8-K filed December 12, 2008.

 

49

---

Table of Contents

SIGNATURES

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

 

				FIDELITY BANCORP, INC.
Date: May 13, 2011				By:		/s/ Richard G. Spencer
						Richard G. Spencer President and Chief Executive Officer
Date: May 13, 2011				By:		/s/ Lisa L. Griffith
						Lisa L. Griffith Sr. Vice President and Chief Financial Officer

 

50