Attached files

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10-Q - 10-Q WATERSTONE FINANCIAL INC (MARYLAND) - Waterstone Financial, Inc.form10q.htm
EX-32.2 - Waterstone Financial, Inc.exhibit322.htm
EX-31.2 - Waterstone Financial, Inc.exhibit312.htm
EX-32.1 - Waterstone Financial, Inc.exhibit321.htm
EX-31.1 - EXHIBIT 1.1 AGENCY AGREEMENT DATED NOVEMBER 6, 2013 - Waterstone Financial, Inc.exhibit311.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

Form 10-Q

T Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2013

OR

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934


Commission File Number 000-51507

WATERSTONE FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

Federal
20-3598485
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
11200 W. Plank Court Wauwatosa, Wisconsin
53226
(Address of principal executive offices)
(Zip Code)

(414) 761-1000
(Registrant's telephone number, including area code)

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

Yes T No o

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

Yes T No o

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 definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer T
Non-accelerated filer o
Smaller reporting company o
(Do not check if smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No T

The number of shares outstanding of the issuer's common stock, $0.01 par value per share, was 31,349,317 at October 31, 2013.


WATERSTONE FINANCIAL, INC.

10-Q INDEX

Page No.
PARTI. FINANCIAL INFORMATION
3
Item l. Financial Statements
3
Consolidated Statements of Financial Condition as of September 30, 2013 (unaudited) and December 31, 2012
3
Consolidated Statements of Income for the three and nine months ended September 30, 2013 and 2012 (unaudited)
4
Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2013 and 2012 (unaudited)
5
Consolidated Statements of Changes in Shareholders' Equity for the nine months ended September 30, 2013 and 2012 (unaudited)
6
Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012 (unaudited)
7
Notes to Consolidated Financial Statements (unaudited)
8 - 32
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
33 - 50
Item 3. Quantitative and Qualitative Disclosures about Market Risk
51
Item 4. Controls and Procedures
51
PART II. OTHER INFORMATION
52
Item 1. Legal Proceedings
52
Item 1A. Risk Factors
52 - 53
Item 6. Exhibits
54
Signatures
54
- 2 -

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements


WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)
September 30, 2013
December 31, 2012
Assets
(In Thousands, except share data)
Cash
$
66,924
37,129
Federal funds sold
10,737
28,576
Interest-earning deposits in other financial institutions and other short term investments
246
5,764
Cash and cash equivalents
77,907
71,469
Securities available for sale (at fair value)
211,629
205,017
Loans held for sale (at fair value)
97,184
133,613
Loans receivable
1,092,176
1,133,672
Less: Allowance for loan losses
24,708
31,043
Loans receivable, net
1,067,468
1,102,629
Office properties and equipment, net
28,484
26,935
Federal Home Loan Bank stock (at cost)
20,193
20,193
Cash surrender value of life insurance
39,231
38,061
Real estate owned
23,147
35,974
Prepaid expenses and other assets
32,575
27,185
Total assets
$
1,597,818
1,661,076
Liabilities and Shareholders' Equity
Liabilities:
Demand deposits
$
91,496
84,140
Money market and savings deposits
124,253
118,453
Time deposits
656,536
736,920
Total deposits
872,285
939,513
Short-term borrowings
37,243
45,888
Long-term borrowings
434,000
434,000
Advance payments by borrowers for taxes
21,934
1,672
Other liabilities
19,523
37,369
Total liabilities
1,384,985
1,458,442
Shareholders' equity:
Preferred stock (par value $.01 per share)
Authorized - 20,000,000 shares, no shares issued
-
-
Common stock (par value $.01 per share)
Authorized - 200,000,000 shares in 2013 and 2012
Issued - 34,073,670 in 2013 and 34,072,909 in 2012
Outstanding - 31,349,317 in 2013 and 31,348,556 in 2012
341
341
Additional paid-in capital
110,456
110,490
Retained earnings
149,258
136,487
Unearned ESOP shares
(1,067
)
(1,708
)
Accumulated other comprehensive (loss) income, net of taxes
(894
)
2,285
Treasury shares (2,724,353 shares), at cost
(45,261
)
(45,261
)
Total shareholders' equity
212,833
202,634
Total liabilities and shareholders' equity
$
1,597,818
1,661,076

See Accompanying Notes to Unaudited Consolidated Financial Statements.
- 3 -


WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

Three months ended September 30,
Nine months ended September 30,
2013
2012
2013
2012
(In Thousands, except per share amounts)
Interest income:
Loans
$
14,425
15,943
44,500
48,834
Mortgage-related securities
455
826
1,311
2,611
Debt securities, federal funds sold and short-term investments
653
505
1,806
1,760
Total interest income
15,533
17,274
47,617
53,205
Interest expense:
Deposits
1,237
1,938
4,055
7,804
Borrowings
4,718
4,701
13,917
13,711
Total interest expense
5,955
6,639
17,972
21,515
Net interest income
9,578
10,635
29,645
31,690
Provision for loan losses
1,000
2,000
3,960
7,100
Net interest income after provision for loan losses
8,578
8,635
25,685
24,590
Noninterest income:
Service charges on loans and deposits
316
395
1,029
1,026
Increase in cash surrender value of life insurance
528
518
929
927
Total other-than-temporary investment losses
-
(1,246
)
-
(1,351
)
Portion of loss recognized in other comprehensive income (before income taxes)
-
1,138
-
1,138
Net impairment losses recognized in earnings
-
(108
)
-
(213
)
Mortgage banking income
18,173
26,668
65,616
63,376
(Loss) gain on sale of available for sale securities
-
-
(9
)
241
Other
2,013
302
3,205
671
Total noninterest income
21,030
27,775
70,770
66,028
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits
16,575
17,823
53,001
43,425
Occupancy, office furniture, and equipment
2,218
1,820
5,995
5,229
Advertising
718
697
2,339
2,021
Data processing
516
401
1,476
1,126
Communications
398
315
1,148
918
Professional fees
626
497
1,762
1,457
Real estate owned
(163
)
1,991
(9
)
6,265
FDIC insurance premiums
516
916
1,569
2,730
Other
3,012
3,357
8,453
10,397
Total noninterest expenses
24,416
27,817
75,734
73,568
Income before income taxes
5,192
8,593
20,721
17,050
Income tax expense
1,973
145
7,950
216
Net income
$
3,219
8,448
12,771
16,834
Income per share:
Basic
$
0.10
0.27
0.41
0.54
Diluted
$
0.10
0.27
0.41
0.54
Weighted average shares outstanding:
Basic
31,163
31,064
31,144
31,045
Diluted
31,414
31,161
31,375
31,125

See Accompanying Notes to Unaudited Consolidated Financial Statements.
- 4 -


WATERSONE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)




Three months ended September 30,
Nine Months Ended September 30,
2013
2012
2013
2012
(In Thousands)
Net income
$
3,219
8,448
12,771
16,834
Other comprehensive income, net of tax:
Net unrealized holding (loss) gain on available for sale securities:
Net unrealized holding (loss) gain arising during the period, net of tax benefit (expense) of ($30), $327, $2,090, ($93), respectively
38
397
(3,184
)
1,319
Reclassification adjustment for net loss (gain) included in net income during the period, net of tax (benefit) expense of $0, ($43),($4), $11, respectively
-
64
5
(17
)
Total other comprehensive (loss) income
38
461
(3,179
)
1,302
Comprehensive income
$
3,257
8,909
9,592
18,136


See Accompanying Notes to Unaudited Consolidated Financial Statements.
- 5 -


WATERSONE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

Accumulated
Additional
Unearned
Other
Total
Common Stock
Paid-In
Retained
ESOP
Comprehensive
Treasury
Shareholders'
Shares
Amount
Capital
Earnings
Shares
Income (Loss)
Shares
Equity
(In Thousands)
Balances at December 31, 2011
31,250
$
340
110,894
101,573
(2,562
)
1,388
(45,261
)
166,372
Comprehensive income:
Net income
-
-
-
16,834
-
-
-
16,834
Other comprehensive income
-
-
-
-
-
1,302
-
1,302
Total comprehensive income
18,136
ESOP shares committed to be released to Plan participants
-
-
(447
)
-
641
-
-
194
Stock based compensation
100
-
110
-
-
-
-
110
Balances at September 30, 2012
31,350
$
340
110,557
118,407
(1,921
)
2,690
(45,261
)
184,812
Balances at December 31, 2012
31,348
$
341
110,490
136,487
(1,708
)
2,285
(45,261
)
202,634
Comprehensive income:
Net income
-
-
-
12,771
-
-
-
12,771
Other comprehensive loss
-
-
-
-
-
(3,179
)
-
(3,179
)
Total comprehensive income
9,592
ESOP shares committed to be released to Plan participants
-
-
(130
)
-
641
-
-
511
Stock based compensation
1
-
96
-
-
-
-
96
Balances at September 30, 2013
31,349
$
341
110,456
149,258
(1,067
)
(894
)
(45,261
)
212,833

See Accompanying Notes to Unaudited Consolidated Financial Statements.
- 6 -


WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

Nine months ended September 30,
2013
2012
(In Thousands)
Operating activities:
Net income
$
12,771
16,834
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses
3,960
7,100
Provision for depreciation
1,936
1,515
Deferred income taxes
4,586
(3,050
)
Stock based compensation
96
110
Net amortization of premium/discount on debt and mortgage related securities
1,764
1,056
Amortization of unearned ESOP shares
511
194
Amortization of mortgage servicing rights
790
194
Gain on sale of loans held for sale
(56,776
)
(63,000
)
Loans originated for sale
(1,419,834
)
(1,245,018
)
Proceeds on sales of loans originated for sale
1,513,039
1,273,144
(Increase) decrease in accrued interest receivable
(499
)
469
Increase in cash surrender value of life insurance
(929
)
(927
)
Decrease in accrued interest on deposits and borrowings
(142
)
(410
)
(Decrease) increase in other liabilities
(4,590
)
7,816
Decrease in accrued tax payable
(2,980
)
(1,349
)
Loss (gain) on sale of available for sale securities
9
(241
)
Impairment of securities
-
213
Net (gain) loss related to real estate owned
(1,313
)
4,282
Gain on sale of mortgage servicing rights
(1,345
)
0
Other
(3,722
)
(4,353
)
Net cash provided by (used in) operating activities
47,332
(5,421
)
Investing activities:
Net decrease in loans receivable
21,084
34,080
Purchases of:
Debt securities
(37,595
)
(6,645
)
Mortgage related securities
(11,182
)
(92,652
)
Certificates of deposit
(1,225
)
(1,470
)
Premises and equipment, net
(3,768
)
(1,035
)
Bank owned life insurance
(241
)
(241
)
Proceeds from:
Principal repayments on mortgage-related securities
30,505
27,289
Maturities of debt securities
4,925
61,376
Sales of debt securities
921
11,908
Calls of structured notes
-
2,648
Sales of real estate owned
23,312
28,209
Redemption of FHLB stock
-
1,342
Net cash provided by investing activities
26,736
64,809
Financing activities:
Net decrease in deposits
(67,228
)
(97,675
)
Net (decrease) increase in short-term borrowings
(8,645
)
29,915
Net increase in advance payments by borrowers for taxes
8,243
9,980
Net cash used in financing activities
(67,630
)
(57,780
)
Increase in cash and cash equivalents
6,438
1,608
Cash and cash equivalents at beginning of period
71,469
80,380
Cash and cash equivalents at end of period
77,907
81,988
Supplemental information:
Cash paid or credited during the period for:
Income tax payments
6,263
4,615
Interest payments
18,114
21,926
Noncash investing activities:
Loans receivable transferred to real estate owned
10,117
19,729
See Accompanying Notes to Unaudited Consolidated Financial Statements.
- 7 -


WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Note 1 — Basis of Presentation

The unaudited interim consolidated financial statements include the accounts of Waterstone Financial, Inc. (the "Company") and the Company's subsidiaries.

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information, Rule 10-01 of Regulation S-X and the instructions to Form 10-Q. The financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position, results of operations, changes in shareholders' equity, and cash flows of the Company for the periods presented.

The accompanying unaudited consolidated financial statements and related notes should be read in conjunction with the Company's December 31, 2012 Annual Report on Form 10-K. Operating results for the nine and three months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013 or for any other period.

The preparation of the unaudited consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Significant items subject to such estimates and assumptions include the allowance for loan losses, deferred income taxes and real estate owned. Actual results could differ from those estimates.


Recent Accounting Pronouncements
In July 2013, the FASB issued ASU No. 2013-10, "Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes (a consensus of the FASB Emerging Issues Task Force)." This ASU permits the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes, in addition to US Treasuries (UST) and London Interbank Offered Rate (LIBOR). The amendment also removes the restriction on using different benchmark rates for similar hedges. The amendment applies to all entities that elect to apply hedge accounting of the benchmark interest rate. This ASU is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial position or results of operations.
In July 2013, the FASB issued ASU No. 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exits." This ASU provides that an unrecognized tax benefit, or a portion thereof, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from disallowance of a tax position, or the tax law does not require the entity to use, and the entity does not intend to use the deferred tax asset for such purpose. In these cases, the unrecognized tax benefit should be presented as a liability. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption and retrospective application is permitted. The Company is in the process of evaluating the impact of this standard to its existing disclosures and currently does not expect this standard to have a material impact on the Company's consolidated financial position or results of operations.


- 8 -

Note 2— Securities Available for Sale

The amortized cost and fair values of the Company's investment in securities available for sale follow:

September 30, 2013
Amortized cost
Gross unrealized gains
Gross unrealized losses
Fair value
(In Thousands)
Mortgage-backed securities
$
104,741
1,462
(524
)
105,679
Collateralized mortgage obligations:
Government sponsored enterprise issued
20,381
285
(27
)
20,639
Mortgage-related securities
125,122
1,747
(551
)
126,318
Government sponsored enterprise bonds
15,911
7
(197
)
15,721
Municipal securities
61,094
952
(2,728
)
59,318
Other debt securities
5,000
102
-
5,102
Debt securities
82,005
1,061
(2,925
)
80,141
Certificates of Deposit
5,145
37
(12
)
5,170
$
212,272
2,845
(3,488
)
211,629


December 31, 2012
Amortized cost
Gross unrealized gains
Gross Unrealized losses
Fair value
(In Thousands)
Mortgage-backed securities
$
116,813
2,349
(106
)
119,056
Collateralized mortgage obligations:
Government sponsored enterprise issued
29,207
373
(1
)
29,579
Mortgage-related securities
146,020
2,722
(107
)
148,635
Government sponsored enterprise bonds
8,000
17
-
8,017
Municipal securities
35,493
2,043
(165
)
37,371
Other debt securities
5,000
70
-
5,070
Debt securities
48,493
2,130
(165
)
50,458
Certificates of Deposit
5,880
45
(1
)
5,924
$
200,393
4,897
(273
)
205,017

The Company's mortgage-backed securities and collateralized mortgage obligations issued by government sponsored enterprises are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. At September 30, 2013, $987,000 of the Company's government sponsored enterprise bonds and $99.7 million of the Company's mortgage related securities were pledged as collateral to secure repurchase agreement obligations of the Company.

The amortized cost and fair values of investment securities by contractual maturity at September 30, 2013 are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

Amortized
Cost
Fair
Value
(In Thousands)
Debt and other securities
Due within one year
$
1,865
1,873
Due after one year through five years
29,606
30,146
Due after five years through ten years
21,919
20,935
Due after ten years
33,760
32,357
Mortgage-related securities
125,122
126,318
$
212,272
211,629

- 9 -

Gross unrealized losses on securities available for sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position were as follows:

September 30, 2013
Less than 12 months
12 months or longer
Total
Fair value
Unrealized loss
Fair value
Unrealized loss
Fair value
Unrealized loss
(In Thousands)
Mortgage-backed securities
$
38,709
(524
)
-
-
38,709
(524
)
Collateralized mortgage obligations:
Government sponsored enterprise issued
2,985
(27
)
-
-
2,985
(27
)
Government sponsored enterprise bonds
12,314
(197
)
-
-
12,314
(197
)
Municipal securities
42,269
(2,581
)
337
(147
)
42,606
(2,728
)
Certificates of Deposit
1,213
(12
)
-
-
1,213
(12
)
$
97,490
(3,341
)
337
(147
)
97,827
(3,488
)

December 31, 2012
Less than 12 months
12 months or longer
Total
Fair value
Unrealized loss
Fair value
Unrealized loss
Fair value
Unrealized loss
(In Thousands)
Mortgage-backed securities
$
19,382
(106
)
-
-
19,382
(106
)
Collateralized mortgage obligations:
Government sponsored enterprise issued
1,419
(1
)
-
-
1,419
(1
)
Municipal securities
9,009
(94
)
398
(71
)
9,407
(165
)
Certificates of Deposit
244
(1
)
-
-
244
(1
)
$
30,054
(202
)
398
(71
)
30,452
(273
)

The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment. In evaluating whether a security's decline in market value is other-than-temporary, management considers the length of time and extent to which the fair value has been less than cost, financial condition of the issuer and the underlying obligors, quality of credit enhancements, volatility of the fair value of the security, the expected recovery period of the security and ratings agency evaluations. In addition the Company may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds and the value of any underlying collateral. For certain securities in unrealized loss positions, the Company prepares cash flow analyses to compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.

As of September 30, 2013, the Company identified two municipal securities that were deemed to be other-than-temporarily impaired. Both securities were issued by a tax incremental district in a municipality located in Wisconsin. During the year ended December 31, 2012, the Company received audited financial statements with respect to the municipal issuer that called into question the ability of the underlying taxing district that issued the securities to operate as a going concern. During the year ended December 31, 2012, the Company's analysis of these securities resulted in $100,000 in credit losses that were charged to earnings with respect to these two municipal securities. No additional credit loss was recognized during the nine months ended September 30, 2013. As of September 30, 2013, these securities had a combined amortized cost of $215,000 and a combined estimated fair value of $189,000. As of September 30, 2013, the Company had one municipal security which had been in an unrealized loss position for twelve months or longer. This security was determined not to be other-than-temporarily impaired as of September 30, 2013. During the year ended December 31, 2012, two private-label collateralized mortgage obligations, that had been identified as other than temporarily impaired, were sold at a combined gain of $282. At the time of sale, these securities had a combined amortized cost of $18.0 million.

The following table presents the change in other-than-temporary credit related impairment charges on securities available for sale for which a portion of the other-than-temporary impairments related to other factors was recognized in other comprehensive loss.

(In Thousands)
Credit-related impairments on securities as of December 31, 2011
$
2,096
Credit-related impairments related to securities for which an other- than-temporary impairment was not previously recognized
100
Increase in credit-related impairments related to securities for which an other-than-temporary impairment was previously recognized
113
Reduction for sales of securities for which other-than-temporary was previously recognized
(2,209
)
Credit-related impairments on securities as of December 31, 2012
100
Credit-related impairments related to securities for which an other- than-temporary impairment was not previously recognized
-
Increase in credit-related impairments related to securities for which an other-than-temporary impairment was previously recognized
-
Credit-related impairments on securities as of September 30, 2013
$
100

Exclusive of the aforementioned securities, the Company has determined that the decline in fair value of the remaining securities is not attributable to credit deterioration. Based on the foregoing evaluation criteria, and as the Company does not intend to sell nor is it more likely than not that it will be required to sell these securities before recovery of the amortized cost basis, these securities are not considered other-than-temporarily impaired.
Continued deterioration of general economic market conditions could result in the recognition of future other-than-temporary impairment losses within the investment portfolio and such amounts could be material to our consolidated financial statements.

During the nine months ended, September 30, 2013, proceeds from the sale of securities totaled $921,000 and resulted in losses totaling $9,000. The $9,000 loss included in (loss) gain on sale of available for sale securities in the consolidated statements of income during the nine months ended, September 30, 2013 was reclassified from accumulated other comprehensive income. During the nine months ended, September 30, 2012, proceeds from the sale of securities totaled $11.9 million and resulted in gains totaling $241,000. The $241,000 gain included in (loss) gain on sale of available for sale securities in the consolidated statements of income during the nine months ended, September 30, 2012 was reclassified from accumulated other comprehensive income.
- 10 -


Note 3 - Loans Receivable

Loans receivable at September 30, 2013 and December 31, 2012 are summarized as follows:

September 30, 2013
December 31, 2012
(In Thousands)
Mortgage loans:
Residential real estate:
One- to four-family
$
419,084
460,821
Over four-family
517,141
514,363
Home equity
35,218
36,494
Construction and land
30,903
33,818
Commercial real estate
70,234
65,495
Consumer
133
132
Commercial loans
19,463
22,549
$
1,092,176
1,133,672

The Company provides several types of loans to its customers, including residential, construction, commercial and consumer loans. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to one borrower or to multiple borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. While credit risks are geographically concentrated in the Company's Milwaukee metropolitan area, and while 88.9% of the Company's loan portfolio involves loans that are secured by residential real estate, there are no concentrations with individual or groups of related borrowers. While the real estate collateralizing these loans is residential in nature, it ranges from owner-occupied single family homes to large apartment complexes. In addition, real estate collateralizing $61.7 million, or 5.7% of total loans, is located outside of the state of Wisconsin.

Qualifying loans receivable totaling $887.5 million and $801.6 million at September 30, 2013 and December 31, 2012, respectively, are pledged as collateral against $350.0 million in outstanding Federal Home Loan Bank of Chicago advances under a blanket security agreement.
An analysis of past due loans receivable as of September 30, 2013 and December 31, 2012 follows:

As of September 30, 2013
1-59 Days Past Due (1)
60-89 Days Past Due (2)
Greater Than 90 Days
Total Past Due
Current (3)
Total Loans
(In Thousands)
Mortgage loans:
Residential real estate:
One- to four-family
$
7,360
1,814
20,362
29,536
389,548
419,084
Over four-family
2,811
-
9,639
12,450
504,691
517,141
Home equity
425
221
239
885
34,333
35,218
Construction and land
90
-
4,204
4,294
26,609
30,903
Commercial real estate
817
-
389
1,206
69,028
70,234
Consumer
-
-
-
-
133
133
Commercial loans
-
-
510
510
18,953
19,463
Total
$
11,503
2,035
35,343
48,881
1,043,295
1,092,176

As of December 31, 2012
Mortgage loans:
Residential real estate:
One- to four-family
$
11,745
5,402
29,259
46,406
414,415
460,821
Over four-family
3,543
1,498
18,336
23,377
490,986
514,363
Home equity
416
111
404
931
35,563
36,494
Construction and land
87
-
2,180
2,266
31,552
33,818
Commercial real estate
290
-
668
959
64,536
65,495
Consumer
-
-
-
-
132
132
Commercial loans
-
-
511
511
22,038
22,549
Total
$
16,081
7,011
51,358
74,450
1,059,222
1,133,672

(1) Includes $3.6 million and $2.4 million for September 30, 2013 and December 31, 2012, respectively, which are on non-accrual status.
(2) Includes $0.7 million and $2.8 million for September 30, 2013 and December 31, 2012, respectively, which are on non-accrual status.
(3) Includes $35.3 million and $18.2 million for September 30, 2013 and December 31, 2012, respectively, which are on non-accrual status.

As of September 30, 2013 and December 31, 2012, there are no loans that are 90 or more days past due and still accruing interest.
- 11 -


A summary of the activity for the nine months ended September 30, 2013 and 2012 in the allowance for loan losses follows:

One- to Four- Family
Over Four-Family
Home Equity
Construction and Land
Commercial Real Estate
Consumer
Commercial
Total
(In Thousands)
Nine months ended September 30, 2013
Balance at beginning of period
$
17,819
7,734
2,097
1,323
1,259
30
781
31,043
Provision (credit) for loan losses
1,178
883
252
1,526
280
(3
)
(156
)
3,960
Charge-offs
(7,986
)
(1,267
)
(575
)
(1,366
)
(128
)
-
(6
)
(11,328
)
Recoveries
694
205
73
51
-
5
5
1,033
Balance at end of period
$
11,705
7,555
1,847
1,534
1,411
32
624
24,708
Nine months ended September 30, 2012
Balance at beginning of period
$
17,475
8,252
1,998
2,922
941
28
814
32,430
Provision (credit) for loan losses
4,233
1,772
475
(219
)
1,492
3
(656
)
7,100
Charge-offs
(5,522
)
(1,038
)
(375
)
(1,661
)
(816
)
(4
)
(59
)
(9,475
)
Recoveries
305
55
12
250
-
-
290
912
Balance at end of period
$
16,491
9,041
2,110
1,292
1,617
27
389
30,967


A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of September 30, 2013 follows:

One- to Four- Family
Over Four
Family
Home
Equity
Construction
and Land
Commercial
Real Estate
Consumer
Commercial
Total
(In Thousands)
Allowance related to loans individually evaluated for impairment
$
2,902
1,544
845
606
303
-
199
6,399
Allowance related to loans collectively evaluated for impairment
8,803
6,011
1,002
928
1,108
32
425
18,309
Balance at end of period
$
11,705
7,555
1,847
1,534
1,411
32
624
24,708
Loans individually evaluated for impairment
$
45,360
29,899
2,106
6,569
974
19
510
85,437
Loans collectively evaluated for impairment
373,724
487,242
33,112
24,334
69,260
114
18,953
1,006,739
Total gross loans
$
419,084
517,141
35,218
30,903
70,234
133
19,463
1,092,176

- 12 -

A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of the year ended December 31, 2012 follows:

One- to Four-
Family
Over Four
Family
Home
Equity
Construction
and Land
Commercial
Real Estate
Consumer
Commercial
Total
(In Thousands)
Allowance related to loans individually evaluated for impairment
$
7,058
3,268
1,033
377
341
-
331
12,408
Allowance related to loans collectively evaluated for impairment
10,761
4,466
1,064
946
918
30
450
18,635
Balance at end of period
$
17,819
7,734
2,097
1,323
1,259
30
781
31,043
Loans individually evaluated for impairment
$
57,467
28,281
2,127
4,470
1,250
24
1,352
94,971
Loans collectively evaluated for impairment
403,354
486,082
34,367
29,348
64,245
108
21,197
1,038,701
Total gross loans
$
460,821
514,363
36,494
33,818
65,495
132
22,549
1,133,672

The following table presents information relating to the Company's internal risk ratings of its loans receivable as of September 30, 2013 and December 31, 2012:

One- to Four- Family
Over Four
Family
Home
Equity
Construction
and Land
Commercial
Real Estate
Consumer
Commercial
Total
(In Thousands)
At September 30, 2013
Substandard
$
44,612
15,177
2,397
6,618
1,334
19
581
70,738
Watch
10,620
24,644
1,124
2,004
1,399
-
1,307
41,098
Pass
363,852
477,320
31,697
22,281
67,501
114
17,575
980,340
$
419,084
517,141
35,218
30,903
70,234
133
19,463
1,092,176
At December 31, 2012
Substandard
$
53,242
24,767
2,913
3,705
1,251
23
1,365
87,266
Watch
17,082
14,157
606
2,803
1,234
-
964
36,846
Pass
390,497
475,439
32,975
27,310
63,010
109
20,220
1,009,560
$
460,821
514,363
36,494
33,818
65,495
132
22,549
1,133,672

Factors that are important to managing overall credit quality include sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, an allowance for loan losses, and sound non-accrual and charge-off policies. Our underwriting policies require an officers' loan committee to review and approve all loans in excess of $500,000. In addition, an independent loan review function exists for all loans. Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans. To do so, we maintain a loan review system under which our credit management personnel review non-owner occupied one- to four-family, over four-family, construction and land, commercial real estate and commercial loans that individually, or as part of an overall borrower relationship, exceed $1.0 million in potential exposure. Loans meeting these criteria are reviewed on an annual basis, or more frequently if the loan renewal is less than one year. With respect to this review process, management has determined that pass loans include loans that exhibit acceptable financial statements, cash flow and leverage. Watch loans have potential weaknesses that deserve management's attention and, if left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credit. Substandard loans are considered inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged. These loans generally have a well-defined weakness that may jeopardize liquidation of the debt and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Finally, a loan is considered to be impaired when it is probable that the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. Management has determined that all non-accrual loans and loans modified under troubled debt restructurings meet the definition of an impaired loan.
- 13 -

The Company's procedures dictate that an updated valuation must be obtained with respect to underlying collateral at the time a loan is deemed impaired. Updated valuations may also be obtained upon transfer from loans receivable to real estate owned based upon the age of the prior appraisal, changes in market conditions or known changes to the physical condition of the property.

Estimated fair values are reduced to account for sales commissions, broker fees, unpaid property taxes and additional selling expenses to arrive at an estimated net realizable value. The adjustment factor is based upon the Company's actual experience with respect to sales of real estate owned over the prior two years. An additional adjustment factor is applied by appraisal vintage to account for downward market pressure since the date of appraisal. The additional adjustment factor is based upon relevant sales data available for our general operating market as well as company-specific historical net realizable values as compared to the most recent appraisal prior to disposition.

With respect to over-four family income-producing real estate, appraisals are reviewed and estimated collateral values are adjusted by updating significant appraisal assumptions to reflect current real estate market conditions. Significant assumptions reviewed and updated include the capitalization rate, rental income and operating expenses. These adjusted assumptions are based upon recent appraisals received on similar properties as well as on actual experience related to real estate owned and currently under Company management.
The following tables present data on impaired loans at September 30, 2013 and December 31, 2012.

As of or for the Nine Months Ended September 30, 2013
Recorded Investment
Unpaid
Principal
Reserve
Cumulative
Charge-Offs
Average
Recorded
Investment
Interest
Paid
(In Thousands)
Total Impaired with Reserve
One- to four-family
$
13,278
13,278
2,902
-
13,856
451
Over four-family
22,717
22,717
1,544
-
23,903
585
Home equity
1,339
1,339
845
-
1,439
42
Construction and land
3,094
3,094
606
-
3,094
67
Commercial real estate
887
1,328
303
442
1,335
28
Consumer
-
-
-
-
-
-
Commercial
510
510
199
-
511
1
41,825
42,266
6,399
442
44,138
1,174
Total Impaired with no Reserve
One- to four-family
32,082
39,001
-
6,919
38,585
1,062
Over four-family
7,182
8,047
-
865
8,598
197
Home equity
767
767
-
-
781
17
Construction and land
3,475
6,168
-
2,693
6,170
50
Commercial real estate
87
163
-
76
175
2
Consumer
19
19
-
-
20
1
Commercial
-
-
-
-
-
-
43,612
54,165
-
10,553
54,329
1,329
Total Impaired
One- to four-family
45,360
52,279
2,902
6,919
52,441
1,513
Over four-family
29,899
30,764
1,544
865
32,501
782
Home equity
2,106
2,106
845
-
2,220
59
Construction and land
6,569
9,262
606
2,693
9,264
117
Commercial real estate
974
1,491
303
518
1,510
30
Consumer
19
19
-
-
20
-
Commercial
510
510
199
-
511
1
$
85,437
96,431
6,399
10,995
98,467
2,502

- 14 -

As of or for the Year Ended December 31, 2012
Recorded Investment
Unpaid
Principal
Reserve
Cumulative
Charge-Offs
Average
Recorded
Investment
Interest
Paid
(In Thousands)
Total Impaired with Reserve
One- to four-family
$
29,057
29,456
7,058
399
29,768
874
Over four-family
17,397
17,642
3,268
245
18,073
722
Home equity
1,544
1,544
1,033
-
1,615
74
Construction and land
2,316
2,316
377
-
2,316
78
Commercial real estate
813
1,179
341
366
1,748
50
Consumer
-
-
-
-
-
-
Commercial
1,352
1,352
331
-
1,352
42
52,479
53,489
12,408
1,010
54,872
1,840
Total Impaired with no Reserve
One- to four-family
28,410
31,315
-
2,905
31,358
1,175
Over four-family
10,884
11,179
-
295
11,649
549
Home equity
583
749
-
166
755
14
Construction and land
2,154
3,655
-
1,501
3,656
5
Commercial real estate
437
461
-
24
473
12
Consumer
24
24
-
-
24
1
Commercial
-
-
-
-
-
-
42,492
47,383
-
4,891
47,915
1,756
Total Impaired
One- to four-family
57,467
60,771
7,058
3,304
61,126
2,049
Over four-family
28,281
28,821
3,268
540
29,722
1,271
Home equity
2,127
2,293
1,033
166
2,370
88
Construction and land
4,470
5,971
377
1,501
5,972
83
Commercial real estate
1,250
1,640
341
390
2,221
62
Consumer
24
24
-
-
24
1
Commercial
1,352
1,352
331
-
1,352
42
$
94,971
100,872
12,408
5,901
102,787
3,596

The difference between a loan's recorded investment and the unpaid principal balance represents a partial charge-off resulting from a confirmed loss due to the value of the collateral securing the loan being below the loan balance and management's assessment that the full collection of the loan balance is not likely.

When a loan is considered impaired, interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower's financial condition and prospects for repayment, including consideration of the borrower's sustained historical repayment performance and other relevant factors.
The determination as to whether an allowance is required with respect to impaired loans is based upon an analysis of the value of the underlying collateral and/or the borrower's intent and ability to make all principal and interest payments in accordance with contractual terms. The evaluation process is subject to the use of significant estimates and actual results could differ from estimates. This analysis is primarily based upon third party appraisals and/or a discounted cash flow analysis. In those cases in which no allowance has been provided for an impaired loan, the Company has determined that the estimated value of the underlying collateral exceeds the remaining outstanding balance of the loan. Of the total $43.6 million of impaired loans as of September 30, 2013 for which no allowance has been provided, $10.6 million in charge-offs have been recorded to reduce the unpaid principal balance to an amount that is commensurate with the loan's net realizable value, using the estimated fair value of the underlying collateral. To the extent that further deterioration in property values continues, the Company may have to reevaluate the sufficiency of the collateral servicing these impaired loans resulting in additional provisions to the allowance for loans losses or charge-offs.

At September 30, 2013, total impaired loans includes $47.7 million of troubled debt restructurings. Troubled debt restructurings involve granting concessions to a borrower experiencing financial difficulty by modifying the terms of the loan in an effort to avoid foreclosure. The vast majority of debt restructurings include a modification of terms to allow for an interest only payment and/or reduction in interest rate. The restructured terms are typically in place for six to twelve months. At December 31, 2012, total impaired loans included $59.6 million of troubled debt restructurings.

- 15 -

The following presents data on troubled debt restructurings:

As of September 30, 2013
Accruing
Non-accruing
Total
Amount
Number
Amount
Number
Amount
Number
(dollars in thousands)
One- to four-family
$
8,024
16
$
14,007
79
$
22,031
95
Over four-family
15,924
7
6,227
5
22,151
12
Home equity
-
-
992
4
992
4
Construction and land
1,408
1
840
2
2,248
3
Commercial real estate
-
-
257
2
257
2
Commercial loans
-
-
-
-
-
-
$
25,356
24
$
22,323
92
$
47,679
116

As of December 31, 2012
Accruing
Non-accruing
Total
Amount
Number
Amount
Number
Amount
Number
(dollars in thousands)
One- to four-family
$
9,921
17
$
21,847
95
$
31,768
112
Over four-family
3,917
4
20,030
13
23,947
17
Home equity
-
-
986
3
986
3
Construction and land
2,173
2
79
1
2,252
3
Commercial real estate
-
-
668
2
668
2
$
16,011
23
$
43,610
114
$
59,621
137


At September 30, 2013, $47.7 million in loans had been modified in troubled debt restructurings and $22.3 million of these loans were included in the non-accrual loan total. The remaining $25.4 million, while meeting the internal requirements for modification in a troubled debt restructuring, were current with respect to payments under their original loan terms at the time of the restructuring and thus, continued to be included with accruing loans. Provided these loans perform in accordance with the modified terms, they will continue to be accounted for on an accrual basis.
All loans that have been modified in a troubled debt restructuring are considered to be impaired. As such, an analysis has been performed with respect to all of these loans to determine the need for a valuation reserve. When a loan is expected to perform in accordance with the restructured terms and ultimately return to and perform under contract terms, a valuation allowance is established for an amount equal to the excess of the present value of the expected future cash flows under the original contract terms as compared with the modified terms, including an estimated default rate. When there is doubt as to the borrower's ability to perform under the restructured terms or ultimately return to and perform under market terms, a valuation allowance is established equal to the impairment when the carrying amount exceeds fair value of the underlying collateral. As a result of the impairment analysis, a $2.9 million valuation allowance has been established as of September 30, 2013 with respect to the $47.7 million in troubled debt restructurings. As of December 31, 2012, a $6.4 million valuation allowance had been established with respect to the $59.6 million in troubled debt restructurings.

After a troubled debt restructuring reverts to market terms, a minimum of six consecutive contractual payments must be received prior to consideration for a return to accrual status. If an updated credit department review indicates no other evidence of elevated credit risk, the loan is returned to accrual status at that time.

The following presents troubled debt restructurings by concession type:

As of September 30, 2013
Performing in
accordance with
modified terms
In Default
Total
Amount
Number
Amount
Number
Amount
Number
(dollars in thousands)
Interest reduction and principal forbearance
$
21,176
51
$
3,757
19
$
24,933
70
Principal forbearance
16,257
10
865
1
17,122
11
Interest reduction
3,373
11
2,251
24
5,624
35
$
40,806
72
$
6,873
44
$
47,679
116

As of December 31, 2012
Performing in
accordance with
modified terms
In Default
Total
Amount
Number
Amount
Number
Amount
Number
(dollars in thousands)
Interest reduction and principal forbearance
$
26,051
77
$
2,770
11
$
28,821
88
Principal forbearance
17,574
11
348
1
17,922
12
Interest reduction
11,984
35
894
2
12,878
37
$
55,609
123
$
4,012
14
$
59,621
137

- 16 -

The following presents data on troubled debt restructurings as of September 30, 2013:

For the three months ended Ended September 30, 2013
For the three months ended Ended September 30, 2012
Amount
Number
Amount
Number
(dollars in thousands)
Loans modified as a troubled debt restructure
One- to four-family
$
865
4
$
4,437
11
Over four-family
-
-
16,050
6
Home equity
-
-
-
-
$
865
4
$
20,487
17
Troubled debt restructuring modified within the past twelve months for which there was a default
One- to four-family
$
-
-
$
-
-
$
-
-
$
-
-

For the nine months ended Ended September 30, 2013
For the nine months ended Ended September 30, 2012
Amount
Number
Amount
Number
(dollars in thousands)
Loans modified as a troubled debt restructure
One- to four-family
$
1,627
9
$
7,951
20
Over four-family
-
-
19,872
9
Home equity
38
1
116
2
$
1,665
10
$
27,939
31
Troubled debt restructuring modified within the past twelve months for which there was a default
One- to four-family
$
-
-
$
-
-
$
-
-
$
-
-


The following table presents data on non-accrual loans as of September 30, 2013 and December 31, 2012:

September 30, 2013
December 31, 2012
(Dollars in Thousands)
Non-accrual loans:
Residential
One- to four-family
$
36,704
46,467
Over four-family
13,634
23,205
Home equity
1,344
1,578
Construction and land
4,237
2,215
Commercial real estate
974
668
Consumer
19
24
Commercial
510
511
Total non-accrual loans
$
57,422
74,668
Total non-accrual loans to total loans receivable
5.26
%
6.59
%
Total non-accrual loans and performing troubled debt restructurings to total loans receivable
7.58
%
8.00
%
Total non-accrual loans to total assets
3.59
%
4.50
%

- 17 -

Note 4— Real Estate Owned

Real estate owned is summarized as follows:

September 30, 2013
December 31, 2012
(In Thousands)
One- to four-family
$
12,478
17,353
Over four-family
4,192
9,890
Construction and land
5,607
7,029
Commercial real estate
870
1,702
$
23,147
35,974

The following table presents the activity in the Company's real estate owned:

Nine months ended September 30,
2013
2012
(In Thousands)
Real estate owned at beginning of the period
$
35,974
56,670
Transferred from loans receivable
10,117
19,729
Sales (net of gains / losses)
(21,999
)
(26,944
)
Write downs
(1,068
)
(5,518
)
Other
123
(100
)
Real estate owned at the end of the period
$
23,147
43,837

- 18 -

Note 5— Mortgage Servicing Rights


The following table presents the activity in the Company's mortgage servicing rights:

Nine months ended, September 30,
2013
2012
(In Thousands)
Mortgage servicing rights at beginning of the period
$
3,220
198
Additions
2,807
2,173
Amortization
(790
)
(194
)
Sales
(1,388
)
-
Mortgage servicing rights at end of the period
3,849
2,177
Valuation allowance at end of period
-
-
Mortgage servicing rights at the end of the period, net
$
3,849
2,177



During the nine months ended September 30, 2013, $1.4 billion in residential loans were originated for sale. During the same period, sales of loans held for sale totaled $1.5 billion, generating mortgage banking income of $65.6 million. The unpaid principal balance of loans serviced for others was $742.3 million and $635.8 million at September 30, 2013 and December 31, 2012 respectively. These loans are not reflected in the consolidated statements of financial condition.

During the three months ended September 30, 2013, the Company sold mortgage servicing rights related to $287.5 million in loans receivable and with a book value of $1.4 million for $2.7 million resulting in a gain on sale of $1.3 million. There were no comparable transactions in prior periods.

The following table shows the estimated future amortization expense for mortgage servicing rights for the periods indicated:

(In Thousands)
Estimate for the period ended December 31:
2013
$
284
2014
736
2015
650
2016
565
2017
480
Thereafter
1,134
Total
$
3,849

- 19 -

Note 6— Deposits

A summary of the contractual maturities of time deposits at September 30, 2013 is as follows:

(In Thousands)
Within one year
$
501,091
More than one to two years
106,678
More than two to three years
10,529
More than three to four years
21,600
More than four through five years
16,638
656,536

Note 7— Borrowings

Borrowings consist of the following:

September 30, 2013
December 31, 2012
Balance
Weighted
Average
Rate
Balance
Weighted
Average
Rate
(Dollars in Thousands)
Short term:
Short-term repurchase agreements
$
37,243
3.21
%
45,888
3.09
%
Long term:
Federal Home Loan Bank, Chicago advances maturing:
2016
220,000
4.34
%
220,000
4.34
%
2017
65,000
3.19
%
65,000
3.19
%
2018
65,000
2.97
%
65,000
2.97
%
Repurchase agreements maturing
2017
84,000
3.96
%
84,000
3.96
%
$
471,243
3.84
%
479,888
3.82
%

The short-term repurchase agreements represent the outstanding portion of a total $90.0 million commitment with two unrelated banks. The short-term repurchase agreements are utilized by Waterstone Mortgage Corporation to finance loans originated for sale. These agreements are secured by the underlying loans being financed. Related interest rates are based upon the note rate associated with the loans being financed. The first of the two short-term repurchase agreements has an outstanding balance of $28.8 million, a rate of 3.18 % and a total commitment of $40.0 million at September 30, 2013. The second short-term repurchase agreement has an outstanding balance of $8.4 million, a rate of 3.30 % and a total commitment of $50.0 million at September 30, 2013.

The $220.0 million in advances due in 2016 consist of eight advances with fixed rates ranging from 4.01% to 4.82% callable quarterly until maturity.

The $65.0 million in advances due in 2017 consist of three advances with fixed rates ranging from 3.09% to 3.46% callable quarterly until maturity.

The $65.0 million in advances due in 2018 consist of three advances with fixed rates ranging from 2.73% to 3.11% callable quarterly until maturity.

The $84.0 million in repurchase agreements have fixed rates ranging from 2.89% to 4.31% callable quarterly until their maturity in 2017. The repurchase agreements are collateralized by securities available for sale with an estimated fair value of $99.7 million at September 30, 2013 and $101.9 million at December 31, 2012.

The Company selects loans that meet underwriting criteria established by the Federal Home Loan Bank Chicago (FHLBC) as collateral for outstanding advances. The Company's borrowings at the FHLBC are limited to 75% of the carrying value of unencumbered one- to four-family mortgage loans, 40% of the carrying value of home equity loans and 60% of the carrying value of over four-family loans. In addition, these advances are collateralized by FHLBC stock of $20.2 million at both September 30, 2013 and December 31, 2012. In the event of prepayment, the Company is obligated to pay all remaining contractual interest on the advance.
- 20 -


Note 8 – Regulatory Capital

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements, or overall financial performance deemed by the regulators to be inadequate, can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items, as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). As of September 30, 2013, the Bank meets all capital adequacy requirements to which it is subject.

Effective December 11, 2012, the WDFI and the Federal Deposit Insurance Corporation terminated a consent order originally agreed to by WaterStone Bank on November 25, 2009 and replaced it with a memorandum of understanding. The memorandum of understanding requires, among other things, maintenance of a minimum Tier I capital ratio of 8.0 % and a minimum Total risk based cpaital ratio of 12.0 %.

As of September 30, 2013 the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as quantitatively "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized," the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios, as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank's category.

As a state-chartered savings bank, the Bank is required to meet minimum capital levels established by the state of Wisconsin in addition to federal requirements. For the state of Wisconsin, regulatory capital consists of retained income, paid-in-capital, capital stock equity and other forms of capital considered to be qualifying capital by the Federal Deposit Insurance Corporation.
The actual and required capital amounts and ratios for the Bank as of September 30, 2013 and December 31, 2012 are presented in the table below:

September 30, 2013
Actual
For Capital
Adequacy Purposes
To Be Well-Capitalized Under Prompt Corrective Action Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
(Dollars In Thousands)
Total capital (to risk-weighted assets)
$
216,611
21.52
%
80,515
8.00
%
100,644
10.00
%
Tier I capital (to risk-weighted assets)
203,900
20.26
%
40,258
4.00
%
60,386
6.00
%
Tier I capital (to average assets)
203,900
12.68
%
64,314
4.00
%
80,393
5.00
%
State of Wisconsin (to total assets)
203,900
12.83
%
95,345
6.00
%
N/
A
N/
A
December 31, 2012
(Dollars In Thousands)
Total capital (to risk-weighted assets)
$
199,098
17.34
%
91,844
8.00
%
114,806
10.00
%
Tier I capital (to risk-weighted assets)
184,542
16.07
%
45,922
4.00
%
68,883
6.00
%
Tier I capital (to average assets)
184,542
11.13
%
66,312
4.00
%
82,890
5.00
%
State of Wisconsin (to total assets)
184,542
11.15
%
99,305
6.00
%
N/
A
N/
A

- 21 -

Note 9 – Income Taxes

Income tax expense increased from $216,000 during the nine months ended September 30, 2012 to $7.9 million for the nine months ended September 30, 2013. This increase was partially due to the increase in our income before income taxes, which increased from $17.1 million during the nine months ended September 30, 2012 to $20.7 million during the nine months ended September 30, 2013. During the third quarter of 2008, we established a valuation allowance against our net deferred tax assets. That valuation allowance effectively resulted in no income tax expense being recognized during the nine months ended September 30, 2012 other than state income taxes for states in which separate company returns are filed. During the fourth quarter of 2012, we released the valuation allowance against our net deferred tax assets. Income tax expense is recognized on the statement of income during the nine months ended September 30, 2013 at an effective rate of 38.4 % of pretax book income.

As of September 30, 2013, net deferred tax assets totaled $14.3 million, which, in the judgment of management, will more-likely-than-not be fully realized. The largest components of the deferred tax asset are associated with the allowance for loan losses and basis adjustments on real estate owned. We are largely relying on earnings generated in the current year and forecasted earnings in future years in making the determination that we will more-likely-than-not realize our deferred tax asset.

Note 10 – Offsetting of Assets and Liabilities

The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. In addition, the Company enters into agreements under which it sells loans held for sale subject to an obligation to repurchase the same loans. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as a sale and subsequent repurchase of assets. The obligation to repurchase the assets is reflected as a liability in the Company's consolidated statements of condition, while the securities and loans held for sale underlying the repurchase agreements remain in the respective investment securities and loans held for sale asset accounts. In other words, there is no offsetting or netting of the investment securities or loans held for sale assets with the repurchase agreement liabilities. One of the Company's two short-term repurchase agreements and all of the Company's long-term repurchase agreements are subject to master netting agreements, which sets forth the rights and obligations for repurchase and offset. Under the master netting agreement, the Company is entitled to set off the collateral placed with a single counterparty against obligations owed to that counterparty.
The following table presents the liabilities subject to an enforceable master netting agreement as of September 30, 2013 and December 31, 2012.

Gross Recognized Liabilities
Gross
Amounts
Offset
Net
Amounts
Presented
Gross
Amounts Not
Offset
Net Amount
(In Thousands)
September 30, 2013
Repurchase Agreements
Short-term
$
28,849
-
28,849
28,849
-
Long-term
84,000
-
84,000
84,000
-
$
112,849
-
112,849
112,849
-
December 31, 2012
Repurchase Agreements
Short-term
$
38,090
-
38,090
38,090
-
Long-term
84,000
-
84,000
84,000
-
$
122,090
-
122,090
122,090
-

- 22 -

Note 11– Financial Instruments with Off-Balance Sheet Risk


The Company is a 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 standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

September 30, 2013
December 31, 2012
(In Thousands)
Financial instruments whose contract amounts represent potential credit risk:
Commitments to extend credit under amortizing loans (1)
$
$18,513
20,836
Commitments to extend credit under home equity lines of credit
15,922
17,628
Unused portion of construction loans
7,827
5,502
Unused portion of business lines of credit
9,197
10,967
Standby letters of credit
882
736
____________

(1) Excludes commitments to originate loans held for sale, which are discussed in the following footnote.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements of the Company. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral obtained generally consists of mortgages on the underlying real estate.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds mortgages on the underlying real estate as collateral supporting those commitments for which collateral is deemed necessary.

The Company has determined that there are no probable losses related to commitments to extend credit or the standby letters of credit as of September 30, 2013 and December 31, 2012.

Residential mortgage loans sold to others are predominantly conventional residential first lien mortgages. The Company's agreements to sell residential mortgage loans in the normal course of business usually require certain representations and warranties on the underlying loans sold related to credit information, loan documentation and collateral, which if subsequently are untrue or breached, could require the Company to repurchase certain loans affected. The Company has only been required to make insignificant repurchases as a result of its representations and warranties. The Company's agreements to sell residential mortgage loans also contain limited recourse provisions. The recourse provisions are limited in that the recourse provision ends after certain payment criteria have been met. With respect to these loans, repurchase could be required if defined delinquency issues arose during the limited recourse period. Given that the underlying loans delivered to buyers are predominantly conventional first lien mortgages and that historical experience shows negligible losses and insignificant repurchase activity, management believes that losses and repurchases under the limited recourse provisions will continue to be insignificant.


Note 12 – Derivative Financial Instruments


In connection with its mortgage banking activities, the Company enters into derivative financial instruments as part of its strategy to manage its exposure to changes in interest rates. Mortgage banking derivatives include interest rate lock commitments provided to customers to fund mortgage loans to be sold in the secondary market and forward commitments for the future delivery of such loans to third party investors. It is the Company's practice to enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on its commitments to fund the loans as well as on its portfolio of mortgage loans held for sale. The Company's mortgage banking derivatives have not been designated as being in hedge relationships. These instruments are used to manage the Company's exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements of ASC 815. Changes in the fair value of derivatives not designated in hedging relationships are recorded as a component of mortgage banking income in the Company's consolidated statements of operations. The Company does not use derivatives for speculative purposes.

Forward commitments to sell mortgage loans represent commitments obtained by the Company from a secondary market agency to purchase mortgages from the Company at specified interest rates and within specified periods of time. Commitments to sell loans are made to mitigate interest rate risk on interest rate lock commitments to originate loans and loans held for sale. At September 30, 2013, the Company had forward commitments to sell mortgage loans with an aggregate notional amount of approximately $167.0 million and interest rate lock commitments with an aggregate notional amount of approximately $135.4 million. The fair value of the forward commitments to sell mortgage loans at September 30, 2013 included a loss of $1.5 million that is reported as a component of other liabilities on the Company's consolidated statement of financial condition. The fair value of the interest rate locks at September 30, 2013 included a gain of $2.7 million that is reported as a component of other assets on the Company's consolidated statements of financial condition.
In determining the fair value of its derivative loan commitments, the Company considers the value that would be generated by the loan arising from exercise of the loan commitment when sold in the secondary mortgage market. That value includes the price that the loan is expected to be sold for in the secondary mortgage market. The fair value of these commitments is recorded on the consolidated statements of financial condition with the changes in fair value recorded as a component of mortgage banking income.

- 23 -

Note 13 – Earnings per share

Earnings per share are computed using the two-class method. Basic earnings per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities have the right to receive dividends at the same rate as holders of the Company's common stock. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding adjusted for the dilutive effect of all potential common shares. Unvested restricted stock and stock options are considered outstanding for diluted earnings per share only. Unvested restricted stock totaling 81,000 and 105,000 shares are considered outstanding for dilutive earnings per share for the nine months ended September 30, 2013 and September 30, 2012, respectively. Unvested stock options totaled 220,000 and 284,000 shares for the nine months ended September 30, 2013 and September 30, 2012, respectively.

Presented below are the calculations for basic and diluted earnings per share:

Three Months Ended September 30,
Nine Months Ended September 30,
2013
2012
2013
2012
(In Thousands, except per share amounts)
Net income
$
3,219
8,448
12,771
16,834
Net income available to unvested restricted shares
8
28
33
57
Net income available to common stockholders
$
3,211
8,420
12,738
16,777
Weighted average shares outstanding
31,163
31,064
31,144
31,045
Effect of dilutive potential common shares
251
97
231
80
Diluted weighted average shares outstanding
31,414
31,161
31,375
31,125
Basic earnings per share
$
0.10
0.27
0.41
0.54
Diluted earnings per share
$
0.10
0.27
0.41
0.54

Note 14 – Fair Value Measurements

The FASB issued an accounting standard (subsequently codified into ASC Topic 820, "Fair Value Measurements and Disclosures") which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This accounting standard applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements. The standard also emphasizes that fair value (i.e., the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. When considering the assumptions that market participants would use in pricing the asset or liability, this accounting standard establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity's own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

The fair value hierarchy prioritizes inputs used to measure fair value into three broad levels.

Level 1 inputs - In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that we have the ability to access.

Level 2 inputs - Fair values determined by Level 2 inputs use inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets where there are few transactions and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs - Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability.

In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
- 24 -


The following table presents information about our assets recorded in our consolidated statement of financial position at their fair value on a recurring basis as of September 30, 2013 and December 31, 2012, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

Fair Value Measurements Using
September 30, 2013
Level 1
Level 2
Level 3
(In Thousands)
Available for sale securities
Mortgage-backed securities
$
105,679
-
105,679
-
Collateralized mortgage obligations
Government sponsored enterprise issued
20,639
-
20,639
-
Government sponsored enterprise bonds
15,721
-
15,721
-
Municipal securities
59,318
-
59,318
-
Other debt securities
5,102
5,102
-
-
Certificates of deposit
5,170
5,170
-
-
Loans held for sale
97,184
-
97,184
-
Mortgage banking derivative assets
2,673
-
-
2,673
Mortgage banking derivative liabilities
1,528
-
-
1,528

Fair Value Measurements Using
December 31, 2012
Level 1
Level 2
Level 3
(In Thousands)
Available for sale securities
Mortgage-backed securities
$
119,056
-
119,056
-
Collateralized mortgage obligations
Government sponsored enterprise issued
29,579
-
29,579
-
Government sponsored enterprise bonds
8,017
-
8,017
-
Municipal securities
37,371
-
37,371
-
Other debt securities
5,070
5,070
-
-
Certificates of deposit
5,924
-
5,924
-
Loans held for sale
133,613
-
133,613
-
Mortgage banking derivative assets
1,668
-
-
1,668
Mortgage banking derivative liabilities
249
-
-
249

The following summarizes the valuation techniques for assets recorded in our consolidated statements of financial condition at their fair value on a recurring basis:

Available for sale securities – The Company's investment securities classified as available for sale include: mortgage-backed securities, collateralized mortgage obligations, government sponsored enterprise bonds, municipal securities and other debt securities. The fair value of mortgage-backed securities, collateralized mortgage obligations and government sponsored enterprise bonds are determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricing model. Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmark securities, prepayment models and bid/offer market data. For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuer spread. These model and matrix measurements are classified as Level 2 and Level 3 in the fair value hierarchy. The fair value of municipal securities is determined by a third party valuation source using observable market data utilizing a multi-dimensional relational pricing model. Standard inputs to this model include observable market data such as benchmark yields, reported trades, broker quotes, rating updates and issuer spreads. These model measurements are classified as Level 2 in the fair value hierarchy. The fair value of other debt securities, which includes a trust preferred security issued by a financial institution, is determined through quoted prices in active markets and is classified as Level 1 in the fair value hierarchy.
- 25 -

Loans held for sale – The Company carries loans held for sale at fair value under the fair value option model. Fair value is generally determined by estimating a gross premium or discount, which is derived from pricing currently observable in the secondary market, principally from observable prices for forward sale commitments. Loans held-for-sale are considered to be Level 2 in the fair value hierarchy of valuation techniques.

Mortgage banking derivatives - Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors. The Company relies on a valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the current interest rate environment and then multiplying by quoted investor prices. The Company also relies on a valuation model to estimate the fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available. While there are Level 2 and 3 inputs used in the valuation models, the Company has determined that one or more of the inputs significant in the valuation of both of the mortgage banking derivatives fall within Level 3 of the fair value hierarchy.

The table below presents reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during 2013 and 2012.

Available for sale
securities
Mortgage banking
derivatives, net
(In Thousands)
Balance at December 31, 2011
$
18,451
527
Unrealized holding losses arising during the period:
Included in other comprehensive income
1,023
-
Other than temporary impairment included in net loss
(113
)
-
Principal repayments
(1,352
)
-
Sales of available for sale securities
(18,009
)
-
Mortgage derivative gain, net
-
892
Balance at December 31, 2012
-
1,419
Mortgage derivative loss, net
-
(274
)
Balance at September 30, 2013
$
-
1,145


There were no transfers in or out of Level 1, 2 or 3 measurements during the periods.
Assets Recorded at Fair Value on a Non-recurring Basis

The following table presents information about our assets recorded in our consolidated statement of financial position at their fair value on a non-recurring basis as of September 30, 2013 and December 31, 2012, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

Fair Value Measurements Using
September 30, 2013
Level 1
Level 2
Level 3
(In Thousands)
Impaired loans, net (1)
$
$35,426
-
-
35,426
Real estate owned
23,147
-
-
23,147

Fair Value Measurements Using
December 31, 2012
Level 1
Level 2
Level 3
(In Thousands)
Impaired loans, net (1)
$
$40,071
-
-
40,071
Real estate owned
35,974
-
-
35,974
_________

(1) Represents collateral-dependent impaired loans, net, which are included in loans.

- 26 -

Loans – We do not record loans at fair value on a recurring basis. On a non-recurring basis, loans determined to be impaired are analyzed to determine whether a collateral shortfall exists, and if such a shortfall exists, are recorded on our consolidated statements of financial condition at net realizable value of the underlying collateral. Fair value is determined based on third party appraisals. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal. Given the significance of the adjustments made to appraised values necessary to estimate the fair value of impaired loans, loans that have been deemed to be impaired are considered to be Level 3 in the fair value hierarchy of valuation techniques. At September 30, 2013, loans determined to be impaired with an outstanding balance of $41.8 million were carried net of specific reserves of $6.4 million for a fair value of $35.4 million. At December 31, 2012, loans determined to be impaired with an outstanding balance of $52.5 million were carried net of specific reserves of $12.4 million for a fair value of $40.1 million. Impaired loans collateralized by assets which are valued in excess of the net investment in the loan do not require any specific reserves.

Real estate owned – On a non-recurring basis, real estate owned, is recorded in our consolidated statements of financial condition at the lower of cost or fair value. Fair value is determined based on third party appraisals and, if less than the carrying value of the foreclosed loan, the carrying value of the real estate owned is adjusted to the fair value. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal. Given the significance of the adjustments made to appraised values necessary to estimate the fair value of the properties, real estate owned is considered to be Level 3 in the fair value hierarchy of valuation techniques. Changes in the value of real estate owned totaled $1.1 million and $5.5 million during the nine months ended September 30, 2013 and 2012, respectively and are recorded in real estate owned expense. At September 30, 2013 and December 31, 2012, real estate owned totaled $23.1 million and $36.0 million, respectively.

Mortgage servicing rights - The Company utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of mortgage servicing rights. The model utilizes prepayment assumptions to project cash flows related to the mortgage servicing rights based upon the current interest rate environment, which is then discounted to estimate an expected fair value of the mortgage servicing rights. The model considers characteristics specific to the underlying mortgage portfolio, such as: contractually specified servicing fees, prepayment assumptions, delinquency rates, late charges and costs to service. Given the significance of the unobservable inputs utilized in the estimation process, mortgage servicing rights are classified as Level 3 within the fair value hierarchy. The Company records the mortgage servicing rights at the lower of amortized cost or fair value. At September 30, 2013 and December 31, 2012, there was no impairment identified for mortgage servicing rights, therefore mortgage servicing rights were not recorded at fair value on a non-recurring basis.
For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2013, the significant unobservable inputs used in the fair value measurements were as follows:

Significant Unobservable
Input Value
Fair Value at
September 30, 2013
Valuation
Technique
Significant
Unobservable
Inputs
Minimum
Value
Maximum
Value
Mortgage banking derivatives
$
1,145
Pricing models
Pull through rate
67.93
%
100.00
%
Impaired loans
35,426
Market approach
Discount rates applied to appraisals
15.00
%
30.00
%
Real estate owned
23,147
Market approach
Discount rates applied to appraisals
6.00
%
89.00
%
Mortgage servicing rights
7,493
Pricing models
Prepayment rate
7.93
%
18.04
%
Note rate
2.78
%
4.14
%
___________

The significant unobservable inputs used in the fair value measurement of the Company's mortgage banking derivatives, including interest rate lock commitments is the loan pull through rate. This represents the percentage of loans currently in a lock position which the Company estimates will ultimately close. Generally, the fair value of an interest rate lock commitment will be positively (negatively) impacted when the prevailing interest rate is lower (higher) than the interest rate lock commitment. Generally, an increase in the pull through rate will result in the fair value of the interest rate lock increasing when in a gain position, or decreasing when in a loss position. The pull through rate is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. The pull through rate is computed using historical data and the ratio is periodically reviewed by the Company.

The significant unobservable inputs used in the fair value measurement of collateral for collateral-dependent impaired loans and real estate owned included in the above table primarily relate to discounting criteria applied to independent appraisals received with respect to the collateral. Discounts applied to the appraisals are dependent on the vintage of the appraisal as well as the marketability of the property. The discount factor is computed using actual realization rates on properties that have been foreclosed upon and liquidated in the open market.

The significant unobservable inputs used in the fair value measurement or mortgage servicing rights include the prepayment rate and note rate. The prepayment rate represents the assumed rate of prepayment of the outstanding principal balance of the underlying mortgage notes. Generally, the fair value of mortgage servicing rights will be positively (negatively) impacted when the prepayment rate (decreases) increases. The note rate represents the contractual rate on the underlying mortgages.

Fair value information about financial instruments follows, whether or not recognized in the consolidated statements of financial condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
- 27 -


The carrying amounts and fair values of the Company's financial instruments consist of the following:

September 30, 2013
December 31, 2012
Carrying
amount
Fair Value
Carrying
amount
Fair Value
Total
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
(In Thousands)
Financial Assets
Cash and cash equivalents
$
77,907
77,907
77,907
-
-
71,649
71,469
71,469
-
-
Securities available-for-sale
211,629
211,629
10,272
201,357
-
205,017
205,017
5,070
199,947
-
Loans held for sale
97,184
97,184
-
97,184
-
133,613
133,613
-
133,613
-
Loans receivable
1,092,176
1,095,828
-
-
1,095,828
1,133,672
1,148,107
-
-
1,148,107
FHLB stock
20,193
20,193
-
20,193
-
20,193
20,193
-
20,193
-
Cash surrender value of life insurance
39,231
39,231
39,231
-
-
38,061
38,061
38,061
-
-
Real estate owned
23,147
23,147
-
-
23,147
35,974
35,974
-
-
35,974
Accrued interest receivable
3,950
3,950
3,950
-
-
3,452
3,452
3,452
-
-
Mortgage servicing rights
3,849
7,493
-
-
7,493
3,220
4,070
-
-
4,070
Mortgage banking derivative assets
2,673
2,673
-
-
2,673
1,668
1,668
-
-
1,668
Financial Liabilities
Deposits
872,285
874,018
215,749
658,269
-
939,513
942,118
202,593
739,525
-
Advance payments by borrowers for taxes
21,934
21,934
21,934
-
-
1,672
1,672
1,672
-
-
Borrowings
471,243
508,902
37,243
471,659
-
479,888
537,299
-
537,299
-
Accrued interest payable
1,573
1,573
1,573
-
-
1,715
1,715
1,715
-
-
Mortgage banking derivative liabilities
1,528
1,528
-
-
1,528
249
249
-
-
249

The following methods and assumptions were used by the Company in determining its fair value disclosures for financial instruments.

Cash and Cash Equivalents

The carrying amount reported in the consolidated statements of financial condition for cash and cash equivalents is a reasonable estimate of fair value.

Securities

The fair value of securities is determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricing model. Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmark securities and bid/offer market data. For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuer spread. Prepayment models are used for mortgage related securities with prepayment features.

Loans Held for Sale

Fair value is estimated using the prices of the Company's existing commitments to sell such loans and/or the quoted market price for commitments to sell similar loans.

Loans Receivable

Loans determined to be impaired are analyzed to determine whether a collateral shortfall exists, and if such a shortfall exists, are recorded on our consolidated statements of financial condition at fair value. Fair value is determined based on third party appraisals. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal. With respect to loans that are not considered to be impaired, fair value is estimated by discounting the future contractual cash flows using discount rates that reflect a current rate offered to borrowers of similar credit standing for the remaining term to maturity. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC 820-10 and generally produces a higher fair value.

- 28 -

FHLBC Stock

For FHLBC stock, the carrying amount is the amount at which shares can be redeemed with the FHLBC and is a reasonable estimate of fair value.

Cash Surrender Value of Life Insurance

The carrying amounts reported in the consolidated statements of financial condition for the cash surrender value of life insurance approximate those assets' fair values.

Deposits and Advance Payments by Borrowers for Taxes

The fair values for interest-bearing and noninterest-bearing negotiable order of withdrawal accounts, savings accounts, and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar remaining maturities to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit. The advance payments by borrowers for taxes are equal to their carrying amounts at the reporting date.

Borrowings

Fair values for borrowings are estimated using a discounted cash flow calculation that applies current interest rates to estimated future cash flows of the borrowings.

Accrued Interest Payable and Accrued Interest Receivable

For accrued interest payable and accrued interest receivable, the carrying amount is a reasonable estimate of fair value.

Commitments to Extend Credit and Standby Letters of Credit

Commitments to extend credit and standby letters of credit are generally not marketable. Furthermore, interest rates on any amounts drawn under such commitments would be generally established at market rates at the time of the draw. Fair values for the Company's commitments to extend credit and standby letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparty's credit standing, and discounted cash flow analyses. The fair value of the Company's commitments to extend credit is not material at September 30, 2013 and December 31, 2012.

Mortgage Banking Derivative Assets and Liabilities

Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors. The Company relies on a valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the current interest rate environment, and then multiplying by quoted investor prices. The Company also relies on a valuation model to estimate the fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available. On the Company's Consolidated Statements of Condition, instruments that have a positive fair value are included in prepaid expenses and other assets, and those instruments that have a negative fair value are included in other liabilities.


Note 15 – Segment Reporting

Selected financial and descriptive information is required to be provided about reportable operating segments, considering a "management approach" concept as the basis for identifying reportable segments. The management approach is based on the way that management organizes the segments within the enterprise for making operating decisions, allocating resources, and assessing performance. Consequently, the segments are evident from the structure of the enterprise's internal organization, focusing on financial information that an enterprise's chief operating decision-makers use to make decisions about the enterprise's operating matters. The Company has determined that it has two reportable segments: community banking and mortgage banking. The Company's operating segments are presented based on its management structure and management accounting practices. The structure and practices are specific to the Company and therefore, the financial results of the Company's business segments are not necessarily comparable with similar information for other financial institutions.

Community Banking

The Community Banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin. Consumer products include loan and deposit products: mortgage, home equity loans and lines, personal term loans, demand deposit accounts, interest bearing transaction accounts and time deposits. Business banking products include secured and unsecured lines and term loans for working capital, inventory and general corporate use, commercial real estate construction loans, demand deposit accounts, interest bearing transaction accounts and time deposits.
- 29 -

Mortgage Banking

The Mortgage Banking segment provides residential mortgage loans for the purpose of sale on the secondary market. Mortgage banking products and services are provided by offices in: Wisconsin, Arizona, Florida, Idaho, Illinois, Indiana, Iowa, Maryland, Minnesota, Ohio and Pennsylvania.

Three months ended September 30, 2013
Community
Banking
Mortgage
Banking
Holding Company and
Other
Consolidated
(In Thousands)
Net interest income
$
9,266
187
125
9,578
Provision for loan losses
1,000
-
-
1,000
Net interest income after provision for loan losses
8,266
187
125
8,578
Noninterest income
985
20,071
(26
)
21,030
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits
3,148
13,460
(33
)
16,575
Occupancy, office furniture and equipment
775
1,458
(15
)
2,218
FDIC insurance premiums
516
-
-
516
Real estate owned
(163
)
-
-
(163
)
Other
953
4,250
67
5,270
Total noninterest expenses
5,229
19,168
19
24,416
Income before income taxes
4,022
1,090
80
5,192
Income tax expense
1,478
451
44
1,973
Net income
$
2,544
639
36
3,219
Total Assets
$
1,529,744
117,262
(49,188
)
1,597,818


Three months ended September 30, 2012
Community
Banking
Mortgage
Banking
Holding Company and
Other
Consolidated
(In Thousands)
Net interest income
$
10,358
151
126
10,635
Provision for loan losses
2,000
-
-
2,000
Net interest income after provision for loan losses
8,358
151
126
8,635
Noninterest income
947
26,828
-
27,775
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits
3,400
14,580
(157
)
17,823
Occupancy, office furniture and equipment
826
994
-
1,820
FDIC insurance premiums
916
-
-
916
Real estate owned
1,991
-
-
1,991
Other
1,033
4,166
68
5,267
Total noninterest expenses
8,166
19,740
(89
)
27,817
Income before income taxes (benefit)
1,139
7,239
215
8,593
Income tax expense (benefit)
(2,846
)
2,906
85
145
Net income
$
3,985
4,333
130
8,448
Total Assets
$
1,595,830
140,484
(56,746
)
1,679,568


- 30 -

Nine months ended September 30, 2013
Community
Banking
Mortgage
Banking
Holding Company and
Other
Consolidated
(In Thousands)
Net interest income
$
28,925
346
374
29,645
Provision for loan losses
3,900
60
-
3,960
Net interest income after provision for loan losses
25,025
286
374
25,685
Noninterest income
2,435
68,451
(116
)
70,770
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits
10,015
43,165
(179
)
53,001
Occupancy, office furniture and equipment
2,372
3,704
(81
)
5,995
FDIC insurance premiums
1,569
-
-
1,569
Real estate owned
(9
)
-
-
(9
)
Other
3,020
11,962
196
15,178
Total noninterest expenses
16,967
58,831
(64
)
75,734
Income before income taxes
10,493
9,906
322
20,721
Income tax expense
3,839
3,992
119
7,950
Net income
$
6,654
5,914
203
12,771

Nine months ended September 30, 2012
Community
Banking
Mortgage
Banking
Holding Company and
Other
Consolidated
(In Thousands)
Net interest income
$
30,940
374
376
31,690
Provision for loan losses
7,100
-
-
7,100
Net interest income after provision for loan losses
23,840
374
376
24,590
Noninterest income
2,391
63,637
-
66,028
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits
9,613
34,359
(547
)
43,425
Occupancy, office furniture and equipment
2,374
2,855
-
5,229
FDIC insurance premiums
2,730
-
-
2,730
Real estate owned
6,265
-
-
6,265
Other
3,572
12,125
222
15,919
Total noninterest expenses
24,554
49,339
(325
)
73,568
Income before income taxes (benefit)
1,677
14,672
701
17,050
Income tax expense (benefit)
(5,953
)
5,889
280
216
Net income
$
7,630
8,783
421
16,834


- 31 -

Note 16 – Other Matters

On June 6, 2013, the Boards of Directors of Lamplighter Financial, MHC (the "Mutual Holding Company"), Waterstone Financial, Inc. (the "Company"), and WaterStone Bank SSB (the "Bank") each unanimously adopted the Plan of Conversion and Reorganization of the Mutual Holding Company (the "Plan") pursuant to which the Mutual Holding Company will undertake a "second-step" conversion and cease to exist.

The Company will merge into a new Maryland corporation named Waterstone Financial, Inc. As part of the conversion, the MHC's ownership interest of the Company will be offered for sale in a public offering. The existing publicly held shares of the Company, which represents the remaining ownership interest in the Company, will be exchanged for new shares of common stock of Waterstone Financial, Inc., the new Maryland corporation. The exchange ratio will ensure that immediately after the conversion and public offering, the public shareholders of the Company will own the same aggregate percentage of Waterstone Financial, Inc. common stock that they owned immediately prior to that time (excluding shares purchased in the stock offering and cash received in lieu of fractional shares). When the conversion and public offering are completed, all of the capital stock of WaterStone Bank will be owned by Waterstone Financial, Inc., the Maryland corporation.

The Plan provides for the establishment, upon the completion of the conversion, of special "liquidation accounts" for the benefit of certain depositors of WaterStone Bank in an amount equal to the greater of the MHC's ownership interest in the retained earnings of the Company as of the date of the latest balance sheet contained in the prospectus or the retained earnings of WaterStone Bank at the time it reorganized into the MHC. Following the completion of the conversion, under the rules of the Board of Governors of the Federal Reserve System, WaterStone Bank will not be permitted to pay dividends on its capital stock to Waterstone Financial, Inc., its sole shareholder, if WaterStone Bank's shareholder's equity would be reduced below the amount of the liquidation accounts. The liquidation accounts will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder's interest in the liquidation accounts.

Direct costs of the conversion and public offering will be deferred and reduce the proceeds from the shares sold in the public offering. Costs of $770,000 have been incurred related to the conversion as of September 30, 2013.
Note 17 - Subsequent Events

Effective November 4, 2013, the WDFI and the Federal Deposit Insurance Corporation terminated the memorandum of understanding originally issued on December 11, 2012 as described in Note 8 - Regulatory Capital.


- 32 -

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

Cautionary Statements Regarding Forward-Looking Information

This report contains various forward-looking statements concerning the Company's financial condition, business plans, growth, operating strategies and prospects that are based on the current expectations and beliefs of management. Forward-looking statements may also be made by the Company from time to time in other reports and documents as well as in oral presentations. When used in written documents or oral statements, the words "anticipate," "believe," "estimate," "expect," "objective" and similar expressions and verbs in the future tense, are intended to identify forward-looking statements. The statements contained herein and such future statements involve or may involve certain assumptions, risks and uncertainties, many of which are beyond the Company's control, that could cause the Company's actual results and performance to differ materially from what is expected. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Company:
general economic conditions, either nationally or in our market areas, that are worse than expected;
competition among depository and other financial institutions;
inflation and changes in the interest rate environment that reduce our margins and yields, our mortgage banking revenues or reduce the fair value of financial instruments or reduce the origination levels in our lending business, or increase the level of defaults, losses and prepayments on loans we have made and make whether held in portfolio or sold in the secondary markets;
adverse changes in the securities or secondary mortgage markets;
changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;
our ability to manage market risk, credit risk and operational risk in the current economic conditions;
our ability to enter new markets successfully and capitalize on growth opportunities;
our ability to successfully integrate acquired entities;
changes in consumer spending, borrowing and savings habits;
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission or the Public Company Accounting Oversight Board;
our ability to retain key employees;
significant increase in our loan losses; and
changes in the financial condition, results of operations or future prospects of issuers of securities that we own.
See also the factors referred to in reports filed by the Company with the Securities and Exchange Commission (particularly those under the caption "Risk Factors" in Item 1A of the Company's 2012 Annual Report on Form 10-K).

Overview

The following discussion and analysis is presented to assist the reader in the understanding and evaluation of the Company's financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Form 10-Q and should be read in conjunction therewith. The detailed discussion focuses on the results of operations for the three and nine months ended September 30, 2013 and 2012 and the financial condition as of September 30, 2013 compared to the financial condition as of December 31, 2012.
Our profitability is highly dependent on our net interest income, mortgage banking income and provision for loan losses. Net interest income is the difference between the interest income we earn on our interest earning assets, which are loans receivable, investment securities and cash and cash equivalents, and the interest we pay on deposits and other borrowings. The Company's banking subsidiary, WaterStone Bank SSB ("WaterStone Bank" or the "Bank"), is primarily a mortgage lender with loans secured by real estate comprising 98.2% of total loans receivable on September 30, 2013. Further, 88.9% of loans receivable are residential mortgage loans with over four-family loans comprising 47.4% of all loans on September 30, 2013. WaterStone Bank funds loan production primarily with retail deposits and Federal Home Loan Bank advances. On September 30, 2013, deposits comprised 63.0% of total liabilities. Time deposits, also known as certificates of deposit, accounted for 75.3% of total deposits at September 30, 2013. Federal Home Loan Bank advances outstanding on September 30, 2013 totaled $350.0 million, or 25.3% of total liabilities. The Bank's mortgage banking subsidiary, Waterstone Mortgage Corporation, utilizes a line of credit provided by the Bank as a primary source of funding loans held for sale. In addition, Waterstone Mortgage Corporation utilizes short-term repurchase agreements with other banks as needed. During the current prolonged period of low interest rates and economic weakness, our investment philosophy has emphasized short-term liquid investments including cash and cash equivalents, which should position the Company to take advantage of the investment, lending and interest rate risk management opportunities that should exist as the local and national economies recover from the recession. Our high level of time deposits, relative to total deposits, will result in a greater increase in our cost of funds when market interest rates begin to increase.
- 33 -

During the nine months ended September 30, 2013, our results of operations were positively impacted by decreases in our provision for loans losses and in real estate owned expense, both of which resulted from an improvement in our asset quality. Our results of operations were also positively impacted by a $1.3 million gain recognized from the sale of mortgage servicing rights. Offsetting these positive factors, a significant decrease in the margin on mortgage loans sold in the secondary market resulted in a $4.8 million decrease in pre-tax earnings from our mortgage banking segment during the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. Our results of operations continue to be challenged by declining net interest-earning assets and compression in our net interest margin. Net interest income decreased $2.0 million to $29.6 million during the nine months ended September 30, 2013 compared to $31.7 million during the nine months ended September 30, 2012.
Our provision for loan losses decreased $3.1 million to $4.0 million for nine months ended September 30, 2013 as compared to $7.1 million for the nine months ended September 30, 2012. The decrease in provision for loan losses reflects an improvement in both the quality of our loan portfolio and the overall local real estate market. The Company has experienced improvement in a number of key loan-related loan quality metrics compared to December 31, 2012, including impaired loans, loans contractually past due and non-accrual loans. In addition, the turnover of loans in each of the three aforementioned metrics has slowed during the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, which has resulted in fewer loans requiring a specific collateral analysis to determine a potential collateral shortfall and subsequent loan loss reserve. Furthermore, as a result of a recovering local real estate market, those loans that have required a specific collateral review to assess the level of impairment have experienced less significant collateral shortfalls when compared to the prior year. This is also reflected in the $6.3 million decrease in real estate owned expense from $6.3 million of expense during the nine months ended September 30, 2012 to net income related to real estate owned operations of $9,000 for the nine months ended September 30, 2013. Additional information regarding loan quality and its impact on our financial condition and results of operations can be found in the "Asset Quality" discussion.
Income tax expense increased from $216,000 during the nine months ended September 30, 2012 to $8.0 million during the nine months ended September 30, 2013. During the third quarter of 2008, we established a valuation allowance against our net deferred tax assets. That valuation allowance effectively resulted in no income tax expense being recognized during the nine months ended September 30, 2012 other than state income taxes for states in which separate company returns are filed. During the fourth quarter of 2012, we released the valuation allowance against our net deferred tax assets. Therefore, income tax expense was recognized during the nine months ended September 30, 2013 at an effective rate of 38.4% of pretax book income.
Comparison of Operating Results for the Three Months Ended September 30, 2013 and 2012

General - Net income for the three months ended September 30, 2013 totaled $3.2 million, or $0.10 for both basic and diluted income per share, compared to net income of $8.4 million, or $0.27 for both basic and diluted income per share, for the three months ended September 30, 2012. The three months ended September 30, 2013 generated an annualized return on average assets of 0.79% and an annualized return on average equity of 6.04%, compared to an annualized return on average assets of 2.00% and an annualized return on average equity of 18.26% for the comparable period in 2012. Income before income taxes decreased $3.4 million to $5.2 million during the three months ended September 30, 2013, compared to $8.6 million during the three months ended September 30, 2012. The pre-tax results of operations for the three months ended September 30, 2013 as compared to the three months ended September 30, 2012 reflect a $6.1 million decrease in pre-tax income from the mortgage banking segment and a $2.9 million increase in pre-tax income from the community banking, including a $1.1 million decrease in net interest income, partially offset by $2.2 million decrease in real estate owned expense and a $1.0 million decrease in provision for loan losses. Income taxes totaled $2.0 million during the three months ended September 30, 2013, compared to $145,000 during the three months ended September 30, 2012.

Segment ReviewAs described in the notes to consolidated financial statements, the Company has two reportable segments: community banking and mortgage banking. Community banking consists of lending and deposit gathering (as well as other banking-related products and services) to consumers and businesses and the support to deliver, fund, and manage such banking services. The Company's mortgage banking segment originates residential mortgage products for sale in the secondary market.

Mortgage banking segment assets (which consist predominantly of loans held for sale) decreased $30.4 million, or 20.6%, to $117.3 million as of September 30, 2013 compared to $147.7 million as of December 31, 2012. This decrease was driven by a decrease in loans held for sale of $36.4 million, or 27.3%, to $97.2 million at September 30, 2013 from $133.6 million at December 31, 2012. Mortgage banking revenues decreased $6.8 million, or 25.2%, to $20.1 million for the three months ended September 30, 2013 compared to $26.8 million during the three months ended September 30, 2012. The $6.8 million decrease in mortgage banking revenues was attributable to a decrease in loan origination volume as well as a significant decrease in sales margins. Loans originated for sale in the secondary market totaled $441.5 million during the three months ended September 30, 2013, which represents a $36.4 million, or 7.6%, decrease in originations from the three months ended September 30, 2012, which totaled $477.9 million. Weighted average margin dropped by 146 basis points to 3.32% of origination volume during the three months ended September 30, 2013 compared to 4.78% during the three months ended September 30, 2012. The major components of mortgage banking revenues include fees and premiums associated with the sale of residential loans held for sale. The major expenses for the mortgage banking segment are compensation, payroll taxes and other employee benefits, as well as occupancy, office furniture and equipment and other expenses, which are covered generally in the consolidated discussion in the section "Noninterest Expense."
- 34 -


Average Balance Sheets, Interest and Yields/Costs
The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. Non-accrual loans were included in the computation of average balances. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

Three Months Ended September 30,
2013
2012
Average Balance
Interest
Yield/Cost
Average Balance
Interest
Yield/Cost
(Dollars in Thousands)
Assets
Interest-earning assets:
Loans receivable and held for sale(1)
$
1,211,089
14,425
4.73
%
$
1,270,414
15,943
4.98
%
Mortgage related securities(2)
126,447
455
1.43
151,162
826
2.17
Debt securities, federal funds sold and short-term investments(2)(6)
176,449
653
1.47
159,035
505
1.26
Total interest-earning assets
1,513,985
15,533
4.07
1,580,611
17,274
4.34
Noninterest-earning assets
96,925
96,074
Total assets
$
1,610,910
$
1,676,685
Liabilities and equity
Interest-bearing liabilities:
Demand accounts
$
46,771
4
0.03
$
42,888
6
0.06
Money market and savings accounts
140,807
32
0.09
135,128
58
0.17
Time deposits
668,397
1,201
0.71
771,158
1,874
0.96
Total interest-bearing deposits
855,975
1,237
0.57
949,174
1,938
0.81
Borrowings
485,488
4,718
3.86
487,078
4,701
3.83
Total interest-bearing liabilities
1,341,463
5,955
1.76
1,436,252
6,639
1.83
Noninterest-bearing liabilities:
Non interest-bearing deposits
44,795
35,446
Other noninterest-bearing liabilities
13,345
21,453
Total noninterest-bearing liabilities
58,140
56,899
Total liabilities
1,399,603
1,493,151
Equity
211,307
183,534
Total liabilities and equity
$
1,610,910
$
1,676,685
Net interest income
$
9,578
$
10,635
Net interest rate spread (3)
2.31
%
2.51
%
Net interest-earning assets (4)
$
172,522
$
144,359
Net interest margin (5)
2.51
%
2.67
%
Average interest-earning assets to average interest-bearing liabilities
112.86
%
110.05
%

__________
(1) Interest income includes net deferred loan fee amortization income of $130,000 and $183,000 for the three months ended September 30, 2013 and 2012, respectively.
(2) Average balance of mortgage related and debt securities are based on amortized historical cost.
(3) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of
average interest-bearing liabilities.
(4) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(5) Net interest margin represents net interest income divided by average total interest-earning assets.
(6) Interest income from tax exempt securities is not significant to total interest income, therefore, interest yield on interest earning assets are not stated on a tax equivalent basis.
The average balance of tax exempt securities totaled $49.6 million and $15.4 million for the three months ended September 30, 2013 and 2012, respectively.
- 35 -


Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

Three Months Ended September 30,
2013 versus 2012
Increase (Decrease) due to
Volume
Rate
Net
(In Thousands)
Interest income:
Loans receivable and held for sale(1) (2)
$
(726
)
(792
)
(1,518
)
Mortgage related securities(3)
(120
)
(251
)
(371
)
Other earning assets(3)
59
89
148
Total interest-earning assets
(787
)
(954
)
(1,741
)
Interest expense:
Demand accounts
1
(3
)
(2
)
Money market and savings accounts
2
(29
)
(27
)
Time deposits
(228
)
(444
)
(672
)
Total interest-bearing deposits
(225
)
(476
)
(701
)
Borrowings
(15
)
32
17
Total interest-bearing liabilities
(240
)
(444
)
(684
)
Net change in net interest income
$
(547
)
(510
)
(1,057
)

______________
(1) Interest income includes net deferred loan fee amortization income of $130,000 and $183,000 for the three months ended September 30, 2013 and 2012, respectively.
(2) Non-accrual loans have been included in average loans receivable balance.
(3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost.

Total Interest Income - Total interest income decreased $1.7 million, or 10.1%, to $15.5 million during the three months ended September 30, 2013 from $17.3 million during the three months ended September 30, 2012.

Interest income on loans decreased $1.5 million, or 9.5%, to $14.4 million during the three months ended September 30, 2013 from $15.9 million during the three months ended September 30, 2012. The decrease in interest income was primarily due to a 25 basis point decrease in the average yield on loans to 4.73% for the three months ended September 30, 2013 from 4.98% for the three months ended September 30, 2012. The decrease in interest income on loans also reflects a $59.3 million, or 4.7%, decrease in the average balance of loans outstanding to $1.21 billion during the three months ended September 30, 2013 from $1.27 billion during the three months ended September 30, 2012.

Interest income from mortgage-related securities decreased $371,000, or 44.9%, to $455,000 during the three months ended September 30, 2013 from $826,000 during the three months ended September 30, 2012. The decrease in interest income was due to a 74 basis point decrease in the average yield on mortgage-related securities to 1.43% for the three months ended September 30, 2013 from 2.17% for the three months ended September 30, 2012. The decrease in interest income on mortgage-related securities also reflects a $24.7 million, or 16.4%, decrease in the average balance of mortgage-related securities to $126.4 million for the three months ended September 30, 2013 from $151.2 million during the three months ended September 30, 2012. The decrease in average yield resulted from a general turnover of the investment security portfolio in which cash flow from higher yielding securities was reinvested in securities at lower yields due to the low interest rate environment.

Interest income from other interest earning assets (comprised of debt securities, federal funds sold and short-term investments) increased $148,000, or 29.3%, to $653,000 for the three months ended September 30, 2013 compared to $505,000 for the three months ended September 30, 2012. Interest income on other interest earning assets increased due to a 21 basis point increase in the average yield on other interest earning assets to 1.47% for the three months ended September 30, 2013 from 1.26% for the three months ended September 30, 2012. The average balance of higher yielding, tax-exempt municipal securities increased to $49.6 million for the three months ended September 30, 2013 from $15.4 million for the three months ended September 30, 2012, accounting for the increase in the average yield for the period. The increase in interest income on other interest earning assets also reflects an increase of $17.4 million, or 11.0%, in the average balance of other earning assets to $176.4 million during the three months ended September 30, 2013 from $159.0 million during the three months ended September 30, 2012.
- 36 -


Total Interest Expense - Total interest expense decreased by $684,000, or 10.3%, to $6.0 million during the three months ended September 30, 2013 from $6.6 million during the three months ended September 30, 2012. This decrease was the result of both a decrease in the average cost of funds as well as a decrease in the average balance of interest-bearing deposits and borrowings. The average cost of funds decreased 7 basis points to 1.76% for the three months ended September 30, 2013 from 1.83% for the three months ended September 30, 2012. Total average interest bearing deposits and borrowings outstanding decreased $94.8 million, or 6.6%, to $1.34 billion for the three months ended September 30, 2013 compared to an average balance of $1.44 billion for the three months ended September 30, 2012.

Interest expense on deposits decreased $701,000, or 36.2%, to $1.2 million during the three months ended September 30, 2013 from $1.9 million during the three months ended September 30, 2012. The decrease in interest expense on deposits was primarily due to a decrease in the average cost of deposits of 24 basis points to 0.57% for the three months ended September 30, 2013 compared to 0.81% for the three months ended September 30, 2012. The decrease in the cost of deposits reflects the current low interest rate environment due to the Federal Reserve's low short-term interest rate policy. These rates are typically used by financial institutions in pricing deposit products. The decrease in the cost of deposits also reflects a shift in the composition of deposits from higher cost time deposits to lower cost demand, money market and savings accounts. The decrease in interest expense attributable to the decrease in the cost of deposits was compounded by a decrease of $93.2 million, or 9.8%, in the average balance of interest bearing deposits to $856.0 million during the three months ended September 30, 2013 from $949.2 million during the three months ended September 30, 2012. The decrease in average interest-bearing deposits was exclusively the result of a decrease in time deposits, which carry a higher cost than demand, money market or savings accounts. The decrease in time deposits was consistent with the Bank's liquidity needs and funding obligations.

Interest expense on borrowings was unchanged at $4.7 million during the three months ended September 30, 2013 and three months ended September 30, 2012. The cost of average borrowings increased by 3 basis points to 3.86% for the three months ended September 30, 2013 compared to 3.83% for the three months ended September 30, 2012. The increase in the cost of borrowings was offset by a $1.6 million, or 0.3%, decrease in average borrowings outstanding to $485.5 million during the three months ended September 30, 2013 from $487.1 million during the three months ended September 30, 2012. The decreased use of borrowings as a funding source during the three months ended September 30, 2013 reflects a decreased use of short-term repurchase agreements within our mortgage banking segment to fund loan originations to be sold in the secondary market.

Net Interest Income - Net interest income decreased by $1.1 million, or 9.9%, to $9.6 million during the three months ended September 30, 2013 as compared to $10.6 million during the three months ended September 30, 2012. The decrease in net interest income resulted primarily from a 20 basis point decrease in our net interest rate spread to 2.31% during the three months ended September 30, 2013 from 2.51% during the three months ended September 30, 2012. The 20 basis point decrease in the net interest rate spread resulted from a 27 basis point decrease in the average yield on interest earning assets, which was partially offset by a 7 basis point decrease in the average cost of interest bearing liabilities.

Provision for Loan Losses – Our provision for loan losses decreased $1.0 million, or 50.0%, to $1.0 million during the three months ended September 30, 2013, from $2.0 million during the three months ended September 30, 2012. The decrease in the provision for loan losses resulted from a decrease in loans exhibiting risk characteristics that require estimated loan loss provisions in excess of our historical average experience rates. While the provision for loan losses has decreased from the prior year, it remains at historically elevated levels. These levels remain elevated due to continued general economic stress resulting in reduced levels of income earned by many of our borrowers combined with loan collateral values, primarily real estate, that remain at levels below those estimated at the time the loans were originally made. These factors result in higher levels of actual loss experience which, when applied to the portfolio in general, require higher loan loss provisions. See the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions.

Noninterest Income - Total noninterest income decreased $6.7 million, or 24.3%, to $21.0 million during the three months ended September 30, 2013 from $27.8 million during the three months ended September 30, 2012. The decrease resulted primarily from a decrease in mortgage banking income.

Mortgage banking income decreased $8.5 million, or 31.9%, to $18.2 million for the three months ended September 30, 2013, compared to $26.7 million during the three months ended September 30, 2012. The $8.5 million decrease in mortgage banking income was the result of a decrease in origination and sales volumes as well as a decrease in average sales margin. The decrease in average sales margin reflects a decrease in pricing and fees on all products in all geographic markets and is reflective of the change in general market conditions during 2013.

Loan origination volumes decreased compared to the prior year, primarily reflecting a decrease in demand for refinanced loans due in large part to an increase in interest rates on these products beginning in the Spring of 2013. Loans originated for sale in the secondary market totaled $441.5 million during the three months ended September 30, 2013, which represents a $36.4 million, or 7.6%, increase in originations from the three months ended September 30, 2012, which totaled $477.9 million.

Weighted average margin dropped by 30.5% to 3.32% of origination volume during the three months ended September 30, 2013 compared to 4.78% during the three months ended September 30, 2012. Our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. During the three months ended September 30, 2013, originations shifted towards governmental loans and loans made to purchase real estate. Loans originated for the purchase of a residential property comprised 79.5% of total originations during the three months ended September 30, 2013, compared to 54.8% during the three months ended September 30, 2012. The mix of loan type also changed slightly, with conventional loans and governmental loans comprising 61.0% and 39.0% of all loan originations, respectively, during the three months ended September 30, 2013. During the three months ended September 30, 2012, conventional loans and governmental loans comprised 69.4% and 30.6% of all loan originations, respectively.

Total other noninterest income increased $1.7 million to $2.0 million during the three months ended September 30, 2013 from $302,000 during the three months ended September 30, 2012. The increase resulted primarily from a $1.3 million gain on sale of mortgage servicing rights during the current period with no comparable transactions during 2012.

- 37 -


Noninterest Expense - Total noninterest expense decreased $3.4 million, or 12.2%, to $24.4 million during the three months ended September 30, 2013 from $27.8 million during the three months ended September 30, 2012. The decrease was primarily attributable to decreased compensation and real estate owned expense.

Compensation, payroll taxes and other employee benefit expense decreased $1.2 million, or 7.0%, to $16.6 million during the three months ended September 30, 2013 compared to $17.8 million during the three months ended September 30, 2012. Due primarily to a decrease in loan origination activity, total compensation, payroll taxes and other benefits at our mortgage banking subsidiary decreased $1.1 million, or 7.7%, to $13.5 million for the three months ended September 30, 2013 compared to $14.6 million during the three months ended September 30, 2012. The decrease in compensation at our mortgage banking subsidiary correlates to the decrease in mortgage banking income due to the commission-based compensation structure in place for our mortgage banking loan officers. However, reduced commissions expense was partially offset by increased corporate salary expense related to increased staffing needed to support accumulated transaction growth.

Real estate owned management and sales activity generated $163,000 of income during the three months ended September 30, 2013 compared to $2.0 million of expense during the three months ended September 30, 2012. Real estate owned income or expense includes the operating costs related to the properties, net of rental income. In addition, it includes net gain or loss recognized upon the sale of real estate acquired through foreclosure, as well as write-downs recognized to maintain the properties at the lower of cost or estimated fair value. The decrease in real estate owned expense results from a decrease in net property management expense and an increase in net gains recognized upon the sale of properties. During the three months ended September 30, 2013, net operating expense, which primarily relates to property taxes, maintenance and management fees, net of rental income, decreased $60,000, or 14.7%, to $348,000 from $408,000 during the three months ended September 30, 2012. The decrease in net operating expense compared to the prior period resulted from both an improvement in the operating results of income producing properties as well as a decrease in the number and average balance of properties owned. The average balance of real estate owned totaled $26.8 million for the three months ended September 30, 2013 compared to $48.8 million for the three months ended September 30, 2012. Sales and write-downs of real estate owned resulted in a net gain of $512,000 during the three months ended September 30, 2013. During the three months ended September 30, 2012, sales and write downs of real estate owned resulted in a net loss of $1.6 million.

Income Taxes – Income tax expense increased from $145,000 during the three months ended September 30, 2012 to $2.0 million for the three months ended September 30, 2013. During the third quarter of 2008, we established a valuation allowance against our net deferred tax assets. That valuation allowance effectively resulted in no income tax expense being recognized during the three months ended September 30, 2012 other than state income taxes for states in which separate company returns are filed. During the fourth quarter of 2012, we released the valuation allowance against our net deferred tax assets. Therefore, income tax expense is recognized during the three months ended September 30, 2013 at an effective rate of 38.0% of pretax book income.

As of September 30, 2013, net deferred tax assets totaled $14.3 million, which, in the judgment of management, will more-likely-than-not be fully realized. The largest components of the deferred tax assets are associated with the allowance for loan losses and basis adjustments on real estate owned. We are largely relying on earnings generated in the current year and forecasted earnings in future years in making the determination that we will more-likely-than-not realize our deferred tax assets.


Comparison of Operating Results for the Nine months Ended September 30, 2013 and 2012

General - Net income for the nine months ended September 30, 2013 totaled $12.7 million, or $0.41 for both basic and diluted income per share, compared to net income of $16.8 million, or $0.54 for both basic and diluted income per share, for the nine months ended September 30, 2012. The nine months ended September 30, 2013 generated an annualized return on average assets of 1.05% and an annualized return on average equity of 8.20%, compared to an annualized return on average assets of 1.33% and an annualized return on average equity of 12.25% for the comparable period in 2012. Income before income taxes increased $3.7 million to $20.7 million during the nine months ended September 30, 2013, compared to $17.0 million during the nine months ended September 30, 2012. The pre-tax results of operations for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 reflect an increase of $8.8 million in pre-tax income from the community banking segment, including a $2.0 million decrease in net interest income, a $6.3 million decrease in real estate owned expense, a $3.1 million decrease in the provision for loan losses and a $1.2 million decrease in FDIC insurance expense, partially offset by $4.8 million decrease in pre-tax income from our mortgage banking operations. Income taxes totaled $8.0 million during the nine months ended September 30, 2013, compared to $216,000 during the nine months ended September 30, 2012.

Segment ReviewAs described in the notes to consolidated financial statements, the Company has two reportable segments: community banking and mortgage banking. Community banking consists of lending and deposit gathering (as well as other banking-related products and services) to consumers and businesses and the support to deliver, fund, and manage such banking services. The Company's mortgage banking segment originates residential mortgage products for sale in the secondary market.

Mortgage banking segment assets (which consist predominantly of loans held for sale) decreased $30.4 million, or 20.6%, to $117.3 million as of September 30, 2013 compared to $147.7 million as of December 31, 2012. This decrease was driven by a decrease in loans held for sale of $36.4 million, or 27.3%, to $97.2 million at September 30, 2013 from $133.6 million at December 31, 2012. Mortgage banking revenues increased $4.8 million, or 7.6%, to $68.5 million for the nine months ended September 30, 2013 compared to $63.6 million during the nine months ended September 30, 2012. The $4.8 million increase in mortgage banking revenues was attributable to an increase in loan origination volume. Loans originated for sale in the secondary market totaled $1.4 billion during the nine months ended September 30, 2013, which represents a $174.8 million, or 14.0%, increase in originations from the nine months ended September 30, 2012, which totaled $1.2 billion. The increase in mortgage banking income attributable to an increase in loan origination and sales volume was partially offset by a decrease in margins. Weighted average margins decreased by 115 basis points to 3.41% of loan originations during the nine months ended September 30, 2013 compared to 4.56% during the nine months ended September 30, 2012. The major components of mortgage banking revenues include fees and premiums associated with the sale of residential loans held for sale, which are discussed in below. The major expenses for the mortgage banking segment are compensation, payroll taxes and other employee benefits, as well as occupancy, office furniture and equipment and other expenses, which are covered generally in the consolidated discussion in the section "Noninterest Expense."
- 38 -


Average Balance Sheets, Interest and Yields/Costs
The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. Non-accrual loans were included in the computation of average balances. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

Nine Months Ended September 30,
2013
2012
Average Balance
Interest
Yield/Cost
Average Balance
Interest
Yield/Cost
(Dollars in Thousands)
Assets
Interest-earning assets:
Loans receivable and held for sale(1)
$
1,229,853
44,500
4.84
%
$
1,279,846
48,834
5.08
%
Mortgage related securities(2)
134,957
1,311
1.30
131,735
2,611
2.64
Debt securities, federal funds sold and short-term investments(2)(6)
163,492
1,806
1.48
184,072
1,760
1.27
Total interest-earning assets
1,528,302
47,617
4.17
1,595,653
53,205
4.44
Noninterest-earning assets
98,310
96,599
Total assets
$
1,626,612
$
1,692,252
Liabilities and equity
Interest-bearing liabilities:
Demand accounts
$
45,570
10
0.03
$
40,578
19
0.06
Money market and savings accounts
129,953
105
0.11
123,365
221
0.24
Time deposits
695,960
3,940
0.76
828,235
7,564
1.22
Total interest-bearing deposits
871,483
4,055
0.62
992,178
7,804
1.05
Borrowings
485,316
13,917
3.83
472,317
13,711
3.87
Total interest-bearing liabilities
1,356,799
17,972
1.77
1,464,495
21,515
1.96
Noninterest-bearing liabilities
Non interest-bearing deposits
42,739
32,124
Other noninterest-bearing liabilities
18,786
12,571
Total noninterest-bearing liabilities
61,525
44,695
Total liabilities
1,418,324
1,509,190
Equity
208,288
183,062
Total liabilities and equity
$
1,626,612
$
1,692,252
Net interest income
$
29,645
$
31,690
Net interest rate spread (3)
2.40
%
2.48
%
Net interest-earning assets (4)
$
171,503
$
131,158
Net interest margin (5)
2.59
%
2.65
%
Average interest-earning assets to average interest-bearing liabilities
112.64
%
108.96
%
__________
(1) Interest income includes net deferred loan fee amortization income of $469,000 and $478,000 for the nine months ended September 30, 2013 and 2012, respectively.
(2) Average balance of mortgage related and debt securities are based on amortized historical cost.
(3) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of
average interest-bearing liabilities.
(4) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(5) Net interest margin represents net interest income divided by average total interest-earning assets.
(6) Interest income from tax exempt securities is not significant to total interest income, therefore, interest yield on interest earning assets are not stated on a tax equivalent basis.
The average balance of tax exempt securities totaled $45.8 million and $18.9 million for the nine months ended September 30, 2013 and 2012, respectively.
- 39 -

Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

Nine Months Ended September 30,
2013 versus 2012
Increase (Decrease) due to
Volume
Rate
Net
(In Thousands)
Interest income:
Loans receivable and held for sale(1) (2)
$
(1,939
)
(2,395
)
(4,334
)
Mortgage related securities(3)
62
(1,362
)
(1,300
)
Other earning assets(3)
(212
)
258
46
Total interest-earning assets
(2,089
)
(3,499
)
(5,588
)
Interest expense:
Demand accounts
2
(11
)
(9
)
Money market and savings accounts
11
(128
)
(117
)
Time deposits
(1,077
)
(2,546
)
(3,623
)
Total interest-bearing deposits
(1,064
)
(2,685
)
(3,749
)
Borrowings
336
(130
)
206
Total interest-bearing liabilities
(728
)
(2,815
)
(3,543
)
Net change in net interest income
$
(1,361
)
(684
)
(2,045
)
______________
(1) Interest income includes net deferred loan fee amortization income of $469,000 and $478,000 for the nine months ended September 30, 2013 and 2012, respectively.
(2) Non-accrual loans have been included in average loans receivable balance.
(3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost.

Total Interest Income - Total interest income decreased $5.6 million, or 10.5%, to $47.6 million during the nine months ended September 30, 2013 from $53.2 million during the nine months ended September 30, 2012.

Interest income on loans decreased $4.3 million, or 8.9%, to $44.5 million during the nine months ended September 30, 2013 from $48.8 million during the nine months ended September 30, 2012. The decrease in interest income was primarily due to a 24 basis point decrease in the average yield on loans to 4.84% for the nine months ended September 30, 2013 from 5.08% for the nine months ended September 30, 2012. The decrease in interest income on loans also reflects a $50.0 million, or 3.9%, decrease in the average balance of loans outstanding to $1.23 billion during the nine months ended September 30, 2013 from $1.28 billion during the nine months ended September 30, 2012.

Interest income from mortgage-related securities decreased $1.3 million, or 49.8%, to $1.3 million during the nine months ended September 30, 2013 from $2.6 million during the nine months ended September 30, 2012. The decrease in interest income was due to a 134 basis point decrease in the average yield on mortgage-related securities to 1.30% for the nine months ended September 30, 2013 from 2.64% for the nine months ended September 30, 2012. The decrease in average yield was partially offset by a $3.2 million, or 2.4%, increase in the average balance of mortgage-related securities to $135.0 million for the nine months ended September 30, 2013 from $131.7 million during the nine months ended September 30, 2012. The decrease in average yield resulted from a general turnover of the investment security portfolio in which cash flows from higher yielding securities were reinvested in lower yielding securities due to the low interest rate environment.

Interest income from other interest earning assets (comprised of debt securities, federal funds sold and short-term investments) increased $46,000, or 2.6%, to $1.8 million for the nine months ended September 30, 2013 compared to $1.8 million for the nine months ended September 30, 2012. Interest income increased due to a 21 basis point increase in the average yield on other earning assets to 1.48% for the nine months ended September 30, 2013 from 1.27% for the nine months ended September 30, 2012. The average balance of higher yielding, tax-exempt municipal securities increased to $45.8 million for the nine months ended September 30, 2013 from $18.9 million for the nine months ended September 30, 2012, accounting for the increase in the average yield for the period. The increase in interest income from other earning assets due to an increase in average yield was partially offset by a decrease of $20.6 million, or 11.2%, in the average balance of other earning assets to $163.5 million during the nine months ended September 30, 2013 from $184.1 million during the nine months ended September 30, 2012.

- 40 -

Total Interest Expense - Total interest expense decreased by $3.5 million, or 16.5%, to $18.0 million during the nine months ended September 30, 2013 from $21.5 million during the nine months ended September 30, 2012. This decrease was the result of both a decrease in the average cost of funds as well as a decrease in the average balance of interest-bearing deposits and borrowings. The average cost of funds decreased 19 basis points to 1.77% for the nine months ended September 30, 2013 from 1.96% for the nine months ended September 30, 2012. Total average interest bearing deposits and borrowings outstanding decreased $107.7 million, or 7.4%, to $1.36 billion for the nine months ended September 30, 2013 compared to an average balance of $1.46 billion for the nine months ended September 30, 2012.

Interest expense on deposits decreased $3.7 million, or 48.0%, to $4.1 million during the nine months ended September 30, 2013 from $7.8 million during the nine months ended September 30, 2012. The decrease in interest expense on deposits was primarily due to a decrease in the average cost of deposits of 43 basis points to 0.62% for the nine months ended September 30, 2013 compared to 1.05% for the nine months ended September 30, 2012. The decrease in the cost of deposits reflects the current low interest rate environment due to the Federal Reserve's low short-term interest rate policy. These rates are typically used by financial institutions in pricing deposit products. The decrease in the cost of deposits also reflects a shift in the composition of deposits from higher cost time deposits to lower cost demand, money market and savings accounts. The decrease in interest expense attributable to the decrease in the cost of deposits was compounded by a decrease of $120.7 million, or 12.2%, in the average balance of interest bearing deposits to $871.5 million during the nine months ended September 30, 2013 from $992.2 million during the nine months ended September 30, 2012. The decrease in average interest-bearing deposits was exclusively the result of a decrease in time deposits, which carry a higher cost than demand, money market or savings accounts. The decrease in time deposits was consistent with the Bank's liquidity needs and funding obligations.

Interest expense on borrowings increased $206,000, or 1.5%, to $13.9 million during the nine months ended September 30, 2013 from $13.7 million during the nine months ended September 30, 2012. The increase primarily resulted from a $13.0 million, or 2.8%, increase in average borrowings outstanding to $485.3 million during the nine months ended September 30, 2013 from $472.3 million during the nine months ended September 30, 2012. The increased use of borrowings as a funding source during the nine months ended September 30, 2013 reflects an increased use of short-term repurchase agreements within our mortgage banking segment to fund loan originations to be sold in the secondary market. The increase in average balance was partially offset by a 4 basis point decrease in the average cost of borrowings to 3.83% during the nine months ended September 30, 2013 compared to 3.87% during the nine months ended September 30, 2012.

Net Interest Income - Net interest income decreased by $2.0 million, or 6.5%, to $29.6 million during the nine months ended September 30, 2013 as compared to $31.7 million during the nine months ended September 30, 2012. The decrease in net interest income resulted primarily from an 8 basis point decrease in our net interest rate spread to 2.40% during the nine months ended September 30, 2013 from 2.48% during the nine months ended September 30, 2012. The 8 basis point decrease in the net interest rate spread resulted from a 27 basis point decrease in the average yield on interest earning assets, which was partially offset by a 19 basis point decrease in the average cost of interest bearing liabilities.

Provision for Loan Losses – Our provision for loan losses decreased $3.1 million, or 44.2%, to $4.0 million during the nine months ended September 30, 2013, from $7.1 million during the nine months ended September 30, 2012. The decrease in the provision for loan losses resulted from a decrease in loans exhibiting risk characteristics that require estimated loan loss provisions in excess of our historical average experience rates. While the provision for loan losses has decreased from the prior year, it remains at historically elevated levels. These levels remain elevated due to continued general economic stress resulting in reduced levels of income earned by many of our borrowers combined with loan collateral values, primarily real estate, that remain at levels below those estimated at the time the loans were originally made. These factors result in higher levels of actual loss experience which, when applied to the portfolio in general, require higher loan loss provisions. See the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions.

Noninterest Income - Total noninterest income increased $4.7 million, or 7.2%, to $70.8 million during the nine months ended September 30, 2013 from $66.0 million during the nine months ended September 30, 2012. The increase resulted primarily from an increase in mortgage banking income and a gain on sale of mortgage servicing rights.

Mortgage banking income increased $2.2 million, or 3.5%, to $65.6 million for the nine months ended September 30, 2013, compared to $63.4 million during the nine months ended September 30, 2012. The $2.2 million increase in mortgage banking income was the result of an increase in origination and sales volumes, partially offset by a decrease in average sales margins. The decrease in average sales margin reflects an decrease in pricing and fees on all products in all geographic markets and is reflective of the change in general market conditions since September 30, 2012.

Loan origination volumes increased compared to the prior year which reflects the demand for fixed-rate loans due in large part to historically low interest rates on these products. Loans originated for sale in the secondary market totaled $1.42 billion during the nine months ended September 30, 2013, which represents a $174.8 million, or 14.0%, increase in originations from the nine months ended September 30, 2012, which totaled $1.25 billion. However, the $441.5 million in loans originated during the three months ended September 30, 2013 represented a 7.6% decrease from the $477.9 million originated during the three months ended September 30, 2012.

Weighted average margins decreased by 25.2% to 3.41% of loan originations during the nine months ended September 30, 2013 compared to 4.56% during the nine months ended September 30, 2012. Our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. During the nine months ended September 30, 2013, originations shifted towards governmental loans and loans made for the purpose of purchasing a home. Loans originated for the purchase of a residential property comprised 64.6% of total originations during the nine months ended September 30, 2013, compared to 58.0% during the nine months ended September 30, 2012. The mix of loan type also changed slightly with conventional loans and governmental loans comprising 62.7% and 37.3% of all loan originations, respectively, during the nine months ended September 30, 2013. During the nine months ended September 30, 2012 conventional loans and governmental loans comprised 66.6% and 33.4% of all loan originations, respectively.

Total other noninterest income increased $2.5 million to $3.2 million during the three months ended September 30, 2013 from $671,000 during the three months ended September 30, 2012. The increase resulted primarily from a $1.3 million gain on sale of mortgage servicing rights during the current period. There were no comparable transactions in 2012.


- 41 -

Noninterest Expense - Total noninterest expense increased $2.2 million, or 2.9%, to $75.7 million during the nine months ended September 30, 2013 from $73.6 million during the nine months September 30, 2012. The increase was primarily attributable to increased compensation, partially offset by a decrease in real estate owned expense.

Compensation, payroll taxes and other employee benefit expense increased $9.6 million, or 22.1%, to $53.0 million during the nine months ended September 30, 2013 compared to $43.4 million during the nine months ended September 30, 2012. Due primarily to an increase in loan origination activity, total compensation, payroll taxes and other benefits at our mortgage banking subsidiary increased $8.8 million, or 25.6%, to $43.2 million for the nine months ended September 30, 2013 compared to $34.4 million during the nine months ended September 30, 2012. The increase in compensation at our mortgage banking subsidiary correlates to the increase in mortgage banking income due to the commission-based compensation structure in place for our mortgage banking loan officers and was also due to an increase in salary expense related to increased staffing needed to support accumulated transaction growth.

Real estate owned management and sales activity generated $9,000 of income during the three months ended September 30, 2013 compared to $6.3 million of expense during the three months ended September 30, 2012. Real estate owned expense includes the operating costs related to the properties, net of rental income. In addition, it includes net gain or loss recognized upon the sale of a foreclosed property, as well as write-downs recognized to maintain the properties at the lower of cost or estimated fair value. The decrease in real estate owned expense results from a decrease in net property management expense and an increase in net gains recognized upon the sale of properties. During the nine months ended September 30, 2013, net operating expense, which primarily relates to property taxes, maintenance and management fees, net of rental income, decreased $708,000, or 35.2%, to $1.3 million, from $2.0 million during the nine months ended September 30, 2012. The decrease in net operating expense compared to the prior period resulted from both an improvement in the operating results of income producing properties as well as a decrease in the number and average balance of properties owned. The average balance of real estate owned totaled $30.6 million for the nine months ended September 30, 2013 compared to $52.8 million for the nine months ended September 30, 2012. Sales and write-downs of real estate owned resulted in a net gain of $1.3 million during the nine months ended September 30, 2013. During the nine months ended September 30, 2012, sales and write downs of real estate owned resulted in a net loss of $4.3 million.

Income Taxes – Income tax expense increased from $216,000 during the nine months ended September 30, 2012 to $8.0 million for the nine months ended September 30, 2013. This increase was partially due to the increase in our income before income taxes, which increased from $17.0 million during the nine months ended September 30, 2012 to $20.7 million during the nine months ended September 30, 2013. In addition, during the third quarter of 2008, we established a valuation allowance against our net deferred tax assets. That valuation allowance effectively resulted in no income tax expense being recognized during the nine months ended September 30, 2012 other than state income taxes for states in which separate company returns are filed. During the fourth quarter of 2012, we released the valuation allowance against our net deferred tax assets. Therefore, income tax expense is recognized during the nine months ended September 30, 2013 at an effective rate of 38.4% of pretax book income.

As of September 30, 2013, net deferred tax assets totaled $14.3 million, which, in the judgment of management, will more-likely-than-not be fully realized. The largest components of the deferred tax assets are associated with the allowance for loan losses and basis adjustments on real estate owned. We are largely relying on earnings generated in the current year and forecasted earnings in future years in making the determination that we will more-likely-than-not realize our deferred tax assets.


Comparison of Financial Condition at September 30, 2013 and December 31, 2012

Total Assets - Total assets decreased by $63.3 million, or 3.8%, to $1.60 billion at September 30, 2013 from $1.66 billion at December 31, 2012. The decrease in total assets reflects decreases in loans receivable of $41.5 million, loans held for sale of $36.4 million and real estate owned of $12.8 million. These funds were used to reduce deposits by $67.2 million, reduce short-term borrowings by $8.6 million and increase available for sale securities by $6.6 million during the nine months ended September 30, 2013.

Cash and Cash EquivalentsCash and cash equivalents increased $6.4 million, or 9.0%, to $77.9 million at September 30, 2013, compared to $71.5 million at December 31, 2012. The overall level of cash and cash equivalents continues to reflect the Company's plan to maintain higher than usual liquidity given the current economic environment and relatively low rates of return available on securities and other investments.

Securities Available for Sale – Securities available for sale increased by $6.6 million, or 3.2%, to $211.6 million at September 30, 2013 from $205.0 million at December 31, 2012. This increase reflects a $21.9 million increase in municipal securities and a $7.7 million increase in government sponsored enterprise bonds, partially offset by a $13.4 million decrease in mortgage-backed securities and an $8.9 million decrease in government sponsored enterprise issued collateralized mortgage obligations. During the nine months ended September 30, 2013, the proceeds from principal repayments on mortgage-related securities were reinvested in municipal securities deemed to provide a better risk-adjusted return.

Loans Held for Sale - Loans held for sale decreased $36.4 million, or 27.3%, to $97.2 million at September 30, 2013 from $133.6 million at December 31, 2012. During the nine months ended September 30, 2013, $1.42 billion in residential loans were originated for sale. During the same period, sales of loans held for sale totaled $1.46 billion.

Loans Receivable - Loans receivable held for investment decreased $41.5 million, or 3.7%, to $1.09 billion at September 30, 2013 from $1.13 billion at December 31, 2012. The decrease in total loans receivable was primarily attributable to a $41.7 million decrease in one- to four-family loans, partially offset by a $4.7 million increase in commercial real estate loans and a $2.8 million increase in over four-family real estate loans. The decrease in one- to four-family loans reflects a decline in loan demand for variable-rate real estate mortgage loans as borrowers continue to prefer long-term fixed-rate products that the Company does not generally retain in its portfolio. This resulted in a shift in the composition of loan originations during 2013 and 2012 from one- to four-family residential variable-rate loans to residential real estate loans collateralized by over four-family properties and commercial real estate, as these categories of borrowers displayed relatively stable levels of demand for our existing products. During the nine months ended September 30, 2013, $10.1 million in loans were transferred to real estate owned and $10.3 million were charged-off, net of recoveries.
- 42 -


The following table shows loan origination, loan purchases, principal repayment activity, transfers to real estate owned, charge-offs and sales during the periods indicated.

As of or for the
As of or for the
Nine Months Ended September 30,
Year Ended
2013
2012
December 31, 2012
(In Thousands)
Total gross loans receivable and held for sale at beginning of period
$
1,267,285
$
1,304,947
1,304,947
Real estate loans originated for investment:
Residential
One- to four-family
14,195
14,705
17,088
Over four-family
56,809
36,144
51,816
Home equity
6,586
2,115
3,112
Construction and land
10,510
2,056
2,695
Commercial real estate
5,239
12,860
14,572
Total real estate loans originated for investment
93,339
67,880
89,283
Consumer loans originated for investment
12
35
35
Commercial business loans originated for investment
5,135
3,801
9,857
Total loans originated for investment
98,486
71,716
99,175
Real estate loans purchased for investment:
One- to four-family
-
12,148
12,148
Home equity
-
3,338
3,338
Total real estate loans purchased for investment
-
15,486
15,486
Principal repayments
(119,570
)
(121,282
)
(165,683
)
Transfers to real estate owned
(10,117
)
(19,729
)
(22,282
)
Loan principal charged-off, net of recoveries
(10,295
)
(8,563
)
(9,687
)
Net activity in loans held for investment
(41,496
)
(62,372
)
(82,991
)
Loans originated for sale
1,419,834
1,245,018
1,749,426
Loans sold
(1,456,263
)
(1,210,144
)
(1,704,097
)
Net activity in loans held for sale
(36,429
)
34,874
45,329
Total gross loans receivable and held for sale at end of period
$
1,189,360
$
1,277,449
1,267,285


Allowance for Loan Losses - The allowance for loan losses decreased $6.3 million, or 20.4%, to $24.7 million at September 30, 2013 from $31.0 million at December 31, 2012. The $6.3 million decrease in the allowance for loan losses during the nine months ended September 30, 2013 reflects improvement in both the quality of the loan portfolio as well as the overall local real estate market. We have experienced an improvement in a number of key loan quality metrics compared to December 31, 2012, including impaired loans, substandard loans, loans contractually past due and non-accrual loans. In addition, the decrease in the allowance for loan losses reflects a decrease in the balance of loans outstanding. As of September 30, 2013, the allowance for loan losses to total loans receivable was 2.26% and was equal to 43.03% of non-performing loans, compared to 2.74% and 41.58%, respectively, at December 31, 2012. The overall $6.3 million decrease in the allowance for loan losses during the nine months ended September 30, 2013 was primarily the result of a $6.1 million decrease in the allowance for loan losses related to the one- to four-family category. The decrease related to this category resulted from the charge-off of specific reserves and improvement of key loan quality metrics, as well as a decrease in the overall balance of loans outstanding. While the local real estate market has improved during the current fiscal year, the risk of loss on loans secured by residential real estate remains at an elevated level. That portion of the allowance for loan losses attributable to mortgage loans secured by residential real estate comprised 85.4% of the total allowance for loan losses at September 30, 2013 and 89.3% at December 31, 2012.
- 43 -


Real Estate Owned – Total real estate owned decreased $12.8 million, or 35.7%, to $23.1 million at September 30, 2013 from $36.0 million at December 31, 2012. During the nine months ended September 30, 2013, $10.1 million was transferred from loans to real estate owned upon completion of foreclosure. Declines in property values evidenced by updated appraisals, responses to list prices on properties held for sale and/or deterioration in the condition of properties resulted in write downs totaling $1.1 million during the nine months ended September 30, 2013. During the same period, sales of real estate owned totaled $22.0 million.

Deposits – Total deposits decreased $67.2 million, or 7.2%, to $872.3 million at September 30, 2013 from $939.5 million at December 31, 2012. The reduction in deposits reflects management's decision to accept a certain level of deposit run-off during a period of diminished loan demand. Total time deposits decreased $80.4 million, or 10.9%, to $656.5 million at September 30, 2013 from $736.9 million at December 31, 2012. The decrease in time deposits was partially offset by an increase in money market and savings deposits and demand deposits. Total money market and savings deposits increased $5.8 million, or 4.9%, to $124.3 million at September 30, 2013 from $118.5 million at December 31, 2012. Total demand deposits increased $7.4 million, or 8.7%, to $91.5 million at September 30, 2013 from $84.1 million at December 31, 2012.

Borrowings – Total borrowings decreased $8.6 million, or 1.8%, to $471.2 million at September 30, 2013 from $479.9 million at December 31, 2012. The decrease in borrowings relates to a decrease in the use of short-term repurchase agreements to finance loans held for sale. The balance of these lines of credit decreased by $8.6 to $37.2 million at September 30, 2013, from $45.9 million at December 31, 2012.

Advance Payments by Borrowers for Taxes - Advance payments by borrowers for taxes increased $20.3 million to $21.9 million at September 30, 2013 from $1.7 million at December 31, 2012. The increase was the result of payments received from borrowers for their real estate taxes and is seasonally normal, as balances increase during the course of the calendar year until real estate tax obligations are paid out in the fourth quarter.

Other Liabilities - Other liabilities decreased $17.8 million, or 47.8%, to $19.5 million at September 30, 2013 from $37.4 million at December 31, 2012. The decrease resulted primarily from a seasonal decrease in outstanding escrow checks. The Company receives payments from borrowers for their real estate taxes during the course of the calendar year until real estate tax obligations are paid out in the fourth quarter. These amounts remain classified as other liabilities until settled. The decrease related to escrow checks was partially offset by an increase in amounts due to third parties related to the origination of loans held for sale.

Shareholders' Equity – Shareholders' equity increased by $10.2 million, or 5.0%, to $212.8 million at September 30, 2013 from $202.6 million at December 31, 2012. The increase in shareholders' equity was primarily due to a $12.8 million increase in retained earnings reflecting net income for the nine months ended September 30, 2013. In addition to the increase in retained earnings, shareholders' equity was positively impacted by a $641,000 decrease in unearned ESOP shares. Partially offsetting the increases was a $3.2 million decrease in accumulated other comprehensive income.

- 44 -



ASSET QUALITY

NONPERFORMING ASSETS

At September 30,
At December 31,
2013
2012
(Dollars in Thousands)
Non-accrual loans:
Residential
One- to four-family
$
36,704
46,467
Over four-family
13,633
23,205
Home equity
1,345
1,578
Construction and land
4,237
2,215
Commercial real estate
974
668
Consumer
19
24
Commercial
510
511
Total non-accrual loans
57,422
74,668
Real estate owned
One- to four-family
12,478
17,353
Over four-family
4,192
9,890
Construction and land
5,607
7,029
Commercial real estate
870
1,702
Total real estate owned
23,147
35,974
Total nonperforming assets
$
80,569
110,642
Total non-accrual loans to total loans, net
5.26
%
6.59
%
Total non-accrual loans and performing troubled debt restructurings to total loans receivable
restructurings to total loans receivable
7.58
%
8.00
%
Total non-accrual loans to total assets
3.59
%
4.50
%
Total nonperforming assets to total assets
5.04
%
6.66
%


All loans that exceed 90 days past due with respect to principal and interest are recognized as non-accrual. Troubled debt restructurings that are non-accrual either due to being past due 90 days or more or which have not yet performed under the modified terms for a reasonable period of time, are included in the table above. In addition, loans that are past due less than 90 days are evaluated to determine the likelihood of collectability given other credit risk factors such as early stage delinquency, the nature of the collateral or the results of a borrower review. When the collection of all contractual principal and interest is determined to be unlikely, the loan is moved to non-accrual status and an updated appraisal of the underlying collateral is ordered. This process generally takes place between contractual past due dates 60 to 90 days. Upon determining the updated estimated value of the collateral, a loan loss provision is recorded to establish a specific reserve to the extent that the outstanding principal balance exceeds the updated estimated net realizable value of the collateral. When a loan is determined to be uncollectible, typically coinciding with the initiation of foreclosure action, the specific reserve is reviewed for adequacy, adjusted if necessary, and charged-off.

The following table sets forth activity in our non-accrual loans for the periods indicated.


At or for the Nine Months
Ended September 30,
2013
2012
(In Thousands)
Balance at beginning of period
$
74,668
78,218
Additions
29,494
36,044
Transfers to real estate owned
(10,117
)
(19,729
)
Charge-offs
(10,908
)
(6,083
)
Returned to accrual status
(20,702
)
(8,043
)
Principal paydowns and other
(5,013
)
(6,779
)
Balance at end of period
$
57,422
73,628


- 45 -

Total non-accrual loans decreased by $17.2 million, or 23.1%, to $57.4 million as of September 30, 2013 compared to $74.7 million as of December 31, 2012. The ratio of non-accrual loans to total loans receivable was 5.26% at September 30, 2013 compared to 6.59% at December 31, 2012. During the nine months ended September 30, 2013, $20.7 million in loans were returned to accrual status, $10.1 million were transferred to real estate owned (net of charge-offs), $10.9 million in loan principal was charged off and $5.0 million in principal payments were received. Offsetting this activity, $29.5 million in loans were placed on non-accrual status during the nine months ended September 30, 2013.

Of the $57.4 million in total non-accrual loans as of September 30, 2013, $50.3 million in loans have been specifically reviewed to assess whether a specific valuation allowance is necessary. A specific valuation allowance is established for an amount equal to the impairment when the carrying value of the loan exceeds the present value of expected future cash flows, discounted at the loan's original effective interest rate or the fair value of the underlying collateral with an adjustment made for costs to dispose of the asset. Based upon these specific reviews, a total of $10.2 million in partial charge-offs have been recorded with respect to these loans as of September 30, 2013. Partially charged-off loans measured for impairment based upon net realizable collateral value are maintained in a "non-performing" status and are disclosed as impaired loans. In addition, specific reserves totaling $4.0 million have been recorded as of September 30, 2013. The remaining $7.2 million of non-accrual loans were reviewed on an aggregate basis and $1.9 million in general valuation allowance was deemed necessary related to those loans as of September 30, 2013. The $1.9 million in general valuation allowance is based upon a migration analysis performed with respect to similar non-accrual loans in prior periods.

There were no accruing loans past due 90 days or more during the nine months ended September 30, 2013 or 2012.


TROUBLED DEBT RESTRUCTURINGS

The following table summarizes troubled debt restructurings:


At September 30,
At December 31,
2013
2012
(Dollars in Thousands)
Troubled debt restructurings
Substandard
$
29,235
48,449
Watch
18,444
11,172
Total troubled debt restructurings
$
47,679
59,621


All troubled debt restructurings are considered to be impaired and are risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in the notes to the financial statements. Specific reserves have been established to the extent that collateral-based impairment analyses indicate that a collateral shortfall exists.

Information with respect to the accrual status of our troubled debt restructurings is provided in the following table.

As of September 30, 2013
Accruing
Non-accruing
Total
(In Thousands)
One- to four-family
$
8,024
14,007
22,031
Over four-family
15,924
6,227
22,151
Home equity
-
992
992
Construction and land
1,408
840
2,248
Commercial real estate
-
257
257
$
25,356
22,323
47,679
As of December 31, 2012
Accruing
Non-accruing
Total
One- to four-family
$
9,921
21,847
31,768
Over four-family
3,917
20,030
23,947
Home equity
-
986
986
Construction and land
2,173
79
2,252
Commercial real estate
-
668
668
$
16,011
43,610
59,621

- 46 -

The following table sets forth activity in our troubled debt restructurings for the periods indicated.


At or for the Nine Months
Ended September 30, 2013
Accrual
Non-accrual
(In Thousands)
Balance at beginning of period
$
16,011
43,609
Additions
329
1,560
Change in accrual status
15,385
(15,385
)
Charge-offs
(102
)
(2,554
)
Returned to contractual/market terms
(4,921
)
(1,927
)
Transferred to real estate owned
-
(2,092
)
Principal paydowns and other
(1,339
)
(888
)
Balance at end of period
$
25,363
22,323


LOAN DELINQUENCY


The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio:

At September 30,
At December 31,
2013
2012
(Dollars in Thousands)
Loans past due less than 90 days
$
13,538
23,092
Loans past due 90 days or more
35,343
51,358
Total loans past due
$
48,881
74,450
Total loans past due to total loans receivable
4.48
%
6.57
%


Past due loans decreased by $25.6 million, or 34.3%, to $48.9 million at September 30, 2013 from $74.5 million at December 31, 2012. Loans past due 90 days or more decreased by $16.0 million, or 31.1%, during the nine months ended September 30, 2013 while loans past due less than 90 days decreased by $9.6 million, or 41.4%. The $16.0 million decrease in loans past due 90 days or more was primarily due to an $11.0 million lending relationship that was brought current under the terms of a troubled debt restructuring during the three months ended September 30, 2013. The $9.6 million decrease in loans past due less than 90 days or more was primarily attributable to a $8.0 million decrease in loans collateralized by one- to four-family residential real estate.


REAL ESTATE OWNED


Total real estate owned decreased by $12.8 million, or 35.7%, to $23.1 million at September 30, 2013, compared to $36.0 million at December 31, 2012. During the nine months ended September 30, 2013, $10.1 million was transferred from loans to real estate owned upon completion of foreclosure. Declines in property values evidenced by updated appraisals, responses to list prices on properties held for sale and/or deterioration in the condition of properties resulted in write-downs totaling $1.1 million during the nine months ended September 30, 2013. During the same period, sales of real estate owned totaled $22.0 million, resulting in a net gain of $2.4 million. New appraisals received on real estate owned and collateral dependent impaired loans are based upon an "as is value" assumption. During the period of time in which we are awaiting receipt of an updated appraisal, loans evaluated for impairment based upon collateral value are measured by the following:
Applying an updated adjustment factor (as described previously) to an existing appraisal;
Confirming that the physical condition of the real estate has not significantly changed since the last valuation date;
Comparing the estimated current value of the collateral to that of updated sales values experienced on similar collateral;
Comparing the estimated current value of the collateral to that of updated values seen on current appraisals of similar collateral; and
Comparing the estimated current value to that of updated listed sales prices on our real estate owned and that of similar properties (not owned by the Company).
Virtually all habitable real estate owned is managed with the intent of attracting a lessee to generate revenue. Foreclosed properties are recorded at the lower of carrying value or fair value, less costs to sell, with charge-offs, if any, charged to the allowance for loan losses upon transfer to real estate owned. The fair value is primarily based upon updated appraisals in addition to an analysis of current real estate market conditions.



- 47 -



ALLOWANCE FOR LOAN LOSSES


At or for the Nine Months
Ended September 30,
2013
2012
(Dollars in Thousands)
Balance at beginning of period
$
31,043
32,430
Provision for loan losses
3,960
7,100
Charge-offs:
Mortgage
One- to four-family
7,986
5,522
Over four-family
1,267
1,038
Home Equity
575
375
Commercial real estate
128
816
Construction and land
1,366
1,661
Consumer
-
4
Commercial
6
59
Total charge-offs
11,328
9,475
Recoveries:
Mortgage
One- to four-family
694
305
Over four-family
205
55
Home Equity
73
12
Construction and land
51
250
Consumer
5
-
Commercial
5
290
Total recoveries
1,033
912
Net charge-offs
10,295
8,563
Allowance at end of period
$
24,708
$
30,967
Ratios:
Allowance for loan losses to non-accrual loans at end of period
43.03
%
42.06
%
Allowance for loan losses to loans receivable at end of period
2.26
%
2.68
%
Net charge-offs to average loans outstanding (annualized)
1.12
%
0.89
%
Current year provision for loan losses to net charge-offs
38.46
%
82.91
%
Net charge-offs (annualized) to beginning of the year allowance
44.34
%
35.30
%

_______________

At September 30, 2013, the allowance for loan losses was $24.7 million, compared to $31.0 million at December 31, 2012. As of September 30, 2013, the allowance for loan losses represented 2.26% of total loans receivable and was equal to 43.03% of non-performing loans, compared to 2.74% and 41.58%, respectively, at December 31, 2012. The $6.3 million decrease in the allowance for loan losses during the nine months ended September 30, 2013 reflects improvement in both the quality of the loan portfolio as well as the overall local real estate market. The Company has experienced improvement in a number of key loan-related loan quality metrics compared to September 30, 2012, including impaired loans, substandard loans, loans contractually past due and non-accrual loans. In addition, the decrease in the allowance for loan losses reflects a decrease in the overall balance of loans outstanding.

Net charge-offs totaled $10.3 million, or an annualized 1.12% of average loans for the nine months ended September 30, 2013, compared to $8.6 million, or an annualized 0.89% of average loans for the nine months ended September 30, 2012. Of the $10.3 million in net charge-offs during the nine months ended September 30, 2013, approximately 71% of the activity related to loans secured by one- to four-family residential loans.

Our underwriting policies and procedures emphasize the fact that credit decisions must rely on both the credit quality of the borrower and the estimated value of the underlying collateral. Credit quality is assured only when the estimated value of the collateral is objectively determined and is not subject to significant fluctuation. The quantified deterioration of the credit quality of our loan portfolio as described above is the direct result of borrowers who were not financially strong enough to make regular interest and principal payments or maintain their properties when the economic environment no longer allowed them the option of converting estimated real estate value increases into short-term cash flow.

The allowance for loan losses has been determined in accordance with GAAP. We are responsible for the timely and periodic determination of the amount of the allowance required. Future provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and the underlying collateral, trends in nonperforming loans, current economic conditions and other relevant factors. To the best of management's knowledge, all probable losses have been provided for in the allowance for loan losses.

The establishment of the amount of the loan loss allowance inherently involves judgments by management as to the appropriateness of the allowance, which ultimately may or may not be correct. Higher than anticipated rates of loan default would likely result in a need to increase provisions in future years. See "Critical Accounting Policies" above for a discussion on the use of judgment in determining the amount of the allowance for loan losses.
- 48 -


Liquidity and Capital Resources

We maintain liquid assets at levels we consider adequate to meet our liquidity needs. Our liquidity ratio averaged 4.1% and 5.0% for the nine months ended September 30, 2013 and 2012, respectively. The liquidity ratio is equal to average daily cash and cash equivalents for the period divided by average total assets. We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans. We also adjust liquidity as appropriate to meet asset and liability management objectives. The operational adequacy of our liquidity position at any point in time is dependent upon the judgment of the senior management as supported by the Asset/Liability Committee. Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators.
Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors. We set the interest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term, interest-earning assets, which provide liquidity to meet lending requirements. Additional sources of liquidity used for the purpose of managing long- and short-term cash flows include advances from the FHLBC.
A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities. At September 30, 2013 and 2012, respectively, $77.9 million and $82.0 million of our assets were invested in cash and cash equivalents. At September 30, 2013 cash and cash equivalents are comprised of the following: $66.9 million in cash held at the Federal Reserve Bank and other depository institutions and $11.0 million in federal funds sold and short-term investments. Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage-related securities, increases in deposit accounts and advances from the FHLBC.
During the nine months ended September 30, 2013, the collection of principal payments on loans, net of loan originations, provided cash flows of $21.1 million, compared to $34.1 million for the nine months ended September 30, 2012. The decrease in loans receivable is reflective of the general decline in loan demand for variable-rate residential real estate mortgage loans combined with the Company's tightened underwriting standards given the current economic environment. The decrease in total loans receivable was primarily attributable to a $41.7 million decrease in one- to four-family loans, partially offset by a $4.7 million increase in commercial real estate loans and a $2.8 million increase in over four-family real estate loans. The decrease in one- to four-family loans reflects a decline in loan demand for variable-rate real estate mortgage loans as borrowers continue to prefer long-term fixed-rate products that the Company does not generally retain in its portfolio.
Deposit flows are generally affected by the level of interest rates, the interest rates and products offered by local competitors, and other factors. Deposits decreased by $67.2 million for the nine months ended September 30, 2013 compared to a $97.7 million decrease during the nine months ended September 30, 2012. The 2013 decrease in deposits was driven by a $80.4 million decrease in time deposits, partially offset by a $5.8 million increase in money market and savings deposits and a $7.4 million increase in demand deposits.
Liquidity management is both a daily and longer-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLBC which provide an additional source of funds. At September 30, 2013, we had $350.0 million in advances from the FHLBC with contractual maturity dates in 2016, 2017 or 2018. All advances are callable quarterly until maturity. As an additional source of funds, we also enter into repurchase agreements. At September 30, 2013, we had $84.0 million in repurchase agreements. The repurchase agreements mature at various times in 2017, however, all are callable quarterly until maturity.
At September 30, 2013, we had outstanding commitments to originate loans receivable of $18.5 million. In addition, at September 30, 2013 we had unfunded commitments under construction loans of $7.8 million, unfunded commitments under business lines of credit of $9.2 million and unfunded commitments under home equity lines of credit and standby letters of credit of $16.8 million. At September 30, 2013 certificates of deposit scheduled to mature in one year or less totaled $501.1 million. Based on prior experience, management believes that, subject to the Bank's funding needs, a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case. In the event a significant portion of our deposits is not retained by us, we will have to utilize other funding sources, such as FHLBC advances, in order to maintain our level of assets. However, we cannot assure that such borrowings would be available on attractive terms, or at all, if and when needed. Alternatively, we could reduce our level of liquid assets, such as our cash and cash equivalents and securities available-for-sale in order to meet funding needs. In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal.
Capital

Waterstone Financial, Inc. is the mid-tier stock holding company subsidiary of Lamplighter Financial, MHC, formed as part of the reorganization of WaterStone Bank into mutual holding company form. WaterStone Bank was converted from a mutual to a stock savings bank as part of our reorganization. At September 30, 2013, 74% of Waterstone Financial, Inc. outstanding shares were held by Lamplighter Financial, HMC and 26% were held by public shareholders.

Shareholders' equity increased by $10.2 million, or 5.0%, to $212.8 million at September 30, 2013 from $202.6 million at December 31, 2012. The increase in shareholders' equity was primarily due to a $12.8 million increase in retained earnings reflecting net income for the nine months ended September 30, 2013. In addition to the increase in retained earnings, shareholders' equity was positively impacted by a $641,000 decrease in unearned ESOP shares. Partially offsetting the increases was a $3.2 million decrease in accumulated other comprehensive income.

Also see "Notes to Consolidated Financial Statements - Regulatory Capital."
- 49 -

Contractual Obligations, Commitments and Contingent Liabilities
The following tables present information indicating various contractual obligations and commitments of the Company as of September 30, 2013 and the respective maturity dates.

More than
More than
One Year
Three Years
Over
One Year
Through
Through
Five
Total
or Less
Three Years
Five Years
Years
(In Thousands)
Demand deposits (4)
$
91,496
91,496
-
-
-
Money market and savings deposits (4)
124,253
124,253
-
-
-
Time deposit (4)
656,536
501,091
117,207
38,238
-
Short-term borrowings (4)
37,243
37,243
-
-
-
Federal Home Loan Bank advances (1)
350,000
-
220,000
130,000
-
Repurchase agreements (2)(4)
84,000
-
-
84,000
-
Operating leases (3)
9,175
2,350
2,353
1,300
3,172
Salary continuation agreements
638
170
340
128
-
$
1,353,341
756,603
339,900
253,666
3,172
_____________
(1) Secured under a blanket security agreement on qualifying assets, principally, mortgage loans. Excludes interest which will accrue on the advances.
All Federal Home Loan Bank advances with maturities exceeding one year are callable on a quarterly basis.
(2) The repurchase agreements are callable on a quarterly basis until maturity.
(3) Represents non-cancelable operating leases for offices and equipment.
(4) Excludes interest.


Off-Balance Sheet Commitments

The following table details the amounts and expected maturities of significant off-balance sheet commitments as of September 30, 2013.


More than
More than
One Year
Three Years
Over
One Year
Through
Through
Five
Total
or Less
Three Years
Five Years
Years
(In Thousands)
Real estate loan commitments (1)
$
18,513
$
18,513
-
-
-
Unused portion of home equity lines of credit (2)
15,922
15,922
-
-
-
Unused portion of construction loans (3)
7,827
7,827
-
-
-
Unused portion of business lines of credit
9,197
9,197
-
-
-
Standby letters of credit
882
882
-
-
-
Total Other Commitments
$
52,341
52,341
-
-
-
______________
General: Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract and generally have fixed expiration dates or other termination clauses.
(1) Commitments for loans are extended to customers for up to 90 days after which they expire.
(2) Unused portions of home equity loans are available to the borrower for up to 10 years.
(3) Unused portions of construction loans are available to the borrower for up to 1 year.


- 50 -

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Management of Market Risk

General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, WaterStone Bank's board of directors has established an Asset/Liability Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors. Management monitors the level of interest rate risk on a regular basis and the Asset/Liability Committee meets at least weekly to review our asset/liability policies and interest rate risk position, which are evaluated quarterly.

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk: (i) emphasizing variable rate loans including variable rate one- to four-family, and commercial real estate loans as well as six to five year commercial real estate balloon loans; (ii) reducing and shortening the expected average life of the investment portfolio; and (iii) whenever possible, lengthening the term structure of our deposit base and our borrowings from the FHLBC. These measures should reduce the volatility of our net interest income in different interest rate environments.
Income Simulation. Simulation analysis is an estimate of our interest rate risk exposure at a particular point in time. At least quarterly we review the potential effect changes in interest rates may have on the repayment or repricing of rate sensitive assets and funding requirements of rate sensitive liabilities. Our most recent simulation uses projected repricing of assets and liabilities at September 30, 2013 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rate assumptions may have a significant impact on interest income simulation results. Because of the large percentage of loans and mortgage-backed securities we hold, rising or falling interest rates may have a significant impact on the actual prepayment speeds of our fixed-rate mortgage related assets that may in turn affect our interest rate sensitivity position. When interest rates rise, prepayment speeds slow and the average expected lives of our fixed-rate assets would tend to lengthen more than the expected average lives of our liabilities and therefore would most likely have a negative impact on net interest income and earnings. This effect is offset by the impact that variable-rate assets have on net interest income as interest rates rise and fall.
Percentage Increase (Decrease) in
Estimated Annual Net Interest
Income Over 12 Months
300 basis point gradual rise in rates
5.63
200 basis point gradual rise in rates
5.81
100 basis point gradual rise in rates
6.09
Unchanged rate scenario
6.18
100 basis point gradual decline in rates (1)
6.02
____________
(1) Given the current low point in the interest rate cycle, down scenarios in excess of 100 basis points are not meaningful.
WaterStone Bank's Asset/Liability policy limits projected changes in net average annual interest income to a maximum decline of 25% for various levels of interest rate changes measured over a 12-month period when compared to the flat rate scenario. In addition, projected changes in the economic value of equity are limited to a maximum decline of 35% for interest rate movements of up to 300 basis points when compared to the flat rate scenario. These limits are re-evaluated on a periodic basis and may be modified, as appropriate. At September 30, 2013, a 100 basis point gradual increase in interest rates had the effect of increasing forecast net interest income by 6.09% while a 100 basis point decrease in rates had the effect of increasing net interest income by 6.02%. At September 30, 2013, a 100 basis point gradual increase in interest rates had the effect of decreasing the economic value of equity by 9.19% while a 100 basis point decrease in rates had the effect of increasing the economic value of equity by 9.32 %. While we believe the assumptions used are reasonable, there can be no assurance that assumed prepayment rates will approximate actual future mortgage-backed security and loan repayment activity.

Item 4. Controls and Procedures

Disclosure Controls and Procedures : Company management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective.

Internal Control Over Financial Reporting : There have been no changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
- 51 -

PART II. OTHER INFORMATION


Item 1. Legal Proceedings

The Company is not involved in any pending legal proceedings as a defendant other than routine legal proceedings occurring in the ordinary course of business. At September 30, 2013, the Company believes that any liability arising from the resolution of any pending legal proceedings will not be material to its financial condition or results of operations.
Item 1A. Risk Factors
In addition to the other information contained this Quarterly Report on Form 10-Q, the following risk factor represents material updates and additions to the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2102 as filed with the Securities and Exchange Commission. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations. Further, to the extent that any of the information contained in this Quarterly Report on Form 10-Q constitutes forward-looking statements, the risk factor set forth below also is a cautionary statement identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of us.

The recent federal government shutdown is expected to result in reduced loan originations and related gains on sale during the fourth quarter of 2013, and any future federal government shutdown could negatively affect our financial condition and results of operations.

Our mortgage banking operations provide a significant portion of our non-interest income. During the recent federal government shutdown, we were not able to close certain loans and recognize non-interest income on the sale of those loans due to our inability to verify information related to borrowers, such as payments of federal income taxes. Also, some of the loans we originate are sold directly to government agencies, and some of these sales were unable to be consummated during the shutdown. Although we expect that we will be able to close a majority of these loans, which would result in a timing difference in our recognition of non-interest income, we will incur higher borrowing costs related to the longer period we maintain an outstanding commitment to fund a loan. In addition, we believe that some of these borrowers have determined or will determine not to proceed with their home purchase and not close on their loans, which would result in a permanent loss of the related non-interest income. The recent federal government shutdown could also result in reduced income for government employees or employees of companies that engage in business with the federal government, which could result in greater loan delinquencies, increases in our nonperforming, criticized and classified assets and a decline in demand for our products and services. Any future federal government shutdown could have the same negative effect.

Proposed and final regulations could restrict our ability to originate and sell loans.

The Consumer Financial Protection Bureau has issued a rule designed to clarify for lenders how they can avoid legal liability under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower's ability to repay a mortgage. Loans that meet this "qualified mortgage" definition will be presumed to have complied with the new ability-to-repay standard. Under the Consumer Financial Protection Bureau's rule, a "qualified mortgage" loan must not contain certain specified features, including:
excessive upfront points and fees (those exceeding 3% of the total loan amount, less "bona fide discount points" for prime loans);
interest-only payments;
negative-amortization; and
terms longer than 30 years.
Also, to qualify as a "qualified mortgage," a borrower's total monthly debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The Consumer Financial Protection Bureau's rule on qualified mortgages could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive/and or time consuming to make these loans, which could limit our growth or profitability.

In addition, the Dodd-Frank Act requires the regulatory agencies to issue regulations that require securitizers of loans to retain not less than 5% of the credit risk for any asset that is not a "qualified residential mortgage." The regulatory agencies have issued a proposed rule to implement this requirement. The Dodd-Frank Act provides that the definition of "qualified residential mortgage" can be no broader than the definition of "qualified mortgage" issued by the Consumer Financial Protection Bureau for purposes of its regulations (as described above). Although the final rule with respect to the retention of credit risk has not yet been issued, the final rule could have a significant effect on the secondary market for loans and the types of loans we originate, and restrict our ability to make loans.

A discontinuation of the Federal Reserve Board's bond purchasing program may adversely affect our mortgage banking revenues.

The Federal Reserve Board has undertaken an unprecedented bond purchase program, known as "quantitative easing." This program is designed to keep market interest rates low and encourage growth. A discontinuation of the Federal Reserve Board's bond repurchase program would likely cause an increase in market interest rates, which may reduce our loan originations by our mortgage banking subsidiary.
- 52 -


We intend to increase our commercial business lending, and we intend to continue our commercial real estate and multi-family residential real estate lending, which may expose us to increased lending risks and have a negative effect on our results of operations.

In an effort to increase our commercial loan portfolio, we established a commercial loan department in 2007 and we currently have four commercial business loan officers. We also continue to focus on originating commercial real estate and multi-family residential real estate loans. These types of loans generally have a higher risk of loss compared to our one- to four-family residential real estate loans. Commercial business loans may expose us to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate. In addition, commercial business and commercial real estate loans may also involve relatively large loan balances to individual borrowers or groups of borrowers. These loans also have greater credit risk than residential real estate loans as repayment is generally dependent upon the successful operation of the borrower's business. Also, the collateral underlying commercial business loans may fluctuate in value. Some of our commercial business loans are collateralized by equipment, inventory, accounts receivable or other business assets, and the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use. Multi-family residential real estate and commercial real estate loans involve increased risk because repayment is dependent on income being generated in amounts sufficient to cover property maintenance and debt service. In addition, if loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses and adversely affect our financial condition and results of operations.

Our inability to achieve profitability on new branches may negatively affect our earnings.

Subject to our ability to receive regulatory approval, we currently intend to open six new full-service branch offices by the end of 2016, with two branch offices opening in each of 2014, 2015 and 2016. The profitability of these branches will depend on whether the income that we generate from the additional branches will offset the increased expenses resulting from operating new branches. We expect that it may take time before new branches become profitable. During this period, operating new branches may negatively affect our operating results.


Acquisitions may disrupt our business and dilute stockholder value.

We regularly evaluate merger and acquisition opportunities with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We would seek acquisition partners that offer us either significant market presence or the potential to expand our market footprint and improve profitability through economies of scale or expanded services.

Acquiring other banks, businesses, or branches may have an adverse effect on our financial results and may involve various other risks commonly associated with acquisitions, including, among other things:
difficulty in estimating the value of the target company;
payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term;
potential exposure to unknown or contingent liabilities of the target company;
exposure to potential asset quality problems of the target company;
potential volatility in reported income associated with goodwill impairment losses;
difficulty and expense of integrating the operations and personnel of the target company;
inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits;
potential disruption to our business;
potential diversion of our management's time and attention;
the possible loss of key employees and customers of the target company; and
potential changes in banking or tax laws or regulations that may affect the target company.



- 53 -

Item 6. Exhibits

(a) Exhibits: See Exhibit Index, which follows the signature page hereof.

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.



WATERSTONE FINANCIAL, INC.
(Registrant)
Date: November 8, 2013
/s/ Douglas S. Gordon
Douglas S. Gordon
Chief Executive Officer
Principal Executive Officer
Date: November 8, 2013
/s/ Richard C. Larson
Richard C. Larson
Chief Financial Officer
Principal Financial and Accounting Officer

- 54 -

 
 
EXHIBIT INDEX

WATERSTONE FINANCIAL, INC.

Form 10-Q for Quarter Ended September 30, 2013



Exhibit No.
Description
Filed Herewith
31.1
Sarbanes-Oxley Act Section 302 Certification signed by the Chief Executive Officer of Waterstone Financial, Inc.
X
31.2
Sarbanes-Oxley Act Section 302 Certification signed by the Chief Financial Officer of Waterstone Financial, Inc.
X
32.1
Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Executive Officer of Waterstone Financial, Inc.
X
32.2
Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Financial Officer of Waterstone Financial, Inc.
X
101.INS*
XBRL Instance Document
X
101.SCH*
XBRL Taxonomy Extension Schema Document
X
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase Document
X
101.LAB*
XBRL Extension Labels Linkbase Document
X
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase Document
X
101.DEF*
XBRL Taxonomy Extension Definition Lankbase Document
X

*In accordance with SEC rules, this interactive data file is deemed "furnished" and not "filed" for purposes of Sections 11 or 12 of the Securities Act of 1933 and Section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under those sections or Acts.



 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
 
 

 



- 55 -
 
 
 
 
 
 
 
 
 
 
 
 
 

Exhibit 31.1

CERTIFICATION

 
I, Douglas S. Gordon, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q for the quarter ended September 30, 2013 of Waterstone Financial, Inc.;
 
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
 
 
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 
c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 
d)
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
 
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
 
 
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

 
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

 
Date: November 8, 2013
 
/s/ Douglas S. Gordon
Douglas S. Gordon
Chief Executive Officer
 
 
 
 
- 56 -
 
 
 
 
 
 
 

Exhibit 31.2

CERTIFICATION

 
I, Richard C. Larson, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q for the quarter ended September 30, 2013 of Waterstone Financial, Inc.;
 
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
 
 
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 
c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 
d)
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
 

 
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

 
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
 
Date: November 8, 2013
 
/s/ Richard C. Larson
Richard C. Larson,
Chief Financial Officer
 
 
 
 
 

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Exhibit 32.1
 
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
 
In connection with the Quarterly Report of Waterstone Financial, Inc. (the "Company") on Form 10-Q for the period ended September 30, 2013, as filed with the Securities and Exchange Commission on or about the date hereof (the "Report"), I, Douglas S. Gordon, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
 
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
 
 
/s/ Douglas S. Gordon
Douglas S. Gordon
Chief Executive Officer
November 8, 2013
 
 
A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Waterstone Financial, Inc. and will be retained by Waterstone Financial, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
- 58 -
 
 
 
 
 
 
 
 
 
 
 
 


 
Exhibit 32.2
 
 
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
 
In connection with the Quarterly Report of Waterstone Financial, Inc. (the "Company") on Form 10-Q for the period ended September 30, 2013 as filed with the Securities and Exchange Commission on or about the date hereof (the "Report"), I, Richard C. Larson, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
 
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
 
 
 
/s/ Richard C. Larson
Richard C. Larson
Chief Financial Officer
November 8, 2013
 
 
A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Waterstone Financial, Inc. and will be retained by Waterstone Financial, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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