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EX-32.2 - EXHIBIT 32.2 - Auburn Bancorp, Inc.ex32-2.htm
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EX-31.2 - EXHIBIT 31.2 - Auburn Bancorp, Inc.ex31-2.htm
EX-32.1 - EXHIBIT 32.1 - Auburn Bancorp, Inc.ex32-1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2011
 
or
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ____________
 
000-53370
(Commission File Number)
 
Auburn Bancorp, Inc.
 
 
(Exact name of registrant as specified in its charter)
 
 
United States
     
26-2139168
(State or other jurisdiction
of incorporation)
     
(IRS Employer
Identification No.)
 
 
256 Court Street, P.O. Box 3157, Auburn, Maine 04212
 
 
(Address and zip code of principal executive offices)
 
 
 
(207) 782-0400
 
 
(Registrant’s telephone number, including area code)
 
 
 
None
 
 
(Former name, former address and former fiscal year, if changed since last report)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  x Yes o No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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).  o Yes  o No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
  Large accelerated filer o   Accelerated filer o  
         
  Non-accelerated filer o   Smaller reporting company x  
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
 
Common Stock, $0.01 par value, 503,284 shares outstanding as of May 12, 2011.
 
 
1

 
 
AUBURN BANCORP, INC. AND SUBSIDIARY
QUARTERLY REPORT ON FORM 10-Q
March 31, 2011
 
TABLE OF CONTENTS
 
   
Page
 
PART I. FINANCIAL INFORMATION (Unaudited)
 
 
Item 1.
Financial Statements
 
     
 
Consolidated Balance Sheets as of March 31, 2011 (Unaudited) and June 30, 2010
3
     
 
Consolidated Statements of Operations (Unaudited) for the Three Months Ended March 31, 2011 and 2010
4
     
 
Consolidated Statements of Operations (Unaudited) for the Nine Months Ended March 31, 2011 and 2010
5
     
 
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Nine Months Ended March 31, 2011 and 2010
6
     
 
Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended March 31, 2011 and 2010
7
     
 
Notes to Consolidated Financial Statements (Unaudited)
8
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
22
     
Item 3.
quantitative and qualitative disclosures about market risk
32
     
Item 4.
Controls and Procedures
32
     
 
PART II. OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
33
     
Item 1A.
Risk Factors
33
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
33
     
Item 3.
Defaults Upon Senior Securities
33
     
Item 4.
[removed and reserved]
33
     
Item 5.
other information
33
     
Item 6.
exhibits
34
     
 
Signatures
35
 
 
2

 
 
PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
AUBURN BANCORP, INC. AND SUBSIDIARY
 
Consolidated Balance Sheets
 
March 31, 2011 (Unaudited) and June 30, 2010
                 
    March 31, 2011     June 30, 2010  
    (Unaudited)        
ASSETS                
Cash and due from banks   $ 2,058,690     $ 1,573,526  
Interest-earning deposits     4,905,543       3,705,910  
      Total cash and cash equivalents     6,964,233       5,279,436  
                 
 Certificates of deposit     745,000       845,000  
                 
 Investment securities available for sale, at fair value     1,518,754       1,112,507  
                 
 Federal Home Loan Bank stock, at cost     1,251,700       1,251,700  
                 
 Loans     69,242,941       69,374,825  
 
   Less allowance for loan losses
    (937,771 )     (492,112 )
      Net loans     68,305,170       68,882,713  
                 
 Property and equipment, net     1,810,538       1,852,414  
                 
 Foreclosed real estate, net of allowance of $15,226 at March 31, 2011                
      and $50,333 at June 30, 2010     972,602       680,712  
                 
 Accrued interest receivable                
   Investments     11,511       13,820  
   Mortgage-backed securities     426       573  
   Loans     261,511       263,353  
                 
 Prepaid expenses and other assets     416,592       405,246  
                 
           Total assets   $ 82,258,037     $ 80,587,474  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY                
                 
Liabilities                
   Deposits   $ 57,275,746     $ 55,769,248  
   Federal Home Loan Bank advances     18,671,319       18,430,662  
   Accrued interest and other liabilities     222,287       337,611  
          Total liabilities     76,169,352       74,537,521  
                 
 Stockholders’ Equity                
   Preferred stock, 1,000,000 shares authorized, no shares issued or outstanding     -       -  
   Common stock, $.01 par value per share, 10,000,000 shares authorized, 503,284 shares issued and outstanding at March 31, 2011 and
        June 30, 2010
    5,033       5,033  
   Additional paid-in-capital     1,466,159       1,468,928  
   Retained earnings     4,740,594       4,719,099  
   Accumulated other comprehensive income     13,011       1,368  
   Unearned compensation (ESOP shares)     (136,112 )     (144,475 )
          Total stockholders’ equity     6,088,685       6,049,953  
                 
           Total liabilities and stockholders’ equity   $ 82,258,037     $ 80,587,474  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
3

 
 
AUBURN BANCORP, INC. AND SUBSIDIARY
 
Consolidated Statements of Operations
 
Three Months Ended March 31, 2011 and 2010
 
   
Three Months Ended March 31,
   
2011
   
2010
   
(Unaudited)
Interest and dividend income:
     
Interest on loans
  $ 1,021,160     $ 1,017,086  
Interest on investments and other interest-earning deposits
    12,556       9,526  
Dividends on Federal Home Loan Bank stock
     946        -  
  Total interest and dividend income
     1,034,662       1,026,612  
                 
Interest expense:
               
Interest on deposits and escrow accounts
    208,318       243,442  
Interest on Federal Home Loan Bank advances
    138,522       168,146  
                  Total interest expense
    346,840       411,588  
                 
                  Net interest income
    687,822       615,024  
                 
Provision for loan losses
    232,928       3,985  
                 
                  Net interest income after provision for loan losses
     454,894        611,039  
                 
Non-interest income:
               
       Net gain on sales of loans
    7,595       16,510  
       Net gain on investment securities
       Other non-interest income
   
1,029
41,604
     
-
37,431
 
                   Total non-interest income
     50,228        53,941  
                 
Non-interest expenses:
               
Salaries and employee benefits
    258,887       256,297  
Occupancy expense
    24,716       23,463  
Depreciation
    23,642       22,800  
Federal deposit insurance premiums
    35,662       29,114  
Computer charges
    46,735       47,280  
Advertising expense
    9,129       20,043  
Consulting expense
    26,774       13,073  
Net provision for losses on foreclosed real estate
    -       57,549  
Other operating expenses
    186,319        138,950  
                   Total non-interest expenses
     611,864        608,569  
                 
                   Income (loss) before income taxes
    (106,742 )     56,411  
                 
Income tax expense (benefit)
     (36,039 )      18,820  
                 
                   Net income (loss)
  $ (70,703 )   $ 37,591  
                 
Net income (loss) per common share
  $ ( .14 )   $ .08  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
4

 

AUBURN BANCORP, INC. AND SUBSIDIARY
 
Consolidated Statements of Operations
 
Nine Months Ended March 31, 2011 and 2010
 
   
Nine Months Ended March 31,
   
2011
   
2010
   
(Unaudited)
Interest and dividend income:
     
Interest on loans
  $ 3,142,312     $ 3,002,841  
Interest on investments and other interest-earning deposits
    40,445       89,616  
Dividends on Federal Home Loan Bank stock
     946        -  
Total interest and dividend income
     3,183,703        3,092,457  
                 
Interest expense:
               
Interest on deposits and escrow accounts
    660,891       760,340  
Interest on Federal Home Loan Bank advances
    434,891       534,322  
                  Total interest expense
     1,095,782        1,294,662  
                 
                  Net interest income
    2,087,921       1,797,795  
                 
Provision for loan losses
     536,942       49,446  
                 
                  Net interest income after provision for loan losses
     1,550,979        1,748,349  
                 
Non-interest income:
               
       Net gain on sales of loans
    100,500       59,209  
       Net loss on sale of other assets
    (14,096 )     -  
       Net gain (loss) on investment securities     1,029       (126,269
       Other non-interest income
      122,175       107,962  
                   Total non-interest income
     209,608       40,902  
                 
Non-interest expenses:
               
Salaries and employee benefits
    745,413       723,163  
Occupancy expense
    73,991       74,049  
Depreciation
    71,461       73,200  
Federal deposit insurance premiums
    73,446       104,670  
Computer charges
    131,444       132,926  
Advertising expense
    51,290       50,225  
Consulting expense
    58,446       36,546  
Net provision for losses on foreclosed real estate
    11,084       67,549  
Other operating expenses
    505,300       435,676  
                   Total non-interest expenses
     1,721,875       1,698,004  
                 
                   Income before income taxes
    38,712       91,247  
                 
Income tax expense
     17,217        35,744  
                 
                   Net income
  $ 21,495     $ 55,503  
                 
Net income per common share
  $ .04     $ .11  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
5

 
 
AUBURN BANCORP, INC. AND SUBSIDIARY
 
Consolidated Statements of Changes in Stockholders’ Equity
 
Nine Months Ended March 31, 2011 and 2010 (Unaudited)

                     
Accumulated
             
                     
Other
   
Unearned
       
   
Common
   
Additional Paid-
   
Retained
   
Comprehensive
   
Compensation
       
   
Stock
   
in-Capital
   
Earnings
   
Income (Loss)
   
(ESOP Shares)
   
Total
 
                                     
Balance, June 30, 2009
  $ 5,033     $ 1,470,790     $ 4,611,470     $ (26,225 )   $ (157,189 )   $ 5,903,879  
                                                 
Comprehensive income
                                               
Net income
    -       -       55,503       -       -       55,503  
Other comprehensive income
                                               
Unrealized holding gain on securities, net of taxes of $12,640
    -       -       -       24,537       -       24,537  
                                                 
Total comprehensive income
    -       -       55,503       24,537       -       80,040  
                                                 
Common stock held by ESOP committed to be released (983 shares)
    -       (1,394 )     -       -       9,825       8,431  
 
Balance, March 31, 2010
  $ 5,033     $ 1,469,396     $ 4,666,973     $ (1,688 )   $ (147,364 )   $ 5,992,350  
                                                 
                                                 
                                                 
                                                 
Balance, June 30, 2010
  $ 5,033     $ 1,468,928     $ 4,719,099     $ 1,368     $ (144,475 )   $ 6,049,953  
                                                 
Comprehensive income
                                               
Net income
    -       -       21,495       -       -       21,495  
Other comprehensive income Unrealized holding gain on securities, net of taxes of $5,998
    -       -       -       11,643       -       11,643  
                                                 
Total comprehensive income
    -       -       21,495       11,643       -       33,138  
                                                 
Common stock held by ESOP committed to be released (836 shares)
    -       (2,769 )     -       -       8,363       5,594  
                                                 
Balance, March 31, 2011
  $ 5,033     $ 1,466,159     $ 4,740,594     $ 13,011     $ (136,112 )   $ 6,088,685  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
6

 
 
AUBURN BANCORP, INC. AND SUBSIDIARY
 
Consolidated Statements of Cash Flows
 
Nine Months Ended March 31, 2011 and 2010 (Unaudited)
 
   
Nine Months Ended
 
   
March 31,
 
   
2011
   
2010
 
Cash flows from operating activities:
           
             
    Net income
  $ 21,495     $ 55,503  
                 
 Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    71,461       73,200  
Net accretion of discounts on investment securities available for sale
    (26,144 )     (1,044 )
Provision for loan losses
    536,942       49,446  
Net provision for losses on foreclosed real estate
    11,084       67,549  
Deferred income tax benefit
    -       (11,380 )
Net loss (gain) on investment securities available for sale
    (1,029 )     126,269  
Gain on sales of loans
    (100,500 )     (59,209 )
Proceeds from sale of loans
    2,226,310       2,604,191  
Originations of loans sold
    (2,127,000 )     (2,609,200 )
Loss on foreclosed real estate
    14,096       -  
ESOP compensation expense
    5,900       8,431  
Net increase in prepaid expenses and other assets
    (11,346 )     (320,613 )
Net(increase) decrease in accrued interest receivable
    4,298       (904 )
Net increase (decrease) in accrued interest payable and other liabilities
    (121,322 )     6,327  
                 
Net cash provided by (used in) operating activities
    504,245       (11,434 )
                 
                 
Cash flows from investing activities:
               
Purchase of investment securities available for sale
    (708,594 )     (263,370 )
Proceeds from sales of investment securities available for sale
    265,620       800,499  
Proceeds from maturities and principal paydowns on investment securities available for sale
    81,541       89,777  
Proceeds from sale of other real estate owned
    103,380       -  
Net change in certificates of deposit
    100,000       4,253,000  
Net increase in loans to customers
    (378,659 )     (7,036,709 )
Purchase of Federal Home Loan Bank stock
    -       (104,700 )
Capital expenditures
    (29,585 )     (22,687 )
                 
Net cash used in investing activities
    (566,297 )     (2,284,190 )
                 
                 
Cash flows from financing activities:
               
Advances from Federal Home Loan Bank
    2,500,000       3,500,000  
Repayment of advances from Federal Home Loan Bank
    (2,150,000 )     (3,750,000 )
Net change in short-term borrowings
    (109,343 )     (2,333,354 )
Net increase in deposits
    1,506,498       7,279,027  
Redemption of ESOP shares
    (306 )     -  
                 
Net cash provided by financing activities
    1,746,849       4,695,673  
                 
                 
Net increase in cash and cash equivalents
    1,684,797       2,400,049  
                 
Cash and cash equivalents, beginning of period
    5,279,436       2,374,636  
                 
Cash and cash equivalents, end of period
  $ 6,964,233     $ 4,774,685  
                 
Supplementary cash flow information:
               
                 
Cash paid during the period for:
               
Interest
  $ 1,098,100     $ 1,301,106  
Taxes
  $ 103,713     $ 26,177  
Transfer of loans to foreclosed real estate
  $ 420,450     $ 344,858  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
7

 
 
AUBURN BANCORP, INC. AND SUBSIDIARY
 
Notes to Consolidated Financial Statements
 
1.        Basis of Presentation
 
The financial information included herein presents the consolidated financial condition and results of operations for Auburn Bancorp, Inc. and its wholly-owned subsidiary, Auburn Savings Bank, FSB, as of March 31, 2011 and June 30, 2010, and for the interim periods ended March 31, 2011 and 2010.  Except for the June 30, 2010 Consolidated Balance Sheet, the financial information is unaudited; however, in the opinion of management, the information reflects all adjustments, consisting of normal recurring adjustments, that are necessary to make the financial statements not misleading.  The results shown for the nine months ended March 31, 2011 and 2010 are not necessarily indicative of the results to be obtained for a full fiscal year. The accompanying consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and with the rules and regulations of the Securities and Exchange Commission for interim financial reporting. Accordingly they do not include all of the information and footnotes required for complete financial statements. These interim financial statements should be read in conjunction with the audited financial statements for the year ended June 30, 2010 included in the Company’s Annual Report on Form 10-K (File No. 000-53370) filed at the Securities and Exchange Commission on September 28, 2010.
 
In preparing financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and valuation of foreclosed real estate. In connection with the determination of these estimates, management obtains independent appraisals for significant properties.
 
2.        Reorganization
 
On January 11, 2008, Auburn Savings Bank, FSB (the “Bank”) reorganized into the mutual holding company structure. As part of the reorganization, the Bank converted to a federal stock savings bank and became a wholly-owned subsidiary of Auburn Bancorp, Inc. (the “Company”), and the Company became a majority-owned subsidiary of Auburn Mutual Holding Company (the “MHC”). In addition, the Company conducted a stock offering.  Immediately following completion of the reorganization and stock offering, the MHC owned 55.0% of the outstanding common stock of the Company and the minority public shareholders owned 45.0%.  So long as the MHC is in existence, the MHC will be required to own at least a majority of the voting stock of the Company.
 
In conjunction with the stock offering, the Company loaned $173,000 to a trust for the Employee Stock Ownership Plan (the “ESOP”), enabling the ESOP to purchase 17,262 shares of common stock in the stock offering, equal to 3.43% of the shares of common stock sold in the stock offering, for the benefit of the Bank’s employees.
 
The Company may not declare or pay a cash dividend on any of its common stock, if the effect thereof would cause the regulatory capital of the Bank to be reduced below the amount required under OTS rules and regulations.
 
Auburn Bancorp, Inc.’s common stock is quoted on the OTC Bulletin Board under the symbol “ABBB.”
 
 
8

 
 
3.        Impact of Recent Accounting Standards 
                 
In June 2009, the Financial Accounting Standards Board (FASB) issued amended guidance with respect to accounting for transfers of financial assets to improve the reporting for the transfer of financial assets resulting from concerns of financial statement users that many of the financial assets (and related obligations) that have been derecognized should continue to be reported in the financial statements of transferors. This Statement was effective for the Company on July 1, 2010.  The Company has reviewed the requirements of this Statement and complies with its requirements.  The adoption of this Statement has not had a material effect on the Company’s consolidated financial statements.
 
In January 2010, the FASB issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance is effective for the Company with the reporting period beginning July 1, 2010, except for the disclosure on the roll forward activities for any Level 3 fair value measurements, which will become effective for the Company with the reporting period beginning July 1, 2011. Other than requiring additional disclosures, adoption of this new guidance will not have a material effect on the Company’s consolidated financial statements.
 
In July 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This ASU is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The guidance is effective for interim and annual reporting periods ending after December 15, 2010. Other than requiring additional disclosures, adoption of this new guidance did not have a material impact on the Company’s consolidated financial statements.
 
In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Trouble Debt Restructuring.  This ASU provides guidance on determining whether a restructuring of a receivable meets the criteria to be considered a Troubled Debt Restructuring (“TDR”).  The new guidance is required to be adopted for the first interim or annual reporting period beginning after June 15, 2011, and is to be applied retrospectively to the beginning of the annual reporting period of adoption.  Early adoption is permitted.  The Company intends to adopt the provisions of this ASU when required, and is evaluating its potential impact on the Company’s consolidated financial statements.
 
 
9

 
 
4.       Securities
 
The amortized cost and fair value of investment securities available for sale, with gross unrealized gains and losses, are as follows:
 
March 31, 2011
                                 
   
Amortized
Cost
    Gross
Unrealized
Gains
   
 Gross
Unrealized
Losses
   
Fair
Value
 
Municipal bond   $ 178,773     $ 1,286     $ -     $ 180,059  
Corporate bonds     1,220,924       24,829       (7,500 )     1,238,253  
FNMA mortgage-backed securities     89,341       1,566       (1,236 )     89,671  
U.S. Government sponsored enterprise securities     2       769       -       771  
Corporate common stock     10,000       -       -       10,000  
                                 
     Total investment securities available for sale   $ 1,499,040     $ 28,450     $ (8,736 )   $ 1,518,754  
 
June 30, 2010
 
    Amortized
Cost
       Gross
Unrealized
Gains
     Gross
Unrealized
Losses
   
Fair
Value
 
Corporate bonds   $ 982,415     $ 13,366     $ (15,640 )   $ 980,141  
FNMA mortgage-backed securities     118,017       3,499       -       121,516  
U.S. Government sponsored enterprise securities     2       848       -       850  
Corporate common stock     10,000       -       -       10,000  
                                 
     Total investment securities available for sale   $ 1,110,434     $ 17,713     $ (15,640 )   $ 1,112,507  
 
Investments with a fair value of $1,518,754 and $1,112,507 at March 31, 2011 and June 30, 2010, respectively, are held in a custody account to collateralize certain deposits.
 
The amortized cost and fair value of debt securities by contractual maturity follow. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
   
March 31, 2011
   
June 30, 2010
 
   
Amortized
   
Fair
   
Amortized
   
Fair
 
   
Cost
   
Value
   
Cost
   
Value
 
                         
One year or less
  $ 514,355     $ 517,933     $ -     $ -  
Over 1 year through 5 years
    506,569       499,867       782,415       766,775  
After 5 years through 10 years
    200,000       220,453       200,000       213,366  
After 10 years
    178,773       180,059       -       -  
      1,399,697       1,418,312       982,415       980,141  
Mortgage-backed securities
    89,341       89,671       118,017       121,516  
                                 
    $ 1,489,038     $ 1,507,983     $ 1,100,432     $ 1,101,657  
 
 
10

 
 
Information pertaining to securities with gross unrealized losses at March 31, 2011 and June 30, 2010, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
                                     
    Less Than 12 Months    
12 Months or Greater
   
Total
 
 
  Fair Value    
Gross
Unrealized
Losses
    Fair Value     Gross
Unrealized
Losses
    Fair Value     Gross
Unrealized
Losses
 
March 31, 2011
                                               
Corporate bonds
  $ -     $ -     $ 242,500     $ 7,500     $ 242,500     $ 7,500  
FNMA mortgage-backed securities
    -       -       48,988       1,236       48,988       1,236  
                                                 
Total
  $ -     $ -     $ 291,488     $ 8,736     $ 291,488     $ 8,736  
                                                 
June 30, 2010
                                               
Corporate bonds
  $ 530,525     $ 1,890     $ 236,250     $ 13,750     $ 766,775     $ 15,640  
                                                 
Total
  $ 530,525     $ 1,890     $ 236,250     $ 13,750     $ 766,775     $ 15,640  
 
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
 
At March 31, 2011, two debt securities with unrealized losses had depreciated 3% in total from the amortized cost basis.  At June 30, 2010, three debt securities with unrealized losses had depreciated 2% in total from the amortized cost basis. These unrealized losses related principally to current interest rates for similar types of securities compared to the underlying yields on these securities.  In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition and the Company’s ability to hold such securities. The Company did not record an other-than-temporary impairment loss during the nine months ended March 31, 2011, but did record $126,269 for the nine months ended March 31, 2010.
 
5.        Credit Quality and Allowance for Credit Losses
 
One of the Bank’s most important operating objectives is to maintain a high level of asset quality.  Management uses a number of strategies in furtherance of this goal including maintaining sound credit standards in loan originations, monitoring the loan portfolio through internal and third-party loan reviews, and employing active collection and workout processes for delinquent or problem loans.
 
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized over the contractual life of the loans as an adjustment of the related loan yield using the interest method.
 
Loans past due 30 days or more are considered delinquent. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in process of collection.  Consumer loans are typically charged off when they are no more than 180 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
 
 
11

 
 
All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. Cash payments on these loans are applied to principal balances until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
Credit risk arises from the inability of a borrower to meet its obligations. The Bank attempts to manage the risk characteristics of the loan portfolio through various control processes defined in part through the Loan Policy, such as credit evaluation of borrowers, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances. Loan origination processes include evaluation of the risk profile of the borrower, repayment sources, the nature of the underlying collateral, and other support given current events, conditions, and expectations. The Bank seeks to rely primarily on the cash flow of borrowers as the principal source of repayment.
 
Although credit policies and evaluation processes are designed to minimize risk, Management recognizes that loan losses will occur and the amount of these losses will fluctuate depending on the risk characteristics of the loan portfolio, as well as general and regional economic conditions.
 
The Bank provides for loan losses through the establishment of an allowance for loan losses which represents an estimated reserve for existing losses in the loan portfolio. On an on-going basis, loans are monitored by loan officers and are subject to periodic independent outsourced loan reviews, and delinquency and watch lists are regularly reviewed. At the end of each quarter, the Bank deploys a systematic methodology for determining credit quality that includes formalization and documentation of this review process. In particular, any bankruptcy and foreclosure activity is reviewed along with delinquency watch list issues. Management also classifies the loan portfolio specifically by loan type and monitors credit risk separately as discussed under Credit Quality Indicators below. Management evaluates the adequacy of our allowance continually based on a review of all significant loans, via delinquency reports and a watch list that strives to identify, track and monitor credit risk, historical losses and current economic conditions.
 
The allowance calculation includes general reserves as well as specific reserves and valuation allowances for individual credits. The specific component relates to loans that are classified as impaired, whereby an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan.  The general component relates to pools of non-impaired loans. On a quarterly basis, management assesses the adequacy of the general reserve allowances based on 1) national, state and local economic factors; 2) interest rate environment and trends; 3) delinquency metrics, including the Bank’s historical loss experience; 4) Bank-specific factors such as changes in lending personnel; 5) changes in the loan review system and related ratings; 6) the Bank’s current underwriting standards; and 7) peer statistics.
 
 
12

 
 
The following tables provide information relative to credit quality and allowance for credit losses as of and for the three and nine months ended March 31, 2011.
                                     
   
Commercial
                               
   
Non-Real
   
Commercial
   
Residential
                   
   
Estate
   
Real Estate
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Three months ended March 31, 2011
                                   
                                     
Allowance for credit losses:
                                   
Beginning balance
  $ 83,528     $ 244,114     $ 354,576     $ 8,328     $ 27,216     $ 717,762  
Charge-offs
    -       (7,072 )     (7,149 )     (483 )     -       (14,704 )
Recoveries
    900       -       -       885       -       1,785  
Provision
    37,902       226,590       (51,393 )     1,549       18,280       232,928  
Ending balance
  $ 122,330     $ 463,632     $ 296,034     $ 10,279     $ 45,496     $ 937,771  
                                                 
Nine months ended March 31, 2011
                                               
                                                 
Allowance for credit losses:
                                               
Beginning balance
  $ 65,874     $ 157,173     $ 261,246     $ 7,819     $ -     $ 492,112  
Charge-offs
    (42,290 )     (14,972 )     (30,957 )     (6,149 )     -       (94,368 )
Recoveries
    900       -       -       2,185       -       3,085  
Provision
    97,846       321,431       65,745       6,424       45,496       536,942  
Ending balance
  $ 122,330     $ 463,632     $ 296,034     $ 10,279     $ 45,496     $ 937,771  
                                                 
As of March 31, 2011
                                               
                                                 
Allowance for credit losses:
                                               
Ending balance
  $ 122,330     $ 463,632     $ 296,034     $ 10,279     $ 45,496     $ 937,771  
Individually evaluated for impairment
    57,300       7,072       19,944       2,277       -       86,593  
Collectively evaluated for impairment
    65,030       456,560       276,090       8,002       45,496       851,178  
                                                 
Loans
                                               
Ending balance:
  $ 4,766,786     $ 16,209,988     $ 47,390,413     $ 875,754     $ -     $ 69,242,941  
Individually evaluated for impairment
    57,300       207,072       127,944       2,277       -       394,593  
Collectively evaluated for impairment
    4,709,486       16,002,916       47,262,469       873,477       -       68,848,348  
 
The Bank’s provision for loan losses was $536,942 and $49,446 for the nine months ended March 31, 2011 and 2010, respectively.  The increase to the provision is the result of an increase in specific reserves of $76,000 and an increase in general valuation reserve of $418,000 due largely to current economic conditions, including declining real estate values and loan performance challenges across all segments of the loan portfolio. The Bank has completed a comprehensive review of the loan portfolio and related allowance for loan losses, and has increased its allowance for loan losses to $937,771 at March 31, 2011 which now represents 1.35% of total loans, compared to an allowance of $492,112, representing 0.71% of total loans at June 30, 2010.
 
Risk by Portfolio Segment
 
One- to Four-Family Residential Loans. The Bank’s primary lending activity consists of the origination of one- to four-family residential mortgage loans, substantially all of which are secured by properties located in its primary market area.  The Bank offers fixed-rate mortgage loans, which generally have terms of 15, 20 or 30 years.  The Bank no longer offers adjustable-rate mortgage loans (“ARMs”).
 
Home Equity Loans.  Home equity lines of credit and loans are secured by a mixture of first and second mortgages on one- to four-family owner occupied properties.  The procedures for underwriting home equity lines of credit and loans include a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan.  All properties securing second mortgage loans are generally required to be appraised by a board-approved independent appraiser unless the first mortgage is also held by Auburn Savings Bank.  Home equity lines of credit and loans are made in amounts such that the combined first and second mortgage balances do not exceed 90% of value.
 
Commercial and Multi-Family Real Estate Loans. The Bank offers commercial real estate loans, including commercial business, and multi-family real estate loans that are generally secured by five or more unit apartment buildings and properties used for business purposes such as small office buildings or retail facilities substantially all of which are located in its primary market area.
 
Commercial and multi-family real estate loan amounts generally do not exceed 80% of the lesser of the property’s appraised value or sales price.
 
The Bank generally requires title insurance for commercial and multi-family real estate loans, an appraisal on all such loans if the total amount of loans with that borrower is in excess of $250,000, and an evaluation of the property by an approved appraiser for loans between $100,000 and $250,000.  We may require a full appraisal on property securing any loan less than $250,000.
 
 
13

 
 
Loans secured by commercial real estate, including multi-family properties, generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate, including multi-family properties, are often dependent on successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy.
 
Construction Loans. The Bank offers construction loans for the development of one- to four-family residential properties located in the Bank’s primary market area.  Residential construction loans are generally offered to individuals for construction of their personal residences.
 
Residential construction loans can be made with a maximum loan-to-value ratio of 95%, provided that the borrower obtains private mortgage insurance on the loan if the loan balance exceeds 80% of the appraised value of the secured property.
 
Construction and development financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed in order to protect the value of the property. Additionally, if the estimate of value proves to be inaccurate, the Bank may be confronted with a project, when completed, having a value which is insufficient to assure full repayment.  
 
Commercial Loans.  The Bank makes commercial business loans primarily in its market area to a variety of small businesses, professionals and sole proprietorships.  Commercial lending products include term loans and revolving lines of credit. Commercial business loans are generally used for longer-term working capital purposes such as purchasing equipment or furniture. When making commercial loans, the Bank considers the financial statements of the borrower, its lending history with the borrower, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral. Commercial loans are generally secured by a variety of collateral, primarily accounts receivable, inventory and equipment, and the Bank also requires the business principals to execute such loans in their individual capacities. Depending on the amount of the loan and the collateral used to secure the loan, commercial loans are made in amounts of up to 50-80% of the value of the collateral securing the loan, or up to 100% of the value of the collateral securing the loan if the collateral consists of cash or cash equivalents. The Bank generally does not make unsecured commercial loans.  The Bank requires adequate insurance coverage including, where applicable, title insurance, flood insurance, builder’s risk insurance and environmental insurance.
 
Commercial loans generally have greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans generally are made on the basis of the borrower’s ability to repay the loan from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. The Bank seeks to minimize these risks through its underwriting standards.
 
Consumer Loans. The Bank offers a limited range of consumer loans, primarily to customers residing in its primary market area.  Consumer loans generally consist of loans on new and used automobiles, loans secured by deposit accounts and unsecured personal loans.
 
Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as motor vehicles. In the latter case, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. Consumer loan collections depend on the borrower’s continuing financial stability, and therefore are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
 
 
14

 
 
Credit Quality Indicators – Loan Rating Methodology
 
The Bank’s Loan Review Policy contains a rating system for credit risk. Loans reviewed are graded based on both risk of default as well as risk of loss. The policy defines risk of default as the risk that the borrower will not be able to make timely payments. This risk is assessed based on the capacity to service debt as structured, repayment history, and current status. The policy defines risk of loss as the assessment of the probability that the Bank will incur a loss of capital on a loan due to repayment default. This risk is assessed based on collateral position and net worth of the borrowing and supporting entities.
 
The rating system is based on the following categories. Loans included as acceptable in the table below represent an aggregation of loans from four categories;
     
  1) Superior - Well established national companies and loans secured by cash or marketable securities;
  2) Excellent - Well established local companies and loans secured by cash or marketable securities;
  3)
Good – Assets secured by well to recently established businesses whose performance is average and   whose industry conditions are fair to good; and
  4) Pass - Assets secured by well to recently established businesses whose performance is average and whose industry conditions are fair to good.  Borrower’s financial condition shows deterioration.
 
 
The other line items in the table are defined within the Loan Review Policy as follows;
 
 
-
Pass/Watch: Cash flow may be temporarily inadequate to cover the debt, projected primary source of repayment has not been verified or a deterioration in the financial condition of the customer that is not yet reflected in the status of the loan.
 
-
Special Mention: Assets are protected but potentially weak. Borrower is experiencing adverse trends or balance sheet issues which have not yet reached a point of jeopardizing loan repayment.
 
-
Substandard: Inadequately protected assets that exhibit one or more well defined weaknesses that jeopardize full collection or liquidation of assets.
 
-
Doubtful: Same standards as “substandard” with added characteristics that current facts, conditions and values make full collection highly improbable.
 
-
Loss: Assets that are considered uncollectible and are not warranted as a bank asset.
 
Credit Quality Indicators
As of March 31, 2011
 
Commercial Credit Exposure
Credit Risk Profile by Internally Assigned Grade
 
 
 
 
Commercial
Non-Real
Estate
   
Commerical
Real Estate
Other
 
 
Grade:
               
 
Acceptable
  $ 3,122,836     $ 11,377,990  
 
Pass/Watch
    1,167,718       2,955,804  
 
Special mention
    -       1,141,365  
 
Substandard
    118,932       243,614  
 
Doubtful
    300,000       484,143  
 
Loss
    57,300       7,072  
 
Total
  $ 4,766,786     $ 16,209,988  
 
 
15

 
 
Residential/Consumer Credit Exposure
Credit Risk Profile by Internally Assigned Grade
 
 
 
 
Residential
Real Estate
   
Consumer
 
 
Grade:
               
 
Acceptable
  $ 46,052,475     $ 858,507  
 
Pass/Watch
    464,488       14,970  
 
Special mention
    551,948       -  
 
Substandard
    301,558       -  
 
Doubtful
    -       -  
 
Loss
    19,944       2,277  
 
Total
  $ 47,390,413     $ 875,754  
 
Impaired Loans
 
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Management considers factors including payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due when determining impairment. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
 
Impaired Loans
As of and for the Three and Nine Months Ended March 31, 2011

                     
Three months ended
   
Nine months ended
 
                      March 31, 2011     March 31, 2011  
         
Unpaid
         
Average
   
Interest
   
Average
   
Interest
 
   
Recorded
   
Principal
   
Related
   
Recorded
   
Income
   
Recorded
   
Income
 
   
Investment
   
Balance
   
Allowance
   
Investment
   
Recognized
   
Investment
   
Recognized
 
                                               
With no related allowance recorded:
                                             
Commercial non-real estate
  $ -     $ -     $  -     $  -     $ -     $  -     $ -  
Commercial real estate
    -       -        -        -        -        -        -  
Residential real estate
    -        -        -        -        -        -        -  
Consumer
    -        -       -        -        -       -        -  
                                                         
With an allowance recorded:
                                                       
Commercial non-real estate
  $ 57,300     $ 57,300     $ 57,300     $ 57,600     $ 2,274     $ 58,200     $ 2,274  
Commercial real estate
    207,072       207,072       7,072       207,072       -       207,072        -  
Residential real estate
    127,944       127,944       19,944       127,944       -       127,944        -  
Consumer
    2,277       2,277       2,277       2,351       10       2,520       52  
                                                         
Total:
                                                       
Commercial non-real estate
  $ 57,300     $ 57,300     $ 57,300     $ 57,600     $ 2,274     $ 58,200     $ 2,274  
Commercial real estate
    207,072       207,072       7,072       207,072        -       207,072        -  
Residential real estate
    127,944       127,944       19,944       127,944        -       127,944        -  
Consumer
    2,277       2,277       2,277       2,351       10       2,520       52  
    $ 394,593     $ 394,593     $ 86,593     $ 394,967     $ 2,284     $ 395,736     $ 2,326  
 
 
16

 
 
Non-performing Loans
 
Loans are placed on non-accrual status when reasonable doubt exists as to the full timely collection of interest and principal or when a loan becomes 90 days past due unless an evaluation clearly indicates that the loan is well-secured and in the process of collection.  When a loan is placed on non-accrual status, unpaid interest credited to income is reversed. Interest received on nonaccrual loans generally is applied against principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt. These policies apply to all types of loans, including commercial and residential/consumer.
 
Real estate acquired as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold.  When property is acquired, it is recorded at fair value at the date of foreclosure.  Holding costs and declines in fair value after acquisition of the property result in charges against income.
 
As of March 31, 2011, the Bank did not have any troubled debt restructurings that involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates or any accruing loans past due 90 days or more.
 
Age Analysis of Past Due Loans
As of March 31, 2011
 
                                       
Recorded
       
                                       
Investment
   
Recorded
 
               
90 Days or
                     
Loans ≥ 90
   
Investment
 
   
30-59 Days
   
60-89 Days
   
Greater Past
   
Total Past
               
Days and
   
Loans on Non-
 
   
Past Due
   
Past Due
   
Due
   
Due
   
Current
   
Total Loans
   
Accruing
   
Accrual Status
 
Commercial non-real estate
 
$
110,534
   
$
-
   
$
-
   
$
110,534
   
$
4,656,252
   
$
4,766,786
   
$
-
   
$
58,910
 
Commercial real estate
   
43,614
     
83,966
     
318,204
     
445,784
     
15,764,204
     
16,209,988
     
-
     
318,203
 
Residential real estate
   
676,727
     
70,337
     
193,243
     
940,307
     
46,450,106
     
47,390,413
     
-
     
193,242
 
Consumer
   
18,840
     
-
     
2,278
     
21,118
     
854,636
     
875,754
     
-
     
2,278
 
                                                                 
   
$
849,715
   
$
154,303
   
$
513,725
   
$
1,517,743
   
$
67,725,198
   
$
69,242,941
   
$
-
   
$
572,633
 
 
6.         Earnings Per Share
 
Basic income (loss) per common share is determined by dividing net income (loss) by the adjusted weighted average number of common shares outstanding during the period. The adjusted outstanding common shares equals the gross number of common shares issued less unallocated shares of the ESOP. Net income (loss) per common share for the three months and nine months ended March 31, 2011 and 2010 is based on the following:
 
    Three Months Ended
March 31,
    Nine Months Ended
March 31,
 
   
2011
   
2010
   
2011
   
2010
 
                                 
Net income (loss)
  $ (70,703 )   $ 37,591     $ 21,495     $ 55,503  
                                 
Weighted average common shares outstanding
    503,284       503,284       503,284       503,284  
                                 
Less: Average unallocated ESOP shares     (13,708 )     (14,833 )     (13,989 )     (15,157 )
                                 
Adjusted weighted average common shares outstanding
    489,576       488,451       489,295       488,127  
                                 
Net income (loss) per common share
  $ (0.14 )   $ 0.08     $ 0.04     $ 0.11  
 
 
17

 
 
7.         Comprehensive Income or Loss
 
GAAP requires that recognized revenue, expenses, gains, and losses be included in net income (loss).  Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income (loss), are components of comprehensive income or loss.
 
The components of total comprehensive income and related tax effects for the three and nine months ended March 31, 2011 and 2010 are as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
March 31,
   
March 31,
 
   
2011
   
2010
   
2011
   
2010
 
                         
Net income (loss)
  $ (70,703 )   $ 37,591     $ 21,495     $ 55,503  
                                 
Other comprehensive income, net of tax:
                               
Unrealized gains (losses) on securities available for sale arising during the period
    14,411       1,741       18,670       (89,092 )
                                 
(Gain) loss on securities available for sale included in net income or loss
    (1,029 )     -       (1,029 )     126,269  
                                 
Tax effect
    4,550       (592 )     5,998       12,640  
                                 
Other comprehensive income, net of tax
    17,932       1,149       23,639       49,817  
                                 
Total comprehensive income (loss)
  $ (52,771 )   $ 38,740     $ 45,134     $ 105,320  
 
8.         Employee Stock Ownership Plan
 
Shares of the Company’s common stock purchased by the ESOP are held in a suspense account until released for allocation to participants.  Shares released are allocated to each eligible participant based on the ratio of each such participant’s compensation, as defined in the ESOP, to the total compensation of all eligible plan participants.  As the unearned shares are released from suspense, the Company recognizes compensation expense equal to the fair value of the ESOP shares committed to be released during the period.  To the extent that the fair value of the ESOP shares differs from the cost of such shares, the difference is charged or credited to equity as additional paid-in capital. Expense related to the ESOP for the three months ended March 31, 2011 and 2010 approximated $2,000 for both periods and for the nine months ended March 31, 2011 and 2010 approximated $6,000 and $8,000 respectively.  The fair value of the unallocated shares as of March 31, 2011 and 2010 was $136,000 and $144,000, respectively.
 
9.         Fair Value Measurement
 
GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. GAAP establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
 
 
18

 
 
Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
 
Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.
 
Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
 
The balances of assets and liabilities measured at fair value on a recurring basis are as follows:
 
          Fair Value Measurements Using  
   
Total
   
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
March 31, 2011
                       
Assets:                        
Investment securities available for sale
                       
Municipal bond
  $ 180,059     $ -     $ 180,059     $ -  
Corporate bonds
    1,238,253       -       1,238,253       -  
FNMA mortgage-backed securities
    89,671       -       89,671       -  
U.S. Government sponsored enterprise securities
    771       -       771       -  
Corporate common stock
    10,000       -       10,000       -  
                                 
June 30, 2010
                               
Assets:
                               
Investment securities available for sale
                               
Corporate bonds
  $ 980,141     $ -     $ 980,141     $ -  
        FNMA mortgage-backed securities
    121,516       -       121,516       -  
U.S. Government sponsored enterprise securities
    850       -       850       -  
Corporate common stock
    10,000       -       10,000       -  
 
 
19

 
 
The balances of assets and liabilities measured at fair value on a nonrecurring basis are as follows:
 
            Fair Value Measurements Using
     
Total
   
Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
 
March 31, 2011
                       
  Assets:                        
 
Impaired loans
  $ 308,000     $ -     $ 308,000     $ -  
 
Foreclosed real estate
    972,602       -       972,602       -  
                                   
 
June 30, 2010
                               
 
Assets:
                               
 
Impaired loans
  $ 328,939     $ -     $ 328,939     $ -  
 
Foreclosed real estate
    680,712       -       680,712       -  
 
Impaired loans were reduced from their carrying amount of $394,593 to their fair value of $308,000 and  $372,307 to their fair value of $328,939 at March 31, 2011 and June 30, 2010, respectively, resulting in an impairment reserve through the allowance for loan losses.   Foreclosed real estate was reduced from its carrying amount of $987,828 to its fair value of $972,602 and $731,045 to its fair value of $680,712 at March 31, 2011 and June 30, 2010, respectively.
 
GAAP requires disclosure of estimated fair values of all financial instruments where it is practicable to estimate such values. 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. Accordingly, 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. The disclosure requirements exclude certain financial instruments and all nonfinancial instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
 
The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
 
Cash and cash equivalents and certificates of deposit: The carrying amounts of cash, due from banks, deposits with the FHLB, federal funds sold and certificates of deposit approximate fair values as these financial instruments have short maturities.
 
Securities: The fair value of securities available for sale, excluding Federal Home Loan Bank stock, are determined by obtaining quoted prices on nationally recognized securities exchanges or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities.  The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the FHLB.
 
Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
 
Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar remaining maturity.
 
Federal Home Loan Bank advances: The fair values of these borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
 
 
20

 
 
Accrued interest: The carrying amounts of accrued interest approximate fair value.
 
Off-balance-sheet instruments: The Company’s off-balance-sheet instruments consist of loan commitments. Fair values for loan commitments have not been presented as the future revenue derived from such financial instruments is not significant.
 
The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows:

     
March 31, 2011
   
June 30, 2010
 
     
Carrying
   
Fair
   
Carrying
   
Fair
 
     
Amount
   
Value
   
Amount
   
Value
 
           
(In thousands)
       
 
  Financial assets
                       
 
  Cash and cash equivalents
  $ 6,964     $ 6,964     $ 5,279     $ 5,279  
 
  Certificates of deposit
    745       745       845       845  
 
  Securities available for sale
    1,519       1,519       1,113       1,113  
 
  Federal Home Loan Bank stock
    1,252       1,252       1,252       1,252  
 
  Loans, net
    68,305       71,167       68,883       71,067  
 
  Accrued interest receivable
    273       273       278       278  
                                   
 
  Financial liabilities
                               
 
  Deposits
    57,276       56,507       55,769       55,396  
 
  Federal Home Loan Bank advances
    18,671       19,038       18,431       19,010  
 
10.       Regulatory Matters
 
On January 26, 2011, the Bank entered into a Memorandum of Understanding with the Office of Thrift Supervision (the “OTS”).  On that same date, the Company and the MHC jointly entered into a separate Memorandum of Understanding with the OTS.  The Memoranda require the Bank, the Company and the MHC to take certain measures to improve their safety and soundness but impose no fines or penalties upon the Bank, the Company or the MHC.  Management is addressing the requirements of the Memoranda and has communicated progress to the OTS.
 
11.       Subsequent Events
 
Subsequent events represent events or transactions occurring after the balance sheet date but before the financial statements are issued. Financial statements are considered “issued” when they are widely distributed to stockholders and others for general use and reliance in a form and format that complies with GAAP.
 
Specifically, there are two types of subsequent events:
 
 
Those comprising events or transactions providing additional evidence about conditions that existed at the balance sheet date, including estimates inherent in the financial statement preparation process (referred to as recognized subsequent events).
 
 
21

 
 
 
Those comprising events that provide evidence about conditions not existing at the balance sheet date but, rather, that arose after such date (referred to as non-recognized subsequent events).
 
Subsequent events have been evaluated and management  determined there were no subsequent events to be recorded or disclosed in these consolidated financial statements.
 
ITEM 2.                  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Overview
 
Our principal business is to acquire deposits from individuals and businesses in the communities surrounding our offices and to use these deposits to fund loans. We focus on providing our products and services to two segments of customers: individuals and businesses.
 
         Income. Our primary source of income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income. A secondary source of income is non-interest income, which includes revenue that we receive from providing products and services. The majority of our non-interest income generally comes from loan servicing fees and service charges on deposit accounts, as well as gains on sales of loans.
 
         Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a regular basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.
 
Expenses. The non-interest expenses we incur in operating our business consist of expenses for salaries and employee benefits, occupancy and equipment, data processing, marketing and advertising, professional services, FDIC insurance premiums and various other miscellaneous expenses. Our largest non-interest expense is salaries and employee benefits, which consist primarily of salaries and wages paid to our employees, payroll taxes, and expenses for health insurance, retirement plans and other employee benefits.
 
Forward-Looking Statements
 
         Certain statements herein constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words like “believe”, “expect”, “anticipate”, “estimate”, and “intend” or future or conditional verbs such as “will”, “would”, “should”, “could”, or “may.”  These forward-looking statements are based on the beliefs and expectations of management, as well as the assumptions made using information currently available to management. Since these statements reflect the views of management concerning future events, these statements involve risks, uncertainties and assumptions. As a result, actual results may differ from those contemplated by these forward-looking statements as a result of any number of factors.  These factors include, but are not limited to, risks related to the Company’s continued ability to originate quality loans, fluctuation in interest rates, real estate conditions in the Company’s lending areas, changes in the securities or financial markets, changes in loan delinquency and charge-off rates, general and local economic conditions, the Company’s continued ability to attract and retain deposits, the Company’s ability to control costs, new accounting pronouncements, and changing regulatory requirements.  For more information about these factors, please see our Annual Report on Form 10-K filed on September 28, 2010.  These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements, which speak only as of the date of this Quarterly Report on Form 10-Q. The Company does not undertake and specifically disclaims any obligation to publicly release updates or revisions to any such forward-looking statements as a result of new information, future events or otherwise.
 
 
22

 
 
Critical Accounting Policies
 
         We consider accounting policies that require management to exercise significant judgment or discretion, or make significant assumptions that have or could have a material impact on the carrying value of certain assets or on income, to be critical accounting policies. We consider the following to be our critical accounting policies.
 
         Allowance for loan losses.  The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.  The allowance for loan losses is evaluated on a regular basis by management and is based on management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of the underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
 
         The allowance consists of specific and general components.  The specific component relates to loans that are classified as impaired, whereby an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan.  The general component relates to pools of non-impaired loans and is based on historical loss experience adjusted for qualitative factors.
 
         A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Management considers factors including payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due when determining impairment. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.  The allowance for loan losses includes specific reserve amounts assigned to individual loans on the basis of loan impairment. Certain loans are evaluated individually and are judged to be impaired when management believes it is probable that not all of the contractual interest and principal payments will be collected as scheduled in the loan agreement.  Under this method, loans are selected for evaluation based on internal risk ratings or non-accrual status. A specific reserve is allocated to an individual loan when that loan has been deemed impaired and when the amount of a probable loss is estimable on the basis of its collateral value, the present value of anticipated future cash flows, or its net realizable value. As of March 31, 2011, four impaired loans were assigned a specific reserve of $87,000.  Specific reserves totaling $11,000 have been assigned as of June 30, 2010.
 
Management believes that, based on information currently available, the allowance for loan losses is sufficient to cover losses inherent in our loan portfolio at this time.  However, no assurances can be given that the level of the allowance will be sufficient to cover loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the appropriate level of the allowance.
 
Actual loan losses may be significantly more than the allowance we have established, which could have a material negative effect on our financial results.
 
 
23

 
 
Securities.  We classify our investments as available for sale. These assets are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income or loss.  Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of individual equity securities that are deemed to be other than temporary are reflected in earnings when identified. For individual debt securities where the Bank does not intend to sell the security and it is not more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary decline in the fair value of the debt security related to 1) credit loss is recognized in earnings and 2) other factors is recognized in other comprehensive income or loss. Credit loss is deemed to exist if the present value of expected future cash flows using the effective rate at date of acquisition is less than the amortized cost basis of the debt security. For individual debt securities where the Bank intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost, the other-than-temporary impairment is recognized in earnings equal to the entire difference between the security’s cost basis and its fair value at the balance sheet date.  Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
 
         Loans.  Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized over the contractual life of the loans as an adjustment of the related loan yield using the interest method.
 
         Loans past due 30 days or more are considered delinquent. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in process of collection.  Consumer loans are typically charged off when they are no more than 180 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
 
         All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. Cash payments on these loans are applied to principal balances until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
Comparison of Financial Condition at March 31, 2011 and June 30, 2010
 
         Total Assets. Total assets increased by $1.7 million, or 2.1%, from $80.6 million at June 30, 2010 to $82.3 million at March 31, 2011. This increase was largely the result of an increase of $1.7 million in cash and cash equivalents.
 
Cash and Cash Equivalents. Cash and correspondent bank balances increased by $1.7 million, or 31.9%, from $5.3 million at June 30, 2010 to $7.0 million at March 31, 2011.  This increase was primarily the result of an increase in deposits.
 
Certificates of Deposit. Certificate of deposit balances decreased $100,000, or 11.8% from $845,000 at June 30, 2010 to $745,000 at March 31, 2011.  This decrease was the result of one certificate of deposit maturity.
 
Securities Available for Sale. Securities available for sale totaled $1.5 million at March 31, 2011, an increase of $406,000, or 36.5%, from $1.1 million at June 30, 2010. The increase was primarily due to the purchase of two corporate bonds and one municipal bond.
 
Net Loans.  Net loans decreased $578,000 or 0.8%, from $68.9 million at June 30, 2010 to $68.3 million at March 31, 2011. The majority of loan growth has been in 1-4 family real estate loans and commercial real estate loans which increased $444,000, or 1.2%, and $1.3 million, or 2.5%, respectively.   The increases were primarily due to the market demand for fixed rate consumer and commercial real estate loans.  Construction loans decreased $326,000, or 79.5%, home equity loans decreased $649,000, or 5.7%, and commercial installment loans decreased $501,000, or 9.5%, from June 30, 2010 to March 31, 2011.  There was also an increase of $446,000, or 90.6% in allowance for loan losses due to the comprehensive review of the loan portfolio.   
 
 
24

 
 
Deposits and Borrowed Funds. Deposits increased $1.5 million, or 2.7%, from $55.8 million at June 30, 2010 to $57.3 million at March 31, 2011. Demand accounts decreased $35,000, or 1.1%.  NOW checking accounts increased $835,000, or 28.8%, and certificates of deposit increased $1.3 million, or 3.9%. Money market accounts decreased $902,000, or 6.5% and savings accounts increased $352,000 or 8.9%.  The increase in certificates of deposit resulted from a special rate offered on one and two year maturities in anticipation of a $1 million withdrawal of a certificate maturing in April, 2011.  The decrease in money market accounts resulted from a large withdrawal upon the death of a customer with a substantial deposit relationship.
 
Total borrowings from the Federal Home Loan Bank of Boston (“FHLB”) increased $241,000, or 1.3%, from $18.4 million at June 30, 2010 to $18.7 million at March 31, 2011.
 
Total Stockholders’ Equity. Total equity increased $39,000 during the nine months ended March 31, 2011, primarily as a result of net income of $21,000 and an increase in unrealized gain on investment securities, net of tax, of $12,000.
 
Comparison of Operating Results for the Three Months Ended March 31, 2011 and March 31, 2010
 
         Net Income (Loss). Net income decreased $108,000 to a net loss of $71,000 for the three months ended March 31, 2011 compared to net income of $38,000 for the three months ended March 31, 2010.   The decrease was the result of higher provision for loan losses.
 
Net Interest Income.  Net interest income increased $73,000, or 11.8%, from $615,000 for the three months ended March 31, 2010 to $688,000 for the three months ended March 31, 2011.  The increase was primarily due to the increase in interest and dividend income of $8,000 and decrease in interest expense of $65,000.  The interest rate spread increased from 3.26% for the three months ended March 31, 2010 to 3.54% for the three months ended March 31, 2011.  Net interest margin increased from 3.41% for the three months ended March 31, 2010 to 3.65% for the three months ended March 31, 2011.
 
Interest and Dividend Income. Interest income increased $8,000, or 0.8%, from $1.02 million for the three months ended March 31, 2010 to $1.03 million for the three months ended March 31, 2011.  This increase was due principally to an increase in the average balance of interest-earning assets, partly offset by a decrease in yield.  Interest income increased by $4,000 on loans and increased $4,000 on investment securities and other interest-earning deposits, including Federal Home Loan Bank stock.  The average yield on the loan portfolio decreased from 6.02% for the three months ended March 31, 2010 to 5.90% for the three months ended March 31, 2011 in the generally lower interest rate environment. The average yield on investments, including securities, FHLB stock and interest-bearing deposits increased from .83% for the three months ended March 31, 2010 to 0.88% for the three months ended March 31, 2011.
 
Interest Expense. Interest expense decreased by $65,000, or 15.7%, to $347,000 for the three months ended March 31, 2011 from $412,000 for the three months ended March 31, 2010.  The decrease was due primarily to lower cost of funds.  While average deposit balances increased, the average cost of these deposits decreased from 2.43% to 1.95% in the generally lower market interest rate environment. Average borrowings from FHLB increased with the average cost of the borrowings decreasing from 3.67% to 2.90%.
 
The following table presents the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). Changes due to the interaction between volume and rate were allocated pro rata between volume and rate.
 
 
25

 
 
   
Three Months Ended March 31, 2011
Compared to Three Months
Ended March 31, 2010
 
   
Volume
   
Rate
   
Net
change
 
Interest-earning assets:
                 
Loans
  $ 25,000     $ (21,000 )   $ 4,000  
Investment securities
    8,000       (3,000 )     5,000  
Federal Home Loan Bank stock
    -       1,000       1,000  
Interest-earning deposits
    1,000       (3,000 )     (2,000 )
Total interest-earning assets
  $ 34,000     $ (26,000 )   $ 8,000  
Interest-bearing liabilities:
                       
Savings deposits
  $ 1,000     $ (4,000 )   $ (3,000 )
NOW accounts
    1,000       (1,000 )     -  
Money market accounts
    (5,000 )     (21,000 )     (26,000 )
Certificates of deposit
    18,000       (24,000 )     (6,000 )
Total deposits
    15,000       (50,000 )     (35,000 )
Federal Home Loan Bank of Boston advances
    7,000       (37,000 )     (30,000 )
Total interest-bearing liabilities
  $ 22,000     $ (87,000 )   $ (65,000 )
Change in net interest income
  $ 12,000     $ 61,000     $ 73,000  
 
Provision for Loan Losses. The Company’s provision for loan losses was $233,000 and $4,000 for the three months ended March 31, 2011 and 2010, respectively.  Loan write-downs totaled $27,000 for the three months ended March 31, 2011.  There were no write-downs during the comparable period in 2010.  The Bank has completed a comprehensive review of the loan portfolio and related allowance for loan losses, and has increased its allowance for loan losses to $938,000 at March 31, 2011 which now represents 1.35% of total loans, compared to an allowance of $492,000, representing 0.71% of total loans at June 30, 2010.  Our analysis of the adequacy of the allowance considers economic conditions, historical losses and management’s estimate of losses inherent in the portfolio. For further discussion of our current methodology, please refer to “Critical Accounting Policies—Allowance for Loan Losses.”
 
Non-interest Income. Total non-interest income decreased $30,000, or 54.8%, to $24,000 for the three months ended March 31, 2011, from $54,000 for the three months ended March 31, 2010. This decrease was primarily a result of losses recognized on foreclosed real estate for the three months ended March 31, 2011.  There were no such losses for the three months ended March 31, 2010.
 
Non-interest Expenses. Non-interest expenses decreased $23,000, or 3.7%, to $586,000 for the three months ended March 31, 2011, compared to $609,000 for the three months ended March 31, 2010. The decrease was primarily the result of $57,000 in provision for losses on real estate owned for the three months ended March 31, 2011 and a decrease of $11,000 in advertising, offset by an increase in Federal deposit insurance premiums of $7,000, $6,000 in increased legal fees, an increase of $10,000 in accounting expenses, and an increase in other operating expenses of $22,000.
 
 Income Taxes. Income tax expense decreased by $55,000, to a tax benefit  of $36,000 for the three months ended March 31, 2011, reflecting an effective tax rate of 33.8%, compared to a tax expense of $19,000 for the three months ended March 31, 2010, reflecting an effective tax rate of 33.4%.
 
Average Daily Balance Sheet.  The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated.  All average balances are daily average balances.  The yields set forth below include the effect of deferred fees, and discounts and premiums that are amortized or accreted to interest income or expense.  We do not accrue interest on loans in non-accrual status, however, the balance of these loans is included in the total average balance, which has the effect of lowering average loan yields.
 
 
26

 
 
    For the Three Months Ended March 31,  
    2011     2010  
   
Average
               
Average
             
   
Outstanding
               
Outstanding
             
   
Balance
   
Interest
   
Yield/Rate
   
Balance
   
Interest
   
Yield/Rate
 
               
(Dollars in Thousands)
             
                                     
Interest-earning assets:
                                   
Loans
  $ 69,219     $  1,021       5.90 %   $ 67,534      1,017     $ 6.02 %
Investment securities(1)
    1,780       11       2.47 %     599       6       4.19 %
Federal Home Loan Bank stock
    1,252       1       0.30 %     1,252       -       0.00 %
Interest-earning deposits
    3,108       2       0.20 %     2,749       3       0.47 %
    Total interest-earning assets
    75,359     $ 1,035       5.49 %     72,134     $ 1,026       5.69 %
Non-interest-earning assets
    5,279                       5,063                  
Total assets
  $ 80,638                     $ 77,197                  
                                                 
Interest-bearing liabilities:
                                               
Savings deposits
  $ 4,245     $  5       0.49 %   $ 3,927     $ 8       0.87 %
NOW accounts
    3,355       5       0.56 %     2,581       5       0.76 %
Money market accounts
    12,279       24       0.77 %     13,745       49       1.43 %
Certificates of deposit
    32,166       174       2.17 %     29,157       181       2.48 %
Total interest-bearing deposits
    52,045       208       1.60 %     49,410       243       1.97 %
FHLB advances
    19,136       139       2.90 %     18,324       168       3.67 %
Total interest-bearing liabilities
  $ 71,181     $ 347       1.95 %   $ 67,734     $ 411       2.43 %
                                                 
                                                 
Non-interest-bearing liabilities:
                                               
Demand deposits
  $ 2,929                     $ 3,145                  
Other non-interest-bearing
                                               
liabilities
    247                       243                  
Total liabilities
    74,357                       71,122                  
Total capital
    6,281                       6,075                  
Total liabilities and capital
  $ 80,638                     $ 77,197                  
                                                 
Net interest income
          $ 688                     $ 615          
Net interest rate spread(2)
                    3.54 %                     3.26 %
Net interest-earning assets(3)
  $ 4,178                     $ 4,400                  
Net interest margin(4)
                    3.65 %                     3.41 %
Average of interest-earning assets to interest-bearing liabilities
    105.87 %                     106.50 %                
 
 
 
 
(1)
Consists of taxable investment securities and one municipal bond.  The municipal bond is presented on a fully taxable basis as the tax equivalent adjustment is not material to the yield.
(2)
Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(3)
Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(4)
Net interest margin represents net interest income divided by average total interest-earning assets.
 
 
27

 
 
Comparison of Operating Results for the Nine Months Ended March 31, 2011 and March 31, 2010
 
            Net Income. Net income decreased $35,000 to $21,000 for the nine months ended March 31, 2011 compared to net income of $56,000 for the nine months ended March 31, 2010. The decrease was primarily the result of higher provision for loan losses, partially offset by higher net interest income and higher non-interest income.
 
Net Interest Income.  Net interest income increased $290,000, or 16.1%, from $1.8 million for the nine months ended March 31, 2010 to $2.1 million for the nine months ended March 31, 2011.  The increase was primarily due to an increase in interest and dividend income of $91,000 and a decrease in interest expense of $199,000.  The interest rate spread increased from 3.15% for the nine months ended March 31, 2010 to 3.55% for the nine months ended March 31, 2011.  Net interest margin increased from 3.32% for the nine months ended March 31, 2010 to 3.68% for the nine months ended March 31, 2011.
 
 Interest and Dividend Income. Interest and dividend income increased $91,000, or 3.0%, from $3.1 million for the nine months ended March 31, 2010 to $3.2 million for the nine months ended March 31, 2011.  This increase was due principally to an increase in the average balance of interest-earning assets, partly offset by a decrease in yield.  Interest income increased by $139,000 on loans and decreased $48,000 on investment securities and other interest-earning deposits, including Federal Home Loan Bank stock.  The average yield on the loan portfolio decreased from 6.09% for the nine months ended March 31, 2010 to 5.98% for the nine months ended March 31, 2011 in the generally lower interest rate environment. The average yield on investments, including securities, FHLB stock and interest-bearing deposits decreased from 1.89% for the nine months ended March 31, 2010 to 0.99% for the nine months ended March 31, 2011.
 
Interest Expense. Interest expense decreased by $199,000, or 15.4%, to $1.1 million for the nine months ended March 31, 2011 from $1.3 million for the nine months ended March 31, 2010.  The decrease was due primarily to lower cost of funds.  While average deposit balances increased, the average cost of these deposits decreased from 2.15% to 1.70% in the generally lower market interest rate environment. Average borrowings from FHLB decreased with the average cost of the borrowings decreasing from 3.59% to 3.02%.
 
The following table presents the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). Changes due to the interaction between volume and rate were allocated pro rata between volume and rate.
 
 
28

 
 
   
Nine Months Ended March 31, 2011
Compared to Nine Months
Ended March 31, 2010
 
   
Volume
   
Rate
   
Net
change
 
Interest-earning assets:
                       
Loans
  $ 192,000     $ (53,000 )   $ 139,000  
Investment securities
    21,000       (16,000 )     5,000  
Federal Home Loan Bank stock
    -       1,000       1,000  
Interest-earning deposits
    (17,000 )     (37,000 )     (54,000 )
Total interest-earning assets
  $ 196,000     $ (105,000 )   $ 91,000  
Interest-bearing liabilities:
                       
Savings deposits
  $ 4,000     $ (8,000 )   $ (4,000 )
NOW accounts
    2,000       (4,000 )     (2,000 )
Money market accounts
    3,000       (65,000 )     (62,000 )
Certificates of deposit
    63,000       (95,000 )     (32,000 )
Total deposits
    72,000       (172,000 )     (100,000 )
Federal Home Loan Bank of Boston advances
    (17,000 )     (82,000 )     (99,000 )
Total interest-bearing liabilities
  $ 55,000     $ (254,000 )   $ (199,000 )
Change in net interest income
  $ 141,000     $ 149,000     $ 290,000  
 
Provision for Loan Losses . The Company’s provision for loan losses was $537,000 and $49,000 for the nine months ended March 31, 2011 and 2010, respectively.  There was an increase in general valuation reserve of $446,000, or 90.6% from June 30, 2010 to March 31, 2011, due largely to the current economic conditions, including declining real estate values and loan performance challenges across all segments of the loan portfolio. The Bank has completed a comprehensive review of the loan portfolio and related allowance for loan losses, and has increased its allowance for loan losses to $938,000 at March 31, 2011 which now represents 1.35% of total loans, compared to an allowance of $434,000, representing 0.63% of total loans at March 31, 2010.  Our analysis of the adequacy of the allowance considers economic conditions, historical losses and management’s estimate of losses inherent in the portfolio. For further discussion of our current methodology, please refer to “Critical Accounting Policies—Allowance for Loan Losses.”
 
Non-interest Income. Total non-interest income increased $118,000, or 287.5%, to $159,000 for the nine months ended March 31, 2011, from $41,000 for the nine months ended March 31, 2010. This increase was the result of having recognized no other than temporary impairment of investment securities for the nine months ended March 31, 2011 compared to $126,000 loss for the nine months ended March 31, 2010.
 
Non-interest Expenses. Non-interest expenses decreased $27,000, or 1.6%, to $1.67 million for the nine months ended March 31, 2011, compared to $1.70 million for the nine months ended March 31, 2010. The decrease was primarily due to a decrease of $31,000 in federal deposit insurance premiums and a decrease of $56,000 in the provision for losses on real estate owned, partially offset by increases of $22,000 in salaries and benefits, $22,000 in consulting expense and $18,000 in other operating expenses.
 
Income Taxes. Income tax expense decreased by $19,000, to $17,000 for the nine months ended March 31, 2011, reflecting an effective tax rate of 44.5%, compared to a tax expense of $36,000 for the nine months ended March 31, 2010, reflecting an effective tax rate of 39.2%.
 
Average Daily Balance Sheet.  The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated.  All average balances are daily average balances.  The yields set forth below include the effect of deferred fees, and discounts and premiums that are amortized or accreted to interest income or expense.  We do not accrue interest on loans in non-accrual status, however, the balance of these loans is included in the total average balance, which has the effect of lowering average loan yields.
 
 
29

 
 
    For the Nine Months Ended March 31,  
    2011     2010  
   
Average
               
Average
             
   
Outstanding
               
Outstanding
             
   
Balance
   
Interest
   
Yield/Rate
   
Balance
   
Interest
   
Yield/Rate
 
               
(Dollars in Thousands)
             
                                     
Interest-earning assets:
                                   
Loans
  $ 70,047     $ 3,143       5.98 %   $ 65,775     $ 3,002       6.09 %
Investment securities(1)
    1,784       34       2.56 %     891       30       4.45 %
Federal Home Loan Bank stock
    1,252       1       0.10 %     1,224       -       0.00 %
Interest-earning deposits
    2,552       6       0.32 %     4,213       60       1.89 %
Total interest-earning assets
    75,635     $ 3,184       5.61 %     72,103     $ 3,092       5.72 %
Non-interest-earning assets
    5,141                       4,500                  
Total assets
  $ 80,776                     $ 76,603                  
                                                 
Interest-bearing liabilities:
                                               
Savings deposits
  $ 4,212     $ 19       0.60 %   $ 3,557     $ 23       0.87 %
NOW accounts
    2,959       12       0.56 %     2,578       15       0.77 %
Money market accounts
    12,764       78       0.81 %     12,491       140       1.49 %
Certificates of deposit
    31,947       552       2.30 %     28,626       582       2.71 %
Total interest-bearing deposits
    51,882       661       1.70 %     47,252       760       2.15 %
FHLB advances
    19,173       435       3.02 %     19,829       534       3.59 %
Total interest-bearing liabilities
  $ 71,055     $ 1,096       2.06 %   $ 67,081     $ 1,294       2.57 %
                                                 
Non-interest-bearing liabilities:
                                               
Demand deposits
  $ 3,249                     $ 3,293                  
Other non-interest-bearing liabilities
    239                       210                  
Total liabilities
    74,543                       70,584                  
Total capital
    6,233                       6,019                  
Total liabilities and capital
  $ 80,776                     $ 76,603                  
                                                 
Net interest income
          $ 2,088                     $ 1,798          
Net interest rate spread(2)
                    3.55 %                     3.15 %
Net interest-earning assets(3)
  $ 4,581                     $ 5,022                  
Net interest margin(4)
                    3.68 %                     3.32 %
Average of interest-earning assets
                                               
to interest-bearing liabilities
    106.45 %                     107.49 %                
 
 
 
 
(1)
Consists of taxable investment securities and one municipal bond.  The municipal bond is presented on a fully taxable basis as the tax equivalent adjustment is not material to the yield.
(2)
Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(3)
Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(4)
Net interest margin represents net interest income divided by average total interest-earning assets.
 
 
30

 
 
Liquidity
 
 Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, loan sales and maturities of investment securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage and mortgage-backed security prepayments are greatly influenced by general interest rates, economic conditions and competition.
 
         We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and federal funds sold. Our most liquid assets are cash and cash equivalents and interest-earning deposits. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At March 31, 2011, cash and cash equivalents totaled $7.0 million, including interest-earning deposits of $4.9 million. Securities classified as available for sale, which provide additional sources of liquidity, totaled $1.5 million at March 31, 2011, and certificates of deposit at other banks totaled $745,000. At March 31, 2011, we had $18.7 million of outstanding borrowings from FHLB, and the ability to borrow an additional $5.6 million.  
 
         At March 31, the Company had $136,000 in loan commitments outstanding and $4.1 million in unused lines of credit, letters of credit and unadvanced portions of construction loans.
 
         Certificates of deposit due to mature within one year of March 31, 2011 totaled $19.7 million, or 34.4% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and lines of credit. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us.
 
         Our primary investing activities are the origination of loans and the purchase of securities. Our primary financing activity consists of activity in deposit accounts. However, we may from time to time utilize borrowings to fund a portion of our operations where the cost of such borrowings is more favorable than that of deposits of a similar duration. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive and to increase core deposits. Occasionally, we offer promotional rates to attract certain deposit products.
 
Other than those discussed above, we are not aware of any known trends, events or uncertainties that will have or are reasonably likely to have a material effect on our liquidity, capital or operations, nor are we aware of any current recommendations by regulatory authorities, which if implemented, would have a material effect on liquidity, capital or operations.
 
Capital Resources
 
The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At March 31, 2011, the Bank exceeded all of its regulatory capital requirements. The Bank is considered “well-capitalized” under regulatory guidelines.
 
 
31

 
 
The actual and minimum capital amounts and ratios for the Bank are presented in the following table:
 
                           
Minimum
 
                           
To Be Well
 
               
Minimum
   
Capitalized Under
 
               
Capital
   
Prompt Corrective
 
   
Actual
   
Requirement
   
Action Provisions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
               
(In Thousands)
             
March 31, 2011
                                   
                                     
Total capital to risk weighted assets
  $ 6,112       12.12 %   $ 4,034       8.00 %   $ 5,042       10.00 %
 
                                               
Tier 1 risked-based capital to risk weighted assets
  $ 5,479       10.87 %   $ 2,017       4.00 %   $ 3,025       6.00 %
                                                 
Tier 1 capital to total assets
  $ 5,899       7.18 %   $ 3,294       4.00 %   $ 4,118       5.00 %
                                                 
June 30, 2010
                                               
                                                 
Total capital to risk weighted assets
  $ 5,933       11.67 %   $ 4,069       8.00 %   $ 5,086       10.00 %
                                                 
Tier 1 risked-based capital to risk weighted assets
  $ 5,838       11.48 %   $ 2,034       4.00 %   $ 3,052       6.00 %
                                                 
Tier 1 capital to total assets
  $ 5,838       7.24 %   $ 3,224       4.00 %   $ 4,031       5.00 %
 
         The capital from the recent stock offering increased the Bank’s liquidity and capital resources. The initial level of liquidity is being reduced as net proceeds from the stock offering are used for general corporate purposes, including the funding of loan originations and repaying a portion of our borrowings. Due to the increase in equity resulting from the capital raised in the stock offering, return on equity has been adversely affected as a result of the reorganization.
 
Memorandum of Understanding
 
           On January 26, 2011, the Bank entered into a Memorandum of Understanding with the Office of Thrift Supervision (the “OTS”).  On that same date, the Company and its mutual holding company parent, Auburn Bancorp, MHC (the “MHC”), jointly entered into a separate Memorandum of Understanding with the OTS.  The Memoranda require the Bank, the Company and the MHC to take certain measures to improve their safety and soundness but impose no fines or penalties upon the Bank, the Company or the MHC.  The Company filed a current report on Form 8K on January 31, 2011, with additional details of the Memoranda, which Form 8K is incorporated by reference herein.
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Not applicable for smaller reporting companies.
 
ITEM 4.
CONTROLS AND PROCEDURES
 
         The Company’s chief executive officer and principal financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report (the “Evaluation Date”), have concluded that as of the Evaluation Date the Company’s disclosure controls and procedures were effective and designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
 
 
32

 
 
         During the period covered by this quarterly report, there were no changes in the Company’s internal control that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
PART II.  OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS
 
        Neither the Company nor the Bank is involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, involve amounts believed by management to be immaterial to the consolidated financial condition and results of operations of the Company.
 
ITEM 1A.
RISK FACTORS
 
Not applicable for smaller reporting companies.
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
The Company did not repurchase any shares during the quarter ended March 31, 2011.
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
 
        None.
 
ITEM 4.
[REMOVED AND RESERVED]
 
ITEM 5.
OTHER INFORMATION
 
 
(a)
None.
 
 
(b)
There were no material changes to the procedures by which security holders may recommend nominees to the Company’s board of directors during the period covered by the Form 10Q.
 
 
33

 
 
ITEM 6.
EXHIBITS
 
Exhibit
Number
 
Exhibit Description
     
2.1
 
Plan of Reorganization from Mutual Savings Bank to Mutual Holding Company and Stock Issuance Plan **
     
3.1
 
Charter of Auburn Bancorp, Inc. **
     
3.2
 
Bylaws of Auburn Bancorp, Inc. **
     
4.1
 
10.1
 
10.2
 
10.3
 
Stock Certificate of Auburn Bancorp, Inc. **
 
Form of Auburn Savings Bank Employee Stock Ownership Plan and Trust **
 
Form of ESOP Loan Commitment Letter and ESOP Loan Documents **
 
Form of Employment Agreement between Auburn Savings Bank and Allen T. Sterling **
     
31.1
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer of the Company
     
31.2
 
Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer of the Company
     
32.1
 
Section 1350 Certification of Chief Executive Officer of the Company in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
     
32.2
 
Section 1350 Certification of Principal Financial Officer of the Company in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
     
 
** Incorporated by reference into this document from the Exhibits filed with the Securities and Exchange Commission on the Company’s Registration Statement on Form S-1, as amended, initially filed on March 14, 2008 and declared effective on May 13, 2008 (File Number 333-149723).
   
 
 
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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.
 
     
Auburn Bancorp, Inc.
     
(Registrant)
       
Date:  May 12, 2011
 
By:
/s/  Allen T. Sterling
     
Allen T. Sterling
     
President and Chief Executive Officer
(Principal Executive Officer)
       
Date:  May 12, 2011
 
By:
/s/  Rachel A. Haines
     
Rachel A. Haines
     
Senior Vice President and Treasurer
(Principal Accounting and Financial Officer)
 
 
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