Bear State Financial 10Q 2013 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

☐

For the quarterly period ended September 30, 2013

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to _______________

Commission File No.:0-28312

First Federal Bancshares of Arkansas, Inc.

(Exact name of registrant as specified in its charter)

Arkansas		71-0785261
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification Number)


1401 Highway 62-65 North
Harrison, Arkansas		72601
(Address of principal executive offices)		(Zip Code)

Registrant's telephone number, including area code: (870) 741-7641

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

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

Large Accelerated Filer ☐ Accelerated Filer ☐ Non-accelerated Filer ☐ Smaller reporting company ☒

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of October 24, 2013, there were issued and outstanding 20,041,497 shares of the Registrant's Common Stock, par value $.01 per share.

FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.

TABLE OF CONTENTS

		Page

Part I.	Financial Information

Item 1.	Financial Statements

	Condensed Consolidated Statements of Financial Condition as ofSeptember 30, 2013 and December 31, 2012 (unaudited)	1

	Condensed Consolidated Statements of Income and Comprehensive Income for thethree and nine months ended September 30, 2013 and 2012 (unaudited)	2

	Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2013 (unaudited)	3

	Condensed Consolidated Statements of Cash Flows for the nine months endedSeptember 30, 2013 and 2012 (unaudited)	4

	Notes to Unaudited Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Conditionand Results of Operations	24

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38

Item 4.	Controls and Procedures	38

Part II.	Other Information

Item 1.	Legal Proceedings	38
Item 1A.	Risk Factors	38
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 6.	Exhibits	40

Signatures

Exhibit Index

Part I. Financial Information

Item 1. Financial Statements

FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(In thousands, except share data)

(Unaudited)

ASSETS	September 30, 2013			December 31, 2012

Cash and cash equivalents	$	23,435		$	42,607
Interest-bearing time deposits in banks		25,111			29,592
Investment securities available for sale		73,335			53,325
Federal Home Loan Bank stock—at cost		259			375
Loans receivable, net of allowance of $13,078 and $15,676, respectively		348,819			337,328
Loans held for sale		3,963			4,435
Accrued interest receivable		1,505			1,501
Real estate owned - net		9,835			16,658
Office properties and equipment - net		18,940			20,634
Cash surrender value of life insurance		23,606			23,003
Prepaid expenses and other assets		933			937

TOTAL	$	529,741		$	530,395

LIABILITIES AND STOCKHOLDERS’ EQUITY

LIABILITIES:
Deposits	$	455,456		$	455,051
Other borrowings		968			3,109
Advance payments by borrowers for taxes and insurance		501			676
Other liabilities		1,330			1,899

Total liabilities		458,255			460,735

STOCKHOLDERS’ EQUITY:
Preferred stock, $.01 par value—5,000,000 shares authorized; none issued at September 30, 2013 and December 31, 2012		--			--
Common stock, $.01 par value—30,000,000 shares authorized; 20,041,497 and 19,302,603 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively		200			193
Additional paid-in capital		92,666			90,719
Accumulated other comprehensive income		105			763
Accumulated deficit		(21,485	)		(22,015	)

Total stockholders’ equity		71,486			69,660

TOTAL	$	529,741		$	530,395

See notes to unaudited condensed consolidated financial statements.

FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(In thousands, except earnings per share)

(Unaudited)

	Three Months Ended					Nine Months Ended
	September 30,			September 30,		September 30,			September 30,
	2013			2012		2013			2012
INTEREST INCOME:
Loans receivable	$	4,033		$	4,318	$	12,084		$	13,381
Investment securities:
Taxable		146			64		256			336
Nontaxable		290			323		896			901
Other		110			135		381			409
Total interest income		4,579			4,840		13,617			15,027

INTEREST EXPENSE:
Deposits		814			1,046		2,477			3,363
Other borrowings		11			23		37			86

Total interest expense		825			1,069		2,514			3,449

NET INTEREST INCOME		3,754			3,771		11,103			11,578

PROVISION FOR LOAN LOSSES		--			--		--			22

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		3,754			3,771		11,103			11,556

NONINTEREST INCOME:
Net gain on sale of investment securities		25			--		25			542
Deposit fee income		780			904		2,352			2,975
Earnings on life insurance policies		205			198		603			586
Gain on sale of loans		267			250		726			668
Other		142			97		307			369

Total noninterest income		1,419			1,449		4,013			5,140

NONINTEREST EXPENSES:
Salaries and employee benefits		2,884			2,681		8,365			8,265
Net occupancy expense		583			625		1,809			1,934
Real estate owned, net		133			118		82			(174	)
FDIC insurance		139			286		480			875
Supervisory assessments		35			72		142			222
Data processing		376			395		1,108			1,658
Professional fees		108			158		518			748
Advertising and public relations		71			54		215			192
Postage and supplies		91			86		308			377
Other		599			392		1,548			1,346

Total noninterest expenses		5,019			4,867		14,575			15,443

INCOME BEFORE INCOME TAXES		154			353		541			1,253

INCOME TAX		11			--		11			--

NET INCOME	$	143		$	353	$	530		$	1,253

Basic earnings per common share	$	0.01		$	0.02	$	0.03		$	0.06

Diluted earnings per common share	$	0.01		$	0.02	$	0.03		$	0.06

OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:

Unrealized holding gains (losses) arising during the period	$	299		$	236	$	(633	)	$	494
Reclassification adjustments for gain included in net income		(25	)		--		(25	)		(542	)
COMPREHENSIVE INCOME (LOSS)	$	417		$	589	$	(128	)	$	1,205

See notes to unaudited condensed consolidated financial statements.

FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013

(In thousands, except share data)

(Unaudited)

	Issued Common Stock				AdditionalPaid-		Accumulated Other Comprehensive			Accumulated			Total Stockholders’
	Shares		Amount		In Capital		Income (Loss)			Deficit			Equity
BALANCE – January 1, 2013		19,302,603	$	193	$	90,719	$	763		$	(22,015	)	$	69,660

Net income		--		--		--		--			530			530
Other comprehensive loss		--		--		--		(658	)		--			(658	)
Exercise of warrants		738,894		7		1,779		--			--			1,786
Stock compensation expense		--		--		168		--			--			168

BALANCE – September 30, 2013		20,041,497	$	200	$	92,666	$	105		$	(21,485	)	$	71,486

See notes to unaudited condensed consolidated financial statements.

FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended September 30,
	2013			2012

OPERATING ACTIVITIES:
Net income	$	530		$	1,253
Adjustments to reconcile net income to net cashused in operating activities:
Provision for loan losses		--			22
Provision for real estate losses		577			585
Deferred tax provision		(621	)		1,318
Deferred tax valuation allowance		621			(1,318	)
Net (accretion) amortization of investment securities		(6	)		19
Federal Home Loan Bank stock dividends		--			(2	)
Gain on sale of fixed assets, net		(42	)		(149	)
Gain on sale of real estate owned, net		(690	)		(1,135	)
Gain on sale of investment securities, net		(25	)		(542	)
Originations of loans held for sale		(37,534	)		(35,388	)
Proceeds from sales of loans held for sale		38,732			33,605
Gain on sale of loans originated to sell		(726	)		(668	)
Depreciation		1,038			1,089
Amortization of deferred loan costs, net		83			56
Stock compensation		168			112
Earnings on life insurance policies		(603	)		(586	)
Changes in operating assets and liabilities:
Accrued interest receivable		(4	)		(216	)
Prepaid expenses and other assets		4			704
Other liabilities		(569	)		(98	)

Net cash provided by (used in) operating activities		933			(1,339	)

INVESTING ACTIVITIES:
Purchases of interest-bearing time deposits in banks		--			(4,470	)
Redemptions of interest-bearing time deposits in banks		4,481			1,743
Purchases of investment securities available for sale		(37,293	)		(22,499	)
Proceeds from sales of investment securities AFS		12,169			5,387
Proceeds from maturities/calls/paydowns of investment securities AFS		4,487			20,951
Redemption of FHLB stock		116			--
Loan originations, net of repayments		(33,278	)		(11,270	)
Loan participations purchased		(3,391	)		(1,662	)
Loans sold		23,938			--
Proceeds from sales of real estate owned		8,004			12,648
Other cash activity - real estate owned		89			(191	)
Proceeds from sales of office properties and equipment		1,871			272
Purchases of office properties and equipment		(1,173	)		(688	)

Net cash (used in) provided by investing activities		(19,980	)		221

(Continued)

FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended September 30,
	2013			2012
FINANCING ACTIVITIES:
Net increase (decrease) in deposits	$	22,097		$	(32,515	)
Sale of deposits in connection with branch sales		(21,692	)		--
Repayment of advances from Federal Home Loan Bank		(2,141	)		(3,505	)
Net decrease in advance payments by borrowersfor taxes and insurance		(175	)		(281	)
Proceeds from exercise of warrants		1,786			--

Net cash used in financing activities		(125	)		(36,301	)

NET DECREASE IN CASH AND
CASH EQUIVALENTS		(19,172	)		(37,419	)

CASH AND CASH EQUIVALENTS:
Beginning of period		42,607			79,799

End of period	$	23,435		$	42,380

SUPPLEMENTAL DISCLOSURES OF CASH FLOWINFORMATION—
Cash paid for:
Interest	$	2,506		$	3,475

Income taxes	$	11		$	--

SUPPLEMENTAL SCHEDULE OF NONCASHINVESTING AND FINANCING ACTIVITIES:
Real estate and other assets acquired in settlement of loans	$	1,972		$	5,707

Sales of real estate owned financed by the Bank	$	815		$	1,378

Investment securities purchased—not settled	$	--		$	1,435

See notes to unaudited condensed consolidated financial statements.

(Concluded)

FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations and Principles of Consolidation—First Federal Bancshares of Arkansas, Inc. (the “Company”) is a unitary holding company that owns all of the stock of First Federal Bank (the “Bank”). The Company, through its ownership of the Bank, is principally in the business of community banking and therefore is considered a banking operation with no separately reportable segments. The Bank provides a broad line of financial products to individuals and small- to medium-sized businesses. The consolidated financial statements also include the accounts of the Bank’s wholly owned subsidiary, First Harrison Service Corporation, which is inactive.

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, such information reflects all adjustments which are, in the opinion of management, necessary for a fair statement of results for the interim periods.

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and the Bank. Intercompany transactions have been eliminated in consolidation. Certain reclassifications of prior period amounts have been made to conform with the current period presentation. These reclassifications had no impact on previously reported net income.

The results of operations for the nine months ended September 30, 2013, are not necessarily indicative of the results to be expected for the year ending December 31, 2013. The unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2012, contained in the Company’s 2012 Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”).

2. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2011, the FASB issued ASU 2011-05,Comprehensive Income (Topic 220):Presentation of ComprehensiveIncome. In December 2011, FASB issued ASU 2011-12, which deferred certain provisions of ASU 2011-05. One of ASU 2011-05’s provisions required the Company to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. ASU 2011-12 deferred this requirement indefinitely. All other requirements in ASU 2011-05 were not affected by ASU 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. The ASU did not amend the components that must be reported in other comprehensive income. Both ASUs were effective for the Company’s reporting periods beginning after December 15, 2011. The Company adopted these ASUs beginning in the quarter ended March 31, 2012. The adoption of these ASUs did not have a material impact on the Company’s financial statements. In February 2013, the FASB issued ASU 2013-02,Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,which requires disclosure, either in a single footnote or parenthetically on the face of the financial statements, of the effect of significant items reclassified from accumulated other comprehensive income to their respective line items in the statement of net income. ASU 2013-02 is effective for reporting periods beginning after December 15, 2012. The Company adopted this ASU effective January 1, 2013. The adoption of this ASU did not have a material impact on the Company’s financial statements.

In July 2013, the FASB issued ASU 2013-11,Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (Topic 740):Income Taxes, which states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. For example, an entity should not evaluate whether the deferred tax asset expires before the statute of limitations on the tax position or whether the deferred tax asset may be used prior to the unrecognized tax benefit being settled. The amendments in this Update do not require new recurring disclosures. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of this ASU is not expected to have a material impact on the Company’s financial statements.

3. PENDING ACQUISITION

On July 1, 2013, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with First National Security Company (“FNSC”) of Hot Springs, Arkansas, pursuant to which FNSC will merge with and into the Company (the “Merger”). Pursuant to the Merger Agreement, shareholders of FNSC will receive, in the aggregate, 6,252,400 shares of Company common stock and $74 million in cash in exchange for their shares of FNSC common stock. The total transaction value will depend on the closing price of the Company’s stock on the closing date of the Merger. Consummation of the Merger is subject to certain conditions, including, among others, approval of the Merger by Company and FNSC shareholders and the receipt of all required governmental regulatory approvals. Under the terms of the Merger Agreement, either party may terminate the Merger Agreement if the Merger is not completed by March 31, 2014.

In connection with the Merger, the Company will sell up to 2,531,645 shares of Company common stock at a price per share equal to $7.90 and issue warrants (the “Investor Warrants”) to purchase 177,215 shares of common stock on the same terms as in the Private Placement to its principal shareholder Bear State Financial Holdings, LLC (“Bear State”) and certain of its members (the “Investors”)(including Richard N. Massey, the Company’s Chairman, and Scott T. Ford, a director of the Company). The Investor Warrants were issued on August 13, 2013, have a five year term, and have an exercise price of $7.90 per share, which was the closing stock price for the Company’s common stock on June 28, 2013 and is the price of the Company’s common stock offered in the Private Placement. On August 23, 2013, the Company entered into a subscription agreement with Bear State for the purchase and sale of 2,291,593 shares of common stock. The Company also entered into a registration rights agreement with Bear State, which provided Bear State with customary registration rights with respect to the shares it has agreed to purchase in the Private Placement. The Company intends to utilize the commitments of the Investors to backstop the remaining 240,052 shares to be purchased in the Private Placement. The Company anticipates the closing of the Private Placement will occur immediately prior to the closing of the Merger.

4. INVESTMENT SECURITIES AVAILABLE FOR SALE

Investment securities available for sale consisted of the following as of the dates indicated (in thousands):

	September 30, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

Municipal securities	$	43,616	$	250	$	(398	)	$	43,468
Mortgage-backed securities		29,614		281		(28	)		29,867

Total	$	73,230	$	531	$	(426	)	$	73,335

	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

Municipal securities	$	44,562	$	849	$	(18	)	$	45,393
Corporate debt securities		8,000		--		(68	)		7,932

Total	$	52,562	$	849	$	(86	)	$	53,325

The following tables summarize the gross unrealized losses and fair value of the Bank's investments with unrealized losses that are not deemed to be other-than-temporarily impaired (“OTTI”), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):

	September 30, 2013
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

Municipal securities	$	17,842	$	392	$	259	$	6	$	18,101	$	398
Mortgage-backed securities		2,822		28		--		--		2,822		28

Total	$	20,664	$	420	$	259	$	6	$	20,923	$	426

	December 31, 2012
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

Municipal securities	$	4,033	$	18	$	--	$	--	$	4,033	$	18
Corporate debt securities		3,980		20		3,952		48		7,932		68

Total	$	8,013	$	38	$	3,952	$	48	$	11,965	$	86

On a quarterly basis, management conducts a formal review of securities for the presence of OTTI. Management assesses whether an OTTI is present when the fair value of a security is less than its amortized cost basis at the balance sheet date. For such securities, OTTI is considered to have occurred if the Bank intends to sell the security, if it is more likely than not the Bank will be required to sell the security before recovery of its amortized cost basis or if the present value of expected cash flows is not sufficient to recover the entire amortized cost.

The unrealized losses are primarily a result of increases in market yields since the time of purchase. In general, as market yields rise, the fair value of securities will decrease; as market yields fall, the fair value of securities will increase. Management generally views changes in fair value caused by changes in interest rates as temporary; therefore, these securities have not been classified as other-than-temporarily impaired. Additionally, the unrealized losses are also considered temporary because scheduled coupon payments have been made, it is anticipated that the entire principal balance will be collected as scheduled, and management neither intends to sell the securities nor is it more likely than not that the Bank will be required to sell the securities before the recovery of the remaining amortized cost.

The Bank has pledged investment securities available for sale with carrying values totaling approximately $1.6 million as of September 30, 2013 and December 31, 2012 as collateral for certain deposits in excess of $250,000. In addition, at December 31, 2012 the Bank pledged investment securities available for sale with carrying values totaling approximately $7.9 million, as collateral for the Federal Reserve Bank (“FRB”) primary discount window. There were no FRB borrowings outstanding at December 31, 2012.

The scheduled contractual maturities of debt securities at September 30, 2013 are shown below (in thousands). Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	September 30, 2013
	Amortized Cost		Fair Value		Weighted Average Rate

Within one year	$	1,377	$	1,382		2.79	%
Due from one year to five years		12,667		12,691		2.29	%
Due from five years to ten years		18,399		18,293		2.75	%
Due after ten years		11,173		11,102		3.60	%
		43,616		43,468		2.83	%
Mortgage-backed securities		29,614		29,867		3.05	%
Total	$	73,230	$	73,335		2.92	%

As of September 30, 2013 and December 31, 2012, investments with amortized cost totaling approximately $35.8 million and $36.8 million, respectively, have call options held by the issuer, of which approximately $13.2 million and $9.2 million, respectively, are or were callable within one year.

Sales of investment securities available for sale are summarized as follows (in thousands):

	Nine Months Ended September 30,
	2013			2012

Sales proceeds	$	12,169		$	5,387

Gross realized gains	$	47		$	542
Gross realized losses		(22	)		--
Net gains on sales of investment securities	$	25		$	542

5. LOANS RECEIVABLE

Loans receivable consisted of the following at September 30, 2013 and December 31, 2012 (in thousands):

	September 30, 2013			December 31, 2012
Real estate:
One- to four-family residential	$	134,341		$	157,936
Multifamily residential		25,641			20,790
Nonfarm nonresidential		161,434			138,014
Construction and land development		18,372			14,551
Commercial		17,414			16,083
Consumer		4,827			5,818
Total loans receivable		362,029			353,192
Unearned discounts and net deferred loan costs		(132	)		(188	)
Allowance for loan and lease losses		(13,078	)		(15,676	)

Loans receivable—net	$	348,819		$	337,328

Mortgage loans serviced for others are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of such loans at September 30, 2013 and December 31, 2012 were $12.3 million and $8.7 million, respectively. Servicing loans for others generally consists of collecting payments, maintaining escrow accounts, if applicable, disbursing payments to investors, and foreclosure processing. Servicing income for the three and nine months ended September 30, 2013 and 2012 was not material.

As of September 30, 2013 and December 31, 2012, qualifying loans collateralized by first lien one- to four-family mortgages with balances totaling approximately $53.9 million and $67.3 million, respectively, were held in custody by the Federal Home Loan Bank of Dallas (“FHLB”) and were pledged for outstanding advances or available for future advances.

The FHLB has custody and endorsement of the loans that collateralize the Bank’s outstanding borrowings with the FHLB. Qualifying loans (i) must not be 90 days or more past due; (ii) must not have been in default within the most recent twelve-month period, unless such default has been cured in a manner acceptable to the FHLB; (iii) must relate to real property that is covered by fire and hazard insurance in an amount at least sufficient to discharge the mortgage loan in case of loss and as to which all real estate taxes are current; (iv) must not have been classified as substandard, doubtful, or loss by the Bank or its regulatory authority; and (v) must not secure the indebtedness to any director, officer, employee, attorney, or agent of the Bank or of any FHLB. The FHLB currently allows an aggregate lendable value on the qualifying loans of approximately 90% of the collateral value of loans pledged to the FHLB.

As of September 30, 2013 and December 31, 2012, qualifying loans collateralized by commercial real estate with balances of $8.4 million and $9.4 million, respectively, were pledged at the FRB and available for future borrowings. The Bank uses qualifying commercial real estate loans as collateral for the discount window. No FRB borrowings were outstanding at September 30, 2013 or December 31, 2012.

The following tables present age analyses of loans, including both accruing and nonaccrual loans, as of the dates indicated (in thousands):

September 30, 2013	30-89 Days Past Due		90 Days or More Past Due		Current		Total

One- to four-family residential	$	694	$	2,577	$	131,070	$	134,341
Multifamily residential		--		--		25,641		25,641
Nonfarm nonresidential		257		2,498		158,679		161,434
Construction and land development		300		2,524		15,548		18,372
Commercial		--		22		17,392		17,414
Consumer		18		4		4,805		4,827
Total	$	1,269	$	7,625	$	353,135	$	362,029

December 31, 2012	30-89 Days Past Due		90 Days or More Past Due		Current		Total

One- to four-family residential	$	7,411	$	3,982	$	146,543	$	157,936
Multifamily residential		3,459		--		17,331		20,790
Nonfarm nonresidential		--		4,523		133,491		138,014
Construction and land development		241		3,145		11,165		14,551
Commercial		341		402		15,340		16,083
Consumer		15		25		5,778		5,818
Total	$	11,467	$	12,077	$	329,648	$	353,192

There were no loans over 90 days past due and still accruing at September 30, 2013 or December 31, 2012. Restructured loans totaled $2.4 million and $9.2 million as of September 30, 2013 and December 31, 2012, respectively, with $2.2 million and $3.4 million of such restructured loans on nonaccrual status at September 30, 2013 and December 31, 2012, respectively.

The following table presents age analyses of nonaccrual loans as of the dates indicated (in thousands):

September 30, 2013	30-89 Days Past Due		90 Days or More Past Due		Current		Total

One- to four-family residential	$	339	$	2,577	$	2,244	$	5,160
Multifamily residential		--		--		--		--
Nonfarm nonresidential		257		2,498		1,740		4,495
Construction and land development		299		2,524		555		3,378
Commercial		--		22		4		26
Consumer		--		4		5		9
Total	$	895	$	7,625	$	4,548	$	13,068

December 31, 2012	30-89 Days Past Due		90 Days or More Past Due		Current		Total

One- to four-family residential	$	1,070	$	3,982	$	1,975	$	7,027
Multifamily residential		--		--		--		--
Nonfarm nonresidential		--		4,523		2,713		7,236
Construction and land development		241		3,145		747		4,133
Commercial		--		402		--		402
Consumer		1		25		--		26
Total	$	1,312	$	12,077	$	5,435	$	18,824

The following tables summarize information pertaining to impaired loans as of September 30, 2013 and December 31, 2012 and for the three and nine months ended September 30, 2013 and 2012 (in thousands):

	September 30, 2013						December 31, 2012
	Unpaid Principal Balance		Recorded Investment		Valuation Allowance		Unpaid Principal Balance		Recorded Investment		Valuation Allowance
Impaired loans with avaluation allowance:
One- to four-family residential	$	1,688	$	1,499	$	265	$	1,517	$	1,424	$	275
Multifamily residential		--		--		--		--		--		--
Nonfarm nonresidential		2,998		2,833		1,051		3,718		3,596		779
Construction and land development		2,034		1,679		674		921		737		130
Commercial		1		1		1		380		380		380
Consumer		5		5		5		5		5		1
		6,726		6,017		1,996		6,541		6,142		1,565

Impaired loans without avaluation allowance:
One- to four-family residential		4,607		3,928		--		7,283		6,718		--
Multifamily residential		--		--		--		3,459		3,459		--
Nonfarm nonresidential		1,791		1,662		--		4,992		4,876		--
Construction and land development		2,440		1,699		--		4,377		3,396		--
Commercial		53		25		--		22		22		--
Consumer		7		4		--		29		27		--
		8,898		7,318		--		20,162		18,498		--
Total impaired loans	$	15,624	$	13,335	$	1,996	$	26,703	$	24,640	$	1,565

	Three and Nine Months Ended September 30, 2013
	Average Recorded Investment		Average Recorded Investment		Interest Income Recognized		Interest Income Recognized
Impaired loans with a valuation allowance:	(Three Months)		(Nine Months)		(Three Months)		(Nine Months)
One- to four-family residential	$	2,115	$	2,093	$	2	$	7
Multifamily residential		--		857		--		--
Nonfarm nonresidential		3,045		3,055		--		--
Construction and land development		1,977		1,592		--		--
Commercial		1		96		--		--
Consumer		5		5		--		--
		7,143		7,698		2		7

Impaired loans without a valuation allowance:
One- to four-family residential		3,659		4,693		--		--
Multifamily residential		--		865		--		--
Nonfarm nonresidential		1,382		2,714		--		--
Construction and land development		1,453		2,076		--		--
Commercial		26		24		--		--
Consumer		5		16		--		--
		6,525		10,388		--		--
Total impaired loans	$	13,668	$	18,086	$	2	$	7

Interest based on original terms					$	478	$	703

Interest income recognized on a cashbasis on impaired loans					$	--	$	--

	Three and Nine Months Ended September 30, 2012
	Average Recorded Investment		Average Recorded Investment		InterestIncome Recognized		Interest Income Recognized
Impaired loans with a valuation allowance:	(Three Months)		(Nine Months)		(Three Months)		(Nine Months)
One- to four-family residential	$	1,759	$	2,774	$	--	$	--
Multifamily residential		--		564		--		--
Nonfarm nonresidential		3,117		2,987		--		40
Construction and land development		1,366		1,514		--		9
Commercial		190		95		--		--
Consumer		--		7		--		--
		6,432		7,941		--		49

Impaired loans without a valuation allowance:
One- to four-family residential		7,137		7,900		18		75
Multifamily residential		1,873		3,173		42		49
Nonfarm nonresidential		5,570		6,834		18		102
Construction and land development		5,327		3,784		--		89
Commercial		212		245		--		--
Consumer		58		55		--		1
		20,177		21,991		78		316
Total impaired loans	$	26,609	$	29,932	$	78	$	365

Interest based on original terms					$	405	$	1,212

Interest income recognized on a cash
basis on impaired loans					$	--	$	203

Credit Quality Indicators.As part of its on-going monitoring of the credit quality of the loan portfolio, the Bank assigns loans into risk categories based on the ability of borrowers to service their debt as determined by available and relevant information such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Bank assigns a credit risk rating to certain non-homogeneous loans over $250,000 on at least an annual basis. Homogeneous loans and non-homogeneous loans under $250,000 are generally not risk rated. The Bank uses the following definitions for risk ratings:

Pass (Grades 1 to 5).Loans rated as pass generally meet or exceed normal credit standards and are rated on a scale from 1 to 5, with 1 being the highest quality loan and 5 being a pass/watch loan. Factors influencing the level of pass grade include repayment source and strength, collateral value, borrower cash flows, existence of and strength of guarantors, industry/business sector, financial trends, performance history, etc.

Special Mention (Grade 6).Loans rated as special mention, while still adequately protected by the borrower’s repayment capability, exhibit distinct weakening trends. If left unchecked or uncorrected, these potential weaknesses may result in deteriorated prospects of repayment. These exposures require management’s close attention so as to avoid becoming adversely classified credits.

Substandard (Grade 7).Loansrated as substandard are inadequately protected by the current sound net worth and repayment capacity of the borrower or the collateral pledged, if any. These assets must have a well-defined weakness based on objective evidence and be characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful (Grade 8).Loansrated as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.

Loss (Grade 9).Loansrated as a loss are considered uncollectible and of such little value that continuance as an asset is not warranted. A loss classification does not mean that an asset has no recovery or salvage value, but that it is not practical or desirable to defer writing off all or a portion of the asset, even though partial recovery could occur in the future.

Based on analyses performed at September 30, 2013 and December 31, 2012, the risk categories of loans are as follows:

	September 30, 2013
	Pass		Special Mention		Substandard		Not Rated		Total
One- to four-family residential	$	31,913	$	2,571	$	7,848	$	92,009	$	134,341
Multifamily residential		25,634		--		--		7		25,641
Nonfarm nonresidential		151,123		5,032		4,510		769		161,434
Construction and land development		11,191		386		4,087		2,708		18,372
Commercial		16,907		--		362		145		17,414
Consumer		161		--		14		4,652		4,827
Total	$	236,929	$	7,989	$	16,821	$	100,290	$	362,029

	December 31, 2012
	Pass		Special Mention		Substandard		Not Rated		Total
One- to four-family residential	$	30,216	$	3,698	$	12,993	$	111,029	$	157,936
Multifamily residential		16,695		--		4,078		17		20,790
Nonfarm nonresidential		117,604		7,445		12,045		920		138,014
Construction and land development		5,298		867		4,934		3,452		14,551
Commercial		15,127		340		425		191		16,083
Consumer		159		--		45		5,614		5,818
Total	$	185,099	$	12,350	$	34,520	$	121,223	$	353,192

As of September 30, 2013 and December 31, 2012, the Bank did not have any loans classified as doubtful or loss.

Troubled Debt Restructurings.Troubled debt restructurings (“TDRs”) are loans where the contractual terms have been modified and both of the following conditions exist: (i) the borrower is experiencing financial difficulty and (ii) the restructuring constitutes a concession that the Bank would not otherwise make. The Bank assesses all loan modifications to determine if the modifications constitute a TDR. Restructurings resulting in an insignificant delay in payment are not considered to be TDRs. 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 and 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.

All TDRs are considered impaired loans. 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 following table summarizes TDRs as of September 30, 2013 and December 31, 2012: (dollars in thousands)

September 30, 2013	Number of Accruing TDR Loans		Balance		Number of Nonaccrual TDR Loans		Balance		Total Number of TDR Loans		Total Balance
One- to four-family residential		2	$	267		8	$	671		10	$	938
Multifamily residential		--		--		--		--		--		--
Nonfarm nonresidential		--		--		3		568		3		568
Construction and land development		--		--		5		934		5		934
Consumer		--		--		1		5		1		5

Total		2	$	267		17	$	2,178		19	$	2,445

December 31, 2012	Number of Accruing TDR Loans		Balance		Number of Nonaccrual TDR Loans		Balance		Total Number of TDR Loans		Total Balance
One- to four-family residential		12	$	1,115		9	$	1,461		21	$	2,576
Multifamily residential		1		3,459		--		--		1		3,459
Nonfarm nonresidential		1		1,235		3		606		4		1,841
Construction and land development		--		--		6		1,315		6		1,315
Consumer		3		7		--		--		3		7

Total		17	$	5,816		18	$	3,382		35	$	9,198

The Bank restructured one loan as a TDR during the three months ended September 30, 2013 in the amount of $111,000 and two loans in the nine months ended September 30, 2013 totaling $117,000. For the three and nine months ended September 30, 2012, there was one loan modified as a TDR with a balance after restructure of $172,000.

The Bank had no loans receivable for which a payment default occurred during the three or nine months ended September 30, 2013 or 2012 and that had been modified as a TDR within 12 months or less of the payment default.

6. ALLOWANCES FOR LOAN AND LEASE LOSSES AND REAL ESTATE OWNED LOSSES

The tables below provide a rollforward of the allowance for loan and lease losses (“ALLL”) by portfolio segment for the three and nine months ended September 30, 2013 and 2012 (in thousands):

	Three Months Ended September 30, 2013
	One- to Four Family Residential			Multifamily Residential		Nonfarm Nonresidential			Construction and Land Development		Commercial			Consumer			Total

Balance, beginning of period	$	6,151		$	580	$	4,435		$	1,213	$	662		$	208		$	13,249
Provision charged to expense		(114	)		458		(246	)		112		(113	)		(97	)		--
Losses charged off		(280	)		--		--			--		--			(32	)		(312	)
Recoveries		118			--		--			12		3			8			141
Balance, end of period	$	5,875		$	1,038	$	4,189		$	1,337	$	552		$	87		$	13,078

	Nine Months Ended September 30, 2013
	One- to Four Family Residential			Multifamily Residential			Nonfarm Nonresidential			Construction and Land Development			Commercial			Consumer			Total

Balance, beginning of period	$	5,099		$	1,319		$	6,949		$	1,130		$	956		$	223		$	15,676
Provision charged to expense		1,630			595			(2,251	)		203			(101	)		(76	)		--
Losses charged off		(1,026	)		(876	)		(1,009	)		(115	)		(380	)		(107	)		(3,513	)
Recoveries		172			--			500			119			77			47			915
Balance, end of period	$	5,875		$	1,038		$	4,189		$	1,337		$	552		$	87		$	13,078

	Three Months Ended September 30, 2012
	One- to Four-Family Residential			Multifamily Residential		Nonfarm Nonresidential			Construction and Land Development			Commercial		Consumer			Total

Balance, beginning of period	$	6,633		$	886	$	7,688		$	1,584		$	313	$	160		$	17,264
Provision charged to expense		400			341		(734	)		(294	)		148		139			--
Losses charged off		(347	)		--		(293	)		(269	)		--		(79	)		(988	)
Recoveries		143			--		8			(22	)		8		19			156
Balance, end of period	$	6,829		$	1,227	$	6,669		$	999		$	469	$	239		$	16,432

	Nine Months Ended September 30, 2012
	One- to Four-Family Residential			Multifamily Residential			Nonfarm Nonresidential			Construction and Land Development			Commercial			Consumer			Total

Balance, beginning of period	$	6,999		$	2,654		$	7,316		$	2,651		$	972		$	226		$	20,818
Provision charged to expense		1,014			(447	)		1,856			(2,045	)		(540	)		184			22
Losses charged off		(1,393	)		(997	)		(2,510	)		(327	)		--			(233	)		(5,460	)
Recoveries		209			17			7			720			37			62			1,052
Balance, end of period	$	6,829		$	1,227		$	6,669		$	999		$	469		$	239		$	16,432

The tables below present the allocation of the ALLL and the related loans receivable balances disaggregated on the basis of impairment method by portfolio segment as of September 30, 2013 and December 31, 2012 (in thousands):

	September 30, 2013
	One- to Four-Family Residential		Multifamily Residential		Nonfarm Nonresidential		Construction and Land Development		Commercial		Consumer		Total
ALLL Balances:
Individually evaluated for impairment	$	265	$	--	$	1,051	$	674	$	1	$	5	$	1,996
Collectively evaluated for impairment		5,610		1,038		3,138		663		551		82		11,082
Ending balance	$	5,875	$	1,038	$	4,189	$	1,337	$	552	$	87	$	13,078

Loan balances:
Individually evaluated for impairment	$	5,427	$	--	$	4,495	$	3,378	$	26	$	9	$	13,335
Collectively evaluated for impairment		128,914		25,641		156,939		14,994		17,388		4,818		348,694
Ending balance	$	134,341	$	25,641	$	161,434	$	18,372	$	17,414	$	4,827	$	362,029

	December 31, 2012
	One- to Four-Family Residential		Multifamily Residential		Nonfarm Nonresidential		Construction and Land Development		Commercial		Consumer		Total
ALLL Balances:
Individually evaluated for impairment	$	275	$	--	$	778	$	130	$	380	$	2	$	1,565
Collectively evaluated for impairment		4,824		1,319		6,171		1,000		576		221		14,111
Ending balance	$	5,099	$	1,319	$	6,949	$	1,130	$	956	$	223	$	15,676

Loan balances:
Individually evaluated for impairment	$	8,142	$	3,459	$	8,472	$	4,133	$	402	$	32	$	24,640
Collectively evaluated for impairment		149,794		17,331		129,542		10,418		15,681		5,786		328,552
Ending balance	$	157,936	$	20,790	$	138,014	$	14,551	$	16,083	$	5,818	$	353,192

A summary of the activity in the allowance for losses on real estate owned is as follows for the three and nine months ended September 30, 2013 and 2012 (in thousands):

	Three Months Ended						Nine Months Ended
	September 30, 2013			September 30, 2012			September 30, 2013			September 30, 2012

Balance—beginning of period	$	9,406		$	19,649		$	14,877		$	20,934

Provisions for estimated losses		358			277			577			585
Recoveries		--			--			--			--
Losses charged off		(111	)		(2,045	)		(5,801	)		(3,638	)

Balance—end of period	$	9,653		$	17,881		$	9,653		$	17,881

7. STOCK BASED COMPENSATION

2011 Omnibus Incentive Plan—The 2011 Omnibus Incentive Plan (the “2011 Plan”), became effective May 3, 2011, after approval by the Company’s stockholders on April 29, 2011. The objectives of the 2011 Plan are to optimize the profitability and growth of the Company through incentives that are consistent with the Company’s goals and that link the personal interests of participants to those of the Company’s stockholders. The 2011 Plan provides for a committee of the Company’s Board of Directors to award nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, and other awards representing up to 1,930,269 shares of Company stock. Awards may be granted under the 2011 Plan up to ten years following the effective date of the plan. Each award under the 2011 Plan is governed by the terms of the individual award agreement, which shall specify pricing, term, vesting, and other pertinent provisions.

Stock Options. Option awards are generally granted with an exercise price equal to the fair market value of the Company’s stock at the date of grant, generally vest based on five years of continuous service and have seven year contractual terms. The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model. Expected volatilities are based on implied volatilities from historical volatility of the Company’s stock and other factors. The Company uses historical data to estimate option exercise, employee termination, and expected term of the options within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

A summary of the stock option activity in the Company’s 2011 Plan for the nine months ended September 30, 2013, is presented below:

	Shares Underlying Awards			Weighted Average Exercise Price

Outstanding—January 1, 2013		223,500		$	6.65
Granted		--		$	--
Forfeited		(6,000	)	$	6.57

Outstanding—September 30, 2013		217,500		$	6.66

The weighted average remaining contractual life of the outstanding options was 5.2 years and the aggregate intrinsic value of the options was approximately $586,000 at September 30, 2013. None of the outstanding options are vested.

As ofSeptember 30, 2013, there was $492,000 of total unrecognized compensation costs related to nonvested stock options under the 2011 Plan. The cost is expected to be recognized over a weighted-average period of 3.3 years. Compensation expense attributable to option awards totaled approximately $37,000 and $110,000 for the three and nine months ended September 30, 2013, respectively and $32,000 and $111,000 for the three and nine months ended September 30, 2012, respectively.

Restricted Stock Units. The fair value of each restricted stock unit (“RSU”) award is determined based on the closing market price of the Company’s stock on the grant date and amortized to compensation expense on a straight-line basis over the vesting period. The vesting periods range from three to seven years.

	Restricted Stock Units		Weighted Average Grant Date Fair Value

Outstanding—January 1, 2013		--	$	--
Granted		65,500	$	8.97
Forfeited		--	$	--

Outstanding—September 30, 2013		65,500	$	8.97

As ofSeptember 30, 2013, there was $528,000 of total unrecognized compensation costs related to nonvested RSUs under the 2011 Plan. The cost is expected to be recognized over a weighted-average period of 4.4 years. None of the RSUs are vested. Compensation expense attributable to awards of RSUs totaled approximately $36,000 and $58,000 for the three and nine months ended September 30, 2013. There were no RSU awards outstanding in 2012, therefore there was no compensation expense recorded during 2012.

8. EARNINGS PER SHARE

Basic earnings per share is computed by dividing reported earnings available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing reported earnings available to common stockholders by the weighted average number of common shares outstanding after consideration of the dilutive effect, if any, of the Company’s outstanding common stock options and warrants using the treasury stock method.

	Three MonthsEnded September 30,				Nine MonthsEnded September 30,
	2013		2012		2013		2012
Basic weighted average shares outstanding		20,013,343		19,302,603		19,779,684		19,302,603
Effect of dilutive securities		897,619		1,375,467		1,065,424		1,233,575
Diluted weighted average shares outstanding		20,910,962		20,678,070		20,845,108		20,536,178

The calculation of diluted earnings per share for the three and nine months ended September 30, 2013 and 2012 excluded antidilutive stock options totaling approximately 7,000 and 8,000 shares, respectively.

9. FAIR VALUE MEASUREMENTS

ASC 820,Fair Value Measurement, provides a framework for measuring fair value and 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. ASC 820 also 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. ASC 820 describes three levels of inputs that may be used to measure fair value:

Level 1	Unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2	Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data at the measurement date for substantially the full term of the assets or liabilities.

Level 3	Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

Financial instruments are broken down by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that, due to an event or circumstance, were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.

The following is a description of inputs and valuation methodologies used for assets recorded at fair value on a recurring basis and recognized in the accompanying statements of financial condition at September 30, 2013 and December 31, 2012, as well as the general classification of such assets pursuant to the valuation hierarchy.

Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. The fair values used by the Company are obtained from an independent pricing service, which represent either quoted market prices for the identical asset or fair values determined by pricing models, or other model-based valuation techniques, that consider observable market data, such as interest rate volatilities, London Interbank Offered Rate (“LIBOR”) yield curve, credit spreads and prices from market makers and live trading systems. Recurring Level 2 securities include mortgage-backed securities, corporate debt securities and municipal bonds. Inputs used for valuing Level 2 securities include observable data that may include dealer quotes, benchmark yields, market spreads, live trading levels and market consensus prepayment speeds, among other things. Additional inputs include indicative values derived from the independent pricing service’s proprietary computerized models. No securities were included in the Recurring Level 3 category at or for the periods ended September 30, 2013 or December 31, 2012.

The following table presents major categories of assets measured at fair value on a recurring basis as of September 30, 2013 and December 31, 2012 (in thousands):

	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2013
Available for sale investment securities:
Municipal securities	$	43,468	$	--	$	43,468	$	--
Mortgage-backed securities		29,867		--		29,867		--
Total	$	73,335	$	--	$	73,335	$	--

December 31, 2012
Available for sale investment securities:
Municipal securities	$	45,393	$	--	$	45,393	$	--
Corporate debt securities		7,932		--		7,932		--
Total	$	53,325	$	--	$	53,325	$	--

The following is a description of valuation methodologies used for significant assets measured at fair value on a nonrecurring basis.

Impaired Loans Receivable

Loans which meet certain criteria are evaluated individually for impairment. A loan is considered impaired when, based upon current information and events, it is probable the Bank will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan agreement. Substantially all of the Bank’s impaired loans at September 30, 2013 and December 31, 2012 are secured by real estate. These impaired loans are individually measured for impairment by comparing the carrying value of the loan to the discounted cash flows or the fair value of the collateral, less estimated selling costs, as appropriate. Fair value is estimated primarily through appraisals, internal valuations, real estate brokers’ opinions or listing prices. Fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3. Fair value adjustments are made by specific allocations to the ALLL or charge-offs to the ALLL.

Real Estate Owned, net

Real estate owned (“REO”) represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is carried at the lower of cost or fair value less estimated selling costs. Fair value is estimated through current appraisals, internal valuations, real estate brokers’ opinions or listing prices. As these properties are actively marketed, estimated fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3. Fair value adjustments are recorded in earnings during the period such adjustments are made. REO loss provisions recorded during the nine months ended September 30, 2013 and 2012 were $577,000 and $585,000, respectively.

The following table presents major categories of assets measured at fair value on a nonrecurring basis for the nine months ended September 30, 2013 and 2012 (in thousands). The assets disclosed in the following table represent REO properties or impaired loans that were remeasured at fair value during the period with a resulting valuation adjustment or fair value write-down.

	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2013
Impaired loans	$	16,043	$	--	$	--	$	16,043
REO, net		5,249		--		--		5,249

September 30, 2012
Impaired loans	$	18,244	$	--	$	--	$	18,244
REO, net		7,989		--		--		7,989

10. FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The estimated fair values of financial instruments that are reported at amortized cost in the Company’s statement of financial condition, segregated by the level of valuation inputs within the fair value hierarchy used to measure fair value, are as follows (in thousands):

	September 30, 2013				December 31, 2012
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
FINANCIAL ASSETS:
Level 1 inputs:
Cash and cash equivalents	$	23,435	$	23,435	$	42,607	$	42,607
Level 2 inputs:
Interest-bearing time deposits in banks		25,111		25,653		29,592		30,413
Federal Home Loan Bank stock		259		259		375		375
Loans held for sale		3,963		3,963		4,435		4,435
Cash surrender value of life insurance		23,606		23,606		23,003		23,003
Accrued interest receivable		1,505		1,505		1,501		1,501
Level 3 inputs:
Loans receivable—net		348,819		358,292		337,328		351,642

FINANCIAL LIABILITIES:
Level 2 inputs:
Checking, money market and savings accounts		197,288		197,288		203,308		203,308
Other borrowings		968		1,046		3,109		3,239
Accrued interest payable		31		31		23		23
Advance payments by borrowers for taxes and insurance		501		501		676		676
Level 3 inputs:
Certificates of deposit		258,168		259,472		251,743		255,573

For cash and cash equivalents, the carrying amount approximates fair value (level 1). For Federal Home Loan Bank stock, loans held for sale, cash surrender value of life insurance and accrued interest receivable, the carrying value is a reasonable estimate of fair value, primarily because of the short-term nature of the instruments or, as to Federal Home Loan Bank stock, the ability to sell the stock back to the Federal Home Loan Bank at cost (level 2). Interest-bearing time deposits in banks were valued using discounted cash flows based on current rates for similar types of deposits (level 2). Fair values of impaired loans are estimated as described in Note 8. Non-impaired loans were valued using discounted cash flows. The discount rates used to determine the present value of these loans were based on interest rates currently being charged by the Bank on comparable loans (level 3).

The fair value of checking accounts, savings accounts and money market deposits is the amount payable on demand at the reporting date (level 2). The fair value for certificates of deposit with stated maturities was calculated by discounting contractual cash flows using current market rates for instruments with similar maturities (Level 3). The fair value of Federal Home Loan Bank advances is estimated using the rates for advances of similar remaining maturities at the reporting date (level 2). For advance payments by borrowers for taxes and insurance and for accrued interest payable the carrying value is a reasonable estimate of fair value, primarily because of the short-term nature of the instruments (level 2).

The fair value estimates presented herein are based on pertinent information available to management as of September 30, 2013 and December 31, 2012. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since the reporting date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

11. REGULATORY MATTERS

The Bank is subject to various regulatory capital requirements administered by the Office of the Comptroller of the Currency (“OCC”), as successor to the Office of Thrift Supervision (“OTS”). Failure to meet minimum capital requirements can result in certain mandatory and possible discretionary actions by regulators that, if undertaken, could have a direct and material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of tangible capital (as defined) to tangible assets (as defined) and core capital (as defined) to adjusted tangible assets (as defined), and of total risk-based capital (as defined) to risk-weighted assets (as defined). Tier 1 (core) capital includes common stockholders’ equity less certain other deductions. Total capital includes Tier 1 capital plus the ALLL, subject to limitations.

As of the most recent notification from regulatory authorities, the Bank was categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, tier 1 risk-based, and tier 1 (core) ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category.

On January 15, 2013, the OCC issued an order terminating, effective immediately, the Cease and Desist Order issued by the OTS on April 12, 2010 (the "Bank Order"). The action also terminates the related Stipulation and Consent to Issuance of Order to Cease and Desist between the Bank and the OTS. On June 21, 2013, the Federal Reserve Bank (the “FRB”), which, as successor to the OTS, is the primary federal regulator of the Company, issued a letter terminating the Cease and Desist Order issued by the OTS on April 12, 2010 (the “Company Order”), effective immediately. The action also terminates the related Stipulation and Consent to Issuance of Order to Cease and Desist between the Company and the OTS.

The Bank’s actual and required capital amounts (in thousands) and ratios are presented in the following table:

	Actual					For Capital Adequacy Purposes					To be Categorized as Well Capitalized Under Prompt Corrective Action Provisions (1)					Other Requirements (2)
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio

As of September 30, 2013:

Tangible Capital to Tangible Assets	$	70,417		13.29	%	$	7,948		1.50	%	N/A		N/A			N/A		N/A

Core Capital to Adjusted Tangible Assets		70,417		13.29	%		21,194		4.00	%	$	21,194		4.00	%	$	42,389		8.00	%

Total Capital to Risk-Weighted Assets		75,197		20.10	%		29,929		8.00	%		29,929		8.00	%		44,893		12.00	%

Tier I Capital to Risk-Weighted Assets		70,417		18.82	%	N/A		N/A				14,964		4.00	%	N/A		N/A

As of December31, 2012:

Tangible Capital to Tangible Assets	$	67,434	12.73	%	$	7,944		1.50	%	N/A		N/A			N/A		N/A

Core Capital to Adjusted Tangible Assets		67,434	12.73	%		21,185		4.00	%	$	21,185		4.00	%		42,371		8.00	%

Total Capital to Risk-Weighted Assets		72,131	19.77	%		29,182		8.00	%		29,182		8.00	%		43,773		12.00	%

Tier I Capital to Risk-Weighted Assets		67,434	18.49	%	N/A		N/A				14,591		4.00	%	N/A		N/A

(1)

Effective with the termination of the Bank Order effective January 15, 2013, the Bank can be categorized as well-capitalized by achieving the required ratios.

(2)

The Bank Order, effective through January 15, 2013, required the Bank to maintain a Tier 1 (core) capital ratio of at least 8% and a total risk-based capital ratio of at least 12%. After such date, the Bank agreed with the OCC to maintain a minimum Tier 1 (core) capital ratio of at least 8% of adjusted total assets and a total risk-based capital ratio of at least 12% of risk-weighted assets. The required amounts presented reflect these ratios.

Dividend Restrictions. The Company may not declare or pay cash dividends on its shares of common stock if the effect thereof would cause the Bank’s stockholders’ equity to be reduced below applicable regulatory capital maintenance requirements for insured institutions or below the special liquidation account established by the Bank in connection with the consummation of the conversion from the mutual holding company structure on May 3, 1996. In addition, federal regulations, as currently applied to the Bank, impose limitations upon payment of capital distributions to the Company.

The principal source of the Company’s revenue is dividends from the Bank. The Company’s ability to pay dividends to stockholders depends to a large extent upon the dividends received from the Bank.

12. BRANCH SALES

On June 21, 2013, the Bank sold all deposits and selected assets associated with its branch office located in Berryville, Arkansas. The transaction was consummated pursuant to a definitive purchase and assumption agreement with The First National Bank in Green Forest (“FNBGF”), of Green Forest, Arkansas, which was entered into on April 1, 2013 and approved by the OCC on May 28, 2013. FNBGF assumed $17.8 million in deposits plus accrued interest of $20,000 from the Bank and took assignment of all real property and equipment associated with the branch, which totaled $216,000 as of the closing date. In addition, as part of the agreement, FNBGF also purchased certain loans not associated with the Berryville branch with a carrying value of approximately $3.3 million. The Bank retained all loans associated with the branch except for approximately $6,000 in loans associated with overdrawn deposit accounts. The net settlement under the terms of the agreement resulted in a total payment of $14.2 million to FNBGF by the Bank. There was no material gain or loss on the transaction.

On September 27, 2013, the Bank sold certain deposits and assets associated with the Bank’s branch office located in Farmington, Arkansas. The transaction was consummated pursuant to a definitive purchase and assumption agreement with First Security Bank (“FSB”) of Searcy, Arkansas, which was entered into on June 24, 2013 and approved by the OCC on August 28, 2013. FSB assumed $3.9 million in deposits and took assignment of all real property and equipment associated with the branch, which totaled $1.5 million as of the closing date. The net settlement under the terms of the agreement resulted in a total payment of $2.2 million to FSB by the Bank. The transaction resulted in a gain of approximately $77,000.

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

Management's discussion and analysis of financial condition and results of operations (“MD&A”) is intended to assist a reader in understanding the consolidated financial condition and results of operations of the Company for the periods presented. The information contained in this section should be read in conjunction with the Condensed Consolidated Financial Statements and the accompanying Notes to the Condensed Consolidated Financial Statements and the other sections contained herein. References to the Company and the Bank throughout MD&A are made using the first person notations of “we”, “us” or “our”.

The Bank is a federally chartered stock savings and loan association that was formed in 1934. As of September 30, 2013, the Bank conducted business from its home office, one limited service office, ten full service branch offices located in a five county area in Arkansas (comprised of Benton and Washington counties in Northwest Arkansas; Boone, Marion and Baxter counties in North-central Arkansas) and a loan production office located in Little Rock, Arkansas. Approval was granted on September 18, 2013 for a branch office in Little Rock, Arkansas, which opened on October 15, 2013. The Company also has executive offices in Little Rock, Arkansas. The Bank sold its Berryville, Arkansas branch in June 2013, closed its Rogers Elm Street branch in August 2013, and sold its Farmington, Arkansas branch in September 2013. The branch sales and closure are part of the Bank’s overall strategy to improve operational efficiency and to support its expansion into other areas of the state.

The Bank is a community-oriented financial institution offering a wide range of retail and commercial deposit accounts, including noninterest-bearing and interest-bearing checking, savings and money market accounts, certificates of deposit, and individual retirement accounts. Loan products offered by the Bank include residential real estate, consumer, construction, lines of credit, commercial real estate and commercial business loans. Other financial services include automated teller machines; 24-hour telephone banking; online banking, including account access, e-statements, and bill payment; mobile banking, including remote deposit capture and funds transfer; Bounce Protection^TM overdraft service; debit cards; and safe deposit boxes.

OVERVIEW

The Company’s net income was $143,000 and $530,000 for the three and nine months ended September 30, 2013, respectively, compared to net income of $353,000 and $1.3 million for the same periods in 2012, respectively. The primary reasons for the decrease in net income during each comparative period were decreases in yields earned on loans receivable and decreases in deposit fee income. The decrease in net income for the nine months ended September 30, 2013 was also impacted by a decrease in gains on sales of investment securities, which was partially offset by decreases in operating expenses.

The Bank continued to reduce its level of nonperforming assets during the first nine months of 2013. Total nonperforming assets at September 30, 2013, including nonaccrual loans and real estate owned, totaled $22.9 million, or 4.32% of total assets, a reduction of $12.6 million compared to December 31, 2012, and a reduction of $17.1 million compared to September 30, 2012. The Bank also reduced its level of classified loans to $16.8 million at September 30, 2013 compared to $34.5 million at December 31, 2012 and $36.2 million at September 30, 2012.

While the Bank is continuing its focus on reducing nonperforming assets, it is equally focused on improving its operational performance through improving its net interest margin, increasing noninterest income, and controlling noninterest expense.

Pending Transaction

The Company also entered into a registration rights agreement with Bear State, which provided Bear State with customary registration rights with respect to the shares it has agreed to purchase in the Private Placement. The Company intends to utilize the commitments of the Investors to backstop the remaining 240,052 shares to be purchased in the Private Placement. The Company anticipates the closing of the Private Placement will occur immediately prior to the closing of the Merger.

As of June 30, 2013, FNSC conducted banking business from 32 locations across Garland, Howard, Scott, Saline, Pulaski, Montgomery, Polk, Pike, Sevier, Little River, Miller, Craighead and Mississippi counties in Arkansas and McCurtain County in Oklahoma, and had total assets of $936.5 million. Based on pro forma combined financial statements as of June 30, 2013, the combined company would have had approximately $1.4 billion in total assets and approximately $1.2 billion in deposits if the transaction had closed as of that date.

CRITICAL ACCOUNTING POLICIES

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, the following estimates, due to the judgments, estimates and assumptions inherent in those policies, are critical to preparation of our financial statements:

●

Determination of our allowance for loan and lease losses (“ALLL”)

●

Valuation of real estate owned

●

Valuation of investment securities

●

Valuation of our deferred tax assets

These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the Condensed Consolidated Financial Statements included herein. We believe that the judgments, estimates and assumptions used in the preparation of our condensed consolidated financial statements are appropriate given the factual circumstances at the time. However, given the sensitivity of our condensed consolidated financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition.

In estimating the amount of credit losses inherent in the loan portfolio, various judgments and assumptions are made. For example, when assessing the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. In the event the economy were to sustain a prolonged downturn, the loss factors applied to the portfolios may need to be revised, which may significantly impact the measurement of the allowance for loan and lease losses. For impaired loans that are collateral dependent and for real estate owned, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold.

The Company has classified all of its investment securities as available for sale. Accordingly, its investment securities are stated at estimated fair value in the consolidated financial statements with unrealized gains and losses, net of related income taxes, reported as a separate component of stockholders’ equity with any related changes included in accumulated other comprehensive income (loss). The Company utilizes independent third parties as its principal sources for determining fair value of its investment securities that are measured on a recurring basis. For investment securities traded in an active market, the fair values are based on quoted market prices if available. If quoted market prices are notavailable, fair values are based on market prices for comparable securities, broker quotes or comprehensive interest rate tables, pricing matrices or a combination thereof. For investment securities traded in a market that is not active, fair value is determined using unobservable inputs. The fair values of the Company’s investment securities traded in both active and inactive markets can be volatile and may be influenced by a number of factors including market interest rates, prepayment speeds, discount rates, credit quality of the issuer, general market conditions including market liquidity conditions and other factors. Factors and conditions are constantly changing and fair values could be subject to material variations that may significantly impact the Company’s financial condition, results of operations and liquidity.

The Company recognizes deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The Company evaluates its deferred tax assets for recoverability using a consistent approach that considers the relative impact of negative and positive evidence, including our historical profitability and projections of future taxable income. The Company is required to establish a valuation allowance for deferred tax assets if it is determined, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, the Company estimates future taxable income based on management-approved business plans and ongoing tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between projected operating performance, our actual results and other factors.

RESULTS OF OPERATIONS

Three and Nine Months Ended September 30, 2013 Compared to Three and Nine Months Ended September 30, 2012

Net Interest Income. The Company's results of operations depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Net interest income for the third quarter of 2013 was $3.8 million, which was unchanged from the same period in 2012. Net interest income for the nine months ended September 30, 2013 was $11.1 million compared to $11.6 million for the same period in 2012. Factors impacting interest income and interest expense for the comparison periods are discussed below.

Interest Income. Interest income for the third quarter of 2013 was $4.6 million compared to $4.8 million for the same period in 2012. Interest income for the nine months ended September 30, 2013 was $13.6 million compared to $15.0 million for the same period in 2012. The decrease in interest income for the three and nine months ended September 30, 2013 compared to comparable periods in 2012 was primarily related to a decrease in yields earned on loans receivable. The decrease in yields earned on loans receivable is primarily due to origination during the period of high quality loans with average market rates lower than the weighted average rate of the Bank’s portfolio in the same period last year.

Interest Expense. Interest expense for the third quarter of 2013 was $825,000 compared to $1.1 million for the same period in 2012. Interest expense for the nine months ended September 30, 2013 was $2.5 million compared to $3.4 million for the same period in 2012. The decrease in interest expense for the three and nine months ended September 30, 2013 compared to comparable periods in 2012 was primarily due to a decrease in the average rates paid on deposit accounts and, to a lesser degree, decreases in the average balances of deposits and borrowings. The decrease in the average rates paid on deposit accounts reflects decreases in market interest rates and Bank management’s pricing of its deposits at such levels to maintain deposit balances commensurate with its overall balance sheet management and liquidity position.

Rate/Volume Analysis.The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided regarding changes attributable to (i) changes in volume (changes in average volume multiplied by prior rate); (ii) changes in rate (change in rate multiplied by prior average volume); (iii) changes in rate-volume (changes in rate multiplied by the change in average volume); and (iv) the net change.

	Three Months Ended September 30,
	2013 vs. 2012
	Increase (Decrease) Due to
	Volume			Rate			Rate/ Volume			Total Increase (Decrease)
	(In Thousands)
Interest income:
Loans receivable	$	1		$	(286	)	$	--		$	(285	)
Investment securities		33			15			1			49
Other interest-earning assets		(41	)		24			(8	)		(25	)
Total interest-earning assets		(7	)		(247	)		(7	)		(261	)

Interest expense:
Deposits		(51	)		(190	)		9			(232	)
Other borrowings		(17	)		19			(14	)		(12	)
Total interest-bearing liabilities		(68	)		(171	)		(5	)		(244	)
Net change in net interest income	$	61		$	(76	)	$	(2	)	$	(17	)

	Nine Months Ended September 30,
	2013 vs. 2012
	Increase (Decrease) Due to
	Volume			Rate			Rate/ Volume			Total Increase (Decrease)
	(In Thousands)
Interest income:
Loans receivable	$	(11	)	$	(1,287	)	$	1		$	(1,297	)
Investment securities		(85	)		--			--			(85	)
Other interest-earning assets		(72	)		53			(9	)		(28	)
Total interest-earning assets		(168	)		(1,234	)		(8	)		(1,410	)

Interest expense:
Deposits		(169	)		(755	)		38			(886	)
Other borrowings		(50	)		2			(1	)		(49	)
Total interest-bearing liabilities		(219	)		(753	)		37			(935	)
Net change in net interest income	$	51		$	(481	)	$	(45	)	$	(475	)

Average Balance Sheets.The following table sets forth certain information relating to the Company's average balance sheets and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing interest income or interest expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are based on daily balances during the periods. Interest rate spread represents the difference between the weighted average yield on average interest earning assets and the weighted average cost of average interest bearing liabilities. Net interest margin represents net interest income as a percentage of average interest earning assets.

	Three Months Ended September 30,
	2013							2012
	Average Balance		Interest		Average Yield/ Cost			Average Balance		Interest		Average Yield/ Cost
	(Dollars in Thousands)
Interest-earning assets:
Loans receivable(1)	$	359,071	$	4,033		4.46	%	$	358,990	$	4,318		4.79	%
Investment securities(2)		61,880		436		2.80			56,992		387		2.70
Other interest-earning assets		52,580		110		0.83			75,859		135		0.71
Total interest-earning assets		473,531		4,579		3.84			491,841		4,840		3.92
Noninterest-earning assets		50,232							58,243
Total assets	$	523,763						$	550,084
Interest-bearing liabilities:
Deposits	$	449,692		814		0.72		$	472,661		1,046		0.88
Other borrowings		978		11		4.29			3,933		23		2.35
Total interest-bearing liabilities		450,670		825		0.73			476,594		1,069		0.89
Noninterest-bearing liabilities		2,122							3,515
Total liabilities		452,792							480,109
Stockholders' equity		70,971							69,975
Total liabilities andstockholders' equity	$	523,763						$	550,084

Net interest income			$	3,754						$	3,771
Net earning assets	$	22,861						$	15,247
Interest rate spread						3.11	%						3.02	%
Net interest margin						3.15	%						3.04	%
Ratio of interest-earning assets to Interest-bearing liabilities						105.07	%						103.20	%

(1) Includes nonaccrual loans.

(2) Includes FHLB of Dallas stock.

	Nine Months Ended September 30,
	2013								2012
	Average Balance		Interest			Average Yield/ Cost			Average Balance		Interest		Average Yield/ Cost
	(Dollars in Thousands)
Interest-earning assets:
Loans receivable(1)	$	355,757	$	12,084			4.54	%	$	356,057	$	13,381		5.02	%
Investment securities(2)		54,873		1,152			2.81			58,918		1,237		2.80
Other interest-earning assets		70,690		381	��		0.72			85,726		409		0.64
Total interest-earning assets		481,320		13,617			3.78			500,701		15,027		4.01
Noninterest-earning assets		51,393								59,689
Total assets	$	532,713							$	560,390
Interest-bearing liabilities:
Deposits	$	457,072		2,477			0.73		$	481,345		3,363		0.93
Other borrowings		2,296		37			2.12			5,576		86		2.06
Total interest-bearing liabilities		459,368		2,514			0.73			486,921		3,449		0.95
Noninterest-bearing liabilities		2,351								3,823
Total liabilities		461,719								490,744
Stockholders' equity		70,994								69,646
Total liabilities andstockholders' equity	$	532,713							$	560,390
	��
Net interest income			$	11,103							$	11,578

Net earning assets	$	21,952							$	13,780
Interest rate spread							3.05	%						3.06	%
Net interest margin							3.08	%						3.08	%
Ratio of interest-earning assets toInterest-bearing liabilities							104.78	%						102.83	%

(1) Includes nonaccrual loans.

(2) Includes FHLB of Dallas stock.

Provision for Loan Losses.The provision for loan losses represents the amount that is added to the allowance for loan and lease losses (“ALLL”) for the purpose of maintaining the ALLL at a level considered adequate by the Bank to cover probable credit losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio that have been incurred as of the balance sheet date. The adequacy of the ALLL is evaluated quarterly by management of the Bank based on the Bank’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and other qualitative factors.

Management determined that no provision for loan losses was required for the three or nine months ended September 30, 2013, primarily due to decreases in nonperforming and classified loans and continued improvement in the Bank’s loan portfolio and ALLL coverage of nonaccrual loans. The ALLL as a percentage of loans receivable was 3.6% at September 30, 2013, compared to 4.4% at December 31, 2012. The ALLL as a percentage of nonaccrual loans was 100.1% at September 30, 2013, compared to 83.3% at December 31, 2012. The ALLL as a percentage of classified loans was 77.8% at September 30, 2013, compared to 45.4% at December 31, 2012. See “Allowance for Loan and Lease Losses” in the “Asset Quality” section.

Noninterest Income.Noninterest income is generated primarily through deposit account fee income, profit on sale of loans and investment securities, and earnings on life insurance policies. Total noninterest income of $1.4 million for the third quarter of 2013 was unchanged compared to the third quarter of 2012. Total noninterest income of $4.0 million for the nine months ended September 30, 2013 decreased from $5.1 million for the same period in 2012. The decrease in the nine month comparison period was primarily due to a decrease in gains on sales of investment securities and a decrease in deposit fee income, primarily due to a decrease in insufficient funds fee revenue.

Noninterest Expense.Noninterest expense consists primarily of employee compensation and benefits, office occupancy expense, data processing expense, real estate owned expense, and other operating expense. Total noninterest expense increased $152,000 or 3.1% during the third quarter of 2013 compared to the third quarter of 2012. Total noninterest expense decreased $868,000 or 5.6% during the nine months ended September 30, 2013 compared to the same period in 2012. The variances in certain noninterest expense items are further explained in the following paragraphs, with the aggregate expense decrease for the nine month comparison period being primarily related to the decrease in nonperforming assets and improvements in the Bank’s operational efficiency and overall staffing levels. The increase in noninterest expense for the three month comparison period was primarily due to an increase in salaries and employee benefits and other noninterest expenses partially offset by a decrease in FDIC insurance expense.

Salaries and Employee Benefits. Salaries and employee benefits increased $203,000 for the three months ended September 30, 2013 compared to the same period in 2012 and increased $100,000 for the nine months ended September 30, 2013 compared to the same period in 2012. The increase in the three month comparison period was primarily due to an increase in incentive and stock compensation expense. The increase in the nine month comparison period was also due to an increase in incentive and stock compensation expense, partially offset by a decrease in expenses related to the Bank’s employee benefit plans.

Real estate owned, net.The changes in the composition of this line item are presented below (in thousands):

	Three Months Ended September 30,									Nine Months Ended September 30,
	2013			2012				Change		2013			2012				Change
Loss provisions	$	358		$	277		$	81		$	533		$	585		$	(52	)
Net gain on sales		(316	)		(344	)		28			(690	)		(1,135	)		445
Rental income		(22	)		(16	)		(6	)		(85	)		(425	)		340
Taxes and insurance		53			104			(51	)		146			399			(253	)
Other		60			97			(37	)		178			402			(224	)
Total	$	133		$	118		$	15		$	82		$	(174	)	$	256

The decreases in gains on sales of REO and rental income for the nine month comparison period are due to decreases in the REO balances. Real estate owned expenses such as taxes, insurance and maintenance as well as rental income are expected to continue to decline as the size of the REO portfolio continues to decline. Future levels of loss provisions and net gains or losses on sales of real estate owned will depend on market conditions.

FDIC Insurance Premium. The Bank’s FDIC insurance premium decreased $147,000 for the three months ended September 30, 2013 compared to the same period in 2012 and decreased $395,000 for the nine months ended September 30, 2013 compared to the same period in 2012 due to decreases in the assessment rate and the assessment base. The base is defined as average consolidated total assets for the assessment period less average tangible equity capital with potential adjustments for unsecured debt, brokered deposits and depository institution debts. The assessment rate declined due to improvements in the Bank’s performance and financial condition.

Data Processing.The decrease in data processing expense of $550,000 for the nine months ended September 30, 2013 compared to the same respective period in 2012 was primarily related to one-time costs incurred in 2012 associated with the Bank’s conversion of its operational software during the second quarter of 2012.

Professional Fees.Professional fees decreased $50,000 or 32% for the quarter ended September 30, 2013 compared to the same period in 2012 and decreased $230,000 or 31% for the nine months ended September 30, 2013 compared to the same periods in 2012, primarily due to a decrease in audit fees and a decrease in loan-related legal fees.

Other Noninterest Expense.Other noninterest expense increased $207,000 or 53% for the quarter ended September 30, 2013 compared to the same period in 2012 and increased $202,000 or 15% for the nine months ended September 30, 2013 compared to the same periods in 2012, primarily due to consulting and third party management fees and expenses incurred in connection with the pending merger with FNSC.

Income Taxes.The Company had no taxable income for the three or nine months ended September 30, 2013 or 2012 and recorded a valuation allowance for the full amount of its net deferred tax asset as of September 30, 2013 and December 31, 2012, respectively. The income tax expense of $11,000 recorded for the three and nine months ended September 30, 2013 represents the Company’s alternative minimum tax payment resulting from the amendment of the Company’s 2010 federal income tax return.

LENDING ACTIVITIES

Loans Receivable.Changes in loan composition between September 30, 2013 and December 31, 2012, are presented in the following table (dollars in thousands).

	September 30, 2013			December 31, 2012			Increase (Decrease)			% Change
One- to four-family residential	$	134,341		$	157,936		$	(23,595	)		(14.9	)%
Multifamily residential		25,641			20,790			4,851			23.3
Nonfarm nonresidential		161,434			138,014			23,420			17.0
Construction and land development		18,372			14,551			3,821			26.3
Total real estate loans		339,788			331,291			8,497			2.6

Commercial		17,414			16,083			1,331			8.3

Consumer		4,827			5,818			(991	)		(17.0	)

Total loans receivable		362,029			353,192			8,837			2.5
Unearned discounts and net deferredloan costs		(132	)		(188	)		56			(29.8	)
Allowance for loan and lease losses		(13,078	)		(15,676	)		2,598			(16.6	)

Loans receivable, net	$	348,819		$	337,328		$	11,491			3.4	%

Total loans receivable increased $8.8 million to $362.0 million at September 30, 2013, compared to $353.2 million at December 31, 2012. The increase in loans was due to loan originations partially offset by repayments and the sale of $14.7 million of classified loans in the second quarter of 2013.

ASSET QUALITY

Nonperforming Assets.The following table sets forth the amounts and categories of the Bank's nonperforming assets at the dates indicated (dollars in thousands).

	September 30, 2013					December 31, 2012
	Net⁽²⁾		% Total Assets			Net⁽²⁾		% Total Assets			Increase (Decrease)
Nonaccrual Loans:
One- to four-family residential	$	5,160		0.97	%	$	7,027		1.32	%	$	(1,867	)
Multifamily residential		--		--			--		--			--
Nonfarm nonresidential		4,495		0.85	%		7,236		1.37	%		(2,741	)
Construction and land development		3,378		0.64	%		4,133		0.77	%		(755	)
Commercial		26		0.01	%		402		0.08	%		(376	)
Consumer		9		--			26		0.01	%		(17	)

Total nonaccrual loans		13,068		2.47	%		18,824		3.55	%		(5,756	)

Accruing loans 90 days or more past due		--		--			--		--			--

Real estate owned		9,835		1.85	%		16,658		3.14	%		(6,823	)

Total nonperforming assets		22,903		4.32	%		35,482		6.69	%		(12,579	)
Performing restructured loans		267		0.05	%		5,816		1.10	%		(5,549	)

Total nonperforming assets and performing restructured loans (1)	$	23,170		4.37	%	$	41,298		7.79	%	$	(18,128	)

(1)

The table does not include substandard loans which were judged not to be impaired totaling $3.5 million and $12.1 million at September 30, 2013 and December 31, 2012, respectively.

(2)

Loan balances are presented net of undisbursed loan funds, partial charge-offs and interest payments recorded as reductions in principal balances for financial reporting purposes.

Nonaccrual Loans.The composition of nonaccrual loans by status was as follows as of the dates indicated (dollars in thousands):

	September 30, 2013					December 31, 2012					Increase (Decrease)
	Balance		Percentage of Total			Balance		Percentage of Total			Balance			Percentage of Total

Bankruptcy or foreclosure	$	1,845		14.1	%	$	2,347		12.5	%	$	(502	)		1.6	%
Over 90 days past due		6,089		46.6			9,913		52.7			(3,824	)		(6.1	)
30-89 days past due		705		5.4			1,311		7.0			(606	)		(1.6	)
Not past due		4,429		33.9			5,253		27.8			(824	)		6.1
	$	13,068		100.0	%	$	18,824		100.0	%	$	(5,756	)		--

The following table presents nonaccrual loan activity for the nine months ended September 30, 2013 and 2012 (in thousands):

	Nine Months Ended September 30, 2013			Nine Months Ended September 30, 2012

Balance of nonaccrual loans—beginning of period	$	18,824		$	33,954
Loans added to nonaccrual status		2,942			10,425
Net cash payments		(4,476	)		(9,560	)
Loans returned to accrual status		(537	)		(5,075	)
Charge-offs to the ALLL		(1,668	)		(3,785	)
Transfers to REO		(2,017	)		(6,444	)

Balance of nonaccrual loans—end of period	$	13,068		$	19,515

Real Estate Owned. Changes in the composition of real estate owned between December 31, 2012 and September 30, 2013 are presented in the following table (dollars in thousands).

	December 31, 2012		Additions		Fair Value Adjustments			Net Sales Proceeds⁽¹⁾			Net Gain (Loss)		September 30, 2013
One- to four-family residential	$	2,586	$	1,475	$	(146	)	$	(2,335	)	$	66	$	1,646
Land		6,583		108		(315	)		(1,915	)		313		4,774
Nonfarm nonresidential		7,489		300		(116	)		(4,569	)		311		3,415
Total	$	16,658	$	1,883	$	(577	)	$	(8,819	)	$	690	$	9,835

(1)Net sales proceeds include $815,000 of loans made by the Bank to finance certain sales of real estate owned.

Classified Assets.Federal regulations require that each insured savings association risk rate its assets on a regular basis. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that some loss will be sustained if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is generally considered uncollectible and of such little value that continuance as an asset is not warranted. As of September 30, 2013 and December 31, 2012, the Bank did not have any assets classified as doubtful or loss. The table below summarizes the Bank’s classified assets as of the dates indicated (dollars in thousands):

	September 30, 2013			December 31, 2012			September 30, 2012
Nonaccrual loans	$	13,068		$	18,824		$	19,515
Accruing classified loans		3,753			15,696			16,688
Classified loans		16,821			34,520			36,203
Real estate owned		9,835			16,658			20,535

Total classified assets	$	26,656		$	51,178		$	56,738

Texas Ratio (1)		27.4	%		42.7	%		47.6	%

Classified Assets Ratio (2)		31.9	%		61.6	%		67.4	%

(1)

Defined as the ratio of nonaccrual loans and real estate owned to Tier 1 capital plus the allowance for loan and lease losses.

(2)

Defined as the ratio of total classified assets to Tier 1 capital plus the allowance for loan and lease losses.

Classified loans decreased $17.7 million from December 31, 2012 to September 30, 2013, primarily due to the sale of $14.7 million of classified loans during the second quarter of 2013.

Allowance for Loan and Lease Losses.The Bank maintains an allowance for loan and lease losses for known and inherent losses in the loan portfolio based on ongoing quarterly assessments of the loan portfolio. The estimated appropriate level of the ALLL is maintained through a provision for loan losses charged to earnings. Charge-offs are recorded against the ALLL when management believes the estimated loss has been confirmed. Subsequent recoveries, if any, are credited to the ALLL.

The ALLL consists of general and allocated (also referred to as specific) loan loss components. For loans that are determined to be impaired that are troubled debt restructurings (“TDRs”) and impaired loans where the relationship totals $250,000 or more, a specific loan loss allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than its carrying value. The general loan loss allowance covers loans that are not impaired and impaired relationships under $250,000 and is based on historical loss experience adjusted for qualitative factors.

The ALLL represents management’s estimate of incurred credit losses inherent in the Bank’s loan portfolio as of the balance sheet date. The estimation of the ALLL is based on a variety of factors, including past loan loss experience, the current credit profile of the Bank’s borrowers, adverse situations that have occurred that may affect the borrowers’ ability to repay, the estimated value of underlying collateral, general economic conditions, and other qualitative factors. Losses are recognized when available information indicates that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or conditions change.

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 note. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. 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. Classified loans where the borrower’s total loan relationship exceeds $250,000 are evaluated quarterly for impairment on a loan-by-loan basis. Nonaccrual loans and TDRs are considered to be impaired loans. TDRs are restructurings in which the Bank, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that the Bank would not otherwise consider. Impairment is measured quarterly on a loan-by-loan basis for all TDRs and impaired loans where the aggregate relationship balance exceeds $250,000 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 under this threshold are aggregated and included in loan pools with their ALLL calculated as described in the following paragraph.

Groups of smaller balance homogeneous loans are collectively evaluated for impairment. Homogeneous loans are those that are considered to have common characteristics that provide for evaluation on an aggregate or pool basis. The Bank considers the characteristics of (1) one- to four-family residential mortgage loans; (2) unsecured consumer loans; and (3) collateralized consumer loans to permit consideration of the appropriateness of the ALLL of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of the ALLL includes segregating impaired loans from the pools of loans, valuing these loans, and then applying a loss factor to the remaining pool balance based on several factors including past loss experience, inherent risks, and economic conditions in the primary market areas.

In estimating the amount of credit losses inherent in the loan portfolio, various judgments and assumptions are made. For example, when assessing the condition of the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. For impaired loans that are collateral dependent, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold in the event that the Bank has to foreclose or repossess the collateral.

The Company considers its ALLL of approximately $13.1 million to be adequate to cover losses inherent in its loan portfolio as of September 30, 2013. Actual losses may substantially differ from currently estimated losses. Adequacy of the ALLL is periodically evaluated, and the allowance could be significantly decreased or increased, which could materially affect the Company’s financial condition and results of operations.

The following table summarizes changes in the ALLL and other selected statistics for the periods indicated.

	Nine Months Ended September 30,
	2013			2012
	(Dollars in Thousands)

Total loans outstanding at end of period	$	362,029		$	356,616
Average loans outstanding	$	355,757		$	356,057
Allowance at beginning of period	$	15,676		$	20,818
Charge-offs:
One- to four-family residential		(1,026	)		(1,393	)
Multifamily residential		(876	)		(997	)
Nonfarm nonresidential		(1,009	)		(2,510	)
Construction and land development		(115	)		(327	)
Commercial		(380	)		--
Consumer (1)		(107	)		(233	)
Total charge-offs		(3,513	)		(5,460	)
Recoveries:
One- to four-family residential		172			209
Multifamily residential		--			17
Nonfarm nonresidential		500			7
Construction and land development		119			720
Commercial		77			37
Consumer (1)		47			62
Total recoveries		915			1,052
Net charge-offs		(2,598	)		(4,408	)
Total provisions for losses		--			22
Allowance at end of period	$	13,078		$	16,432

ALLL as a percentage of total loans outstanding at end of period		3.6	%		4.6	%

Net loans charged-off as a percentage of average loans outstanding		0.98	%		1.66	%

ALLL as a percentage of nonaccrual loans		100.1	%		84.2	%

(1) Consumer loan charge-offs include overdraft charge-offs of $90,000 and $144,000 for the nine months ended September 30, 2013 and 2012, respectively. Consumer loan recoveries include recoveries of overdraft charge-offs of $41,000 and $56,000 for the nine months ended September 30, 2013 and 2012, respectively.

The following table presents the allocation of the Bank's ALLL by the type of loan at each of the dates indicated as well as the percentage of loans in each category to total loans receivable. These allowance amounts have been computed using the Bank’s internal model. The amounts shown are not necessarily indicative of the actual future losses that may occur within a particular category.

	September 30,
	2013					2012
	Amount		Percentage of Loans			Amount		Percentage of Loans
	(Dollars in Thousands)

One-to-four family residential	$	5,875		37.11	%	$	6,829		45.07	%
Multifamily residential		1,038		7.08			1,227		6.43
Nonfarm nonresidential		4,189		44.59			6,669		36.74
Construction and land development		1,337		5.08			999		4.36
Commercial		552		4.81			469		5.66
Consumer		87		1.33			239		1.74
Total	$	13,078		100.00	%	$	16,432		100.00	%

The decrease in the ALLL from $16.4 million as of September 30, 2012 to $13.1 million as of September 30, 2013 was primarily related to a decrease in general allowances primarily due to an improvement in the credit quality of the loan portfolio as well as a decrease in the overall historical net charge-off rate. The ALLL remains at an elevated level due to the level of nonperforming loans and estimated inherent losses remaining in the portfolio as the Bank continues its efforts to reduce nonperforming assets.

INVESTMENT SECURITIES

The following table sets forth the carrying values of the Company's investment securities available for sale (in thousands).

	September 30, 2013		December 31, 2012		Increase (Decrease)

Municipal securities	$	43,468	$	45,393	$	(1,925	)
Mortgage-backed securities		29,867		--		29,867
Corporate debt securities		--		7,932		(7,932	)
Total	$	73,335	$	53,325	$	20,010

Municipal securities decreased due to calls and maturities in excess of purchases. Mortgage-backed securities increased due to purchases in the third quarter of 2013. The corporate debt securities were sold in the third quarter of 2013 at a net gain of $1,000. The overall yield of the investment portfolio was 2.92% as of September 30, 2013 compared to 2.85% at December 31, 2012.

DEPOSITS

Changes in the composition of deposits between September 30, 2013 and December 31, 2012, are presented in the following table (dollars in thousands).

	September 30, 2013		December 31, 2012		Increase (Decrease)			% Change

Checking accounts	$	128,491	$	131,826	$	(3,335	)		(2.5	)%
Money market accounts		38,298		40,818		(2,520	)		(6.2	)
Savings accounts		30,499		30,664		(165	)		(0.5	)
Certificates of deposit		258,168		251,743		6,425			2.6

Total deposits	$	455,456	$	455,051	$	405			0.1	%

Deposits increased slightly in the comparison period primarily due to an increase of $36.1 million in brokered certificates of deposit (“CDs”) and non-brokered CDs obtained through a listing service, offset by the sale of $21.7 million of deposits in connection with the branch sales, including $8.9 million of checking accounts, $1.4 million of savings accounts, and $11.4 million of certificates of deposit. The Bank reduced the cost of its certificate of deposit accounts with the weighted average cost of funds decreasing from 1.32% at December 31, 2012 to 1.16% at September 30, 2013. The Bank manages the pricing of its deposits to maintain deposit balances commensurate with its overall balance sheet management and liquidity position. The overall cost of deposit funds decreased from 0.83% at December 31, 2012 to 0.75% at September 30, 2013.

OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS

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

The Bank does not use financial instruments with off-balance sheet risk as part of its asset/liability management program or for trading purposes. The Bank’s exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations for off-balance sheet arrangements as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

In the normal course of business, the Company makes commitments to buy or sell assets or to incur or fund liabilities. Commitments include, but are not limited to:

■	the origination, purchase or sale of loans; and

■	the fulfillment of commitments under letters of credit, extensions of credit on home equity lines of credit, construction loans, and under predetermined overdraft protection limits.

The funding period for construction loans is generally six to eighteen months and commitments to originate mortgage loans are generally outstanding for 60 days or less.

At September 30, 2013, the Bank’s off-balance sheet arrangements principally included lending commitments, which are described below. At September 30, 2013, the Company had no interests in non-consolidated special purpose entities.

At September 30, 2013, commitments included:

■	total approved loan origination commitments outstanding amounting to $15.9 million, including approximately $1.0 million of loans committed to sell;

■	rate lock agreements with customers of $7.7 million, all of which have been locked with an investor;

■	funded mortgage loans committed to sell of $4.0 million;

■	unadvanced portion of construction loans of $13.7 million;

■	unused lines of credit of $6.8 million;

■	outstanding standby letters of credit of $696,000; and

■	total predetermined overdraft protection limits of $8.2 million.

Total unfunded commitments to originate loans for sale and the related commitments to sell of $7.7 million meet the definition of a derivative financial instrument. The related asset and liability are considered immaterial at September 30, 2013.

Historically, a small percentage of predetermined overdraft limits have been used. At September 30, 2013, overdrafts of accounts with Bounce Protection™ represented usage of 2.3% of the limit.

Liquidity and Capital Resources

Liquidity management is both a daily and long-term function. The Bank's liquidity, represented by cash and cash equivalents and eligible investment securities, is a product of its operating, investing and financing activities. The Bank's primary sources of funds are deposits; borrowings; payments on outstanding loans; maturities, sales and calls of investment securities and other short-term investments; and funds provided from operations. While scheduled loan amortization and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Calls of investment securities are determined by the issuer and are generally influenced by the level of market interest rates at the bond’s call date compared to the coupon rate of the bond. The Bank manages the pricing of its deposits to maintain deposit balances at levels commensurate with the operating, investing and financing activities of the Bank. In addition, the Bank invests excess funds in overnight deposits and other short-term interest-earning assets that provide liquidity to meet lending requirements and pay deposit withdrawals.When funds from the retail deposit market are inadequate for the liquidity needs of the Bank or the pricing of retail deposits are not as favorable as other sources, the Bank has borrowed from the FHLB of Dallas and has utilized the services of bulletin board deposit listing services and brokered deposits to acquire funds.

The Bank uses qualifying loans as collateral for FHLB advances. The FHLB retains custody and endorsement of the loans that collateralize the Bank’s outstanding borrowings with the FHLB. The FHLB currently allows an aggregate lendable value on qualifying loans (as defined) of approximately 90% of the outstanding balance of the loans pledged to the FHLB. During the nine months ended September 30, 2013, FHLB borrowings decreased by $2.1 million, or 69%, from FHLB borrowings at December 31, 2012. At September 30, 2013, the Bank’s additional borrowing capacity with FHLB was $46.8 million, comprised of qualifying loans collateralized by first-lien one- to four-family mortgages with a lendable value of $47.8 million less outstanding advances at September 30, 2013 of $1.0 million. Outstanding borrowings with the FHLB are reported as “Other Borrowings” in the Company’s Condensed Consolidated Statements of Financial Condition.

The Bank uses qualifying commercial real estate loans as collateral for the discount window. The FRB will permit only certain commercial real estate loans to be pledged as collateral for the discount window. At September 30, 2013, the Bank pledged qualifying commercial real estate loans with a collateral value of approximately $7.4 million, or 87% of the fair market value of the loans as determined by the FRB taking into consideration the rate and duration of the loans pledged. No FRB borrowings were outstanding at September 30, 2013.

At September 30, 2013, the Bank’s liquidity ratio was 25% which represents liquid assets as a percentage of deposits and borrowings. As of the same date, the Bank’s adjusted liquidity ratio was 39%, which includes liquid assets plus borrowing capacity at the FHLB and FRB as a percentage of deposits and borrowings. The Bank anticipates that it will continue to rely primarily on deposits, calls and maturities of investment securities, loan repayments, and funds provided from operations to provide liquidity. As necessary, the sources of borrowed funds described above will be used to augment the Bank’s funding sources. The Bank uses its sources of funds primarily to meet its ongoing commitments, to pay maturing savings certificates and savings withdrawals, to repay maturing borrowings, to fund loan commitments, and to purchase investment securities.

The Bank’s liquidity risk management program assesses our current and projected funding needs to ensure that sufficient funds or access to funds exist to meet those needs. The program also includes effective methods to achieve and maintain sufficient liquidity and to measure and monitor liquidity risk, including the preparation and submission of liquidity reports on a regular basis to the Board of Directors. The program also contains a Contingency Funding Plan that forecasts funding needs and sources under different stress scenarios. The Contingency Funding Plan approved by the Board of Directors is designed to respond to an overall decline in the economic environment, the banking industry or a problem specific to the Bank. A number of different contingency funding conditions may arise which may result in strains or expectation of strains in the Bank’s normal funding activities including customer reaction to negative news of the banking industry, in general, or the Bank, specifically. As a result of negative news, some depositors may reduce the amount of deposits held at the Bank if concerns persist, which could affect the level and composition of the Bank’s deposit portfolio and thereby directly impact the Bank’s liquidity, funding costs and net interest margin. The Bank’s funding costs may also be adversely affected in the event that activities of the FRB and the United States Department of the Treasury to provide liquidity for the banking system and improvement in capital markets are curtailed or are unsuccessful. Such events could reduce liquidity in the markets, thereby increasing funding costs to the Bank or reducing the availability of funds to the Bank to finance its existing operations and thereby adversely affect the Company’s results of operations, financial condition, future prospects, and stock price.

Since the Company is a holding company and does not conduct independent operations, its primary source of liquidity is dividends from the Bank. The Company has no borrowings from outside sources. The Company funds its expenses from cash deposits maintained in the Bank, which amounted to $0.8 million at September 30, 2013.

At September 30, 2013, the Bank's core and risk-based capital ratios amounted to 13.29% and 20.10%, respectively, compared to regulatory capital adequacy standards of 4% and 8%. However, the Bank has agreed with the OCC to maintain a Tier 1 (core) capital ratio of 8% and a total risk-based capital ratio of 12%.

CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS

This Form 10-Q contains certain forward-looking statements and information relating to the Company that are based on the beliefs of management as well as assumptions made by and information currently available to management. As used in this document, the words "anticipate," "believe," "estimate," "expect," "intend," "should" and similar expressions, or the negative thereof, as they relate to the Company or the Company's management, are intended to identify forward-looking statements.

The statements presented herein with respect to, among other things, the Company’s plans, objectives, expectations and intentions, including our pending merger with FNSC and the anticipated timing of and impact on the Company of such acquisition, anticipated changes in non-interest expenses in future periods (including changes as a result of the pending merger with FNSC), changes in earnings, continued increases in net interest income, hiring and acquisition possibilities, our belief that we have identified any problem assets and that our borrowers will continue to remain current on their loans, being well positioned to capitalize on potential opportunities in a healthy economy, impact of outstanding off-balance sheet commitments, sources of liquidity and that we have sufficient liquidity, the sufficiency of the allowance for loan losses, expected loan, asset, balance sheet and earnings growth, growth in new and existing customer relationships, potential increases in certain components of non-interest income, sale of existing other real estate owned and anticipated gains from such sales, expected losses on and our intentions with respect to our investment securities, the amount of potential problem loans, and financial and other goals and plans are forward looking.

Such statements reflect the current views of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions, including those risk factors described in Part I, Item 1A. of the Company’s Annual Report on Form 10-K filed with the SEC on March 8, 2013 and in Part II, Item 1A. hereof. Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. The Company cautions readers not to place undue reliance on any forward-looking statements. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause actual results for the remainder of fiscal 2013 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us and could negatively affect the Company’s operating and stock performance.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

For a discussion of the Company’s asset and liability management position as well as the potential impact of interest rate changes upon the market value of the Bank’s net portfolio value of equity, see “Item 7A. Quantitative and Qualitative Disclosures about Market Risk” in the Company’s Annual Report on Form 10-K filed with the SEC on March 8, 2013. There has been no material change in the Company’s asset and liability position or the Bank’s net portfolio value of equity since December 31, 2012.

Item 4. Controls and Procedures

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are operating effectively.

No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2013 that has materially affected, or is 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 a party to or involved in any pending legal proceedings other than non-material legal proceedings occurring in the ordinary course of business.

Item 1A. Risk Factors

Our operations involve various risks that could have adverse consequences, including those described below and in Part I, Item 1A. of the Company’s Annual Report on Form 10-K filed with the SEC on March 8, 2013.

The management of the Company may be required to dedicate significant time and effort to the merger with FNSC and the integration of FNSC into the Company, all of which may divert their attention from other business concerns of and their responsibility to the Company.

The Merger will cause the management of the Company to focus a portion of its time and energies on matters related to the Merger that otherwise would be directed to the business and operations of the Company. Any significant diversion of management’s attention could affect the Company’s ability to service existing business and develop new business and adversely affect the earnings of the Company.

If the Merger is not completed, the Company’s business may be adversely affected.

The Merger Agreement may be terminated prior to the closing, before or after approval by FNSC and/or Company shareholders, for various reasons, which could have negative consequences for the Company. For example, the Company’s business may have been impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the Merger, without realizing any of the anticipated benefits of completing the Merger. Additionally, if the Merger Agreement is terminated, the market price of the Company’s common stock could decline to the extent that the current market prices reflect an assumption that the Merger will be completed. If the Merger Agreement is terminated under certain circumstances involving consummation of a competing transaction, the Company may be required to pay FNSC a termination fee of $3,000,000.

Combining the Company and FNSC may be more difficult, costly or time-consuming than expected, and failure to do so quickly and efficiently could reduce the Company’s profitability, affect its stock price and either delay or prevent realization of many of the potential benefits of the Merger.

The success of the Company following the Merger may depend in large part on the ability to integrate the two businesses, and cultures. If the Company and FNSC are not able to integrate their operations efficiently and timely, the expected benefits of the Merger may not be realized. It is possible that the integration process following completion of the Merger could result in the loss of key employees, disruption of each company’s ongoing business or inconsistencies in standards, controls, procedures and policies, any of which could adversely affect the combined company’s ability to maintain relationships with the Company’s or FNSC’s existing customers and employees or to achieve the anticipated benefits of the Merger. As with any merger of banking institutions, there also may be business disruptions that cause the Company and FNSC to lose customers. Following the Merger, the Company may be required to spend additional time and money on operating compatibility, which could otherwise be spent on developing the Company’s business. If the Company and FNSC do not integrate operations effectively or efficiently, it could harm the Company’s business, financial condition and results of operations.

Concentrations of loans may increase risk.

The Company’s success depends primarily on the general economic conditions in its primary market areas – Northwest and North central Arkansas. As of September 30, 2013, approximately 61% of the Bank’s total loans receivable consisted of loans collateralized by real estate located in a six county region in northern Arkansas. Accordingly, the local economic conditions in Northwest and North central Arkansas have a significant impact on the ability of borrowers to repay loans as well as the Bank’s ability to originate new loans. As such, a decline in real estate valuations in this market could lower the value of the collateral securing those loans.

Changes in interest rates could have a material adverse effect on the Bank’s profitability and asset values.

The operations of financial institutions such as the Bank are dependent to a large extent on net interest income, which is the difference between the interest income earned on interest earning assets such as loans and investment securities and the interest expense paid on interest bearing liabilities such as deposits and borrowings. Changes in the general level of interest rates can affect net interest income by affecting the difference between the weighted average yield earned on interest earning assets and the weighted average rate paid on interest bearing liabilities, or interest rate spread, and the average life of interest earning assets and interest bearing liabilities. Changes in interest rates also can affect our ability to originate loans; the value of our interest earning assets; our ability to obtain and retain deposits in competition with other available investment alternatives; and the ability of borrowers to repay adjustable or variable rate loans. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control.

As of September 30, 2013, the Bank estimates that its one-year cumulative repricing gap position was a positive 2% of total assets and the one-year ratio of interest earning assets to interest bearing liabilities was 105% with both measures including assumptions for loan prepayments. Based on these measures, the Bank estimates a limited impact on earnings for various interest rate change scenarios. Floating or adjustable rate loans made up approximately 38% of the $362.0 million of total loans receivable. Fixed rate loans of approximately 62% of total loans receivable had a weighted average remaining contractual term of approximately 5.5 years. Significant composition changes in our rate sensitive assets or liabilities could result in a more unbalanced position and then interest rate changes could have a material impact on our earnings. In addition, earnings may be adversely affected during any period of changes in interest rates due to a number of factors including among other items, call features and interest rate caps and floors on various assets and liabilities, prepayments, the current interest rates on assets and liabilities to be repriced in each period, and the relative changes in interest rates on different types of assets and liabilities.

In addition a significant and prolonged increase in interest rates could have a material adverse effect on the fair value of the investment securities portfolio classified as available for sale and, accordingly, shareholders’ equity. At September 30, 2013 the Bank had $73.3 million of investment securities, all of which were classified as available for sale which resulted in recording a net unrealized gain of $105,000. Based on market rates at September 30, 2013 it was estimated that a 200 basis point increase in rates would have resulted in an approximate 7.7% decrease in the fair value of the securities.

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

On July 1, 2013, the Company entered into Commitment Letters with five members of Bear State (the “Investors”), which Investors include Richard N. Massey, the Company’s Chairman, and Scott T. Ford, a director of the Company, whereby each Investor agreed to “backstop” a portion of the Private Placement (described in Part I, Item 2. above) and agreed to purchase up to 506,329 shares of Company common stock in the event the Company was unable to cause the Private Placement to be fully subscribed or was otherwise unable to raise sufficient funds from other sources. In exchange for providing a Commitment Letter, each of the Investors was issued warrants to purchase 35,443 shares of Company common stock on the same terms as in the Private Placement.

The Investor warrants were issued on August 13, 2013, have a five year term, and have an exercise price of $7.90 per share, which was the closing stock price for the Company’s common stock on June 28, 2013 and is the price of the Company’s common stock offered in the Private Placement. The Investors are entitled to customary registration rights for the shares of common stock underlying the warrants.

In connection with the Private Placement, on August 23, 2013, the Company entered into a subscription agreement with Bear State for the purchase and sale of 2,291,593 shares of common stock. The Company intends to utilize the commitments of the Investors to backstop the remaining 240,052 shares to be purchased in the Private Placement. Bear State and the Investors will be entitled to customary registration rights with respect to the shares of common stock to be issued to them in the Private Placement.

The closing of the Private Placement is conditioned upon (i) the approval of the Private Placement by the shareholders of the Company, (ii) the consummation of the previously-announced merger of FNSC with and into the Company, and (iii) the fairness opinion issued by Southard Financial, LLC with regard to the Private Placement shall not have been withdrawn or modified.

The Company anticipates the closing of the Private Placement will occur concurrent with or immediately prior to the closing of the merger of FNSC with and into the Company. Upon the closing of the Private Placement, the Company anticipates it will receive aggregate proceeds of approximately $20 million, consisting of approximately $18.1 million in proceeds from the sale of common stock to Bear State and approximately $1.9 million in proceeds from the sale of common stock to the Investors.

Both the Investor warrants and the shares of common stock to be sold in the Private Placement were offered and sold or will be sold pursuant to the exemption from registration provided in Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”). The Company complied with the exemption requirements of Section 4(a)(2) of the Securities Act based on the following: (1) the offering of the securities involved isolated private transactions by the Company which did not involve a public offering; (2) the offerees had access to the kind of information which registration would disclose, and (3) the offerees are financially sophisticated.

Item 6. Exhibits

The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Exhibit Index attached hereto and are incorporated herein by reference.

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.

FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.

Date:	October 31, 2013	By:	/s/ Christopher M. Wewers
			Christopher M. Wewers
			Chief Executive Officer

Date:	October 31, 2013	By:	/s/ Sherri R. Billings
			Sherri R. Billings
			Chief Financial Officer

First Federal Bancshares of Arkansas, Inc.

Exhibit Index

Exhibit No.	Description

2.1	Agreement and Plan of Merger by and between First Federal Bancshares of Arkansas, Inc. and First National Security Company, dated July 1, 2013 (incorporated herein by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on July 3, 2013).(1)
2.2	List of Schedules to the Agreement and Plan of Merger (incorporated herein by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K filed with the SEC on July 3, 2013).
3.1	Articles of Incorporation of First Federal Bancshares of Arkansas, Inc. (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed with the SEC on July 21, 2011).
3.2	Bylaws of First Federal Bancshares of Arkansas, Inc. (incorporated herein by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K filed with the SEC on July 21, 2011).
10.1	Form of Commitment Letter (incorporated herein by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on July 3, 2013).
10.2	Subscription Agreement by and between First Federal Bancshares of Arkansas, Inc. and Bear State Financial Holdings, LLC dated August 23, 2013 (incorporated herein by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on August 28, 2013).
10.3	Form of Registration Rights Agreement (incorporated herein by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on August 28, 2013).
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Section 906 Certification of the CEO
32.2	Section 906 Certification of the CFO

101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema
101.CAL	XBRL Taxonomy Extension Calculation Linkbase
101.LAB	XBRL Taxonomy Extension Label Linkbase
101.PRE	XBRL Taxonomy Extension Presentation Linkbase
101.DEF	XBRL Taxonomy Extension Definition Linkbase

(1) Pursuant to Item 601(b)(2) of Regulation S-K, certain schedules to this Agreement have not been filed with this exhibit. The schedules contain various items relating to the business of and the representations and warranties made by the Company and FNSC. The Registrant agrees to furnish supplementally any omitted schedule to the SEC upon request.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. junior Bad

Bear State Financial Inactive 10-Q2013 Q3 Quarterly report

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