Service Bancorp (SERC) 10-Q 2009 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2009

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

For the transition period from            to            

Commission File Number 0-24935

SERVICE BANCORP, INC.

(Exact name of registrant as specified in its charter)

Massachusetts	04-3430806
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

81 Main Street,

Medway, Massachusetts 02053

(Address and zip code of principal executive offices)

(888) 578-7282

(Registrant’s telephone number, including area code)

Not Applicable

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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 definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

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

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practical date: At May 12, 2009, there were 1,677,004 shares of common stock outstanding, par value $0.01 per share.

SERVICE BANCORP, INC. AND SUBSIDIARY

FORM 10-Q

Index

		Page
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of March 31, 2009 and June 30, 2008	1
	Consolidated Statements of Operations for the three and nine months ended March 31, 2009 and 2008	2
	Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended March 31, 2009 and 2008	3
	Consolidated Statements of Cash Flows for the nine months ended March 31, 2009 and 2008	4
	Notes to Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	19
Item 4.	Controls and Procedures	19
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	20
Item 1A.	Risk Factors	20
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21
Item 3.	Defaults upon Senior Securities	21
Item 4.	Submission of Matters to a Vote of Security Holders	21
Item 5.	Other Information	21
Item 6.	Exhibits	22
	Signatures	23

PART I—FINANCIAL INFORMATION

ITEM 1. Financial Statements

SERVICE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS (unaudited)

(Dollars in thousands, except share amounts)

	March 31, 2009			June 30, 2008
ASSETS
Cash and due from banks	$	7,896		$	6,767
Short-term investments		13			1,991
Total cash and cash equivalents		7,909			8,758
Securities available for sale, at fair value		25,561			50,301
Securities held to maturity, at amortized cost		975			1,176
Federal Home Loan Bank stock, at cost		6,530			6,530
Loans		310,908			330,780
Less allowance for loan losses		(3,634	)		(3,307	)
Loans, net		307,274			327,473
Banking premises and equipment, net		4,676			4,962
Accrued interest receivable		1,417			1,590
Net deferred tax asset		6,171			2,370
Bank-owned life insurance		5,372			5,223
Other real estate owned		4,544			3,684
Other assets		3,089			3,009
Total assets	$	373,518		$	415,076
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits	$	245,158		$	260,768
Borrowings		104,686			122,121
Subordinated debentures		3,093			3,093
Other liabilities		1,600			3,285
Total liabilities		354,537			389,267
Commitments and contingencies (Note 4)
Stockholders’ equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued		—			—
Common stock, $.01 par value, 12,000,000 shares authorized, 1,712,630 shares issued		17			17
Additional paid-in capital		8,142			8,351
Retained earnings		13,558			19,949
Accumulated other comprehensive loss		(1,877	)		(1,367	)
Treasury stock, at cost (33,816 and 53,037 shares, respectively)		(687	)		(1,025	)
Unearned restricted shares (17,837 and 6,927 shares, respectively)		(172	)		(116	)
Total stockholders’ equity		18,981			25,809
Total liabilities and stockholders’ equity	$	373,518		$	415,076

See accompanying notes to consolidated financial statements.

-1-

SERVICE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

(Dollars in thousands, except share amounts)

	Three Months Ended March 31,						Nine Months Ended March 31,
	2009			2008			2009			2008
Interest and dividend income:
Interest and fees on loans	$	4,500		$	5,094		$	14,250		$	15,484
Interest and dividends on securities and Federal Home Loan Bank stock		393			839			1,656			2,380
Interest on short-term investments		4			32			22			60
Total interest and dividend income		4,897			5,965			15,928			17,924
Interest expense:
Interest on deposits		1,260			1,789			4,068			5,555
Interest on borrowings		1,151			1,391			3,726			4,298
Interest on subordinated debentures		33			56			140			184
Total interest expense		2,444			3,236			7,934			10,037
Net interest income		2,453			2,729			7,994			7,887
Provision for loan losses		135			265			655			1,125
Net interest income, after provision for loan losses		2,318			2,464			7,339			6,762
Non-interest income:
Customer service fees		313			290			954			931
Mortgage banking gains, net		25			20			46			31
Securities sales gains (losses), net		4			152			(168	)		352
Loss on write-down of investments to fair value		—			—			(8,712	)		—
Other income		118			114			311			394
Total non-interest income (loss)		460			576			(7,569	)		1,708
Non-interest expense:
Salaries and employee benefits		1,509			1,494			4,490			4,403
Occupancy		406			390			1,181			1,144
Data processing		309			307			903			935
Equipment		100			116			311			349
Professional fees		208			155			792			514
Advertising		30			81			74			239
Foreclosed real estate		45			11			257			103
Other general and administrative		525			448			1,834			1,201
Total non-interest expense		3,132			3,002			9,842			8,888
(Loss) income before income taxes		(354	)		38			(10,072	)		(418	)
Income tax benefit		(16	)		(65	)		(3,681	)		(277	)
Net (loss) income	$	(338	)	$	103		$	(6,391	)	$	(141	)
Weighted average shares outstanding – basic		1,656,499			1,646,367			1,654,461			1,645,111
Weighted average shares outstanding – diluted		1,656,499			1,652,592			1,654,461			1,645,111
(Loss) earnings per share – basic	$	(0.20	)	$	0.06		$	(3.86	)	$	(0.09	)
(Loss) earnings per share – diluted	$	(0.20	)	$	0.06		$	(3.86	)	$	(0.09	)

See accompanying notes to consolidated financial statements.

-2-

SERVICE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited)

NINE MONTHS ENDED MARCH 31, 2009 AND 2008

(Dollars in thousands, except share amounts)

	Common Stock		Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Treasury Stock			Unearned Restricted Shares			Total
Balance at June 30, 2007	$	17	$	8,475		$	22,598		$	(427	)	$	(1,203	)	$	(152	)	$	29,308
Comprehensive loss:
Net loss		—		—			(141	)		—			—			—			(141	)
Net unrealized loss on securities available for sale, net of taxes and reclassification adjustment		—		—			—			(198	)		—			—			(198	)
Total comprehensive loss																			(339	)
Purchase of treasury stock (3,600 shares)		—		—			—			—			(87	)		—			(87	)
Forfeiture of restricted stock (3,000 shares)		—		—			—			—			(81	)		61			(20	)
Stock option exercises (9,500 shares)		—		(57	)		—			—			181			—			124
Income tax benefit on options exercised		—		2			—			—			—			—			2
Amortization of restricted stock (1,284 shares)		—		3			—			—			—			32			35
Balance at March 31, 2008	$	17	$	8,423		$	22,457		$	(625	)	$	(1,190	)	$	(59	)	$	29,023

	Common Stock		Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Treasury Stock			Unearned Restricted Shares			Total
Balance at June 30, 2008	$	17	$	8,351		$	19,949		$	(1,367	)	$	(1,025	)	$	(116	)	$	25,809
Comprehensive loss:
Net loss		—		—			(6,391	)		—			—			—			(6,391	)
Net unrealized loss on securities available for sale, net of taxes and reclassification adjustment		—		—			—			(510	)		—			—			(510	)
Total comprehensive loss																			(6,901	)
Restricted stock granted (18,000 shares)		—		(200	)		—			—			348			(148	)		—
Forfeiture of restricted stock (1,960 shares)		—		—			—			—			(46	)		46			—
Stock option exercises (3,181 shares)		—		(36	)		—			—			36			—			—
Income tax benefit on options exercised		—		29			—			—			—			—			29
Amortization of restricted stock (5,130 shares)		—		(2	)		—			—			—			46			44
Balance at March 31, 2009	$	17	$	8,142		$	13,558		$	(1,877	)	$	(687	)	$	(172	)	$	18,981

See accompanying notes to consolidated financial statements.

-3-

SERVICE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(Dollars in thousands)

	Nine Months Ended March 31,
	2009			2008
Cash flows from operating activities:
Net loss	$	(6,391	)	$	(141	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Provision for loan losses		655			1,125
Net loss (gain) on securities		168			(352	)
Loss on write-down of investments to fair value		8,712			—
Loans originated for sale		(6,776	)		(4,663	)
Sales of loans originated for sale		6,430			5,076
Net accretion of securities		(14	)		(152	)
Depreciation and amortization expense		314			345
Stock-based compensation		44			35
Decrease in accrued interest receivable		173			212
Net amortization of deferred loan costs and premiums		152			141
Increase in bank-owned life insurance		(149	)		(140	)
Deferred tax benefit		(3,534	)		(250	)
Other, net		(1,681	)		79
Net cash (used in) provided by operating activities		(1,897	)		1,315
Cash flows from investing activities:
Activity in securities available for sale:
Sales		10,448			18,329
Maturities, prepayments and calls		5,036			4,755
Purchases		(384	)		(22,945	)
Activity in securities held to maturity:
Maturities, prepayments and calls		198			203
Net decrease (increase) in loans, excluding loan purchases and sales		17,648			(3,569	)
Sales of other real estate owned		1,175			454
Purchase of banking premises and equipment		(28	)		(89	)
Purchase of Federal Home Loan Bank stock		—			(642	)
Net cash provided by (used in) investing activities		34,093			(3,504	)
Cash flows from financing activities:
Net decrease in deposits		(15,610	)		(15,969	)
Proceeds from long-term borrowings		25,000			55,500
Repayment of long-term borrowings		(40,080	)		(28,075	)
Net decrease in short-term borrowings		(2,355	)		(9,050	)
Purchase of treasury stock		—			(87	)
Stock option exercises		—			124
Net cash (used in) provided by financing activities		(33,045	)		2,443
Net change in cash and cash equivalents		(849	)		254
Cash and cash equivalents at beginning of year		8,758			9,385
Cash and cash equivalents at end of period	$	7,909		$	9,639
Supplementary information:
Interest paid on deposits	$	4,155		$	5,638
Interest paid on borrowings and subordinated debt		3,914			4,368
Income taxes paid, net of refunds		17			34
Loans transferred to other real estate owned		2,090			1,182

See accompanying notes to consolidated financial statements.

-4-

SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(1) Basis of Presentation and Consolidation

The accompanying unaudited consolidated financial statements include the accounts of Service Bancorp, Inc. (the “Company”) and its wholly-owned subsidiary, Strata Bank (the “Bank”), a Massachusetts chartered savings bank, and the Bank’s wholly-owned subsidiaries, Medway Security Corporation and Franklin Village Security Corporation, both of which engage solely in the purchase and sale of securities. All significant intercompany balances and transactions have been eliminated in consolidation.

These unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions for Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation and in order to make the financial statements not misleading have been included. Interim results are not necessarily indicative of the results that may be expected for the entire year. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with GAAP have been omitted. A summary of significant accounting policies followed by the Company is set forth in the Notes to Consolidated Financial Statements of the Company’s Annual Report on Form 10-K for the year ended June 30, 2008.

(2) Recent Developments

The Company entered into an Agreement and Plan of Merger dated as of December 8, 2008 and amended as of March 18, 2009 (the “Agreement”) under which the Bank will be merged into Middlesex Savings Bank (“Middlesex”), headquartered in Natick, Massachusetts. Pursuant to the Agreement, the Company and Service Bancorp, MHC, the mutual holding company parent of the Company and the Bank, will merge with and into Middlesex Bancorp, MHC (“Middlesex MHC”), a mutual holding company which Middlesex is expected to form (subject to receipt of required approvals) prior to the consummation of the transactions contemplated by the Agreement. The Company’s stockholders voted to approve the Agreement on April 23, 2009 and the corporators of Service Bancorp, MHC voted to approve the Agreement on April 28, 2009. The transaction remains subject to several conditions, including the receipt of regulatory approvals and the approval of the corporators of Middlesex MHC.

(3) Earnings per Share

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares (common stock equivalents) that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options and unvested restricted stock and are determined using the treasury stock method. Assumed conversion of the outstanding dilutive stock options and unvested restricted stock would increase the shares outstanding but would not require an adjustment to income as a result of the conversion.

Weighted average diluted shares outstanding have been calculated based on the following:

	Quarter Ended March 31,		Nine Months Ended March 31,
	2009	2008	2009	2008
Weighted average shares outstanding	1,656,499	1,646,367	1,654,461	1,645,111
Effect of dilutive stock options	—	6,225	—	—
Effect of unvested shares of restricted stock	—	—	—	—
Weighted average diluted shares outstanding	1,656,499	1,652,592	1,654,461	1,645,111

For the quarter and nine months ended March 31, 2009 and for the nine months ended March 31, 2008, as a result of the Company reporting a net loss, all outstanding stock options and unvested shares of restricted stock were anti-dilutive and therefore excluded from the earnings per share calculations. For the quarter ended March 31, 2009, 21,562 vested stock option shares and 17,081 unvested restricted stock shares were anti-dilutive and therefore excluded from the earnings per share calculations. For the nine months ended March 31, 2009, 23,636 vested stock option shares and 17,081 unvested restricted stock shares were anti-dilutive and therefore excluded from the earnings per share calculations. For the quarter ended March 31, 2008, 600 vested stock option shares and 2,415 unvested restricted stock shares were anti-dilutive and therefore excluded from the earnings per share calculations. For the nine months ended March 31, 2008, 31,398 vested stock option shares and 2,415 unvested restricted stock shares were anti-dilutive and therefore excluded from the earnings per share calculations.

-5-

SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(4) Commitments

At March 31, 2009, the Company had outstanding commitments to originate loans of $2.7 million. Unused lines of credit and open commitments available to customers at March 31, 2009 amounted to $44.0 million, of which $22.1 million were home equity lines of credit.

(5) Securities

The following table sets forth the Company’s securities at the dates indicated:

	March 31, 2009				June 30, 2008
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(Dollars in thousands)
Securities Available for Sale
Government sponsored enterprise obligations	$	2,549	$	2,607	$	6,578	$	6,664
Government sponsored enterprise mortgage-backed securities		15,441		16,186		21,966		21,878
Other debt securities		6,132		3,700		12,487		11,466
Municipal securities		1,798		1,722		1,798		1,744
Total debt securities available for sale		25,920		24,215		42,829		41,752
Marketable equity securities		2,498		1,346		9,552		8,549
Total securities available for sale	$	28,418	$	25,561	$	52,381	$	50,301
Securities Held to Maturity
Government sponsored enterprise mortgage-backed securities	$	975	$	1,035	$	1,176	$	1,210

On September 30, 2008, the Company recorded other-than-temporary impairment (“OTTI”) charges of $6.6 million related to its investments in preferred securities issued by the Federal National Mortgage Association (“FNMA”) and the Federal Home Loan Mortgage Corporation (“FHLMC”) and $1.9 million related to its investments related to corporate bonds issued by Lehman Brothers Holdings. On December 31, 2008, the Company recorded an OTTI charge of $200,000 related to its investment in common stock issued by Citigroup.

-6-

SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(6) Loans

The following table presents data relating to the composition of the Company’s loan portfolio by type of loan at the dates indicated:

	March 31, 2009					June 30, 2008
	Amount			Percent		Amount			Percent
	(Dollars in thousands)
Real estate loans:
One- to four-family residential	$	162,468		52.39	%	$	171,519		51.99	%
Commercial and multi-family		91,219		29.42			86,879		26.34
Commercial construction		7,825		2.52			18,408		5.58
Residential construction		926		0.30			1,942		0.59
Residential loans held for sale		346		0.11			—		—
Total real estate loans		262,784		84.74			278,748		84.50
Commercial loans		23,686		7.64			27,373		8.30
Consumer loans:
Home equity		17,259		5.57			16,723		5.07
Second mortgages		5,581		1.80			6,206		1.88
Passbook secured		274		0.09			256		0.08
Other		483		0.16			555		0.17
Total consumer loans		23,597		7.62			23,740		7.20
Total gross loans		310,067		100.00	%		329,861		100.00	%
Net deferred loan costs and premiums		841					919
Allowance for loan losses		(3,634	)				(3,307	)
Total loans, net	$	307,274				$	327,473

(7) Deposits

The following table indicates types and balances in deposit accounts at the dates indicated:

	March 31, 2009				June 30, 2008
	Amount		Percent		Amount		Percent
	(Dollars in thousands)
Demand	$	34,811	14.20	%	$	39,120	15.00	%
NOW		16,598	6.77			18,987	7.28
Money market deposits		17,693	7.22			12,255	4.70
Regular and other savings		49,114	20.03			56,348	21.61
Total non-certificate accounts		118,216	48.22			126,710	48.59
Term certificates of $100,000 or greater		49,577	20.22			58,995	22.62
Term certificates less than $100,000		77,365	31.56			75,063	28.79
Total certificate accounts		126,942	51.78			134,058	51.41
Total deposits	$	245,158	100.00	%	$	260,768	100.00	%

-7-

SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(8) Borrowings

As of March 31, 2009, there were no overnight borrowings with the Federal Home Loan Bank of Boston (“FHLB”), compared to $2.4 million at a rate of 2.50% as of June 30, 2008. In addition, borrowings included the following advances from the FHLB and are presented by the earlier of the maturity date or the callable date by the FHLB.

	March 31, 2009				June 30, 2008
	Amount		Percent		Amount		Percent
	(Dollars in thousands)
Less than one year	$	58,975	56.34	%	$	44,000	36.74	%
One to three years		39,000	37.25			66,039	55.14
Greater than three years		6,711	6.41			9,727	8.12
Total	$	104,686	100.00	%	$	119,766	100.00	%

(9) Subordinated Debentures

In March 2004, Service Capital Trust I (“Trust I”), a special purpose trust sponsored by the Company, participated in a pooled offering of trust preferred securities. In connection with this offering, Trust I issued $3.1 million of trust preferred securities and reinvested the proceeds in a 30-year $3.1 million junior subordinated debenture issued by the Company. Interest is calculated on the subordinated debenture and trust preferred securities at a rate equal to the three-month London Interbank Offering Rate plus 285 basis points. The junior subordinated debenture represents the sole asset of Trust I. The Company has guaranteed, on a subordinated basis, distributions and other payments due on the trust preferred securities (the “Guarantee”). The Guarantee, when taken together with the Company’s obligations under (i) the junior subordinated debentures; (ii) the indenture pursuant to which the junior subordinated debentures was issued; and (iii) the Amended and Restated Declaration of Trust governing Trust I, constitutes a full and unconditional guarantee of Trust I’s obligations under the trust preferred securities.

Under regulatory capital guidelines, trust preferred securities, within certain limitations, qualify as regulatory capital. Trust I, consistent with the FASB Interpretation No. 46, “Variable Interest Entities”, is not consolidated in the consolidated financial statements of the Company. Therefore, the Company presents in its consolidated financial statements junior subordinated debt as a liability and its investment in Trust I as a component of other assets.

(10) Stock Repurchase Plan

In February 2003, the Board of Directors of the Company approved a Stock Repurchase Plan under which the Company is authorized to acquire up to 4% of the outstanding common stock, or up to approximately 65,925 shares of the issued and outstanding shares of its common stock in the open market or in private transactions. Under the Stock Repurchase Plan, shares may be repurchased from time to time and in such amounts as market conditions warrant, and subject to regulatory considerations. In September 2008, the Board of Directors terminated the Stock Repurchase Plan, and the Company does not expect to repurchase shares for the foreseeable future. Prior to termination, 59,428 shares had been repurchased under the plan at an average price of $25.18.

-8-

SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(11) Fair Value Measurement

Effective July 1, 2008, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,” which provides a framework for measuring fair value in accordance with generally accepted accounting principles.

SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact. In October 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP No. 157-3”). FSP No. 157-3 clarifies the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP No. 157-3 was effective immediately upon issuance, and includes prior periods for which financial statements have not been issued. The Company applied the guidance contained in FSP No. 157-3 in determining fair values at March 31, 2009, and it did not have a material impact on the consolidated financial statements.

SFAS No. 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, SFAS No. 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

• Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

• Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

• Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets carried at fair value effective July 1, 2008.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

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SERVICE BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

Securities Available for Sale. Equity securities are reported at fair value utilizing Level 1 inputs based on quoted market prices. Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Impaired Loans. Impaired loans are reported at the fair value as based primarily on the appraised value of the collateral. Appraised values are typically based on a blend of (a) an income approach using unobservable cash flows to measure fair value, and (b) a market approach using observable market comparables. These appraised values may be discounted based on management’s historical knowledge, expertise or changes in market conditions from the time of valuation. For these reasons, impaired loans are categorized as Level 3 assets.

Financial assets measured at fair value on a recurring basis as of March 31, 2009, segregated by the level of valuation inputs within the fair value hierarchy, are summarized below. There were no financial liabilities measured at fair value on a recurring basis at March 31, 2009.

	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
	(In thousands)
Assets:
Securities available for sale:
Government sponsored enterprise obligations	$	—	$	2,607	$	—	$	2,607
Government sponsored enterprise mortgage-backed securities		—		16,186		—		16,186
Other debt securities		—		3,700		—		3,700
Municipal securities		—		1,722		—		1,722
Marketable equity securities		1,346		—		—		1,346
Total assets	$	1,346	$	24,215	$	—	$	25,561

Financial assets measured at fair value on a non-recurring basis as of March 31, 2009, segregated by the level of valuation inputs within the fair value hierarchy, are summarized below. There were no financial liabilities measured at fair value on a non-recurring basis at March 31, 2009.

	Level 1		Level 2		Level 3
	(In thousands)
Assets:
Impaired loans	$	—	$	—	$	3,412
Total assets	$	—	$	—	$	3,412

The Company also adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” as of July 1, 2008. SFAS No. 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company did not elect fair value treatment for any financial assets or liabilities upon adoption.

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ITEM 2. Management’s Discussion and Analysis

General

This quarterly report on Form 10-Q contains forward-looking statements. For this purpose, statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believe”, “anticipates”, “plans”, “expects” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company’s actual results to differ materially from those contemplated by such forward-looking statements. These important factors include, without limitation, competitive conditions in the Bank’s marketplace generally, the Bank’s continued ability to originate quality loans, fluctuation in interest rates including fluctuations which may affect the Bank’s interest rate spread, real estate conditions in the Bank’s lending areas, changes in the securities or financial markets, changes in loan defaults and charge-off rates, general and local economic conditions, the Bank’s continued ability to attract and retain deposits, the Company’s and the Bank’s ability to control costs, new accounting pronouncements, and changing regulatory requirements. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Comparison of Financial Condition at March 31, 2009 and June 30, 2008

Total assets were $373.5 million at March 31, 2009, a decrease of $41.6 million, or 10.0%, from $415.1 million at June 30, 2008. Net loans decreased $20.2 million, or 6.2%, to $307.3 million at March 31, 2009. The investment securities portfolio decreased $24.9 million, or 43.0%, since June 30, 2008 to $33.1 million at March 31, 2009. Short-term investments, which consist mostly of money market mutual fund investments and overnight federal funds sold, decreased $2.0 million. Total deposits decreased $15.6 million, or 6.0%, since June 30, 2008 to $245.2 million at March 31, 2009. Borrowings decreased $17.4 million, or 14.3%, since June 30, 2008.

Total investment securities, including FHLB stock, were $33.1 million at March 31, 2009, a decrease of $24.9 million, or 43.0%, since June 30, 2008. This decline was primarily due to OTTI charges totaling $8.7 million, securities sales and maturities and an increase in unrealized losses on securities available for sale due to unfavorable changes in the market prices for corporate debt and equity securities since June 30, 2008. On December 31, 2008, the Company recorded an OTTI charge related to its investment in common stock issued by Citigroup of $200,000, which followed the OTTI charges recorded on September 30, 2008 related to investments in preferred securities issued by FNMA and FHLMC of $6.6 million and in corporate bonds issued by Lehman Brothers Holdings of $1.9 million. There were no further OTTI charges recorded on March 31, 2009.

Residential real estate loans are originated through the residential mortgage division of the Bank, the Strata Mortgage Center. During the nine months ended March 31, 2009, the Strata Mortgage Center originated $14.8 million in residential real estate loans, which was $13.2 million, or 47.1%, lower than the same period last year. Also during the nine months ended March 31, 2009, the Bank sold $6.4 million in residential loans compared with residential loan sales of $5.1 million during the same period last year. As of March 31, 2009, residential loans held for sale totaled $346,000 compared to no residential loans held for sale as of June 30, 2008. Total residential mortgage portfolio loans decreased $10.1 million, or 5.8%, since June 30, 2008 to $163.4 million at March 31, 2009. The Company expects to continue to reduce the amount of loans held in portfolio and to sell its residential loan production during the year ended June 30, 2009. Home equity and second mortgage loans decreased $89,000, or 0.4%, since June 30, 2008 to $22.8 million at March 31, 2009 as loan amortization exceeded new loans and advances.

Total commercial loans, comprised of commercial real estate, commercial construction and commercial business loans, decreased $9.9 million, or 7.5%, since June 30, 2008 to $122.7 million. The Bank originated $11.1 million in commercial, commercial real estate and construction loans and lines of credit since June 30, 2008, which was $2.3 million, or 26.5%, higher than the $8.8 million originated during the same period last year. The continuing low level of commercial originations reflects the slower commercial real estate and construction loan market due to declines in new home sales, higher levels of residential construction loan inventory in the market area and competitive loan pricing pressures. The Company expects to have reductions in commercial loans for the year ending June 30, 2009 compared to the year ended June 30, 2008 as the Bank seeks to reduce its risk profile, including non-accruing loans, and strengthen its regulatory capital ratios.

Other real estate owned (“OREO”) totaled $4.5 million at March 31, 2009, representing an increase of $860,000 from $3.7 million at June 30, 2008, reflecting three commercial real estate properties totaling $2.1 million acquired through foreclosure and OREO sales totaling $1.2 million during the nine months ended March 31, 2009. Net deferred tax assets were $6.2 million at March 31, 2009, an increase of $3.8 million from $2.4 million at June 30, 2008, due to the benefit for deferred income taxes of $3.5 million during the nine months ended March 31, 2009. Management performed an analysis of the realizability of the Company’s deferred tax assets as of March 31, 2009, and determined that is more likely than not that the taxes are realizable.

Total deposits decreased $15.6 million, or 6.0%, since June 30, 2008 to $245.2 million at March 31, 2009. Demand deposits, savings, and NOW deposits decreased $4.3 million, $7.2 million, and $2.4 million, respectively. The decreases in these categories

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reflected customer transfers to the Company’s higher yielding money market deposits and certificates of deposit, as well as outflows that reflected the planned reduction in the Bank’s asset size. The decrease in NOW deposits was also significantly affected by lower balances in certain NOW accounts used by attorneys in connection with residential loan closings, as influenced by the slower residential loan market during the nine months ended March 31, 2009. Money market deposits increased $5.4 million, or 44.4%, to $17.7 million, and retail certificates of deposit decreased $7.1 million, or 5.3%, to $126.9 million, during the nine months ended March 31, 2009.

Borrowings decreased $17.4 million, or 14.3%, to $104.7 million during the nine months ended March 31, 2009. The Company reduced term advances from the Federal Home Loan Bank of Boston (“FHLB”) by $15.1 million, or 12.6%, and overnight borrowings from the FHLB by $2.4 million, since June 30, 2008. The Company expects to continue to utilize several sources of liquidity as the need for additional funds arises, including, but not limited to, additional core deposits and certificates of deposit and borrowings from the FHLB.

Stockholders’ equity decreased to $19.0 million, or $11.43 book value per share, at March 31, 2009 from $25.8 million, or $15.62 book value per share, at June 30, 2008. The Company’s ratio of stockholders’ equity to total assets at March 31, 2009 was 5.08%, compared to 6.22% at June 30, 2008. These decreases were primarily due to the year-to-date net loss of $6.4 million. For additional information regarding the Bank’s regulatory capital ratios, refer to “–Liquidity and Capital Resources,” below.

Non-Performing Assets and Allowance for Loan Losses – Critical Accounting Estimate

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

	March 31, 2009			June 30, 2008
	(Dollars in thousands)
Non-accruing loans:
One- to-four-family residential	$	1,247		$	223
Commercial and multi-family real estate		4,222			4,582
Commercial		488			997
Consumer		256			—
Total		6,213			5,802
Accruing loans delinquent more than 90 days		—			—
OREO		4,544			3,684
Total non-performing assets	$	10,757		$	9,486
Total as a percentage of total assets		2.88	%		2.28	%

Non-performing loans totaled $6.2 million at March 31, 2009, representing an increase of $103,000, or 1.7%, from $6.1 million at December 31, 2008, and an increase of $411,000, or 7.1%, from $5.8 million at June 30, 2008. Non-performing loans at March 31, 2009 were comprised of six commercial real estate loan relationships totaling $4.2 million, five commercial business loan relationships totaling $488,000, six residential loans totaling $1.2 million and four home equity loans totaling $256,000.

Other real estate owned (OREO) totaled $4.5 million at March 31, 2009, representing a decrease of $81,000 from $4.6 million at December 31, 2008 and an increase of $860,000 from $3.7 million at June 30, 2008. OREO at March 31, 2009 was comprised of one completed commercial construction property of $2.6 million, and two commercial real estate properties totaling $2.0 million. During the nine months ended March 31, 2009, the Company sold three commercial real estate properties with initial fair values at their dates of foreclosure of $1.1 million and a condominium unit for $110,000 from the completed commercial construction property.

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The allowance for loan losses totaled $3.6 million at March 31, 2009, compared to $3.3 million at June 30, 2008. The following table sets forth activity in the Company’s allowance for loan losses for the periods indicated:

	For the Three Months Ended March 31,						For the Nine Months Ended March 31,
	2009			2008			2009			2008
	(Dollars in thousands)
Balance at beginning of period	$	3,574		$	3,466		$	3.307		$	3,144
Provision for loan losses		135			265			655			1,125
Charge-offs:
One-to-four family residential		(16	)		—			(16	)		—
Commercial and multi-family real estate		—			—			(55	)		(30	)
Consumer		(6	)		(38	)		(17	)		(50	)
Commercial business loans		(80	)		(369	)		(274	)		(904	)
Total		(102	)		(407	)		(362	)		(984	)
Recoveries		27			47			34			86
Net charge-offs		(75	)		(360	)		(328	)		(898	)
Balance at end of period	$	3,634		$	3,371		$	3,634		$	3,371
Ratio of net charge-offs (annualized) to average loans during the period		0.09	%		0.43	%		0.13	%		0.36	%

The provision for loan losses was $135,000 for the quarter ended March 31, 2009, a decline of $130,000, or 49.1%, compared to the $265,000 recorded for the same quarter last year. For the nine months ended March 31, 2009, the provision for loan losses was $655,000, a decline of $470,000, or 41.8%, compared to the $1.1 million recorded for the same period last year. The allowance for loan losses as a percentage of loans was 1.17% at March 31, 2009, compared to 1.00% at June 30, 2008. The loan loss provisions and the resulting allowance for loan losses were based primarily on management’s assessment of several key factors, including internal loan review classifications reflecting loan relationships deemed by the Company to be impaired, historical loss experience, changes in portfolio size and composition, and current economic conditions. The valuation allowance related to impaired loans totaled $404,000 at March 31, 2009 compared with $158,000 at June 30, 2008.

While management believes that, based on information currently available, the allowance for loan losses is sufficient to cover losses inherent in the Bank’s loan portfolio at this time, no assurances can be given that the level of the allowance will be sufficient to cover loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the adequacy of the current level of the allowance. In addition, the Federal Deposit Insurance Corporation (“FDIC”), as an integral part of their examination process, periodically reviews the Bank’s allowance for loan losses. The FDIC may require the Bank to adjust the allowance for loan losses based upon judgments different from those of management. For a further discussion of the allowance, refer to “Allowance for Loan Losses” in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended June 30, 2008.

Comparison of Operating Results for the Quarter and Nine Months Ended March 2009 and 2008

Overview

Operating results are primarily dependent on the Bank’s net interest income, which is the difference between the interest earned on the Bank’s earning assets (short-term investments, loans, and securities) and the interest paid on deposits and borrowings. Operating results are also affected by provisions for loan losses, the level of income from non-interest sources such as fees and sales of securities and residential loans, operating expenses and income taxes. Operating results are also significantly affected by general economic conditions, particularly changes in interest rates, as well as government policies and actions of regulatory authorities.

The net loss for the quarter ended March 31, 2009 was $338,000, or $0.20 per diluted share, compared with net income of $103,000, or $0.06 per diluted share, for the same quarter a year ago. The decrease in earnings during the quarter ended March 31, 2009 was due to a lower net interest income of $276,000, or 10.1%, lower non-interest income of $116,000, or 20.1%, higher non-interest expenses of $130,000, or 4.3%, and a lower income tax benefit of $49,000, partially offset by a lower loan loss provision of $130,000, or 49.1%. The net loss for the nine months ended March 31, 2009 was $6.4 million, or $3.86 per diluted share, compared with a net loss of $141,000, or $0.09 per diluted share, for the same period a year ago. The increased net loss during the nine months ended March 31, 2009 was due to lower non-interest income of $9.3 million, reflecting a loss on the write-down of investments to fair value of $8.7 million, and higher non-interest expenses of $954,000, or 10.7%, partially offset by higher net interest income of $107,000, or 1.4%, a lower loan loss provision of $470,000, or 41.8%, and a higher tax benefit of $3.4 million.

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Net Interest Income

Net interest income for the quarter ended March 31, 2009 was $2.5 million, a decrease of $276,000, or 10.1%, compared with the same period last year. This decrease was primarily due to a $21.6 million decrease in average net interest-earning assets to $24.3 million and a decrease of 42 basis points in the yield on interest-earning assets to 5.64%, the effects of which were partially offset by a decrease of 67 basis points in the cost of interest-bearing liabilities to 3.03%. The net interest rate spread and net interest margin were 2.61% and 2.85%, respectively, for the quarter ended March 31, 2009, compared to 2.36% and 2.79%, respectively, for the same quarter last year. For the nine months ended March 31, 2009, net interest income was $8.0 million, an increase of $107,000, or 1.4%, compared with the same period last year. This increase was primarily due to a decrease of 73 basis points in the cost of interest-bearing liabilities to 3.10%, partially offset by a decrease of 32 basis points in the yield on interest-earning assets to 5.77% and a $15.8 million decrease in average net interest-earning assets to $29.7 million. The interest rate spread and margin for the current year to date period rose to 2.67% and 2.89%, respectively, which was 41 and 18 basis points, respectively, higher than last year.

The following tables present, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the amount of interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made. Average balances are derived from the best available daily or monthly data, which management believes approximates the average balances computed on a daily basis. Non-accruing loans have been included in the tables:

	Three Months Ended March 31,
	2009							2008
	Average Balance		Interest Earned/ Paid			Yield/ Rate		Average Balance		Interest Earned/ Paid			Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans (1)	$	314,114	$	4,500		5.77	%	$	331,753	$	5,094		6.15	%
Securities (2)		34,712		393		4.53			57,947		839		5.79
Short-term investments		749		4		2.17			4,921		32		2.89
Total interest-earning assets		349,575		4,897		5.64			394,621		5,965		6.06
Non-interest-earning assets		30,138							22,153
Total assets	$	379,713						$	416,774
Interest-bearing liabilities:
Savings deposits	$	47,398		102		0.87		$	52,717		188		1.43
Money market deposits		16,108		57		1.44			11,389		49		1.73
NOW accounts		16,322		4		0.10			18,230		6		0.13
Certificates of deposit		131,781		1,097		3.38			127,180		1,419		4.49
Brokered certificates of deposit		—		—		—			10,134		127		5.04
Total interest-bearing deposits		211,609		1,260		2.42			219,650		1,789		3.27
Borrowings and subordinated debt		113,625		1,184		4.17			129,027		1,447		4.44
Total interest-bearing liabilities		325,234		2,444		3.03			348,677		3,236		3.70
Demand deposits		33,401							35,537
Other non-interest bearing liabilities		1,177							2,730
Stockholders’ equity		19,901							29,830
Total liabilities and stockholders’ equity	$	379,713						$	416,774
Net interest income			$	2,453						$	2,729
Net interest rate spread						2.61	%						2.36	%
Net earning assets	$	24,341						$	45,944
Net interest margin						2.85	%						2.79	%
Average interest-earning assets to average interest-bearing liabilities				107.48	%						113.18	%

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	Nine Months Ended March 31,
	2009							2008
	Average Balance		Interest Earned/ Paid			Yield/ Rate		Average Balance		Interest Earned/ Paid			Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans (1)	$	321,737	$	14,250		5.90	%	$	331,390	$	15,484		6.21	%
Securities (2)		44,701		1,656		4.94			57,579		2,380		5.51
Short-term investments		1,644		22		1.78			2,428		60		3.52
Total interest-earning assets		368,082		15,928		5.77			391,397		17,924		6.09
Non-interest-earning assets		28,120							21,985
Total assets	$	396,202						$	413,382
Interest-bearing liabilities:
Savings deposits	$	49,741		372		1.00		$	53,691		665		1.65
Money market deposits		15,151		191		1.68			11,058		147		1.77
NOW accounts		15,772		12		0.10			19,632		25		0.17
Certificates of deposit		134,432		3,453		3.42			123,911		4,251		4.57
Brokered certificates of deposit		1,715		40		3.11			11,889		467		5.23
Total interest-bearing deposits		216,811		4,068		2.50			220,181		5,555		3.35
Borrowings and subordinated debt		121,538		3,866		4.18			125,649		4,482		4.67
Total interest-bearing liabilities		338,349		7,934		3.10			345,830		10,037		3.83
Demand deposits		34,405							35,296
Other non-interest bearing liabilities		1,983							2,527
Stockholders’ equity		21,465							29,729
Total liabilities and stockholders’ equity	$	396,202						$	413,382
Net interest income			$	7,994						$	7,887
Net interest rate spread						2.67	%						2.26	%
Net earning assets	$	29,733						$	45,567
Net interest margin						2.89	%						2.71	%
Average interest-earning assets to average interest-bearing liabilities				108.79	%						113.18	%

(1) Calculated net of deferred loan costs and premium and allowance for loan losses.

(2) Securities include securities available for sale and held to maturity and FHLB stock.

The Bank intends to emphasize the growth in core deposits as the need for additional funds arises. In addition, management intends to supplement core funding with borrowings from the FHLB and certificates of deposits, subject to the limitations discussed in “–Liquidity and Capital Resources,” below. In the near term, the Bank expects that the current low interest rate environment will continue, along with diminished levels of demand for residential and commercial loans. In addition, the elimination of dividend income from the FNMA and FHLMC preferred stock and FHLB stock, and interest income from Lehman Brothers Holdings corporate bonds, will adversely affect the Company’s net interest income in future periods. The declines in dividends from FHLB stock totaled $92,000 for the quarter ended March 31, 2009 and $200,000 for the nine months ended March 31, 2009 as compared to the same periods last year. These factors will cause the Bank’s net interest income and interest rate spread to remain relatively flat for at least the next several quarters.

Non-interest Income

Non-interest income for the quarter ended March 31, 2009 was $460,000, a decrease of $116,000, or 20.1%, from the same period last year, primarily due to lower gains on securities sales of $148,000, partially offset by higher customer service fees of $23,000. For the nine months ended March 31, 2009, non-interest income decreased $9.3 million to a loss of $7.6 million from income of $1.7 million for the same period last year, primarily due to the total OTTI fiscal year-to-date write-down of $8.7 million. Non-interest income during the nine months ended March 31, 2009 also reflected lower gains on securities sales of $520,000 and other income of $83,000, partially offset by higher customer service fees of $23,000 and mortgage banking gains of $15,000 as compared to the same periods last year.

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Non-interest Expense

Total non-interest expense for the quarter ended March 31, 2009 increased $130,000, or 4.3%, to $3.1 million compared to the same quarter last year, primarily due to increases in professional fees of $53,000 and expenses related to the pending merger with Middlesex of $98,000. For the nine months ended March 31, 2009, non-interest expense increased $954,000, or 10.7%, to $9.8 million compared to the same period last year, primarily due to increases in salaries and benefits expenses of $87,000, professional fees of $278,000, expenses related to the pending merger with Middlesex of $250,000 and other operating expenses of $383,000. The increases for the quarter and nine-month periods in professional fees were primarily due to higher legal fees. In addition, the increases in other operating expenses were primarily due to higher expenses associated with problem loans and foreclosed properties and increased estimates for deposit insurance premium assessments, partially offset by decreases in advertising expenses.

The operating efficiency ratio (total non-interest expense divided by the sum of net interest income plus total non-interest income, excluding OTTI write-downs) for the quarter ended March 31, 2009 was 107.5% compared with 90.8% for the same quarter a year ago. The operating efficiency ratio for the nine months ended March 31, 2009 was 107.7% compared with 92.6% for the same period a year ago.

Income Taxes

The benefit for income taxes decreased $49,000 to $16,000 for the quarter ended March 31, 2009. For the nine months ended March 31, 2009, the benefit for income taxes increased $3.4 million to $3.7 million. The effective income tax benefit rate for the nine months ended March 31, 2009 was 36.5% compared to 66.3% for the same period last year. On October 3, 2008, the Emergency Economic Stabilization Act (“EESA”) was enacted with a provision permitting banks to recognize losses related to FNMA and FHLMC preferred stocks as ordinary losses for tax purposes. The pre-tax losses for the comparative periods have also affected the effective tax rates and the utilization by the Company of certain tax preference items such as bank-owned life insurance, dividends received deductions and security corporation subsidiaries to reduce the statutory corporate tax rates.

Asset/Liability Management

A principal operating objective of the Bank is to produce stable earnings by achieving a favorable interest rate spread that can be sustained during fluctuations in prevailing interest rates. Since the Bank’s principal interest-earning assets generally have longer terms to maturity than its primary source of funds,i.e., deposit liabilities, increases in general interest rates will generally result in an increase in the Bank’s cost of funds before the yield on its asset portfolio adjusts upward. Financial institutions have generally sought to reduce their exposure to adverse changes in interest rates by attempting to achieve a closer match between the repricing periods of interest rate sensitive assets and liabilities. Such matching, however, is carefully monitored so as not to sacrifice net interest margin performance for the perfect matching of these interest rate sensitive instruments. The Bank has established an Asset/Liability Management Committee (“ALCO”) made up of the chief executive officer, the chief financial officer, the senior lending officer, and others to assess the asset/liability mix and recommend strategies that will enhance income while seeking to mitigate the Bank’s vulnerability to changes in interest rates. This committee meets regularly to discuss interest rate conditions and potential product lines that would enhance the Bank’s income performance.

Certain strategies have been implemented to improve the match between interest rate sensitive assets and liabilities. These strategies include, but are not limited to: daily monitoring of the Bank’s cash requirements, originating adjustable and fixed rate mortgage loans, both residential and commercial, for the Bank’s own portfolio, selling loans, managing the cost and structure of deposits, short and long-term borrowings and using matched borrowings to fund specific purchases of loan packages and large loan originations. Occasionally, management may choose to deviate from specific matching of maturities of assets and liabilities if an attractive opportunity to enhance yield becomes available.

ALCO modeling, which is performed quarterly with the assistance of an outside advisor, projects the Bank’s financial performance over the next twenty-four months using loan and deposit projections, projections of changes in interest rates, and anticipated changes in other income and operating expenses to reveal the full impact of the Bank’s operating strategies on financial performance. The results of the ALCO process are reported to the Board of Directors at least on a quarterly basis.

Liquidity and Capital Resources

The Bank’s primary sources of funds consist of deposits, borrowings, repayment and prepayment of loans, sales of loans and securities, maturities and early calls of securities, and funds provided from operations. While scheduled repayments of loans and maturities of securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the general level of interest rates, economic conditions, and competition. The Bank primarily uses its liquidity resources to fund existing and future loan commitments, to fund net deposit outflows, to invest in other interest-earning assets, to maintain liquidity, and to pay operating expenses.

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The Bank utilizes advances from the FHLB as a primary source of funds and in connection with its management of the interest rate sensitivity of its assets and liabilities. Total advances outstanding at March 31, 2009 amounted to $104.7 million. The Bank’s ability to borrow from the FHLB is dependent upon the amount and type of collateral the Bank has to secure the loans. Such collateral consists of, but is not limited to, one-to-four family owner-occupied residential property, multi-family residential property and commercial real estate. As of March 31, 2009, the Bank had a borrowing capacity with the FHLB to borrow an additional $25.7 million, for a total of $130.4 million.

A significant portion of the Bank’s liquidity consists of cash and cash equivalents, short-term investments and investment securities. The level of these assets is dependent upon the Bank’s operating, lending, and financing activities during any given period.

At March 31, 2009, the Company had outstanding commitments to originate loans of $2.7 million. Unused lines of credit and open commitments available to customers at March 31, 2009 amounted to $44.0 million, of which $22.1 million were home equity lines of credit. Certificates of deposit, which are scheduled to mature in one year or less, totaled $106.4 million at March 31, 2009. Based upon historical experience, management believes that a significant portion of such deposits will remain with the Bank.

At March 31, 2009, the Bank met all regulatory capital requirements necessary to qualify as “adequately capitalized,” having Tier 1 capital of $18.1 million and a Tier 1 leverage capital ratio of 4.81%, which was above the adequately capitalized level of $15.1 million or 4.0%. The Bank’s Tier 1 capital to risk-weighted assets ratio was 6.78%, which was above the adequately capitalized level of $10.7 million or 4.0%. In addition, with total capital of $21.5 million, the Bank’s total capital to risk-weighted assets ratio was 8.03%, which was above the adequately capitalized level of $21.4 million, or 8.0%. The FDIC may, however, impose higher leverage and risk-based capital requirements on the Bank when circumstances warrant.

Recent Accounting Pronouncements

In December 2007, the FASB issued Statement No. 141 (revised), “Business Combinations.” This Statement replaces FASB Statement No. 141, and applies to all business entities, including mutual entities that previously used the pooling-of-interests method of accounting for certain business combinations. Under Statement No. 141 (revised) an acquirer is required to recognize at fair value the assets acquired, liabilities assumed, and any non-controlling interest in the acquired at the acquisition date. This replaces the cost-allocation process under Statement No. 141, which resulted in the non-recognition of some assets and liabilities at the acquisition date and in measuring some assets and liabilities at amounts other than their fair values at the acquisition date. This Statement requires that acquisition costs and expected restructuring costs be recognized separately from the acquisition, and that the acquirer in a business combination achieved in stages recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquired, at the full amounts of their fair values. This Statement also requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, while Statement 141 allowed for the deferred recognition of pre-acquisition contingencies until certain recognition criteria were met, and an acquirer is only required to recognize assets or liabilities arising from all other contingencies if it is more likely than not that they meet the definition of an asset or a liability. Under this Statement, an acquirer is required to recognize contingent consideration at the acquisition date, whereas contingent consideration obligations usually were not recognized at the acquisition date under Statement 141. Further, this Statement eliminates the concept of negative goodwill and requires gain recognition in instances in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any non-controlling interest in the acquired. This Statement makes significant amendments to other Statements and other authoritative guidance, and applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date.

In December 2007, the FASB issued Statement No. 160, “Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB No. 51.” This Statement establishes accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years beginning on or after December 15, 2008, and is not expected to have a material impact on the Company’s consolidated financial statements.

In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133.” This Statement changes disclosure requirements for derivative instruments and hedging activities accounted for under Statement No. 133 and its related interpretations, including enhanced disclosures regarding use, methodology and financial impacts. This Statement is effective for fiscal years and interim periods beginning after November 15, 2008, and is not expected to have a material impact on the Company’s consolidated financial statements.

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In January 2009, the FASB issued a FASB Staff Position (“FSP”) on the Emerging Issues Task Force (“EITF”) Issue No. 03-06-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” (FSP EITF 03-06-1). Under FSP EITF 03-06-1, unvested share-based awards which include the right to receive nonforfeitable dividends or dividend equivalents are considered to participate with common stock in undistributed earnings. Companies that issue share-based awards considered to be participating securities under FSP EITF 03-06-1 are required to calculate basic and diluted earnings per common share amounts under the two-class method. The two-class method excludes from earnings per common share calculations any dividends paid or owed to participating securities and any undistributed earnings considered to be attributable to participating securities. FSP EITF 03-06-1 requires retrospective application to all prior-period earnings per share data presented. The adoption of this EITF by the Company on January 1, 2009 did not have an impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued the following three FSPs intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities:

FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability have decreased significantly. FSP FAS 157-4 also provides guidance on identifying circumstances that indicate a transaction is not orderly. The provisions of FSP FAS 157-4 are effective for the Company’s annual reporting period ending on June 30, 2009. Management is currently evaluating the effect that the provisions of FSP FAS 157-4 may have on the Company’s consolidated financial statements.

FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” requires disclosures about fair value of financial instruments in interim reporting periods of publicly traded companies that were previously only required to be disclosed in annual financial statements. The provisions of FSP FAS 107-1 and APB 28-1 are effective for the Company’s interim reporting period ending on September 30, 2009. The adoption of this EITF by the Company is not expected to have a material impact on the Company’s consolidated financial statements.

FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” amends current other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The provisions of FSP FAS 115-2 and FAS 124-2 are effective for the Company’s annual reporting period ending on June 30, 2009. Management is currently evaluating the effect that the provisions of FSP FAS 115-2 and FAS 124-2 may have on the Company’s consolidated financial statements.

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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

ITEM 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures.

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company’s management conducted an evaluation with the participation of the Company’s Interim Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of Rule 15d-15(e) under the Exchange Act), as of the end of the last fiscal quarter. Based upon that evaluation, the Interim Chief Executive Officer and Chief Financial Officer concluded that they believe the Company’s disclosure controls and procedures were effective as of March 31, 2009 to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. We intend to continue to review and document our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and we may from time to time make changes to the disclosure controls and procedures to enhance their effectiveness and to ensure that our systems evolve with our business. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only a reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures.

(b) Changes in internal controls over financial reporting.

There were no changes in the Company’s internal controls over financial reporting identified in connection with the Company’s evaluation of its disclosure controls and procedures that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

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PART II—OTHER INFORMATION

ITEM 1. Legal Proceedings

There were no new legal proceedings other than legal proceedings occurring in the ordinary course of business which, in the aggregate, involve amounts believed by management to be immaterial to the financial condition and operations of the Company or material developments in ongoing proceedings during the quarter ended March 31, 2009.

ITEM 1A. Risk Factors

A summary of the Company’s risk factors appears in Part I, Item 1A, “Risk Factors” in the Company’s Form 10-K for the fiscal year ended June 30, 2008. There have been no other material changes to the risk factors, except as discussed below.

We recognized a material write-down of various investment securities on September 30, 2008, which caused the Company to incur a substantial loss for that quarter, and we may need to recognize further write-downs in the future.

The Company owns shares of two series of preferred stock issued by the FNMA and the FHLMC that had aggregate amortized cost of $7.2 million and a fair value of $6.6 million at June 30, 2008. On September 7, 2008, the Federal Housing Finance Agency (“FHFA”) was appointed as conservator of both FNMA and FHLMC, and the U.S. Treasury Department disclosed that it had entered into a Senior Preferred Stock Purchase Agreement with each of FNMA and FHLMC, contemplating an investment of up to $100 billion in each entity. The senior preferred stock has a liquidation preference senior to all FNMA and FHLMC stock, including the two series of preferred stock that the Company owns. In addition, the terms of the senior preferred stock prohibit each of FNMA and FHLMC from declaring or paying any dividend or making any other distribution with respect to any stock other than the senior preferred stock without the consent of the U.S. Treasury Department. In connection with the appointment of the FHFA as conservator, the FHFA announced that it was eliminating the payment of all future dividends on all FNMA and FHLMC stock, including dividends on the two series of preferred stock that the Company owns. After assessing these events, on September 30, 2008, the Company recorded other-than-temporary impairment (“OTTI”) write-downs of $6.6 million related to its investments in preferred securities issued by FNMA and FHLMC.

In addition, on September 30, 2008 the Company recognized an OTTI charge of $1.9 million with respect to senior and subordinated debt securities issued by Lehman Brothers Holdings, Inc., which filed for bankruptcy protection on September 14, 2008. And on December 31, 2008, the Company recorded an OTTI charge of $200,000 related to its investment in common stock issued by Citigroup. The Company recorded no OTTI charges on March 31, 2009.

The Company has not recognized OTTI write-downs with respect to debt securities it owns that were issued by American General Financial Services and International Lease Finance Corporation, subsidiaries of American International Group Inc. (“AIG”). On September 16, 2008, AIG announced that it entered into a revolving credit facility with the Federal Reserve Bank of New York under which AIG may borrow up to $85 billion at a rate per annum equal to three-month LIBOR plus 8.50% secured by a pledge of all of the assets of AIG and its “material subsidiaries” including American General Financial Services and International Lease Finance Corporation. Since then the government has taken various measures to increase aid to AIG. At the same time, AIG reported a loss of $61.7 billion for its quarter ended December 31, 2008. As a result, the trading market for AIG debt securities has been irregular, making it difficult for the Company to ascertain the fair value of those holdings. As of March 31, 2009, the Company’s AIG securities had a cost of $3.0 million and an estimated fair value of $1.4 million. There can be no assurance, however, that the Company’s estimates of those fair values in fact reflect the amount that the Company would realize if it sold those securities at the present time, and there can be no assurance that the fair values of such securities will not decline further.

Further, the Company is required to own common stock of the Federal Home Loan Bank of Boston (“FHLBB”) to qualify for membership in the Federal Home Loan Bank System and to be eligible to borrow funds under the FHLBB’s advance program. The aggregate book value of the FHLBB common stock as of March 31, 2009 was $6.5 million based on its cost. FHLBB common stock is not a marketable security. The FHLBB has reported a net loss of $73.2 million for the year ended December 31, 2008, voted to suspend dividends for the quarter ended December 31, 2008 and disclosed that dividend payments in 2009 are unlikely. These and other developments could put into question whether the fair value of FHLBB stock owned by the Company was less than its cost.

The write-down of various investment securities taken on September 30, 2008 materially reduced the Company and the Bank’s regulatory capital levels, and any further write-downs could further materially reduce regulatory capital levels.

The aggregate amount of the Company’s OTTI charges recognized for the quarter ended September 30, 2008 caused the Bank’s capital levels to fall below those thresholds necessary to qualify as “well capitalized.” Due to several factors, including a planned reduction in the Bank’s asset size, the Bank’s total risk-based capital has not fallen below 8.0% as of March 31, 2009, which would

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have resulted in the Bank being classified as “undercapitalized” for regulatory purposes. A primary factor was management’s determination that the Company’s AIG securities were not other than temporarily impaired. If, in the future, management determines that the AIG securities are other than temporarily impaired, or if other investment securities held by the Bank are determined to be other-than-temporarily impaired, the Bank could be classified as undercapitalized, and would then be subject to various regulatory restrictions and requirements. Among other things, an undercapitalized bank must submit to the FDIC and abide by a capital restoration plan acceptable to the FDIC. In addition, an undercapitalized bank may not accept, renew or roll over any brokered deposit or offer deposits rates with an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the relevant market area. There can be no assurance that the Bank will be able to submit an acceptable capital plan or implement such a plan in all material respects if it becomes undercapitalized. A bank that is undercapitalized and that fails to submit an acceptable capital restoration plan or that fails in any material respect to implement such a plan, would be subject to all of the provisions applicable to a “significantly undercapitalized” bank. The Bank has briefed the FDIC and the Division regarding developments relating to its investment securities. At the request of the FDIC and the Division, the Bank submitted a plan to restore the Bank to a “well capitalized” status generally and to increase its leverage capital ratio to at least 7.0%.

The Company has recently appointed an Interim President and Chief Executive Officer.

Pamela J. Montpelier, the President and Chief Executive Officer of the Company and the Bank, resigned effective October 21, 2008 from all of her positions with Service Bancorp, Inc., Service Bancorp, MHC and Strata Bank. Edward A. Hjerpe, III, who previously was appointed as Interim President and Chief Executive Officer of the Company and the Bank, continues to serve in that capacity. There is no guarantee that the transition between Ms. Montpelier and Mr. Hjerpe will not cause any interruption or that these events will not have an adverse effect on the Company’s operations.

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

(a) Not applicable.

(b) Not applicable.

(c) Not applicable.

ITEM 3. Defaults Upon Senior Securities

Not applicable.

ITEM 4. Submission of Matters to a Vote of Security Holders

Not applicable

ITEM 5. Other Information

Not applicable

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ITEM 6. Exhibits

Exhibits

3.1	Articles of Organization of Service Bancorp, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form SB-2 (SEC File No. 333-156851))
3.2	Articles of Amendment to Articles of Organization of Service Bancorp, Inc. (incorporated by reference to Exhibit 3.1(A) to the Company’s Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004)
3.3	Bylaws of Service Bancorp, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed October 22, 2008)
4.1	Form of Certificate representing the Company Common Stock (incorporated by reference to Exhibit 4 to the Company’s Registration Statement on Form SB-2 (SEC File No. 333-156851))
31.1	Certification of Interim Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
32.1	Certification of Interim Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

In accordance with 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.

	SERVICE BANCORP, INC.
Date: May 15, 2009	By:	/s/ EDWARD A. HJERPE, III
		Edward A. Hjerpe, III
		Interim President and Chief Executive Officer

Date: May 15, 2009	By:	/s/ MARK L. ABBATE
		Mark L. Abbate
		Executive Vice President and Chief Financial Officer

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