Alaska Pacific Bancshares (AKPB) 10-Q 2012 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2012

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

For the transition period from _____________  to ___________

Commission file number: 0-26003

ALASKA PACIFIC BANCSHARES, INC. 

(Exact name of registrant as specified in its charter)

Alaska	92-0167101
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

2094 Jordan Avenue, Juneau, Alaska  99801

(Address of Principal Executive Offices)

(907) 789-4844

(Registrant’s telephone number, including area code)

NA

(Former name, former address and former fiscal year,

if changed since last report)

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

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

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

Large accelerated filer _____	Accelerated filer  _____
Non-accelerated filer  _____	Smaller reporting company  __X___
(do not check if a smaller reporting company)

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

State the number of shares outstanding of each of the issuer's classes of common equity as of the latest practicable date:        654,486   shares outstanding on November 1, 2012

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ALASKA PACIFIC BANCSHARES, INC.

Juneau, Alaska

INDEX

PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements
Condensed Consolidated Balance Sheets	3
Condensed Consolidated Statements of Income	4
Condensed Consolidated Statements of Comprehensive Income (Loss)	5
Condensed Consolidated Statements of Cash Flows	6
Selected Notes to Condensed Consolidated Interim Financial Statements	7
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations	38
Item 3.  Quantitative and Qualitative Disclosures About Market Risk	47
Item 4.  Controls and Procedures	47
PART II.  OTHER INFORMATION
Item 1. Legal Proceedings	48
Item 1A. Risk Factors	48
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	48
Item 3. Defaults Upon Senior Securities	48
Item 4.  Mine Safety Disclosures	48
Item 5. Other Information	48
Item 6. Exhibits	49
Signatures	51

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PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Alaska Pacific Bancshares, Inc. and Subsidiary

Condensed Consolidated Balance Sheets

(Unaudited)

(in thousands except share data)	September 30,  2012			December 31, 2011
Assets
Cash and due from banks	$	15,157		$	8,307
Interest-earning deposits in financial institutions		1,937			2,751
Total cash and cash equivalents		17,094			11,058
Investment securities available for sale, at fair value  (amortized cost: September     30, 2012 - $4,759; December 31, 2011 - $5,546)		4,968			5,714
Federal Home Loan Bank stock		1,768			1,784
Loans held for sale		473			976
Loans		150,454			147,766
Less allowance for loan losses		(1,855	)		(1,865	)
Loans, net		148,599			145,901
Interest receivable		587			585
Premises and equipment, net		3,297			2,451
Real estate owned and repossessed assets, net		390			880
Mortgage servicing rights, at fair value		1,002			1,098
Other assets		1,936			1,610
Total Assets	$	180,114		$	172,057
Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing demand	$	37,890		$	31,748
Interest-bearing demand		33,565			33,033
Money market		32,230			27,843
Savings		22,218			20,987
Certificates of deposit		29,478			33,590
Total deposits		155,381			147,201
Federal Home Loan Bank advances		3,000			3,000
Advances from borrowers for taxes and insurance		213			691
Accounts payable and accrued expenses		750			331
Interest payable		132			131
Other liabilities		88			161
Total liabilities		159,564			151,515
Shareholders’ Equity:
Preferred stock ($0.01 par value; 1,000,000 shares authorized; Series A –    Liquidation preference $1,000 per share, 4,781 shares issued and outstanding    at September 30, 2012 and at December 31, 2011)		4,685			4,631
Common stock ($0.01 par value; 20,000,000 shares authorized; 655,415 shares     issued; 654,486 shares outstanding at September 30, 2012 and at December 31,     2011)		7			7
Additional paid-in capital		6,494			6,486
Treasury stock		(11	)		(11	)
Retained earnings		9,212			9,290
Accumulated other comprehensive income, net		163			139
Total shareholders’ equity		20,550			20,542
Total Liabilities and Shareholders’ Equity	$	180,114		$	172,057
See selected notes to condensed consolidated interim financial statements.

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Alaska Pacific Bancshares, Inc. and Subsidiary

Condensed Consolidated Statements of Income

(Unaudited)

	Three Months Ended September 30,					Nine Months Ended September 30,
(in thousands, except per share data)	2012			2011		2012			2011
Interest Income
Loans	$	2,126		$	2,122	$	6,219		$	6,340
Investment securities		33			10		102			76
Interest-earning deposits with financial institutions		5			9		9			23
Total interest income		2,164			2,141		6,330			6,439
Interest Expense
Deposits		110			137		346			425
Federal Home Loan Bank advances		28			29		85			108
Total interest expense		138			166		431			533
Net Interest Income		2,026			1,975		5,899			5,906
Provision for loan losses		60			60		240			313
Net interest income after provision for loan losses		1,966			1,915		5,659			5,593
Noninterest Income
Mortgage servicing income (expense)		(2	)		93		149			260
Service charges on deposit accounts		156			171		489			487
Other service charges and fees		73			70		199			193
Gain on sale of loans		134			88		331			217
Gain on sale of investment securities available for sale		15			-		15			-
Total noninterest income		376			422		1,183			1,157
Noninterest Expense
Compensation and benefits		1,150			1,084		3,409			3,331
Occupancy and equipment		369			332		1,064			995
Data processing		70			70		203			208
Professional and consulting fees		117			84		425			364
Marketing and public relations		70			50		181			166
Real estate owned and repossessed assets, net		(13	)		36		237			22
FDIC assessment		54			55		208			224
Other		322			262		855			734
Total noninterest expense		2,139			1,973		6,582			6,044
Income before provision for income taxes		203			364		260			706
Provision for income taxes		80			-		104			-
Net income	$	123		$	364	$	156		$	706
Preferred stock dividend and discount accretion
Preferred stock dividends		60		$	60		180		$	181
Preferred stock discount accretion		18			17		54			51
Net income (loss) available to common shareholders	$	45		$	287	$	(78	)	$	474
Income (Loss) per common share:
Basic	$	0.07		$	0.44	$	(0.12	)	$	0.72
Diluted		0.06			0.39	$	(0.12	)	$	0.65
See selected notes to condensed consolidated interim financial statements.

4

Alaska Pacific Bancshares, Inc. and Subsidiary

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

	Three Months Ended September 30,					Nine Months Ended September 30,
(in thousands, except per share data)	2012			2011		2012			2011
Net income (loss) available to common shareholders	$	45		$	287	$	(78	)	$	474
Other comprehensive income (loss)
Net unrealized gains on investment securities available for sale, net of tax		11			36		33			46
Reclassification adjustment for net gains on sale of investment securities available for sale realized in earnings (net of tax expense $6 for the three months ended September 30, 2012, and net of tax expense of $6 for the nine months ended September 30, 2012)		(9	)		-		(9	)		-
Comprehensive income (loss)	$	47		$	323	$	(54	)	$	520

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Alaska Pacific Bancshares, Inc. and Subsidiary

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Nine Months Ended September 30,
(in thousands)	2012			2011
Operating Activities
Net income	$	156		$	706
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		240			313
Gain on sale of loans		(331	)		(217	)
Fair value valuation adjustment mortgage servicing rights		96			7
Depreciation and amortization		218			207
Amortization of fees, discounts, and premiums, net		(92	)		(133	)
Stock compensation expense		8			12
(Gain) Loss on sale and impairment of real estate owned and repossessed assets		194			(39	)
Gain on sale of investment securities available for sale		(15	)		-
Loans originated for sale		(18,463	)		(16,898	)
Proceeds from sale of loans originated for sale		19,297			16,951
Cash provided by (used in) changes in operating assets and liabilities:
Interest receivable		(2	)		75
Other assets		(342	)		654
Advances from borrowers for taxes and insurance		(478	)		(403	)
Interest payable		1			(28	)
Accounts payable and accrued expenses		419			(496	)
Other liabilities		(73	)		137
Net cash provided by operating activities		833			848
Investing Activities
Purchase of investment securities available for sale		(258	)		(4,119	)
Proceeds from sale of investment securities available for sale		569			-
Maturities and principal repayments of investment securities available for sale, net		467			419
Proceeds from FHLB stock redemption		16			-
Loan originations, net of principal repayments		(2,979	)		(3,666	)
Proceeds from sale of real estate owned and repossessed assets		452			891
Purchase of premises and equipment		(1,064	)		(116	)
Net cash used in investing activities		(2,797	)		(6,591	)
Financing Activities
Net decrease in Federal Home Loan Bank advances		-			(2,000	)
Net increase in demand and savings deposits		12,292			7,899
Net decrease in certificates of deposit		(4,112	)		(3,526	)
Cash dividends paid on preferred stock		(180	)		(300	)
Net cash provided by financing activities		8,000			2,073
Increase (Decrease) in cash and cash equivalents		6,036			(3,670	)
Cash and cash equivalents at beginning of period		11,058			21,023
Cash and cash equivalents at end of period	$	17,094		$	17,353
Supplemental information:
Cash paid for interest	$	430		$	561
Net cash paid for (received from) income taxes		320			(222	)
Loans foreclosed and transferred to real estate owned and repossessed assets		156			435
Net change in fair value of securities available for sale, net of tax		24			46
Accrued dividends on Series A preferred stock issued to United States Department of Treasury
in Troubled Asset Relief Program Capital Purchase Plan		31			31

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Alaska Pacific Bancshares, Inc. and Subsidiary

Selected Notes to Condensed Consolidated Interim Financial Statements

(Unaudited)

Note 1 – Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Alaska Pacific Bancshares, Inc. (the “Company”) and its wholly owned subsidiary, Alaska Pacific Bank (the “Bank”), and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and to general practices within the financial institutions industry, where applicable.  All significant intercompany balances have been eliminated in the consolidation.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  They should be read in conjunction with the audited consolidated financial statements included in the Form 10-K for the year ended December 31, 2011.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included pursuant to the requirements of the Securities and Exchange Commission (“SEC”) for interim reporting.  The results of operations for the interim periods ended September 30, 2012, are not necessarily indicative of the results which may be expected for an entire year or any other period.  In preparing these financial statements, the Company has evaluated events and transactions subsequent to September 30, 2012 for potential recognition and disclosure.

Certain amounts in prior-period consolidated financial statements have been reclassified to conform to the current-period presentation.  These reclassifications had no effect on net income (loss) or shareholders’ equity.

Note 2 – Mortgage Loan Servicing

The Company generally retains the right to service mortgage loans sold to others.  The unpaid principal balance of loans serviced for others at September 30, 2012 and December 31, 2011 were $138.0 million and $138.5 million, respectively.  The Company accounts for mortgage servicing rights (“MSR”) in accordance with Accounting Standards Codification (“ASC”) 860-50, Servicing Assets and Liabilities, which provides an election to record changes in fair value to be reported in earnings in the period in which the change occurs.  The Company uses a model derived valuation methodology to update the estimate of fair value of the MSR obtained from an independent financial advisor on an annual basis.  The annual valuation is reviewed on a quarterly basis for significant changes in assumptions and current market rates.  The model pools loans into tranches of homogeneous characteristics and performs a present value analysis of the expected future cash flows.  The tranches are created by individual loan characteristics such as note rate, product type, and the remittance schedule.  Current market rates are utilized for discounting the future cash flows.  Significant assumptions used in the annual valuation of the MSR include discount rates, projected repayment speeds, escrow calculations, ancillary income, delinquencies and option adjusted spreads.

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Key assumptions used in measuring the fair value of the MSR as of September 30, 2012 and 2011 were as follows:

(in thousands)	September 30,
	2012			2011
Constant prepayment rate		18.56	%		16.83	%
Discount rate		8.08	%		7.94	%
Weighted average life (years)		23.6			23.9

The change in the balance of mortgage servicing assets is included in the following table:

	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands)	2012			2011			2012			2011
Balance beginning of period	$	1,085		$	1,235		$	1,098		$	1,242
Change in fair value:
Due to additions to servicing assets		78			43			253			111
Due to payoffs of servicing assets		(76	)		(43	)		(215	)		(111	)
Fair value adjustment		(85	)		-			(134	)		(7	)
Total change in fair value		(83	)		-			(96	)		(7	)
Balance end of period	$	1,002		$	1,235		$	1,002		$	1,235

Note 3 – Fair Value Measurements

We have elected to record certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP standard (ASC 820, Fair Value Measurements and Disclosures) establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements.  The standard requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions.  These two types of inputs create the following fair value hierarchy:

Level 1 - Unadjusted quoted prices for identical instruments in active markets;

Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable; and

Level 3 - Instruments whose significant value drivers are unobservable.

An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

8

The following table sets forth the Company’s assets and liabilities by level within the fair value hierarchy that were measured at fair value on a recurring and non-recurring basis at September 30, 2012 and December 31, 2011.

(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs  (Level 3)
September 30, 2012:
Recurring:
Available for sale securities:
Mortgage-backed securities	$	1,970	$	-	$	1,970	$	-
Municipal securities		1,417		-		1,417		-
U.S. government agencies		1,581		-		1,581		-
Mortgage servicing rights		1,002		-		-		1,002
Non-recurring:
Impaired loans		1,946		-		-		1,946
Real estate owned and repossessed assets		390		-		-		390
December 31, 2011:
Recurring:
Available for sale securities:
Mortgage-backed securities	$	2,421	$	-	$	2,421	$	-
Municipal securities		1,706		-		1,706		-
U.S. government agencies		1,587		-		1,587		-
Mortgage servicing rights		1,098		-		-		1,098
Non-recurring:
Impaired loans		2,045		-		-		2,045
Real estate owned and repossessed assets		880		-		-		880

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For the three months ended September 30, 2012, the changes in Level 3 assets and liabilities measured at fair value on a recurring (MSR) and non-recurring (impaired loans and real estate owned and repossessed assets) basis were as follows:

(in thousands)	Mortgage Servicing Rights			Impaired Loans			Real Estate Owned and  Repossessed Assets
Balance as of June 30, 2012	$	1,085		$	1,982		$	258
Additions to servicing assets, net		2			-			-
Principal repayments		-			(36	)		-
Proceeds from sale of real estate owned and repossessed assets		-			-			(41	)
Loans foreclosed and transferred to real estate owned and repossessed assets		-			-			156
Fair value adjustment		(85	)		-			-
Impairment and loss on sale of real estate owned and repossessed assets, net		-			-			17
Balance as of September 30, 2012	$	1,002		$	1,946		$	390

For the nine months ended September 30, 2012, the changes in Level 3 assets and liabilities measured at fair value on a recurring (MSR) and non-recurring (impaired loans and real estate owned and repossessed assets) basis were as follows:

(in thousands)	Mortgage Servicing Rights			Impaired Loans			Real Estate Owned and Repossessed Assets
Balance as of January 1, 2012	$	1,098		$	2,045		$	880
Additions to servicing assets, net		38			-			-
Principal repayments		-			(99	)		-
Proceeds from sale of real estate owned and repossessed assets		-			-			(452	)
Loans foreclosed and transferred to real estate owned and repossessed assets		-			-			156
Fair value adjustment		(134	)		-			-
Impairment and loss on sale of real estate owned and repossessed assets, net		-			-			(194	)
Balance as of September 30, 2012	$	1,002		$	1,946		$	390

The following table presents the total losses resulting from nonrecurring fair value adjustments for the periods presented:

	Three Months Ended September 30,		Nine Months Ended September 30,
(in thousands)	2011		2011
Impaired loans *	$	96	$	668
Real estate owned and repossessed assets		-		1
Total	$	96	$	669

*Amounts include specific reserves on impaired loans at September 30, 2011.

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For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2012, the significant unobservable inputs used in the fair value measurements were as follows:

	Fair Value at September 30, 2012 (in thousands)		Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input
Mortgage servicing     rights	$	1,002	Discounted Cash Flow	Weighted Average Constant Prepayment Rate		19.0	%
				Weighted Average Discount Rate		8.0	%
Impaired loans		1,946	Appraised value less cost to sell, net of discount	Discount Rate Range		10% - 30	%
Real estate    owned and    repossessed    assets		390	Appraised value less cost to sell, net of discount	Discount Rate Range		10% - 30	%

The following table sets forth the estimated fair values of the Company’s financial instruments at September 30, 2012 and December 31, 2011:

(in thousands			Fair Value Measurements at September 30, 2012
	Carrying Amount		Level 1		Level 2		Level 3		Total
Financial Assets
Cash and cash equivalents	$	17,094	$	17,094	$	-	$	-	$	17,094
Investment securities available for sale		4,968		-		4,968		-		4,968
Federal Home Loan Bank stock		1,768		-		1,768		-		1,768
Loans, including held for sale, net		150,927		-		-		136,992		136,992
Interest receivable		587		-		587		-		587
Mortgage servicing rights		1,002		-		-		1,002		1,002
Financial Liabilities
Demand and savings deposits		125,903		-		125,903		-		125,903
Certificates of deposit		29,478		-		-		29,308		29,308
Federal Home Loan Bank advances		3,000		-		-		3,273		3,273
Interest payable		132		-		132		-		132

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(in thousands			Fair Value Measurements at December 31, 2011
	Carrying Amount		Level 1		Level 2		Level 3		Total
Financial Assets
Cash and cash equivalents	$	11,058	$	11,058	$	-	$	-	$	11,058
Investment securities available for sale		5,714		-		5,714		-		5,714
Federal Home Loan Bank stock		1,784		-		1,784		-		1,784
Loans, including held for sale, net		148,742		-		-		129,941		129,941
Interest receivable		585		-		585		-		585
Mortgage servicing rights		1,098		-		-		1,098		1,098
Financial Liabilities
Demand and savings deposits		113,611		-		113,611		-		113,611
Certificates of deposit		33,590		-		-		33,888		33,888
Federal Home Loan Bank advances		3,000		-		-		3,111		3,111
Interest payable		131		-		131		-		131

The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

Cash, cash equivalents, and accrued interest:  The fair value of cash and cash equivalents and accrued interest is estimated to be equal to the carrying value, due to their short-term nature.

Investment Securities:  Securities available-for-sale are recorded at fair value on a recurring basis.  Fair values are based on quoted market prices, where available.  If quoted market prices are not available, fair values are estimated based on quoted market prices of comparable instruments with similar characteristics.  Changes in fair market value are recorded in other comprehensive income.

Mortgage servicing rights:  MSR are measured at fair value on a recurring basis.  These assets are classified as Level 3 as quoted prices are not available and the Company uses a model derived valuation methodology to estimate the fair value of MSR obtained from an independent financial advisor on an annual basis.   The annual valuation is reviewed on a quarterly basis for significant changes in assumptions and current market rates.  The model pools loans into tranches of homogeneous characteristics and performs a present value analysis of the expected future cash flows.  The tranches are created by individual loan characteristics such as note rate, product type, and the remittance schedule.  Current market rate assumptions are utilized for discounting the future cash flows.

Impaired loans:  Impaired loans are measured at fair value on a non-recurring basis and included in the table are impaired loans with a current specific valuation allowance.  These assets are classified as Level 3 where significant value drivers are unobservable.  The fair value of impaired

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loans are determined using a discounted cash flow basis or the fair value of each loan’s collateral for collateral-dependent loans as determined by an appraisal of the property, less estimated costs related to liquidation of the collateral.  The appraisal amount may also be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business.  Impaired loans with a specific valuation allowance were $2.4 million at September 30, 2012 and $2.5 million at December 31, 2011 with estimated reserves for impairment of $473,000 on both dates.

Real estate owned and repossessed assets:  The $390,000 in real estate owned and repossessed assets at September 30, 2012, represents impaired real estate and repossessed assets that have been adjusted to fair value. Real estate owned and repossessed assets primarily represents real estate and other assets which the Bank has taken control of in partial or full satisfaction of loans. At the time of foreclosure, real estate owned and repossessed assets are recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell.  The fair value of real estate owned is determined by appraisal of the property, less estimated costs related to liquidation of the asset.  The appraisal amount may also be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the asset.  Fair value adjustments on real estate owned and repossessed assets are recognized in noninterest expense.

Federal Home Loan Bank (“FHLB”) stock:  The fair value of FHLB stock is considered to be equal to its carrying value, since it may be redeemed at that value.

Loans including held for sale, net:  The fair value of loans net of allowance for loan losses is estimated using present value methods which discount the estimated cash flows, including prepayments as well as contractual principal and interest, using current interest rates appropriate for the type and maturity of the loans.

Deposits and other liabilities:  The fair value disclosed for demand deposits, savings, and money market accounts are, by definition, equal to the amount payable on demand at the reporting date.  For accrued interest payable, fair value is considered to be carrying value.

Certificates of deposit:  The fair values of fixed-rate certificates of deposit are estimated using present value methods and current offering rates for such deposits.

FHLB advances:  The estimated fair value approximates carrying value for short-term borrowings. The fair value of long-term fixed-rate borrowings is estimated by discounting future cash flows using current interest rates for similar financial instruments.

13

Note 4 – Investment Securities Available for Sale

Amortized cost and fair values of investment securities available for sale, including mortgage-backed securities, are summarized as follows:

(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
September 30, 2012:
Mortgage-backed securities:	$	1,837	$	133	$	-		$	1,970
Municipal securities:		1,354		63		-			1,417
U.S. government agencies		1,568		13		-			1,581
Total	$	4,759	$	209		-		$	4,968
December 31, 2011:
Mortgage-backed securities:	$	2,303	$	118	$	-		$	2,421
Municipal securities:		1,668		38		-			1,706
U.S. government agencies		1,575		13		(1	)		1,587
Total	$	5,546	$	169	$	(1	)	$	5,714

There are no available for sale securities that are in an unrealized loss position at September 30, 2012.

Available for sale securities at December 31, 2011 that have been in a continuous unrealized loss position are as follows:

	Impaired less than 12 months					Impaired 12 months or more				Total
(in thousands)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Government Agencies	$	499	$	(1	)	$	-	$	-	$	499	$	(1	)

There were no securities with unrealized losses at September 30, 2012 and one security at December 31, 2011 which was an agency security issued by a U.S. government agency; collectability of principal and interest of these securities is considered to be reasonably assured.  The fair values of individual securities fluctuate significantly with interest rates and with market demand for securities with specific structures and characteristics.  Management does not consider these unrealized losses to be other than temporary because the Company does not intend to sell them and the Company will likely not be required to sell them.

No securities were designated as trading or held to maturity at September 30, 2012 or December 31, 2011.

The fair value and amortized cost of investment securities at September 30, 2012 is presented in the following table by contractual maturity.  Actual maturities may vary as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

14

in thousands	Fair Value Mortgage Backed Securities		Amortized Cost Mortgage Backed Securities		Fair Value Municipal Securities		Amortized Cost Municipal Securities		Fair Value U.S Government Agencies		Amortized Cost U.S Government Agencies
Maturing within 1 to 5 years	$	6	$	5		-		-	$	500	$	500
Maturing between 5 and 10 years		292		281		1,417		1,354		1,081		1,068
Maturing beyond 10 years		1,672		1,551		-		-		-		-
Total	$	1,970	$	1,837	$	1,417	$	1,354	$	1,581	$	1,568

The amortized cost and market value of investment securities pledged to secure public funds deposited with the Bank at September 30, 2012 was $4.8 million and $5.0 million, respectively.  The amortized cost and market value of investment securities pledged to secure public funds deposited with the Bank at December 31, 2011 were $5.5 million and $5.7 million, respectively.

There was one sale of securities during the nine months ended September 30, 2012 resulting in gain on sale of investment securities available for sale of $15,000.

15

At September 30, 2012 the Bank owned $1.8 million of stock of the FHLB of Seattle. As a condition of membership in the FHLB, the Bank is required to purchase and hold a certain amount of FHLB stock, which is based, in part, upon the outstanding principal balance of advances from the FHLB and is calculated in accordance with the Capital Plan of the FHLB.  FHLB stock has a par value of $100 per share, is carried at cost, and is subject to impairment testing per ASC 320-10-35.  In October 2010, the FHLB entered into a Stipulation and Consent to the Issuance of a Consent Order with the Federal Housing Finance Agency (Finance Agency). The Stipulation and Consent provides that the FHLB of Seattle agrees to a Consent Order issued by the Finance Agency, which requires the bank to take certain specified actions related to its business and operations. During 2012, the FHFA designated FHLB to be adequately capitalized and FHLB repurchased some of its outstanding capital stock.  The FHLB has communicated that it believes the calculation of risk-based capital under the current rules of the FHFA significantly overstates the market risk of the FHLB’s private label mortgage-backed securities in the current market environment and that it has enough capital to cover the risks reflected in the FHLB’s balance sheet. As a result, an “other than temporary impairment” has not been recorded for the Bank’s investment in FHLB stock. However, continued deterioration in the FHLB’s financial position may result in impairment in the value of those securities. Management will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of the Bank’s investment in FHLB stock.

Note 5 – Loans

Loans are summarized as follows:

(in thousands)	September 30,  2012		December 31, 2011
Real estate:
Permanent:
One- to four-family	$	22,163	$	24,554
Multifamily		3,032		2,951
Commercial nonresidential		71,248		70,926
Land		8,299		8,435
Construction:
One- to four-family		2,903		1,103
Commercial nonresidential		1,737		2,042
Commercial business		24,557		19,197
Consumer:
Home equity		9,907		11,532
Boat		4,657		5,011
Automobile		783		913
Other		1,168		1,102
Total loans	$	150,454	$	147,766

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Impaired Loans.  Loans are deemed to be impaired when management determines that it is probable that all amounts due under the contractual terms of the loan agreements will not be collectible in accordance with the original loan agreement. All problem-graded loans are evaluated for impairment.  Impairment is measured by comparing the fair value of the collateral or discounted cash flows to the recorded investment in the loan.  Impaired loans include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties.  These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

Impaired loans are set forth in the following table as of September 30, 2012.

(in thousands)	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance
Real estate:
Permanent:
One- to four-family	$	223	$	223	$	-	$	223	$	-
Multifamily		-		-		-		-		-
Commercial nonresidential		7,363		4,663		2,419		7,082		473
Land		2,021		2,021		-		2,021		-
Construction:
One- to four-family		-		-		-		-		-
Commercial nonresidential		-		-		-		-		-
Commercial business		1,535		1,535		-		1,535		-
Consumer:
Home equity		60		60		-		60		-
Boat		-		-		-		-		-
Automobile		-		-		-		-		-
Other		-		-		-		-		-
Total	$	11,202	$	8,502	$	2,419	$	10,921	$	473

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Impaired loans are set forth in the following table as of December 31, 2011.

(in thousands)	Unpaid  Contractual Principal Balance		Recorded  Investment With No Allowance		Recorded  Investment With Allowance		Total Recorded Investment		Related Allowance
Real estate:
Permanent:
One- to four-family	$	-	$	-	$	-	$	-	$	-
Multifamily		659		659		-		659		-
Commercial nonresidential		7,479		4,877		2,518		7,395		473
Land		2,237		2,224		-		2,224		-
Construction:

One- to four-family		-		-		-		-		-
Commercial nonresidential		-		-		-		-		-
Commercial business		1,626		1,626		-		1,626		-
Consumer:
Home equity		123		76		-		76		-
Boat		-		-		-		-		-
Automobile		-		-		-		-		-
Other		-		-		-		-		-
Total	$	12,124	$	9,462	$	2,518	$	11,980	$	473

The following table presents interest income recognized and average recorded investment of impaired loans for the period ended:

	Three Months Ended September 30, 2012				Three Months Ended September 30, 2011
(in thousands)	Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment
Real estate:
Permanent:
One- to four-family	$	-	$	223	$	-	$	75
Multifamily		-		-		6		666
Commercial nonresidential		73		7,126		84		8,009
Land		26		2,114		21		2,067
Construction:
One- to four-family		-		-		-		-
Commercial nonresidential		-		-		-		-
Commercial business		3		1,546		6		1,898
Consumer:
Home equity		-		60		-		41
Boat		-		-		-		-
Automobile		-		-		-		-
Other		-		-		-		-
Total	$	102	$	11,069	$	117	$	12,756

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	Nine Months Ended September 30, 2012				Nine Months Ended September 30, 2011
(in thousands)	Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment
Real estate:
Permanent:
One- to four-family	$	-	$	149	$	-	$	37
Multifamily		5		218		17		333
Commercial nonresidential		212		7,209		351		8,277
Land		62		2,150		80		2,044
Construction:
One- to four-family		-		-		-		-
Commercial nonresidential		-		-		-		-
Commercial business		14		1,578		51		1,290
Consumer:
Home equity		1		53		2		21
Boat		-		-		-		-

Automobile		-		-		-		-
Other		-		-		1		21
Total	$	294	$	11,357	$	502	$	12,023

Nonaccrual loans at September 30, 2012 and December 31, 2011, were as follows:

	September 30,		December 31,
(in thousands)	2012		2011
Commercial business	$	1,549	$	1,449
Real Estate:
One- to four-family		223
Commercial nonresidential		3,802		957
Land		-		202
Consumer:
Home equity		60		37
Total	$	5,634	$	2,645

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Troubled Debt Restructurings.  Troubled debt restructured loans are loans for which the Company, for economic or legal reasons related to the borrower’s financial condition, has granted a significant concession to the borrower that it would otherwise not consider.  The Company accounts for troubled debt restructurings in accordance with ASU No. 2011-02.  Troubled debt restructurings of certain receivables identified are deemed impaired under the guidance of Section 310-10-35 of ASU No. 2011-02.  As of September 30, 2012 and December 31, 2011, the recorded investment in receivables that have been modified in a troubled debt restructuring and that are impaired was $9.0 million and $9.6 million, respectively.  Included in these amounts, the Company had $4.4 million and $9.6 million of troubled debt restructurings as of September 30, 2012 and December 31, 2011, respectively, which were performing in accordance with their modified loan terms.  The Company has not committed any additional amounts to lend to borrowers with loans considered to be troubled debt restructurings.

Modification Categories:  The Bank considers a variety of modifications to borrowers.  The types of modifications considered can generally be described in the following categories:

  ·   Rate Modification: A modification in which the interest rate is changed.

 ·  Term Modification:  A modification in which the maturity date, timing of payments, or frequency of payments is changed.

 ·  Interest Only Modification:  A modification in which the loan is converted to interest only payments for a period of time.

  ·  Payment Modification:  A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

    ·   Combination Modification:  Any other type of modification, including the use of multiple categories above.

The following table presents the accrual status of troubled debt restructurings as of September 30, 2012:

(dollars in thousands)	Number of Contracts		Accrual Status		Non- Accrual Status		Total Modifications
Real Estate:
Commercial nonresidential		11	$	3,280	$	3,802	$	7,082
Land		1		400		-		400
Commercial business		3		108		1,427		1,535
Total		15	$	3,788	$	5,229	$	9,017

The following table presents the accrual status of troubled debt restructurings as of December 31, 2011:

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(dollars in thousands)	Number of Contracts		Accrual Status		Non- Accrual Status		Total Modifications
Real Estate:
Commercial nonresidential		11	$	6,438	$	957	$	7,395
Land		3		400		202		602
Commercial business		4		177		1,427		1,604
Consumer:
Home equity		1		40		-		40
Total		19	$	7,055	$	2,586	$	9,641

There were no newly restructured loans that occurred during the three months ended September 30, 2012.

The following tables present newly restructured loans that occurred during the nine months ended September 30, 2012:

(dollars in thousands)	Number of Contracts		Payment Modification
Real Estate:
Commercial nonresidential		1	$	532

The following tables present newly restructured loans that occurred during the three and nine months ended September 30, 2011:

	Three months Ended September 30, 2011
(in thousands)	Term Modification
Land	$	400

	Nine months Ended September 30, 2011
(in thousands)	Term Modification
Real Estate:
Commercial nonresidential	$	2,009
Land		400
Total	$	2,409

There was one commercial business loan for $1.4 million and four commercial non-residential loans totaling $3.2 million modified as troubled debt restructuring within the previous 12 months for which there was a payment default.

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The Bank’s policy is that loans placed in nonaccrual may be restored to accrual status when delinquent principal and interest payments are brought current and future monthly principal and interest payments are expected to be collected.  In general, the Bank’s policy requires six months of payment performance in order for the loan to return to accrual status.

An age analysis of past due loans, segregated by class of loans, as of September 30, 2012 were as follows:

(in thousands)	Loans 30-59 Days Past Due		Loans 60-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate:
Permanent:
One- to four-   family	$	149	$	-	$	223	$	372	$	21,791	$	22,163	$	-
Multifamily		-		-		-		-		3,032		3,032		-
Commercial   nonresidential		750		3,725		807		5,282		65,966		71,248		-
Land		-		-		-		-		8,299		8,299		-
Construction:
One- to four-   family		-		-		-		-		2,903		2,903		-
Commercial   nonresidential		-		-		-		-		1,737		1,737		-
Commercial business		111		-		1,426		1,537		23,020		24,557		-
Consumer:
Home equity		9		-		60		69		9,838		9,907		-
Boat		-		-		-		-		4,657		4,657		-
Automobile		-		-		-		-		783		783		-
Other		-		-		-		-		1,168		1,168		-
Total	$	1,019	$	3,725	$	2,516	$	7,260	$	143,194	$	150,454	$	-

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An age analysis of past due loans, segregated by class of loans, as of December 31, 2011 were as follows:

(in thousands)	Loans 30-59 Days Past Due		Loans 60-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate:
Permanent:
One- to four-   family	$	-	$	-	$	-	$	-	$	24,554	$	24,554	$	-
Multifamily		-		-		-		-		2,951		2,951		-
Commercial    nonresidential		229		-		-		229		70,697		70,926		-
Land		-		-		-		-		8,435		8,435		-
Construction:
One- to four-   family		-		-		-		-		1,103		1,103		-
Commercial    nonresidential		-		-		-		-		2,042		2,042		-
Commercial business		-		-		-		-		19,197		19,197		-
Consumer:
Home equity		38		-		37		75		11,457		11,532		-
Boat		17		-		-		17		4,994		5,011		-
Automobile		8		-		-		8		905		913		-
Other		-		-		-		-		1,102		1,102		-
Total	$	292	$	-	$	37	$	329	$	147,437	$	147,766	$	-

Credit Quality / Risk Rating System:  The Bank utilizes a risk rating system to segment the risk profile of its loan portfolio. As part of this on-going monitoring system of the credit quality of the Bank’s loan portfolio, management tracks certain credit quality indicators including trends in past due and nonaccrual loans, gross and net charge-offs, and movement in loan balances within the risk classifications.  The Bank’s risk rating system is comprised of nine ranges (1-9) based upon industry best practice and regulator definitions. A brief summary of the general characteristics of the nine risk classes is as follows:

·   Ratings 1-2: Include loans with the highest credit quality based upon financial performance, high net worth borrowers, an industry category with very positive trends, collateral of readily marketable government securities, time certificates or cash value of life insurance, and other strong financial performance ratios.

·   Ratings 3-4: Include loans with satisfactory financial performance, adequate liquidity and compare favorably to industry performance measurements.  Loans in these categories are typically secured by real estate, inventory, accounts receivable or other collateral that may not be as easily converted to cash.  Loans graded a 4 might, for example, be loans where the borrower’s business is tied to a cyclical or seasonal industry such as tourism or fishing.

·   Rating 5:  This is a “Pass/Watch” category requiring additional management attention.  These are performing loans where there is still no perception of unwarranted or undue credit risk, but

23

because of external events in the marketplace, management change, a shift in financial performance or other conditions, which if not addressed could cause further problems.  This is typically a temporary classification.

·   Rating 6:  These are “Special Mention” loans which are currently performing as agreed but have developed a financial weakness, which if not corrected, pose unwarranted risk to the institution. This classification is used when the degree of risk initially evaluated has increased beyond conditions that would have prevented the loan from being originated initially. Prompt corrective action is needed.

·   Rating 7:  These are “Substandard” loans which are no longer protected by adequate cash flow, net worth, or collateral.  There is a well-defined weakness that jeopardizes the repayment of the debt and subjects the institution to the possibility of loss.  Loans in this category may or may not have specific valuation allowance assigned to the loan depending on conditions.

·   Ratings 8:  These are loans classified as “Doubtful” which, based upon a variety of negative conditions, will more than likely result in a loss if a set of events do not occur.  These loans have specific valuation allowance to the extent of the calculated impairment.

·   Ratings 9:  These are loans classified as “Loss”.  They are to be charged-off or charged-down because that repayment is uncertain or when the timing or value of payments cannot be determined.  This classification does not imply that the loan will never be paid, nor does it imply that there has been a forgiveness of debt, but does indicate that the value will not be carried on the books of the institution as an earning asset.

The loan portfolio, segmented by risk range at September 30, 2012, is shown below:

	Weighted Average Risk Grade
(in thousands)		1 - 4		5 - 6		7 - 9	Total Loans
Real estate:
Permanent:
One- to four-family	$	21,896	$	44	$	223	$	22,163
Multifamily		2,388		644		-		3,032
Commercial nonresidential		61,162		6,098		3,988		71,248
Land		6,278		-		2,021		8,299
Construction:
One- to four-family		2,903		-		-		2,903
Commercial nonresidential		1,737		-		-		1,737
Commercial business		22,048		628		1,881		24,557
Consumer:
Home equity		9,847		-		60		9,907
Boat		4,657		-		-		4,657
Automobile		783		-		-		783
Other		1,168		-		-		1,168
Total	$	134,867	$	7,414	$	8,173	$	150,454

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The loan portfolio, segmented by risk range at December 31, 2011, is shown below:

	Weighted Average Risk Grade
(in thousands)		1 - 4		5 - 6		7 - 9	Total Loans
Real estate:
Permanent:
One- to four-family	$	24,506	$	48	$	-	$	24,554
Multifamily		2,292		659		-		2,951
Commercial nonresidential		62,206		4,689		4,031		70,926
Land		5,879		333		2,223		8,435
Construction:
One- to four-family		1,103		-		-		1,103
Commercial nonresidential		2,042		-		-		2,042
Commercial business		16,524		1,118		1,555		19,197
Consumer:
Home equity		11,495		-		37		11,532
Boat		5,011		-		-		5,011
Automobile		913		-		-		913
Other		1,102		-		-		1,102
Total	$	133,073	$	6,847	$	7,846	$	147,766

The Bank’s Asset Classification Policy requires an ongoing quarterly assessment of the probable estimated losses in the portfolios.  The Bank’s Asset Classification Committee reviews the following information to analyze the credit risk inherent in the Bank’s portfolio:

·   All loans classified during the previous analysis. Current information as to payment history or actions taken to correct the deficiency is reviewed, and if justified, the loan is no longer classified. If conditions have not improved, the loan classification is reviewed to ensure that the appropriate action is being taken to mitigate loss.

·   Growth and composition of the portfolio.  The Committee considers changes in composition of loan portfolio and the relative risk of these loan portfolios in assessing the adequacy of the allowance.

·   Historical loan losses.  The Committee reviews the Bank’s historical loan losses and historical industry losses in considering losses inherent in the Bank’s loan portfolio.

·   Past due loans.  The Committee reviews loans that are past due 30 days or more, taking into consideration the borrower, nature of the collateral and its value, the circumstances that have caused the delinquency, and the likelihood of the borrower correcting the conditions that have resulted in the delinquent status. The Committee may recommend

25

more aggressive collection activity, inspection of the collateral, or no change in its classification.

·   Reports from the Bank’s managers and analysis of potential problem loans.  Lending managers may be aware of a borrower’s circumstances that have not yet resulted in any past due payments but has the potential for problems in the future.  Each lending manager reviews their respective lending unit’s loans and identifies any that may have developing weaknesses. This “self identification” process is an important component of maintaining credit quality, as each lender is accountable for monitoring as well as originating loans.

·   Current economic conditions. The Bank takes into consideration economic conditions in its market area, the state’s economy, and national economic factors that could influence the quality of the loan portfolio in general. The unique, isolated geography of the Bank’s market area of Southeast Alaska requires that each community’s economic activity be reviewed.  The Bank also reviews out of market economic data associated with participation loans and their respective markets.

·   Trends in the Bank’s delinquencies.  The Bank’s market area has seasonal trends and as a result, the portfolio tends to have similar fluctuations. Prior period statistics are reviewed and evaluated to determine if the current conditions exceed expected trends.

Our methodology for assessing the appropriateness of the allowance for loan loss reserves consists of several key elements, which include specific allowances for individual loans, general loan loss reserves and an unallocated allowance.  Theamount that is to be added to the allowance for loan losses is based upon a variety of factors.  An important component is a loss percentage set for each major category of loan that is based upon the Bank’s past loss experience.  In certain instances, the Bank’s own loss experience has been minimal, and the related loss factor is modified based on consideration of published national loan loss data.  The loss percentages are also influenced by economic factors as well as management experience.

Each individual loan, previously classified by management or newly classified during the quarterly review, is evaluated for loss potential, and any specific estimates of impairment are added to the overall required reserve amount.  As a result of the size of the Company, the size of the loan portfolio, and the relatively small number of classified loans, most members of the Asset Classification Committee are often familiar with the borrower, the collateral or the circumstances giving rise to the concerns.  For the remaining portion of the portfolio, comprised of “pass” loans, the loss percentages discussed above are applied to each loan category.

The calculated reserve amount as re-evaluated by management is compared to the actual amount recorded in the allowance at the end of each quarter, and a determination is made as to whether the allowance is adequate or needs to be increased.  Management’s determination of adequacy may be reflected as an adjustment to the reserve that is unallocated to a major category of loan.    The unallocated allowance is based upon our evaluation of various factors that are not directly measured in the determination of the general and specific allowances.  Management increases the amount of the allowance for loan losses by charges to income and decreases it by loans (charged off) net of recoveries.

26

The following table details activity in the allowance for loan losses by class for the three months ended September 30, 2012.  Allocation of a portion of the allowance to one class of loans does not preclude its availability to absorb losses in other categories.

													Period end allowance amount allocated to:
(in thousands)	Beginning balance		Provision for loan losses			Charge offs			Recoveries		Ending balance		Loans individually  evaluated for impairment		Loans collectively evaluated for impairment
Real estate:
Permanent:
One-to-four-   family	$	104	$	(11	)	$	-		$	-	$	93	$	-	$	93
Multifamily		17		1			-			-		18		-		18
Commercial    nonresidential		1,230		(106	)		-			-		1,124		473		651
Land		13		32			(30	)		-		15		-		15
Construction:
One-to-four-   family		4		1			-			-		5		-		5
Multifamily		-		-			-			-		-		-		-
Commercial    nonresidential		5		(2	)		-			-		3		-		3
Commercial business		271		(133	)		(19	)		-		119		-		119
Consumer:
Home equity		37		(2	)		-			-		35		-		35
Boat		30		(2	)		-			-		28		-		28
Automobile		2		(1	)		-			-		1		-		1
Other		2		-			-			-		2		-		2
Unallocated		129		283			-			-		412		-		412
Total allowance for loan    losses	$	1,844	$	60		$	(49	)	$	-	$	1,855	$	473	$	1,382

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The following table details activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2011.  Allocation of a portion of the allowance to one segment of loans does not preclude its availability to absorb losses in other categories.

													Period end allowance amount allocated to:
(in thousands)	Beginning balance		Provision for loan losses			Charge offs			Recoveries		Ending balance		Loans  individually evaluated for impairment		Loans collectively evaluated for impairment
Real estate:
Permanent:
One-to-four-   family	$	92	$	85		$	-		$	-	$	177	$	85	$	92
Multifamily		3		2			-			-		5		-		5
Commercial    non-residential		1,219		73			-			-		1,292		583		709
Land		10		3			-			-		13		-		13
Construction:
One-to-four-   family		2		-			-			-		2		-		2
Commercial    nonresidential		2		-			-			-		2		-		2
Commercial		580		(165	)		-			-		415		-		415
Consumer:
Home equity		21		(2	)		-			2		21		-		21
Boat		34		3			(2	)		-		35		-		35
Automobile		4		(3	)		-			-		1		-		1
Other		1		2			-			-		3		-		3
Unallocated		11		62			-			-		73		-		73
Total allowance for loan    losses	$	1,979	$	60		$	(2	)	$	2	$	2,039	$	668	$	1,371

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The following table details activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2012.  Allocation of a portion of the allowance to one segment of loans does not preclude its availability to absorb losses in other categories.

(in thousands)	Beginning balance		Provision for loan losses			Charge offs			Recoveries		Ending balance
Real estate:
Permanent:
One-to-four-family	$	102	$	(9	)	$	-		$	-	$	93
Multifamily		5		13			-			-		18
Commercial non-residential		1,223		67			(166	)		-		1,124
Land		13		32			(30	)		-		15
Construction:
One-to-four-family		2		3			-			-		5
Multifamily		-		-			-			-		-
Commercial nonresidential		4		(1	)		-			-		3
Commercial		216		(78	)		(19	)		-		119
Consumer:
Home equity		26		46			(37	)		-		35
Boat		34		(8	)		-			2		28
Automobile		2		(1	)		-			-		1
Other		3		(1	)		-			-		2
Unallocated		235		177			-			-		412
Total allowance for loan losses	$	1,865	$	240		$	(252	)	$	2	$	1,855

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The following table details activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2011.  Allocation of a portion of the allowance to one segment of loans does not preclude its availability to absorb losses in other categories.

(in thousands)	Beginning balance		Provision for loan losses			Charge offs			Recoveries		Ending balance
Real estate:
Permanent:
One-to-four-family	$	73	$	119		$	(15	)	$	-	$	177
Multifamily		14		(9	)		-			-		5
Commercial non-residential		858		434			-			-		1,292
Land		11		2			-			-		13
Construction:
One-to-four-family		4		(2	)		-			-		2
Multifamily		-		-			-			-		-
Commercial nonresidential		3		(251	)		-			250		2
Commercial		537		(118	)		(4	)		-		415
Consumer:
Home equity		23		86			(90	)		2		21
Boat		29		12			(6	)		-		35
Automobile		4		(9	)		-			6		1
Other		3		-			-			-		3
Unallocated		24		49			-			-		73
Total allowance for loan losses	$	1,583	$	313		$	(113	)	$	256	$	2,039

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The Company’s recorded investment in loans as of September 30, 2012 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Company’s impairment methodology was as follows:

(in thousands)	Loans individually  evaluated for impairment		Loans collectively evaluated for impairment		Ending Balance
Real estate:
Permanent:
One-to-four-family	$	223	$	21,940	$	22,163
Multifamily		-		3,032		3,032
Commercial nonresidential		7,082		64,166		71,248
Land		2,021		6,278		8,299
Construction:
One-to-four-family		-		2,903		2,903
Commercial nonresidential		-		1,737		1,737
Commercial business		1,535		23,022		24,557
Consumer:
Home equity		60		9,847		9,907
Boat		-		4,657		4,657
Automobile		-		783		783
Other		-		1,168		1,168
Total loans	$	10,921	$	139,533	$	150,454

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The Company’s recorded investment in loans as of December 31, 2011 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Company’s impairment methodology was as follows:

2011 (in thousands)	Loans individually evaluated for impairment		Loans collectively evaluated for impairment		Ending Balance
Real estate:
Permanent:
One-to-four-family	$	-	$	24,554	$	24,554
Multifamily		659		2,292		2,951
Commercial non-residential		7,395		63,531		70,926
Land		2,224		6,211		8,435
Construction:
One-to-four-family		-		1,103		1,103
Commercial nonresidential		-		2,042		2,042
Commercial		1,626		17,571		19,197
Consumer:
Home equity		76		11,456		11,532
Boat		-		5,011		5,011
Automobile		-		913		913
Other		-		1,102		1,102
Total loans	$	11,980	$	135,786	$	147,766

Note 6 – Capital Compliance

At September 30, 2012, the Bank exceeded each of the three current minimum quantitative regulatory capital requirements under the “prompt corrective action” regulatory framework.  The following table summarizes the Bank's regulatory capital position and minimum requirements under the “prompt corrective action” regulatory framework at September 30, 2012 and December 31, 2011:

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(in thousands)	Capital	Capital Ratio
September 30, 2012:
Tier 1 Leverage Capital:
Actual	$20,181	11.28%
Required	7,159	4.00
Excess	$13,022	7.28%
Tier 1 Risk Based Capital:
Actual	$20,181	14.63%
Required	5,517	4.00
Excess	$14,664	10.63%
Total Risk-Based Capital:
Actual	$21,907	15.88%
Required	11,034	8.00
Excess	$10,873	7.88%
December 31, 2011:
Tangible Capital:
Actual	$20,209	11.81%
Required	2,567	1.50
Excess	$17,642	10.31%
Tier 1 Leverage Capital:
Actual	$20,209	11.81%
Required	6,846	4.00
Excess	$13,363	7.81%
Total Risk-Based Capital:
Actual	$21,843	16.71%
Required	10,458	8.00
Excess	$11,385	8.71%

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Note 7 – Earnings (Loss) Per Share

Basic earnings (loss) per share (“EPS”) is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the period less treasury stock. Diluted EPS is calculated by dividing net income (loss) by the weighted-average number of common shares used to compute basic EPS plus the incremental amount of potential common stock from stock options, determined by the treasury stock method.

	Three Months Ended September 30,
(in thousands except for per share data)	2012			2011
Net income	$	123		$	364
Preferred stock dividends		(60	)		(60	)
Preferred stock discount accretion		(18	)		(17	)
Net income available to common shareholders	$	45		$	287
Weighted average common shares issued		655			655
Less treasury stock		(1	)		(1	)
Weighted average common shares outstanding - basic		654			654
Net incremental shares		91			75
Weighted average common shares outstanding and incremental shares due to potentially dilutive common shares		745			729
Earnings per common share
Basic	$	0.07		$	0.44
Diluted	$	0.06		$	0.39

	Nine Months Ended September 30,
	2012			2011
Net income	$	156		$	706
Preferred stock dividend accrual		(180	)		(181	)
Preferred stock discount accretion		(54	)		(51	)
Net income (loss) available to common shareholders	$	(78	)	$	474
Weighted average common shares issued		655			655
Less treasury stock		(1	)		(1	)
Weighted average common shares outstanding - basic		654			654

Net incremental shares		81			76
Weighted average common shares outstanding and incremental shares due to potentially dilutive common shares		736			731
Earnings (loss) per common share
Basic	$	(0.12	)	$	0.72
Diluted	$	(0.12	)	$	0.65

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Options to purchase an additional 23,000 shares of common stock were not included in the computation of diluted earnings per share for the three and nine months ended September 30, 2012 and 2011, respectively, because their exercise price resulted in them being anti-dilutive.  The warrant issued to the U.S. Treasury to purchase up to 175,772 shares of common stock was included in the computation of diluted EPS for the three and nine months ended September 30 2012 and 2011, respectively, because the warrant’s exercise price was less than the average market price of the Company’s common shares during those periods.

Note 8 – Preferred Stock

On February 6, 2009, as part of the TARP Capital Purchase Program, the Company entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with the United States Department of the Treasury (“Treasury”), pursuant to which the Company sold (i) 4,781 shares of the Company’s Series A Preferred Stock and (ii) a warrant (the “Warrant”) to purchase 175,772 shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), for an aggregate issuance price of $4.8 million in cash.

The Series A Preferred Stock qualifies as Tier 1 capital and is entitled to cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Series A Preferred Stock may be redeemed by the Company after three years. Prior to the end of three years, the Series A Preferred Stock may be redeemed by the Company only with proceeds from the sale of qualifying equity securities of the Company (a “Qualified Equity Offering”). The restrictions on redemption are set forth in the Certificate of Designation attached to the Statement of Establishment and Designation of Series of Preferred Stock, which amends the Company’s Articles of Incorporation (the “Certificate of Designation”).

The Warrant has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $4.08 per share of the Common Stock.  Treasury has agreed not to exercise voting power with respect to any shares of Common Stock issued upon exercise of the Warrant that it holds.

Pursuant to the terms of the Purchase Agreement, the ability of the Company to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its Junior Stock (as defined below) and Parity Stock (as defined below) is subject to restrictions, including a restriction against increasing dividends from the last quarterly cash dividend per share ($0.10) declared on the Common Stock prior to February 6, 2009. The redemption, purchase or other acquisition of trust preferred securities of the Company or its affiliates also is restricted. These restrictions will terminate on the earlier of (a) the third anniversary of the date of issuance of the Series A Preferred Stock, (b) the date on which the Series A Preferred Stock has been redeemed in whole, and (c) the date Treasury has transferred all of the Series A Preferred Stock to third parties.

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In addition, pursuant to the Certificate of Designation, the ability of the Company to declare or pay dividends or distributions on, or repurchase, redeem or otherwise acquire for consideration, shares of its Junior Stock and Parity Stock is subject to restrictions in the event that the Company fails to declare and pay full dividends (or declare and set aside a sum sufficient for payment thereof) on its Series A Preferred Stock.

“Junior Stock” means the Common Stock and any other class or series of stock of the Company the terms of which expressly provide that it ranks junior to the Series A Preferred Stock as to dividend rights and/or rights on liquidation, dissolution or winding up of the Company. “Parity Stock” means any class or series of stock of the Company the terms of which do not expressly provide that such class or series will rank senior or junior to the Series A Preferred Stock as to dividend rights and/or rights on liquidation, dissolution or winding up of the Company (in each case without regard to whether dividends accrue cumulatively or non-cumulatively).

In accordance with the relevant accounting pronouncements, the Company recorded the Series A Preferred Stock and Warrants within Shareholders’ Equity on the Consolidated Balance Sheets. The Series A Preferred Stock and Warrants were initially recognized based on their relative fair values at the date of issuance. As a result, the Series A Preferred Stock’s carrying value is at a discount to the liquidation value or stated value. In accordance with the SEC’s Staff Accounting Bulletin No. 68, Increasing Rate Preferred Stock, the discount is considered an unstated dividend cost that is amortized over the period preceding commencement of the perpetual dividend using the effective interest method, by charging the imputed dividend cost against retained earnings and increasing the carrying amount of the Series A Preferred Stock by a corresponding amount. The discount is therefore being amortized over five years using a 6.71% effective interest rate. The total stated dividends (whether or not declared) and unstated dividend cost combined represents a period’s total preferred stock dividend, which is deducted from net income (loss) to arrive at net income (loss) available to common shareholders on the Condensed Consolidated Statements of Income.

The Company may not declare or pay dividends on its Common Stock or, with certain exceptions, repurchase Common Stock without first having paid all cumulative preferred dividends that are due.  If dividends on the Series A Preferred Stock are not paid for six quarters, whether or not consecutive, the Treasury has the right to appoint two members to the Board of Directors of the Company.  The Company has paid all dividends payable and deferred dividends payable through September 30, 2012 on its Series A Preferred Stock.  There can be no assurances that our regulators will approve such payments or dividends in the future.

The Series A Preferred Stock and Warrants were initially recognized based on their relative fair values at the date of issuance in accordance with ASU 470-20, Debt with Conversion and Other Topics.  As a result, the value allocated to the Warrant is different than the estimated fair value of

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the Warrant as of the grant date. The following assumptions were used to determine the fair value of the Warrant as of the grant date:

Dividend yield 1.50%

Expected life (years) 10.0

Expected volatility 37%

Risk-free rate 3.05%

Fair value per warrant at grant date $ 4.15

Note 9 – Commitments

Commitments to extend credit, including unused lines of credit, totaled $9.5 million and $10.6 million at September 30, 2012 and December 31, 2011, respectively.  Commitments to extend credit are arrangements 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 (of less than one year) or other termination clauses and may require payment of a fee by the customer.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Bank evaluates creditworthiness for commitments on an individual customer basis.

Undisbursed loan proceeds, primarily for real estate construction loans, totaled $3.0 million and $4.2 million at September 30, 2012 and December 31, 2011, respectively.  These amounts are excluded from loan balances.

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

Forward-Looking Statements

This discussion contains forward-looking statements which are based on assumptions and describe future plans, strategies and expectations of the Company.  These forward-looking statements are generally identified by use of the word “believe,” “expect,” “intend,” anticipate,” “estimate,” “project,” or similar words.  The Company’s ability to predict results or the actual effect of future plans or strategies is uncertain.   These forward-looking statements relate to, among other things, expectations of the business environment in which we operate, projections of future performance, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs that may be impacted by deterioration in the housing and commercial real estate markets and may lead to increased losses and non-performing assets in our loan portfolio, result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our reserves; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; deposit flows; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; adverse changes in the securities markets; results of examinations by our banking regulators including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; the possibility that we will be unable to comply with the conditions imposed upon us in the Order entered into with the OTS, as determined by its successor, the Federal Reserve; computer systems on which we depend could fail or experience a security breach, or the implementation of new technologies may not be successful; our ability to retain key members of our senior management team; legislative or regulatory changes such as the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and implementing regulations that adversely affect our business including changes in regulatory policies and principles, and the interpretation of regulatory capital or other rules including changes related to Basel III; the time it may take to lease excess space in Company-owned buildings; future legislative changes in the United States Department of Treasury TARP Capital Purchase Program; and other risks detailed in our reports filed with the SEC, including our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.  Accordingly, these factors should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements.  We undertake no responsibility to update or revise any forward-looking statements.

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Regulatory Matters

On September 28, 2010, the Company each entered into a Stipulation and Consent to the Issuance of an Order to Cease and Desist with the OTS (individually an “Order” and collectively the “Orders”).  As a result of the elimination of the OTS on July 21, 2011, the Board of Governors of the Federal Reserve System (“FRB”), the Company’s new primary regulator, has continued to administer the Order.

Under the terms of the Order, the Company, without the prior written approval of the FRB, may not:

·     Pay dividends;

·     Repurchase shares of the Company’s outstanding Common Stock;

·     Issue any debt securities or incur any debt (other than that incurred in the normal course of business); and

·     Make payments on any existing debt.

Other material provisions of the Order require the Bank and the Company to:

·     develop a capital plan for preserving and enhancing capital levels that is acceptable to the Banking Regulators;

·     develop a business plan for enhancing, measuring and maintaining profitability, increasing earnings, acceptable to the Banking Regulators;

·     not appoint any new director or senior executive officer or change the responsibilities of any current senior executive officers without notifying the Banking Regulators;

·     not enter into, renew, extend or revise any compensation or benefit agreements for directors or senior executive officers;

·     not make any indemnification, severance or golden parachute payments;

·     ensure the Bank’s compliance with applicable laws, rules, regulations and agency guidelines, including the terms of the order; and

·     prepare and submit progress reports to the Banking Regulators regarding compliance with the capital plan, business plan

The Order will remain in effect until modified or terminated by the FRB.

All customer deposits remain fully insured to the fullest extent permitted by the FDIC. The Bank expects to continue to serve its customers in all areas including making loans, establishing lines of credit, accepting deposits and processing banking transactions.

For additional information regarding the terms of the Order, please see our Form 8-K that we filed with the SEC on October 4, 2010.  Further, we may be subject to more severe future regulatory enforcement actions, including but not limited to civil money penalties, if we do not comply with the terms of the Order.

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Critical Accounting Policies

The discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s condensed consolidated interim financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the financial statements.  The most significant estimates are the allowance for loan losses, valuation of real estate owned and repossessed assets, valuation of deferred tax assets and valuation of mortgage servicing rights.  Actual results may differ from these estimates under different assumptions or conditions.

Accounting for the allowance for loan losses involves significant judgment and assumptions by management, which has a material impact on the carrying value of net loans.  Management considers this accounting policy to be a critical accounting policy. We maintain an allowance for loan losses consistent, in all material respects, with the GAAP guidelines outlined in ASC 450, Contingencies.  The allowance has three components: (i) a formula allowance for groups of homogeneous loans, (ii) a specific valuation allowance for identified problem loans and (iii) an unallocated allowance. Each of these components is based upon estimates that can change over time.  The formula allowance is based primarily on historical experience and as a result can differ from actual losses incurred in the future.  The history is reviewed at least quarterly and adjustments are made as needed.  Various techniques are used to arrive at specific loss estimates, including historical loss information, discounted cash flows and fair market value of collateral.  The use of these techniques is inherently subjective and the actual losses could be greater or less than the estimates.  For further details, see “Results of Operations - Provision for Loan Losses” included in this Form 10-Q.

The allowance for loan losses represents management's best estimate of incurred credit losses inherent in the Company's loan portfolio as of the balance sheet date. The estimate of the allowance is based on a variety of factors, including past loan loss experience, the current credit profile of borrowers, adverse situations that have occurred that may affect a borrower's ability to meet their financial obligations, the estimated value of underlying collateral, general economic conditions, and the impact that changes in interest rates and employment conditions have on a borrower's ability to repay adjustable-rate loans.

The fair value of impaired loans is determined using a discounted cash flow basis or the fair value of each loan’s collateral for collateral-dependent loans as determined, when possible, by an appraisal of the property, less estimated costs related to liquidation of the collateral.  The appraisal amount may also be adjusted for current market conditions.  Adjustments to reflect the fair value of collateral-dependent loans are a component in determining our best estimate of the allowance for loan losses.

Interest is generally not accrued on any loan when its contractual payments are more than 90 days delinquent unless collection of interest is considered probable.  In addition, interest is not recognized on any loan where management has determined that collection is not reasonably

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assured.  A nonaccrual loan may be restored to accrual status when delinquent principal and interest payments are brought current and future monthly principal and interest payments are expected to be collected.

Real estate owned and repossessed assets primarily represents real estate and other assets which the Bank has taken control of in partial or full satisfaction of loans. At the time of foreclosure, real estate owned and repossessed assets are recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, management periodically performs valuations when possible, by an appraisal of the property, such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Fair value adjustments on real estate owned and repossessed assets are recognized within results of operations.

As of September 30, 2012 and December 31, 2011, the Company had recorded a net deferred income tax asset (which is included in other assets in the accompanying Condensed Consolidated Balance Sheets) of $496,000 and $544,000, respectively.  As of September 30, 2012 and December 31, 2011 the Company had a total valuation allowance of $94,000 against its deferred tax asset of $590,000 and $638,000, respectively, due to uncertainty about the Company’s ability to generate sufficient taxable income in the near term. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized.  “More likely than not” is defined as greater than a 50% probability of occurrence.  All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed.  Management’s assessment is primarily dependent on historical taxable income and projections of future taxable income, which are directly related to the Company’s core earnings capacity and its prospects to generate core earnings in the future.  In assessing the need for a valuation allowance, we examine our historical cumulative trailing three-year pre-tax income (loss) quarterly.  If we have historical cumulative income, we consider this to be strong positive evidence.  To the extent we do not have cumulative income, we examine this to determine if there were any unusual or non-recurring items which would not be indicative of our operating results or expected to occur in the future.  The Company will not be able to recognize the tax benefits on future losses until it can show that it is more likely than not that it will generate enough taxable income in future periods to realize the benefits of its deferred tax asset and loss carryforwards.

The Company, however, cannot give any assurance that in the future its deferred tax asset will not be impaired further since such determination is based on projections of future earnings, which are subject to uncertainty and estimates that may change given uncertain economic outlook, banking industry conditions and other factors.

The Company accounts for MSR in accordance with ASC 860-50, Servicing Assets and Liabilities, which provides that changes in fair value will be reported in earnings in the period in which the change occurs.  See Note 2 of the Selected Notes to Condensed Consolidated Interim

41

Financial Statements for information the Company’s methodology to estimate the fair value of MSR.

Recent Accounting Pronouncements

In September 2012, the FASB issued ASU No. 2012-03, Technical Amendments and Corrections to SEC Sections:  Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22.   This ASU amends various SEC paragraphs: (a) pursuant to the issuance of Staff Accounting Bulletin No. 114; (b) pursuant to the issuance of the SEC’s Final Rule, “Technical Amendments to Commission Rules and Forms Related to the FASB’s Accounting Standards Codification,” Release Nos. 33-9250, 34-65052, and IC-29748 August 8, 2011; and (c) related to ASU 2010-22,Accounting for Various Topics.   The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities (Topic 210). ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. ASU 2011-11 is effective for interim and annual periods beginning on or after January 1, 2013 and should be applied retrospectively for all comparative periods presented. The Company is evaluating the impact this ASU will have on its consolidated financial statements.

FASB ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 , was issued in December 2011 updating and superseding certain pending paragraphs relating to the presentation 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. This Update is effective concurrent with ASU 2011-05, Presentation of Comprehensive Income, and will not have a material effect on the Company’s consolidated financial statements at the date of adoption.

In July 2012, the FASB issued ASU No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment. With the Update, a company testing indefinite-lived intangibles for impairment now has the option to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with current guidance. An entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments are effective for annual and interim goodwill impairment

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tests performed for fiscal years beginning after September 15, 2012. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

Financial Condition

Total assets of the Company at September 30, 2012 were $180.1 million, an increase of $8.0 million or 4.6%, from $172.1 million at December 31, 2011.  The increase is primarily the result of an increase in loans and cash and cash equivalents.

Loans (excluding loans held for sale and the allowance for loan losses) were $150.5 million at September 30, 2012, a $2.7 million, or 1.8%, increase from $147.8 million at December 31, 2011.  Commercial business loans increased $5.4 million, or 27.9%, to $24.6 million offset by a decline in permanent one-to-four family loans of $2.4 million, or 9.7%.  Loans held for sale were $473,000 at September 30, 2012, a $503,000 decrease from $976,000 at December 31, 2011.

Deposits increased $8.2 million, or 5.6%, to $155.4 million at September 30, 2012, compared with $147.2 million at December 31, 2011.  The increase is primarily the result of a seasonal increase in demand deposit accounts and money market accounts.

The Bank began using CDARS deposits in 2005 as an alternative source of funds in addition to advances from the FHLB.  These are insured time deposits obtained through the nationwide Certificate of Deposit Account Registry Service.  They range in maturities from one month to three years, and are generally priced higher than locally obtained deposits but are generally less expensive than other brokered deposits.  There were no CDARS deposits included in certificates of deposit at September 30, 2012 and there were $377,000 of CDARS deposits included in certificates of deposit at December 31, 2011.

Total shareholders’ equity increased by $8,000, or 0.04% and was $20.6 million at September 30, 2012 compared with $20.5 million at December 31, 2011.  The change in shareholders’ equity during the nine months ended September 30, 2012 was primarily attributable to net income of $156,000 offset by preferred stock dividends of $180,000 and preferred stock discount accretion of $54,000.

Results of Operations

Net Income.  Net income excluding the preferred stock dividend and discount accretion for the third quarter of 2012 and 2011 was $123,000 and $364,000, respectively.  After preferred stock dividend and discount accretion of $78,000 and $77,000, net income available to common shareholders for the third quarter of 2012 and 2011 was $45,000 and $287,000, or $0.06 and $0.39 per diluted share, respectively.

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For purposes of comparison, income can be separated into major components as follows:

	Three Months Ended September 30,									Nine Months Ended September 30,
(in thousands)	2012			2011			Income Incr. (Decr.)			2012			2011			Income Incr. (Decr.)
Net interest income	$	2,026		$	1,975		$	51		$	5,899		$	5,906		$	(7	)
Noninterest income		376			422			(46	)		1,183			1,157			26
Provision for loan losses		(60	)		(60	)		-			(240	)		(313	)		73
Noninterest ex­pense		(2,139	)		(1,973	)		(166	)		(6,582	)		(6,044	)		(538	)
Income before provision for income tax		203			364			(161	)		260			706			(446	)
Provision for income tax		(80	)		-			(80	)		(104	)		-			(104	)
Net income	$	123		$	364		$	(241	)	$	156		$	706		$	(550	)

Net Interest Income.  Net interest income for the third quarter of 2012 increased $51,000 compared with the third quarter of 2011.  Average loans increased $5.6 million, or 3.8%, to $152.7 million for the third quarter of 2012 compared to $147.1 million for the third quarter of 2011.  At the same time, the yield on loans decreased 20 basis points (“bp”) for the third quarter of 2012 to 5.57% compared to 5.77% for the third quarter of 2011 as a result of a continued low interest rate environment and non-performing loans.  Average interest bearing deposits decreased $41,000, or 0.04%, to $116.2 million for the third quarter of 2012 compared to $116.3 million for the third quarter of 2011.  The cost of average interest bearing liabilities declined nine bp to 0.38% for the third quarter of 2012 compared to 0.47% for the third quarter of 2011.  The interest rate spread, which is the difference between the yield on average interest-earning assets and the average cost of interest-bearing liabilities, decreased one bp to 4.91% for the third quarter 2012 compared to 4.92% for the third quarter of 2011.

Provision for Loan Losses.  The provision for loan losses was $60,000 for the third quarter of 2012 and 2011.  The provisions in these periods reflect management’s assessment of asset quality, overall risk, and estimated loan impairments and were considered appropriate in order to maintain the allowance for loan losses at a level that represents management’s best estimate of the probable credit losses inherent in the loan portfolio.  Net loan charge offs were $49,000 for the third quarter of 2012.  There were no net loan charge offs for the third quarter of 2011.

Noninterest Income.  Noninterest income for the third quarter of 2012 decreased $46,000, or 10.9%, to $376,000 compared with $422,000 for the third quarter of 2011.  The decrease is primarily in mortgage servicing income due to the fair value adjustment to mortgage servicing rights of $(85,000).

Noninterest Expense.   Noninterest expense for the third quarter of 2012 increased $166,000, or 8.4%, to $2.1 million compared to $2.0 million for the comparable period in 2011.  The increase was primarily related to an increase in compensation and benefits expense and other expenses.

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Provision for income taxes:  Provision for income taxes was $80,000 for the third quarter of 2012.  There was no provision for income taxes for the third quarter of 2011.

Asset Quality

Nonaccrual loans were $5.6 million at September 30, 2012 compared with $2.6 million at December 31, 2011.  The increase is due primarily to two commercial nonresidential loans totaling $2.4 million to the same borrower that were troubled debt restructurings deemed to be impaired and were placed on nonaccrual status due to a decline in the borrowers’ net worth and global cash flow.

Loans with balances totaling $10.9 million at September 30, 2012 and $12.0 million at December 31, 2011 were considered to be impaired.  At September 30, 2012 and December 31, 2011, there were 18 and 23 impaired loans, respectively.  In evaluating the adequacy of the allowance for loan losses, total estimated impairments of $473,000 were specifically reserved on impaired loans at September 30, 2012 and December 31, 2011.

The following table reflects loan balances considered to be impaired by asset type at September 30, 2012 and December 31, 2011.

	September 30,		December 31,
(in thousands)	2012		2011
Commercial non residential	$	7,082	$	7,395
Permanent one- to four-family		223		-
Permanent multifamily		-		659
Land		2,021		2,224
Consumer		60		76
Commercial business		1,535		1,626
Total impaired loans	$	10,921	$	11,980

At September 30, 2012, 95% of impaired loans totaling $10.4 million included loans to seven borrowers.  Additional information regarding these borrowers, by market area as of September 30, 2012 is provided in the following table:

		Loan Balance September 30, 2012
Loan Type	Market Area	(in thousands)
Land	Alaska	$	2,021
Commercial business	Alaska		1,427
Commercial real estate	Alaska		1,382
Commercial real estate	Idaho		1,887
Commercial real estate	Alaska		2,319
Commercial real estate	Alaska		803
Commercial real estate	Idaho		532
Total – Impaired loans of seven largest credit relationships		$	10,371

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The Bank had $390,000 and $880,000 of real estate owned and repossessed assets at September 30, 2012 and December 31, 2011, respectively.  The decrease is due to the sale and final charge off of real estate owned from one of the remaining out of state problem credits and additional impairment on another out of state real estate owned property, offset with two loans foreclosed and transferred to real estate owned and repossessed assets.

Liquidity and Capital Resources

The Company's primary sources of funds are deposits, borrowings, and principal and interest payments on loans.  While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition.  The Company's primary investing activity is loan originations.  The Company maintains liquidity levels believed to be adequate to fund loan commitments, investment opportunities, deposit withdrawals and other financial commitments.  In addition, the Bank has available a line of credit with the FHLB generally equal to the lower of 25% of the Bank’s total assets, or pledged collateral of approximately $45.0 million at September 30, 2012, of which $40.0 million was unused.    At September 30, 2012, there was $3.0 million outstanding on the line and an additional $2.0 million of the borrowing line was committed to secure public deposits.  There was $3.0 million outstanding on the line at December 31, 2011.

As disclosed in our Condensed Consolidated Statements of Cash Flows in Item 1 of this Quarterly Report on Form 10-Q, cash and cash equivalents increased $6.0 million to $17.1 million as of September 30, 2012, from $11.1 million as of December 31, 2011.  Net cash provided by operating activities was $833,000 for the nine months ended September 30, 2012.  Net cash of $2.8 million used in investing activities during the nine months ended September 30, 2012 consisted principally of loan originations, net of principal repayments and purchases of premises and equipment.  The $8.0 million of cash provided by financing activities during the nine months ended September 30, 2012 primarily consisted of a $12.3 million net increase in demand and money market deposits.

At September 30, 2012, management had no knowledge of any trends, events or uncertainties that may have material effects on the liquidity, capital resources, or operations of the Company.

In accordance with the Order, the Company is subject to regulatory capital requirements separate from its banking subsidiary.  The Company and the Bank exceeded all of its regulatory capital requirements at September 30, 2012.  See Note 6 of the Selected Notes to Condensed Consolidated Interim Financial Statements contained herein for information regarding the Bank's regulatory capital position at September 30, 2012.

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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:  An evaluation of the registrant’s disclosure controls and procedures (as defined in Rule 13(a)-15(e) of the Securities Exchange Act of 1934 (the “Act”)) was carried out under the supervision and with the participation of the registrant’s Chief Executive Officer, Chief Financial Officer and other members of the registrant’s senior management.  The registrant’s Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2012, the registrant’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the registrant in the reports it files or submits under the Act is (i) accumulated and communicated to the registrant’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

The Company does not expect that its disclosure controls and procedures will prevent all error and or fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

(b)Changes in Internal Controls:  In the quarter ended September 30, 2012, the Company did not make any significant changes in, nor take any corrective actions regarding, its internal controls or other factors that could significantly affect these controls.

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PART II. OTHER INFORMATION 

Item 1.  Legal Proceedings

From time to time, the Company and its subsidiary may be a party to various legal proceedings incident to its or their business.  At September 30, 2012, there were no legal proceedings to which the Company or any subsidiary was a party, or to which any of their property was subject, which were expected by management to result in a material loss.

Item 1A. Risk Factors

There have not been any material changes to the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011.

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

None

Item 3.  Defaults Upon Senior Securities

None

Item 4.  Mine Safety Disclosures

None

Item 5.  Other Information

None

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Item 6.      Exhibits

3.1	Articles of Incorporation of Alaska Pacific Bancshares, Inc. (1)
3.2	Statement of Establishment and Designations of Series of Preferred Stock for the Series A Preferred Stock (2)
3.3	Bylaws of Alaska Pacific Bancshares, Inc. (3)
4.1	Warrant For Purchase of shares of Common Stock (2)
4.2	Letter Agreement dated February 6, 2009 between Alaska Pacific Bancshares, Inc. and United States Department of the Treasury, will respect to the issuance and sale of the Series A Preferred Stock and the Warrant(2)
10.1	Employment Agreement with Craig E. Dahl (4)
10.2	Severance Agreement with Julie M. Pierce (9)
10.3	Severance Agreement with Thomas C. Sullivan (4)
10.4	Severance Agreement with Tammi L. Knight (4)
10.5	Severance Agreement with Christopher P. Bourque (9)
10.6	Alaska Federal Savings Bank 401(k) Plan (1)
10.7	Alaska Pacific Bancshares, Inc. Employee Stock Ownership Plan (4)
10.8	Alaska Pacific Bancshares, Inc. Employee Severance Compensation Plan (4)
10.9	Alaska Pacific Bancshares, Inc. 2000 Stock Option Plan (5)
10.10	Alaska Pacific Bancshares, Inc. 2003 Stock Option Plan (7)
10.11	Form of Compensation Modification Agreement (2)
14	Code of Ethics (8)
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	The following materials from Alaska Pacific Banshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, formatted on Extensible Business Reporting Language (XBRL) (a) Condensed Consolidated Balance Sheets; (b) Condensed  Consolidated Statements of Operations; (c) Condensed Consolidated Statements of Comprehensive Income (Loss); (d) Condensed Consolidated Statements of Cash Flows; and (e) Notes to Unaudited Condensed Consolidated Interim Financial Statements (10)

________________

(1)     Incorporated by reference to the registrant’s Registration Statement on Form SB-2 (333-74827).

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(2)     Incorporated by reference to the registrant’s current report on Form 8-K filed on February 6, 2009.

(3)     Incorporated by reference to the registrant’s Current Report on Form 8-K filed on January 24, 2012.

(4)     Incorporated by reference to the registrant’s Annual Report on Form 10-KSB for the year ended December 31, 1999.

(5)     Incorporated by reference to the registrant’s annual meeting proxy statement dated May 5, 2000.

(6)     Incorporated by reference to the registrant’s quarterly report on Form 10-QSB for the quarterly period ended March 31, 2004.

(7)     Incorporated by reference to the registrant’s annual meeting proxy statement dated April 10, 2004.

(8)     Incorporated by reference to the registrant’s Annual Report on Form 10-KSB for the year ended December 31, 2005

(9)     Incorporated by reference to the registrant’s quarterly report on Form 10-QSB for the quarterly period ended September 30, 2007.

(10)   Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise not subject to liability under those sections.

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SIGNATURES

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

	Alaska Pacific Bancshares, Inc.
November 14, 2012	/s/Craig E. Dahl
Date	Craig E. Dahl
	President and Chief Executive Officer

November 14, 2012	/s/Julie M. Pierce
Date	Julie M. Pierce
	Senior Vice President and Chief Financial Officer

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EXHIBIT INDEX

31.1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1   Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2   Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101 The following materials from Alaska Pacific Banshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, formatted on Extensible Business Reporting Language (XBRL) (a) Condensed Consolidated Balance Sheets; (b) Condensed  Consolidated Statements of Operations; (c) Condensed Consolidated Statements of Comprehensive Income (Loss); (d) Condensed Consolidated Statements of Cash Flows; and (e) Notes to Unaudited Condensed Consolidated Interim Financial Statements

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