VSB Bancorp 10-Q 2009 Q2 Quarterly report

UNITED STATES
SECURITY AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20849

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	FOR THE QUARTER ENDED JUNE 30, 2009
o	TRANSITION REPORT PURSUANT TO SECTION 13 OF THE EXCHANGE ACT FOR THE TRANSITION PERIOD
	COMMISSION FILE NUMBER 0-50237

VSB Bancorp, Inc.

(Exact name of registrant as specified in its charter)

New York

(State or other jurisdiction of incorporation or organization)

11 - 3680128

(I. R. S. Employer Identification No.)

4142 Hylan Boulevard, Staten Island, New York 10308

(Address of principal executive offices)

(718) 979-1100

Registrant’s telephone number

Common Stock

(Title of Class)

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

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 o  No o

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

Large Accelerated Filero Accelerated Filero Non-Accelerated Filero Smaller Reporting Companyx

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

Par Value: $0.0001 Class of Common Stock

The Registrant had 1,850,491 common shares outstanding as of August 5, 2009.

CROSS REFERENCE INDEX

		Page
PART I
Item 1	Consolidated Statements of Financial Condition as of June 30, 2009 and December 31, 2008 (unaudited)	4
	Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2009 and 2008 (unaudited)	5
	Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2009 and the Year Ended December 31, 2008 (unaudited)	6
	Consolidated Statements of Cash Flows for the Three and Six Months Ended June 30, 2009 and 2008 (unaudited)	7
	Notes to Consolidated Financial Statements for the Three and Six Months Ended June 30, 2009 and 2008 (unaudited)	8 to 20
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20 to 30
Item 3	Control and Procedures	31
PART II
Item 1	Legal Proceedings	31
Signature Page		32
	Exhibit 31.1, 31.2, 32.1, 32.2	33 to 36

2

Forward-Looking Statements

          When used in this periodic report, or in any written or oral statement made by us or our officers, directors or employees, the words and phrases “will result,” “expect,” “will continue,” “anticipate,” “estimate,” “project,” or similar terms are intended to identify “forward-looking statements.” A variety of factors could cause our actual results and experiences to differ materially from the anticipated results or other expectations expressed in any forward-looking statements. Some of the risks and uncertainties that may affect our operations, performance, development and results, the interest rate sensitivity of our assets and liabilities, and the adequacy of our loan loss allowance, include, but are not limited to:

· deterioration in local, regional, national or global economic conditions which could result in, among other things, an increase in loan delinquencies, a decrease in property values, or a change in the real estate turnover rate;

· changes in market interest rates or changes in the speed at which market interest rates change;

· changes in laws and regulations affecting the financial service industry;

· changes in competition; and

· changes in consumer preferences by our customers or the customers of our business borrowers.

          Please do not place undue reliance on any forward-looking statement, which speaks only as of the date made. There are many factors, including those described above, that could affect our future business activities or financial performance and could cause our actual future results or circumstances to differ materially from those we anticipate or project. We do not undertake any obligation to update any forward-looking statement after it is made.

3

VSB Bancorp, Inc.
Consolidated Statements of Financial Condition
(unaudited)

	June 30, 2009			December 31, 2008
Assets:
Cash and due from banks	$	37,386,551		$	21,240,223
Investment securities, available for sale		115,350,244			120,288,588
Loans receivable		69,306,455			66,246,652
Allowance for loan loss		(928,064	)		(987,876	)
Loans receivable, net		68,378,391			65,258,776
Bank premises and equipment, net		3,461,215			3,695,822
Accrued interest receivable		710,936			723,473
Deferred taxes		—			525,839
Other assets		642,598			925,007
Total assets	$	225,929,935		$	212,657,728
Liabilities and stockholders’ equity:
Liabilities:
Deposits:
Demand and checking	$	65,288,402		$	58,598,579
NOW		34,622,620			17,636,154
Money market		23,909,746			22,829,789
Savings		13,534,421			12,412,561
Time		62,106,445			76,323,494
Total Deposits		199,461,634			187,800,577
Escrow deposits		361,965			308,872
Accounts payable and accrued expenses		1,681,182			1,344,512
Total liabilities		201,504,781			189,453,961
Stockholders’ equity:
Common stock, ($.0001 par value, 3,000,000 shares authorized, 1,945,134 issued, 1,850,491 outstanding at June 30, 2009 and 1,923,884 issued, 1,882,461 outstanding at December 31, 2008)		195			192
Additional paid in capital		9,276,908			9,200,010
Retained earnings		15,331,339			14,714,143
Treasury stock, at cost (94,643 shares at June 30, 2009 and 41,423 shares at December 31, 2008)		(858,863	)		(395,891	)
Unearned Employee Stock Ownership Plan shares		(817,211	)		(901,750	)
Accumulated other comprehensive gain, net of taxes of $1,258,894 and $488,735, respectively		1,492,786			587,063
Total stockholders’ equity		24,425,154			23,203,767
Total liabilities and stockholders’ equity	$	225,929,935		$	212,657,728

See notes to consolidated financial statements.

4

VSB Bancorp, Inc.
Consolidated Statements of Operations
(unaudited)

	Three months ended June 30, 2009			Three months ended June 30, 2008			Six months ended June 30, 2009			Six months ended June 30, 2008
Interest and dividend income:
Loans receivable	$	1,323,189		$	1,172,917		$	2,653,895		$	2,417,408
Investment securities		1,314,667			1,431,362			2,697,286			2,815,659
Other interest earning assets		5,693			74,552			10,434			176,845
Total interest income		2,643,549			2,678,831			5,361,615			5,409,912
Interest expense:
NOW		35,990			32,702			62,773			64,933
Money market		62,944			72,509			123,455			168,601
Savings		13,219			18,191			26,321			37,173
Subordinated debt		—			89,039			—			178,079
Time		220,765			380,380			531,317			899,827
Total interest expense		332,918			592,821			743,866			1,348,613
Net interest income		2,310,631			2,086,010			4,617,749			4,061,299
Provision for loan loss		100,000			55,000			375,000			85,000
Net interest income after provision for loan loss		2,210,631			2,031,010			4,242,749			3,976,299
Non-interest income:
Loan fees		24,773			21,285			50,524			43,508
Service charges on deposits		538,187			545,902			1,084,049			1,025,517
Net rental income		12,567			11,103			24,084			10,092
Other income		39,556			45,944			69,595			111,019
Total non-interest income		615,083			624,234			1,228,252			1,190,136
Non-interest expenses:
Salaries and benefits		911,745			868,263			1,823,728			1,778,671
Occupancy expenses		373,242			358,466			752,323			716,190
Legal expense		59,847			65,700			134,496			119,786
Professional fees		75,500			62,100			152,500			123,500
Computer expense		70,896			57,198			137,696			112,304
Directors’ fees		60,675			57,700			111,775			114,950
FDIC and NYSBD assessments		101,500			46,500			177,000			93,000
Other expenses		319,268			346,250			635,618			641,926
Total non-interest expenses		1,972,673			1,862,177			3,925,136			3,700,327
Income before income taxes		853,041			793,067			1,545,865			1,466,108
Provision/(benefit) for income taxes:
Current		450,353			400,690			876,203			733,590
Deferred		(56,609	)		(33,898	)		(162,686	)		(55,702	)
Total provision for income taxes		393,744			366,792			713,517			677,888
Net income	$	459,297		$	426,275		$	832,348		$	788,220
Earnings per share:
Basic	$	0.26		$	0.23		$	0.46		$	0.43
Diluted	$	0.25		$	0.23		$	0.46		$	0.42
Comprehensive income/(loss)	$	463,129		$	(585,163	)	$	1,738,071		$	820,213
Book value per common share	$	13.20		$	11.31		$	13.20		$	11.31

See notes to consolidated financial statements.

5

VSB Bancorp, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
Year Ended December 31, 2008 and Six Months Ended June 30, 2009
(unaudited)

	Number of Common Shares			Common Stock		Additional Paid-In Capital			Retained Earnings			Treasury Stock, at cost			Unearned ESOP Shares			Accumulated Other Comprehensive Income(Loss)			Total Stockholders’ Equity
Balance at January 1, 2008		1,900,509		$	190	$	9,107,119		$	13,226,395		$	—		$	(1,070,827	)	$	(379,072	)	$	20,883,805
Exercise of stock option, including tax benefit		23,375			2		164,857															164,859
Stock-based compensation							1,278															1,278
Amortization of earned portion of ESOP common stock																169,077						169,077
Amortization of cost over fair value - ESOP							(73,244	)														(73,244	)
Transfer from ESOP repurchase obligation																						—
Cash dividends declared ($0.24 per share)										(443,996	)											(443,996	)
Purchase of treasury stock, at cost		(41,423	)										(395,891	)								(395,891	)
Comprehensive income:
Net income										1,931,744												1,931,744
Other comprehensive income, net:
Change in unrealized loss on securities available for sale, net of tax effects		—			—		—			—			—			—			966,135			966,135
Total comprehensive income																						2,897,879
Balance at December 31, 2008		1,882,461		$	192	$	9,200,010		$	14,714,143		$	(395,891	)	$	(901,750	)	$	587,063		$	23,203,767
Exercise of stock option, including tax benefit		21,250			3		118,624															118,627
Stock-based compensation							639															639
Amortization of earned portion of ESOP common stock																84,539						84,539
Amortization of cost over fair value - ESOP							(42,365	)														(42,365	)
Cash dividends declared ($0.12 per share)										(215,152	)											(215,152	)
Purchase of treasury stock, at cost		(53,220	)										(462,972	)								(462,972	)
Comprehensive income:
Net income										832,348												832,348
Other comprehensive income, net:
Change in unrealized gain on securities available for sale, net of tax effects		—			—		—			—			—			—			905,723			905,723
Total comprehensive income																						1,738,071
Balance at June 30, 2009		1,850,491		$	195	$	9,276,908		$	15,331,339		$	(858,863	)	$	(817,211	)	$	1,492,786		$	24,425,154

See notes to consolidated financial statements.

6

VSB Bancorp, Inc.
Consolidated Statements of Cash Flows
(unaudited)

	Three months ended June 30, 2009			Three months ended June 30, 2008			Six months ended June 30, 2009			Six months ended June 30, 2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	459,297		$	426,275		$	832,348		$	788,220
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		168,227			153,602			338,781			304,596
Accretion of income, net of amortization of premium		826			(57,913	)		(14,521	)		(111,312	)
ESOP compensation expense		22,470			23,380			42,174			49,577
Stock-based compensation expense		319			319			639			639
Provision for loan losses		100,000			55,000			375,000			85,000
Decrease in prepaid and other assets		42,259			36,899			282,409			38,599
Decrease/(increase) in accrued interest receivable		9,254			(22,807	)		12,537			67,205
Increase in deferred income taxes		(3,234	)		(208,572	)		(244,320	)		(230,376	)
(Decrease)/increase in accrued expenses and other liabilities		(29,769	)		185,747			336,670			(30,768	)
Net cash provided by operating activities		769,649			591,930			1,961,717			961,380
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loan receivable		(658,774	)		(1,853,016	)		(3,439,003	)		(821,792	)
Proceeds from repayment of investment securities, available for sale		11,005,945			6,995,036			18,349,346			14,402,118
Purchases of investment securities, available for sale		(5,976,388	)		(12,113,438	)		(11,776,211	)		(21,612,383	)
Purchases of premises and equipment		(45,213	)		(124,358	)		(104,174	)		(167,884	)
Net cash provided by/(used in) investing activities		4,325,570			(7,095,776	)		3,029,958			(8,199,941	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		2,791,047			7,411,671			11,714,150			12,726,092
Exercise of stock options		118,627			52,000			118,627			52,000
Purchase of treasury stock, at cost		—			—			(462,972	)		—
Cash dividends paid		(108,285	)		(114,518	)		(215,152	)		(228,549	)
Net cash provided by financing activities		2,801,389			7,349,153			11,154,653			12,549,543
NET INCREASE IN CASH AND CASH EQUIVALENTS		7,896,608			845,307			16,146,328			5,310,982
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		29,489,943			22,162,554			21,240,223			17,696,879
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	37,386,551		$	23,007,861		$	37,386,551		$	23,007,861
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest	$	326,212		$	574,367		$	882,111		$	1,636,236
Taxes	$	457,002		$	405,326		$	525,852		$	727,326

See notes to consolidated financial statements.

7

VSB BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008

1. GENERAL

          VSB Bancorp, Inc. (referred to using terms such as “we,” “us,” or the “Company”) became the holding company for Victory State Bank (the “Bank”), a New York chartered commercial bank, upon the completion of a reorganization of the Bank into the holding company form of organization. The reorganization was effective in May 2003. All the outstanding stock of Victory State Bank was exchanged for stock of VSB Bancorp, Inc. on a three for two basis so that the stockholders of Victory State Bank became the owners of VSB Bancorp, Inc. and VSB Bancorp, Inc. owns all the stock of Victory State Bank. The common stock we issued in the transaction qualifies as exempt securities under Section 3(a)(12) of the Securities Act of 1933. Our primary business is owning all of the issued and outstanding stock of the Bank. Our common stock is listed on the NASDAQ Global Market, effective on August 4, 2008. We continue to trade under the symbol “VSBN”.

          Through the Bank, the Company is primarily engaged in the business of commercial banking, and to a lesser extent retail banking. The Bank gathers deposits from individuals and businesses primarily in Staten Island, New York and makes loans throughout that community. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the local Staten Island economic and real estate markets. The Bank invests funds that are not used for lending primarily in government securities, mortgage backed securities and collateralized mortgage obligations. Customer deposits are insured, up to the applicable limit, by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is supervised by the New York State Banking Department and the FDIC.

          Management evaluated events and transactions that occurred through August 11, 2009, the date these financial statements were issued, for potential recognition or disclosure, in accordance with the requirements of Statement of Financial Accounting Standards No. 165.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

          The following is a description of the significant accounting and reporting policies followed in preparing and presenting the accompanying consolidated financial statements. These policies conform with accounting principles generally accepted in the United States of America (“GAAP”).

          Principles of Consolidation - The consolidated financial statements of the Company include the accounts of the Company, including its subsidiary Victory State Bank. All significant inter-company accounts and transactions between the Company and Bank have been eliminated in consolidation.

          Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting period. Actual results can differ from those estimates. The allowance for loan losses, prepayment estimates on the mortgage-backed securities and Collateralized Mortgage Obligation portfolios, contingencies and fair values of financial instruments are particularly subject to change.

          Reclassifications –Some items in the prior year financial statements were reclassified to conform to the current presentation.

8

          Cash and Cash Equivalents – Cash and cash equivalents consists of cash on hand, due from banks and interest-bearing deposits. Net cash flows are reported for customer loan and deposit transactions and interest-bearing deposits with original maturities of 90 days or less. Regulation D of the Board of Governors of the Federal Reserve System requires that Victory State Bank maintain non-interest-bearing deposits or cash on hand as reserves against its demand deposits. The amount of reserves which Victory State Bank is required to maintain depends upon its level of transaction accounts. During the fourteen day period from June 18, 2009 through July 1, 2009, Victory State Bank was required to maintain reserves, after deducting vault cash, of $4,172,000. Reserves are required to be maintained on a fourteen day basis, so, from time to time, Victory State Bank may use available cash reserves on a day to day basis, so long as the fourteen day average reserves satisfy Regulation D requirements. Victory State Bank is required to report transaction account levels to the Federal Reserve on a weekly basis.

          Interest-bearing bank balances– Interest-bearing bank balances mature overnight and are carried at cost.

          Investment Securities, Available for Sale - Investment securities, available for sale, are to be held for an unspecified period of time and include securities that management intends to use as part of its asset/liability strategy. These securities may be sold in response to changes in interest rates, prepayments or other factors and are carried at estimated fair value. Gains or losses on the sale of such securities are determined by the specific identification method. Interest income includes amortization of purchase premium and accretion of purchase discount. Premiums and discounts are recognized in interest income using a method that approximates the level yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are estimated. Unrealized holding gains or losses, net of deferred income taxes, are excluded from earnings and reported as other comprehensive income in a separate component of stockholders’ equity until realized. Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the Company’s intent and probability of being required to sell the securities before recovery of the amortized cost basis less any current-period loss.

          The Company invests primarily in agency Collateralized Mortgage-Backed Obligations (“CMOs”) with estimated average lives primarily under 4.5 years and Mortgage-Backed Securities. These securities are primarily issued by the Federal National Mortgage Association (“FNMA”), the Government National Mortgage Association (“GNMA”) or the Federal Home Loan Mortgage Corporation (“FHLMC”) and are primarily comprised of mortgage pools guaranteed by FNMA, GNMA or FHLMC. The Company also invests in whole loan CMOs, all of which are AAA rated. These securities expose the Company to risks such as interest rate, prepayment and credit risk and thus pay a higher rate of return than comparable treasury issues.

          Loans Receivable - Loans receivable, that management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are stated at unpaid principal balances, adjusted for deferred net origination and commitment fees and the allowance for loan losses. Interest income on loans is credited as earned.

          It is the policy of the Company to provide a valuation allowance for probable incurred losses on loans based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations which may affect the borrower’s ability to repay, estimated value of underlying collateral and current economic conditions in the Company’s lending area. The allowance is increased by provisions for loan losses charged to earnings and is reduced by charge-offs, net of recoveries. While management uses available information to estimate losses on loans, future additions to the allowance may be necessary based upon the expected growth of the loan portfolio and any changes in economic conditions beyond management’s control. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management. Management believes, based upon all relevant and available information, that the allowance for loan losses is appropriate.

          The Company has a policy that all loans 90 days past due are placed on non-accrual status. It is the Company’s policy to cease the accrual of interest on loans to borrowers past due less than 90 days where a probable loss is estimated and to reverse out of income all interest that is due. The Company applies payments received on non-accrual loans to the outstanding principal balance due before applying any amount to interest, until the loan is restored to an accruing status. On a limited basis, the Company may apply a payment to interest on a non-accrual loan if there is no impairment or no estimated loss on this asset. The Company continues to accrue interest on construction loans that are 90 days past contractual maturity date if the loan is expected to be paid in full in the next 60 days and all interest is paid up to date.

9

          Loan origination fees and certain direct loan origination costs are deferred and the net amount recognized over the contractual loan terms using the level-yield method, adjusted for periodic prepayments in certain circumstances.

          The Company considers a loan to be impaired when, based on current information, it is probable that the Company will be unable to collect all principal and interest payments due according to the contractual terms of the loan agreement. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Impairment is measured on a loan by loan basis for commercial and construction loans. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral. The fair value of the collateral, as reduced by costs to sell, is utilized if a loan is collateral dependent. Large groups of smaller balance homogeneous loans, such as consumer loans and residential loans, are collectively evaluated for impairment.

          Long-Lived Assets - The Company periodically evaluates the recoverability of long-lived assets, such as premises and equipment, to ensure the carrying value has not been impaired. In performing the review for recoverability, the Company would estimate the future cash flows expected to result from the use of the asset. If the sum of the expected future cash flows is less than the carrying amount an impairment will be recognized. The Company reports these assets at the lower of the carrying value or fair value.

          Subordinated Debt - In August of 2003, the Company formed VSB Capital Trust I (the “Trust”). The Trust is a statutory business trust organized under Delaware law and the Company owns all of its common securities. The Trust issued $5.0 million of Trust Preferred Capital Securities to an independent investor and $155,000 of common securities to the Company. The Company issued a $5.16 million subordinated debenture to the Trust. The subordinated debenture was the sole asset of the Trust. On August 8, 2008, the Company repaid the subordinated debenture in full at par, received payment of $155,000 on account of its common securities of the Trust, and all the outstanding Trust Preferred Capital Securities were likewise redeemed, thereby ending the entire arrangement. The Trust was not consolidated with the Company.

          Premises and Equipment - - Premises, leasehold improvements, and furniture and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are accumulated by the straight-line method over the estimated useful lives of the respective assets, which range from three to fifteen years. Leasehold improvements are amortized at the lesser of their useful life or the term of the lease.

          Federal Home Loan Bank (FHLB) Stock - - The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment. Because this stock is viewed as a long term investment, impairment is based on ultimate recovery of par value, which is the price the Bank pays for the FHLB Stock. Both cash and stock dividends are reported as income.

          Income Taxes - The Company utilizes the liability method to account for income taxes. Under this method, deferred tax assets and liabilities are determined on differences between financial reporting and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws expected to be in effect when the differences are expected to reverse. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

          The Company adopted FASB Interpretation 48,Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1, 2007. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The adoption had no affect on the Company’s financial statements.

10

          The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

          Financial Instruments - - In the ordinary course of business, the Company has entered into off-balance sheet financial instruments, primarily consisting of commitments to extend credit.

          Basic and Diluted Net Income Per Common Share - Basic net income per share of common stock is based on 1,792,629 shares and 1,849,448 shares, the weighted average number of common shares outstanding for the three months ended June 30, 2009 and 2008, respectively. Diluted net income per share of common stock is based on 1,809,660 and 1,880,697, the weighted average number of common shares and potentially dilutive common shares outstanding for the three months ended June 30, 2009 and 2008, respectively. The weighted average number of potentially dilutive common shares excluded in calculating diluted net income per common share due to the anti-dilutive effect is 56,677 and 55,843 shares for the three months ended June 30, 2009 and 2008, respectively. Common stock equivalents were calculated using the treasury stock method.

          Basic net income per share of common stock is based on 1,800,264 shares and 1,847,272 shares, the weighted average number of common shares outstanding for the six months ended June 30, 2009 and 2008, respectively. Diluted net income per share of common stock is based on 1,816,269 and 1,880,409, the weighted average number of common shares and potentially dilutive common shares outstanding for the six months ended June 30, 2009 and 2008, respectively. The weighted average number of potentially dilutive common shares excluded in calculating diluted net income per common share due to the anti-dilutive effect is 65,532 and 48,349 shares for the six months years ended June 30, 2009 and 2008, respectively. Common stock equivalents were calculated using the treasury stock method.

          The reconciliation of the numerators and the denominators of the basic and diluted per share computations for the three and six months ended June 30, are as follows:

Reconciliation of EPS	Three months ended June 30, 2009						Three months ended June 30, 2008
	Net Income		Weighted Average Shares		Per Share Amount		Net Income		Weighted Average Shares		Per Share Amount
Basic earnings per common share
Net income available to common stockholders	$	459,297		1,792,629	$	0.26	$	426,575		1,849,448	$	0.23
Effect of dilutive shares
Weighted average shares, if converted				17,031						31,249
Diluted earnings per common share
Net income available to common stockholders	$	459,297		1,809,660	$	0.25	$	426,575		1,880,697	$	0.23

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Reconciliation of EPS	Six months ended June 30, 2009						Six months ended June 30, 2008
	Net Income		Weighted Average Shares		Per Share Amount		Net Income		Weighted Average Shares		Per Share Amount
Basic earnings per common share
Net income available to common stockholders	$	832,348		1,800,264	$	0.46	$	788,220		1,847,272	$	0.43
Effect of dilutive shares
Weighted average shares, if converted				16,005						33,137
Diluted earnings per common share
Net income available to common stockholders	$	832,348		1,816,269	$	0.46	$	788,220		1,880,409	$	0.42

          Stock Based Compensation - FAS 123, Revised, requires companies to record compensation expense for stock options provided to employees in return for employment service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employment service period, which is normally the vesting period of the options. This applies to awards granted or modified in fiscal years beginning in 2006.

          Employee Stock Ownership Plan (“ESOP”) - The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of stockholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Cash dividends on allocated ESOP shares reduce retained earnings; cash dividends on unearned ESOP shares reduce debt and accrued interest. As of August 4, 2008, the Company listed its common stock on the NASDAQ Global Market.

          Stock Repurchase Program –On September 8, 2008, the Company announced that its Board of Directors had authorized a Rule 10b5-1 stock repurchase program for the repurchase of up to 100,000 shares of the Company’s common stock. On April 21, 2009, Company announced that its Board of Directors had authorized a second Rule 10b5-1 stock repurchase program for the repurchase of up to an additional 100,000 shares of the Company’s common stock and also announced that the Company had repurchased 94,643 shares of its common stock under the first stock repurchase program as of the date of the announcement. Stock repurchases under the program have and will be accounted for using the cost method, in which the Company will reflect the entire cost of repurchased shares as a separate reduction of stockholders’ equity on its balance sheet.

          Comprehensive Income - Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses, net of taxes, on securities available for sale which are also recognized as separate components of equity.

          Fair Value Option and Fair Value Measurement - In September 2006, the FASB issued Statement No. 157,Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The standard is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued Staff Position (FSP) 157-2,Effective Date of FASB Statement No. 157. This FSP delayed the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) until 2009. The impact of adoption was not material.

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Recently-Adopted Accounting Standards - In December 2007, the FASB issued FAS No. 141 (revised 2007), Business Combinations (“FAS 141(R)”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. FAS No. 141(R) is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position.

          In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS No. 160”), which changed the accounting and reporting for minority interests, which will be re-characterized as non-controlling interests and classified as a component of equity within the consolidated balance sheets. FAS No. 160 was effective as of the beginning of the first fiscal year beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of FAS No. 160 did not have a significant impact on Company’s results of operations or financial position.

          In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133”. FAS No. 161 amends and expands the disclosure requirements of SFAS No. 133 for derivative instruments and hedging activities. FAS No. 161 requires qualitative disclosure about objectives and strategies for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements. FAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position.

          In April 2009, the FASB issued Staff Position (FSP) No. 115-2 and No. 124-2,Recognition and Presentation of Other-Than-Temporary Impairments,which amends existing guidance for determining whether impairment is other-than-temporary for debt securities. The FSP requires an entity to assess whether it intends to sell, or it is more likely than not that it will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized in earnings. For securities that do not meet the aforementioned criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income. Additionally, the FSP expands and increases the frequency of existing disclosures about other-than-temporary impairments for debt and equity securities. This FSP is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position.

          In April 2009, the FASB issued Staff Position (FSP) No. 157-4,Determining Fair Value When the Volume and Level of Activity for the Asset and Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. This FSP emphasizes that even if there has been a significant decrease in the volume and level of activity, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants. The FSP provides a number of factors to consider when evaluating whether there has been a significant decrease in the volume and level of activity for an asset or liability in relation to normal market activity. In addition, when transactions or quoted prices are not considered orderly, adjustments to those prices based on the weight of available information may be needed to determine the appropriate fair value. The FSP also requires increased disclosures. This FSP is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position.

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          In April 2009, the FASB issued Staff Position (FSP) No. 107-1 and APB 28-1,Interim Disclosures about Fair Value of Financial Instruments. This FSP amends FASB Statement No. 107,Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies that were previously only required in annual financial statements. This FSP is effective for interim reporting periods ending after June 15, 2009. The Company adopted this FSP in the second quarter of 2009, which resulted in additional disclosures but no impact to the financial statements.

          In June 2008, the FASB issued Staff Position (FSP) EITF 03-6-1,Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. This FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (EPS) under the two-class method described in paragraphs 60 and 61 of FASB Statement No. 128,Earnings per Share.FSP EITF 03-6-1 is effective for years beginning after December 15, 2008 and interim periods within those years. Adoption of this FSP in 2009 did not have a material impact to the Company’s financial statements or earnings per share calculation.

          In May 2009, the FASB issued SFAS No. 165 “Subsequent Events.” The objective of this statement is to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statement are issued or available to be issued. The Statement is effective for interim and annual financial periods ending after June 15, 2009. The adoption this quarter resulted in additional disclosure, but no material impact to the results over operations or financial position.

Recently Issued but Not Yet Effective Standards

          On June 12, 2009, the FASB issued Statements No. 166,Accounting for Transfers of Financial Assets, and No. 167,Amendments to FASB Interpretation No. 46(R). Statement No. 166 is a revision to FASB Statement No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and will require more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures. Statement No. 167 amends FIN 46(R) to replace the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with a qualitative approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity (VIE) that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Unlike FIN 46 (R), this Statement requires ongoing reconsideration of whether (1) an entity is a VIE and (2) an enterprise is the primary beneficiary of a VIE. Statement Nos. 166 and 167 will be effective at the start of the first fiscal year beginning after November 15, 2009. The adoption of these standards are not expected to impact the Company’s consolidated financial statements.

          On June 29, 2009, the FASB issued FASB Statement No. 168,The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – A Replacement of FASB Statement No. 162. With the issuance of this statement, theFASB Accounting Standards Codification^TM (Codification) became the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of this Statement, the Codification superseded all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification became nonauthoritative. The issuance of the Codification is not intended to change GAAP. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of this standard is not expected to impact the Company’s consolidated financial statements.

14

          The SEC’s Office of the Chief Accountant published Staff Accounting Bulletin (SAB) No. 112. SAB 112 which was effective June 10, 2009 and amends or rescinds portions of the interpretive guidance included in the Staff Accounting Bulletin Series to make the relevant interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. Specifically, SAB 112 aims to bring existing guidance into conformity with recent pronouncements by the FASB, including FASB Statement No. 141 (Revised December 2007),Business Combinations, and FASB Statement No. 160,Noncontrolling Interests in Consolidated Financial Statements.The adoption of this bulletin is not expected to impact the Company’s consolidated financial statements.

3. INVESTMENT SECURITIES, AVAILABLE FOR SALE

          The following table summarizes the amortized cost and fair value of the available-for-sale investment securities portfolio at June 30, 2009 and December 31, 2008 and the corresponding amounts of unrealized gains and losses therein:

	June 30, 2009
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
US Government Agency	$	—	$	—	$	—		$	—
FNMA MBS - Residential		5,559,196		151,028		—			5,710,224
FHLMC MBS - Residential		—		—		—			—
GNMA MBS - Residential		1,446,549		58,959		—			1,505,508
Whole Loan MBS - Residential		2,227,302		—		(37,571	)		2,189,731
Collateralized mortgage obligations		103,365,517		2,916,533		(337,269	)		105,944,781
	$	112,598,564	$	3,126,520	$	(374,840	)	$	115,350,244

	December 31, 2008
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
US Government Agency	$	—	$	—	$	—		$	—
FNMA MBS - Residential		6,646,322		82,351		(38,079	)		6,690,594
FHLMC MBS - Residential		37,410		232		—			37,642
GNMA MBS - Residential		1,576,764		56,026		—			1,632,790
Whole Loan MBS - Residential		2,620,965		—		(61,928	)		2,559,037
Collateralized mortgage obligations		108,331,329		1,477,051		(439,855	)		109,368,525
	$	119,212,790	$	1,615,660	$	(539,862	)	$	120,288,588

          The amortized cost and fair value of the investment securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

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	June 30, 2009
Securities, Available for Sale Expected Maturity	Amortized Cost		Fair Value
Less than one year	$	—	$	—
Due after one year through five years		3,400,114		3,502,293
Due after five years through ten years		49,020,943		50,585,938
Due after ten years		60,177,507		61,262,013
	$	112,598,564	$	115,350,244

          The following table summarizes the investment securities with unrealized losses at June 30, 2009 and December 31, 2008 by aggregated major security type and length of time in a continuous unrealized loss position:

June 30, 2009	Less than 12 months					More than 12 months					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
US Government Agency	$	—	$	—		$	—	$	—		$	—	$	—
FHLMC MBS		—		—			—		—			—		—
FNMA MBS		—		—			—		—			—		—
GNMA MBS		—		—			—		—			—		—
Whole Loan MBS		—		—			2,189,731		(37,571	)		2,189,731		(37,571	)
Collateralized mortgage obligations		13,490,796		(223,016	)		2,635,291		(114,253	)		16,126,087		(337,269	)
	$	13,490,796	$	(223,016	)	$	4,825,022	$	(151,824	)	$	18,315,818	$	(374,840	)

December 31, 2008	Less than 12 months					More than 12 months					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
US Government Agency	$	—	$	—		$	—	$	—		$	—	$	—
FHLMC MBS		—		—			—		—			—		—
FNMA MBS		3,674,817		(34,814	)		251,470		(3,265	)		3,926,287		(38,079	)
GNMA MBS		—		—			—		—			—		—
Whole Loan MBS		1,451,015		(54,787	)		1,108,022		(7,141	)		2,559,037		(61,928	)
Collateralized mortgage obligations		13,662,143		(76,957	)		8,808,164		(362,898	)		22,470,307		(439,855	)
	$	18,787,975	$	(166,558	)	$	10,167,656	$	(373,304	)	$	28,955,631	$	(539,862	)

          The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.

16

          At June 30, 2009, the unrealized loss on investment securities was caused by interest rate increases. We expect that these securities, at maturity, will not be settled for less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the securities and it is not more likely than not the Company will be required to sell the securities before recovery of the amortized cost basis less any current-period loss, these investments are not considered other-than-temporarily impaired. At June 30, 2009, there were two debt securities with unrealized losses with aggregate depreciation of 5% or more from the Company’s amortized cost basis. As the market value decline of these securities is caused by interest rate increases and management has the ability to hold these securities until maturity, or for the foreseeable future, if classified as available for sale, these securities are not deemed to be other-than-temporarily impaired.

          There were no sales of investment securities for the six months ended June 30, 2009 and 2008.

4. FAIR VALUE OF FINANCIAL INSTRUMENTS

          The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, “Disclosures about Fair Value of Financial Instruments.” The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

          The following methods and assumptions were used by the Company in estimating fair values of financial instruments:

Interest-bearing Bank Balances – Interest-bearing bank balances mature within one year and are carried at cost which are estimated to be reasonably close to fair value.

Money Market Investments – The fair value of these securities approximates their carrying value due to the relatively short time to maturity

Investment Securities, Available For Sale – The estimated fair value of these securities is determined by using available market information and appropriate valuation methodologies. The estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.

Loans Receivable - The fair value of commercial and construction loans are approximated by the carrying value as the loans are tied directly to the Prime Rate and are subject to change on a daily basis. The fair value of the remainder of the portfolio is determined by discounting the future cash flows of the loans using the appropriate discount rate.

Other Financial Assets - The fair value of these assets, principally accrued interest receivable, approximates their carrying value due to their short maturity.

Non-Interest Bearing and Interest Bearing Deposits - The fair value disclosed for non-interest bearing deposits is equal to the amount payable on demand at the reporting date. The fair value of interest bearing deposits is based upon the current rates for instruments of the same remaining maturity. Interest bearing deposits with a maturity of greater than one year are estimated using a discounted cash flow approach that applies interest rates currently being offered.

Other Liabilities - The estimated fair value of other liabilities, which primarily include accrued interest payable, approximates their carrying amount.

17

          In accordance with FSP FAS 107-1, the carrying amounts and estimated fair values of financial instruments, at June 30, 2009 and December 31, 2008 are as follows:

	June 30, 2009				December 31, 2008
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial Assets:
Cash and cash equivalents	$	37,386,551	$	37,386,551	$	21,240,223	$	21,240,223
Investment securities, available for sale		115,350,244		115,350,244		120,288,588		120,288,588
Loans receivable		69,306,455		67,574,143		65,258,776		63,767,118
Other financial assets		710,936		710,936		723,473		723,473
Total Financial Assets	$	222,754,186	$	221,021,874	$	207,511,060	$	206,019,402
Financial Liabilities:
Non-interest bearing deposits	$	65,650,367	$	65,650,367	$	58,907,451	$	58,907,451
Interest bearing deposits		134,173,232		133,955,678		129,201,998		129,096,378
Other liabilities		27,231		27,231		162,731		162,731
Total Financial Liabilities	$	199,850,830	$	199,633,276	$	188,272,180	$	188,166,560

Statement 157 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing and asset or liability.

The fair value of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used to in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

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Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:

	Fair Value Measurements at June 30, 2009 Using
	June 30, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
FNMA MBS - Residential	$	5,710,224	$	—	$	5,710,224	$	—
GNMA MBS - Residential		1,505,508		—		1,505,508		—
Whole Loan MBS - Residential		2,189,731		—		2,189,731		—
Collateralized mortgage obligations		105,944,781		—		105,944,781		—
Total Available for sale Securities	$	115,350,244	$	—	$	115,350,244	$	—

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:

	Fair Value Measurements at December 31, 2008 Using
	December 31, 2008		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
FNMA MBS - Residential	$	6,690,594	$	—	$	6,690,594	$	—
FHLMC MBS - Residential		37,642		—		37,642		—
GNMA MBS - Residential		1,632,790		—		1,632,790		—
Whole Loan MBS - Residential		2,559,037		—		2,559,037		—
Collateralized mortgage obligations		109,368,525		—		109,368,525		—
Total Available for sale Securities	$	120,288,588	$	—	$	120,288,588	$	—

Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 3 inputs based on internally customized discounting criteria. As of June 30, 2009, we did not have any impaired loans that were collateral dependent.

19

Assets and Liabilities Measured on a Non-Recurring Basis

There were no assets and liabilities measured at fair value on a non-recurring basis as of June 30, 2009.

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

	Fair Value Measurements at December 31, 2008 Using
	December 31, 2008		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans	$	85,000		—		—	$	85,000

          As of December 31, 2008, we had one impaired loan that was collateral dependent. Collateral dependent impaired loans, which are measured for impairment using the fair value of the collateral, had a carrying amount of $85,000, with a valuation allowance of $60,241, resulting in an additional provision for loan losses of $40,000 for the period.

          Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets and financial liabilities measured at fair value on a non-recurring basis were not significant at June 30, 2009.

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

Financial Condition at June 30, 2009

          Total assets were $225,929,935 at June 30, 2009, an increase of $13,272,207 or, 6.2%, from December 31, 2008. The increase resulted from the investment of funds available to us as the result of an increase in deposits. The deposit increase was caused generally by our efforts to grow our franchise and specifically by the deposit increases at our branch offices. We invested these funds primarily in cash and cash equivalents, and in loans. The net increase in assets can be summarized as follows:

· A $16,146,328 net increase in cash and cash equivalents and

· A $3,119,615 net increase in net loans receivable, partially offset by

· A $4,938,344 net decrease in investment securities available for sale.

          The decrease in investment securities was the result of a deliberate decision by management not to purchase investment securities during the first half of 2009 due to the extremely low yields that were available. Although the yields on cash equivalent liquid investments, such as overnight federal funds sold, were even lower, we elected to use funds from our increase in deposits to increase cash and cash equivalents so as to avoid locking those funds into low yielding securities investments with longer terms to maturity.

          In addition to these changes in major asset categories, we also experienced changes in other asset categories due to normal fluctuations in operations.

20

          Our deposits (including escrow deposits) were $199,823,599 at June 30, 2009, an increase of $11,714,150 or 6.2%, from December 31, 2008. The increase in deposits resulted from increases of $16,986,466 in NOW accounts, $6,742,916 in non-interest demand deposits, $1,121,860 in savings accounts and $1,079,957 in money market accounts, partially offset by a decrease of $14,217,049 in time deposits. The decrease in time deposits, and the primary increase in NOW accounts, was primarily due to the conversion of a $10 million municipal certificate of deposit into a NOW account. This deposit had been made in conjunction with the Bank Development District program.

          Total stockholders’ equity was $24,425,154 at June 30, 2009, an increase of $1,221,387 from December 31, 2008. The increase reflected (i) net income of $832,348 for the six months ended June 30, 2009, (ii) an increase of additional paid in capital of $118,624 due to the exercise by officers and directors of options to purchase 21,250 shares of common stock, (iii) an increase in the net unrealized gain on securities available for sale of $905,723 and (iv) a reduction of $84,539 in Unearned ESOP shares reflecting the gradual payment of the loan we made to fund the ESOP’s purchase of our stock. These increases were partially offset by $215,152 of dividends paid, representing the first and second quarters $0.06 per share cash dividends in 2009, and $462,972 representing the cost of 53,220 shares of common stock we repurchased in the first quarter of 2009 under our Company’s previously announced stock repurchase plans.

          The unrealized gain on securities available for sale is excluded from the calculation of regulatory capital. Management does not anticipate selling securities in this portfolio, but changes in market interest rates or in the demand for funds may change management’s plans with respect to the securities portfolio. If there is a material increase in interest rates, the market value of the available for sale portfolio may decline. Management believes that the principal and interest payments on this portfolio, combined with the existing liquidity, will be sufficient to fund loan growth and potential deposit outflow.

          For financial statement reporting purposes, we record the compensation expense related to the ESOP when shares are committed to be released from the security interest for the loan. The amount of the compensation expense is based upon the fair market value of the shares at that time, not the original purchase price. The initial sale of shares to the ESOP did not increase our capital by the amount of the purchase price because the purchase price was paid by the loan we made to the ESOP. Instead, capital increases as the shares are allocated or committed to be allocated to employee accounts (i.e., as the ESOP loan is gradually repaid), based upon the fair market value of the shares at that time. When we calculate earnings per share, only shares allocated or committed to be allocated to employee accounts are considered to be outstanding. However, all shares that the ESOP owns are legally outstanding, so they have voting rights and, if we pay dividends, dividends will be paid on all ESOP shares.

The Current Economic Turmoil

          The economy in the United States, including the economy in Staten Island, is in a recession and there is substantial stress on many financial institutions and financial products. The federal government has intervened by making hundreds of billions of dollars in capital contributions to the banking industry. We draw a substantial portion of our customer base from local businesses, especially those in the building trades and related industries. Our customers are already being adversely affected by the economic downturn, and if the recession continues, it will become more difficult for us to conduct prudent and profitable business in our community.

          Making permanent residential mortgage loans is not a material part of our business, and our investments in mortgage-backed securities and collateralized mortgage obligations have been made with a view towards avoiding the types of securities that are backed by low quality mortgage-related assets. However, one of the primary focuses of our local business is receiving deposits from, and making loans to, businesses involved in the construction and building trades industry on Staten Island. Construction loans represented a significant component of our loan portfolio, reaching 39.8% of total loans at year end 2005. As we monitored the economy and the strength of the local construction industry, we elected to reduce our portfolio of construction loans. By June 30, 2009, the percentage had declined to 14.6%. However, developers and builders provide not only a source of loans, but they also provide us with deposits and other business. If the weakness in the economy continues or worsens, then that could have a substantial adverse effect on our customers and potential customers, making it more difficult for us to find satisfactory loan opportunities and low-cost deposits. This could compel us to invest in lower yielding securities instead of higher-yielding loans and could also reduce low cost funding sources such as checking accounts and require that we replace them with higher cost deposits such as time deposits. Either or both of those shifts could reduce our net income.

21

Changes in FDIC Assessment Rates

          In the past year, there have been many failures and near-failures among financial institutions. The number of FDIC-insured banks that have failed has increased, and the FDIC insurance fund reserve ratio, representing the ratio of the fund to the level of insured deposits, has declined due to losses caused by bank failures. As a result, the FDIC has increased its deposit insurance premiums on remaining institutions, including well-capitalized institutions like Victory State Bank, in order to replenish the insurance fund. If bank failures continue to occur, and more so if the level of failures increases, the FDIC insurance fund will further decline, and the FDIC is likely to continue to impose higher premiums on healthy banks. Thus, despite the prudent steps we may take to avoid the mistakes made by other banks, our costs of operations may increase as a result of those mistakes by others.

          Our FDIC insurance premium was $122,869 in 2008. In 2009, the FDIC announced an increase in deposit insurance premiums so institutions like our Bank, even though we are in the lowest regulatory risk category, will be subject to an assessment rate between seven (7) and twelve (12) basis points per annum, which is higher than the assessment rate in 2008 of from five (5) to seven (7) basis points. Additionally, the FDIC has imposed a 5 basis point special assessment, based on June 30, 2009 total assets net of Tier 1 capital, payable on September 30, 2009. The special assessment amounts to $100,000. The FDIC has also announced a probable second special assessment of 5 basis points coming in the second half of 2009. These assessments will significantly increase our deposit insurance expense in 2009.

Results of Operations for the Three Months Ended June 30, 2009 and June 30, 2008

          Our results of operations depend primarily on net interest income, which is the difference between the income we earn on our loan and investment portfolios and our cost of funds, consisting primarily of interest we pay on customer deposits. Our operating expenses principally consist of employee compensation and benefits, occupancy expenses, professional fees, advertising and marketing expenses and other general and administrative expenses. Our results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.

          General. We had net income of $459,297 for the quarter ended June 30, 2009, compared to net income of $426,275 for the comparable quarter in 2008. The principal categories which make up the 2009 net income are:

· Interest income of $2,643,549

· Reduced by interest expense of $332,918

· Reduced by a provision for loan losses of $100,000

· Increased by non-interest income of $615,083

· Reduced by non-interest expense of $1,972,673

· Reduced by income tax expense of $339,744

          We discuss each of these categories individually and the reasons for the differences between the quarters ended June 30, 2009 and 2008 in the following paragraphs. In general, the principal reason for the increase in net income when comparing the second quarter of 2009 with the same quarter in 2008 was an improvement in our interest rate spread and margin coupled with the increase in average assets, partially offset by the increase in provision for loan losses and an increase in FDIC and NYSBD assessments.

22

          Interest Income.Interest income was $2,643,549 for the quarter ended June 30, 2009, compared to $2,678,831 for the quarter ended June 30, 2008, a decrease of $35,282, or 1.3%. Interest income on loans increased by $150,272 in the second quarter of 2009. We had a $7.9 million increase in the average loan balances for the second quarter of 2009 compared to the second quarter of 2008 as management sought to deploy funds in loans, our highest yielding major asset category. The volume increase was the principal reason for the increase in interest income. However, the volume increase was partially offset by a 10 basis point decrease in loan yield due to the decline of the prime rate. The decline in yields on loans was less than the decline in yields on overnight investments because we have introduced interest rate floors on most of our loans that limit the decrease in yield when market interest rates are declining. In addition, interest income on loans during the second quarter of 2009 included $47,793 of interest paid in 2009 on a loan that was classified as non-accrual in 2008 but restored to performing and accrual status in 2009.

          The increase in interest income on loans was partially offset by a $68,859 decline in interest income on cash and due from banks (other interest earning assets), which resulted from a 195 basis point decrease in the yield on those assets (principally overnight investments) due to lower market interest rates. Beginning October 9, 2008, average other interest-earning assets included the deposit balances held at the Federal Reserve Bank of New York (“FRBNY”) because the FRBNY started paying interest on deposit balances. Previously, the deposits held at the FRBNY were categorized as non-interest earning assets. This change represented more than half of the increase in average other interest earning assets and more than half of the corresponding decrease in average non-interest earning assets.

          We also experienced a 38 basis point decrease in the average yield on our investment securities portfolio, from 4.75% to 4.37%, due to the purchase of new investment securities at lower market rates than the yields on the principal paydowns we received. The average balance of our investment portfolio decreased by $552,926, or 0.5%, between the periods. The decrease in volume and the decrease in yield resulted in an overall $116,695 decrease in interest income from investment securities. The investment securities portfolio represented 82.2% of average non-loan interest earning assets in the 2009 period compared to 89.2% in the 2008 period as we deliberately limited our investment of available funds in investment securities due to the loan yields available to us in the first half of 2009.

          Interest Expense. Interest expense was $332,918 for the quarter ended June 30, 2009, compared to $592,821 for the quarter ended June 30, 2008, a decrease of 43.8%. The decrease was primarily the result of a decrease in the rates we paid on deposits, principally on time deposits (an 81 basis point decrease) and money market accounts (a 34 basis point decrease), combined with the reduction in interest expense caused by our repayment of the subordinated debt in August 2008. Our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 1.01% from 1.90% between the periods, due to the decline in market interest rates. We also note, however, that our interest rate spread and net interest margin may come under pressure in future periods if market interest rates rise. The yields on some of our loans may not adjust as rapidly as our cost of funds because those yields will not begin to adjust upwards until the prime rate rises sufficiently so that the yields exceed the interest rate floors.

          Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $2,310,631 for the quarter ended June 30, 2009, an increase of $224,621, or 10.8% over the $2,086,010 in the comparable 2008 quarter. The increase in net interest income before the provision for loan losses was primarily due to the reduced interest cost of deposits and subordinated debt. Our interest rate spread increased to 3.82% in the second quarter of 2009 from 3.50% in the second quarter of 2008. We were able to increase the spread due principally to the combined effect of the interest rate floors on most of our loans and our purchases of investment securities during 2008 prior to the most recent series of market rate declines that began in the fourth quarter of 2008. Our net interest margin increased to 4.21% in the second quarter of 2009 from 4.20% in the second quarter of 2008. The margin is higher than the spread because it takes into account the effect of interest free demand deposits and capital, but the improvement in margin is less than the improvement in spread because those interest-free funding sources are less valuable during periods of lower market interest rates.

23

          Provision for Loan Losses.We took a provision for loan losses of $100,000 for the quarter ended June 30, 2009 compared to a provision for loan losses of $55,000 for the quarter ended June 30, 2008. The $45,000 increase in the provision was due to an increase in loan delinquencies and continuing deterioration of the real estate market and local economy. We are aggressively collecting charged-off loans in an effort to recover amounts charged off. The provision for loan losses in any period depends upon the amount necessary to bring the allowance for loan losses to the level management believes is appropriate, after taking into account charge offs and recoveries. Our allowance for loan losses is based on management’s evaluation of the risks inherent in our loan portfolio and the general economy. Management periodically evaluates both broad categories of performing loans and problem loans individually to assess the appropriate level of the allowance.

          Although management uses available information to assess the appropriateness of the allowance on a quarterly basis in consultation with outside advisors and the board of directors, changes in national or local economic conditions, the circumstances of individual borrowers, or other factors, may change, increasing the level of problem loans and requiring an increase in the level of the allowance. The allowance for loan losses represented 1.34% of total loans at June 30, 2009. There can be no assurance that a higher level, or a higher provision for loan losses, will not be necessary in the future.

          Non-interest Income.Non-interest income was $615,083 for the quarter ended June 30, 2009, compared to $624,234 during the same period last year. The $9,151, or 1.5%, decrease in non-interest income was a direct result of normal fluctuations in fee based customer transactions such as non-sufficient funds charges, the purchase of money orders, late charges on loans and similar retail banking transactions.

          Non-interest Expense. Non-interest expense was $1,972,673 for the quarter ended June 30, 2009, compared to $1,862,177 for the quarter ended June 30, 2008, an increase of $110,496. The shifts in the individual categories were:

· $55,000 increase in FDIC and NYSBD assessments due to an increase in the FDIC assessment rate and the imposition of a special assessment to help replenish the FDIC insurance fund which has be substantially depleted by many current bank failures;

· $43,482 increased in salaries and benefits due to additional staff and higher related benefit costs;

· $14,776 increase in occupancy expenses due to higher utility bills.

          Income Tax Expense. Income tax expense was $393,744 for the quarter ended June 30, 2009, compared to income tax expense of $366,792 for the quarter ended June 30, 2008. The increase in income tax expense was due to the $59,974 increase in income before income taxes in the 2009 quarter. Our effective tax rate for the quarter ended June 30, 2009 was 46.2%, the same as for the quarter ended June 30, 2008.

Results of Operations for the Six Months Ended June 30, 2009 and June 30, 2008

          Our results of operations depend primarily on net interest income, which is the difference between the income we earn on our loan and investment portfolios and our cost of funds, consisting primarily of interest we pay on customer deposits. Our operating expenses principally consist of employee compensation and benefits, occupancy expenses, professional fees, advertising and marketing expenses and other general and administrative expenses. Our results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.

24

          General. We had net income of $832,348 for the six months ended June 30, 2009, compared to net income of $788,220 for the comparable period in 2008. The principal categories which make up the 2009 net income are:

· Interest income of $5,361,615

· Reduced by interest expense of $743,866

· Reduced by a provision for loan losses of $375,000

· Increased by non-interest income of $1,228,252

· Reduced by non-interest expense of $3,925,136

· Reduced by income tax expense of $713,517

          We discuss each of these categories individually and the reasons for the differences between the six months ended June 30, 2009 and 2008 in the following paragraphs. In general, the principal reason for the increase in net income when comparing the first six months of 2009 with the same period in 2008 was an improvement in our interest rate spread and margin coupled with an increase in average assets, partially offset by the increase in provision for loan losses and an increase in FDIC and NYSBD assessments.

          Interest Income.Interest income was $5,361,615 for the six months ended June 30, 2009, compared to $5,409,912 for the six months ended June 30, 2008, a decrease of $48,297, or 0.9%. The principal reason for the decline was a decline in market interest rates, which was the primary cause of $166,411 decline in interest income from other interest earning assets (principally overnight investments) and a $118,373 decline in interest income on investment securities. On the positive side, interest income on loans increased by $236,487.

          The average yield on other interest earning assets (principally overnight investments) declined 241 basis points from 2.5% in the first six months of 2008 to 0.09% in the first six months of 2009 as the target federal funds rate declined from 4.25% at the beginning of 2008 to its current level of a range from 0.00% to 0.25%. Beginning October 9, 2008, average other interest-earning assets included the deposit balances held at the Federal Reserve Bank of New York (“FRBNY”) because the FRBNY started paying interest on deposit balances. Previously, the deposits held at the FRBNY were categorized as non-interest earning assets. This change represented more than half of the increase in average other interest earning assets and more than half of the corresponding decrease in average non-interest earning assets.

We also experienced a 26 basis point decrease in the average yield on our investment securities portfolio, from 4.75% to 4.49%, due to the purchase of new investment securities at lower market rates than the yields on the principal paydowns we received. The average balance of our investment portfolio increased by $1,940,172, or 1.63%, between the periods. The increase in volume was moderated by our decision, discussed above, to limit the purchases of investment securities to avoid locking in the very low rates at which they were available during the first half of 2009. The investment securities portfolio represented 84.4% of average non-loan interest earning assets in the 2009 period compared to 89.4% in the 2008 period.

          There were three principal causes of the $236,487 increase in interest on loans. First, we received $136,598 of interest due in 2008 but not paid or accrued on various loans. That interest was paid in 2009 and included in 2009 interest income. Second, we experienced a $6,394,523 increase in the average balance of loans as the result of management’s efforts to increase the volume of loans, our highest yielding major asset category. Third, the interest rate floors on many of our prime-based loans buffered the effect of the declining prime rate so that our average yield on loans decline only 24 basis points, from 7.70% to 7.56%.

          Interest Expense. Interest expense was $743,866 for the six months ended June 30, 2009, compared to $1,348,613 for the six months ended June 30, 2008, a decrease of $604,747 or 44.8%. The decrease was primarily the result of a decrease in the rates we paid on deposits, principally on time deposits (a 115 basis point decrease) and money market accounts (a 53 basis point decrease), combined with the reduction in interest expense caused by our repayment of the subordinated debt in August 2008, which had previously had an interest cost of 6.91%. As a result, our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 1.15% from 2.20% between the periods due to the decline in market interest rates and the repayment of the subordinated debt.

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          Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $4,617,749 for the six months ended June 30, 2009, an increase of $556,450, or 13.7% over the $4,061,299 in the comparable 2008 period. Our interest rate spread increased to 3.87% in the first six months of 2009 from 3.33% in the same period of 2008. We were able to increase the spread due principally to the combined effect of the interest rate floors on most of our loans; our purchases of investment securities during 2008 prior to the most recent series of market rate declines that began in the fourth quarter of 2008; and the repayment of the relatively high cost subordinated debt. Our net interest margin increased to 4.32% in the first six months of 2009 from 4.15% in the same period of 2008. The margin is higher than the spread because it takes into account the effect of interest free demand deposits and capital, but the improvement in margin is less than the improvement in spread because those interest-free funding sources are less valuable during periods of lower market interest rates.

          Provision for Loan Losses.We took a provision for loan losses of $375,000 for the six months ended June 30, 2009 compared to a provision for loan losses of $85,000 for the six months ended June 30, 2008. The $290,000 increase in the provision was due to a higher level of charge-offs, $466,893 for the first six months of 2009 as compared to $251,716 in the same period in 2008, and continuing deterioration of the real estate market and local economy. We are aggressively collecting these charged-off loans in an effort to recover the amounts charged off. The provision for loan losses in any period depends upon the amount necessary to bring the allowance for loan losses to the level management believes is appropriate, after taking into account charge offs and recoveries. Our allowance for loan losses is based on management’s evaluation of the risks inherent in our loan portfolio and the general economy. Management periodically evaluates both broad categories of performing loans and problem loans individually to assess the appropriate level of the allowance.

          Although management uses available information to assess the appropriateness of the allowance on a quarterly basis in consultation with outside advisors and the board of directors, changes in national or local economic conditions, the circumstances of individual borrowers, or other factors, may change, increasing the level of problem loans and requiring an increase in the level of the allowance. The allowance for loan losses represented 1.34% of total loans at June 30, 2009. There can be no assurance that a higher level, or a higher provision for loan losses, will not be necessary in the future.

          Non-interest Income.Non-interest income was $1,228,252 for the six months ended June 30, 2009, compared to $1,190,136 during the same period last year. The $38,116, or 3.2%, increase in non-interest income was a direct result of normal fluctuations in retail banking transactions and the fees derived from them, such as insufficient funds fees, and an increase in net rental income because the Bank was able to sublease a portion of a leased property that was previously vacant. Other non-interest income declined because we lost a licensed check cashing company as a customer, which had previously generated substantial transaction fees, in the first quarter of 2008.

          Non-interest Expense. Non-interest expense was $3,925,136 for the six months ended June 30, 2009, compared to $3,700,327 for the six months ended June 30, 2008. The shifts in the individual categories were:

· $84,000 increase in FDIC and NYSBD assessments due to an increase in the FDIC assessment rate and the imposition of a special assessment to help replenish the FDIC insurance fund which has be substantially depleted by many current bank failures;

· $45,057 increased in salaries and benefits due to additional staff and higher related benefit costs;

· $36,133 increase in occupancy expenses due to higher utility bills;

· $29,000 increase in professional fees primarily due the costs of initial compliance with Section 404 of the Sarbanes-Oxley Act, which requires management and the independent accountant to report on the company’s internal control over financial reporting; and

· $25,392 increase in computer expenses primarily due to increased fees associated with our disaster recovery program.

26

          Income Tax Expense. Income tax expense was $713,517 for the six months ended June 30, 2009, compared to income tax expense of $677,888 for the same period ended June 30, 2008. The increase in income tax expense was due to the $79,757 increase in income before income taxes in the 2009 period. Our effective tax rate for the first six months ended June 30, 2009 was 46.2%, the same as for the same period ended June 30, 2008.

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VSB Bancorp, Inc.
Consolidated Average Balance Sheets
(unaudited)

	Three Months Ended June 30, 2009							Three Months Ended June 30, 2008							Six Months Ended June 30, 2009							Six Months Ended June 30, 2008
	Average Balance			Interest		Yield/ Cost		Average Balance			Interest		Yield/ Cost		Average Balance			Interest		Yield/ Cost		Average Balance			Interest		Yield/ Cost
Assets:
Interest-earning assets:
Loans receivable	$	70,088,567		$	1,323,189	7.37	%	$	62,185,996		$	1,172,917	7.47	%	$	68,979,199		$	2,653,895	7.56	%	$	62,584,676		$	2,417,408	7.70	%
Investment securities, afs		120,536,100			1,314,667	4.37			121,089,026			1,431,362	4.75			121,134,122			2,697,286	4.49			119,193,950			2,815,659	4.75
Other interest-earning assets		26,117,641			5,693	0.09			14,704,057			74,552	2.04			22,313,262			10,434	0.09			14,209,342			176,845	2.50
Total interest-earning assets		216,742,308			2,643,549	4.83			197,979,079			2,678,831	5.40			212,426,583			5,361,615	5.02			195,987,968			5,409,912	5.53
Non-interest earning assets		4,940,609							12,990,338							5,230,752							13,071,773
Total assets	$	221,682,917						$	210,969,417						$	217,657,335						$	209,059,741
Liabilities and equity:
Interest-bearing liabilities:
Savings accounts	$	13,245,440			13,219	0.40		$	11,816,546			18,191	0.62		$	12,980,502			26,321	0.41		$	11,402,990			37,173	0.66
Time accounts		63,005,008			220,765	1.41			69,021,801			380,380	2.22			69,006,358			531,317	1.55			67,104,083			899,827	2.70
Money market accounts		24,109,694			62,944	1.05			20,940,525			72,509	1.39			23,778,459			123,455	1.05			21,399,289			168,601	1.58
Now accounts		31,570,563			35,990	0.46			18,385,134			32,702	0.72			25,069,622			62,773	0.50			18,129,757			64,933	0.72
Subordinated debt		—			—	—			5,155,000			89,039	6.91			—			—	—			5,155,000			178,079	6.91
Total interest-bearing liabilities		131,930,705			332,918	1.01			125,319,006			592,821	1.90			130,834,941			743,866	1.15			123,191,119			1,348,613	2.20
Checking accounts		63,715,256							62,800,182							61,481,194							62,906,868
Total deposits and subordinated debt		195,645,961							188,119,188							192,316,135							186,097,987
Other liabilities		1,658,579							968,801							1,469,923							1,160,933
Total liabilities		197,304,540							189,087,989							193,786,058							187,258,920
Equity		24,378,377							21,881,428							23,871,277							21,800,821
Total liabilities and equity	$	221,682,917						$	210,969,417						$	217,657,335						$	209,059,741
Net interest income/net interest rate spread				$	2,310,631	3.82	%				$	2,086,010	3.50	%				$	4,617,749	3.87	%				$	4,061,299	3.33	%
Net interest earning assets/net interest margin	$	84,811,603				4.21	%	$	72,660,073				4.20	%	$	81,591,642				4.32	%	$	72,796,849				4.15	%
Ratio of interest-earning assets to interest-bearing liabilities		1.64	x						1.58	x						1.62	x						1.59	x
Return on Average Assets (1)		0.80	%						0.79	%						0.74	%						0.75	%
Return on Average Equity (1)		7.24	%						7.65	%						6.72	%						7.17	%
Tangible Equity to Total Assets		10.81	%						9.94	%						10.81	%						9.94	%

(1) Ratios have been annualized.

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Liquidity and Capital Resources

          Our primary sources of funds are increases in deposits, proceeds from the repayment of investment securities, and the repayment of loans. We use these funds to purchase new investment securities and to fund new and renewing loans in our loan portfolio. Remaining funds are invested in short-term liquid assets such as overnight federal funds loans and bank deposits.

          During the six months ended June 30, 2009, we had a net increase in total deposits of $11,714,150 due to increases of $16,986,466 in NOW accounts, $6,742,916 in non-interest demand deposits, $1,121,860 in savings accounts and $1,079,957 in money market accounts, partially offset by a decrease of $14,217,049 in time deposits. We also received proceeds from repayment of investment securities of $18,349,346. We used $11,776,211 of available funds to purchase new investment securities and we had a net loan increase of $3,439,003. These changes resulted in an overall increase in cash and cash equivalents of $16,146,328 because we elected not to use those funds to purchase investment securities, as discussed above.

          In contrast, during the six months ended June 30, 2008, we had a net increase in total deposits of $12,726,092 due to increases of $5,584,881 in time deposits, $3,928,274 in non-interest demand deposits, $2,198,478 in NOW accounts and $1,134,606 in savings accounts, partially offset by a decrease of $120,147 in money market accounts. We also received proceeds from repayment of investment securities of $14,402,118. We used $21,612,383 of available funds to purchase new investment securities and we had a net loan increase of $821,792. These changes resulted in an overall increase in cash and cash equivalents of $5,310,982.

          At June 30, 2009, cash and cash equivalents represented 17% of total assets. We anticipate, based upon historical experience that these funds, combined with cash inflows we anticipate from payments on our loan and investment securities portfolios, will be sufficient to fund loan growth and unanticipated deposit outflows. As a secondary source of liquidity, at June 30, 2009 we had in excess of $115 million of investment securities classified available for sale. The disposition of these securities prior to maturity is an option available to us in the event, which we believe is unlikely, that our primary sources of liquidity and expected cash flows are insufficient to meet our need for funds. Additionally, we have the ability to borrow funds at the Federal Home Loan Bank of New York using securities in our investment portfolio as collateral if the need arises. We do not anticipate a need for additional capital resources and do not expect to raise funds through a stock offering in the near future. As a result of our strong capital resources and available liquidity, we did not participate in the Treasury Departments TARP Capital Purchase Program. We have sufficient resources to allow us to continue to make loans as appropriate opportunities arise without having to rely on government funds to support our lending activities.

          Victory State Bank satisfied all capital ratio requirements of the Federal Deposit Insurance Corporation at June 30, 2009, with a Tier I Leverage Capital ratio of 10.13%, a ratio of Tier I Capital to Risk-Weighted Assets ratio of 24.09%, and a Total Capital to Risk-Weighted Assets ratio of 25.08%.

          VSB Bancorp, Inc. satisfied all capital ratio requirements of the Federal Reserve at June 30, 2009, with a Tier I Leverage Capital ratio of 10.34%, a ratio of Tier I Capital to Risk-Weighted Assets ratio of 24.11%, and a Total Capital to Risk-Weighted Assets ratio of 25.08%.

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          The following table sets forth our contractual obligations and commitments for future lease payments, time deposit maturities and loan commitments.

Contractual Obligations and Commitments at June 30, 2009

Contractual Obligations	Payment due by Period
	Less than One Year		One to three years		Four to five years		After five years		Total Amounts committed
Minimum annual rental payments under non-cancelable operating leases	$	401,591	$	825,690	$	831,224	$	1,597,147	$	3,655,652
Remaining contractual maturities of time deposits		58,321,701		1,131,238		2,653,506		—		62,106,445
Total contractual cash obligations	$	58,723,292	$	1,956,928	$	3,484,730	$	1,597,147	$	65,762,097

Other commitments	Amount of commitment Expiration by Period
	Less than One Year		One to three years		Four to five years		After five years		Total Amounts committed
Loan commitments	$	41,666,591	$	4,189,382	$	—	$	—	$	45,855,973

          Our loan commitments shown in the above table represent both commitments to make new loans and obligations to make additional advances on existing loans, such as construction loans in process and lines of credit. Substantially all of these commitments involve loans with fluctuating interest rates, so the outstanding commitments do not expose us to interest rate risk upon fluctuation in market rates.

Non-Performing Loans

          Management closely monitors non-performing loans and other assets with potential problems on a regular basis. We had eight non-performing loans, totaling $2,005,654, at June 30, 2009, compared to thirteen non-performing loans, totaling $2,279,067, at December 31, 2008. The following is information about the five largest non-performing loans, totaling $1,385,096 in outstanding principal balance at June 30, 2009. Management believes it has taken appropriate steps with a view towards maximizing recovery and minimizing loss on these loans.

· $859,968 in three construction loans to a builder secured and cross-collateralized by first mortgage liens on three lots in Staten Island on which single family houses are near completion. The loans are past maturity and we have commenced foreclosure actions. A motion to appoint a referee to calculate the amount owed on the loans, which is a predicate to an actual foreclosure sale, was submitted and we are awaiting the court’s decision on that motion.

· $510,095 in a loan to a local business. The loan is in arrears but the borrower continues to make partial payments. The loan is secured by a first mortgage on a commercial building, a third mortgage on the borrower’s personal residence, a security interest in the business, and the personal guaranties of the principals. This loan was repaid in full in July 2009.

· $396,996 in a loan to a local business in which we are a participant in the loan with another bank. We are not the lead lender. The loan is in arrears and the lead lender has commenced a foreclosure action. The loan is secured by a first mortgage on a commercial building, a security interest in the business, and the personal guaranties of the principals.

Critical Accounting Policies and Judgments
          We are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting period. The allowance for loan losses, prepayment estimates on the mortgage-backed securities and Collateralized Mortgage Obligation portfolios, contingencies and fair values of financial instruments are particularly subject to change and to management’s estimates. Actual results can differ from those estimates and may have an impact on our financial statements.

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Item 3 – Controls and Procedures

          Evaluation of Disclosure Controls and Procedures: As of June 30, 2009, we undertook an evaluation of our disclosure controls and procedures under the supervision and with the participation of Raffaele M. Branca, President, CEO and CFO. Disclosure controls are the systems and procedures we use that are designed to ensure that information we are required to disclose in the reports we file or submit under the Securities Exchange Act of 1934 (such as annual reports on Form 10-K and quarterly periodic reports on Form 10-Q) is recorded, processed, summarized and reported, in a manner which will allow senior management to make timely decisions on the public disclosure of that information. Mr. Branca concluded that our current disclosure controls and procedures are effective in ensuring that such information is (i) collected and communicated to senior management in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Since our last evaluation of our disclosure controls, we have not made any significant changes in, or taken corrective actions regarding, either our internal controls or other factors that could significantly affect those controls.

          We intend to continually review and evaluate the design and effectiveness of our disclosure controls and procedures and to correct any deficiencies that we may discover. Our goal is to ensure that senior management has timely access to all material financial and non-financial information concerning our business so that they can evaluate that information and make determinations as to the nature and timing of disclosure of that information. While we believe the present design of our disclosure controls and procedures is effective to achieve this goal, future events may cause us to modify our disclosure controls and procedures.

Part II

Item 1 – Legal Proceedings

          There have been no material developments in the legal action pending in Supreme Court, Richmond County, commenced by IndyMac Bank, F.S.B. against the Bank, LaMattina & Associates, Inc. and others which was described in the report on Form 10-Q for the company for the quarter ended March 31, 2009. The litigation is in the discovery phase and depositions of former officers and employees of Old IndyMac, the first depositions in the case, began in April 2009, but have not concluded.

          VSB Bancorp, Inc. is not involved in any pending legal proceedings. The Bank, from time to time, is involved in routine collection proceedings in the ordinary course of business on loans in default. Management believes that such other routine legal proceedings in the aggregate are immaterial to our financial condition or results of operations.

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Signature Page

          In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	VSB Bancorp, Inc.
Date: August 11, 2009	/s/ Raffaele M. Branca
	Raffaele M. Branca
	President and Chief Executive Officer

EXHIBIT INDEX

Exhibit Number	Description of Exhibit
31.1	Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer
31.2	Rule 13A-14(a)/15D-14(a) Certification of Chief Financial Officer
32.1	Certification by CEO pursuant to 18 U.S.C. 1350.
32.2	Certification by CFO pursuant to 18 U.S.C. 1350.

Item 6 - Exhibits

Exhibit Number	Description of Exhibit
31.1	Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer
31.2	Rule 13A-14(a)/15D-14(a) Certification of Chief Financial Officer
32.1	Certification by CEO pursuant to 18 U.S.C. 1350.
32.2	Certification by CFO pursuant to 18 U.S.C. 1350.

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