Waterstone Financial 10-Q 2012 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.20549

Form 10-Q

R	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended March 31, 2012
	OR
*	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number 000-51507

WATERSTONE FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

Federal	20-3598485
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

11200 W. Plank Ct.

Wauwatosa, WI53226

(414) 761-1000

(Address, including Zip Code, and telephone number,

including area code, of registrant’s principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes R No *

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes R No *

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

Large accelerated filer * Accelerated filer R Non-accelerated filer * Smaller Reporting Company *

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

Yes * No R

The number of shares outstanding of the issuer’s common stock, $0.01 par value per share, was 31,350,097 at April 30, 2012.

WATERSTONE FINANCIAL, INC.

10-Q INDEX

	Page No.
PARTI. FINANCIAL INFORMATION
Item l. Financial Statements	3
Consolidated Statements of Financial Condition as of March 31, 2012 (unaudited) and December 31, 2011	3
Consolidated Statements of Operations for the three months ended March 31, 2012 and 2011 (unaudited)	4
Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2012 and 2011 (unaudited)	5
Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2012 and 2011 (unaudited)	6
Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011 (unaudited)	7
Notes to Consolidated Financial Statements (unaudited)	8 - 38
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	38 - 54
Item 3. Quantitative and Qualitative Disclosures about Market Risk	54 - 55
Item 4. Controls and Procedures	55
PART II. OTHER INFORMATION	56
Item 1. Legal Proceedings	56
Item 1A. Risk Factors	56
Item 6. Exhibits	56
Signatures	56
Certification
Certification
Certification
Certification

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

WATERSTONE FINANCIAL, INC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

	(Unaudited)
	March 31,			December 31,
	2012			2011
Assets	(In Thousands, except share data)
Cash	$	54,986			72,336
Federal funds sold		20,621			8,044
Cash and cash equivalents		75,607			80,380
Securities available for sale (at fair value)		214,958			206,519
Securities held to maturity (at amortized cost),
fair value of $2,542 at December 31, 2011		-			2,648
Loans held for sale (at fair value)		90,701			88,283
Loans receivable		1,200,477			1,216,664
Less: Allowance for loan losses		(33,047	)		(32,430	)
Loans receivable, net		1,167,430			1,184,234
Office properties and equipment, net		27,266			27,356
Federal Home Loan Bank stock (at cost)		20,801			21,653
Cash surrender value of life insurance		36,895			36,749
Real estate owned		56,010			56,670
Prepaid expenses and other assets		9,234			8,359
Total assets	$	1,698,902			1,712,851
Liabilities and Shareholders’ Equity
Liabilities:
Demand deposits	$	68,673			68,457
Money market and savings deposits		109,334			104,102
Time deposits		865,747			878,733
Total deposits		1,043,754			1,051,292
Short-term borrowings		25,193			27,138
Long-term borrowings		434,000			434,000
Advance payments by borrowers for taxes		7,394			942
Other liabilities		19,701			33,107
Total liabilities		1,530,042			1,546,479
Shareholders’ equity:
Preferred stock (par value $.01 per share)
Authorized 20,000,000 shares, no shares issued		—			—
Common stock (par value $.01 per share)
Authorized - 200,000,000 shares in 2012 and 2011
Issued - 33,974,450 shares in 2012 and in 2011
Outstanding - 31,350,097 shares in 2012 and 31,250,097 in 2011		340			340
Additional paid-in capital		110,764			110,894
Retained earnings		103,781			101,573
Unearned ESOP shares		(2,348	)		(2,562	)
Accumulated other comprehensive income, net of taxes		1,584			1,388
Treasury shares (2,724,353 shares), at cost		(45,261	)		(45,261	)
Total shareholders’ equity		168,860			166,372
Total liabilities and shareholders’ equity	$	1,698,902			1,712,851

See Accompanying Notes to Unaudited Consolidated Financial Statements.

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WATERSTONE FINANCIAL, INC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three months ended March 31,
	2012			2011
	(In Thousands, except per share amounts)
Interest income:
Loans		16,572			18,465
Mortgage-related securities		863			1,037
Debt securities, federal funds sold and short-term investments		707			835
Total interest income		18,142			20,337
Interest expense:
Deposits		3,204			4,099
Borrowings		4,512			4,311
Total interest expense		7,716			8,410
Net interest income		10,426			11,927
Provision for loan losses		3,675			4,875
Net interest income after provision for loan losses		6,751			7,052
Noninterest income:
Service charges on loans and deposits		249			249
Increase in cash surrender value of life insurance		145			152
Total other-than-temporary investment losses		(901	)		-
Portion of loss recognized in other comprehensive income (before tax)		897			-
Net impairment losses recognized in earnings		(4	)		-
Mortgage banking income		14,201			6,163
Gain on sale of available for sale securities		241			-
Other		170			233
Total noninterest income		15,002			6,797
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		10,637			7,917
Occupancy, office furniture and equipment		1,721			1,619
Advertising		555			321
Data processing		392			350
Communications		296			258
Professional fees		426			394
Real estate owned		1,435			1,795
FDIC insurance premiums		941			1,061
Other		3,112			1,639
Total noninterest expenses		19,515			15,354
Income (loss) before income taxes		2,238			(1,505	)
Income taxes		30			39
Net income (loss)		2,208			(1,544	)
Income (loss) per share:
Basic	$	0.07			(0.05	)
Diluted	$	0.07			(0.05	)
Weighted average shares outstanding:
Basic		30,683,089			30,898,687
Diluted		30,695,661			30,898,687

See Accompanying Notes to Unaudited Consolidated Financial Statements.

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WATERSONE FINANCIAL, INC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

	Three months ended March 31,
	2012			2011
	(In Thousands)
Net income (loss)	$	2,208			(1,544	)
Other comprehensive income (loss), net of tax:
Net unrealized holding gain (loss) on available for sale securities
arising during the period, net of tax (expense) benefit
of ($100) and $51, respectively		340			(324	)
Reclassification adjustment for net gains on available for sale
securities realized during the period, net of taxes of $96		(144	)		—
Total other comprehensive income (loss)		196			(324	)
Comprehensive income (loss)	$	2,404			(1,868	)

See Accompanying Notes to Unaudited Consolidated Financial Statements.

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WATERSONE FINANCIAL, INC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

														Accumulated
					Additional						Unearned			Other						Total
	Common Stock				Paid-In			Retained			ESOP			Comprehensive			Treasury			Shareholders'
	Shares		Amount		Capital			Earnings			Shares			Income			Shares			Equity
	(In Thousands)
Balances at December 31, 2010		31,250	$	340		109,953			109,046			(3,416	)		1,558			(45,261	)		172,220
Comprehensive loss:
Net loss		—		—		—			(1,544	)		—			—			—			(1,544	)
Other comprehensive loss:		—		—		—			—			—			(324	)		—			(324	)
Total comprehensive loss																					(1,868	)
ESOP shares committed to be released to Plan participants		—		—		(160	)		—			214			—			—			54
Stock based compensation		—		—		431			—			—			—			—			431
Balances at March 31, 2011		31,250	$	340		110,224			107,502			(3,202	)		1,234			(45,261	)		170,837
Balances at December 31, 2011		31,250	$	340		110,894			101,573			(2,562	)		1,388			(45,261	)		166,372
Comprehensive income:
Net income		—		—		—			2,208			—			—			—			2,208
Other comprehensive income:		—		—		—			—			—			196			—			196
Total comprehensive income																					2,404
ESOP shares committed to be released to Plan participants		—		—		(170	)		—			214			—			—			44
Stock based compensation		100		—		40			—			—			—			—			40
Balances at March 31, 2012		31,350	$	340		110,764			103,781			(2,348	)		1,584			(45,261	)		168,860

See Accompanying Notes to Unaudited Consolidated Financial Statements.

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WATERSTONE FINANCIAL, INC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Three months ended March 31,
	2012			2011
	(In Thousands)
Operating activities:
Net income (loss)	$	2,208		$	(1,544	)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Provision for loan losses		3,675			4,875
Depreciation		486			466
Deferred income taxes		—			39
Stock based compensation		40			431
Net amortization of premium on debt and mortgage-related securities		216			135
Amortization of unearned ESOP shares		44			54
Net realized and unrealized loss related to real estate owned		533			215
Gain on sale of loans held for sale		(14,964	)		(6,163	)
Loans originated for sale		(326,882	)		(182,970	)
Proceeds on sales of loans originated for sale		339,428			256,174
Increase (decrease) in accrued interest receivable		147			(80	)
Increase in cash surrender value of bank owned life insurance		(145	)		(152	)
Decrease in accrued interest on deposits and borrowings		(117	)		(166	)
Decrease in other liabilities		(2,610	)		(10,679	)
Decrease in accrued tax payable		(17	)		(67	)
Gain on sale or impairment of securities		(236	)		—
Other		(1,233	)		2,028
Net cash provided by operating activities		573			62,596
Investing activities:
Net decrease in loans receivable		6,779			20,777
Purchases of:
Mortgage-related securities		(51,367	)		—
Debt securities		(980	)		(25,382	)
Premises and equipment, net		(396	)		(287	)
Proceeds from:
Principal repayments on mortgage-related securities		7,339			9,727
Sales of debt securities		11,908			—
Maturities of debt securities		25,072			8,184
Calls of structured notes		2,648			—
Redemption of FHLB stock		852			—
Sales of real estate owned and other assets		6,490			5,609
Net cash provided by investing activities		8,345			18,628

Financing activities:
Net decrease in deposits		(7,538	)		(16,121	)
Net change in short-term borrowings		(1,945	)		(21,980	)
Net change in advance payments by borrowers for taxes		(4,208	)		6,388
Net cash used in financing activities		(13,691	)		(31,713	)
Increase (decrease)in cash and cash equivalents		(4,773	)		49,511
Cash and cash equivalents at beginning of period		80,380			75,331
Cash and cash equivalents at end of period	$	75,607		$	124,842
Supplemental information:
Cash paid, credited or (received) during the period for:
Income tax payments		47			67
Interest payments		7,833			8,575
Noncash investing activities:
Loans receivable transferred to real estate owned		6,349			9,311

See Accompanying Notes to Unaudited Consolidated Financial Statements.

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WATERSTONE FINANCIAL, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 — Basis of Presentation

The unaudited interim consolidated financial statements include the accounts of Waterstone Financial, Inc. (the “Company”) and the Company’s subsidiaries.

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information, Rule 10-01 of Regulation S-X and the instructions to Form 10-Q. The financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position, results of operations, changes in shareholders’ equity, and cash flows of the Company for the periods presented.

The accompanying unaudited consolidated financial statements and related notes should be read in conjunction with the Company’s December 31, 2011 Annual Report on Form 10-K. Operating results for the three months ended March 31, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

The preparation of the unaudited consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period.  Significant items subject to such estimates and assumptions include the allowance for loan losses, deferred income taxes, certain investment securities and real estate owned.  Actual results could differ from those estimates.

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Note 2— Securities Available for Sale

The amortized cost and fair values of the Company’s investment in securities available for sale follow:

	March 31, 2012
			Gross		Gross
	Amortized		unrealized		unrealized
	cost		gains		losses			Fair value
	(In Thousands)
Mortgage-backed securities	$	67,933		1,866		(253	)		69,546
Collateralized mortgage obligations:
Government sponsored enterprise issued		42,595		597		(5	)		43,187
Private-label issued		19,038		—		(897	)		18,141
Mortgage-related securities		129,566		2,463		(1,155	)		130,874
Government sponsored enterprise bonds		47,266		83		(11	)		47,338
Municipal securities		24,967		1,773		(210	)		26,530
Other debt securities		5,000		294		—			5,294
Debt securities		77,233		2,150		(221	)		79,162
Certificates of Deposit		4,900		25		(3	)		4,922
	$	211,699		4,638		(1,379	)		214,958

	December 31, 2011
			Gross		Gross
	Amortized		unrealized		unrealized
	cost		gains		losses			Fair value
	(In Thousands)
Mortgage-backed securities	$	33,561		1,857		(1	)		35,417
Collateralized mortgage obligations:
Government sponsored enterprise issued		32,650		559		(13	)		33,196
Private-label issued		19,475		16		(1,040	)		18,451
Mortgage-related securities		85,686		2,432		(1,054	)		87,064
Government sponsored enterprise bonds		71,210		152		(13	)		71,349
Municipal securities		37,644		1,744		(320	)		39,068
Other debt securities		5,000		118		—			5,118
Debt securities		113,854		2,014		(333	)		115,535
Certificates of Deposit		3,920		2		(2	)		3,920
	$	203,460		4,448		(1,389	)		206,519

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The majority of the Company’s mortgage-backed securities and collateralized mortgage obligations issued by government sponsored enterprises are guaranteed by either Fannie Mae or Freddie Mac.  At March 31, 2012, $36.0 million of the Company’s government sponsored enterprise bonds and $67.4 million of mortgage-related securities were pledged as collateral to secure repurchase agreement obligations of the Company.  An additional $1.1 million in municipal securities were pledged as collateral related to mortgage banking activities.

The amortized cost and fair values of investment securities by contractual maturity at March 31, 2012, are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized		Fair
	Cost		Value
	(In Thousands)
Debt and other securities
Due within one year	$	4,234		4,240
Due after one year through five years		58,772		59,606
Due after five years through ten years		3,390		3,775
Due after ten years		15,737		16,463
Mortgage-related securities		129,566		130,874
	$	211,699		214,958

Gross unrealized losses on securities available for sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position were as follows:

	March 31, 2012
	Less than 12 months					12 months or longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	value		loss			value		loss			value		loss
	(In Thousands)
Mortgage-backed securities	$	28,307		(253	)		—		—			28,307		(253	)
Collateralized mortgage obligations:
Government sponsored enterprise issued		3,898		(5	)		—		—			3,898		(5	)
Private-label issued		2,860		(21	)		15,281		(876	)		18,141		(897	)
Government sponsored enterprise bonds		2,989		(11	)		—		—			2,989		(11	)
Municipal securities		230		(85	)		1,319		(125	)		1,549		(210	)
Certificates of Deposit		1,222		(3	)		—		—			1,222		(3	)
	$	39,506		(378	)		16,600		(1,001	)		56,106		(1,379	)
	December 31, 2011
	Less than 12 months					12 months or longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	value		loss			value		loss			value		loss
	(In Thousands)
Mortgage-backed securities	$	1,167		(1	)		—		—			1,167		(1	)
Collateralized mortgage obligations:
Government sponsored enterprise issued		5,726		(13	)		—		—			5,726		(13	)
Private-label issued		—		—			15,408		(1,040	)		15,408		(1,040	)
Government sponsored enterprise bonds		12,487		(13	)		—		—			12,487		(13	)
Municipal securities		228		(87	)		1,989		(233	)		2,217		(320	)
Certificates of Deposit		1,958		(2	)		—		—			1,958		(2	)
	$	21,566		(116	)		17,397		(1,273	)		38,963		(1,389	)

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The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment.  In evaluating whether a security’s decline in market value is other-than-temporary, management considers the length of time and extent to which the fair value has been less than cost, financial condition of the issuer and the underlying obligors, quality of credit enhancements, volatility of the fair value of the security, the expected recovery period of the security and ratings agency evaluations.  In addition the Company may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds and the value of any underlying collateral.  For certain securities in unrealized loss positions, the Company prepares cash flow analyses to compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.

As of March 31, 2012, the Company had three securities which had been in an unrealized loss position for twelve months or longer, including one private-label collateralized mortgage obligation security and two municipal securities.  Based upon the aforementioned factors, the Company identified two private-label collateralized mortgage obligation securities at March 31, 2012 with a combined amortized cost of $19.0 million for which a cash flow analysis was performed to determine whether an other-than-temporary impairment was warranted.  This evaluation indicated that the two private-label collateralized mortgage obligations were other-than-temporarily impaired.  Estimates of discounted cash flows based on expected yield at time of original purchase, prepayment assumptions based on actual and anticipated prepayment speed, actual and anticipated default rates and estimated level of severity given the loan to value ratios, credit scores, geographic locations, vintage and levels of subordination related to the security and its underlying collateral resulted in a projected credit loss on the collateralized mortgage obligations.

During the three months ended March 31, 2012, the Company’s analysis resulted in $4,000 in credit losses that were charged to earnings with respect to one of these two collateralized mortgage obligations.  This security had an amortized cost of $16.2 million and an estimated fair value of $15.3 million as of March 31, 2012.  The analysis with respect to the second collateralized mortgage obligation indicated no additional estimated credit loss.  This security had an amortized cost of $2.88 million and an estimated fair value of $2.86 million as of March 31, 2012.

The following table presents the change in other-than-temporary credit related impairment charges on collateralized mortgage obligations for which a portion of the other-than-temporary impairments related to other factors was recognized in other comprehensive loss.

	(In Thousands)
Credit related impairments on securities as of December 31, 2010	$	1,640
Credit related impairments related to securities for which an other-than-temporary
impairment was not previously recognized		-
Increase in credit related impairments related to securities for which an other-than-
temporary impairment was previously recognized		456
Credit related impairments on securities as of December 31, 2011		2,096
Credit related impairments related to securities for which an other-than-temporary
impairment was not previously recognized		-
Increase in credit related impairments related to securities for which an other-than-
temporary impairment was previously recognized		4
Credit related impairments on securities as of March 31, 2012	$	2,100

Exclusive of the one aforementioned private-label collateralized mortgage obligation, the Company has determined that the decline in fair value of the remaining securities is not attributable to credit deterioration, and based on the foregoing evaluation criteria and as the Company does not intend to sell nor is it more likely than not that it will be required to sell these securities before recovery of the amortized cost basis, these securities are not considered other-than-temporarily impaired.

Continued deterioration of general economic market conditions could result in the recognition of future other-than-temporary impairment losses within the investment portfolio and such amounts could be material to our consolidated financial statements.

Securities Held to Maturity

As of March 31, 2012, the Company does not hold any securities that are designated as held to maturity.  During the three months ended March 31, 2012, the one security held by the Company that had been designated as held to maturity was called by the issuer.  This security had an amortized cost of $2.6 million at the time that it was called.

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Note 3 - Loans Receivable

Loans receivable at March 31, 2012 and December 31, 2011 are summarized as follows:

	March 31,		December 31,
	2012		2011
Mortgage loans:	(In Thousands)
Residential real estate:
One- to four-family	$	487,138		496,736
Over four-family		548,139		552,240
Home equity		37,438		38,599
Construction and land		39,429		39,528
Commercial real estate		64,630		65,434
Consumer		129		109
Commercial loans		23,574		24,018
		1,200,477		1,216,664

The Company provides several types of loans to its customers, including residential, construction, commercial and consumer loans.  Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to one borrower or to multiple borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions.  While credit risks tend to be geographically concentrated in the Company’s Milwaukee metropolitan area and while 89.4% of the Company’s loan portfolio involves loans that are secured by residential real estate, there are no concentrations with individual or groups of related borrowers.  While the real estate collateralizing these loans is residential in nature, it ranges from owner-occupied single family homes to large apartment complexes.  In addition, real estate collateralizing $91.8 million or 7.7% of total mortgage loans is located outside of the state of Wisconsin.

During the three months ended March 31, 2012, $326.9 million in residential loans were originated for sale.  During the same period, sales of loans held for sale totaled $339.4 million, generating noninterest income of $14.2 million.   During the year ended December 31, 2011, the Company began selectively selling loans on a servicing retained basis.  The unpaid principal balance of loans serviced for others was $99.4 million and $29.9 million at March 31, 2012 and December 31, 2011, respectively. These loans are not reflected in the consolidated statements of financial condition.

Qualifying loans receivable totaling $808.1 million and $715.7 million are pledged as collateral against $350.0 million in outstanding Federal Home Loan Bank of Chicago advances under a blanket security agreement at both March 31, 2012 and December 31, 2011.

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An analysis of past due loans receivable as of March 31, 2012 and December 31, 2011 follows:

	As of March 31, 2012
	1-59 Days Past Due (1)		60-89 Days Past Due (2)		Greater Than 90 Days		Total Past Due		Current (3)		Total Loans
Mortgage loans:	(In Thousands)
Residential real estate:
One- to four-family	$	11,345		197		39,081		50,623		436,515		487,138
Over four-family		5,716		-		19,940		25,656		522,483		548,139
Home equity		1,520		81		870		2,471		34,967		37,438
Construction and land		129		-		6,035		6,164		33,265		39,429
Commercial real estate		2,011		-		497		2,508		62,122		64,630
Consumer		-		-		-		-		129		129
Commercial loans		534		-		59		593		22,981		23,574
Total	$	21,255		278		66,482		88,015		1,112,462		1,200,477
	As of December 31, 2011
Mortgage loans:
Residential real estate:
One- to four-family	$	12,650		5,536		40,001		58,187		438,549		496,736
Over four-family		13,044		2,630		8,946		24,620		527,620		552,240
Home equity		1,982		131		290		2,403		36,196		38,599
Construction and land		49		155		6,790		6,994		32,534		39,528
Commercial real estate		70		-		515		585		64,849		65,434
Consumer		8		-		-		8		101		109
Commercial loans		543		-		70		613		23,405		24,018
Total	$	28,346		8,452		56,612		93,410		1,123,254		1,216,664

(1)  Includes $6.4 million and $4.6 million for March 31, 2012 and December 31, 2011, respectively, which are on non-accrual status.

(2)  Includes $278,000 and $1.4 million for March 31, 2012 and December 31, 2011, respectively, which are on non-accrual status.

(3)  Includes $18.3 million and $15.7 million for March 31, 2012 and December 31, 2011, respectively, which are on non-accrual status.

As of March 31, 2012 and December 31, 2011, there are no loans that are 90 or more days past due and still accruing interest.

-- 13 --

A summary of the activity for the three months ended March 31, 2012 and the years ended December 31, 2011 and 2010 in the allowance for loan losses follows:

	One- to Four- Family			Over Four Family			Home Equity			Construction and Land			Commercial Real Estate			Consumer			Commercial			Total
	(In Thousands)
As of March 31, 2012
Balance at beginning of period	$	17,475			8,252			1,998			2,922			941			28			814			32,430
Provision for loan losses		2,245			762			448			264			14			(1	)		(57	)		3,675
Charge-offs		(2,446	)		(447	)		(150	)		(120	)		(35	)		-			-			(3,198	)
Recoveries		116			4			7			-			-			-			13			140
Balance at end of period	$	17,390			8,571			2,303			3,066			920			27			770			33,047
Year ended December 31, 2011
Balance at beginning of period	$	16,150			6,877			1,196			3,252			671			28			1,001			29,175
Provision for loan losses		12,567			5,331			1,429			1,346			998			9			397			22,077
Charge-offs		(11,553	)		(3,996	)		(634	)		(1,745	)		(734	)		(10	)		(619	)		(19,291	)
Recoveries		311			40			7			69			6			1			35			469
Balance at end of period	$	17,475			8,252			1,998			2,922			941			28			814			32,430
Year ended December 31, 2010
Balance at beginning of period	$	17,875			5,208			1,642			2,635			720			43			371			28,494
Provision for loan losses		15,054			5,053			170			2,934			525			(3	)		2,099			25,832
Charge-offs		(16,906	)		(3,439	)		(619	)		(2,319	)		(575	)		(13	)		(1,470	)		(25,341	)
Recoveries		127			55			3			2			1			1			1			190
Balance at end of period	$	16,150			6,877			1,196			3,252			671			28			1,001			29,175

-- 14 --

A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of March 31, 2012 follows:

	One- to Four- Family		Over Four Family		Home Equity		Construction and Land		Commercial Real Estate		Consumer		Commercial		Total
	(In Thousands)
Allowance related to loans
individually evaluated for impairment	$	6,771		3,982		1,093		2,168		-		-		227		14,241
Allowance related to loans
collectively evaluated for impairment		10,619		4,589		1,210		898		920		27		543		18,806
Balance at end of period	$	17,390		8,571		2,303		3,066		920		27		770		33,047
Loans individually evaluated for impairment	$	70,881		37,514		2,623		7,525		2,292		28		900		121,763
Loans collectively evaluated for impairment		416,257		510,625		34,815		31,904		62,338		101		22,674		1,078,714
Total gross loans	$	487,138		548,139		37,438		39,429		64,630		129		23,574		1,200,477

A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of the year ended December 31, 2011 follows:

	One- to Four- Family		Over Four Family		Home Equity		Construction and Land		Commercial Real Estate		Consumer		Commercial		Total
	(In Thousands)
Allowance related to loans
individually evaluated for impairment	$	5,707		3,719		803		2,077		-		-		269		12,575
Allowance related to loans
collectively evaluated for impairment		11,768		4,533		1,195		845		941		28		545		19,855
Balance at end of period	$	17,475		8,252		1,998		2,922		941		28		814		32,430
Loans individually evaluated for impairment	$	68,321		40,783		2,227		8,436		515		-		1,115		121,397
Loans collectively evaluated for impairment		428,415		511,457		36,372		31,092		64,919		109		22,903		1,095,267
Total gross loans	$	496,736		552,240		38,599		39,528		65,434		109		24,018		1,216,664

-- 15 --

The following table presents information relating to the Company’s internal risk ratings of its loans receivable as of March 31, 2012 and December 31, 2011:

	One- to Four- Family		Over Four Family		Home Equity		Construction and Land		Commercial Real Estate		Consumer		Commercial		Total
At March 31, 2012	(In Thousands)
Substandard	$	65,679		37,213		3,334		7,525		2,887		28		915		117,581
Watch		22,180		13,296		1,101		6,186		1,542		-		1,064		45,369
Pass		399,279		497,630		33,003		25,718		60,201		101		21,595		1,037,527
	$	487,138		548,139		37,438		39,429		64,630		129		23,574		1,200,477
At December 31, 2011
Substandard	$	68,566		37,502		3,188		8,436		1,114		-		1,116		119,922
Watch		14,341		16,993		721		6,199		1,549		-		1,108		40,911
Pass		413,829		497,745		34,690		24,893		62,771		109		21,794		1,055,831
	$	496,736		552,240		38,599		39,528		65,434		109		24,018		1,216,664

Factors that are important to managing overall credit quality include sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, an allowance for loan losses, and sound non-accrual and charge-off policies.  Our underwriting policies require an officers’ loan committee review and approval of all loans in excess of $500,000.  In addition, an independent loan review function exists for all loans.  Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans.  To do so, we maintain a loan review system under which our credit management personnel review non-owner occupied one- to four-family, over four-family, construction and land, commercial real estate and commercial loans that individually, or as part of an overall borrower relationship exceed $1.0 million in potential exposure.  Loans meeting these criteria are reviewed on an annual basis, or more frequently, if the loan renewal is less than one year.  With respect to this review process, management has determined that pass loans include loans that exhibit acceptable financial statements, cash flow and leverage.  Watch loans have potential weaknesses that deserve management’s attention, and if left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credit.  Substandard loans are considered inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged.  These loans generally have a well-defined weakness that may jeopardize liquidation of the debt and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.  Finally, a loan is considered to be impaired when it is probable that the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. Management has determined that all non-accrual loans and loans modified under troubled debt restructurings meet the definition of an impaired loan.

The Company’s procedures dictate that an updated valuation must be obtained with respect to underlying collateral at the time a loan is deemed impaired.  Updated valuations may also be obtained upon transfer from loans receivable to real estate owned based upon the age of the prior appraisal, changes in market conditions or known changes to the physical condition of the property.

Estimated fair values are reduced to account for sales commissions, broker fees, unpaid property taxes and additional selling expenses to arrive at an estimated net realizable value.  The adjustment factor is based upon the Company’s actual experience with respect to sales of real estate owned over the prior two years.  An additional adjustment factor is applied by appraisal vintage to account for downward market pressure since the date of appraisal.  The additional adjustment factor is based upon relevant sales data available for our general operating market as well as company-specific historical net realizable values as compared to the most recent appraisal prior to disposition.

With respect to over-four family income producing real estate, appraisals are reviewed and estimated collateral values are adjusted by updating significant appraisal assumptions to reflect current real estate market conditions.  Significant assumptions reviewed and updated include the capitalization rate, rental income and operating expenses.  These adjusted assumptions are based upon recent appraisals received on similar properties as well as on actual experience related to real estate owned and currently under Company management.

-- 16 --

The following tables present data on impaired loans at March 31, 2012 and December 31, 2011.

	As of or for the Three Months Ended March 31, 2012
	Recorded Investment		Unpaid Principal		Reserve		Cumulative Charge-Offs		Average Recorded Investment		Int Paid YTD
Total Impaired with Reserve
One- to four-family	$	33,991		34,095		6,771		104		34,327		279
Over four-family		20,004		20,249		3,982		245		20,469		223
Home equity		1,709		1,709		1,093		-		1,742		19
Construction and land		6,543		6,543		2,168		-		6,543		12
Commercial real estate		-		-		-		-		-		-
Consumer		-		-		-		-		-		-
Commercial		841		841		227		-		841		7
	$	63,088		63,437		14,241		349		63,922		540
Total Impaired with no Reserve
One- to four-family	$	36,890		42,502		-		5,612		42,658		270
Over four-family		17,510		18,921		-		1,411		19,186		89
Home equity		914		954		-		40		957		3
Construction and land		982		1,440		-		458		1,440		1
Commercial real estate		2,292		4,115		-		1,823		2,376		2
Consumer		28		28		-		-		28		-
Commercial		59		342		-		283		355		3
	$	58,675		68,302		-		9,627		67,000		368
Total Impaired
One- to four-family	$	70,881		76,597		6,771		5,716		76,985		549
Over four-family		37,514		39,170		3,982		1,656		39,655		312
Home equity		2,623		2,663		1,093		40		2,699		22
Construction and land		7,525		7,983		2,168		458		7,983		13
Commercial real estate		2,292		4,115		-		1,823		2,376		2
Consumer		28		28		-		-		28		-
Commercial		900		1,183		227		283		1,196		10
	$	121,763		131,739		14,241		9,976		130,922		908

-- 17 --

	As of or for the Year Ended December 31, 2011
	Recorded Investment		Unpaid Principal		Reserve		Cumulative Charge-Offs		Average Recorded Investment		Int Paid YTD
Total Impaired with Reserve
One- to four-family	$	25,735		25,913		5,707		178		26,093		579
Over four-family		21,268		21,648		3,719		380		21,846		761
Home equity		1,428		1,428		803		-		1,448		2
Construction and land		6,543		6,543		2,077		-		6,543		113
Commercial real estate		-		-		-		-		-		-
Commercial		1,033		1,033		269		-		1,037		42
	$	56,007		56,565		12,575		558		56,967		1,497
Total Impaired with no Reserve
One- to four-family	$	42,586		48,482		-		5,896		48,552		1,448
Over four-family		19,515		21,264		-		1,749		21,535		780
Home equity		799		799		-		-		833		3
Construction and land		1,893		3,413		-		1,520		3,413		60
Commercial real estate		515		539		-		24		538		17
Commercial		82		100		-		18		90		-
	$	65,390		74,597		-		9,207		74,961		2,308
Total Impaired
One- to four-family	$	68,321		74,395		5,707		6,074		74,645		2,027
Over four-family		40,783		42,912		3,719		2,129		43,381		1,541
Home equity		2,227		2,227		803		-		2,281		5
Construction and land		8,436		9,956		2,077		1,520		9,956		173
Commercial real estate		515		539		-		24		538		17
Commercial		1,115		1,133		269		18		1,127		42
	$	121,397		131,162		12,575		9,765		131,928		3,805

The difference between a loan’s recorded investment and the unpaid principal balance represents a partial charge-off resulting from a confirmed loss due to the value of the collateral securing the loan being below the loan balance and management’s assessment that the full collection of the loan balance is not likely.

When a loan is considered impaired, interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower’s financial condition and prospects for repayment, including consideration of the borrower’s sustained historical repayment performance and other relevant factors.

-- 18 --

The determination as to whether an allowance is required with respect to impaired loans is based upon an analysis of the value of the underlying collateral and/or the borrower’s intent and ability to make all principal and interest payments in accordance with contractual terms.  The evaluation process is subject to the use of significant estimates and actual results could differ from estimates.  This analysis is primarily based upon third party appraisals and/or a discounted cash flow analysis.  In those cases in which no allowance has been provided for an impaired loan, the Company has determined that the estimated value of the underlying collateral exceeds the remaining outstanding balance of the loan.  Of the total $58.7 million of impaired loans as of March 31, 2012 for which no allowance has been provided, $9.6 million in charge-offs have been recorded to reduce the unpaid principal balance to an amount that is commensurate with the loan’s net realizable value, using the estimated fair value of the underlying collateral.  To the extent that further deterioration in property values continues, the Company may have to reevaluate the sufficiency of the collateral servicing these impaired loans resulting in additional provisions to the allowance for loans losses or charge-offs.

At March 31, 2012, total impaired loans includes $55.3 million of troubled debt restructurings.  The vast majority of debt restructurings include a modification of terms to allow for an interest only payment and/or reduction in interest rate.  The restructured terms are typically in place for six to twelve months.  At December 31, 2011, total impaired loans included $55.4 million of troubled debt restructurings.

The following presents data on troubled debt restructurings:

	As of March 31, 2012
	Accruing				Non-accruing				Total
	Amount		Number		Amount		Number		Amount		Number
	(dollars in thousands)
One- to four-family	$	12,468		27	$	26,361		92	$	38,829		119
Over four-family		11,826		12		1,658		5		13,484		17
Home equity		43		1		1,019		5		1,062		6
Construction and land		1,408		1		79		1		1,487		2
Commercial real estate		-		-		449		1		449		1
	$	25,745		41	$	29,566		104	$	55,311		145
	As of December 31, 2011
	Accruing				Non-accruing				Total
	Amount		Number		Amount		Number		Amount		Number
	(dollars in thousands)
One- to four-family	$	8,293		26	$	26,773		93	$	35,066		119
Over four-family		14,845		13		2,453		8		17,298		21
Home equity		43		1		1,024		4		1,067		5
Construction and land		1,408		1		79		1		1,487		2
Commercial real estate		-		-		452		1		452		1
Commercial		-		-		42		2		42		2
	$	24,589		41	$	30,823		109	$	55,412		150

Troubled debt restructurings involve granting concessions to a borrower experiencing financial difficulty by modifying the terms of the loan in an effort to avoid foreclosure.  Typical restructured terms include six to twelve months of principal forbearance, a reduction in interest rate or both.  In no instances have the restructured terms included a reduction of outstanding principal balance.  At March 31, 2012, $55.3 million in loans had been modified in troubled debt restructurings and $29.6 million of these loans were included in the non-accrual loan total.  The remaining $25.7 million, while meeting the internal requirements for modification in a troubled debt restructuring, were current with respect to payments under their original loan terms at the time of the restructuring and thus, continued to be included with accruing loans.  Provided these loans perform in accordance with the modified terms, they will continue to be accounted for on an accrual basis.

-- 19 --

All loans that have been modified in a troubled debt restructuring are considered to be impaired.  As such, an analysis has been performed with respect to all of these loans to determine the need for a valuation reserve.  When a loan is expected to perform in accordance with the restructured terms and ultimately return to and perform under contract terms, a valuation allowance is established for an amount equal to the excess of the present value of the expected future cash flows under the original contract terms as compared with the modified terms, including an estimated default rate.  When there is doubt as to the borrower’s ability to perform under the restructured terms or ultimately return to and perform under market terms, a valuation allowance is established equal to the impairment when the carrying amount exceeds fair value of the underlying collateral.  As a result of the impairment analysis, a $5.8 million valuation allowance has been established as of March 31, 2012 with respect to the $55.3 million in troubled debt restructurings.  As of December 31, 2011, $6.2 million in valuation allowance had been established with respect to the $55.4 million in troubled debt restructurings.

After a troubled debt restructuring reverts to market terms, a minimum of six consecutive contractual payments must be received prior to consideration for a return to accrual status.  If an updated credit department review indicates no other evidence of elevated credit risk, the loan is returned to accrual status at that time.

The following presents troubled debt restructurings by concession type as of March 31, 2012 and December 31, 2011:

	As of March 31, 2012
	Performing in accordance with modified terms				In Default				Total
	Amount		Number		Amount		Number		Amount		Number
	(dollars in thousands)
Interest reduction and principal
forbearance		27,609		71		2,776		14		30,385		85
Principal forbearance		3,880		29		352		1		4,232		30
Interest reduction		19,916		27		778		3		20,694		30
	$	51,405		127		3,906		18		55,311		145
	As of December 31, 2011
	Performing in accordance with modified terms				In Default				Total
	Amount		Number		Amount		Number		Amount		Number
	(dollars in thousands)
Interest reduction and principal
forbearance		22,752		61		6,564		22		29,316		83
Principal forbearance		3,894		29		1,771		9		5,665		38
Interest reduction		20,006		27		425		2		20,431		29
	$	46,652		117		8,760		33		55,412		150

-- 20 --

The following presents data on troubled debt restructurings as of March 31, 2012 and December 31, 2011:

	For the Three Months Ended March 31, 2012
	Amount		Number
	(dollars in thousands)
Loans modified as a troubled debt restructure
One- to four-family	$	2,971		7
	$	2,971		7
Troubled debt restructuring modified within the
past twelve months for which there was a default
One- to four-family	$	520		1
	$	520		1

	For the Year Ended December 31, 2011
	Amount		Number
	(dollars in thousands)
Loans modified as a troubled debt restructure
One- to four-family	$	23,049		86
Over four-family		10,340		12
Home equity		1,062		3
	$	34,451		101
Troubled debt restructuring modified within the
past twelve months for which there was a default
One- to four-family	$	702		6
	$	702		6

-- 21 --

The following table presents data on non-accrual loans as of March 31, 2012 and December 31, 2011:

	March 31,			December 31,
	2012			2011
	(Dollars in Thousands)
Non-accrual loans:
Residential
One- to four-family	$	56,178			55,609
Over four-family		25,225			13,680
Home equity		2,019			1,334
Construction and land		6,035			6,946
Commercial real estate		2,292			514
Commercial		59			135
Consumer		28			-
Total non-accrual loans	$	91,836			78,218
Total non-accrual loans to total loans, net		7.65	%		6.43	%
Total non-accrual loans and performing troubled
debt restructurings to total loans receivable		9.79	%		8.45	%
Total non-accrual loans to total assets		5.41	%		4.57	%

Note 4— Real Estate Owned

Real estate owned is summarized as follows:

	March 31		December 31,
	2012		2011
	(In Thousands)
One- to four-family	$	27,826		27,449
Over four-family		14,942		16,231
Construction and land		9,490		8,796
Commercial real estate		3,752		4,194
	$	56,010		56,670

During the three months ended March 31, 2012, $6.3 million was transferred from loans to real estate owned upon completion of foreclosure.  Declines in property values evidenced by updated appraisals, responses to list prices on properties held for sale and/or deterioration in the condition of properties resulted in write downs totaling $875,000 during the three months ended March 31, 2012.  During the same period, sales of real estate owned totaled $6.1 million.  During the three months ended March 31, 2011, $9.3 million was transferred from loans to real estate owned upon completion of foreclosure.  Declines in property values evidenced by updated appraisals, responses to list prices on properties held for sale and/or deterioration in the condition of properties resulted in write downs totaling $923,000 during the three months ended March 31, 2011.  During the same period, sales of real estate owned totaled $5.6 million.

-- 22 --

Note 5— Mortgage Servicing Rights

The following table presents the activity in the Company’s mortgage servicing rights:

	Three months ended
	March 31, 2012
	(In thousands)
Mortgage servicing rights at beginning of the period	$	198
Additions		439
Amortization		(22	)
Mortgage servicing rights at end of the period		615
Valuation allowance at end of period		-
Mortgage servicing rights at the end of the period, net	$	615

The following table shows the estimated future amortization expense for mortgage servicing rights for the periods indicated:

		(In thousands)
Estimate for the nine months ended December 31:	2012		123
Estimate for the years ended December 31:	2013		134
	2014		112
	2015		89
	2016		67
	2017		44
	Thereafter		46
	Total	$	615

-- 23 --

Note 6— Deposits

A summary of the contractual maturities of time deposits at March 31, 2012 is as follows:

	(In Thousands)
Within one year	$	687,718
More than one to two years		142,183
More than two to three years		15,524
More than three to four years		10,522
More than four through five years		9,800
	$	865,747

Note 7— Borrowings

Borrowings consist of the following:

		March 31, 2012					December 31, 2011
				Weighted					Weighted
				Average					Average
		Balance		Rate			Balance		Rate
		(Dollars in Thousands)
Short term:
Bank lines of credit		$	25,193		3.86	%		27,138		4.50	%
Long term:
Federal Home Loan Bank, Chicago (FHLB) advances maturing:
	2016		220,000		4.34	%		220,000		4.34	%
	2017		65,000		3.19	%		65,000		3.19	%
	2018		65,000		2.97	%		65,000		2.97	%
Repurchase agreements maturing	2017		84,000		3.96	%		84,000		3.96	%
		$	459,193		3.89	%		461,138		3.93	%

The bank lines of credit are the outstanding portion of revolving lines with two unrelated banks which represent a $90 million commitment.  The lines of credit are utilized by Waterstone Mortgage Corporation to finance loans originated for sale.  The lines of credit are secured by the underlying loans being financed.  Related interest rates are based upon the note rate associated with the loans being financed.

The $220.0 million in advances due in 2016 consist of eight advances with rates ranging from 4.01% to 4.82% callable quarterly until maturity.

The $65.0 million in advances due in 2017 consist of three advances with rates ranging from 3.09% to 3.46% callable quarterly until maturity.

The $65.0 million in advances due in 2018 consist of three callable advances with rates ranging from 2.73% to 3.11% callable quarterly until maturity.

The $84.0 million in repurchase agreements due in 2017 have rates ranging from 2.89% to 4.31% callable quarterly until maturity.  The repurchase agreements are collateralized by securities available for sale with an estimated fair value of $103.4 million at March 31, 2012.

The Company selects loans that meet underwriting criteria established by the FHLBC as collateral for outstanding advances.  The Company’s FHLBC borrowings are limited to 65% of the carrying value of qualifying, unencumbered one- to four-family mortgage loans, 30% of the carrying value of home equity loans and 45% of the carrying value of over four-family loans.  In addition, these advances are collateralized by FHLBC stock totaling $20.8 million at March 31, 2012 and $21.7 million at December 31, 2011.  In the event of prepayment, the Company is obligated to pay all remaining contractual interest on long-term borrowings.

-- 24 --

Note 8 – Regulatory Capital

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements, or overall financial performance deemed by the regulators to be inadequate, can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items, as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). As of March 31, 2012, the Bank meets all capital adequacy requirements to which it is subject.  On December 18, 2009, WaterStone Bank entered into a consent order with its federal and state bank regulators whereby it has agreed to maintain a minimum Tier 1 capital ratio of 8.50% and a minimum total risk based capital ratio of 12.00%.  At March 31, 2012, these higher capital requirements were satisfied.    The consent order prohibits the payment of cash dividends or repurchases of common stock, and restricts the ability of the Company to incur debt, in each case without the prior regulatory non-objection.    At March 31, 2012, the Company is in compliance with all requirements of the consent order.

As of March 31, 2012 the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as quantitatively “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios, as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category, however, the outstanding consent order limits transactions otherwise available to “well capitalized” banks, such as acceptance of brokered deposits.

As a state-chartered savings bank, the Bank is required to meet minimum capital levels established by the state of Wisconsin in addition to federal requirements. For the state of Wisconsin, regulatory capital consists of retained income, paid-in-capital, capital stock equity and other forms of capital considered to be qualifying capital by the Federal Deposit Insurance Corporation.

The actual and required capital amounts and ratios for the Bank as of March 31, 2012 and December 31, 2011 are presented in the table below:

	March 31, 2012
											To Be Well-Capitalized
						For Capital					Under Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars In Thousands)
Total capital (to risk-weighted assets)	$	177,231		14.69	%		96,539		8.00	%		120,674		10.00	%
Tier I capital (to risk-weighted assets)		161,925		13.42	%		48,270		4.00	%		72,404		6.00	%
Tier I capital (to average assets)		161,925		9.60	%		67,447		4.00	%		84,309		5.00	%
State of Wisconsin (to total assets)		161,925		9.56	%		101,621		6.00	%		N/A		N/A
	December 31, 2011
Total capital (to risk-weighted assets)	$	174,144		14.58	%		95,579		8.00	%		119,474		10.00	%
Tier I capital (to risk-weighted assets)		158,994		13.31	%		47,790		4.00	%		71,684		6.00	%
Tier I capital (to average assets)		158,994		9.16	%		69,447		4.00	%		86,808		5.00	%
State of Wisconsin (to total assets)		158,994		9.31	%		102,463		6.00	%		N/A		N/A

-- 25 --

Note 9 – Stock Based Compensation

Stock-Based Compensation Plan

In 2006, the Company’s shareholders approved the 2006 Equity Incentive Plan.  All stock awards granted under these plans vest over a period of five years and are required to be settled in shares of the Company’s common stock.  The exercise price for all stock options granted is equal to the quoted NASDAQ market close price on the date that the awards were granted and expire ten years after the grant date, if not exercised.  All restricted stock grants are issued from previously unissued shares.

Accounting for Stock-Based Compensation Plan

The fair value of stock options granted is estimated on the grant date using a Black-Scholes pricing model.   The fair value of restricted shares is equal to the quoted NASDAQ market close price on the date of grant.  The fair value of stock grants is recognized as compensation expense on a straight-line basis over the vesting period of the grants.  Compensation expense is included in compensation, payroll taxes and other employee benefits in the consolidated statements of income.

Assumptions are used in estimating the fair value of stock options granted.  The weighted average expected life of the stock options represent the period of time that the options are expected to be outstanding and is based on the SEC simplified approach to calculating expected term.  The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant.  The expected volatility is based on the historical volatility of Company stock since the 2005 initial public offering.  The following assumptions were used in estimating the fair value of options granted during the three months ended March 31, 2012 and the year ended December 31, 2010.  There were no options granted during the year ended December 31, 2011.

	2012			2011
Dividend Yield		0.00	%		0.00	%
Risk-free interest rate		0.25	%		0.25	%
Expected volatility		74.53	%		75.67	%
Weighted average expected life	6.5 years			6.5 years
Weighted average per share value of options	$	1.25		$	2.54

The Company estimates potential forfeitures of stock grants and adjusts compensation expense recorded accordingly.  The estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates.  Changes in estimated forfeitures will be recognized in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods.

-- 26 --

A summary of the Company’s stock option activity for the three months ended March 31, 2012 and the years ended December 31, 2011 and 2010 is presented below.

						Weighted Average		Aggregate
				Weighted Average		Years Remaining in		Instrinsic Value
Stock Options	Shares			Exercise Price		Contractual Term		(000's)
Outstanding December 31, 2009		757,500		$	17.41		7.07		-
Options exercisable at December 31, 2009		298,000			17.60		7.03		-
Granted		50,000			3.80				-
Exercised		-							-
Forfeited		(5,000	)		17.67				-
Outstanding December 31, 2010		802,500			16.44		6.34		-
Options exercisable at December 31, 2010		446,500			17.54		6.04		-
Granted		-							-
Exercised		-							-
Forfeited		(10,000	)		17.16				-
Outstanding December 31, 2011		792,500			16.32		5.37		-
Options exercisable at December 31, 2011		599,000			17.28		5.12		-
Granted		245,000			1.89				-
Exercised		-							-
Forfeited		-			1.89				-
Outstanding March 31, 2012		1,037,500			13.07		6.33		-
Options exercisable at March 31, 2012		742,500			17.36		5.07		-

The following table summarizes information about the Company’s nonvested stock option activity for the three months ended March 31, 2012 and the years ended December 31, 2011 and 2010:

				Weighted Average
Stock Options	Shares			Grant Date Fair Value
Nonvested at December 31, 2009		459,500		$	6.13
Granted		50,000			2.54
Vested		(150,500	)		6.17
Forfeited		(3,000	)		6.27
Nonvested at December 31, 2010		356,000			5.60
Granted		-
Vested		(160,500	)		5.79
Forfeited		(2,000	)		6.04
Nonvested at December 31, 2011		193,500			5.31
Granted		245,000			1.25
Vested		(143,500	)		6.27
Forfeited		-			-
Nonvested at March 31, 2012		295,000			1.47

-- 27 --

The Company amortizes the expense related to stock options as compensation expense over the vesting period.  During the three months ended March 31, 2012, 245,000 options were granted.  During the year ended December 31, 2011, 10,000 options were forfeited, of which 8,000 had vested in prior years.  During the year ended December 31, 2010, 50,000 options were granted and 5,000 were forfeited, of which 2,000 had vested in prior years.  Expense for the stock options granted of $27,000, $745,000 and $810,000 was recognized during the three months ended March 31, 2012 and the years ended December 31, 2011 and 2010, respectively.  At March 31, 2012, the Company had $347,000 in estimated unrecognized compensation costs related to outstanding stock options that is expected to be recognized over a weighted average period of 49 months.

The following table summarizes information about the Company’s restricted stock shares activity for the three months ended March 31, 2012 and the years ended December 31, 2011 and 2010:

				Weighted Average
Restricted Stock	Shares			Grant Date Fair Value
Nonvested at December 31, 2009		150,600		$	17.02
Granted		-			-
Vested		(49,200	)		17.24
Forfeited		-			-
Nonvested at December 31, 2010		101,400			16.91
Granted		-			-
Vested		(49,200	)		17.24
Forfeited		-			-
Nonvested at December 31, 2011		52,200			16.61
Granted		100,000			1.89
Vested		(47,200	)		17.67
Forfeited		-			-
Nonvested at March 31, 2012		105,000			2.11

The Company amortizes the expense related to restricted stock awards as compensation expense over the vesting period.  During the three months ended March 31, 2012, 100,000 shares of restricted stock were awarded and no shares were forfeited.  During the years ended December 31, 2011 and 2010, no shares of restricted stock were awarded and no shares were forfeited.  Expense for the restricted stock awards of $13,000, $848,000 and $848,000 was recorded for the three months ended March 31, 2012 and the years ended December 31, 2011 and 2010, respectively.  At March 31, 2012, the Company had $205,000 of unrecognized compensation expense related to restricted stock shares that is expected to be recognized over a weighted average period 47 months.

Note 10 – Income Taxes

Income tax expense for the three months ended March 31, 2012 and 2011 relates to various states in which our mortgage banking segment conducts business and will file a separate company income tax return.  There is neither a consolidated federal or state income tax expense nor benefit due to a combination of anticipated current year taxable losses, net operating loss carry forwards and valuation reserves offsetting deferred tax assets.

Under generally accepted accounting principles, a deferred tax asset valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized.  The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. We consider both positive and negative evidence regarding the ultimate realizability of our deferred tax assets.  Examples of positive evidence may include the existence, if any, of taxes paid in available carry-back years and the likelihood that taxable income will be generated in future periods.  Examples of negative evidence may include a cumulative loss in the current year and prior two years and negative general business and economic trends.  We currently maintain a valuation allowance against substantially all of our net deferred tax assets because it is “more likely than not” that all of these net deferred tax assets will not be realized.  This determination was based largely on the negative evidence of a cumulative loss in the most recent three-year period caused primarily by the loan loss provisions made during those periods.  In addition, general uncertainty surrounding future economic and business conditions has increased the likelihood of volatility in our future earnings.

-- 28 --

Note 11– Financial Instruments with Off-Balance Sheet Risk

Off-balance sheet financial instruments or obligations whose contract amounts represent credit and/or interest rate risk are as follows:

	March 31,		December 31,
	2012		2011
	(In Thousands)
Financial instruments whose contract amounts represent
potential credit risk:
Commitments to extend credit under amortizing loans (1)	$	25,521		14,259
Commitments to extend credit under home equity lines of credit		19,885		21,403
Unused portion of construction loans		6,388		5,684
Unused portion of business lines of credit		10,099		10,347
Standby letters of credit		970		970

____________

(1) Excludes commitments to originate loans held for sale and are addressed in Note 12.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements of the Company. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counter-party. Collateral obtained generally consists of mortgages on the underlying real estate.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds mortgages on the underlying real estate as collateral supporting those commitments for which collateral is deemed necessary.

The Company has determined that there are no probable losses related to commitments to extend credit or the standby letters of credit as of March 31, 2012 and December 31, 2011.

Residential mortgage loans sold to others are predominantly conventional residential first lien mortgages that are sold on a servicing released basis.  The Company’s agreements to sell residential mortgage loans in the normal course of business usually require certain representations and warranties on the underlying loans sold related to credit information, loan documentation and collateral, which if subsequently are untrue or breached, could require the Company to repurchase certain loans affected.  There have been insignificant instances of repurchase under representations and warranties.  The Company’s agreements to sell residential mortgage loans also contain limited recourse provisions.  The recourse provisions are limited in that the recourse provision ends after certain payment criteria have been met.  With respect to these loans, repurchase could be required if defined delinquency issues arose during the limited recourse period.  Given that the underlying loans delivered to buyers are predominantly conventional first lien mortgages and that historical experience shows negligible losses and insignificant repurchase activity, management believes that losses and repurchases under the limited recourse provisions will continue to be insignificant.

Note 12 – Derivative Financial Instruments

In connection with its mortgage banking activities, the Company enters into derivative financial instruments as part of its strategy to manage its exposure to changes in interest rates.   Mortgage banking derivatives include interest rate lock commitments provided to customers to fund mortgage loans to be sold in the secondary market and forward commitments for the future delivery of such loans to third party investors.  It is the Company’s practice to enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on its commitments to fund the loans as well as on its portfolio of mortgage loans held-for-sale. The Company’s mortgage banking derivatives have not been designated as being in hedge relationships.  These instruments are used to manage the Company’s exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements of ASC 815. Changes in the fair value of derivatives not designated in hedging relationships are recorded as a component of mortgage banking income in the Company’s consolidated statements of operations. The Company does not use derivatives for speculative purposes.

-- 29 --

Forward commitments to sell mortgage loans represent commitments obtained by the Company from a secondary market agency to purchase mortgages from the Company at specified interest rates and within specified periods of time.  Commitments to sell loans are made to mitigate interest rate risk on interest rate lock commitments to originate loans and loans held for sale.    At March 31, 2012, the Company had forward commitments to sell mortgage loans with an aggregate notional amount of approximately $124.9 million and interest rate lock commitments with an aggregate notional amount of approximately $124.2 million.  The fair value of the mortgage derivatives at March 31, 2012 included a cumulative net gain of $1.4 million on mortgage banking derivative assets is reported as a component of other asset on the Company’s consolidated statements of financial condition.

In determining the fair value of its derivative loan commitments, the Company considers the value that would be generated when the loan arising from exercise of the loan commitment is sold in the secondary mortgage market. That value includes the price that the loan is expected to be sold for in the secondary mortgage market.  The fair value of these commitments is recorded on the consolidated statements of financial condition with the changes in fair value recorded as a component of mortgage banking income.

Note 13 – Earnings (loss) per share

Earnings (loss) per share are computed using the two-class method.  Basic earnings per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the applicable period, excluding outstanding participating securities.  Participating securities include unvested restricted shares.  Unvested restricted shares are considered participating securities because holders of these securities have the right to receive dividends at the same rate as holders of the Company’s common stock.  Diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding adjusted for the dilutive effect of all potential common shares.  Unvested restricted stock and stock options are considered outstanding for diluted earnings (loss) per share only.  Unvested restricted stock totaling 105,000 shares is considered outstanding for dilutive earnings per share only for the three months ended March 31, 2012.  Unvested stock options totaling 295,000 shares for the three months ended March 31, 2012 and unvested restricted stock and stock options totaling 54,200 and 211,500 shares for the three months ended March 31, 2011 are antidilutive and are excluded from the loss per share calculation.

Presented below are the calculations for basic and diluted earnings (loss) per share:

	Three Months Ended
	March 31,
	2012		2011
Net income (loss)	$	2,208	$	(1,544	)
Net income (loss) available to unvested restricted shares		7		-
Net income (loss) available to common stockholders	$	2,201	$	(1,544	)
Weighted average shares outstanding		30,683		30,899
Effect of dilutive potential common shares		13		-
Diluted weighted average shares outstanding		30,696		30,899
Basic earnings (loss) per share	$	0.07	$	(0.05	)
Diluted earnings (loss) per share	$	0.07	$	(0.05	)

Note 14 – Fair Value Measurements

The FASB issued an accounting standard (subsequently codified into ASC Topic 820, “Fair Value Measurements and Disclosures”) which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This accounting standard applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements. The standard also emphasizes that fair value (i.e., the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. When considering the assumptions that market participants would use in pricing the asset or liability, this accounting standard establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

-- 30 --

The fair value hierarchy prioritizes inputs used to measure fair value into three broad levels.

Level 1 inputs - In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that we have the ability to access.

Level 2 inputs - Fair values determined by Level 2 inputs use inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly.  Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets where there are few transactions and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs - Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability.

In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.  The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The following table presents information about our assets recorded in our consolidated statement of financial position at their fair value on a recurring basis as of March 31, 2012 and December 31, 2011, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

			Fair Value Measurements Using
	March 31, 2012		Level 1		Level 2		Level 3
	(In Thousands)
Available for sale securities
Mortgage-backed securities	$	69,546		-		69,546		-
Collateralized mortgage obligations
Government sponsored enterprise bonds		43,187		-		43,187		-
Private-label issued		18,141		-		-		18,141
Government sponsored enterprise bonds		47,338		-		47,338		-
Municipal securities		26,530		-		26,530		-
Other debt securities		5,294		5,294		-		-
Certificates of Deposit		4,922		-		4,922		-
Loans held for sale		90,701		-		90,701		-
Mortgage banking derivative assets		1,404		-		-		1,404
Mortgage banking derivative liabilities		-
			Fair Value Measurements Using
	December 31, 2011		Level 1		Level 2		Level 3
	(In Thousands)
Available for sale securities
Mortgage-backed securities	$	35,417		-		35,417		-
Collateralized mortgage obligations
Government sponsored enterprise bonds		33,196		-		33,196		-
Private-label issued		18,451		-		-		18,451
Government sponsored enterprise bonds		71,349		-		71,349		-
Municipal securities		39,068		-		39,068		-
Other debt securities		5,118		5,118		-		-
Certificates of Deposit		3,920		-		3,920		-
Loans held for sale		88,283		-		88,283		-
Mortgage banking derivative assets		924		-		-		924
Mortgage banking derivative liabilities		397		-		-		397

-- 31 --

The following summarizes the valuation techniques for assets recorded in our consolidated statements of financial condition at their fair value on a recurring basis:

Available for sale securities – The Company’s investment securities classified as available for sale include: mortgage-backed securities, collateralized mortgage obligations, government sponsored enterprise bonds, municipal securities and other debt securities. The fair value of mortgage-backed securities, collateralized mortgage obligations and government sponsored enterprise bonds are determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricing model.  Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmark securities, prepayment models and bid/offer market data.  For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuer spread.  These model and matrix measurements are classified as Level 2 and Level 3 in the fair value hierarchy.  The fair value of municipal securities is determined by a third party valuation source using observable market data utilizing a multi-dimensional relational pricing model.  Standard inputs to this model include observable market data such as benchmark yields, reported trades, broker quotes, rating updates and issuer spreads.  These model measurements are classified as Level 2 in the fair value hierarchy.  The fair value of other debt securities, which includes a trust preferred security issued by a financial institution, is determined through quoted prices in active markets and is classified as Level 1 in the fair value hierarchy.

Loans held for sale – The Company carries loans held for sale at fair value under the fair value option model.  Fair value is generally determined by estimating a gross premium or discount, which is derived from pricing currently observable in the secondary market, principally from observable prices for forward sale commitments.  Loans held-for-sale are considered to be Level 2 in the fair value hierarchy of valuation techniques.

Mortgage banking derivatives - Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors.  The Company relies on a valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the current interest rate environment and then multiplying by quoted investor prices.  The Company also relies on a valuation model to estimate the fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available.  While there are Level 2 and 3 inputs used in the valuation models, the Company has determined that one or more of the inputs significant in the valuation of both of the mortgage banking derivatives fall within Level 3 of the fair value hierarchy.

The table below presents reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during 2012 and 2011.

	Available for sale securities			Mortgage banking derivatives
	(In Thousands)
Balance at December 31, 2010	$	20,301			407
Transfer into level 3		-			-
Unrealized holding losses arising during the period:
Included in other comprehensive income		(142	)		-
Other than temporary impairment included in net loss		(456	)		-
Principal repayments		(1,252	)		-
Net accretion of discount/amortization of premium		-			-
Mortgage derivative gain, net		-			120
Balance at December 31, 2011		18,451			527
Transfer into level 3		-			-
Unrealized holding losses arising during the period:
Included in other comprehensive income		126			-
Other than temporary impairment included in net loss		(4	)		-
Principal repayments		(432	)		-
Net accretion of discount/amortization of premium		-			-
Mortgage derivative gain, net		-			877
Balance at March 31, 2012	$	18,141			1,404

Level 3 available-for-sale securities include two corporate collateralized mortgage obligations.  The market for these securities was not active as of March 31, 2012.  As such, the Company valued this security based on the present value of estimated future cash flows   Additional impairment may be incurred in future periods if estimated future cash flows are less than the cost basis of the securities. There were no transfers in or out of Level 1 or Level 2 measurements during the periods.

-- 32 --

Assets Recorded at Fair Value on a Non-recurring Basis

The following table presents information about our assets recorded in our consolidated statement of financial position at their fair value on a non-recurring basis as of March 31, 2012 and December 31, 2011, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

			Fair Value Measurements Using
	March 31, 2012		Level 1		Level 2		Level 3
	(In Thousands)
Impaired loans, net (1)	$	48,847		-		-		48,847
Real estate owned		56,010		-		-		56,010
			Fair Value Measurements Using
	December 31, 2011		Level 1		Level 2		Level 3
	(In Thousands)
Impaired loans, net (1)	$	43,432		-		-		43,432
Real estate owned		56,670		-		-		56,670

_________

(1)  Represents collateral-dependent impaired loans, net, which are included in loans.

Loans – We do not record loans at fair value on a recurring basis.  On a non-recurring basis, loans determined to be impaired are analyzed to determine whether a collateral shortfall exists, and if such a shortfall exists, are recorded on our consolidated statements of financial condition at net realizable value of the underlying collateral.  Fair value is determined based on third party appraisals.  Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal.  Given the significance of the adjustments made to appraised values necessary to estimate the fair value of impaired loans, loans that have been deemed to be impaired are considered to be Level 3 in the fair value hierarchy of valuation techniques.  At March 31, 2012, loans determined to be impaired with an outstanding balance of $63.1 million were carried net of specific reserves of $14.2 million for a fair value of $48.8 million.  At December 31, 2011, loans determined to be impaired with an outstanding balance of $56.0 million were carried net of specific reserves of $12.6 million for a fair value of $43.4 million.  Impaired loans collateralized by assets which are valued in excess of the net investment in the loan do not require any specific reserves.

Real estate owned – On a non-recurring basis, real estate owned, is recorded in our consolidated statements of financial condition at the lower of cost or fair value.  Fair value is determined based on third party appraisals and, if less than the carrying value of the loan, the carrying value of the loan is adjusted to the fair value.  Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal.  Given the significance of the adjustments made to appraised values necessary to estimate the fair value of the properties, real estate owned is considered to be Level 3 in the fair value hierarchy of valuation techniques.  Changes in the value of real estate owned totaled $875,000 and $923,000 during the three months ended March 31, 2012 and 2011, respectively and are recorded in real estate owned expense. At March 31, 2012 and December 31, 2011, real estate owned totaled $56.0 million and $56.7 million, respectively.

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of March 31, 2012, the significant unobservable inputs used in the fair value measurements were as follows:

				Significant	Significant
	Fair Value at		Valuation	Unobservable	Unobservable
	March 31, 2012		Technique	Inputs	Input Value
Collateralized Mortgage Obligations
Private-label issued	$	18,141	Discounted cash flow	Prepayment rate	9.6% to 21.1%
				Default rate	5.3% to 6.0%
				Discount rate		8.00%
				Loss severity rate	43% to 52%
Mortgage banking derivatives		1,404	Pricing models	Pull through rate	68% to 92%
Impaired loans, net		48,847	Pricing models	Discount rates applied to appraisals	15% to 30%
Real estate owned		56,010	Pricing models	Discount rates applied to appraisals	5% to 85%

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The fair value of the Company’s private label-issued collateralize mortgage obligations was determined using a discounted cash flow analysis.  With respect to the first of two securities, the significant unobservable inputs included a prepayment rate of 9.6%, a default rate of 6.0%, a discount rate of 8.0% and a loss severity rate of 43%.  With respect to the second security the significant unobservable inputs included a prepayment rate of 21.1%, a default rate of 5.3%, a discount rate of 8.0% and a loss severity rate of 52%.

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage banking derivatives, including interest rate lock commitments is the loan pull through rate.  This represents the percentage of loans currently in a lock position which the Company estimates will ultimately close.  Generally, the fair value of an interest rate lock commitment will be positively (negatively) impacted when the prevailing interest rate is lower (higher) than the interest rate lock commitment.  Generally, an increase in the pull through rate will result in the fair value of the interest rate lock increasing when in a gain position, or decrease when in a loss position.  The pull through rate is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock.  The pull through rate is computed using historical data and the ratio is periodically reviewed by the Company.

The significant unobservable inputs used in the fair value measurement of collateral for collateral-dependent impaired loans included in the above table primarily relate to discounting criteria applied to independent appraisals received with respect to the collateral.  Discounts applied to the appraisals are dependent on the vintage of the appraisal as well as the marketability of the property.  As of March 31, 2012, discounts applied to appraisals ranged from 15% to 30%.  The discount factor is computed using actual realization rates on properties that have been foreclosed upon and liquidated in the open market.

The significant unobservable inputs used in the fair value measurement of real estate owned included in the above table primarily relate to discounting criteria applied to independent appraisals received with respect to the property.  Discounts applied to the appraisals are dependent on the vintage of the appraisal as well as the marketability of the property.  As of March 31, 2012, discounts applied to appraisals ranged from 5% to 85%.  The discount factor is computed using actual realization rates on properties that have been foreclosed upon and liquidated in the open market.

Fair value information about financial instruments follows, whether or not recognized in the consolidated statements of financial condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The carrying amounts and fair values of the Company’s financial instruments consist of the following at March 31, 2012 and December 31, 2011:

	March 31, 2012										December 31, 2011
	Carrying										Carrying		Fair
	amount		Fair Value								amount		value
			Total		Level 1		Level 2		Level 3
Financial Assets	(In Thousands)
Cash and cash equivalents	$	75,607		75,607		75,607		-		-		80,380		80,380
Securities available-for-sale		214,958		214,958		5,294		191,523		18,141		206,519		206,519
Securities held-to-maturity		-		-		-		-		-		2,648		2,542
Loans held for sale		90,701		90,701		-		90,701		-		88,283		88,283
Loans receivable		1,200,477		1,202,890		-		-		1,202,890		1,216,664		1,225,141
FHLB stock		20,801		20,801		-		20,801		-		21,653		21,653
Cash surrender value of life insurance		36,895		36,895		36,895		-		-		36,749		36,749
Real estate owned		56,010		56,010		-		-		56,010		56,670		56,670
Accrued interest receivable		3,916		3,916		3,916		-		-		4,064		4,064
Mortgage banking derivative assets		1,404		1,404		-		-		1,404		924		924
Financial Liabilities
Deposits		1,043,754		1,044,771		178,007		866,764		-		1,051,292		1,052,663
Advance payments by
borrowers for taxes		7,394		7,394		7,394		-		-		942		942
Borrowings		459,193		514,044		-		514,044		-		461,138		517,624
Accrued interest payable		1,970		1,970		1,970		-		-		2,087		2,087
Mortgage banking derivative liabilities		-		-		-		-		-		397		397
Other Financial Instruments
Stand-by letters of credit		6		6		-		6		-		6		6

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The following methods and assumptions were used by the Company in determining its fair value disclosures for financial instruments.

Cash and Cash Equivalents

The carrying amount reported in the consolidated statements of financial condition for cash and cash equivalents is a reasonable estimate of fair value.

 Securities

The fair value of securities is determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricing model.  Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmark securities and bid/offer market data.  For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuer spread.  Prepayment models are used for mortgage related securities with prepayment features.

Loans Held for Sale

Fair value is estimated using the prices of the Company’s existing commitments to sell such loans and/or the quoted market price for commitments to sell similar loans.

Loans Receivable

Loans determined to be impaired are analyzed to determine whether a collateral shortfall exists, and if such a shortfall exists, are recorded on our consolidated statements of financial condition at fair value.  Fair value is determined based on third party appraisals.  Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal.  With respect to loans that are not considered to be impaired, fair value is estimated by discounting the future contractual cash flows using discount rates that reflect a current rate offered to borrowers of similar credit standing for the remaining term to maturity.  This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC 820-10 and generally produces a higher fair value.

FHLBC Stock

For FHLBC stock, the carrying amount is the amount at which shares can be redeemed with the FHLBC and is a reasonable estimate of fair value.

Cash Surrender Value of Life Insurance

The carrying amounts reported in the consolidated statements of financial condition for the cash surrender value of life insurance approximate those assets’ fair values.

Deposits and Advance Payments by Borrowers for Taxes

The fair values for interest-bearing and noninterest-bearing negotiable order of withdrawal accounts, savings accounts, and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar remaining maturities to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit. The advance payments by borrowers for taxes are equal to their carrying amounts at the reporting date.

Borrowings

Fair values for borrowings are estimated using a discounted cash flow calculation that applies current interest rates to estimated future cash flows of the borrowings.

Accrued Interest Payable and Accrued Interest Receivable

For accrued interest payable and accrued interest receivable, the carrying amount is a reasonable estimate of fair value.

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Commitments to Extend Credit and Standby Letters of Credit

Commitments to extend credit and standby letters of credit are generally not marketable. Furthermore, interest rates on any amounts drawn under such commitments would be generally established at market rates at the time of the draw. Fair values for the Company’s commitments to extend credit and standby letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparty’s credit standing, and discounted cash flow analyses. The fair value of the Company’s commitments to extend credit is not material at March 31, 2012 and December 31, 2011.

Mortgage Banking Derivative Assets and Liabilities

Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors.  The Company relies on a valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the current interest rate environment, and then multiplying by quoted investor prices.  The Company also relies on a valuation model to estimate the fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available.  On the Company’s Consolidated Statements of Condition, instruments that have a positive fair value are included in prepaid expenses and other assets, and those instruments that have a negative fair value are included in other liabilities.

Note 15 – Segment Reporting

Selected financial and descriptive information is required to be provided about reportable operating segments, considering a “management approach” concept as the basis for identifying reportable segments. The management approach is based on the way that management organizes the segments within the enterprise for making operating decisions, allocating resources, and assessing performance. Consequently, the segments are evident from the structure of the enterprise’s internal organization, focusing on financial information that an enterprise’s chief operating decision-makers use to make decisions about the enterprise’s operating matters.  The Company has determined that it has two reportable segments: community banking and mortgage banking.  The Company’s operating segments are presented based on its management structure and management accounting practices.  The structure and practices are specific to the Company and therefore, the financial results of the Company’s business segments are not necessarily comparable with similar information for other financial institutions.

Community Banking

The Community Banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin. Consumer products include loan and deposit products:  mortgage, home equity loans and lines, personal term loans, demand deposit accounts, interest bearing transaction accounts and time deposits.  Business banking products include secured and unsecured lines and term loans for working capital, inventory and general corporate use, commercial real estate construction loans, demand deposit accounts, interest bearing transaction accounts and time deposits.

Mortgage Banking

The Mortgage Banking segment provides residential mortgage loans for the purpose of sale on the secondary market.  Mortgage banking products and services are provided by offices in: Wisconsin, Arizona, Colorado, Florida, Idaho, Illinois, Indiana, Iowa, Maryland, Minnesota, Ohio and Pennsylvania.

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	Three Months ended March 31, 2012
	Community Banking			Mortgage Banking			Holding Company and Other			Consolidated
	(in thousands)
Net interest income	$	10,247			54			125			10,426
Provision for loan losses		3,600			75			-			3,675
Net interest income after provision for loan losses		6,647			(21	)		125			6,751
Noninterest income:		774			14,228			-			15,002
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		3,127			7,727			(217	)		10,637
Occupancy, office furniture and equipment		790			931			-			1,721
FDIC insurance premiums		941			-			-			941
Real estate owned		1,435			-			-			1,435
Other		1,218			3,497			66			4,781
Total noninterest expenses		7,511			12,155			(151	)		19,515
Income (loss) before income taxes (benefit)		(90	)		2,052			276			2,238
Income taxes (benefit)		(794	)		824			-			30
Net income (loss)	$	704			1,228			276			2,208
Total Assets	$	1,654,117			101,578			(56,793	)		1,698,902

	Three months ended March 31, 2011
	Community Banking			Mortgage Banking			Holding Company and Eliminations			Consolidated
	(in thousands)
Net interest income	$	11,739			67			121			11,927
Provision for loan losses		4,860			15			-			4,875
Net interest income after provision for loan losses		6,879			52			121			7,052
Noninterest income:		580			6,217						6,797
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		3,746			4,373			(202	)		7,917
Occupancy, office furniture and equipment		898			721			-			1,619
FDIC insurance premiums		1,061			-			-			1,061
Real estate owned		1,795			-			-			1,795
Other		1,144			1,583			235			2,962
Total noninterest expenses		8,644			6,677			33			15,354
Income (loss) before income taxes		(1,185	)		(408	)		88			(1,505	)
Income taxes		135			(96	)		-			39
Net income (loss)	$	(1,320	)		(312	)		88			(1,544	)
Total Assets	$	1,747,227			40,584			(26,785	)		1,761,026

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Note 16 – Recent Accounting Developments

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  The amendments change the wording used to describe many of the requirements for measuring fair value and for disclosing information about fair value measurements.  The amendments also clarify the Board’s intent about the application of existing fair value measurement and disclosure requirements.  The amendments are effective for interim  and annual periods beginning after December 15, 2011.  The adoption of the standard did not have a material impact on our results of operations, financial position or liquidity.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income, to increase the prominence of other comprehensive income in financial statements.  Under this ASU, an entity will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements.  The ASU eliminates the option in U.S. GAAP to present other comprehensive income in the statement of changes in equity.  An entity should apply the ASU retrospectively.  The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  The adoption of the standard did not have a material impact on our results of operations, financial position or liquidity.

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

Cautionary Statements Regarding Forward-Looking Information

This report contains or incorporates by reference various forward-looking statements concerning the Company’s prospects that are based on the current expectations and beliefs of management.  Forward-looking statements may also be made by the Company from time to time in other reports and documents as well as in oral presentations.  When used in written documents or oral statements, the words “anticipate,” “believe,” “estimate,” “expect,” “objective” and similar expressions and verbs in the future tense, are intended to identify forward-looking statements.  The statements contained herein and such future statements involve or may involve certain assumptions, risks and uncertainties, many of which are beyond the Company’s control, that could cause the Company’s actual results and performance to differ materially from what is expected.  In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Company:

             ●   our ability to maintain higher regulatory capital levels as imposed by federal and state regulators;

             ●   adverse changes in the real estate markets;

             ●   adverse changes in the securities markets;

             ●   general economic conditions, either nationally or in our market areas, that are worse than expected;

             ●   inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;

             ●   changes in interest rates that reduce loan origination volumes and, ultimately, income from our mortgage banking operations;

             ●   our ability to maintain adequate levels of liquidity given regulatory limits on sources of funding and rates that can be paid for funding;

             ●   legislative or regulatory changes that adversely affect our business;

             ●   our ability to enter new markets successfully and take advantage of growth opportunities;

             ●   significantly increased competition among depository and other financial institutions;

             ●   changes in accounting policies and practices, as may be adopted by the bank regulatory agencies and the Financial Accounting Standards Board; and

             ●   changes in consumer spending, borrowing and savings habits.

See also the factors referred to in reports filed by the Company with the Securities and Exchange Commission (particularly those under the caption “Risk Factors” in Item 1A of the Company’s 2011 Annual Report on Form 10-K).

Overview

The following discussion and analysis is presented to assist the reader in the understanding and evaluation of the Company’s financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Form 10-Q and should be read in conjunction therewith. The detailed discussion focuses on the results of operations for the three months ended March 31, 2012 and 2011 and the financial condition as of March 31, 2012 compared to the financial condition as of December 31, 2011.

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Our profitability is highly dependent on our net interest income, mortgage banking income, provision for loan losses and expenses related to real estate owned.  Net interest income is the difference between the interest income we earn on our interest earnings assets which are loans receivable, investment securities and cash and cash equivalents and the interest we pay on deposits and other borrowings.  The Company’s banking subsidiary, WaterStone Bank SSB (“WaterStone Bank” or “Bank”) is primarily a mortgage lender with loans secured by real estate comprising 98.0% of total loans receivable on March 31, 2012.  Further, 89.4% of loans receivable are residential mortgage loans with over four-family loans comprising 45.7% of all loans on March 31, 2012.  WaterStone Bank funds loan production primarily with retail deposits and Federal Home Loan Bank advances.  The Bank’s mortgage banking subsidiary, Waterstone Mortgage Corporation, utilizes a line of credit provided by the Bank as its primary source of funding loans held for sale.  In addition, Waterstone Mortgage Corporation utilizes lines of credit with external banks when needed.  On March 31, 2012, deposits comprised 68.2% of total liabilities.  Time deposits, also known as certificates of deposit, accounted for 82.9% of total deposits at March 31, 2012.  Federal Home Loan Bank advances outstanding on March 31, 2012 totaled $350.0 million, or 22.9% of total liabilities.  During the current prolonged period of low interest rates and economic weakness, we have determined that an investment philosophy emphasizing short-term liquid investments (primarily cash and cash equivalents) is prudent and positions the Company to take advantage of the investment, lending and interest rate risk management opportunities that will exist as the local and national economies recover from the recession.  Our high level of time deposits, relative to total deposits, may result in an increase in our cost of funds when market interest rates begin to increase.

During the three months ended March 31, 2012, our results of operations continued to be adversely affected by elevated levels of nonperforming loans and real estate owned.  Weaknesses in our loan portfolio have required that we establish higher provisions for loan losses and incur significant loan charge-offs.  Continued weakness in the local real estate market requires the Company to continually re-evaluate the inputs and assumptions used to determine the fair value of collateral and net present value of discounted future estimated cash flows related to loans receivable to ensure that the allowance for loan losses continues to be an accurate reflection of management’s best estimate of the amount needed to provide for the probable and estimable loss on impaired loans and other incurred losses in the loan portfolio.  As a result, the Company determined that a provision for loan losses of $3.7 million was necessary during the three months ended March 31, 2012 in order to maintain the allowance for loan losses at an appropriate level in relation to the risks management believes are inherent and estimable in our portfolio.  At March 31, 2012, our allowance for loan losses totaled $33.0 million and represented 36.0% of non-accrual loans at the end of the period.  The $3.7 million provision for loan losses represents a $1.2 million decrease from the $4.9 million provision for loan losses during the three months ended March 31, 2011.  Additional information regarding loan quality and its impact on our financial condition and results of operations can be found in the “Asset Quality” discussion.

Our results of operations are also affected by noninterest income and noninterest expense.  Noninterest income consists primarily of mortgage banking income.  A significant increase in both sales volumes and margins earned on the sale of mortgage loans in the secondary market yielded an $8.0 million increase in mortgage banking income during the three months ended March 31, 2012 compared to the three months ended March 31, 2011.  Noninterest expense consists primarily of compensation and employee benefits, real estate owned expense and FDIC insurance premiums.  Noninterest expense increased $4.2 million for the three months ended March 31, 2012 compared to the three months ended March 31, 2011.  The primary reason for the increase in noninterest expense compared to the prior year relates to a $5.5 million increase in expense resulting from increased origination volume with respect to mortgage banking operations.  The increase in noninterest expense related to our mortgage banking operations were partially offset by a $360,000 decrease in real estate owned expense during the three months ended March 31, 2012 compared to the comparable period in the prior year.  During 2012 our noninterest expense has been and will continue to be adversely affected by higher deposit insurance premium assessments from the FDIC.  FDIC insurance premium expense totaled $941,000 and $1.1 million during the three months ended March 31, 2012 and 2011, respectively.  Our results of operations are also significantly affected by general and local economic and competitive conditions, governmental policies and actions of regulatory authorities.

Critical Accounting Policies

Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets.

Allowance for Loan Losses. WaterStone Bank establishes valuation allowances on loans deemed to be impaired. A loan is considered impaired when, based on current information and events, it is probable that WaterStone Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. A valuation allowance is established for an amount equal to the impairment when the carrying amount of the loan exceeds the present value of the expected future cash flows discounted at the loan’s original effective interest rate or the estimated net realizable fair value of the underlying collateral (specific component).  The Company recognizes the change in present value of expected future cash flows on impaired loans attributable to the passage of time as provision for loan losses.  On an ongoing basis, at least quarterly for financial reporting purposes, the fair value of collateral dependent impaired loans and real estate owned is determined or reaffirmed by the following procedures:

·   Obtaining updated real estate appraisals or performing updated discounted cash flow analysis;

·   Confirming that the physical condition of the real estate has not significantly changed since the last valuation date;

·   Comparison of the estimated current book value to that of updated sales values experienced on similar real estate owned;

·   Comparison of the estimated current book value to that of updated values seen on more current appraisals of similar properties; and

·   Comparison of the estimated current book value to that of updated listed sales prices on our real estate owned and that of similar properties (not owned by the Company).

WaterStone Bank also establishes valuation allowances based on an evaluation of the various risk components that are inherent in the credit portfolio (general component). The risk components that are evaluated include past loan loss experience; the level of non-performing and classified assets; current economic conditions; volume, growth, and composition of the loan portfolio; adverse situations that may affect the borrower’s ability to repay; the estimated value of any underlying collateral; regulatory guidance; and other relevant factors. The allowance is increased by provisions charged to earnings and recoveries of previously charged-off loans and reduced by charge-offs. Charge-offs approximate the amount by which the outstanding principal balance exceeds the estimated net realizable value of the underlying collateral.  The adequacy of the allowance for loan losses is reviewed and approved quarterly by the WaterStone Bank board of directors. The allowance reflects management’s best estimate of the amount needed to provide for the probable loss on impaired loans and other inherent losses in the loan portfolio, and is based on a risk model developed and implemented by management and approved by the WaterStone Bank board of directors.

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Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in loan quality and economic conditions.  More specifically, if our future charge-off experience increases substantially from our past experience; or if the value of underlying loan collateral, in our case real estate, declines in value by a substantial amount; or if unemployment in our primary market area increases significantly; our allowance for loan losses may be inadequate and we will incur higher provisions for loan losses and lower net income in the future.

 In addition, state and federal regulators periodically review the WaterStone Bank allowance for loan losses. Such regulators have the authority to require WaterStone Bank to recognize additions to the allowance at the time of their examination.

Income Taxes.  The Company and its subsidiaries file consolidated federal and combined state income tax returns. The provision for income taxes is based upon income in the consolidated financial statements, rather than amounts reported on the income tax return.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as for net operating loss carry forwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.  

Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not��� that a deferred tax asset will not be realized.  The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Examples of positive evidence may include the existence of taxes paid in available carry-back years as well as the probability that taxable income will be generated in future periods.  Examples of negative evidence may include cumulative losses in a current year and prior two years and general business and economic trends.  At both March 31, 2012 and December 31, 2011, the Company determined a valuation allowance continued to be necessary, largely based on the negative evidence represented by a cumulative loss in the most recent three-year period caused by the significant loan loss provisions recorded during those three years.  In addition, general uncertainty regarding the economy and the housing market has increased the potential volatility and uncertainty of projected earnings.  Management is required to re-evaluate the deferred tax asset and the related valuation allowance quarterly.

Positions taken in the Company’s tax returns are subject to challenge by the taxing authorities upon examination.  The benefit of uncertain tax positions are initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the tax authorities.  Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts.   Interest and penalties on income tax uncertainties are classified within income tax expense in the income statement.

Management believes the Company’s tax policies and practices are critical because the determination of the tax provision and current and deferred tax assets and liabilities have a material impact on our net income and the carrying value of our assets.  We have no plans to change the tax recognition methodology in the future without hard evidence of sustainable earnings trends which are reliant on net interest income, mortgage banking income and significantly reduced credit losses.  If the estimated valuation allowance against our deferred asset is adjusted it will affect our future net income.

Fair Value Measurements.  The Company determines the fair value of its assets and liabilities in accordance with ASC 820. ASC 820 establishes a standard framework for measuring and disclosing fair value under GAAP. A number of valuation techniques are used to determine the fair value of assets and liabilities in the Company’s financial statements. The valuation techniques include quoted market prices for investment securities, appraisals of real estate from independent licensed appraisers and other valuation techniques. Fair value measurements for assets and liabilities where limited or no observable market data exists are based primarily upon estimates, and are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the valuation results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there are inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. Significant changes in the aggregate fair value of assets and liabilities required to be measured at fair value or for impairment are recognized in the income statement under the framework established by GAAP.

-- 40 --

Comparison of Operating Results for the Three Months Ended March 31, 2012 and 2011

General - Net income for the three months ended March 31, 2012 totaled $2.2 million, or $0.07 for both basic and diluted income per share, compared to a net loss of $1.5 million, or $0.05 for both basic and diluted loss per share, for the three months ended March 31, 2011.  The three months ended March 31, 2012 generated an annualized return on average assets of 0.52% and an annualized return on average equity of 5.24%, compared to an annualized loss on average assets of 0.35% and an annualized loss on average equity of 3.67% for the comparable period in 2011.  The results of operations for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011 reflect a $2.5 million increase in the pre-tax results of operations from our mortgage banking operations, a $1.2 million decrease in the provision for loan losses, a $360,000 decrease in expense related to real estate owned, a $241,000 increase in gains recognized upon the sale of available for sale securities, partially offset by a $1.5 million decrease in net interest income.  The provision for loan losses totaled $3.7 million during the three months ended March 31, 2012, compared to $4.9 million for the three months ended March 31, 2011.  Loan charge-off activity and specific loan loss reserves are discussed in additional detail in the Asset Quality section.

Segment Review – As described in Note 15 of the notes to consolidated financial statements, the Company’s primary reportable segment is community banking.  Community banking consists of lending and deposit gathering (as well as other banking-related products and services) to consumers and businesses and the support to deliver, fund, and manage such banking services. The Company’s mortgage banking segment provides residential mortgage products for the purpose of sale on the secondary market.

Mortgage banking segment assets (which consist predominantly of loans held for sale) increased $1.4 million, or 1.4%, to $101.6 million as of March 31, 2012 compared to $100.2 million as of December 31, 2011.  Additional details are provided in the “Loans Held for Sale” section.  Mortgage banking revenues increased $8.0 million, or 130.4%, to $14.2 million for the three months ended March 31, 2012 compared to $6.2 million during the three months ended March 31, 2011.   The $8.0 million increase in mortgage banking revenues was attributable to both an increase in loan origination volume, as well as increased margins.  Loans originated for sale on the secondary market totaled $326.9 million during the three months ended March 31, 2012, which represents a $143.9 million, or 78.6%, increase in originations from the three months ended March 31, 2011, which totaled $183.0 million.  In addition to the increase in revenues resulting from the increase in origination volume, mortgage banking revenues increased due to an increase in average sales margin.  The increase in average sales margin was driven by the following factors:  an increase in pricing on all products in all geographic markets, a change in product mix towards real estate purchases which yield a higher margin than loans originated for the purpose of a refinancing and a change in the geographic composition or origination activity towards higher yielding markets.  The major components of mortgage banking revenues include fees and premiums associated with the sale of residential loans held for sale, which are discussed in section “Mortgage Banking Income.” The major expenses for the mortgage banking segment are compensation, payroll taxes and other employee benefits, as well as occupancy, office furniture and equipment and other expenses, which are covered generally in the consolidated discussion in section “Noninterest Expense.”

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Average Balance Sheets, Interest and Yields/Costs

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated.  No tax-equivalent yield adjustments were made, as the effect thereof was not material.  Non-accrual loans were included in the computation of average balances.  The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

	Three Months Ended March 31,
	2012							2011
	Average Balance		Interest		Yield/Cost			Average Balance		Interest		Yield/Cost
	(Dollars in Thousands)
Assets
Interest-earning assets:
Loans receivable, net(1)	$	1,294,031		16,572		5.14	%	$	1,341,460		18,465		5.58	%
Mortgage related securities(2)		103,039		863		3.36			103,249		1,037		4.07
Debt securities, (2) federal funds sold and short-term investments		198,266		707		1.43			224,900		835		1.51
Total interest-earning assets		1,595,336		18,142		4.56			1,669,609		20,337		4.94
Noninterest-earning assets		96,883							107,791
Total assets	$	1,692,219						$	1,777,400
Liabilities and equity
Interest-bearing liabilities:
Demand accounts	$	38,563		7		0.07		$	36,376		7		0.08
Money market and savings accounts		110,686		86		0.31			111,235		95		0.35
Time deposits		869,367		3,111		1.43			964,549		3,997		1.68
Total interest-bearing deposits		1,018,616		3,204		1.26			1,112,160		4,099		1.50
Borrowings		457,658		4,512		3.95			446,666		4,311		3.91
Total interest-bearing liabilities		1,476,274		7,716		2.10			1,558,826		8,410		2.19
Noninterest-bearing liabilities
Non interest-bearing deposits		28,194							29,216
Other noninterest-bearing liabilities		18,692							18,730
Total noninterest-bearing liabilities		46,886							47,946
Total liabilities		1,523,160							1,606,772
Equity		169,059							170,628
Total liabilities and equity	$	1,692,219						$	1,777,400
Net interest income			$	10,426						$	11,927
Net interest rate spread (3)						2.46	%						2.75	%
Net interest-earning assets (4)	$	119,062						$	110,783
Net interest margin (5)						2.62	%						2.90	%
Average interest-earning assets to average interest-bearing liabilities						108.07	%						107.11	%

__________

(1)  Interest income includes net deferred loan fee amortization income of $150,000 and $220,000 for the three months ended March 31, 2012 and 2011, respectively.

(2)  Average balance of mortgage related and debt securities are based on amortized historical cost.

(3)  Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4)  Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(5)  Net interest margin represents net interest income divided by average total interest-earning assets.

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Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated.  The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume).  The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate).  The net column represents the sum of the prior columns.  For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

	Three Months Ended March 31,
	2012 versus 2011
	Increase (Decrease) due to
	Volume			Rate			Net
	(In Thousands)
Interest income:
Loans receivable(1) (2)	$	(581	)		(1,312	)		(1,893	)
Mortgage related securities(3)		(2	)		(172	)		(174	)
Other earning assets(3)		(90	)		(38	)		(128	)
Total interest-earning assets		(673	)		(1,522	)		(2,195	)
Interest expense:
Demand accounts	��	-			-			-
Money market and savings accounts		(1	)		(7	)		(8	)
Time deposits		(357	)		(530	)		(887	)
Total interest-bearing deposits		(358	)		(537	)		(895	)
Borrowings		141			60			201
Total interest-bearing liabilities		(217	)		(477	)		(694	)
Net change in net interest income	$	(456	)		(1,045	)		(1,501	)

______________

    (1)    Interest income includes net deferred loan fee amortization income of $150,000 and $220,000 for the three months ended March 31, 2012 and 2011, respectively.

(2)    Non-accrual loans have been included in average loans receivable balance.

(3)    Includes available for sale securities.  Average balance of available for sale securities is based on amortized historical cost.

Total Interest Income - Total interest income decreased $2.2 million, or 10.8%, to $18.1 million during the three months ended March 31, 2012 from $20.3 million during the three months ended March 31, 2011.

Interest income on loans decreased $1.9 million, or 10.3%, to $16.6 million during the three months ended March 31, 2012 from $18.5 million during the three months ended March 31, 2011.  The decrease in interest income was primarily due to a 44 basis point decrease in the average yield on loans to 5.14% for the three-month period ended March 31, 2012 from 5.58% for the comparable period in 2011.  The decrease in interest income on loans also reflects $47.4 million, or 3.5%, decrease in the average balance of loans outstanding to $1.29 billion during the three months ended March 31, 2012 from $1.34 billion during the comparable period in 2011.

Interest income from mortgage-related securities decreased $174,000, or 16.8%, to $863,000 during the three months ended March 31, 2012 from $1.0 million during the three months ended March 31, 2011.  The decrease in interest income was primarily due to a 71 basis point decrease in the average yield on mortgage-related securities to 3.36% for the three months ended March 31, 2012 from 4.07% for the comparable period in 2011.  The decrease in interest income from mortgage-related securities also reflects a $210,000, or 0.2%, decrease in the average balance of mortgage-related securities to $103.0 million for the three months ended March 31, 2012 from $103.2 million during the comparable period in 2011.

Finally, interest income from other interest earning assets (comprised of debt securities, federal funds sold and short-term investments) decreased to $707,000 for the three months ended March 31, 2012 compared to $835,000 for the three months ended March 31, 2011.  Interest income decreased due to a decrease of $26.6 million, or 11.8%, in the average balance of other earning assets to $198.3 million during the three months ended March 31, 2012 from $224.9 million during the comparable period in 2011.  The decrease in interest income from other earning assets also reflects a 8 basis point decline in the average yield on other earning assets to 1.43% for the three months ended March 31, 2012 from 1.51% for the comparable period in 2011.

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Total Interest Expense - Total interest expense decreased by $694,000, or 8.3%, to $7.7 million during the three months ended March 31, 2012 from $8.4 million during the three months ended March 31, 2011.  This decrease was the result of both a decrease in the average cost of funds as well as a decrease in the average balance of interest bearing deposits and borrowings.  The average cost of funds decreased 9 basis points to 2.10% for the three months ended March 31, 2012 from 2.19% for the three months ended March 31, 2011.  Total average interest bearing deposits and borrowings outstanding decreased $82.6 million, or 5.3%, to $1.48 billion for the three months ended March 31, 2012 compared to an average balance of $1.56 billion for the three months ended March 31, 2011.

Interest expense on deposits decreased $895,000, or 21.8%, to $3.2 million during the three months ended March 31, 2012 from $4.1 million during the comparable period in 2011.  The decrease in interest expense on deposits was primarily due to a decrease in the cost of average deposits of 24 basis points to 1.26% for the three months ended March 31, 2012 compared to 1.50% for the comparable period during 2011.  The decrease in the cost of deposits reflects the low interest rate environment due to the Federal Reserve’s low short term interest rate policy.  These rates are typically used by financial institutions in pricing deposit products.  The decrease in interest expense attributable to the decrease in the cost of deposits was compounded by a decrease of $93.5 million, or 8.4%, in the average balance of interest bearing deposits to $1.02 billion during the three months ended March 31, 2012 from $1.11 billion during the comparable period in 2011.  Consistent with the Bank’s liquidity needs and funding obligations the Bank has reduced its level of higher cost time deposits.

Interest expense on borrowings increased $201,000, or 4.7%, to $4.5 million during the three months ended March 31, 2012 from $4.3 million during the comparable period in 2011.  The increase primarily resulted from an $11.0 million, or 2.5%, increase in average borrowings outstanding to $457.7 million during the three months ended March 31, 2012 from $446.7 million during the comparable period in 2011.  The increased use of borrowings as a funding source during the three months ended March 31, 2012 reflects an increased use of external lines of credit within our mortgage banking segment to fund loan originations to be sold on the secondary market.  The increased use of these lines of credit as a funding source resulted in a slight increase in the average cost of borrowings during the three months ended March 31, 2012.  The average cost of borrowings increased 4 basis points to 3.95% during the three months ended March 31, 2012 compared to 3.91% during the three months ended March 31, 2011.

Net Interest Income - Net interest income decreased by $1.5 million, or 12.6%, to $10.4 million during the three months ended March 31, 2012 as compared to $11.9 million during the comparable period in 2011.  The decrease in net interest income resulted primarily from a 29 basis point decrease in our interest rate spread to 2.46% during the three months ended March 31, 2012 from to 2.75% during the three months ended March 31, 2011.  The 29 basis point decrease in the interest rate spread resulted from a 38 basis point decrease in the average yield on interest earning assets, which was partially offset by a 9 basis point decrease in the average cost of interest bearing liabilities.

Provision for Loan Losses – Our provision for loan losses decreased $1.2 million, or 24.6%, to $3.7 million during the three months ended March 31, 2012, from $4.9 million during the three months ended March 31, 2011.  The decrease in the provision for loan losses resulted from a decrease in loans exhibiting risk characteristics that require estimated loan loss provisions in excess of our historical average experience rates when compared to the same period of the prior year.  Loans with elevated levels of risk profiles include loans internally classified as watch.  While the provision for loan losses has decreased from the prior year, it remains at historical high levels.  These levels remain high due to continued general economic stress resulting in reduced levels of income earned by many of our borrowers combined with loan collateral values, primarily real estate, that remain at levels below those estimated at the time the loans were originally made.  These factors result in higher levels of actual loss experience which when applied to the portfolio in general require higher loan loss provisions.  They also result in more loans exhibiting risk characteristics that require estimated loan loss provisions in excess of our historical average experience rates.  These risk characteristics include reduced borrower cash flow, reduced borrower FICO scores and known declines in collateral value even though the loan may still be performing.  The provision for the three months ended March 31, 2012 reflected a $3.1 million of net loan charge-offs, as well as continued weakness in local real estate markets which required an overall increase to the allowance for loan losses.  See the Asset Quality section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions.

Noninterest Income - Total noninterest income increased $8.2 million, or 120.7%, to $15.0 million during the three months ended March 31, 2012 from $6.8 million during the comparable period in 2011.  The increase resulted primarily from an increase in mortgage banking income.  In addition to the increase in mortgage banking income, the Company realized a gain of $241,000 on the sale of available for sale securities during the three months ended March 31, 2012.

Mortgage banking income increased $8.0 million, or 130.4%, to $14.2 million for the three months ended March 31, 2012, compared to $6.2 million during the comparable period in 2011.  The $8.0 million increase in mortgage banking income was the result of an increase in origination and sales volumes as well as an increase in average sales margins.  The increase in average sales margin reflects an increase in pricing and fees on all products in all geographic markets and a change in the geographic composition of origination activity towards higher yielding geographic markets.

Despite the increase in pricing, overall loan origination volumes increased significantly compared to the prior year which reflects the continued strong demand for fixed-rate loans due in large part to historically low interest rates on these products.  Loans originated for sale on the secondary market totaled $326.9 million during the three months ended March 31, 2012, which represents a $143.9 million, or 78.6%, increase in originations from the three months ended March 31, 2011, which totaled $183.0 million.

In addition to the increase in income due to an increase in origination volume and an increase in the overall level of pricing, mortgage banking income increased due to a shift in origination volume by geographic market.  Loan origination volumes increased by a combined $78.0 million during the year three months ended March 31, 2012 as compared to the three months ended March 31, 2011 with respect to five of our geographic markets which yielded the largest increase in average margin compared to the prior year.  These five markets accounted for 49.9% of the overall increase in originations compared to the prior year.

Our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance), however, both remained relatively consistent during the three months ended March 31, 2012 as compared to the three months ended March 31, 2011.  Loans originated for the purpose of a residential property purchase, which generally yields a higher margin than loans originated for the purpose of a refinance, comprised 55% of total originations during the three months ended March 31, 2012, compared to 54% during the three months ended March 31, 2011.  The mix of loan type also remained relatively consistent with loans conventional loans and governmental loans comprising 64% and 36% of all loan originations, respectively during the three months ended March 31, 2012.  During the three months ended March 31, 2011 conventional loans and governmental loans comprised 63% and 37% of all loan originations, respectively.

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In addition to the increase in mortgage banking income, noninterest income increased during the three months ended March 31, 2012 resulting from a gain on the sale of available for sale securities during the current year.  During the three months ended March 31, 2012, the Company sold $11.6 million in municipal securities at a gain of $241,000.  There were no such security sales during the comparable period in 2011.

Noninterest Expense - Total noninterest expense increased $4.2 million, or 27.1%, to $19.5 million during the three months ended March 31, 2012 from $15.4 million during the comparable period in 2011.  The increase was primarily attributable to increased compensation, real estate owned expense and other noninterest expense.

Compensation, payroll taxes and other employee benefit expense increased $2.7 million, or 34.4%, to $10.6 million during the three months ended March 31, 2012 compared to $7.9 million during the comparable period in 2011.  Due primarily to an increase in loan origination activity total compensation, payroll taxes and other benefits at our mortgage banking subsidiary increased $3.3 million to $7.7 million for the three months ended March 31, 2012 compared to $4.4 million during the comparable period in 2010.  The increase in compensation at our mortgage banking subsidiary correlates to the increase in mortgage banking income due to the commission based compensation structure in place for our mortgage banking loan officers.  The increase in total compensation, payroll taxes and other benefits at our mortgage banking subsidiary was partially offset by a decrease in compensation, payroll taxes and other employee benefits at our banking segment.   Due to a decrease in stock based compensation, health care related expense and a reduction in staffing, compensation, payroll taxes and other employee benefits at our banking segment decreased $619,000 to $3.1 million for the three months ended March 31, 2012 compared to $3.7 million during the comparable period in 2011.

Real estate owned expense decreased $360,000, or 20.1%, to $1.4 million during the three months ended March 31, 2012 from $1.8 million during the comparable period in 2011.  Real estate owned expense includes the net operating and carrying costs related to the properties.  In addition, it includes net gain or loss recognized upon the sale of a foreclosed property, as well as write-downs recognized to maintain the properties at the appropriate estimated fair value.  The decrease in real estate owned expense results from a decrease in net property management expense and a decrease in write-downs of asset values, partially offset by a decrease in gains on the sales of properties.  During the three months ended March 31, 2012, net operating expense, which includes but is not limited to property taxes, maintenance and management fees, net of rental income decreased $642,000, or 40.9%, to $929,000 from $1.6 million during the comparable period in 2011.  The decrease in net operating expense compared to the prior period resulted from a decrease in average balance of properties owned.  The average balance of real estate owned totaled $56.4 million for the three months ended March 31, 2012 compared to $60.8 million for the three months ended March 31, 2011.  Net losses recognized on the sale or write-down of real estate owned totaled $506,000 during the three months ended March 31, 2012, compared to a net loss of $225,000 during the comparable period in 2011.

Other noninterest expense increased $1.5 million or 89.9%, to $3.1 million during the three months ended March 31, 2012 from $1.6 million during the comparable period in 2011.  The increase resulted from an increase in operational costs related to the expansion of our mortgage banking operations of $2.0 million to $3.5 million for the three months ended March 31, 2012, compared to $1.6 million during the comparable period in 2011.  Increases in other noninterest expenses due to the expansion of our mortgage banking operations were partially offset by a decrease in expense within our community banking segment.

Income Taxes – During the three months ended March 31, 2012 and March 31, 2011, the Company recorded income tax expense of $30,000 and $39,000, respectively, which relates to certain states in which our mortgage banking segment conducts business and will file a separate company state income tax return.

Comparison of Financial Condition at March 31, 2012 and December 31, 2011

Total Assets - Total assets decreased by $13.9 million, or 0.8%, to $1.70 billion at March 31, 2012 from $1.71 billion at December 31, 2011. The decrease in total assets reflects decreases in loans receivable of $16.2 million, cash and cash equivalents of $4.8 million and securities held to maturity of $2.6 million.  Funds received from the repayment of loans held in portfolio were combined with cash and used to reduce deposits by $7.5 million, reduce other liabilities by $13.4 million and increase securities available for sale by $8.4 million during the three months ended March 31, 2012.

Cash and Cash Equivalents – Cash and cash equivalents decreased by $4.8 million, or 5.9%, to $75.6 million at March 31, 2012 from $80.4 million at December 31, 2011.  The decrease in cash and cash equivalents is not reflective of an overall change in strategy with respect to cash management.  The overall level of cash and cash equivalents continues to reflect the Company’s plan to maintain higher than usual liquidity given the current economic environment and relatively low rates of return available on securities and other investments.

Securities Available for Sale – Securities available for sale increased by $8.4 million, or 4.1%, to $215.0 million at March 31, 2012 from $206.5 million at December 31, 2011.  This increase reflects a $34.1 million increase in mortgage backed securities and a $10.0 million increase in government sponsored enterprise issued collateralized mortgage obligations, partially offset by a $24.0 million decrease in government sponsored enterprise bonds and a $12.5 million decrease in municipal securities.  During the three months ended March 31, 2012, the proceeds from maturities and calls of government sponsored enterprise securities and from the sale of municipal securities were reinvested in mortgage related securities deemed to provide a better risk-adjusted return.  The Company sold $11.6 million in short-term municipal securities in March of 2012 at a gain of $241,000 in order to capture the related value of the tax-exempt feature of the securities not otherwise realized due to the Company’s taxable loss position.  As of March 31, 2012, the Company holds two available for sale private label issue collateralized mortgage obligations with a total fair value of $18.1 million and an amortized cost of $19.0 million that were determined to be other than temporarily impaired.  The $897,000 unrealized loss (before taxes) is included in other comprehensive income.  During the three months ended March 31, 2012, $4,000 was recognized as additional other than temporary impairment with respect to one of the private label issue collateralized mortgage obligations which was charged against earnings.

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Loans Receivable - Loans receivable held for investment decreased $16.2 million, or 1.3%, to $1.20 billion at March 31, 2012 from $1.22 billion at December 31, 2011.  The 2012 decrease in total loans receivable was primarily attributable to a $9.6 million decrease in one- to four-family loans and a $4.1 million decrease in over four-family loans.  The decrease in one- to four-family loans reflects a decline in loan demand for variable-rate real estate mortgage loans as borrowers continue to prefer long-term fixed-rate products that the Company does not generally retain in its portfolio.  As a result of the low interest rate environment with respect to long-term fixed-rate real estate mortgage products, the Company continued to experience a shift in the composition of loan originations during 2012 and 2011 from one- to four-family residential variable-rate loans to residential real estate loans collateralized by over four-family properties and commercial real estate, as these categories of borrowers displayed relatively stable levels of demand for our existing products.  During the three months ended March 31, 2012, $6.3 million in loans were transferred to real estate owned and $3.1 million were charged-off, net of recoveries.

The following table shows loan origination, principal repayment activity, transfers to real estate owned, charge-offs and sales during the periods indicated.

	As of or for the						As of or for the
	Three Months Ended March 31,						Year Ended
	2012			2011			December 31, 2011
	(In Thousands)
Total gross loans receivable and held for sale at
beginning of period	$	1,304,947		$	1,443,824			1,443,824
Real estate loans originated for investment:
Residential
One- to four-family		3,047			2,969			13,651
Over four-family		10,959			10,119			60,367
Home equity		981			1,189			4,328
Construction and land		202			1,589			3,487
Commercial real estate		4,950			4,512			25,398
Total real estate loans originated for investment		20,139			20,378			107,231
Commerical business loans originated for investment		1,294			5,559			9,366
Total loans originated for investment		21,433			25,937			116,597
Principal repayments		(28,212	)		(47,201	)		(200,544	)
Transfers to real estate owned		(6,349	)		(9,311	)		(28,259	)
Loan principal charged-off, net of recoveries		(3,059	)		(1,956	)		(18,821	)
Net activity in loans held for investment		(16,187	)		(32,531	)		(131,027	)
Loans originated for sale		326,882			182,970			1,027,346
Loans sold		(324,464	)		(250,011	)		(1,035,196	)
Net activity in loans held for sale		2,418			(67,041	)		(7,850	)
Total gross loans receivable and held for sale at end of period	$	1,291,178		$	1,344,252			1,304,947

Allowance for Loan Losses - The allowance for loan losses increased $617,000, or 1.9%, to $33.0 million at March 31, 2012 from $32.4 million at December 31, 2011.  The $617,000 increase in the allowance for loan losses during the three months ended March 31, 2012 is attributable to a $1.6 million increase in specific loan loss reserves related to impaired loans, partially offset by a $1.0 million decrease in the general valuation allowance.  The $1.6 million increase in specific loan loss reserves was primarily the result of an increase in number and amount of impaired loans with significant collateral shortfalls.  The $1.0 million decrease in the general valuation allowance resulted primarily from a decrease in the overall balance of loans outstanding.  As of March 31, 2012, the allowance for loan losses to total loans receivable was 2.75% and was equal to 35.98% of non-performing loans, compared to 2.67% and 41.46%, respectively, at December 31, 2011.  Of the overall $617,000 increase in the allowance for loan losses during the three months ended March 31, 2012, $319,000 related to the over four-family category and $305,000 related to the home equity category.  Weakness in the residential real estate market has continued for the past four years and the risk of loss on loans secured by residential real estate remains at an elevated level.  That portion of the allowance for loan losses attributable to mortgage loans secured by residential real estate is unchanged at 85.5% of the total allowance for loan losses at both March 31, 2012 and December 31, 2011.

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Real Estate Owned – Total real estate owned decreased $660,000, or 1.2%, to $56.0 million at March 31, 2012 from $56.7 million at December 31, 2011.  During the three months ended March 31, 2011, $6.3 million was transferred from loans to real estate owned upon completion of foreclosure.  Declines in property values evidenced by updated appraisals, responses to list prices on properties held for sale and/or deterioration in the condition of properties resulted in write downs totaling $875,000 during the three months ended March 31, 2012.  During the same period, sales of real estate owned totaled $6.1 million.

Prepaid Expenses and Other Assets – Prepaid expenses and other assets increased by $874,000 or 10.5%, to $9.2 million at March 31, 2012 from $8.4 million at December 31, 2011.  The increase is primarily due to an increase in receivables due from third parties related to the origination of loans held for sale as well as an increase in the mortgage servicing rights intangible asset that relates to an increase in loans sold on a servicing retained basis.

Deposits – Total deposits decreased $7.5 million, or 0.7%, to $1.04 billion at March 31, 2012 from $1.05 billion at December 31, 2011.  The reduction in deposits is the direct result of weak loan demand.  Total time deposits decreased $13.0 million, or 1.5%, to $865.7 million at March 31, 2012 from $878.7 million at December 31, 2011.  The decrease in time deposits was partially offset by an increase in money market and demand deposits.  Total money market and savings deposits increased $5.2 million, or 5.0%, to $109.3 million at March 31, 2012 from $104.1 million at December 31, 2011.  Total demand deposits increased $215,000, or 0.3%, to $68.7 million at March 31, 2012 from $68.5 million at December 31, 2011.

Borrowings – Total borrowings decreased $1.9 million, or 0.4%, to $459.2 million at March 31, 2012 from $461.1 million at December 31, 2011.  The decrease in borrowings relates entirely to a reduction in the use of bank lines of credit to finance loans held for sale.  The balance of these lines of credit decreased by $1.9 million, to $25.2 million at March 31, 2012, from $27.1 million at December 31, 2011.

Advance Payments by Borrowers for Taxes - Advance payments by borrowers for taxes increased $6.5 million to $7.4 million at March 31, 2012 from $942,000 at December 31, 2011.  The increase was the result of payments received from borrowers for their real estate taxes and is seasonally normal, as balances increase during the course of the calendar year until real estate tax obligations are paid out in the fourth quarter.

Other Liabilities - Other liabilities decreased $13.4 million, or 40.5%, to $19.7 million at March 31, 2012 from $33.1 million at December 31, 2011.  The decrease resulted primarily from a $13.3 million seasonal decrease in outstanding escrow checks.  The Company receives payments from borrowers for their real estate taxes during the course of the calendar year until real estate tax obligations are paid out in the fourth quarter.  These amounts remain classified as other liabilities until settled.

Shareholders’ Equity – Shareholders’ equity increased by $2.5 million, or 1.5%, to $168.9 million at March 31, 2012 from $166.4 million at December 31, 2011.  The increase in stockholders’ equity was primarily due to a $2.2 million increase in retained earnings reflecting net income for the three months ended March 31, 2012.  In addition to the increase in retained earnings, shareholders’ equity was positively impacted by a $196,000 increase in accumulated other comprehensive income and a $213,000 decrease in unearned ESOP shares.

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ASSET QUALITY

NONPERFORMING ASSETS

The following table summarizes nonperforming loans and assets:

	At March 31,			At December 31,
	2012			2011
	(Dollars in Thousands)
Non-accrual loans:
Residential
One- to four-family	$	56,178			55,609
Over four-family		25,225			13,680
Home equity		2,019			1,334
Construction and land		6,035			6,946
Commercial real estate		2,292			514
Consumer		28			-
Commercial		59			135
Total non-accrual loans		91,836			78,218
Real estate owned
One- to four-family		27,826			27,449
Over four-family		14,942			16,231
Construction and land		9,490			8,796
Commercial real estate		3,752			4,194
Total real estate owned		56,010			56,670
Total nonperforming assets	$	147,846			134,888
Total non-accrual loans to total loans, net		7.65	%		6.43	%
Total non-accrual loans and performing troubled
debt restructurings to total loans receivable		9.79	%		8.45	%
Total non-accrual loans to total assets		5.41	%		4.57	%
Total nonperforming assets to total assets		8.70	%		7.88	%

All loans that exceed 90 days past due with respect to principal and interest are recognized as non-accrual.  Troubled debt restructurings which are nonaccrual either due to being past due greater than 90 days or which have not yet performed under the modified terms for a reasonable period of time, are included in the table above.  In addition, loans which are past due less than 90 days are evaluated to determine the likelihood of collectability given other credit risk factors such as early stage delinquency, the nature of the collateral or the results of a borrower review.  When the collection of all contractual principal and interest is determined to be unlikely, the loan is moved to non-accrual status and an updated appraisal of the underlying collateral is ordered.  This process generally takes place between contractual past due dates 60 to 90 days.  Upon determining the updated estimated value of the collateral, a loan loss provision is recorded to establish a specific reserve to the extent that the outstanding principal balance exceeds the updated estimated net realizable value of the collateral.  When a loan is determined to be uncollectible, typically coinciding with the initiation of foreclosure action, the specific reserve is reviewed for adequacy, adjusted if necessary, and charged-off.

Total non-accrual loans increased by $13.6 million, or 17.4%, to $91.8 million as of March 31, 2012 compared to $78.2 million as of December 31, 2011.  The ratio of non-accrual loans to total loans receivable was 7.65% at March 31, 2012 compared to 6.43% at December 31, 2011.  The $13.6 million net increase in non-accrual loans during the three months ended March 31, 2012 was primarily attributable to one $12.2 million lending relationship that migrated to non-accrual status during the period.  During the three months ended March 31, 2012, a total of $23.8 million in loans were placed on non-accrual status.  Offsetting the addition of loans added to non-accrual status were $6.3 million in transfers to real estate owned (net of charge-offs), $2.3 million in charge-offs and $777,000 in principal repayments.

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Of the $91.8 million in total non-accrual loans as of March 31, 2012, $78.1 million in loans have been specifically reviewed to assess whether a specific valuation allowance is necessary.  A specific valuation allowance is established for an amount equal to the impairment when the carrying value of the loan exceeds the present value of expected future cash flows, discounted at the loan’s original effective interest rate or the fair value of the underlying collateral with an adjustment made for costs to dispose of the asset.  Based upon these specific reviews, a total of $9.7 million in partial charge-offs have been recorded with respect to these loans as of March 31, 2012.  Partially charged-off loans measured for impairment based upon net realizable collateral value are maintained in a “non-performing” status and are disclosed as impaired loans.  In addition, specific reserves totaling $10.1 million have been recorded as of March 31, 2012.  The remaining $13.7 million of non-accrual loans were reviewed on an aggregate basis and $3.2 million in general valuation allowance was deemed necessary as of March 31, 2012.   The $3.2 million in general valuation allowance is based upon a migration analysis performed with respect to similar non-accrual loans in prior periods.

There were no accruing loans past due 90 days or more during the three months ended March 31, 2012 and 2011.

TROUBLED DEBT RESTRUCTURINGS

The following table summarizes troubled debt restructurings:

	At March 31,		At December 31,
	2012		2011
	(Dollars in Thousands)
Troubled debt restructurings
Substandard	$	45,183		47,220
Watch		10,128		8,192
Total troubled debt restructurings	$	55,311		55,412

All troubled debt restructurings are considered to be impaired and are risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in Note 3 in the notes to the financial statements.  Specific reserves have been established to the extent that these collateral-based impairment analyses indicate that a collateral shortfall exists.

LOAN DELINQUENCY

The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio:

	At March 31,			At December 31,
	2012			2011
	(Dollars in Thousands)
Loans past due less than 90 days	$	21,533			36,798
Loans past due 90 days or more		66,482			56,612
Total loans past due	$	88,015			93,410
Total loans past due to total loans receivable		7.33	%		7.68	%

Loans past due decreased by $5.4 million, or 5.8%, to $88.0 million at March 31, 2012 from $93.4 million at December 31, 2011.  Loans past due 90 days or more increased by $9.9 million, or 17.4%, during the three months ended March 31, 2012 while loans past due less than 90 days decreased by $15.3 million, or 41.5%.  The $9.9 million increase in loans past due 90 days or more was primarily attributable to an $11.0 million increase in loan collateralized by over four-family residential real estate.  This increase relates to one borrower relationship that was past due less than 90 days as of December 31, 2011.  Within the category of loans past due less than 90 days, only the category of loans collateralized by commercial real estate experienced an increase in overall delinquent balance when compared to December 31, 2011.  All other loan categories experienced declines in total loan balance past due less than 90 days.

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REAL ESTATE OWNED

Total real estate owned decreased by $660,000, or 1.2%, to $56.0 million at March 31, 2012, compared to $56.7 million at December 31, 2011.  During the three months ended March 31, 2012, $6.3 million was transferred from loans to real estate owned upon completion of foreclosure.  Declines in property values evidenced by updated appraisals, responses to list prices on properties held for sale and/or deterioration in the condition of properties resulted in write-downs totaling $875,000 during the three months ended March 31, 2012.  During the same period, sales of real estate owned totaled $6.1 million.  New appraisals received on real estate owned and collateral dependent impaired loans are based upon an “as is value” assumption.  During the period of time in which we are awaiting receipt of an updated appraisal, loans evaluated for impairment based upon collateral value are measured by the following:

 ●  Applying an updated adjustment factor (as described previously) to an existing appraisal;

 ●  Confirming that the physical condition of the real estate has not significantly changed since the last valuation date;

 ●  Comparing the estimated current value of the collateral to that of updated sales values experienced on similar collateral;

 ●  Comparing the estimated current value of the collateral to that of updated values seen on current appraisals of similar collateral; and

 ●  Comparing the estimated current value to that of updated listed sales prices on our real estate owned and that of similar properties (not owned by the Company).

We owned 322 properties as of March 31, 2012, compared to 323 properties at December 31, 2011.  Of the $56.0 million in real estate owned properties as of March 31, 2012, $46.5 million consist of one– to four-family, over four-family and commercial real estate properties.  Of all real estate owned, these property types present the greatest opportunity to offset operating expenses through the generation of rental income.  Of the $46.5 million in one- to four-family, over four-family and commercial real estate properties, $31.3 million, or 67.2%, represent properties that are generating rental revenue or are being managed with the intent of attracting a lessee to generate revenue.  Foreclosed properties are recorded at the lower of carrying value or fair value with charge-offs, if any, charged to the allowance for loan losses upon transfer to real estate owned.  The fair value is primarily based upon updated appraisals in addition to an analysis of current real estate market conditions.

-- 50 --

A summary of the allowance for loan losses is shown below:

ALLOWANCE FOR LOAN LOSSES

	At or for the Three Months
	Ended March 31,
	2012			2011
	(Dollars in Thousands)
Balance at beginning of period	$	32,430		$	29,175
Provision for loan losses		3,675			4,875
Charge-offs:
Mortgage
One- to four-family		2,446			1,033
Over four-family		447			524
Home Equity		150			73
Commercial real estate		35			176
Construction and land		120			4
Consumer		-			8
Commercial		-			185
Total charge-offs		3,198			2,003
Recoveries:
Mortgage
One- to four-family		116			33
Over four-family		4			11
Home Equity		7			2
Consumer		-			1
Commercial		13			-
Total recoveries		140			47
Net charge-offs		3,058			1,956
Allowance at end of period	$	33,047		$	32,094
Ratios:
Allowance for loan losses to non-accrual loans at end of period		35.98	%		38.24	%
Allowance for loan losses to loans receivable at end of period		2.75	%		2.52	%
Net charge-offs to average loans outstanding (annualized)		0.96	%		0.59	%
Current year provision for loan losses to net charge-offs		120.15	%		249.19	%
Net charge-offs (annualized) to beginning of the year allowance		38.25	%		27.19	%

_______________

At March 31, 2012, the allowance for loan losses was $33.0 million, compared to $32.4 million at December 31, 2011.  As of March 31, 2012, the allowance for loan losses represented 2.75% of total loans receivable and was equal to 35.98% of non-performing loans, compared to 2.67% and 41.46%, respectively, at December 31, 2011.  The $617,000 increase in the allowance for loan losses during the three months ended March 31, 2012 is attributable to a $1.6 million increase in specific loan loss reserves related to impaired loans, partially offset by a $1.0 million decrease in the general valuation allowance.  The $1.6 million increase in specific loan loss reserves was primarily the result of an increase in number and amount of impaired loans with significant collateral shortfalls.  The $1.0 million decrease in the general valuation allowance resulted primarily from a decrease the overall balance of loans outstanding.

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Net charge-offs totaled $3.1 million, or an annualized 0.96% of average loans for the three months ended March 31, 2012, compared to $2.0 million, or an annualized 0.59% of average loans for the three months ended March 31, 2011.  Of the $3.1 million in net charge-offs during the three months ended March 31, 2012, $2.4 million related to loans secured by one- to four-family residential loans.  Weakness in the residential real estate market has continued for the past three years and the risk of loss on loans secured by residential real estate remains at an elevated level.

The loan loss provision of $3.7 million for the three months ended March 31, 2012 reflects the Company’s conclusion as to the need for the ending allowance to be $33.0 million following the net charge-offs recorded during the period and a review of the Bank’s loan portfolio and general economic conditions.

Our underwriting policies and procedures emphasize the fact that credit decisions must rely on both the credit quality of the borrower and the estimated value of the underlying collateral.  Credit quality is assured only when the estimated value of the collateral is objectively determined and is not subject to significant fluctuation.  The quantified deterioration of the credit quality of our loan portfolio as described above is the direct result of borrowers who were not financially strong enough to make regular interest and principal payments or maintain their properties when the economic environment no longer allowed them the option of converting estimated real estate value increases into short-term cash flow.

The allowance for loan losses has been determined in accordance with GAAP. We are responsible for the timely and periodic determination of the amount of the allowance required. Future provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and the underlying collateral, trends in nonperforming loans, current economic conditions and other relevant factors. To the best of management’s knowledge, all probable losses have been provided for in the allowance for loan losses.

The establishment of the amount of the loan loss allowance inherently involves judgments by management as to the adequacy of the allowance, which ultimately may or may not be correct. Higher than anticipated rates of loan default would likely result in a need to increase provisions in future years. See “Critical Accounting Policies” above for a discussion on the use of judgment in determining the amount of the allowance for loan losses.

Impact of Inflation and Changing Prices

The financial statements and accompanying notes of the Company have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects of inflation.

Liquidity and Capital Resources

We maintain liquid assets at levels we consider adequate to meet our liquidity needs.  Our liquidity ratio averaged 4.1% and 6.0% for the three months ended March 31, 2012 and 2011, respectively.  The liquidity ratio is equal to average daily cash and cash equivalents for the period divided by average total assets.  We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans.  We also adjust liquidity as appropriate to meet asset and liability management objectives.  The operational adequacy of our liquidity position at any point in time is dependent upon the judgment of the senior management as supported by the Asset/Liability Committee.  Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators.

Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations.  While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors.  We set the interest rates on our deposits to maintain a desired level of total deposits.  In addition, we invest excess funds in short-term, interest-earning assets, which provide liquidity to meet lending requirements.  Additional sources of liquidity used for the purpose of managing long- and short-term cash flows include advances from the FHLBC.

A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities.  At March 31, 2012 and 2011, respectively, $75.6 million and $124.8 million of our assets were invested in cash and cash equivalents.  At March 31, 2012 cash and cash equivalents are comprised of the following: $55.0 million in cash held at the Federal Reserve Bank and other depository institutions and $20.6 million in federal funds sold.  Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage-related securities, increases in deposit accounts, federal funds purchased and advances from the FHLBC.

During the three months ended March 31, 2012, the collection of principal payments on loans, net of loan originations provided cash flow of $6.8 million, compared to $20.8 million for the three months ended March 31, 2011.  The decrease in loans receivable is reflective of the general decline in loan demand for variable-rate residential real estate mortgage loans combined with the Company’s tightened underwriting standards given the current economic environment.  The decrease in the loan portfolio during the three months ended March 31, 2012 was primarily attributable to a $9.6 million decrease in one- to four-family loans.

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Deposit flows are generally affected by the level of interest rates, the interest rates and products offered by local competitors, and other factors.  Deposits decreased by $7.5 million for the three months ended March 31, 2012.  The decrease in deposits was driven by a $13.0 million decrease in time deposits, partially offset by a $5.2 million increase in money market and savings deposits. As a result of the consent order issued by state and federal regulators effective December 18, 2009, the Bank is prohibited from accepting or renewing brokered deposits and all other deposit rates are capped by the FDIC.

Liquidity management is both a daily and longer-term function of business management.  If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLBC which provide an additional source of funds.  At March 31, 2012, we had $350.0 million in advances from the FHLBC with contractual maturity dates in 2016, 2017 or 2018.  All advances are callable quarterly until maturity.  As an additional source of funds, we also enter into repurchase agreements.  At March 31, 2012, we had $84.0 million in repurchase agreements.  The repurchase agreements mature at various times in 2017, however, all are callable quarterly until maturity.

At March 31, 2012, we had outstanding commitments to originate loans of $25.5 million.  In addition, at March 31, 2012 we had unfunded commitments under construction loans of $6.4 million, unfunded commitments under business lines of credit of $10.1 million and unfunded commitments under home equity lines of credit and standby letters of credit of $20.9 million.  At March 31, 2012 certificates of deposit scheduled to mature in one year or less totaled $687.7 million.  Based on prior experience, management believes that, subject to the Bank’s funding needs, a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case.  In the event a significant portion of our deposits is not retained by us, we will have to utilize other funding sources, such as FHLBC advances, in order to maintain our level of assets.  However, we cannot assure that such borrowings would be available on attractive terms, or at all, if and when needed.  Alternatively, we could reduce our level of liquid assets, such as our cash and cash equivalents and securities available-for-sale in order to meet funding needs.  In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal.

Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements

The following tables present information indicating various contractual obligations and commitments of the Company as of March 31, 2012 and the respective maturity dates.

Contractual Obligations
					More than		More than
					One Year		Three Years		Over
			One Year		Through		Through		Five
	Total		or Less		Three Years		Five Years		Years
	(In Thousands)
Deposits without a stated maturity (4)	$	178,007		178,007		-		-		-
Certificates of deposit (4)		865,747		687,717		157,707		20,323		-
Bank lines of credit (4)		25,193		25,193		-		-		-
Federal Home Loan Bank advances (1)		350,000		-		-		245,000		105,000
Repurchase agreements (2)(4)		84,000		-		-		24,000		60,000
Operating leases (3)		3,802		1,872		1,567		363		-
Salary continuation agreements		893		170		340		340		43
	$	1,507,642		892,959		159,614		290,026		165,043

_____________

(1)  Secured under a blanket security agreement on qualifying assets, principally, mortgage loans.  Excludes interest which will accrue on the advances.  

      All Federal Home Loan Bank advances with maturities exceeding one year are callable on a quarterly basis.

(2)  The repurchase agreements are callable on a quarterly basis until maturity.

(3)  Represents non-cancelable operating leases for offices and equipment.

(4)  Excludes interest.

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The following table details the amounts and expected maturities of significant off-balance sheet commitments as of March 31, 2012.

Other Commitments
					More than		More than
					One Year		Three Years		Over
			One Year		Through		Through		Five
	Total		or Less		Three Years		Five Years		Years
	(In Thousands)
Real estate loan commitments (1)	$	25,521		25,521		-		-		-
Unused portion of home equity lines of credit (2)		19,885		19,885		-		-		-
Unused portion of construction loans (3)		6,388		6,388		-		-		-
Unused portion of business lines of credit		10,099		10,099		-		-		-
Standby letters of credit		970		970		-		-		-
Total Other Commitments	$	62,863		62,863		-		-		-

______________

General:  Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract and generally have fixed expiration dates or other termination clauses.

(1)  Commitments for loans are extended to customers for up to 90 days after which they expire.

(2)  Unused portions of home equity loans are available to the borrower for up to 10 years.

(3)  Unused portions of construction loans are available to the borrower for up to 1 year.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Management of Market Risk

General.The majority of our assets and liabilities are monetary in nature.  Consequently, our most significant form of market risk is interest rate risk.  Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits.  As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates.  Accordingly, WaterStone Bank’s board of directors has established an Asset/Liability Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors.  Management monitors the level of interest rate risk on a regular basis and the Asset/Liability Committee meets at least weekly to review our asset/liability policies and interest rate risk position, which are evaluated quarterly.

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates.  We have implemented the following strategies to manage our interest rate risk: (i) emphasizing variable rate loans including variable rate one- to four-family, and commercial real estate loans as well as three to five year commercial real estate balloon loans; (ii) reducing and shortening the expected average life of the investment portfolio; and (iii) whenever possible, lengthening the term structure of our deposit base and our borrowings from the FHLBC.  These measures should reduce the volatility of our net interest income in different interest rate environments.

Income Simulation.  Simulation analysis is an estimate of our interest rate risk exposure at a particular point in time.  At least quarterly we review the potential effect changes in interest rates may have on the repayment or repricing of rate sensitive assets and funding requirements of rate sensitive liabilities.  Our most recent simulation uses projected repricing of assets and liabilities at March 31, 2012 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments.  Prepayment rate assumptions may have a significant impact on interest income simulation results.  Because of the large percentage of loans and mortgage-backed securities we hold, rising or falling interest rates may have a significant impact on the actual prepayment speeds of our fixed-rate mortgage related assets that may in turn affect our interest rate sensitivity position.  When interest rates rise, prepayment speeds slow and the average expected lives of our fixed-rate assets would tend to lengthen more than the expected average lives of our liabilities and therefore would most likely have a negative impact on net interest income and earnings.  This effect is offset by the impact that variable-rate assets have on net interest income as interest rates rise and fall.

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	Percentage Increase (Decrease) in Estimated Annual Net Interest Income Over 12 Months
300 basis point gradual rise in rates		(7.10)
200 basis point gradual rise in rates		(6.87)
100 bassis point gradual rise in rates		(6.64)
Unchanged rate scenario		(5.99)
100 bassis point gradual decline in rates		(6.56)
200 bassis point gradual decline in rates		(9.37)
300 bassis point gradual decline in rates		(10.55)

WaterStone Bank’s Asset/Liability policy limits projected changes in net average annual interest income to a maximum decline of 20% for various levels of interest rate changes measured over a 12-month period when compared to the flat rate scenario.  In addition, projected changes in the economic value of equity are limited to a maximum decline of 10% to 80% for interest rate movements of 100 to 300 basis points when compared to the flat rate scenario.  These limits are re-evaluated on a periodic basis and may be modified, as appropriate.  Because our balance sheet is asset sensitive, net interest income is projected to decline as interest rates fall.  At March 31, 2012, a 100 basis point gradual increase in interest rates had the effect of decreasing forecast net interest income by 6.64% while a 100 basis point decrease in rates had the effect of decreasing net interest income by 6.56%.  At March 31, 2012, a 100 basis point gradual increase in interest rates had the effect of decreasing the economic value of equity by 4.83% while a 100 basis point decrease in rates had the effect of decreasing the economic value of equity by 1.80%.  While we believe the assumptions used are reasonable, there can be no assurance that assumed prepayment rates will approximate actual future mortgage-backed security and loan repayment activity.

Item 4. Controls and Procedures

Disclosure Controls and Procedures : Company management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.

Internal Control Over Financial Reporting : There have been no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are not involved in any pending legal proceedings as a defendant other than routine legal proceedings occurring in the ordinary course of business.  At March 31, 2012, we believe that any liability arising from the resolution of any pending legal proceedings will not be material to our financial condition or results of operations.

Item 1A. Risk Factors

In addition to the “Risk Factors” in Item 1A of the Company’s annual report on Form 10-K for the year ended December 31, 2011, we set forth the following additional risk factors.

A Significant Portion of our Liabilities are Time Deposits

If interest rates rise, our cost of funds could significantly increase, adversely affecting our ability to generate a profit.  At March 31, 2012, time deposits totaled $865.7 million, comprising 82.9% of our total deposits.  If market rates begin to rise our costs of funds may significantly increase or we may experience significant deposit outflows.  Either of which will adversely affect our ability to operate profitably.

Item 6. Exhibits

    (a) Exhibits: See Exhibit Index, which follows the signature page hereof.

Signatures

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

	WATERSTONE FINANCIAL, INC. (Registrant)
Date:  May 4, 2012
	/s/ Douglas S. Gordon
	Douglas S. Gordon
	Chief Executive Officer
Date:  May 4, 2012
	/s/ Richard C. Larson
	Richard C. Larson
	Chief Financial Officer

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EXHIBIT INDEX

WATERSTONE FINANCIAL, INC.

Form 10-Q for Quarter Ended March 31, 2012

Exhibit No.	Description	Filed Herewith
31.1	Sarbanes-Oxley Act Section 302 Certification signed by the Chief Executive Officer of Waterstone Financial, Inc.	X
31.2	Sarbanes-Oxley Act Section 302 Certification signed by the Chief Financial Officer of Waterstone Financial, Inc.	X
32.1	Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Executive Officer of Waterstone Financial, Inc.	X
32.2	Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Financial Officer of Waterstone Financial, Inc.	X