Mutual Federal Bancorp 10Q 2008 Q2 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(mark one)

ý QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2008

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

For the transition period from _______to_______

Commission File Number 000-51876

MUTUAL FEDERAL BANCORP, INC.

(Exact name of registrant specified in its charter)

Federal (State or other jurisdiction of incorporation or organization)	33-1135091 (I.R.S. Employer Identification Number)
2212 West Cermak Road Chicago, Illinois 60608 (Address of principal executive offices)

(773) 847-7747

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year,

if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 ý No ¨

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:

Class	Outstanding as of August 1, 2008
Common Stock, $0.01 par value	3,470,317

MUTUAL FEDERAL BANCORP, INC.

FORM 10-Q

For the quarterly period ended June 30, 2008

TABLE OF CONTENTS

	Page

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements
Consolidated Statements of Financial Condition as of June 30, 2008 (unaudited) and December 31, 2007	1
Consolidated Statements of Income (unaudited) for the three months and the six months ended June 30, 2008 and 2007	2
Consolidated Statements of Stockholders’ Equity (unaudited) for the six months ended June 30, 2008 and 2007	3
Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2008 and 2007	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3. Quantitative and Qualitative Disclosures About Market Risk	26
Item 4. Controls and Procedures	26

PART II – OTHER INFORMATION
Item 1. Legal Proceedings	28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3. Defaults Upon Senior Securities	28
Item 4. Submission of Matters to a Vote of Security Holders	28
Item 5. Other Information	29
Item 6. Exhibits	29

SIGNATURES	30

EXHIBIT INDEX

Table of Contents

PART I. – FINANCIAL INFORMATION

Item 1. Financial Statements

MUTUAL FEDERAL BANCORP, INC.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (unaudited)

(Dollar amounts in thousands except share data)

	June 30, 2008			December 31, 2007
ASSETS
Cash and cash equivalents	$	5,315		$	2,264
Trading securities		2,322			—
Securities available-for-sale		11,775			16,345
Loans, net of allowance for loan losses of $558 at June 30, 2008; $290 at December 31, 2007		53,418			53,047
Federal Home Loan Bank stock, at cost		610			610
Premises and equipment, net		232			250
Accrued interest receivable		333			360
Other assets		445			135
Total assets	$	74,450		$	73,011
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Non-interest-bearing deposits	$	241		$	331
Interest-bearing deposits		39,649			39,388
Total deposits		39,890			39,719
Advance payments by borrowers for taxes and insurance		357			236
Advances from the Federal Home Loan Bank		7,000			5,000
Accrued interest payable and other liabilities		996			1,037
Common stock in ESOP subject to contingent repurchase obligation		144			108
Total liabilities		48,387			46,100
Commitments and contingencies
Stockholders’ equity
Preferred stock, $0.01 par value, 1,000,000 shares authorized at June 30, 2008 and December 31, 2007		—			—
Common stock, $0.01 par value, 12,000,000 shares authorized, 3,636,875 shares issued at June 30, 2008 and December 31, 2007		36			36
Additional paid-in capital		9,848			9,738
Treasury stock, at cost, 166,558 shares at June 30, 2008 and 108,696 at December 31, 2007		(1,925	)		(1,286	)
Retained earnings		18,937			19,077
Reclassification of ESOP shares		(144	)		(108	)
Unearned ESOP shares		(739	)		(768	)
Accumulated other comprehensive income		50			222
Total stockholders’ equity		26,063			26,911
Total liabilities and stockholders’ equity	$	74,450		$	73,011

See accompanying notes to unaudited consolidated financial statements.

Table of Contents

MUTUAL FEDERAL BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

(Dollar amounts in thousands except share data)

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2008			2007		2008			2007
Interest and dividend income
Loans, including fees	$	810		$	859	$	1,633		$	1,712
Securities		173			214		362			435
Interest earning deposits		16			8		31			17
Federal Home Loan Bank stock dividends		—			3		—			7
Total interest and dividend income		999			1,084		2,026			2,171
Interest expense
Deposits		250			293		522			585
Advances from Federal Home Loan Bank		55			31		117			60
Total interest expense		305			324		639			645
Net interest income		694			760		1,387			1,526
Provision for loan losses		228			—		268			10
Net interest income after provision for loan losses		466			760		1,119			1,516

Non-interest income
Gain on sale of securities		152			—		152			—
Impairment charge on securities available-for-sale		(31	)		—		(31	)		—
Changes in fair value of trading securities		(139	)		—		(147	)		—
Other income		11			13		22			22
Total non-interest income		(7	)		13		(4	)		22
Non-interest expense
Compensation and benefits		374			325		747			670
Occupancy and equipment		46			39		86			82
Data processing		25			27		51			55
Professional fees		94			131		211			261
Other expense		74			76		146			145
Total non-interest expense		613			598		1,241			1,213
Income (loss) before income taxes		(154	)		175		(126	)		325
Income tax (benefit) expense		(51	)		65		(38	)		130
Net income (loss)	$	(103	)	$	110	$	(88	)	$	195

Earnings (loss) per share (basic and diluted)	$	(0.03	)	$	0.03	$	(0.03	)	$	0.05

Total comprehensive income (loss)	$	(310	)	$	35	$	(260	)	$	129

See accompanying notes to unaudited consolidated financial statements.

Table of Contents

MUTUAL FEDERAL BANCORP, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited)

(Dollar amounts in thousands)

	Common Stock		Additional Paid-in Capital			Treasury Stock			Retained Earnings		Amount Reclassified on ESOP Shares			Unearned ESOP Shares			Accumulated Other Comprehensive Income/(Loss)			Total

Balance at January 1, 2007	$	36	$	10,175		$	—		$	18,782	$	(66	)	$	(827	)	$	133		$	28,233
Comprehensive income:
Net income		—		—			—			195		—			—			—			195
Change in net unrealized gain (loss) on securities available-for-sale, net of taxes and reclassification adjustments		—		—			—			—		—			—			(66	)		(66	)
Total comprehensive income (loss)																					129
Treasury stock purchases, 83,300 shares at cost		—		—			(1,103	)		—		—			—			—			(1,103	)
MRP share grants, 52,748 shares at cost		—		(699	)		699			—		—			—			—			—
MRP shares earned		—		70			—			—		—			—			—			70
Stock option shares earned		—		48			—			—		—			—			—			48
Adjustment to fair value of common stock in ESOP subject to contingent repurchase obligation of ESOP shares		—		—			—			—		(33	)		—			—			(33	)
ESOP shares committed to be released		—		11			—			—		—			29			—			40
Balance at June 30, 2007	$	36	$	9,605		$	(404	)	$	18,977	$	(99	)	$	(798	)	$	67		$	27,384

See accompanying notes to unaudited consolidated financial statements.

Table of Contents

	Common Stock		Additional Paid-in Capital			Treasury Stock			Retained Earnings			Amount Reclassified on ESOP Shares			Unearned ESOP Shares			Accumulated Other Comprehensive Income/(Loss)			Total

Balance at January 1, 2008	$	36	$	9,738		$	(1,286	)	$	19,077		$	(108	)	$	(768	)	$	222		$	26,911
Comprehensive income:
Net loss		—		—			—			(88	)		—			—			—			(88	)
Change in net unrealized gain (loss) on securities available-for-sale, net of taxes and reclassification adjustments		—		—			—			—			—			—			(172	)		(172	)
Total comprehensive income (loss)																						(260	)
Dividends paid		—		—			—			(59	)		—			—			—			(59	)
Treasury stock purchases, 60,000 shares at cost		—		—			(664	)		—			—			—			—			(664	)
MRP share grants, 2,138 shares at cost		—		(25	)		25			—			—			—			—			—
MRP shares earned		—		78			—			3			—			—			—			81
Stock option shares earned		—		53			—			—			—			—			—			53
Adjustment to fair value of common stock in ESOP subject to contingent repurchase obligation of ESOP shares		—		—			—			—			(36	)		—			—			(36	)
ESOP shares committed to be released		—		4			—			4			—			29			—			37
Balance at June 30, 2008	$	36	$	9,848		$	(1,925	)	$	18,937		$	(144	)	$	(739	)	$	50		$	26,063

See accompanying notes to unaudited consolidated financial statements.

Table of Contents

MUTUAL FEDERAL BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(Dollar amounts in thousands)

	Six Months Ended June 30,
	2008			2007
Cash flows from operating activities
Net income (loss)	$	(88	)	$	195
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses		268			10
Depreciation		26			30
Net amortization of securities		8			15
Dividends reinvested on securities		(45	)		(59	)
Gain on sale of securities		(152	)		—
Impairment charge on securities available-for-sale		31			—
Changes in fair value of trading securities		147			—
ESOP expense		37			40
MRP expense		81			70
Option expense		53			48
Increase in accrued interest receivable and other assets		(283	)		(125	)
Increase in accrued interest payable and other liabilities		24			435
Net cash provided by operating activities		107			659

Cash flows from investing activities
Activity in securities available-for-sale:
Proceeds from maturities, calls, and principal repayments		2,503			2,114
Proceeds from sales		160			—
Purchases		(641	)		—
Purchase of FHLB stock		—			(110	)
Loan originations and payments, net		(639	)		(1,252	)
Additions to premises and equipment		(8	)		(9	)
Net cash provided by investing activities		1,375			743

Cash flows from financing activities
Net increase (decrease) in deposits		171			(1,174	)
Net increase in advance payments by borrowers for taxes and insurance		121			54
Advances from the Federal Home Loan Bank		4,000			1,000
Repayment of advances from the Federal Home Loan Bank		(2,000	)		(500	)
Dividends paid		(59	)		—

Purchases of treasury stock		(664	)		(1,103	)

Net cash provided by (used in) financing activities		1,569			(1,723	)

Net increase (decrease) in cash and cash equivalents		3,051			(321	)

Cash and cash equivalents at beginning of period		2,264			2,268

See accompanying notes to unaudited consolidated financial statements.

Table of Contents

	Six Months Ended June 30,
	2008		2007

Cash and cash equivalents at end of period	$	5,315	$	1,947

Supplemental disclosure of cash flow information
Adoption of fair value option
Securities transferred from available-for-sale to trading	$	2,423		—
Loans transferred to real estate owned		—	$	222
Cash paid during the year for:
Interest	$	659	$	619
Income taxes		191		25

See accompanying notes to unaudited consolidated financial statements.

Table of Contents

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with instructions to Form 10-Q (as applicable to smaller reporting companies) and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments consisting of normal recurring accruals necessary for a fair presentation have been included. The results of operations and other data for the three months and the six months ended June 30, 2008, are not necessarily indicative of results that may be expected for the entire fiscal year ended December 31, 2008.

The consolidated financial statements include Mutual Federal Bancorp, Inc. (the “Company”), and its wholly owned subsidiary Mutual Federal Savings and Loan Association of Chicago and its wholly owned subsidiary, EMEFES Service Corporation, together referred to as “the Bank.” Intercompany transactions and balances are eliminated in consolidation. As of June 30, 2008, Mutual Federal Bancorp, MHC (the “MHC”) was the majority (73%) stockholder of the Company. The MHC is owned by the depositors of the Bank. The financial statements included in this Form 10-Q do not include the transactions and balances of the MHC. EMEFES Service Corporation is an insurance agency that sells insurance products to the Bank’s customers. The insurance products are underwritten and provided by a third party.

The Bank provides financial services through its office in Chicago. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage loans and loans on deposit accounts. Substantially all loans are secured by specific items of collateral, including one- to four-family and multifamily residential real estate, and deposit accounts. There are no significant concentrations of loans to any one customer. However, the customers’ ability to repay their loans is dependent on the real estate and general economic conditions in the Chicagoland area.

Note 2 – Capital Resources

The Bank is subject to regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a material impact on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated for regulatory accounting purposes. 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 of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets and of tangible capital to average assets. As of June 30, 2008, the Bank met the capital adequacy requirements to which it is subject. The Bank’s tangible capital ratio at June 30, 2008 was 30.98%. The Tier 1 capital ratio was 30.98%, the Tier 1 risk-based capital ratio was 55.16%, and the total risk-based capital ratio was 55.96%.

The most recent notification from the federal banking agencies categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios. There are no conditions or events since that notification that have changed the Bank’s category.

Table of Contents

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 3 – Commitments

At June 30, 2008, the Bank had outstanding commitments to make loans of $2.1 million. At December 31, 2007, the Bank had outstanding commitments to make loans of $205,000.

Note 4 – Fair Value Option and Fair Value Measurements

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

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The new standard is effective for the Company on January 1, 2008. The Company has elected the fair value option for various mutual funds included in trading securities as of January 1, 2008. The impact of adoption is not material, as the Company recognized an impairment charge at December 31, 2007, resulting in the mutual funds being carried at fair value.

Note 5 – Fair Value

Fair Value Option

The Company has elected the fair value option for various mutual funds in order to make them more readily available for liquidity management. The mutual funds are the only assets being designated as trading assets. The Company’s investments in Federal Home Loan Mortgage Corporation preferred stock, and all debt securities, will continue to be held as available for sale, carried at fair value with unrealized gains and losses recorded through accumulated other comprehensive income.

Fair Value Measurement.

Statement 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Statement 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

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

Table of Contents

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 5 – Fair Value (continued)

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

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

The Company determines the fair values of trading securities and securities available for sale by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The Company determines the fair values of impaired loans by obtaining current appraisals of the collateral real estate properties (Level 2 or 3 inputs).

			Fair Value Measurements at June 30, 2008 Using
	June 30, 2008		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
			Level 1		Level 2		Level 3
Trading securities	$	2,322	$	2,322	$	—	$	—
Securities available-for-sale		11,775		370		11,405		—
	$	14,097	$	2,692	$	11,405	$	—

Dividend income earned on trading securities was reinvested and used to purchase additional shares through May 31, 2008. The Company discontinued reinvesting dividends in these securities as of June 1, 2008. Changes in share price are recorded through the income statement as changes in fair value of trading securities. During the six months ended June 30, 2008, the Company recognized an unrealized loss of $147,000 on changes in fair value of trading securities. The Company also recognized a $31,000 loss for other than temporary impairment of FHLMC preferred stock held as available-for-sale, because the fair value of the preferred stock has continued to decline subsequent to June 30, 2008, and we are unable to forecast a recovery.

			Fair Value Measurements at June 30, 2008 Using
	June 30, 2008		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
			Level 1		Level 2		Level 3
Impaired loans	$	938	$	—	$	938	$	—

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $1.2 million, with a valuation allowance of $221,000, resulting in an additional provision for loan losses of $221,000 for the six months ended June 30, 2008.

Table of Contents

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 6 – Stock Based Compensation

On January 16, 2007, the Company awarded 52,748 shares of common stock, with a fair value of $14.41 per share, to the Company’s officers and directors under its 2006 Management Recognition and Retention Plan. The Company also awarded 131,871 options to purchase the Company’s common stock at a strike price of $14.41 per share, to the Company’s officers and directors under its 2006 Stock Option Plan.

On March 18, 2008, the Company awarded 2,138 shares of common stock, with a fair value of $11.35 per share, to a director of the Company under its 2006 Management Recognition and Retention Plan. The Company also awarded to this director options to purchase 5,346 shares of the Company’s common stock at a strike price of $11.35 per share under its 2006 Stock Option Plan.

The awards vest over a five year period. Total compensation cost that has been charged against income for those plans for the six months ended June 30, 2008 and 2007, was $134,000 and $118,000, respectively. The total income tax benefits were estimated at $37,000 and $32,000, respectively.

Stock Option Plan

The Company’s 2006 Stock Option Plan, which is shareholder-approved, permits the grant of stock options to its officers, directors and employees for up to an aggregate 178,206 shares of common stock. The Company believes that such awards better align the interests of its employees with those of its shareholders. Option awards are granted with an exercise price that is no less than the market price of the Company’s common stock at the date of grant, have vesting periods of five years, and have 10-year contractual terms. The Company anticipates purchasing shares to satisfy share option exercises.

The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Since the Company stock has only been trading since April 6, 2006, the Company has used the price volatility of similar entities to estimate volatility. The Company has no historical data on which to base forfeiture estimates, and has assumed no forfeitures. The expected term of options granted is based on the calculation for “plain vanilla options” permitted by Staff Accounting Bulletin No. 107, and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

The fair value of options granted during 2008 and 2007 were determined using the following weighted-average assumptions as of grant date:

	2008			2007

Risk-free interest rate		3.47	%		4.50	%
Expected term	6.50 years			6.50 years
Expected stock price volatility		13.51	%		9.40	%
Dividend yield		0.00	%		0.00	%

Table of Contents

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 6 – Stock Based Compensation (continued)

A summary of the activity in the stock option plan for 2008 and 2007 follows:

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value

Outstanding at January 1, 2008		131,871	$	14.41		9.0	$	—
Granted		5,346		11.35		10.0		—
Exercised		—		—		—		—
Forfeited or expired		—		—		—		—
Outstanding at June 30, 2008		137,217	$	14.29		8.5	$	—

Exercisable at June 30, 2008		26,374	$	14.41			$	—

Outstanding at January 1, 2007		—	$	—		—	$	—
Granted		131,871		14.41		10.0		—
Exercised		—		—		—		—
Forfeited or expired		—		—		—		—
Outstanding at June 30, 2007		131,871	$	14.41		9.5	$	—

Information related to the stock option plan during 2008 and 2007 follows:

	2008		2007

Intrinsic value of options exercised	$	—	$	—
Cash received from option exercises		—		—
Tax benefit realized from option exercises		—		—
Weighted average fair value of options granted	$	2.83	$	3.96

As of June 30, 2008, there was $384,000 of total unrecognized compensation cost related to non-vested stock options granted under the Plan. The cost is expected to be recognized over a weighted-average remaining period of 3.5 years.

Stock Award Plan

The Company’s 2006 Management Recognition and Retention Plan (“MRP”), which is shareholder approved, permits awards of up to an aggregate 71,282 shares of the Company’s common stock to officers, directors and employees. Compensation expense is recognized over the vesting period of the shares based on the market value of the shares at issue date.

A summary of changes in the Company’s non-vested shares for the six months ended June 30, 2008 and 2007, follows:

Table of Contents

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 6 – Stock Based Compensation (continued)

	Shares			Weighted Average Grant Price		Weighted Average Grant-Date Fair Value

Non-vested at January 1, 2008		52,748		$	14.41	$	760,000
Granted		2,138			11.35		24,000
Vested		(10,553	)		14.41		(152,000	)
Forfeited		—			—		—
Non-vested at June 30, 2008		44,333		$	14.26	$	632,000

Non-vested at January 1, 2007		—		$	—	$	—
Granted		52,748			14.41		760,000
Vested		—			—		—
Forfeited		—			—		—
Non-vested at June 30, 2007		52,748		$	14.41	$	760,000

As of June 30, 2008, there was $561,000 of total unrecognized compensation cost related to non-vested shares granted under the Plan. The cost is expected to be recognized over a weighted-average remaining period of 3.5 years.

Note 7 – Earnings Per Share

Basic earnings per share are computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Both basic and fully diluted weighted average shares outstanding for the three months and the six months ended June 30, 2008, are 3,436,879 and 3,444,643, respectively. Both basic and fully diluted weighted average shares outstanding for the three months and the six months ended June 30, 2007, are 3,551,109 and 3,552,978, respectively. During the six months ended June 30, 2008 and 2007, the average fair value of the Company’s common stock was less than the exercise price, and the stock option awards had no dilutive effect on earnings per share.

The factors used in the earnings per share computation for the three months and the six months ended June 30, 2008 and 2007, follow:

Table of Contents

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 7 – Earnings Per Share (continued)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
Basic
Net income (loss)	$	(103	)	$	110		$	(88	)	$	195

Weighted average common shares outstanding		3,511,539			3,631,634			3,520,023			3,634,244
Less: average unallocated ESOP shares		(74,660	)		(80,525	)		(75,380	)		(81,266	)

Average shares		3,436,879			3,551,109			3,444,643			3,552,978

Basic earnings (loss) per common share	$	(0.03	)	$	0.03		$	(0.03	)	$	0.05

Diluted
Net income (loss)	$	(103	)	$	110		$	(88	)	$	195

Weighted average common shares outstanding for basic earnings per common share		3,436,879			3,551,109			3,444,643			3,552,978
Add: dilutive effects of assumed exercises of stock options		—			—			—			—

Average shares and dilutive potential common shares		3,436,879			3,551,109			3,444,643			3,552,978

Diluted earnings (loss) per common share	$	(0.03	)	$	0.03		$	(0.03	)	$	0.05

Table of Contents

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

General

This discussion and analysis reflects our consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial condition and results of operations. You should read the information in this section in conjunction with our audited consolidated financial statements for the years ended December 31, 2007 and 2006, which are included in Form 10-KSB filed with the Securities and Exchange Commission on March 21, 2008.

Forward-Looking Information

This report contains forward-looking statements, which can be identified by the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions. These forward-looking statements include statements of our goals, intentions and expectations; statements regarding our business plans and prospects and growth and operating strategies; statements regarding the asset quality of our loan and investment portfolios; and estimates of our risks and future costs and benefits. These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following important factors that could affect the actual outcome of future events:

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

·	adverse changes in the securities markets;

·	deterioration in asset quality due to adverse changes in the residential real estate market;

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

·	significantly increased competition among depository and other financial institutions;

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

·	our ability to successfully implement our business plan;

·	legislative or regulatory changes that adversely affect our business;

·	changes in consumer spending, borrowing and savings habits;

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

·	changes in our organization, compensation and benefit plans.

These risks and uncertainties should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

Table of Contents

Overview

Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, U.S. government and agency securities, mortgage-backed securities and other interest earning assets (primarily cash and cash equivalents), and the interest we pay on our interest-bearing liabilities, consisting of savings accounts, time deposits, and advances from the Federal Home Loan Bank. Our results of operations are also affected by our provisions for loan losses, non-interest income and non-interest expense. Non-interest income consists primarily of miscellaneous fees and charges on loan and deposit accounts, and changes in the fair value of trading securities. Non-interest expense currently consists primarily of salaries and employee benefits, occupancy, data processing, professional fees, and other operating expenses. Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.

Critical Accounting Policies

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider our critical accounting policies to be those related to our allowance for loan losses.

The allowance for loan losses is the estimated amount considered necessary to cover probable incurred losses in the loan portfolio at the balance sheet date. The allowance is established through a provision for loan losses that is charged against income. In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of our most critical.

Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be subject to significant change.

The analysis has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We also analyze historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allowance for loan losses. Actual loan losses may be significantly more than the allowances we have established which could have a material negative effect on our financial results.

Comparison of Financial Condition at June 30, 2008 and December 31, 2007

Our total assets increased $1.4 million, or 2.0%, to $74.5 million at June 30, 2008, compared to $73.0 million at December 31, 2007. Loans receivable increased $371,000, or 0.7%, to $53.4 million at June 30, 2008, from $53.0 million at December 31, 2007, reflecting an increase of $167,000, or 0.5%, in one-to-four family residential mortgage loans and an increase of $453,000, or 2.4%, in multi-family residential mortgage loans during the period, offset by an increase of $268,000 in the allowance for loan losses.

Table of Contents

Total deposits increased $171,000, or 0.4%, to $39.9 million at June 30, 2008, from $39.7 million at December 31, 2007. Mortgage escrow accounts increased by $121,000, or 51.3% during this period. The Company borrowed an additional $2.0 million from the Federal Home Loan Bank in order to lock in lower rates and to fund loans.

Stockholders’ equity decreased $848,000, to $26.1 million at June 30, 2008, from $26.9 million at December 31, 2007. The decrease reflects a net loss of $88,000 for the six months ended June 30, 2008, a $172,000 decrease in accumulated other comprehensive income from net unrealized gains on securities available-for-sale ($152,000 in gains from the sale of FHLMC common stock was realized through earnings during the period), and $664,000 in repurchases of the Company’s common stock. The Company paid its first dividend of $59,000 ($0.06 per share of common stock) to minority shareholders. Mutual Federal Bancorp, MHC, the majority shareholder, waived its dividend. Stockholders’ equity also reflects a $171,000 increase from recognition of stock benefits earned under the Company’s Employee Stock Ownership Plan, Management Recognition and Retention Plan, and Stock Option Plan, offset by a $36,000 reclassification due to the commitment for release and change in fair value of common stock in the ESOP subject to the contingent repurchase obligation of ESOP shares.

Comparison of Operating Results for the Three Months Ended June 30, 2008 and 2007

General. The Company had a net loss of $103,000 for the three months ended June 30, 2008, compared to net income of $110,000 for the three months ended June 30, 2007. The primary reasons for the decrease were a $66,000, or 8.7% decrease in net interest income, to $694,000 for the three months ended June 30, 2008, from $760,000 for the three months ended June 30, 2007, and the increased provision for loan losses of $228,000 for the three months ended June 30, 2008, from none in the second quarter of 2007.

Compensation and benefits increased $49,000, or 15.1%, to $374,000 for the three months ended June 30, 2008, from $325,000 for the three months ended June 30, 2007, primarily due to new employees, normal salary increases, a $25,000 increase in health insurance costs, and a $6,000 increase in the amortization of stock awards and stock option expense. The increase in compensation and benefits was partially offset by a $37,000, or 28.2% decrease in professional fees, to $94,000 for the current period, from $131,000 for the same period last year. The decrease in professional fees was due primarily to compliance, market research and executive search fees in 2007 which were not repeated in 2008.

The annualized return on average assets was (0.56)% for the three months ended June 30, 2008, compared to 0.59% for the same period last year, and the annualized return on equity was (1.54)% and 1.56%, respectively, for these two periods.

Interest Income. Interest and dividend income decreased $85,000, or 7.8%, to $999,000 for the three months ended June 30, 2008, compared to $1.1 million for the three months ended June 30, 2007. The decrease resulted from the $1.4 million, or 1.9%, decrease in the average balance of interest-earning assets, to $71.1 million in the second quarter of 2008, compared to $72.5 million in the second quarter of 2007, and to a decrease of 36 basis points in the average yield on interest earning assets, to 5.62% in 2008, from 5.98% in 2007. In addition, it is the Company’s policy to reserve all accrued interest on loans 90 days or more delinquent, which resulted in a $61,000 reduction in interest income on loans during the second quarter of 2008, compared to an $8,000 increase during the second quarter of 2007.

Interest income and fees from loans receivable decreased $49,000, or 5.7%, to $810,000 for the three months ended June 30, 2008, from $859,000 for the three months ended June 30, 2007. The primary reason was the increase in the reserve for uncollected interest. In addition, the decrease resulted from a $1.0 million, or 1.9%, decrease in the average balance of loans receivable, to $52.6 million in the second quarter of 2008, compared to $53.6 million in the second quarter of 2007, and from a decrease of

Table of Contents

25 basis points in the average yield on loans receivable, to 6.16% in 2008, from 6.41% in 2007. Without the need for the interest reserve adjustment, the yield on loans receivable would have been 6.62%

Interest and dividend income from securities, FHLB stock, and interest-earning deposits decreased $36,000, or 16.0%, to $189,000 for the three months ended June 30, 2008, from $225,000 for the three months ended June 30, 2007. The primary reasons for the decrease were a $399,000, or 2.1%, decrease in the average balances of securities, FHLB stock, and interest-earning deposits, to $18.5 million in 2008, from $18.9 million in 2007, as well as a 68 basis point decrease in average yield to 4.09% in 2008, from 4.77% in 2007. In addition, the FHLB of Chicago has suspended its dividend, which amounted to $3,000 of income during the second quarter of 2007, and the Federal Home Loan Mortgage Corporation reduced the dividend on its common stock by one half, resulting in a reduction of $2,000 in dividend income from this source during the second quarter of 2008.

Interest Expense. Interest expense on deposits decreased $43,000, or 14.7%, to $250,000 for the three months ended June 30, 2008, from $293,000 for the three months ended June 30, 2007. The decrease in interest expense was due primarily to a $2.4 million decrease in the average balance of interest bearing deposits. The average rate paid on deposits decreased 26 basis points, to 2.52% for the quarter ended June 30, 2008, from 2.78% for the quarter ended June 30, 2007. Interest expense on certificates of deposit decreased $39,000, or 16.9%, to $192,000 in 2008, from $231,000 in 2007, because of a $1.3 million decrease in the average balance of certificates of deposit, and by a decrease in the average rate paid on certificates of deposit of 48 basis points, to 3.74% in 2008, from 4.22% in 2007.

Interest expense on FHLB advances increased $24,000, to $55,000 for the three months ended June 30, 2008, compared to $31,000 for the three months ended June 30, 2007. The average balance of FHLB advances increased $3.3 million, to $5.6 million for the second quarter of 2008, from $2.3 million for the second quarter of 2007. The average rate paid on advances decreased 146 basis points, to 3.94% in 2008, from 5.40% in 2007. The overall average cost of funds decreased 23 basis points, to 2.69% in 2008, from 2.92% in 2007.

Net Interest Income. Net interest income decreased $66,000, or 8.7%, to $694,000 for the three months ended June 30, 2008, from $760,000 for the same quarter last year. Our net interest margin decreased 29 basis points, to 3.91% in 2008, from 4.20% in 2007. A 36 basis point decrease in the average yield on interest-earning assets, to 5.62% in 2008, from 5.98% in 2007, and a decrease of $1.4 million in the average balance of interest-earning assets, both contributed to interest income decreasing by $85,000. The average rate paid on interest-bearing liabilities decreased, to 2.69% in 2008, from 2.92% in 2007, and the average balance of interest-bearing liabilities increased $856,000, with interest expense decreasing by $19,000. The interest rate spread between interest earning assets and interest bearing liabilities decreased 13 basis points, to 2.93% in 2008, from 3.06% in 2007.

Provision for Loan Losses. During the three months ended June 30, 2008, management made a $228,000 provision for losses on loans, based on its quarterly evaluation of the level of the allowance necessary to absorb probable incurred loan losses at June 30, 2008. Management established $166,000 in specific allowances against $1.2 million of impaired loans, and increased the general allowance for loan losses by $62,000.

Management considers changes in delinquencies, changes in the composition and volume of loans, historical loan loss experience, general economic and real estate market conditions, as well as peer group data, when determining the level on the allowance for loan losses. The increase in the general allowance resulted from increases in the factors used for delinquency trends, both in our portfolio and in the current economic environment, and declines in the value of real estate reflected in the current market.

Table of Contents

During the three months ended June 30, 2008, non-performing (non-accrual) loans increased to $3.2 million, from $1.7 million at March 31, 2008. Loans delinquent 60-89 days were $2.1 million at June 30, 2008, compared to $2.6 million at March 31, 2008. The loan portfolio increased $1.1 million, or 2.2%, to $53.4 million at June 30, 2008, from $52.3 million at March 31, 2008. During this period, one- to four-family residential mortgage loans increased $742,000, or 2.2%, and multi-family residential mortgage loans increased $639,000, or 3.4%.

At June 30, 2008, the allowance for loan losses, including specific allowances, was $558,000, or 1.03% of loans receivable, compared to $330,000, or 0.63% of loans receivable at March 31, 2008. In a similar evaluation of the allowance for loan losses at June 30, 2007, management determined that there was no need for a provision for the three months then ended.

Non-interest Income. Non-interest income decreased $20,000, to a loss of $7,000 for the three month period ended June 30, 2008, compared to $13,000 income for the three months ended June 30, 2007. The decrease was due in part to a $139,000 fair value adjustment to various mutual funds carried as trading securities and accounted for under FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which was adopted for these mutual funds on January 1, 2008.

The Company also recognized a $31,000 loss for other than temporary impairment of FHLMC preferred stock held as available-for-sale, because the fair value of the preferred stock has continued to decline subsequent to June 30, 2008, and we are unable to forecast a recovery. Partially offsetting these recognized losses, the Company sold its remaining shares of FHLMC common stock and realized a gain of $152,000.

Non-interest Expense. Non-interest expense increased $15,000, or 2.5%, to $613,000 for the three months ended June 30, 2008, from $598,000 for the same quarter last year. Compensation and employee benefits increased $49,000, or 15.1%, to $374,000 in 2008, from $325,000 in 2007, primarily due to new employees, normal salary increases, a $25,000 increase in health insurance costs, and a $6,000 increase in the amortization of stock awards and stock option expense.

Occupancy costs increased $7,000, or 18.0%, to $46,000 in 2008, from $39,000 in 2007. Data processing fees decreased $2,000, or 7.4%, to $25,000, from $27,000 in 2007. Professional fees, including legal, accounting and consulting fees, decreased $37,000, or 28.2%, to $94,000 in 2008, from $131,000 in 2007. (Legal, accounting, and consulting expenses decreased $6,000, $10,000, and $21,000, respectively.) Miscellaneous expenses decreased $2,000, or 2.6%, to $74,000 for the second quarter of 2008, from $76,000 for the second quarter of 2007.

The Company’s ratio of non-interest expense to average assets increased to 3.33% in the first quarter of 2008, from 3.21% in 2007, and its efficiency ratio was 87.0% in 2008, compared to 77.4% in 2007.

Income Tax Expense. The provision for income taxes decreased $116,000, to a benefit of $51,000 in 2008, from an expense of $65,000 in 2007, largely due to the $329,000 decrease in pre-tax income. The effective tax rate for the quarter ended June 30, 2008, decreased to 33.12%, compared to 37.1% for this quarter last year.

Average Balance Sheet

The following table sets forth average balance sheets, average annualized yields and costs, and certain other information for the three months ended June 30, 2008 and 2007. No tax-equivalent yield adjustments were made, as their effects were not material. All average balances are based on an average of daily balances. Non-accrual loans are included in the computation of average balances, but have been

Table of Contents

reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

	For the Three Months Ended June 30,
	2008							2007
	Average Outstanding Balance		Interest		Yield/Rate			Average Outstanding Balance		Interest		Yield/Rate
Interest-earning assets:
Loans	$	52,596	$	810		6.16	%	$	53,605	$	859		6.41	%
Securities available for sale		14,626		173		4.73			17,743		214		4.82
Interest-earning deposits		3,227		16		1.98			521		8		6.14
Federal Home Loan Bank Stock		610		-		0.00			598		3		2.01
Total interest-earning assets		71,059	$	999		5.62	%		72,467	$	1,084		5.98	%
Non-interest-earning assets		2,625							2,149
Total assets	$	73,684						$	74,616
Interest-Bearing Liabilities:(1)
Savings deposits	$	19,171	$	58		1.21	%	$	20,278	$	62		1.22	%
Certificates of deposit		20,558		192		3.74			21,881		231		4.22
Total interest-bearing deposits		39,729		250		2.52			42,159		293		2.78
Federal Home Loan Bank advances		5,582		55		3.94			2,296		31		5.40
Total interest-bearing liabilities		45,311		305		2.69	%		44,455		324		2.92	%
Non-interest-bearing liabilities		1,692							1,945
Total liabilities		47,003							46,400
Stockholders’ equity		26,681							28,216
Total liabilities and stockholders’ equity	$	73,684						$	74,616
Net interest income			$	694						$	760
Net interest rate spread(2)						2.93	%						3.06	%
Net interest-earning assets(3)	$	25,748						$	28,012
Net interest margin(4)						3.91	%						4.20	%
Ratio of interest-earning assets to interest-bearing liabilities						156.83	%						163.01	%

__________

(1)	Non-interest-bearing checking deposits are included in non-interest-bearing liabilities.

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

(3)	Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

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

Comparison of Operating Results for the Six Months Ended June 30, 2008 and 2007

General. The Company had a net loss of $88,000 for the six months ended June 30, 2008, compared to net income of $195,000 for the six months ended June 30, 2007. The primary reasons for the decrease were a $139,000, or 9.1% decrease in net interest income, to $1.4 million for the six months

Table of Contents

ended June 30, 2008, from $1.5 million for the six months ended June 30, 2007, and the increased provision for loan losses, to $268,000 for the six months ended June 30, 2008, from $10,000 in 2007.

Compensation and benefits increased $77,000, or 11.5%, to $747,000 for the six months ended June 30, 2008, from $670,000 for the six months ended June 30, 2007, primarily due to new employees, normal salary increases, a $38,000 increase in health insurance premiums, and a $16,000 increase in the amortization of stock awards and stock option expense. The increase in compensation and benefits was partially offset by a $50,000, or 19.2% decrease in professional fees, to $211,000 for the current period, from $261,000 for the same period last year. The decrease in professional fees was due primarily to compliance, market research and executive search fees in 2007 which were not repeated in 2008.

The annualized return on average assets was (0.24)% for the six months ended June 30, 2008, compared to 0.52% for the same period last year, and the annualized return on equity was (0.65)% and 1.38%, respectively, for these two periods.

Interest Income. Interest and dividend income decreased $145,000, or 6.7%, to $2.0 million for the six months ended June 30, 2008, compared to $2.2 million for the six months ended June 30, 2007. The decrease resulted from a $1.8 million, or 2.4%, decrease in the average balance of interest-earning assets, to $71.0 million in the first half of 2008, compared to $72.7 million in the first half of 2007, and to a decrease of 26 basis points in the average yield on interest earning assets, to 5.71% in 2008, from 5.97% in 2007. In addition, it is the Company’s policy to reserve all accrued interest on loans 90 days or more delinquent, which resulted in a $97,000 reduction in interest income on loans during the first half of 2008, compared to a $10,000 increase during the first half of 2007.

Interest income and fees from loans receivable decreased $79,000, or 4.6%, to $1.6 million for the six months ended June 30, 2008, from $1.7 million for the six months ended June 30, 2007. The primary reason was the increase in the reserve for uncollected interest. In addition, the decrease resulted from a $586,000, or 1.1%, decrease in the average balance of loans receivable, to $52.6 million in the first half of 2008, compared to $53.1 million in the first half of 2007, and from a decrease of 23 basis points in the average yield on loans receivable, to 6.21% in 2008, from 6.44% in 2007. Without the need for the reserve adjustment, the yield on loans receivable would have been 6.58%.

Interest and dividend income from securities, FHLB stock, and interest-earning deposits decreased $66,000, or 14.4%, to $393,000 for the six months ended June 30, 2008, from $459,000 for the six months ended June 30, 2007. The primary reasons for the decrease were a $1.2 million, or 5.9%, decrease in average balances of securities, FHLB stock, and interest-earning deposits, to $18.4 million in 2008, from $19.6 million in 2007, as well as a 42 basis point decrease in average yield to 4.26% in 2008, from 4.68% in 2007. In addition, the FHLB of Chicago has suspended its dividend, which amounted to $7,000 of income during the first half of 2007, and the Federal Home Loan Mortgage Corporation reduced the dividend on its common stock by one half, resulting in a reduction of $4,000 in dividend income from this source during the first half of 2008.

Interest Expense. Interest expense on deposits decreased $63,000, or 10.8%, to $522,000 for the six months ended June 30, 2008, from $585,000 for the six months ended June 30, 2007. The decrease in interest expense was due primarily to a $3.0 million decrease in the average balance of interest bearing deposits. The average rate paid on deposits decreased 11 basis points, to 2.65% for the six months ended June 30, 2008, from 2.76% for the six months ended June 30, 2007. Interest expense on certificates of deposit decreased $54,000, or 11.7%, to $407,000 in 2008, from $461,000 in 2007, because of a $1.6 million decrease in the average balance of certificates of deposit, and by a decrease in the average rate paid on certificates of deposit of 21 basis points, to 3.95% in 2008, from 4.16% in 2007.

Table of Contents

Interest expense on FHLB advances increased $57,000, to $117,000 for the six months ended June 30, 2008, compared to $60,000 for the six months ended June 30, 2007. The average balance of FHLB advances increased $3.4 million, to $5.6 million for the first half of 2008, from $2.2 million for the first half of 2007. The average rate paid on advances decreased 118 basis points, to 4.18% in 2008, from 5.36% in 2007. The overall average cost of funds decreased 5 basis points, to 2.84% in 2008, from 2.89% in 2007.

Net Interest Income. Net interest income decreased $139,000, or 9.1%, to $1.4 million for the six months ended June 30, 2008, from $1.5 million for the same period last year. Our net interest margin decreased 29 basis points, to 3.91% in 2008, from 4.20% in 2007. A 26 basis point decrease in the average yield on interest-earning assets, to 5.71% in 2008, from 5.97% in 2007, and a decrease of $1.2 million in the average balance of interest-earning assets, both contributed to interest income decreasing by $145,000. The average rate paid on interest-bearing liabilities decreased to 2.84% in 2008, from 2.89% in 2007, and the average balance of interest-bearing liabilities increased $349,000, with interest expense decreasing by $6,000. The interest rate spread between interest earning assets and interest bearing liabilities decreased 21 basis points, to 2.87% in 2008, from 3.08% in 2007.

Provision for Loan Losses. During the six months ended June 30, 2008, management made an additional $268,000 provision for losses on loans, based on its quarterly evaluation of the level of the allowance necessary to absorb probable incurred loan losses at June 30, 2008. Management established $221,000 in specific allowances against $1.2 million of impaired loans, and increased the general allowance for loan losses by $47,000.

During the six months ended June 30, 2008, non-performing (non-accrual) loans increased to $3.2 million, from $259,000 at December 31, 2007. Loans delinquent 60-89 days were $2.1 million at June 30, 2008, decreasing $513,000, from $2.6 million at December 31, 2007. The loan portfolio increased $371,000, or 0.7%, to $53.4 million at June 30, 2008, from $53.0 million at December 31, 2007. During this period, one- to four-family residential mortgage loans increased $167,000, or 0.5%, and multi-family residential mortgage loans increased $453,000, or 2.4%.

At June 30, 2008, the allowance for loan losses, including specific allowances, was $558,000, or 1.03% of loans receivable, compared to $290,000, or 0.54% of loans receivable at December 31, 2007. In a similar evaluation of the allowance for loan losses at June 30, 2007, management determined that there was a need for a provision of $10,000 for the six months then ended.

Non-interest Income. Non-interest income decreased $26,000, to a loss of $4,000 for the six months ended June 30, 2008, compared to $22,000 income for the six months ended June 30, 2007. The decrease was due primarily to an $147,000 fair value adjustment to various mutual funds carried as trading securities and accounted for under FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which was adopted for these mutual funds on January 1, 2008.

Table of Contents

Non-interest Expense. Non-interest expense increased $28,000, or 2.3%, to $1.2 million for the six months ended June 30, 2008, approximately the same as last year. Compensation and employee benefits increased $77,000, or 11.5%, to $747,000 in 2008, from $670,000 in 2007, primarily due to new employees, normal salary increases, a $38,000 increase in health insurance premiums, and to a $16,000 increase in the amortization of stock grant and stock option expense.

Occupancy costs increased $4,000, or 4.9%, to $86,000 in 2008, from $82,000 in 2007. Data processing fees decreased $4,000, or 7.3%, to $51,000, from $55,000 in 2007. Professional fees, including legal, accounting and consulting fees, decreased $50,000, or 19.2%, to $211,000 in 2008, from $261,000 in 2007. (Legal, accounting, and consulting expenses decreased $16,000, $19,000, and $15,000, respectively.) Miscellaneous expenses increased $1,000, or 0.7%, to $146,000 for the first half of 2008, from $145,000 for the first half of 2007.

The Company’s ratio of non-interest expense to average assets increased to 3.37% in the first quarter of 2008, from 3.24% in 2007, and its efficiency ratio was 88.1% in 2008, compared to 78.4% in 2007.

Income Tax Expense. The provision for income taxes decreased $168,000, to a tax benefit of $38,000 in 2008, from a tax expense of $130,000 in 2007, largely due to the $451,000 decrease in pre-tax income to a loss of $126,000 in 2008, from income of $325,000 in 2007. The effective tax rate for the six months ended June 30, 2008, decreased to 30.2%, compared to 40.0% for this period last year.

Average Balance Sheet

The following table sets forth average balance sheets, average annualized yields and costs, and certain other information for the six months ended June 30, 2008 and 2007. No tax-equivalent yield adjustments were made, as their effects were not material. All average balances are based on an average of daily balances. Non-accrual loans are included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

Table of Contents

	For the Six Months Ended June 30,
	2008							2007
	Average Outstanding Balance		Interest		Yield/Rate			Average Outstanding Balance		Interest		Yield/Rate
Interest-earning assets:
Loans	$	52,558	$	1,633		6.21	%	$	53,144	$	1,712		6.44	%
Securities available for sale		15,213		362		4.76			18,417		435		4.72
Interest-earning deposits		2,616		31		2.37			637		17		5.34
Federal Home Loan Bank Stock		610		-		0.00			549		7		2.55
Total interest-earning assets		70,997	$	2,026		5.71	%		72,747	$	2,171		5.97	%
Non-interest-earning assets		2,731							2,192
Total assets	$	73,728						$	74,939
Interest-Bearing Liabilities:(1)
Savings deposits	$	18,846	$	115		1.22	%	$	20,291	$	124		1.22	%
Certificates of deposit		20,583		407		3.95			22,148		461		4.16
Total interest-bearing deposits		39,429		522		2.65			42,439		585		2.76
Federal Home Loan Bank advances		5,599		117		4.18			2,240		60		5.36
Total interest-bearing liabilities		45,028		639		2.84	%		44,679		645		2.89	%
Non-interest-bearing liabilities		1,797							2,004
Total liabilities		46,825							46,683
Stockholders’ equity		26,903							28,256
Total liabilities and stockholders’ equity	$	73,728						$	74,939
Net interest income			$	1,387						$	1,526
Net interest rate spread(2)						2.87	%						3.08	%
Net interest-earning assets(3)	$	25,969						$	28,068
Net interest margin(4)						3.91	%						4.20	%
Ratio of interest-earning assets to interest-bearing liabilities						157.67	%						162.82	%

__________

(1)	Non-interest-bearing checking deposits are included in non-interest-bearing liabilities.

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

(3)	Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

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

Liquidity and Capital Resources

We maintain liquid assets at levels we consider adequate to meet our liquidity needs. We adjust our liquidity levels to fund deposit outflows, pay real estate taxes on mortgage loans, repay our borrowings and to fund loan commitments. We also adjust liquidity as appropriate to meet asset and liability management objectives.

Our primary sources of liquidity are deposits, amortization and prepayment of loans, maturities of investment securities and other short-term investments, and earnings and funds provided from operations.

Table of Contents

While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition. 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.

A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities. At June 30, 2008, $5.3 million of our assets were invested in cash and cash equivalents. Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of investment securities, increases in deposit accounts, and FHLB advances. Our cash flows are derived from operating activities, investing activities and financing activities as reported in our consolidated statements of cash flows.

Our primary investing activities are the origination of loans and the purchase of investment securities. During the six months ended June 30, 2008, net loan originations totaled $639,000. During the six months ended June 30, 2007, net loan originations totaled $1.3 million. We do not sell loans. Cash received from principal repayments, calls and maturities of securities totaled $2.5 million and $2.1 million for the six months ended June 30, 2008 and 2007, respectively. We purchased $641,000 in securities during the six months ended June 30, 2008, and sold $160,000 in securities during this period. We purchased $110,000 in Federal Home Loan Bank common stock during the first six months of 2007 to meet the minimum required for membership in the FHLB of Chicago.

Deposit flows are generally affected by the level of interest rates, the interest rates and products offered by us and by local competitors, and other factors. There was a net increase in total deposits of $171,000 for the six months ended June 30, 2008, and a net decrease of $1.2 million in 2007.

Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank of Chicago, which provide an additional source of funds. During the six months ended June 30, 2008, the Company borrowed $4.0 million in advances from the Federal Home Loan Bank, and repaid $2.0 million. Our available borrowing limit was $12.2 million, an additional $5.2 million over the $7.0 million borrowed at June 30, 2008.

During the six months ended June 30, 2008, we repurchased 60,000 shares of our common stock for $664,000, under a share repurchase program. During the same period last year, we repurchased 83,300 shares for $1.1 million.

At June 30, 2008, we had outstanding commitments to originate loans of $2.1 million. At June 30, 2008, certificates of deposit scheduled to mature in less than one year totaled $18.5 million. Based on prior experience, management believes that 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 we do not retain a significant portion of our maturing certificates of deposit, we will have to utilize other funding sources, such as Federal Home Loan Bank of Chicago advances, in order to maintain our level of assets. Alternatively, we would reduce our level of liquid assets, such as our cash and cash equivalents. In addition, the cost of such deposits may be significantly higher if market interest rates are higher at the time of renewal.

Off-Balance-Sheet Arrangements

In the ordinary course of business, the Company is a party to credit-related financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.

Table of Contents

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. Therefore, the total commitment amounts do not necessarily represent future cash requirements.

At June 30, 2008, the we had outstanding commitments to make loans of $2.1 million. At December 31, 2007, the we had outstanding commitments to make loans of $205,000.

Impact of Inflation and Changing Prices

Our financial statements and related notes have been prepared in accordance with U.S. generally accepted accounting principles (“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 the effects of inflation.

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, which consist 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. Our board of directors has approved a series of policies for evaluating 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 these policies. Senior management regularly monitors the level of interest rate risk and reports to the board of directors on our compliance with our asset/liability policies and on our interest rate risk position.

We have sought to manage our interest rate risk in order to control the exposure of our earnings and capital to changes in interest rates. During the low interest rate environment that has existed in recent years, we have managed our interest rate risk by maintaining a high equity-to-assets ratio and building and maintaining portfolios of shorter-term fixed rate residential loans and second mortgage loans. By maintaining a high equity-to-assets ratio, we believe that we are better positioned to absorb more interest rate risk in order to improve our net interest margin. However, maintaining high equity balances reduces our return on equity ratio, and investments in shorter-term assets generally bear lower yields than longer-term investments.

Net Portfolio Value. In past years, many savings institutions have measured interest rate sensitivity by computing the “gap” between the assets and liabilities that are expected to mature or reprice within certain time periods, based on assumptions regarding loan prepayment and deposit decay rates formerly provided by the OTS. However, the OTS now requires the computation of amounts by which the net present value of an institution’s cash flow from assets, liabilities and off balance sheet items (the institution’s net portfolio value or “NPV”) would change in the event of a range of assumed changes in market interest rates. The OTS provides all institutions that file a Consolidated Maturity/Rate Schedule as a part of their quarterly Thrift Financial Report with an interest rate sensitivity report of net portfolio value. The OTS simulation model uses a discounted cash flow analysis and an option-based pricing approach to measuring the interest rate sensitivity of net portfolio value. Historically, the OTS model estimated the economic value of each type of asset, liability and off-balance sheet contract under the assumption that the United States Treasury yield curve increases or decreases instantaneously by 100

Table of Contents

to 300 basis points in 100 basis point increments. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. The OTS provides us the results of the interest rate sensitivity model, which is based on information we provide to the OTS to estimate the sensitivity of our net portfolio value.

The table below sets forth, as of March 31, 2008, the latest date available, the estimated changes in our NPV and our net interest income that would result from the designated instantaneous changes in the U.S. Treasury yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.

Change In	NPV			Net Portfolio Value as a Percentage of Present Value of Assets
Interest Rates (Basis Points)	Estimated NPV	Amount of Change	Percentage Change	NPV Ratio	Change in Basis Points
(dollars in thousands)
+300	$21,896	$(5,979)	-21%	31.07%	-508bp
+200	24,022	(3,853)	-14	33.00	-315
+100	26,068	(1,807)	-6	34.73	-142
+50	27,007	(868)	-3	35.48	-67
Unchanged	27,875	—	—	36.15	—
-50	28,676	801	+3	36.75	+60
-100	29,445	1,570	+6	37.30	+115

The table above indicates that at March 31, 2008, in the event of a 100 basis point decrease in interest rates, we would experience a 6% increase in net portfolio value. (The OTS model did not report a calculation for a 200 basis point decrease in interest rates at March 31, 2008.) In the event of a 200 basis point increase in interest rates, we would experience a 14% decrease in net portfolio value.

Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in net portfolio value requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net portfolio value table presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the net portfolio value table provides an indication of our interest rate risk exposure at a particular point in time, such measurements do not provide a precise forecast of the effect of changes in market interest rates on net interest income and will differ from actual results.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Disclosure for this item is currently not required for smaller reporting companies on an interim basis.

Item 4. Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision, and with the participation of our management, including our Chief Executive Officer and

Table of Contents

Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as contemplated by Exchange Act Rule 13a-15. Based upon, and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company and the Bank’s disclosure controls and procedures are effective, in all material respects, in timely alerting them to material information relating to the Company (and its consolidated subsidiaries) required to be included in the periodic reports the Company is required to file and submit to the Securities and Exchange Commission under the Exchange Act.

There have been no changes in the Company’s internal controls during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

Table of Contents

PART II. – OTHER INFORMATION

Item 1A is currently not required for smaller reporting companies and has been omitted.

Item 1. Legal Proceedings.

The Company and the Bank are not involved in any pending proceedings other than the legal proceedings occurring in the ordinary course of business. Such legal proceedings in the aggregate are believed by management to be immaterial to the Company’s business, financial condition, results of operations and cash flows.

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

Period	Total number of shares purchased		Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs		Maximum number of shares that may yet be purchased under the plans or programs(1)(2)

4/1/08–4/30/08		—		—		—		20,544
5/1/08–5/31/08		—		—		—		20,544
6/1/08–6/30/08		60,000	$	11.07		60,000		136,044

__________

(1)

On May 21, 2007 the Company announced that its Board of Directors had approved a stock repurchase program that authorized the purchase of up to 5%, or 181,844 shares, of the Company’s then outstanding shares of common stock, from time to time in open market or privately negotiated transactions. As of June 30, 2008, the Company had repurchased the maximum number of shares authorized under this program, and the program was terminated.

(2)

On May 29, 2008 the Company announced that its Board of Directors had approved a stock repurchase program that authorized the purchase of up to 5%, or 175,500 shares, of the Company’s then outstanding shares of common stock, from time to time in open market or privately negotiated transactions. Unless terminated or amended earlier by the Board of Directors, the stock repurchase program will end when the Company has repurchased all 175,500 shares authorized for repurchase.

Item 3. Defaults Upon Senior Securities.

None

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

At the annual meeting of stockholders of the Company held on May 14, 2008, the following matters were submitted to and approved by a vote of stockholders:

(1) The election of two Class II directors for a three-year term expiring at the annual meeting of stockholders to be held in 2011:

Directors	Votes For	Votes Withheld

Robert P. Kazan	3,376,890	38,990
Stanley Balzekas III	3,376,890	38,990

The following persons continue to serve as directors of the Company following the 2008 annual meeting:

Stephanie Simonaitis

Amy P. Keane

Table of Contents

Julie H. Oksas

Leonard F. Kosacz

Stephen M. Oksas

John L. Garlanger (appointed to the Board of Directors on July 15, 2008)

(2) The ratification of the appointment of Crowe Chizek and Company LLC as the Company’s independent auditor for the fiscal year ending December 31, 2008:

	Total votes for	3,387,106
	Total votes against	27,193
	Total votes abstaining	1,581

Item 5. Other Information.

None

Item 6. Exhibits.

The exhibits filed as part of this Form 10-Q are listed in the Exhibit Index, which is incorporated herein by reference.

Table of Contents

SIGNATURES

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

Date: August 13, 2008	MUTUAL FEDERAL BANCORP, INC.

	By:	/s/Stephen M. Oksas
		Stephen M. Oksas
		President and Chief Executive Officer


Date: August 13, 2008
	By:	/s/John L. Garlanger
		John L. Garlanger
		Chief Financial Officer

Table of Contents

EXHIBIT INDEX

3.1	Bylaws of Mutual Federal Bancorp, Inc., as amended
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	8th grade Avg

Mutual Federal Bancorp (MFDB) Inactive 10-Q2008 Q2 Quarterly report

Content analysis