Mutual Federal Bancorp 10Q 2009 Q3 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 September 30, 2009

¨ 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ 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 November 1, 2009
Common Stock, $0.01 par value	3,334,273

MUTUAL FEDERAL BANCORP, INC.

FORM 10-Q

For the quarterly period ended September 30, 2009

TABLE OF CONTENTS

	Page
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of September 30, 2009 (unaudited) and December 31, 2008	1
Consolidated Statements of Income (unaudited) for the three months and the nine months ended September 30, 2009 and 2008	2
Consolidated Statements of Stockholders’ Equity (unaudited) for the nine months ended September 30, 2009 and 2008	3
Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2009 and 2008	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3. Quantitative and Qualitative Disclosures About Market Risk	33
Item 4. Controls and Procedures	33

PART II – OTHER INFORMATION
Item 1. Legal Proceedings	34
Item 1A. Risk Factors	34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 3. Defaults Upon Senior Securities	34
Item 4. Submission of Matters to a Vote of Security Holders	34
Item 5. Other Information	34
Item 6. Exhibits	34

SIGNATURES	35

EXHIBIT INDEX

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)

	September 30, 2009			December 31, 2008
ASSETS
Cash and cash equivalents	$	7,068		$	3,454
Trading securities		1,326			2,100
Securities available-for-sale		8,008			10,812
Loans, net of allowance for loan losses of $1,174 at September 30, 2009; $1,287 at December 31, 2008		45,161			51,464
Real estate owned		2,070			235
Federal Home Loan Bank stock, at cost		610			610
Premises and equipment, net		1,305			918
Investment in de novo bank		2,000			—
Accrued interest receivable		236			343
Other assets		1,490			1,272
Total assets	$	69,274		$	71,208
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Non-interest-bearing deposits	$	243		$	199
Interest-bearing deposits		38,973			38,293
Total deposits		39,216			38,492
Advance payments by borrowers for taxes and insurance		729			364
Advances from the Federal Home Loan Bank		5,000			6,000
Accrued interest payable and other liabilities		1,120			1,443
Common stock in ESOP subject to contingent repurchase obligation		150			138
Total liabilities		46,215			46,437
Commitments and contingencies
Stockholders’ equity
Preferred stock, $0.01 par value, 1,000,000 shares authorized at September 30, 2009 and December 31, 2008		—			—
Common stock, $0.01 par value, 12,000,000 shares authorized, 3,636,875 shares issued at September 30, 2009 and December 31, 2008		36			36
Additional paid-in capital		10,174			9,981
Treasury stock, at cost, 302,602 shares at September 30, 2009 and 235,558 at December 31, 2008		(3,146	)		(2,558	)
Retained earnings		16,635			18,015
Reclassification of ESOP shares		(150	)		(138	)
Unearned ESOP shares		(669	)		(711	)
Accumulated other comprehensive income		179			146
Total stockholders’ equity		23,059			24,771
Total liabilities and stockholders’ equity	$	69,274		$	71,208

See accompanying notes to unaudited consolidated financial statements.

MUTUAL FEDERAL BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

(Dollar amounts in thousands except share data)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
Interest and dividend income
Loans, including fees	$	675		$	829		$	2,191		$	2,462
Securities		106			156			363			518
Interest earning deposits		—			11			1			42
Total interest and dividend income		781			996			2,555			3,022
Interest expense
Deposits		174			229			570			751
Advances from Federal Home Loan Bank		45			59			152			176
Total interest expense		219			288			722			927
Net interest income		562			708			1,833			2,095
Provision for loan losses		473			285			1,181			553
Net interest income after provision for loan losses		89			423			652			1,542

Non-interest income
Gain on sale of securities		—			—			—			152
Impairment charge on securities available-for-sale		—			(351	)		—			(382	)
Changes in fair value of trading securities		36			(147	)		(24	)		(294	)
Other income		11			17			30			39
Total non-interest income		47			(481	)		6			(485	)
Non-interest expense
Compensation and benefits		363			375			1,129			1,122
Occupancy and equipment		46			36			133			122
Data processing		38			34			108			85
Professional fees		134			74			436			285
Real estate owned		99			—			293			—
Other expense		76			88			266			234
Total non-interest expense		756			607			2,365			1,848
Income (loss) before income taxes		(620	)		(665	)		(1,707	)		(791	)
Income tax (benefit) expense		(246	)		(244	)		(459	)		(282	)
Net income (loss)	$	(374	)	$	(421	)	$	(1,248	)	$	(509	)

Earnings (loss) per share (basic and diluted)	$	(0.11	)	$	(0.12	)	$	(0.38	)	$	(0.15	)

Total comprehensive income (loss)	$	(370	)	$	(423	)	$	(1,215	)	$	(683	)

See accompanying notes to unaudited consolidated financial statements.

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, 2009	$	36	$	9,981		$	(2,558	)	$	18,015		$	(138	)	$	(711	)	$	146	$	24,771
Comprehensive income:
Net loss		—		—			—			(1,248	)		—			—			—		(1,248	)
Change in net unrealized gain (loss) on securities available-for-sale, net of taxes and reclassification adjustments		—		—			—			—			—			—			33		33
Total comprehensive income (loss)																					(1,215	)
Treasury stock purchases at cost		—		—			(588	)		—			—			—			—		(588	)
Dividends paid		—		—			—			(146	)		—			—			—		(146	)
Income tax benefit of dividends on non-vested MRP shares		—		2			—			—			—			—			—		2
MRP shares earned		—		117			—			—			—			—			—		117
Stock option shares earned		—		81			—			—			—			—			—		81
Adjustment to fair value of common stock in ESOP subject to contingent repurchase obligation of ESOP shares		—		—			—			—			(12	)		—			—		(12	)
ESOP shares committed to be released		—		(7	)		—			14			—			42			—		49
Balance at September 30, 2009	$	36	$	10,174		$	(3,146	)	$	16,635		$	(150	)	$	(669	)	$	179	$	23,059

See accompanying notes to unaudited consolidated financial statements.

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, 2008	$	36	$	9,738		$	(1,286	)	$	19,077		$	(108	)	$	(768	)	$	222		$	26,911
Comprehensive income:
Net loss		—		—			—			(509	)		—			—			—			(509	)
Change in net unrealized gain (loss) on securities available-for-sale, net of taxes and reclassification adjustments		—		—			—			—			—			—			(174	)		(174	)
Total comprehensive income (loss)																						(683	)
Dividends paid		—		—			—			(114	)		—			—			—			(114	)
Treasury stock purchases at cost		—		—			(664	)		—			—			—			—			(664	)
MRP share grants, 2,138 shares at cost		—		(25	)		25			—			—			—			—			—
MRP shares earned		—		117			—			5			—			—			—			122
Stock option shares earned		—		80			—			—			—			—			—			80
Adjustment to fair value of common stock in ESOP subject to contingent repurchase obligation of ESOP shares		—		—			—			—			(29	)		—			—			(29	)
ESOP shares committed to be released		—		4			—			10			—			43			—			57
Balance at September 30, 2008	$	36	$	9,914		$	(1,925	)	$	18,469		$	(137	)	$	(725	)	$	48		$	25,680

See accompanying notes to unaudited consolidated financial statements.

MUTUAL FEDERAL BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(Dollar amounts in thousands)

	Nine Months Ended September 30,
	2009			2008
Cash flows from operating activities
Net income (loss)	$	(1,248	)	$	(509	)
Adjustments to reconcile net loss to net cash from operating activities
Provision for loan losses		1,181			553
Provision for loss on real estate owned		139			—
Depreciation		37			38
Net amortization of securities		5			10
Dividends reinvested on securities		—			(46	)
Gain on sale of securities		—			(152	)
Impairment charge on securities available-for-sale		—			382
Changes in fair value of trading securities		24			294
ESOP expense		49			57
MRP expense		117			122
Option expense		81			80
Increase in accrued interest receivable and other assets		(112	)		(620	)
Increase (decrease) in accrued interest payable and other liabilities		(342	)		336
Net cash provided by (used in) operating activities		(69	)		545
Cash flows from investing activities
Activity in securities available-for-sale:
Proceeds from maturities, calls, and principal repayments		2,854			2,909
Proceeds from sales		750			160
Purchases		—			(641	)
Investment in de novo bank		(2,000	)		—
Loan originations and payments, net		3,148			(912	)
Additions to premises and equipment		(424	)		(670	)
Net cash provided by investing activities		4,328			846
Cash flows from financing activities
Net increase (decrease) in deposits		724			(339	)
Net increase in advance payments by borrowers for taxes and insurance		365			486
Advances from the Federal Home Loan Bank		—			4,000
Repayment of advances from the Federal Home Loan Bank		(1,000	)		(3,000	)
Dividends paid		(146	)		(114	)
Purchases of treasury stock		(588	)		(664	)
Net cash provided by (used in) financing activities		(645	)		369
Net increase in cash and cash equivalents		3,614			1,760

See accompanying notes to unaudited consolidated financial statements.

MUTUAL FEDERAL BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(Dollar amounts in thousands)

	Nine Months Ended September 30,
	2009		2008
Cash and cash equivalents at beginning of period		3,454		2,264
Cash and cash equivalents at end of period	$	7,068	$	4,024
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	$	1,974		—
Cash paid during the year for:
Interest	$	733	$	950
Income taxes		—		263

See accompanying notes to unaudited consolidated financial statements.

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 nine months ended September 30, 2009, are not necessarily indicative of results that may be expected for the entire fiscal year ending December 31, 2009.

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 subsidiaries, EMEFES Service Corporation and 2212 Holdings, LLC, together referred to as “the Bank.” Intercompany transactions and balances are eliminated in consolidation. As of September 30, 2009, Mutual Federal Bancorp, MHC (the “MHC”) was the majority (76%) 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. 2212 Holdings, LLC was established in 2008 to hold and manage real estate acquired through foreclosure.

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 Chicago 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 September 30, 2009, the Bank met the capital adequacy requirements to which it is subject. The Bank’s tangible capital ratio at September 30, 2009 was 28.57%. The Tier 1 capital ratio was 28.57%, the Tier 1 risk-based capital ratio was 44.89%, and the total risk-based capital ratio was 46.14%.

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.

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 3 – Commitments

The Bank had no outstanding commitments to make loans at September 30, 2009 or December 31, 2008.

Note 4 – Recently Issued Accounting Standards

On July 1, 2009, the FASB’s GAAP Codification (“Codification” or “ASC”) became effective as the sole authoritative source of US GAAP. This codification reorganizes current GAAP for non-governmental entities into a topical index to facilitate accounting research and to provide users additional assurance that they have referenced all related literature pertaining to a given topic. Existing GAAP prior to the Codification was not altered in compilation of the GAAP Codification. The GAAP Codification encompasses all FASB Statements of Financial Accounting Standards (SFAS), Emerging Issues Task Force (EITF) statements, FASB Staff Positions (FSP), FASB Interpretations (FIN), FASB Derivative Implementation Guides (DIG), American Institute of Certified Public Accountants (AICPA) Statement of Positions (SOPS), Accounting Principals Board (APB) Opinions and Accounting Research Bulletins (ARBs) along with the remaining body of GAAP effective as of June 30, 2009. Financial Statements issued for all interim and annual periods ending after September 15, 2009 will need to reference accounting guidance embodied in the Codification as opposed to referencing the previously authoritative pronouncements. Accounting literature included in the codification is referenced by Topic, Subtopic, Section and paragraph.

Effective April 1, 2009, the Company adopted Recognition and Presentation of Other-Than-Temporary Impairments (ASC 320-10-65), which amends existing guidance for determining whether impairment is other-than-temporary for debt securities. The standard requires an entity to assess whether it intends to sell, or it is more likely than not that it will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized in earnings. For securities that do not meet the aforementioned criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income. Additionally, the standard expands and increases the frequency of existing disclosures about other-than-temporary impairments for debt and equity securities. The adoption had no material effect on the results of operations or financial position.

Effective April 1, 2009, the Company adopted Determining Fair Value When the Volume and Level of Activity for the Asset and Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (ASC 820-10). This standard emphasizes that even if there has been a significant decrease in the volume and level of activity, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants. The standard provides a number of factors to consider when evaluating whether there has been a significant decrease in the volume and level of activity for an asset or liability in relation to normal market activity. In addition, when transactions or quoted prices are not considered orderly, adjustments to those prices based on the weight of available information may be needed to determine the appropriate fair value. The standard also requires increased disclosures. The adoption had no material effect on the results of operations or financial position.

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 4 – Recently Issued Accounting Standards (continued)

Effective April 1, 2009, the Company adopted Interim Disclosures about Fair Value of Financial Instruments (ASC 825-10). This standard requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies that were previously only required in annual financial statements. Since the standard affects only disclosures, it did not impact the Company’s results of operations or financial position upon adoption.

In May 2009, the FASB issued Subsequent Events (ASC 855-10). The standard establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. The standard defines (i) the period after the balance sheet date during which a reporting entity’s management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (iii) the disclosures an entity should make about events or transactions that occurred after the balance sheet date. The standard became effective for periods ending after June 15, 2009. The standard did not have a material impact on the Company’s financial statements. Subsequent events for the quarter ended September 30, 2009 were evaluated through November 13, 2009, the date of this filing.

Newly Issued But Not Yet Effective Accounting Standards

In June 2009, the FASB issued SFAS No. 166, Accounting for the Transfer of Financial Assets and Amendment of FASB Statement No. 140 Instruments (“SFAS 166”). Under FASB’s Codification at ASC 105-10-65-1-d, SFAS 166 will remain authoritative until integrated into the FASB Codification. SFAS 166 removes the concept of a qualified special purpose entity (QSPE) from Statement 140 and removes the exception of applying FASB Interpretation 46 Variable Interest Entities, to Variable Interest Entities that are SPEs. It limits the circumstances in which a transferor derecognizes a financial asset. SFAS166 amends the requirements for the transfer of a financial asset to meet the requirements for “sale” accounting. The statement is effective for all interim and annual periods beginning after November 15, 2009. The Company does not expect the adoption to have a material impact on the Company’s financial condition, results of operations or cash flows.

In June 2009 the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (“SFAS 167”). Under FASB’s Codification at ASC 105-10-65-1-d, SFAS 167 will remain authoritative until integrated into the FASB Codification. SFAS 167 amends Interpretation 46(R) to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest give it a controlling financial interest in the variable interest entity. SFAS 167 is effective for all interim and annual periods beginning after November 15, 2009. The Company does not expect the adoption to have a material impact on the Company’s financial condition, results of operations or cash flows.

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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.

Fair Value Measurements (ASC 825-10) 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. Fair Value Measurements (ASC 825-10) 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.

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 and other real estate owned by obtaining current appraisals of the collateral real estate properties (Level 2 inputs) or adjusting estimated fair values of appraisals using management judgment (Level 3 inputs).

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 5 – Fair Value (continued)

(Dollar amounts in thousands)			Fair Value Measurements Using
Assets Measured on a Recurring Basis			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
			Level 1		Level 2		Level 3
At September 30, 2009
Trading securities	$	1,326	$	1,326	$	—	$	—

Securities available-for-sale
U.S. agency and government-sponsored entity bonds	$	2,615	$	—	$	2,615	$	—
GNMA certificates		669		—		669		—
FNMA certificates		2,257		—		2,257		—
FHLMC certificates		2,111		—		2,111		—
Collateralized mortgage obligations		349		—		349		—
FHLMC preferred stock		7		7		—		—
Total available-for-sale	$	8,008	$	7	$	8,001	$	—
	$	9,334	$	1,333	$	8,001	$	—
At December 31, 2008
Trading securities	$	2,100	$	2,100	$	—	$	—

Securities available-for-sale
U.S. agency and government-sponsored entity bonds	$	4,195	$	—	$	4,195	$	—
GNMA certificates		754		—		754		—
FNMA certificates		2,820		—		2,820		—
FHLMC certificates		2,655		—		2,655		—
Collateralized mortgage obligations		381		—		381		—
FHLMC preferred stock		7		7		—		—
Total available-for-sale	$	10,812	$	7	$	10,805	$	—
	$	12,912	$	2,107	$	10,805	$	—

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 nine months ended September 30, 2009, the Company recognized an unrealized loss of $24,000 on changes in fair value of trading securities. Restrictions on redemption of these securities have been imposed by the manager of these funds, limiting cash redemptions to $250,000 per fund (there are three funds) per quarter. The Company requested redemptions for all three funds during the nine months ended September 30, 2009, realizing proceeds of $750,000 and an aggregate loss of $174,000. The realized loss on sold securities has previously been recorded in the statement of income within changes in fair value of trading securities. The Company has not decided whether or not to continue redemptions in following quarters.

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 5 – Fair Value (continued)

			Fair Value Measurements Using
Assets Measured on a Non-Recurring Basis			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
			Level 1		Level 2		Level 3
At September 30, 2009
Impaired loans	$	5,083	$	—	$	—	$	5,083
Real estate owned		2,070		—		—		2,070
	$	7,153	$	—	$	—	$	7,153

At December 31, 2008
Impaired loans	$	1,756	$	—	$	—	$	1,756
Real estate owned		235		—		—		235
	$	1,991	$	—	$	—	$	1,991

At September 30, 2009, impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans and include both nonaccrual loans and restructured loans, had valuation allowances of $369,000 and a net carrying amount of $5.1 million. For the nine months ended September 30, 2009 and 2008, additional provisions for loan loss of $1.2 million and $553,000 were recorded on impaired loans. At December 31, 2008, impaired loans had valuation allowances of $850,000 and a net carrying amount of $1.8 million.

Real estate owned, acquired through foreclosure or by deed in lieu of foreclosure, is measured for impairment using the fair value of the collateral, less estimated costs to sell. During the nine months ended September 30, 2009, additional loss provisions of $139,000 were recorded on real estate owned.

Note 6 – Fair Values of Financial Instruments

Carrying amount and estimated fair values of financial instruments were as follows:

	September 30, 2009				December 31, 2008
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	7,068	$	7,068	$	3,454	$	3,454
Trading securities		1,326		1,326		2,100		2,100
Securities available-for-sale		8,008		8,008		10,812		10,812
Loans, net		45,161		45,684		51,464		52,242
Federal Home Loan Bank stock		610		N/A		610		N/A
Accrued interest receivable		236		236		343		343
Financial liabilities:
Deposits		39,216		39,434		38,492		38,638
Advances from Federal Home Loan Bank		5,000		5,075		6,000		6,142
Advance payments by borrowers for taxes and insurance		729		729		364		364
Accrued interest payable		61		61		72		72

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 6 – Fair Values of Financial Instruments (continued)

The methods and assumptions used to estimate fair value are described as follows.

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, advance payments by borrowers for taxes and insurance, demand deposits, and variable-rate loans, deposits and advances that reprice frequently and fully. Security fair values are based on market prices or dealer quotes and, if no such information is available, on the rate and term of the security and information about the issuer. It is not practical to determine the fair market value of FHLB stock due to restrictions placed on its transferability. For fixed-rate loans or deposits and for variable-rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. The fair value of off-balance-sheet items is not material.

Note 7 – Securities

Trading Securities:

Upon adoption of SFAS 159 on January 1, 2008, the Company reclassified mutual funds from available-for-sale to trading securities. For the nine months ended September 30, 2009, the Company recorded losses in the fair value of trading securities of $24,000 as a charge against income. The Company requested partial redemptions from these mutual funds during the nine months ended September 30, 2009, realizing proceeds of $750,000 and an aggregate loss of $174,000. As an equity security, the mutual funds do not have a designated maturity date.

Securities available-for-sale:

The amortized cost and fair value of securities available-for-sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
September 30, 2009
U.S. agency and government-sponsored entity bonds	$	2,500	$	115	$	—		$	2,615
GNMA certificates		664		5		—			669
FNMA certificates		2,171		86		—			2,257
FHLMC certificates		2,022		89		—			2,111
Collateralized mortgage obligations		350		—		(1	)		349
FHLMC preferred stock		7		—		—			7
Total available-for-sale	$	7,714	$	295	$	(1	)	$	8,008

December 31, 2008
U.S. agency and government-sponsored entity bonds	$	3,998	$	197	$	—		$	4,195
GNMA certificates		791		3		(40	)		754
FNMA certificates		2,763		61		(4	)		2,820
FHLMC certificates		2,607		55		(7	)		2,655
Collateralized mortgage obligations		408		—		(27	)		381
FHLMC preferred stock		7		—		—			7
Total available-for-sale	$	10,574	$	316	$	(78	)	$	10,812

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 7 – Securities (continued)

At September 30, 2009 and December 31, 2008, there were no holdings of securities of any one issuer, other than U.S. agency and U.S. government-sponsored entities, in an amount greater than 10% of equity.

There were no securities pledged at September 30, 2009 or December 31, 2008.

There were no investment securities sales in the nine months ended September 30, 2009. The Company sold 8,000 shares of FHLMC common stock for $160,000 resulting in a gain of $152,000 for the nine months ended December 31, 2008.

The amortized cost and fair values of debt securities available-for-sale at September 30, 2009 by contractual maturity were as follows:

	Amortized Cost		Fair Value

Due in one year or less	$	1,000	$	1,033
Due from one to five years		1,500		1,582
Due from five to ten years		—		—
CMO’s and mortgage backed securities		5,207		5,386
Total	$	7,707	$	8,001

Securities with unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position are as follows:

	September 30, 2009
	Less Than 12 Months				12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss			Fair Value		Unrealized Loss

Collateralized mortgage obligations	$	—	$	—	$	349	$	(1	)	$	349	$	(1	)
Total temporarily impaired	$	—	$	—	$	349	$	(1	)	$	349	$	(1	)

	December 31, 2008
	Less Than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss

GNMA certificates	$	108	$	(1	)	$	570	$	(39	)	$	678	$	(40	)
FNMA certificates		256		(3	)		239		(1	)		495		(4	)
FHLMC certificates		—		—			144		(7	)		144		(7	)
Collateralized mortgage obligations		—		—			378		(27	)		378		(27	)
Total temporarily impaired	$	364	$	(4	)	$	1,331	$	(74	)	$	1,695	$	(78	)

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 7 – Securities (continued)

At September 30, 2009, there was one debt security with an unrealized loss that has depreciated 0.3% from the Company’s amortized cost basis. At December 31, 2008, there were 15 debt securities with unrealized losses that have depreciated 4.4% from the Company’s amortized cost basis. These unrealized losses related principally to current interest rates for similar types of securities. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and what the results are of reviews of the issuer’s financial condition. The fair value is expected to recover as securities approach their maturity date. The Company does not intend to sell the securities and it is more likely than not that the Company will not be required to sell the securities prior to recovery.

The Company owns 10,000 shares of Federal Home Loan Mortgage Corporation (“FHLMC”) 5.79% non-cumulative preferred stock with an original cost basis of $500,000. As previously disclosed, for the year ended December 31, 2008, the Company has recognized $394,000 in pre-tax charges for an other-than-temporary decline in fair value, because it was unable to forecast a recovery in the fair value of this security in the foreseeable future.

Note 8 – 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 nine months ended September 30, 2009, are 3,266,695 and 3,276,688, respectively. Both basic and fully diluted weighted average shares outstanding for the three months and the nine months ended September 30, 2008, are 3,397,097 and 3,428,679, respectively. During the nine months ended September 30, 2009 and 2008, 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.

In June 2008, the FASB issued ASC 260-10 Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. This standard addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (EPS) under the two-class method. The standard provides that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. This standard was effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. Adoption of this standard did not impact the Company's EPS calculation as the Company's EPS calculation has always considered stock grant awards under its Management Recognition Plan (MRP) that remain subject to vesting to be outstanding stock due to their dividend and voting rights.

MUTUAL FEDERAL BANCORP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Note 8 – Earnings Per Share (continued)

The factors used in the earnings per share computation for the three months and the nine months ended September 30, 2009 and 2008, follow:

(Dollar amounts in thousands, except per share amounts)	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Basic
Net loss	$	(374	)	$	(421	)	$	(1,248	)	$	(509	)
Weighted average common shares outstanding		3,334,274			3,470,317			3,345,649			3,503,334
Less: average unallocated ESOP shares		(67,579	)		(73,220	)		(68,961	)		(74,655	)
Average shares		3,266,695			3,397,097			3,276,688			3,428,679
Basic loss per common share	$	(0.11	)	$	(0.12	)	$	(0.38	)	$	(0.15	)
Diluted
Net loss	$	(374	)	$	(421	)	$	(1,248	)	$	(509	)
Weighted average common shares outstanding for basic earnings per common share		3,266,695			3,397,097			3,276,688			3,428,679
Add: dilutive effects of assumed exercises of stock options		—			—			—			—

Average shares and dilutive potential common shares		3,266,695			3,397,097			3,276,688			3,428,679

Diluted loss per common share	$	(0.11	)	$	(0.12	)	$	(0.38	)	$	(0.15	)

Item 2. 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, 2008 and 2007, which are included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 27, 2009.

As previously disclosed in our Form 8-K filing dated February 23, 2009, the “Company previously entered into a non-binding term sheet agreement that sets forth the material terms of a proposed investment by the Company in Great American Bank, a de novo Illinois state commercial bank in organization (the “de novo”). During the third quarter of 2009, the Company placed $2.0 million in escrow for this investment. The de novo has yet to receive regulatory approval for a bank charter and FDIC insurance and a timeline for approval is not currently known. The amount the Company invests may, at its discretion, be adjusted to ensure that the Company owns 20% of the outstanding stock of the de novo at the closing of the de novo’s offering. In connection with its proposed investment, the Company would receive the right to nominate annually one member to the de novo’s board of directors for so long as it holds at least 10% of the de novo’s outstanding common stock. The Company also would be granted certain preemptive purchase and sale rights in order to maintain its ownership percentage in the de novo. If the de novo does not receive the necessary regulatory approval, the Company's funds, currently held in escrow, will be returned to the Company.

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, 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, continue to deteriorate or become worse than expected;

adverse changes or continued volatility and disruption in the securities and credit 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, which can decrease our earnings;

any need to increase our allowance for loan losses;

charges related to asset impairments;

adverse developments in our loan or investment portfolios;

increased expenses due to, among other things, increased fees and expenses related to foreclosed property;

our ability to realize our deferred tax assets in the future and avoid further increases in our valuation reserve recorded against our deferred tax assets;

significantly increased competition among depository and other financial institutions in our market area;

our ability to enter new markets 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.

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, expenses related to real estate acquired through foreclosure, 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.

Throughout 2008 and continuing into 2009, there have been severe disruptions in the mortgage, credit and housing markets, both locally and nationally. These disruptions have had a significant negative impact on real estate and related industries, which has led to decreases in commercial and residential real estate sales, construction and property values. These disruptions have had a significant negative impact on the Bank’s loan portfolio, resulting in a reduction in demand for new loans, with a consequential effect in the size of our loan portfolio, and an increase in the number of non-performing loans. At September 30, 2009 and December 31, 2008, non-performing loans represented 6.24% and 5.59% of loans receivable, respectively, which is significantly in excess of the historical experience of the Bank. We also recorded net loan charge-offs of $1.3 million on foreclosed mortgages during the first nine months of 2009, compared to no charge-offs for the first nine months of 2008. Accordingly, the decreased demand

for new residential mortgage loans and the significant increase in non-performing loans, including increased fees and expenses related to foreclosed property, continues to have a material adverse impact on our financial condition and results of operations, including a contraction in net interest margin and the need to increase the provision for loan losses. Should the housing market and economic conditions in the Chicago area stagnate or continue to deteriorate, it may continue to have a negative effect on the Company’s business and results of operations.

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 and to our allowance for deferred tax assets.

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.

Management performs a quarterly evaluation of deferred income tax assets to determine whether or not it expects to realize these assets in the foreseeable future. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Deferred income tax assets result primarily from expenses, such as the allowance for losses on loans, deferred compensation, and fair value write-downs of securities, that are recognized in the Company’s financial statements currently, but cannot be deducted on the Company’s tax returns until future periods. We consider the Company’s history of pretax income, the availability of net operating loss carry-backs to offset prior years’ taxable income, and the likelihood that there will be future taxable income against which we will be able to offset net operating loss carry-forwards. We also consider the nature of these timing differences, whether ordinary or capital, and the likelihood that there will be ordinary income or capital gains income necessary to realize the tax benefits of these deductions.

Comparison of Financial Condition at September 30, 2009 and December 31, 2008

Our total assets decreased $1.9 million, or 2.7%, to $69.3 million at September 30, 2009, compared to $71.2 million at December 31, 2008. Cash and cash equivalents increased $3.6 million, or

104.6 %, to $7.1 million at September 30, 2009, from $3.5 million at December 31, 2008, primarily due to loan and securities repayments which have not yet been reinvested, and managements decision to maintain a higher level of readily available funds. Loans receivable decreased $6.3 million, or 12.3%, to $45.2 million at September 30, 2009, from $51.5 million at December 31, 2008, reflecting $2.1 million in transfers of collateral real estate properties from mortgage loans to real estate owned, acquired through foreclosure, $3.1 million in net loan repayments and a $1.0 million addition to the allowance for loan losses. The allowance for loan losses decreased $113,000, to $1.2 million at September 30, 2009, from $1.3 million at December 31, 2008, after the provision of $1.2 million and net charge-offs of $1.3 million.

Total deposits increased $724,000, or 1.9%, to $39.2 million at September 30, 2009, from $38.5 million at December 31, 2008. Mortgage escrow accounts increased by $365,000, or 100.3% during this same period. The Company repaid $1.0 million of advances from the Federal Home Loan Bank during the nine months ended September 30, 2009.

Stockholders’ equity decreased $1.7 million, to $23.1 million at September 30, 2009, from $24.8 million at December 31, 2008. The decrease reflects a net loss of $1.2 million for the nine months ended September 30, 2009, a $33,000 increase in accumulated other comprehensive income from net unrealized gains on securities available-for-sale, and $588,000 in treasury stock purchases. The Company paid dividends of $146,000 ($0.18 per share of common stock) to minority shareholders during the nine months ended September 30, 2009. Mutual Federal Bancorp, MHC, the majority shareholder, waived its dividend. Stockholders’ equity also reflects a $249,000 increase from recognition of stock benefits earned under the Company’s Employee Stock Ownership Plan, Management Recognition and Retention Plan, and Stock Option Plan for the nine months ended September 30, 2009.

Comparison of Operating Results for the Three Months Ended September 30, 2009 and 2008

General. The Company had a net loss of $374,000 for the three months ended September 30, 2009, compared to a net loss of $421,000 for the three months ended September 30, 2008. Our interest income decreased $215,000, to $781,000 for the three months ended September 30, 2009, from $996,000 for the three months ended September 30, 2008, primarily due to uncollected interest on nonaccrual loans and a reduction in the average balance of loans and investment securities. This was partially offset by a $69,000 decrease in our cost of funds, to $219,000 in third quarter of 2009, from $288,000 in the third quarter of 2008. Our net interest income decreased $146,000, to $562,000 for the three months ended September 30, 2009, from $708,000 for the three months ended September 30, 2008

The provision for loan losses increased $188,000, to $473,000 for the three months ended September 30, 2009, from $285,000 for the three months ended September 30, 2008.

Non-interest income increased to $47,000 for the three months ended September 30, 2009, from a loss of $481,000 for the three months ended September 30, 2008, primarily due to $498,000 in write downs of securities in 2008 that were not repeated in 2009.

Compensation and benefits decreased $12,000, to $363,000 for the three months ended September 30, 2009, from $375,000 for the three months ended September 30, 2008. Occupancy costs increased $10,000, to $46,000 for this period, from $36,000 for this period last year, primarily due to building maintenance on existing facilities done during the construction period of our new drive-up facility. Data processing costs increased $4,000, to $38,000 for the three months ended September 30, 2009, from $34,000 for the three months ended September 30, 2008, primarily due to new products and services being offered, including interest-bearing checking accounts and on-line banking and bill pay.

Professional fees increased $60,000, to $134,000 for the three months ended September 30, 2009, from $74,000 for the three months ended September 30, 2008, primarily due to increased audit and

consulting costs related to regulatory compliance, and $50,000 in increased legal fees related to loan foreclosures.

Real estate owned expense was $99,000 for the three months ended September 30, 2009, compared to none for the three months ended September 30, 2008. This expense was primarily attributable to $23,000 in fair value write downs of real estate owned subsequent to acquisition, and to real estate taxes accrued on properties recently acquired through foreclosure, and other expenses such as maintenance and insurance.

Other expenses decreased $12,000, to $76,000 for the three months ended September 30, 2009, from $88,000 for the three months ended September 30, 2008.

The annualized return on average assets was (2.15)% for the three months ended September 30, 2009, compared to (2.27)% for the same period last year, and the annualized return on average equity was (6.39)% and (6.48)%, respectively, for these two periods.

Interest Income. Interest and dividend income decreased $215,000, or 21.6%, to $781,000 for the three months ended September 30, 2009, compared to $996,000 for the three months ended September 30, 2008. The decrease resulted from a $9.4 million, or 13.3%, decrease in the average balance of interest-earning assets, to $61.0 million in the third quarter of 2009, compared to $70.4 million in the third quarter of 2008, and to a decrease of 54 basis points in the average yield on interest earning assets, to 5.12% in 2009, from 5.66% in 2008.

Interest income and fees from loans receivable decreased $154,000, or 18.6%, to $675,000 for the three months ended September 30, 2009, from $829,000 for the three months ended September 30, 2008. The decrease resulted primarily from an $8.3 million, or 15.4%, decrease in the average balance of loans receivable, to $45.9 million in the third quarter of 2009, compared to $54.2 million in the third quarter of 2008. Contributing to the decrease in average balances of loans was the continued lack of demand from qualified borrowers in the Company’s market area. There was a decrease of 23 basis points in the average yield on loans receivable, to 5.89% in 2009, from 6.12% in 2008. The reserve for uncollected interest on loans 90 days or more past due increased $67,000 during the third quarter of 2009, compared to $38,000 during the third quarter of 2008.

Interest and dividend income from securities and interest-earning deposits decreased $61,000, or 36.5%, to $106,000 for the three months ended September 30, 2009, from $167,000 for the three months ended September 30, 2008. The primary reasons for the decrease were a $4.1 million, or 29.9%, decrease in the average balances of securities, to $9.6 million in 2009, from $13.7 million in 2008, as well as a 14 basis point decrease in average yield to 4.40% in 2009, from 4.54% in 2008. While the average balance of interest-earning deposits, primarily at the FHLB of Chicago, increased by $3.0 million, or 121.6%, to $5.5 million during the quarter ended September 30, 2009, compared to $2.5 million during the same quarter last year, the average rate earned was almost zero percent in 2009, compared to 1.76% in 2008. Management decided it was prudent to maintain a higher level of readily available funds during this period despite the low rate of interest on these deposits.

Interest Expense. Interest expense on deposits decreased $55,000, or 24.0%, to $174,000 for the three months ended September 30, 2009, from $229,000 for the three months ended September 30, 2008. The decrease in interest expense was due primarily to a decrease in the average rate paid on deposits of 54 basis points, to 1.78% for the quarter ended September 30, 2009, from 2.32% for the quarter ended September 30, 2008. Interest expense on certificates of deposit decreased $47,000, or 27.8%, to $122,000 in 2009, from $169,000 in 2008, because of a decrease in the average rate paid on certificates of deposit of 88 basis points, to 2.44% in 2009, from 3.32% in 2008.

Interest expense on FHLB advances decreased $14,000, to $45,000 for the three months ended September 30, 2009, compared to $59,000 for the three months ended September 30, 2008. The average balance of FHLB advances decreased $1.3 million, to $5.0 million for the third quarter of 2009, from $6.3 million for the third quarter of 2008. The average rate paid on advances decreased 15 basis points, to 3.60% in 2009, from 3.75% in 2008. The overall average cost of funds decreased 53 basis points, to 1.99% in 2009, from 2.52% in 2008.

Net Interest Income. Net interest income decreased $146,000, or 20.6%, to $562,000 for the three months ended September 30, 2009, from $708,000 for the same quarter last year. Our net interest margin decreased 34 basis points, to 3.68% in 2009, from 4.02% in 2008. A 54 basis point decrease in the average yield on interest-earning assets, to 5.12% in 2009, from 5.66% in 2008, and a decrease of $9.4 million in the average balance of interest-earning assets, both contributed to interest income decreasing by $215,000. The average rate paid on interest-bearing liabilities decreased 53 basis points, to 1.99% in 2009, from 2.52% in 2008, and the average balance of interest-bearing liabilities decreased $1.7 million, with interest expense decreasing by $69,000. The interest rate spread between interest earning assets and interest bearing liabilities decreased one basis point, to 3.13% in 2009, from 3.14% in 2008.

Provision for Loan Losses. During the three months ended September 30, 2009, management provided $473,000 for losses on loans, compared to $285,000 for the three months ended September 30, 2008, based on its quarterly evaluation of the level of the allowance necessary to absorb probable incurred loan losses at September 30, 2009. 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.

During the three months ended September 30, 2009, non-performing (non-accrual) loans increased $1.4 million, to $2.9 million at September 30, 2009, from $1.5 million at June 30, 2009. Loans delinquent 60-89 days increased $67,000, to $1.8 million at September 30, 2009, compared to $1.7 million at June 30, 2009. Loans receivable decreased $1.0 million, or 2.1%, to $46.5 million at September 30, 2009, from $47.5 million at June 30, 2009. During this period, one- to four-family residential mortgage loans decreased $838,000, or 3.0%, and multi-family residential mortgage loans decreased $177,000, or 0.9%.

There were $187,000 in transfers of one-to-four family properties to real estate owned, acquired through foreclosure, during the third quarter of 2009. The allowance for loan losses increased $80,000, to $1.2 million at September 30, 2009, from $1.1 million at June 30, 2009, following net charge-offs of $393,000 on foreclosed residential mortgages and a provision of $473,000 for the quarter. Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a gross carrying amount of $2.9 million, with specific valuation allowances of $369,000 at September 30, 2009.

At September 30, 2009, the allowance for loan losses was $1.2 million, or 2.53% of gross loans receivable, compared to $1.1 million, or 2.33% of gross loans receivable at June 30, 2009. At September 30, 2009, specific allowances of $369,000 were 12.72% of non-performing loans, compared to 29.25% of non-performing loans at June 30, 2009. The ratio of specific reserves to non-performing loans will fluctuate quarter to quarter as non-performing loans are charged off, transferred to real estate owned, or underlying collateral values change. At September 30, 2009, the general valuation allowance was increased by $136,000, to $805,000, or 1.85% of performing loans, compared to $669,000, or 1.45% of performing loans at June 30, 2009. The increase was due primarily to an increase in our historical loss experience.

Non-interest Income. Non-interest income was $47,000 for the three months ended September 30, 2009, compared to a loss of $481,000 for the three months ended September 30, 2008. During the

three months ended September 30, 2009, the Company recorded a $36,000 fair value increase in mutual funds carried as trading securities, compared to a $147,000 fair value decrease on these mutual funds recorded during the same period last year. During the three months ended September 30, 2008, the Company also recognized a $351,000 loss for other than temporary impairment of FHLMC preferred stock held as available-for-sale.

Non-interest Expense. Non-interest expense increased $149,000, or 24.6%, to $756,000 for the three months ended September 30, 2009, from $607,000 for the same quarter last year. Compensation and employee benefits decreased $12,000, or 3.2%, to $363,000 in 2009, from $375,000 in 2008. Occupancy costs increased $10,000, or 27.8%, to $46,000 in 2009, from $36,000 in 2008, primarily due to building maintenance on existing facilities done during the construction period of our new drive-up facility.

Data processing costs increased $4,000, or 11.8%, to $38,000 for the three months ended September 30, 2009, from $34,000 for the three months ended September 30, 2008, primarily due to new products and services being offered, including interest-bearing checking accounts and on-line banking and bill pay.

Professional fees increased $60,000, or 81.1%, to $134,000 for the three months ended September 30, 2009, from $74,000 for the three months ended September 30, 2008, primarily due to increased audit and consulting costs related to regulatory compliance and increased legal fees related to loan foreclosures. Audit costs increased $14,000, to $45,000 for the three months ended September 30, 2009, compared to $31,000 for the three months ended September 30, 2008, primarily due to increased costs of compliance with Section 404(b) of the Sarbanes Oxley Act. Compliance consulting costs increased $16,000, to $24,000 for the third quarter of 2009, compared to $8,000 for the third quarter of 2008. Legal costs increased $30,000, to $65,000 in the third quarter of 2009, from $35,000 in the third quarter of 2008, primarily due to loan foreclosures. Legal costs for foreclosures were $50,000 during the third quarter of 2009, compared to none in this quarter last year.

Real estate owned expense was $99,000 for the three months ended September 30, 2009, compared with none incurred in 2008. This expense was primarily attributable to $23,000 in fair value write downs on real estate owned subsequent to acquisition, and to real estate taxes accrued on properties recently acquired through foreclosure, and other expenses such as maintenance and insurance.

Other expenses decreased $12,000, or 13.6%, to $76,000 for the three months ended September 30, 2009, from $88,000 for the three months ended September 30, 2008. The Company’s ratio of non-interest expense to average assets increased to 4.34% in the third quarter of 2009, from 3.28% in 2008, and its efficiency ratio was 131.94% in 2009, compared to 83.72% in 2008.

Income Tax Expense. The Company recognized a net income tax benefit of $246,000 for the three months ended September 30, 2009, compared to a net benefit of $244,000 during the three months ended September 30, 2008. The effective tax benefit rate for the three months ended September 30, 2009, was 39.7%, compared to 36.7% during the same quarter last year. During the three months ended September 30, 2009, the Company reduced its valuation allowance against deferred income tax assets related to certain stock benefit plans and capital losses by $18,000, to $172,000 at September 30, 2009, from $190,000 at June 30, 2009, which resulted in the increase in the effective tax benefit rate. Management established the valuation allowance during the second quarter of 2009 because it could not forecast a reversal of these specific timing differences in the foreseeable future. Management expects to realize the remaining deferred tax assets based on the Company’s long history of pretax income, available net operating loss carry-backs to 2008 and 2007, and its expectation that the current period losses attributable to loan foreclosures and real estate owned will be resolved in the foreseeable future.

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 September 30, 2009 and 2008. 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.

	For the Three Months Ended September 30,
	2009							2008
	Average Outstanding Balance		Interest		Yield/Rate			Average Outstanding Balance		Interest		Yield/Rate
Interest-earning assets:
Loans	$	45,862	$	675		5.89	%	$	54,192	$	829		6.12	%
Securities available for sale		9,637		106		4.40			13,738		156		4.54
Interest-earning deposits		5,546		0		0.00			2,503		11		1.76
Total interest-earning assets		61,045	$	781		5.12	%		70,433	$	996		5.66	%
Non-interest-earning assets		8,600							3,609
Total assets	$	69,645						$	74,042
Interest-Bearing Liabilities:(1)
Savings deposits	$	18,986	$	52		1.10	%	$	19,064	$	60		1.26	%
Certificates of deposit		20,041		122		2.44			20,342		169		3.32
Total interest-bearing deposits		39,027		174		1.78			39,406		229		2.32
Federal Home Loan Bank advances		5,000		45		3.60			6,293		59		3.75
Total interest-bearing liabilities.		44,027		219		1.99	%		45,699		288		2.52	%
Non-interest-bearing liabilities.		2,224							2,346
Total liabilities		46,251							48,045
Stockholders’ equity		23,394							25,997
Total liabilities and stockholders’ equity	$	69,645						$	74,042
Net interest income			$	562						$	708
Net interest rate spread(2)						3.13	%						3.14	%
Net interest-earning assets(3)	$	17,018						$	24,734
Net interest margin(4)						3.68	%						4.02	%
Ratio of interest-earning assets to interest-bearing liabilities						138.65	%						154.12	%

(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 Nine Months Ended September 30, 2009 and 2008

General. The Company had a net loss of $1.2 million for the nine months ended September 30, 2009, compared to a net loss of $509,000 for the nine months ended September 30, 2008. Our interest income decreased $467,000, to $2.6 million for the nine months ended September 30, 2009, from $3.0 million for the nine months ended September 30, 2008, primarily due to uncollected interest on nonaccrual loans and a reduction in the average balance of loans and investment securities. This was partially offset by a $205,000 decrease in our cost of funds, to $722,000 in 2009, from $927,000 in 2008. Our net interest income decreased $262,000, to $1.8 million for the nine months ended September 30, 2009, from $2.1 million for the nine months ended September 30, 2008.

The provision for loan losses increased $628,000, to $1.2 million for the nine months ended September 30, 2009, from $553,000 for the nine months ended September 30, 2008, and there was also a $139,000 write down of real estate owned during the first nine months of 2009 and none in 2008.

Non-interest income increased to $6,000 for the nine months ended September 30, 2009, from a loss of $485,000 for the nine months ended September 30, 2008, primarily due to $524,000 in net securities gains and write downs in 2008 that were not repeated in 2009.

Compensation and benefits increased $7,000, or $1.1 million for the first nine months of both 2009 and 2008. Occupancy costs increased $11,000, to $133,000 for this period, from $122,000 for this period last year, primarily due to building maintenance on existing facilities done during the construction period of our new drive-up facility. Data processing costs increased $23,000, to $108,000 for the nine months ended September 30, 2009, compared to $85,000 for this period last year, primarily due to new products and services being offered, including interest-bearing checking accounts and on-line banking and bill pay.

Professional fees increased $151,000, to $436,000 for the nine months ended September 30, 2009, from $285,000 for the nine months ended September 30, 2008, primarily due to increased audit and consulting costs related to regulatory compliance, and $115,000 in increased legal fees related to loan foreclosures.

Real estate owned expense was $293,000 for the nine months ended September 30, 2009. This expense was primarily attributable to depreciation in the fair value of real estate owned during the nine months ended September 30, 2009, resulting in a valuation allowance of $139,000 recorded as a charge to real estate owned expense.

Other expenses increased $32,000, to $266,000 for the nine months ended September 30, 2009, from $234,000 for the nine months ended September 30, 2008, primarily due to a $34,000 increase in FDIC insurance premiums, including a $25,000 special assessment by FDIC at June 30, 2009.

The annualized return on average assets was (2.35)% for the nine months ended September 30, 2009, compared to (0.92)% for the same period last year, and the annualized return on average equity was (6.94)% and (2.55)%, respectively, for these two periods.

Interest Income. Interest and dividend income decreased $467,000, or 15.5%, to $2.6 million for the nine months ended September 30, 2009, compared to $3.0 million for the nine months ended September 30, 2008. The decrease resulted from a $6.2 million, or 8.9%, decrease in the average balance of interest-earning assets, to $64.2 million in the first nine months of 2009, compared to $70.4 million in the first nine months of 2008, and to a decrease of 41 basis points in the average yield on interest earning assets, to 5.31% in 2009, from 5.72% in 2008.

Interest income and fees from loans receivable decreased $271,000, or 11.0%, to $2.2 million for the nine months ended September 30, 2009, from $2.5 million for the nine months ended September 30, 2008. The decrease resulted primarily from a $5.1 million, or 9.6% decrease in the average balance of loans receivable, to $48.0 million for the nine months ended September 30, 2009, from $53.1 million for the nine months ended September 30, 2008. The decrease in average balances of loans was due primarily to lack of demand from qualified borrowers during this period of uncertainty in the local residential real estate market. There was a decrease of 10 basis points in the average yield on loans receivable, to 6.08% in 2009, from 6.18% in 2008. The reserve for uncollected interest on loans 90 days or more past due increased $171,000 during the first nine months of 2009, compared to $135,000 during the first nine months of 2008.

Interest and dividend income from securities and interest-earning deposits decreased $196,000, or 35.0%, to $364,000 for the nine months ended September 30, 2009, from $560,000 for the nine months ended September 30, 2008. The primary reasons for the decrease were a $3.9 million, or 26.8%, decrease in average balances of securities, to $10.8 million in 2009, from $14.7 million in 2008, as well as a 20 basis point decrease in average yield to 4.49% in 2009, from 4.69% in 2008. While the average balance of interest earning deposits, primarily at the FHLB of Chicago, increased $2.8 million, or 108.1%, to $5.4 million in 2009, compared to $2.6 million in 2008, the average rate earned decreased by 215 basis points, to 0.02% in 2009, from 2.17% in 2008. Management decided it was prudent to maintain a higher level of readily available funds during this period despite the low rate of interest on these deposits.

Interest Expense. Interest expense on deposits decreased $181,000, or 24.1%, to $570,000 for the nine months ended September 30, 2009, from $751,000 for the nine months ended September 30, 2008. The decrease in interest expense was due primarily to a 59 basis point decrease in the average rate paid on deposits, to 1.95% for the nine months ended September 30, 2009, from 2.54% for the nine months ended September 30, 2008. Interest expense on certificates of deposit decreased $169,000, or 29.3%, to $407,000 in 2009, from $576,000 in 2008, primarily because of a decrease in the average rate paid on certificates of deposit of 105 basis points, to 2.70% in 2009, from 3.75% in 2008.

Interest expense on FHLB advances decreased $24,000, or 13.6%, to $152,000 for the nine months ended September 30, 2009, compared to $176,000 for the nine months ended September 30, 2008. The decrease was due primarily to a 42 basis point decrease in the average rate paid on advances, to 3.60% in 2009, from 4.02% in 2008. The overall average cost of funds decreased 58 basis points, to 2.15% in 2009, from 2.73% in 2008.

Net Interest Income. Net interest income decreased $262,000, or 12.5%, to $1.8 million for the nine months ended September 30, 2009, from $2.1 million for the same period last year. Our net interest margin decreased 16 basis points, to 3.81% in 2009, from 3.97% in 2008. A 41 basis point decrease in the average yield on interest-earning assets, to 5.31% in 2009, from 5.72% in 2008, and a decrease of $6.2 million in the average balance of interest-earning assets, both contributed to interest income decreasing by $467,000. The average rate paid on interest-bearing liabilities decreased to 2.15% in 2009, from 2.73% in 2008, with the average balance of interest-bearing liabilities decreasing $550,000, and with interest expense decreasing by $205,000. The interest rate spread between interest earning assets and interest bearing liabilities increased 17 basis points, to 3.16% in 2009, from 2.99% in 2008.

Provision for Loan Losses. During the nine months ended September 30, 2009, management provided $1.2 million for losses on loans, compared to $553,000 for the nine months ended September 30, 2008, based on its quarterly evaluation of the level of the allowance necessary to absorb probable incurred loan losses at September 30, 2009. 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.

During the nine months ended September 30, 2009, non-performing (non-accrual) loans decreased $53,000, to $2.9 million at September 30, 2009, from $3.0 million at December 31, 2008. Loans delinquent 60-89 days were $1.8 million at September 30, 2009, decreasing $429,000, from $2.2 million at December 31, 2008. Gross loans receivable decreased $6.4 million, or 12.1%, to $46.5 million at September 30, 2009, from $52.9 million at December 31, 2008. During this period, one- to four-family residential mortgage loans decreased $5.2 million, or 15.9%, and multi-family residential mortgage loans decreased $1.2 million, or 6.0%.

There were $2.0 million in transfers of one-to-four family properties to real estate owned, acquired through foreclosure, and $250,000 in transfers of multifamily properties, during the first nine months of 2009. The allowance for loan losses decreased $113,000, to $1.2 million at September 30, 2009, from $1.3 million at December 31, 2008, following net charge-offs of $1.3 million on foreclosed residential mortgages and a provision of $1.2 million for the nine months ended September 30, 2009. Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a gross carrying amount of $2.9 million, with specific valuation allowances of $369,000 at September 30, 2009. At December 31, 2008, impaired loans had a gross carrying amount of $3.8 million, with specific valuation allowances of $850,000.

At September 30, 2009, the allowance for loan losses was $1.2 million, or 2.53% of gross loans receivable, compared to $1.3 million, or 2.43% of gross loans receivable at December 31, 2008. At September 30, 2009, specific allowances of $369,000 were 12.72% of non-performing loans, compared to 28.78% of non-performing loans at December 31, 2008. The ratio of specific reserves to non-performing loans will fluctuate quarter to quarter as non-performing loans are charged off, transferred to real estate owned, or underlying collateral values change. At September 30, 2009, the general valuation allowance was increased by $368,000, to $805,000, or 1.85% of performing loans, compared to $437,000, or 0.88% of performing loans at December 31, 2008. The increase was due primarily to an increase in our historical loss experience.

Non-interest Income. Non-interest income was $6,000 for the nine months ended September 30, 2009, compared to a loss of $485,000 for the nine months ended September 30, 2008. During the nine months ended September 30, 2009, the Company recorded a $24,000 fair value write down to mutual funds carried as trading securities, compared to a $294,000 fair value write down on these mutual funds recorded during the same period last year. During the nine months ended September 30, 2008, the Company also recognized a $382,000 loss for other than temporary impairment of FHLMC preferred stock held as available-for-sale. Partially offsetting these recognized losses in 2008, the Company sold its remaining shares of FHLMC common stock and realized a gain of $152,000.

Non-interest Expense. Non-interest expense increased $517,000, or 28.0%, to $2.4 million for the nine months ended September 30, 2009, compared to $1.8 million for the nine months ended September 30, 2008. Compensation and employee benefits increased $7,000, or 0.6%, to $1.1 million in 2009, from a similar $1.1 million in 2008. Occupancy costs increased $11,000, or 9.0%, to $133,000 for the nine months ended September 30, 2009, compared to $122,000 in 2008, primarily due to building maintenance on existing facilities done during the construction period of our new drive-up facility.

Data processing costs increased $23,000, or 27.1%, to $108,000 for the nine months ended September 30, 2009, compared to $85,000 for this period last year, primarily due to new products and services being offered, including interest-bearing checking accounts and on-line banking and bill pay.

Professional fees increased $151,000, or 53.0%, to $436,000 for the nine months ended September 30, 2009, from $285,000 for the nine months ended September 30, 2008, primarily due to increased audit and consulting costs related to regulatory compliance and increased legal fees related to loan foreclosures. Audit costs increased $40,000, to $134,000 for the nine months ended September 30, 2009, compared to $94,000 for the nine months ended September 30, 2008, primarily due to increased costs of compliance with Section 404(b) of the Sarbanes-Oxley Act. Compliance consulting costs increased $3,000, to $57,000 for the first nine months of 2009, compared to $54,000 for the first nine months of 2008. Legal costs increased $107,000, to $244,000 in 2009, from $137,000 in 2008, primarily due to $115,000 in legal costs related to foreclosures during the first nine months of 2009, compared to none in 2008.

Real estate owned expense was $293,000 for the nine months ended September 30, 2009, compared with none incurred in 2008. This expense was primarily attributable to $139,000 in fair value write downs on real estate owned subsequent to acquisition, and to real estate taxes accrued on properties recently acquired through foreclosure, and to other expenses such as maintenance and insurance.

Other expenses increased $32,000, or 13.7%, to $266,000 for the nine months ended September 30, 2009, from $234,000 for the nine months ended September 30, 2008, primarily due to a $34,000 increase in FDIC insurance premiums, including a $25,000 special assessment by FDIC at June 30, 2009.

The Company’s ratio of non-interest expense to average assets increased to 4.46% in the first nine months of 2009, from 3.33% in 2008, and its efficiency ratio was 127.0% in 2009, compared to 86.6% in 2008.

Income Tax Expense. The Company recognized a net income tax benefit of $459,000 for the nine months ended September 30, 2009, compared to a net benefit of $282,000 during the nine months ended September 30, 2008. During the nine months ended September 30, 2009, the Company established a $172,000 valuation allowance against deferred income tax assets of approximately $1.1 million, based on timing differences related to certain stock benefit plans and capital losses. Management established the valuation allowance because it could not forecast a reversal of these specific timing differences in the foreseeable future. Management expects to realize the remaining deferred tax assets based on the Company’s long history of pretax income, available net operating loss carry-backs to 2008 and 2007, and its expectation that the current period losses attributable to loan foreclosures and real estate owned will be resolved in the foreseeable future.

Average Balance Sheet

The following table sets forth average balance sheets, average annualized yields and costs, and certain other information for the nine months ended September 30, 2009 and 2008. 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.

	For the Nine Months Ended September 30,
	2009							2008
	Average Outstanding Balance		Interest		Yield/Rate			Average Outstanding Balance		Interest		Yield/Rate
Interest-earning assets:
Loans	$	48,025	$	2,191		6.08	%	$	53,106	$	2,462		6.18	%
Securities available for sale		10,778		363		4.49			14,718		518		4.69
Interest-earning deposits		5,365		1		0.02			2,578		42		2.17
Total interest-earning assets		64,168	$	2,555		5.31	%		70,402	$	3,022		5.72	%
Non-interest-earning assets		6,549							3,596
Total assets	$	70,717						$	73,998
Interest-Bearing Liabilities:(1)
Savings deposits	$	18,951	$	163		1.15	%	$	18,918	$	175		1.23	%
Certificates of deposit		20,121		407		2.70			20,502		576		3.75
Total interest-bearing deposits		39,072		570		1.95			39,420		751		2.54
Federal Home Loan Bank advances		5,630		152		3.60			5,832		176		4.02
Total interest-bearing liabilities.		44,702		722		2.15	%		45,252		927		2.73	%
Non-interest-bearing liabilities.		2,038							2,151
Total liabilities		46,740							47,403
Stockholders’ equity		23,977							26,595
Total liabilities and stockholders’ equity	$	70,717						$	73,998
Net interest income			$	1,833						$	2,095
Net interest rate spread(2)						3.16	%						2.99	%
Net interest-earning assets(3)	$	19,466						$	25,150
Net interest margin(4)						3.81	%						3.97	%
Ratio of interest-earning assets to interest-bearing liabilities						143.55	%						155.58	%

(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. 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 September 30, 2009, $7.1 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 nine months ended September 30, 2009, net loan repayments totaled $3.1 million, due primarily to lack of demand from qualified borrowers during this period of uncertainty in the local residential real estate market. During the nine months ended September 30, 2008, net loan originations totaled $912,000. We do not sell loans. Cash received from principal repayments and calls and maturities of securities totaled $2.9 million for the nine months ended September 30, 2009 and 2008. During the nine months ended September 30, 2009, we sold shares in three mutual funds for proceeds of $750,000, incurring a realized loss of $174,000 in order to reduce our exposure to these securities. We did not purchase any securities during 2009. We purchased $641,000 in securities during the nine months ended September 30, 2008, and sold $160,000 in FHLMC common stock for a gain of $152,000 during this period.

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 $724,000 for the nine months ended September 30, 2009, and a net decrease of $339,000 during this same nine month period in 2008.

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 nine months ended September 30, 2009, the Company repaid $1.0 million in advances from the Federal Home Loan Bank. Our available borrowing limit is $12.2 million, an additional $7.2 million over the $5.0 million borrowed at September 30, 2009.

During the nine months ended September 30, 2009, we repurchased 67,044 shares of our common stock for $588,000, under a share repurchase program. During the same period last year, we repurchased 60,000 shares for $664,000.

At September 30, 2009, we had no outstanding commitments to originate loans. At September 30, 2009, certificates of deposit scheduled to mature in less than one year totaled $19.7 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.

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. However, we had no outstanding commitments to make loans at September 30, 2009, or December 31, 2008.

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 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 June 30, 2009, 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 Interest Rates (Basis Points)		NPV								Net Portfolio Value as a Percentage of Present Value of Assets
Change In Interest Rates (Basis Points)		Estimated NPV		Amount of Change			Percentage Change			NPV Ratio			Change in Basis Points
(dollars in thousands)
	+300	$	18,790	$	(4,527	)		-19	%		27.44	%		-426	bp
	+200		20,357		(2,960	)		-13			28.99			-271
	+100		21,921		(1,396	)		-6			30.46			-124
	+50		22,643		(674	)		-3			31.11			-59
Unchanged			23,316		—			—			31.70			—
	-50		23,946		629			+3			32.24			+53
	-100		24,514		1,198			+5			32.71			+101

The table above indicates that at June 30, 2009, in the event of a 100 basis point decrease in interest rates, we would experience a 5% increase in net portfolio value. In the event of a 200 basis point increase in interest rates, we would experience a 13% 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 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’s disclosure controls and procedures (as such term is defined under Rule 13a-15(e) of the Exchange Act) were effective, in all material respects.

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.

PART II. – OTHER INFORMATION

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 1A. Risk Factors.

The Company has included in Part I, Item 1A of its Annual Report on Form 10-K for the year ended December 31, 2008 and in Part II, Item 1A of its Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2009, descriptions of certain risks and uncertainties that could affect the Company’s business, operating results and financial condition (“Risk Factors”). In addition to all the other information contained in the reports the Company files with the SEC, including in this Form 10-Q, investors should consider the risks described in the Risk Factors prior to making an investment decision with respect to the Company’s stock. The risks described in our Risk Factors, however, are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently consider immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

None

Item 3. Defaults Upon Senior Securities.

None

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

None

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.

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: November 13, 2009	MUTUAL FEDERAL BANCORP, INC. By: /s/Stephen M. Oksas Stephen M. Oksas President and Chief Executive Officer
Date: November 13, 2009	By: /s/John L. Garlanger John L. Garlanger Chief Financial Officer

EXHIBIT INDEX

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

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Mutual Federal Bancorp (MFDB) Inactive 10-Q2009 Q3 Quarterly report

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