ES Bancshares (ESBS) 10-Q 2008 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

_______________________________________

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

 OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

ES BANCSHARES, INC.

(Exact name of small business issuer as specified in its charter)

MARYLAND	20-4663714
(State or other jurisdiction of Incorporation or organization)	(I.R.S. Employer Identification No.)

68 North Plank Road, Newburgh, New York 12550

(Address of principal executive offices)

(866) 646-0003

Issuer’s telephone number, including area code:

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

Indicate by check mark whether the registrant is a large 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 o	Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.      YES o  NO x.

State the number of shares outstanding of each of the issuer’s classes of common equity as of the latest practicable date.

As of October 22, 2008 there were 1,825,075 issued and outstanding shares of the Registrant’s Common Stock.

ES BANCSHARES, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD SEPTEMBER 30, 2008

PART I – FINANCIAL INFORMATION

		PAGE
Item 1.	Financial Statements (Unaudited)
	Consolidated Balance Sheets at September 30, 2008 and December 31, 2007	2
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2008, and 2007	3
	Consolidated Statement of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2008 and 2007	4
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007	5
	Notes to Unaudited Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	22
Item 4T.	Controls and Procedures	23
PART 11 – OTHER INFORMATION
Item 1.	Legal Procedures	23
Item 1A.	Risk Factors	23
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 3.	Defaults Upon Senior Securities	24
Item 4.	Submission of Matters to a Vote of Security Holders	24
Item 5.	Other Information	24
Item 6.	Exhibits	24
	Signatures	25

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Part 1. Item 1.

ES BANCSHARES, INC

CONSOLIDATED BALANCE SHEET

(Unaudited)

	September 30, 2008			December 31, 2007
	(Dollars in thousands)
ASSETS
Cash and cash equivalents:
Cash and due from banks	$	2,296		$	2,016
Due from Federal Home Loan Bank of New York		7,343			5
Federal funds sold		10			4,731
Total cash and cash equivalents		9,649			6,752
Certificates of deposit at other financial institutions		3,985			5,794
Securities:
Available for sale, at fair value		5,020			7,037
Held to maturity, at amortized cost
(fair value of $22,268 at September 30, 2008)		22,598			—
Total securities		27,618			7,037
Real estate mortgage loans held for sale		—			350
Loans receivable, net
Real estate mortgage loans		59,263			41,519
Commercial and lines of credit		16,647			14,335
Home equity and consumer loans		8,826			8,714
Construction loans		4,580			7,137
Deferred cost		491			364
Allowance for loan losses		(748	)		(624	)
Total loans receivable, net		89,059			71,445
Accrued interest receivable		592			515
Federal Reserve Bank stock		299			324
Federal Home Loan Bank stock		538			89
Goodwill		581			581
Office properties and equipment, net		672			838
Other assets		390			191
Total assets	$	133,383		$	93,916
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits:
Non-interest bearing	$	11,903		$	7,249
Interest bearing		100,537			75,093
Borrowed funds		10,307			89
Accrued interest payable		175			103
Other liabilities		1,206			1,000
Total liabilities		124,128			83,534
Commitments and contingencies
Stockholders’ equity
Capital stock (par value $0.01; 5,000,000 shares authorized;
1,823,475 shares issued at September 30, 2008 and
1,721,437 shares issued at December 31, 2007)		18			17
Additional paid-in-capital		17,606			16,911
Accumulated deficit		(8,092	)		(6,553	)
Accumulated other comprehensive income / (loss)		(277	)		7
Total stockholders’ equity		9,255			10,382
Total liabilities and stockholders’ equity	$	133,383		$	93,916

See accompanying notes to financial statements

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ES BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

(Unaudited)

(In thousands, except per share data)

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2008			2007			2008			2007
Interest and dividend income:
Loans	$	1,354		$	1,317		$	3,786		$	3,738
Securities		335			105			714			296
Certificates of deposit		36			81			172			243
Fed Funds and other earning assets		46			121			149			400
Total interest and dividend income		1,771			1,624			4,821			4,677
Interest expense:
Deposits		771			933			2,138			2,701
Borrowed funds		80			2			150			4
Total interest expense		851			935			2,288			2,705
Net interest income		920			689			2,533			1,972
Provision for loan losses		46			27			129			36
Net interest income after provision for loan losses		874			662			2,404			1,936
Non-interest income:
Service charges and fees		132			71			339			225
Net gain on sales of real estate mortgage
loans held for sale		13			69			51			135
Net gain on securities available for sale		—			—			7			—
Other		69			33			111			57
Total non-interest income		214			173			508			417
Non-interest expense:
Compensation and benefits		605			520			1,756			1,455
Occupancy and equipment		192			156			597			472
Data processing service fees		66			52			196			136
Loss on CD		900			—			900			—
Other		354			245			1,002			755
Total non-interest expense		2,117			973			4,451			2,818
Net (loss) before income taxes		(1,029	)		(138	)		(1,539	)		(465	)
Income tax expense		—			—			—			—
Net (loss)	$	(1,029	)	$	(138	)	$	(1,539	)	$	(465	)
Other comprehensive income (loss):
Net unrealized gain/(loss) on available-for-sale securities		(248	)		45			(284	)		74
Comprehensive income (loss)	$	(1,277	)	$	(93	)	$	(1,823	)	$	(391	)
Weighted average:
Common shares		1,767,333			1,721,336			1,736,847			1,720,115
(Loss) per common share:
Basic & diluted	$	(0.58	)	$	(0.08	)	$	(0.89	)	$	(0.27	)

See accompanying notes to financial statements

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ES BANCSHARES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

(Unaudited)

(In thousands of dollars except, share data)

	Capital Stock Shares		Amount		Additional Paid-In Capital		Accumulated Deficit			Accumulated Other Comprehensive (Loss)			Total
Balance at January 1, 2007		1,719,227	$	17	$	16,869	$	(5,845	)	$	(99	)	$	10,942
Exercise of stock warrants		2,210		—		22		—			—			22
Stock based compensation, net		—		—		15		—			—			15
Comprehensive loss:
Net loss for the period		—		—		—		(465	)		—			(465	)
Net unrealized gain on available-for-sale securities		—		—		—		—			74			74
Total comprehensive loss														(391	)
Balance at September 30, 2007		1,721,437	$	17	$	16,906	$	(6,310	)	$	(25	)	$	10,588
Balance at January 1, 2008		1,721,437	$	17	$	16,911	$	(6,553	)	$	7		$	10,382
Exercise of stock warrants		102,038		1		688		—			—			689
Stock based compensation, net		—		—		7		—			—			7
Comprehensive loss:
Net loss for the period		—		—		—		(1,539	)		—			(1,539	)
Net unrealized (loss) on available-for-sale securities		—		—		—		—			(284	)		(284	)
Total comprehensive loss														(1,823	)
Balance at September 30, 2008		1,823,475	$	18	$	17,606	$	(8,092	)	$	(277	)	$	9,255

See accompanying notes to financial statements

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ES Bancshares, Inc.

CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

	For the Nine Months
	Ended September 30,
	2008			2007
	(In thousands)
Cash flows from operating activities:
Net loss for period	$	(1,539	)	$	(465	)
Adjustments to reconcile net losses to net cash provided by operating activities:
Provision for loan losses		129			36
Depreciation expense		251			130
Amortization of deferred fees, discounts and premiums, net		(9	)		2
Net originations on loans held for sale		402			(4	)
Net gain on sale of real estate mortgage loans held for sale		(51	)		(135	)
Net (gain) on sale of securities available for sale		(7	)		—
Gain on sale of fixed assets		(9	)		—
Stock compensation expense		7			15
Loss of uninsured deposit at failed financial institution		900			—
Changes in assets and liabilities
Increase in other assets		(276	)		(152	)
Increase in accrued expenses and other liabilities		278			449
Net cash used in operating activities		76			(124	)
Cash flows from investing activities:
Maturity and redemption of CDs at other financial institutions		8,009			6,645
Purchase of cerfificates of deposit at other financial institutions		(7,102	)		(6,694	)
Purchase of available-for-sale securities		(2,929	)		(3,500	)
Purchase of held-to-maturity securities		(23,250	)		—
Proceeds on sale of securities available for sale		506			—
Proceeds from principal payments and maturities/calls of securities		4,823			2,947
Proceeds on sale of fixed assets		9			—
Net disbursements for loan originations		(17,742	)		(10,248	)
Purchase of Federal Home Loan Bank stock		(463	)		(89	)
Redemption of Federal Home Loan Bank stock		14			—
Redemption of Federal Reserve Bank stock		26			11
Leasehold improvements and acquisitions of capital assets		(85	)		(107	)
Net cash used in investing activities		(38,184	)		(11,035	)
Cash flows from financing activities:
Net increase in deposits		30,098			4,495
Proceeds of advance from line of credit & FHLB		10,525			31
Repayment of advances		(307	)		—
Proceeds from stock issuance		689			22
Net cash provided by financing activities		41,005			4,548
Net increase (decrease) in cash and cash equivalents		2,897			(6,611	)
Cash and cash equivalents at beginning of period		6,752			14,343
Cash and cash equivalents at end of period	$	9,649		$	7,732
Supplemental cash flow information
Interest paid	$	2,705		$	2,705
Income taxes paid	$	—		$	—

See accompanying notes to financial statements

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ES BANCSHARES, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

Note 1.   Commencement of Operations

On April 28, 2004, Empire State Bank, NA (the “Bank”) sold 1,650,000 shares of its common stock at a price of $10.00 per share, for an aggregate consideration of $16,500,000 (the “Offering”).  In addition, for every five (5) shares of common stock purchased by a subscriber in the offering, such subscriber received a warrant to purchase, within a three-year period, one (1) share of common stock at an exercise price of $12.50 per share.  The Bank commenced operations on June 28, 2004.

Note 2.   Holding Company Formation

On August 15, 2006, the Bank reorganized into a one-bank holding company structure (the “Reorganization”).  In connection with the Reorganization, the Bank formed ES Bancshares, Inc. (the “Company”), a Maryland corporation, to serve as the holding company.  The Reorganization was effected by an exchange of all of the outstanding shares of Bank Common Stock for shares of Company Common Stock (the “Share Exchange”).  Following the Share Exchange, the Bank became a wholly-owned subsidiary of the Company and former shares of Bank Common Stock represent the same number of shares of Company Common Stock.

Note 3.   Basis of Presentation

The consolidated financial statements included herein include the accounts of the Company and the Bank, subsequent to the elimination of all significant intercompany balances and transactions, and have been prepared by the Company without audit.  In the opinion of management, the unaudited financial statements include all adjustments, consisting of normal recurring accruals, necessary (i) so that such statements are not misleading and (ii) for a fair presentation of the financial position and results of operations, for the periods presented.  Certain information and footnote disclosures normally included in accordance with generally accepted accounting principles of the United States have been condensed or omitted pursuant to the rules and regulations of the SEC, however, the Company believes that the disclosures are adequate to make the information presented not misleading.  The operating results for the periods presented are not necessarily indicative of results to be expected for any other interim period or for the entire fiscal year ending December 31, 2008.  The unaudited interim financial statements presented herein should be read in conjunction with the annual financial statements of the Company as of and for the fiscal year ended December 31, 2007, included in Form 10-KSB filed with the SEC.

The financial statements have been prepared in conformity with generally accepted accounting principles of the United States.  In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, income and expense.  Actual results could differ significantly from these estimates.  Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans, and the valuation allowance on deferred tax assets.

Note 4.   Stock Based Compensation

Warrants

Effective June 30, 2008 the Company modified the terms of the warrants to purchase common stock of the Company attached to the 2004 Offering by reducing the exercise price of $10.00 to $6.75, and extended the expiration date from June 28, 2008 to October 31, 2008.  Previously, on April 15, 2007, the Company modified the original expiration term of the warrants from June 28, 2007 to June 28, 2008 and reduced the original exercise price from $12.50 to $10.00.  During the three-month period ending on

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September 30, 2008 there were 29,890 stockholder warrants exercised at $6.75, which left 297,800 stockholder warrants still outstanding at September 30, 2008.

Also effective June 30, 2008, the Company reduced the exercise price of its 190,000 issued and outstanding organizer warrants from $10.00 to $6.75 for a period ending on October 31, 2008 after which the exercise price will revert back to $10.00 per share.  The organizer warrants, which had an original exercise price of $10.00 per share and expiration date of June 28, 2009, were granted to the Bank’s organizers in connection with the opening of the Bank.  The organizer warrants were valued at $323,000 and were expensed at the time of issuance in accordance with FAS 123.   There was no additional expense recognized as a result of any of the modifications.  During the three-month period ending on September 30, 2008 there were 72,148 organizer warrants exercised at $6.75, which left 117,852 organizer warrants still outstanding at September 30, 2008.

Stock Options

On October 19, 2004 the Board of Directors approved the adoption of the Company’s Stock Option Plan which allows for 180,000 options.  These options have a 10-year term and may be either non-qualified stock options or incentive stock options.  These options were not deemed granted until shareholder approval occurred on May 3, 2005.  The options vest at a rate of 20% on each of five annual vesting dates except for 65,000 options granted to Directors, which vested immediately.  Each option entitles the holder to purchase one share of common stock at an exercise price equal to the fair market value of the stock on the grant date.

The Company accounts for stock options under Statement of Financial Accounting Standards No. 123 (revised 2004) “Share-based Payment” (“SFAS 123(R)”), using the modified prospective transition method.  For accounting purposes, the Company recognizes expense for shares of common stock awarded under the Company’s Stock Option Plan over the vesting period at the fair market value of the shares on the date they are awarded.

Provided below are the assumptions used for grants in 2008, 2007, and 2006.

	2008		2007		2006
Risk free interest rate		3.02%		4.74%		4.35%
Expected option life		5.0		5.0		5.0
Expected stock price volatility		0.10%		0.10%		0.10%
Dividend yield		0.00%		0.00%		0.00%
Weighted average fair value of options granted	$	—	$	—	$	2.20

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A summary of options outstanding under the Bank’s Stock Option Plan as of September 30, 2008, and changes during the nine-month period then ended is presented below.

						Weighted
				Weighted		Average
				Average		Remaining
				Exercise		Contractual		Intrinsic
	Shares			Price		Term (yrs.)		Value
Outstanding at
January 1, 2008		157,750		$	10.47		6.4		—
Granted		5,000			9.00		9.6		—
Exercised		—			—		—		—
Forfieited or expired		(5,000	)		10.50		—		—
Outstanding at
September 30, 2008		157,750		$	10.42		6.5		—
Options exerciseable at
September 30, 2008		106,700		$	10.48		6.3		—
Vested and expected to vest		157,750		$	10.42		6.5		—

As of September 30, 2008, there was $24,804 of total unrecognized compensation cost related to nonvested stock options granted under the Stock Option Plan.  The cost is expected to be recognized over a period of approximately 20 months.

Note 5.   Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period.  Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock warrants and options) were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.  Diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted-average number of shares outstanding for the period plus common-equivalent shares computed using the treasury stock method. None of the 297,800 stockholder warrants, or 117,852 organizer warrants, or 157,750 stock options were considered in computing diluted earnings (loss) per share because to do so would have been antidilutive.

Note 6.   Income Taxes

Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using tax rates.  Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The tax benefit on net operating losses, included in deferred tax assets, was approximately $3.4 million at September 30, 2008.  The net operating losses are being carried forward and will be available to reduce future taxable income.  Realization of deferred tax assets is dependent upon the generation of future taxable income.  A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized.  Because the Bank has no operating history, management recorded a valuation allowance against the total amount of deferred tax assets.

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Note 7.   Non-Performing Assets

Loans are reviewed monthly and any loan whose collectability is doubtful is placed on non-accrual status.  Loans are placed on non-accrual status when either principal or interest is 90 days or more past due, unless, in the judgment of management, the loan is well collateralized and in the process of collection.  Interest accrued and unpaid at the time a loan is placed on non-accrual status is reversed from interest income related to current year income and charged to the allowance for loan losses with respect to income that was recorded in the prior fiscal year.  Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectability of the loan.  We did not have any non-accrual loans nor did we have any troubled debt restructurings (which involved forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates) or foreclosed assets acquired in settlement of loans, at and for the nine-month periods ending September 30, 2008.  At and for the nine-month period ending September 30, 2007, we had one non-accrual loan in the amount of $10,000.

Note 8.   Allowance for Loan Losses

The allowance for loan losses is increased by provisions for loan losses charged to income.  Losses are charged to the allowance when all or a portion of a loan is deemed to be uncollectible.  Subsequent recoveries of loans previously charged off are credited to the allowance for loan losses when realized.

The allowance for loan losses is a significant estimate based upon management’s periodic evaluation of the loan portfolio under current economic conditions, considering factors such as the Company’s past loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, and the estimated value of the underlying collateral.  Establishing the allowance for loan losses involves significant management judgment, utilizing the best available information at the time of review.  Those judgments are subject to further review by various sources, including the Bank’s regulators, who may require the Company to recognize additions to the allowance based on their judgment about information available to them at the time of their examination.  While management estimates loan losses using the best available information, future adjustments to the allowance may be necessary based on changes in economic and real estate market conditions, further information obtained regarding known problem loans, the identification of additional problem loans, and other factors.  Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that in management’s judgment should be charged off.

Note 9.   Adoption of New Accounting Standards

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements.  This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset.  The standard is effective for fiscal years beginning after November 15, 2007.  In February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of FASB Statement No. 157.  This FSP delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.  In October 2008, FASB issued FASB Staff Position (FSP) No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active, which clarifies the application of FASB Statement No. 157, Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.  The impact of adoption was not material.

- 9 - -

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities.  The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities.  The new standard is effective for the Company on January 1, 2008.  The Company did not elect the fair value option for any financial assets or financial liabilities as of January 1, 2008.

On November 5, 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value through Earnings (“SAB 109”).  Previously, SAB 105, Application of Accounting Principles to Loan Commitments, stated that in measuring the fair value of a derivative loan commitment, a company should not incorporate the expected net future cash flows related to the associated servicing of the loan.  SAB 109 supersedes SAB 105 and indicates that the expected net future cash flows related to the associated servicing of the loan should be included in measuring fair value for all written loan commitments that are accounted for at fair value through earnings.  SAB 105 also indicated that internally-developed intangible assets should not be recorded as part of the fair value of a derivative loan commitment, and SAB 109 retains that view.  SAB 109 is effective for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007.   The impact of adoption was not material.

Note 10.   Fair Value

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

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

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

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

The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used 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).

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

	September 30		Identical Assets		Inputs		Inputs
	2008		(Level 1)		(Level 2)		(Level 3)
Assets
Available for sale securities	$	5,020	$	—	$	5,020	$	—

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Note 11.   Commitments and Contingencies

Legal Proceedings

The Company has not been a party to any legal proceedings, which may have a material effect on the Company’s results of operations and financial condition.  However, in the normal course of its business, the Company may become involved as plaintiff or defendant in proceedings such as judicial mortgage foreclosures and proceedings to collect on loan obligations and to enforce contractual obligations.

Operating Lease Commitments

The Company is obligated under non-cancelable operating leases for its main office location in Newburgh, New York and its branch office locations in New Paltz, New York and Staten Island, New York.  The leases are for initial terms of 10 years, 15 years, and 10 years, respectively and have various renewal options.  Rent expense under operating leases was $74,000 for the three months ended September 30, 2008.  At September 30, 2008, the future minimum rental payments under operating lease agreements for the fiscal years ending December 31 are $67,000 in 2008, $266,000 in 2009, $273,000 in 2010, $276,000 in 2011, $279,000 in 2012 and a total of $1,213,000 for 2013 and thereafter.

Off-Balance Sheet Financial Instruments

The Company’s off-balance sheet financial instruments at September 30, 2008 were limited to loan origination commitments of $12.2 million (including one-to-four family loans held for sale of $2.6 million) and unused lines of credit (principally commercial and home equity lines) extended to customers of $11.9 million.  Substantially all of these commitments and lines of credit have been provided to customers within the Bank’s primary lending area.  Loan origination commitments at September 30, 2008 consisted of adjustable and fixed rate commitments of $10.9 million and $1.3 million respectively, with interest rates ranging from 5.80% to 7.00%.

Item 2.

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

Forward-Looking Statements

This Report on Form 10-Q of the Company includes “forward-looking statements” within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, that are based on the current beliefs of, as well as assumptions made by and information currently available to, the management of the Company.  All statements other than statements of historical facts included in this Report, including, without limitation, statements contained under the caption “Management’s Discussion and Analysis” regarding the Company’s business strategy and plans and objectives of the management of the Company for future operations, are forward-looking statements.  When used in this Report, the words “anticipate,” “believe,” “estimate,” “project,” “predict,” “expect,” “intend” or words or phrases of similar import, as they relate to the Company or the Company’s management, are intended to identify forward-looking statements.  Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, such expectations may not prove to be correct.  All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated, believed, estimated, projected, predicted, expected or intended including risks and uncertainties including changes in economic conditions in our market area, changes in local real estate values, changes in regulatory policies, fluctuations in interest rates, local loan and deposit demand levels, competition, our ability to control expenses, our ability to increase our lower cost deposits, our capital raising efforts, our ability to execute our plan to grow our assets and liabilities and attain profitability, and other factors.  The Company does not intend to update these forward-looking statements.  All subsequent written and oral forward-looking statements

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attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by applicable cautionary statements.

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

Total assets.  Total assets at September 30, 2008 amounted to $133.4 million, representing an increase of $39.5 million, or 42.1%, from $93.9 million at December 31, 2007.  The increase in assets was primarily attributable to a $20.6 million increase in total securities, a $17.6 million increase in total loans receivable, net, and a $2.9 million increase in total cash and cash equivalents, mitigated by a $1.8 million decrease in certificates of deposit at other financial institutions.  We have recently decided to accelerate our growth of assets and liabilities.  This is based on several factors.  First, we believe that, over time, we can achieve better operating results with a larger asset and liability base.  Moreover, we believe that the recent changes in the yield curve provides us with an opportunity to grow at a higher interest rate spread.  Additionally, the recent cutbacks in lending by our competitors provides us with selected opportunities to expand our lending activities, provided that we do so while maintaining high underwriting standards.  Finally, the opening of our full service Staten Island office in November 2007 has provided us with an improved platform to conduct banking operations in that attractive market.

Net loans.   Overall, net loans, increased $17.6 million, or 24.7%, to $89.1 million at September 30, 2008 from $71.4 million at December 31, 2007.  The increase in net loans was primarily attributable to the $17.7 million, or 42.7% increase in commercial and residential real estate mortgage loans, which increased from $41.5 million to $59.3 million.  The $17.7 million net increase included $16.3 million in primarily fixed rate one-to-four family residential real estate loans and $1.5 million in commercial real estate loans.  Commercial loans and commercial lines of credit increased $2.3 million, or 16.1%, from $14.3 million to $16.6 million, and home equity and consumer loans increased $112,000, or 1.3%, from $8.7 million to $8.8 million.  Management believes that the significant increase in loans has increased the Company’s interest rate risk but that the added risk is reasonable as it will result in improved earnings due to the wider spreads now available, and is manageable, as management believes the Company’s balance sheet has the capacity for such added risk.  Over the same nine-month period the above increases were partially offset by a decrease in construction or development loans of $2.5 million, or 35.2%, from $7.1 million to $4.6 million.  We did not have any non-accrual loans, nor any accruing loans contractually past due 90 days or more, nor did we have any troubled debt restructurings (which involved forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates) or foreclosed assets acquired in settlement of loans, at and for the nine-month period ending September 30, 2008.

Total securities.  Total securities at September 30, 2008 increased $20.6 million, or 294.3%, to $27.6 million from $7.0 million at December 31, 2007.  Securities available for sale decreased by $2.0 million, or 28.7%, primarily as the result of prepayments on its Ginnie Mae mortgage-backed securities portfolio coupled with calls of relatively higher-yielding government sponsored agency notes that were called as a result of the recent decline in interest rates.  Securities held to maturity increased by $23.0 million, net, as the Bank invested approximately $18.3 million of its excess deposits and borrowed funds from the Federal Home Loan Bank of New York into Fannie Mae and Freddie Mac pass through mortgage-backed securities and $4.7 million into government sponsored agency notes,which included $1.0 million in Fannie Mae notes and $3.7 million in Federal Home Loan Bank notes.  The expected weighted average lives and yields of the new mortgage backed securities were approximately 6.2 years and 5.09%, respectively, on the date of purchase, while the yield on the government sponsored agency notes was approximately 3.42%, and mature in less than five years.

Certificates of deposit at other financial institutions.  Certificates of deposit at other financial institutions decreased $1.8 million, or 31.0%, to $4.0 million at September 30, 2008 from $5.8 million at December 31, 2007.  All certificates have terms of twelve months or less.  In addition, all of our certificates at September 30, 2008 were in amounts of $100,000 or less.

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Cash and cash equivalents.  Total cash and cash equivalents at September 30, 2008 increased $2.8 million, or 41.2%, to $9.6 million from $6.8 million at December 31, 2007, to ensure that sufficient liquidity was readily available to meet the Company’s immediate funding needs.

Federal Home Loan Bank stock.  As a result of its utilization of secured advances from the Federal Home Loan Bank of New York, the Bank increased its investment in Federal Home Loan Bank of New York capital stock from $89,000 at December 31, 2007 to $538,000 at September 30, 2008.

Deposits.  Interest bearing deposits grew $25.4 million, or 33.8%, to $100.5 million at September 30, 2008 from $75.1 million at December 31, 2007.  The net growth over the nine-month period consisted of a $36.4 million increase in certificates of deposit, a $2.8 million increase in savings accounts and an $780,000 increase in NOW accounts that was partially offset by an $14.6 million decrease in money market accounts. Over the same nine-month period non-interest bearing accounts increased $4.6 million, or 63.0%, from $7.3 million to $11.9 million.  The increases in our various deposit categories reflect our ability to attract and service new deposit relationships in order to support the increases to our total assets.  The decline in money market accounts followed decreases in the interest rate offered on that type of deposit, and depositors elected to transfer balances into higher-yielding certificates of deposit.  A significant contributing factor to the increase in total deposits was the opening of the Bank’s third full service branch office in Staten Island, New York in November 2007.  As of September 30, 2008, 23.7% of the Bank’s total deposits were attributable to this new branch.

Borrowings.  Our borrowings increased from $89,000 at December 31, 2007 to $10.3 million at September 30, 2008 primarily as a result of our borrowing $10.0 million from the Federal Home Loan Bank of New York in five-year amortizing and structured advances to purchase mortgage-backed securities.  At September 30, 2008, the weighted average term to maturity of our borrowings was approximately 3.8 years.

Stockholders’ equity.Stockholders’ equity decreased by $1.1 million to $9.3 million at September 30, 2008 from $10.4 million at December 31, 2007.  The decrease is primarily attributable to a net loss for the nine-month period of $1.5 million and a $284,000 increase in net unrealized loss in market value of securities available-for-sale, that was mitigated by a combined $689,000 in capital stock and  additional paid in capital from warrant holders who exercised their warrants.  The ratio of stockholders’ equity to total assets decreased to 6.9% at September 30, 2008 from 11.1% at December 31, 2007.  Book value per share decreased to $5.08 at September 30, 2008 from $6.03 at December 31, 2007.  See “Liquidity and Capital Resources” for information regarding the Bank’s regulatory capital amounts and ratios.

We recently reduced the exercise price of our two classes of warrants in an effort of raising a modest amount of additional capital to support our operations and growth plans.  See Note 4 of the Notes to our Consolidated Financial Statements.  In addition, we are considering applying to the United State Treasury (“UST”) to participate in its Capital Purchase Program through the issuance of preferred stock and warrants to the UST.  We would use any capital we receive from the UST to support our plan to grow our assets and liabilities.  While we will focus our growth efforts on loans and deposits, we will also invest in securities and fund our operations through borrowings where justified on an asset/liability management basis.

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Analysis of Net Interest Income

The following tables summarize the Company’s average balance sheets for interest earning assets and interest bearing liabilities, average yields and costs (on an annualized basis), and certain other information for the three and nine-month periods ended September 30, 2008 as compared to the comparable three and nine-month periods ended September 30, 2007.  The yields and costs were derived by dividing interest income or expense by the average balance of assets and liabilitiesfor the period shown.  Substantially all average balances were computed based on daily balances.  The yields include deferred fees and discounts, which are considered yield adjustments.

	For the Three Months Ended September 30,
	2008							2007
	Average Balance			Interest		Average Yield / Cost		Average Balance			Interest		Average Yield /  Cost
	(Dollars in thousands)
Assets
Interest-earning assets:
Loans	$	86,219		$	1,354		6.28%	$	71,504		$	1,317		7.37%
Fed Funds		5,458			28		2.04%		8,772			114		5.16%
Certificates of deposit		6,899			36		2.07%		5,917			81		5.43%
Securities		26,964			335		4.97%		8,297			105		5.06%
Other earning assets		2,391			18		3.01%		468			7		5.98%
Total interest-earning assets		127,931		$	1,771		5.54%		94,958		$	1,624		6.84%
Allowance for loan losses		(708	)						(607	)
Cash & Due from banks		2,757							1,983
Other Non-interest earning assets		2,161							1,915
Total assets	$	132,141						$	98,249
Liabilities and  Stockholders’ Equity
Interest-bearing liabilities:
NOW accounts	$	2,820		$	8		1.13%	$	1,657		$	5		1.20%
Money Market accounts		26,320			140		2.11%		46,958			583		4.93%
Regular savings accounts		13,732			79		2.28%		8,399			76		3.59%
Certficates of Deposit		56,322			544		3.83%		21,294			269		5.01%
Total interest-bearing deposits		99,194			771		3.08%		78,308			933		4.73%
Borrowings		9,951			80		3.19%		84			2		8.25%
Total interest-bearing liabilities	$	109,145		$	851		3.09%	$	78,392		$	935		4.73%
Non-interest-bearing liabilities		13,330							9,003
Total liabilities		122,475							87,395
Stockholders’ equity		9,666							10,854
Total liabilities and stockholders’ equity	$	132,141						$	98,249
Net interest income				$	920						$	689
Average interest rate spread (1)							2.44%							2.11%
Net interest margin (2)							2.88%							2.90%
Net interest-earning assets (3)	$	18,786						$	16,566
Ratio of average interest-earning assets to average interest-bearing liabilities							117.21%							121.13%

(1) Average interest rate spread represents the difference between the yield on average interest-earning assets andand the cost of average interest-bearing liabilities.

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

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

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	For the Nine Months Ended September 30,
	2008							2007
	Average Balance			Interest		Average Yield / Cost		Average Balance			Interest		Average Yield / Cost
	(Dollars in thousands)
Assets
Interest-earning assets:
Loans	$	78,926		$	3,786		6.40%	$	67,737		$	3,738		7.36%
Fed Funds		6,337			115		2.39%		9,734			383		5.19%
Certificates of deposit		6,274			172		3.67%		5,985			243		5.43%
Securities		19,042			714		5.00%		8,034			296		4.91%
Other Earning Assets		1,326			34		3.42%		418			17		5.42%
Total interest-earning assets		111,905		$	4,821		5.76%		91,908		$	4,677		6.80%
Allowance for loan losses		(651	)						(592	)
Cash & Due from banks		2,450							2,018
Other Non-interest earning assets		2,147							1,898
Total assets	$	115,851						$	95,232
Liabilities and  Stockholders’ Equity
Interest-bearing liabilities:
NOW accounts	$	2,355		$	23		1.31%	$	1,232		$	8		0.87%
Money Market accounts		31,289			597		2.55%		47,888			1,785		4.98%
Regular savings accounts		13,086			250		2.55%		6,997			185		3.54%
Certficates of Deposit		41,533			1,268		4.08%		19,267			723		5.02%
Total interest-bearing deposits		88,263			2,138		3.24%		75,384			2,701		4.79%
Borrowings		6,206			150		3.23%		67			4		8.75%
Total interest-bearing liabilities	$	94,469		$	2,288		3.24%	$	75,451		$	2,705		4.79%
Non-interest-bearing liabilities		11,313							8,660
Total liabilities		105,782							84,111
Stockholders’ equity		10,069							11,121
Total liabilities and stockholders’ equity	$	115,851						$	95,232
Net interest income				$	2,533						$	1,972
Average interest rate spread (1)							2.52%							2.01%
Net interest margin (2)							3.03%							2.87%
Net interest-earning assets (3)	$	17,436						$	16,457
Ratio of average interest-earning assets to average interest-bearing liabilities							118.46%							121.81%

(1) Average interest rate spread represents the difference between the yield on average interest-earning assets andand the cost of average interest-bearing liabilities.

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

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

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Comparison of Operating Results for the Quarters Ended September 30, 2008 and September 30, 2007

General.    For the quarter ended September 30, 2008, the Company recognized a net loss of $1.0 million, or ($0.58) per diluted share, as compared to a net loss of $138,000, or ($0.08) per diluted share, for the comparable quarter ended one year earlier.  The $891,000 increase in net loss was primarily attributable to a $900,000 loss of the uninsured principal of a certificate of deposit at Silver State Bank in Henderson, Nevada that failed and was closed by the Nevada Financial Institutions Division and placed into receivership of the Federal Deposit Insurance Corporation on September 5, 2008.  The increased net loss also resulted from increased non-interest operating expense that was mainly related to the opening of a new full service branch during the fourth quarter of 2007, and an increased provision for loan loss that resulted from management’s assessment of the adequacy of the allowance for loan and lease loss.  The increases in expense were partially mitigated by increases in net interest income and non-interest income related to the Company’s larger asset size.

Interest Income.  Interest income increased to $1.8 million for the quarter ended September 30, 2008, an increase of $147,000, or 9.1%, compared to the quarter ended September 30, 2007.  Average interest earning assets increased $32.9 million, or 34.6% to $127.9 million for the quarter ended September 30, 2008 from $95.0 million for the quarter ended September 30, 2007.  However, primarily due to the overall lower interest rate environment in 2008 as compared to 2007, the average yields on interest earning assets fell by 130 basis points to 5.54% for the quarter ended September 30, 2008 from 6.84% for the comparable period in 2007, as incremental earning assets were added at lower yields, and floating rate assets repriced at lower market interest rates.

Average loan balances increased by $14.7 million from $71.5 million for the quarter ended September 30, 2007 to $86.2 million for the quarter ended September 30, 2008, while the average yield decreased from 7.37% to 6.28% over the same respective periods in part due to the percentage of our portfolio consisting of residential mortgage loans.Over the same comparable periods, the average balances of the Company’s investment securities portfolio increased $18.7 million, from $8.3 million to $27.0 million primarily as the result of our large mortgage backed securities purchase in 2008.  Part of the increase in average balances was funded with secured advances obtained from the Federal Home Loan Bank of New York in order to enhance net interest income.  The average yield earned by the securities portfolio decreased to 4.97% for the quarter ended September 30, 2008, from 5.06% for the same quarter ended one year earlier.  The average balance and yield of the Bank’s certificates of deposit at other financial institutions for the quarter ended September 30, 2008 was $6.9 million and 2.07%, respectively, as compared to an average balance of $5.9 million and a yield of 5.43% for the quarter ended September 30, 2007, while the average yield earned on Fed Funds sold during the quarter ended September 30, 2008 decreased to 2.04% as compared to 5.16% earned over the same quarter ended one year earlier.

Interest Expense.  Total interest expense for the quarter ended September 30, 2008 decreased by $84,000 from $935,000 to $851,000 for the same three-month period one year earlier.  The decrease was primarily due to decreases in short-term interest rates, notwithstanding the increase in the average balances of the Company’s interest-bearing deposits and borrowings.  Average money market account balances decreased $20.7 million, from $47.0 million for the quarter ended September 30, 2007 to $26.3 million for the quarter ended September 30, 2008, as management chose to emphasize other funding sources that were deemed more attractive from a cost/duration standpoint.  Over those respective quarters the average costs for those balances decreased 282 basis points, from 4.93% to 2.11%.  The average balances of the Company’s certificates of deposit portfolio increased to $56.3 million at an average cost of 3.83% over the quarter ended September 30, 2008, from $21.3 million at an average cost of 5.01% over the same quarter ended one-year earlier.  Average regular savings account balances increased $5.3 million to $13.7 million for the quarter ended September 30, 2008, from $8.4 million for the quarter ended September 30, 2007, while the average costs decreased 131 basis points, to 2.28% from 3.59%, over the same respective periods.  For the quarter ended September 30, 2008, the average balance of the Company’s borrowed funds was $10.0 million at an average cost of 3.19% as compared to an average

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balance of $84,000 at an average cost of 8.25% one year-earlier.  The increase in borrowed funds was primarily used to help fund the increase in the investment securities portfolio discussed above.

Net Interest Income.  Net interest income was approximately $920,000 for the quarter ended September 30, 2008 as compared to $689,000 for the same quarter in the prior year, an increase of $231,000.  The Company’s average interest rate spread increased to 2.44% for the quarter ended September 30, 2008 from 2.11% for the quarter ended September 30, 2007, while the net interest margin decreased to 2.88% from 2.90%, over the same respective periods.

Provision for Loan Losses.  For the three months ended September 30, 2008 the provision for loan losses was $46,000 as compared to $27,000 for the three months ended September 30, 2007.  The increase resulted primarily because the portfolio’s net loan growth was greater in 2008 than in 2007.  In addition, as a result of management’s analysis of the adequacy of the allowance for loan losses, the Company determined that an increased provision was further warranted due to increased credit risk that has likely resulted from economic weakness in its market area resulting from falling home values, rising unemployment and the spiraling increases in energy and other commodity prices.

Non-interest Income.  Non-interest income for the quarter ended September 30, 2008 was approximately $214,000 as compared to $173,000 for the quarter ended September 30, 2007.  Service charges and fees increased $61,000 from $71,000 in 2007 to $132,000 in 2008 primarily as a result of the Company’s increased number of customer relationships.  The net gain on sale of real estate mortgages held for sale decreased to $13,000 from $69,000 primarily because of a general softening in the overall housing market evident this year relative to last, and because the Company elected to retain more of the real estate mortgage loans that it originated for its own portfolio instead of selling them.  Other non-interest income categories increased to $69,000 from $33,000 primarily from increased annuity sales.

Non-interest Expense.  Non-interest expense for the quarter ended September 30, 2008 increased $1.1 million when compared to the same quarter in 2007.  Compensation and benefits increased $85,000 primarily from the increase in personnel needed to staff the new full-service branch in Staten Island, New York that opened in November 2007.  The new branch office was also primarily responsible for the increase in occupancy and equipment expense and contributed to the increase in data processing fees.

The substantive portion of the overall increase in non-interest expense was attributable to management’s recognition of a $900,000 loss, which was the uninsured portion of a six-month certificate of deposit scheduled to mature on September 8, 2008, that had been invested at Silver State Bank in Henderson, Nevada, that failed on September 5, 2008.  If the Company receives any recovery of the $900,000 uninsured amount, such amount will be added to income from operations.  However, there can be no assurance whether, or when, the Company will receive any recovery of this amount.

Other non-interest expense increased by $109,000 to $354,000 for the quarter ended September 30, 2008 from $245,000 for the quarter ended September 30, 2007.  This increase was primarily due to increases in professional and consulting fees, advertising, FDIC assessments and other operating expenses related to the expansion of the Bank’s business activities.

Income Tax Expense.  We receive no tax benefit from our net operating losses as they are being carried forward and will be available to reduce future taxable income.

Results of Operations for the Nine Months Ended September 30, 2008 and September 30, 2007

General.  For the nine months ended September 30, 2008, the Company recognized a net loss of $1.5 million, or ($0.89) per diluted share, as compared to a net loss of $465,000, or ($0.27) per diluted share, for the comparable nine-month period ended one year earlier.  The $1.1 million increase in net loss was primarily the result of the $900,000 loss recognized on the loss of uninsured principal that had been on deposit at the failed Silver State Bank in Henderson, Nevada, together with the increased operating

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expenses that resulted from the opening of the Company’s third full service branch banking office in November of 2007.

Interest Income.  Interest income for the nine-month period ended September 30, 2008 totaled $4.8 million, which was $144,000 higher than the $4.7 million reported for the nine-month period ended September 30, 2007.  The amount of interest income earned resulted from an increase in average interest-earning assets to $111.9 million for the nine-month period ended September 30, 2008 from $91.9 million for the comparable nine-month period ended one year earlier, and to the lower overall yield associated with those assets.  Over the comparable periods average loan balances increased from $67.7 million to $78.9 million, while their average yield decreased from 7.36% to 6.40%.  The average balances of the investment securities portfolio increased by $11.0 million, from $8.0 million to $19.0 million, while the average balances of its fed funds sold decreased by nearly $3.4 million, from $9.7 million to $6.3 million, over the nine-month period ended September 30, 2008 as compared to the same nine-month period in the previous year.  The yield earned by the investments portfolio increased to 5.00% from 4.91% over the nine-month period ended September 30, 2008 as compared to the nine-month period ended September 30, 2007 primarily from the longer-term and higher-yielding investments purchased since the end of 2007.  The yield earned by the fed funds sold average balances decreased to 2.39% from 5.19% over the same respective periods as a result of the decrease in short-term interest rates commented on earlier.

During the nine-month period ended September 30, 2008 the Company continued to maintain an approximate $6.3 million average balance invested in a variety of certificates of deposit at other financial institutions with maturities ranging from three to twelve months.  Due to the decrease in short-term interest rates available in the marketplace, the average yield of this asset segment decreased from 5.43% during the nine-month period ended September 30, 2007 to 3.67% over the comparable nine-month period in 2008.

Interest Expense.  Total interest expense for the nine-month period ended September 30, 2008 decreased by $417,000 when compared to the nine-month period ended September 30, 2007.  The decrease resulted from the decreases in short-term interest rates, notwithstanding the increase in the average balances of the Bank’s interest-bearing deposits and borrowings.  Average money market account balances decreased $16.6 million, from $47.9 million for the nine-month period ended September 30, 2007 to $31.3 million for the nine-month period ended September 30, 2008.  Over those respective periods the average costs for those balances decreased 243 basis points, from 4.98% to 2.55%.  The average balances of the Bank’s certificates of deposit portfolio increased to $41.5 million at an average cost of 4.08% over the nine-month period ended September 30, 2008, from $19.3 million at an average cost of 5.02% over the same nine-month period ended one-year earlier.  Average regular savings account balances increased $6.1 million to $13.1 million for the nine-month period ended September 30, 2008, from $7.0 million for the nine-month period ended September 30, 2007, while the average costs decreased 99 basis points, to 2.55% from 3.54%, over the same respective periods.  For the nine-month period ended September 30, 2008, the average balance of the Company’s borrowed funds was $6.2 million at an average cost of 3.23% as compared to an average balance of $67,000 at an average cost of 8.75% one year-earlier.  The increase in borrowed funds was primarily used to help fund the increase in the investment securities portfolio discussed above.

Provision for Loan Losses.  The provision for loan losses for the nine months ended September 30, 2008 increased $93,000 compared to the nine months ended September 30, 2007 primarily because of  loan growth, the loan portfolio’s overall risk profile under current market conditions, and from economic weakness in its market areas.

Net Interest Income.  Net interest income was approximately $2.5 million for the nine-month period ended September 30, 2008 as compared to $2.0 million for the nine-month period ended September 30, 2007.  The average interest rate spread increased to 2.52% from 2.01%, while the net interest margin increased to 3.03% from 2.87%, over the same comparable periods

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Non-Interest Income.  Non-interest income for the nine-month period ended September 30, 2008 totaled $508,000, which represented an increase of $91,000 from the $417,000 earned over the nine-month period ended September 30, 2007.  Most of the change resulted from a $114,000 increase in service charges and fees earned from an increased number of deposit and loan customer relationships that was mitigated by an $3,000 decrease in the net gain on the sale of real estate mortgage loans held for sale that decreased because of a decrease in real estate mortgage loan sale activity.  There was also a $54,000 increase in other categories of non-interest income, attributable, primarily, to increased earnings from the sale of annuities.

Non-Interest Expense.  Non-interest expense for the nine-month period ended September 30, 2008 increased $1.6 million to $4.5 million from $2.8 million for the nine-month period ended September 30, 2007.  Compensation and benefits increased $301,000, or 20.7%, from the increase in personnel needed to staff the previously mentioned new full-service branch in Staten Island, New York that opened in November 2007.  The new branch office was also primarily responsible for the increase in occupancy and equipment expense and contributed to the increase in data processing fees.  As previously discussed within the quarterly comparison, the substantive portion of the overall increase in non-interest expense was attributable to management’s recognition of a $900,000 loss, which was the uninsured portion of a six-month certificate of deposit scheduled to mature on September 8, 2008, that had been invested at Silver State Bank in Henderson, Nevada, that failed on September 5, 2008.  If the Company receives any recovery of the $900,000 uninsured amount, such amount will be added to income from operations.  However, there can be no assurance whether, or when, the Company will receive any recovery of this amount.  Other non-interest expense increased by $247,000 to $1.0 million for the nine-month period ended September 30, 2008 from $755,000 for the comparable nine-month period ended September 30, 2007.  This increase was primarily due to increases in professional and consulting fees, advertising, FDIC assessments and other operating expenses related to the expansion of the Bank’s business activities.

Non-Performing Assets

Regulations require that the Company classify its own assets on a regular basis and establish prudent valuation allowances based on such classifications.  There are three classifications for problem assets: substandard, doubtful, and loss.  Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses of substandard assets, with the additional characteristics that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss.  An asset classified loss is considered uncollectible and of such little value that continuance as an asset on the balance sheet of the institution is not warranted.  Assets classified as substandard or doubtful require the Company to establish general allowances for loan losses.  If an asset or portion thereof is classified as loss, the Company must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge off such amount.  On the basis of management’s review, at September 30, 2008, the Bank had $50,000 of assets classified as doubtful.  There were no assets classified as substandard or loss.

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The following table sets forth the activity in the Company’s allowance for loan losses at and for the periods indicated.

	Nine Months Ended						Year Ended
	September 30,						December 31,
	2008			2007			2007
	(dollars in thousands)
Balance at beginning of year	$	624		$	581		$	581
Charge-offs
Real estate mortgage loans		—			—			—
Commerical loans and lines of credit		—			—			—
Home equity and consumer loans		5			—			—
Construction loans		—			—			—
Total charge-offs		5			—			—
Recoveries
Real estate mortgage loans		—			—			—
Commerical loans and lines of credit		—			—			—
Home equity and consumer loans		—			—			—
Construction loans		—			—			—
Total recoveries		—			—			—
Provision for losses		129			36			43
Balance at end of period	$	748		$	617		$	624
Ratio of net charge-offs to average total loans		0.01	%		0.00	%		0.00	%
Ratio of allowance for loan losses to total loans		0.83	%		0.85	%		0.86	%

The following table sets forth the allocation of the Company’s allowance for loan losses at September 30, 2008

	At September 30, 2008
			Percent of
			Loans in
			Category to
Category	Balance		Total Loans
Commercial real estate loans	$	277		46.98	%
Residential mortgage loans		73		20.36	%
Commerical loans and lines of credit		272		18.64	%
Home equity and consumer loans		62		9.88	%
Construction loans		37		4.14	%
Unallocated		27		—
Total allowance for loan loss	$	748		100.00	%

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Liquidity and Capital Resources

The primary sources of funds are deposits, wholesale funding from the Federal Home Loan Bank of New York or other bank borrowings, capital, proceeds from the sale of loans, and principal and interest payments on loans and securities.  While maturities and scheduled payments on loans and securities provide an indication of the timing of the receipt of funds, other sources of funds such as loan prepayments and deposit inflows are less predictable due to the effects of changes in interest rates, economic conditions and competition.

The primary investing activities of the Company are the origination of loans and the purchase of investment securities.  Investing activities are funded primarily by net deposit inflows, sales of loans, principal repayments on loans and securities, and borrowed funds.  For the nine months ended September 30, 2008, the Company originated loans of approximately $43.0 million including real estate mortgage loans held for sale.  At September 30, 2008, the Company had outstanding loan origination commitments of $12.2 million (including one-to-four-family real estate mortgage loans held for sale of $2.6 million) and undisbursed lines of credit and construction loans in process of $11.9 million.  The Company anticipates that it will have sufficient funds available to meet its current loan originations and other commitments.

At September 30, 2008, total deposits were approximately $112.4 million of which approximately $59.9 million was in certificates of deposit.  Certificates of deposit scheduled to mature in one year or less from September 30, 2008 totaled $37.6 million.  Based on past experience the Company anticipates that most such certificates of deposit can be renewed upon their expiration.

As stated earlier, the Company completed the holding company formation during the quarter ended September 30, 2006.  In order to pay the various costs associated with the formation, as well as other subsequent expenses as incurred, the Company secured a credit facility of $200,000 from its wholesale correspondent bank, Atlantic Central Bankers Bank, of which the Company had exercised $114,000 at June 30, 2008.  During the quarter ended September 30, 2008, the Company obtained a replacement credit facility with Atlantic Central Bankers Bank for $3.2 million.  Incremental proceeds drawn from the credit facility are for the purpose of providing funds as needed to the Bank to maintain strong capital ratios and enable it to grow at a managed pace and potentially add new branch locations.  As of September 30, 2008 the refinanced balance of the facility was $615,000.

In general the Bank monitors and manages its liquidity on a regular basis by maintaining appropriate levels of liquid assets so that funds are available when needed.  Excess liquidity is invested in overnight federal funds sold and other short-term investments.  As a member of the Federal Home Loan Bank of New York, the Bank has the availability of credit secured by qualifying collateral.  At September 30, 2008 the Bank had $12.5 million of such unencumbered collateral available.  Additionally, the Bank has unused credit lines of $5.0 million if the need arises with its correspondent bank, Atlantic Central Bankers Bank, which is separate from the Company’s credit facility mentioned above.

Applicable regulations require banks to maintain a minimum leverage ratio of core (Tier 1) capital to total adjusted tangible assets of 3.0%, and a minimum ratio of total capital (core capital and supplementary capital) to risk-weighted assets of 8.0%, of which 4.0% must be core (Tier 1) capital.  Under prompt corrective action regulations, our regulator is required to take certain supervisory actions with respect to an undercapitalized institution.  The regulations establish a framework for the classification of depository institutions into five categories: (1) well-capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized.  Generally an institution is considered well capitalized if it has a core (Tier 1) capital ratio of at least 5.0%, a core (Tier 1) risk-based capital ratio of at least 6.0%, and a total risk-based capital ratio of a least 10.0%.  As of September 30, 2008, the most recent regulatory notifications categorized the Bank as well

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capitalized under the regulatory framework for prompt corrective action.  There are no conditions or events since that notification that management believes have changed the institution’s category.

The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.  Capital amounts and classifications are also subject to qualitative judgments by the OCC about capital components, risk weightings and other factors.

Management believes that, as of September 30, 2008 and December 31, 2007, the Bank met all capital adequacy requirements to which it was subject.

The following is a summary of the Bank’s actual capital amounts and ratios, compared to the requirements for minimum capital adequacy and for classification as a well-capitalized institution at September 30, 2008 and December 31, 2007.  The capital ratios of the Company are not significantly different than those shown in the table below for the Bank and exceed the requirements to be well capitalized.  In accordance with the applicable regulatory requirements, the Bank’s actual tangible and Tier 1 capital amounts exclude goodwill, while the total risk-based capital amounts include the allowance for loan losses.

						Minimum Capital					Classification as
	Bank Actual					Adequacy					Well Capitalized
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
September 30, 2008
Tier I (core)capital	$	9,528		7.2	%	$	3,947		3.0	%	$	6,579		5.0
Risk-based capital:
Tier I		9,528		9.9			N/A		N/A			5,764		6.0
Total		10,276		10.7			7,685		8.0			9,606		10.0

						Minimum Capital					Classification as
	Bank Actual					Adequacy					Well Capitalized
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
December 31, 2007
Tier I (core)capital	$	9,886		11.5	%	$	2,818		3.0	%	$	4,696		5.0
Risk-based capital:
Tier I		9,886		12.5			N/A		N/A			3,865		6.0
Total		10,510		13.3			5,153		8.0			6,441		10.0

Item 3.  Quantitative and Qualitative Disclosure About Market Risk

Unlike most industrial companies, nearly all of our assets and liabilities are financial in nature.  As a result, our net income is directly impacted by changes in interest rates, which areinfluenced by inflationary expectations.  We generally do not seek to match the interest sensitivity of our financial assets to the interest sensitivity of our financial liabilities as part of our interest rate risk management program.  However, management believes that by maintaining a significant portion of our assets in short-term investments, adjustable rate mortgage-backed securities and adjustable rate loans, we will be able to redeploy a portion of our assets as rates change.  Whereas the Company has increased its total assets during this reporting period, particularly in longer-term loans and mortgage backed security investments,

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it has also increased its cash and cash equivalents, its level of non-interest bearing deposits, and funded significant portions of its asset growth with longer-term interest-bearing liabilities in an effect to manage the vulnerability of its operating results to change in interest rates.

A commonly used tool to manage and analyze the interest rate sensitivity of a bank is a computer simulation model.  To quantify the extent of risks in both the Company’s current position and in transactions it might make in the future, the Company uses a model to simulate the impact of different interest rate scenarios on net interest income.  The hypothetical impact of a 12 month horizontal and instantaneous interest rate shift (generally, a horizontal change in interest rates of +2.00% or –1.00%) and smaller incremental interest rate changes are modeled at least quarterly, representing the primary means the Company uses for interest rate risk management decisions.

At September 30, 2008, given a +2.00% or –1.00% shock in interest rates, our model results in the Company’s net interest income for the next twelve months changing by $(30,000) and $62,000, respectively. 

The Company measures its economic value of equity at risk on a quarterly basis using the computer model referred to above.  Economic value of equity at risk measures the Company’s exposure to equity due to changes in a forecast interest rate environment.  At September 30, 2008, given a +2.00% or -2.00% shock in interest rates, our model results in the Company’s economic value of equity at risk changing by $(4.1 million), or (33.47)%, and $2.6 million, or 20.66%, respectively.  

In its modeling, the Company makes significant assumptions about the lag in the rate of change in various asset and liability categories.  The Company bases its assumptions on past experience and comparisons with other banks, and tests the validity of its assumptions by reviewing actual results with projected expectations.

Item 4T.   Controls and Procedures

The Company has adopted disclosure controls and procedures designed to facilitate the Company’s financial reporting.  The disclosure controls currently consist of communications among the Chief Executive Officer, the Chief Operations Officer, the Chief Financial Officer and each department head to identify any transactions, events, trends, risks or contingencies which may be material to the Company’s operations.  In addition, the Chief Executive Officer, Chief Operating Officer, Chief Financial Officer and the Audit Committee meet on a quarterly basis and discuss the Company’s material accounting policies.  The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of these controls as of September 30, 2008 and found them to be adequate.

The Company maintains internal control over financial reporting.  There have not been any significant changes in such internal control over financial reporting that have materially been affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II

Item 1.   Legal Proceedings

The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business.  At September 30, 2008, we were not involved in any legal proceedings, the outcome of which would be material to our financial condition or results of operations.

Item 1A.   Risk Factors

A smaller reporting company is not required to provide information required of this item.

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Item 2.   Unregistered Sales of 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

Exhibit Number	Document	Reference to Previous Filing If Applicable
3.1	Articles of Incorporation	*
3.2	Amended Bylaws	*
4	Form of Stock Certificate	**
10.1	Employment Agreement dated September 23, 2004 Between the Bank and Anthony P. Costa.	**
10.2	Employment Agreement dated September 23, 2004 Between the Bank and Philip Guarnieri	**
10.3	Employment Agreement dated October 20, 2005 Between the Bank and Arthur Budich	**
10.4	Empire State Bank, N.A. 2004 Stock Option Plan	**
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

* Previously filed with the SEC as an exhibit to the Company’s Quarterly Report on Form 10-QSB for the period ended September 30, 2006.

** Previously filed with the SEC as an exhibit to the Company’s Registration Statement on Form S-4 filed on April 14, 2006 and subsequently amended on April 18, 2006, May 1, 2006 and May 23, 2006 and a post-effective amendment filed on June 9, 2006.  All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-B.

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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934 (the “Exchange Act”), the registrant caused this report to be signed on its behalf by the undersigned, hereunto duly authorized, as of October 28, 2008.

Date:  October 28, 2008	Empire State Bank, National Association By:   /s/ Anthony P Costa Anthony P. Costa Chairman and Chief Executive Officer
Date:  October 28, 2008	By:   /s/ Arthur W Budich Arthur W. Budich Executive Vice President and Chief Financial Officer

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