Franklin Financial (FRNK) 10-Q 2013 Q3 Quarterly report

 UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark one) 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period endedJune 30, 2013

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to _____________

Commission file number:1-35085

FRANKLIN FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Virginia	27-4132729
(State or other jurisdiction	(I.R.S. Employer Identification No.)
of incorporation or organization)
4501 Cox Road, Glen Allen, VA 23060
(Address of principal executive offices, including zip code)
(804) 967-7000
(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 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. Yesx No¨

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

Large accelerated filer¨Accelerated Filerx Non-accelerated filer¨Smaller reporting company¨

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

Yes¨ Nox

12,500,440 shares of the registrant’s common stock, par value $0.01 per share, were outstanding at July 31, 2013.

Franklin Financial Corporation

Form 10-Q

Table of Contents

	Page No.
Part I.  Financial Information
Item 1.  Financial Statements
Consolidated Balance Sheets at June 30, 2013 (unaudited) and September 30, 2012	2
Consolidated Income Statements for the Three and Nine Months Ended June 30, 2013 and 2012 (unaudited)	3
Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended June 30, 2013 and 2012 (unaudited)	4
Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended June 30, 2013 and 2012 (unaudited)	5
Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2013 and 2012 (unaudited)	6
Notes to the Unaudited Consolidated Financial Statements	7
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations Operations	28
Item 3.    Quantitative and Qualitative Disclosures About Market Risk	44
Item 4.    Controls and Procedures	45
Part II.   Other Information
Item 1.     Legal Proceedings	45
Item 1A. Risk Factors	45
Item 2    Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 3.   Defaults Upon Senior Securities	46
Item 4.   Mine Safety Disclosures	46
Item 5.   Other Information	46
Item 6.   Exhibits	46
Signatures	47

1

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

(Dollars in thousands, except per share amounts)	June 30, 2013			September 30, 2012
	(unaudited)
Assets
Cash and cash equivalents:
Cash and due from banks	$	21,423		$	6,784
Interest-bearing deposits in other banks		103,865			98,344
Money market investments		4,021			14,751
Total cash and cash equivalents		129,309			119,879
Securities available for sale		331,521			394,179
Securities held to maturity		16,061			20,372
Loans, net of deferred loan fees		506,444			460,749
Less allowance for loan losses		9,912			10,284
Net loans		496,532			450,465
Loans held for sale		113			1,458
Federal Home Loan Bank stock		9,779			10,082
Office properties and equipment, net		6,956			6,167
Other real estate owned		7,049			16,502
Accrued interest receivable:
Loans		2,245			2,028
Mortgage-backed securities and collateralized mortgage obligations		632			741
Other investment securities		996			1,679
Total accrued interest receivable		3,873			4,448
Cash surrender value of bank-owned life insurance		33,970			33,008
Prepaid expenses and other assets		15,467			14,221
Total assets	$	1,050,630		$	1,070,781
Liabilities and Stockholders’ Equity
Deposits:
Savings deposits	$	277,903		$	267,464
Time deposits		351,731			372,840
Total deposits		629,634			640,304
Federal Home Loan Bank borrowings		173,162			172,204
Advance payments by borrowers for property taxes and insurance		1,926			2,325
Accrued expenses and other liabilities		6,748			6,481
Total liabilities		811,470			821,314
Commitments and contingencies (see note 8)
Stockholders’ equity:
Preferred stock, $0.01 par value: 10,000,000 shares authorized, no shares issued or outstanding		-			-
Common stock, $0.01 par value: 75,000,000 shares authorized, 12,506,840 and 13,342,138 shares issued and outstanding, respectively		125			133
Additional paid-in capital		116,430			129,391
Unearned ESOP shares		(10,014	)		(10,442	)
Unearned equity incentive plan shares		(7,725	)		(7,411	)
Undistributed stock-based deferral plan shares		(2,646	)		(2,533	)
Retained earnings		133,595			132,251
Accumulated other comprehensive income		9,395			8,078
Total stockholders’ equity		239,160			249,467
Total liabilities and stockholders’ equity	$	1,050,630		$	1,070,781

The accompanying notes are an integral part of these consolidated financial statements. 

2

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Income Statements

Three and Nine Months Ended June 30, 2013 and 2012 (Unaudited)

	Three Months Ended June 30,						Nine Months Ended June 30,
(Dollars in thousands, except per share amounts)	2013			2012			2013			2012
Interest and dividend income:
Interest and fees on loans	$	7,608		$	7,558		$	22,209		$	23,173
Interest on deposits in other banks		61			47			161			101
Interest and dividends on securities:
Taxable		2,118			3,022			7,194			9,663
Nontaxable		-			71			135			215
Total interest and dividend income		9,787			10,698			29,699			33,152
Interest expense:
Interest on deposits		1,574			1,934			4,883			5,944
Interest on borrowings		1,931			2,055			5,788			6,658
Total interest expense		3,505			3,989			10,671			12,602
Net interest income		6,282			6,709			19,028			20,550
Provision (credit) for loan losses		171			(390	)		532			(542	)
Net interest income after provision (credit) for loan losses		6,111			7,099			18,496			21,092
Noninterest income (expense):
Service charges on deposit accounts		14			14			37			38
Other service charges and fees		136			167			471			781
Gains on sales of loans held for sale		2			65			96			206
Gains (losses) on sales of securities, net		205			(777	)		1,618			(777	)
Gains on sales of other real estate owned		50			711			1,614			1,336
Impairment of securities, net:
Impairment of securities		(190	)		(2,005	)		(1,269	)		(4,884	)
Less: Impairment recognized in other comprehensive income		(52	)		53			(936	)		(500	)
Net impairment reflected in income		(138	)		(2,058	)		(333	)		(4,384	)
Increase in cash surrender value of bank-owned life insurance		320			323			962			965
Other operating income		200			214			568			439
Total noninterest income (expense)		789			(1,341	)		5,033			(1,396	)
Other noninterest expenses:
Personnel expense		2,498			2,665			8,032			6,743
Occupancy expense		275			227			756			667
Equipment expense		213			249			667			707
Advertising expense		85			46			144			156
Federal deposit insurance premiums		165			207			518			618
Impairment of other real estate owned		78			611			78			611
Other operating expenses		1,284			1,060			3,709			2,729
Total other noninterest expenses		4,598			5,065			13,904			12,231
Income before provision for income taxes		2,302			693			9,625			7,465
Federal and state income tax expense		640			1,047			2,939			3,536
Net income (loss)	$	1,662		$	(354	)	$	6,686		$	3,929
Basic net income (loss) per common share	$	0.14		$	(0.03	)	$	0.56		$	0.30
Diluted net income (loss) per common share	$	0.14		$	(0.03	)	$	0.56		$	0.30

The accompanying notes are an integral part of these consolidated financial statements. 

3

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

Three and Nine Months Ended June 30, 2013 and 2012 (Unaudited)

	Three Months Ended June 30,
(Dollars in thousands)	2013						2012
Net income (loss)				$	1,662					$	(354	)
Other comprehensive (loss) income, net of income tax expense (benefit):
Net unrealized holding gains or losses arising during the period (net of tax 2013: $(1,147), 2012: $(509))	$	(85	)				$	(714	)
Reclassification adjustment for gains or losses included in net income (net of tax 2013: $78, 2012: ($295))		(126	)					2,385
Other-than-temporary impairment of held-to-maturity securities related to factors other than credit, net of amortization (net of tax 2013: $17, 2012: $47)		27						77
Amortization of previously recognized other-than-temporary impairment of available-for-sale securities related to factors other than credit (net of tax 2013: $0, 2012: $358)		-						585
Other comprehensive (loss) income					(184	)					2,333
Total comprehensive income				$	1,478					$	1,979

	Nine Months Ended June 30,
(Dollars in thousands)	2013					2012
Net income				$	6,686				$	3,929
Other comprehensive income (loss), net of income tax expense (benefit):
Net unrealized holding gains or losses arising during the period (net of tax 2013: $(1,338), 2012: $6)	$	2,727				$	6,052
Reclassification adjustment for gains or losses included in net income (net of tax 2013: $598, 2012: ($556))		(975	)				4,323
Other-than-temporary impairment of held-to-maturity securities related to factors other than credit, net of amortization (net of tax 2013: $(267), 2012: ($110))		(435	)				(180	)
Amortization of previously recognized other-than-temporary impairment of available-for-sale securities related to factors other than credit (net of tax 2013: $0, 2012: $467)		-					763
Other comprehensive income					1,317					10,958
Total comprehensive income				$	8,003				$	14,887

The accompanying notes are an integral part of these consolidated financial statements.

4

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity

Nine Months Ended June 30, 2013 and 2012 (Unaudited)

(Dollars in thousands, except per share amount)	Common Stock			Additional Paid-in Capital			Unearned ESOP Shares			Unearned Equity Incentive Plan Shares			Undistributed Stock-Based Deferral Plan Shares			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity
Balance at September 30, 2011	$	143		$	142,882		$	(11,082	)	$	-		$	(2,533	)	$	125,770		$	(5,622	)	$	249,558
ESOP shares allocated		-			141			496			-			-			-			-			637
Repurchase of common stock		(5	)		(7,989	)		-			-			-			-			-			(7,994	)
Stock-based compensation expense		-			717			-			-			-			-			-			717
Common stock purchased for equity incentive plan		-			-			-			(4,320	)		-			-			-			(4,320	)
Net income		-			-			-			-			-			3,929			-			3,929
Other comprehensive income		-			-			-			-			-			-			10,958			10,958
Balance at June 30, 2012	$	138		$	135,751		$	(10,586	)	$	(4,320	)	$	(2,533	)	$	129,699		$	5,336		$	253,485
Balance at September 30, 2012	$	133		$	129,391		$	(10,442	)	$	(7,411	)	$	(2,533	)	$	132,251		$	8,078		$	249,467
ESOP shares allocated		-			319			428			-			-			-			-			747
Repurchase of common stock		(8	)		(14,709	)		-			-			-			-			-			(14,717	)
Stock-based compensation expense		-			2,489			-			-			-			-			-			2,489
Common stock purchased for equity incentive plan		-			-			-			(1,754	)		-			-			-			(1,754	)
Common stock purchased by stock-based deferral plan		-			113			-			-			(113	)		-			-			-
Tax benefit from exercise/vesting of stock awards		-			168			-			-			-			-			-			168
Vesting of restricted stock		-			(1,440	)		-			1,440			-			-			-			-
Exercise of stock options		-			99			-			-			-			-			-			99
Cash dividend paid ($0.45 per share)		-			-			-			-			-			(5,342	)		-			(5,342	)
Net income		-			-			-			-			-			6,686			-			6,686
Other comprehensive income		-			-			-			-			-			-			1,317			1,317
Balance at June 30, 2013	$	125		$	116,430		$	(10,014	)	$	(7,725	)	$	(2,646	)	$	133,595		$	9,395		$	239,160

The accompanying notes are an integral part of these consolidated financial statements. 

5

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Nine Months Ended June 30, 2013 and 2012 (Unaudited)

	2013			2012
(Dollars in thousands)
Cash Flows From Operating Activities
Net income	$	6,686		$	3,929
Adjustments to reconcile net income to net cash and cash
equivalents provided by operating activities:
Depreciation and amortization		653			630
Provision for loan losses		532			(542	)
Impairment charges on other real estate owned		78			611
(Gains) losses on sales of securities available for sale, net		(1,618	)		777
Impairment charge on securities		333			4,384
Loss on sales or disposal of office properties and equipment, net		44			13
Gains on sales of other real estate owned, net		(1,614	)		(1,336	)
Net amortization on securities		1,963			1,864
Amortization of deferred amounts related to Federal Home Loan Bank borrowings		958			195
Gains on sales of loans held for sale		(96	)		(206	)
Originations of loans held for sale		(2,853	)		(9,127	)
Sales and principal payments on loans held for sale		4,294			9,591
ESOP compensation expense		747			637
Stock-based compensation expense		2,489			717
Changes in assets and liabilities:
Accrued interest receivable		575			633
Cash surrender value of bank-owned life insurance		(962	)		(965	)
Prepaid expenses and other assets		1,125			(369	)
Advance payments by borrowers for property taxes and insurance		(399	)		(809	)
Accrued expenses and other liabilities		(20	)		974
Net cash and cash equivalents provided by operating activities		12,915			11,601
Cash Flows From Investing Activities
Net redemptions of Federal Home Loan Bank stock		303			808
Proceeds from maturities, calls and paydowns of securities available for sale		106,013			102,972
Proceeds from sales of securities available for sale		19,023			12,646
Purchases of securities available for sale		(63,301	)		(98,196	)
Proceeds from maturities and paydowns of securities held to maturity		3,670			3,566
Net (increase) decrease in loans		(45,286	)		13,576
Purchases of office properties and equipment		(1,448	)		(541	)
Proceeds from sales of other real estate owned		9,925			744
Net cash and cash equivalents provided by investing activities		28,899			35,575
Cash Flows From Financing Activities
Net increase (decrease) in savings deposits		10,439			(416	)
Net decrease in time deposits		(21,109	)		(1,014	)
Proceeds from the exercise of stock options		99			-
Repurchase of common stock		(14,717	)		(7,994	)
Common stock purchased for equity incentive plan		(1,754	)		(4,320	)
Cash dividends paid to common stockholders		(5,342	)		-
Deferred Federal Home Loan Bank prepayment penalty		-			(18,308	)
Net cash and cash equivalents used by financing activities		(32,384	)		(32,052	)
Net increase in cash and cash equivalents		9,430			15,124
Cash and cash equivalents at beginning of period		119,879			115,749
Cash and cash equivalents at end of period	$	129,309		$	130,873
Supplemental disclosures of cash flow information
Cash payments for interest	$	9,681		$	12,345
Cash payments for income taxes	$	1,657		$	4,104
Supplemental schedule of noncash investing and financing activities
Unrealized gains on securities available for sale	$	185		$	12,167
Transfer of loans to other real estate owned	$	1,979		$	4,058
Sales of other real estate owned financed by the Bank	$	3,292		$	1,529

 .

The accompanying notes are an integral part of these consolidated financial statements.

6

FRANKLIN FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

Note 1. Nature of Business and Summary of Significant Accounting Policies

Organization and Description of Business —Franklin Financial Corporation (“Franklin Financial”), a Virginia corporation, is the holding company for Franklin Federal Savings Bank (“Franklin Federal” or the “Bank”), a federally chartered capital stock savings bank engaged in the business of attracting retail deposits from the general public and originating non-owner-occupied one- to four-family loans as well as multi-family loans, nonresidential real estate loans, construction loans, and land and land development loans. The Bank has three wholly owned subsidiaries, Franklin Service Corporation, which provides trustee services on loans originated by the Bank; Reality Holdings LLC, which, through its subsidiaries, holds and manages foreclosed properties purchased from the Bank; and Franklin Federal Mortgage Holdings LLC, which through a 49% owned joint venture with TowneBank Mortgage, originates, sells and services mortgage loans, primarily on owner-occupied single-family properties. The interim consolidated financial statements presented in this report include the unaudited financial information of Franklin Financial and subsidiaries on a consolidated basis. The Company (as defined below) operates as one segment.

These interim consolidated financial statements do not contain all necessary disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements and, therefore, should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2012 (“2012 Form 10-K”).  These interim consolidated financial statements include all normal and recurring adjustments that management believes are necessary in order to conform to GAAP.  The results for the three and nine months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending September 30, 2013 or any other future period. The consolidated balance sheet as of September 30, 2012 was derived from the Company’s audited annual consolidated financial statements in the 2012 Form 10-K.

Principles of Consolidation —The consolidated financial statements include the accounts of Franklin Financial, the Bank, Franklin Service Corporation, Reality Holdings LLC and its subsidiaries, and Franklin Federal Mortgage Holdings LLC and its joint venture (collectively, the “Company”). All significant intercompany transactions and balances have been eliminated in consolidation. The accounting and reporting policies of the Company conform to GAAP.

Use of Estimates —Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with GAAP. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan losses, the projected benefit obligation for the defined benefit pension plan, the valuation of deferred taxes, the valuation of stock-based compensation, and the analysis of securities for other-than-temporary impairment.

Loans —Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balance adjusted for any charge-offs and net of the allowance for loan losses and any deferred fees or costs. Loan origination fees and certain direct loan origination costs are deferred and recognized over the contractual lives of the related loans as an adjustment of the loans’ yields using the level-yield method on a loan-by-loan basis.

Loans are placed on nonaccrual status when they are three monthly payments or more past due unless management believes, based on individual facts, that the delay in payment is temporary and that the borrower will be able to bring past due amounts current and remain current or unless adverse events affecting the borrower indicate that a loan should be placed on nonaccrual status before three monthly payments are past due. All interest accrued but not collected for loans that are placed on non-accrual status is reversed against interest income. Any payments made on these loans while on non-accrual status are accounted for on a cash-basis until the loan qualifies for return to accrual status or is subsequently charged-off. Loans are returned to accrual status when the principal and interest amounts due are brought current and management believes that the borrowers will be able to continue to make required contractual payments.

7

Allowance for Loan Losses —The allowance for loan losses is maintained at an amount estimated to be sufficient to absorb probable principal losses, net of principal recoveries (including recovery of collateral), inherent in the existing loan portfolio. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. The allowance for loan losses consists of specific and general components.

The specific component relates to loans identified as impaired. The Company determines and recognizes impairment of certain loans when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans that experience insignificant delays and payment shortfalls generally are not classified as impaired. An impaired loan is measured at net realizable value, which is equal to present value less estimated costs to sell. The present value is estimated using expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral. See note 4 “Allowance for Loan Losses” in the notes to the unaudited consolidated financial statements for additional details on impaired loans.

The general component covers loans not identified for specific allowances and is based on historical loss experience adjusted for various qualitative factors. The allowance for loan losses is increased by provisions for loan losses and decreased by charge-offs (net of recoveries). In estimating the allowance, management segregates its portfolio by loan type. Management’s periodic determination of the allowance for loan losses is based on consideration of various factors, including the Company’s past loan loss experience, current delinquency status and loan performance statistics, industry loan loss statistics, periodic loan evaluations, real estate value trends in the Company’s primary lending areas, regulatory requirements, and current economic conditions. The delinquency status of loans is computed based on the contractual terms of the loans.

Management’s estimate of the adequacy of the allowance is subject to evaluation and adjustment by the Bank’s regulators. Management believes that the current allowance for loan losses is a reasonable estimate of known and inherent losses in the loan portfolio.

Stock-Based Compensation —The Company has issued restricted stock and stock options under the Franklin Financial Corporation 2012 Equity Incentive Plan to key officers and outside directors. In accordance with the requirements of ASC 718,Compensation – Stock Compensation, the Company uses a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured based on the fair value of the award as of the grant date and recognized over the vesting period.

Income Taxes —Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss, capital loss, and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount deemed more likely than not to be realized in future periods. It is the Company’s policy to provide for uncertain tax positions and the related interest and penalties based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. Any interest and penalties assessed on tax positions are recognized in income tax expense.

Reclassifications —Certain reclassifications have been made to the financial statements of prior periods to conform to the current period presentation. Net income, earnings per share, and stockholders’ equity previously reported were not affected by these reclassifications.

Concentrations of Credit Risk —Most of the Company’s activities are with customers in Virginia with primary geographic focus in the Richmond metropolitan area, which includes the city of Richmond and surrounding counties. Securities and loans also represent concentrations of credit risk and are discussed in note 2 “Securities” and note 3 “Loans” in the notes to the unaudited consolidated financial statements. Although the Company believes its underwriting standards are conservative, the nature of the Company’s portfolio of construction loans, land and land development loans, and income-producing nonresidential real estate loans and multi-family loans results in a smaller number of higher-balance loans. As a result, the default of loans in these portfolio segments may result in more significant losses to the Company.

8

Recent Accounting Pronouncements --In February 2013, the FASB issued Accounting Standards Update (ASU) No. 2013-02,Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, to improve the transparency of reporting these reclassifications. This ASU requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. For public entities, the ASU is effective for reporting periods beginning after December 15, 2012. The adoption of ASU 2013-02 did not have an impact on the Company’s consolidated financial statements.

Note 2. Securities

The amortized cost, gross unrealized gains and losses, and estimated fair value of securities at June 30, 2013 and September 30, 2012 are summarized as follows:

	June 30, 2013
(Dollars in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair value
Available for sale:
States and political subdivisions	$	5,728	$	270	$	-	$	5,998
Agency mortgage-backed securities		122,623		1,202		719		123,106
Agency collateralized mortgage obligations		94,219		1,396		-		95,615
Corporate equity securities		11,136		7,829		8		18,957
Corporate debt securities		82,598		5,340		93		87,845
Total	$	316,304	$	16,037	$	820	$	331,521

	September 30, 2012
(Dollars in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair value
Available for sale:
States and political subdivisions	$	11,938	$	1,187	$	-	$	13,125
Agency mortgage-backed securities		80,508		1,323		51		81,780
Agency collateralized mortgage obligations		164,650		2,161		210		166,601
Corporate equity securities		11,885		2,951		40		14,796
Corporate debt securities		109,796		8,209		128		117,877
Total	$	378,777	$	15,831	$	429	$	394,179

	June 30, 2013
(Dollars in thousands)	Adjusted amortized cost		OTTI recognized in AOCI		Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair value
Held to maturity:
Agency mortgage-backed securities	$	4,046	$	-	$	4,046	$	155	$	-	$	4,201
Agency collateralized mortgage obligations		3,723		-		3,723		329		-		4,052
Non-agency collateralized mortgage obligations		8,292		1,955		10,247		1,344		1,798		9,793
Total	$	16,061	$	1,955	$	18,016	$	1,828	$	1,798	$	18,046

9

	September 30, 2012
(Dollars in thousands)	Adjusted amortized cost		OTTI recognized in AOCI		Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair value
Held to maturity:
Agency mortgage-backed securities	$	4,714	$	-	$	4,714	$	221	$	-	$	4,935
Agency collateralized mortgage obligations		5,079		-		5,079		567		-		5,646
Non-agency collateralized mortgage obligations		10,579		1,253		11,832		875		2,533		10,174
Total	$	20,372	$	1,253	$	21,625	$	1,663	$	2,533	$	20,755

The amortized cost and estimated fair value of securities at June 30, 2013, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

	June 30, 2013
	Available for sale				Held to maturity
	Amortized		Estimated fair		Amortized		Estimated fair
(Dollars in thousands)	cost		value		cost		value
Non-mortgage debt securities:
Due in one year or less	$	23,256	$	23,613	$	-	$	-
Due after one year through five years		32,251		33,787		-		-
Due after five years through ten years		17,346		19,702		-		-
Due after ten years		15,473		16,741		-		-
Total non-mortgage debt securities		88,326		93,843		-		-
Mortgage-backed securities		122,623		123,106		4,046		4,201
Collateralized mortgage obligations		94,219		95,615		13,970		13,845
Corporate equity securities		11,136		18,957		-		-
Total securities	$	316,304	$	331,521	$	18,016	$	18,046

The following tables indicate the length of time that individual securities have been in a continuous unrealized loss position as of June 30, 2013 and September 30, 2012:

	June 30, 2013
	Less Than 12 Months				12 Months or Longer				Total
	Estimated		Gross		Estimated		Gross		Estimated		Gross
	fair		unrealized		fair		unrealized		fair		unrealized
(Dollars in thousands)	value		losses		value		losses		value		losses
Available for sale:
Agency mortgage-backed securities	$	39,753	$	719	$	-	$	-	$	39,753	$	719
Corporate equity securities		22		8		-		-		22		8
Corporate debt securities		4,985		15		4,922		78		9,907		93
Total available for sale		44,760		742		4,922		78		49,682		820
Held to maturity:
Non-agency collateralized mortgage obligations		66		14		5,089		1,784		5,155		1,798
Total held to maturity		66		14		5,089		1,784		5,155		1,798
Total	$	44,826	$	756	$	10,011	$	1,862	$	54,837	$	2,618

10

	September 30, 2012
	Less Than 12 Months				12 Months or Longer				Total
(Dollars in thousands)	Estimated fair value		Gross unrealized losses		Estimated fair value		Gross unrealized losses		Estimated fair value		Gross unrealized losses
Available for sale:
Agency mortgage-backed securities	$	25,531	$	50	$	2,435	$	1	$	27,966	$	51
Agency collateralized mortgage obligations		3,380		4		18,043		206		21,423		210
Corporate equity securities		232		35		10		5		242		40
Corporate debt securities		2,984		16		4,888		112		7,872		128
Total available for sale		32,127		105		25,376		324		57,503		429
Held to maturity:
Non-agency collateralized mortgage obligations		258		43		7,953		2,490		8,211		2,533
Total held to maturity		258		43		7,953		2,490		8,211		2,533
Total	$	32,385	$	148	$	33,329	$	2,814	$	65,714	$	2,962

The Company’s securities portfolio consists of investments in various debt and equity securities as permitted by regulations of the Office of the Comptroller of the Currency (“OCC”) and the Board of Governors of the Federal Reserve System (“FRB”), including mortgage-backed securities, collateralized mortgage obligations, state and local government obligations, corporate debt obligations, and common stock of various companies.

During the three months ended June 30, 2013, the Company recognized gross gains on sales of securities available for sale of $205,000 and no losses. During the nine months ended June 30, 2013, the Company recognized gross gains on sales of securities available for sale of $1.6 million and no losses. During the three and nine months ended June 30, 2012, the Company recognized gross gains on sales of securities available for sale of $693,000 and gross losses of $1.5 million.

The Company performs an other-than-temporary impairment analysis of the securities portfolio on a quarterly basis. The determination of whether a security is other-than-temporarily impaired is highly subjective and requires a significant amount of judgment. In evaluating for other-than-temporary impairment, management considers the duration and severity of declines in fair value, the financial condition of the issuers of each security, as well as whether it is more likely than not that the Company will be required to sell these securities prior to recovery, which may be maturity, based on market conditions and cash flow requirements. In performing its analysis for debt securities, the Company’s consideration of the financial condition of the issuer of each security focuses on the issuer’s ability to continue to perform on its debt obligations, including any concerns about the issuer’s ability to continue as a going concern. In performing its analysis for equity securities, the Company’s analysis of the financial condition of the issuer of each security includes the issuer’s economic outlook, distressed capital raises, large write-downs causing dilution of capital, distressed dividend cuts, discontinuation of significant segments, replacement of key executives, and the existence of a pattern of significant operating losses.

The Company recognized total impairment charges in income on debt securities of $138,000 and $333,000 for the three and nine months ended June 30, 2013, respectively. The Company recognized total impairment charges in income on debt and equity securities of $2.1 million and $4.4 million during the three and nine months ended June 30, 2012, respectively.

The table below provides a cumulative rollforward of credit losses recognized in earnings for debt securities for which a portion of OTTI is recognized in AOCI:

(Dollars in thousands)
Balance of credit losses at September 30, 2012	$	164
Additions for credit losses on securities not previously recognized		5
Additional credit losses on securities previously recognized as impaired		107
Reductions for securities for which OTTI previously in OCI was recognized in earnings		(20	)
Reductions for increases in expected cash flows		(175	)
Balance of credit losses at June 30, 2013	$	81

11

To determine the amount of other-than-temporary impairment losses that are related to credit versus the portion related to other factors, management compares the current period estimate of future cash flows to the prior period estimated future cash flows, both discounted at each security’s yield at purchase. Any other-than-temporary impairment recognized in excess of the difference of these two values is deemed to be related to factors other than credit.

Unrealized losses in the remainder of the Company’s portfolio of collateralized mortgage obligations, mortgage-backed securities, and corporate debt securities were related to forty-six securities and were caused by increases in market interest rates, spread volatility, or other factors that management deems to be temporary; and because management believes that it is not more likely than not that the Company will be required to sell these securities prior to maturity or a full recovery of the amortized cost, the Company does not consider these securities to be other-than-temporarily impaired.

Unrealized losses in the Company’s portfolio of equity securities were related to two securities and were considered temporary. Because management believes that it is not more likely than not that the Company will be required to sell these equity positions for a reasonable period of time sufficient for a recovery of fair value, the Company does not consider these equity securities to be other-than-temporarily impaired.

The Company pledges certain securities as collateral for its FHLB borrowings. Securities collateralizing FHLB borrowings had a carrying value of $175.1 million at June 30, 2013 compared to $266.0 million at September 30, 2012.

Note 3. Loans

Loans held for investment at June 30, 2013 and September 30, 2012 are summarized as follows:

	June 30,		September 30,
(Dollars in thousands)	2013		2012
Loans
One- to four-family	$	95,470	$	104,560
Multi-family		102,571		81,503
Nonresidential		233,800		208,225
Construction		31,454		25,489
Land and land development		46,305		43,761
Other		408		498
Total loans		510,008		464,036
Deferred loan fees		3,564		3,287
Loans, net of deferred loan fees		506,444		460,749
Allowance for loan losses		9,912		10,284
Net loans	$	496,532	$	450,465

The Company pledges certain loans as collateral for its FHLB borrowings. Loans collateralizing FHLB borrowings had a carrying value of $310.9 million at June 30, 2013 compared to $290.7 million at September 30, 2012.

Note 4. Allowance for Loan Losses

The allowance for loan losses is maintained at a level considered adequate to provide for our estimate of probable credit losses inherent in the loan portfolio. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. While the Company uses the best information available to make its evaluation, future adjustments may be necessary if there are significant changes in conditions.

The allowance is comprised of two components: (1) a general allowance related to loans both collectively and individually evaluated and (2) a specific allowance related to loans individually evaluated and identified as impaired. A summary of the methodology the Company employs on a quarterly basis related to each of these components to estimate the allowance for loan losses is as follows.

12

Credit Rating Process

The Company's loan grading system analyzes various risk characteristics of each loan type when considering loan quality, including loan-to-value ratios, debt service coverage ratios, debt yields, current real estate market conditions, location and appearance of properties, income and net worth of any guarantors, and rental stability and cash flows of income-producing nonresidential real estate loans and multi-family loans. The credit rating process results in one of the following classifications for each loan in order of increasingly adverse classification: Excellent, Good, Satisfactory, Watch List, Special Mention, Substandard, and Impaired. The Company continually monitors the credit quality of loans in the portfolio through communications with borrowers as well as review of delinquency and other reports that provide information about credit quality. Credit ratings are updated at least annually with more frequent updates performed for problem loans or when management becomes aware of circumstances related to a particular loan that could materially impact the loan’s credit rating. Management maintains a classified loan list consisting of watch list loans along with loans rated special mention or lower that is reviewed on a monthly basis by the Company’s Internal Asset Review Committee.

General Allowance

To determine the general allowance, the Company segregates loans by portfolio segment as defined by loan type. The Company determines a base reserve rate for each portfolio segment by calculating the average charge-off rate for each segment over a historical time period determined by management, typically one to three years. The base reserve rate is then adjusted based on qualitative factors that management believes could result in future loan losses differing from historical experience. Such qualitative factors can include delinquency rates, loan-to-value ratios, market interest rate changes, legal and competitive factors, and local economic and real estate conditions. The base reserve rate plus these qualitative adjustments results in a total reserve rate for each portfolio segment. During the three months ended March 31, 2013, the Company modified its methodology for calculating the general allowance. Previously, a multiple of the total reserve rate calculated for each loan type was applied to the loan balance in each segment based on credit rating. At March 31, 2013 this methodology was discontinued. The impact of this change at March 31, 2013 was an increase to the allowance of approximately $894,000, which was mostly offset by a decrease in reserve rates due to improvements in several qualitative factors.

Specific Allowance for Impaired Loans

Impaired loans include loans identified as impaired through our credit rating system as well as loans modified in a troubled debt restructuring. Loans are identified as impaired when management believes, based on current information and events, it is probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the underlying loan agreement. Once a loan is identified as impaired, management determines a specific allowance by comparing the outstanding loan balance to net realizable value. The net realizable value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. The amount of any allowance recognized is the amount by which the loan balance exceeds the net realizable value. If the net realizable value exceeds the loan balance, no allowance is recorded. During the three months ended June 30, 2013, the methodology for recording a specific allowance was changed. For loans using the collateral method to estimate the net realizable value, a charge-off is recorded instead of a specific allowance for the amount by which the loan balance exceeds the net realizable value. The impact of this change was a decrease to the allowance of approximately $951,000 and a corresponding decrease to the loan balances, with no net effect on the net loan balance or the consolidated income statement. Of the $43.9 million of loans classified as impaired at June 30, 2013, $38.4 million were considered “collateral dependent” and evaluated using the fair value of collateral method and $5.5 million were evaluated using discounted estimated cash flows.

13

Activity in the allowance for loan losses by portfolio segment is summarized as follows:

	Three Months Ended June 30, 2013
(Dollars in thousands)	One- to four-family			Multi- family			Non- residential		Construction			Land and land development			Other			Total
Balance, March 31, 2013	$	1,744		$	1,778		$	4,539	$	881		$	1,689		$	7		$	10,638
Provision		(26	)		(23	)		55		179			(13	)		(1	)		171
Recoveries		3			-			-		17			35			1			56
Charge-offs		(942	)		-			-		(6	)		(5	)		-			(953	)
Balance, June 30, 2013	$	779		$	1,755		$	4,594	$	1,071		$	1,706		$	7		$	9,912

	Three Months Ended June 30, 2012
(Dollars in thousands)	One- to  four-family			Multi- family			Non- residential		Construction			Land and land development			Other			Total
Balance, March 31, 2012	$	1,662		$	1,261		$	2,701	$	1,564		$	4,012		$	6		$	11,206
Provision		(140	)		(92	)		266		(384	)		(39	)		(1	)		(390	)
Recoveries		2			-			-		2			8			-			12
Charge-offs		-			-			-		(1	)		(21	)		-			(22	)
Balance, June 30, 2012	$	1,524		$	1,169		$	2,967	$	1,181		$	3,960		$	5		$	10,806

	Nine Months Ended June 30, 2013
(Dollars in thousands)	One- to  four-family			Multi- family		Non- residential		Construction			Land and land development			Other			Total
Balance, September 30, 2012	$	1,404		$	1,060	$	3,428	$	1,014		$	3,373		$	5		$	10,284
Provision		312			695		1,133		91			(1,714	)		15			532
Recoveries		5			-		33		122			52			1			213
Charge-offs		(942	)		-		-		(156	)		(5	)		(14	)		(1,117	)
Balance, June 30, 2013	$	779		$	1,755	$	4,594	$	1,071		$	1,706		$	7		$	9,912

	Nine Months Ended June 30, 2012
(Dollars in thousands)	One- to four-family			Multi- family			Non- residential			Construction			Land and land development			Other			Total
Balance, September 30, 2011	$	1,324		$	1,357		$	3,146		$	1,724		$	7,064		$	9		$	14,624
Provision		263			(188	)		(179	)		(539	)		105			(4	)		(542	)
Recoveries		5			-			-			5			8			-			18
Charge-offs		(68	)		-			-			(9	)		(3,217	)		-			(3,294	)
Balance, June 30, 2012	$	1,524		$	1,169		$	2,967		$	1,181		$	3,960		$	5		$	10,806

During the three and nine months ended June 30, 2013, the Company recorded net charge-offs of $897,000 and $904,000, respectively, compared to $10,000 and $3.3 million, respectively, in the three and nine months ended June 30, 2012. Charge-offs for the three and nine months ended June 30, 2013 were primarily due to the methodology change for the calculation of specific allowance for impaired loans as discussed above. For the nine months ended June 30, 2013, the Company recorded a provision for loan losses of $695,000 and $1.1 million for its portfolios of multi-family loans and nonresidential loans, respectively, due to increased loan balances in these portfolios. For the nine months ended June 30, 2013, the Company also recorded a provision for loan losses of $312,000 for its portfolio of one- to four-family loans. These provisions were partially offset by a decrease in the allowance for the Company’s land and land development loan portfolio for the nine months ended June 30, 2013. This decrease was the result of a decline in the reserve rate for this portfolio due to improvements in qualitative factors.

14

Details of the allowance for loan losses by portfolio segment and impairment methodology at June 30, 2013 and September 30, 2012 are as follows:

	June 30, 2013
	General Allowance				Specific Allowance											Allowance as
(Dollars in thousands)	Balance		Allowance		Balance		Allowance		Total Balance		Total Allowance		Coverage			% of total allowance
One- to four-family	$	87,843	$	779	$	7,627	$	-	$	95,470	$	779		0.82	%		7.9	%
Multi-family		89,971		1,755		12,600		-		102,571		1,755		1.71			17.7
Nonresidential		226,287		4,594		7,513		-		233,800		4,594		1.96			46.3
Construction		31,411		1,071		43		-		31,454		1,071		3.41			10.8
Land and land development		30,141		1,706		16,164		-		46,305		1,706		3.68			17.2
Other		408		7		-		-		408		7		1.61			0.1
Total allowance	$	466,061	$	9,912	$	43,947	$	-	$	510,008	$	9,912		1.94			100.0	%

	September 30, 2012
	General Allowance				Specific Allowance											Allowance as
(Dollars in thousands)	Balance		Allowance		Balance		Allowance		Total Balance		Total Allowance		Coverage			% of total allowance
One- to four-family	$	99,420	$	946	$	5,140	$	458	$	104,560	$	1,404		1.34	%		13.7	%
Multi-family		68,839		1,060		12,664		-		81,503		1,060		1.30			10.3
Nonresidential		202,734		3,428		5,491		-		208,225		3,428		1.65			33.3
Construction		25,445		1,014		44		-		25,489		1,014		3.98			9.9
Land and land development		34,644		3,373		9,117		-		43,761		3,373		7.71			32.8
Other		498		5		-		-		498		5		1.00			-
Total allowance	$	431,580	$	9,826	$	32,456	$	458	$	464,036	$	10,284		2.22			100.0	%

Details regarding classified loans and impaired loans at June 30, 2013 and September 30, 2012 are as follows:

	June 30,		September 30,
(Dollars in thousands)	2013		2012
Special mention
One- to four-family	$	5,650	$	2,880
Nonresidential		6,080		3,114
Construction		494		664
Land and land development		10,236		10,925
Total special mention loans		22,460		17,583
Substandard
One- to four-family		1,910		2,631
Nonresidential		-		2,053
Construction		492		743
Land and land development		3,673		4,653
Total substandard loans		6,075		10,080
Impaired
One- to four-family		7,627		5,140
Multi-family		12,600		12,664
Nonresidential		7,513		5,491
Construction		43		44
Land and land development		16,164		9,117
Total impaired loans		43,947		32,456
Total rated loans	$	72,482	$	60,119

15

The increase in special mention loans at June 30, 2013 compared to September 30, 2012 was primarily the result of the classification of one loan on multiple one- to four-family properties with a balance of $4.7 million and one loan on a retail shopping center with a balance of $2.5 million as special mention at June 30, 2013. Both loans were current and performing in accordance with their terms at June 30, 2013. A portion of the increase in impaired loans and virtually all of the decrease in substandard loans were due to the reclassification of certain loans classified as substandard at September 30, 2012 to impaired at June 30, 2013. The reason for the increase in impaired land and land development loans at June 30, 2013 was the addition of two loans totaling $7.0 million secured by land in the western part of Virginia. These loans matured at December 31, 2012 and as of June 30, 2013 had not been renewed or restructured, though the borrower has continued to make payments according to the original loan terms.

Included in impaired loans are troubled debt restructurings of $6.4 million and $6.5 million at June 30, 2013 and September 30, 2012, respectively that had related allowance balances of zero and $93,000, respectively. Troubled debt restructurings that were performing in accordance with modified terms were $5.5 million at both June 30, 2013 and September 30, 2012.

Troubled Debt Restructurings

During the nine months ended June 30, 2013, the Company had no loans modified in troubled debt restructurings. The Company did not identify any restructured loans that went into default during the nine months ended June 30, 2013 that had been restructured during the previous twelve months. Interest recognized on a cash basis on nonaccrual restructured loans was not material for the three and nine months ended June 30, 2013.

During the nine months ended June 30, 2012, the Company modified five loans in troubled debt restructurings, including two construction loans to one borrower, one nonresidential loan and two land and land development loans. The restructuring of the construction loans involved the reduction in the loans’ interest rate floor and monthly principal payment requirement to accommodate cash flow difficulties being experienced by the borrower. A discounted cash flows analysis for these loans determined that no specific allowance was necessary. These loans remained on accrual status as the borrower was current at June 30, 2012 and remained current at June 30, 2013. The nonresidential loan modification consisted of further principal payment reductions and an extension of the call date on a loan previously recognized as a troubled debt restructuring. This loan was returned to accrual status during the nine months ended June 30, 2012 as it had remained current on restructured payment requirements for over nine months, and the loan remained current at June 30, 2013. The two land and land development loans restructured share the same collateral and had been previously identified as impaired loans. These loans have matured, and the restructurings consisted of forbearance agreements extending the maturity dates of the loans in order to provide the developers more time to sell the collateral. These loans have since been foreclosed on, the properties taken into other real estate owned, and a portion of the properties sold. Interest recognized on a cash basis on restructured loans was not material for the three and nine months ended June 30, 2012.

Loans summarized by loan type and credit rating at June 30, 2013 and September 30, 2012 are as follows:

	June 30, 2013
(Dollars in thousands)	Total		Excellent		Good		Satisfactory		Watch List		Special Mention		Substandard		Impaired		Not Rated
One- to four-family	$	95,470	$	-	$	388	$	26,364	$	-	$	5,650	$	1,910	$	7,627	$	53,531
Multi-family		102,571		285		22,928		57,151		-		-		-		12,600		9,607
Nonresidential		233,800		-		76,752		117,009		-		6,080		-		7,513		26,446
Construction		31,454		-		-		18,082		-		494		492		43		12,343
Land and land     development		46,305		-		-		5,100		782		10,236		3,673		16,164		10,350
Other		408		-		-		-		-		-		-		-		408
Total loans	$	510,008	$	285	$	100,068	$	223,706	$	782	$	22,460	$	6,075	$	43,947	$	112,685

16

	September 30, 2012
(Dollars in thousands)	Total		Good		Satisfactory		Watch List		Special Mention		Substandard		Impaired		Not Rated
One- to four-family	$	104,560	$	252	$	30,323	$	-	$	2,880	$	2,631	$	5,140	$	63,334
Multi-family		81,503		24,214		41,294		-		-		-		12,664		3,331
Nonresidential		208,225		86,872		102,339		3,060		3,114		2,053		5,491		5,296
Construction		25,489		-		13,666		370		664		743		44		10,002
Land and land development		43,761		-		16,128		827		10,925		4,653		9,117		2,111
Other		498		-		-		-		-		-		-		498
Total loans	$	464,036	$	111,338	$	203,750	$	4,257	$	17,583	$	10,080	$	32,456	$	84,572

Details regarding the delinquency status of the Company’s loan portfolio at June 30, 2013 and September 30, 2012 are as follows:

	June 30, 2013
(Dollars in thousands)	Total		Current		31-60 Days		61-90 Days		91-120 Days		121-150 Days		151-180 Days		180+  Days
One- to four-family	$	95,470	$	84,774	$	849	$	1,169	$	1,846	$	1,110	$	-	$	5,722
Multi-family		102,571		96,513		-		-		-		-		-		6,058
Nonresidential		233,800		231,753		-		-		2,047		-		-		-
Construction		31,454		31,086		-		-		-		-		-		368
Land and land development		46,305		34,238		2,941		-		-		-		-		9,126
Other		408		408		-		-		-		-		-		-
Total	$	510,008	$	478,772	$	3,790	$	1,169	$	3,893	$	1,110	$	-	$	21,274

	September 30, 2012
(Dollars in thousands)	Total		Current		31-60 Days		61-90 Days		91-120 Days		121-150 Days		151-180 Days		180+ Days
One- to four-family	$	104,560	$	96,103	$	2,092	$	215	$	322	$	50	$	113	$	5,665
Multi-family		81,503		75,428		-		-		-		-		-		6,075
Nonresidential		208,225		207,758		467		-		-		-		-		-
Construction		25,489		25,311		-		-		-		-		-		178
Land and land development		43,761		30,583		4,041		-		-		-		-		9,137
Other		498		498		-		-		-		-		-		-
Total	$	464,036	$	435,681	$	6,600	$	215	$	322	$	50	$	113	$	21,055

The following is a summary of information pertaining to impaired and non-accrual loans:

	June 30, 2013				September 30, 2012
(Dollars in thousands)	Amount		Allowance		Amount		Allowance
Impaired loans with a specific allowance
One- to four-family	$	-	$	-	$	5,140	$	458
Total impaired loans with a specific allowance	$	-	$	-	$	5,140	$	458
Impaired loans for which no specific allowance is necessary
One- to four-family	$	7,627	$	-	$	-	$	-
Multi-family		12,600		-		12,664		-
Nonresidential		7,513		-		5,491		-
Construction		43		-		44		-
Land and land development		16,164		-		9,117		-
Total impaired loans for which no specific allowance is necessary	$	43,947	$	-	$	27,316	$	-

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	Nine Months Ended  June 30, 2013							Nine Months Ended June 30, 2012
(Dollars in thousands)	Weighted Average Balance		Interest Income Recognized		Annualized Yield			Weighted Average Balance		Interest Income Recognized		Annualized Yield
Impaired loans
One- to four-family	$	6,786	$	218		4.30	%	$	4,575	$	158		4.61	%
%Multi-family		12,636		390		4.13			15,042		522		4.64
Nonresidential		5,708		279		6.54			9,762		203		2.78
Construction		52		2		5.14			128		2		2.09
Land and land development		13,793		120		1.16			17,246		599		4.64
Total impaired loans	$	38,975	$	1,009		3.46		$	46,753	$	1,484		4.24

(Dollars in thousands)	June 30, 2013		September 30, 2012
Nonaccrual loans
One- to four-family	$	10,360	$	9,884
Multi-family		12,600		12,664
Nonresidential		2,047		-
Construction		-		178
Land and land development		16,177		9,841
Total non-accrual loans	$	41,184	$	32,567

Interest recognized on a cash basis on all nonaccrual loans was $455,000 and $394,000 for the three months ended June 30, 2013 and 2012, respectively, and $910,000 and $821,000 for the nine months ended June 30, 2013 and 2012, respectively. There were no loans past due ninety days or more and accruing at June 30, 2013 or September 30, 2012.

Note 5. Other Real Estate Owned

Other real estate owned at June 30, 2013 and September 30, 2012 was $7.0 million and $16.5 million, respectively. During the nine months ended June 30, 2013, the Company sold other real estate owned totaling $11.3 million. The Company recognized net gains on sales of other real estate owned of $50,000 and $1.6 million for the three and nine months ended June 30, 2013, respectively, compared with net gains of $711,000 and $1.3 million for the three and nine months ended June 30, 2012. Gains on sales for the nine months ended June 30, 2013 included the recognition of $58,000 in gains on properties sold in previous periods that had been deferred in accordance with GAAP because financing was provided by the Company and the sale did not meet either initial or continuing investment criteria to qualify for gain recognition. There were no deferred gains included in gains on sale of other real estate owned for the three months ended June 30, 2013. At June 30, 2013, the Company had deferred gains on sales of other real estate owned of $538,000 compared to $251,000 at September 30, 2012. Impairment charges on other real estate owned of $78,000 were recognized for the three and nine months ended June 30, 2013 compared to impairment charges of $611,000 for the three and nine months ended June 30, 2012.

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Note 6. 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 are computed using the weighted average number of common shares outstanding during the period, including the effect of dilutive potential common shares outstanding attributable to stock awards.

	Three Months Ended June 30,					Nine Months Ended     June 30,
(Amounts in thousands, except per share data)	2013		2012			2013		2012
Numerator:
Net income (loss) available to common stockholders	$	1,662	$	(354	)	$	6,686	$	3,929
Denominator:
Weighted-average common shares outstanding		11,499		13,029			11,850		13,152
Effect of dilutive securities		210		21			161		7
Weighted-average common shares outstanding - assuming dilution		11,709		13,050			12,011		13,159
Earnings (loss) per common share - basic	$	0.14	$	(0.03	)	$	0.56	$	0.30
Earnings (loss) per common share - diluted	$	0.14	$	(0.03	)	$	0.56	$	0.30

Note 7. Employee Benefit Plans

Pension Plan

The Bank has a noncontributory defined benefit pension plan (the “Pension Plan”) for substantially all of the Bank’s employees who were employed on or before July 31, 2011. The Bank froze the Pension Plan to new participants effective August 1, 2011, and, therefore, employees hired after July 31, 2011 are not eligible to participate in the Pension Plan. Retirement benefits under this plan are generally based on an employee’s years of service and compensation during the five consecutive years of highest compensation in the ten years immediately preceding retirement. The Company uses a September 30 measurement date for the Pension Plan.

The Pension Plan assets are held in a trust fund by the plan trustee. The trust agreement under which assets of the Pension Plan are held is a part of the Virginia Bankers Association Master Defined Benefit Pension Plan (the
“Plan”). The Plan’s administrative trustee is appointed by the board of directors of the Virginia Bankers Association Benefits Corporation. At June 30, 2013, Reliance Trust Company was investment manager for the Plan. Contributions are made to the Pension Plan, at management’s discretion, subject to meeting minimum funding requirements, up to the maximum amount allowed under the Employee Retirement Income Security Act of 1974 (ERISA), based upon the actuarially determined amount necessary for meeting plan obligations. Contributions are intended to provide not only for benefits attributed to service to date, but also for benefits expected to be earned by employees in the future.

Components of net periodic benefit cost for the three and nine months ended June 30, 2013 and 2012 are as follows:

	Three Months Ended June 30,						Nine Months Ended June 30,
(Dollars in thousands)	2013			2012			2013			2012
Service cost	$	105		$	150		$	316		$	451
Interest cost		154			166			462			498
Expected return on plan assets		(237	)		(203	)		(711	)		(609	)
Recognized net actuarial loss		30			58			90			173
Net periodic benefit cost	$	52		$	171		$	157		$	513

The net periodic benefit cost is included in personnel expense in the consolidated income statements.

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Equity Incentive Plan

On February 21, 2012, the Company adopted the Franklin Financial Corporation 2012 Equity Incentive Plan (the “2012 Equity Incentive Plan”), which provides for awards of restricted stock and stock options to key officers and outside directors. The cost of the 2012 Equity Incentive Plan is based on the fair value of restricted stock and stock option awards on their grant date. The maximum number of shares that may be awarded under the plan is 2,002,398, including 1,430,284 for stock option exercises and 572,114 restricted stock shares.

Shares of common stock issued under the 2012 Equity Incentive Plan may be authorized unissued shares or, in the case of restricted stock awards, may be shares repurchased on the open market. As of June 30, 2013, the Company, through an independent trustee, had repurchased all 572,114 shares on the open market for $9.2 million, or an average cost of $16.02 per share.

The table below presents stock option activity for the nine months ended June 30, 2013:

(Dollars in thousands, except per share amounts)	Options			Weighted- average exercise price		Remaining contractual life (years)		Aggregate intrinsic value
Options outstanding at September 30, 2012		1,115,000		$	13.42		9.50	$	4,059
Granted		-			-
Exercised		(7,400	)		13.42
Forfeited		-			-
Expired		-			-
Options outstanding at June 30, 2013		1,107,600		$	13.42		8.75	$	5,084

At June 30, 2013, the Company had $3.0 million of unrecognized compensation expense related to 1,068,191 stock options vested or expected to vest. The period over which compensation cost related to non-vested awards is expected to be recognized was 3.75 years at June 30, 2013. As of June 30, 2013, 215,600 shares were vested and outstanding. The table below presents information about stock options vested or expected to vest over the remaining vesting period at June 30, 2013:

(Dollars in thousands, except per share amount)
Options vested or expected to vest at period end		1,068,191
Weighted-average exercise price	$	13.42
Remaining contractual life (years)		8.75
Aggregate intrinsic value	$	4,903

The table below presents restricted stock award activity for the nine months ended June 30, 2013:

	Restricted stock awards			Weighted- average grant date fair value
Non-vested at September 30, 2012		449,500		$	13.42
Granted		-			-
Vested		(89,900	)		13.42
Forfeited		-			-
Non-vested at June 30, 2013		359,600		$	13.42

At June 30, 2013, unrecognized compensation expense adjusted for expected forfeitures was $2.7 million related to 343,707 shares of restricted stock expected to vest over the remaining vesting period. The weighted-average period over which compensation cost related to non-vested restricted stock awards is expected to be recognized was 3.75 years at June 30, 2013.

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The estimated unamortized compensation expense, net of estimated forfeitures, related to nonvested stock options and restricted stock issued and outstanding as of June 30, 2013 that will be recognized in future periods is as follows:

(Dollars in thousands)	Stock Options		Restricted Stock		Total
For the three months ending September 30, 2013	$	204	$	376	$	580
For the year ending September 30, 2014		809		1,188		1,997
For the year ending September 30, 2015		809		699		1,508
For the year ending September 30, 2016		809		364		1,173
For the six months ending March 31, 2017		396		110		506
Total	$	3,027	$	2,737	$	5,764

Share-based compensation related to stock options and restricted stock recognized for the three and nine months ended June 30, 2013 was $625,000 and $2.5 million, respectively, and the related income tax benefit was $238,000 and $946,000, respectively. Share-based compensation related to stock options and restricted stock recognized for the three and nine months ended June 30, 2012 was $700,000 and $717,000, respectively, and the related income tax benefit was $266,000 and $273,000, respectively.

Employee Stock Ownership Plan

In connection with the Company’s stock conversion completed in April 2011, the Bank established an employee stock ownership plan (“ESOP”) for the benefit of all of its eligible employees. Employees at the date of conversion and employees of the Bank hired after the conversion who have been credited with at least 1,000 hours of service during a 12-month period and who have attained age 21 are eligible to participate in the ESOP. It is anticipated that the Bank will make contributions to the ESOP in amounts necessary to amortize the ESOP loan payable to Franklin Financial over a period of 20 years.

Unearned ESOP shares are shown as a reduction of stockholders’ equity. Dividends on unearned ESOP shares, if paid, will be considered to be compensation expense. The Company recognizes compensation cost equal to the fair value of the ESOP shares during the periods in which they become committed to be released. To the extent that the fair value of the Company’s ESOP shares differs from the cost of such shares, the differential is recognized in stockholders’ equity. The Company receives a tax deduction equal to the cost of the shares released. As the ESOP is internally leveraged, the loan receivable by Franklin Financial from the ESOP is not reported as an asset nor is the debt of the ESOP shown as a liability in the consolidated financial statements.

Compensation expense related to the ESOP for the three and nine months ended June 30, 2013 was $257,000 and $747,000, respectively, compared to $215,000 and $637,000, respectively, for the three and nine months ended June 30, 2012. The fair value of unearned ESOP shares, using the closing quoted market price per share of the Company’s stock, was $18.0 million at June 30, 2013. A summary of ESOP share allocation for the nine months ended June 30, 2013 is as follows:

Shares allocated at September 30, 2012	100,041
Shares allocated during the period	42,751
Shares distributed during the period	(1,307	)
Allocated shares held by the ESOP trust at June 30, 2013	141,485
Unearned shares at June 30, 2013	1,001,435
Total ESOP shares	1,142,920

Stock-Based Deferral Plan

In connection with the Company’s stock conversion completed in April 2011, the Company adopted a stock-based deferral plan whereby certain officers and directors could use funds from previously existing nonqualified deferred compensation plans to invest in stock of the Company. The Company established a trust to hold shares purchased through the stock-based deferral plan. The trust qualifies as a rabbi trust that will be settled upon the retirement of participating officers and directors through the distribution of shares held by the trust. As a result, shares held by the trust are accounted for in a manner similar to treasury stock, and the deferred compensation balance is recorded as a component of additional paid-in capital on the Company’s consolidated balance sheet in accordance with GAAP.

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Note 8. Financial Instruments with Off-Balance-Sheet Risk

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet its investment and funding needs and the financing needs of its customers. These financial instruments include commitments to extend credit, commitments to sell loans, and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized or disclosed in the consolidated financial statements. The contractual or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Company uses the same credit and collateral policies in making commitments to extend credit and standby letters of credit 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 by the customer. Since some commitments may expire without being funded, the commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The total amount of loan commitments was $86.3 million and $104.9 million at June 30, 2013 and September 30, 2012, respectively.

Standby letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk and recourse provisions involved in issuing letters of credit are essentially the same as those involved in extending loans to customers, and the estimated fair value of these letters of credit, which is included in accrued expenses and other liabilities, was not material at June 30, 2013 and September 30, 2012, respectively. The amount of standby letters of credit was $1.5 million and $799,000 at June 30, 2013 and September 30, 2012, respectively. The Company believes that the likelihood of having to perform on standby letters of credit is remote based on the financial condition of the guarantors and the Company’s historical experience.

At June 30, 2013, the Company had no rate lock commitments to originate mortgage loans and mortgage loans held for sale of $113,000 compared to $691,000 and $1.5 million, respectively, at September 30, 2012.At June 30, 2013, the Company had corresponding commitments outstanding of $113,000 to sell loans on a best-efforts basis compared to $2.1 million at September 30, 2012. These commitments to sell loans are designed to eliminate the Company’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.

Note 9. Fair Value Measurements

In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. Accounting standards set forth a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability, which are developed based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s assumptions about the variables that the market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.

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The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). A financial asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

• 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, and other inputs that are observable or can be corroborated by observable market data.

• Level 3: Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

The following is a description of valuation methodologies used for assets recorded at fair value on a recurring or non-recurring basis. The determination of where an asset or liability falls in the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter and, based on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. However, the Company expects that changes in classifications between levels will be rare.

Securities available for sale: Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using a combination of methods, including model pricing based on spreads obtained from new market issues of similar securities, dealer quotes, and trade prices. Level 1 securities include common equity securities traded on nationally recognized securities exchanges. Level 2 securities include mortgage-backed securities and collateralized mortgage obligations issued by government sponsored entities, municipal bonds, and corporate debt securities. Level 3 securities include corporate debt securities.

Securities held to maturity: Securities held-to-maturity are recorded at fair value on a non-recurring basis. A held-to-maturity security’s amortized cost is adjusted only in the event that a decline in fair value is deemed to be other-than-temporary. At June 30, 2013, certain held-to-maturity securities were deemed to be other-than-temporarily impaired. These securities are classified as Level 3 securities and were written down to fair value at the balance sheet date determined by discounting estimated future cash flows. Management believes that classification and valuation of these securities, consisting of non-agency collateralized mortgage obligations, as Level 3 assets was necessary as the market for such securities severely contracted beginning in 2008 and became and has remained inactive since that time. While the market for highly-rated private-label securities with low delinquency levels and high subordination saw significant price improvement beginning in the second half of fiscal 2010, the market for securities similar to those recognized as other-than-temporarily impaired, which had low ratings, high delinquency levels, and low subordination levels, remained inactive. As a result, management does not believe that quoted prices on similar assets were representative of fair value as there were few transactions, and transactions were often executed at distressed prices. Management estimates and discounts future cash flows based on a combination of observable and unobservable inputs, including a security’s subordination percentage, projected delinquency rates, and estimated loss severity given default. These estimates are discounted using observable current market rates for securities with similar credit quality.

Loans held for sale: The fair value of loans held for sale is determined using quoted secondary-market prices. If the fair value of a loan is below its carrying value, a lower-of-cost-or-market adjustment is made to reduce the basis of the loan. If fair value exceeds carrying value, no adjustment is made. As such, the Company classifies loans held for sale as Level 2 assets and makes fair value adjustments on a non-recurring basis.

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Impaired loans: The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and, if necessary, a specific allowance for loan losses is established. Loans for which it is probable that payment of principal and interest will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management writes the loan down to net realizable value either through a specific allowance or a charge-off, which, for “collateral dependent” impaired loans, is equal to fair value of the collateral less estimated costs to sell, if the loan balance exceeds net realizable value. For loans deemed to be “collateral dependent,” fair value is estimated using the appraised value of the related collateral. At the time the loan is identified as impaired, the Company determines if an updated appraisal is needed and orders an appraisal if necessary. Subsequent to the initial measurement of impairment, management considers the need to order updated appraisals each quarter if changes in market conditions lead management to believe that the value of the collateral may have changed materially. Impaired loans where net realizable value is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or an appraised value less than one year old estimated utilizing information gathered from an active market, the Company classifies the impaired loan as a Level 2 asset. When an appraised value is not available, is greater than one year old, or if management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company classifies the impaired loan as a Level 3 asset. Additionally, if the fair value of an impaired loan is determined using an appraisal less than one year old that utilizes information gathered from an inactive market or contains material adjustments based upon unobservable market data, the Company classifies the impaired loan as a Level 3 asset.

Other real estate owned: Other real estate owned (“OREO”) is adjusted to net realizable value, which is equal to fair value less costs to sell, upon foreclosure. Subsequently, OREO is adjusted on a non-recurring basis to the lower of carrying value or net realizable value. Fair value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the OREO. When the fair value of OREO is based on an observable market price or an appraised value less than one year old estimated utilizing information gathered from an active market, the Company classifies the OREO as a Level 2 asset. When an appraised value is not available, is greater than one year old, or if management determines the fair value of the OREO is further impaired below the appraised value and there is no observable market price, the Company classifies the OREO as a Level 3 asset. Additionally, if the fair value of the OREO is determined using an appraisal less than one year old that utilizes information gathered from an inactive market or contains material adjustments based upon unobservable market data, the Company classifies the OREO as a Level 3 asset.

Assets measured at fair value on a recurring basis as of June 30, 2013 are summarized below:

(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Securities available for sale
States and political subdivisions	$	5,998	$	-	$	5,998	$	-
Agency mortgage-backed securities		123,106		-		123,106		-
Agency collateralized mortgage obligations		95,615		-		95,615		-
Corporate equity securities		18,957		18,957		-		-
Corporate debt securities		87,845		-		83,206		4,639
Total assets at fair value	$	331,521	$	18,957	$	307,925	$	4,639

A rollforward of securities classified as Level 3 measured at fair value on a recurring basis from the prior year end is as follows (dollars in thousands):

Balance of Level 3 assets measured on a recurring basis at September 30, 2012	$	6,433
Principal payments in period		(153	)
Sales of securities in period		(1,496	)
Accretion (amortization) of premiums or discounts		(20	)
Other-than-temporary impairment charges included in noninterest income		(44	)
Net change in unrealized gains or losses included in accumulated other comprehensive income		(81	)
Balance of Level 3 assets measured on a recurring basis at June 30, 2013	$	4,639

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Level 3 securities measured at fair value on a recurring basis at June 30, 2013 consisted of one corporate debt security for which the Company was not able to obtain dealer quotes due to lack of trading activity. For this security the Company obtained a bid indication from a third-party trading desk to determine the fair value.

The Company may be required, from time to time, to measure certain assets at fair value on a non-recurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period, including held-to-maturity securities, impaired loans, and real estate owned. Held-to-maturity securities are measured at fair value in a period in which an other-than-temporary impairment charge is recognized. Impaired loans are measured at fair value when a change in the value of the underlying collateral or a change in the present value of estimated future cash flows result in a change in the specific allowance for such a loan. Real estate owned is measured at fair value in the period of foreclosure or in a period in which a change in net realizable value results in an impairment charge.

Assets measured at fair value on a non-recurring basis as of June 30, 2013 are included in the table below:

(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Non-agency collateralized mortgage obligations	$	1,551	$	-	$	-	$	1,551
Impaired loans
One- to four-family		3,765		-		-		3,765
Nonresidential		2,046		-		-		2,046
Other real estate owned		792		-		189		603
Total assets at fair value	$	8,154	$	-	$	189	$	7,965

In estimating the fair value of non-agency collateralized mortgage obligations (“CMOs”), the Company performs a discounted cash flow analysis that uses certain unobservable inputs, including delinquency and loss severity rates for the collateral underlying each security, cash flow estimates obtained from a third-party service, and the discount rate applied. Since there is no readily-available discount rate for each individual security, the Company begins with the rate of a seven-year corporate bond (which management believes mirrors the expected remaining life of these securities) with a credit rating of B as of the balance sheet date. The Company applies this rate as the discount rate on non-agency CMOs rated as “investment grade” by the major rating agencies and applies multiples of this rate to non-agency CMO’s of lower credit quality. For securities rated one level below investment grade, the Company applies this rate times a factor of two; for securities rated two levels below investment grade, the Company applies this rates times a factor of three; and for securities rate three or more levels below investment grade, the Company applies this rate times a factor of four. The following table provides information about unobservable inputs used in the valuation of non-agency CMOs at June 30, 2013:

	Range	Weighted Average
Delinquency rate	0.00% - 84.54%		13.84	%
Loss severity	0.03% - 90.25%		40.81	%
Discount rate	5.23% - 20.92%		16.88	%

The following methods and assumptions were used to estimate fair value of other classes of financial instruments:

Cash and cash equivalents: The carrying amount is a reasonable estimate of fair value.

Loans held for investment: The fair value of loans held for investment is determined by discounting the future cash flows using the rates currently offered for loans of similar remaining maturities. Estimates of future cash flows are based upon current account balances, contractual maturities, prepayment assumptions, and repricing schedules.

Federal Home Loan Bank stock: The carrying amount of restricted stock approximates the fair value based on the redemption provisions.

Accrued interest receivable: The carrying amount is a reasonable estimate of fair value.

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Deposits: The carrying values of money market savings and money market checking accounts are reasonable estimates of fair value. The fair value of fixed-maturity certificates of deposit is determined by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

FHLB borrowings: The fair values of FHLB borrowings are determined by discounting the future cash flows using rates currently offered for borrowings with similar terms.

Accrued interest payable: The carrying amount is a reasonable estimate of fair value.

Advance payments by borrowers for property taxes and insurance: The carrying amount is a reasonable estimate of fair value.

Commitments to extend credit: The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The majority of the Company’s commitments to extend credit carry current interest rates if converted to loans.

Standby letters of credit: The fair value of standby letters of credit is based on fees the Company would have to pay to have another entity assume its obligation under the outstanding arrangement.

The estimated fair values of the Company’s financial instruments, as well as their classifications in the fair value hierarchy, at June 30, 2013 and September 30, 2012 are as follows:

	June 30, 2013
	Total				Level 1				Level 2				Level 3
	Carrying		Fair		Carrying		Fair		Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Value		Value		Value		Value		Value		Value		Value		Value
Financial assets:
Cash and cash equivalents	$	129,309	$	129,309	$	129,309	$	129,309	$	-	$	-	$	-	$	-
Securities available for sale		331,521		331,521		18,957		18,957		307,925		307,925		4,639		4,639
Securities held to maturity		16,061		18,046		-		-		7,769		8,253		8,292		9,793
Net loans		496,532		509,976		-		-		-		-		496,532		509,976
Loans held for sale		113		113		-		-		113		113		-		-
FHLB stock		9,779		9,779		9,779		9,779		-		-		-		-
Accrued interest receivable		3,873		3,873		3,873		3,873		-		-		-		-
Financial liabilities:
Deposits		629,634		635,328		-		-		629,634		635,328		-		-
FHLB borrowings		173,162		194,389		-		-		173,162		194,389		-		-
Accrued interest payable		909		909		909		909		-		-		-		-
Advance payments by borrowers for taxes and insurance		1,926		1,926		1,926		1,926		-		-		-		-
Off-balance-sheet financial instruments:
Commitments to extend credit		86,299		-		-		-		-		-		86,299		-
Standby letters of credit		1,488		12		-		-		-		-		1,488		12

26

	September 30, 2012
	Total				Level 1				Level 2				Level 3
	Carrying		Fair		Carrying		Fair		Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Value		Value		Value		Value		Value		Value		Value		Value
Financial assets:
Cash and cash equivalents	$	119,879	$	119,879	$	119,879	$	119,879	$	-	$	-	$	-	$	-
Securities available for sale		394,179		394,179		14,796		14,796		372,950		372,950		6,433		6,433
Securities held to maturity		20,372		20,755		-		-		9,793		10,581		10,579		10,174
Net loans		450,465		469,359		-		-		-		-		450,465		469,359
Loans held for sale		1,458		1,458		-		-		1,458		1,458		-		-
FHLB stock		10,082		10,082		10,082		10,082		-		-		-		-
Accrued interest receivable		4,448		4,448		4,448		4,448		-		-		-		-
Financial liabilities:
Deposits		640,304		647,640		-		-		640,304		647,640		-		-
FHLB borrowings		172,204		213,040		-		-		172,204		213,040		-		-
Accrued interest payable		912		912		912		912		-		-		-		-
Advance payments by borrowers for taxes and insurance		2,325		2,325		2,325		2,325		-		-		-		-
Off-balance-sheet financial instruments:
Commitments to extend credit		104,926		-		-		-		-		-		104,926		-
Standby letters of credit		799		18		-		-		-		-		799		18

Note 10. Stock Repurchase Program

On September 12, 2012, the board of directors approved a second stock repurchase program whereby the Company was authorized to repurchase up to 5%, or 679,385 shares, of its outstanding common stock upon completion of the initial share repurchase program. During the nine months ended June 30, 2013, the Company repurchased 433,826 shares of its outstanding common stock under this second program for $7.4 million, or an average price of $16.94 per share, completing this program.

On November 15, 2012, the board of directors approved a third stock repurchase program whereby the Company was authorized to repurchase up to 645,415 shares, or approximately 5% of its common stock that was outstanding upon completion of the second stock repurchase program. During the three and nine months ended June 30, 2013, the Company repurchased 237,300 shares and 389,200 shares, respectively, of its outstanding common stock under this third program for $4.3 million and $7.0 million, respectively, or an average price of $18.16 per share and $18.01 per share, respectively.

27

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

Safe Harbor Statement for Forward-Looking Statements

This report may contain forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts; rather they are statements based on our current expectations regarding our business strategies and their intended results and our future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions. Forward-looking statements are not guarantees of future performance. Numerous risks and uncertainties could cause or contribute to our actual results, performance and achievements being materially different from those expressed or implied by the forward-looking statements. These forward-looking statements are subject to significant risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:

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

• a decline in real estate values;

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

• increased competitive pressures among financial services companies;

• changes in consumer spending, borrowing and savings habits;

• legislative, regulatory or supervisory changes that adversely affect our business;

• adverse changes in the securities markets; and

• changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board or the Public Company Accounting Oversight Board.

Additional factors that may affect our results are discussed in the Company’s Annual Report on Form 10-K for the year ended September 30, 2012 under Item 1A titled “Risk Factors.” These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, we assume no obligation and disclaim any obligation to update any forward-looking statements.

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.

Allowance for Loan Losses.The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged or credited to income. Determining the amount of the allowance for loan losses involves a high degree of judgment. Among the material estimates required to establish the allowance are: the likelihood of default; the loss exposure at default; the amount and timing of future cash flows on impaired loans; the value of collateral; and the determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectibility of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, our regulator, as an integral part of its examination process, periodically reviews our allowance for loan losses and may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See note 4 of the notes to the unaudited consolidated financial statements.

28

Other-Than-Temporary Impairment.Investment securities are reviewed at each quarter to determine whether the fair value is below the current amortized cost. When the fair value of any of our investment securities has declined below its amortized cost, management is required to assess whether the decline is other than temporary. In making this assessment, we consider such factors as the type of investment, the length of time and extent to which the fair value has been below the carrying value, the financial condition and near-term prospects of the issuer, and our intent and ability to hold the investment long enough to allow for any anticipated recovery. The decision to record a write-down, its amount and the period in which it is recorded could change if management’s assessment of the above factors were different. We do not record impairment write-downs on debt securities when impairment is due to changes in interest rates, since we have the intent and ability to realize the full value of the investments by holding them to maturity. Quoted market value is considered to be fair value for actively traded securities. For illiquid and thinly traded securities where market quotes are not available, we use discounted cash flows to determine fair value. Additional information regarding our accounting for investment securities is included in note 2 of the notes to the unaudited consolidated financial statements.

Income Taxes.Management makes estimates and judgments to calculate certain tax liabilities and to determine the recoverability of certain deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. The Company also estimates a valuation allowance for deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective.

In evaluating the recoverability of deferred tax assets, management considers all available positive and negative evidence, including past operating results, recent cumulative losses – both capital and operating – and the forecast of future taxable income – also both capital and operating. In determining future taxable income, management makes assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require judgments about future taxable income and are consistent with the plans and estimates to manage the Company’s business. Any reduction in estimated future taxable income may require the Company to record a valuation allowance against deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on future earnings.

Valuation of Stock-Based Compensation. The Company accounts for its stock options and restricted stock in accordance with ASC Topic 718,Compensation – Stock Compensation. ASC Topic 718 requires companies to expense the fair value of stock-based compensation. Management uses the Black-Scholes option valuation model and the Monte Carlo model to estimate the fair value of stock options and restricted stock, respectively. These models require the input of highly subjective assumptions, including expected stock price volatility, option life and ability to achieve performance and market conditions stipulated for restricted stock awards. These subjective input assumptions materially affect the fair value estimate.

Pension Plan.The Company has a noncontributory defined benefit pension plan. This plan is accounted for under the provisions of ASC Topic 715:Compensation-Retirement Benefits, which requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The funded status of a benefit plan is measured as the difference between plan assets at fair value and the benefit obligation. For a pension plan, the benefit obligation is the projected benefit obligation. ASC Topic 715 also requires an employer to measure the funded status of a plan as of the date of its year-end balance sheet. Management must make certain estimates and assumptions when determining the projected benefit obligation. These estimates and assumptions include the expected return on plan assets, the rate of compensation increases over time, and the appropriate discount rate to be used in determining the present value of the obligation.

29

Comparison of Financial Condition at June 30, 2013 and September 30, 2012

Assets.Total assets at June 30, 2013 were $1,050.6 million, a decrease of $20.2 million, or 1.9%, from total assets of $1,070.8 million at September 30, 2012.

Cash and cash equivalents increased $9.4 million to $129.3 million at June 30, 2013 compared to $119.9 million at September 30, 2012, an increase of 7.9%. The increase in cash and cash equivalents from September 30, 2012 to June 30, 2013 was primarily due to net income as well as sales, prepayments and maturities of securities and sales of other real estate owned, partially offset by an increase in loans, a decrease in deposits, stock repurchases and a special cash dividend. Securities decreased $67.0 million, or 16.2%, to $347.6 million at June 30, 2013 compared to $414.6 million at September 30, 2012. The decrease in securities included $94.4 million of normal principal payments on securities, $15.3 million of maturities and calls on corporate debt securities, and $19.0 million of sales of corporate debt securities and municipal bonds, partially offset by the purchase of $63.3 million of MBSs.

Total loans, excluding loans held for sale, increased $46.0 million, or 9.9%, to $510.0 million at June 30, 2013 compared to $464.0 million at September 30, 2012. Multi-family loans increased $21.1 million, nonresidential loans increased $25.6 million, construction loans increased $6.0 million and land and land development loans increased $2.5 million. These increases were partially offset by a decline in one- to four-family loans of $9.1 million.

Liabilities. Total liabilities at June 30, 2013 were $811.5 million compared to $821.3 million at September 30, 2012, a decrease of $9.8 million, or 1.2%, primarily as a result of a $21.1 million decrease in certificates of deposit, partially offset by a $10.4 million increase in money market checking and money market savings accounts.

Stockholders’ equity.Stockholders’ equity was $239.2 million at June 30, 2013, a decrease of $10.3 million, or 4.1%, from September 30, 2012. The decrease was the result of the repurchase of $14.7 million of common stock as part of the Company’s stock repurchase programs, the purchase of $1.8 million of common stock for the 2012 Equity Incentive Plan and the payment of a $5.3 million special cash dividend, partially offset by net income of $6.7 million, stock-based compensation expense of $2.5 million, the allocation of $747,000 of ESOP shares, and other comprehensive income of $1.3 million.

30

Average Balances, Interest and Dividend Income and Interest Expense, Yields and Rates

The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing annualized income or expense by the average daily balances of assets or liabilities, respectively, for the periods presented. Non-accrual loans are included in average loan balances only. Loan fees are included in interest income on loans and are not material.

	For the Three Months Ended June 30,
	2013								2012
(Dollars in thousands)	Average Balance			Interest and Dividends		Yield/ Cost			Average Balance			Interest and Dividends		Yield/ Cost
Assets:
Interest-earning assets:
Loans:
One- to four-family	$	95,945		$	1,634		6.83	%	$	110,056		$	1,895		6.93	%
Multi-family		98,653			1,508		6.13			80,502			1,346		6.72
Nonresidential		227,228			3,547		6.26			204,794			3,405		6.69
Construction		27,829			391		5.64			23,577			362		6.18
Land and land development		46,023			519		4.52			49,671			539		4.36
Other		415			9		8.70			550			11		8.04
Total loans		496,093			7,608		6.15			469,150			7,558		6.48
Securities:
Collateralized mortgage obligations		121,375			538		1.78			218,310			918		1.69
Mortgage-backed securities		118,642			290		0.98			43,860			262		2.40
States and political subdivisions		6,326			89		5.64			13,554			180		5.34
Corporate equity securities		17,360			95		2.19			26,404			121		1.84
Corporate debt securities		90,471			1,050		4.66			123,406			1,572		5.12
Total securities		354,174			2,062		2.34			425,534			3,053		2.89
Investment in FHLB stock		9,779			56		2.30			10,395			40		1.55
Other interest-earning assets		115,768			61		0.21			113,823			47		0.17
Total interest-earning assets		975,814			9,787		4.02			1,018,902			10,698		4.22
Allowance for loan losses		(10,230	)							(11,653	)
Noninterest-earning assets		87,683								87,010
Total assets	$	1,053,267							$	1,094,259
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Deposits:
Money market savings	$	230,485			298		0.52		$	220,002			252		0.46
Money market checking		45,614			49		0.43			43,905			52		0.48
Certificates of deposit		349,868			1,227		1.41			380,057			1,630		1.72
Total deposits		625,967			1,574		1.01			643,964			1,934		1.21
FHLB borrowings		172,954			1,931		4.48			179,652			2,055		4.60
Total interest-bearing liabilities		798,921			3,505		1.76			823,616			3,989		1.95
Noninterest bearing liabilities		13,519								9,686
Total liabilities		812,440								833,302
Stockholders’ equity		240,827								260,957
Total liabilities and stockholders’ equity	$	1,053,267							$	1,094,259
Net interest income				$	6,282							$	6,709
Interest rate spread(1)							2.26	%							2.27	%
Net interest margin(2)							2.58	%							2.65	%
Average interest-earning assets to average interest-bearing liabilities							122	%							124	%

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

⁽²⁾ Net interest margin represents net interest income as a percentage of average interest-earning assets.

31

Comparison of Operating Results for the Three Months Ended June 30, 2013 and June 30, 2012

General.We had net income of $1.7 million, or $0.14 per share, for the three months ended June 30, 2013 compared to a net loss of $354,000, or $0.03 per share, for the three months ended June 30, 2012, an improvement of $2.0 million. The increase was primarily the net result of a $1.9 million decrease in other-than-temporary impairment charges on securities included in income, a $982,000 increase in gains on sales of securities, a $467,000 decrease in other noninterest expenses and a $407,000 decrease in income tax expense, partially offset by a $427,000 decrease in net interest income, a $561,000 increase in the provision for loan losses, and a $661,000 decrease in gains on sales of other real estate owned.

Net Interest Income.Net interest income decreased $427,000, or 6.4%, to $6.3 million in the three months ended June 30, 2013 from $6.7 million in the three months ended June 30, 2012. The decrease in net interest income was the result of the sale, maturity and prepayment of higher yielding securities and loans, which resulted in lower yields on these asset classes. The average balances of interest-earning assets declined $43.1 million from the three months ended June 30, 2012 to the three months ended June 30, 2013 and the yield declined 20 basis points.

Total interest and dividend income decreased $911,000, or 8.5%, to $9.8 million for the three months ended June 30, 2013 from $10.7 million for the three months ended June 30, 2012. Interest income on loans increased $50,000 primarily due to an increase of $26.9 million in the average balance of loans, partially offset by a 33 basis point decline in yield. The decline in yield was the result of a lower interest rate environment as well as increased competition for quality loans. The average balance of nonresidential loans increased $22.4 million and the yield declined 43 basis points. The average balance of multi-family loans increased $18.2 million and the yield decreased 59 basis points. The average balance of construction loans increased $4.3 million and the yield decreased 54 basis points. These increases in average balances were partially offset by a $14.1 million decrease in the average balance of one- to four-family loans, with a decrease in yield of 10 basis points, and a $3.6 million decrease in the average balance of land and land development loans, with an increase in yield of 16 basis points.

Interest and dividend income on investment securities (excluding FHLB stock) decreased $991,000, or 32.5%, due to a $71.4 million decrease in the average balance of investment securities for the three months ended June 30, 2013 compared to the three months ended June 30, 2012 as well as a 55 basis point decline in yield. The average balance of CMOs decreased $96.9 million due to prepayments and the yield increased 9 basis points, resulting in a decrease in interest income of $380,000. The average balance of corporate debt securities decreased $32.9 million and the yield decreased 46 basis points due to the sale of longer-term corporate bonds, resulting in a decrease in interest income of $522,000. These decreases were partially offset by a $74.8 million increase in the average balance of MBSs that was partially offset by a 142 basis point decline in yield, resulting in an increase in interest income of $28,000. The severe decline in the yield on MBSs was due in part to the decline in market interest rates in March and April 2013, which resulted in a more rapid refinancing of MBSs purchased at premiums than projected. This scenario is expected to reverse in the fourth quarter of fiscal 2013 due to the rise in market interest rates in May and June 2013. The Company has significantly increased its investment in short-term MBSs and CMOs to meet regulatory qualified thrift lender requirements and to better position the Company for rising interest rates.

Total interest expense decreased $484,000, or 12.1%, to $3.5 million for the three months ended June 30, 2013 from $4.0 million for the three months ended June 30, 2012. The decline was the result of a $360,000 decrease in deposit costs and a $124,000 decrease in Federal Home Loan Bank (“FHLB”) borrowings costs. The average balance of interest-bearing deposits decreased $18.0 million due to a $30.2 million decrease in the average balance of certificates of deposit, partially offset by an increase in the average balance of money market savings and money market checking accounts of $12.2 million. The Company has not been aggressive in deposit pricing since its mutual to stock conversion because of the large amount of cash raised in the conversion. The average interest rate paid on deposits decreased 20 basis points as a result of the lower interest rate environment for deposits in the three months ended June 30, 2013 compared to the comparable period in the prior year. As the economy has improved, depositors have been more willing to move their certificates of deposit to higher risk assets to get a greater return on their funds. The average balance of FHLB borrowings decreased $6.7 million and the average interest rate paid declined 12 basis points due to debt modifications made during the third quarter of fiscal 2012.

32

Provision for Loan Losses.The provision for loan losses increased $561,000 to $171,000 for the three months ended June 30, 2013 compared to a credit provision of $390,000 for the three months ended June 30, 2012. The increase in the provision was primarily due to a $28.0 million increase in total loans from March 31, 2013 to June 30, 2013. Net loan charge-offs were $897,000 for the three months ended June 30, 2013 compared to $10,000 for the three months ended June 30, 2012. The overall allowance rate decreased 27 basis points at June 30, 2013 to 1.94% of total loans from 2.21% of total loans at March 31, 2013. The higher charge-offs and the decline in the allowance rate during the three months ended June 30, 2013 resulted from a change in the methodology for computing the specific allowance on impaired loans. See note 4 of the notes to the unaudited consolidated financial statements for a discussion of our methodology for estimating the allowance for loan losses.

Noninterest Income (Expense)

The following table presents the components of noninterest income (expense) and the percentage increase (decrease) from the comparable prior year quarter:

	Three Months Ended June 30,						Increase (Decrease)
(Dollars in thousands)	2013			2012			%
Service charges on deposit accounts	$	14		$	14			-	%
Other service charges and fees		136			167			(18.6	)
Gains on sales of loans held for sale		2			65			(96.4	)
Gains (losses) on sales of securities, net		205			(777	)		NM
Gains on sales of other real estate owned		50			711			(93.0	)
Impairment of securities		(190	)		(2,005	)		(90.5	)
Impairment recognized in OCI		(52	)		53			NM
Net impairment reflected in earnings		(138	)		(2,058	)		(93.3	)
Increase in cash surrender value of bank-owned life insurance		320			323			(0.9	)
Other operating income		200			214			(6.2	)
Total noninterest income (expense)	$	789		$	(1,341	)		NM

Gains, Losses, and Impairment Charges on Securities.Other-than-temporary-impairment charges on securities reflected in earnings decreased $1.9 million to $138,000 for the three months ended June 30, 2013 compared to $2.1 million for the three months ended June 30, 2012. Impairment charges reflected in earnings related entirely to debt securities for the three months ended June 30, 2013 compared to $153,000 on debt securities and $1.9 million on equity securities in the three months ended June 30, 2012. Impairment charges for the three months ended June 30, 2013 related to the Company’s portfolio of non-agency CMOs. Sales of securities resulted in gains of $205,000 for the three months ended June 30, 2013 compared to losses of $777,000 for the three months ended June 30, 2012.

Noninterest Income, Excluding Gains, Losses, and Impairment Charges on Securities.Total other noninterest income excluding gains, losses, and impairment charges on securities decreased $772,000, or 51.6%, for the three months ended June 30, 2013 compared to the three months ended June 30, 2012. The decrease was primarily the result of net gains on sales of other real estate owned of $50,000 in the three months ended June 30, 2013 compared to $711,000 in the three months ended June 30, 2012, a decrease of $661,000. The decrease was also due to a decrease in gains on sales of loans held for sale of $63,000.

33

Other Noninterest Expenses.

The following table presents the components of other noninterest expenses and the percentage increase (decrease) from the comparable prior year quarter:

	Three Months Ended June 30,				Increase (Decrease)
(Dollars in thousands)	2013		2012		%
Personnel expense	$	2,498	$	2,665		(6.3	)%
Occupancy expense		275		227		21.4
Equipment expense		213		249		(14.6	)
Advertising expense		85		46		83.6
Federal deposit insurance premiums		165		207		(20.4	)
Impairment of other real estate owned		78		611		(87.2	)
Other operating expenses		1,284		1,060		21.1
Total other noninterest expenses	$	4,598	$	5,065		(9.2	)

Total noninterest expenses decreased $467,000, or 9.2%, to $4.6 million for the three months ended June 30, 2013 compared to $5.1 million for the three months ended June 30, 2012. The decrease in noninterest expenses was primarily due to a $533,000 decrease in impairment of other real estate owned. The decrease was also due to a $167,000 decrease in personnel expense due to decreased stock compensation expense related to the stock options and restricted stock granted under the Company’s 2012 Equity Incentive Plan in March 2012 as well as decreased pension expense. These decreases were partially offset by an increase in other operating expenses of $224,000 due to increased technology costs as we prepared for the introduction of additional checking products in fiscal 2013.

Income Tax Expense.Income tax expense was $640,000 for the three months ended June 30, 2013 compared to $1.0 million for the three months ended June 30, 2012. The effective income tax rate for the three months ended June 30, 2013 was 27.8% compared to an effective income tax rate of 151.1% for the three months ended June 30, 2012. The effective tax rate for the three months ended June 30, 2012 was affected by losses incurred on sales and impairments of equity securities. Losses on equity securities are capital losses and can only be used for tax purposes to offset capital gains. Because the Company is in a capital loss carryforward position and unable to use capital losses, no related tax benefit was recognized for the three months ended June 30, 2012.

34

Average Balances, Interest and Dividend Income and Interest Expense, Yields and Rates

The following table presents information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing annualized income or expense by the average daily balances of assets or liabilities, respectively, for the periods presented. Non-accrual loans are included in average loan balances only. Loan fees are included in interest income on loans and are not material.

	For the Nine Months Ended June 30,
	2013								2012
(Dollars in thousands)	Average Balance			Interest and Dividends		Yield/ Cost			Average Balance			Interest and Dividends		Yield/ Cost
Assets:
Interest-earning assets:
Loans:
One- to four-family	$	100,032		$	5,046		6.74	%	$	110,858		$	5,815		7.01	%
Multi-family		91,546			4,219		6.16			79,094			3,937		6.65
Nonresidential		214,880			10,335		6.43			194,156			9,837		6.77
Construction		25,160			1,091		5.80			33,060			1,562		6.31
Land and land development		45,408			1,490		4.39			59,477			1,986		4.46
Other		441			28		8.49			582			36		8.26
Total loans		477,467			22,209		6.22			477,227			23,173		6.49
Securities:
Collateralized mortgage obligations		146,374			1,702		1.55			241,177			3,394		1.88
Mortgage-backed securities		107,812			1,161		1.44			35,176			729		2.77
States and political subdivisions		10,410			422		5.42			14,725			556		5.04
U. S. government agencies		-			-		-			1,660			18		1.45
Corporate equity securities		16,165			267		2.21			24,929			306		1.64
Corporate debt securities		101,867			3,599		4.72			121,000			4,779		5.28
Total securities		382,628			7,151		2.50			438,667			9,782		2.98
Investment in FHLB stock		9,977			178		2.39			10,627			96		1.21
Other interest-earning assets		106,589			161		0.20			96,860			101		0.14
Total interest-earning assets		976,661			29,699		4.07			1,023,381			33,152		4.33
Allowance for loan losses		(10,555	)							(12,874	)
Noninterest-earning assets		92,475								82,350
Total assets	$	1,058,581							$	1,092,857
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Deposits:
Money market savings	$	227,658			808		0.47		$	221,116			762		0.46
Money market checking		46,479			151		0.43			43,430			155		0.48
Certificates of deposit		357,404			3,924		1.47			373,830			5,027		1.80
Total deposits		631,541			4,883		1.03			638,376			5,944		1.24
FHLB borrowings		172,633			5,788		4.48			186,563			6,658		4.77
Total interest-bearing liabilities		804,174			10,671		1.77			824,939			12,602		2.04
Noninterest bearing liabilities		11,474								10,396
Total liabilities		815,648								835,335
Stockholders’ equity		242,933								257,522
Total liabilities and stockholders’ equity	$	1,058,581							$	1,092,857
Net interest income				$	19,028							$	20,550
Interest rate spread(1)							2.30	%							2.29	%
Net interest margin(2)							2.60	%							2.67	%
Average interest-earning assets to average interest-bearing liabilities							121	%							124	%

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

⁽²⁾ Net interest margin represents net interest income as a percentage of average interest-earning assets.

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Comparison of Operating Results for the Nine Months Ended June 30, 2013 and June 30, 2012

General.We had net income of $6.7 million, or $0.56 per share, for the nine months ended June 30, 2013 compared to net income of $3.9 million, or $0.30 per share, for the nine months ended June 30, 2012, an improvement of $2.8 million, or 70.2%. The increase was primarily the net result of a $4.1 million decrease in other-than-temporary impairment charges on securities included in income, a $2.4 million increase in gains on sales of securities, and a $597,000 decrease in income tax expense, partially offset by a $1.5 million decrease in net interest income, a $1.1 increase in the provision for loan losses, and a $1.7 million increase in other noninterest expenses.

Net Interest Income.Net interest income decreased $1.5 million, or 7.4%, to $19.0 million in the nine months ended June 30, 2013 from $20.5 million in the nine months ended June 30, 2012. The decrease in net interest income was the result of the sale, maturity and prepayment of higher yielding securities and loans, which resulted in lower yields on these asset classes. The average balances of interest-earning assets declined $46.7 million from the nine months ended June 30, 2012 to the nine months ended June 30, 2013 and the yield declined 26 basis points.

Total interest and dividend income decreased $3.5 million, or 10.4%, to $29.7 million for the nine months ended June 30, 2013 from $33.2 million for the nine months ended June 30, 2012. Interest income on loans decreased $964,000 primarily due to a 27 basis point decline in yield, partially offset by a $240,000 increase in the average balance of loans. The decline in yield was the result of a lower interest rate environment as well as increased competition for quality loans. The average balance of one- to four-family loans decreased $10.8 million and the yield declined 27 basis points. The average balance of land and land development loans decreased $14.1 million and the yield declined 7 basis points. The average balance of construction loans decreased $7.9 million and the yield decreased 51 basis points. These decreases in average balances were partially offset by a $20.7 million increase in the average balance of nonresidential loans and a $12.5 million increase in the average balance of multi-family loans. Their yields declined 34 basis points and 49 basis points, respectively.

Interest and dividend income on investment securities (excluding FHLB stock) decreased $2.6 million, or 26.9%, due to a $56.0 million decrease in the average balance of investment securities for the nine months ended June 30, 2013 compared to the nine months ended June 30, 2012 as well as a 48 basis point decline in yield. The average balance of CMOs decreased $94.8 million and the yield decreased 33 basis points due to substantial prepayments of higher yielding CMOs, resulting in a decrease in interest income of $1.7 million. The average balance of corporate debt securities decreased $19.1 million and the yield declined 56 basis points due to the sale of longer-term corporate bonds, resulting in a decrease in interest income of $1.2 million. These decreases were partially offset by an increase in interest income on MBSs of $432,000 from the nine months ended June 30, 2012 to the nine months ended June 30, 2013 due to a $72.6 million increase in the average balance that was partially offset by a 133 basis point decline in yield. The severe decline in the yield on MBSs was due in part to the decline in market interest rates in March and April 2013, which resulted in a more rapid refinancing of MBSs purchased at premiums than projected. This scenario is expected to reverse in the fourth quarter of fiscal 2013 due to the rise in market interest rates in May and June 2013. The Company has significantly increased its investment in short-term MBSs and CMOs to meet regulatory qualified thrift lender requirements and to better position the Company for rising interest rates.

Total interest expense decreased $1.9 million, or 15.3%, to $10.7 million for the nine months ended June 30, 2013 from $12.6 million for the nine months ended June 30, 2012. The decline was the result of a $1.1 million decrease in deposit costs and a $870,000 decrease in FHLB borrowings costs. The average balance of interest-bearing deposits decreased $6.8 million due to a decrease in the average balance of certificates of deposit of $16.4 million, partially offset by an $9.6 million increase in the average balance of money market savings and money market checking accounts. The Company has not been aggressive in deposit pricing since its mutual to stock conversion because of the large amount of cash raised in the conversion. The average interest rate paid on deposits decreased 21 basis points as a result of the lower interest rate environment for deposits in the nine months ended June 30, 2013 compared to the comparable period in the prior year. As noted above, as the economy has improved, depositors have been more willing to move their certificates of deposit to higher risk assets to get a greater return on their funds. The average balance of FHLB borrowings decreased $13.9 million and the average interest rate paid declined 29 basis points due to debt modifications made during the third quarter of fiscal 2012.

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Provision for Loan Losses.The provision for loan losses increased $1.1 million to $532,000 for the nine months ended June 30, 2013 compared to a credit provision of $542,000 for the nine months ended June 30, 2012. The increase in the provision was primarily due to a $46.0 million increase in total loans from September 30, 2012 to June 30, 2013. Net loan charge-offs were $904,000 for the nine months ended June 30, 2013 compared to $3.3 million for the nine months ended June 30, 2012. The overall allowance rate decreased 28 basis points at June 30, 2013 to 1.94% of total loans from 2.22% of total loans at September 30, 2012. See note 4 of the notes to the unaudited consolidated financial statements for a discussion of our methodology for estimating the allowance for loan losses.

Noninterest Income (Expense)

The following table presents the components of noninterest income (expense) and the percentage increase (decrease) from the comparable prior year nine months:

	Nine Months Ended June 30,						Increase (Decrease)
(Dollars in thousands)	2013			2012			%
Service charges on deposit accounts	$	37		$	38			(2.3	)%
Other service charges and fees		471			781			(39.7	)
Gains on sales of loans held for sale		96			206			(53.1	)
Gains (losses) on sales of securities, net		1,618			(777	)		NM
Gains on sales of other real estate owned		1,614			1,336			20.8
Impairment of securities		(1,269	)		(4,884	)		(74.0	)
Impairment recognized in OCI		(936	)		(500	)		87.3
Net impairment reflected in earnings		(333	)		(4,384	)		(92.4	)
Increase in cash surrender value of bank-owned life insurance		962			965			(0.3	)
Other operating income		568			439			29.5
Total noninterest income (expense)	$	5,033		$	(1,396	)		NM

Gains, Losses, and Impairment Charges on Securities.Other-than-temporary-impairment charges on securities reflected in earnings decreased $4.1 million to $333,000 for the nine months ended June 30, 2013 compared to $4.4 million for the nine months ended June 30, 2012. Impairment charges reflected in earnings related entirely to debt securities for the nine months ended June 30, 2013 compared to $968,000 on debt securities and $3.4 million on equity securities in the nine months ended June 30, 2012. Impairment charges for the nine months ended June 30, 2013 related to the Company’s investment in an auction-rate municipal bond backed by student loans that experienced deteriorating collateral quality as well as our portfolio of non-agency CMOs. Sales of securities resulted in gains of $1.6 million for the nine months ended June 30, 2013 compared to losses of $777,000 for the nine months ended June 30, 2012.

Noninterest Income, Excluding Gains, Losses, and Impairment Charges on Securities.Total other noninterest income excluding gains, losses, and impairment charges on securities decreased $17,000, or 0.4%, for the nine months ended June 30, 2013 compared to the nine months ended June 30, 2012. The decrease was due to a $310,000 decrease in other service charges and fees due to fees received on the prepayment of several large loans in the prior year partially offset by a $278,000 increase in net gains on sales of other real estate owned.

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Other Noninterest Expenses.

The following table presents the components of other noninterest expenses and the percentage increase (decrease) from the comparable prior year nine months:

	Nine Months Ended June 30,				Increase (Decrease)
(Dollars in thousands)	2013		2012		%
Personnel expense	$	8,032	$	6,743		19.1	%
Occupancy expense		756		667		13.5
Equipment expense		667		707		(5.6	)
Advertising expense		144		156		(8.0	)
Federal deposit insurance premiums		518		618		(16.1	)
Impairment of other real estate owned		78		611		(87.2	)
Other operating expenses		3,709		2,729		35.9
Total other noninterest expenses	$	13,904	$	12,231		13.7

Total noninterest expenses increased $1.7 million, or 13.7%, to $13.9 million for the nine months ended June 30, 2013 compared to $12.2 million for the nine months ended June 30, 2012. The increase in noninterest expenses was primarily due to a $1.3 million increase in personnel expense and a $980,000 increase in other operating expenses primarily due to increased stock compensation expense related to the stock options and restricted stock granted to officers and directors under the Company’s 2012 Equity Incentive Plan in March 2012. The increase in other operating expenses was also due to increased technology costs as we prepared for the introduction of additional checking products in fiscal 2013. These increases were partially offset by a $533,000 decrease in impairment of other real estate owned.

Income Tax Expense.Income tax expense was $2.9 million for the nine months ended June 30, 2013 compared to $3.5 million for the nine months ended June 30, 2012. The effective income tax rate for the nine months ended June 30, 2013 was 30.5% compared to an effective income tax rate of 47.4 % for the nine months ended June 30, 2012. The decrease in the effective tax rate was due to the $3.4 million impairment losses on equity securities for the nine months ended June 30, 2012 compared to no losses for the nine months ended June 30, 2013. Losses on equity securities are capital losses and can only be used for tax purposes to offset capital gains. Because the Company is in a capital loss carryforward position and unable to use capital losses, no related tax benefit was recognized for the nine months ended June 30, 2012.

38

Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. The net changes attributable to the combined impact of both rate and volume have been allocated proportionately to the changes due to volume and the changes due to rate.

	Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 2012									Nine Months Ended June 30, 2013 Compared to Nine Months Ended June 30, 2012
	Increase (Decrease)   Due to:									Increase (Decrease) Due to:
(Dollars in thousands)	Volume			Rate			Net			Volume			Rate			Net
Interest income:
Loans	$	1,466		$	(1,416	)	$	50		$	33		$	(997	)	$	(964	)
Securities		(473	)		(518	)		(991	)		(1,171	)		(1,460	)		(2,631	)
Investment in FHLB stock		(16	)		32			16			(18	)		100			82
Other interest earning assets		1			13			14			11			49			60
Total		978			(1,889	)		(911	)		(1,145	)		(2,308	)		(3,453	)
Interest expense:
Deposits:
Money market savings		12			34			46			34			12			46
Money market checking		10			(13	)		(3	)		17			(21	)		(4	)
Certificates of deposit		(126	)		(277	)		(403	)		(311	)		(792	)		(1,103	)
FHLB borrowings		(88	)		(36	)		(124	)		(487	)		(383	)		(870	)
Total		(192	)		(292	)		(484	)		(747	)		(1,184	)		(1,931	)
Increase/(decrease) in net interest income	$	1,170		$	(1,597	)	$	(427	)	$	(398	)	$	(1,124	)	$	(1,522	)

Asset Quality

Nonperforming Assets (NPAs)

At June 30, 2013, nonperforming assets (NPAs) totaled $48.2 million, a decrease of $836,000 from $49.1 million at September 30, 2012. Our level of NPAs remains elevated over historical experience as a result of continued stresses in certain real estate markets as well as the time consuming process of resolving certain large loans working their way through the bankruptcy system. While we intend to actively work to reduce our NPAs, these levels of nonperforming assets are likely to remain elevated in the near term as problem loans work to resolution, which in some cases may be foreclosure.

Nonperforming assets at June 30, 2013 included $41.2 million in nonperforming loans (NPLs) as summarized in the table below. The following table reflects the balances and changes from the prior quarter:

(Dollars in thousands)	June 30, 2013		March 31, 2013		Increase (Decrease)
Nonaccrual loans:
One- to four-family	$	10,360	$	11,344	$	(984	)
Multi-family		12,600		12,625		(25	)
Nonresidential		2,047		-		2,047
Construction		-		20		(20	)
Land and land development		16,177		16,182		(5	)
Total nonperforming loans	$	41,184	$	40,171	$	1,013

The primary reason for the increase in nonperforming loans at June 30, 2013 was the addition of a $2.0 million nonresidential loan secured by a day care center and twenty-six developed lots in central Virginia. See below for further discussion of this loan.

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At June 30, 2013, the allowance for loan losses as a percentage of total loans was 1.94% compared to 2.22% at September 30, 2012. See note 4 of the notes to the unaudited consolidated financial statements for further analysis of the allowance for loan losses.

The following table sets forth selected asset quality data and ratios for the dates indicated:

(Dollars in thousands)	June 30, 2013			September 30, 2012
Nonperforming loans	$	41,184		$	32,567
Other real estate owned		7,049			16,502
Total nonperforming assets		48,233			49,069
Performing troubled debt restructurings(1)		5,510			5,534
Total nonperforming assets and troubled debt restructurings	$	53,743		$	54,603
Allowance for loan losses	$	9,912		$	10,284
Total loans	$	510,008		$	464,036
Ratios
Allowance as a percentage of total loans		1.94	%		2.22	%
Allowance as a percentage of nonperforming loans		24.07	%		31.58	%
Total nonperforming loans to total loans		8.08	%		7.02	%
Total nonperforming loans to total assets		3.92	%		3.04	%
Total nonperforming assets and troubled debt restructurings to total assets		5.12	%		5.10	%

⁽¹⁾ Performing troubled debt restructurings do not include troubled debt restructurings that remain on nonaccrual status and are included in nonaccrual loans above.

At June 30, 2013, nonaccrual loans were primarily comprised of the following:

• Land and land development loans:

- One loan on several hundred acres of undeveloped land in central Virginia proposed for a residential development within a planned unit development. This loan had a balance of $5.0 million and was classified as impaired at June 30, 2013. The collateral was valued at $8.9 million based upon a September 2012 appraisal. The borrower and guarantor on this loan declared bankruptcy and the Company is petitioning the bankruptcy court for release of its collateral. This loan was over 180 days delinquent at June 30, 2013.

- One loan on several hundred acres of undeveloped land in central Virginia proposed for multi-use development within a planned unit development. This loan is a participation loan with two other banks, each having a one-third interest. The balance of the Company’s portion of this loan was $4.1 million and was classified as impaired at June 30, 2013. The collateral was valued at $15.1 million (of which $5.0 million is attributable to the Company) based upon a September 2012 appraisal. The borrower and guarantor on this loan declared bankruptcy and the Company is petitioning the bankruptcy court for release of its collateral. This loan was over 180 days delinquent at June 30, 2013.

- Two loans on over one hundred acres of mixed-use land in central Virginia. These loans had a combined balance of $7.0 million and were classified as impaired at June 30, 2013. The collateral was valued at $8.2 million based upon a March 2013 appraisal. Both loans were current at June 30, 2013.

• Multifamily

- Three loans on a 580-unit apartment complex in central Virginia that had a combined balance of $11.4 million. The apartment complex is valued at $12.3 million based upon June 2013 appraisals. These loans were considered impaired at June 30, 2013. At June 30, 2013, two loans with a balance of $5.3 million were current and one loan with a balance of $6.1 million was over 180 days delinquent.

- One loan on a 64-unit apartment complex in central Virginia with a balance of $1.2 million at June 30, 2013. The apartment complex does not generate enough cash to service the debt and requires support from the guarantor. The apartment complex is valued at $1.5 million based upon a June 2012 appraisal. This loan was identified as impaired at June 30, 2013. This loan was current at June 30, 2013.

40

• One- to four-family

- Sixty-six loans on one- to four-family residential properties in central Virginia to multiple borrowers with an aggregate balance of $6.6 million at June 30, 2013.

- Two loans outstanding to separate entities controlled by the same guarantor totaling $3.8 million secured by twenty-one non-owner-occupied one- to four-family homes, almost all of which were rented at June 30, 2013. The collateral was valued at $4.2 million based upon May 2013 appraisals. At June 30, 2013, the loans were identified as impaired and were over 180 days delinquent because the rental cash flows from the properties were not sufficient to fully cover debt service.

· Nonresidential

- One loan secured by a day care center and twenty-six developed lots in central Virginia. This loan had a balance of $2.0 million and was 61-90 days delinquent at June 30, 2013. This loan was identified as impaired at June 30, 2013. The collateral for this loan was valued at $2.1 million based on a June 2013 appraisal of the day care center and the lots. We have two other loans to entities controlled by the guarantor on this loan as described above in one- to four-family loans.

The following table shows the aggregate amounts of our classified and criticized loans and securities at the dates indicated in accordance with regulatory classification definitions.

(Dollars in thousands)	June 30, 2013		September 30, 2012
Loans(1)
Special mention	$	22,460	$	17,583
Substandard		44,512		37,002
Total criticized loans		66,972		54,585
Other real estate owned
Substandard		7,049		16,502
Total classified other real estate owned		7,049		16,502
Securities
Substandard		7,200		10,710
Total classified securities		7,200		10,710
Total criticized assets	$	81,221	$	81,797

⁽¹⁾ For regulatory reporting, performing troubled debt restructurings can be reclassified at the beginning of each calendar year. As a result, total classified and criticized loans for GAAP and regulatory reporting may be different.

At June 30, 2013, substandard loans, other than nonperforming loans, were comprised primarily of the following:

- One loan secured by several hundred acres of partially-developed residential land in central Virginia. The remaining property is zoned for 106 potential lots. The “as-is” value of the collateral based on a June 2012 appraisal is $6.6 million, and the Company’s loan balance at June 30, 2013 was $3.6 million. The loan was current at June 30, 2013 and, to date, has received support from the guarantors as needed.

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Liquidity and Capital Resources

Liquidity

Liquidity is the ability to meet current and future financial obligations of a short-term and long-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of securities and borrowings from the FHLB. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, calls of investment securities and borrowed funds, and prepayments on loans, mortgage-backed securities and collateralized mortgage obligations are greatly influenced by general interest rates, economic conditions and competition.

Our most liquid assets are cash and cash equivalents and securities classified as available-for-sale. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At June 30, 2013, cash and cash equivalents totaled $129.3 million. In addition, at June 30, 2013, we had the ability to borrow a total of approximately $208.4 million in additional funds from the FHLB. Additionally, we established a borrowing arrangement with the Federal Reserve Bank of Richmond, although no borrowings have occurred to date. We intend to use corporate bonds as collateral for this arrangement and have pledged bonds with an estimated fair value of $5.4 million at June 30, 2013.

At June 30, 2013, we had $86.3 million in loan commitments outstanding, which included $84.0 million in undisbursed loans. Certificates of deposit due within one year of June 30, 2013 totaled $202.4 million. The large percentage of certificates of deposit that mature within one year reflects customers’ hesitancy to invest their funds for long periods. If these maturing deposits are not renewed, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit. Management believes, however, based on past experience that a significant portion of our certificates of deposit will be renewed. We have the ability to attract and retain deposits by adjusting the interest rates offered.

In addition, we believe that our branch network, which is presently comprised of eight full-service retail banking offices located throughout our primary market area, and the general cash flows from our existing lending and investment activities, will afford us sufficient long-term liquidity.

Regulatory Capital

The Bank is subject to various regulatory capital requirements administered by the Office of the Comptroller of the Currency (“OCC”). Failure to meet minimum capital requirements can initiate certain mandatory and possible discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. In addition, the Bank is required to notify the OCC before paying dividends to Franklin Financial.

The regulations require that savings institutions meet prescribed capital requirements. The Tier 1 capital regulations require a savings institution to maintain Tier 1 capital of not less than 4% of adjusted total assets and 4% of risk-weighted assets. The risk-based capital regulations require savings institutions to maintain capital of not less than 8% of risk-weighted assets.

At June 30, 2013, the Bank had regulatory capital in excess of that required under each requirement and was classified as a “well capitalized” institution as determined by the OCC. There are no conditions or events that management believes have changed the Bank’s classification. As a savings and loan holding company regulated by the Federal Reserve Board (“FRB”), Franklin Financial is not currently subject to any separate regulatory capital requirements. The Dodd-Frank Act, however, requires the FRB to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. These capital requirements will apply to savings and loan holding companies beginning in 2015. Currently, capital requirements are proposed for all savings and loan holding companies as part of the Dodd-Frank Act. The following table reflects the level of required capital and actual capital of the Bank at June 30, 2013 and September 30, 2012:

42

	Actual					Amount required to be "adequately capitalized"					Amount required to be "well capitalized"
(Dollars in thousands)	Amount		Percentage			Amount		Percentage			Amount		Percentage
June 30, 2013
Tier 1 capital	$	177,191		17.68	%	$	40,081		4.00	%	$	50,286		5.00	%
(to adjusted tangible assets)
Tier 1 risk-based capital		177,191		26.98			26,270		4.00			39,405		6.00
(to risk weighted assets)
Risk-based capital		185,420		28.23			52,540		8.00			65,675		10.00
(to risk weighted assets)

	Actual					Amount required to be "adequately capitalized"					Amount required to be "well capitalized"
(Dollars in thousands)	Amount		Percentage			Amount		Percentage			Amount		Percentage
September 30, 2012
Tier 1 capital	$	179,110		17.68	%	$	40,518		4.00	%	$	50,996		5.00	%
(to adjusted tangible assets)
Tier 1 risk-based capital		179,110		26.62			26,912		4.00			40,368		6.00
(to risk weighted assets)
Risk-based capital		187,538		27.87			53,824		8.00			67,280		10.00
(to risk weighted assets)

During the nine months ended June 30, 2013, the board of directors of the Bank declared a $15.0 million dividend that was paid to Franklin Financial on December 10, 2012. In June 2013, Franklin Financial transferred $5.9 million of bank-owned life insurance to the Bank as a contribution to its capital.

The following is a reconciliation of the Bank’s GAAP capital to regulatory capital at June 30, 2013 and September 30, 2012 (dollars in thousands):

	June 30, 2013
(Dollars in thousands)	Tier 1 capital			Tier 1 risk- based capital			Risk-based capital
GAAP capital	$	179,072		$	179,072		$	179,072
Accumulated gains on certain available-for-sale securities		(3,373	)		(3,373	)		(3,373	)
Disallowed deferred tax assets		(308	)		(308	)		(308	)
Pension plan		1,800			1,800			1,800
General allowance for loan losses		-			-			8,229
Regulatory capital – computed	$	177,191		$	177,191		$	185,420

	September 30, 2012
(Dollars in thousands)	Tier 1 capital			Tier 1 risk- based capital			Risk-based capital
GAAP capital	$	184,277		$	184,277		$	184,277
Accumulated gains on certain available-for-sale securities		(6,967	)		(6,967	)		(6,967	)
Pension plan		1,800			1,800			1,800
General allowance for loan losses		-			-			8,428
Regulatory capital – computed	$	179,110		$	179,110		$	187,538

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Off-Balance Sheet Arrangements

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.

For the year ended September 30, 2012 and the nine months ended June 30, 2013, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our consolidated financial condition, results of operations or cash flows.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity Analysis

Management uses an interest rate sensitivity analysis to review our level of interest rate risk. This analysis measures interest rate risk by computing changes in the present value of our cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. The present value of equity is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 300 basis point increase or a 100 basis point decrease in market interest rates with no effect given to any future steps that management might take to counter the impact of that interest rate movement. The following table presents the change in the present value of Franklin Federal’s equity at June 30, 2013 that would occur in the event of an immediate change in interest rates based on management assumptions. The table does not include the effect of approximately $27.0 million of investable assets held by Franklin Financial Corporation at June 30, 2013.

		Present Value of Equity
Change in		Market
Basis Points		Value		$ Change			% Change
		(Dollars in thousands)
	300	$	219,460	$	5,835			2.7	%
	200		218,393		4,768			2.2
	100		216,783		3,158			1.5
	0		213,625		-			-
	-100		200,810		(12,815	)		(6.0	)

Using the same assumptions as above, the sensitivity of our projected net interest income for the twelve months ending June 30, 2014 is as follows:

		Projected Net Interest Income
Change in		Net Interest
Basis Points		Income		$ Change			% Change
		(Dollars in thousands)
	300	$	24,534	$	256			1.1	%
	200		24,519		241			1.0
	100		24,392		114			0.5
	0		24,278		-			-
	-100		23,691		(587	)		(2.4	)

Assumptions made by management relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others. As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets have features, such as rate caps or floors, that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.

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Item 4. Controls and Procedures

The Company’s management has carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act (1) is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.

In addition, based on that evaluation, there has been no change in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Our management believes that such routine legal proceedings, in the aggregate, are immaterial to our consolidated financial condition and results of operations.

Item 1A. Risk Factors

For information regarding the Company’s risk factors, see “Risk Factors” in the Company’s Annual Report filed on Form 10-K for the year ended September 30, 2012. As of June 30, 2013, the risk factors of the Company have not changed materially from those disclosed in the Form 10-K.

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

(a) Not applicable.

(b) Not applicable.

(c) Purchases of securities

The Company’s purchases of its common stock made during the three months ended June 30, 2013 are summarized as follows:

	Total Number of Shares Purchased		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans(1)		Maximum Remaining Number of Shares Available for Repurchase Pursuant to Publicly-Announced Plan
April 1 – 30, 2013		58,700	$	18.09		58,700		434,815
May 1 – 31, 2013		86,700		18.13		86,700		348,115
June 1 – 30, 2013		91,900		18.24		91,900		256,215
Total		237,300		18.16		237,300

_______________

(1) On November 15, 2012, the board of directors approved a third stock repurchase program whereby the Company was authorized to repurchase up to 645,415 shares, or approximately 5% of its common stock that was outstanding upon completion of the second stock repurchase program. During the three months ended June 30, 2013, the Company repurchased 237,300 shares of its outstanding common stock under this third program.

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Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

3.1	Articles of Incorporation of Franklin Financial Corporation (1)
3.2	Bylaws of Franklin Financial Corporation (2)
4.0	Form of Common Stock Certificate of Franklin Financial Corporation (3)
31.1	Rule 13a-14(a) Certification of Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
32	Section 1350 Certifications
101	Thefollowing materials from the Franklin Financial Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 are formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets; (ii) the Consolidated Income Statements;  (iii) the Consolidated Statements of Comprehensive Income; (iv) the Consolidated Statements of  Changes in Stockholders’ Equity; (v) the Consolidated Statements of Cash Flows; and (vi) related notes.

_______________

(1) Incorporated herein by reference to Exhibit 3.1 of pre-effective amendment No. 1 to the Company’s Registration Statement on Form S-1 (File No. 333-171108), filed with the Securities and Exchange Commission on January 28, 2011.

(2) Incorporated herein by reference to Exhibit 3.2 of pre-effective amendment No. 1 to the Company’s Registration Statement on Form S-1 (File No. 333-171108), filed with the Securities and Exchange Commission on January 28, 2011.

(3) Incorporated herein by reference to Exhibit 4.0 to the Company’s Registration Statement on Form S-1 (File No. 333-171108), as amended, initially filed with the Securities and Exchange Commission on December 10, 2010.

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SIGNATURES

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

	FRANKLIN FINANCIAL CORPORATION
	Registrant
August 7, 2013	By:	/s/Richard T. Wheeler, Jr.
		Richard T. Wheeler, Jr.
		Chairman, President and Chief Executive Officer
		(Principal Executive Officer)
August 7, 2013	By:	/s/Donald F. Marker
		Donald F. Marker
		Vice President, Chief Financial Officer and Secretary/Treasurer
		(Principal Financial and Accounting Officer)

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