West End Indiana Bancshares (WEIN) 10-Q 2013 Q3 Quarterly report

 UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x Quarterly Report Pursuant To Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2013

OR

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from _______________ to _______________

Commission File No. 000-54578

West End Indiana Bancshares, Inc.

(Exact name of registrant as specified in its charter)

Maryland	36-4713616
(State or other jurisdiction of in Company or organization)	(I.R.S. Employer Identification Number)
34 South 7th Street, Richmond, Indiana	47374
(Address of Principal Executive Offices)	Zip Code

(765) 962-9587

(Registrant’s telephone number)

N/A

(Former name or former address, 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 requirements for the past 90 days.

YES x     NO o

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

YES x     NO o

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 o	Accelerated filer o
Non-accelerated filer o	Smaller reporting company x
(Do not check if 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 o     NO x

As of November 13, 2013, there were 1,387,048 issued and outstanding shares of the Registrant’s Common Stock.

West End Indiana Bancshares, Inc.

Form 10-Q

Index

		Page
Part I. Financial Information
Item 1.	Condensed Consolidated Financial Statements
	Condensed Consolidated Balance Sheets	1
	Condensed Consolidated Statements of Income	2
	Condensed Consolidated Statements of Comprehensive Income	3
	Condensed Consolidated Statements of Cash Flows	4
	Condensed Statement of Stockholders’ Equity	5
	Notes to Condensed Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	41
Item 4.	Controls and Procedures	41
Part II. Other Information
Item 1.	Legal Proceedings	42
Item 1A.	Risk Factors	42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 3.	Defaults upon Senior Securities	42
Item 4.	Mine Safety Disclosures	42
Item 5.	Other Information	42
Item 6.	Exhibits	43
	Signature Page	44

Part I. – Financial Information

Item 1. Financial Statements

West End Indiana Bancshares, Inc.

Condensed Consolidated Balance Sheets

	September 30, 2013			December 31, 2012
	(Unaudited)
Assets
Cash and due from banks	$	1,914,020		$	1,867,663
Interest-bearing demand deposits		4,685,233			8,840,694
Cash and cash equivalents		6,599,253			10,708,357
Investment securities available for sale		62,370,110			60,609,524
Loans held for sale		953,741			1,301,747
Loans, net of allowance for loan losses of $2,250,820 and $2,013,088		167,309,062			159,571,336
Premises and equipment		3,605,903			3,529,277
Federal Home Loan Bank stock		1,722,100			1,722,100
Interest receivable		991,688			1,012,946
Bank-owned life insurance		5,000,528			4,888,928
Foreclosed real estate held for sale		418,854			443,150
Other assets		3,549,102			2,743,342
Total assets	$	252,520,341		$	246,530,707
Liabilities and Equity
Liabilities
Deposits	$	196,618,873		$	189,799,680
Federal Home Loan Bank advances		26,000,000			24,000,000
Interest payable		86,494			84,816
Other liabilities		985,791			1,718,446
Total liabilities		223,691,158			215,602,942
Commitments and Contingencies
Stockholders’ Equity
Common stock, $0.01 par value per share: Issued and outstanding – 1,387,048 and 1,401,008		13,870			14,010
Additional paid in capital		11,714,484			12,920,031
Retained earnings		19,284,805			18,649,758
Unearned employee stock ownership plan (ESOP)		(1,022,730	)		(1,064,760	)
Accumulated other comprehensive income (loss)		(1,161,246	)		408,726
Total stockholders’ equity		28,829,183			30,927,765
Total liabilities and stockholders’ equity	$	252,520,341		$	246,530,707

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

1

West End Indiana Bancshares, Inc.

Condensed Consolidated Statements of Income

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
	(Unaudited)
Interest and Dividend Income
Loans receivable, including fees	$	2,520,059		$	2,515,416		$	7,431,412		$	7,469,187
Investment securities		263,719			286,633			812,576			810,184
Other		16,736			18,636			49,939			64,174
Total interest income		2,800,514			2,820,685			8,293,927			8,343,545
Interest Expense
Deposits		344,120			474,818			1,077,730			1,510,291
Federal Home Loan Bank advances		136,603			129,057			417,356			432,536
Total interest expense		480,723			603,875			1,495,086			1,942,827
Net Interest Income		2,319,791			2,216,810			6,798,841			6,400,718
Provision for loan losses		446,000			340,000			951,000			850,000
Net Interest Income After Provision for Loan Losses		1,873,791			1,876,810			5,847,841			5,550,719
Other Income
Service charges on deposit accounts		154,336			142,598			428,555			397,711
Loan servicing income, net		150,101			16,574			174,666			41,512
Debit card income		65,206			54,488			185,000			162,676
Gain on sale of loans		49,334			184,634			233,590			385,999
Net realized gains on sales of available-for-sale securities (includes $0 and $57,258, $19,839 and $58,330, respectively, related to accumulated other comprehensive earnings reclassifications)		—			57,258			19,839			58,330
Gain on cash surrender value of life insurance		37,200			35,412			111,600			109,599
Gain (loss) on sale of other assets		(2,578	)		(13,890	)		(64,412	)		(36,883	)
Other income		2,358			2,931			8,004			38,839
Total other income		455,957			480,005			1,096,842			1,157,783
Other Expense
Salaries and employee benefits		1,097,322			942,528			3,111,967			2,984,749
Net occupancy		129,499			117,132			369,219			338,676
Data processing fees		74,674			82,765			244,543			250,036
Professional fees		108,381			103,741			329,650			335,512
Advertising		61,337			61,767			177,149			141,882
ATM charges		52,514			44,702			138,327			167,109
Postage and courier		40,793			44,165			132,506			130,684
FDIC insurance premiums		54,000			49,337			143,401			144,117
Donation to establish the West End Bank Charitable Foundation		—			—			—			505,000
Other expenses		327,061			365,362			1,055,469			1,017,181
Total other expenses		1,945,581			1,811,499			5,702,231			6,014,946
Income Before Income Tax		384,167			545,316			1,242,452			693,555
Income tax expense (includes $0 and $22,680, $7,858 and $23,105, respectively, related to income tax expense from reclassification items)		107,890			238,840			375,950			267,611
Net Income	$	276,277		$	306,476		$	866,502		$	425,944
Earnings Per Share
Basic	$	0.21		$	0.24		$	0.67		$	0.34
Diluted		0.21			0.24			0.67			0.34
Dividends Per Share		0.06			N/A			0.18			N/A

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

2

West End Indiana Bancshares, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

	Three Months Ended September 30					Nine Months Ended September 30,
	2013			2012		2013			2012
	(Unaudited)
Net income	$	276,277		$	306,476	$	866,502		$	425,944
Other comprehensive income (loss), net of tax
Unrealized gain (loss) on securities available for sale
Unrealized holding gains (loss) arising during the period, net of tax expense (benefit) of $(98,863) and $164,016, $(1,021,460) and $275,764		(150,790	)		250,151		(1,557,991	)		420,592
Less:  Reclassification adjustment for gains included in net income, net of tax expense of $0 and $22,680, $7,858 and $23,105		—			34,578		11,981			35,225
		(150,790	)		215,573		(1,569,972	)		385,367
Comprehensive income (loss)	$	125,487		$	522,049	$	(703,470	)	$	811,311

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

3

West End Indiana Bancshares, Inc.

Condensed Consolidated Statements of Cash Flows

	Nine Months Ended September 30,
	2013			2012
	(Unaudited)
Operating Activities
Net income	$	866,502		$	425,944
Items not requiring (providing) cash
Provision for loan losses		951,000			850,000
Depreciation and amortization		174,220			169,205
Investment securities amortization, net		832,229			762,592
Investment securities gains		(19,839	)		(58,330	)
Loss (gain) on sale of other assets		—			36,883
Loan originated for sale		(7,006,204	)		(12,696,636	)
Proceeds on loan sold		7,461,463			12,624,412
Gain on loans sold		(233,590	)		(385,999	)
Contribution of common stock to West End Bank Charitable Foundation		—			380,000
Net change in
Interest receivable		21,258			(14,903	)
Interest payable		1,678			(11,305	)
Cash surrender value of life insurance		(111,600	)		(109,599	)
Prepaid FDIC insurance		—			133,454
Other adjustments		(185,502	)		698,720
Net cash provided by operating activities		2,751,615			2,804,438
Investing Activities
Purchases of securities available for sale		(15,230,736	)		(32,690,906	)
Proceeds from maturities of securities available for sale		9,587,129			10,582,499
Proceeds from sales of securities available for sale		471,527			9,963,233
Net change in loans		(8,776,289	)		(2,867,879	)
Purchase of premises and equipment		(250,846	)		(87,176	)
Proceeds from sale of foreclosed real estate		147,723			192,304
Other investing activities		—			(1,850	)
Net cash used in investing activities		(14,051,492	)		(14,909,775	)
Financing Activities
Net change in demand deposits, money market, NOW and savings accounts		635,123			10,628,925
Net change in certificates of deposit		6,184,070			(1,817,232	)
Repurchased shares		(1,319,209	)		—
Repayment of FHLB advances		(11,500,000	)		(3,000,000	)
Proceeds from FHLB advances		13,500,000			—
Proceeds from stock conversion		—			463,666
Cash dividends		(309,211	)		—
Net cash provided by financing activities		7,190,773			6,275,359
Net Change in Cash and Cash Equivalents		(4,109,104	)		(5,829,978	)
Cash and Cash Equivalents, Beginning of Period		10,708,357			22,734,455
Cash and Cash Equivalents, End of Period	$	6,599,253		$	16,904,477
Additional Cash Flows Information
Interest paid	$	1,493,409		$	1,954,132
Income taxes paid		830,000			124,000
Real estate acquired in settlement of loans		545,981			261,611
Sale and financing of foreclosed real estate		395,273			132,226
Release of stock conversion escrow to equity, net		—			10,952,861

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

4

West End Indiana Bancshares, Inc.

Condensed Statement of Changes in Stockholders’ Equity

For the Nine Months Ended September 30, 2013

	Common Stock															Accumulated Other Comprehensive Income (Loss)
	Shares Outstanding			Amount			Additional Paid-In Capital			Retained Earnings			Unearned ESOP Shares						Total Stockholders’ Equity
	(Unaudited)
Balances at January 1, 2013		1,401,008		$	14,010		$	12,920,031		$	18,649,758		$	(1,064,760	)	$	408,726		$	30,927,765
Net income		—			—			—			866,502			—			—			866,502
Other comprehensive loss		—			—			—			—			—			(1,569,972	)		(1,569,972	)
ESOP shares earned		—			—			32,522			—			42,030			—			74,552
Restricted Shares Issued		56,040			560			(560	)		—			—			—			—
Stock Based Compensation Expense		—			—			81,000			—			—			—			81,000
Shares Repurchased		(70,000	)		(700	)		(1,318,509	)		—			—			—			(1,319,209	)
Cash dividends ($0.18 per share)		—			—			—			(231,455	)		—			—			(231,455	)
Balances at September 30, 2013		1,387,048		$	13,870		$	11,714,484		$	19,284,805		$	(1,022,730	)	$	(1,161,246	)	$	28,829,183

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

5

West End Indiana Bancshares, Inc.

Form 10-Q

Notes to Condensed Consolidated Financial Statements

NOTE 1:  Nature of Operations and Conversion

West End Bank, S.B. (the “Bank”), a wholly owned subsidiary of West End Indiana Bancshares, Inc. (the “Company”), is an Indiana-chartered savings bank that was organized in 1894 and is headquartered in Richmond, Indiana.

The Bank provides financial services to individuals, families and businesses through its four banking offices located in the Indiana counties of Union and Wayne and limited service branches located in the elementary school and high school in Richmond, Indiana at which the Bank offers more limited banking services and at which it provides banking seminars to students who assist in the branch operations.  Our principal business consists of attracting retail deposits from the general public in our market area and investing those deposits, together with funds generated from operations, and to a lesser extent, borrowings, in one- to four- family residential real estate loans, indirect automobile loans, commercial and multi-family real estate loans, and to a lesser extent, second mortgages and equity lines of credit, construction loans and commercial business loans.  We also purchase investment securities consisting primarily of SBA loan pools, municipal bonds, and mortgage-backed securities.

The Bank reorganized into a mutual holding company structure in 2007.  On January 11, 2012, in accordance with a Plan of Conversion and Reorganization ( the “Conversion”), West End Bank, MHC (MHC), the Bank’s former federally chartered mutual holding company completed a mutual-to-stock conversion pursuant to which the Bank became the wholly owned subsidiary of West End Indiana Bancshares, Inc. (the “Company”), a Maryland corporation.  In connection with the Conversion, the Company sold 1,363,008 shares of common stock, at an offering price of $10 per share, and issued an additional 38,000 shares of its common stock to the West End Bank Charitable Foundation (the “Foundation”), resulting in an aggregate issuance of 1,401,008 shares of common stock.  The Company’s stock began being quoted for listing on the OTC Bulletin Board on January 11, 2012, under the symbol “WEIN.”

The proceeds from the stock offering net of issuance costs of $1,092,000 amounted to $12,537,000.

As set forth above, in connection with the Conversion, the Bank established and funded the Foundation with 38,000 shares of the Company’s common stock and $125,000 in cash.  This contribution resulted in recognition of expense in the quarter ended June 30, 2012 based on the $10 per share offering price.  The Foundation supports charitable causes and community development activities in the Bank’s areas of operations.

Also, in connection with the Conversion, the Bank established an employee stock ownership plan (“ESOP”), which purchased 112,080 shares of the Company’s common stock at a price of $10 per share.

6

In accordance with Federal conversion regulations, at the time of the Conversion from a mutual holding company to a stock holding company, the Company was required to substantially restrict retained earnings by establishing a liquidation account and the Bank established a parallel liquidation account.  The liquidation account will be maintained for the benefit of eligible account holders who continue to maintain their accounts at the Bank after conversion.  The liquidation account will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits.  Subsequent increases will not restore an eligible account holder’s interest in the liquidation account.  In the event of a complete liquidation of the Bank, and only in such event, each account holder will be entitled to receive a distribution for the liquidation account in an amount proportionate to the adjusted qualifying account balances then held.  The Bank may not pay dividends if those dividends would reduce equity capital below the required liquidation account amount.

The Conversion was accounted for as a change in corporate form with the historical basis of the MHC’s consolidated assets, liabilities and equity unchanged as a result.

NOTE 2:  Basis of Presentation

The accompanying unaudited consolidated condensed financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles.  Accordingly, these financial statements should be read in conjunction with the consolidated financial statements and notes thereto of the Company included in the Annual Report on Form 10-K for the year ended December 31, 2012.  However, in the opinion of management, all adjustments (consisting of only normal recurring accruals) which are necessary for a fair presentation of the financial statements have been included.  The results of operations for the three-month and nine-month periods ended September 30, 2013, are not necessarily indicative of the results which may be expected for the entire year.  The consolidated condensed balance sheet of the Company as of December 31, 2012 has been derived from the audited consolidated balance sheet of the Company as of that date.

NOTE 3:  Principles of Consolidation

The consolidated financial statements include the accounts of West End Indiana Bancshares, Inc. and its wholly owned subsidiary, West End Bank, S.B.  All significant intercompany accounts and transactions have been eliminated in consolidation.

7

NOTE 4: Securities

The amortized cost and approximate fair values of securities are as follows:

	September 30, 2013 (Unaudited)
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Approximate Fair Value
	(In Thousands)
Available for sale
Municipal bonds	$	16,268	$	4	$	(1,248	)	$	15,024
SBA loan pools		3,142		14		(7	)		3,149
Mortgage-backed securities - GSE residential		44,883		186		(872	)		44,197
Total available for sale	$	64,293	$	204	$	(2,127	)	$	62,370

	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Approximate Fair Value
	(In Thousands)
Available for sale
Municipal Bonds	$	12,978	$	264	$	(61	)	$	13,181
SBA loan pools		3,569		151		—			3,720
Mortgage-backed securities – GSE residential		43,386		491		(168	)		43,709
Total available for sale	$	59,933	$	906	$	(229	)	$	60,610

The amortized cost and fair value of securities available for sale at September 30, 2013 (unaudited) and December 31, 2012, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	September 30, 2013 (Unaudited)				December 31, 2012
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In Thousands)
One to five years	$	—	$	—	$	—	$	—
Five to ten years		3,913		3,801		3,340		3,407
After ten years		12,355		11,223		9,638		9,774
		16,268		15,024		12,978		13,181
SBA loan pools		3,142		3,149		3,569		3,720
Mortgage-backed securities - GSE residential		44,883		44,197		43,386		43,709
Totals	$	64,293	$	62,370	$	59,933	$	60,610

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $431,000 at September 30, 2013 (unaudited).  Securities pledged at December 31, 2012 were $546,000.

8

Activities related to the sales of securities available for sale for the three and nine months ended September 30, 2013 (unaudited) and 2012 (unaudited) are summarized as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
	(In Thousands)
Proceeds from sales of available-for sale securities	$	—	$	9,182	$	472	$	9,963
Gross gains on sales		—		73		20		74
Gross losses on sales		—		16		—		16

Certain investments in debt securities are reported in the consolidated financial statements at an amount less than their historical cost.  Total fair value of these investments at September 30, 2013 (unaudited) and December 31, 2012 was $50,806,000 and $17,887,000, which is approximately 82% and 34% of the Company’s available-for-sale investment portfolio.  These declines primarily resulted from changes in market interest rates.

Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these securities are temporary.

Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

Securities with unrealized losses at September 30, 2013 (unaudited) were as follows:

	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
	(In Thousands)
Available-for-sale securities
Municipal bonds	$	13,376	$	(1,138	)	$	869	$	(110	)	$	14,245	$	(1,248	)
SBA pools		1,446		(7	)		—		—			1,446		(7	)
Mortgage-backed securities - GSE residential		29,412		(729	)		5,703		(143	)		35,115		(872	)
	$	44,234	$	(1,874	)	$	6,572	$	(253	)	$	50,806	$	(2,127	)

Securities with unrealized losses at December 31, 2012 were as follows:

	Less Than 12 Months					12 Months or Longer				Total
	Fair Value		Unrealized Losses			Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
	(In Thousands)
Available-for-sale securities
Municipal	$	3,377	$	(61	)	$	—	$	—	$	3,377	$	(61	)
Mortgage-backed securities - GSE residential		14,510		(168	)		—		—		14,510		(168	)
	$	17,887	$	(229	)	$	—	$	—	$	17,887	$	(229	)

9

Mortgage-backed Securities – GSE Residential

The unrealized losses on the Company’s investment in mortgage-backed securities were caused by interest rate increases.  The Company expects to recover the amortized cost basis over the term of the securities.  Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2013.

Municipal Bonds

The unrealized losses on the Company’s investments in municipal bonds were caused by interest rate increases.  The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments.  Because the Company does not intend to sell the investments and it is not, more likely than not, the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2013.

NOTE 5:  Loans and Allowance

The Company’s loan and allowance policies are as follows:

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoffs are reported at their outstanding principal balances adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.

For loans amortized at cost, interest income is accrued based on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and amortized as a level yield adjustment over the respective term of the loan.

For all loan classes, the accrual of interest is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection.  Past due status is based on contractual terms of the loan.  For all loan classes, the entire balance of the loan is considered past due if the minimum payment contractually required to be paid is not received by the contractual due date.  For all loan classes, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible.  The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined.

For all loan portfolio segments except residential and consumer loans, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations.  For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

10

The Company charges-off residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss.  The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge down to the net realizable value when other secured loans are 120 days past due.  Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.

For all classes, all interest accrued but not collected for loans that are placed on nonaccrual or charged off are reversed against interest income.  The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.  Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal.  The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.

When cash payments are received on impaired loans in each loan class, the Company records the payment as interest income unless collection of the remaining recorded principal amount is doubtful, at which time payments are used to reduce the principal balance of the loan.  Troubled debt restructured loans recognize interest income on an accrual basis at the renegotiated rate if the loan is in compliance with the modified terms.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of allocated and general components.  The allocated component relates to loans that are classified as impaired.  For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.  The general component covers non-impaired loans and is based on historical charge-off experience by segment.  The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the prior three years.  Management believes the three year historical loss experience methodology is appropriate in the current economic environment.Other adjustments (qualitative/environmental considerations) for each segment may be added to the allowance for each loan segment after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.

11

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when duebased on the loan’s current payment status and the borrower’s financial condition including available sources of cash flows.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loan basis for non-homogenous type loans such as commercial, non-owner residential and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.  For impaired loans where the Company utilizes the discounted cash flows to determine the level of impairment, the Company includes the entire change in the present value of cash flows as bad debt expense.

The fair values of collateral dependent impaired loans are based on independent appraisals of the collateral.  In general, the Company acquires an updated appraisal upon identification of impairment and annually thereafter for commercial, commercial real estate and multi-family loans.  If the most recent appraisal is over a year old, and a new appraisal is not performed, due to lack of comparable values or other reasons, the existing appraisal is utilized and discounted 20% - 30% based on the age of the appraisal, condition of the subject property, and overall economic conditions.  After determining the collateral value as described, the fair value is calculated based on the determined collateral value less selling expenses.  The potential for outdated appraisal values is considered in our determination of the allowance for loan losses through our analysis of various trends and conditions including the local economy, trends in charge-offs and delinquencies, etc. and the related qualitative adjustments assigned by the Company.

Segments of loans with similar risk characteristics are collectively evaluated for impairment based on the segment’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans.  Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

12

Categories of loans include:

	(Unaudited)
	September 30,		December 31,
	2013		2012
	(In Thousands)
Commercial	$	8,879	$	8,505
Real estate loans
Residential		59,652		56,145
Commercial and multi-family		34,254		34,048
Construction		1,695		2,483
Second mortgages and equity lines of credit		4,154		4,114
Consumer loans
Indirect		49,842		46,930
Other		11,202		9,464
		169,678		161,689
Less
Net deferred loan fees, premiums and discounts		118		105
Allowance for loan losses		2,251		2,013
Total loans	$	167,309	$	159,571

The risk characteristics of each loan portfolio segment are as follows:

Commercial

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower.  The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value.  Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis.  In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial and Multi-Family Real Estate

These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.  Commercial and multi-family real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.

Commercial and multi-family real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy.  The properties securing the Company’s commercial and multi-family real estate portfolio are diverse in terms of type and geographic location.  Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria.  In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

13

Construction

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews and financial analysis of the developers and property owners.  Construction loans are generally based on estimates of costs and value associated with the complete project.  These estimates may be inaccurate.  Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project.  Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained.  These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Residential, Second Mortgages and Equity Lines of Credit and Consumer

With respect to residential loans that are secured by 1-4 family residences, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded.  Second mortgages and equity lines of credit loans are typically secured by a subordinate interest in 1-4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles.  Some consumer loans are unsecured such as small installment loans.  Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels.  Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

14

The following presents by portfolio segment, the activity in the allowance for loan losses for the three and nine months ended September 30, 2013 (unaudited) and 2012 (unaudited).

	(Unaudited)
				Real Estate
	Commercial				Residential			Commercial and Multi-Family			Construction			Seconds and Equity Line			Consumer			Total
	(In Thousands)
Three Months Ended September 30, 2013
Balance, beginning of period	$	59			$	486		$	816		$	8		$	36		$	635		$	2,040
Provision for losses		(2	)			103			206			(6	)		4			141			446
Recoveries on loans		—				1			—			—			—			16			17
Loans charged off		—				(104	)		—			—			(4	)		(144	)		(252	)
Balance, end of period	$	57			$	486		$	1,022		$	2		$	36		$	648		$	2,251
Nine Months Ended September 30, 2013:
Balance, beginning of period	$	54			$	542		$	829		$	4		$	32		$	552		$	2,013
Provision for losses		3				135			261			(2	)		19			535			951
Recoveries on loans		—				4			—			—			—			49			53
Loans charged off		—				(195	)		(68	)		—			(15	)		(488	)		(766	)
Balance, end of period	$	57			$	486		$	1,022		$	2		$	36		$	648		$	2,251

	(Unaudited)
				Real Estate
	Commercial				Residential			Commercial and Multi-Family			Construction			Seconds and Equity Line			Consumer			Total
	(In Thousands)
Three Months Ended September 30, 2012:
Balance, beginning of period	$	130			$	647		$	624		$	3		$	36		$	560		$	2,000
Provision for losses		(6	)			98			112			(2	)		(12	)		150			340
Recoveries on loans		—				1			—			—			5			17			23
Loans charged off		—				(168	)		(144	)		—			—			(192	)		(504	)
Balance, end of period	$	124			$	578		$	592		$	1		$	29		$	535		$	1,859
Nine Months Ended September 30, 2012:
Balance, beginning of period	$	145			$	642		$	593		$	4		$	29		$	491		$	1,904
Provision for losses		31				208			143			(3	)		15			456			850
Recoveries on loans		—				2			—			—			7			43			52
Loans charged off		(52	)			(274	)		(144	)		—			(22	)		(455	)		(947	)
Balance, end of period	$	124			$	578		$	592		$	1		$	29		$	535		$	1,859

15

The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of September 30, 2013 (unaudited) and December 31, 2012:

	(Unaudited)
	September 30, 2013
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
Allowance:
Balance, end of year	$	57	$	486	$	1,022	$	2	$	36	$	648	$	2,251
Individually evaluated for impairment		—		—		837		—		—		—		837
Collectivity evaluated for impairment		57		486		185		2		36		648		1,414
Loans:
Ending balance		8,879		59,652		34,254		1,695		4,154		61,044		169,678
Individually evaluated for impairment		—		—		4,298		—		—		—		4,298
Collectivity evaluated for impairment		8,879		59,652		29,956		1,695		4,154		61,044		165,380

	December 31, 2012
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
Allowance:
Balance, end of year	$	54	$	542	$	829	$	4	$	32	$	552	$	2,013
Individually evaluated for impairment		—		30		645		—		—		—		675
Collectivity evaluated for impairment		54		512		184		4		32		552		1,338
Loans:
Ending balance		8,505		56,145		34,048		2,483		4,114		56,394		161,689
Individually evaluated for impairment		—		39		4,396		—		—		—		4,435
Collectivity evaluated for impairment		8,505		56,106		29,652		2,483		4,114		56,394		157,254

16

The following tables present the credit risk profile of the Bank’s loan portfolio based on rating category and payment activity as of September 30, 2013 (unaudited) and December 31, 2012:

	(Unaudited)
	September 30, 2013
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
Pass	$	8,490	$	59,072	$	27,115	$	1,695	$	3,846	$	61,044	$	161,262
Watch		—		580		1,859		—		—		—		2,439
Special Mention		—		—		982		—		308		—		1,290
Substandard		389		—		4,298		—		—		—		4,687
Doubtful		—		—		—		—		—		—		—
Loss		—		—		—		—		—		—		—
Total	$	8,879	$	59,652	$	34,254	$	1,695	$	4,154	$	61,044	$	169,678

	December 31, 2012
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
Pass	$	7,990	$	55,624	$	28,365	$	2,483	$	4,023	$	56,394	$	154,879
Watch		75		482		177		—		—		—		734
Special Mention		—		—		1,104		—		91		—		1,195
Substandard		440		39		4,402		—		—		—		4,881
Doubtful		—		—		—		—		—		—		—
Loss		—		—		—		—		—		—		—
Total	$	8,505	$	56,145	$	34,048	$	2,483	$	4,114	$	56,394	$	161,689

17

The Company generally categorizes all classes of loans into risk categories based on relevant information about the ability of borrowers to service their debt such as:  current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.  Generally, smaller dollar consumer loans are excluded from this grading process and are reflected in the Pass category.  The delinquency trends of these consumer loans are monitored on homogeneous basis and the related delinquent amounts are reflected in the aging analysis table below.  The Company uses the following definitions for risk ratings:

The Pass asset quality rating encompasses assets that have generally performed as expected.  With the exception of some smaller consumer and residential loans, these assets generally do not have delinquency.  Loans assigned this rating include loans to borrowers possessing solid credit quality with acceptable risk.  Borrowers in these grades are differentiated from higher grades on the basis of size (capital and/or revenue), leverage, asset quality, stability of the industry or specific market area and quality/coverage of collateral.  These borrowers generally have a history of consistent earnings and reasonable leverage.   

The Watch asset quality rating encompasses assets that have been brought to the attention of management and may, if not corrected, warrant a more serious quality rating by management. These assets are usually in the first phase of a deficiency situation and may possess similar criteria as Special Mention assets.  This grade includes “pass grade” loans to borrowers which require special monitoring because of deteriorating financial results, declining credit ratings, decreasing cash flow, increasing leverage, marginal collateral coverage or industry stress that has resulted or may result in a changing overall risk profile.

The Special Mention asset quality rating encompasses assets that have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date.  Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.  This grade is intended to include loans to borrowers whose credit quality has clearly deteriorated and where risk of further decline is possible unless active measures are taken to correct the situation.  Weaknesses are considered potential at this state and are not yet fully defined.

The Substandard asset quality rating encompasses assets that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any; assets having a well-defined weakness(es) based upon objective evidence; assets characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected; or the possibility that liquidation will not be timely.  Loans categorized in this grade possess a well-defined credit weakness and the likelihood of repayment from the primary source is uncertain.  Significant financial deterioration has occurred and very close attention is warranted to ensure the full repayment without loss.  Collateral coverage may be marginal and the accrual of interest has been suspended.

The Doubtful asset quality rating encompasses assets that have all of the weaknesses of those classified as Substandard.  In addition, these weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

The Loss asset quality rating encompasses assets that are considered uncollectible and of such little value that their continuance as assets of the bank is not warranted.  A loss classification does not mean that an asset has no recovery or salvage value; instead, it means that it is not practical or desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be realized in the future.

The Company evaluates the loan grading system definitions and allowance for loan loss methodology on an ongoing basis.  No significant changes were made to either during 2013.

18

The following table presents the Bank’s loan portfolio aging analysis as of September 30, 2013 (unaudited) and December 31, 2012:

	(Unaudited)
	September 30, 2013
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
30-59 days past due	$	—	$	203	$	—	$	—	$	—	$	852	$	1,055
60-89 days past due		—		282		—		—		25		274		581
Greater than 90 days and accruing		—		152		—		—		3		577		732
Nonaccrual		—		757		2,023		—		—		—		2,780
Total past due and nonaccrual		—		1,394		2,023		—		28		1,703		5,148
Current		8,879		58,258		32,231		1,695		4,126		59,341		164,530
Total	$	8,879	$	59,652	$	34,254	$	1,695	$	4,154	$	61,044	$	169,678

	December 31, 2012
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
30-59 days past due	$	—	$	188	$	—	$	—	$	55	$	1,041	$	1,284
60-89 days past due		—		111		—		—		29		416		556
Greater than 90 days and accruing		—		343		—		—		11		607		961
Nonaccrual		—		1,121		521		—		—		—		1,642
Total past due and nonaccrual		—		1,763		521		—		95		2,064		4,443
Current		8,505		54,382		33,527		2,483		4,019		54,330		157,246
Total	$	8,505	$	56,145	$	34,048	$	2,483	$	4,114	$	56,394	$	161,689

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan.  Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties.  These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

19

The following table presents impaired loans and specific valuation allowance based on class level at September 30, 2013 (unaudited) and December 31, 2012:

	(Unaudited)
	September 30, 2013
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
Impaired loans without a specific allowance:
Recorded investment	$	—	$	—	$	450	$	—	$	—	$	—	$	450
Unpaid principal balance		—		—		594		—		—		—		594
Impaired loans with a specific allowance:
Recorded investment		—		—		3,848		—		—		—		3,848
Unpaid principal balance		—		—		3,848		—		—		—		3,848
Specific allowance		—		—		837		—		—		—		837
Total impaired loans:
Recorded investment		—		—		4,298		—		—		—		4,298
Unpaid principal balance		—		—		4,442		—		—		—		4,442
Specific allowance		—		—		837		—		—		—		837

	December 31, 2012
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
Impaired loans without a specific allowance:
Recorded investment	$	—	$	—	$	450	$	—	$	—	$	—	$	450
Unpaid principal balance		—		—		594		—		—		—		594
Impaired loans with a specific allowance:
Recorded investment		—		39		3,946		—		—		—		3,985
Unpaid principal balance		—		39		3,946		—		—		—		3,985
Specific allowance		—		30		645		—		—		—		675
Total impaired loans:
Recorded investment		—		39		4,396		—		—		—		4,435
Unpaid principal balance		—		39		4,540		—		—		—		4,579
Specific allowance		—		30		645		—		—		—		675

20

The following presents by portfolio segment, information related to the average recorded investment and interest income recognized on impaired loans for the three and nine months ended September 30, 2013 (unaudited) and 2012 (unaudited):

(Unaudited)
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
Three Months Ended September 30, 2013:
Total impaired loan:
Average recorded investment	$	—	$	—	$	4,306	$	—	$	—	$	—	$	4,306
Interest income recognized		—		—		32		—		—		—		32
Interest income recognized on a cash basis		—		—		—		—		—		—		—

	(Unaudited)
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
Nine Months Ended September 30, 2013:
Total impaired loan:
Average recorded investment	$	—	$	—	$	4,350	$	—	$	—	$	—	$	4,350
Interest income recognized		—		—		126		—		—		—		126
Interest income recognized on a cash basis		—		—		—		—		—		—		—

	(Unaudited)
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
Three Months Ended September 30, 2012:
Total impaired loan:
Average recorded investment	$	—	$	44	$	2,835	$	—	$	—	$	—	$	2,879
Interest income recognized		—		—		32		—		—		—		32
Interest income recognized on a cash basis		—		—		—		—		—		—		—

	(Unaudited)
			Real Estate
	Commercial		Residential		Commercial and Multi-Family		Construction		Seconds and Equity Line		Consumer		Total
	(In Thousands)
Nine Months Ended September 30, 2012:
Total impaired loan:
Average recorded investment	$	12	$	122	$	2,852	$	—	$	—	$	—	$	2,986
Interest income recognized		—		—		95		—		—		—		95
Interest income recognized on a cash basis		—		—		—		—		—		—		—

21

Troubled Debt Restructurings

In the course of working with borrowers, the Company may choose to restructure the contractual terms of certain loans.  In restructuring the loan, the Company attempts to work out an alternative payment schedule with the borrower in order to optimize collectability of the loan.  Any loans that are modified, whether through a new agreement replacing the old or via changes to an existing loan agreement, are reviewed by the Company to identify if a troubled debt restructuring (“TDR”) has occurred.  A TDR occurs when, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider.  Terms may be modified to fit the ability of the borrower to repay in line with its current financial status, and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two.  If such efforts by the Company do not result in a satisfactory arrangement, the loan is referred to legal counsel, at which time foreclosure proceedings are initiated.  At any time prior to a sale of the property at foreclosure, the Company may terminate foreclosure proceedings if the borrower is able to work out a satisfactory payment plan.

Nonaccrual loans, including TDRs that have not met the six month minimum performance criterion, are reported in this report as nonperforming loans.  For all loan classes, it is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being restructured remain on nonaccrual status until six months of satisfactory borrower performance, at which time management would consider its return to accrual status.  A loan is generally classified as nonaccrual when the Company believes that receipt of principal and interest is questionable under the terms of the loan agreement.  Most generally, this is at 90 or more days past due.

With regard to determination of the amount of the allowance for credit losses, all restructured loans are considered to be impaired.  As a result, the determination of the amount of impaired loans for each portfolio segment within troubled debt restructurings is the same as detailed previously above.

During the three and nine months ended September 30, 2013 (unaudited) and 2012 (unaudited), there were no new restructurings classified as TDRs.  No loans restructured during the last twelve months defaulted during the three and nine months ended September 30, 2013 (unaudited) and 2012 (unaudited).

22

NOTE 6:  Disclosures About Fair Value of Assets and Liabilities

ASC Topic 820, Fair Value Measurements, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Topic 820 also specifies a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes six levels of inputs that may be used to measure fair value:

The standard describes three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities

Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

Recurring Measurements

The following is a description of the valuation methodologies and inputs used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the security’s terms and conditions.  Additionally, matrix pricing is used for certain investment securities and is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities.  Level 2 securities include SBA loan pools, municipal bonds and mortgage-backed securities.  At September 30, 2013 (unaudited) and December 31, 2012, all mortgage-backed securities are residential government sponsored enterprises.  In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

Mortgage-Servicing Rights

Mortgage-servicing rights do not trade in an active, open market with readily observable prices.  Accordingly, fair value is estimated using discounted cash flow models having significant inputs of actual and expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions.  Due to the nature of the valuation inputs, mortgage-servicing rights are classified within Level 3 of the hierarchy.  Significant changes in any of the inputs could significantly impact the fair value measurement.

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Fair value determinations for Level 3 measurements are the responsibility of the Finance Department.  The Finance Department contracts with a pricing specialist to generate fair value estimates on a quarterly basis.  The Finance Department challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States.  Using the data from the quarterly valuation, the Finance Department adjusts to fair value on a monthly basis

The following tables present the fair value measurements of assets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2013 and December 31, 2012:

			(Unaudited)
			September 30, 2013
			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In Thousands)
Available-for-sale securities:
Municipal bonds	$	15,024	$	—	$	15,024	$	—
SBA loan pools		3,149		—		3,149		—
Mortgage-backed securities - GSE residential		44,197		—		44,197		—
Mortgage-servicing rights		617		—		—		617

			December 31, 2012
			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In Thousands)
Available-for-sale securities:
Municipal bonds	$	13,181	$	—	$	13,181	$	—
SBA loan pools		3,720		—		3,720		—
Mortgage-backed securities - GSE residential		43,709		—		43,709		—
Mortgage-servicing rights		497		—		—		497

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The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying consolidated balance sheets using significant unobservable (Level 3) inputs:

	(Unaudited)
	Mortgage-Servicing Rights
	Three Months Ended September 30						Nine Months Ended September 30
	2013			2012			2013			2012
	(In Thousands)
Balances, beginning of period	$	500		$	443		$	497		$	440
Total unrealized gains (losses) included in net income		127			18			124			10
Additions (rights recorded on sale of loans)		6			42			63			90
Settlements (payments)		(16	)		(38	)		(67	)		(75	)
Balances, end of period	$	617		$	465		$	617		$	465

Total unrealized gains and losses included in net income reflected in the table above are included in other income.

Nonrecurring Measurements

The following is a description of the valuation methodologies used for instruments measured at fair value on a nonrecurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Impaired Loans (Collateral Dependent)

Loans, for which it is probable that the Company will not collect all principal and interest due according to contractual terms, are measured for impairment.  Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral-dependent loans.

The fair values of collateral dependent impaired loans are based on independent appraisals of the collateral.  In general, the Company acquires an updated appraisal upon identification of impairment and annually thereafter for commercial, commercial real estate and multi-family loans.  If the most recent appraisal is over a year old, and a new appraisal is not performed, due to lack of comparable values or other reasons, the existing appraisal is utilized and discounted 20% - 30% based on the age of the appraisal, condition of the subject property, and overall economic conditions.  After determining the collateral value as described, the fair value is calculated based on the determined collateral value less selling expenses.

Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

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The following tables present the fair value measurements of assets and liabilities measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall:

			(Unaudited)
			September 30, 2013
			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In Thousands)
Impaired loans	$	1,678	$	—	$	—	$	1,678

			December 31, 2012
			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In Thousands)
Impaired loans	$	3,760	$	—	$	—	$	3,760

Unobservable (Level 3) Inputs

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements.

	Fair Value at September 30, 2013		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans	$	1,678	Comparative sales based on independent appraisals	Marketability Discount		20.0% - 30.0% (20.0%)
Mortgage-servicing rights	$	617	Discounted Cash Flow	Discount rate Conditional prepayment rate Expected loan servicing years		5.6% - 6.6% (6.3%) 7.2% - 12.1% (11.3%) 3.5 - 4.2 (4.0)

	Fair Value at December 31, 2012		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Impaired loans	$	3,760	Comparative sales based on independent appraisals	Marketability Discount		20.0% - 30.0% (20.0%)
Mortgage-servicing rights	$	497	Discounted Cash Flow	Discount rate Conditional prepayment rate Expected loan servicing years		4.8% -5.4% (5.25%) 12.6% - 20.7% (18.8%) 3.0-3.7 (3.2)

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Sensitivity of Significant Unobservable Inputs

The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in unobservable inputs on the fair value measurement.

Mortgage –Servicing Rights

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage-servicing rights are discount rates, conditional prepayment rates and expected loan servicing years.  Significant increases or decreases in any of those inputs in isolation would result in a significant change in the fair value measurement.

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value.

Cash and Cash Equivalents, Federal Home Loan Bank Stock, Interest Receivable and Interest Payable

The carrying amount approximates fair value.

Loans Held for Sale

Loans held for sale are based on current market prices

Loans

The fair value of loans is estimated by discounting the future cash flows using the market rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  Loans with similar characteristics were aggregated for purposes of the calculations.

Deposits

Deposits include demand deposits, savings accounts, NOW accounts and certain money market deposits.  The carrying amount approximates fair value.  The fair value of fixed-maturity time deposits is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Federal Home Loan Bank Advances

Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt.  Fair value of long-term debt is based on quoted market prices or dealer quotes for the identical liability when traded as an asset in an active market.  If a quoted market price is not available, an expected present value technique is used to estimate fair value.

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The following table presents estimated fair values of the Company’s financial instruments at September 30, 2013 (unaudited) and December 31, 2012.

	(Unaudited) September 30, 2013
			Fair Value
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In Thousands)
Financial assets
Cash and cash equivalents	$	6,599	$	6,599	$	––	$	––
Available-for-sale securities		62,370		––		62,370		––
Loan held for sale		954		––		954		––
Loans, net		167,309		––		––		169,530
Federal Home Loan Bank stock		1,722		––		1,722		––
Interest receivable		992		––		992		––
Mortgage servicing rights		617		––		––		617
Financial liabilities
Deposits		196,619		97,105		100,037		––
Federal Home Loan Bank advances		26,000		—		25,986		––
Interest payable		86		––		86		––

	December 31, 2012
			Fair Value
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In Thousands)
Financial assets
Cash and cash equivalents	$	10,708	$	10,708	$	—	$	—
Available-for-sale securities		60,610		—		60,610		—
Loan held for sale		1,302		—		1,302		—
Loans, net		159,571		—		—		164,820
Federal Home Loan Bank stock		1,722		—		1,722		—
Interest receivable		1,013		—		1,013		—
Mortgage servicing rights		497		—		—		497
Financial liabilities
Deposits		189,800		96,470		94,131		—
Federal Home Loan Bank advances		24,000		—		24,416		—
Interest payable		85		—		85		—

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NOTE 7:  Recent Accounting Pronouncements

FASB ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income

In February 2013, the FASB issued ASU 2013-02 to improve the transparency of reporting reclassifications out of accumulated other comprehensive income.

Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income.

The amendments in the Update do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this Update requires already is required to be disclosed elsewhere in the financial statements under U.S. Generally Accepted Accounting Principles (U.S. GAAP).

The new amendments will require an organization to:

Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income–but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period.

Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items that are not required under U.S. GAAP to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense.

The amendments apply to all public and private companies that report items of other comprehensive income.  Public companies are required to comply with these amendments for all reporting periods (interim and annual).

The amendments are effective for reporting periods beginning after December 15, 2012, for public companies.  The adoption of this ASU did not have a material effect on the Company’s financial position or results of operations.

FASB ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities

In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.  The Update clarifies the scope of transactions that are subject to the disclosures about offsetting.

The Update clarifies that ordinary trade receivables and payables are not in the scope of Accounting Standards Update No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. Specifically, Update 2011-11 applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in FASB Accounting Standards Codification or subject to a master netting arrangement or similar agreement.

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Issued in December 2011, Update 2011-11 was the result of a joint project with the International Accounting Standards Board. Its objective was to improve transparency and comparability between U.S. GAAP and International Financial Reporting Standards by requiring enhanced disclosures about financial instruments and derivative instruments that are either (1) offset on the statement of financial position or (2) subject to an enforceable master netting arrangement or similar agreement.

The Board undertook this clarification project in response to concerns expressed by U.S. stakeholders about the standard’s broad definition of financial instruments  After the standard was finalized, companies realized that many contracts have standard commercial provisions that would equate to a master netting arrangement, significantly increasing the cost of compliance at minimal value to financial statement users.

The amendments are effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods.  Required disclosures should be provided retrospectively for all comparative periods presented.  The adoption of this ASU did not have a material effect on the Company’s financial position or results of operations.

FASB ASU 2012-04, Technical Corrections and Improvements

In October 2012, the FASB issued ASU 2012-04, Technical Corrections and Improvements.  The amendments in this ASU make technical corrections, clarifications and limited-scope improvements to various Topics throughout the Codification.

This ASU is effective for public entities for fiscal periods beginning after December 15, 2012.  For nonpublic entities, the amendments will be effective for fiscal periods beginning after December 15, 2013.  The adoption of this ASU did not have a material effect on the Company’s financial position or results of operations.

FASB ASU 2011-11, Balance Sheet (Topic 210):  Disclosures about Offsetting Assets and Liabilities

The eligibility criteria for offsetting are different in international financial reporting standards (IFRS) and U.S. generally accepted accounting principles (GAAP).  Offsetting, otherwise known as netting, is the presentation of assets and liabilities as a single net amount in the statement of financial position (balance sheet).  Unlike IFRS, U.S. GAAP allows companies the option to present net in their balance sheets derivatives that are subject to a legally enforceable netting arrangement with the same party where rights of set-off are only available in the event of default or bankruptcy.

To address these differences between IFRS and U.S. GAAP, in January 2011 the FASB and the IASB (the Boards) issued an exposure draft that proposed new criteria for netting, which were narrower than the current conditions in U.S. GAAP.  Nevertheless, in response to feedback from their respective stakeholders, the Boards decided to retain their existing offsetting models.  Instead, the Boards have issued common disclosure requirements related to offsetting arrangements to allow investors to better compare financial statements prepared in accordance with IFRS or U.S. GAAP.

The amendments to the FASB Accounting Standards Codification in this ASU require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position.  Coinciding with the release of ASU No. 2011-11, the IASB has issued Disclosures—Offsetting Financial Assets and Financial Liabilities (Amendments to IFRS 7).  This amendment requires disclosures about the offsetting of financial assets and financial liabilities common to those in ASU No. 2011-11.

An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods  The adoption of this ASU did not have a material effect on the Company’s financial position or results of operations.

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NOTE 8:  Earnings per Share

The Company has granted stock compensation awards with non-forfeitable dividend rights, which are considered participating securities.  Accordingly, earnings per share (EPS) is computed using the two-class method as required by ASC 260-10-45.  Basic EPS is computed by dividing net income allocated to common stock by the weighted average number of common shares outstanding during the period which excludes the participating securities.  Diluted EPS includes the dilutive effect of additional potential common shares from stock compensation awards, but excludes awards considered participating securities.  ESOP shares are not considered outstanding for EPS until they are earned.  The following table presents the computation of basic and diluted EPS for the periods indicated (in thousands, except for share and per share data):

	(Unaudited)
	Three Months Ended September 30						Nine Months Ended September 30
	2013			2012			2013			2012
Net Income	$	276		$	306		$	867		$	426
Allocated to participating securities		(12	)		—			(15	)		—
Net income allocated to common stockholders	$	264		$	306		$	852		$	426
Weighted average common shares outstanding, gross		1,405,795			1,401,008			1,402,470			1,354,989
Less:  Average unearned ESOP shares and participating securities		(159,237	)		(108,801	)		(125,738	)		(106,512	)
Weighted average common shares outstanding, net		1,246,558			1,292,207			1,276,732			1,248,477
Effect of diluted based awards		—			—			—			—
Weighted average shares and common stock equivalents		1,246,558			1,292,207			1,276,732			1,248,477
Income per common share:
Basic	$	0.21		$	0.24		$	0.67		$	0.34
Diluted	$	0.21		$	0.24		$	0.67		$	0.34
Options excluded from the calculation due to their anti-dilutive effect on earnings per share		125,300			N/A			125,300			N/A

NOTE 9:  Reclassifications

Certain reclassifications have been made to the 2012 condensed consolidated financial statements to conform to the September 30, 2013 presentation.

NOTE 10:  Share Based Compensation (Unaudited)

In May 2013, the Company’s stockholders approved the West End Indiana Bancshares, Inc. 2013 Equity Incentive Plan (“Plan”) which provides for awards of stock options and restricted stock to key officers and outside directors.  The cost of the Plan is based on the fair value of the awards on the grant date.  The fair value of restricted stock awards is based on the closing price of the Company’s stock on the grant date.  The fair value of stock options is estimated using a Black-Scholes option pricing model using assumptions for dividend yield, stock price volatility, risk-free interest rate, and option term.  These assumptions are based on management’s judgments regarding future events, are subjective in nature, and contain uncertainties inherent in an estimate.  The cost of the awards are being recognized on a straight-line basis over the five-year vesting period during which participants are required to provide services in exchange for the awards.

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Until such time as awards of stock are granted and vest or options are exercised, shares of the Company’s common stock under the Plan shall be authorized but unissued shares.  The maximum number of shares authorized under the plan is 196,140.  Total share-based compensation expense for the three and nine months ended September 30, 2013 was $71,000 and $81,000.

Stock Options

The table below represents the stock option activity for the period shown:

	Options		Weighted average exercise price		Remaining contractual life (years)
Options outstanding at January 1, 2013		—		—		—
Granted		125,300	$	18.75		10.0
Exercised		—		—		—
Forfeited		—		—		—
Expired		—		—		—
Options outstanding at September 30, 2013		125,300	$	18.75		9.7

Stock options of 125,300 were granted on June 19, 2013.  No stock options were granted in the first and third quarters of 2013.

As of September 30, 2013, the Company had $336,000 of unrecognized compensation expense related to stock options.  The cost of stock options will be amortized in monthly installments over the five-year vesting period.  There were no exercisable options vested in the three or nine months ended September 30, 2013.  Stock option expense for the three and nine months ended September 30, 2013 was $18,000 and $21,000.  The aggregate grant date fair value of the stock options was $357,000.  The total intrinsic value of options as of September 30, 2013 was $44,000.

The fair value of the Company’s stock options was determined using the Black-Scholes option pricing formula.  The following assumptions were used in the formula:

Expected volatility	13.67%
Risk-free interest rate	1.86%
Expected dividend yield	1.28%
Expected life (in years)	7.5
Exercise price for the stock options	$   18.75

Expected volatility - Based on the historical volatility of share price for similar companies.

Risk-free interest rate - Based on the U.S. Treasury yield curve and expected life of the options at the time of grant.

Dividend yield - West End Indiana Bancshares, Inc. pays a regular quarterly dividend of $0.06 per share.

Expected life – Based on average of the five year vesting period and the ten year contractual term of the stock option plan.

Exercise price for the stock options - Based on the closing price of the Company’s stock on the date of grant.

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Restricted Stock Awards

Restricted stock awards are accounted for as fixed grants using the fair value of the Company’s stock at the time of the grant.  Unvested restricted stock awards may not be disposed of or transferred during the vesting period.  Restricted stock awards carry with them the right to receive dividends.

The table below presents the restricted stock award activity for the period shown:

	Service-Based Restricted stock  awards		Weighted average grant date fair value
Non-vested at January 1, 2013		—		—
Granted		56,040	$	18.75
Vested		—		—
Forfeited		—		—
Non-vested at September 30, 2013		56,040	$	18.75

Restricted stock awards of 56,040 were granted on June 19, 2013.  No restricted stock awards were granted during the first quarter of 2013.

As of September 30, 2013, the Company had $990,000 of unrecognized compensation expense related to restricted stock awards.  The cost of the restricted stock awards will be amortized in monthly installments over the five-year vesting period.  Restricted stock expense for the three and nine months ended September 30, 2013 was $53,000 and $60,000.

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

General

Management’s discussion and analysis of the financial condition and results of operations at and for three and nine months ended September 30, 2013 and 2012 is intended to assist in understanding the financial condition and results of operations of the Company on a consolidated basis.  The information contained in this section should be read in conjunction with the unaudited financial statements and the notes thereto, appearing on Part I, Item 1 of this quarterly report on Form 10- Q.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning.  These forward-looking statements include, but are not limited to:

● statements of our goals, intentions and expectations;

● statements regarding our business plans, prospects, growth and operating strategies;

● statements regarding the asset quality of our loan and investment portfolios; and

● estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control.  In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.  We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this quarterly report.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

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

● competition among depository and other financial institutions;

● our success in continuing to emphasize consumer lending, including indirect automobile lending;

● our ability to improve our asset quality even as we increase our non-residential lending;

● our success in maintaining our commercial and multi-family real estate and our non-owner occupied one- to four-family residential real estate and commercial business lending;

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

● adverse changes in the securities markets;

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● changes in laws or government regulations or policies affecting financial institutions, including changes in deposit insurance premiums, regulatory fees and capital requirements, which increase our compliance costs;

● our ability to enter new markets successfully and capitalize on growth opportunities;

● changes in consumer spending, borrowing and savings habits;

● changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission and the Public Company Accounting Oversight Board;

● changes in our organization, compensation and benefit plans;

● loan delinquencies and changes in the underlying cash flows of our borrowers;

● changes in our financial condition or results of operations that reduce capital available to pay dividends; and

● changes in the financial condition or future prospects of issuers of securities that we own.

Critical Accounting Policies

There are no material changes to the critical accounting policies disclosed in West End Indiana Bancshares, Inc.’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 29, 2013.

Comparison of Financial Condition at September 30, 2013 and December 31, 2012

Total assets increased $6.0 million, or 2.4%, to $252.5 million at September 30, 2013 from $246.5 million at December 31, 2012.  The increase was primarily the result of an increase in investment securities available for sale of $1.8 million; in net loans, including loans held for sale of $7.4 million; and $1.0 million in all other assets. These increases were partially offset as total cash and cash equivalents decreased $4.1 million, from $10.7 million to $6.6 million.

Total cash and cash equivalents decreased $4.1 million, or 38.3%, to $6.6 million at September 30, 2013 from $10.7 million at December 31, 2012.  The decrease in total cash and cash equivalents reflected funding of investment and loan activity and liquidity management.

Securities classified as available for sale increased $1.8 million, or 2.9%, to $62.4 million at September 30, 2013 from $60.6 million at December 31, 2012.  Low-cost funding comprised of public funds and FHLB advances were utilized to purchase securities with matching maturities and allowing for a greater than 1% margin with minimal associated overhead.  At September 30, 2013, securities classified as available for sale consisted of mortgage-backed securities, municipal obligations, and SBA loans.

Net loans, including loans held for sale, increased $7.4 million, or 4.6%, to $168.3 million at September 30, 2013 from $160.9 million at December 31, 2012 due to increases in real estate loans of $3.5 million and consumer loans of $4.7 million.  These increases were offset by a decrease in construction loans of $800,000, or 32.0%, to $1.7 million at September 30, 2013 from $2.5 million at December 31, 2012.  Total non-performing loans increased to $3.5 million at September 30, 2013 from $2.6 million at December 31, 2012.

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Deposits increased $6.8 million, or 3.6%, to $196.6 million at September 30, 2013 from $189.8 million at December 31, 2012.  The increase was a result of acquisitions of local public fund certificates of deposit which were invested in short-term securities held for sale and used to fund loan growth.

Borrowings, consisting entirely of Federal Home Loan Bank advances, increased $2.0 million or 8.3%, to $26.0 million at September 30, 2013 from $24.0 million at December 31, 2012, as management employed asset and liability strategies to match funding terms with securities purchases and to fund loan growth.

Total equity decreased to $28.8 million at September 30, 2013 from $30.9 million at December 31, 2012, based on net income for the 2013 year to date of $867,000 offset by a decrease in other accumulated comprehensive income of $1.6 million, stock repurchases of $1.3 million and year to date dividends of $321,000.

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

General.  We recorded net income of $276,000 for the quarter ended September 30, 2013 compared to net income of $306,000 for the quarter ended September 30, 2012.  Although our net interest income after provision remained relatively flat quarter to quarter, the decrease in net income resulted primarily from a decrease of $24,000 in total other income and an increase of $134,000 in total other expense.

Interest and Dividend Income.  Interest and dividend income decreased $20,000, or 0.71%, to $2.80 million for the quarter ended September 30, 2013 from $2.82 million for the quarter ended September 30, 2012.  The average balance of total interest-earning assets increased $9.9 million, or 4.2%, to $243.3 million for the quarter ended September 30, 2013 from $233.5 million for the quarter ended September 30, 2012. Increases were in securities available for sale which increased $7.2 million, or 12.3% to $65.7 million from quarter ended September 30, 2013 from $58.4 million from prior year quarter.  Loans increased $8.5 million, or 5.3% to $169.5 million for the quarter ended September 30, 2013 from $161.0 million for the quarter ended September 30, 2012.  Other interest-earning assets decreased $5.8 million, or 41.4% to $8.2 million for the quarter ended September 30, 2013 from $14.0 million for the quarter ended September 30, 2012, offsetting the increase in average balances, the average yield on interest-earning assets decreased 28 basis points to 4.57% for the 2013 period from 4.85% for the 2012 period.

Interest income on loans increased $5,000, or 0.20%, to $2.52 million for the quarter ended September 30, 2013 from $2.52 million for the quarter ended September 30, 2012, as the increase in the average balance of loans was more than offset by a decrease in the average yield on our loans.  The average balance of net loans increased $8.5 million, or 5.3%, to $169.5 million for the quarter ended September 30, 2013 from $161.0 million for the quarter ended September 30, 2012. However, the average yield on our loan portfolio decreased 36 basis points to 5.90% for the quarter ended September 30, 2013 from 6.26% for the quarter ended September 30, 2012, reflecting the lower market interest rate environment.

Interest income on investment securities decreased $23,000 to $264,000 for the 2013 quarter from $287,000 for the 2012 quarter.  The average balance of our securities available for sale increased $7.2 million, or 12.3%, to $65.7 million for the quarter ended September 30, 2013 from $58.4 million for the quarter ended September 30, 2012. Funds from cash equivalents, non-interest bearing deposits and FHLB advances were used to purchase these securities. The average yield on our securities portfolio decreased 37 basis points, to 1.60% for the quarter ended September 30, 2013 from 1.97% for the quarter ended September 30, 2012.  Purchased instruments primarily included short-term mortgage-backed securities.

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Interest Expense.  Interest expense decreased $123,000, or 20.4%, to $481,000 for the quarter ended September 30, 2013 from $604,000 for the quarter ended September 30, 2012. This reflected a decrease of 30 basis points in rates paid on deposit accounts, to 0.74% for the quarter ended September 30, 2013, from 1.04% for the quarter ended September 30, 2012. The average balance of interest-bearing deposits increased $1.9 million, or 1.0%, to $184.7 million for the quarter ended September 30, 2013 from $182.8 million for the quarter ended September 30, 2012. The average balance of interest-bearing checking accounts increased $600,000 and certificates of deposits increased $1.2 million. Additionally, non-interest bearing checking accounts increased $2.1 million.  Total average balance deposits increased $4.1 million to $198.3 million for the quarter ended September 30, 2013 from $194.2 million for the quarter ended September 30, 2012.

The average balance of our money market accounts remained at $41.7 million, for the quarters ended September 30, 2013 and 2012. There was a decrease of 13 basis points on the average rate paid on money market accounts changing to 0.38% in the 2013 quarter from 0.51% in 2012.  In addition, the interest expense on our money market accounts declined from $53,000 to $40,000.   Interest expense onour certificates of deposit decreased $108,000, or 27.1%, to $291,000 for the quarter ended September 30, 2013 from $399,000 for the 2012 period as a result of a 47 basis point decrease in the average rate paid on these deposits to 1.15% for the 2013 period from 1.62% for the 2012 period.

Interest expense on borrowed funds, consisting entirely of Federal Home Loan Bank advances, increased $7,000, or 5.4%, to $136,000 for the quarter ended September 30, 2013 from $129,000 for the quarter ended September 30, 2012 as the average balance increased $2.0 million for the current period.

Net Interest Income.  Net interest income increased $103,000, or 4.6%, to $2.32 million for the quarter ended September 30, 2013 from $2.22 million for the quarter ended September 30, 2012,  as our net interest rate spread decreased to 3.67% from 3.69%, and our net interest margin increased to 3.82% from 3.80%.  The increase of net interest margin resulted from the increase in our average interest earning assets to our interest bearing liabilities to 115.33% for the 2013 quarter from 112.24% for the 2012 quarter while managing rates to enhance the net margin.

Provision for Loan Losses.  Based on our analysis of the factors described in “Critical Accounting Policies — Allowance for Loan Losses,” we recorded a provision for loan losses of $446,000 for the quarter ended September 30, 2013 compared to $340,000 for the quarter ended September 30, 2012.  At September 30, 2013, non-performing loans including troubled debt restructurings, totaled $3.5 million, or 2.0% of total loans, as compared to $2.8 million, or 1.8% of total loans, at September 30, 2012.  The allowance for loan losses to total loans increased to 1.33% at September 30, 2013 from 1.18% at September 30, 2012.

The allowance for loan losses as a percentage of non-performing loans decreased to 64.09% at September 30, 2013 from 66.87% at September 30, 2012. To the best of our knowledge, we have provided for all losses that are both probable and reasonable to estimate at September 30, 2013 and 2012.

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Other Income.  Other income decreased $24,000, or 5.0%, to $456,000 for the quarter ended September 30, 2013 from $480,000 for the quarter ended September 30, 2012.  The decrease was primarily due to the decrease in gain on sale of loans.  Gain on sale of loans decreased $135,000 to $49,000 for the quarter ended September 30, 2013 as compared to $184,000 for the quarter ended September 30, 2012 due to the determination that for asset liability management it was more advantageous to hold newly originated 1-4 family fixed rate mortgages in the Bank’s portfolio than to sell them. Additionally, there was a decrease of $57,000 in the gain of available for sale securities, as no securities were sold in the 2013 quarter. The decreases were offset by increases in service charges on deposits of $12,000; debit card income of $11,000; and loan servicing income, net of $134,000. Loan servicing income, net increased $134,000 to $150,000 for the quarter ended September 30, 2013 from $16,000 for the quarter ended September 30, 2012, based on the mortgage servicing rights valuation.

Other Expense.Other expense increased $134,000, or 7.4%, to $1.9 million for the quarter ended September 30, 2013 from $1.8 million for the quarter ended September 30, 2012.  Notable changes included an increase in salaries and employee benefits of $155,000 and a net increase in all other expenses of $22,000.  Salaries and employee benefits increased due to normal cost of living adjustments, increased medical insurance premiums and contribution to the ESOP and stock awards and incentives. Net occupancy expenses increased $12,000 due to normal maintenance on facilities.  Other expenses decreased $38,000 due to several smaller decreases in a number of expense categories.

Income Tax Expense.  We recorded $108,000 in income tax expense for the quarter ended September 30, 2013 compared to $239,000 in income tax expense for the 2012 period, reflecting income of $384,000 before income tax expense during the 2013 quarter versus income before income tax expense of $545,000 for the quarter ended September 30, 2012.  Our effective tax rate was 28.1% for the quarter ended September 30, 2013 compared to 43.8% for the quarter ended September 30, 2012 as we implemented our tax strategy to purchase more municipal bonds, generating non-taxable income.

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

General.  Net income increased to $867,000 for the nine months ended September 30, 2013 from $426,000 for the nine months ended September 30, 2012.  The increase in net income was primarily due to a decrease in non-interest expense as there was a one-time expenditure of $505,000 during the 2012 period to establish the West End Bank Charitable Foundation.

Interest and Dividend Income.  Interest and dividend income decreased $50,000, or 0.60%, to $8.29 million for the nine months ended September 30, 2013 from $8.34 million for the nine months ended September 30, 2013.  The average balance of total interest-earning assets increased $8.6 million, or 3.7%, to $240.6 million for the nine months ended September 30, 2013 from $232.0 million for the nine months ended September 30, 2012.  The increase in total interest-earning assets was offset by a 20 basis point decrease in the average yield on interest-earning assets to 4.61% for the 2013 period from 4.81% for the 2012 period, as a result of generally declining market interest rates.

Interest income and fees on loans decreased $38,000, or 0.51%, to $7.4 million for the nine months ended September 30, 2013 from $7.5 million for the nine months ended September 30, 2012, as the increase in the average balance of loans was more than offset by a decrease in the average yield on loans.  The average balance of loans increased $7.3 million, or 4.6%, to $165.4 million for the nine months ended September 30, 2013 from $158.1 million for the nine months ended September 30, 2012. However, the average yield on the loan portfolio decreased 31 basis points to 6.01% for the nine months ended September 30, 2013 from 6.32% for the six months ended September 30, 2012, reflecting the lower market interest rate environment.

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Interest income on investment securities, other interest earning assets and FHLB of Indianapolis stock, decreased $11,000, or 1.26%, to $863,000 for the nine months ended September 30, 2013 from $874,000 for the nine months ended September 30, 2012.  The decrease resulted primarily from a decrease in the other interest-bearing accounts which decreased $14,000, or 21.9% to $50,000 for the nine months ended September 30, 2013 from $64,000 for the nine months ended September 30, 2012.  The average balance of securities available for sale, increased $13.5 million, or 25.7%, to $66.1 million for the nine months ended September 30, 2013 from $52.5 million for the 2012 period, as funds from deposits were deployed to purchase these securities. The average yield on the securities portfolio decreased to 1.65% for the nine months ended September 30, 2013 from 2.06% for the nine months ended September 30, 2012 reflecting lower market rates.

Interest Expense.  Interest expense decreased $448,000, or 23.1%, to $1.5 million for the nine months ended September 30, 2013 from $1.9 million for the nine months ended September 30, 2012, as the decrease in the average cost of deposits more than offset the increase in the average balance of deposits.  Interest expense decreases included certificates of deposits of $339,000, core deposits of $93,000 and Federal Home Loan Bank advances of $16,000.  The average rate we paid on deposits decreased 29 basis points to 0.80% for the nine months ended September 30, 2013 from 1.09% for the nine months ended September 30, 2012, as deposits repriced downward in the declining interest rate environment.  The average balance of interest-bearing deposits decreased $4.4 million, or 2.4%, to $180.3 million for the nine months ended September 30, 2013 from $184.7 million for the nine months ended September 30, 2012.  The decrease in the average balance of our deposits resulted from increases in non-interest bearing and interest bearing checking and money market accounts offset by decreases in certificates of deposit and savings accounts.

           The average balance of our money market accounts increased $2.8 million, or 7.3%, to $40.9 million for the nine months ended September 30, 2013 from $38.1 million for the nine months ended September 30, 2012 as customers with maturing certificates of deposit elected to keep funds more liquid in the low rate environment.  In addition, the interest expense on our money market accounts declined from $174,000 to $125,000 due to the decrease of 20 basis points in the cost of these deposits to 0.41% for the nine months ended September 30, 2013 from 0.61% for the nine months ended September 30, 2012, reflecting lower market interest rates.

The average balance of our certificates of deposit decreased $2.8 million, or 2.8%, to $95.7 million for the nine months ended September 30, 2013 from $98.5 million for the nine months ended September 30, 2012.  The decline was strategic in allowing these certificates to roll off and as needed, replaced with core deposits or FHLB advances.  The interest expense on our certificates of deposit declined from $1.25 million to $911,000, due to lower balances and the decrease of 43 basis points in the cost of these deposits to 1.27% for the nine months ended September 2013 from 1.70% for the nine months ended September 30, 2012, which more than offset the increase in the average balances held.  Core interest-bearing deposit accounts decreased $1.6 million, or 1.9%, to $84.5 million for the 2013 period from $86.2 million for the 2012 period.

Interest expense on core deposits decreased $93,000 to $167,000 for the nine months ended September 30, 2013 from $260,000 for the six months ended September 30, 2012, reflecting lower market interest rates.

Interest expense on borrowed funds, consisting entirely of Federal Home Loan Bank advances, decreased $16,000, or 3.7%, to $417,000 for the nine months ended September 30, 2013 from $433,000 for the nine months ended September 30, 2012, reflecting the lower market interest rate environment.

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Net Interest Income.  Net interest income increased $399,000, or 6.2%, to $6.8 million for the nine months ended September 30, 2013 from $6.4 million for the nine months ended September 30, 2012.  The increase reflected an increase in interest rate spread to 3.65% for the 2013 period from 3.58% for the 2012 period, and an increase in net interest margin to 3.77% for the nine months ended September 30, 2013 from 3.68% for nine months ended September 30, 2012.  The increase in interest rate spread and net interest margin was the result of an increase in interest earning assets to interest bearing liabilities and rapid repricing of our interest-bearing liabilities in the ratio of our declining interest rate environment compared to interest-earning assets.

Provision for Loan Losses.  A provision for loan losses of $951,000 was recorded for the nine months ended September 30, 2013 and $850,000 for the nine months ended September 30, 2012.  The allowance for loan losses was $2.25 million, or 1.33% of total loans, at September 30, 2013, compared to $1.86 million, or 1.18% of total loans, at September 30, 2012.  Total nonperforming loans were $3.5 million at September 30, 2013, compared with $2.8 million at September 30, 2012.

The allowance for loan losses as a percentage of non-performing loans decreased to 64.09% at September 30, 2013 from 66.87% at September 30, 2012.  The increase in non-performing loans was due to a single commercial credit previously identified as impaired and provided with a specific reserve allocated in the allowance for loan losses that has now been placed on non-accrual.  This commercial credit was previously, and remains, current with terms of the loan agreement.  To the best of our knowledge, we have provided for all losses that are both probable and reasonable to estimate at September 30, 2013 and 2012.

Other Income.  Other income decreased $61,000, or 5.3%, to $1.1 million for the nine months ended September 30, 2013 from $1.2 million for the nine months ended September 30, 2012. The decrease was primarily due to increased losses on sale of other assets and a decrease in gain on sale of loans, offset partly by an increase in fee income of loan servicing. Gain on sale of loans decreased $152,000 to $234,000 for the nine months ended September 30, 2013 as compared to $386,000 for the same period in 2012 as we sold fewer loans in 2013 due to the rapid rate changing environment. Additionally, we recorded a loss on other assets of $64,000 during the nine months ended 2013 as compared to a loss of $37,000 recorded during the same period in 2012. Loan servicing fee income increased to $175,000 from $42,000 reflecting increases in fair market value of the related serving assets.

Other Expense.Other expense decreased $313,000, or 5.2%, to $5.7 million for the nine months ended September 30, 2013 from $6.0 million for the nine months ended September 30, 2012. The decrease resulted primarily from our contribution to the West End Bank Charitable Foundation in the first quarter of 2012 which resulted in the recording of a one-time expense of $505,000 with no corresponding expense during the 2013 period.  Additionally, salaries and employee benefits increased $127,000 to $3.1 million for the 2013 quarter from $3.0 million for the 2012 quarter.  Other increases include occupancy expense of $31,000 and advertising of $35,000.

Income Tax Expense.  A $376,000 income tax expense was recorded for the nine months ended September 30, 2013 compared to a $268,000 income tax expense for the 2012 period, reflecting income of $1.2 million before income tax expense for the nine months ended September 30, 2013, compared to income before income tax expense of $694,000 for the nine months ended September 30, 2012.  Our effective tax rate was 30.3% for the nine months ended September 30, 2013, compared to 38.6% for the nine months ended September 30, 2012 as we implemented our tax strategy to purchase more municipal bonds generating non-taxable income.

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Liquidity and Capital Resources.  Our primary sources of funds are deposits, principal and interest payments on loans and securities, proceeds from sale of loans, proceeds from maturities and calls of securities, and Federal Home Loan Bank advances.  While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition.  Our most liquid assets are cash and short-term investments including interest-bearing demand deposits.  The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities.  Net cash provided by operating activities was $2.8 million and $2.8 million for the nine months ended September 30, 2013 and 2012, respectively.  Net cash used in investing activities, which consists primarily of disbursements for loan originations and the purchase of securities, offset by principal collections on loans, proceeds from the sale of loans and securities and proceeds from maturing securities and pay downs on mortgage-backed securities, was $14.1 million and $15.0 million for the nine months ended September 30, 2013 and 2012, respectively.  Net cash provided by financing activities, consisting primarily of the activity in deposit accounts and Federal Home Loan Bank advances, was $7.2 million and $6.3 million for the nine months ended September 30, 2013 and 2012, respectively, resulting from our strategy of growing our public fund certificates of deposit, deposit accounts from our commercial borrowers and a general growth in all deposit categories resulting from customers seeking the relative stability of insured accounts in the uncertain economic environment.

At September 30, 2013, we exceeded all of our regulatory capital requirements with a Tier 1 (core) capital level of $27.9 million, or 11.0% of adjusted total assets, which is above the required level of $10.1 million, or 4%; and total risk-based capital of $30.0 million, or 17.9% of risk-weighted assets, which is above the required level of $13.4 million, or 8%.  Accordingly West End Bank, S.B. was categorized as well capitalized at September 30, 2013.  Management is not aware of any conditions or events since the most recent notification that would change our category.

At September 30, 2013, we had outstanding commitments to originate loans of $16.0 million and stand-by letters of credit of $1.1 million.  We anticipate that we will have sufficient funds available to meet our current loan origination commitments.  Certificates of deposit that are scheduled to mature in less than one year from September 30, 2013 totaled $51.0 million.  Management expects that a substantial portion of the maturing certificates of deposit will be renewed.  However, if a substantial portion of these deposits is not retained, we may utilize Federal Home Loan Bank advances or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable, as the Registrant is a smaller reporting company.

Item 4. Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of September 30, 2013.  Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.

During the quarter ended September 30, 2013, there have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II – Other Information

Item 1. Legal Proceedings

We are subject to various legal actions arising in the normal course of business.  In the opinion of management, the resolution of these legal actions is not expected to have a material adverse effect on our financial condition or results of operations.

Item 1A.                      Risk Factors

Not applicable, as the Registrant is a smaller reporting company.

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

(a) There were no sales of unregistered securities during the period covered by this Report.

(b) Not applicable.

(c) There were no issuer repurchases of securities during the period covered by this Report.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

None.

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Item 6. Exhibits

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

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

32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS XBRL Instance Document.

101.SCH XBRL Schema Document.

101.CAL XBRL Calculation Linkbase Document.

101.DEF XBRL Definition Linkbase Document.

101.LAB XBRL Label Linkbase Document.

101.PRE Presentation Linkbase Document

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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.

	WEST END INDIANA BANCSHARES, INC.
Date:  November 14, 2013	/s/ John P. McBride
	John P. McBride
	President and Chief Executive Officer
Date:  November 14, 2013	/s/ Shelley D. Miller
	Shelley D. Miller
	Executive Vice President and Chief Financial Officer

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