HF Financial (HFFC) 10-Q 2011 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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

For the Quarterly Period Ended September 30, 2010

OR

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

Commission file number 0-19972

HF FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

Delaware	46-0418532
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
225 South Main Avenue, Sioux Falls, SD	57104
(Address of principal executive offices)	(ZIP Code)

(605) 333-7556

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the Registrant 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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).   Yes o 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 (Do not check if a smaller reporting company)	Smaller reporting company x

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

As of November 5, 2010, there were 6,963,039 shares of the registrant’s common stock outstanding.

Quarterly Report on Form 10-Q

Table of Contents

		Page Number
PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited):
	Consolidated Statements of Financial Condition
	At September 30, 2010 and June 30, 2010	1
	Consolidated Statements of Income for the
	Three Months Ended September 30, 2010 and 2009	2
	Consolidated Statements of Cash Flows for the
	Three Months Ended September 30, 2010 and 2009	3
	Notes to Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	38
Item 4.	Controls and Procedures	39
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	40
Item 1A.	Risk Factors	40
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 3.	Defaults upon Senior Securities	40
Item 4.	[Removed and Reserved]	40
Item 5.	Other Information	40
Item 6.	Exhibits	40
Form 10-Q	Signature Page	41

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands, except share data)

	September 30, 2010			June 30, 2010
	(Unaudited)			(Audited)
ASSETS
Cash and cash equivalents	$	21,838		$	20,805
Securities available for sale	268,716			264,442
Federal Home Loan Bank stock	11,648			10,334
Loans held for sale	18,120			25,287
Loans and leases receivable	880,067			872,279
Allowance for loan and lease losses	(12,319		)	(9,575		)
Net loans and leases receivable	867,748			862,704
Accrued interest receivable	10,688			8,785
Office properties and equipment, net of accumulated depreciation	15,305			14,973
Foreclosed real estate and other properties	942			946
Cash value of life insurance	15,284			15,144
Servicing rights	12,970			12,733
Goodwill, net	4,366			4,366
Other assets	12,859			12,496
Total assets	$	1,260,484		$	1,253,015
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Deposits	$	877,618		$	914,264
Advances from Federal Home Loan Bank and other borrowings	230,366			190,719
Subordinated debentures payable to trusts	27,837			27,837
Advances by borrowers for taxes and insurance	16,491			11,460
Accrued expenses and other liabilities	14,799			14,300
Total liabilities	1,167,111			1,158,580
STOCKHOLDERS’ EQUITY
Preferred stock, $.01 par value, 500,000 shares authorized, none outstanding	—			—
Common stock, $.01 par value, 10,000,000 shares authorized, 9,046,494 and 9,025,792 shares issued at September 30, 2010 and June 30, 2010, respectively	90			90
Common stock subscribed for but not issued	—			—
Additional paid-in capital	44,768			44,496
Retained earnings, substantially restricted	83,719			84,011
Accumulated other comprehensive (loss), net of related deferred tax effect	(4,307		)	(3,265		)
Less cost of treasury stock, 2,083,455 and 2,083,455 shares at September 30, 2010 and June 30, 2010, respectively	(30,897		)	(30,897		)
Total stockholders’ equity	93,373			94,435
Total liabilities and stockholders’ equity	$	1,260,484		$	1,253,015

See accompanying notes to unaudited consolidated financial statements.

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HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except share data)

(Unaudited)

	Three Months Ended
	September 30,
	2010			2009
Interest, dividend and loan fee income:
Loans and leases receivable	$	12,708		$	12,343
Investment securities and interest-earning deposits	1,483			2,290
	14,191			14,633
Interest expense:
Deposits	2,612			3,524
Advances from Federal Home Loan Bank and other borrowings	1,954			2,358
	4,566			5,882
Net interest income	9,625			8,751
Provision for losses on loans and leases	3,367			343
Net interest income after provision for losses on loans and leases	6,258			8,408
Noninterest income:
Fees on deposits	1,609			1,446
Loan servicing income	502			491
Gain on sale of loans, net	747			496
Earnings on cash value of life insurance	166			164
Trust income	154			257
Gain on sale of securities, net	397			533
Total other-than-temporary impairment losses	—			(3,914		)
Portion of loss recognized in other comprehensive income (before taxes)	—			2,056
Net impairment losses recognized in earnings	—			(1,858		)
Other	207			169
	3,782			1,698
Noninterest expense:
Compensation and employee benefits	5,547			5,163
Occupancy and equipment	1,139			1,084
FDIC insurance	344			325
Check and data processing expense	706			698
Professional fees	591			600
Marketing and community investment	406			471
Foreclosed real estate and other properties, net	25			19
Other	669			589
	9,427			8,949
Income before income taxes	613			1,157
Income tax expense	123			302
Net income	$	490		$	855
Comprehensive income (loss)	$	(552	)	$	2,098
Basic earnings per common share:	$	0.07		$	0.21
Diluted earnings per common share:	0.07			0.21
Dividends declared per common share	0.11			0.11

See accompanying notes to unaudited consolidated financial statements.

2

HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands, except share data)

(Unaudited)

	Three Months Ended September 30,
	2010			2009
Cash flows from operating activities
Net income	$	490		$	855
Adjustments to reconcile net income to net cash provided by (used in) operating activities
Provision for losses on loans and leases	3,367			343
Depreciation	490			497
Amortization of discounts and premiums on securities and other	930			707
Stock based compensation	133			152
Net change in loans held for resale	7,914			(7,415		)
(Gain) on sale of loans, net	(747		)	(496		)
Realized (gain) on sale of securities, net	(395		)	(533		)
Other-than-temporary impairments recognized in noninterest income	—			1,858
(Gains) losses and provision-for-losses on sales of foreclosed real estate and other properties, net	3			(5		)
Change in other assets and liabilities	(3,182		)	(3,936		)
Net cash provided by (used in) operating activities	9,003			(7,973		)
Cash flows from investing activities
Loan participations purchased	(305		)	(921		)
Net change in loans outstanding	(8,135		)	17,536
Securities available for sale
Sales, maturities, repayments and adjustments	30,140			23,783
Purchases	(34,679		)	(21,505		)
Purchase of Federal Home Loan Bank stock	(2,720		)	—
Redemption of Federal Home Loan Bank stock	1,406			—
Purchase of office properties and equipment	(822		)	(936		)
Purchase of servicing rights	(292		)	(349		)
Proceeds from sale of foreclosed real estate and other properties	48			147
Net cash provided by (used in) investing activities	(15,359		)	17,755
Cash flows from financing activities
Net (decrease) in deposit accounts	(36,646		)	(7,627		)
Proceeds of advances from Federal Home Loan Bank and other borrowings	259,817			991,599
Payments on advances from Federal Home Loan Bank and other borrowings	(220,170		)	(997,190		)
Increase in advances by borrowers	5,031			4,095
Proceeds from issuance of common stock	139			—
Cash dividends paid	(782		)	(453		)
Net cash provided by (used in) financing activities	7,389			(9,576		)
Increase in cash and cash equivalents	1,033			206
Cash and cash equivalents
Beginning	20,805			18,511
Ending	$	21,838		$	18,717
Supplemental disclosures of cash flows information
Cash payments for interest	$	4,405		$	5,509
Cash payments for income and franchise taxes, net	13			310		��

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HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009

(Unaudited)

NOTE 1—SELECTED ACCOUNTING POLICIES

Basis of Financial Statement Presentation

The consolidated financial information of HF Financial Corp. (the “Company”) and its wholly-owned subsidiaries included in this Quarterly Report on Form 10-Q is unaudited.  However, in the opinion of management, adjustments (consisting of normal recurring adjustments) necessary for a fair presentation for the interim periods have been included.  Results for any interim period are not necessarily indicative of results to be expected for the fiscal year.  Interim consolidated financial statements and the notes thereto should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2010 (“fiscal 2010”), filed with the Securities and Exchange Commission.  The accounting and reporting policies of the Company and its subsidiaries conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practice within the industry.

The interim consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, Home Federal Bank (the “Bank”), HF Financial Group, Inc. (“HF Group”) and HomeFirst Mortgage Corp. (the “Mortgage Corp.”), and the Bank’s wholly-owned subsidiaries, Mid America Capital Services, Inc. (“Mid America Capital”), Hometown Investment Services, Inc. (“Hometown”), Mid-America Service Corporation and PMD, Inc.  The interim consolidated financial statements reflect the deconsolidation of the wholly-owned subsidiary trusts of the Company: HF Financial Capital Trust III (“Trust III”), HF Financial Capital Trust IV (“Trust IV”), HF Financial Capital Trust V (“Trust V”) and HF Financial Capital Trust VI (“Trust VI”). See Note 10 of “Notes to Consolidated Financial Statements.”  All intercompany balances and transactions have been eliminated in consolidation.

Management has evaluated subsequent events for potential disclosure or recognition through November 12, 2010, the date of the filing of the consolidated financial statements with the Securities and Exchange Commission.

NOTE 2—REGULATORY CAPITAL

The following table sets forth the Bank’s compliance with its minimum capital requirements for a well-capitalized institution at September 30, 2010:

	Amount		Percent
	(Dollars in Thousands)
Tier I (core) capital (to adjusted total assets):
Required	$	62,750	5.00	%
Actual	109,532		8.73
Excess over required	46,782		3.73
Total Risk-based capital (to risk-weighted assets):
Required	$	101,441	10.00	%
Actual	118,790		11.71
Excess over required	17,349		1.71

NOTE 3—EARNINGS PER COMMON SHARE

Basic earnings per common share is computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period.  Shares issued during the period and shares reacquired during the period are weighted for the portion of the period they were outstanding. The weighted average number of basic common shares outstanding for the three months ended September 30, 2010 and 2009 was 6,946,303 and 4,030,391, respectively.

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Dilutive earnings per common share is similar to the computation of basic earnings per common share except the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive options outstanding had been exercised. The weighted average number of common and dilutive potential common shares outstanding for the three months ended September 30, 2010 and 2009 was 6,946,547 and 4,041,650, respectively.

NOTE 4—INVESTMENTS IN SECURITIES

The amortized cost and fair values of investments in securities, all of which are classified as available for sale according to management’s intent, are as follows:

	September 30, 2010
			Total Other-Than
			Temporary
			Impairment
			Recognized in			Adjusted		Gross		Gross
	Amortized		Accumulated Other			Carrying		Unrealized		Unrealized			Fair
	Cost		Comprehensive Income			Cost		Gains		( Losses )			Value
Debt securities:
U.S. government agencies	$	4,550	$	—		$	4,550	$	30	$	—		$	4,580
Municipal bonds	14,161		—			14,161		583		(12		)	14,732
Trust preferred securities	12,370		(3,080		)	9,290		—		(6,021		)	3,269
	31,081		(3,080		)	28,001		613		(6,033		)	22,581
Equity securities:
FNMA	8		(8		)	—		—		—			—
Federal Ag Mortgage	7		—			7		—		(3		)	4
Other Investments	253		—			253		—		—			253
	268		(8		)	260		—		(3		)	257
Residential mortgage-backed securities	241,532		—			241,532		4,632		(286		)	245,878
	$	272,881	$	(3,088	)	$	269,793	$	5,245	$	(6,322	)	$	268,716

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	September 30, 2009
			Total Other-Than
			Temporary
			Impairment
			Recognized in			Adjusted		Gross		Gross
	Amortized		Accumulated Other			Carrying		Unrealized		Unrealized			Fair
	Cost		Comprehensive Income			Cost		Gains		( Losses )			Value
Debt securities:
U.S. government agencies	$	2,632	$	—		$	2,632	$	40	$	—		$	2,672
Municipal bonds	14,210		—			14,210		444		(37		)	14,617
Trust preferred securities	12,283		(2,255		)	10,028		—		(4,379		)	5,649
	29,125		(2,255		)	26,870		484		(4,416		)	22,938
Equity securities:
FNMA	8		(8		)	—		—		—			—
Federal Ag Mortgage	7		—			7		—		(3		)	4
Other Investments	253		—			253		—		—			253
	268		(8		)	260		—		(3		)	257
Residential mortgage-backed securities	194,819		—			194,819		4,030		(907		)	197,942
	$	224,212	$	(2,263	)	$	221,949	$	4,514	$	(5,326	)	$	221,137

Management has implemented a process to identify securities that could potentially have a credit impairment that is other-than-temporary.  This process involves evaluation of the length of time and extent to which the fair value has been less than the amortized cost basis, review of available information regarding the financial position of the issuer, monitoring the rating of the security, cash flow projections, and the Company’s intent to sell a security or whether it is more likely than not it will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity.  To the extent the Company determines that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.

For all securities that are considered temporarily impaired, the Company does not intend to sell these securities (has not made a decision to sell) and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost, which may occur at maturity.  The Company believes that it will collect all principal and interest due on all investments that have amortized cost in excess of fair value that are considered only temporarily impaired.

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The following table presents the fair value and age of gross unrealized losses by investment category at September 30, 2010:

	Less than 12 Months					12 Months or More					Total
			Gross					Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		(Losses)			Value		(Losses)			Value		(Losses)
	(Dollars in Thousands)
Debt securities:
Municipal bonds	$	669	$	(7	)	$	514	$	(5	)	$	1,183	$	(12	)
Trust preferred securities	—		—			3,269		(6,021		)	3,269		(6,021		)
	669		(7		)	3,783		(6,026		)	4,452		(6,033		)
Equity securities:
Federal Ag Mortgage	4		(3		)	—		—			4		(3		)
	4		(3		)	—		—			4		(3		)
Agency residential mortgage-backed securities	46,053		(286		)	164		—			46,217		(286		)
	$	46,726	$	(296	)	$	3,947	$	(6,026	)	$	50,673	$	(6,322	)

For the three months ended September 30, 2010, gross proceeds from the securities sold at a gain were $12.6 million, resulting in a gain on sale of securities of $397,000.  This compares to gross proceeds of $24.2 million, resulting in a gain on sale of securities of $1.1 million for the three months ended September 30, 2009.  No securities were sold for a loss during the first quarters of fiscal 2011 and fiscal 2010.

The unrealized losses reported for municipal bonds relate to six municipal general obligation or revenue bonds.  The unrealized losses are primarily attributed to changes in credit spreads or market interest rate increases since the securities were originally acquired, rather than due to credit or other causes.  Management does not believe any individual unrealized losses as of September 30, 2010 represent an other-than-temporary impairment for these investments.  The Company does not have the intent to sell these securities (has not made a decision to sell) and has assessed that it is not more likely than not that the Company will be required to sell these securities before anticipated recovery of fair value.

The unrealized losses reported for agency residential mortgage-backed securities relate to 16 securities issued by the Federal National Mortgage Association (“FNMA”), the Government National Mortgage Association (“GNMA”), or the Federal Home Loan Mortgage Corporation (“FHLMC”).  These unrealized losses are primarily attributable to changes in interest rates and the contractual cash flows of those investments which are guaranteed by an agency of the U.S. government.  Management does not believe any of these unrealized losses as of September 30, 2010 represent an other-than-temporary impairment for those investments.  The Company does not have the intent to sell these securities (has not made a decision to sell) and has assessed that it is not more likely than not that the Company will be required to sell these securities before anticipated recovery of fair value.

The unrealized losses reported for trust preferred securities are attributable to six rated pooled securities. Rating downgrades regarding these investments have occurred placing each in a below investment grade rating. The securities have an adjusted carrying cost of $1.9 million rated Caa3, $2.4 million rated Caa1, and $5.0 million rated Ca.  The market for these securities is currently inactive. The CUSIPs of the trust preferred securities are 74042TAE1 rated Caa3, 740417AB6 and 74042CAE8 rated Caa1, and 74041EAC9, 74041RAB2, and 55312HAE9 rated Ca. The Company performed assessments of available information for each security during the first quarter ended September 30, 2010, and also considered factors such as overall deal structure and its position within the structure, quality of underlying issuers within each pool, defaults and recoveries, loss severities and prepayments. Based upon scenarios developed in regard to this information, management compared the present value of best estimates of cash flows expected to be collected from each security at the security’s effective interest rate to the amortized cost basis of each security. Management determined that no trust preferred securities exhibited an other-than-temporary impairment credit loss for the quarter ended September 30,  2010.  See Note 13 “Financial Instruments” for additional information related to the determination of fair value. The Company does not have the intent to sell these six securities (has not made a decision to sell) and has assessed that it is not more likely than not that the Company will be required to sell these securities before anticipated recovery of

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fair value. Within this segment, five securities with amortized cost of $7.5 million are quarterly variable-rate securities tied to 3-month LIBOR.

The following table presents the amounts recognized in the Consolidated Statements of Income for other-than-temporary impairments related to credit losses charged to earnings:

	Three Months Ended
	September 30, 2010
	(Dollars in Thousands)
Beginning balance of credit losses on securities held as of July 1, 2010 for which a portion of other-than-temporary impairment was recognized in other comprehensive income (1)	$	3,088
Credit losses for which an other-than-temporary impairment was not previously recognized	—
Increases to the amount related to the credit losses for which other-than-temporary was previously recognized	—
Ending balance of credit losses on securities held as of September 30, 2010 for which a portion of other-than-temporary impairment was recognized in other comprehensive income	$	3,088

(1) Includes $8 of other-than-temporary impairment related to Fannie Mae common stock

The composition and maturities of the investment securities portfolio, excluding equity securities, are indicated in the following table:

	At September 30, 2010
									TOTAL
	Less than		1 to 5		5 to 10		Over 10		Adjusted		Fair
	1 Year		Years		Years		Years		Carrying Cost		Values
	(Dollars in Thousands)
U.S. government agencies	$	—	$	4,550	$	—	$	—	$	4,550	$	4,580
Municipal bonds	1,302		5,085		4,973		2,801		14,161		14,732
Trust preferred securities	—		—		—		9,290		9,290		3,269
Agency residential mortgage-backed securities	—		1,644		8,402		231,486		241,532		245,878
Total investment securities	$	1,302	$	11,279	$	13,375	$	243,577	$	269,533	$	268,459

NOTE 5—LOAN SERVICING

Mortgage loans serviced for others (primarily the South Dakota Housing Development Authority) are not included in the accompanying consolidated statements of financial condition.

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The following tables summarize the activity in, and the main assumptions used to estimate the amortization of servicing rights:

	Three Months Ended
	September 30,
	2010			2009
	(Dollars in Thousands)
Balance, beginning	$	12,733		$	11,768
Additions	621			654
Amortization	(384		)	(424		)
Balance, ending	$	12,970		$	11,998
Servicing fees received	$	886		$	915
Balance of loans serviced at:
Beginning of period	1,133,649			1,046,600
End of period	1,154,502			1,073,658

Amortization of servicing rights is adjusted each quarter as the result of the evaluation of historical prepayment activity.  For the first quarter ended September 30, 2010 and 2009, the constant prepayment rates (CPR) used to calculate the amortization was 8.00% and 11.00%, respectively.  Management utilized a discount rate of 9.00% and 10.00% for valuation purposes for both periods, respectively.

NOTE 6—SEGMENT REPORTING

Operating segments are defined as components of an enterprise for which discrete financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance.  The Company’s reportable segments are “banking” (including leasing activities) and “other.”  The “banking” segment is conducted through the Bank and Mid America Capital and the “other” segment is composed of smaller non-reportable segments, the Company and intersegment eliminations.

The management approach is used as the conceptual basis for identifying reportable segments and is based on the way that management organizes the segments within the enterprise for making operating decisions, allocating resources and monitoring performance, which is primarily based on products.

	Three Months Ended September 30,
	2010									2009
	Banking			Other			Total			Banking			Other			Total
	(Dollars in Thousands)
Net interest income	$	10,076		$	(451	)	$	9,625		$	9,241		$	(490	)	$	8,751
Provision for losses on loans and leases	(3,367		)	—			(3,367		)	(343		)	—			(343		)
Non-interest income	3,666			116			3,782			1,582			116			1,698
Intersegment non-interest income	(49		)	(15		)	(64		)	(24		)	(39		)	(63		)
Non-interest expense	(8,937		)	(490		)	(9,427		)	(8,530		)	(419		)	(8,949		)
Intersegment non-interest expense	—			64			64			—			63			63
Income (loss) before income taxes	$	1,389		$	(776	)	$	613		$	1,926		$	(769	)	$	1,157
Total assets at September 30	$	1,246,841		$	13,643		$	1,260,484		$	1,163,296		$	5,166		$	1,168,462

NOTE 7—DEFINED BENEFIT PLAN

The Company has a noncontributory (cash balance) defined benefit pension plan covering all employees of the Company and its wholly-owned subsidiaries who have attained the age of 21 and have completed 1,000 hours of service

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in a plan year.  The benefits are based on 6% of each eligible participant’s annual compensation, plus income earned in the accounts at a rate determined annually based on 30-year treasury note rates.  The Company’s funding policy is to make the minimum annual required contribution plus such amounts as the Company may determine to be appropriate from time to time.  One hundred percent vesting occurs after three years with a retirement age of the later of age 65 or three years of participation.  The Company has adopted all plan provisions required by the Pension Protection Act of 2006.  Information relative to the components of net periodic benefit cost for the Company’s defined benefit plan is presented below:

	Three Months Ended
	September 30,
	2010			2009
	(Dollars in Thousands)
Service cost	$	147		$	142
Interest cost	154			144
Amortization of prior losses	23			45
Expected return on plan assets	(159		)	(139		)
Total costs recognized in expense	$	165		$	192

The Company previously disclosed in its consolidated financial statements for fiscal 2010, which are included in Part II, Item 8 “Financial Statements and Supplementary Data” of the Company’s Annual Report on Form 10-K that it contributed $425,000 in fiscal 2010 to fund its qualified pension plan.  The Company anticipates that a contribution of $455,000 will be made in the second quarter of fiscal 2011.

NOTE 8—SELF-INSURED HEALTHCARE PLAN

The Company has had a self-insured health plan for its employees, subject to certain limits, since January 1994.  The Bank is named the plan administrator for this plan and has retained the services of an independent third party administrator to process claims and handle other duties for this plan.  The third party administrator does not assume liability for benefits payable under this plan.

The Company assumes the responsibility for funding the plan benefits out of general assets; however, employees cover some of the costs of covered benefits through contributions, deductibles, co-pays and participation amounts.  An employee is eligible for coverage upon completion of 30 calendar days of regular employment.  The plan, which is on a calendar year basis, is intended to comply with, and be governed by, the Employee Retirement Income Security Act of 1974, as amended.

The accrual estimate for pending and incurred but not reported health claims is based upon a pending claims lag report provided by a third party provider.  Although management believes that it uses the best information available to determine the accrual, unforeseen health claims could result in adjustments and net earnings being significantly affected if circumstances differ substantially from the assumptions used in estimating the accrual.  Net healthcare costs are inclusive of health claims expenses and administration fees offset by stop loss and employee reimbursement.  The following table is a summary of net healthcare costs by quarter:

	Fiscal Years Ended June 30,
	2011		2010
	(Dollars in Thousands)
Quarter ended September 30	$	587	$	748
Quarter ended December 31	—		311
Quarter ended March 31	—		486
Quarter ended June 30	—		602
Net healthcare costs	$	587	$	2,147

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NOTE 9—STOCK-BASED COMPENSATION PLANS

The fair value of each incentive stock option and each stock appreciation right grant is estimated at the grant date using the Black-Scholes option-pricing model.  There were no stock appreciation rights (SARs) granted in the first quarter of fiscal 2011.  The following assumptions were used for grants in the three months ended September 30, 2009:

Expected volatility	22.00	%
Expected dividend yield	3.61	%
Risk-free interest rate	2.35	%
Expected term (in years)	5

Stock option activity for the three months ended September 30, 2010 was as follows:

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
			Exercise		Contractual	Intrinsic
	Shares		Price		Term	Value
Beginning balance	133,240		$	13.15
Granted	—		—
Forfeited	(379	)	7.75
Exercised	(13,855	)	10.05
Ending balance	119,006		$	13.52	3.16	$	3,153
Vested and exercisable	119,006		$	13.52	3.16	$	3,153

Stock appreciation rights activity for the three months ended September 30, 2010 was as follows:

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
			Exercise		Contractual	Intrinsic
	SARs		Price		Term	Value
Beginning balance	198,136		$	13.70
Granted	—		—
Forfeited	(1,005	)	15.70
Exercised	—		—
Ending balance	197,131		$	13.69	8.25	$	—
Vested and exercisable	83,739		$	14.49	7.71	$	—

The total intrinsic value of options exercised during the three months ended September 30, 2010 and 2009 was $3,000 and $0, respectively.  Cash received from the exercise of these options was $139,000 and $0, respectively.  There were no cashless option exercises or related tax benefit realized for the three months ended September 30, 2010 and 2009.   There were no stock appreciation rights (SARs) granted during the three months ended September 30, 2010, while the weighted-average grant date fair value of SARs granted during the three months ended September 30, 2009 was $1.75.  The total unrecognized compensation cost related to nonvested SARs awards at September 30, 2010 was $232,000.  This unrecognized cost is expected to be recognized over a weighted average period of 23 months.

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Nonvested share activity for the three months ended September 30 follows:

	2010				2009
			Weighted				Weighted
			Average				Average
			Grant Date				Grant Date
	Shares		Fair Value		Shares		Fair Value
Nonvested balance, beginning	69,475		$	13.68	90,708		$	15.81
Granted	6,847		9.92		18,436		12.48
Vested	(31,190	)	16.33		(40,415	)	16.31
Forfeited	—		—		—		—
Nonvested balance, ending	45,132		$	11.29	68,729		$	14.62

Pretax compensation expense recognized for nonvested shares for the three months ended September 30, 2010, and 2009 was $71,000 and $92,000, respectively.  The tax benefit for the three months ended September 30, 2010, and 2009 was $24,000 and $31,000, respectively.  As of September 30, 2010, there was $375,000 of total unrecognized compensation cost related to nonvested shares granted under the Company’s 2002 Stock Option and Incentive Plan, as amended (“the Plan”).  The cost is expected to be recognized over a weighted-average period of 22 months.  The total fair value of shares vested during the three months ended September 30, 2010 and 2009 was $648,000 and $659,000, respectively.

In association with the 2002 Option Plan, awards of nonvested shares of the Company’s common stock are made to outside directors of the Company.  Each outside director is entitled to all voting, dividend and distribution rights during the vesting period.  During the second quarter of fiscal 2010, 19,626 shares of nonvested stock were awarded, which vest on the first anniversary of the date of grant.  As of September 30, 2010, there was $40,000 of total unrecognized compensation cost related to nonvested shares, which are expected to be recognized over the remaining period of three months.  For the three months ended September 30, 2010, amortization expense was recorded in the amount of $40,000.

These stock option and incentive plans are described more fully in Part II, Item 8 “Financial Statements and Supplementary Data” of the Company’s Annual Report on Form 10-K for fiscal 2010, under Note 16 of “Notes to Consolidated Financial Statements.”

NOTE 10—SUBORDINATED DEBENTURES PAYABLE TO TRUSTS

On December 19, 2002, the Company issued 5,000 shares totaling $5.0 million of Company Obligated Mandatorily Redeemable Preferred Securities of Trust III. Trust III was established and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust III. The securities provide for cumulative cash distributions calculated at a rate based on three-month LIBOR plus 3.35% adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond January 7, 2033. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities must be redeemed on January 7, 2033; however, the Company has the option to shorten the maturity date as the call option date has passed. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company’s indebtedness and senior to the Company’s capital stock.

On September 25, 2003, the Company issued 7,000 shares totaling $7.0 million of Company Obligated Mandatorily Redeemable Preferred Securities of Trust IV. Trust IV was established and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust IV. The securities provide for cumulative cash distributions calculated at a rate based on three-month LIBOR plus 3.10% adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond October 8, 2033. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities must

12

be redeemed on October 8, 2033; however, the Company has the option to shorten the maturity date as the call option date has passed. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company’s indebtedness and senior to the Company’s capital stock.

On December 7, 2006, the Company issued 10,000 shares totaling $10.0 million of Company Obligated Mandatorily Redeemable Preferred Securities of Trust V. Trust V was established and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust V. The securities provide for cumulative cash distributions calculated at a rate based on three-month LIBOR plus 1.83%, fixed for five years at 6.61%; thereafter, adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond March 1, 2037. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities must be redeemed on March 1, 2037; however, the Company has the option to shorten the maturity date to a date not earlier than March 1, 2012. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company’s indebtedness and senior to the Company’s capital stock.

On July 5, 2007, the Company issued 5,000 shares totaling $5.0 million of Company Obligated Mandatorily Redeemable Preferred Securities of Trust VI. Trust VI was established and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust VI. The securities provide for cumulative cash distributions calculated at a rate based on three- month LIBOR plus 1.65% adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond October 1, 2037. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities must be redeemed on October 1, 2037; however, the Company has the option to shorten the maturity date to a date not earlier than October 1, 2012. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company’s indebtedness and senior to the Company’s capital stock.

NOTE 11—INTEREST RATE CONTRACTS

Interest rate swap contracts are entered into primarily as an asset/liability management strategy of the Company to modify interest rate risk.  The primary risk associated with all swaps is the exposure to movements in interest rates and the ability of the counterparties to meet the terms of the contract.  The Company is exposed to losses if the counterparty fails to make its payments under a contract in which the Company is in a receiving status. The Company minimizes its risk by monitoring the credit standing of the counterparties.  The Company anticipates the counterparties will be able to fully satisfy the obligations under the remaining agreements.  These contracts are designated as cash flow hedges.

During the first quarter of fiscal 2008, the Company entered into an interest rate swap agreement with a $5.0 million notional amount to convert the variable-rate Trust Preferred VI security into a fixed-rate instrument for a term of five years at a fixed rate of 6.69%. The fair value of the derivative was an unrealized loss of $507,000 and $534,000 at September 30, 2010, and 2009, respectively.   During the second quarter of fiscal 2010, the Company entered into a forward-starting interest rate swap agreement and will replace the existing swap agreement for the variable-rate Trust Preferred VI security upon the existing swap’s maturity.  The $5.0 million notional amount fixed-rate instrument has a term of five years at a fixed rate of 5.95%, effective October 1, 2012.  The fair value of the derivative was an unrealized loss of $396,000 at September 30, 2010.

During the fourth quarter of fiscal 2008, the Company entered into an interest rate swap agreement with a $7.0 million notional amount to convert the variable-rate Trust Preferred IV security into a fixed-rate instrument for a term of three years at a fixed rate of 6.19%.  The fair value of the derivative was an unrealized loss of $97,000 and $250,000 at September 30, 2010, and 2009, respectively.  During the second quarter of fiscal 2010, the Company entered into a forward-starting interest rate swap agreement and will replace the existing swap agreement for the variable-rate Trust Preferred IV security upon the existing swap’s maturity.  The $7.0 million notional amount fixed-rate instrument has a term of three years at a fixed rate of 5.93%, effective January 8, 2011.  The fair value of the derivative was an unrealized loss of $381,000 at September 30, 2010.

During the first quarter of fiscal 2009, the Company entered into an interest rate swap agreement with a $3.0 million notional amount to convert a portion of the variable-rate Trust Preferred III security into a fixed-rate instrument for a term of three years at a fixed rate of 6.70%. The Company also entered into an interest rate swap agreement with a $2.0 million notional amount to convert the remaining portion of variable-rate Trust Preferred III security into a fixed rate

13

instrument for a term of four years at a fixed rate of 6.91%. The fair value of the $3.0 million notional derivative was an unrealized loss of $111,000 and $147,000 at September 30, 2010, and 2009, respectively.  The fair value of the $2.0 million notional derivative was an unrealized loss of $136,000 and $117,000 at September 30, 2010, and 2009, respectively.  During the fourth quarter of fiscal 2010, the Company entered into two forward-starting interest rate swap agreements and will replace the existing swap agreements for the variable-rate Trust Preferred III security upon the existing swaps’ maturity.  The $3.0 million notional amount fixed-rate instrument has a term of four years at a fixed rate of 6.58%, effective October 7, 2011.  The $2.0 million notional amount fixed-rate instrument has a term of two years at a fixed rate of 6.58%, effective October 9, 2012.  The fair values of the $3.0 million and $2.0 million notional amount derivatives were unrealized losses of $172,000 and $57,000, respectively, at September 30, 2010.

During the second quarter of fiscal 2010, the Company entered into a forward-starting interest rate swap agreement with a $10.0 million notional amount to convert the variable-rate Trust Preferred V security into a fixed-rate instrument.  The $10.0 million notional amount fixed-rate instrument has a term of five years at a fixed rate of 5.68%, effective December 1, 2011.  The fair value of the derivative was an unrealized loss of $818,000 at September 30, 2010.

During the fourth quarter of fiscal 2010, the Bank entered into five forward-starting interest rate swap agreements with notional amounts totaling $35.0 million to convert the variable-rate attributes of a pool of deposits into fixed-rate instruments.  The $3.0 million notional amount fixed-rate instrument has a term of four years at a fixed rate of 2.20%, effective November 18, 2010.  The $7.0 million notional amount fixed-rate instrument has a term of 30 months at a fixed rate of 2.09%, effective March 7, 2011. The $10.0 million notional amount fixed-rate instrument has a term of 42 months at a fixed rate of 2.44%, effective May 10, 2011.  The $10.0 million notional amount fixed-rate instrument has a term of three years at a fixed rate of 2.56%, effective April 21, 2011.  The $5.0 million notional amount fixed-rate instrument has a term of three years at a fixed rate of 2.30%, effective January 21, 2011.  The fair values of the $3.0 million, $7.0 million, $10.0 million, $10.0 million and $5.0 million notional amount derivatives were unrealized losses of $161,000, $275,000, $519,000, $542,000 and $253,000, respectively, at September 30, 2010.

No gain or loss was recognized in earnings for the three months ended September 30, 2010, and 2009 related to interest rate swaps.  No deferred net losses on interest rate swaps in other comprehensive loss as of September 30, 2010, are expected to be reclassified into earnings during the current fiscal year.  See Note 12 “Accumulated Other Comprehensive Loss” for amounts reported as other comprehensive loss.

The Company posted $2.7 million in cash and $2.4 million in investment securities under collateral arrangements as of September 30, 2010, to satisfy collateral requirements associated with its interest rate swap contracts.

The following table summarizes the derivative financial instruments utilized as of September 30, 2010:

	Balance	Notional		Estimated Fair Value
Cash flow hedge	Sheet Location	Amount		Gain		Loss
		(Dollars in Thousands)
Interest rate swap contracts	Other assets	$	44,000	$	—	$	(2,675	)
Interest rate swap contracts	Accrued expenses and other liabilities	35,000		—		(1,750		)
		$	79,000	$	—	$	(4,425	)

The following table details the derivative financial instruments, the average remaining maturities and the weighted-average interest rates being paid and received as of September 30, 2010: 

			Average
	Notional		Maturity	Fair			Weighted Average Rate
Liability conversion swaps	Amount		(years)	Value			Receive		Pay
	(Dollars in Thousands)
Interest rate swap contracts	$	79,000	3.1	$	(4,425	)	3.3	%	4.5	%

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NOTE 12—ACCUMULATED OTHER COMPREHENSIVE LOSS

The components of accumulated other comprehensive loss are as follows:

	Three Months Ended
	September 30,
	2010			2009
	(Dollars in Thousands)
Net income	$	490		$	855
Other comprehensive income (loss), net of tax:
Securities available for sale:
Change in unrealized losses on available-for-sale securities for which a portion of an other-than-temporary impairment has been recognized in earnings	—			(418		)
Change in unrealized gain (losses) on other securities available for sale	278			1,202
Reclassification adjustment:
Net impairment credit loss recognized in earnings	—			1,858
Security (gains) recognized in earnings	(397		)	(533		)
Net unrealized gains (losses)	(119		)	2,109
Income tax benefit (expense)	45			(802		)
Other comprehensive income (loss) on securities available for sale	(74		)	1,307
Defined benefit plan:
Other comprehensive (loss) on defined benefit plan	—			—
Cash flow hedging activities-interest rate swap contracts:
Net unrealized gains (losses)	(1,467		)	(96		)
Income tax benefit (expense)	499			32
Other comprehensive income (loss) on cash flow hedging activities-interest rate swap contracts	(968		)	(64		)
Total other comprehensive income (loss)	(1,042		)	1,243
Comprehensive income	$	(552	)	$	2,098
Cumulative other comprehensive (loss) balances were:
Unrealized loss on securities available for sale, net of related tax effect of $409 and $308	$	(668	)	$	(504	)
Unrealized loss on defined benefit plan, net of related tax effect of $441 and $1,177	(719		)	(1,920		)
Unrealized loss on cash flow hedging activities, net of related tax effect of $1,504 and $356	(2,920		)	(692		)
	$	(4,307	)	$	(3,116	)

NOTE 13—FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENT

The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of amounts recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of the Bank’s involvement in particular classes of financial instruments.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the

15

contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Unless noted otherwise, the Bank does not require collateral or other security to support financial instruments with credit risk.

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Cash and cash equivalents—The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate their fair values.

Securities—Fair values for investment securities are based on quoted market prices or whose value is determined using discounted cash flow methodologies, except for stock in the Federal Home Loan Bank for which fair value is assumed to equal cost.

Loans and leases, net—The fair values for loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms and credit quality. Leases are stated at cost which equals fair value.

Accrued interest receivable—The carrying value of accrued interest receivable approximates its fair value.

Servicing rights—Fair values are estimated using discounted cash flows based on current market rates of interest.

Interest rate swap contracts—Valuations of interest rate swap contracts are based on inputs observed in active markets for similar instruments. Typical inputs include the LIBOR curve, option volatility and option skew.

Off-balance sheet instruments - Loan commitments are negotiated at current market rates and are relatively short-term in nature.  Therefore, the estimated value of loan commitments approximates the face amount.   Rates for these commitments are set at time of loan closing, such that no adjustment is necessary to reflect these commitments at market value.

Deposits—The fair values for deposits with no defined maturities equal their carrying amounts, which represent the amount payable on demand. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on a comparably termed wholesale funding alternative (i.e., FHLB borrowings).

Interest rate swap contracts on deposits—Valuations of interest rate swap contracts are based on inputs observed in active markets for similar instruments. Typical inputs include the LIBOR curve, option volatility and option skew.

Borrowed funds—The carrying amounts reported for variable rate advances approximate their fair values. Fair values for fixed-rate advances and other borrowings are estimated using a discounted cash flow calculation that applies interest rates currently being offered on advances and borrowings with corresponding maturity dates.

Subordinated debentures payable to trusts—Fair values for subordinated debentures are estimated using a discounted cash flow calculation that applies interest rates on comparable borrowing instruments with corresponding maturity dates.

Accrued interest payable and advances by borrowers for taxes and insurance—The carrying values of accrued interest payable and advances by borrowers for taxes and insurance approximate their fair values.

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Estimated fair values of the Company’s financial instruments are as follows:

	September 30, 2010						June 30, 2010
	Carrying			Fair			Carrying			Fair
	Amount			Value			Amount			Value
	(Dollars in Thousands)
Financial Assets
Cash and cash equivalents	$	21,838		$	21,838		$	20,805		$	20,805
Securities	268,716			268,716			264,442			264,442
Federal Home Loan Bank Stock	11,648			11,648			10,334			10,334
Loans and leases	885,868			891,684			887,991			893,282
Accrued interest receivable	10,688			10,688			8,785			8,785
Servicing rights	12,970			14,795			12,733			17,022
Interest rate swap contracts	(2,675		)	(2,675		)	(1,957		)	(1,957		)
Financial liabilities
Deposits	877,618			885,217			914,264			921,410
Interest rate swap contracts on deposits	1,750			1,750			1,000			1,000
Borrowed funds	230,366			241,171			190,719			199,323
Subordinated debentures payable to trusts	27,837			20,838			27,837			16,344
Accrued interest payable and advances by borrowers for taxes and insurance	20,397			20,397			15,205			15,205

Fair Value Measurement

ASC Topic 820 applies the provisions of fair value measurement to non-financial assets and liabilities.  In addition, ASC 820-10-65 defines fair value and establishes a consistent framework for measuring fair value under GAAP and expands disclosure requirements for fair value measurements. Fair values represent the estimated price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The standard describes three levels of inputs that may be used to measure fair value:

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

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

Level 3:  Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

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The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis by level within the hierarchy at September 30, 2010:

	Quoted Prices		Significant			Significant
	In Active		Other Observable			Unobservable
	Markets		Inputs			Inputs		Total at
	(Level 1)		(Level 2)			(Level 3)		Fair Value
	(Dollars in Thousands)
Securities available for sale
Debt securities:
U.S. government agencies	$	—	$	4,580		$	—	$	4,580
Municipal bonds	—		14,732			—		14,732
Trust preferred securities	—		—			3,269		3,269
Equity securities:
Federal Ag Mortgage	4		—			—		4
Other investments	—		253			—		253
Agency residential mortgage-backed securities	—		245,878			—		245,878
Securities available for sale	4		265,443			3,269		268,716
Interest rate swaps	—		(2,675		)	—		(2,675		)
Total assets	4		262,768			3,269		266,041
Interest rate swaps on deposits	—		1,750			—		1,750
Total liabilities	$	—	$	1,750		$	—	$	1,750

The Company used the following methods and significant assumptions to estimate the fair value of items:

Securities available for sale: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).  The Company outsources this valuation primarily to a third party provider which utilizes several sources for valuing fixed-income securities.  Sources utilized by the third party provider include pricing models that vary based by asset class and include available trade, bid, and other market information.  This methodology includes broker quotes, proprietary models, descriptive terms and conditions databases, as well as extensive quality control programs.  As further valuation sources, the third party provider uses a proprietary valuation model and capital markets trading staff.  This proprietary valuation model is used for valuing municipal securities. This model includes a separate curve structure for Bank-Qualified municipal securities. The grouping of municipal securities is further broken down according to insurer, credit support, state of issuance, and rating to incorporate additional spreads and municipal curves.

The securities shown in Level 3 relate to trust preferred securities which are currently part of an inactive market.  The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which these securities trade, and then by a significant decrease in the volume of trades relative to historical levels.  Given conditions in the debt markets and the absence of observable orderly transactions in the secondary and new issue markets, management determined that an income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique. The results of third party valuation and valuation derived by management cash flow scenarios were weighted each at 50% and used to measure fair value for each security.

The approaches to determining fair value for the trust preferred securities included the following factors:

1.The credit quality of the collateral is estimated using average probability of default values.

18

2.The loss given default was assumed to be 100% (i.e. no recovery) for third party valuations.  Management utilized a range of loss given default based upon a review of the financial condition of underlying issuers in each pool.

3.The cash flows were forecasted for the underlying collateral and applied to each tranche to determine the resulting distribution among the securities.

4.The best estimates of expected cash flows were discounted to calculate the present value of the security. Management considered a range of discount rates based upon three factors: (1) a risk-free rate based on the rate of return on government debt securities, (2) the credit spread for BBB Bank Corporate Debt Index, and (3) a liquidity or “risk premium”.

5.The calculations were modeled in several thousand scenarios and the average price was used for the third party valuations.  Management utilized an average price derived from various cash flow scenarios.

Interest rate swaps:  The fair values of interest rate swaps relate to cash flow hedges of trust preferred debt securities issued by the Company, as well as cash flow hedges of a pool of variable rate deposits.  The fair value is estimated by a third party using inputs that are observable or that can be corroborated by observable market data and, therefore, are classified within Level 2 of the valuation hierarchy. These fair value estimations include primarily market observable inputs, such as yield curves, and include the value associated with counterparty credit risk.

The following table reconciles the beginning and ending balances of the assets or liabilities of the Company that are measured at fair value on a recurring basis using significant unobservable inputs:

Fair Value Measurements Using Significant

Unobservable Inputs (Level 3)

	Three Months Ended
	September 30,
	2010			2009
	(Dollars in Thousands)
Beginning balance	$	3,902		$	6,051
Total realized/unrealized gains (losses)
Included in earnings	—			(1,858		)
Included in other comprehensive loss	(666		)	1,449
Purchases, issuances, (paydowns) and (sales)	33			7
Transfers into or (out) of Level 3	—			—
Ending balance	$	3,269		$	5,649

The table below presents the Company’s assets subject to the nonrecurring fair value measurements by level within the hierarchy at September 30, 2010:

	Quoted Prices		Significant Other		Significant
	In Active		Observable		Unobservable		Fiscal 2011
	Markets		Inputs		Inputs		Incurred
	(Level 1)		(Level 2)		(Level 3)		Losses
Loans held for sale	$	—	$	18,120	$	—	$	—
Impaired loans	—		10,450		6,671		—
Mortgage servicing rights	—		—		12,970		—
Foreclosed assets	—		—		36		—

Loans held for sale, which consist generally of current production of certain fixed-rate, first-lien residential mortgage loans and student loans, are carried at the lower of cost or estimated fair value. The estimated fair value is based

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on what secondary markets are currently offering for portfolios with similar characteristics, which the Company classifies as a Level 2 nonrecurring fair value measurement.

Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or market value. Market value is measured based on the value of the collateral securing these loans.  Collateral is primarily real estate and its fair value is generally determined based on real estate appraisals or other evaluations by qualified professionals, for which the Company classifies within Level 2 of the fair value hierarchy. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. Impaired loans that are collateral dependent are written down to their fair value, less costs to sell, through the establishment of specific reserves or by recording charge-offs when the carrying value exceeds the fair value. Valuation techniques consistent with the market approach, income approach, and/or cost approach were used to measure fair value and primarily included observable inputs such as recent sales of similar assets or observable market data for operational or carrying costs, for which the Company classifies within Level 3 of the fair value hierarchy.

Mortgage servicing rights do not trade in an active, open market with readily observable prices. While sales of mortgage servicing rights do occur, the precise terms and conditions typically are not readily available to allow for a “quoted price for similar assets” comparison. Accordingly, the Company relies on an internal discounted cash flow model to estimate the fair value of its mortgage servicing rights. The Company uses a valuation model to project mortgage servicing rights cash flows based on the current interest rate scenario, which is then discounted to estimate an expected fair value of the mortgage servicing rights. The valuation model considers portfolio characteristics of the underlying mortgages, contractually specified servicing fees, prepayment assumptions, discount rate assumptions, other ancillary revenue, costs to service, and other economic factors. The Company reassesses and periodically adjusts the underlying inputs and assumptions used in the model to reflect market conditions and assumptions that a market participant would consider in valuing the mortgage servicing rights asset. In addition, the Company compares its fair value estimates and assumptions to observable market data for mortgage servicing rights, where available, and to recent market activity and actual portfolio experience. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the fair value hierarchy. The Company uses the amortization method (i.e., lower of amortized cost or estimated fair value measured on a nonrecurring basis), not fair value measurement accounting, for its mortgage servicing rights assets.

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q (“Form 10-Q”), as well as other reports issued by the Company include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, the Company’s management may make forward-looking statements orally to the media, securities analysts, investors and others from time to time. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Words such as “optimism,” “look-forward,” “bright,” “believe,” “expect,” “anticipate,” “intend,” “hope,” “plan,” “estimate” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may,” are intended to identify these forward-looking statements.

These forward-looking statements might include one or more of the following:

·projections of income, loss, revenues, earnings or losses per share, dividends, capital expenditures, capital structure, tax benefit or other financial items.

·descriptions of plans or objectives of management for future operations, products or services, transactions, investments and use of subordinated debentures payable to trusts.

·      forecasts of future economic performance.

·      use and descriptions of assumptions and estimates underlying or relating to such matters.

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Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

·adverse economic and market conditions of the financial services industry in general, including, without limitation, the credit markets;

·the effect of recent legislation to help stabilize the financial markets;

·      future losses on our holdings of trust preferred securities;

·      increase of non-performing loans and additional provisions for loan losses;

·      the failure of assumptions underlying the establishment of reserves for loan losses and other estimates;

·      the failure to maintain our reputation in our market area;

·      prevailing economic, political and business conditions in South Dakota;

·the effects of competition from a wide variety of local, regional, national and other providers of financial services;

·compliance with existing and future banking laws and regulations, including, without limitation, regulatory capital requirements and FDIC insurance coverages and costs;

·      changes in the availability and cost of credit and capital in the financial markets;

·      the effects of FDIC deposit insurance premiums and assessments;

·the risks of changes in market interest rates on the composition and costs of deposits, loan demand, net interest income, and the values and liquidity of loan collateral, and our ability or inability to manage interest rate and other risks;

·changes in the prices, values and sales volumes of residential and commercial real estate;

·an extended period of low commodity prices, significantly reduced yields on crops, reduced levels of governmental assistance to the agricultural industry, and reduced farmland values;

·      soundness of other financial institutions;

·the risks of future acquisitions and other expansion opportunities, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and expense savings from such transactions;

·      security and operations risks associated with the use of technology;

·the loss of one or more of our key personnel, or the failure to attract, assimilate and retain other highly qualified personnel in the future;

·      changes in or interpretations of accounting standards, rules or principles; and

·other factors and risks described under Part I, Item 2—“Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 3—“Quantitative and Qualitative Disclosures About Market Risk” in this Form 10-Q.

Forward-looking statements speak only as of the date they are made. Forward-looking statements are based upon management’s then-current beliefs and assumptions, but management does not give any assurance that such beliefs and

21

assumptions will prove to be correct. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this Form 10-Q or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise, except to the extent required by federal securities laws. Based upon changing conditions, should any one or more of the above risks or uncertainties materialize, or should any of our underlying beliefs or assumptions prove incorrect, actual results may vary materially from those described in any forward-looking statement.

References in this Form 10-Q to “we,” “our,” “us” and other similar references are to the Company, unless otherwise expressly stated or the context requires otherwise.

Executive Summary

The Company’s net income for the first quarter of fiscal 2011 was $490,000, or $0.07 in diluted earnings per common share, compared to $855,000, or $0.21 in diluted earnings per common share, for the first quarter of fiscal 2010.

Net interest income for the first three months of fiscal 2011 was $9.6 million, an increase of $874,000, or 10.0%, compared to the same period a year ago.  For the three months ended September 30, 2010, average interest-earning assets and average interest-bearing liabilities increased 6.6% and 4.4%, respectively, compared to the same period a year ago.  Yields on earning assets decreased to 4.85% for the first three months of fiscal 2011, compared to 5.33% a year ago, a decrease of 48 basis points.  For the same period, interest-bearing cost of funds decreased to 1.80%, compared to 2.42%, a decrease of 62 basis points.

The net interest margin on a fully taxable equivalent basis (“Net Interest Margin, TE”) for the three months ended September 30, 2010 was 3.33%, compared to 3.24% for the same period a year ago, an increase of 9 basis points.  During the first quarter of fiscal 2011, an interest income reversal  due to loans placed in nonaccrual status negatively impacted the Net Interest Margin, TE percentage by 7 basis points for the period.  A sustained overall decline in the interest rate yield curve has affected both the yield for the interest-earning assets and the interest-bearing liabilities, while the average balances for these categories increased over the comparable period of the prior year.  Net Interest Margin, TE is a non-GAAP financial measure.  See “Analysis of Net Interest Income” for a calculation of this non-GAAP financial measure and for further discussion as to the reasons we believe this non-GAAP financial measure is useful.

The allowance for loan and lease losses increased $2.7 million to $12.3 million at September 30, 2010, compared to June 30, 2010.  The ratio of allowance for loan and lease losses to total loans and leases was 1.37% as of September 30, 2010 compared to 1.07% at June 30, 2010.  Total nonperforming assets at September 30, 2010 were $23.1 million as compared to $9.2 million at June 30, 2010, an increase of $14.0 million.  The ratio of nonperforming assets to total assets increased to 1.84% at September 30, 2010, compared to 0.73% at June 30, 2010.  The overall increase in nonperforming assets was primarily attributed to the deterioration in certain dairy operations which caused three of our dairy loan relationships to be moved to nonaccrual status this quarter.  The recent deterioration in the sector is related to continued low commodity prices for milk combined with increases in the cost of feed and operations. The specific valuation allowance on identified impaired loans increased to $2.9 million at September 30, 2010, compared to $325,000 at June 30, 2010.  All identified impaired loans are reviewed to assess the borrower’s inability to make payments under the terms of the loan and/or a shortfall in collateral value that would result in charging off the loan or the portion of the loan that was impaired.

The allowance for loan and lease losses is calculated based on loan and lease levels, loan and lease loss history over 12, 36, and 60 month time periods, credit quality of the loan and lease portfolio, and environmental factors such as economic health of the region and management experience.  This risk rating analysis is designed to give the Company a consistent and systematic methodology to determine proper levels for the allowance at a given time.  Management intends to continue its disciplined credit administration and loan underwriting processes and to remain focused on the creditworthiness of new loan originations.  Management believes that it has identified the most significant nonperforming assets in its loan portfolio and is working to clarify and resolve the credit, credit administration, and environmental factor issues related to these assets to obtain the most favorable outcome for the Company.

The Company held $9.3 million in trust preferred securities at September 30, 2010 that are currently impaired under applicable accounting rules.  These are comprised of pooled securities issued primarily by banks throughout the United States, and were downgraded to a below investment grade rating.  The Company performed analysis to determine if any of the securities had a credit loss by estimating if any of the cash flows are not expected to be received as

22

contracted.  Based upon the analysis, the Company recognized no other-than-temporary impairment credit loss for the three months ended September 30, 2010, compared to $1.9 million for the first quarter of the prior year.  Fair value on these investments was recorded at $3.3 million at September 30, 2010.

Total deposits at September 30, 2010, were $877.6 million, a decrease of $36.7 million, or 4.0% from June 30, 2010.  During the three month period, in-market deposits decreased $43.2 million while out-of-market deposits increased $6.5 million.  This decrease is primarily due to the decrease in public fund deposits of $37.1 million since June 30, 2010, due to seasonal trends and fluctuations associated with public funds.   The primary factor affecting interest expense was the decrease in the average rates paid on total deposits for the three month period ended September 30, 2010, of 1.32% compared to 1.92% for the three month period ended September 30, 2009.

On October 25, 2010, the Company announced it will pay a quarterly cash dividend of 11.25 cents per common share for the first quarter of fiscal 2011.  The dividend will be paid on November 12, 2010, to stockholders of record on November 5, 2010.

The total risk-based capital ratio of 11.71% at September 30, 2010, increased by 3 basis points from 11.68% at June 30, 2010.  This continues to place the Bank in the “well-capitalized” category within OTS regulation at September 30, 2010 and is consistent with the “well-capitalized” OTS category in which the Company plans to operate.  The Company historically has been able to manage the size of its assets through secondary market loan sales of single-family mortgages and student loans.

Noninterest income was $3.8 million for the three months ended September 30, 2010, compared to $1.7 million for the same period in the prior fiscal year, an increase of $2.1 million.  This increase is due primarily to net impairment credit losses recognized in earnings of $1.9 million for the three months ended September 30, 2009, compared to the current quarter for which no impairment credit losses were recorded.   Net gain on sale of loans and fees on deposits increased $251,000 and $163,000, respectively, while net gain on sale of securities and trust income decreased $136,000 and $103,000, respectively.

Noninterest expense was $9.4 million for the three months ended September 30, 2010, as compared to $8.9 million for the three months ended September 30, 2009, an increase of $478,000, or 5.3%.  The increase was attributed to an increase in compensation and employee benefits of $384,000 and partially offset by a decrease in marketing and community investment of $65,000.  Performance-based incentive pay and increased personnel drove costs higher, while savings in healthcare costs partially offset these increases.

The Bank is a member of the Deposit Insurance Fund (the “DIF”), which is administered by the Federal Deposit Insurance Corporation (“FDIC”).  Deposits are insured up to the applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government.  Under the Dodd-Frank Act, deposits of the Bank are permanently insured up to $250,000 per depositor for each account ownership category (prior to the legislation, the increased insurance coverage from $100,000 to $250,000 was temporary until December 31, 2013).  As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions.  On November 12, 2009, the FDIC Board approved a rule requiring prepayment of the quarterly assessments for the fourth quarter of calendar year 2009 and the entire calendar years of 2010, 2011, and 2012.  On December 30, 2009, the Company paid $4.9 million which was recorded as a prepaid asset and is being proportionally expensed as each quarter elapses. At September 30, 2010, the remaining balance recorded as a prepaid asset was $3.4 million.  The FDIC may impose additional special assessments, which would be recorded as they are incurred.  The FDIC also instituted the Transaction Account Guarantee Program (“TAGP”).  The TAGP extended the FDIC’s insurance to full coverage of non-interest bearing transaction accounts for participating institutions through December 31, 2010 at an annualized rate of 10 basis points on deposit balances in excess of the $250,000 insurance limit currently in place.  The Bank is a participant in the TAGP, but does not expect this program to have a material impact on the FDIC assessment.

General

The Company is a financial services provider and, as such, has inherent risks that must be managed in order to achieve net income.  Primary risks that affect net income include credit risk, liquidity risk, operational risk, regulatory compliance risk and reputation risk.  The Company’s net income is derived by managing net interest margin, the ability to collect fees from services provided, by controlling the costs of delivering services and the management of loan and lease losses.  The primary source of revenues comes from the net interest margin, which represents the difference between

23

income on interest-earning assets (i.e. loans and investment securities) and expense on interest-bearing liabilities (i.e. deposits and borrowed funding).  The net interest margin is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows.  Fees earned include charges for deposit services, trust services and loan services.  Personnel costs are the primary expenses required to deliver the services to customers.  Other costs include occupancy and equipment and general and administrative expenses.

Financial Condition Data

At September 30, 2010, the Company had total assets of $1.3 billion, an increase of $7.5 million from the level at June 30, 2010.  The increase in assets in the three months of fiscal 2011 was due primarily to an increases in net loans and leases receivable and securities available for sale of $5.0 million and $4.3 million, respectively.  Total liabilities increased $8.5 million at September 30, 2010, as compared to June 30, 2010.  This increase was primarily due to an increase in advances from the FHLB and other borrowings of $39.6 million and offset by decreases in deposits of $36.6 million.  Stockholders’ equity decreased $1.1 million to $93.4 million at September 30, 2010, due primarily to a decrease in accumulated other comprehensive losses, net of deferred tax effect.

Net loans and leases receivable increased $5.0 million at September 30, 2010, as compared to June 30, 2010, due primarily to increases in balances of $7.7 million and partially offset by an increase in the allowance for loan and lease losses of $2.7 million.  Securities available for sale increased $4.3 million primarily as the result of net increases of agency residential mortgage-backed securities of $3.4 million during the first quarter of fiscal 2011.

Cash and cash equivalents increased $1.0 million at September 30, 2010 as compared to June 30, 2010.  See the Consolidated Statement of Cash Flows for an in-depth analysis in the change in cash and cash equivalents for the three months ended September 30, 2010.

Deposits decreased $36.6 million at September 30, 2010 as compared to June 30, 2010.  Money market and savings accounts decreased $21.6 and $15.4 million, respectively, during the three month period ended September 30, 2010, partially offset by an increase in certificates of deposits of $10.8 million.  Public fund account balances, which are included in money markets, savings and certificates of deposits, decreased $37.1 million to $177.8 million at September 30, 2010 in part as a result of seasonal fluctuations typical with these types of municipal deposits.  Advances from the FHLB and other borrowings increased $39.6 million at September 30, 2010 as compared to June 30, 2010, due to the decrease in deposits during the three month period.

Stockholders’ equity decreased $1.0 million at September 30, 2010 when compared to June 30, 2010.  This decrease was due primarily to accumulated other comprehensive losses from cash flow hedging activities of $968,000.

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The following tables show the composition of the Company’s loan and lease portfolio and deposit accounts:

Loan and Lease Portfolio Composition

	September 30, 2010				June 30, 2010
	Amount		Percent		Amount		Percent
	(Dollars in Thousands)
One-to four-family (1)	$	73,024	8.30	%	$	72,392	8.30	%
Commercial real estate	219,722		24.96		216,479		24.82
Commercial business (2)	97,940		11.13		99,892		11.45
Multi-family real estate	49,393		5.61		50,064		5.74
Equipment finance leases	9,043		1.03		10,642		1.22
Consumer direct (3)	125,843		14.30		122,832		14.08
Consumer indirect (4)	6,121		0.70		8,186		0.94
Agricultural	277,415		31.52		270,568		31.02
Construction	21,566		2.45		21,225		2.43
Total loans and leases receivable (5)	$	880,067	100.00	%	$	872,280	100.00	%

(1) Excludes $16,830 and $20,394 loans held for sale at September 30, 2010 and June 30, 2010, respectively.

(2) Includes $2,599 and $2,599 tax exempt leases at September 30, 2010 and June 30, 2010, respectively.

(3) Excludes $1,290 and $4,893 student loans held for sale at September 30, 2010 and June 30, 2010, respectively.

(4) The Company announced Consumer Indirect originations ceased during the first quarter of Fiscal 2008.

(5) Includes deferred loan fees and discounts.

Deposit Composition

	September 30, 2010				June 30, 2010
	Amount		Percent		Amount		Percent
	(Dollars in Thousands)
Noninterest bearing checking accounts	$	107,037	12.20	%	$	117,139	12.81	%
Interest bearing checking accounts	99,820		11.37		100,231		10.96
Money market accounts	168,198		19.17		189,821		20.76
Savings accounts	67,782		7.72		83,136		9.10
In-market certificates of deposit	405,370		46.19		401,033		43.86
Out-of-market certificates of deposit	29,411		3.35		22,904		2.51
Total deposits	$	877,618	100.00	%	$	914,264	100.00	%

Analysis of Net Interest Income

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities.  Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them.

Average Balances, Interest Rates and Yields.  The following table presents for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin.  The table does not reflect any effect of income taxes, except where noted.  Average balances consist of daily average balances for the Bank with simple average balances for all other subsidiaries of the Company.  The average balances include nonaccruing loans and leases.  The yields on loans and leases include origination fees, net of costs, which are considered adjustments to yield.

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	Three Months Ended September 30,
	2010						2009
	Average		Interest				Average		Interest
	Outstanding		Earned/		Yield/		Outstanding		Earned/		Yield/
	Balance		Paid		Rate		Balance		Paid		Rate
	(Dollars in Thousands)
Interest-earning assets:
Loans and leases receivable (1) (3)	$	892,630	$	12,708	5.65	%	$	851,419	$	12,343	5.75	%
Investment securities (2) (3)	258,379		1,430		2.20	%	225,312		2,228		3.92	%
FHLB stock	10,609		53		1.98	%	12,476		62		1.97	%
Total interest-earning assets	1,161,618		$	14,191	4.85	%	1,089,207		$	14,633	5.33	%
Noninterest-earning assets	79,949						71,444
Total assets	$	1,241,567					$	1,160,651
Interest-bearing liabilities:
Deposits:
Checking and money market	$	269,008	$	381	0.56	%	$	228,639	$	324	0.56	%
Savings	76,507		65		0.34	%	66,592		62		0.37	%
Certificates of deposit	436,885		2,166		1.97	%	432,573		3,138		2.88	%
Total interest-bearing deposits	782,400		2,612		1.32	%	727,804		3,524		1.92	%
FHLB advances and other borrowings	195,220		1,493		3.03	%	207,028		1,899		3.64	%
Subordinated debentures payable to trusts	27,837		461		6.57	%	27,837		459		6.54	%
Total interest-bearing liabilities	1,005,457		4,566		1.80	%	962,669		5,882		2.42	%
Noninterest-bearing deposits	104,727						98,213
Other liabilities	37,184						30,143
Total liabilities	1,147,368						1,091,025
Equity	94,199						69,626
Total liabilities and equity	$	1,241,567					$	1,160,651
Net interest income; interest rate spread (4)			$	9,625	3.05	%			$	8,751	2.91	%
Net interest margin (4) (5)					3.29	%					3.19	%
Net interest margin, TE (6)					3.33	%					3.24	%

(1)Includes loan fees and interest on accruing loans and leases past due 90 days or more.

(2)Includes federal funds sold.

(3)Yields do not reflect the tax-exempt nature of loans, equipment leases and municipal securities.

(4)Percentages for the three months ended September 30, 2010 and September 30, 2009 have been annualized.

(5)Net interest income divided by average interest-earning assets.

(6)Net interest margin expressed on a fully taxable equivalent basis (“Net Interest Margin, TE”) is a non-GAAP financial measure.  The tax-equivalent adjustment to net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets and adjusting for federal and state exemption of interest income and certain other permanent income tax differences.  We believe that it is a standard practice in the banking industry to present net interest margin expressed on a fully taxable equivalent basis, and accordingly believe the presentation of this non-GAAP financial measure may be useful for peer comparison purposes.  As a non-GAAP financial measure, Net Interest Margin, TE should be considered supplemental to and not a substitute for or superior to, financial measures calculated in accordance with GAAP.  As other companies may use different calculations for Net Interest Margin, TE, this presentation may not be comparable to similarly titled measures reported by other companies.

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The reconciliation of the net interest income (GAAP) to Net Interest Margin, TE (non-GAAP) is as follows:

	Three Months Ended
	September 30,
	2010			2009
	(Dollars in Thousands)
Net interest income	$	9,625		$	8,751
Taxable equivalent adjustment	129			145
Adjusted net interest income	9,754			8,896
Average interest-earning assets	1,161,618			1,089,207
Net interest margin, TE	3.33		%	3.24		%

Rate/Volume Analysis of Net Interest Income

The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities.  It distinguishes between the increases and decreases due to fluctuating outstanding balances resulting from  the levels and volatility of interest rates.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume).

For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.

	Three Months Ended September 30,
	2010 vs 2009
	Increase			Increase
	(Decrease)			(Decrease)			Total
	Due to			Due to			Increase
	Volume			Rate			(Decrease)
	(Dollars in Thousands)
Interest-earning assets:
Loans and leases receivable (1)	$	592		$	(227	)	$	365
Investment securities (2)	326			(1,124		)	(798		)
FHLB stock	(9		)	—			(9		)
Total interest-earning assets	909			(1,351		)	(442		)
Interest-bearing liabilities:
Deposits:
Checking and money market	57			—			57
Savings	9			(6		)	3
Certificates of deposit	31			(1,003		)	(972		)
Total interest-bearing deposits	97			(1,009		)	(912		)
FHLB advances and other borrowings	(107		)	(299		)	(406		)
Subordinated debentures payable to trusts	—			2			2
Total interest-bearing liabilities	(10		)	(1,306		)	(1,316		)
Net interest income increase	$	919		$	(45	)	$	874

(1)  Includes loan fees and interest on accruing loans and leases past due 90 days or more.

(2)  Includes federal funds sold.

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Application of Critical Accounting Policies

GAAP requires management to utilize estimates when reporting financial results.  The Company has identified the policies discussed below as Critical Accounting Policies because the accounting estimates require management to make certain assumptions about matters which may be uncertain at the time the estimate was made and a different method of estimating could have been reasonably made which could have a material impact on the presentation of the Company’s financial condition, changes in financial condition or results of operations.

Allowance for Loan and Lease Losses. GAAP requires the Company to set aside reserves or maintain an allowance against probable loan and lease losses in the loan and lease portfolio.  Management must develop a consistent and systematic approach to estimate the appropriate balances to cover the probable losses.  Due to the uncertainty of future events, the approach includes a process that may differ significantly from other methodologies and still produce an estimate in accordance with GAAP.

The allowance is compiled by utilizing the Company’s loan and lease risk rating system, which is structured to identify weaknesses in the loan and lease portfolio.  The risk rating system has evolved to a process whereby management believes the system will properly identify the credit risk associated with the loan and lease portfolio.  Due to the stratification of loans and leases for the allowance calculation, the estimate of the allowance for loan and lease losses could change materially if the loan and lease risk rating system would not properly identify the strength of a large or a few large loan and lease customers.  Although management believes it uses the best information available to determine the allowance, unforeseen market or borrower conditions could result in adjustments and net earnings being significantly affected if circumstances differ substantially from the assumptions used in making the final determinations.

Mortgage Servicing Rights (“MSR”).  The Company records a servicing asset for contractually separated servicing from the underlying mortgage loans.   The asset is initially recorded at fair value and represents an intangible asset backed by an income stream from the serviced assets.  The asset is amortized in proportion to and over the period of estimated net servicing income.

At each balance sheet date, the MSRs are analyzed for impairment, which occurs when the fair value of the MSRs is lower than the amortized book value. The Company’s MSRs are primarily servicing rights acquired on South Dakota Housing Development Authority first time homebuyers program.  Due to the lack of quoted markets for the Company’s servicing portfolio, the Company estimates the fair value of the MSRs using present value of future cash flow analysis.  If the analysis produces a fair value greater than or equal to the amortized book value of the MSRs, no impairment is recognized.  If the fair value is less than the book value, an expense for the difference is charged to earnings by initiating a MSR valuation account.  If the Company determines this impairment is temporary, any future changes in fair value are recorded as a change in earnings and the valuation.  If the Company determines the impairment to be permanent, the valuation is written off against the MSRs, which results in a new amortized balance.

The Company has included MSRs as a critical accounting policy because the use of estimates for determining fair value using present value concepts may produce results which may significantly differ from other fair value analysis perhaps even to the point of recording impairment.  The risk to earnings is when the underlying mortgages pay off significantly faster than the assumptions used in the previously recorded amortization.  Estimating future cash flows on the underlying mortgages is a difficult analysis and requires judgment based on the best information available.  The Company looks at alternative assumptions and projections when preparing a reasonable and supportable analysis.  Based on the Company’s quarterly analysis of MSRs, there was no impairment to the MSRs at September 30, 2010.

Security Impairment.  Management continually monitors the investment security portfolio for impairment on a security by security basis under the guidance of ASC Subtopic 320-10.  Management has a process in place to identify securities that could potentially have a credit impairment that is other-than-temporary.  This process involves the length of time and extent to which the fair value has been less than the amortized cost basis, review of available information regarding the financial position of the issuer, monitoring the rating of the security, cash flow projections, and the Company’s intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity.  To the extent we determine that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.  If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the Company recognizes an other-than-temporary impairment in earnings for the difference between amortized cost and fair value.  If we do not expect to recover the amortized cost basis, we do not plan to sell the security and if it is not more likely than not that the Company would be required to sell a

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security before the recovery of it amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment is bifurcated.  For those securities, the Company separates the total impairment into a credit loss component recognized in earnings, and the amount of the loss related to other factors is recognized in other comprehensive income net of taxes.

The amount of the credit loss component of a debt security impairment is estimated as the difference between amortized cost and the present value of the expected cash flows of the security.  The present value is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security.  Cash flow estimates for trust preferred securities are derived from scenario-based outcomes of forecasted default rates, loss severity, prepayment speeds and structural support.

Level 3 Fair Value Measurement.  GAAP requires the Company to measure the fair value of financial instruments under a standard which describes three levels of inputs that may be used to measure fair value. Level 3 measurement includes significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. Although management believes that it uses a best estimate of information available to determine fair value, due to the uncertainty of future events, the approach includes a process that may differ significantly from other methodologies and still produce an estimate that is in accordance with GAAP.

Self-Insurance.  The Company has a self-insured healthcare plan for its employees up to certain limits.  To mitigate a portion of these risks, the Company has a stop-loss insurance policy through a commercial insurance carrier for coverage in excess of $65,000 per individual occurrence with no maximum aggregate limitation.  The estimate of self-insurance liability is based upon known claims and an estimate of incurred, but not reported (“IBNR”) claims.  IBNR claims are estimated using historical claims lag information received by a third party claims administrator.  Due to the uncertainty of health claims, the approach includes a process which may differ significantly from other methodologies and still produce an estimate in accordance with GAAP.  Although management believes it uses the best information available to determine the accrual, unforeseen health claims could result in adjustments to the accrual.  These adjustments could significantly affect net earnings if circumstances differ substantially from the assumptions used in estimating the accrual.

Asset Quality and Potential Problem Loans and Leases

Nonperforming assets (nonaccrual loans and leases, accruing loans and leases delinquent more than 90 days and foreclosed assets) increased to $23.1 million at September 30, 2010 from $9.2 million at June 30, 2010, an increase of $13.9 million.  Nonaccruing loans and leases increased  $12.0 million from June 30, 2010 to September 30, 2010, to a total of $18.0 million.  Accruing loans and leases delinquent more than 90 days increased $2.0 million to $4.2 million at September 30, 2010 from $2.2 million at June 30, 2010.  Foreclosed assets decreased $4,000 to $942,000 at September 30, 2010, from $946,000 at June 30, 2010.  In addition, the ratio of nonperforming assets to total assets, which is one indicator of credit risk exposure, was 1.84% at September 30, 2010, which is an increase from 0.73% as reported at June 30, 2010.  The overall increase in nonperforming assets was primarily attributed to the deterioration in certain dairy operations which caused three of our dairy loan relationships to be moved to nonaccrual status this quarter.  The deterioration in the sector is related to continued low commodity prices for milk combined with increases in the cost of feed and operations.

Nonaccruing loans and leases increased $12.0 million to $18.0 million at September 30, 2010 compared to $6.0 million at June 30, 2010.  The loans and leases included in nonaccruing loans and leases at September 30, 2010 were five loans totaling $275,000 secured by one- to four-family real estate, 15 loans totaling $7.1 million secured by agricultural real estate, 25 loans totaling $7.7 million secured by agricultural business assets, nine loans totaling $1.3 million secured by commercial real estate, 10 loans totaling $554,000 secured by commercial business assets, 21 leases totaling $374,000 secured by equipment, and 24 loans totaling $623,000 secured by consumer assets.

Accruing loans and leases delinquent more than 90 days increased $2.0 million, to $4.2 million at September 30, 2010 compared to $2.2 million at June 30, 2010.  Included in accruing loans and leases delinquent more than 90 days at September 30, 2010 were three loans totaling $300,000 secured by commercial real estate, one loan for $120,000 secured by one-to four-family real estate, four loans totaling $432,000 secured by agricultural real estate, nine loans totaling $446,000 secured by commercial business assets, 16  loans totaling $2.7 million secured by agricultural business assets,

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two leases totaling $91,000 secured by equipment and eight loans totaling $143,000 of unsecured overdraft and reserve accounts.

The risk rating system in place is designed to identify and manage the nonperforming loans and leases.  Commercial and agricultural loans and equipment finance leases will have specific reserve allocations based on collateral values or based on the present value of expected cash flows if the loans and leases are deemed impaired.  Loans and leases that are not performing do not necessarily result in a loss.

As of September 30, 2010, foreclosed assets decreased by $4,000, or 0.4%, to $942,000 as compared to $946,000 at June 30, 2010.  The balance at September 30, 2010 consisted of $229,000 of one- to four-family collateral owned, $55,000 of commercial business collateral owned, $205,000 of leased equipment owned, $42,000 of agricultural real estate owned, $404,000 of agricultural business collateral owned, and $7,000 of consumer collateral owned.

At September 30, 2010, the Company had designated $46.2 million of its loans as special mention and $48.4 million of its loans as classified, which management has determined need to be closely monitored because of possible credit problems of the borrowers or the cash flows of the secured properties.  The Company also classified $9.3 million of trust preferred securities in accordance with OTS debt security classification guidelines.  At September 30, 2010, the Company had $12.0 million in multi-family, commercial business, commercial real estate and agricultural participation loans purchased, of which none was classified.  These loans and leases were considered in determining the adequacy of the allowance for loan and lease losses.  The allowance for loan and lease losses is established based on management’s evaluation of the risks probable in the loan and lease portfolio and changes in the nature and volume of loan and lease activity.  Such evaluation, which includes a review of all loans and leases for which full collectability may not be reasonably assured, considers the estimated fair market value of the underlying collateral, present value of expected principal and interest payments, economic conditions, historical loss experience and other factors that warrant recognition in providing for an adequate loan and lease loss allowance.

Although the Company’s management believes the September 30, 2010 recorded allowance for loan and lease losses was adequate to provide for probable losses on the related loans and leases, there can be no assurance the allowance will be adequate in the future.  In addition, the Company’s determination as to the amount of our allowance for loan losses is subject to review by the Bank’s principal federal regulator, the OTS. The OTS will begin its periodic review in the second quarter of fiscal year 2011.  As an integral part of its examination, the OTS will review our allowance for loan losses, and may require us to recognize adjustments to the allowance based on its judgments after a review of the information available to it at the time of its examination.

In accordance with the Company’s internal classification of assets policy, management evaluates the loan and lease portfolio on a monthly basis to identify loss potential and determines the adequacy of the allowance for loan and lease losses quarterly.  Loans and leases are placed on nonaccrual status when the collection of principal and/or interest becomes doubtful.  Foreclosed assets include assets acquired in settlement of loans and leases.

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The following table sets forth the amounts and categories of the Company’s nonperforming assets for the periods indicated.

	Nonperforming Assets
	September 30, 2010			June 30, 2010
	(Dollars in Thousands)
Nonaccruing loans and leases:
One- to four-family	$	275		$	159
Commercial real estate	1,307			716
Commercial business	554			469
Equipment finance leases	374			862
Consumer	623			649
Agricultural	14,823			3,181
Total	17,956			6,036
Accruing loans and leases delinquent more than 90 days:
One- to four-family	120			—
Commercial real estate	300			201
Commercial business	446			167
Equipment finance leases	91			334
Consumer	143			22
Agricultural	3,135			1,472
Total	4,235			2,196
Foreclosed assets:
One- to four-family	229			212
Equipment finance leases	205			212
Commercial business	55			32
Consumer	7			8
Agricultural	446			482
Total (1)	942			946
Total nonperforming assets (2)	$	23,133		$	9,178
Ratio of nonperforming assets to total assets (3)	1.84		%	0.73		%
Ratio of nonperforming loans and leases to total loans and leases (4) (5)	2.47		%	0.92		%
Accruing troubled debt restructures	$	4,000		$	4,000

(1)Total foreclosed assets do not include land or other real estate owned held for sale.

(2)Nonperforming assets include nonaccruing loans and leases, accruing loans and leases delinquent more than 90 days and foreclosed assets.

(3)Percentage is calculated based upon total assets of the Company and its direct and indirect subsidiaries on a consolidated basis.

(4)Nonperforming loans and leases include both nonaccruing and accruing loans and leases delinquent more than 90 days.

(5)Total loans and leases include loans held for sale.

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The following table sets forth information with respect to activity in the Company’s allowance for loan and lease losses during the periods indicated.

	Three Months Ended September 30,
	2010			2009
	(Dollars in Thousands)
Balance at beginning of period	$	9,575		$	8,470
Charge-offs:
One- to four-family	(15		)	(83		)
Commercial real estate	(4		)	(4		)
Commercial business	(219		)	(5		)
Equipment finance leases	(148		)	(113		)
Consumer	(296		)	(150		)
Agricultural	(36		)	—
Total charge-offs	(718		)	(355		)
Recoveries:
One- to four-family	1			3
Commercial business	15			—
Consumer	79			42
Total recoveries	95			45
Net recoveries (charge-offs)	(623		)	(310		)
Additions charged to operations	3,367			343
Balance at end of period	$	12,319		$	8,503
Ratio of allowance for loan and lease losses to total loans and leases at end of period (1)	1.37		%	0.99		%
Ratio of allowance for loan and lease losses to nonperforming loans and leases at end of period (2)	55.51		%	68.15		%
Ratio of net charge offs to average loans and leases for the year-to-date period (3)	0.28		%	0.14		%

(1)  Total loans and leases include loans held for sale.

(2)  Nonperforming loans and leases include both nonaccruing and accruing loans and leases delinquent more than 90 days.

(3)  Percentages for the three months ended September 30, 2010 and September 30, 2009 have been annualized.

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The distribution of the Company’s allowance for loan and lease losses and impaired loss summary as required by ASC Topic 310 (FASB Statement No. 114), “Accounting by Creditors for Impairment of a Loan” are summarized in the following tables.  The combination of ASC Topic 450 (FASB Statement No. 5) “Accounting for Contingencies” and FASB Statement No. 114 calculations comprise the Company’s allowance for loan and lease losses.

	FAS 5		FAS 114		FAS 5		FAS 114
	Allowance		Impaired Loan		Allowance		Impaired Loan
	for Loan and		Valuation		for Loan and		Valuation
	Lease Losses		Allowance		Lease Losses		Allowance
Loan Type	September 30, 2010				June 30, 2010
	(Dollars in Thousands)
One- to four-family	$	206	$	—	$	216	$	—
Commercial real estate	1,680		229		1,614		165
Multi-family real estate	26		—		105		—
Commercial business	1,937		67		1,923		67
Equipment finance leases	472		—		579		—
Consumer	1,468		—		1,273		—
Agricultural	3,616		2,618		3,540		93
Total	$	9,405	$	2,914	$	9,250	$	325

FAS 114 Impaired Loan Summary

				Impaired					Impaired
	Number			Loan		Number			Loan
	of Loan	Loan		Valuation		of Loan	Loan		Valuation
	Customers	Balance		Allowance		Customers	Balance		Allowance
Loan Type	September 30, 2010					June 30, 2010
	(Dollars in Thousands)
Commercial real estate	2	$	795	229		4	731		165
Commercial business	2	166		67		5	362		67
Agricultural	6	19,074		2,618		5	7,728		93
Total	10	$	20,035	$	2,914	14	$	8,821	$	325

The allowance for loan and lease losses was $12.3 million at September 30, 2010, as compared to $8.5 million at September 30, 2009.  The ratio of the allowance for loan and lease losses to total loans and leases was 1.37% at September 30, 2010, compared to 0.99% at September 30, 2009.  The Company’s management has considered nonperforming loans and leases and potential problem loans and leases in establishing the allowance for loan and lease losses.  The Company continues to monitor its allowance for probable loan and lease losses and make future additions or reductions in light of the level of loans and leases in its portfolio and as economic conditions dictate.  The current level of the allowance for loan and lease losses is a result of management’s assessment of the risks within the portfolio based on the information revealed in credit reporting processes. The Company utilizes a risk-rating system on all commercial business, agricultural, construction and multi-family and commercial real estate loans, including purchased loans and leases.  A periodic credit review is performed on all types of loans and leases to establish the necessary reserve based on the estimated risk within the portfolio. This assessment of risk takes into account the composition of the loan and lease portfolio, historical loss experience for each loan and lease category, previous loan and lease experience, concentrations of credit, current economic conditions and other factors that in management’s judgment deserve recognition.

Real estate properties acquired through foreclosure are recorded at the lower of cost or fair value (less a deduction

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for disposition costs).  Valuations are periodically updated by management and a specific provision for losses on such properties is established by a charge to operations if the carrying values of the properties exceed their estimated net realizable values.

Although management believes it uses the best information available to determine the allowances, unforeseen market conditions could result in adjustments and net earnings being significantly affected if circumstances differ substantially from the assumptions used in making the final determinations.  Future additions to the Company’s allowances may result from periodic loan, property or collateral reviews which cannot be predicted in advance.

Comparison of the Three Months Ended September 30, 2010 and September 30, 2009

General.  The Company’s net income was $490,000, or $0.07 in basic and diluted earnings per common share for the three months ended September 30, 2010, as compared to net income of $855,000, or $0.21 in basic and diluted earnings per common share for the same period in the prior fiscal year.  For the first quarter of fiscal 2011, the return on average equity and the return on average assets was 2.06% and 0.16%, respectively, compared to 4.87% and 0.29%, respectively, for the same period in the prior fiscal year.

Interest, Dividend and Loan Fee Income.  Interest, dividend and loan fee income was $14.2 million for the three months ended September 30, 2010, as compared to $14.6 million for the same period in the prior fiscal year, a decrease of $442,000 or 3.0%.  This decrease was primarily the result of declining average yields on the investment securities.  Loans and leases receivable had an average yield of 5.65% for the three months ended September 30, 2010, which is 10 basis points less than the average yield of 5.75% for the three months ended September 30, 2009.  Investment securities had a decline in average yield of 172 basis points when comparing the first quarter of fiscal 2011 against the same period of the prior year.  The average balance for loans and leases receivables for the first quarter of fiscal 2011 increased $41.2 million, or 4.8% to $892.6 million when compared to the average balance of the first quarter of fiscal 2010.  The average balance of investment securities increased $33.1 million, or 14.7% to $258.4 million for the first quarter of fiscal 2011, when compared to the average balance of the same quarter of the prior fiscal year.  The revenue decrease attributable to the overall declining yield for interest-earning assets was $1.4 million, which was partially offset by the revenue increase due to an increase in average interest-earning assets balances of $909,000.

Interest Expense.  Interest expense was $4.6 million for the three months ended September 30, 2010, as compared to $5.9 million for the same period in the prior fiscal year, a decrease of $1.3 million or 22.4%.  A $1.0 million decrease in interest expense was the result of a decrease in the average rate paid of 1.32% on interest-bearing deposits for the three months ended September 30, 2010, compared to an average rate paid of 1.92% for the three months ended September 30, 2009.  The average balance of interest-bearing deposits increased by $54.6 million, or 7.5%, which increased interest expense by $97,000 for the three months ended September 30, 2010, as compared to the same period of fiscal 2010.  The net effect of interest-bearing deposits on interest expense due to rate and volume was a decrease of $912,000 for the first quarter of fiscal 2011 as compared to the first quarter of 2010.  FHLB advances and other borrowings decreased by $11.8 million, or 5.7% for the three month period ended September 30, 2010, as compared to the three month period ended September 30, 2009, while the rate decreased to 3.03% from 3.64% for the periods.  The resulting reduction in volume and rate decreased interest expense by $406,000 due to these liabilities.  The average rate paid on total interest-bearing liabilities, which include interest-bearing deposits and liabilities, was 1.80% for the three months ended September 30, 2010 as compared to 2.42% for the same period in fiscal 2010.

Net Interest Income. The Company’s net interest income for the three months ended September 30, 2010, increased $874,000 or 10.0%, to $9.6 million compared to $8.8 million for the same period in the prior fiscal year.  The net increase in volumes of interest-earning assets in excess of increased volumes of interest-bearing liabilities resulted in a net increase in net interest income of $919,000.  This was partially offset by the net effect of the reduction of rates earned for interest-earning assets in excess of the reduction of rates paid for interest-bearing liabilities and resulted in a net decrease in net interest income of $45,000.  The Company’s Net Interest Margin, TE was 3.33% for the three months ended September 30, 2010, as compared to 3.24% for the three months ended September 30, 2009.  Net Interest Margin, TE is a non-GAAP financial measure.  See “Analysis of Net Interest Income” for a calculation of this non-GAAP financial measure and for further discussion as to the reasons we believe this non-GAAP financial measure is useful.

Provision for Losses on Loans and Leases. The allowance for loan and lease losses is maintained at a level which is considered by management to be adequate to absorb probable losses on existing loans and leases that may become uncollectible, based on an evaluation of the collectability of loans and leases and prior loan and lease loss

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experience.  The evaluation takes into consideration such factors as changes in the nature and volume of the loan and lease portfolio, overall portfolio quality, review of specific problem loans and leases, and current economic conditions that may affect the borrower’s ability to pay.  The allowance for loan and lease losses is established through a provision for losses on loans and leases charged to expense.

During the three months ended September 30, 2010, the Company recorded a provision for losses on loans and leases of $3.4 million compared to $343,000 for the three months ended September 30, 2009.  See “Asset Quality and Potentially Problem Loans and Leases” for further discussion.

Noninterest Income.  Noninterest income was $3.8 million for the quarter ended September 30, 2010, compared to $1.7 million for the quarter ended September 30, 2009, an increase of $2.1 million.  This increase is due primarily to a decrease in net impairment losses recognized in earnings of $1.9 million.  Fees on deposits and net gain on sale of loans increased $163,000 and $251,000, respectively, which added to the increase over the prior year’s amount.  Trust fees and net gain on the sale of securities decreased by $103,000 and $136,000, respectively, which partially offset the increase in noninterest income when comparing the two periods.

There were no net impairment credit losses recognized in earnings for the quarter ended September 30, 2010, compared to a net credit loss of $1.9 million recognized in earnings for the first quarter of fiscal 2010.  Fees on deposits increased by $163,000 to $1.6 million for the quarter ended September 30, 2010, compared to $1.4 million for the quarter ended September 30, 2009, primarily due to a $107,000 increase in net fees from insufficient funds and depositor overdrafts, and a $28,000 net increase in income from point-of-sale purchases by customers and ATM service fees.  Net gain on sale of loans increased $251,000, primarily due to an increase in mortgage loan activity and the related loan sales when comparing the quarter-over-quarter activity.  Net gain on the sale of securities totaled $397,000, a decrease of $136,000 for the three months ended September 30, 2010, as compared to the same period in fiscal 2010.  Trust income decreased $103,000 from $257,000 to $154,000 when comparing the first quarter of fiscal 2010 to fiscal 2011.  The prior year’s quarter activity included a one-time estate fee of $79,000, which was not present in the current quarter’s activity.

Noninterest Expense.  Noninterest expense was $9.4 million for the three months ended September 30, 2010 as compared to $8.9 million for the three months ended September 30, 2009, an increase of $478,000, or 5.3%.  Compensation and employee benefits increased $384,000 and was the primary factor in the overall increase.  Marketing and community investment decreased $65,000 to partially offset the overall increase for the first quarter of fiscal 2011 compared to the same period of fiscal 2010.

Compensation and employee benefits were $5.5 million for the three months ended September 30, 2010, an increase of $384,000 or 7.4% when compared to the three months ended September 30, 2009.  Employee compensation increased $326,000, or 8.8% when compared to the prior year’s quarter due to increased staffing needs for local and new market expansion.  Of the total increase, annual salary increases to existing staff accounted for approximately half of this total.  Performance-based incentives and commissions increased $163,000 due to an increase in performance outcomes for the first quarter of fiscal 2011 as compared to the prior year’s quarter.  Net healthcare costs, which are included in the total for compensation and employee benefits, decreased $161,000, or 21.5% to $587,000 when comparing the three month period ended September 30, 2010 to the same quarter in the prior year.  This decrease is due to the overall utilization decreases and employee reimbursement increases anticipated from the plan modifications initiated on January 1, 2010.  Management currently believes the self-insured structure is a reasonable alternative to traditional healthcare plans over the long term.  The level of healthcare costs which the Company incurs may vary from year to year.

Marketing and community investment decreased $65,000, or 13.8% to $406,000 for the first quarter of fiscal 2011, compared to the first quarter of fiscal 2010.  The ancillary rewards program and community investment were the primary factors in the decrease as compared to the prior year’s quarter.  The ancillary rewards program was initiated in the beginning of fiscal 2010 and higher costs were associated with the bonus rewards to customers.  The prior year’s quarter costs included bulk rewards costs, which were not present in the current quarter.  Community investments also decreased for the current quarter as compared to the prior year’s quarter due to the timing of larger contributions in the prior fiscal year.  These decreases were partially offset by an increase in advertising costs for the first quarter of fiscal 2011 as compared to the first quarter of fiscal 2010.

Income tax expense.  The Company’s income tax expense for the three months ended September 30, 2010 decreased to $123,000 compared to $302,000 for the same period in the prior fiscal year.  The effective tax rate was 20.1% and 26.1% for the three months ended September 30, 2010 and 2009, respectively.  The amount of permanent tax

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difference as a net deduction was a higher percentage to income before income taxes in the first quarters of fiscal 2011 and fiscal 2010 than anticipated, which reduces the overall effective tax rate.

Liquidity and Capital Resources

The Bank’s primary sources of funds are earnings, in-market deposits, FHLB advances and other borrowings, repayments of loan principal, agency residential mortgage-backed securities and callable agency securities and, to a lesser extent, sales of mortgage loans, sales and maturities of securities, out-of-market deposits and short-term investments.  While scheduled loan payments and maturing securities are relatively predictable, deposit flows and loan and security prepayments are more influenced by interest rates, general economic conditions and competition. The Bank attempts to price its deposits to meet its asset/liability objectives consistent with local market conditions.  Excess balances are invested in overnight funds.

Liquidity management is both a daily and long-term responsibility of management.  The Bank adjusts its investments in liquid assets based upon management’s assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits, and (v) the objectives of its asset/liability management program.  Excess liquidity is invested generally in interest-bearing overnight deposits and other short-term government and agency obligations.

Although in-market deposits is one of the Bank’s primary source of funds, the Bank’s policy has been to utilize borrowings where the funds can be invested in either loans or securities at a positive rate of return or to use the funds for short-term liquidity purposes. As of September 30, 2010, the Bank had the following sources of additional borrowings:

·$15.0 million in an uncommitted, unsecured line of federal funds with First Tennessee Bank, NA;

·$10.0 million in an uncommitted, unsecured line of federal funds with Zions Bank;

·$66.3 million of available credit from the Federal Reserve Bank; and

·$47.3 million of available credit from FHLB of Des Moines (after deducting outstanding borrowings with FHLB of Des Moines).

The Bank may also seek other sources of contingent liquidity including additional federal funds purchased lines with correspondent banks and lines of credit with the Federal Reserve Bank. There were no funds drawn on the uncommitted, unsecured lines of federal funds with First Tennessee Bank, NA and Zions Bank at September 30, 2010. The Bank, as a member of the FHLB of Des Moines, is required to acquire and hold shares of capital stock in the FHLB of Des Moines equal to 0.12% of the total assets of the Bank at December 31 annually. The Bank is also required to own activity-based stock, which is based on 4.45% of the Bank’s outstanding advances. These percentages are subject to change at the discretion of the FHLB Board of Directors.

The Company has a line of credit for $4.0 million with United Bankers’ Bank for liquidity needs, which was renewed and amended on Ocotober 1, 2010 to reduce the line of credit from $6.0 million to $4.0 million.  The Company pledged 100% of the stock of the Bank as collateral on the line of credit. At September 30, 2010, there are no outstanding advances under this Loan Agreement and the note has a maturity of October 1, 2011.  In connection with entering into the Loan Agreement, the Company also entered into a Commercial Pledge Agreement with the Lender, granting the Lender a first security interest in all of the stock of the Bank.  The Loan Agreement contains customary events of default and affirmative covenants with which the Company and Bank were in compliance at September 30, 2010.

In addition to the above sources of additional borrowings, the Bank has implemented arrangements to acquire out-of-market certificates of deposit as an additional source of funding. As of September 30, 2010, the Bank had $29.4 million in out-of-market certificates of deposit.

The Bank anticipates that it will have sufficient funds available to meet current loan commitments. At September 30, 2010, the Bank had outstanding commitments to originate and purchase mortgage and commercial loans of $18.2 million and to sell mortgage loans of $28.1 million. Commitments by the Bank to originate loans are not necessarily executed by the customer. The Bank monitors the ratio of commitments to funding for use in liquidity

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management. At September 30, 2010, the Bank had outstanding commitments to purchase $195,000 of investment securities available for sale.

The Company uses its capital resources to pay dividends to its stockholders, to support organic growth, to make acquisitions, to service its debt obligations and to provide funding for investment into the Bank of Tier 1 (core) capital.

Savings institutions insured by the Federal Deposit Insurance Corporation are required by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 to meet three regulatory capital requirements.  If a requirement is not met, regulatory authorities may take legal or administrative actions, including restrictions on growth or operations or, in extreme cases, seizure.  Institutions not in compliance may apply for an exemption from the requirements and submit a recapitalization plan.  At September 30, 2010, the Bank met all current regulatory capital requirements.

The minimum OTS Tier 1 (core) capital requirement for well-capitalized institutions is 5.00% of total adjusted assets for thrifts.  The Bank had Tier 1 (core) capital of 8.73% at September 30, 2010.  The minimum OTS total risk-based capital requirement for well-capitalized institutions is 10.00% of risk-weighted assets.  The Bank had total risk-based capital of 11.71% at September 30, 2010.

Impact of Inflation and Changing Prices

The unaudited consolidated financial statements and notes thereto presented in this Quarterly Report on Form 10-Q have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation.  The impact of inflation is reflected in the increased cost of the Bank’s operations.  Unlike most industrial companies, nearly all the assets and liabilities of the Bank are monetary in nature.  As a result, interest rates have a greater impact on the Bank’s performance than do the effects of general levels of inflation.  Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Recent Accounting Pronouncements

On June 12, 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets” (ASC Topic 860). This updated guidance removed the concept of a qualifying special-purpose entity and removed the exception from applying consolidation guidance to these entities. This update also clarified the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. ASC Topic 860 is reportable for interim and annual reports and effective for the Company on reporting periods beginning July 1, 2010.  The Company adopted this guidance effective in the first quarter of fiscal 2011 and the adoption did not have a material effect on the Company’s consolidated financial condition, results of operations or cash flow.

In April 2010, the FASB issued ASU No. 2010-18,”Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset”.  As a result of this update, modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring.  An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change.  The Company adopted this update effective in the first quarter of fiscal 2011 and the adoption did not have a material effect on the Company’s consolidated financial condition, results of operations or cash flow.

In July 2010, FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (ASC Topic 310). This guidance will require significant new disclosures about the allowance for credit losses and the credit quality of financing receivables. The requirements are intended to enhance transparency regarding credit losses and the credit quality of loan and lease receivables. Under this statement, allowance for credit losses and fair value are to be disclosed by portfolio segment, while credit quality information, impaired financing receivables and nonaccrual status are to be presented by class of financing receivable.  Disclosure of the nature and extent, the financial impact and segment information of restructured loans will also be required.  The disclosures are to be presented at the level of disaggregation that management uses when assessing and monitoring the portfolio’s risk and performance. ASU 2010-20 is effective for the Company for interim and annual reporting periods ending after

37

December 15, 2010 and the Company does not expect the adoption to have a material effect on the Company’s consolidated financial condition, results of operations or cash flow.

During the first quarter of fiscal 2011, the FASB issued several ASUs: ASU No. 2010-20 through ASU No. 2010-26.  Except for ASU No. 2010-20, mentioned above, the other ASUs issued have minimal, if any, impact on the Company.

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk Management

The Company’s net income is largely dependent on its net interest income.  Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities with short- and medium-term maturities mature or reprice more rapidly than its interest-earning assets.  When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income.  Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income.

In an attempt to manage its exposure to change in interest rates, management monitors the Company’s interest rate risk.  The Company’s Asset/Liability Committee meets periodically to review the Company’s interest rate risk position and profitability, and to recommend adjustments for consideration by executive management.  Management also reviews the Bank’s securities portfolio, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of the Board’s objectives in the most effective manner.  In managing market risk and the asset/liability mix, the Bank has placed its emphasis on developing a portfolio in which, to the extent practicable, assets and liabilities reprice within similar periods.  Notwithstanding the Company’s interest rate risk management activities, the potential for changing interest rates is an uncertainty which may have an adverse effect on net income.

The Company adjusts its asset/liability position to mitigate the Company’s interest rate risk.  At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, management may increase the Company’s interest rate risk position in order to increase its net interest margin.  The Company’s results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long- and short-term interest rates.

As set forth below, the volatility of a rate change, the change in asset or liability mix of the Company or other factors may produce a decrease in net interest margin in an upward moving rate environment even as the net portfolio value (“NPV”) estimate indicates an increase in net value.  The inverse situation may also occur.  One approach used by the Company to quantify interest rate risk is an NPV analysis.  This analysis calculates the difference between the present value of the liabilities and the present value of expected cash flows from assets and off-balance sheet contracts.  The following tables set forth, at September 30, 2010 and 2009, respectively, an analysis of the Company’s interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve.  Management does not believe that the Company has experienced any material changes in its market risk position from that disclosed in the Company’s Annual Report on Form 10-K for fiscal 2010 or that the Company’s primary market risk exposures and how those exposures were managed during the three months ended September 30, 2010 changed significantly when compared to June 30, 2010.

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Even if interest rates change in the designated amounts, there can be no assurance that the Company’s assets and liabilities would perform as set forth below.  In addition, a change in U.S. Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause significantly different changes to the NPV than indicated below.

September 30, 2010
			Estimated Increase
Change in	Estimated		(Decrease) in NPV
Interest Rates	NPV Amount		Amount			Percent
Basis Points	(Dollars in Thousands)
+300	$	136,425	$	21,075		18	%
+200	132,959		17,609			15
+100	125,646		10,296			9
—	115,350		—			—
-100	103,819		(11,531		)	(10	)

September 30, 2009
			Estimated Increase
Change in	Estimated		(Decrease) in NPV
Interest Rates	NPV Amount		Amount			Percent
Basis Points	(Dollars in Thousands)
+300	$	130,136	$	10,102		8	%
+200	129,045		9,011			8
+100	125,825		5,791			5
—	120,034		—			—
-100	112,835		(7,199		)	(6	)

In managing market risk and the asset/liability mix, the Bank has placed an emphasis on developing a portfolio in which, to the extent practicable, assets and liabilities reprice within similar periods.  The goal of this policy is to provide a relatively consistent level of net interest income in varying interest rate cycles and to minimize the potential for significant fluctuations from period to period.

Item 4.  Controls and Procedures

As of September 30, 2010, an evaluation was performed by the Company’s management, including the Company’s Chairman, President and Chief Executive Officer and the Company’s Executive Vice President, Chief Financial Officer and Treasurer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) to provide reasonable assurance that information required to be disclosed in the reports the Company files and submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Based upon that evaluation, the Company’s Chairman, President and Chief Executive Officer and the Company’s Executive Vice President, Chief Financial Officer and Treasurer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2010.  There were no changes in the Company’s internal control over financial reporting that occurred during the first quarter ended September 30, 2010, 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

The Company, the Bank and each of their subsidiaries are, from time to time, involved as plaintiff or defendant in various legal actions arising in the normal course of their businesses.  While the ultimate outcome of any such proceedings cannot be predicted with certainty, it is generally the opinion of management, after consultation with counsel representing the Bank and the Company in any such proceedings, the resolution of any such proceedings should not have a material effect on the Company’s consolidated financial position or results of operations.  The Company, the Bank and each of their subsidiaries are not aware of any legal actions or other proceedings contemplated by governmental authorities outside of the normal course of business.

Item 1A.  Risk Factors

The discussion of our business and operations should be read together with the risk factors contained in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 30, 2010, which describe various risks and uncertainties to which we are or may become subject.  These risks and uncertainties have the potential to affect our business, financial condition, results of operations, cash flows, strategies or prospects in a material and adverse manner.  Other than as set forth below, there have been no material changes to the risk factors set forth in the above-referenced filing as of September 30, 2010.

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

None.

Item 3.  Defaults upon Senior Securities

None.

Item 4.  [Removed and Reserved]

Item 5.  Other Information

None.

Item 6.  Exhibits

See “Exhibit Index.”

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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.

			HF Financial Corp.
			(Registrant)
Date:	November 12, 2010	By:	/s/ Curtis L. Hage
			Curtis L. Hage, Chairman, President
			and Chief Executive Officer
			(Principal Executive Officer)
Date:	November 12, 2010	By:	/s/ Darrel L. Posegate
			Darrel L. Posegate, Executive Vice President,
			Chief Financial Officer and Treasurer
			(Principal Financial and Accounting Officer)

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Exhibit Index

Exhibit Number	Description
10.1	Form of Restated Employment Agreement, made and entered into as of April 26, 2010, between Home Federal Bank and Stephen M. Bianchi (incorporated herein by reference to Exhibit 10.2 from the Company’s Current Report on Form 8-K dated December 31, 2008, and filed with the SEC on January 7, 2009, file no. 033-44383).
10.2	Revised Employment Agreement by and among Home Federal Bank and Curtis L. Hage (incorporated herein by reference to Exhibit 10.1 from the Company’s Current Report on 8-K dated July 22, 2010 and filed with the SEC on July 22, 2010, file no. 033-44383).
10.3	Amendment No. 1 to Loan Agreement, dated October 01, 2010, by and between the Company and United Bankers’ Bank.
31.1	Certification of Chairman, President and Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Executive Vice President, Chief Financial Officer and Treasurer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chairman, President and Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Executive Vice President, Chief Financial Officer and Treasurer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Index