Edgar Filing: MALVERN BANCORP, INC.

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended: March 31, 2014
or
o	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the transition period from ______ to ______

Commission File Number: 000-54835

MALVERN BANCORP, INC.
(Exact name of Registrant as specified in its charter)

Pennsylvania		45-5307782
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification Number)

42 E. Lancaster Avenue, Paoli, Pennsylvania		19301
(Address of Principal Executive Offices)		(Zip Code)

	(610) 644-9400
	(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 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months 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 (§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 x NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer	o	Accelerated filer	o
Non-accelerated filer	o	Smaller reporting company	x

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s class of common stock, as of the latest practicable date: As of May 12, 2014, 6,558,473 shares of the Registrant’s common stock were issued and outstanding.

MALVERN BANCORP, INC.

TABLE OF CONTENTS


			Page
PART I—FINANCIAL INFORMATION

Item 1.	Financial Statements

		Consolidated Statements of Financial Condition as of March 31, 2014 and September 30, 2013 (Unaudited)	2

		Consolidated Statements of Operations for the Three and Six Months Ended March 31, 2014 and 2013 (Unaudited)	3

		Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended March 31, 2014 and 2013 (Unaudited)	4

		Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended March 31, 2014 and 2013 (Unaudited)	5

		Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2014 and 2013 (Unaudited)	6

		Notes to Consolidated Financial Statements (Unaudited)	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		40

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		52

Item 4.	Controls and Procedures		53

PART II—OTHER INFORMATION

Item 1.	Legal Proceedings		53

Item 1A.	Risk Factors		53

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		53

Item 3.	Defaults Upon Senior Securities		53

Item 4.	Mine Safety Disclosure		53

Item 5.	Other Information		53

Item 6.	Exhibits		53

SIGNATURES			54

Table of Contents

Malvern Bancorp, Inc. and Subsidiaries

Consolidated Statements of Financial Condition (Unaudited)


	March 31, 2014			September 30, 2013
	(Dollars in thousands, except per share data)

Assets

Cash and due from depository institutions	$	1,336		$	1,251
Interest bearing deposits in depository institutions		12,909			22,436
Cash and Cash Equivalents		14,245			23,687
Investment securities available for sale, at fair value		122,208			124,667
Restricted stock, at cost		3,376			3,038
Loans held for sale		-			10,367
Loans receivable, net of allowance for loan losses of $4,847 and $5,090, respectively		409,058			401,857
Other real estate owned		2,358			3,962
Accrued interest receivable		1,380			1,404
Property and equipment, net		7,031			7,259
Deferred income taxes, net		2,532			2,464
Bank-owned life insurance		20,863			21,341
Other assets		1,503			1,508

Total Assets	$	584,554		$	601,554

Liabilities and Shareholders’ Equity

Liabilities
Deposits:
Deposits-noninterest-bearing	$	24,756		$	24,761
Deposits-interest-bearing		433,967			459,835
Total Deposits		458,723			484,596
Federal Home Loan Bank (FHLB) line of credit		2,000			-
FHLB advances		43,000			38,000
Advances from borrowers for taxes and insurance		3,132			1,118
Accrued interest payable		128			139
Other liabilities		2,302			2,295
Total Liabilities		509,285			526,148

Commitments and Contingencies		-			-

Shareholders’ Equity

Preferred stock, $0.01 par value, 10,000,000 shares authorized, none issued		-			-
Common stock, $0.01 par value, 40,000,000 shares authorized, issued and outstanding: 6,558,473		66			66
Additional paid-in capital		60,313			60,302
Retained earnings		19,431			19,793
Unearned Employee Stock Ownership Plan (ESOP) shares		(1,994	)		(2,067	)
Accumulated other comprehensive loss		(2,547	)		(2,688	)
Total Shareholders’ Equity		75,269			75,406

Total Liabilities and Shareholders’ Equity	$	584,554		$	601,554

See notes to unaudited consolidated financial statements.

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Malvern Bancorp, Inc. and Subsidiaries

Consolidated Statements of Operations (Unaudited)


	Three Months Ended March 31,						Six Months Ended March 31,
	2014			2013			2014			2013
	(Dollars in thousands, except per share data)

Interest and Dividend Income
Loans, including fees	$	4,445		$	5,001		$	8,972		$	10,534
Investment securities, taxable		549			366			1,104			695
Investment securities, tax-exempt		54			57			108			109
Dividends, restricted stock		19			3			33			8
Interest-bearing cash accounts		12			36			27			67
Total Interest and Dividend Income		5,079			5,463			10,244			11,413

Interest Expense
Deposits		999			1,417			2,066			2,934
FHLB borrowings		262			421			525			851
Total Interest Expense		1,261			1,838			2,591			3,785

Net Interest Income		3,818			3,625			7,653			7,628
Provision for Loan Losses		-			1,045			80			1,445
Net Interest Income after Provision for Loan Losses		3,818			2,580			7,573			6,183

Other Income
Service charges and other fees		224			208			482			539
Rental income – other		64			63			128			126
Gain on sale of investments, net		-			183			14			210
Gain on sale of loans, net		29			22			56			186
Earnings on bank-owned life insurance		140			148			285			870
Total Other Income		457			624			965			1,931

Other Expense
Salaries and employee benefits		2,072			1,947			4,139			3,795
Occupancy expense		589			529			1,105			1,011
Federal deposit insurance premium		177			220			368			437
Advertising		216			282			374			462
Data processing		308			313			638			632
Professional fees		690			451			1,175			815
Other real estate owned expense, net		84			220			97			645
Other operating expenses		564			630			1,000			1,088
Total Other Expenses		4,700			4,592			8,896			8,885

Loss before income tax expense (benefit)		(425	)		(1,388	)		(358	)		(771	)

Income tax expense (benefit)		1			(543	)		4			(597	)

Net Loss	$	(426	)	$	(845	)	$	(362	)	$	(174	)
Basic Loss Per Share	$	(0.07	)	$	(0.13	)	$	(0.06	)	$	(0.03	)
Dividends Declared Per Share	$	0.00		$	0.00		$	0.00		$	0.00

See notes to unaudited consolidated financial statements.

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Malvern Bancorp, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)


	Three Months Ended March 31,						Six Months Ended March 31,
	2014			2013			2014			2013
	(In thousands)

Net Loss	$	(426	)	$	(845	)	$	(362	)	$	(174	)

Other Comprehensive Income (Loss):
Changes in net unrealized gains and losses on securities available for sale		1,582			(319	)		228			(314	)
Gains realized in net income(1)		-			(183	)		(14	)		(210	)
		1,582			(502	)		214			(524	)
Deferred income tax effect		(538	)		170			(73	)		178
Total other comprehensive income (loss)		1,044			(332	)		141			(346	)
Total comprehensive income (loss)	$	618		$	(1,177	)	$	(221	)	$	(520	)

(1) Amounts are included in net gains on sales of securities on the Consolidated Statements of Operations in total other income. Related income tax expense in the amount of $0, $62, $4 and $71, respectively, are included in income tax expense (benefit).

See notes to unaudited consolidated financial statements.

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Malvern Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)


	Common Stock			Additional Paid-In Capital			Retained Earnings			Treasury Stock			Unearned ESOP Shares			Accumulated Other Comprehensive Income			Total Shareholders’ Equity
	(Dollars in thousands, except share and per share data)
Balance, October 1, 2012	$	62		$	25,846		$	38,596		$	(477	)	$	(2,032	)	$	641		$	62,636
Net Loss		-			-			(174	)		-			-			-			(174	)
Other comprehensive loss		-			-			-			-			-			(346	)		(346	)
Cancellation of common stock		(62	)		62			-			-			-			-			-
Cancellation of treasury stock		-			(477	)		-			477			-			-			-
Additional ESOP shares converted at exchange rate of 1.0748 (18,040 shares at $10/share)		-			180			-			-			(180	)		-			-
Dissolution of mutual holding company		-			100			-			-			-			-			100
Proceeds from issuance of common stock, net of offering expenses of $1.6 million		66			34,567			-			-			-			-			34,633
Committed to be released ESOP shares (7,171 shares)		-			13			-			-			72			-			85
Balance, March 31, 2013	$	66		$	60,291		$	38,422		$	-		$	(2,140	)	$	295		$	96,934

Balance, October 1, 2013	$	66		$	60,302		$	19,793		$	-		$	(2,067	)	$	(2,688	)	$	75,406
Net Loss		-			-			(362	)		-			-			-			(362	)
Other comprehensive income		-			-			-			-			-			141			141
Committed to be released ESOP shares (7,200 shares)		-			11			-			-			73			-			84
Balance, March 31, 2014	$	66		$	60,313		$	19,431		$	-		$	(1,994	)	$	(2,547	)	$	75,269

See notes to unaudited consolidated financial statements.

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Malvern Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)


	Six Months Ended March 31,
	2014			2013
	(In thousands)
Cash Flows from Operating Activities
Net loss	$	(362	)	$	(174	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation expense		321			347
Provision for loan losses		80			1,445
Deferred income taxes benefit		(141	)		(477	)
ESOP expense		84			85
Accretion of premiums and discounts on investment securities, net		(628	)		(82	)
Amortization of loan origination fees and costs		(333	)		(574	)
Amortization of mortgage servicing rights		7			10
Net gain on sale of investment securities available for sale		(14	)		(210	)
Net gain on sale of loans		-			(186	)
Net gain on sale of secondary market loans		(56	)		-
Proceeds on sale of secondary market loans		3,626			-
Originations of secondary market loans		(3,570	)		-
Gain on sale of other real estate owned		-			(97	)
Write down of other real estate owned		56			652
Decrease in accrued interest receivable		24			148
Decrease in accrued interest payable		(11	)		(2	)
Increase in other liabilities		7			244
Earnings on bank-owned life insurance		(285	)		(870	)
Decrease (increase) in other assets		23			(529	)
Decrease in prepaid FDIC assessment		-			200
Net Cash Used in Operating Activities		(1,172	)		(70	)

Cash Flows from Investing Activities

Proceeds from maturities and principal collections of investment securities available for sale	6,757		15,882
Proceeds from sales of investment securities available for sale	824		14,020
Purchases of investment securities available for sale	(4,266	)	(53,162	)
Proceeds from sale of loans	10,367		7,856
Loan buyback from sale of loans	(1,117	)	-
Loan purchases	(15,934	)	(11,843	)
Loan originations and principal collections, net	10,021		13,408
Proceeds from sale of other real estate owned	1,629		454
Additions to mortgage servicing rights	(24	)	(31	)
Purchases of bank-owned life insurance	-		(6,000	)
Proceeds from cash surrender on bank-owned life insurance	763		-
Proceeds from death benefit of bank-owned life insurance	-		1,121
Net (increase) decrease in restricted stock	(338	)	436
Purchases of property and equipment	(93	)	(124	)
Net Cash Provided by (Used in) Investing Activities	8,589		(17,983	)

Cash Flows from Financing Activities

Net decrease in deposits		(25,873	)		(6,891	)
Net increase in FHLB line of credit		2,000			-
Proceeds for FHLB advances		5,000			-
Repayment of FHLB advances		-			(85	)
Increase in advances from borrowers for taxes and insurance		2,014			1,477
Return of excess stock subscription funds		-			(20,841	)
Cash from mutual holding company reorganization		-			100
Net Cash Used in Financing Activities		(16,859	)		(26,240	)

Net Decrease in Cash and Cash Equivalents		(9,442	)		(44,293	)
Cash and Cash Equivalents - Beginning		23,687			131,910
Cash and Cash Equivalents – Ending	$	14,245		$	87,617

Supplementary Cash Flows Information

Interest paid	$	2,602	$	3,785
Income taxes paid	$	17	$	10
Non-cash transfer of loans to other real estate owned	$	81	$	754
Stock subscription funds transferred to shareholders’ equity	$	-	$	34,633

See notes to unaudited consolidated financial statements.

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Notes to Consolidated Financial Statements (Unaudited)

Note 1 – Organizational Structure and Nature of Operations

Malvern Bancorp, Inc., a Pennsylvania company (the “Company” or “Malvern Bancorp”), is the holding company for the Malvern Federal Savings Bank (“Malvern Federal Savings” or the “Bank”) and owns all of the issued and outstanding shares of the common stock of the Bank. In connection with the “second-step” conversion and reorganization which we completed in October 2012, 3,636,875 shares of common stock, par value $0.01 per share, of Malvern Bancorp were sold in a subscription offering to certain depositors of the Bank and other investors for $10 per share, or $36.4 million in the aggregate, and 2,921,598 shares of common stock were issued in exchange for the outstanding shares of common stock of the former federally chartered mid-tier holding company, Malvern Federal Bancorp, Inc. (the “Mid-Tier Holding Company”), held by the “public” shareholders of the Mid-Tier Holding Company (all shareholders except Malvern Federal Mutual Holding Company). Each share of common stock of the Mid-Tier Holding Company was converted into the right to receive 1.0748 shares of common stock of the new Malvern Bancorp, Inc. in the conversion and reorganization.

The Bank was originally organized in 1887 and is headquartered in Paoli, Pennsylvania. The Bank operates eight full service financial center offices in Chester and Delaware Counties, Pennsylvania. The Bank is primarily engaged in attracting deposits from the general public through its branch offices and using such deposits primarily to (i) originate various loan types including single-family residential mortgage loans, commercial real estate mortgage loans, construction and development loans, home equity loans and lines of credit and other consumer loans and (ii) invest in securities issued by the U.S. Government and agencies thereof, municipal and corporate debt securities and mortgage-backed securities. The Bank derives its income principally from interest earned on loans, mortgage-backed securities and investments and, to a lesser extent, from fees received in connection with the origination of loans and for other services. The Bank’s primary expenses are interest expense on deposits and borrowings and general operating expenses.

The Bank, as a federally chartered savings association, is subject to federal regulation and oversight by the Office of the Comptroller of the Currency (the “OCC”) extending to all aspects of its operations. The Bank is also subject to regulation and examination by the Federal Deposit Insurance Corporation (“FDIC”), which insures its deposits to the maximum extent permitted by law, and requirements established by the Federal Reserve Board. As a registered savings and loan holding company, the Company is subject to examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or the “FRB”).

Note 2 – Summary of Significant Accounting Policies

Basis of Presentation and Consolidation - The consolidated financial statements include the accounts of the Company and its subsidiaries, Malvern Federal Holdings, Inc., a Delaware company, and the Bank and the Bank’s subsidiaries, Strategic Asset Management Group, Inc. (“SAMG”) and Malvern Federal Investments, Inc., a Delaware company. SAMG owns 50% of Malvern Insurance Associates, LLC. Malvern Insurance Associates, LLC offers a full line of business and personal lines of insurance products.

The accompanying unaudited consolidated financial statements were prepared in accordance with the instructions to Form 10-Q, and therefore, do not include all the information or footnotes necessary for a complete presentation of financial condition, operations, changes in shareholders’ equity, and cash flows in conformity with accounting principles generally accepted in the United States of America (“US GAAP”). However, all normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the consolidated financial statements have been included. The results for the three and six months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2014, or any other period. All significant intercompany transactions and balances have been eliminated. The unaudited consolidated financial statements presented herein should be read in conjunction with the audited consolidated financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2013.

Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, other real estate owned, the valuation of deferred tax assets, the evaluation of other-than-temporary impairment of investment securities and fair value measurements.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 2 – Summary of Significant Accounting Policies (Continued)

Significant Group Concentrations of Credit Risk - Most of the Company’s activities are with customers located within Chester and Delaware Counties, Pennsylvania. Note 5 discusses the types of investment securities that the Company invests in. Note 6 discusses the types of lending that the Company engages in. The Company does not have any significant concentrations to any one industry or customer. Although the Company has a diversified portfolio, its debtors’ ability to honor their contracts is influenced by, among other factors, the region’s economy.

Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from depository institutions and interest bearing deposits.

The Company maintains cash deposits in other depository institutions that occasionally exceed the amount of deposit insurance available. Management periodically assesses the financial condition of these institutions and believes that the risk of any possible credit loss is minimal.

Investment Securities - Debt securities held to maturity are securities that the Company has the positive intent and the ability to hold to maturity; these securities are reported at amortized cost and adjusted for unamortized premiums and discounts. Securities held for trading are securities that are bought and held principally for the purpose of selling in the near term; these securities are reported at fair value, with unrealized gains and losses reported in current earnings. At March 31, 2014 and September 30, 2013, the Company had no investment securities classified as trading or held to maturity. Debt securities that will be held for indefinite periods of time and equity securities, including securities that may be sold in response to changes in market interest or prepayment rates, needs for liquidity and changes in the availability of and the yield of alternative investments, are classified as available for sale. Realized gains and losses are recorded on the trade date and are determined using the specific identification method. Securities held as available for sale are reported at fair value, with unrealized gains and losses, net of tax, reported as a component of accumulated other comprehensive income (“AOCI”). Management determines the appropriate classification of investment securities at the time of purchase.

Securities are evaluated on a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether declines in their value are other-than-temporary. To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline and whether or not management intends to sell or expects that it is more likely than not that it will be required to sell the security prior to an anticipated recovery of the fair value. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value for a debt security is determined to be other-than-temporary, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.

Loans Receivable - The Company, through the Bank, grants mortgage, construction, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by residential and commercial mortgage loans secured by properties located throughout Chester County, Pennsylvania and surrounding areas. The ability of the Company’s debtors to honor their contracts is dependent upon, among other factors, the real estate and general economic conditions in this area.

Loans receivable that management has the intent and ability to hold until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees and costs. Interest income is accrued on the unpaid principal balance. Loan origination fees and costs are deferred and recognized as an adjustment of the yield (interest income) of the related loans using the interest method. The Company is amortizing these amounts over the contractual lives of the loans.

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Notes to Consolidated Financial Statements (Unaudited)

Note 2 – Summary of Significant Accounting Policies (Continued)

The loans receivable portfolio is segmented into residential loans, construction and development loans, commercial loans and consumer loans. The residential loan segment has one class, one- to four-family first lien residential mortgage loans. The construction and development loan segment consists of the following classes: residential and commercial construction and development loans and land loans. Residential construction loans are made for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are made for the purpose of acquiring, developing and constructing a commercial structure. The commercial loan segment consists of the following classes: commercial real estate loans, multi-family real estate loans, and other commercial loans, which are also generally known as commercial and industrial loans or commercial business loans. The consumer loan segment consists of the following classes: home equity lines of credit, second mortgage loans and other consumer loans, primarily unsecured consumer lines of credit.

For all classes of loans receivable, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collection of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on nonaccrual loans, including impaired loans, generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.

In addition to originating loans, the Company purchases consumer and residential mortgage loans from brokers in our market area. Such purchases are reviewed for compliance with our underwriting criteria before they are purchased, and are generally purchased without recourse to the seller. Premiums and discounts on purchased loans are amortized as adjustments to interest income using the effective yield method.

Loans Held-For-Sale - Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value on the consolidated balance sheet. Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in noninterest income, and direct loan origination costs and fees are deferred at origination of the loan and are recognized in noninterest income upon sale of the loan. Servicing is retained at the Bank for loans sold in the secondary market and are placed as a mortgage servicing asset on the consolidated balance sheet (see “Loan Servicing” for more detail). There were no loans classified as held for sale as of March 31, 2014. As of September 30, 2013, there were $10.4 million in loans classified as held for sale. The loans held for sale at September 30, 2013 were sold in a bulk transaction to one purchaser in October 2013, they were not sold in the secondary market for residential mortgage loans.

Allowance for Loan Losses - The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the consolidated statement of financial condition date and is recorded as a reduction to loans. Reserves for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated statement of financial condition. The allowance for loan losses (“ALLL”) is increased by the provision for loan losses and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged-off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Non-residential consumer loans are generally charged off no later than when they become 120 days past due on a contractual basis or earlier in the event of the borrower’s bankruptcy or if there is an amount deemed uncollectible. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan losses.

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Notes to Consolidated Financial Statements (Unaudited)

Note 2 – Summary of Significant Accounting Policies (Continued)

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably estimated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, the composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class that are not considered impaired. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these classes of loans, as adjusted for qualitative factors. These qualitative risk factors include:

	1.	Lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices.
	2.	National, regional, and local economic and business conditions as well as the condition of various market segments, including the value of underlying collateral for collateral dependent loans.
	3.	The nature and volume of the loan portfolio and terms of loans.
	4.	The experience, ability, and depth of lending management and staff.
	5.	The volume and severity of past due, classified and nonaccrual loans as well as loan modifications.
	6.	The quality of the Company’s loan review system, and the degree of oversight by the Company’s Board of Directors.
	7.	The existence and effect of any concentrations of credit and changes in the level of such concentrations.
	8.	The value of underlying collateral.

The qualitative factors are applied to the historical loss rates for each class of loan. In addition, while not reported as a separate factor, changes in the value of underlying collateral (for regional property values) for collateral dependent loans is considered and addressed within the economic trends factor. A quarterly calculation is made adjusting the reserve allocation for each factor within a risk weighted range as it relates to each particular loan type, collateral type and risk rating within each segment. Data is gathered and evaluated through internal, regulatory, and government sources quarterly for each factor.

In addition, the allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial and consumer loans. Credit quality risk ratings include categories of “pass,” “special mention,” “substandard” and “doubtful.” Assets classified as “Pass” are those protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. Assets which do not currently expose the insured institution to sufficient risk to warrant classification as substandard or doubtful but possess certain identified weaknesses are required to be designated “special mention.” If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.”

Residential Lending. Residential mortgage originations are secured primarily by properties located in the Company’s primary market area and surrounding areas. We currently originate fixed-rate, fully amortizing mortgage loans with maturities of 15 to 30 years. We also offer adjustable rate mortgage (“ARM”) loans where the interest rate either adjusts on an annual basis or is fixed for the initial one, three, five or seven years and then adjusts annually.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 2 – Summary of Significant Accounting Policies (Continued)

We underwrite one- to four-family residential mortgage loans with loan-to-value ratios of up to 95%, provided that the borrower obtains private mortgage insurance on loans that exceed 80% of the appraised value or sales price, whichever is less, of the secured property. We also require that title insurance, hazard insurance and, if appropriate, flood insurance be maintained on all properties securing real estate loans. We require that a licensed appraiser from our list of approved appraisers perform and submit to us an appraisal on all properties secured by a first mortgage on one- to four-family first mortgage loans.

In underwriting one- to four-family residential mortgage loans, the Company evaluates both the borrower’s ability to make monthly payments and the value of the property securing the loan. Most properties securing real estate loans made by the Company are appraised by independent fee appraisers approved by the Bank’s Board of Directors. The Company generally requires borrowers to obtain an attorney’s title opinion or title insurance, and fire and property insurance (including flood insurance, if necessary) in an amount not less than the amount of the loan. Real estate loans originated by the Company generally contain a “due on sale” clause allowing the Company to declare the unpaid principal balance due and payable upon the sale of the security property. The Company has not engaged in sub-prime residential mortgage loan originations. Our single-family residential mortgage loans generally are underwritten on terms and documentation conforming to guidelines issued by Freddie Mac and Fannie Mae.

Construction and Development Loans. We originate construction loans for residential and, to a lesser extent, commercial uses within our market area. We generally limit construction loans to builders and developers with whom we have an established relationship, or who are otherwise known to officers of the Bank. Our construction and development loans currently in the portfolio typically have variable rates of interest tied to the prime rate which improves the interest rate sensitivity of our loan portfolio.

Construction and development loans generally are considered to involve a higher level of risk than one-to four-family residential lending, due to the concentration of principal in a limited number of loans and borrowers and the effect of economic conditions on developers, builders and projects. Additional risk is also associated with construction lending because of the inherent difficulty in estimating both a property’s value at completion and the estimated cost (including interest) to complete a project. The nature of these loans is such that they are more difficult to evaluate and monitor. In addition, speculative construction loans to a builder are not pre-sold and thus pose a greater potential risk than construction loans to individuals on their personal residences. In order to mitigate some of the risks inherent to construction lending, we inspect properties under construction, review construction progress prior to advancing funds, work with builders with whom we have established relationships, require annual updating of tax returns and other financial data of developers and obtain personal guarantees from the principals.

Commercial Lending. Commercial and multi-family real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial and multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, or a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.

Most of the Company’s commercial business loans have been extended to finance local and regional businesses and include short-term loans to finance machinery and equipment purchases, inventory and accounts receivable. The commercial business loans which we originated may be either a revolving line of credit or for a fixed term of generally 10 years or less. Interest rates are adjustable, indexed to a published prime rate of interest, or fixed. Generally, equipment, machinery, real property or other corporate assets secure such loans. Personal guarantees from the business principals are generally obtained as additional collateral.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 2 – Summary of Significant Accounting Policies (Continued)

Consumer Lending. The Company currently originates most of its consumer loans in its primary market area and surrounding areas. The Company originates consumer loans on both a direct and indirect basis. Consumer loans generally have higher interest rates and shorter terms than residential mortgage loans; however, they have additional credit risk due to the type of collateral securing the loan or in some case the absence of collateral. As a result of continued uncertainty in the market value of real estate and in the overall economy, we are continuing to evaluate and monitor the credit conditions of our consumer loan borrowers and the real estate values of the properties securing our second mortgage loans as part of our on-going efforts to assess the overall credit quality of the portfolio in connection with our review of the allowance for loan losses.

Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or recreational equipment. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

Once all factor adjustments are applied, general reserve allocations for each segment are calculated, summarized and reported on the ALLL summary. ALLL final schedules, calculations and the resulting evaluation process are reviewed quarterly by the Bank’s Asset Classification Committee and the Bank’s Board of Directors.

In addition, Federal bank regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. Based on management’s comprehensive analysis of the loan portfolio, management believes the level of the allowance for loan losses at March 31, 2014 is adequate.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.

An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral.

For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.

For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

Troubled Debt Restructurings - Loans whose terms are modified are classified as troubled debt restructurings (“TDRs”) if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring may be modified by means of extending the maturity date of the loan, reducing the interest rate on the loan to a rate which is below market, a combination of rate adjustments and maturity extensions, or by other means including covenant modifications, forbearances or other concessions. However, the Company generally only restructures loans by modifying the payment structure to interest only or by reducing the actual interest rate.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 2 – Summary of Significant Accounting Policies (Continued)

We do not accrue interest on loans that were non-accrual prior to the troubled debt restructuring until they have performed in accordance with their restructured terms for a period of at least six months. We continue to accrue interest on troubled debt restructurings which were performing in accordance with their terms prior to the restructure and continue to perform in accordance with their restructured terms. Management evaluates the ALLL with respect to TDRs under the same policy and guidelines as all other performing loans are evaluated with respect to the ALLL.

Loan Servicing - Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing right based on relative fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Capitalized servicing rights are reported in other assets and are amortized into non-interest expense in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranche. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income.

Other Real Estate Owned - Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the previously established carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other expenses from other real estate owned.

Restricted Stock - Restricted stock represents required investments in the common stock of a correspondent bank and is carried at cost. As of March 31, 2014 and September 30, 2013, restricted stock consisted solely of the common stock of the Federal Home Loan Bank of Pittsburgh (“FHLB”).

Management’s evaluation and determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of an investment’s cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB.

Property and Equipment - Property and equipment are carried at cost. Depreciation is computed using the straight-line and accelerated methods over estimated useful lives ranging from 3 to 39 years beginning when assets are placed in service. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is reflected in income for the period. The cost of maintenance and repairs is charged to income as incurred.

Transfers of Financial Assets - Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 2 – Summary of Significant Accounting Policies (Continued)

Bank-Owned Life Insurance - The Company invests in bank owned life insurance (“BOLI”) as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Bank on a chosen group of employees. The Bank is the owner and beneficiary of the policies. This life insurance investment is carried at the cash surrender value of the underlying policies. Earnings from the increase in cash surrender value of the policies are included in other income on the statement of operations.

Advertising Costs - The Company follows the policy of charging the costs of advertising to expense as incurred.

Income Taxes - Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. These calculations are based on many complex factors including estimates of the timing of reversals of temporary differences, the interpretation of federal income tax laws and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax assets and liabilities.

A valuation allowance is required to be recognized if it is “more likely than not” that a portion of the deferred tax assets will not be realized. The Company’s policy is to evaluate the deferred tax asset on a quarterly basis and record a valuation allowance for our deferred tax asset if we do not have sufficient positive evidence indicating that it is more likely than not that some or all of the deferred tax asset will be realized. The Company’s policy is to account for interest and penalties as components of income tax expense.

Commitments and Contingencies - In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the statement of financial condition when they are funded.

Segment Information - The Company has one reportable segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent upon the ability of the Company to fund itself with deposits and other borrowings and manage interest rate and credit risk. Accordingly, all significant operating decisions are based upon analysis of the Company as one segment or unit.

Comprehensive Income - Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale investment securities, are reported as a separate component of the shareholders’ equity section of the statement of financial condition, such items, along with net income, are components of comprehensive income.

Recent Accounting Pronouncements - In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-04, “Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40) - Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” The amendments are intended to clarify when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate recognized. These amendments clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (a) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure; or (b) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additional disclosures are required. The amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2014. We have not determined the effect that the adoption of this ASU will have on our financial position or results of operations.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 2 – Summary of Significant Accounting Policies (Continued)

In July 2013, the FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” This amendment provides that an unrecognized tax benefit, or a portion thereof, be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from disallowance of a tax position, or the tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, then the unrecognized tax benefit should be presented as a liability. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

Note 3 – Earnings Per Share

Basic earnings per common share is computed based on the weighted average number of shares outstanding reduced by unearned ESOP shares. Diluted earnings per share is computed based on the weighted average number of shares outstanding and common stock equivalents (“CSEs”) that would arise from the exercise of dilutive securities reduced by unearned ESOP shares. As of March 31, 2014 and for the three and six months ended March 31, 2014 and 2013, the Company had not issued and did not have any outstanding CSEs and, at the present time, the Company’s capital structure has no potential dilutive securities.

The following table sets forth the composition of the weighted average shares (denominator) used in the earnings per share computations.


	Three Months Ended March 31,						Six Months Ended March 31,
	2014			2013			2014			2013
	(Dollars in thousands, except per share amounts)

Net Loss	$	(426	)	$	(845	)	$	(362	)	$	(174	)

Weighted average shares outstanding		6,558,473			6,558,473			6,558,473			6,530,914
Average unearned ESOP shares		(181,352	)		(195,752	)		(183,166	)		(196,491	)
Weighted average shares outstanding – basic		6,377,121			6,362,721			6,375,307			6,334,423

Loss per share – basic	$	(0.07	)	$	(0.13	)	$	(0.06	)	$	(0.03	)

Note 4 – Employee Stock Ownership Plan

The Company established an employee stock ownership plan (“ESOP”) for substantially all of its full-time employees. Certain senior officers of the Bank have been designated as Trustees of the ESOP. Shares of the Company’s common stock purchased by the ESOP are held until released for allocation to participants. Shares released are allocated to each eligible participant based on the ratio of each such participant’s base compensation to the total base compensation of all eligible plan participants. As the unearned shares are committed to be released and allocated among participants, the Company recognizes compensation expense equal to the fair value of the ESOP shares during the periods in which they become committed to be released. To the extent that the fair value of the ESOP shares released differs from the cost of such shares, the difference is charged or credited to additional paid-in capital. During the period from May 20, 2008 to September 30, 2008, the ESOP purchased 241,178 shares of the common stock for approximately $2.6 million, an average price of $10.86 per share, which was funded by a loan from Malvern Federal Bancorp, Inc. The ESOP loan is being repaid principally from the Bank’s contributions to the ESOP. The loan, which bears an interest rate of 5%, is being repaid in quarterly installments through 2026. Shares are released to participants proportionately as the loan is repaid. During the three and six months ended March 31, 2014, there were 3,600 and 7,200 shares, respectively, committed to be released. During the three and six months ended March 31, 2013, there were 3,600 and 7,171 shares, respectively, committed to be released. At March 31, 2014, there were 179,565 unallocated shares and 79,653 allocated shares held by the ESOP which had an aggregate fair value of approximately $1.8 million.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 5 - Investment Securities

At March 31, 2014 and September 30, 2013, the Company’s mortgage-backed securities consisted solely of securities backed by residential mortgage loans. The Company held no mortgage-backed securities backed by commercial mortgage loans at either date.

Investment securities available for sale at March 31, 2014 and September 30, 2013 consisted of the following:


	March 31, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses				Fair Value
	(In thousands)

U.S. government agencies	$	20,566	$	5		$	(645	)	$	19,926
State and municipal obligations		11,558		6			(325	)		11,239
Single issuer trust preferred security		1,000		-			(165	)		835
Corporate debt securities		1,505		27			(2	)		1,530
		34,629		38			(1,137	)		33,530
Mortgage-backed securities:
Federal National Mortgage Association (FNMA):
Adjustable-rate		1,763		49			-			1,812
Fixed-rate		18,263		8			(817	)		17,454
Federal Home Loan Mortgage Corporation (FHLMC):
Adjustable-rate		5,738		31			(7	)		5,762
Fixed-rate		12,894		-			(476	)		12,418
Collateralized mortgage obligations (CMO), fixed-rate		52,779		100			(1,647	)		51,232
		91,437		188			(2,947	)		88,678
	$	126,066	$	226		$	(4,084	)	$	122,208


	September 30, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)

U.S. government agencies	$	20,108	$	7	$	(683	)	$	19,432
State and municipal obligations		12,381		19		(462	)		11,938
Single issuer trust preferred security		1,000		-		(190	)		810
Corporate debt securities		1,756		28		(2	)		1,782
		35,245		54		(1,337	)		33,962
Mortgage-backed securities:
Federal National Mortgage Association:
Adjustable-rate		1,967		52		(5	)		2,014
Fixed-rate		18,967		6		(882	)		18,091
Federal Home Loan Mortgage Corporation:
Adjustable-rate		5,032		11		(22	)		5,021
Fixed-rate		13,391		-		(541	)		12,850
Collateralized mortgage obligations, fixed-rate		54,137		122		(1,530	)		52,729
		93,494		191		(2,980	)		90,705
	$	128,739	$	245	$	(4,317	)	$	124,667

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 5 - Investment Securities (Continued)

During the first six months of fiscal 2014, proceeds from sales of securities available for sale were $824,000. Gross gains of $14,000 were realized on these sales. Proceeds from sales of securities available for sale during the first six months of fiscal 2013 were $14.0 million. Gross gains of $229,000 and gross losses of $19,000 were realized on these sales.

The following tables summarize the aggregate investments at March 31, 2014 and September 30, 2013 that were in an unrealized loss position.


	March 31, 2014
	Less than 12 Months					More than 12 Months					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(In thousands)
Investment Securities Available for Sale:
U.S. government obligations and agencies	$	18,113	$	(645	)	$	-	$	-		$	18,113	$	(645	)
State and municipal obligations		9,145		(263	)		1,720		(62	)		10,865		(325	)
Single issuer trust preferred security		-		-			835		(165	)		835		(165	)
Corporate securities		249		(2	)		-		-			249		(2	)
Mortgage-backed securities:
FNMA, fixed rate		17,358		(817	)		-		-			17,358		(817	)
FHLMC:
Adjustable-rate		920		(7	)		-		-			920		(7	)
Fixed-rate		11,076		(412	)		1,342		(64	)		12,418		(476	)
CMO, fixed rate		35,394		(1,178	)		7,351		(469	)		42,745		(1,647	)
	$	92,255	$	(3,324	)	$	11,248	$	(760	)	$	103,503	$	(4,084	)


	September 30, 2013
	Less than 12 Months					More than 12 Months					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(In thousands)
Investment Securities Available for Sale:
U.S. government obligations and agencies	$	18,104	$	(683	)	$	-	$	-		$	18,104	$	(683	)
State and municipal obligations		10,748		(462	)		-		-			10,748		(462	)
Single issuer trust preferred security		-		-			810		(190	)		810		(190	)
Corporate securities		249		(2	)		-		-			249		(2	)
Mortgage-backed securities:
FNMA:
Adjustable-rate		966		(5	)		-		-			966		(5	)
Fixed-rate		17,990		(882	)		-		-			17,990		(882	)
FHLMC:
Adjustable-rate		4		(22	)		-		-			4		(22	)
Fixed-rate		12,850		(541	)		-		-			12,850		(541	)
CMO, fixed-rate		43,271		(1,530	)		-		-			43,271		(1,530	)
	$	104,182	$	(4,127	)	$	810	$	(190	)	$	104,992	$	(4,317	)

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 5 - Investment Securities (Continued)

As of March 31, 2014, the estimated fair value of the securities disclosed above was primarily dependent upon the movement in market interest rates particularly given the negligible inherent credit risk associated with these securities. These investment securities are comprised of securities that are rated investment grade by at least one bond credit rating service. Although the fair value will fluctuate as the market interest rates move, management believes that these fair values will recover as the underlying portfolios mature and are reinvested in market rate yielding investments. As of March 31, 2014, the Company held 21 U.S. government agency securities, 30 tax-free municipal bonds, one corporate bond, 67 mortgage-backed securities and one single issuer trust preferred security which were in an unrealized loss position. The Company does not intend to sell and expects that it is not more likely than not that it will be required to sell these securities until such time as the value recovers or the securities mature. Management does not believe any individual unrealized loss as of March 31, 2014 represents other-than-temporary impairment.

During the six months ended March 31, 2014, the gross unrealized loss of the single issuer trust preferred security improved by $25,000 from an unrealized loss at September 30, 2013 of $190,000 to an unrealized loss of $165,000 as of March 31, 2014. Increases in long-term interest rate, specifically the 10-year U.S. Treasury bond during the period, caused the pricing of agency securities, mortgage-backed securities, and trust preferred securities to decrease. On a quarterly basis, management will continue to monitor the performance of this security and the markets to determine the true economic value of this security.

At March 31, 2014 and September 30, 2013 the Company had no securities pledged to secure public deposits.

The amortized cost and fair value of debt securities by contractual maturity at March 31, 2014 follows:


	Available for Sale
	Amortized Cost		Fair Value
	(In thousands)

Within 1 year	$	1,821	$	1,660
Over 1 year through 5 years		7,505		7,432
After 5 years through 10 years		24,810		23,950
Over 10 years		493		488
		34,629		33,530
Mortgage-backed securities		91,437		88,678
	$	126,066	$	122,208

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses

Loans receivable in the Company’s portfolio (which does not include loans held for sale) consisted of the following at the dates indicated below:


	March 31, 2014			September 30, 2013
	(In thousands)

Residential mortgage	$	250,280		$	239,900
Construction and Development:
Residential and commercial		8,500			6,672
Land		1,908			2,439
Total Construction and Development		10,408			9,111
Commercial:
Commercial real estate		69,992			70,571
Multi-family		2,065			1,971
Other		5,510			5,573
Total Commercial		77,567			78,115
Consumer:
Home equity lines of credit		20,147			20,431
Second mortgages		50,170			54,532
Other		3,074			2,648
Total Consumer		73,391			77,611

Total loans		411,646			404,737

Deferred loan costs, net		2,259			2,210
Allowance for loan losses		(4,847	)		(5,090	)
Total loans receivable, net	$	409,058		$	401,857

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses (Continued)

The following tables summarize the primary classes of the allowance for loan losses, segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of March 31, 2014 and September 30, 2013. Activity in the allowance is presented for the three and six months ended March 31, 2014 and 2013 and the year ended September 30, 2013, respectively.


	Three Months Ended March 31, 2014
				Construction and Development					Commercial								Consumer
	Residential Mortgage			Residential and Commercial		Land			Commercial Real Estate			Multi-family		Other			Home Equity Lines of Credit		Second Mortgages			Other			Unallocated			Total
	(In thousands)
Allowance for loan losses:
Beginning balance	$	1,680		$	193	$	53		$	1,433		$	26	$	74		$	130	$	1,142		$	23		$	91		$	4,845
Charge-offs		(5	)		-		-			-			-		-			-		(83	)		(3	)		-			(91	)
Recoveries		1			72		-			3			-		-			-		17			-			-			93
Provision		107			190		(21	)		(213	)		41		(19	)		22		(87	)		19			(39	)		-
Ending balance	$	1,783		$	455	$	32		$	1,223		$	67	$	55		$	152	$	989		$	39		$	52		$	4,847


	Three Months Ended March 31, 2013
				Construction and Development					Commercial								Consumer
	Residential Mortgage			Residential and Commercial			Land		Commercial Real Estate			Multi- family		Other			Home Equity Lines of Credit			Second Mortgages			Other			Unallocated		Total
	(In thousands)
Allowance for loan losses:
Beginning balance	$	1,485		$	1,202		$	8	$	2,989		$	102	$	85		$	169		$	1,485		$	12		$	34	$	7,571
Charge-offs		(252	)		(1,485	)		-		(400	)		-		-			-			(328	)		(1	)		-		(2,466	)
Recoveries		12			-			-		1			-		-			2			136			1			-		152
Provision		186			1,006			1		(186	)		9		(6	)		(35	)		68			(5	)		7		1,045
Ending Balance	$	1,431		$	723		$	9	$	2,404		$	111	$	79		$	136		$	1,361		$	7		$	41	$	6,302

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses (Continued)


	Six Months Ended March 31, 2014
				Construction and Development						Commercial								Consumer
	Residential Mortgage			Residential and Commercial			Land			Commercial Real Estate			Multi-family		Other			Home Equity Lines of Credit			Second Mortgages			Other			Unallocated			Total
	(In thousands)
Allowance for loan losses:
Beginning balance	$	1,414		$	164		$	56		$	1,726		$	40	$	59		$	137		$	1,393		$	22		$	79		$	5,090
Charge-offs		(5	)		(37	)		-			-			-		-			(14	)		(403	)		(5	)		-			(464	)
Recoveries		12			72			-			5			-		1			-			50			1			-			141
Provision		362			256			(24	)		(508	)		27		(5	)		29			(51	)		21			(27	)		80
Ending balance	$	1,783		$	455		$	32		$	1,223		$	67	$	55		$	152		$	989		$	39		$	52		$	4,847
Ending balance: individually evaluated for impairment	$	-		$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-		$	-		$	-
Ending balance: collectively evaluated for impairment	$	1,783		$	455		$	32		$	1,223		$	67	$	55		$	152		$	989		$	39		$	52		$	4,847

Loans receivable:
Ending balance	$	250,280		$	8,500		$	1,908		$	69,992		$	2,065	$	5,510		$	20,147		$	50,170		$	3,074					$	411,646
Ending balance: individually evaluated for impairment	$	2,161		$	802		$	237		$	-		$	-	$	900		$	205		$	533		$	-					$	4,838
Ending balance: collectively evaluated for impairment	$	248,119		$	7,698		$	1,671		$	69,992		$	2,065	$	4,610		$	19,942		$	49,637		$	3,074					$	406,808

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses (Continued)

	Six Months Ended March 31, 2013
				Construction and Development						Commercial								Consumer
	Residential Mortgage			Residential and Commercial			Land			Commercial Real Estate			Multi-family		Other			Home Equity Lines of Credit			Second Mortgages			Other			Unallocated			Total
	(In thousands)
Allowance for loan losses:
Beginning balance	$	1,487		$	724		$	11		$	3,493		$	10	$	226		$	160		$	1,389		$	16		$	65		$	7,581
Charge-offs		(296	)		(1,535	)		-			(555	)		-		-			-			(512	)		(5	)		-			(2,903	)
Recoveries		12			-			-			1			-		21			2			142			1			-			179
Provision		228			1,534			(2	)		(535	)		101		(168	)		(26	)		342			(5	)		(24	)		1,445
Ending Balance	$	1,431		$	723		$	9		$	2,404		$	111	$	79		$	136		$	1,361		$	7		$	41		$	6,302
Ending balance: individually evaluated for impairment	$	-		$	79		$	-		$	-		$	-	$	-		$	-		$	-		$	-		$	-		$	79
Ending balance: collectively evaluated for impairment	$	1,431		$	644		$	9		$	2,404		$	111	$	79		$	136		$	1,361		$	7		$	41		$	6,223

Loans receivable:
Ending balance	$	239,794		$	16,069		$	2,990		$	100,736		$	2,161	$	6,685		$	20,802		$	60,080		$	833					$	450,150
Ending balance: individually evaluated for impairment	$	4,004		$	9,496		$	-		$	4,894		$	-	$	175		$	22		$	654		$	-					$	19,245
Ending balance: collectively evaluated for impairment	$	235,790		$	6,573		$	2,990		$	95,842		$	2,161	$	6,510		$	20,780		$	59,426		$	833					$	430,905

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 – Loans Receivable and Related Allowance for Loan Losses (Continued)

	Year Ended September 30, 2013
				Construction and Development						Commercial								Consumer
	Residential Mortgage			Residential and Commercial			Land			Commercial Real Estate			Multi-family		Other			Home Equity Lines of Credit			Second Mortgages			Other			Unallocated		Total
	(In thousands)
Allowance for loan losses:
Beginning balance	$	1,487		$	724		$	11		$	3,493		$	10	$	226		$	160		$	1,389		$	16		$	65	$	7,581
Charge-offs		(994	)		(5,768	)		(99	)		(6,315	)		-		(94	)		-			(1,042	)		(9	)		-		(14,321	)
Recoveries		199			-			-			117			-		23			17			235			4			-		595
Provision		722			5,208			144			4,431			30		(96	)		(40	)		811			11			14		11,235
Ending Balance	$	1,414		$	164		$	56		$	1,726		$	40	$	59		$	137		$	1,393		$	22		$	79	$	5,090
Ending balance: individually evaluated for impairment	$	-		$	-		$	-		$	-		$	-	$	-		$	-		$	-		$	-		$	-	$	-
Ending balance: collectively evaluated for impairment	$	1,414		$	164		$	56		$	1,726		$	40	$	59		$	137		$	1,393		$	22		$	79	$	5,090

Loans receivable:
Ending balance	$	239,900		$	6,672		$	2,439		$	70,571		$	1,971	$	5,573		$	20,431		$	54,532		$	2,648				$	404,737
Ending balance: individually evaluated for impairment	$	1,295		$	209		$	237		$	-		$	-	$	900		$	34		$	572		$	-				$	3,247
Ending balance: collectively evaluated for impairment	$	238,605		$	6,463		$	2,202		$	70,571		$	1,971	$	4,673		$	20,397		$	53,960		$	2,648				$	401,490

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses (Continued)

The following table presents impaired loans in portfolio by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of March 31, 2014 and September 30, 2013.

	Impaired Loans With Specific Allowance				Impaired Loans With No Specific Allowance		Total Impaired Loans
	Recorded Investment		Related Allowance		Recorded Investment		Recorded Investment		Unpaid Principal Balance
	(In thousands)
March 31, 2014:
Residential mortgage	$	-	$	-	$	2,161	$	2,161	$	2,396
Construction and Development:
Residential and commercial		-		-		802		802		1,291
Land		-		-		237		237		337
Commercial:
Other		-		-		900		900		900
Consumer:
Home equity lines of credit		-		-		205		205		222
Second mortgages		-		-		533		533		882
Total impaired loans	$	-	$	-	$	4,838	$	4,838	$	6,028

September 30, 2013:
Residential mortgage	$	-	$	-	$	1,295	$	1,295	$	1,510
Construction and Development:
Residential and commercial		-		-		209		209		297
Land		-		-		237		237		337
Commercial:
Other		-		-		900		900		900
Consumer:
Home equity lines of credit		-		-		34		34		50
Second mortgages		-		-		572		572		1,101
Total impaired loans	$	-	$	-	$	3,247	$	3,247	$	4,195

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses (Continued)

The following table presents the average recorded investment in impaired loans in portfolio and related interest income recognized for the three and six months ended March 31, 2014 and 2013.

	Three Months Ended March 31, 2014						Six Months Ended March 31, 2014
	Average Impaired Loans		Interest Income Recognized on Impaired Loans		Cash Basis Collection on Impaired Loans		Average Impaired Loans		Interest Income Recognized on Impaired Loans		Cash Basis Collection on Impaired Loans
	(In thousands)

Residential mortgage	$	1,992	$	-	$	26	$	1,674	$	-	$	42
Construction and Development:
Residential and commercial		973		6		469		769		9		1,368
Land		237		4		4		237		7		7
Commercial:
Other		900		7		8		900		14		15
Consumer:
Home equity lines of credit		120		-		2		70		-		2
Second mortgages		564		-		11		567		-		20
Total	$	4,786	$	17	$	520	$	4,217	$	30	$	1,454

	Three Months Ended March 31, 2013						Six Months Ended March 31, 2013
	Average Impaired Loans		Interest Income Recognized on Impaired Loans		Cash Basis Collection on Impaired Loans		Average Impaired Loans		Interest Income Recognized on Impaired Loans		Cash Basis Collection on Impaired Loans
	(In thousands)

Residential mortgage	$	4,214	$	16	$	26	$	4,188	$	29	$	47
Construction and Development:
Residential and commercial		3,840		-		100		3,697		-		297
Commercial:
Commercial real estate		4,852		54		78		4,865		118		167
Other		176		2		2		176		4		4
Consumer:
Home equity lines of credit		22		-		1		22		1		2
Second mortgages		678		-		1		601		1		3
Total	$	13,782	$	72	$	208	$	13,549	$	153	$	520

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses (Continued)

The following table presents the classes of the loan portfolio summarized by loans considered to be rated as pass and the categories of special mention, substandard and doubtful within the Company’s internal risk rating system as of March 31, 2014 and September 30, 2013.


	Pass		Special Mention		Substandard		Doubtful		Total
	(In thousands)

March 31, 2014:
Residential mortgage	$	247,870	$	140	$	2,270	$	-	$	250,280
Construction and Development:
Residential and commercial		7,358		-		1,142		-		8,500
Land		1,671		-		237		-		1,908
Commercial:
Commercial real estate		64,585		4,148		1,259		-		69,992
Multi-family		2,065		-		-		-		2,065
Other		3,651		959		900		-		5,510
Consumer:
Home equity lines of credit		19,942		-		205		-		20,147
Second mortgages		49,615		22		533		-		50,170
Other		3,056		18		-		-		3,074
Total	$	399,813	$	5,287	$	6,546	$	-	$	411,646


September 30, 2013:
Residential mortgage	$	238,461	$	144	$	1,295	$	-	$	239,900
Construction and Development:
Residential and commercial		5,564		159		949		-		6,672
Land		2,202		-		237		-		2,439
Commercial:
Commercial real estate		67,028		3,166		377		-		70,571
Multi-family		1,971		-		-		-		1,971
Other		4,363		310		900		-		5,573
Consumer:
Home equity lines of credit		20,397		-		34		-		20,431
Second mortgages		53,790		14		728		-		54,532
Other		2,625		23		-		-		2,648
Total	$	396,401	$	3,816	$	4,520	$	-	$	404,737

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses (Continued)

The following table presents loans that are no longer accruing interest by portfolio class.

	March 31, 2014		September 30, 2013
	(In thousands)
Non-accrual loans:
Residential mortgage	$	2,161	$	1,295
Construction and Development:
Residential and commercial		393		-
Consumer:
Home equity lines of credit		205		34
Second mortgages		533		572
Total non-accrual loans	$	3,292	$	1,901

Under the Bank’s loan policy, once a loan has been placed on non-accrual status, we do not resume interest accruals until the loan has been brought current and has maintained a current payment status for not less than six consecutive months. Interest income that would have been recognized on nonaccrual loans had they been current in accordance with their original terms was $32,000 and $196,000 for the three months ended March 31, 2014 and 2013, respectively, and was $75,000 and $348,000 for the six months ended March 31, 2014 and 2013, respectively. There were no loans past due 90 days or more and still accruing interest at March 31, 2014 or September 30, 2013.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses (Continued)

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by whether a loan payment is “current,” that is, it is received from a borrower by the scheduled due date, or the length of time a scheduled payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories as of March 31, 2014 and September 30, 2013.


	Current		30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due		Total Past Due		Total Loans Receivable
	(In thousands)
March 31, 2014:
Residential mortgage	$	247,602	$	517	$	-	$	2,161	$	2,678	$	250,280
Construction and Development:
Residential and commercial		8,107		-		-		393		393		8,500
Land		1,908		-		-		-		-		1,908
Commercial:
Commercial real estate		69,992		-		-		-		-		69,992
Multi-family		2,065		-		-		-		-		2,065
Other		5,510		-		-		-		-		5,510
Consumer:
Home equity lines of credit		19,942		-		-		205		205		20,147
Second mortgages		48,958		679		-		533		1,212		50,170
Other		3,074		-		-		-		-		3,074
Total	$	407,158	$	1,196	$	-	$	3,292	$	4,488	$	411,646

September 30, 2013:
Residential mortgage	$	237,584	$	820	$	201	$	1,295	$	2,316	$	239,900
Construction and Development:
Residential and commercial		6,672		-		-		-		-		6,672
Land		2,439		-		-		-		-		2,439
Commercial:
Commercial real estate		70,416		-		155		-		155		70,571
Multi-family		1,971		-		-		-		-		1,971
Other		5,573		-		-		-		-		5,573
Consumer:
Home equity lines of credit		20,397		-		-		34		34		20,431
Second mortgages		52,698		1,022		240		572		1,834		54,532
Other		2,643		4		1		-		5		2,648
Total	$	400,393	$	1,846	$	597	$	1,901	$	4,344	$	404,737

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses (Continued)

Restructured loans deemed to be TDRs are typically the result of extension of the loan maturity date or a reduction of the interest rate of the loan to a rate that is below market, a combination of rate and maturity extension, or by other means including covenant modifications, forbearance and other concessions. However, the Company generally only restructures loans by modifying the payment structure to require payments of interest only for a specified period or by reducing the actual interest rate. Once a loan becomes a TDR, it will continue to be reported as a TDR during the term of the restructure.

The Company had seven loans classified as TDRs with an outstanding balance of $1.9 million and $1.3 million at March 31, 2014 and September 30, 2013, respectively. All of our TDR loans at March 31, 2014 were also classified as impaired; however, they were performing prior to the restructure and all except one loan continued to perform under their restructured terms through March 31, 2014, and, accordingly, were deemed to be performing loans at March 31, 2014 and we continued to accrue interest on such loans through such date. At March 31, 2014, one construction and development TDR loan with a balance of $393,000 was deemed a non-accruing TDR, which was also deemed impaired at March 31, 2014. At September 30, 2013, seven loans deemed TDRs with an aggregate balance of $1.3 million were classified as impaired; however, they were performing prior to the restructure and continued to perform under their restructured terms as of September 30, 2013, and, accordingly, were deemed to be performing loans at September 30, 2013 and we continued to accrue interest on such loans through such date. At September 30, 2013, none of our TDRs were deemed non-accruing TDRs. All of such loans have been classified as TDRs since we modified the payment terms and in some cases interest rate from the original agreements and allowed the borrowers, who were experiencing financial difficulty, to make interest only payments for a period of time in order to relieve some of their overall cash flow burden. Some loan modifications classified as TDRs may not ultimately result in the full collection of principal and interest, as modified, and result in potential incremental losses. These potential incremental losses have been factored into our overall estimate of the allowance for loan losses. The level of any defaults will likely be affected by future economic conditions. A default on a troubled debt restructured loan for purposes of this disclosure occurs when the borrower is 90 days past due or a foreclosure or repossession of the applicable collateral has occurred.

The following table presents our TDR loans as of March 31, 2014 and September 30, 2013.

	Total Troubled Debt Restructurings				Troubled Debt Restructured Loans That Have Defaulted on Modified Terms Within the Past 12 Months
	Number of Loans		Recorded Investment		Number of Loans		Recorded Investment
	(Dollars in thousands)

At March 31, 2014:
Construction and Development:
Residential and commercial		5	$	802		1	$	393
Land		1		237		-		-
Commercial:
Other		1		900		-		-
Total		7	$	1,939		1	$	393

At September 30, 2013:
Construction and Development:
Residential and commercial		5	$	209		-	$	-
Land		1		237		-		-
Commercial:
Other		1		900		-		-
Total		7	$	1,346		-	$	-

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 6 - Loans Receivable and Related Allowance for Loan Losses (Continued)

The following table reports the performing status of TDR loans. The performing status is determined by the loan’s compliance with the modified terms.

	March 31, 2014				September 30, 2013
	Performing		Non- Performing		Performing		Non- Performing
	(In thousands)

Construction and Development:
Residential and commercial	$	409	$	393	$	209	$	-
Land		237		-		237		-
Commercial:
Other		900		-		900		-
Total	$	1,546	$	393	$	1,346	$	-

The following table shows the activity in loans which were first deemed to be TDRs during the three months and six months ended March 31, 2014 and 2013. No loans were first deemed TDRs during the three months ended March 31, 2014.

	For the Three Months Ended March 31,
	2014						2013
	Restructured During Period
	Number of Loans		Pre-Modifications Outstanding Recorded Investments		Post-Modifications Outstanding Recorded Investments		Number of Loans		Pre-Modifications Outstanding Recorded Investments		Post-Modifications Outstanding Recorded Investments
	(Dollars in thousands)
Troubled Debt Restructurings:
Construction and Development:
Residential and commercial		-	$	-	$	-		4	$	8,434	$	7,375
Total troubled debt restructurings		-	$	-	$	-		4	$	8,434	$	7,375

	For the Six Months Ended March 31,
	2014						2013
	Restructured During Period
	Number of Loans		Pre-Modifications Outstanding Recorded Investments		Post-Modifications Outstanding Recorded Investments		Number of Loans		Pre-Modifications Outstanding Recorded Investments		Post-Modifications Outstanding Recorded Investments
	(Dollars in thousands)
Troubled Debt Restructurings:
Construction and Development:
Residential and commercial		1	$	437	$	437		4	$	8,434	$	7,375
Total troubled debt restructurings		1	$	437	$	437		4	$	8,434	$	7,375

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 7 - Regulatory Matters

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of tangible and core capital (as defined in the regulations) to total adjusted tangible assets (as defined) and of risk-based capital (as defined) to risk-weighted assets (as defined).

Management believes, as of March 31, 2014, that the Bank met all capital adequacy requirements to which it was subject including individual minimum capital ratios imposed by the Office of the Comptroller of the Currency of 8.5% Tier 1 capital to adjusted total assets, 10.5% Tier 1 risk-based capital to risk-weighted assets and 12.5% total risk-based capital to risk-weighted assets.

The Bank’s actual capital amounts and ratios are also presented in the table:

Actual

For Capital Adequacy
Purposes

To be Well Capitalized
under Prompt
Corrective Action
Provisions

Amount

Ratio

Amount

Ratio

Amount

Ratio

(Dollars in thousands)

As of March 31, 2014:

Tangible Capital (to tangible assets)

64,201

11.17

≥ 8,619

≥1.50

N/A

Core Capital (to adjusted tangible assets)

64,201

11.17

≥22,983

≥4.00

≥28,729

≥ 5.00

Tier 1 Capital (to risk-weighted assets)

64,201

18.28

≥14,047

≥4.00

≥21,070

≥ 6.00

Total Risk-Based Capital (to risk-weighted assets)

68,597

19.53

≥28,093

≥8.00

≥35,117

≥10.00

As of September 30, 2013:

Tangible Capital (to tangible assets)

64,524

10.91

≥ 8,874

≥1.50

N/A

Core Capital (to adjusted tangible assets)

64,524

10.91

≥23,664

≥4.00

≥29,580

≥ 5.00

Tier 1 Capital (to risk-weighted assets)

64,524

17.72

≥14,566

≥4.00

≥21,849

≥ 6.00

Total Risk-Based Capital (to risk-weighted assets)

69,084

18.97

≥29,132

≥8.00

≥36,415

≥10.00

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 8 - Fair Value Measurements

The Company follows FASB ASC Topic 820 “Fair Value Measurements,” to record fair value adjustments to certain assets and to determine fair value disclosures for the Company’s financial instruments. Investment and mortgage-backed securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, real estate owned and certain other assets. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets.

The Company groups its assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1—

Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2—

Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3—

Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset.

The Company bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy.

Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon the Company’s or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future valuations.

FASB ASC Topic 825 “Financial Instruments” provides an option to elect fair value as an alternative measurement for selected financial assets and financial liabilities not previously recorded at fair value. The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 8 - Fair Value Measurements (Continued)

The table below presents the balances of assets measured at fair value on a recurring basis:

	March 31, 2014
	Total		Level 1		Level 2		Level 3
	(In thousands)

Investment securities available for sale:
Debt securities:
U.S. government agencies	$	19,926	$	-	$	19,926	$	-
State and municipal obligations		11,239		-		11,239		-
Single issuer trust preferred security		835		-		835		-
Corporate debt securities		1,530		-		1,530		-
Total investment securities available for sale		33,530		-		33,530		-

Mortgage-backed securities available for sale:
FNMA:
Adjustable-rate		1,812		-		1,812		-
Fixed-rate		17,454		-		17,454		-
FHLMC:
Adjustable-rate		5,762				5,762
Fixed-rate		12,418		-		12,418		-
CMO, fixed-rate		51,232		-		51,232		-
Total mortgage-backed securities available for sale		88,678		-		88,678		-

Total	$	122,208	$	-	$	122,208	$	-

	September 30, 2013
	Total		Level 1		Level 2		Level 3
	(In thousands)

Investment securities available for sale:
Debt securities:
U.S. government agencies	$	19,432	$	-	$	19,432	$	-
State and municipal obligations		11,938		-		11,938		-
Single issuer trust preferred security		810		-		810		-
Corporate debt securities		1,782		-		1,782		-
Total investment securities available for sale		33,962		-		33,962		-

Mortgage-backed securities available for sale:
FNMA:
Adjustable-rate		2,014		-		2,014		-
Fixed-rate		18,091		-		18,091		-
FHLMC:
Adjustable-rate		5,021		-		5,021
Fixed-rate		12,850		-		12,850		-
CMO, fixed-rate		52,729		-		52,729		-
Total mortgage-backed securities available for sale		90,705		-		90,705		-

Total	$	124,667	$	-	$	124,667	$	-

The Company monitors and evaluates available data to perform fair value measurements on an ongoing basis and recognizes transfers among the levels of the fair value hierarchy as of the date event or a change in circumstances that affects the valuation method chosen. There were no changes at March 31, 2014 and September 30, 2013.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 8 - Fair Value Measurements (Continued)

For assets measured at fair value on a nonrecurring basis that were still held at the end of the period, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets or portfolios at March 31, 2014 and September 30, 2013:

	March 31, 2014
	Total		Level 1		Level 2		Level 3
	(In thousands)

Other real estate owned	$	810	$	-	$	-	$	810
Impaired loans		580				-		580
Mortgage servicing rights		368		-		368		-
Total	$	1,758	$	-	$	368	$	1,390

	March 31, 2014
	Fair Value at March 31, 2014		Valuation Technique	Unobservable Input	Range/(Weighted Average)
	(Dollars in thousands)

Other real estate owned	$	810	Appraisal of collateral(1)	Collateral discounts(2)		0-6%/(6%)
Impaired loans(3)		580	Appraisal of collateral(1)	Collateral discounts(2)		1-73%/(15%)
Total	$	1,390

(1) Fair value is generally determined through independent appraisals of the underlying collateral primarily using comparable sales.
(2) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.
(3) Includes assets directly charged-down to fair value during the year-to-date period.

	September 30, 2013
	Total		Level 1		Level 2		Level 3
	(In thousands)

Loans held for sale	$	10,367	$	10,367	$	-	$	-
Other real estate owned		2,341						2,341
Impaired loans		1,047						1,047
Mortgage servicing rights		337		-		337		-
Total	$	14,092	$	10,367	$	337	$	3,388

	September 30, 2013
	Fair Value at September 30, 2013		Valuation Technique	Unobservable Input	Range/(Weighted Average)
	(Dollars in thousands)

Other real estate owned	$	2,341	Appraisal of collateral(1)	Collateral discounts(2)		14-84%/(39%)%
Impaired loans(3)		1,047	Appraisal of collateral(1)	Collateral discounts(2)		1-73%/(28%)
Total	$	3,388

(1) Fair value is generally determined through independent appraisals of the underlying collateral primarily using comparable sales.
(2) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.
(3) Includes assets directly charged-down to fair value during the year-to-date period.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 8 - Fair Value Measurements (Continued)

The following table shows quantitative information regarding significant techniques and inputs used at March 31, 2014 for assets measured using observable inputs (Level 2):


	Fair Value at March 31, 2014	Valuation Technique	Observable Input	Method or Value as of March 31, 2014
	(In thousands)
Servicing rights	$368	Discounted rate	Discount rate	11.00-12.00%	Rate used through modeling period

			Loan prepayment speeds	14.03%	Weighted-average CPR

			Servicing fees	0.25%	Of loan balance

			Servicing costs	6.25%	Monthly servicing cost per account

				$300- $400	Additional monthly servicing cost per loan on loans more than 30 days delinquent

The following table shows quantitative information regarding significant techniques and inputs used at September 30, 2013 for assets measured using observable inputs (Level 2):


	Fair Value at September 30, 2013	Valuation Technique	Observable Input	Method or Value as of September 30, 2013
	(In thousands)
Servicing rights	$337	Discounted rate	Discount rate	11.00-12.00%	Rate used through modeling period

			Loan prepayment speeds	15.58%	Weighted-average CPR

			Servicing fees	0.25%	Of loan balance

			Servicing costs	6.25%	Monthly servicing cost per account

				$150	Additional monthly servicing cost per loan on loans more than 30 days delinquent

The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of FASB ASC 825. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methods. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company would realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. FASB ASC 825 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 8 - Fair Value Measurements (Continued)

The fair value estimates presented herein are based on pertinent information available to management as of March 31, 2014 and September 30, 2013. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since March 31, 2014 and September 30, 2013 and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

The following assumptions were used to estimate the fair value of the Company’s financial instruments:

Cash and Cash Equivalents—These assets are carried at historical cost. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the instrument and its expected realization.

Investment Securities—Investment and mortgage-backed securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are measured at fair value on a recurring basis. Fair value measurements for these securities are typically obtained from independent pricing services that we have engaged for this purpose. When available, we, or our independent pricing service, use quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that incorporate available trade, bid and other market information and for structured securities, cash flow and, when available, loan performance data. Because many fixed income securities do not trade on a daily basis, our independent pricing service’s applications apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing to prepare evaluations. For each asset class, pricing applications and models are based on information from market sources and integrate relevant credit information. All of our securities available for sale are valued using either of the foregoing methodologies to determine fair value adjustments recorded to our financial statements. The Company had no Level 1 or Level 3 securities as of March 31, 2014 or September 30, 2013.

Loans Receivable— We do not record loans at fair value on a recurring basis. As such, valuation techniques discussed herein for loans are primarily for estimating fair value for FASB ASC 825 disclosure purposes. However, from time to time, we record nonrecurring fair value adjustments to loans to reflect partial write-downs for impairment or the full charge-off of the loan carrying value. The valuation of impaired loans is discussed below. The fair value estimate for FASB ASC 825 purposes differentiates loans based on their financial characteristics, such as product classification, loan category, pricing features and remaining maturity. Prepayment and credit loss estimates are evaluated by loan type and rate. The fair value of loans is estimated by discounting contractual cash flows using discount rates based on current industry pricing, adjusted for prepayment and credit loss estimates.

Loans Held-For-Sale—The fair values of mortgage loans originated and intended for sale in the secondary market are based on current quoted market prices. There were no loans held for sale at March 31, 2014. The loans held for sale at September 30, 2013 were sold in a bulk transaction to one purchaser in October 2013, they were not sold in the secondary market for residential mortgage loans.

Impaired Loans—Impaired loans are valued utilizing independent appraisals that rely upon quoted market prices for similar assets in active markets. These appraisals include adjustments to comparable assets based on the appraisers’ market knowledge and experience. The appraisals are adjusted downward by management, as necessary, for changes in relevant valuation factors subsequent to the appraisal date and are considered level 3 inputs.

Accrued Interest Receivable—This asset is carried at historical cost. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the instrument and its expected realization.

Restricted Stock—Although restricted stock is an equity interest in the FHLB, it is carried at cost because it does not have a readily determinable fair value as its ownership is restricted and it lacks a market. The estimated fair value approximates the carrying amount.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 8 - Fair Value Measurements (Continued)

Other Real Estate Owned—Assets acquired through foreclosure or deed in lieu of foreclosure are recorded at estimated fair value less estimated selling costs when acquired, thus establishing a new cost basis. Fair value is generally based on independent appraisals. These appraisals include adjustments to comparable assets based on the appraisers’ market knowledge and experience, and are considered level 3 inputs. When an asset is acquired, the excess of the loan balance over fair value, less estimated selling costs, is charged to the allowance for loan losses. If the estimated fair value of the asset declines, a write-down is recorded through expense. The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of, among other factors, changes in the economic conditions.

Deposits—Deposit liabilities are carried at cost. As such, valuation techniques discussed herein for deposits are primarily for estimating fair value for FASB ASC 825 disclosure purposes. The fair value of deposits is discounted based on rates available for borrowings of similar maturities. A decay rate is estimated for non-time deposits. The discount rate for non-time deposits is adjusted for servicing costs based on industry estimates.

Long-Term Borrowings—Advances from the FHLB are carried at amortized cost. However, we are required to estimate the fair value of long-term debt under FASB ASC 825. The fair value is based on the contractual cash flows discounted using rates currently offered for new notes with similar remaining maturities.

Accrued Interest Payable—This liability is carried at historical cost. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the instrument and its expected realization.

Commitments to Extend Credit and Letters of Credit—The majority of the Company’s commitments to extend credit and letters of credit carry current market interest rates if converted to loans. Because commitments to extend credit and letters of credit are generally unassignable by either the Bank or the borrower, they only have value to the Company and the borrower. The estimated fair value approximates the recorded deferred fee amounts, which are not significant.

Mortgage Servicing Rights—The fair value of mortgage servicing rights is based on observable market prices when available or the present value of expected future cash flows when not available. Assumptions, such as loan default rates, costs to service, and prepayment speeds significantly affect the estimate of future cash flows. Mortgage servicing rights are carried at the lower of cost or fair value.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 8 - Fair Value Measurements (Continued)

The carrying amount and estimated fair value of the Company’s financial instruments as of March 31, 2014 and September 30, 2013 are presented below:

	March 31, 2014
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
	(In thousands)
Financial assets:
Cash and Cash Equivalents	$	14,245	$	14,245	$	14,245	$	-	$	-
Investment securities available for sale		122,208		122,208		-		122,208		-
Loans receivable, net		409,059		410,963		-		-		410,963
Accrued interest receivable		1,380		1,380		-		1,380		-
Restricted stock		3,376		3,376		-		3,376		-
Mortgage servicing rights		288		368		-		368		-

Financial liabilities:
Savings accounts		44,601		44,601		-		44,601		-
Checking and NOW accounts		114,366		114,366		-		114,366		-
Money market accounts		63,542		63,542		-		63,542		-
Certificates of deposit		236,214		241,310		-		241,310		-
FHLB line of credit		2,000		2,000		-		2,000		-
FHLB advances		43,000		45,476		-		45,476		-
Accrued interest payable		128		128		-		128		-

	September 30, 2013
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
	(In thousands)
Financial assets:
Cash and cash equivalents	$	23,687	$	23,687	$	23,687	$	-	$	-
Investment securities available for sale		124,667		124,667		-		124,667		-
Loans receivable, net		401,857		405,802		-		-		405,802
Loans held for sale		10,367		10,367		10,367		-		-
Accrued interest receivable		1,404		1,404		-		1,404		-
Restricted stock		3,038		3,038		-		3,038		-
Mortgage servicing rights		271		337		-		337		-

Financial liabilities:
Savings accounts		42,932		42,932		-		42,932		-
Checking and NOW accounts		112,338		112,338		-		112,338		-
Money market accounts		67,372		67,372		-		67,372		-
Certificates of deposit		261,954		267,181		-		267,181		-
FHLB advances		38,000		41,281		-		41,281		-
Accrued interest payable		139		139		-		139		-

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 9 – Income Taxes

The following is reconciliation between the statutory federal income tax rate of 34% and the effective income tax rate on income before income taxes:

	Six Months Ended March 31,
	2014			2013
	(In thousands)

At federal statutory rate	$	-		$	(262	)
Adjustments resulting from:
State tax, net of federal benefit		4			-
Tax-exempt interest		-			(37	)
Earnings on bank-owned life insurance		-			(296	)
Other		-			(2	)
	$	4		$	(597	)
Effective tax rate		(1.14	%)		77.43	%

Deferred income taxes at March 31, 2014 and September 30, 2013 were as follows:

	March 31, 2014			September 30, 2013
	(In thousands)
Deferred Tax Assets:
Unrealized loss on investments available for sale	$	1,312		$	1,385
Allowance for loan losses		3,004			3,091
Nonaccrual interest		147			87
Write-down of real estate owned		349			573
Alternative minimum tax (AMT) credit carryover		64			64
Low-income housing tax credit carryover		337			337
Supplement Employer Retirement Plan		463			435
Charitable contributions		20			202
Depreciation		201			150
State net operating loss		611			1,528
Federal net operating loss		7,387			7,046
Other		128			112
Total Deferred Tax Assets		14,023			15,010
Valuation allowance for Deferred Tax Asset		(11,393	)		(12,454	)
Total Deferred Tax Assets, Net of Valuation Allowance	$	2,630		$	2,556
Deferred Tax Liabilities:
Mortgage servicing rights		(98	)		(92	)
Total Deferred Tax Liabilities		(98	)		(92	)

Deferred Tax Assets, Net	$	2,532		$	2,464

Table of Contents

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain forward looking statements (as defined in the Securities Exchange Act of 1934, as amended, and the regulations thereunder). Forward looking statements are not historical facts but instead represent only the beliefs, expectations or opinions of Malvern Bancorp, Inc. and its management regarding future events, many of which, by their nature, are inherently uncertain. Forward looking statements may be identified by the use of such words as: “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” or words of similar meaning, or future or conditional terms such as “will,” “would,” “should,” “could,” “may,” “likely,” “probably,” or “possibly.” Forward looking statements include, but are not limited to, financial projections and estimates and their underlying assumptions; statements regarding plans, objectives and expectations with respect to future operations, products and services; and statements regarding future performance. Such statements are subject to certain risks, uncertainties and assumptions, many of which are difficult to predict and generally are beyond the control of Malvern Bancorp, Inc. and its management, that could cause actual results to differ materially from those expressed in, or implied or projected by, forward looking statements. The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward looking statements: (1) economic and competitive conditions which could affect the volume of loan originations, deposit flows and real estate values; (2) the levels of non-interest income and expense and the amount of loan losses; (3) competitive pressure among depository institutions increasing significantly; (4) changes in the interest rate environment causing reduced interest margins; (5) general economic conditions, either nationally or in the markets in which Malvern Bancorp, Inc. is or will be doing business, being less favorable than expected; (6) political and social unrest, including acts of war or terrorism; or (7) legislation or changes in regulatory requirements adversely affecting the business in which Malvern Bancorp, Inc. is or will be engaged. Malvern Bancorp, Inc. undertakes no obligation to update these forward looking statements to reflect events or circumstances that occur after the date on which such statements were made.

As used in this report, unless the context otherwise requires, the terms “we,” “our,” “us,” or the “Company” refer to Malvern Bancorp, Inc., a Pennsylvania chartered corporation, and the term the “Bank” refers to Malvern Federal Savings Bank, a federally chartered savings bank and wholly owned subsidiary of the Company. In addition, unless the context otherwise requires, references to the operations of the Company include the operations of the Bank.

General

Malvern Bancorp, Inc. (the “Company” or “Malvern Bancorp”) is a Pennsylvania corporation and registered savings and loan holding company. Malvern Federal Savings Bank (“the Bank” or “Malvern Federal Savings”) is a federally chartered savings bank and wholly owned subsidiary of the Company.

Critical Accounting Policies

In reviewing and understanding financial information for the Company, you are encouraged to read and understand the significant accounting policies used in preparing our consolidated financial statements. These policies are described in Note 2 of the notes to our consolidated financial statements included elsewhere. The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America (US GAAP) and to general practices within the banking industry. Accordingly, the consolidated financial statements require certain estimates, judgments, and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the periods presented. The following accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require numerous estimates or economic assumptions that may prove inaccurate or may be subject to variations which may affect our reported results and financial condition for the period or in future periods.

Table of Contents

Allowance for Loan Losses. The allowance for loan losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the statement of financial condition date and is recorded as a reduction to loans. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated statement of financial condition. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Non-residential consumer loans are generally charged off no later than when they become 120 days past due on a contractual basis or earlier in the event of the borrower’s bankruptcy, or if there is an amount deemed uncollectible. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan losses.

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, the composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class including commercial loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, as adjusted for qualitative factors.

An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Once all factor adjustments are applied, general reserve allocations for each segment are calculated, summarized and reported on the allowance for loan losses summary. Allowance for loan losses schedules, calculations and the resulting evaluation process are reviewed quarterly by the Asset Classification Committee and the Board of Directors.

In addition, Federal bank regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not previously have been available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the level of the allowance for loan losses at March 31, 2014 was appropriate under US GAAP.

The allowance is adjusted for other significant factors that affect the collectibility of the loan portfolio as of the evaluation date including changes in lending policy and procedures, loan volume and concentrations, seasoning of the portfolio, loss experience in particular segments of the portfolio, and bank regulatory examination results. Other factors include changes in economic and business conditions affecting our primary lending areas and credit quality trends. Loss factors are reevaluated each reporting period to ensure their relevance in the current economic environment. We review key ratios such as the allowance for loan losses to total loans receivable and as a percentage of non-performing loans; however, we do not try to maintain any specific target range for these ratios.

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While management uses the best information available to make loan loss allowance evaluations, adjustments to the allowance may be necessary based on changes in economic and other conditions or changes in accounting guidance. In addition, the Office of the Comptroller of the Currency (the “OCC”), as an integral part of its examination processes, periodically reviews our allowance for loan losses. The OCC may require the recognition of adjustments to the allowance for loan losses based on their judgment of information available to them at the time of their examinations. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance for loan losses may be required that would adversely impact earnings in future periods.

Fair Value Measurements. The Company uses fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures. Investment and mortgage-backed securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, real estate owned and certain other assets. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets.

Under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements, the Company groups its assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

●

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

●

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

●

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset.

Under FASB ASC Topic 820, the Company bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FASB ASC Topic 820.

Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon the Company’s or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, that could significantly affect the results of current or future valuations. At March 31, 2014, the Company had $1.4 million of assets that were measured at fair value on a non-recurring basis using Level 3 measurements.

Income Taxes. We make estimates and judgments to calculate some of our tax liabilities and determine the recoverability of some of our deferred tax assets (“DTAs”), which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We also estimate a reserve for deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective.

In evaluating our ability to recover deferred tax assets, we consider all available positive and negative evidence, including our past operating results and our forecast of future taxable income. In determining future taxable income, we make assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business. Any reduction in estimated future taxable income may require us to record an addition to the valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.

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Realization of a deferred tax asset requires us to exercise significant judgment and is inherently uncertain because it requires the prediction of future occurrences. Our net deferred tax asset amounted to $2.5 million at March 31, 2014 and September 30, 2013. In evaluating the need for a valuation allowance, we must estimate our taxable income in future years and viable tax planning strategies we could employ so that the asset would not go unused. Our total deferred tax assets decreased to $14.0 million at March 31, 2014 compared to $15.0 million at September 30, 2013. Our DTA valuation allowance amounted to $11.4 million at March 31, 2014 compared to $12.5 million at September 30, 2013. In the future, the DTA allowance may be reversed, depending on the Company’s financial position and results of operations in the future, among other factors, and, in such event, may be available to increase future net income. There can be no assurance, however, as to when we could be in a position to recapture our DTA allowance.

Other-Than-Temporary Impairment of Securities. Securities are evaluated on a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether declines in their value are other-than-temporary. To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline and whether or not management intends to sell or expects that it is more likely than not that it will be required to sell the security prior to an anticipated recovery of the fair value. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value for a debt security is determined to be other-than-temporary, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.

Comparison of Financial Condition at March 31, 2014 and September 30, 2013

Total assets decreased $17.0 million or 2.8% to $584.6 million at March 31, 2014 compared to $601.6 million at September 30, 2013. The decrease was primarily due to a $10.4 million or 100.0% decrease in loans held for sale, a $9.4 million or 39.9% decrease in cash and cash equivalents, a $2.5 million or 2.0% decrease in investment securities and a $1.6 million or 40.5% reduction in other real estate owned (“REO”). These decreases were partially offset by a $7.2 million or 1.8% increase in net loans receivable. The decrease in loans held for sale was due to the completion of our bulk sale of $10.4 million of loans in October 2013. The loans sold were designated as held for sale at September 30, 2013 and were comprised of non-accruing loans, performing troubled debt restructurings (“TDRs”) and classified and other loans which had an aggregate book balance of $20.4 million prior to an aggregate of $10.2 million in charge-offs taken in the quarter ended September 30, 2013. The decrease in cash and cash equivalents was due primarily to the runoff in higher yielding certificates of deposit as well as funding new loan growth.

Total liabilities decreased by $16.9 million, or 3.2% to $509.3 million at March 31, 2014 compared to $526.1 million at September 30, 2013. The decrease was primarily due to a $25.9 million or 5.6% decrease in interest bearing deposits. Total deposits decreased to $458.7 million at March 31, 2014 compared to $484.6 million at September 30, 2013. The decrease was partially offset by a $5.0 million or 13.2% increase in FHLB advances, a $2.0 million increase in our FHLB line of credit and a $2.0 million or 180.1% increase in advances from borrowers for taxes and insurance. The increase in FHLB advances was due to a $5.0 million purchase of relatively lower costing advances during the first half of fiscal 2014.

Shareholders’ equity decreased $137,000 to $75.3 million at March 31, 2014 compared to $75.4 million at September 30, 2013. The decrease was due to a net loss of $362,000 during the first six months of fiscal 2014 which decreased retained earnings to $19.4 million at March 31, 2014. The decrease was partially offset by a $141,000 reduction in accumulated other comprehensive loss. Our ratio of equity to assets was 12.88% at March 31, 2014.

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Asset Quality

The table below sets forth the amounts and categories of loans delinquent more than 30 days but less than 90 days at the dates indicated.

	March 31, 2014		December 31, 2013		September 30, 2013
	(In thousands)
Loans 31-89 days delinquent:
Residential mortgage	$	517	$	2,124	$	1,021
Commercial:
Commercial real estate		-		-		155
Consumer:
Home equity lines of credit		-		26		-
Second mortgages		679		1,255		1,262
Other		-		-		5
Total	$	1,196	$	3,405	$	2,443

Federal regulations and our policies require that we utilize an internal asset classification system as a means of reporting problem and potential problem assets. We have incorporated an internal asset classification system, substantially consistent with Federal banking regulations, as a part of our credit monitoring system. Federal banking regulations set forth a classification scheme for problem and potential problem assets as “substandard,” “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected.

Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “special mention.”

The table below sets forth information on our classified assets and assets designated special mention at the dates indicated.

	March 31, 2014		December 31, 2013		September 30, 2013
	(In thousands)
Classified assets:
Substandard(1)	$	8,904	$	8,745	$	8,482
Doubtful		-		-		-
Loss		-		-		-
Total classified assets		8,904		8,745		8,482
Special mention assets		5,287		2,722		3,816
Total classified and special mention assets	$	14,191	$	11,467	$	12,298

(1)	Includes other real estate owned of $2.4 million, $2.5 million and $4.0 million, at March 31, 2014, December 31, 2013 and September 30, 2013, respectively.

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The following table sets forth non-performing assets and performing troubled debt restructurings which are neither non-accruing nor more than 90 days past due and still accruing in our portfolio at the dates indicated. Loans are generally placed on non-accrual status when they are 90 days or more past due as to principal or interest or when the collection of principal and/or interest becomes doubtful. There were no loans past due 90 days or more and still accruing interest for the periods shown. Troubled debt restructurings are loans which are modified in a manner constituting a concession to the borrower, such as forgiving a portion of interest or principal making loans at a rate materially less than that of market rates, when the borrower is experiencing financial difficulty.

	March 31, 2014			December 31, 2013			September 30, 2013
	(Dollars in thousands)
Non-accruing loans:
Residential mortgage	$	2,161		$	1,821		$	1,295
Construction and Development:
Residential and commercial(1)		393			484			-
Consumer:
Home equity lines of credit		205			20			34
Second mortgages		533			583			572
Total non-accruing loans		3,292			2,908			1,901
Other real estate owned and other foreclosed assets:
Residential mortgage		473			542			725
Construction and Development:
Residential and commercial		-			-			675
Commercial:
Commercial real estate		1,711			1,756			1,929
Multi-family		-			-			81
Other		174			174			174
Consumer:
Second mortgages		-			-			378
Total REO		2,358			2,472			3,962
Total non-performing assets		5,650			5,380			5,863
Performing troubled debt restructurings:
Construction and Development:
Residential and commercial		409			509			209
Land		237			237			237
Commercial:
Other		900			900			900
Total TDRs		1,546			1,646			1,346
Total non-performing assets and performing troubled debt restructurings	$	7,196		$	7,026		$	7,209
Ratios:
Total non-accrual loans as a percent of gross loans		0.80	%		0.71	%		0.47	%
Total non-performing assets as a percent of total assets		0.97	%		0.91	%		0.97	%
Total non-performing assets and performing troubled debt restructurings as a percent of total assets		1.23	%		1.18	%		1.20	%

(1)	Includes one loan classified as a TDR in the amount of $393,000 at March 31, 2014 and two loans classified as TDRs in the aggregate amount of $484,000 at December 31, 2013.

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At March 31, 2014, our total non-performing assets amounted to $5.7 million, a decrease of $213,000 compared to total non-performing assets at September 30, 2013. At March 31, 2014, the Company’s total non-accruing loans amounted to $3.3 million, or 0.80% of total loans, compared to $1.9 million of non-accruing loans, or 0.47% of total loans at September 30, 2013. The primary reason for the $1.4 million increase in non-accruing loans at March 31, 2014 compared to September 30, 2013 was five single-family residential loans with an aggregate outstanding balance of $997,000 becoming more than 90 days past due and being placed on non-accrual status during fiscal 2014. In addition, we had one construction and development loan relationship with an outstanding balance of $393,000 at March 31, 2014 which had originally been included in our October 2013 bulk loan sale (we were required to repurchase this loan in November 2013), which was placed on non-accrual status during the quarter ended December 31, 2013.

For the six months ended March 31, 2014 and 2013, additional gross interest income which would have been recorded had all of our non-accruing loans been current in accordance with their original terms amounted to $75,000 and $348,000, respectively. The amount of interest payments made on such loans was $32,000 for the six months ended March 31, 2014.

Our non-performing assets include REO in addition to non-performing loans. At March 31, 2014, our total REO amounted to $2.4 million, a decrease of $1.6 million compared to total REO at September 30, 2013. The $1.6 million decrease in REO at March 31, 2014 compared to September 30, 2013, was due primarily to $1.6 million of sales of REO.

While not considered non-performing, our performing troubled debt restructurings are closely monitored as they consist of loans that have been modified where the borrower is experiencing financial difficulty. Troubled debt restructurings may be deemed to have a higher risk of loss than loans which have not been restructured. At March 31, 2014, our total performing troubled debt restructurings amounted to $1.5 million compared to $1.3 million of performing troubled debt restructurings at September 30, 2013. The increase in troubled debt restructurings at March 31, 2014 compared to September 30, 2013 was due primarily to a $400,000 advance taken on a line of credit tied to one borrower with three relationships that are performing TDRs of which $200,000 was repaid.

Comparison of Operating Results for the Three and Six Months Ended March 31, 2014 and 2013

General. The Company reported a net loss of $426,000, or $0.07 per share, for the three months ended March 31, 2014 compared to net loss of $845,000, or $0.13 per share for the three months ended March 31, 2013. The $419,000 or 49.6% improvement in net loss was primarily due to a $1.0 million reduction in provision of loan losses. The decrease was partially offset by a $167,000 or 26.8% decrease in other income, a $108,000 or 2.4% increase in other expenses and a $544,000 or 100.2% increase in income tax expense. Our net interest rate spread and net interest margin was 2.60% and 2.74%, respectively, for the three months ended March 31, 2014, compared to net interest rate spread and net interest margin of 2.11% and 2.28%, respectively, for the three months ended March 31, 2013.

The Company reported a net loss of $362,000, or $0.06 per share, for the six months ended March 31, 2014 compared to net loss of $174,000, or $0.03 per share, for the six months ended March 31, 2013. The $188,000 or 108.1% improvement was primarily due to a $1.4 million reduction in the provision for loan losses which was partially offset by a $1.2 million, or 10.2% decrease in total interest and dividend income, a $966,000, or 50.0% decrease in other income and a $601,000, or 100.7% increase in income tax expense. During the first six months of fiscal 2014 compared to the first six months of fiscal 2013, our interest expense was lower by $1.2 million, or 31.6%. Net interest rate spread and net interest margin was 2.62% and 2.74%, respectively, for the six months ended March 31, 2014, compared to net interest rate spread and net interest margin of 2.18% and 2.36%, respectively, for the six months ended March 31, 2013.

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Average Balances, Net Interest Income, and Yields Earned and Rates Paid. The following table shows for the periods indicated the total dollar amount of interest 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. Tax-exempt income and yields have not been adjusted to a tax-equivalent basis. All average balances are based on monthly balances. Management does not believe that the monthly averages differ significantly from what the daily averages would be.

	Three Months Ended March 31,
	2014								2013
	Average Balance			Interest		Average Yield/Rate			Average Balance			Interest		Average Yield/Rate
	(Dollars in thousands)
Interest Earning Assets:
Loans receivable(1)	$	407,653		$	4,445		4.36	%	$	446,145		$	5,001		4.48	%
Investment securities		124,950			603		1.93			95,188			423		1.78
Deposits in other banks		21,978			12		0.22			91,969			36		0.16
Restricted stock		3,276			19		2.32			3,681			3		0.33
Total interest-earning assets		557,857			5,079		3.64			636,983			5,463		3.43
Non-interest-earning assets		34,871								45,469
Total assets	$	592,728							$	682,452

Interest Bearing Liabilities:
Demand and NOW accounts	$	88,117			21		0.10		$	90,481			33		0.15
Money market accounts		66,047			38		0.23			68,805			60		0.35
Savings accounts		43,688			6		0.05			43,674			5		0.05
Time deposits		244,629			934		1.53			304,574			1,319		1.73
Total deposits		442,481			999		0.90			507,534			1,417		1.12
FHLB borrowings		43,342			262		2.42			48,000			421		3.51
Total interest-bearing liabilities		485,823			1,261		1.04			555,534			1,838		1.32
Non-interest-bearing liabilities		31,489								28,988
Total liabilities		517,312								584,522
Shareholders’ Equity		75,416								97,930
Total liabilities and shareholders’ equity	$	592,728							$	682,452
Net interest-earning assets	$	72,034							$	81,449
Net interest income; average interest rate spread				$	3,818		2.60	%				$	3,625		2.11	%
Net interest margin							2.74	%							2.28	%
Average interest-earning assets to average interest-bearing liabilities		114.83	%							114.66	%

(1)	Includes non-accrual loans during the respective periods. Calculated net of deferred loan fees, loan discounts, loans in process and loss reserves.

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	Six Months Ended March 31,
	2014								2013
	Average Balance			Interest		Average Yield/Rate			Average Balance			Interest		Average Yield/Rate
	(Dollars in thousands)
Interest Earning Assets:
Loans receivable(1)	$	405,696		$	8,972		4.42	%	$	450,889		$	10,534		4.68	%
Investment securities		125,754			1,212		1.92			90,259			804		1.78
Deposits in other banks		22,953			27		0.24			99,479			67		0.14
Restricted stock		3,168			33		2.08			3,735			8		0.42
Total interest-earning assets		557,571			10,244		3.68			644,362			11,413		3.54
Non-interest-earning assets		36,570								13,901
Total assets	$	594,141							$	658,263

Interest Bearing Liabilities:
Demand and NOW accounts	$	87,346			43		0.10		$	88,833			73		0.16
Money market accounts		66,379			83		0.26			68,990			132		0.38
Savings accounts		43,217			12		0.06			42,886			12		0.06
Time deposits		249,835			1,928		1.54			309,715			2,717		1.76
Total deposits		446,777			2,066		0.92			510,424			2,934		1.14
FHLB borrowings		41,067			525		2.56			48,007			851		3.54
Total interest-bearing liabilities		487,844			2,591		1.06			558,431			3,785		1.36
Non-interest-bearing liabilities		30,926								23,585
Total liabilities		518,770								582,016
Shareholders’ Equity		75,371								76,247
Total liabilities and shareholders’ equity	$	594,141							$	658,263
Net interest-earning assets	$	69,727							$	85,931
Net interest income; average interest rate spread				$	7,653		2.62	%				$	7,628		2.18	%
Net interest margin							2.74	%							2.36	%
Average interest-earning assets to average interest-bearing liabilities		114.29	%							115.39	%

(1)	Includes non-accrual loans during the respective periods. Calculated net of deferred loan fees, loan discounts, loans in process and loss reserves.

Interest and Dividend Income. Interest and dividend income decreased by $384,000, or 7.0%, to $5.1 million for the three months ended March 31, 2014 compared to the same period in fiscal 2013. The decrease was due primarily to a $556,000 or 11.1% decrease in interest income earned on loans. This decrease was partially offset by an $180,000 or 42.6% increase in interest income on investment securities and a $16,000 or 533.3% increase on FHLB stock. The decrease in interest income on loans was due to a $38.5 million, or 8.6%, decrease in the average balance of our outstanding loans as well as a 12 basis point or 2.7% decrease in the average yield earned on our loan portfolio. During the three months ended March 31, 2014, we also had a $24,000 decrease in interest due from depository institutions due to a $70.0 million or 76.1% decrease in the average balance of balances due from depository institutions. The increase in interest income on investment securities was due to a $29.8 million or 31.3% increase in the average balance of investment securities and a 15 basis point or 8.4% increase in the average yield earned on investment securities. The average yield on investment securities increased to 1.93% for the three months ended March 31, 2014 from 1.78% for the same period in fiscal 2013.

Interest and dividend income decreased $1.2 million, or 10.2% to $10.2 million for the six months ended March 31, 2014 compared to the same period in fiscal 2013. The decrease was due to a $1.6 million or 14.8% decrease in interest income earned on loans and a $40,000 or 59.7% decrease in interest income on balances due from depository institutions. These decreases were partially offset by a $408,000 or 50.7% increase in interest income on investment securities and a $25,000 or 312.5% increase in dividends earned on restricted stock. The decrease in interest income on loans was due to a $45.2 million, or 10.0%, decrease in the average balance of our outstanding loans as well as a 26 basis point or 5.6% decrease in the average yield earned on our loan portfolio. The decrease in interest due from depository institutions was due to a $76.5 million or 76.9% decrease in the average balance of balances due from depository institutions. The increase in interest income on investment securities was due to a $35.5 million or 39.3% increase in the average balance of investment securities and a 14 basis point or 7.9% increase in the average yield earned on investment securities. The average yield on investment securities increased to 1.92% for the six months ended March 31, 2014 from 1.78% for the same period in fiscal 2013.

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Interest Expense. Interest expense decreased $577,000 or 31.4% for the three month period ended March 31, 2014, compared to the same period in fiscal 2013. The decrease was due to a $418,000 or 29.5% decrease in interest expense on deposits and a $159,000 or 37.8% decrease in interest expense on FHLB borrowings. The decrease in interest expense on deposits was due to a $65.1 million or 12.8% decrease in the average balance of deposits and a 22 basis point or 19.6% decrease in the rates paid on deposits. The average rate paid on total deposits decreased to 0.90% for the second quarter of fiscal 2014 from 1.12% for the second quarter of fiscal 2013. The decrease in interest expense on FHLB borrowings was due to a $4.7 million or 9.7% decrease in the average balance of FHLB borrowings and a 109 basis point or 31.1% decrease in the rates paid on borrowings. The average cost of borrowed funds decreased to 2.42% in the second quarter of fiscal 2014 compared to 3.51% in the second quarter of fiscal 2013.

Interest expense decreased $1.2 million or 31.6% for the six month period ended March 31, 2014, compared to the same period in fiscal 2013. The decrease was due to an $868,000 or 29.6% decrease in interest expense on deposits and a $326,000 or 38.3% decrease in interest expense on FHLB borrowings. The decrease in interest expense on deposits was due to a $63.6 million or 12.5% decrease in the average balance of deposits and a 22 basis point or 19.3% decrease in the rates paid on deposits. The average rate paid on total deposits decreased to 0.92% for the first six months of fiscal 2014 from 1.14% for the first six months of fiscal 2013. The decrease in interest expense on FHLB borrowings was due to a $6.9 million or 14.5% decrease in the average balance of FHLB borrowings and 98 basis point or 27.7% decrease in the rates paid on borrowings. The average rate paid on borrowed funds decreased to 2.56% in the first six months of fiscal 2014 compared to 3.54% in the first six months of fiscal 2013. The reduction in our total cost and average rate paid on borrowings in the first half of fiscal 2014 reflects, in large part, our determination to prepay certain higher rate FHLB advances in the fourth quarter of fiscal 2013.

Provision for Loan Losses. We had no provision for loan losses for the three months ended March 31, 2014 compared to $1.0 million for the three months ended March 31, 2013. The provision for loan losses was $80,000 for the six months ended March 31, 2014 compared to $1.4 million for the six months ended March 31, 2013. The $1.0 million and $1.4 million decrease in the provision for loan losses for the three and six months ended March 31, 2014 compared to the three and six months ended March 31, 2013, among other things, reflected the overall improvement in the trend of our levels of delinquent, impaired and non-performing loans. We had a net recovery of $2,000 for the three months ended March 31, 2014 compared to a net charge-offs of $2.3 million for the three months ended March 31, 2013. Net charge-offs for the six months ended March 31, 2014 were $323,000 compared to $2.7 million for the six months ended March 31, 2013. The ratio of annualized net charge-offs to average loans outstanding was 0.16% for the six months ended March 31, 2014 compared to 1.20% for the six months ended March 31, 2013. As of March 31, 2014, the balance of the allowance for loan losses was $4.8 million, or 1.18% of gross loans and 147.24% of non-accruing loans, compared to an allowance for loan losses of $5.1 million or 1.26% of gross loans and 267.75% of non-accruing loans at September 30, 2013.

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The following table sets forth an analysis of our allowance for loan losses for the periods indicated.

	For the Six Months End March 31,						For the Year Ended September 30,
	2014			2013			2013
	(Dollars in thousands)

Balance at beginning of period	$	5,090		$	7,581		$	7,581
Provision for loan losses		80			1,445			11,235

Charge-offs:
Residential mortgage		5			296			994
Construction and Development
Residential and commercial		37			1,535			5,768
Land		-			-			99
Commercial:
Commercial real estate		-			555			6,315
Other		-			-			94
Consumer:
Home equity lines of credit		14			-			-
Second mortgages		403			512			1,042
Other		5			5			9
Total charge-offs		464			2,903			14,321
Recoveries:
Residential mortgage		12			12			199
Construction and Development
Residential and commercial		72			-			-
Commercial:
Commercial real estate		5			1			117
Other		1			21			23
Consumer:
Home equity lines of credit		-			2			17
Second mortgages		50			142			235
Other		1			1			4
Total recoveries		141			179			595

Net charge-offs		323			2,724			13,726
Balance at end of period	$	4,847		$	6,302		$	5,090
Ratios:
Ratio of allowance for loan losses to non-accrual loans		147.24	%		36.53	%		267.75	%
Ratio of net charge-offs to average loans outstanding (annualized for the six-month periods ended March 31, 2014 and 2013)		0.16	%		1.20	%		3.12	%
Ratio of net charge-offs to total allowances for loan losses (annualized for the six-month periods ended March 31, 2014 and 2013)		13.32	%		86.44	%		269.67	%

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Other Income. Other, or non-interest, income decreased by $167,000, or 26.8% to $457,000 for the three months ended March 31, 2014 compared to $624,000 for the same period in fiscal 2013. The decrease in other income during the second quarter of fiscal 2014 was primarily due to a $183,000 decrease in gain on sale of investments which was partially offset by $16,000 increase in service charges and other fees.

Other, or non-interest, income decreased by $966,000, or 50.0%, to $965,000 for the six months ended March 31, 2014 compared to $1.9 million for the same period in fiscal 2013. The decrease in other income during the first six months of fiscal 2014 was primarily due to a $585,000 decrease in earnings on bank-owned life insurance as a result of a tax free death benefit of approximately $596,000 received in the first quarter of 2013, a $196,000 decrease in gain on sale of investments and a $130,000 decrease in gain on sale of loans due to a decrease in the volume of loans sold.

Other Expenses. Other, or non-interest, expenses increased by $108,000, or 2.4%, to $4.7 million for the three months ended March 31, 2014 compared to $4.6 million for the three months ended March 31, 2013. The increase was primarily due to a $239,000, or 53.0% increase in professional fees, a $125,000, or 6.4% increase in salaries and employee benefits and a $60,000, or 11.3% increase in occupancy expense. These decreases were partially offset by a $136,000, or 61.8% decrease in other real estate owned expense, a $66,000, or 23.4% decrease in advertising, a $43,000, or 19.6% decrease in federal deposit insurance premiums and a $66,000, or 10.5% decrease in other operating expenses in the quarter ended March 31, 2014 compared to the quarter ended March 31, 2013. The increase in professional fees was primarily due to increased legal and professional fees associated with the search for a new President and Chief Executive Officer and consulting fees related to the temporary engagement of an advisor to the Board of Directors. The increase in salaries and employee benefits expense was due to the increase in the number of employees. The decrease in other REO expense was due to the reduction of other real estate owned.

Other, or non-interest, expenses increased slightly by $11,000, or 0.1%, to $8.9 million for the six months ended March 31, 2014 compared to $8.9 million for the six months ended March 31, 2013. The increase was primarily due to a $360,000, or 44.2% increase in professional fees, a $344,000, or 9.1% increase in salaries and employee benefits and a $94,000, or 9.3% increase in occupancy expense. These increases were partially offset by a $548,000, or 85.0% decrease in other real estate owned expense, an $88,000, or 19.1% decrease in advertising, a $69,000, or 15.8% decrease in federal deposit insurance premiums and an $88,000, or 8.1% decrease in other operating expenses in the six months ended March 31, 2014 compared to the six months ended March 31, 2013. The increase in professional fees was primarily due to increased legal and professional fees associated with the search for a new President and Chief Executive Officer and consulting fees related to the temporary engagement of an advisor to the Board of Directors. The increase in salaries and employee benefits expense was due to an increase in the number of employees in various departments. The decrease in other REO expense was due to the reduction of other real estate owned.

Income Tax Expense/(Benefit). Income tax expense amounted to $1,000 for the three months ended March 31, 2014 compared to an income tax benefit of $543,000 for the three months ended March 31, 2013. Income tax expense for the quarter ended March 31, 2014 primarily reflects the $963,000 difference in loss before taxes during the quarter ended March 31, 2014. The effective combined state and Federal tax rate was 0.2% and (39.1%) for the three months ended March 31, 2014 and 2013, respectively. Our tax expense for the current quarter was related to state, not federal, taxes. We evaluate our tax obligations on a quarterly basis and do not expect to resume making provisions for Federal income tax expense until we have reported net income before taxes for several consecutive fiscal quarters.

Income tax expense amounted to $4,000 for the six months ended March 31, 2014 compared to an income tax benefit of $597,000 for the six months ended March 31, 2013. The income tax expense for the six months ended March 31, 2014 primarily reflects the $413,000 difference in loss before taxes during the first six months of fiscal 2014. The effective combined state and Federal tax rate was 1.1% and (77.4%) for the six months ended March 31, 2014 and 2013, respectively.

Liquidity and Capital Resources

Our primary sources of funds are from deposits, FHLB borrowings, amortization of loans, loan prepayments and the maturity of loans, mortgage-backed securities and other investments, and other funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities are relatively predictable sources of funds, deposit flows and loan prepayments can be greatly influenced by general interest rates, economic conditions and competition. We also maintain excess funds in short-term, interest-bearing assets that provide additional liquidity. At March 31, 2014, our cash and cash equivalents amounted to $14.2 million. In addition, at such date our available for sale investment securities amounted to $122.2 million.

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In addition to cash flow from loan and securities payments and prepayments as well as from sales of available for sale securities, we have significant borrowing capacity available to fund liquidity needs. In recent years we have utilized borrowings as a cost efficient addition to deposits as a source of funds. Our borrowings consist primarily of advances from the Federal Home Loan Bank of Pittsburgh, of which we are a member. Under terms of the collateral agreement with the Federal Home Loan Bank, we pledge residential mortgage loans and mortgage-backed securities as well as our stock in the Federal Home Loan Bank as collateral for such advances.

We use our liquidity to fund existing and future loan commitments, to fund maturing certificates of deposit and demand deposit withdrawals, to invest in other interest-earning assets, and to meet operating expenses. At March 31, 2014, we had certificates of deposit maturing within the next 12 months amounting to $103.2 million. Based upon historical experience, we anticipate that a significant portion of the maturing certificates of deposit will be remaining with us. For the six months ended March 31, 2014, the average balance of our outstanding FHLB borrowings was $41.1 million. At March 31, 2014, we had $43.0 million in outstanding long-term FHLB advances and we had $162.6 million in potential FHLB advances available to us. In addition, at March 31, 2014, we had a $50.0 million in line of credit with the FHLB, of which $2.0 million was outstanding.

The following table summarizes our contractual cash obligations at March 31, 2014.

	Payments Due by Period
	To One Year		After One to Three Years		After Three to Five Years		After Five Years		Total
	(In thousands)

FHLB advances	$	-	$	15,000	$	-	$	28,000	$	43,000
Certificates of deposit		103,166		87,015		41,297		4,736		236,214
Operating lease obligations		279		409		429		4,334		5,451
Total contractual obligations	$	103,445	$	102,424	$	41,726	$	37,070	$	284,665

We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.

Impact of Inflation and Changing Prices

The financial statements, accompanying notes, and related financial data of the Company presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations. Most of our assets and liabilities are monetary in nature; therefore, the impact of interest rates has a greater impact on our performance than 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.

Item 3 - Quantitative and Qualitative Disclosures About Market Risk

For a discussion of the Company’s asset and liability management policies as well as the methods used to manage its exposure to the risk of loss from adverse changes in market prices and rates market, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – How We Manage Market Risk” in the Company’s Annual Report on Form 10-K for the year ended September 30, 2013. There has been no material change in the Company’s asset and liability position since September 30, 2013.

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Item 4. Controls and Procedures

Our management evaluated, with the participation of our Chief Financial Officer (who was also performing the duties as acting principal executive officer as of the date of filing this Quarterly Report on Form 10-Q) the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on such evaluation, our Chief Financial Officer (who was also performing the duties as acting principal executive officer as of the date of filing this Quarterly Report on Form 10-Q) concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and are operating in an effective manner.

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15(d)-15(f) under the Securities Exchange Act of 1934) occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1 - Legal Proceedings

Not applicable.

Item 1A - Risk Factors

See Item 1A, “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended September 30, 2013. There have been no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended September 30, 2013.

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

Not applicable.

Item 3 - Defaults Upon Senior Securities

There are no matters required to be reported under this item.

Item 4 - Mine Safety Disclosure

There are no matters required to be reported under this item.

Item 5 - Other Information

There are no matters required to be reported under this item.

Item 6 - Exhibits

31.1	Rule 13a-14(a)/15d-14(a) Section Certification

31.2	Rule 13a-14(a)/15d-14(a) Section 302 Certification

32.1	Section 1350 Certification

No.		Description
101.INS		XBRL Instance Document.
101.SCH		XBRL Taxonomy Extension Schema Document.
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB		XBRL Taxonomy Extension Label Linkbase Document.
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF		XBRL Taxonomy Extension Definitions Linkbase Document.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.


		MALVERN BANCORP, INC.

May 13, 2014	By:	/s/ Dennis Boyle
		Dennis Boyle
		Senior Vice President and Chief Financial Officer
		(Also authorized to sign this report as acting principal executive officer at the time this Form 10-Q is filed.)