UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x	Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended SEPTEMBER 30, 2012
-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: 0-51214

PRUDENTIAL BANCORP, INC. OF PENNSYLVANIA

(Exact Name of Registrant as Specified in its Charter)

PENNSYLVANIA (State or other jurisdiction of incorporation or organization) 68-0593604 (IRS Employer Identification No.)

1834 OREGON AVENUE	19145
PHILADELPHIA, PENNSYLVANIA	(Zip Code)
(Address of Principal Executive Offices)

Registrant’s telephone number: (including area code) (215) 755-1500

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class	Name of Each Exchange on Which Registered
Common Stock (par value $0.01 per share)	The Nasdaq Stock Market, LLC

Securities registered pursuant to Section 12(g) of the Act: NONE

 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o  NO x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES o  NO x

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

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     YES x NO o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

Large Accelerated Filer  o	Accelerated Filer o
Non-Accelerated Filer  o (Do not check if a smaller reporting company)	Smaller Reporting Company x

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

The aggregate market value of the voting stock held by non-affiliates of the Registrant based on the closing price of $5.37 on March 30, 2012, the last business day of the Registrant’s second quarter was approximately $10.3 million (10,023,495) shares outstanding less approximately 8.1 million shares held by affiliates at $5.37 per share).  Although directors and executive officers of the Registrant and certain employee benefit plans were assumed to be “affiliates” of the Registrant for purposes of the calculation, the classification is not to be interpreted as an admission of such status.

As of the close of business on December 1, 2012 there were 10,023,495 shares of the Registrant’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

1. Portions of the Definitive Proxy Statement for the 2012 Annual Meeting of Shareholders are incorporated by reference into Part III, Items 10-14 of this Form 10-K.

Prudential Bancorp, Inc. of Pennsylvania and Subsidiaries

FORM 10-K INDEX

For the Fiscal Year Ended September 30, 2012

PART I		Page
Item 1.	Business	1
Item 1A.	Risk Factors	40
Item 1B.	Unresolved Staff Comments	40
Item 2.	Properties	41
Item 3.	Legal Proceedings	42
Item 4.	Mine Safety Disclosures	42
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	43
Item 6.	Selected Financial Data	44
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	46
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	58
Item 8.	Financial Statements and Supplementary Data	59
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	104
Item 9A.	Controls and Procedures	104
Item 9B.	Other Information	105
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	105
Item 11.	Executive Compensation	105
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	106
Item 13.	Certain Relationships and Related Transactions, and Director Independence	106
Item 14.	Principal Accounting Fees and Services	106
PART IV
Item 15.	Exhibits and Financial Statement Schedules	106
	Signatures

Forward-looking Statements.

In addition to historical information, this Annual Report on Form 10-K includes certain “forward-looking statements” based on management’s current expectations. Prudential Bancorp, Inc. of Pennsylvania’s (the “Company” or “Prudential Bancorp”) actual results could differ materially, as such term is defined in the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, from management’s expectations. These forward looking statements are intended to be covered by the safe harbor for forward looking statements provided by the Private Securities Litigation Reform Act of 1995.  Such forward-looking statements include statements regarding management’s current intentions, beliefs or expectations as well as the assumptions on which such statements are based. These forward-looking statements are subject to significant business, economic and competitive uncertainties and contingencies, many of which are not subject to the Company’s control. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Factors that could cause future results to vary from current management expectations include, but are not limited to, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal, state and local tax authorities, changes in interest rates, deposit flows, the cost of funds, demand for loan products, demand for financial services, competition, changes in the quality or composition of the Company’s loan, investment and mortgage-backed securities portfolios, changes in accounting principles, policies or guidelines and other economic, competitive, governmental and technological factors affecting the Company’s operations, markets, products, services and fees.

The Company undertakes no obligation to update or revise any forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results that occur subsequent to the date such forward-looking statements are made.

PART I

Item 1. Business

General

Prudential Bancorp is a Pennsylvania corporation which was organized as a mid-tier holding company for Prudential Savings Bank, a Pennsylvania-chartered, FDIC-insured savings bank (the “Bank” or “Prudential Savings Bank”).  The Bank is a wholly owned subsidiary of the Company. The Company’s results of operations are primarily dependent on the results of the Bank.  As of September 30, 2012, the Company, on a consolidated basis, had total assets of approximately $490.5 million, total deposits of approximately $425.6 million, and total stockholders’ equity of approximately $59.8 million.

The Company was formed when the Bank reorganized from a mutual savings bank into a mutual holding company structure in March 2005.  Prudential Mutual Holding Company, a Pennsylvania mutual holding company, is the mutual holding company parent of the Company.  As of September 30, 2012, Prudential Mutual Holding Company owned 74.6% (7,478,062 shares) of the Company’s outstanding common stock and must continue to own at least a majority of the outstanding voting stock of the Company.

1

           The Bank is a community-oriented savings bank headquartered in South Philadelphia which was originally organized in 1886 as a Pennsylvania-chartered building and loan association known as “The South Philadelphia Building and Loan Association No. 2.”  We grew through a number of mergers with other mutual institutions with the last merger being with Continental Savings and Loan Association in 1983.  The Bank converted to a Pennsylvania-chartered savings bank in August 2004.  The banking office network currently consists of the headquarters and main office and six full-service branch offices.  Six of the banking offices are located in Philadelphia (Philadelphia County) and one is in Drexel Hill in neighboring Delaware County, Pennsylvania.  The Bank maintains ATMs at six of the banking offices.  We also provide on-line banking services.

We are primarily engaged in attracting deposits from the general public and using those funds to invest in loans and securities.  The Company’s principal sources of funds are deposits, repayments of loans and mortgage-backed securities, maturities and calls of investment securities and interest-bearing deposits, funds provided from operations and funds borrowed from the Federal Home Loan Bank of Pittsburgh.  These funds are primarily used for the origination of various loan types including single-family residential mortgage loans, construction and land development loans, non-residential or commercial real estate mortgage loans, home equity loans and lines of credit, commercial business loans and consumer loans.  We are an active originator of residential home mortgage loans in the market area.  Traditionally, the Bank focused on originating long-term single-family residential mortgage loans for portfolio.  This focus has continued as we have decreased in recent periods the Company’s involvement in construction and land development lending due to adverse market conditions.  Construction and land development loans decreased from $42.6 million or 16.5% of the total loan portfolio at September 30, 2008 to $14.9 million or 5.7% of the total loan portfolio at September 30, 2012.  If there is improvement in the real estate market, as well as the Company’s asset quality situation, the Company’s involvement in construction and land development lending may increase in the future.  See “-Asset Quality”.

The investment and mortgage-backed securities portfolio has decreased by $55.2 million to $129.1 million at September 30, 2012 from $184.3 million at September 30, 2011.  The decrease was due to securities sold and called, the proceeds of which at September 30, 2012 were still in the process of being deployed primarily into the purchase of U.S. government agency securities and the origination of residential mortgage loans.  A significant portion of the investment securities consist of debt and mortgage-backed securities issued by government sponsored enterprises (“GSEs”) or U.S. government agencies.  At September 30, 2012, the investment and mortgage-backed securities had an aggregate gross unrealized loss of $343,000 which reflected primarily unrealized losses related to non-agency mortgage-backed securities in the portfolio due in large part to continued turbulence in the mortgage industry.

At September 30, 2012, the Company’s non-performing assets totaled$16.0 million or 3.3% of total assets as compared to $14.9 million or 3.0% of total assets at September 30, 2011.  Non-performing assets at September 30, 2012 included $14.0 million in non-performing loans of which $12.7 million consisted of one-to-four family residential loans, $517,000 were construction and land development loans and $755,000 consisted of commercial real estate loans.  Included in the $12.7 million of non-performing one-to four-family residential loans were $8.1 million of troubled debt restructurings.  These troubled debt restructurings relate to a 133-unit completed condominium project in Philadelphia and consist of five loans extended to the same borrower.  Non-performing assets also included seven one-to-four family residential real estate owned properties totaling $2.0 million.  The allowance for loan losses totaled $1.9 million, or 0.7% of total loans and 13.4% of total non-performing loans at September 30, 2012.See “-Asset Quality”.

The executive offices are located at 1834 Oregon Avenue, Philadelphia, Pennsylvania and the Company’s telephone number is (215) 755-1500.

2

Market Area and Competition

The primary market area is Philadelphia, in particular South Philadelphia and Center City, as well as Delaware County.  We also conduct business in Bucks, Chester and Montgomery Counties which, along with Delaware County, comprise the suburbs of Philadelphia.  We also make loans in contiguous counties in southern New Jersey.  This area is referred to as the Delaware Valley region.  The Philadelphia metropolitan area is one of the leading regions for biotech and pharmaceutical research with many of the largest pharmaceutical companies maintaining a presence in the region.  It is also a major health care area with a number of teaching and research hospitals being operated.

Since 2008, the Philadelphia area has been affected by the downturn in the national economy.  Manufacturers and retailers reported declines.  In general, overall credit quality of bank loans deteriorated and residential real estate sales, construction activity, and commercial real estate investment declined.  The deterioration in the local economy had a negative impact on the Bank’s loan portfolio which was the primary factor in the determination to increase provisions for loan losses and charge-offs in recent periods.  See “-Asset Quality”.

We face significant competition in originating loans and attracting deposits.  This competition stems primarily from commercial banks, other savings banks and savings associations and mortgage-banking companies.  Many of the financial service providers operating in the market area are significantly larger, and have greater financial resources, than us.  We face additional competition for deposits from short-term money market funds and other corporate and government securities funds, mutual funds and from other non-depository financial institutions such as brokerage firms and insurance companies.

Lending Activities

General.  At September 30, 2012, the net loan portfolio totaled $260.7 million or 53.1% of total assets.  Historically, the principal lending activity has been the origination of residential real estate loans collateralized by one- to four-family, also known as “single-family” homes secured by properties located in the Company’s market area.

The types of loans that we may originate are subject to federal and state banking laws and regulations.  Interest rates charged by us on loans are affected principally by the demand for such loans and the supply of money available for lending purposes and the rates offered by competitors.  These factors are, in turn, affected by general and economic conditions, the monetary policy of the federal government, including the Board of Governors of the Federal Reserve System (“Federal Reserve Board”), legislative tax policies and governmental budgetary matters.

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Loan Portfolio Composition.  The following table shows the composition of the loan portfolio by type of loan at the dates indicated.

	September 30,
	2012						2011						2010						2009						2008
	Amount			%			Amount			%			Amount			%			Amount			%			Amount			%
	(Dollars in Thousands)
Real estate loans:
One- to four-family residential (1)	$	222,793			84.64	%	$	196,533			79.53	%	$	197,164			74.96	%	$	201,396			75.98	%	$	191,344			74.02	%
Multi-family residential		5,051			1.92	%		5,723			2.32	%		4,006			1.52	%		4,178			1.58	%		2,801			1.08	%
Commercial real estate		19,333			7.35	%		21,175			8.57	%		19,710			7.49	%		19,907			7.51	%		20,518			7.94	%
Construction and land development		14,873			5.65	%		22,226			9.00	%		40,650			15.46	%		36,764			13.87	%		42,634			16.49	%
Total real estate loans		262,050			99.56	%		245,657			99.42	%		261,530			99.43	%		262,245			98.94	%		257,297			99.53	%
Commercial business		632			0.24	%		814			0.33	%		893			0.34	%		2,232			0.84	%		465			0.18	%
Consumer		523			0.20	%		613			0.25	%		595			0.23	%		586			0.22	%		739			0.29	%
Total loans		263,205			100.00	%		247,084			100.00	%		263,018			100.00	%		265,063			100.00	%		258,501			100.00	%
Less:
Undisbursed portion of loans in process		1,629						3,773						5,366						6,281						13,515
Deferred loan costs		(989	)					(564	)					(590	)					(644	)					(574	)
Allowance for loan losses		1,881						3,364						3,151						2,732						1,591
Net loans	$	260,684					$	240,511					$	255,091					$	256,694					$	243,969

(1) Includes home equity loans and lines of credit totaling $8.1 million and $11.7 million, respectively, as of September 30, 2012.

Contractual Terms to Final Maturities.  The following table shows the scheduled contractual maturities of loans as of September 30, 2012, before giving effect to net items.  Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.  The amounts shown below do not take into account loan prepayments.

	One-to-Four						Construction
	Family		Multi-family		Commercial		and Land		Commercial
	Residential		Residential		Real Estate		Development		Business		Consumer		Total
	(In Thousands)
Amounts due after September 30, 2012 in:
One year or less	$	8,594	$	166	$	1,196	$	4,970	$	20	$	81	$	15,027
After one year through two years		11,933		-		1,302		5,216		-		25		18,476
After two years through three years		2,004		170		2,930		4,201		53		127		9,485
After three years through five years		9,861		520		4,936		486		-		156		15,959
After five years through ten years		56,104		3,672		8,324		-		92		134		68,326
After ten years through fifteen years		60,656		381		317		-		332		-		61,686
After fifteen years		73,641		142		328		-		135		-		74,246
Total	$	222,793	$	5,051	$	19,333	$	14,873	$	632	$	523	$	263,205

4

The following table shows the dollar amount of all loans due after one year from September 30, 2012, as shown in the table above, which have fixed interest rates or which have floating or adjustable interest rates.

			Floating or
	Fixed-Rate		Adjustable-Rate		Total
	(In Thousands)
One- to four-family residential (1)	$	206,804	$	7,395	$	214,199
Multi-family residential		4,885		-		4,885
Commercial real estate		17,303		834		18,137
Construction and land development		1,368		8,535		9,903
Commercial business		612		-		612
Consumer		442		-		442
Total	$	231,414	$	16,764	$	248,178

(1)  Includes home equity loans and lines of credit.

The Company originates one, three, and five year adjustable-rate mortgages, consisted primarily of one-to four-family residential mortgage loans.  None of these mortgages had artificially low initial interest rates at the date of origination commonly known as “teaser rates” as of September 30, 2012.

Loan Originations.  The lending activities are subject to underwriting standards and loan origination procedures established by our board of directors and management.  Loan originations are obtained through a variety of sources, primarily existing customers as well as new customers obtained from referrals and local advertising and promotional efforts.  We also use loan correspondents and brokers as a source for a substantial part of our residential mortgage loans, either having them originate such loans using our documentation or purchasing such loans from them immediately upon closing.  Loans obtained from loan correspondents are underwritten using the same underwriting standards as loans originated internally.  Consumer loan applications are taken at any of our offices while loan applications for all other types of loans are taken only at our main office.  All loan applications are processed and underwritten centrally at our main office.

Single-family residential mortgage loans are written on standardized documents used by the Federal Home Loan Mortgage Corporation (“FHLMC” or “Freddie Mac”) and Federal National Mortgage Association (“FNMA” or “Fannie Mae”).  Property valuations of loans secured by real estate are undertaken by independent third-party appraisers approved by the board of directors. At both September 30, 2012 and September 30, 2011, the Company had no real estate loans that would be considered subprime loans, which are defined as mortgage loans advanced to borrowers who do not qualify for loans bearing market interest rates because of problems with their credit history.  Prudential Savings Bank does not originate and has not in the past originated subprime loans. 

5

In addition, the Company utilizes correspondents to assist in the origination of single-family residential loans.  However, all of such loans are underwritten by us using the Bank’s underwriting criteria and are approved by the executive committee or the full board of directors prior to loan closing.  We also occasionally purchase participation interests in larger balance loans, typically commercial real estate loans, from other financial institutions in the Company’s market area.  Such participations are reviewed for compliance with our underwriting criteria and are approved by the executive committee or the full board before they are purchased.  Generally, loan purchases have been without any recourse to the seller.  However, we actively monitor the performance of such loans through the receipt of regular updates, including inspections reports, from the lead lender regarding the loan’s performance, discussing the loan with the lead lender on a regular basis and receiving copies of updated financial statements of the borrower from the lead lender.

The Company has sold participation interests in construction and land development loans originated by it to other institutions in its market area.  When we have sold participation interests, it has been done without recourse.  We generally have sold participation interests in loans only when a loan would exceed the Bank’s internal loans to one borrower limits.  With respect to the sale of participation interests in such loans, we have received commitments to purchase such participation interests prior to the time the loan is closed.  In addition, beginning in fiscal 2002, we have sold to the Federal Home Loan Bank of Pittsburgh pursuant to the Mortgage Partnership Finance program long-term, fixed-rate single-family residential loans originated which had interest rates below certain levels established by the board of directors.  Such sales provide for a limited amount of recourse.  There were no loan sales during the fiscal years ended September 30, 2012 and 2011.  At September 30, 2012, the Company’s recourse exposure was approximately $64,000.

As part of the Bank’s loan policy, we are permitted, subject to certain exceptions as approved by the loan committee, to make loans to one borrower in an aggregate amount of up to 15% of the capital accounts of the Bank which consist of the aggregate of its capital, surplus, undivided profits, capital securities and allowance for loan losses.  At September 30, 2012, the Bank’s loans to one borrower limit pursuant to our loan policy was approximately $8.5 million.  At September 30, 2012, our three largest loans to one borrower and related entities amounted to $12.2 million, $11.8 million, and $9.8 million.  All of such loans were performing in accordance with their terms, as revised in certain cases, and primarily consist of loans to fund single-family residential construction projects.  All three of the borrowers referenced above are members of a limited partnership to which the Company has extended as of September 30, 2012 loans totaling $8.1 million, all of which are included in the loan amounts referenced above.  The loans to the limited partnership are in non-accrual status due to impairment issues related to collateral valuation.  Policy exceptions were made related to these borrowing relationships in order to protect the Bank’s security interest in the existing loans.  For more information regarding such loans, see “Lending Activities - Construction and Land Development Lending”.

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The following table shows our total loans originated, purchased, sold and repaid during the periods indicated.

	Year Ended September 30,
	2012			2011			2010
	(In Thousands)
Loan originations (1)
One- to four-family residential	$	60,913		$	27,947		$	28,120
Multi-family residential		770			1,891			300
Commercial real estate		1,576			2,487			915
Construction and land development		7,960			9,622			20,929
Commercial business		1,049			986			2,941
Consumer		193			370			302
Total loan originations		72,461			43,303			53,507
Loans purchased		1,624			-			-
Total loans originated and acquired		74,085			43,303			53,507
Loans sold		-			-			-
Loans transferred to real estate owned		223			461			1,692
Loan principal repayments		53,302			52,914			52,456
Total loans sold and principal repayments		53,525			53,375			54,148
Decrease due to other items, net (2)		(387	)		(4,508	)		(962	)
Net (decrease) increase in loan portfolio	$	20,173		$	(14,580	)	$	(1,603	)

(1) Includes loan participations with other lenders.

(2) Other items consist of the undisbursed portion of loans in process, deferred fees and the allowance for loan losses.  The 2012 balance consisted primarily of the $725,000 loan loss provision expense offset by in part by a $338,000 accretion of deferred loan fee income.  The 2011 balance consisted primarily of $4.6 million loan loss provision expense partially offset by a $122,000 accretion of deferred loan fee income.  The 2010 balance consisted primarily of the $1.1 million loan loss provision expense offset by in part by a $148,000 accretion of deferred loan fee income.

One- to Four-Family Residential Mortgage Lending.  The primary lending activity continues to be the origination or purchase of loans secured by first mortgages on one- to four-family residential properties located in the Company’s market area.  Our single-family residential mortgage loans are obtained through the lending department and branch personnel as well as through correspondents.  The balance of such loans increased from $191.3 million or 74.0% of total loans at September 30, 2008 to $222.8 million, or 84.6% of total loans at September 30, 2012.

Single-family residential mortgage loans generally are underwritten on terms and documentation conforming to guidelines issued by Freddie Mac and Fannie Mae.  We generally have retained for portfolio a substantial portion of the single-family residential mortgage loans that we originate, only selling certain long-term, fixed-rate loans bearing interest rates below certain levels established by the board.  All of such loans have been sold to the Federal Home Loan Bank of Pittsburgh pursuant to the Mortgage Partnership Finance Program.  No sales occurred during the past three fiscal years.  We service all loans that we have originated, including loans that we subsequently sell. We currently originate fixed-rate, fully amortizing mortgage loans with maturities of 15, 20 or 30 years.  We also offer adjustable-rate mortgage (“ARM”) and balloon loans, which are structured as shorter term fixed-rate loans (generally 15 years or less) followed by a final payment of the full amount of the principal due at the maturity date.  However, due to local market conditions, originations of such loans have been limited in recent years.  At September 30, 2012, $6.3 million, or 3.1%, of our one- to four-family residential loan portfolio (excluding home equity loans and lines of credit) consisted of ARM loans.

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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.  A licensed appraiser appraises all properties securing one- to four-family first mortgage loans.  Our mortgage loans generally include due-on-sale clauses which provide us with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property.

Our single-family residential mortgage loans also include home equity loans and lines of credit, which amounted to $8.1 million and $11.7 million, respectively, at September 30, 2012.  The unused portion of home equity lines was $5.2 million at such date. Our home equity loans are fully amortizing and have terms to maturity of up to 20 years.  While home equity loans also are secured by the borrower’s residence, we generally obtain a second mortgage position on these loans.  Our lending policy provides that our home equity loans have loan-to-value ratios, when combined with any first mortgage, of 80% or less at time of origination, although the preponderance of our home equity loans have combined loan-to-value ratios of 75% or less at time of origination. We also offer home equity revolving lines of credit with interest tied to the Wall Street Journal prime rate. Generally, we have a second mortgage on the borrower’s residence as collateral on our home equity lines. In addition, our home equity lines generally have loan-to-value ratios (combined with any loan secured by a first mortgage) of 75% or less at time of origination. Our customers may apply for home equity lines as well as home equity loans at any banking office.  While there has been recent decline in some collateral values due to the weak real estate market, we believe our conservative underwriting guidelines have minimized our exposure in that regard.

Construction and Land Development Lending.  We have been an active originator of construction and land development loans for more than 25 years.   Construction loan originations prior to 2007 was a growth area for us because construction loans have shorter terms to maturity and they generally have floating or adjustable interest rates.  However, since 2007, our construction loan portfolio has decreased as market conditions made these loans less desirable due to the weakening of the real estate market resulting in slower sales and reduced housing prices in certain instances.  We have focused our construction lending on making loans to developers and homebuilders in our primary market area to acquire, develop and build single-family residences or condominium projects.  Our construction loans include, to a lesser extent, loans for the construction of multi-family residential or mixed-use properties.  At September 30, 2012, our construction and loan development loans amounted to $14.9 million, or 5.7% of our total loan portfolio.  This amount includes $1.6 million of undisbursed loans in process.  Our construction loan portfolio has decreased substantially since September 30, 2008 when construction loans amounted to $42.6 million or 16.5% of our total loan portfolio.

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Loans to finance the construction of condominium projects or single-family homes and subdivisions are generally offered to experienced builders in our primary market area with whom we have an established relationship.  Residential construction and development loans are offered with terms of up to 36 months although typically the terms are 12 to 24 months. The maximum loan-to-value limit applicable to these loans is 75% of the appraised post construction value and the policy does not require amortization of the principal during the term of the loan.  We often establish interest reserves and obtain personal and corporate guarantees as additional security on the construction loans.  Interest reserves are used to pay the monthly interest payments during the development phase of the loan and are treated as an addition to the loan balance.  Interest reserves pose an additional risk to the Company if it does not become aware of deterioration in the borrower’s financial condition before the interest reserve is fully utilized.  In order to help monitor the risk, financial statements and tax returns are obtained from borrowers on an annual basis.  Additionally, construction loans are reviewed at least annually pursuant to a third party loan review.  Construction loan proceeds are disbursed periodically in increments as construction progresses and as inspection by approved appraisers or loan inspectors warrants.  Construction loans are negotiated on an individual basis but typically have floating rates of interest based upon the Wall Street Journal prime rate.  Additional fees may be charged as funds are disbursed.  In addition to interest payments during the term of the construction loan, we typically require that payments to reduce the principal outstanding be made as units are completed and released.  Generally such principal payments must be equal to 110% of the amount attributable to acquisition and development of the lot plus 100% of the amount attributable to construction of the individual home.  We permit a pre-determined number of model homes to be constructed on an unsold or “speculative” basis.  All other units must be pre-sold before we will disburse funds for construction.  Construction loans also include loans to acquire land and loans to develop the basic infrastructure, such as roads and sewers. The majority of the construction loans are secured by properties located in Philadelphia, Pennsylvania. However, we also make construction loans in Bucks, Delaware and Montgomery Counties, Pennsylvania as well as the New Jersey suburbs of Philadelphia.  In addition, we have sold participation interests in a number of the larger construction projects, although we generally retain at least a 20% interest.  Such sales do not provide for any recourse against the Bank.

Set forth below is a brief description of the five largest construction loans.

The Bank’s largest loan relationship consists of several loans made to finance the construction and development of a 133-unit residential condominium project located in Center City Philadelphia.  The Bank along with five other banks that have participation interests in the loans advanced $29.0 million to the borrower, an established Philadelphia developer.  As the lead lender in the project, the Bank retained the largest interest in the loan, $5.8 million or 20% of the aggregate loan balance.  Construction of the units was completed in September 2010.  Sales of the units have been slower than projected and, as such, in fiscal 2011, the loans were restructured and a lower interest rate was granted in exchange for the pledging of additional collateral.  The restructured loans were classified as trouble debt restructurings and placed on non-accrual status and reflected in the Bank’s non-performing assets.  At September 30, 2012 there were 80 unsold units all of which are being used as rental properties to provide cash flow to service the debt.  As of September 30, 2012, the principal balance of the loan was $20.7 million (which reflected reductions to recognize charge-offs and discounts) with the portion retained by the Bank aggregating $8.8 million (including the additional loan referenced below).  The Bank’s interest in the loans reflected the acquisition by the Bank and another participant of the interests of two other participants in the loans.  In October 2012, the Bank and one of the participants acquired the interest of a third participant in the loans increasing the Bank's interest to $9.2 million.  In addition, in fiscal 2010 the Bank extended a new loan of $790,000 to the borrower to finance the construction of 21 commercial condominiums at the same location. During November 2012, the Bank entered into an agreement with a third party to sell all the loans for $14.0 million, which is anticipated to be completed by January 31,2013. In connection with such sale, the Bank and the other participants have agreed to extend a loan to an affiliate of the borrower in the amount of $2.25 million, the proceeds of which will be provided to the Bank and the other participants in partial payment of principal due on the loans sold to the third party.  Additional real estate collateral with an aggregate value of approximately $2.8 million will be provided to secure the loan. The new loan will initially be classified as a troubled debt restructuring.  No additional losses are anticipated to be incurred upon the consummation of the loan sale.  

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In June 2010, we extended a $5.1 million loan to a local real estate developer for the construction of 19 single-family homes in Bucks County Pennsylvania.  The loan has a 36 month term with interest only due during the term and a variable interest rate indexed to the Wall Street Journal prime rate plus a margin.  The loan has a floor of 6.0%.  The loan-to-value ratio at the date of origination was approximately 67% which includes certain additional collateral.  We retained the entire interest in the loan. As of September 30, 2012, the outstanding loan balance was approximately $4.2 million and 13 units have been sold with an additional four lots under agreements of sale.  The loan is performing in accordance with its terms.

In September 2009, we extended a $3.9 million construction and land development loan to a local developer to purchase land for future development of 39 single-family residential real estate units.  The loan was a variable-rate loan indexed to the Wall Street Journal prime rate plus a margin.  The loan has a floor of 5.5% and with a maturity date after pre-approved extensions of June 2011.  During 2011, a new appraisal revealed that the market value of the collateral had substantially decreased in value.  The borrower subsequently agreed to provide additional collateral resulting in a revised loan to value ratio of 73%.  The loan has been converted to a 30 year amortizing loan with a three year balloon maturing in September 2014.  Additionally, a portion of proceeds received by the developer from the sale of units in other projects must be applied to reduce the principal of this loan.  The borrower has agreed not to develop the project until certain other projects are completed.  The modification was not considered a troubled debt restructuring as the loans were current at the time of the restructuring and the restructured loans were made at current market rates.  As of September 30, 2012, the outstanding loan balance was approximately $3.8 million.  The loan is performing in accordance with its terms.

In 2007, we extended a $2.4 million construction loan to a local developer for the purchase and renovation of a property in Center City Philadelphia.  During 2009, an additional $530,000 was made available as part of the issuance of two home equity lines of credit secured by the renovated property and the developer’s primary residence.   Although construction is complete, the property remains unsold.  The loans were modified during June 2011, being restructured to three year balloon loans bearing interest at 4.875% amortizing based on a 30 year schedule.  The modification was not considered a troubled debt restructuring as the loans were current at the time of the restructuring and the restructured loans were made at current market rates.  The loans are classified as substandard due to the need for several extensions when the loans could not be satisfied at their original maturity date as well as due to delinquency issues in prior periods.  As of September 30, 2012, the loan balance was $2.8 million.  There was a $71,000 charge-off recognized during fiscal 2012 based on a decrease in the appraised values of the loan collateral.

In March 2010, we extended a $2.5 million loan to a local real estate developer for the financing of a 5 unit condominium project in Center City Philadelphia.  The loan has a 36 month term with interest only due during the term and a variable interest rate indexed to the Wall Street Journal prime rate plus a margin.  The loan has a floor of 6.25%.  At the end of the 36 month term, the loan will convert to a five year balloon with principal and interest amortization based on a 30 year schedule.  The loan-to-value ratio at the date of origination was approximately 55% which includes certain additional collateral.  We retained the entire interest in the loan. As of September 30, 2012, the outstanding loan balance was approximately $2.5 million.  The loan is performing in accordance with its terms.

Construction financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction compared to the estimated costs, including interest, of construction and other assumptions. Additionally, if the estimate of value proves to be inaccurate, we may be confronted with a project, when completed, having a value less than the loan amount. We have attempted to minimize these risks by generally concentrating on residential construction loans in our market area to contractors with whom we have established lending relationships and by selling, with respect to larger construction and land development loans, participation interests in order to reduce the Bank’s exposure.

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Multi-Family Residential and Commercial Real Estate Loans. At September 30, 2012, multi-family residential and commercial real estate loans amounted in the aggregate to $24.4 million or 9.3% of the total loan portfolio.

The commercial real estate and residential multi-family real estate loan portfolio consists primarily of loans secured by small office buildings, strip shopping centers, small apartment buildings and other properties used for commercial and multi-family purposes located in the Company’s market area.  At September 30, 2012, the average commercial and multi-family real estate loan size was approximately $262,000.   The largest multi-family residential or commercial real estate loan at September 30, 2012 was a $1.8 million participation interest in a loan serviced by another lender secured by a hotel in suburban Philadelphia.  The loan was performing in accordance with its terms at such date.  Substantially all of the properties securing the multi-family residential and commercial real estate loans are located in the Company’s primary market area.

Although terms for commercial real estate and multi-family loans vary, our underwriting standards generally allow for terms up to 15 yearswith loan-to-value ratios of not more than 75%. Most of the loans are structured with balloon payments of 10 years or less and amortization periods of up to 25 years.  Interest rates are either fixed or adjustable, based upon designated market indices such as the Wall Street Journal prime rate plus a margin or, with respect to our multi-family residential loans, the Average Contract Interest Rate for previously occupied houses as reported by the Federal Housing Finance Board.  In addition, fees are charged to the borrower at the origination of the loan.  We generally obtain personal guarantees of the principals as well as additional collateral for commercial real estate and multi-family real estate loans.

Commercial real estate and multi-family real estate lending involves different risks than single-family residential lending. These risks include larger loans to individual borrowers and loan payments that are dependent upon the successful operation of the project or the borrower’s business. These risks can be affected by supply and demand conditions in the project’s market area of rental housing units, office and retail space and other commercial space. We attempt to minimize these risks by limiting loans to proven businesses, only considering properties with existing operating performance which can be analyzed, using conservative debt coverage ratios in our underwriting, and periodically monitoring the operation of the business or project and the physical condition of the property.

Various aspects of commercial and multi-family loan transactions are evaluated in an effort to mitigate the additional risk in these types of loans. In our underwriting procedures, consideration is given to the stability of the property’s cash flow history, future operating projections, current and projected occupancy levels, location and physical condition. Generally, we impose a debt service ratio (the ratio of net cash flows from operations before the payment of debt service to debt service) of not less than 120%. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. Appraisal reports prepared by independent appraisers are reviewed by us prior to the closing of the loan.  With respect to loan participation interests we purchase, we underwrite the loans as if we were the originating lender.

Our origination of commercial real estate and multi-family loans were modest during the periods from fiscal 2010 through fiscal 2012. Although some delinquencies have existed with respect to these types of loans in our portfolio, no losses have been incurred over the past several years.

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Consumer Lending Activities.  We offer various types of consumer loans such as loans secured by deposit accounts and unsecured personal loans.  Consumer loans are originated primarily through existing and walk-in customers and direct advertising.  At September 30, 2012, $523,000, or 0.2% of the total loan portfolio consisted of these types of loans.

Consumer loans generally have higher interest rates and shorter terms than residential loans. However, consumer loans have additional credit risk due to the type of collateral securing the loan or in some cases the absence of collateral.

Commercial Business Loans.  Our commercial business loans amounted to $632,000 or 0.2% of the total loan portfolio at September 30, 2012.

Our commercial business loans typically are made to small to mid-sized businesses in our market area primarily to provide working capital.  Small business loans may have adjustable or fixed rates of interest and generally have terms of three years or less but may be as long as 15 years.  Our commercial business loans generally are secured by real estate. In addition, we generally obtain personal guarantees from the principals of the borrower with respect to commercial business loans.

Loan Approval Procedures and Authority. Our Board of Directors establishes Prudential Savings Bank’s lending policies and procedures. Our various lending policies are reviewed at least annually by our management team and the Board in order to consider modifications as a result of market conditions, regulatory changes and other factors.  All modifications must be approved by either the Executive Committee of the Board or the full Board of Directors.

Home equity loans and lines of credit up to $100,000 can be approved by one underwriter and either of two lending officers.  Amounts in excess of the individual lending limit with respect to home equity loans and lines of credit must be approved by our two lending officers, and our President or Chief Financial Officer.  All other loans must be approved by either the Executive Committee of the Board or the full Board of Directors of Prudential Savings Bank.

Asset Quality

General.  One of our key objectives has been, and continues to be, maintaining a high level of asset quality.  In addition to maintaining credit standards for new originations which we believe are prudent, we are proactive in our loan monitoring, collection and workout processes in dealing with delinquent or problem loans.  We also retain an independent, third party to undertake periodic reviews of the credit quality of a random sample of new loans as well as all of our major loans on at least an annual  basis.

Reports listing all delinquent accounts are generated and reviewed by management on a monthly basis.  These reports include information regarding all loans 30 days or more delinquent and all real estate owned properties and are provided to the Board of Directors.  The procedures we take with respect to delinquencies vary depending on the nature of the loan, period and cause of delinquency and whether the borrower is habitually delinquent.  When a borrower fails to make a required payment on a loan, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status.  We generally send the borrower a written notice of non-payment after the loan is first past due.   Our guidelines provide that telephone, written correspondence and/or face-to-face contact will be attempted to ascertain the reasons for delinquency and the prospects of repayment.  When contact is made with the borrower at any time prior to foreclosure, we will attempt to obtain full payment, work out a repayment schedule with the borrower to avoid foreclosure or, in some instances, accept a deed in lieu of foreclosure.  In the event payment is not then received or the loan not otherwise satisfied, additional letters and telephone calls generally are made.  If the loan is still not brought current or satisfied and it becomes necessary for us to take legal action, which typically occurs after a loan is 90 days or more delinquent, we will commence foreclosure proceedings against any real property that secures the loan.  If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before foreclosure sale, the property securing the loan generally is sold at foreclosure and, if purchased by us, becomes real estate owned.  Since there has not been a significant increase in recent years in the loans that are 90 days past due in our one-to four-family residential loan portfolio, the Company was not adversely impacted by any recent government programs related to the foreclosure process.

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On loans where the collection of principal or interest payments is doubtful, the accrual of interest income ceases (“non-accrual” loans). On loans 90 days or more past due as to principal and interest payments, our policy is to discontinue accruing additional interest and reverse any interest currently accrued.  On occasion, this action may be taken earlier if the financial condition of the borrower raises significant concern with regard to his/her ability to service the debt in accordance with the terms of the loan agreement. Interest income is not accrued on these loans until the borrower’s financial condition and payment record demonstrate an ability to service the debt.

Property acquired by Prudential Savings Bank through foreclosure is initially recorded at the lower of cost, which is the carrying value of the loan, or fair value at the date of acquisition, which is fair value of the related assets at the date of foreclosure, less estimated costs to sell.  Thereafter, if there is a further deterioration in value, we charge earnings for the diminution in value.  The Company’s policy is to obtain an appraisal on real estate subject to foreclosure proceedings prior to the time of foreclosure if the property is located outside the Company’s market area or consists of other than single-family residential property.  We obtain re-appraisals on a periodic basis, generally on at least an annual basis, on foreclosed properties.  We also conduct inspections on foreclosed properties.

We account for our impaired loans in accordance with generally accepted accounting principles.  An impaired loan generally is one for which it is more likely than not, based on current information, that the lender will not collect all the amounts due under the contractual terms of the loan.  Large groups of smaller balance, homogeneous loans are collectively evaluated for impairment.  Loans collectively evaluated for impairment include smaller balance commercial real estate loans, residential real estate loans and consumer loans.  These loans are evaluated as a group because they have similar characteristics and performance experience.  Larger commercial real estate, construction and land development and commercial business loans are individually evaluated for impairment on at least a quarterly basis by management and the independent third party loan review function.  All loans classified as substandard as part of the loan review process or due to delinquency status are evaluated for potential impairment.  There were $30.6 million of loans evaluated for impairment as of September 30, 2012, consisting of $25.4 million of one-to four-family residential loans, $2.6 million of commercial real estate loans, $2.6 million of construction and land development loans and $916,000 of multi-family loans.  Of the one-to four-family loans, $8.1 million related to one condominium construction project previously described herein.  Although no specific allocations were applied to these loans, there were partial charge-offs of $2.2 million applicable to the loans that were reviewed for impairment during fiscal 2012, a portion of which was expensed in prior years as part of specific allocations previously recognized.  There was $11.4 million of impaired loans as of September 30, 2011.

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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, consistent with Federal banking regulations, as a part of our credit monitoring system.  We currently classify problem and potential problem assets as “special mention”, “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.”

When an insured institution classifies one or more assets, or portions thereof, as “substandard” or “doubtful,” it is required that a general valuation allowance for loan losses be established for loan losses in accordance with established methodology.  General valuation allowances represent loss allowances which have been established to recognize the inherent losses associated with lending activities, but which, unlike specific allocations, have not been allocated to particular problem assets.  When an insured institution classifies one or more assets, or portions thereof, as “loss,” it is required either to establish a specific allocation equal to 100% of the amount of the loss or to charge off such amount.

Our allowance for loan losses includes a portion which is allocated by type of loan, based primarily upon our periodic reviews of the risk elements within the various categories of loans.  The specific components relate to certain impaired loans.  The general components cover non-classified loans and are based on historical loss experience adjusted for qualitative factors in response to changes in risk and market conditions.  Our management believes that, based on information currently available, the allowance for loan losses is maintained at a level which covers all known and inherent losses that are both probable and reasonably estimable at each reporting date.  However, actual losses are dependent upon future events and, as such, further additions to the level of the allowance for loan losses may become necessary.

We review and classify assets on a quarterly basis and the Board of Directors is provided with reports on our classified and criticized assets.  We classify assets in accordance with the management guidelines described above.  At September 30, 2012 and 2011, we had no assets classified as “doubtful” or “loss”, and  $30.6 million and  $19.0 million, respectively, of assets classified as “substandard.”  In addition, there were $6.8 million of loans designated as “special mention” as of September 30, 2011 but no loans were designated “special mention” as of September 30, 2012.

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Delinquent Loans.  The following table shows the delinquencies in the loan portfolio as of the dates indicated.

	September 30, 2012										September 30, 2011
	30-89					90 or More Days					30-89					90 or More Days
	Days Overdue					Overdue					Days Overdue					Overdue
	Number			Principal		Number			Principal		Number			Principal		Number			Principal
	of Loans			Balance		of Loans			Balance		of Loans			Balance		of Loans			Balance
	(Dollars in Thousands)
One- to four-family residential		10		$	1,108		31		$	4,624		26		$	3,048		20		$	2,663
Multi-family residential		-			-		-			-		-			-		-			-
Commercial real estate		1			233		1			241		1			358		3			545
Construction and land development		-			-		1			517		-			-		3			1,772
Commercial business		-			-		-			-		-			-		-			-
Consumer		1			1		-			-		-			-		-			-
Total delinquent loans		12		$	1,342		33		$	5,382		27		$	3,406		26		$	4,980
Delinquent loans to total net loans		0.51	%				2.06	%				1.42	%				2.07	%
Delinquent loans to total loans		0.51	%				2.04	%				1.38	%				2.02	%

Non-Performing Loans and Real Estate Owned.  The following table sets forth information regarding the non-performing loans and real estate owned.  The Company’s general policy is to cease accruing interest on loans, other than single-family residential loans, which are 90 days or more past due and to reverse all accrued interest.  At September 30, 2012, all of the loans listed as 90 or more days past due in the table above were in non-accrual status.  In addition, five loans totaling $8.1 million related to one condominium project discussed previously which were classified as troubled debt restructurings, were also in non-accrual status as of September 30, 2012 and 2011.

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The following table shows the amounts of non-performing assets (defined as non-accruing loans, accruing loans 90 days or more past due and real estate owned) at the dates indicated.

	September 30,
	2012			2011			2010			2009			2008
	(Dollars in Thousands)
Non-accruing loans:
One- to four-family residential	$	12,904		$	10,314		$	-		$	-		$	-
Multi-family residential		-			-			-			-			-
Commercial real estate		597			545			-			-			-
Construction and land development		517			1,772			-			640			3,640
Commercial business		-			-			-			-			-
Consumer		-			-			-			-			-
Total non-accruing loans		14,018			12,631			-			640			3,640
Accruing loans 90 days or more past due:
One- to four-family residential		-			-			1,811			851			152
Multi-family residential		-			-			-			-			-
Commercial real estate		-			-			1,462			491			244
Construction		-			-			206			-			-
Commercial business		-			-			-			-			-
Consumer		-			-			-			-			-
Total accruing loans 90 days or more past due		-			-			3,479			1,342			396
Total non-performing loans (1)		14,018			12,631			3,479			1,982			4,036
Real estate owned, net (2)		1,972			2,268			3,197			3,622			1,488
Total non-performing assets	$	15,990		$	14,899		$	6,676		$	5,604		$	5,524
Total non-performing loans as a percentage of loans, net		5.38	%		5.25	%		1.36	%		0.77	%		1.65	%
Total non-performing loans as a percentage of total assets		2.86	%		2.53	%		0.66	%		0.39	%		0.82	%
Total non-performing assets as a percentage of total assets		3.26	%		2.98	%		1.26	%		1.09	%		1.13	%

(1) Non-performing loans consist of non-accruing loans plus accruing loans 90 days or more past due.

(2) Real estate owned balances are shown net of related loss allowances and consist solely of real property.

Interest income on non-accrual loans is recognized only as collected.  There was $406,000 of such interest recognized during fiscal 2012 while there was $251,000 of such interest recognized for non-accrual loans for fiscal 2011.  Approximately $295,000 in additional interest income would have been recognized during the year ended September 30, 2012 if these loans had been performing during fiscal 2012.

At September 30, 2012, the Company’s non-performing assets totaled$16.0 million or 3.3% of total assets as compared to $14.9 million or 3.0% of total assets at September 30, 2011.  Non-performing assets at September 30, 2012 included $14.0 million in non-performing loans of which there were 37 one-to four-family residential loans totaling $12.9 million, one construction and land development loan totaling $517,000 and four commercial real estate loans extended to the same borrower totaling $597,000.  A principal of the borrower also has a single-family residential loan on non-accrual in the amount of $160,000 at September 30, 2012.  Included in the $12.9 million of non-performing one-to four-family residential loans were $8.1 million of troubled debt restructurings.  These troubled debt restructurings relate to a 133-unit completed condominium project in Philadelphia and consist of five loans extended to the same borrower.  (See “Lending Activities – Construction and Land Development Lending” for information regarding this loan relationship including the proposed sale of the loans to a third party).  Non-performing assets also included seven one-to-four family residential real estate owned properties totaling $2.0 million.

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As of September 30, 2012, there were seven real estate owned properties totaling $2.0 million, all of which consisted of residential properties.  Four of the real estate owned properties totaling $1.4 million consist of four townhouses in the same development project located in Philadelphia.  Four of the seven properties are being rented at this time.  All of the properties are currently being marketed for sale.  As of September 30, 2011, the real estate owned balance was $2.3 million consisting of six properties.

Allowance for Loan Losses.  The allowance for loan losses is established through a provision for loan losses charged to expense.  We maintain the allowance at a level believed, to the best of management’s knowledge, to cover all known and inherent losses in the portfolio that are both probable and reasonable to estimate at each reporting date.  Management reviews the allowance for loan losses on no less than a quarterly basis in order to identify those inherent losses and to assess the overall collection probability for the loan portfolio.  For each primary type of loan, we establish a loss factor reflecting an estimate of the known and inherent losses in such loan type using both a quantitative analysis as well as consideration of qualitative factors.  Management’s evaluation process includes, among other things, an analysis of delinquency trends, non-performing loan trends, the level of charge-offs and recoveries, prior loss experience, total loans outstanding, the volume of loan originations, the type, size and geographic concentration of our loans, the value of collateral securing the loan, the borrower’s ability to repay and repayment performance, the number of loans requiring heightened management oversight, local economic conditions and industry experience.

The carrying value of loans is periodically evaluated and the allowance is adjusted accordingly. The establishment of the allowance for loan losses is significantly affected by management judgment and uncertainties and there is a likelihood that different amounts would be reported under different conditions or assumptions.  Various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses.  Such agencies may require us to make additional provisions for estimated loan losses based upon judgments that differ from those of management.  As of September 30, 2012, our allowance for loan losses of $1.9 million was 0.7% of total loans receivable and 13.4% of non-performing loans.

Charge-offs on loans totaled $2.2 million and $4.4 million for the years ended September 30, 2012 and 2011, respectively.  The charge-offs during fiscal 2012 and 2011 were the primarily the result of the decline in collateral value on certain collateral dependent loans which are classified as substandard.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Comparison of Operating Results For the Years Ended September 30, 2012 and September 30, 2011” in Item 7.

Management will continue to monitor and modify the allowance for loan losses as conditions dictate.  No assurances can be given that the level of allowance for loan losses will cover all of the inherent losses on our loans or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses.

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The following table shows changes in the allowance for loan losses during the periods presented.

	At or For the Year Ended September 30,
	2012			2011			2010			2009			2008
	(Dollars in Thousands)
Total loans outstanding at end of period	$	263,205		$	247,084		$	263,018		$	265,063		$	258,501
Average loans outstanding		242,781			246,188			254,781			253,278			227,662
Allowance for loan losses, beginning of period		3,364			3,151			2,732			1,591			1,011
Provision for loan losses		725			4,630			1,110			1,403			1,084
Charge-offs:
One- to four-family residential		1,905			750			51			45			-
Multi-family residential and commercial real estate		-			-			-			-			-
Construction and land development		303			3,667			640			217			504
Commercial business		-			-			-			-			-
Consumer		-			-			-			-			-
Total charge-offs		2,208			4,417			691			262			504
Recoveries on loans previously charged off		-			-			-			-			-
Allowance for loan losses, end of period	$	1,881		$	3,364		$	3,151		$	2,732		$	1,591
Allowance for loan losses as a percent of total loans		0.71	%		1.36	%		1.20	%		1.03	%		0.62	%
Allowance for loan losses as a percent of non-performing loans		13.42	%		26.63	%		90.57	%		137.77	%		39.42	%
Ratio of net charge-offs during the period to average loans outstanding during the period		0.91	%		1.79	%		0.27	%		0.10	%		0.22	%

18

The following table shows how the allowance for loan losses is allocated by type of loan at each of the dates indicated.

	September 30,
	2012					2011					2010					2009					2008
			Loan					Loan					Loan					Loan					Loan
			Category					Category					Category					Category					Category
	Amount		as a %			Amount		as a %			Amount		as a %			Amount		as a %			Amount		as a %
	of		of Total			of		of Total			of		of Total			of		of Total			of		of Total
	Allowance		Loans			Allowance		Loans			Allowance		Loans			Allowance		Loans			Allowance		Loans
	(Dollars in Thousands)
One- to four-family residential	$	830		84.64	%	$	1,651		79.53	%	$	672		74.96	%	$	403		75.98	%	$	155		74.02	%
Multi-family residential		7		1.92	%		7		2.32	%		4		1.52	%		7		1.58	%		4		1.08	%
Commercial real estate		125		7.35	%		221		8.57	%		560		7.49	%		193		7.51	%		106		7.94	%
Construction and land development		745		5.65	%		1,481		9.00	%		1,909		15.46	%		2,114		13.87	%		1,323		16.49	%
Commercial business		3		0.24	%		3		0.33	%		3		0.34	%		7		0.84	%		1		0.18	%
Consumer		1		0.20	%		1		0.25	%		1		0.23	%		1		0.22	%		2		0.29	%
Unallocated		170		-			-		-			2		-			7		-			-		-
Total allowance for loan losses	$	1,881		100.00	%	$	3,364		100.00	%	$	3,151		100.00	%	$	2,732		100.00	%	$	1,591		100.00	%

The aggregate allowance for loan losses decreased by $1.5 million from September 30, 2011 to September 30, 2012 due to charge-offs of $2.2 million as the Company has taken an aggressive approach in writing down all substandard loans to the net realizable value of the applicable collateral.  The fluctuation in the allowance was determined based on management’s consideration of the known and inherent losses in the loan portfolio that are reasonably estimateable as well as current qualitative and quantitative risk factors as of September 30, 2012.

Investment Activities

General.  We invest in securities in accordance with policies approved by our board of directors.  The investment policy designates the President, Chief Financial Officer and Treasurer as the Investment Committee, which is authorized by the board to make the Bank’s investments consistent with the investment policy.  The Board of Directors of Prudential Savings Bank reviews all investment activity on a monthly basis.

The investment policy is designed primarily to manage the interest rate sensitivity of the assets and liabilities, to generate a favorable return without incurring undue interest rate and credit risk, to complement the lending activities and to provide and maintain liquidity.  The current investment policy generally permits securities investments in debt securities issued by the U.S. government and U.S. agencies, municipal bonds, and corporate debt obligations, as well as investments in preferred and common stock of government agencies and government sponsored enterprises such as Fannie Mae, Freddie Mac and the Federal Home Loan Bank of Pittsburgh (federal agency securities) and, to a lesser extent, other equity securities. Securities in these categories are classified as “investment securities” for financial reporting purposes. The policy also permits investments in mortgage-backed securities, including pass-through securities issued and guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae as well as collateralized mortgage obligations (“CMOs”) issued or backed by securities issued by these government sponsored agencies.

19

Ginnie Mae is a government agency within the Department of Housing and Urban Development which is intended to help finance government-assisted housing programs. Ginnie Mae securities are backed by loans insured by the Federal Housing Administration, or guaranteed by the Department of Veterans Affairs.  The timely payment of principal and interest on Ginnie Mae securities is guaranteed by Ginnie Mae and backed by the full faith and credit of the U.S. Government.  Freddie Mac is a private corporation chartered by the U.S. Government.  Freddie Mac issues participation certificates backed principally by conventional mortgage loans.  Freddie Mac guarantees the timely payment of interest and the ultimate return of principal on participation certificates.  Fannie Mae is a private corporation chartered by the U.S. Congress with a mandate to establish a secondary market for mortgage loans.  Fannie Mae guarantees the timely payment of principal and interest on Fannie Mae securities.  Freddie Mac and Fannie Mae securities are not backed by the full faith and credit of the U.S. Government. On September 7, 2008, Freddie Mac and Fannie Mae were placed into conservatorship by the U.S. Government.  During 2011 and 2012 the Federal Housing Administration Agency indicated that the Treasury Department is committed to fund Freddie Mac and Fannie Mae to levels needed in order to sufficiently to meet their funding needs.

Investments in mortgage-backed securities involve a risk that actual prepayments will be greater than estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby changing the net yield on such securities.  There is also reinvestment risk associated with the cash flows from such securities or in the event such securities are redeemed by the issuer.  In addition, the market value of such securities may be adversely affected by changes in interest rates.  Further, privately issued mortgage-backed securities and CMOs also have a higher risk of default due to adverse changes in the creditworthiness of the issuer. Management’s  practice is generally to not invest in such securities, and the current portfolio is limited to the securities received as a result of the redemption in kind of an investment in a mutual fund. See further discussion in Note 4 of the Notes to Consolidated Financial Statements included in Item 8 herein.

At September 30, 2012, the investment and mortgage-backed securities amounted to $129.1 million or 26.3% of total assets at such date.  The largest component of the securities portfolio as of September 30, 2012 was U.S. Government agency mortgage-backed securities, which amounted to $66.3 million or 51.4% of the securities portfolio at September 30, 2012.  In addition, we invest in U.S Government and agency obligations and to a significantly lesser degree, municipal securities and other securities.

The securities are classified at the time of acquisition as available for sale, held to maturity or trading.  Securities classified as held to maturity must be purchased with the intent and ability to hold that security until its final maturity, and can be sold prior to maturity only under rare circumstances.  Held to maturity securities are accounted for based upon the amortized cost of the security.  Available for sale securities can be sold at any time based upon needs or market conditions.  Available for sale securities are accounted for at fair value, with unrealized gains and losses on these securities, net of income tax provisions, reflected as accumulated other comprehensive income.  At September 30, 2012, we had $63.1 million of investment and mortgage-backed securities classified as held to maturity, $66.0 million of investment and mortgage-backed securities classified as available for sale and no securities classified as trading securities.

We do not purchase mortgage-backed derivative instruments nor do we purchase corporate obligations which are not rated investment grade or better.  However, certain investments acquired through a redemption in kind during 2008 of our entire investment in a mutual fund are below investment grade.  As of September 30, 2012, we held $4.1 million of such securities.

20

The mortgage-backed securities consist primarily of mortgage pass-through certificates issued by Ginnie Mae, Fannie Mae or Freddie Mac.  At September 30, 2012, approximately 6.2% of the mortgage-backed securities were non-agency securities, all of which were acquired through the 2008 redemption in kind.  See further discussion in Note 4 of the Notes to Consolidated Financial Statements in Item 8.

The following table sets forth certain information relating to the investment and mortgage-backed securities portfolios at the dates indicated.

	September 30,
	2012				2011				2010
	Amortized		Market		Amortized		Market		Amortized		Market
	Cost		Value		Cost		Value		Cost		Value
	(In Thousands)
Mortgage-backed securities - U.S. Government agencies	$	64,357	$	68,364	$	78,588	$	85,220	$	78,036	$	83,342
Mortgage-backed securities - Non-agency		4,308		4,103		5,249		4,357		8,067		7,199
U.S. Government and agency obligations		58,469		59,902		97,068		98,508		95,978		97,995
Municipal obligations		-		-		-		-		475		475
Total debt securities		127,134		132,369		180,905		188,085		182,556		189,011
FHLB stock		2,239		2,239		2,887		2,887		3,545		3,545
FHLMC preferred stock		6		7		6		6		8		8
Total investment and mortgage-backed securities	$	129,379	$	134,615	$	183,798	$	190,978	$	186,109	$	192,564

The following tables set forth the amortized cost of investment and mortgage-backed securities which mature during each of the periods indicated and the weighted average yields for each range of maturities at September 30, 2012.  Tax-exempt yields have not been adjusted to a tax-equivalent basis.

	Amounts at September 30, 2012 Which Mature In
						Over One					Over Five
			Weighted			Year		Weighted			Years		Weighted			Over		Weighted					Weighted
	One Year		Average			Through		Average			Through		Average			Ten		Average					Average
	or Less		Yield			Five Years		Yield			Ten Years		Yield			Years		Yield			Total		Yield
	(Dollars in Thousands)
Bonds and other debt securities:
U.S. Government and agency obligations	$	1,000		0.87	%	$	4,000		1.59	%	$	16,496		2.66	%	$	36,973		2.85	%	$	58,469		2.68	%
Mortgage-backed securities		-		-			-		-			22		2.56	%		68,643		3.79	%		68,665		3.79	%
Total	$	1,000		0.87	%	$	4,000		1.59	%	$	16,518		2.66	%	$	105,616		3.46	%	$	127,134		3.28	%

21

The following table sets forth the purchases and principal repayments of our mortgage-backed securities at amortized cost during the periods indicated.

	At or For the
	Year Ended September 30,
	2012			2011			2010
	(Dollars in Thousands)
Mortgage-backed securities at beginning of period	$	83,837		$	86,103		$	95,217
Purchases		25,821			14,613			11,853
Sale of mortgage-backed securities available for sale		(19,528	)		(90	)		-
Other than temporary impairment of securities (1)		(154	)		(202	)		(560	)
Maturities and repayments		(21,623	)		(16,918	)		(20,810	)
Amortizations of premiums and discounts, net		312			331			403
Mortgage-backed securities at end of period	$	68,665		$	83,837		$	86,103
Weighted average yield at end of period		3.79	%		4.55	%		5.37	%

(1) Impairment primarily relates to non-agency mortgage-backed securities received in redemption in kind from the sale of the investment in a mutual fund.

Sources of Funds

General.  Deposits, loan repayments and prepayments, proceeds from sales of loans, cash flows generated from operations and FHLB advances are the primary sources of funds for use in lending, investing and for other general purposes.

Deposits.  We offer a variety of deposit accounts with a range of interest rates and terms.  Deposits consist of checking, both interest-bearing and non-interest-bearing, money market, savings and certificate of deposit accounts.  At September 30, 2012, 41.9% of the funds deposited with Prudential Savings Bank were in core deposits, which are deposits other than certificates of deposit.

The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition.  Deposits are obtained predominantly from the areas where the branch offices are located.  We have historically relied primarily on customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions significantly affect the Company’s ability to attract and retain deposits. The interest rates offered on deposits are competitive in the market place and have increased over the past year as market rates have increased.

Prudential Savings Bank uses traditional means of advertising its deposit products, including broadcast and print media and generally does not solicit deposits from outside its market area.

We do not actively solicit certificate accounts of $100,000 and above, known as “jumbo CDs,” or use brokers to obtain deposits.  At September 30, 2012, jumbo CDs amounted to $96.2 million, of which $58.2 million are scheduled to mature within twelve months subsequent to such date.  At September 30, 2012, the weighted average remaining period until maturity of the certificate of deposit accounts was 16.2 months.

22

The following table shows the distribution of, and certain other information relating to, deposits by type of deposit, as of the dates indicated.

	September 30,
	2012					2011					2010
	Amount		% of Total Deposits			Amount		% of Total Deposits			Amount		% of Total Deposits
	(Dollars in Thousands)
Certificate accounts:
Less than 1.00%	$	62,984		14.80	%	$	23,195		5.32	%	$	4,786		1.03	%
1.00% - 1.99%		63,981		15.03	%		105,366		24.17	%		90,381		19.46	%
2.00% - 2.99%		84,887		19.95	%		77,636		17.81	%		114,170		24.58	%
3.00% - 3.99%		19,460		4.57	%		21,801		5.00	%		28,962		6.24	%
4.00% - 4.99%		10,101		2.37	%		10,914		2.50	%		21,096		4.54	%
5.00% - 5.99%		6,001		1.41	%		17,325		3.97	%		30,695		6.61	%
Total certificate accounts	$	247,414		58.13	%	$	256,237		58.77	%	$	290,090		62.46	%
Transaction accounts:
Savings		71,083		16.70	%		70,623		16.20	%		69,901		15.05	%
Checking:
Interest-bearing		33,659		7.91	%		29,658		6.80	%		26,146		5.63	%
Non-interest-bearing		3,711		0.87	%		3,847		0.88	%		2,496		0.54	%
Money market		69,735		16.39	%		75,649		17.35	%		75,822		16.32	%
Total transaction accounts	$	178,188		41.87	%	$	179,777		41.23	%	$	174,365		37.54	%
Total deposits	$	425,602		100.00	%	$	436,014		100.00	%	$	464,455		100.00	%

The following table shows the average balance of each type of deposit and the average rate paid on each type of deposit for the periods indicated.

	Year Ended September 30,
	2012							2011							2010
	Average Balance		Interest Expense		Average Rate Paid			Average Balance		Interest Expense		Average Rate Paid			Average Balance		Interest Expense		Average Rate Paid
	(Dollars in Thousands)
Savings	$	70,186	$	401		0.57	%	$	69,741	$	700		1.00	%	$	69,363	$	1,230		1.77	%
Interest-bearing checking and money market accounts		103,988		490		0.47	%		105,046		779		0.74	%		105,724		1,119		1.06	%
Certificate accounts		258,154		4,884		1.89	%		271,758		5,612		2.07	%		264,082		6,321		2.39	%
Total interest-bearing  deposits		432,328	$	5,775		1.34	%		446,545	$	7,091		1.59	%		439,169	$	8,670		1.97	%
Non-interest-bearing deposits		3,924							3,291							2,241
Total deposits	$	436,252				1.32	%	$	449,836				1.58	%	$	441,410				1.96	%

23

The following table shows the savings flows during the periods indicated.

	Year Ended September 30,
	2012			2011			2010
	(In Thousands)
Deposits made	$	322,480		$	419,733		$	478,078
Withdrawals		(336,952	)		(453,949	)		(451,630	)
Interest credited		4,060			5,775			5,633
Total (decrease) increase in deposits	$	(10,412	)	$	(28,441	)	$	32,081

The following table presents, by various interest rate categories and maturities, the amount of certificates of deposit at September 30, 2012.

	Balance at September 30, 2012
	Maturing in the 12 Months Ending September 30,
Certificates of Deposit	2013		2014		2015		Thereafter		Total
	(In Thousands)
Less than 1.00%	$	49,756	$	13,228	$	-	$	-	$	62,984
1.00% - 1.99%		28,886		18,469		9,749		6,877		63,981
2.00% - 2.99%		52,813		1,118		2,035		28,921		84,887
3.00% - 3.99%		596		6,823		11,767		274		19,460
4.00% - 4.99%		7,314		2,787		-		-		10,101
5.00% - 5.99%		6,001		-		-		-		6,001
Total certificate accounts	$	145,366	$	42,425	$	23,551	$	36,072	$	247,414

The following tables show the maturities of our certificates of deposit of $100,000 or more at September 30, 2012, by time remaining to maturity.

			Weighted
Quarter Ending:	Amount		Avg Rate
	(Dollars in Thousands)
December 31, 2012	$	13,020		1.72	%
March 31, 2013		13,598		1.78	%
June 30, 2013		20,805		1.87	%
September 30, 2013		10,758		1.51	%
After September 30, 2013		38,064		2.15	%
Total certificates of deposit with balances of $100,000 or more	$	96,245		1.91	%

24

Borrowings.  We utilize advances from the Federal Home Loan Bank of Pittsburgh as an alternative to retail deposits to fund the operations as part of the operating and liquidity strategy.  See “Liquidity and Capital Resources” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation.  These FHLB advances are collateralized primarily by certain mortgage loans and mortgage-backed securities and secondarily by an investment in capital stock of the Federal Home Loan Bank of Pittsburgh.  There are no specific credit covenants associated with these borrowings.  FHLB advances are made pursuant to several different credit programs, each of which has its own interest rate and range of maturities.  The maximum amount that the Federal Home Loan Bank of Pittsburgh will advance to member institutions, including Prudential Savings Bank, fluctuates from time to time in accordance with the policies of the Federal Home Loan Bank.  At September 30, 2012, we had $483,000 in outstanding FHLB advances (as described below) and $115.6 million of additional FHLB advances available.  At such date, maturities of our outstanding advances range from one month to three years.  We have not utilized any other types of borrowings such as securities sold under agreements to repurchase.

        The following table shows certain information regarding borrowings at or for the dates indicated:

	At or For the Year Ended September 30,
	2012		2011		2010
	(Dollars in Thousands)
FHLB advances:
Average balance outstanding	$	537	$	591	$	16,676
Maximum amount outstanding at any month-end during the period		567		611