t72169_10k.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended September 30, 2011; 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: 000-51208

	BROOKLYN FEDERAL BANCORP, INC.
(Exact name of registrant as specified in its charter)

	Federal			20-2659598
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification No.)

81 Court Street, Brooklyn, New York			11201
(Address of principal executive offices)		(Zip Code)

	(718) 855-8500
(Registrant’s telephone number, including area code)

	Common Stock, $.01 par value
(Securities registered pursuant to Section 12(b) of the Act)

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

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 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 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 the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K of 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.

	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. Yes o No x

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the price at which the common equity was last sold on the NASDAQ Stock Market as of the last business day of the registrant’s 2011 second fiscal quarter was $2,392,571.

The number of shares outstanding of the registrant’s common stock was 12,871,385 as of December 8, 2011 (including 9,257,500 shares owned by BFS Bancorp, MHC, a federal mutual holding company).

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be delivered to shareholders in connection with the 2012 Annual Meeting of Shareholders are incorporated by reference into Part III.

BROOKLYN FEDERAL BANCORP, INC.

2011 FORM 10-K

TABLE OF CONTENTS


		Page Number

PART I

Item 1.	Business	2
Item 1A.	Risk Factors	38
Item 1B.	Unresolved Staff Comments	44
Item 2.	Properties	45
Item 3.	Legal Proceedings	45
Item 4.	[Removed and Reserved]	47

PART II

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	48
Item 6.	Selected Financial Data	49
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation	50
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	101
Item 9A.	Controls and Procedures	101
Item 9B.	Other Information	102

PART III

Item 10.	Directors, Executive Officers and Corporate Governance	103
Item 11.	Executive Compensation	103
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	103
Item 13.	Certain Relationships and Related Transactions, and Director Independence	103
Item 14.	Principal Accounting Fees and Services	103

PART IV

Item 15.	Exhibits, Financial Statement Schedules	104

SIGNATURES		106

Warning About Forward-Looking Statements

Certain statements contained herein are not based on historical facts and are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as “may,” “could,” “will,” “believe,” “expect,” “intend,” “should,” “potential,” “will likely result,” “are expected to,” “projected,” “estimate,” “anticipate,” “continue,” or similar terms or variations on those terms, or the negative of those terms. Forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, those related to the economic environment, particularly in the market areas in which Brooklyn Federal Bancorp, Inc. and its consolidated subsidiaries (which are referred to herein as the “Company,” “we,” “our,” and “us”) operate and which affect the creditworthiness of borrowers; competitive products and pricing; the timing and occurrence or non-occurrence of events that may be subject to circumstances beyond our control; fiscal and monetary policies of the U.S. Government; the ability of customers to repay their obligations; the adequacy of the allowance for loan losses (and position of banking regulators with respect to the adequacy of loan losses); changes in deposit flows; changes in loan delinquency rates or in our levels of non-performing assets; changes in real estate values; changes in accounting or tax principles, policies, or guidelines; changes in legislation and regulation, particularly those affecting financial institutions, including regulatory fees and capital requirements; changes in prevailing interest rates; the closing of our expected merger transactions; credit risk management; asset-liability management; the financial and securities markets and the availability of and costs associated with sources of liquidity.

The Company wishes to caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made. Actual results could differ from those expressed or implied by the forward-looking statements and certain risks could cause our results to differ materially from any opinions or statements expressed with respect to future periods in any current statements. For a description of the material factors that could affect such forward-looking statements, see the discussion contained under the heading “Item 1A. Risk Factors.” The Company does not undertake and specifically declines any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of the original statement or to reflect the occurrence of anticipated or unanticipated events.

PART I

Item 1 Business

BFS Bancorp, MHC

BFS Bancorp, MHC is the federally chartered mutual holding company parent of Brooklyn Federal Bancorp, Inc. The only business that BFS Bancorp, MHC has engaged in is managing its majority ownership of Brooklyn Federal Bancorp, Inc. BFS Bancorp, MHC was formed upon completion of the reorganization of Brooklyn Federal Savings Bank (the “Bank”) into the mutual holding company structure. So long as BFS Bancorp, MHC exists, it will own a majority of the voting stock of Brooklyn Federal Bancorp, Inc.

Brooklyn Federal Bancorp, Inc.

Brooklyn Federal Bancorp, Inc. was formed to serve as the stock holding company for the Bank as part of the Bank’s reorganization into the mutual holding company structure. The Company issued 9,257,500 shares to BFS Bancorp, MHC, resulting in a total of 13,225,000 shares issued and outstanding after completion of the reorganization. At September 30, 2011, there were 12,871,385 total shares outstanding resulting in a 71.9% ownership by BFS Bancorp, MHC. The Company completed its initial public offering on April 5, 2005.

Brooklyn Federal Savings Bank

The Bank is a federally chartered savings bank headquartered in Brooklyn, New York. The Bank was originally founded in 1887. We conduct our business from our main office and four branch offices. All of our offices are located in New York. The telephone number at our main office is (718) 855-8500.

At September 30, 2011, we had total assets of $459.1 million, total deposits of $400.9 million and stockholders’ equity of $42.4 million. Our net loss for the fiscal year ended September 30, 2011 was $5.6 million. Our principal business activity is the origination of mortgage loans secured by one- to four-family residential real estate, multi-family real estate, commercial real estate, construction loans, land loans and, to a limited extent, a variety of consumer loans and home equity loans. The Bank offers a variety of deposit accounts, including checking, savings and certificates of deposit, and it emphasizes personal and efficient service for its customers.

Our website address is www.brooklynbank.com. Information on our website should not be considered a part of this document.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, the Bank and the Bank’s wholly owned subsidiaries. The Bank’s wholly-owned subsidiaries are Thrift Investors Service Corporation (“TISCO”), 3D Holding Corp., Inc. and BFS REIT, Inc. BFS REIT is a real estate investment trust formed to hold mortgage-related assets. TISCO’s wholly owned subsidiary, BFS Agency, provides insurance services to the customers of the Bank. 3D Holding Corp. Inc. wholly owned subsidiaries Ash Real Estate Holding Corp. and Birch Real Estate Holding Corp. were formed to hold title to certain properties acquired by the Bank through foreclosure.

Merger Agreement

As previously reported, on August 16, 2011, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) by and between (i) Investors Savings Bank (“Investors Bank”), Investors Bancorp, Inc. (“Investors Bancorp”), and Investors Bancorp, MHC (“Investors MHC”), and (ii) the Bank, the Company and BFS Bancorp, MHC. The Merger Agreement provides, among other things, that as a result of the merger of the Company into Investors Bancorp, or a newly-formed subsidiary thereof (the “Mid-Tier Merger”), each outstanding share of the Company’s common stock (other than shares owned by BFS Bancorp, MHC), will be converted into the right to receive $0.80 in cash, and potentially an additional $0.07 per share pursuant to settlement of certain litigation relating to the Mergers (as defined below). See “Item 3. Legal Proceedings”.

The merger transactions below (which are collectively referred to as the “Mergers”) will be effected as follows:

	●	BFS Bancorp, MHC will merge with and into Investors MHC, with Investors MHC as the surviving entity. The separate corporate existence of BFS Bancorp, MHC will cease (the “MHC Merger”).

	●	Immediately following the MHC Merger, the Company will merge with and into Investors Bancorp, or a to-be-formed wholly owned subsidiary of Investors Bancorp, with Investors Bancorp (or its wholly-owned subsidiary) as the surviving entity. The separate corporate existence of the Company will cease.

	●	The Bank will merge with and into Investors Bank, with Investors Bank as the surviving entity (the “Bank Merger”). The separate corporate existence of the Bank will cease. This Bank Merger will follow the MHC Merger and the Mid-Tier Merger.

The obligations of the parties to complete the Mergers is subject to various customary conditions, including, among others: the Merger Agreement and applicable transactions must have been approved by the required vote of the shareholders of the Company and members of BFS Bancorp, MHC; the absence of any law or order prohibiting the closing of the Mergers; receipt of required regulatory approvals; no proceedings shall have been initiated or threatened by the U.S. Securities and Exchange Commission (“SEC”) challenging the merger proxy statement; and Investors Bancorp must have received an opinion from its legal counsel Luse Gorman Pomerenk & Schick, P.C., dated as of the closing date, indicating that the Mergers will qualify as tax-free reorganizations within the meaning of the Internal Revenue Code of 1986, as amended. A special meeting of the stockholders of the Company has been scheduled for December 22, 2011, at which time the stockholders will vote upon approval of the Merger Agreement. If the stockholders of the Company approve the Merger Agreement, and all other conditions are satisfied or waived, the Company expects that the Mergers will be consummated in January 2012.

If the Mergers are terminated under specified situations in the Merger Agreement (because the Company accepts a proposal to acquire it superior to the one contained in the Merger Agreement, enters into an agreement related to such a proposal and terminates the Merger Agreement, or fails to make, withdraws, modifies or qualifies its recommendation regarding the Merger Agreement), the Company may be required to pay a termination fee to Investors Bancorp of approximately $460,000 (which may be reduced to $300,000 upon settlement of certain litigation relating to the Mergers), plus out-of-pocket expenses not to exceed the sum of $50,000 less certain reimbursable expenses paid by the Bank. The Company agreed to this termination fee arrangement in order to induce Investors Bancorp to enter into the Merger Agreement.

Enforcement Actions: Going Concern

The Company and the Bank are subject to enforcement actions and other requirements imposed by federal banking regulators. In particular, and as previously reported, the Bank is subject to a Cease and Desist Order (the “Bank Order”) issued by the former Office of Thrift Supervision (the “OTS”) on March 31, 2011 that required, among other things, the Bank to implement an updated business plan to improve the Bank’s core earnings, reduce expenses, maintain an appropriate level of liquidity and achieve profitability. The Bank Order also required that the Bank achieve and maintain a Tier 1 Capital Ratio equal to or greater than 10% and a Total Risk-Based Capital Ratio equal to or greater than 15%, after the funding of its allowance for loan and lease losses, by April 30, 2011. As of April 30, 2011, the Bank did not meet these capital requirements and continued not to meet the capital requirements through September 30, 2011.

As the Bank failed to achieve the capital ratios required by the Bank Order, the Bank was required to file a Contingency Plan with the OTS within 15 days of April 30, 2011. The Bank Order required that the Contingency Plan detail actions to be taken and specific time frames to achieve either a merger with, or acquisition by, another federally insured depository institution or holding company thereof, or a voluntary dissolution by the later of the date of all required regulatory approvals or sixty (60) days after implementation of the Contingency Plan. The Bank filed the Contingency Plan with the OTS on May 12, 2011 and by letter dated June 15, 2011, the OTS directed the Bank to immediately implement and adhere to such Contingency Plan. Moreover, as the holding companies of the Bank, the Company and BFS Bancorp, MHC also are subject to a separate but related Cease and Desist Order issued by the OTS on the same date as the Bank’s Order, which required, among other terms, that the Company and BFS Bancorp, MHC ensure the Bank’s compliance with the terms of the Bank Order. The consummation of the Mergers is intended to comply with the requirements of the Bank Order and related Cease and Desist Order applicable to the Company and BFS Bancorp, MHC.

The audited consolidated financial statements contained in this report have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. Failure to comply with the requirements of the Contingency Plan to complete the Mergers or an alternative merger or acquisition would result in the imposition of the Contingency Plan requirement to voluntarily dissolve. These factors give rise to substantial doubt as to the Company’s ability to continue as a going concern. The audited financial statements herein do not include any adjustments that may result should the Company be unable to continue as a going concern.

SEC Subpoena

By letter dated August 11, 2011, as part of a formal investigation being conducted by the U.S. Securities and Exchange Commission’s Division of Enforcement (“Enforcement Division”), the Company received from the Enforcement Division a subpoena to produce, among other things, information related to its provisions and allowances for loan losses and deferred tax asset valuation allowances contained in its annual and quarterly reports for fiscal years 2008 through 2010, the restatement of its consolidated financial statements for the first three quarters of 2010 and the effectiveness of its internal controls. The subpoena covers the time period from October 1, 2007 through August 11, 2011. Brooklyn intends to cooperate fully with the investigation.

Competition

We face intense competition within our market area both in making loans and attracting deposits. The New York City metropolitan area has a high concentration of financial institutions including large money center and regional banks, community banks and credit unions. Some of our competitors offer products and services that we currently do not offer, such as trust services and private banking. As of June 30, 2011, our market share of deposits represented 0.51%, 0.25% and 0.26% of deposits in each of Kings, Nassau and Suffolk Counties, New York, respectively.

Our competition for loans and deposits comes principally from commercial banks, savings institutions, mortgage banking firms and credit unions. We face additional competition for deposits from short-term money market funds, brokerage firms, mutual funds and insurance companies. Our primary focus is to develop and build profitable customer relationships across all lines of business while maintaining our role as a community bank.

Market Area

We are part of the diverse economy of the New York City metropolitan area. Brooklyn (Kings County) is an urban market area while Nassau and Suffolk Counties are suburban. Our market area has a stable population and household base. In 2010, the median household income for Kings, Nassau, and Suffolk Counties was $42,143, $91,104 and $81,551, respectively. Our primary lending area is concentrated in Brooklyn and Nassau and Suffolk Counties, New York, although we originate loans in all five boroughs of New York City as well as Westchester County, New York. One- to four-family residential real estate in our market area is characterized by a large number of attached and semi-detached houses, including a number of two- and three-family homes and cooperative apartments. Most of our deposit customers are residents of the greater New York metropolitan area. Our customer base consists primarily of middle-income households, and to a lesser extent, low- to moderate-income households. The median household income for Brooklyn is below the national and New York state median household incomes. In addition, the unemployment rate in Kings County is higher than in the surrounding suburbs.

Lending Activities

Commercial real estate loans totaled $76.0 million, or 27.1% of our total loans receivable at September 30, 2011. One- to four-family residential real estate mortgage loans represented $82.4 million, or 29.3%, of our loans receivable at September 30, 2011. Multi-family real estate loans totaled $36.3 million, or 12.9% of the total loans receivable at September 30, 2011. Construction loans totaled $70.1 million, or 25.0% and land loans totaled $15.5 million, or 5.5% of the total loans receivable at September 30, 2011. We originate consumer loans on a limited basis. We sell most of our longer-term residential loans to the Federal Home Loan Bank of New York and other investors, on a servicing-retained basis. We syndicate and sell participation interests in portions of our multi-family, commercial real estate and construction loans because of our legal lending limits and our internal portfolio management guidelines. On December 3, 2009, the Bank agreed with the OTS that the Bank will not originate any commercial real estate, construction or multi-family loans without prior OTS approval, which restriction is still in effect for the Bank and is now enforced by the OTS’ successor, the OCC.

Loans Receivable Portfolio Composition. The following table sets forth the composition of our loan portfolio, excluding loans held-for-sale (which were zero in 2011 and 2010), by type of loan at the dates indicated.

	At September 30,
	2011						2010
	Amount			Percent			Amount			Percent
	(Dollars in thousands)

Mortgage loans:
One-to four-family	$	82,397			29.36	%	$	73,457			18.90	%
Multi-family		36,319			12.94	%		65,209			16.77	%
Commercial real estate		75,996			27.07	%		119,727			30.80	%
Construction		70,144			24.99	%		95,824			24.65	%
Land		15,547			5.54	%		34,084			8.77	%
Consumer and other		291			0.10	%		449			0.12	%

Total loans receivable		280,694			100.00	%		388,750			100.00	%

Other items:
Net deferred loan fees		(238	)					(967	)
Allowance for loan losses		(16,853	)					(17,941	)

Total loans receivable, net	$	263,603					$	369,842

Loan Portfolio Maturities. The following table summarizes the scheduled repayments of our loan portfolio at September 30, 2011. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.

	One-to				Commercial						Consumer
	Four-Family		Multi-Family		Real Estate		Construction		Land		and Other		Total
Due During the Years	(In thousands)
Ending September 30,

2012	$	6,980	$	18,583	$	44,177	$	70,144	$	15,547	$	89	$	155,520
2013		5,080		3,427		16,821		-		-		54		25,382
2014		4,850		8,391		6,404		-		-		16		19,661
2015 to 2016		9,857		4,945		5,802		-		-		-		20,604
2017 to 2021		20,298		973		2,664		-		-		-		23,935
2022 to 2026		15,271		-		128		-		-		-		15,399
2027 and beyond		20,061		-		-		-		-		132		20,193

Total	$	82,397	$	36,319	$	75,996	$	70,144	$	15,547	$	291	$	280,694

The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at September 30, 2011 that are contractually due after September 30, 2012.

	Due After September 30, 2012
	Fixed		Adjustable		Total
	(In thousands)

One-to four-family	$	57,582	$	17,835		75,417
Multi-family		13,152		4,584		17,736
Commercial real estate		23,610		8,209		31,819
Construction		-		-		-
Land		-		-		-
Consumer and other		202		-		202

Total loans	$	94,546	$	30,628	$	125,174

Loan Originations, Sales and Repayments. Historically, we have originated one- to four-family mortgage loans pursuant to underwriting standards that generally conform to government-sponsored agency guidelines. Loan origination activities are primarily concentrated in New York, Kings, Nassau and Suffolk Counties, New York. New loans are generated primarily from walk-in customers, customer referrals, a network of mortgage brokers, and other parties with whom we do business, and from the efforts of employees and advertising. Loan applications are underwritten and processed at our main office in Brooklyn, New York. We syndicate and sell participation interests in portions of our multi-family, commercial real estate and construction loans because of our legal lending limits and our internal portfolio management guidelines. We generally sell longer-term, fixed rate mortgage loans and generally retain in our portfolio the majority of our adjustable rate and shorter-term, fixed rate mortgage loans.

In loan participation transactions, we originate and fund the full loan amount and subsequently identify other lending institutions that purchase participation interests in the loan. Participations differ from loan syndication transactions that are not transfers of financial assets for financial reporting purposes. As the manager of a loan syndication, prior to closing the loan, we identify other lenders who agree to fund portions of the total loan at closing. We record our share of the loan syndication as a loans receivable. The amounts funded at closing by other syndication lenders, which are not reflected as loan originations and sales in our consolidated financial statements totaled $9.2 million and $41.4 million for syndications completed during the years ended September 30, 2011 and 2010, respectively.

One- to Four-Family Residential Loans. At September 30, 2011, approximately $82.4 million, or 29.3% of our loans receivable consisted of one- to four-family residential loans. Our originations of one- to four-family loans increased by $4.0 million compared to 2010. Generally, one- to four-family residential mortgage loans are originated in amounts up to 95% of the lesser of the appraised value or purchase price of the property. Private mortgage insurance is required on loans with a loan-to-value ratio in excess of 80%. At the Bank’s discretion, we originate and sell some of the one-to-four family residential mortgage loans into the secondary market. Fixed-rate loans are originated for terms of 10, 15, 20, 25 and 30 years. At September 30, 2011, our largest loan secured by one- to four-family real estate had a principal balance of approximately $1.4 million and our second largest loan secured by one- to four-family real estate had a principal balance of approximately $0.9 million. The loans were secured by a two-family and a one-family residence, respectively.

We also offer adjustable rate mortgage loans with one, three and five-year adjustment periods based on changes in a designated U.S. Treasury index. We originated $5.2 million of adjustable rate one- to four-family residential loans during the year ended September 30, 2011 and $5.6 million during the year ended September 30, 2010. Our adjustable rate mortgage loans provide for maximum rate adjustments of 200 basis points per adjustment, with a lifetime maximum adjustment of 600 basis points. We currently do not offer adjustable rate mortgage loans with interest rates that adjust below the initial interest rate or adjustable rate mortgage loans with terms that provide the borrower options with regard to the amount or timing of periodic payments. Our adjustable rate mortgage loans amortize over terms of up to 30 years.

Adjustable rate mortgage loans decrease the risk associated with changes in market interest rates by periodically re-pricing, but involve other risks because, as interest rates increase, the interest payments on the loan increase, thus increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustments permitted by our loan documents, and therefore, is potentially limited in effectiveness during periods of extended or rapidly rising interest rates. At September 30, 2011, $19.0 million, or 23.1%, of our one- to four-family residential loans had adjustable rates of interest.

All one- to four-family residential mortgage loans that we originate include “due-on-sale” clauses, which give us the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid.

Investor guidelines limit the amount that a savings association may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal of the property at the time the loan is originated. For all loans, we utilize outside independent appraisers approved by our board of directors. All borrowers are required to obtain title insurance, except for equity loans with balances under $50,000. We also require fire and casualty insurance and, where circumstances warrant, flood insurance.

Multi-Family Real Estate Loans. Loans secured by multi-family real estate totaled approximately $36.3 million, or 12.9% of the total loans receivable at September 30, 2011. Multi-family real estate loans generally are secured by rental properties (including multi-family apartment buildings). Substantially all multi-family real estate loans are secured by properties located within our lending area. At September 30, 2011, we had 34 multi-family real estate loans with an average principal balance of $1.1 million. At September 30, 2011, our largest multi-family real estate loan balance was $6.2 million. Multi-family real estate loans generally are offered with fixed interest rates. Multi-family real estate loans also generally are originated for terms ranging from one year to 15 years with the majority of these loans being originated for shorter terms within this range.

We consider a number of factors in originating multi-family real estate loans. We evaluate the qualifications and financial condition of the borrower (including credit history), profitability and expertise, as well as the value and condition of the mortgaged property securing the loan. When evaluating the qualifications of a borrower, we consider the financial resources of the borrower, the borrower’s experience in owning or managing similar property and the borrower’s payment history with us and other financial institutions. In evaluating the property securing the loan, the factors we consider include the net operating income of the mortgaged property before debt service and depreciation, the ratio of the loan amount to the appraised value of the mortgaged property and the debt service coverage ratio (the ratio of net operating income to debt service) to ensure that it is at least 120% of the monthly debt service. Multi-family real estate loans are originated in amounts up to 75% of the appraised value of the mortgaged property securing the loan. All multi-family loans are appraised by outside independent appraisers approved by our board of directors.

Loans secured by multi-family real estate generally involve a greater degree of credit risk than one- to four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects 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 multi-family real estate typically depends upon the successful operation of the real estate property securing the loan. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired. All borrowers are required to obtain title insurance. We also require fire and casualty insurance and, where circumstances warrant, flood insurance.

Commercial Real Estate Loans. At September 30, 2011, $76.0 million, or 27.1% of our total loans receivable, consisted of commercial real estate loans. Commercial real estate loans are secured by office buildings, mixed-use properties and other commercial properties. We generally originate fixed-rate commercial real estate loans with an initial term ranging from one to five years and a re-pricing option, and a maximum term of up to 20 years. The majority of commercial real estate loans originated have shorter terms within this range. The maximum loan-to-value ratio of our commercial real estate loans is 75%. At September 30, 2011, we had 67 commercial real estate loans with an average outstanding balance of $1.1 million. At September 30, 2011, our largest commercial real estate loan balance was $6.0 million.

We consider a number of factors in originating commercial real estate loans. We evaluate the qualifications and financial condition of the borrower, including credit history, profitability and expertise, as well as the value and condition of the mortgaged property securing the loan. When evaluating the qualifications of the borrower, we consider the financial resources of the borrower, the borrower’s experience in owning or managing similar property and the borrower’s payment history with us and other financial institutions. In evaluating the property securing the loan, the factors we consider include the net operating income of the mortgaged property before debt service and depreciation, the ratio of the loan amount to the appraised value of the mortgaged property and the debt service coverage ratio (the ratio of net operating income to debt service) to ensure that it is at least 120% of the monthly debt service. All commercial real estate loans are appraised by outside independent appraisers approved by our board of directors. Personal guarantees are obtained from commercial real estate borrowers although we will consider waiving this requirement based upon the loan-to-value ratio of the proposed loan. All borrowers are required to obtain title insurance. We also require fire and casualty insurance and, where circumstances warrant, flood insurance.

Loans secured by commercial real estate generally are larger than one- to four-family residential loans and involve greater credit risk. Commercial real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Repayment of these loans depends to a large degree on the results of operations and management of the properties securing the loans or the businesses conducted on this property, and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of these loans makes them more difficult for management to monitor and evaluate.

Construction Loans. At September 30, 2011, $70.1 million, or 25.0%, of our total loans receivable consisted of construction loans. Most of our construction loans are for the construction of multi-family and mixed-use properties. The majority of our construction loans are referred by mortgage brokers who make the initial contact with the potential borrower and forward to us additional loan information that we review to determine whether the applicant satisfies our underwriting criteria. If the loan information meets our criteria, we issue a letter of intent listing the terms and conditions of any potential loan. If the potential borrower agrees to these terms and conditions, we will continue our standard underwriting practice. We offer primarily adjustable rate residential construction loans. Construction loans are generally structured with an option for permanent mortgage financing once the construction is completed. Construction loans generally have a two-year term and are generally repaid from the sale of units or refinancing upon completion. These loans generally have interest rates that adjust daily with prime and generally will not have an interest rate that adjusts below the initial interest rate. Construction loans require only the payment of interest during the construction period. Construction loans will generally be made in amounts of up to 75% of the appraised value of the completed property, or the actual cost of the improvements. Funds are disbursed based on our inspections in accordance with a schedule reflecting the completion of portions of the project. At September 30, 2011, our largest construction loan balance was $8.3 million.

Construction loans generally involve a greater degree of credit risk than one- to four-family residential mortgage loans. The risk of loss on a construction loan depends upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost of construction as well as the ability to complete construction on a timely basis, and the ability to sell or refinance the property. For all loans, we utilize outside independent appraisers approved by our board of directors. All borrowers are required to obtain title insurance. We also require fire and casualty insurance and, where circumstances warrant, flood insurance.

Land Loans. In 2005, we began to originate land loans based on our increased construction loan activity. At September 30, 2011, $15.5 million, or 5.5% of our total loans receivable consisted of land loans. Our land loans are made generally in conjunction with anticipated construction loan financing. The highest combined exposure is $9.6 million. In most cases the value of the land represents the borrower’s up-front equity in our construction loans. When the land value exceeds the borrower’s equity requirement, which is usually 25% of total project costs, including land, we will consider originating this type of land loan. The majority of our land loans are referred by mortgage brokers who make the initial contact with the potential borrower and forward to us additional loan information that we review to determine whether the applicant satisfies our underwriting criteria. If the loan information meets our criteria, we issue a letter of intent listing the terms and conditions of any potential loan. If the potential borrower agrees to these terms and conditions, we will continue our standard underwriting practice. We currently offer primarily adjustable rate residential land loans. At September 30, 2011, our largest land loan balance was $2.6 million, and the average land loan balance was $1.1 million. Land loans are generally repaid at the end of a two-year period. These loans generally have interest rates that adjust daily in conjunction with the prime rate and generally will not have an interest rate that adjusts below the initial interest rate. Land loans will generally be made in amounts of up to 75% of the appraised value.

Land loans generally involve a greater degree of credit risk than one- to four-family residential mortgage loans. The risk of loss on a land loan depends upon the accuracy of the initial estimate of the value of the property as well as being able to complete development on a timely basis. For all loans, we utilize outside independent appraisers approved by our board of directors. All borrowers are required to obtain title insurance. We also require fire and casualty insurance and, where circumstances warrant, flood insurance.

Other Loans. We offer loans that are either unsecured or secured by property other than real estate. These loans include loans secured by deposits and personal loans. At September 30, 2011, these other loans totaled $291,000 or 0.1% of the loans receivable portfolio.

Loan Approval Procedures and Authority. The loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan, and the adequacy of the value of the property that will secure the loan. To assess the borrower’s ability to repay, we review each borrower’s employment and credit history and information on the historical and projected income and expenses of mortgagors. All residential mortgage loans up to the Fannie Mae limit can be approved by one of the following officers: the President, the Chief Financial Officer and the Vice President and Manager of Residential Lending. All residential mortgage loans above the Fannie Mae limit and up to $850,000 must be approved by two of the following officers: the President, the Chief Financial Officer and the Vice President and Manager of Residential Lending. All loans in excess of $850,000 must be approved by the Directors’ Loan Committee. In addition, the board of directors ratifies all loans approved by management including those approved by the Management Loan Committee. The Bank agreed with the OTS that the Bank will not originate any multi-family, commercial real estate, construction and land loans without prior OTS approval.

Non-Performing Loans and Potential Problem Assets

After a one- to four-family residential loan becomes 15 days late, we deliver a computer generated late charge notice to the borrower. Approximately one week later, we deliver a reminder notice. When a loan becomes 30 days delinquent, the loan servicing department manager determines whether to send an acceleration letter to the borrower and attempts to make personal contact. After 60 days, we will generally refer the matter to legal counsel who is authorized to commence foreclosure proceedings. Management is authorized to begin foreclosure proceedings on any loan after 60 days, after determining that it is prudent to do so and the proper acceleration letter has been sent.

After a multi-family, commercial real estate or construction loan becomes 10 days delinquent, we deliver a computer generated late charge notice to the borrower and attempt to make personal contact with the borrower. If there is no successful resolution of the delinquency at that time, we may accelerate the payment terms of the loan and issue a letter notifying the borrower of this acceleration. After such a loan is 15 days delinquent, we may refer the matter to legal counsel who is authorized to commence foreclosure proceedings. Management is authorized to begin foreclosure proceedings on any loan after determining that it is prudent to do so.

Mortgage loans are reviewed on a regular basis by management’s Asset Classification Committee and are placed on non-accrual status when they become 90 days or more delinquent and collection is doubtful or when, regardless of how many days delinquent the loan is, other factors indicate that the collection of these amounts is doubtful. When loans are placed on non-accrual status, unpaid accrued interest is reversed, and further income is recognized only to the extent received.

Non-Performing Loans. Non-performing loans are either in non-accrual status and/or past contractual maturity date. At September 30, 2011, $114.9 million of our loans, or 40.9% of our total loans, were non-accrual and/or past maturity and therefore non-performing. These loans consist of one- to four-family loans of $1.0 million, multi-family loans of $21.7 million, commercial real estate loans of $25.1 million, construction loans of $61.0 million, and land loans of $6.0 million.

At September 30, 2010, $86.2 million of our loans, or 22.2% of our total loans, were non-accrual and/or past maturity and therefore non-performing. These loans consisted of multi-family loans of $25.3 million, commercial real estate loans of $38.7 million, construction loans of $14.5 million and land loans of $7.7 million.

Non-Performing Assets. The table below sets forth the amounts and categories of our non-performing assets, at the dates indicated. We may from time to time agree to modify the contractual terms of a borrower’s loan. In cases where these modifications represent a concession (for which a portion of interest or principal has been forgiven and loans modified at interest rates materially less than current market rates) to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring. Loans modified in a troubled debt restructuring are generally placed on non-accrual status until we determine that future collection of principal and interest is reasonably assured, which requires that the borrower demonstrate performance according to the restructured terms generally for a period of six months. Loans modified in a troubled debt restructuring that are not placed on non-accrual status are loans that have demonstrated performance up to the time that the loan has been restructured. At September 30, 2011, eleven loans were modified in troubled debt restructurings totaling $29.0 million versus $28.7 million at September 30, 2010. Of the eleven, one loan totaling $0.4 million was performing at the time its terms were modified and is performing in accordance with its new terms. Therefore, it is not included in the table below. The recent sharp deterioration in the real estate market has resulted in a deterioration of the Bank’s loans receivable portfolio, which in turn has caused increases in non-performing loans. At September 30, 2011, 61 loans totaling $114.9 million, were in non-performing status versus 49 loans totaling $86.2 million, in non-performing status at September 30, 2010.

	At September 30,
	2011			2010
	(Dollars in thousands)
Non-accrual loans:
One-to four-family	$	1,007		$	-
Multi-family		21,688			23,956
Commercial real estate		25,127			34,948
Construction		61,000			7,890
Land		6,035			5,109
Consumer		-			-
Total non-accrual loans		114,857			71,903

Loans past maturity and still accruing		-			14,321
Loans past due 90 days or more and still accruing		-			-
Total non-performing loans		-			14,321
Real estate owned		-			-
Total non-performing assets	$	114,857		$	86,224

Ratios:
Total non-performing loans to total loans		40.92	%		22.18	%
Total non-performing loans to total assets		25.02	%		17.68	%
Total non-performing assets to total assets		25.02	%		17.68	%

Delinquencies. The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated.

	Loans Delinquent For
	30-89 Days				90 Days and Over				Total
	Number		Amount		Number		Amount		Number		Amount
	(Dollars in thousands)

At September 30, 2011
Mortgage Loans:
1-4 Family(secured by first liens)		3	$	65		2	$	953		5	$	1,018
1-4 Family(secured by junior liens)		3		377		1		54		4		431
Multi-family		-		-		13		21,688		13		21,688
Construction		-		-		18		61,000		18		61,000
Commercial Real Estate		1		323		20		25,127		21		25,450
Land		-		-		7		6,035		7		6,035

Non-Mortgage Loans:
Other-Personal		1		6		-		-		1		6
Total		8	$	771		61	$	114,857		69	$	115,628

At September 30, 2010
Mortgage Loans:
1-4 Family(secured by first liens)		3	$	115		-	$	-		3	$	115
1-4 Family(secured by junior liens)		-		-		-		-		-		-
Multi-family		3		2,807		7		23,956		10		26,763
Construction		2		6,615		7		7,890		9		14,505
Commercial Real Estate		3		6,963		22		34,948		25		41,911
Land		2		2,628		7		5,109		9		7,737

Non-Mortgage Loans:
Other-Personal		-		-		-		-		-		-
Total		13	$	19,128		43	$	71,903		56	$	91,031

For the fiscal year ended September 30, 2011, there was $7.9 million in interest income that would have been recorded had our non-accruing loans been current in accordance with their original terms. Interest of $16 thousand was recognized on these loans and recorded in net income for fiscal 2011.

Classified Assets. Regulations of the Office of the Comptroller of the Currency (the “OCC”) and our Asset Classification Policy provide that loans and other assets should be classified as “substandard,” “doubtful” or “loss” assets where a significant question as to collectability arises. 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 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 they should be entirely charged-off. We classify an asset as “special mention” if the asset has a potential weakness that warrants management’s close attention. While “special mention” assets have not deteriorated to the point of being classified as “substandard,” management has concluded that if the potential weakness in the asset is not addressed, the value of the asset may deteriorate, thereby adversely affecting the repayment of the asset. Assets classified as substandard, doubtful or loss are considered impaired assets.

An institution is required to establish general allowances for loan losses in an amount deemed prudent by management for loans classified as “special mention.” General allowances represent loss allowances which have been established to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an institution classifies assets as “substandard or doubtful”, it is required either to establish a specific allowance for losses equal to the amount its internal analysis determines the potential loss to be on the asset or to charge off the amount. When an institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of the amount of the asset so classified or deemed uncollectable to charge off the amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OCC which can order the establishment of additional general or specific loss allowances.

On the basis of management’s review of assets, at September 30, 2011, we classified $16.8 million of our assets as special mention or potential problem loans compared to $62.5 million at September 30, 2010. In addition, at September 30, 2011 we classified $124.9 million as impaired compared to $125.0 million at September 30, 2010.

The loan portfolio is reviewed on a regular basis by management’s Asset Classification Committee to determine whether any loans require classification in accordance with applicable regulations. Not all classified assets constitute non-performing assets.

The following table sets forth certain information related to our assets classified as impaired:

	As of and for the year ended September 30, 2011
	Unpaid
	Principal		Recorded		Specific
	Balance		Balance		Allowance
Loans without a specific valuation allowance:
One-to-Four Family	$	1,014	$	953
Multi-Family		13,123		11,454
Commercial Real Estate		26,326		19,877
Construction		25,949		23,911
Land		5,061		5,061
Consumer and Other		-		-
Loans with a specific valuation allowance:
One-to-Four Family		54		54	$	3
Multi-Family		11,341		10,234		2,030
Commercial Real Estate		16,041		12,772		2,117
Construction		38,736		37,089		6,443
Land		4,841		3,526		547
Consumer and Other		-		-		-
Total:
One-to-Four Family		1,068		1,007		3
Multi-Family		24,464		21,688		2,030
Commercial Real Estate		42,367		32,649		2,117
Construction		64,685		61,000		6,443
Land		9,902		8,587		547
Consumer and Other		-		-		-
Total impaired loans	$	142,486	$	124,931	$	11,140

	As of and for the year ended September 30, 2010
	Unpaid
	Principal		Recorded		Specific
	Balance		Balance		Allowance
Loans without a specific valuation allowance:
One-to-Four Family	$	-	$	-
Multi-Family		38,903		31,380
Commercial Real Estate		64,191		47,146
Construction		25,726		24,660
Land		22,582		15,938
Consumer and Other		-		-

Loans with a specific valuation allowance:
One-to-Four Family		-		-	$	-
Multi-Family		-		-		-
Commercial Real Estate		5,414		5,414		1,081
Construction		-		-		-
Land		437		437		6
Consumer and Other		-		-		-

Total:
One-to-Four Family		-		-		-
Multi-Family		38,903		31,380		-
Commercial Real Estate		69,605		52,560		1,081
Construction		25,726		24,660		-
Land		23,019		16,375		6
Consumer and Other		-		-		-
Total impaired loans	$	157,253	$	124,975	$	1,087

Allowance for Loan Losses

Our allowance for loan losses is intended to be maintained at a level necessary to absorb loan losses that are both probable and reasonably estimable. Management, in determining the allowance for loan losses, considers the losses inherent in its loan portfolio and changes in the nature and volume of loan activities, along with the general economic and real estate market conditions. We utilize a two-tier approach: (1) identification of impaired loans and establishment of specific loss allowances on impaired loans, if any; and (2) establishment of general valuation allowances on the remainder of our loan portfolio. We maintain a loan review system, which provides for a periodic review of our loan portfolio and the identification of potential impaired loans. This system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. Specific loan loss allowances are established for identified losses based on a review of this information. A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. We do not aggregate these loans for evaluation purposes. Loan impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loan loss experience, composition of the loan portfolio, current economic conditions and management’s judgment. The allowance is increased through provisions charged against current earnings and recoveries of previously charged-off loans. Loans that are determined to be uncollectible are charged against the allowance. While management uses available information to recognize probable and reasonably estimable loan losses, future loss provisions may be necessary based on changing economic conditions, particularly in the real estate sector.

As discussed in Item 9A. “Controls and Procedures” in this annual report, following the end of fiscal year 2010 and in connection with the preparation of our consolidated financial statements for the fiscal year ended September 30, 2010, we identified certain miscalculations in our allowance for loan losses resulting from delays in the provision of updated appraisal information to our accounting staff to enable us to identify impaired loans and appropriately recognize charge-offs as needed. During the third quarter of fiscal year 2011, we modified our procedures related to the handling of appraisals and the timing of impairment analysis to ensure that charge-offs are recognized in a timely manner. However, we are unable to conclude as to whether the previously reported material weakness has been remediated due to the limited amount of time that has passed since these procedures were modified.

A federally chartered savings association’s determinations as to the classification of its assets, charge-offs and the amount of its valuation allowances are subject to review by the OCC. The OCC, in conjunction with the other federal banking agencies, provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate valuation allowances and guidance for banking agency examiners to use in determining the adequacy of valuation allowances. All institutions are required to have effective systems and controls to identify, monitor and address asset quality problems, analyze all significant factors that affect the collectability of the portfolio in a reasonable manner and establish acceptable allowance evaluation processes that meet the objectives of the federal regulatory agencies. There can be no assurance that the OCC, as a result of reviewing our loan portfolio and/or allowance, will not request that we alter our allowance for loan losses or require additional charge-offs, particularly in light of the material weakness identified in our internal control over financial reporting, thereby affecting our financial condition and earnings.

Allowance for loan losses decreased by $1.1 million, to $16.9 million for the fiscal year ended September 30, 2011 from $17.9 million for the fiscal year ended September 30, 2010. There were net charge-offs of $2.3 million during the fiscal year ended September 30, 2011 compared to $35.5 million at September 30, 2010. The loan loss provision also decreased $41.5 million to $1.2 million for fiscal year 2011 compared to $42.7 million for fiscal year 2010. Although the charge-offs have decreased we continue to see a general decline in economic conditions in our lending footprint. While the national and local economies have shown signs of improvement since the second half of 2009, unemployment has remained at elevated levels and real estate values continued to be volatile.

The following table sets forth activity in our allowance for loan losses for the periods indicated.


	At or For the Years
	Ended September 30,
	2011			2010
	(Dollars in thousands)

Balance at beginning of year	$	17,941		$	10,750

Charge-offs:
One-to-four-family		61			216
Multi-family		448			8,741
Commercial real estate		695			18,035
Construction		2,339			6,644
Land		891			1,853
Consumer and other		-			35
Recoveries		(2,116	)		(33	)
Net charge-offs		2,318			35,491

Provision for loan losses		1,230			42,682

Balance at end of year	$	16,853		$	17,941

Ratios:
Net charge-offs to average loans outstanding		0.68	%		8.83	%
Allowance for loan losses to total loans at end of period		6.00	%		4.62	%

Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category, the percentage of the allowance for loan losses in each category to the total allowance for loan losses, and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.

		At September 30,
		2011									2010
							Percent of									Percent of
							Loans in									Loans in
				Percent of			Each						Percent of			Each
				Allowance			Category						Allowance			Category
				to Total			to Total						to Total			to Total
	Amount			Allowance			Loans			Amount			Allowance			Loans
		(Dollars in thousands)									(Dollars in thousands)
Mortgage loans:
One-to four-family		$	939		5.57	%		29.36	%		$	547		3.05	%		18.90	%
Multi-family			2,719		16.13	%		12.94	%			3,125		17.42	%		16.77	%
Commercial real estate			4,957		29.41	%		27.07	%			9,484		52.87	%		30.79	%
Construction			6,942		41.19	%		24.99	%			1,664		17.30	%		24.65	%
Land			1,294		7.69	%		5.54	%			3,104		9.27	%		8.77	%
Consumer and other			2		0.01	%		0.10	%			17		0.09	%		0.12	%

Total allowance for loan losses		$	16,853		100.00	%		100.00	%		$	17,941		100.00	%		100.00	%

Each quarter, management evaluates the total balance of the allowance for loan losses based on several factors that are reflective of the inherent losses in the loan portfolio. This process includes, but is not limited to, a periodic review of loan collectability in light of historical experience, the nature and volume of loan activity, conditions that may affect the ability of the borrower to repay, the underlying value of collateral, if applicable, and economic conditions in our immediate market area. First, we group loans by delinquency status. All loans deemed impaired are evaluated individually, based primarily on the value of the collateral securing the loan. Specific loss allowances are established as required by this analysis. All loans are segregated by type and delinquency status and a loss allowance is established by using loss experience data and management’s judgment concerning other matters it considers significant. The allowance is allocated to each category of loans based on the results of the above analysis.

This analysis process is inherently subjective, as it requires us to make estimates that are susceptible to revisions as more information becomes available. Although we believe that we have established the allowance at levels to absorb probable and estimable losses, future additions may be necessary if economic or other conditions continue to deteriorate from the current environment.

Investments

Investments and Mortgage-Backed Securities. Our investment portfolio at September 30, 2011 is classified as available for sale and included $137.8 million of mortgage-backed securities, $13.2 million of U.S. Treasury and government agency bonds and $0.5 million of mutual fund shares. Our investment policy objectives are to maintain liquidity within the guidelines established by the board of directors. We also hold at cost $1.6 million of Federal Home Loan Bank of New York stock.

At September 30, 2011, we held in mortgage-backed securities $118.2 million issued by Freddie Mac and Fannie Mae, which are U.S. government-sponsored enterprises and $19.6 million issued by Ginnie Mae, which is a U.S. government agency. The government-sponsored enterprises’ portion of the mortgage-backed securities portfolio consisted of $115.4 million in fixed-rate mortgage-backed securities and $2.8 million in adjustable rate mortgage-backed securities.

The only securities of individual issuers that we hold with an aggregate book value exceeding 10% of our equity at September 30, 2011, were mortgage-backed securities issued by government agencies and government-sponsored enterprises.

For further discussion of our securities portfolio, please see Note 5 of Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data.”

The following table sets forth the composition of our investment securities portfolio at the dates indicated

	At September 30,
	2011				2010
	Carrying Cost		Estimated Fair Value		Carrying Cost		Estimated Fair Value
	(In thousands)				(In thousands)
Securities available-for-sale:
Mortgage-backed securities:
Government agency	$	19,299	$	19,620	$	16,522	$	16,737
Government-sponsored enterprises		114,781		118,173		24,440		24,889
Private issuers		-		-		22,055		21,352
Government debentures		10,044		10,184		2,990		3,029
US Treasury note		3,003		3,063		-		-
Mutual funds		500		528		3,079		3,100
Total securities available-for-sale	$	147,627	$	151,568	$	69,086	$	69,107

Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at September 30, 2011 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. This table does not reflect the Bank’s investment in mutual funds which have no contractual maturity date and are classified as available-for-sale.

	One Year or Less					More than One Year through Five Years					More than Five Years through Ten Years					More than Ten Years					Total Securities
	Amortized Cost		Weighted Average Yield			Amortized Cost		Weighted Average Yield			Amortized Cost		Weighted Average Yield			Amortized Cost		Weighted Average Yield			Amortized Cost		Fair Value		Weighted Average Yield
	(Dollars in thousands)

Government-sponsored enterprises	$	-		0.00	%	$	506		4.43	%	$	14,310		2.67	%	$	99,965		3.41	%		114,781	$	118,173		3.32	%
Government agency		-		0.00	%		-		0.00	%		76		4.00	%		19,223		3.18	%		19,299		19,620		3.18	%
Government debentures		-		0.00	%		-		0.00	%		2,990		2.04	%		7,054		2.39	%		10,044		10,184		2.28	%
US Treasury		-		0.00	%		3,003		1.21	%		-		0.00	%		-		0.00	%		3,003		3,063		1.21	%
Private issuers		-		0.00	%		-		0.00	%		-		0.00	%		-		0.00	%		-		-		0.00	%
Total securities available-for-sale	$	-		0.00	%	$	3,509		1.67	%	$	17,376		2.57	%	$	126,242		3.32	%	$	147,127	$	151,040		3.19	%

Sources of Funds

General. Deposits have traditionally been our primary source of funds for our lending and investment activities. In addition to deposits, funds are derived from scheduled loan payments, investment maturities, loan prepayments and income on earning assets. While scheduled loan payments and income on earning assets have been relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition. Borrowings from the Federal Home Loan Bank of New York may be used to compensate for reductions in deposits and to fund loan and securities growth. As of September 30, 2011, we had $8.2 million of borrowings outstanding from the Federal Home Loan Bank of New York.

Deposits. Substantially all of our depositors are persons who work or reside in Kings, Nassau or Suffolk Counties in New York. We offer a variety of deposit instruments that include demand deposits consisting of non-interest bearing checking accounts, negotiable order of withdrawal (“NOW”) accounts, money market accounts, passbook savings and club accounts, and fixed-term certificates of deposit. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds must remain on deposit and the interest rate. We do not have any brokered deposits at this time.

We establish and adjust periodically the interest rates paid, maturity terms, service fees and withdrawal penalties on our deposits. Deposit rates and terms are based primarily on current operating strategies and market rates, liquidity requirements, rates paid by competitors and growth goals. We rely on personalized customer service and long-standing relationships with customers to attract and retain deposits.

The flow of deposits is influenced significantly by general economic conditions, changes in money market and other prevailing interest rates and competition. The variety of deposit accounts offered allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on experience, management believes that our deposits are relatively stable. However, our ability to attract and maintain certificates of deposit, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. At September 30, 2011, $236.9 million, or 59.1%, of our deposit accounts were certificates of deposit, of which $145.2 million had maturities of one year or less.

Deposit Accounts. The following table sets forth the distribution of total deposit accounts, by account type, at the dates indicated.


	At September 30,
	2011								2010
	Balance		Percent			Weighted Average Rate			Balance		Percent			Weighted Average Rate
	(Dollars in thousands)								(Dollars in thousands)
Deposit type:
NOW accounts	$	12,463		3.11	%		0.25	%	$	12,817		3.03	%		0.35	%
Checking accounts		15,757		3.93	%		0.00	%		16,033		3.79	%		0.00	%
Money market accounts		66,863		16.68	%		0.72	%		75,341		17.79	%		0.73	%
Total deposit accounts		95,083		23.72	%		0.54	%		104,191		24.61	%		0.57	%

Passbook savings accounts		68,883		17.18	%		0.35	%		66,642		15.74	%		0.40	%

Certificates of deposit		236,936		59.10	%		1.92	%		252,573		59.65	%		2.14	%

Total deposits	$	400,902		100.00	%		1.32	%	$	423,406		100.00	%		1.48	%

Large Certificates of Deposits. As of September 30, 2011, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was approximately $87.2 million. The following table sets forth the maturity of those certificates as of September 30, 2011.

	At
	September 30, 2011
	(In thousands)

Three months or less	$	23,122
Over three months through six months		8,966
Over six months through one year		20,184
Over one year to three years		20,010
Over three years		14,904
Total	$	87,186

Certificate of Deposit Maturity Schedule. The following table presents, by rate category, the remaining period to maturity of certificate of deposit accounts outstanding as of September 30, 2011.

	Less than one year		Over one year to two years		Over two years to three years		Over three years to four years		Over four years to five years		Total		Percentage of total certificate accounts
	(Dollars in thousands)
Interest Rate
0.00% - 1.99%	$	124,029	$	18,624	$	5,448	$	-	$	644	$	148,745		62.78	%
2.00% - 2.99%		15,991		6,048		10		10,737		9,200		41,986		17.72	%
3.00% - 3.99%		-		1,924		11,946		15,481		-		29,351		12.39	%
4.00% - 4.99%		5,144		8,843		2,867		-		-		16,854		7.11	%

Total	$	145,164	$	35,439	$	20,271	$	26,218	$	9,844	$	236,936		100.00	%

Certificates of Deposit Classified By Rate. The following table sets forth certificates of deposit classified by range of interest rates as of the dates indicated.

	At September 30,
	2011		2010
	(In thousands)
Interest Rate
Less than 2%	$	148,745	$	140,354
2.00% - 2.99%		41,986		54,596
3.00% - 3.99%		29,351		35,766
4.00% - 4.99%		16,854		21,204
5.00% - 5.99%		-		653

Total	$	236,936	$	252,573

Borrowings. Our borrowings consist of advances from the Federal Home Loan Bank of New York. At September 30, 2011, we had access to Federal Home Loan Bank advances of up to $51.1 million. The following table sets forth information concerning balances and interest rates on our borrowings at the dates and for the periods indicated.

	At or For the Years Ended September 30,
	2011			2010
	(Dollars in thousands)

Balance at end of year	$	8,200		$	10,500
Average balance during year		9,072			11,833
Maximum outstanding at any month end		29,500			25,300

Weighted average interest rate at end of year		2.87	%		2.51	%
Average interest rate during the year		2.82	%		2.04	%

Subsidiary Activities

OCC regulations permit federal savings associations to invest in the capital stock, obligations or other specified types of securities of certain subsidiaries referred to as “service corporations” and to make loans to service corporations and joint ventures in which service corporations are participants in an aggregate amount not exceeding 2% of the association’s assets, plus an additional 1% of assets if the amount over 2% is used for specified community or inner-city development purposes. Service corporations may engage in certain activities not otherwise permissible for the Company but may not take deposits. In addition, federal regulations permit associations to make specified types of loans to service corporations (other than special-purpose finance subsidiaries) in an aggregate amount not exceeding 50% of the association’s regulatory capital if the association’s regulatory capital is in compliance with applicable regulations.

3D Holding Company was incorporated in New York in 1993, for the purpose of acquiring, managing, and disposing of real estate held by the Bank. As of September 30, 2011, 3D Holding Company had two subsidiaries, Ash Real Estate Holdings and Birch Real Estate Holdings, each of which held cash and did not hold any real estate owned as of such date. As of September 30, 2011, total assets of 3D Holding Company were $157,000, and consisted solely of cash.

BFS REIT, Inc. was incorporated in New York in 1999. The corporation is a wholly-owned subsidiary of the Bank created for the purpose of acquiring, holding, and investing in certain real estate-related loans and other assets that constitute permissible investments by the Bank. As of September 30, 2011, BFS REIT, Inc.’s total aggregate assets were $89.2 million. In connection with the expected Mergers, BFS REIT, Inc. is expected to be liquidated.

Thrift Investors Service Corporation (“TISCO”) was incorporated in New York in 1982, for the purpose of holding BFS Agency, Inc., a company that sells insurance and fixed annuity products through licensed employees in the Bank’s branches. As of September 30, 2011, TISCO’s total aggregate assets were $274,000 of which $243,000 represented the investment in BFS Agency, Inc.

Legal Proceedings

Except as disclosed in Item 3. “Legal Proceedings”, we are not involved in any pending legal proceedings as a defendant other than routine legal proceedings occurring in the ordinary course of business.

Personnel

As of September 30, 2011, we had 76 full-time employees and 20 part-time employees. Our employees are not represented by any collective bargaining group. Management believes that we have good relations with our employees.

FEDERAL, STATE AND LOCAL TAXATION

General. The Bank’s Federal and state tax returns have not been audited during the past five years. The Company’s New York City tax returns have been audited for the 2005, 2006 and 2007 tax years. No adjustments to taxable income resulted from these audits.

Federal Taxation

General. The Company and the Bank are subject to Federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The Company and the Bank file consolidated income tax returns. The following discussion of Federal taxation is intended only to summarize certain pertinent Federal income tax matters and is not a comprehensive description of the tax rules applicable to the Company or the Bank.

Method of Accounting. For Federal income tax purposes, the Bank and Company report their income and expenses on the accrual method of accounting and use a tax year ending September 30 for filing Federal income tax returns.

Bad Debt Reserve and Recapture. Prior to the Small Business Protection Act of 1996 (the “1996 Act”), the Bank was permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at our taxable income. The Bank is now required to use the specific charge off method (i.e., to claim a deduction equal to its actual loan loss experience) in computing its bad debt deduction beginning with its 1996 Federal tax return. The Bank has previously recaptured (i.e., taken into income) over a multi-year period its excess reserves established after December 31, 1987 and before December 31, 1995. Generally, the Bank’s bad debt reserve balance as of December 31, 1987 (the “base year reserve”) is only subject to recapture upon distribution of such reserves. See below “ – Taxable Distributions and Recapture”).

Taxable Distributions and Recapture. The Bank’s “non-dividend distributions,” will be considered distributions from the Bank’s base year reserve, to the extent thereof, and then from its supplemental tax-basis reserve for losses on loans. “Non-dividend distributions” include distributions in excess of the Bank’s current and accumulated earnings and profits, as calculated for federal income tax purposes; distributions in redemption of its stock; and distributions in partial or complete liquidation.

In such cases, an amount based on the total non-dividend distribution paid will be includable into the Bank’s taxable income in the year of distribution. Dividends paid out of current or accumulated earnings and profits will not be included in the Bank’s income. The amount of additional taxable income created from a non-dividend distribution is the amount that, when reduced by the amount of the tax attributable to this income, is equal to the amount of the distribution. Thus, assuming a 35% federal corporate income tax rate, approximately one and one-half times the amount of such distribution (but not in excess of the amount of the above-mentioned reserves) would be includable in income for federal income tax purposes.

At September 30, 2011, our base year reserve was approximately $1.6 million.

Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended (the “Code”), imposes an alternative minimum tax (“AMT”) at a rate of 20% on a base of regular taxable income plus certain tax preferences (“alternative minimum taxable income” or “AMTI”). The AMT is payable to the extent such AMTI is in excess of an exemption amount and the AMT exceeds the regular income tax. Net operating losses can offset no more than 90% of AMTI. Certain payments of AMT may be used as credits against regular tax liabilities in future years. The Bank has not been subject to the AMT and has no such amounts available as credits for carryover.

Net Operating Loss Carryovers. The Company may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. At September 30, 2011, the Company will carry forward the fiscal year 2011 net operating loss 20 years. Due to the valuation allowance recorded against the Company’s net deferred tax asset, the tax benefit of these net operating losses and other tax attributes are not currently recorded on the Company’s balance sheet as of September 30, 2011.

Internal Revenue Code Section 382 applies an annual limitation on the use of certain net operating loss carryovers and certain other tax attributes if a corporation experiences an ownership change as defined in that code section. An ownership change generally occurs if there is a greater than 50% shift in ownership of the corporation over a 36 month period, measured by the ownership of the greater than 5% shareholders. Complex rules and calculations apply in determining whether an ownership change has occurred. If the annual limitation of Internal Revenue Code section 382 is applied as a result of an ownership change, the annual limitation can significantly lengthen the period over which the net operating loss carryovers and certain other tax attributes of the corporation can be utilized. Furthermore, as a result of the limited carryforward life of these tax attributes, the annual limitation may, in some cases, render them to be partially worthless to the Company or any successor of the Company after the ownership change.

Corporate Dividends-Received Deduction. The Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends received deduction is generally 80% in the case of dividends received from corporations with which a corporate recipient does not file a consolidated return, and corporations which own less than 20% of the stock of a corporation distributing a dividend may generally deduct 70% of dividends received or accrued on their behalf.

Dividends received by the Bank from BFS REIT, Inc., a real estate investment trust, are not entitled to a dividends received deduction.

State and Local Taxation

New York State Taxation. The Company and the Bank are subject to the New York State banking corporation tax. This tax is imposed in an amount equal to the greater of (a) 7.1% of “entire net income” allocable to New York State, (b) 3% of “alternative entire net income” allocable to New York State, (c) 0.01% of the average value of assets allocable to New York State, or (d) a nominal minimum tax. Entire net income is based on Federal taxable income, subject to certain modifications. Alternative entire net income is equal to entire net income without certain modifications. The Company and the Bank are also subject to the New York State tax surcharge equal to 17.0% of the New York State banking corporation tax allocable to business activities carried on in the Metropolitan Commuter Transportation District.

Dividends received by the Bank from BFS REIT, Inc., a real estate investment trust, are subject to a 60% dividends-received deduction, which generally results in only 40% of BFS REIT, Inc.’s earnings being subject to New York State tax.

New York City Taxation. The Company and the Bank are also subject to the New York City banking corporation tax, which is calculated, subject to a New York City income and expense allocation, on a similar basis as the New York State banking corporation tax. The New York City tax is imposed on an amount equal to the greater of (a) 9.0% of “entire net income” allocable to New York City, (b) 3% of “alternative entire net income” allocable to New York City, (c) 0.01% of the average value of assets allocable to New York City, or (d) a nominal minimum tax. Alternative entire net income is equal to entire net income with certain modifications.

Bad Debt Reserves. New York State and New York City enacted legislation for tax years beginning in 2010 to conform with the federal tax law with regards to bad debt deductions. As a result, the Bank no longer establishes or maintains a reserve for losses on loans and is required to claim a deduction for bad debts in an amount equal to its actual loan loss experience. In addition, this legislation eliminated the potential recapture of the Bank’s reserve that could have otherwise occurred in certain circumstances under New York State and New York City law prior to 2010.

Net Operating Loss Carryovers. Neither New York State nor New York City allow net operating losses to be carried back but both permit such losses to be carried forward for 20 years, subject to certain limitations.

SUPERVISION AND REGULATION

General

BFS Bancorp, MHC and the Company are non-diversified savings and loan holding companies within the meaning of the Home Owners’ Loan Act, as amended (“HOLA”). Accordingly, BFS Bancorp, MHC and the Company are registered with the Federal Reserve and are subject to primary regulation, examination and supervision by the Federal Reserve. In addition, the Federal Reserve has enforcement authority over the Company and BFS Bancorp, MHC, and their subsidiaries. Among other things, this authority permits the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.

The Bank is a federal savings association that is subject to primary regulation, examination and supervision by the OCC. The Bank is regulated to a lesser extent by the Federal Deposit Insurance Corporation (“FDIC”), with respect to the insurance of deposit accounts held at the Bank. This regulation and supervision establishes a comprehensive framework for the types of permissible activities in which the Bank may engage and is intended primarily for the protection of the Deposit Insurance Fund, which is administered by the FDIC for the benefit of the Bank’s depositors. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates.

On March 31, 2011, the Company and BFS Bancorp, MHC (together, the “Holding Companies”), and the Bank became subject to Cease and Desist Orders (the “Orders”) issued by the OTS. The Order issued to the Bank which we refer to as the “Bank Order” required, among other things, the Bank to submit a contingency plan for review and approval by the OTS if the Bank failed to meet certain minimum capital levels established in the Bank Order, or comply with the terms of a required capital plan, or is otherwise requested by the OTS to submit a contingency plan, which contingency plan would require the Bank to merge with, or be acquired by another federally insured depository institution or voluntarily liquidate. Upon determining that the minimum capital levels set forth in the Bank Order would not be achieved by the deadline, on April 29, 2011, the Holding Companies and the Bank each sent a letter to the OTS confirming that, since the Bank would not be able to meet the minimum capital levels contained in the Bank Order by the deadline, it was agreed-upon with the OTS staff that, rather than submitting a capital plan as mandated by the Bank Order, the Bank would submit its contingency plan to the OTS. On May 12, 2011, the Bank submitted a contingency plan to the OTS. The contingency plan detailed the Holding Companies’ and the Bank’s proposed actions to engage in a transaction involving the merger or acquisition of the Bank and, should the Bank not be able to complete that transaction, to adopt a plan for the Bank to voluntarily liquidate.

On July 1, 2011, the Bank received a letter from the OTS with a proposed Amended Order to Cease and Desist (“Proposed OTS Order”) which was intended to supplement and partially supersede the Bank Order to the extent proposed. On July 21, 2011, the Bank was notified by the OCC that it intended to issue a Consent Order to the Bank, which would replace the Bank Order and also encompass the requirements of the Proposed OTS Order.

On August 16, 2011, the Holding Companies and the Bank entered into an Agreement and Plan of Merger with Investors Bancorp, MHC, Investors Bancorp, Inc. and Investors Bank (formerly known as Investors Savings Bank), which contemplates the mergers of BFS Bancorp, MHC, the Company and the Bank with and into Bancorp, MHC, Investors Bancorp, Inc. and Investors Bank, respectively. The consummation of the Mergers, which are expected to close in the second quarter of fiscal year 2012, is intended to comply with the Bank Order.

To date, the OCC has not issued such Consent Order to the Bank, and the Holding Companies and the Bank continue to operate under the requirements and restrictions imposed on them under the March 31, 2011 Orders.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”)

Major financial reform legislation, known as the Dodd-Frank Act, was signed into law by the President on July 21, 2010. Among other things, the Dodd-Frank Act impacts the rules governing the provision of consumer financial products and services, and many of the provisions of the Dodd-Frank Act affecting BFS Bancorp, MHC, the Company and the Bank have effective dates ranging from immediately upon enactment of the legislation to several years following enactment of the Dodd-Frank Act. Of particular significance to federal savings associations and their holding companies is that, as a result of regulatory restructuring called for by the Dodd-Frank Act, BFS Bancorp, MHC, the Company and the Bank transitioned to the jurisdiction of their current new and separate primary federal regulators on July 21, 2011. Prior to that date, BFS Bancorp, MHC, the Company and the Bank had been subject to consolidated supervision and regulation by the Office of Thrift Supervision, or the OTS, which has now been abolished as a result of the completed transfer of all of the OTS’ supervisory and rulemaking responsibilities to other federal agencies.

Along with the transfer of ongoing responsibilities for the supervision and examination of federal savings associations and their holding companies, the Dodd-Frank Act also transferred to the Federal Reserve and OCC rulemaking authority (except for consumer protection) of the OTS relating to savings and loan holding companies and all savings associations, respectively. The legislation continues in effect all OTS orders, resolutions, determinations, agreements, regulations, interpretive rules, other interpretations, guidelines, procedures and other advisory materials in effect the day before the transfer date, and allows the Federal Reserve and OCC to enforce these issuances with respect to savings and loan holding companies and federal savings associations, respectively, unless the Federal Reserve or OCC modifies, terminates, or sets aside such guidance or until superseded by the Federal Reserve or OCC, a court, or operation of law.

The following discussion is intended to provide a summary of the material statutes and regulations applicable to savings and loan holding companies and federal savings associations as they are to be administered and enforced by the Federal Reserve and OCC respectively, going forward as of July 21, 2011, and does not purport to be a comprehensive explanation of all applicable laws and regulations and is qualified in its entirety by reference to the actual laws and regulations involved. Any change in these laws or regulations, whether by the FDIC, OCC, Federal Reserve or the United States Congress, could have a material adverse impact on the Company and the Bank and their operations.

Regulation of Federal Savings Associations

Primary Regulation by the OCC. As of July 21, 2011, the OCC has extensive authority to regulate and supervise the operations of federal savings associations, including the Bank. This regulation and supervision establishes a comprehensive framework of activities in which a federal savings association can engage and is intended primarily for the protection of the deposit insurance fund and depositors, and to assure the ongoing safety and soundness of institutions regulated by the OCC. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. The Bank is required to file periodic reports with the OCC and is subject to periodic examinations primarily by the OCC.

Given the extensive transfer of former OTS authority to multiple agencies, section 316 of the Dodd-Frank Act requires the OCC to identify and publish in the Federal Register separate lists of the current OTS regulations that the OCC will continue to enforce for federal savings associations after the transfer date. In carrying out this mandate, and in connection with its assumption of responsibility for the ongoing examination, supervision, and regulation of federal savings associations, the OCC published a final rule on July 21, 2011 that republishes those OTS regulations that the OCC has the authority to promulgate and enforce as of the July 21 transfer date, with nomenclature and other technical amendments to reflect OCC supervision of federal savings associations. The OCC’s regulations supersede the OTS regulations for purposes of OCC supervision and regulation of federal savings associations.

In promulgating the final rule, the OCC noted that the final rule is part of the OCC’s review of its regulations and those of the OTS to determine what changes are needed for the transition to OCC supervision of federal savings associations, and that in future phases of the OCC’s regulatory review, the OCC will consider more comprehensive substantive amendments, as necessary, to these regulations. For example, the OCC notes that it may propose to repeal or combine provisions in cases where OCC and former OTS rules are substantively identical or substantially overlap. In addition, the OCC may propose to repeal or modify OCC or former OTS rules where differences in regulatory approach are not required by statute or warranted by features unique to either charter. This substantive review also will provide an opportunity for the OCC to ask for comments suggesting revisions to the rules for both national banks and federal savings associations that would remove provisions that are ‘‘outmoded, ineffective, insufficient, or excessively burdensome,’’ consistent with the goals outlined in an executive order issued by the President. Accordingly, it is possible that additional OCC rulemaking could require significant revisions to the regulations under which the Bank operates and is supervised. Any change in such laws and regulations or interpretations thereof, whether by the OCC, the FDIC or through legislation, could have a material adverse impact on the Bank, and its operations and on us and our stockholders.

Business Activities. The activities of federal savings associations are generally governed by federal laws and regulations. These laws and regulations delineate the nature and extent of the activities in which federal savings associations may engage. In particular, many types of lending authority for federal savings associations are limited to a specified percentage of the institution’s capital or assets.

Lending and Investment Authority. The Bank derives its lending and investment powers from the HOLA and the implementing regulations of the OCC. Under these laws and regulations, the Bank may originate mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, and it may invest in certain types of debt securities and certain other assets, up to limits prescribed in the HOLA and implementing regulations. Certain types of lending, such as commercial and consumer loans, are subject to an aggregate limit calculated as a specified percentage of the Bank’s capital assets. The Bank also may establish service corporations that may engage in activities not otherwise permissible for the Bank, including real estate equity investments and securities and insurance brokerage activities. In addition to the statutory limits on its lending and investment activities, the Bank is also subject to lending and asset restrictions imposed by the OTS (now currently enforced by the OCC) as a result of the Bank Order.

Capital Requirements. OCC regulations require savings associations such as the Bank to meet three minimum capital standards:

	(1)	a tangible capital ratio requirement of 1.5% of total assets, as adjusted under the OCC regulations;

	(2)	a leverage ratio requirement of 4.0% of core capital to such adjusted total assets (3.0% if a savings association has been assigned the highest composite rating of 1 under the Uniform Financial Institutions Rating System); and

	(3)	a risk-based capital ratio requirement of 8.0% of core and supplementary capital to total risk-based assets, provided that the amount of supplementary capital used to satisfy this requirement shall not exceed the amount of core capital.

The risk-based capital standard for savings associations could require the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% assigned by the OCC based on the risks believed inherent in the type of asset. Core capital is defined to include common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock, certain accounts and deposits and related surplus and minority interests in equity accounts of consolidated subsidiaries, less goodwill, certain credit-enhancing credit only strips, certain deferred tax assets and intangibles other than certain servicing assets and credit card relationships. The components of Tier 2 (supplementary) capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.

However, as a result of the Bank Order, the Bank is subject to enhanced capital requirements, having been required to achieve and maintain a Tier 1 Capital Ratio equal to or greater than 10% and a Total Risk-Based Capital Ratio equal to or greater than 15%, after the funding of its allowance for loan and lease losses, by April 30, 2011. As of April 30, 2011, the Bank did not meet these capital requirements.

In assessing an institution’s capital adequacy, the OCC takes into consideration not only these numeric factors but also qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions where necessary.

Loans to One Borrower. Under the HOLA, the Bank is generally subject to the same limits on loans to one borrower as a national bank. Specifically, a federal savings association generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of the Bank’s unimpaired capital and surplus, if the loan is fully secured by readily marketable collateral, which generally does not include real estate. As of September 30, 2011, the Bank was in compliance with the loans-to-one borrower limitations

Qualified Thrift Lender Test. Under the HOLA, the Bank must comply with the qualified thrift lender, or “QTL,” test. Under the QTL test, the Bank is required to maintain at least 65% of its “portfolio assets” in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities, credit card loans, student loans and small business loans) in at least nine months of the most recent 12-month period. “Portfolio assets” means, in general, the Bank’s total assets less the sum of:

● specified liquid assets up to 20% of total assets;

● goodwill and other intangible assets; and

● the value of property used to conduct the Bank’s business.

A savings association that fails the QTL test and is unable to demonstrate a reasonable likelihood of meeting it in the future may be required to convert to a commercial bank charter and will generally be prohibited from: (i) engaging in any new activity not permissible for a national bank, (ii) paying dividends not permissible under national bank regulations, and (iii) establishing any new branch office in a location not permissible for a national bank.

In addition, if the institution fails to regain the QTL status within one year after failing the test, then its holding company will be deemed to be a bank holding company and will be required to register with the Federal Reserve as such.

At September 30, 2011, the Bank maintained substantially all of its portfolio assets in qualified thrift investments and in each of the prior 12 months, and therefore is a “qualified thrift lender.”

Assessments. The Dodd-Frank Act transferred authority to collect assessments for federal savings associations from the OTS to the OCC, effective as of the transfer date, July 21, 2011. The Dodd-Frank Act also provides that, in establishing the amount of an assessment, the Comptroller of the Currency may consider the nature and scope of the activities of the entity, the amount and type of assets it holds, the financial and managerial condition of the entity, and any other factor that is appropriate. Prior to the transfer date, the OCC and the OTS assessed banks and savings associations, respectively, using different methodologies, although the agencies’ methodologies generally resulted in similar levels of assessments. Under the OTS assessment system, assessments were due each year on January 31 and July 31, and were calculated based on an institution’s asset size, condition, and complexity. Under the OCC assessment system, assessments are due March 31 and September 30 of each year, based on call report information as of December 31 and June 30 respectively.

The OCC final rule effective on July 21, 2011 amended the assessment rules applicable to federal savings associations by using the same methodologies, rates, fees, and payment due dates that apply currently to national banks. However, during the first two assessment cycles after the transfer date, the OCC will base savings association assessments on either the OCC’s assessment regulation (as amended to include federal savings associations) or the former OTS assessment structure, whichever yields the lower assessment for that savings association. After the March 2012 assessment, all national banks and federal savings associations will be assessed using the OCC’s assessment structure. Under the OCC’s assessment system, some savings associations will pay marginally more assessments than in the past, while others will pay lower assessments.

Capital Distributions. OCC regulations govern capital distributions by a federal savings association, which include cash dividends, stock repurchases and other transactions charged to the capital account, to the association’s holding company or other stockholders. A savings association must file an application for approval of a capital distribution if:

●

the total capital distributions for the applicable calendar year exceed the sum of the association’s net income for that year to date plus the association’s retained net income for the preceding two years;

●

the association would not be at least adequately capitalized following the distribution;

●

the distribution would violate any applicable statute, regulation, agreement or OTS-imposed or OCC-imposed condition, which would include restrictions in the cease and desist order issued to the Bank by the OTS on March 31, 2011; or

●

the association is not eligible for expedited treatment of its filings.

Even if an application is not otherwise required, every savings association that is a subsidiary of a holding company must file a notice of a declaration of a dividend with the Federal Reserve at least 30 days before the board of directors declares a dividend or approves a capital distribution. In the case of cash dividends, OCC regulations require that federal savings associations that are subsidiaries of a stock savings and loan holding company and that are not otherwise specifically required to file an application with the OCC must file an informational copy of that notice with the OCC at the same time it is filed with the Federal Reserve.

A federal savings association proposing to make a capital distribution and that is not otherwise specifically required to file an application with the OCC is required to submit a prior notice to the OCC if: (1) the association would not be well capitalized following the distribution; (2) the proposed capital distribution would reduce the amount of or retire any part of the association’s common or preferred stock or retire any part of debt instruments such as notes or debentures included in the association’s capital (other than regular payments required under a debt instrument); or (3) the association is a subsidiary of a savings and loan holding company and is not otherwise required to file a notice regarding the proposed distribution with the Federal Reserve (as noted above), in which case only an informational copy of the notice filed with the Federal Reserve needs to be simultaneously provided to the OCC.

The Federal Reserve or the OCC may disapprove a notice or application if:

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the association would be undercapitalized following the distribution;

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the proposed capital distribution raises safety and soundness concerns; or

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the capital distribution would violate a prohibition contained in any statute, regulation or a regulatory agreement or order issued to the association or holding company, which would include the cease and desist orders issued by the OTS to the Bank, Company and BFS Bancorp, MHC on March 31, 2011.

In addition, the Federal Deposit Insurance Act provides that an insured depository institution shall not make any capital distribution, if after making the distribution the institution would be undercapitalized.

Liquidity. All federal savings associations, including the Bank, are required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation. For a discussion of what the Bank includes in liquid assets, see Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.

Community Reinvestment Act. Under the Community Reinvestment Act (“CRA”), as implemented by OCC regulations, the Bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of the entire communities in which they serve, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for the Bank, nor does it limit the Bank’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. Rather, the CRA requires the OCC, in connection with its examination of the Bank, to assess the association’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by the Bank. An association’s failure to comply with the provisions of the CRA could result in denial of certain corporate applications, such as branches or mergers, or restrictions on its activities.

The CRA regulations establish an assessment system that bases an institution’s rating on its actual performance in meeting community needs. The rules establish a streamlined examination approach to evaluate the CRA performance of smaller institutions. The OCC (and formerly, the OTS) evaluates intermediate small savings associations, such as the Bank, using the following lending criteria:

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the savings association’s loan-to-deposit ratio, adjusted for seasonal variation and, as appropriate, other lending-related activities, such as loan originations for sale to the secondary markets, community development loans or qualified investments;

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the percentage of loans and, as appropriate, other lending-related activities located in the savings association’s assessment areas;

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the savings association’s record of lending to and, as appropriate, engaging in other lending-related activities for borrowers of different income levels and business sizes;

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the geographic distribution of the savings association’s loans; and

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the savings association’s record of taking action, if warranted, in response to written complaints about its performance in helping to meet credit needs in its assessment areas.

In a CRA exam, an intermediate small savings association’s community development performance also is evaluated pursuant to the following criteria:

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the number and amount of community development loans;

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the number and amount of qualified investments;

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the extent to which the savings association provides community development services; and

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the savings association’s responsiveness through such activities to community development lending, investment, and services needs.

The CRA also requires all institutions to publicly disclose their CRA ratings. The Bank received a CRA rating of “satisfactory” in its most recent federal examination.

Consumer Protection and Other Laws and Regulations. The Bank is subject to various laws and regulations dealing generally with consumer protection matters. The Bank may be subject to potential liability under these laws and regulations for material violations, in the form of litigation by governmental and consumer groups, as well as enforcement actions by the Consumer Financial Protection Bureau (“CFPB”), the OCC and other federal regulatory agencies including the Department of Justice. The CFPB is a new agency created under the Dodd-Frank Act that has broad powers to supervise and enforce the federal consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings associations, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and savings associations with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets will continue to be examined by their applicable primary bank regulators. The Bank’s lending operations are subject to federal laws applicable to credit transactions, such as the:

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Federal Truth In Lending Act, governing disclosures of credit terms for open-end and closed-end loan products to consumer borrowers;

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Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

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Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

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Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections and certain credit and other disclosures;

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Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

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Servicemembers’ Civil Relief Act, providing certain protections to members of the armed forces while in active military service;

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Real Estate Settlement Procedures Act, governing disclosures of fee estimates that would be incurred by a borrower during the mortgage process; and

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Rules and regulations of the federal agencies, primarily the CFPB, charged with the responsibility of implementing these federal laws.

The Bank’s deposit operations are subject to federal laws applicable to deposit transactions, such as the:

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Truth in Savings Act, which imposes disclosure obligations to enable consumers to make informed decisions about their deposit accounts at depository institutions;

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Electronic Fund Transfer Act, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

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Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

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Rules and regulations of the federal agencies, primarily the CFPB, charged with the responsibility of implementing these federal laws.

Transactions with Affiliates and Insiders. A federal savings association’s authority to engage in transactions with its “affiliates” is limited by Sections 23A and 23B of the Federal Reserve Act (“FRA”) and its implementing regulations. The term “affiliates” for these purposes generally means any company that controls, is controlled by, or is under common control with an institution. The Company is an affiliate of the Bank. In general, transactions with affiliates must be on terms that are as favorable to the association as comparable transactions with non-affiliates. In addition, under the FRA and Regulation W of the Federal Reserve, the aggregate amount of covered transactions that an association may engage in with any individual affiliate is generally limited to 10% of the unimpaired capital and surplus of the savings association. The aggregate amount of covered transactions with all affiliates is generally limited to 20% of the association’s unimpaired capital and surplus. Loans and other specified transactions with affiliates are required to be secured by collateral in an amount and of a type described under federal law. The purchase of low-quality assets from affiliates is permitted only under certain circumstances.

In addition, amendments to Regulation W address additional restrictions on savings associations under Section 11 of the HOLA, including provisions prohibiting a savings association from making a loan to an affiliate that is engaged in activities that are not permitted for bank holding companies under the Bank Holding Company Act (“BHCA”) and provisions prohibiting a savings association from purchasing or investing in securities issued by an affiliate that is not a subsidiary. A savings association also may not purchase or invest in securities issued by any affiliate other than with respect to shares of a subsidiary, which may include a bank and a savings association.

The Bank’s authority to extend credit to its directors, executive officers and 10% shareholders (“Insiders”), as well as to entities controlled by Insiders, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the Federal Reserve. Among other things, these provisions generally require that extensions of credit to Insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to Insiders, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. In addition, the Bank’s board of directors must approve extensions of credit in excess of certain limits.

Section 402 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) prohibits the extension of personal loans to directors and executive officers of issuers (as defined in the Sarbanes-Oxley Act). The prohibition, however, does not apply to mortgages advanced by an insured depository institution, such as the Bank, that is subject to the insider lending restrictions of Section 22(h) of the FRA.

Enforcement. The OCC has primary enforcement responsibility over federal savings associations and has the authority to bring enforcement actions against all “institution-affiliated parties,” including controlling stockholders, attorneys, appraisers and accountants, who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement actions may range from the issuance of a capital directive or cease and desist order to prohibition or removal of officers and/or directors of the institution, receivership, conservatorship or the termination of deposit insurance. Civil money penalties cover a wide range of violations and actions, and can range up to $1.375 million per day for findings of knowing or reckless conduct that results in a substantial loss to the savings association or a substantial pecuniary gain or other benefit to such party by reason of a violation of law, unsafe or unsound practice, or breach of fiduciary duty. The FDIC also has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings association. If the OCC does not take action, the FDIC has authority to take action under specified circumstances.

Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted Interagency Guidelines Establishing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder.

Moreover, the OCC has adopted regulations that authorize, but do not require, the OCC to require the submission of a compliance plan from a savings association that has been given notice that it is not satisfying safety and soundness standards. If, after being notified, a savings association fails to submit an acceptable plan or fails in any material respect to implement an accepted plan, the OCC must issue an order directing action to correct the deficiency. Further, the OCC may issue an order directing other actions of the types to which an undercapitalized association is subject under the “prompt corrective action” provisions of federal law. If a savings association fails to comply with such an order, the OCC may seek to enforce the order in judicial proceedings and/or impose civil money penalties.

Prompt Corrective Action Regulations. Under the “prompt corrective action regulations” of the OCC, the agency is required to take certain, and is authorized to take other, supervisory actions against undercapitalized savings associations, including restrictions on growth of assets and other forms of expansion. For this purpose, a savings association is placed in one of the following five categories based on the association’s capital:

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well-capitalized (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total risk-based capital);

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adequately capitalized (at least 4% leverage capital (or at least 3% for associations receiving the highest CAMELS rating), 4% Tier 1 risk-based capital and 8% total risk-based capital);

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undercapitalized (less than 4% leverage capital (or less than 3% for associations receiving the highest CAMELS rating), 4% Tier 1 risk-based capital and 8% total risk-based capital);

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significantly undercapitalized (less than 3% leverage capital, 3% Tier 1 risk-based capital and 6% total risk-based capital); and

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critically undercapitalized (less than 2% tangible capital).

Generally, the OCC is required by law to appoint a receiver or conservator for a federal savings association within a specific time frame from when the association becomes “critically undercapitalized.” The OCC regulations provide that a capital restoration plan must be filed with the OCC within 45 days (or earlier, if so notified) of the date an association receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” the performance of which must be guaranteed by any company controlling the association up to specified limits. The aggregate liability of a holding company is limited to the lesser of (i) an amount equal to 5% of the savings association’s total assets at the time it was notified that it became undercapitalized; and (ii) the amount that is necessary to restore the savings association’s capital ratios to the levels required to be classified as “adequately capitalized.” If the association fails to submit an acceptable plan, it is treated as if it were “significantly undercapitalized.” In addition, numerous mandatory supervisory actions become immediately applicable to the association, including, but not limited to, restrictions on growth, investment activities, capital distributions and affiliate transactions. The OCC may also take any one of a number of discretionary supervisory actions against undercapitalized associations, including the issuance of a capital directive and the replacement of senior executive officers and directors.

As an institution’s capital decreases within the three undercapitalized categories listed above, the severity of the action that is authorized or required to be taken by the institution’s regulator under the prompt corrective action regulations increases. All banks are prohibited from paying dividends or other capital distributions or paying management fees to any controlling person if, following such distribution, the bank would be undercapitalized. The OCC is required to monitor closely the condition of an undercapitalized institution and to restrict the growth of its assets.

Insurance of Deposit Accounts. The Bank is a member of, and pays deposit insurance assessments to, the Deposit Insurance Fund, or DIF, which is administered by the FDIC. As a result of such membership, all deposit accounts held at the Bank are permanently insured up to $250,000 per depositor for each account ownership category. This standard maximum deposit insurance coverage was raised from $100,000 first on a temporary basis under the Emergency Economic Stabilization Act of 2008 and then made permanent under the Dodd-Frank Act. The Dodd-Frank Act extended the FDIC’s provision of unlimited deposit insurance on non-interest bearing transaction accounts (subject to a modified definition for eligible accounts) through December 31, 2012.

FDIC insurance of deposits is backed by the full faith and credit of the U.S. government. In order to maintain the DIF, member institutions are assessed an insurance premium. The FDIC imposes deposit insurance premiums on insured institutions and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the DIF. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OCC an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition.

In December 2009, along with each institution’s risk-based deposit insurance assessment for the third quarter of 2009, all non-exempt insured depository institutions were required to prepay their quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012. For purposes of calculating the prepaid amount, the base assessment rate in effect at September 30, 2009 was used for 2010. That rate is to be increased by an annualized 3 basis points for 2011 and 2012 assessments. The prepayment calculation also assumes a five percent annual deposit growth rate, increased quarterly, through the end of 2012. As provided for in the final rule implementing the prepaid assessment requirement, institutions were instructed to account for the prepayment by recording the entire amount of its prepaid assessment as a prepaid expense (an asset) as of December 31, 2009. Subsequently, each institution records an expense (charge to earnings) for its regular quarterly assessment and an offsetting credit to the prepaid assessment until the asset is exhausted. Once the asset is exhausted, the institution will resume paying and accounting for quarterly deposit insurance assessments as they would normally. On December 30, 2009, the Bank paid $2.3 million which was recorded as a prepaid asset and will be proportionally expensed over future periods. At September 30, 2011, the remaining balance recorded as a prepaid asset was $0.4 million.

The amount of each institution’s premium has historically generally been based on the balance of insured deposits and the degree of risk the institution poses to the DIF. On February 7, 2011, the FDIC Board approved a final rule that implements a new deposit insurance assessment system for insured depository institutions, including a new pricing structure for institutions with more than $10 billion in assets. Effective April 1, 2011, and beginning with the invoice payable on September 30, 2011, the new assessment structure modified an institution’s current deposit insurance assessment base from adjusted domestic deposits to an institution’s average consolidated total assets minus average tangible equity, as required by the Dodd-Frank Act. Pursuant to the final rule, Tier 1 capital is used as the measure for tangible equity. Depository institutions with less than $1 billion in assets report average weekly balances during the calendar quarter, unless they elect to report daily averages. The new assessment base is larger than the former base and includes revisions to the total base assessment rate schedule by lowering assessment rates, after adjustments, to a range between 2.5 and 9 basis points for depository institutions in the lowest risk category, and 30 to 45 basis points for institutions in the highest risk category. The various adjustments incorporated into the schedule take into account the heightened risk with respect to certain types of funding such as unsecured debt and brokered deposits. The final rule eliminated the secured liability adjustment and includes a new adjustment requirement for long-term debt held by an insured depository institution where the debt is issued by another insured depository institution.

The Bank’s assessment rate utilized for the final quarter of fiscal year ending September 30, 2011, was 0.06 % and the premium paid for fiscal 2011 was $0.8 million. No institution may pay a dividend if in default of its FDIC assessment. The FDIC has authority to increase insurance assessments. A significant increase in insured premiums would have an adverse effect on the operating expenses and results of operations of the Bank.

Under federal law, insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OCC.

In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by FICO in the 1980’s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by FICO are due to mature in 2017 through 2019. For the quarter ended September 30, 2011, the annualized FICO assessment was equal to 0.680 basis points for each $100 in domestic deposits maintained at an institution. Assessments related to the FICO bond obligations were not subject to the prepayment requirements described above.

Reserve Requirements. Under the FRA and the Federal Reserve’s regulations, the Bank is required to maintain reserves against its transaction accounts (primarily negotiable order of withdrawal (“NOW”) and regular checking accounts). The FRA provides that, before December 31 of each year, the Federal Reserve shall issue regulations adjusting the reserve requirement exemption amount for the next calendar year if total reservable liabilities held at all depository institutions increase from one year to the next. For 2012, reserve requirement thresholds set forth in the Federal Reserve’s regulations exempt the first $11.5 million of otherwise reservable balances from the reserve requirements. A 3% reserve is required for transaction account balances over $11.5 million and up to $71.0 million. Transaction account balances over $71.0 million are subject to a reserve requirement of approximately $1.785 million plus 10% of any amount over $71.0 million. Because required reserves must be maintained in the form of vault cash, a noninterest-bearing account at a Federal Reserve Bank, or a pass-through account as defined by the Federal Reserve, the effect of this reserve requirement is to reduce the Bank’s interest-earning assets. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements imposed by the OCC. At September 30, 2011, the Bank was in compliance with these reserve requirements.

Prohibitions Against Tying Arrangements. Federal savings associations are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the association or its affiliates or not obtain services of a competitor of the association.

Privacy Regulations. The Bank is subject to OCC regulations implementing the privacy protection provisions of the Gramm-Leach Bliley Act (the “GLB Act”). These regulations require the Bank to disclose its privacy policy, including identifying with whom it shares “nonpublic personal information,” to customers at the time of establishing the customer relationship and annually thereafter. The regulations also require the Bank to provide its customers with initial and annual notices that accurately reflect its privacy policies and practices. The Bank is also required to provide its customers with the ability to “opt-out” of having their personal information shared with unaffiliated third parties except under limited circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.

The Bank is subject to regulatory guidelines establishing standards for safeguarding customer information. These regulations implement certain provisions of the GLB Act. The guidelines describe the agencies’ expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer. Federal guidelines also impose certain customer disclosures and other actions in the event of unauthorized access to customer information.

In addition, pursuant to section 114 of the Fair and Accurate Credit Transactions Act (the “FACT Act”) and the implementing regulations of the federal banking agencies and Federal Trade Commission, the Bank is required to have in place an “identity theft red flags” program to detect, prevent and mitigate identity theft.

Affiliate Marketing. The federal banking agencies, including the OCC, have issued a joint rule implementing Section 214 of the FACT Act, which provides consumers with the ability to restrict companies from using certain information obtained from affiliates to make marketing solicitations. In general, a person is prohibited from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and had a reasonable opportunity to opt out of such solicitations. The rule permits opt-out notices to be given by any affiliate that has a preexisting business relationship with the consumer and permits a joint notice from two or more affiliates. Moreover, such notice would not be applicable to the company using the information if it has a pre-existing business relationship with the consumer. The notice that is required under the FACT Act may be combined with other required disclosures to be provided under other provisions of law, including notices required under the privacy provisions of the GLB Act.

Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of the Federal Home Loan Bank of New York, the Bank is required to acquire and hold a certain minimum number of shares of capital stock in the Federal Home Loan Bank. As of September 30, 2011, the Bank was in compliance with this requirement.

The USA PATRIOT Act

The Bank and Company are subject to the Bank Secrecy Act, as amended by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (“USA PATRIOT Act”), which gives the federal government powers to address money laundering and terrorist threats through enhanced domestic security measures, expanded surveillance powers, and increased information sharing and broadened anti-money laundering requirements.

Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among financial institutions, bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act. Among other requirements, the USA PATRIOT Act and OCC regulations impose the following obligations on financial institutions:

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financial institutions must establish an anti-money laundering program that includes, at a minimum: (i) internal policies, procedures, and controls designed to detect and prevent money laundering activities, (ii) specific designation of an anti-money laundering compliance officer, (iii) ongoing employee training programs, and (iv) an independent audit function to test the anti-money laundering program;

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financial institutions must establish and meet minimum standards for customer due diligence, identification and verification;

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financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) must establish appropriate, specific and, where necessary, enhanced due diligence policies, procedures, and controls to detect and report instances of money laundering through those accounts;

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financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country) and are subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks; and

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bank regulators are directed to consider a bank’s or holding company’s effectiveness in combating money laundering when ruling on FRA and Bank Merger Act applications.

The Office of Foreign Assets Control (“OFAC”), which is a division of the U.S. Department of the Treasury (“Treasury”), is responsible for helping to ensure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. The Bank and the Company, like all United States companies and individuals, are prohibited from transacting business with the individuals and entities named on OFAC’s list of Specially Designated Nationals and Blocked Persons. If the Bank finds a name on any transaction account or wire transfer that is on an OFAC list, the Bank is required to investigate, and if the match is confirmed, the Bank must take additional actions including freezing such account, filing a suspicious activity report and notifying the FBI. Failure to comply may result in fines and other penalties. OFAC has issued guidance directed at financial institutions in which it asserted that it may, in its discretion, examine institutions determined to be high-risk or to be lacking in their efforts to comply with these prohibitions.

The USA PATRIOT Act also requires the federal banking agencies to take into consideration the effectiveness of controls designed to combat money laundering activities in determining whether to approve a merger or other acquisition application of a member institution. Accordingly, if we engage in a merger or other acquisition, our controls designed to combat money laundering would be considered as part of the application process. We have established policies, procedures and systems designed to comply with these regulations.

Holding Company Regulation

General. BFS Bancorp, MHC and the Company are non-diversified savings and loan holding companies within the meaning of the HOLA. Accordingly, BFS Bancorp, MHC and the Company are registered with the Federal Reserve and are subject to Federal Reserve’s regulations, examinations, supervision and reporting requirements. In addition, the Federal Reserve has enforcement authority over the Company and BFS Bancorp, MHC, and their subsidiaries. Among other things, this authority permits the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.

As noted above, pursuant to the Dodd-Frank Act, the Federal Reserve assumed responsibility for the primary supervision and regulation of all savings and loan holding companies, including the Company, on July 21, 2011. Given the extensive transfer of former OTS authority to multiple agencies, the Dodd-Frank Act requires the Federal Reserve to identify and publish in the Federal Register separate lists of the OTS regulations that the Federal Reserve will continue to enforce for savings and loan holding companies after the transfer date. In carrying out this mandate, and in connection with its assumption of responsibility for the ongoing examination, supervision, and regulation of savings and loan holding companies, the Federal Reserve has published an interim final rule which became effective on September 13, 2011, that provides for the corresponding transfer from the OTS to the Federal Reserve of the regulations necessary for the Federal Reserve to administer the statutes governing savings and loan holding companies. The Federal Reserve’s regulations supersede OTS regulations for purposes of Federal Reserve supervision and regulation of savings and loan holding companies.

Capital. Savings and loan holding companies are currently not subject to specific regulatory capital requirements. Pursuant to the Dodd-Frank Act, however, savings and loan holding companies will for the first time become subject to the same capital and activity requirements as those applicable to bank holding companies. All savings and loan holding companies generally have a five year phase-in period from the date of enactment of the Dodd-Frank Act to comply with the new capital requirements. Moreover, the Dodd-Frank Act requires the Federal Reserve to promulgate consolidated capital requirements for depository institution holding companies that are not less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. Accordingly, such mandate eliminates the inclusion of certain instruments, such as trust preferred securities issued on or after May 19, 2010, from Tier 1 holding company capital.

In addition, the Federal Reserve has indicated that, together with the other federal banking agencies, it is currently reviewing consolidated capital requirements for all depository institutions and their holding companies pursuant to section 171 of the Dodd-Frank Act and the Basel Committee on Banking Supervision’s “Basel III: A global regulatory framework for more resilient banks and banking systems” report (“Basel III”). It is expected that the Basel III notice of proposed rulemaking also would address any proposed application of Basel III-based requirements to savings and loan holding companies. When the rule-making process is complete, this definition will be changed to be more closely aligned to the definition of well-capitalized for bank holding companies.

Examination. In connection with its assumption of responsibility for the ongoing supervision and examination of savings and loan holding companies, the Federal Reserve issued a supervisory letter on July 21, 2011 that describes the supervisory approach the Federal Reserve will use during the first supervisory cycle and going forward generally for savings and loan holding companies. For purposes of the guidance, the first supervisory cycle is the period of time between July 21, 2011, and the close of the first required inspection. To help facilitate the transition of savings and loan holding companies to the supervisory jurisdiction of the Federal Reserve, the Federal Reserve noted in its letter that the first cycle of savings and loan holding company inspections will be instructive to both the Federal Reserve and savings and loan holding company management in terms of practical issues that arise in the supervision of a savings and loan holding company. In particular, examiners will be using the first supervisory cycle to inform savings and loan holding companies how their operations compare to the Federal Reserve’s supervisory expectations, which is expected to allow for savings and loan holding company management to make operational changes in response to the Federal Reserve’s supervisory expectations, if necessary. Also, the Federal Reserve plans to use the first inspections for the Federal Reserve supervisory staff to better understand a savings and loan holding company’s operations and business model and how the Federal Reserve’s holding company supervision framework can most effectively be implemented at these companies. Accordingly, the Federal Reserve’s focus for inspection activities during the first supervisory cycle will be on gaining an understanding of the structure and operations of each savings and loan holding company.

After the first supervisory cycle and going forward, the Federal Reserve intends, to the greatest extent possible taking into account any unique characteristics of savings and loan holding companies and the requirements of the HOLA, to assess the condition, performance, and activities of savings and loan holding companies on a consolidated basis in a manner that is consistent with the Federal Reserve’s established risk-based approach regarding bank holding company supervision. As with bank holding companies, the Federal Reserve’s objective will be to ensure that a savings and loan holding company and its nondepository subsidiaries are effectively supervised and can serve as a source of strength for, and do not threaten the soundness of, its subsidiary depository institution(s).

In accordance with its goal to assess the condition, performance, and activities of savings and loan holding companies on a consolidated basis in a manner that is consistent with the Federal Reserve’s established risk-based approach regarding bank holding company supervision, the Federal Reserve anticipates transitioning savings and loan holding companies to the Federal Reserve’s “RFI/C(D)” rating system (commonly referred to as “RFI”). The Federal Reserve expects to issue a notice shortly outlining application of the RFI rating system to savings and loan holding companies and any modifications that the Federal Reserve believes are necessary to accommodate savings and loan holding companies. That notice will provide the public with an additional opportunity to comment and will provide for a transition period before Federal Reserve examiners will assign final RFI ratings.

Source of Strength. The Dodd-Frank Act extends the Federal Reserve “source of strength” doctrine to savings and loan holding companies. Such policy requires holding companies to act as a source of financial strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of an institution’s financial distress. The regulatory agencies must issue joint regulations implementing this policy.

Change of Control. The federal banking laws require that appropriate regulatory approvals must be obtained before an individual or company may take actions to “control” a bank or savings association. The definition of control found in the HOLA is similar to that found in the BHCA for bank holding companies. Both statutes apply a similar three-prong test for determining when a company controls a bank or savings association. Specifically, a company has control over either a bank or savings association if the company:

(1)

directly or indirectly or acting in concert with one or more persons, owns, controls, or has the power to vote 25% or more of the voting securities of a company;

(2)

controls in any manner the election of a majority of the directors (or any individual who performs similar functions in respect of any company, including a trustee under a trust) of the board; or

(3)

directly or indirectly exercises a controlling influence over the management or policies of the bank.

The Federal Reserve has adopted an interim final rule that became effective on September 13, 2011 which, among other things, implements the HOLA to govern the operations of savings and loan holding companies. The new rule, known as Regulation LL, includes a specific definition of “control” similar to the statutory definition, with certain additional provisions. Additionally, Regulation LL modifies the regulations previously used by the OTS for purposes of determining when a company or natural person acquires control of a savings association or savings and loan holding company under the HOLA or the Change in Bank Control Act (“CBCA”). In light of the similarity between the statutes governing bank holding companies and savings and loan holding companies, the Federal Reserve has indicated that it intends to use its established rules and processes with respect to control determinations under HOLA and the CBCA to ensure consistency between equivalent statutes administered by the same agency.

The Federal Reserve stated in its rulemaking that it will review investments and relationships with savings and loan holding companies by companies using the current practices and policies applicable to bank holding companies to the extent possible. Overall, the indication of control used by the Federal Reserve under the BHCA to determine whether a company has a controlling influence over the management or policies of a banking organization (which for Federal Reserve purposes, will now include savings associations and savings and loan holding companies) are similar to the control factors found in the former OTS regulations. However, the OTS rules weighed these factors somewhat differently and used a different review process designed to be more mechanical.

Among the differences highlighted by the Federal Reserve with respect to OTS procedures on determinations of control, the Federal Reserve noted that it does not limit its review of companies with the potential to have a controlling influence to the two largest shareholders. Specifically, the Federal Reserve reviews all investors based on all of the facts and circumstances to determine if a controlling influence is present.

The federal banking laws require minority investors that are unwilling to bear the responsibilities associated with controlling a banking organization to limit their influence over the management and policies of the banking organization. That is, investors seeking the protection of being free from regulation and oversight as a savings and loan holding company under the HOLA are limited in their involvement and influence over the management and policies of the savings and loan holding company and its subsidiaries. In situations where investors believe no application is required, the Federal Reserve encourages investors to consult with staff at the appropriate Reserve Bank or the Federal Reserve to determine what type of review is appropriate to confirm that the Federal Reserve concurs that no BHCA or HOLA filing is necessary. As with OTS practice, the Federal Reserve often obtains a series of commitments from investors seeking non-control determinations.

Waivers of Dividends by BFS Bancorp, MHC. The Dodd-Frank Act and implementing regulations of the Federal Reserve require a mutual holding company to give the Federal Reserve notice before waiving the receipt of dividends, and prescribe the standards for granting a waiver. The Dodd-Frank Act and implementing regulations further provide that the Federal Reserve shall consider waived dividends in determining an appropriate exchange ratio in the event of a full conversion of the mutual holding company to stock form, except that the Federal Reserve may not consider waived dividends in determining an appropriate exchange ratio in a conversion to stock form by any federal mutual holding company that has waived dividends prior to December 1, 2009. Notwithstanding the Company’s plans to consummate the Mergers contemplated in the Agreement and Plan of Merger dated August 16, 2011, there can be no assurance that the Federal Reserve would approve waivers in the future or predictions as to what conditions, if any, the Federal Reserve would place on future dividend waivers, if we continue as an independent organization.

Effect of Governmental Monetary Polices

Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve has, and is likely to continue to have, an important impact on the operating results of financial institutions through its power to implement national monetary policy, among other things, in order to curb inflation or combat a recession. The Federal Reserve affects the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.

Federal Securities Laws

Shares of our common stock are registered with the SEC under Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We are also subject to the proxy rules, tender offer rules, insider trading restrictions, annual and periodic reporting, and other requirements of the Exchange Act.

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 was enacted in response to public concerns regarding corporate accountability in connection with certain accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the SEC, under the Exchange Act.

The Sarbanes-Oxley Act includes specific additional disclosure requirements, requires the SEC and national securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the SEC. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

We have incurred and anticipate that we will continue to incur additional expense in complying with the provisions of the Sarbanes-Oxley Act and the regulations that have been promulgated to implement the Sarbanes-Oxley Act, particularly those regulations relating to the establishment of internal controls over financial reporting.

Item 1A. Risk Factors

Failure to consummate the Mergers could materially and adversely affect the Company’s results of operations and stock price and cause the Bank to be placed into conservatorship or receivership.

If the Mergers are not consummated for any reason:

●

The Company will remain liable for significant transaction costs relating to the Mergers;

●

The market price of the Company’s common stock may further decline to the extent that the current market price reflects a market belief that the offer and the Mid-Tier Merger will be completed; and

●

BFS Bancorp, MHC, the Company and the Bank will be unable to comply with the Orders;

Accordingly, should the Mergers not be consummated, there is substantial risk that the Bank will be placed into receivership by the OCC, which would appoint the FDIC as a receiver and that the Company will be unable to continue as a going concern, which would likely result in a complete loss of a shareholder’s investment.

Additionally, the failure to consummate the Mergers may lead to uncertainty for the Company’s employees and its customers and suppliers. This uncertainty may mean:

●

The attention of the Company’s management and employees may be diverted from day-to-day operations; and

●

The Company’s ability to attract new employees and retain existing employees may be harmed by uncertainties associated with the Mergers.

The occurrence of any of these events individually or in combination could materially and adversely affect the Company’s results of operations and stock price and the Company’s ability to continue as a going concern.

We Have Stipulated To Cease And Desist Orders With The OTS, Which Are Now Enforced By the OTS’ Successor Agencies. So Long As These or Additional Orders Are in Effect, They Will Continue to Significantly Restrict Our Operations. The Failure To Comply With These Orders Can Result In Significant Penalties.

Effective March 31, 2011, the Company, BFS Bancorp, MHC and the Bank, consented to the issuance of Cease and Desist Orders from the OTS, which are now enforced by the Federal Reserve (for the Company and BFS Bancorp, MHC) and the OCC (for the Bank). While the entry into the Merger Agreement was intended to satisfy several requirements of the Orders, the Company, BFS Bancorp, MHC and the Bank continue to be subject to the significant restrictions imposed on our operations, including asset growth limitations, an inability to originate new commercial real estate loans without prior regulatory approval and restrictions on the Bank’s and Company’s abilities to make capital distributions.

In the event we are in material non-compliance with the terms of the Orders, the Federal Reserve and OCC have the authority to subject us to the terms of more restrictive enforcement orders, to impose civil money penalties on us and our directors and officers, and to remove directors and officers from their positions with the Company and the Bank.

An Inability To Improve Our Regulatory Capital Position Could Adversely Affect Our Operations.

Due to the capital requirements imposed by the Bank Order, as of September 30, 2011, the Bank was classified as “adequately capitalized,” and not “well capitalized.” As a result of our capital levels: (i) our loans to one borrower limit has been reduced, which affects the size of the loans that we can originate and also requires us to sell, participate, or refuse to renew loans that exceed our lower loans to one borrower limit, both of which could negatively impact our earnings; (ii) we cannot renew or accept brokered deposits without prior regulatory approval; (iii) we must obtain prior regulatory approval to undertake any branch expansion activities; and (iv) we will pay higher insurance premiums to the FDIC, which will reduce our earnings. We may not be able to raise additional capital or reduce the Bank’s assets on favorable terms. In addition, equity offerings may dilute the holdings of our existi