UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to _______________

Commission File No.: 0-28312

                    Bear State Financial, Inc.                

(Exact name of registrant as specified in its charter)

	Arkansas	71-0785261
	(State or other jurisdiction	(I.R.S. Employer
	of incorporation or organization)	Identification Number)
900 South Shackleford Rd, Suite 401
	Little Rock, Arkansas	72211
(Address of principal executive offices)		(Zip Code)

Registrant's telephone number, including area code: (501) 320-4904

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 ☒ No☐

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 ☒ No ☐

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

 Large Accelerated Filer  ☐  Accelerated Filer   ☐   Non-accelerated Filer  ☐     Smaller reporting company  ☒

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of November 5, 2014, there were issued and outstanding 30,030,344 shares of the Registrant's Common Stock, par value $.01 per share.

BEAR STATE FINANCIAL, INC.

TABLE OF CONTENTS

Part I.	Financial Information	Page
Item 1.	Financial Statements
	Condensed Consolidated Statements of Financial Condition as of September 30, 2014 and December 31, 2013 (unaudited)	1
	Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2014 and 2013 (unaudited)	2
	Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2014 and 2013 (unaudited)	3
	Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2014 (unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 (unaudited)	5
	Notes to Unaudited Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47
Item 4.	Controls and Procedures	48
Part II.	Other Information
Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	48
Item 6.	Exhibits	48
Signatures		49
Exhibit Index		50

Part I. Financial Information

Item 1. Financial Statements

BEAR STATE FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(In thousands, except share data)

(Unaudited)

	September 30, 2014			December 31, 2013
ASSETS
Cash and cash equivalents	$	87,586		$	23,970
Federal funds sold		10,250			--
Interest-bearing time deposits in banks		14,660			24,118
Investment securities available for sale		190,376			70,828
Other investment securities, at cost		7,104			457
Loans receivable, net of allowance of $12,964 and $12,711, respectively		1,049,867			371,149
Loans held for sale		7,539			4,205
Accrued interest receivable		5,045			1,473
Real estate owned - net		5,542			8,627
Office properties and equipment - net		48,982			18,769
Cash surrender value of life insurance		43,132			23,811
Goodwill		25,801			--
Core deposit intangible - net		7,494			--
Deferred tax asset, net		20,426			--
Prepaid expenses and other assets		4,583			1,465
TOTAL	$	1,528,387		$	548,872
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES:
Noninterest bearing deposits	$	169,962		$	19,427
Interest bearing deposits		1,107,344			450,298
Total deposits		1,277,306			469,725
Short term borrowings		12,081			--
Other borrowings		69,302			5,941
Other liabilities		4,279			2,019
Total liabilities		1,362,968			477,685
STOCKHOLDERS’ EQUITY:
Preferred stock, $0.01 par value—5,000,000 shares authorized; none issued at September 30, 2014 and December 31, 2013		--			--
Common stock, $0.01 par value—100,000,000 and 30,000,000 shares authorized at September 30, 2014 and December 31, 2013, respectively; 30,030,344 and 20,041,497 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively		300			200
Additional paid-in capital		166,434			92,740
Accumulated other comprehensive income (loss)		479			(467	)
Accumulated deficit		(1,794	)		(21,286	)
Total stockholders’ equity		165,419			71,187
TOTAL	$	1,528,387		$	548,872

See notes to unaudited condensed consolidated financial statements.

1

BEAR STATE FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except earnings per share)

(Unaudited)

	Three Months Ended					Nine Months Ended
	September 30,			September 30,		September 30,			September 30,
	2014			2013		2014			2013
INTEREST INCOME:
Loans receivable	$	15,390		$	4,033	$	25,381		$	12,084
Investment securities:
Taxable		415			146		952			256
Nontaxable		313			290		894			896
Other		105			110		321			381
Total interest income		16,223			4,579		27,548			13,617
INTEREST EXPENSE:
Deposits		1,320			814		3,174			2,477
Other borrowings		247			11		334			37
Total interest expense		1,567			825		3,508			2,514
NET INTEREST INCOME		14,656			3,754		24,040			11,103
PROVISION FOR LOAN LOSSES		600			--		830			--
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		14,056			3,754		23,210			11,103
NONINTEREST INCOME:
Net gain on sales of investment securities		30			25		30			25
Deposit fee income		1,956			780		3,445			2,352
Earnings on life insurance policies		349			205		758			603
Gain on sale of loans		968			267		1,923			726
Other		328			142		497			307
Total noninterest income		3,631			1,419		6,653			4,013
NONINTEREST EXPENSES:
Salaries and employee benefits		6,261			2,836		15,795			8,232
Net occupancy expense		1,569			583		2,850			1,809
Real estate owned, net		650			133		1,458			82
FDIC insurance		249			139		494			480
Amortization of intangible assets		157			--		183			--
Data processing		4,177			376		5,159			1,108
Professional fees		213			108		644			518
Advertising and public relations		494			71		795			215
Postage and supplies		263			91		466			308
Other		1,291			682		2,839			1,823
Total noninterest expenses		15,324			5,019		30,683			14,575
INCOME (LOSS) BEFORE INCOME TAXES		2,363			154		(820	)		541
INCOME TAX PROVISION (BENEFIT)		(20,312	)		11		(20,312	)		11
NET INCOME	$	22,675		$	143	$	19,492		$	530
Basic earnings per common share	$	0.76		$	0.01	$	0.81		$	0.03
Diluted earnings per common share	$	0.75		$	0.01	$	0.79		$	0.03

See notes to unaudited condensed consolidated financial statements.

2

BEAR STATE FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2014			2013			2014			2013
Net income	$	22,675		$	143		$	19,492		$	530
Other comprehensive income (loss):
Unrealized holding (losses) gains arising during the period		(27	)		299			1,272			(633	)
Less: reclassification adjustments for realized gain included in net income		(30	)		(25	)		(30	)		(25	)
Other comprehensive income (loss), before tax effect		(57	)		274			1,242			(658	)
Tax effect		(296	)		--			(296	)		--
Other comprehensive income (loss)		(353	)		274			946			(658	)
COMPREHENSIVE INCOME (LOSS)	$	22,322		$	417		$	20,438		$	(128	)

See notes to unaudited condensed consolidated financial statements.

3

BEAR STATE FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014

(In thousands, except share data)

(Unaudited)

	Issued Common Stock
	Shares		Amount		Additional Paid-In Capital		Accumulated Other  Comprehensive Income (Loss)			Accumulated  Deficit			Total  Stockholders’ Equity
BALANCE – January 1, 2014		20,041,497	$	200	$	92,740	$	(467	)	$	(21,286	)	$	71,187
Net income		--		--		--		--			19,492			19,492
Other comprehensive income		--		--		--		946			--			946
Shares issued – merger with FNSC, net of issuance costs of approximately $542		6,252,400		63		49,789		--			--			49,852
Shares issued – private placement		2,531,646		25		19,975		--			--			20,000
Shares issued – warrant exercises		1,196,667		12		3,578		--			--			3,590
Shares issued – option exercises		3,600		--		24		--			--			24
Shares issued – restricted stock unit vesting		4,534		--		--		--			--			--
Stock compensation		--		--		328		--			--			328
BALANCE – September 30, 2014		30,030,344	$	300	$	166,434	$	479		$	(1,794	)	$	165,419

See notes to unaudited condensed consolidated financial statements.

4

BEAR STATE FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended September 30,
	2014			2013
OPERATING ACTIVITIES:
Net income	$	19,492		$	530
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Provision for loan losses		830			--
Provision for real estate losses		1,513			577
Deferred tax provision (benefit)		(773	)		(621	)
Deferred tax valuation allowance		(19,539	)		621
Net amortization (accretion) of investment securities		111			(6	)
Federal Home Loan Bank stock dividends		(6	)		--
Gain on sale of fixed assets, net		(12	)		(42	)
Gain on sale of real estate owned, net		(188	)		(690	)
Gain on sale of investment securities, net		(30	)		(25	)
Originations of loans held for sale		(73,423	)		(37,534	)
Proceeds from sales of loans held for sale		73,682			38,732
Gain on sale of loans originated to sell		(1,923	)		(726	)
Depreciation		1,524			1,038
Amortization of deferred loan costs, net		65			83
Accretion of purchased loans, net		(2,927	)		--
Amortization of other intangible assets		183			--
Stock compensation		328			168
Earnings on life insurance policies		(758	)		(603	)
Changes in operating assets and liabilities:
Accrued interest receivable		(618	)		(4	)
Prepaid expenses and other assets		(398	)		4
Other liabilities		(66	)		(744	)
Net cash (used in) provided by operating activities		(2,933	)		758
INVESTING ACTIVITIES:
Cash paid for purchase of FNSC, net of cash received		(8,985	)		--
Net decrease in federal funds sold		32,775			--
Redemptions of interest-bearing time deposits in banks		9,458			4,481
Purchases of investment securities available for sale (“AFS”)		(9,280	)		(37,293	)
Proceeds from sales of investment securities AFS		3,875			12,169
Proceeds from maturities/calls/paydowns of investment securities AFS		25,682			4,487
Redemptions of Federal Home Loan Bank stock		1,170			116
Purchases of Federal Home Loan Bank stock		(331	)		--
Loan originations, net of repayments		(48,919	)		(33,278	)
Loan participations purchased		(25,286	)		(3,391	)
Loans sold		--			23,938
Proceeds from sales of real estate owned		3,138			8,004
Other cash activity - real estate owned		--			89
Proceeds from sales of office properties and equipment		377			1,871
Purchases of office properties and equipment		(1,803	)		(1,173	)
Purchase of bank owned life insurance		(16,628	)		--
Net cash used in investing activities		(34,757	)		(19,980	)

(Continued)

5

BEAR STATE FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended September 30,
	2014			2013
FINANCING ACTIVITIES:
Net increase in deposits	$	44,043		$	22,097
Sale of deposits in connection with branch sale		--			(21,692	)
Proceeds from advances from Federal Home Loan Bank		22,000			--
Repayment of advances from Federal Home Loan Bank		(537	)		(2,141	)
Proceeds from other borrowings		19,650			--
Repayments of other borrowings		(5,250	)		--
Net decrease in short term borrowings		(2,214	)		--
Proceeds from private placement		20,000			--
Proceeds from exercise of warrants		3,590			1,786
Proceeds from exercise of stock options		24			--
Net cash provided by financing activities		101,306			50
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS		63,616			(19,172	)
CASH AND CASH EQUIVALENTS:
Beginning of period		23,970			42,607
End of period	$	87,586		$	23,435
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION—
Cash paid for:
Interest	$	3,400		$	2,506
Income taxes	$	--		$	11
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Real estate and other assets acquired in settlement of loans	$	1,313		$	1,972
Sales of real estate owned financed by the Bank	$	--		$	815
Investment securities purchased—not settled	$	624		$	--
Common stock issued for purchase of FNSC	$	49,852		$	--

See notes to unaudited condensed consolidated financial statements.

(Concluded)

6

BEAR STATE FINANCIAL, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

General — Bear State Financial, Inc. (the “Company”) is a bank holding company headquartered in Little Rock, Arkansas. On June 13, 2014, the Company completed its merger with First National Security Company (“FNSC”). The FNSC merger was accounted for under the acquisition method of accounting. The purchased assets, assumed liabilities and identifiable intangible assets were recorded at their acquisition date estimated fair values. Fair values are subject to refinement for up to one year after the closing date of the transaction as additional information regarding closing date fair values becomes available. The Company’s results of operations for the nine months ended September 30, 2014 includes results of operations for First National Bank and Heritage Bank, N.A. (banks acquired in the FNSC merger) for the period from June 14 through September 30, 2014. See Note 3 for additional information regarding the merger transaction.

Nature of Operations —The Company is a bank holding company headquartered in Little Rock, Arkansas.  Its principal subsidiaries, First Federal Bank (“First Federal”), First National Bank (“First National”) and Heritage Bank, N.A. (“Heritage”) (collectively, the “Banks”), are community oriented financial institutions providing a broad line of financial products to individuals and business customers.  Collectively, the Banks operate 45 branch offices throughout Arkansas and Southeast Oklahoma.

The Company completed its acquisition of First National Security Company (“FNSC”) and its subsidiaries, including FNB and Heritage, on June 13, 2014. 

Principles of Consolidation—The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiary holding companies and banks. The consolidated financial statements also include the accounts of First Federal’s wholly owned subsidiary, First Harrison Service Corporation (“FHSC”), which is inactive. Intercompany transactions have been eliminated in consolidation.

Basis of Presentation—The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles (“GAAP”) for complete financial statements. However, such information reflects all adjustments which are, in the opinion of management, necessary for a fair statement of results for the interim periods. Those adjusting entries consist only of normal recurring adjustments.

Certain reclassifications of prior period amounts have been made to conform with the current period presentation. These reclassifications had no impact on previously reported net income.

The Company is substantially in the business of community banking and therefore is considered a banking operation with no separately reportable segments.

The results of operations for the three and nine months ended September 30, 2014, are not necessarily indicative of the results to be expected for the year ending December 31, 2014. The unaudited condensed consolidated financial statements of the Company and notes thereto should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2013, contained in the Company’s 2013 Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”). The condensed consolidated balance sheet of the Company has been derived from the audited consolidated balance sheet of the Company as of that date.

Acquired Loans— Acquired loans and leases are recorded at fair value at the date of acquisition. No allowance for loan and lease losses is recorded on the acquisition date as the fair value of the acquired assets incorporates assumptions regarding credit risk. The fair value adjustment on acquired loans without evidence of credit deterioration since origination will be accreted into earnings as a yield adjustment using the effective yield method over the remaining life of the loan.

Acquired loans and leases with evidence of credit deterioration since origination such that it is probable at acquisition that the bank will be unable to collect all contractually required payments are accounted for under the guidance in ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. As of the acquisition date, the difference between contractually required payments and the cash flows expected to be collected is the nonaccretable difference, which is included as a reduction of the carrying amount of acquired loans and leases. If the timing and amount of the future cash flows is reasonably estimable, any excess of cash flows expected at acquisition over the estimated fair value is the accretable yield and is recognized in interest income over the asset's remaining life using a level yield method.

7

Acquired loan amounts deemed uncollectible at acquisition date become part of the fair value calculation and are excluded from the ALLL. Following acquisition, a regular review will be completed on acquired loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL. Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan and lease losses and related ALLL, if any, or prospective adjustment to the accretable yield if no provision for loan and lease losses had been recorded.

2.       RECENT ACCOUNTING PRONOUNCEMENTS

In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (Topic 740): Income Taxes, which states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. For example, an entity should not evaluate whether the deferred tax asset expires before the statute of limitations on the tax position or whether the deferred tax asset may be used prior to the unrecognized tax benefit being settled. The amendments in this Update do not require new recurring disclosures. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of this ASU did not have a material impact on the Company’s financial statements.

In January 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (Topic 310-40): Receivables – Troubled Debt Restructurings by Creditors, which clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this Update are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. An entity can elect to adopt the amendments in this Update using either a modified retrospective transition method or a prospective transition method. Early adoption is permitted. The Company is in the process of evaluating the impact of this Update on its financial statements.

In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Components of an Entity, which changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. The guidance applies prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date. The standard is required to be adopted by public business entities in annual periods beginning on or after December 15, 2014, and interim periods within those annual periods. The Company will be required to adopt this ASU beginning with the quarter ending March 31, 2015. The adoption of this ASU is not expected to have a material impact on the Company’s financial statements.

3.       ACQUISITION

On June 13, 2014, the Company completed its previously-announced acquisition of First National Security Company (“FNSC”) whereby FNSC merged with and into the Company in a transaction valued at approximately $124.4 million. In connection with the merger, former FNSC stockholders received in the aggregate 6,252,400 shares of Company common stock, valued at approximately $50.4 million and $74 million in cash in exchange for 100% of the outstanding shares of FNSC common stock. The Company paid $50 million of the total cash consideration and FNSC paid $24 million of the total cash consideration to its stockholders from funds it received immediately prior to the closing of the acquisition from its subsidiary bank, First National Bank. The acquisition expanded the Company’s market into Northeast and Southwest Arkansas and further diversified the Company’s loan, customer and deposit base.

8

The following table provides a summary of the assets acquired and liabilities assumed as recorded by FNSC, the fair value adjustments necessary to adjust those acquired assets and assumed liabilities to estimated fair value, and the resultant fair values of those assets and liabilities as recorded by the Company. As provided for under GAAP, management has up to 12 months following the date of acquisition to finalize the fair values of the acquired assets and assumed liabilities. The estimated fair values are subject to refinement as additional information relative to the closing date fair values becomes available through the measurement period. As a result, the Company updated the previously reported consolidated balance sheet for the period adjustments. The goodwill recognized by the Company will not be deductible for income tax purposes.

	June 13, 2014
	As Recorded by FNSC			Fair Value Adjustments			As Recorded by the Company
	(Dollars in thousands)
Assets acquired:
Cash and cash equivalents	$	41,015		$	--		$	41,015
Federal funds sold		43,025			--			43,025
Investment securities available for sale		138,140			--			138,140
Other investment securities, at cost		7,480			--			7,480
Loans receivable		622,758			(17,294	)		605,464
Allowance for loan losses		(13,179	)		13,179			--
Loans receivable, net		609,579			(4,115	)		605,464
Accrued interest receivable		2,954			--			2,954
Real estate owned - net		69			--			69
Office properties and equipment, net		33,074			(2,775	)		30,299
Cash surrender value of life insurance		1,935			--			1,935
Core deposit intangible		568			7,109			7,677
Deferred tax asset, net		542			(135	)		407
Prepaid expenses and other assets		2,899			362			3,261
Total assets acquired		881,280			446			881,726
Liabilities assumed:
Deposits – noninterest bearing		151,331			--			151,331
Deposits – interest bearing		611,841			366			612,207
Total deposits		763,172			366			763,538
Short term borrowings		14,295			--			14,295
Other borrowings		27,434			64			27,498
Other liabilities		1,802			--			1,802
Total liabilities assumed		806,703			430			807,133
Net assets acquired	$	74,577		$	16			74,593
Consideration paid:
Cash								50,000
Common stock								50,394
Total consideration paid								100,394
Goodwill							$	25,801

The following is a description of the fair value adjustments used to determine the fair values of assets and liabilities presented above:

Loans – Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates. The discount rates used for loans are based on current market rates for new originations of comparable loans and include adjustments for liquidity concerns. The fair value adjustment reflects the elimination of the recorded allowance for loan and lease losses.

9

Office properties and equipment – Office properties and equipment were acquired from FNSC with a $2.8 million adjustment to market value. This represents the difference between current appraisal value completed in connection with the acquisition and FNSC’s book value at the time of acquisition.

Deferred tax asset – Deferred income tax assets and liabilities are recorded to reflect the differences in the carrying values of the acquired assets and assumed liabilities for financial reporting purposes and the cost basis for federal income tax purposes, at the Company’s statutory federal and state income tax rate of 38.29%.

Core deposit intangible – This intangible asset represents the value of the relationships that FNSC had with its deposit customers. The fair value of this intangible asset was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the deposit base, and the net maintenance cost attributable to customer deposits. The Company recorded a $7.7 million core deposit intangible with a weighted average life of 12.3 years.

Deposits – The weighted average interest rate of FNSC’s time deposits was estimated to be slightly above the current market rates, resulting in a $366,000 fair value adjustment for time deposits.

Other borrowings – The fair value of FHLB borrowed funds is estimated based on borrowing rates currently available to the Company for borrowings with similar terms and maturities.

Beginning June 14, 2014, the operations of FNSC are included in the Company’s consolidated results of operations and contributed $12.0 million of net interest income and $3.8 million of net income for the nine months ended September 30, 2014. The following unaudited pro-forma combined consolidated financial information presents how the combined financial information of the Company and FNSC might have appeared had the businesses actually been combined as of the beginning of each period presented. The following schedule represents the unaudited pro-forma combined financial information as of the nine month comparative periods ended September 30, 2014 and 2013, assuming the acquisition was completed as of January 1, 2014 and 2013, respectively (in thousands, except per share data):

	Nine Months Ended September 30, 2014		Nine Months Ended September 30, 2013
Net interest income	$	36,488	$	38,116
Total noninterest income		9,399		9,976
Net income		21,664		9,800
Basic earnings per common share	$	0.74	$	0.34
Diluted earnings per common share	$	0.73	$	0.33

The unaudited pro-forma consolidated financial information is presented for illustrative purposes only and does not indicate the financial results of the combined company had the companies actually been combined at the beginning of the period presented and had the impact of possible revenue enhancements and expense efficiencies, among other factors, been considered and, accordingly, does not attempt to predict or suggest future results. It also does not necessarily reflect what the historical results of the combined company would have been had the companies been combined during this period.

10

4.       INVESTMENT SECURITIES AVAILABLE FOR SALE

Investment securities available for sale consisted of the following as of the dates indicated (in thousands):

	September 30, 2014
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
U.S. government agencies	$	106,655	$	13	$	(163	)	$	106,505
Municipal securities		46,864		445		(52	)		47,257
Mortgage-backed securities		36,083		554		(23	)		36,614
Total	$	189,602	$	1,012	$	(238	)	$	190,376

	December 31, 2013
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Municipal securities	$	42,203	$	199	$	(478	)	$	41,924
Mortgage-backed securities		29,092		11		(199	)		28,904
Total	$	71,295	$	210	$	(677	)	$	70,828

The following tables summarize the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired (“OTTI”), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):

	September 30, 2014
	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
U.S. government agencies	$	53,634	$	163	$	--	$	--	$	53,634	$	163
Municipal securities		4,024		27		3,014		25		7,038		52
Mortgage-backed securities		5,098		23		--		--		5,098		23
Total	$	62,756	$	213	$	3,014	$	25	$	65,770	$	238

	December 31, 2013
	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
Municipal securities	$	17,851	$	424	$	945	$	54	$	18,796	$	478
Mortgage-backed securities		27,004		199		--		--		27,004		199
Total	$	44,855	$	623	$	945	$	54	$	45,800	$	677

On a quarterly basis, management conducts a formal review of securities for the presence of OTTI.  Management assesses whether an OTTI is present when the fair value of a security is less than its amortized cost basis at the balance sheet date.  For such securities, OTTI is considered to have occurred if the Company intends to sell the security, if it is more likely than not the Company will be required to sell the security before recovery of its amortized cost basis or if the present values of expected cash flows is not sufficient to recover the entire amortized cost.

The unrealized losses are primarily a result of increases in market yields from the time of purchase.  In general, as market yields rise, the fair value of securities will decrease; as market yields fall, the fair value of securities will increase. Management generally views changes in fair value caused by changes in interest rates as temporary; therefore, these securities have not been classified as other-than-temporarily impaired.  Additionally, the unrealized losses are also considered temporary because scheduled coupon payments have been made, it is anticipated that the entire principal balance will be collected as scheduled, and management neither intends to sell the securities nor is it more likely than not that the Company will be required to sell the securities before the recovery of the remaining amortized cost amount.

11

The Company has pledged investment securities with carrying values of approximately $143.3 million at September 30, 2014 and $398,000 at December 31, 2013, as collateral for certain deposits in excess of $250,000 and for other purposes, including investment securities with carrying values of approximately $12.1 million at September 30, 2014, for securities sold under agreements to repurchase. There were no investment securities pledged by the Company for securities sold under agreements to repurchase at December 31, 2013.

The following table sets forth the amount (dollars in thousands) of investment securities available for sale that contractually mature during each of the periods indicated and the weighted average yields for each range of maturities at September 30, 2014. Weighted average yields for municipal obligations have not been adjusted to a tax-equivalent basis. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay the obligation without prepayment penalties.

	September 30, 2014
	Amortized		Fair		Weighted
	Cost		Value		Average Rate
Within one year	$	37,960	$	37,971		0.22	%
Due from one year to five years		87,416		87,380		0.78	%
Due from five years to ten years		22,172		22,339		2.59	%
Due after ten years		5,971		6,072		3.43	%
		153,519		153,762		1.01	%
Mortgage-backed securities		36,083		36,614		2.81	%
Total	$	189,602	$	190,376		1.35	%

As of September 30, 2014 and December 31, 2013, investments with amortized cost totaling approximately $52.1 million and $34.4 million, respectively, have call options held by the issuer, of which approximately $25.1 million and $13.0 million, respectively, are or were callable within one year.

Sales of investment securities available for sale are summarized as follows (in thousands):

	Nine Months Ended September 30,
	2014		2013
Sales proceeds	$	3,875	$	12,169
Gross realized gains	$	30	$	47
Gross realized losses		--		(22	)
Net gains on sales of investment securities	$	30	$	25

12

5.       LOANS RECEIVABLE

Loans receivable consisted of the following at September 30, 2014 and December 31, 2013 (in thousands):

	September 30, 2014			December 31, 2013
Real estate:
One- to four-family residential	$	318,673		$	129,308
Multifamily residential		44,365			25,773
Nonfarm nonresidential		379,560			168,902
Farmland		48,892			2,663
Construction and land development		89,165			23,891
Commercial		149,073			29,033
Consumer		33,268			4,368
Total loans receivable		1,062,996			383,938
Unearned discounts and net deferred loan costs		(165	)		(78	)
Allowance for loan and lease losses		(12,964	)		(12,711	)
Loans receivable—net	$	1,049,867		$	371,149

Mortgage loans serviced for others are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of such loans at September 30, 2014 and December 31, 2013 were $24.0 million and $12.9 million, respectively. Servicing loans for others generally consists of collecting payments and disbursing payments to investors. Servicing income for the three and nine months ended September 30, 2014 and 2013 was not significant.

As of September 30, 2014 and December 31, 2013, qualifying loans collateralized by first lien one- to four-family mortgages with balances totaling approximately $43.2 million and $50.6 million, respectively, were held in custody by the Federal Home Loan Bank of Dallas (“FHLB”) and were pledged for outstanding advances or available for future advances. The Banks also pledged substantially all of the remaining loans at September 30, 2014 under a blanket lien with the FHLB.

As of September 30, 2014 and December 31, 2013, qualifying loans collateralized by commercial real estate with balances of $7.0 million and $8.2 million, respectively, were pledged at the FRB. No FRB borrowings were outstanding at September 30, 2014.

The Company evaluated $583.6 million of net loans ($595.1 million gross loans less $11.5 million discount) purchased in conjunction with the acquisition of FNSC in accordance with the provisions of FASB ASC Topic 310-20,  Nonrefundable Fees and Other Costs . The fair value discount is being accreted into interest income over the weighted average life of the loans using a constant yield method.

The Company evaluated $21.1 million of net loans ($26.9 million gross loans less $5.8 million discount) purchased in conjunction with the acquisition of FNSC in accordance with the provisions of FASB ASC Topic 310-30,  Loans and Debt Securities Acquired with Deteriorated Credit Quality. The following table reflects the carrying amount of purchased credit impaired (“PCI”) loans, which are included in the loan categories above (in thousands):

	September 30, 2014		June 13, 2014
One- to four-family residential	$	4,552	$	4,728
Multifamily residential		--		--
Nonfarm nonresidential		10,671		10,790
Farmland		90		95
Construction and land development		3,534		3,432
Commercial		1,344		1,882
Consumer		149		178
Total carrying value of PCI loans	$	20,340	$	21,105
Outstanding principal balance of PCI loans	$	26,209	$	26,942

13

The following table documents changes to the amount of accretable yield since the acquisition date of June 13, 2014 (in thousands).

Balance at June 13, 2014	$	2,306
Accretion		(354	)
Changes in expected cash flows that do not affect nonaccretable differences		(1,423	)
Balance at September 30, 2014	$	529

Age analyses of loans as of the dates indicated, including both accruing and nonaccrual loans, are presented below (in thousands):

September 30, 2014	30-89 Days Past Due		90 Days or More Past Due		Current		Total
One- to four-family residential	$	2,159	$	2,511	$	314,003	$	318,673
Multifamily residential		--		--		44,365		44,365
Nonfarm nonresidential		1,721		2,422		375,417		379,560
Farmland		20		628		48,244		48,892
Construction and land development		268		593		88,304		89,165
Commercial		363		30		148,680		149,073
Consumer		182		25		33,061		33,268
Total	$	4,713	$	6,209	$	1,052,074	$	1,062,996

December 31, 2013	30-89 Days Past Due		90 Days or More Past Due		Current		Total
One- to four-family residential	$	3,511	$	1,664	$	124,133	$	129,308
Multifamily residential		--		--		25,773		25,773
Nonfarm nonresidential		176		2,340		166,386		168,902
Farmland		--		666		1,997		2,663
Construction and land development		30		2,133		21,728		23,891
Commercial		--		348		28,685		29,033
Consumer		--		19		4,349		4,368
Total	$	3,717	$	7,170	$	373,051	$	383,938

As of September 30, 2014, there were $1.7 million of purchased credit impaired loans acquired in the merger with FNSC that were 90 days or more past due and accruing. There were no loans over 90 days past due and still accruing at December 31, 2013. Restructured loans totaled $2.5 million and $2.6 million as of September 30, 2014 and December 31, 2013, respectively, with $1.9 million and $2.1 million of such restructured loans on nonaccrual status at September 30, 2014 and December 31, 2013, respectively.

14

The following table presents age analyses of nonaccrual loans as of the dates indicated (in thousands):

September 30, 2014	30-89 Days Past Due		90 Days or More Past Due		Current		Total
One- to four-family residential	$	317	$	2,068	$	2,184	$	4,569
Nonfarm nonresidential		338		1,235		1,641		3,214
Farmland		--		628		109		737
Construction and land development		--		582		33		615
Commercial		--		--		316		316
Consumer		1		9		16		26
Total	$	656	$	4,522	$	4,299	$	9,477

December 31, 2013	30-89 Days Past Due		90 Days or More Past Due		Current		Total
One- to four-family residential	$	637	$	1,664	$	1,957	$	4,258
Nonfarm nonresidential		--		2,340		1,717		4,057
Farmland		--		666		116		782
Construction and land development		--		2,133		334		2,467
Commercial		--		348		2		350
Consumer		--		19		5		24
Total	$	637	$	7,170	$	4,131	$	11,938

The following tables summarize information pertaining to impaired loans as of September 30, 2014 and December 31, 2013 and for the three and nine months ended September 30, 2014 and 2013 (in thousands). Purchased credit impaired loans acquired in the merger with FNSC are not included these tables.

	September 30, 2014						December 31, 2013
	Unpaid Principal Balance		Recorded Investment		Valuation Allowance		Unpaid Principal Balance		Recorded Investment		Valuation Allowance
Impaired loans with a valuation allowance:
One- to four-family residential	$	1,472	$	1,217	$	256	$	1,213	$	1,085	$	279
Nonfarm nonresidential		2,540		2,260		623		3,287		3,105		1,119
Farmland		621		487		125		623		495		133
Construction and land development		685		525		125		1,865		1,505		631
Commercial		--		--		--		--		--		--
Consumer		16		16		14		--		--		--
		5,334		4,505		1,143		6,988		6,190		2,162
Impaired loans without a valuation allowance:
One- to four-family residential		4,454		3,838		--		4,430		3,668		--
Nonfarm nonresidential		1,675		955		--		1,077		952		--
Farmland		537		250		--		554		287		--
Construction and land development		172		160		--		1,189		962		--
Commercial		369		330		--		388		350		--
Consumer		10		10		--		27		24		--
		7,217		5,543		--		7,665		6,243		--
Total impaired loans	$	12,551	$	10,048	$	1,143	$	14,653	$	12,433	$	2,162

15

	Three and Nine Months Ended September 30, 2014
	Average Recorded Investment		Average Recorded Investment		Interest  Income Recognized		Interest  Income Recognized
	(Three Months)		(Nine Months)		(Three Months)		(Nine Months)
Impaired loans with a valuation allowance:
One- to four-family residential	$	1,127	$	1,126	$	2	$	7
Nonfarm nonresidential		2,278		2,590		--		--
Farmland		488		491		--		--
Construction and land development		347		748		2		5
Commercial		--		63		--		--
Consumer		16		11		--		--
		4,256		5,029		4		12
Impaired loans without a valuation allowance:
One- to four-family residential		3,783		3,642		1		2
Nonfarm nonresidential		934		1,030		--		--
Farmland		257		269		--		--
Construction and land development		350		625		--		--
Commercial		326		338		--		--
Consumer		9		14		--		--
		5,659		5,918		1		2
Total impaired loans	$	9,915	$	10,947	$	5	$	14
Interest based on original terms					$	134	$	532
Interest income recognized on a cash basis on impaired loans					$	--	$	--

	Three and Nine Months Ended September 30, 2013
	Average Recorded Investment		Average Recorded Investment		Interest Income Recognized		Interest Income Recognized
Impaired loans with a valuation allowance:	(Three Months)		(Nine Months)		(Three Months)		(Nine Months)
One- to four-family residential	$	2,115	$	2,093	$	2	$	7
Multifamily residential		--		857		--		--
Nonfarm nonresidential		3,045		3,055		--		--
Farmland		499		408		--		--
Construction and land development		1,478		1,184		--		--
Commercial		1		96		--		--
Consumer		5		5		--		--
		7,143		7,698		2		7
Impaired loans without a valuation allowance:
One- to four-family residential		3,659		4,693		--		--
Multifamily residential		--		865		--		--
Nonfarm nonresidential		1,382		2,714		--		--
Farmland		306		420		--		--
Construction and land development		1,147		1,656		--		--
Commercial		26		24		--		--
Consumer		5		16		--		--
		6,525		10,388		--		--
Total impaired loans	$	13,668	$	18,086	$	2	$	7
Interest based on original terms					$	478	$	703
Interest income recognized on a cash basis on impaired loans					$	--	$	--

16

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Bank’s loan portfolio, the Banks categorize loans into risk categories based on available and relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. First Federal analyzes loans individually by assigning a credit risk rating to loans on at least an annual basis for non-homogeneous loans over $250,000. FNB and Heritage assign a credit rating to loans at origination and review these ratings periodically thereafter. The Banks use the following definitions for risk ratings:

Pass. Loans rated as pass generally meet or exceed normal credit standards. Factors influencing the level of pass grade include repayment source and strength, collateral, borrower cash flows, existence of and strength of guarantors, industry/business sector, financial trends, performance history, etc.

Special Mention. Loans rated as special mention, while still adequately protected by the borrower’s repayment capability, exhibit distinct weakening trends. If left unchecked or uncorrected, these potential weaknesses may result in deteriorated prospects of repayment. These exposures require management’s close attention so as to avoid becoming adversely classified credits.

Substandard. Loans rated as substandard are inadequately protected by the current sound net worth and paying capacity of the borrower or the collateral pledged, if any. These assets must have a well-defined weakness based on objective evidence and be characterized by the distinct possibility that the Banks will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans rated as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.

Loss. Loans rated as a loss are considered uncollectible and of such little value that continuance as an asset is not warranted. A loss classification does not mean that an asset has no recovery or salvage value, but that it is not practical or desirable to defer writing off or reserving all or a portion of the asset, even though partial recovery may be effected in the future.

Based on analyses performed at September 30, 2014 and December 31, 2013, the risk categories of loans are as follows (in thousands):

			September 30, 2014
	Pass		Special Mention		Substandard		Not Rated		Total
One- to four-family residential	$	226,117	$	2,586	$	11,188	$	78,782	$	318,673
Multifamily residential		37,757		--		--		6,608		44,365
Nonfarm nonresidential		360,679		4,418		8,602		5,861		379,560
Farmland		47,684		--		1,208		--		48,892
Construction and land development		82,906		108		2,409		3,742		89,165
Commercial		147,583		3		1,205		282		149,073
Consumer		27,310		6		197		5,755		33,268
Total	$	930,036	$	7,121	$	24,809	$	101,030	$	1,062,996

	December 31, 2013
	Pass		Special Mention		Substandard		Not Rated		Total
One- to four-family residential	$	34,333	$	329	$	6,371	$	88,275	$	129,308
Multifamily residential		25,773		--		--		--		25,773
Nonfarm nonresidential		159,629		4,490		4,057		726		168,902
Farmland		1,491		--		1,172		--		2,663
Construction and land development		18,241		295		2,770		2,585		23,891
Commercial		28,555		--		350		128		29,033
Consumer		151		--		45		4,172		4,368
Total	$	268,173	$	5,114	$	14,765	$	95,886	$	383,938

As of September 30, 2014 and December 31, 2013, the Banks did not have any loans classified as doubtful or loss.

Troubled Debt Restructurings. Troubled debt restructurings (“TDRs”) are loans where the contractual terms on the loan have been modified and both of the following conditions exist: (i) the borrower is experiencing financial difficulty and (ii) the restructuring constitutes a concession that the Bank would not otherwise make. The Banks assess all loan modifications to determine if the modifications constitute a TDR. Restructurings resulting in an insignificant delay in payment are not considered to be TDRs. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length and the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. All TDRs are considered impaired loans. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

17

The following table summarizes TDRs as of September 30, 2014 and December 31, 2013: (dollars in thousands)

September 30, 2014	Number of Accruing TDR Loans		Balance		Number of Nonaccrual TDR Loans		Balance		Total Number of TDR Loans		Total Balance
One- to four-family residential		4	$	486		9	$	732		13	$	1,218
Nonfarm nonresidential		--		--		3		519		3		519
Farmland		--		--		1		250		1		250
Construction and land development		1		85		2		398		3		483
Consumer		--		--		2		16		2		16
Total		5	$	571		17	$	1,915		22	$	2,486

December 31, 2013	Number of Accruing TDR Loans		Balance		Number of Nonaccrual TDR Loans		Balance		Total Number of TDR Loans		Total Balance
One- to four-family residential		4	$	495		8	$	658		12	$	1,153
Nonfarm nonresidential		--		--		3		556		3		556
Farmland		--		--		1		287		1		287
Construction and land development		--		--		4		569		4		569
Consumer		--		--		1		5		1		5
Total		4	$	495		17	$	2,075		21	$	2,570

Loans receivable that were restructured as TDRs during the nine months ended September, 30 2014 and 2013 were as follows: (dollars in thousands)

	Nine Months Ended September 30, 2014
							Nature of Modification
		Number of Loans		Balance Prior to TDR		Balance at September 30, 2014	Payment Term (1)		Other (2)
One- to four-family residential		1	$	103	$	96	$	103	$	--
Construction and land development		1		85		85		--		85
Consumer		1		11		11		11		--
Total		3	$	199	$	192	$	114	$	85

__________________________

(1)	Concessions represent skipped payments/maturity date extensions or amortization term extensions.
(2)	The borrower did not have the financial ability to refinance at another bank at renewal.

	Nine Months Ended September 30, 2013
							Nature of Modification
		Number of Loans		Balance Prior to TDR		Balance at September 30, 2013	Payment Term (1)		Other
One- to four-family residential		2	$	118	$	105	$	118	$	--
Total		2	$	118	$	105	$	118	$	--

__________________________

(1) Concessions represent skipped payments/maturity date extensions or amortization term extensions.

There were no loans receivable for which a payment default occurred during the three and nine months ended September 30, 2014 or 2013 that had been modified as a TDR within 12 months or less of the payment default.

18

6.       ALLOWANCES FOR LOAN AND LEASE LOSSES AND REAL ESTATE LOSSES

The tables below provide a rollforward of the allowance for loan and lease losses (“ALLL”) by portfolio segment for the three and nine months ended September 30, 2014 and 2013 (in thousands):

	Three Months Ended September 30, 2014
	One- to Four-Family Residential			Multifamily Residential			Nonfarm Nonresidential		Farmland		Construction and Land Development		Commercial		Consumer			Total
Balance, beginning of period	$	4,490		$	1,030		$	3,910	$	282	$	868	$	1,721	$	91		$	12,392
Provision charged to expense		91			(114	)		314		8		43		208		50			600
Losses charged off		(61	)		--			--		--		--		--		(57	)		(118	)
Recoveries		36			--			3		--		30		4		17			90
Balance, end of period	$	4,556		$	916		$	4,227	$	290	$	941	$	1,933	$	101		$	12,964

	Nine Months Ended September 30, 2014
	One- to Four-Family Residential			Multifamily Residential			Nonfarm Nonresidential			Farmland		Construction and Land Development			Commercial			Consumer			Total
Balance, beginning of period	$	4,549		$	1,001		$	4,271		$	158	$	1,383		$	1,268		$	81		$	12,711
Provision charged to expense		22			(85	)		65			132		(81	)		684			93			830
Losses charged off		(70	)		--			(115	)		--		(444	)		(29	)		(122	)		(780	)
Recoveries		55			--			6			--		83			10			49			203
Balance, end of period	$	4,556		$	916		$	4,227		$	290	$	941		$	1,933		$	101		$	12,964

	Three Months Ended September 30, 2013
	One- to Four-Family Residential			Multifamily Residential		Nonfarm Nonresidential			Farmland		Construction and Land Development		Commercial			Consumer			Total
Balance, beginning of period	$	6,151		$	580	$	4,435		$	273	$	940	$	662		$	208		$	13,249
Provision charged to expense		(114	)		458		(246	)		7		105		(113	)		(97	)		--
Losses charged off		(280	)		--		--			--		--		--			(32	)		(312	)
Recoveries		118			--		--			--		12		3			8			141
Balance, end of period	$	5,875		$	1,038	$	4,189		$	280	$	1,057	$	552		$	87		$	13,078

	Nine Months Ended September 30, 2013
	One- to Four-Family Residential			Multifamily Residential			Nonfarm Nonresidential			Farmland		Construction and Land Development			Commercial			Consumer			Total
Balance, beginning of period	$	5,099		$	1,319		$	6,949		$	251	$	879		$	956		$	223		$	15,676
Provision charged to expense		1,630			595			(2,251	)		29		174			(101	)		(76	)		--
Losses charged off		(1,026	)		(876	)		(1,009	)		--		(115	)		(380	)		(107	)		(3,513	)
Recoveries		172			--			500			--		119			77			47			915
Balance, end of period	$	5,875		$	1,038		$	4,189		$	280	$	1,057		$	552		$	87		$	13,078

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The tables below present the allocation of the ALLL and the related loans receivable balances disaggregated on the basis of impairment method by portfolio segment as of September 30, 2014 and December 31, 2013 (in thousands):

	September 30, 2014
	One- to Four-Family Residential		Multifamily Residential		Nonfarm Nonresidential		Farmland		Construction and Land Development		Commercial		Consumer		Total
ALLL Balances:
Individually evaluated for impairment	$	256	$	--	$	623	$	125	$	125	$	--	$	14	$	1,143
Collectively evaluated for impairment		4,300		916		3,604		165		816		1,933		87		11,821
Ending balance	$	4,556	$	916	$	4,227	$	290	$	941	$	1,933	$	101	$	12,964
Loan balances:
Individually evaluated for impairment	$	5,055	$	--	$	3,215	$	737	$	685	$	330	$	26	$	10,048
Collectively evaluated for impairment		313,618		44,365		376,345		48,155		88,480		148,743		33,242		1,052,948
Ending balance	$	318,673	$	44,365	$	379,560	$	48,892	$	89,165	$	149,073	$	33,268	$	1,062,996

	December 31, 2013
	One- to Four-Family Residential		Multifamily Residential		Nonfarm Nonresidential		Farmland		Construction and Land Development		Commercial		Consumer		Total
ALLL Balances:
Individually evaluated for impairment	$	279	$	--	$	1,119	$	133	$	631	$	--	$	--	$	2,162
Collectively evaluated for impairment		4,270		1,001		3,152		25		752		1,268		81		10,549
Ending balance	$	4,549	$	1,001	$	4,271	$	158	$	1,383	$	1,268	$	81	$	12,711
Loan balances:
Individually evaluated for impairment	$	4,753	$	--	$	4,057	$	782	$	2,467	$	350	$	24	$	12,433
Collectively evaluated for impairment		124,555		25,773		164,845		1,881		21,424		28,683		4,344		371,505
Ending balance	$	129,308	$	25,773	$	168,902	$	2,663	$	23,891	$	29,033	$	4,368	$	383,938

A summary of the activity in the allowance for losses on real estate owned is as follows for the three and nine months ended September 30, 2014 and 2013 (in thousands):

	Three Months Ended						Nine Months Ended
	September 30, 2014			September 30, 2013			September 30, 2014			September 30, 2013
Balance—beginning of period	$	8,481		$	9,406		$	8,794		$	14,877
Provisions for estimated losses		653			358			1,513			577
Recoveries		--			--			--			--
Losses charged off		(711	)		(111	)		(1,884	)		(5,801	)
Balance—end of period	$	8,423		$	9,653		$	8,423		$	9,653

7.       OFFICE PROPERTIES AND EQUIPMENT

Office properties and equipment consisted of the following as of September 30, 2014 and December 31, 2013 (in thousands):

	September 30, 2014			December 31, 2013
Land and land improvements	$	10,872		$	5,340
Buildings and improvements		42,135			19,358
Furniture and equipment		8,240			5,770
Automobiles		823			210
Total		62,070			30,678
Accumulated depreciation		(13,088	)		(11,909	)
Office properties and equipment—net	$	48,982		$	18,769

Depreciation expense for the nine months ended September 30, 2014 and 2013 was approximately $1.5 million and $1.0 million, respectively.

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8.       GOODWILL AND CORE DEPOSIT INTANGIBLE - NET

Goodwill represents the excess of the cost over the fair value of net assets acquired in a business combination. Goodwill is not amortized but is tested for impairment at least annually and updated quarterly if necessary. At September 30, 2014, goodwill consisted of $25.8 million related to the FNSC acquisition. This goodwill is not deductible for tax purposes. The Company’s core deposit intangible is related to the core deposit premiums of FNB and Heritage. These core deposit intangibles are amortized on a straight line basis over their estimated lives ranging from 12 to 13 years.

Changes in the carrying amount and accumulated amortization of the Company’s core deposit intangible for the nine months ended September 30, 2014 were as follows (in thousands):

	September 30, 2014
Balance—beginning of period	$	--
FNSC merger		7,677
Amortization expense		(183	)
Balance—end of period	$	7,494

The Company’s projected amortization expense for the remainder of 2014 is approximately $156,000, $625,000 in each of the years ending December 31, 2015 through 2018, and $4.8 million thereafter.

9.       DEPOSITS

Deposits are summarized as follows (in thousands):

	September 30, 2014		December 31, 2013
Checking accounts	$	559,935	$	127,764
Money market accounts		117,018		45,153
Savings accounts		115,149		30,150
Certificates of deposit		485,204		266,658
Total	$	1,277,306	$	469,725

The aggregate amount of time deposits in denominations of $100 thousand or more was approximately $250.4 million and $138.6 million at September 30, 2014 and December 31, 2013, respectively.

At September 30, 2014, scheduled maturities of certificates of deposit were as follows (in thousands):

	Amount
Within one year	$	270,278
One to two years		68,519
Two to three years		47,741
Three to four years		51,630
Four to five years		27,927
Over five years		19,109
Total	$	485,204

10.     SHORT TERM BORROWINGS

Short term borrowings consist of repurchase agreements totaling $12.1 million at September 30, 2014. Securities sold under repurchase agreements generally have maturities of one day and are recorded based on the amount of cash received in connection with the borrowing. Securities pledged as collateral under repurchase agreements are included in investment securities on the Condensed Consolidated Balance Sheets and are disclosed in Note 4. The fair value of the collateral pledged to a third party is continually monitored and additional collateral is pledged or returned, as deemed appropriate.

At September 30, 2014, the Company and its subsidiary banks had unused credit lines allowing contingent access to overnight borrowings of up to $123.9 million on an unsecured basis.

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11.     OTHER BORROWINGS

Other borrowings are summarized as follows (in thousands):

	September 30, 2014		December 31, 2013
Federal Home Loan Bank advances with rates ranging from 0.15% to 7.80% maturing through July 1, 2024	$	49,783	$	5,941
Line of credit with a bank, $14.75 million total credit line, floating rate of 1.95% above the three-month LIBOR rate, reset quarterly, interest payments due quarterly, maturing May 30, 2016		14,400		--
Term note payable to a bank, floating rate of 1.95% above the three-month LIBOR rate, reset quarterly, principal and interest payments due quarterly, maturing May 30, 2019		5,119		--
Total	$	69,302	$	5,941

Federal Home Loan Bank. The Banks are members of the Federal Home Loan Bank System. As a member of this system, they are required to maintain an investment in capital stock of the FHLB in an amount equal to the sum of 0.04% of total assets as of the previous December 31 and 4.10% of outstanding advances. No ready market exists for such stock and it has no quoted market value. The carrying value of the stock is its cost. The Banks currently pledge as collateral for FHLB advances certain qualifying one- to four-family mortgage loans.

Notes Payable. The line of credit and note payable to a bank are collateralized by 100% of the stock of the Banks, FCBC and HCC. The related loan agreement requires the Company and the Banks to maintain certain financial ratios. As of September 30, 2014, the Company was in compliance with the applicable material covenants imposed by the loan agreement.

At September 30, 2014, scheduled maturities of other borrowings were as follows: (in thousands):

	Weighted
	Average
	Rate			Amount
Within one year		0.47	%	$	25,368
One to two years		2.19			15,409
Two to three years		1.19			6,006
Three to four years		2.11			5,936
Four to five years		1.94			9,373
Over five years		2.68			7,210
Total		1.48	%	$	69,302

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12. INCOME TAXES

The provisions (benefits) for income taxes are summarized as follows (in thousands):

	Nine Months Ended
	September, 30 2014			September 30, 2013
Income tax provision (benefit):
Current:
Federal	$	--		$	11
State		--			--
Total current		--			11
Deferred:
Federal		(672	)		(570	)
State		(101	)		(51	)
Valuation allowance		(19,539	)		621
Total deferred		(20,312	)		--
Total	$	(20,312	)	$	11

The reasons for the differences between the statutory federal income tax rates and the effective tax rates are summarized as follows (in thousands):

	Nine Months Ended September 30
	2014					2013
Taxes at statutory rate	$	(279	)	34.0	%	$	185		34.0	%
Increase (decrease) resulting from:
State income tax—net		(34	)	4.1			24		4.4
Section 382 write-down		79		(9.7	)		758		140.2
Change in valuation allowance		(19,539	)	2,382.5			(452	)	(83.5	)
Earnings on life insurance policies		(259	)	31.5			(205	)	(37.9	)
Nontaxable investments		(313	)	38.2			(303	)	(55.9	)
Other—net		33		(3.9	)		4		0.8
Total	$	(20,312	)	2,476.7	%	$	11		2.1	%

The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined on the basis of the differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

The Company recognizes deferred tax assets to the extent that the Company believes these assets are more likely than not to be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies and results of recent operations. If the Company determines that it would be able to realize the deferred tax assets in the future in excess of its net recorded amount, the Company would make an adjustment to the deferred tax valuation allowance, which would reduce the provision for income taxes.

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The Company’s net deferred tax asset account was comprised of the following (in thousands):

	September 30, 2014			December 31, 2013
Deferred tax assets:
Allowance for loan and lease losses	$	5,979		$	6,011
Discount on purchased loans		5,530			--
Real estate owned		3,358			3,511
Section 382 net operating loss carryforward		2,286			2,390
Net operating loss carryforward		12,231			10,410
Nonaccrual loan interest		869			806
Other		716			422
Total deferred tax assets		30,969			23,550
Valuation allowance		(3,334	)		(22,873	)
Deferred tax asset, net of allowance		27,635			677
Deferred tax liabilities:
Office properties		(3,373	)		(430	)
Core deposit intangible		(2,870	)		--
Unrealized gain on securities available for sale		(296	)		--
Pension plan contribution		(16	)		(118	)
Prepaid expenses and other		(654	)		(129	)
Total deferred tax liabilities		(7,209	)		(677	)
Net deferred tax asset (liability)	$	20,426		$	--

A financial institution may, for federal income tax purposes, carryback net operating losses ("NOLs") to the preceding two taxable years and forward to the succeeding 20 taxable years. At September 30, 2014, the Company had a $36.4 million NOL for federal income tax purposes that will be carried forward. The federal NOL carryforwards, if unused, expire in calendar years 2029 through 2034. The $36.4 million federal NOL includes $6.7 million of IRC Section 382 NOL carryforwards that have an annual limit of $405,000 that can be utilized to offset taxable income. At September 30, 2014, the Company had a $49.9 million NOL for state income tax purposes. The state NOL carryforwards, if unused, expire in calendar years 2014 through 2019.

Specifically exempted from deferred tax recognition requirements are bad debt reserves for tax purposes of U.S. savings and loans in the institution’s base year, as defined. Base year reserves totaled approximately $4.2 million. Consequently, a deferred tax liability of approximately $1.6 million related to such reserves was not provided for in the consolidated statements of financial condition at September 30, 2014 and December 31, 2013. Payment of dividends to stockholders out of retained earnings deemed to have been made out of earnings previously set aside as bad debt reserves may create taxable income to the Bank. No provision has been made for income tax on such a distribution as the Bank does not anticipate making such distributions.

During the nine months ended September 30, 2014, the Company recorded a valuation allowance reversal of $19.5 million on the basis of management’s assessment of the amount of its deferred tax assets that are more likely than not to be realized.

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The Company regularly evaluates the need for deferred tax asset valuation allowances based on a more likely than not standard as defined by generally accepted accounting principles. In accordance with ASC Topic 740-10, Income Taxes (ASC 740), a valuation allowance is deemed to be needed when, based on the weight of the available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or all of a deferred tax asset will not be realized. The ability to realize deferred tax assets depends on the ability to generate sufficient taxable income within the carryback and carryforward periods provided for in the tax law for each applicable tax jurisdiction. The Company considers the following possible sources of taxable income when assessing the realization of deferred tax assets:

● Future reversals of existing temporary differences;

● Future taxable income exclusive of reversing temporary differences and carryforwards;

● Taxable income in prior carryback years; and

● Tax planning strategies

The assessment regarding whether a valuation allowance is required or should be adjusted also considers all positive and negative evidence, including but not limited to:

● Nature, frequency and severity of recent losses;

● Duration of statutory carryforward periods;

● Historical experience with tax attributes expiring unused; and

● Near- and medium-term financial outlook.

The Company acquired FNSC on June 13, 2014.  The pretax income generated by FNSC since the acquisition on June 13, 2014 is approximately $6.1 million.  As a result of the acquisition, the Company achieved its first quarter of positive taxable income in the quarter ended September 30, 2014. FNSC has a long history of achieving positive pretax income. The pretax income of FNSC for each of the years of 2011, 2012 and 2013 exceeded $13 million.  The Company viewed these positive factors in light of the negative evidence of the Company’s historical losses and concluded that the structural change of the Company as a result of the acquisition, as evidenced by its quarterly results, outweighs this negative factor.

Other positive evidence considered in connection with the Company’s decision to reverse its deferred tax valuation allowance include the significant improvement in the asset quality of the Company, as well as its detailed forecasts projecting the complete realization of all federal deferred tax assets before expiration under a stressed earnings scenario. In order to realize the federal net operating loss carryforwards, the Company needs to generate $36.4 million of pretax earnings. The Company believes that it is more likely than not that this level of pretax earnings will be achievable even under a stressed scenario to utilize the net operating loss carryforwards and the remaining net deferred tax assets.

The Company had a total state net operating loss carryforward as of September 30, 2014 of $49.9 million. In connection with the ongoing assessment of deferred taxes, the Company determined the amount of such net operating loss that is expected to expire unused and did not reverse the valuation allowance on the amount which is not likely to be realized. At September 30, 2014, the state deferred tax asset which will not likely be realized due to carryover limitations was $917,000 and a valuation allowance remains for this amount.

In addition, at September 30, 2014 the Company has certain deferred tax assets related to net unrealized built-in losses (“NUBILs”) established under IRC Section 382 on the date of the ownership change of May 3, 2011. If these losses are recognized before May 3, 2016 (five years after the ownership change date), then they are not allowed to be taken as a deduction and are therefore permanently lost. The NUBILs at September 30, 2014 amounted to $3.432 million or $1.167 million on a tax effected basis. Since these NUBILs may be lost, the valuation allowance of $1.167 million was not reversed. If any of the NUBILs still remain on the books on May 3, 2016, the valuation allowance can be reversed at that time.

Upon considering all the positive and negative evidence, and the extent to which that evidence was objectively verifiable, the Company determined that the positive evidence outweighed the negative evidence and the deferred tax assets, with the exception of $2.1 million related to state NOLs and NUBILs, are more likely than not realizable, as of and for the nine months ended September 30, 2014. In addition, a valuation allowance of $1.25 million remains that is expected to be reversed through a reduction for the provision for income taxes during the three months ended December 31, 2014 in accordance with intra-period tax allocation rules under GAAP. As a result, the valuation allowance has been reversed in the amount of $19.5 million, or $0.79 per diluted share, during the nine months ended September 30, 2014 that benefited income tax expense.

The Company will continue to regularly assess the realizability of its deferred tax assets. Changes in earnings performance and future earnings projections, among other factors, may cause the Company to adjust its valuation allowance, which will impact the Company’s income tax in the period it determines that these factors have changes.

The Company files consolidated income tax returns in the U.S. federal jurisdiction and the state of Arkansas. The Company is subject to U.S. federal and state income tax examinations by tax authorities for tax years ended December 31, 2010 and forward.

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13.     STOCK BASED COMPENSATION

2011 Omnibus Incentive Plan— The 2011 Omnibus Incentive Plan (the “2011 Plan”), became effective May 3, 2011, after approval by the Company’s stockholders on April 29, 2011. The objectives of the 2011 Plan are to optimize the profitability and growth of the Company through incentives that are consistent with the Company’s goals and that link the personal interests of participants to those of the Company’s stockholders. The 2011 Plan provides for a committee of the Company’s Board of Directors to award nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, and other awards representing up to 1,930,269 shares of Company stock. Awards may be granted under the 2011 Plan up to ten years following the effective date of the plan. Each award under the 2011 Plan is governed by the terms of the individual award agreement, which shall specify pricing, term, vesting, and other pertinent provisions. Shares issued in connection with stock compensation awards are issued from available authorized shares.

Stock Options. Option awards are generally granted with an exercise price equal to the fair market value of the Company’s stock at the date of grant, generally vest based on five years of continuous service and have seven year contractual terms. The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model. Expected volatilities are based on implied volatilities from historical volatility of the Company’s stock and other factors. The Company uses historical data to estimate option exercise, employee termination, and expected term of the options within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

A summary of the stock option activity in the Company’s 2011 Plan for the nine months ended September 30, 2014, is presented below:

	Shares Underlying Awards			Weighted Average Exercise Price
Outstanding—January 1, 2014		217,500		$	6.66
Granted		--		$	--
Exercised		(3,600	)	$	6.57
Forfeited		(2,100	)	$	6.57
Outstanding—September 30, 2014		211,800		$	6.66
Exercisable—September 30, 2014		48,900		$	6.57

The weighted average remaining contractual life of the outstanding options was 4.2 years and the aggregate intrinsic value of the options was approximately $496,000 at September 30, 2014. The weighted average remaining contractual life of options exercisable was 3.8 years at September 30, 2014.

As of September 30, 2014, there was $338,000 of total unrecognized compensation costs related to nonvested stock options under the 2011 Plan. The cost is expected to be recognized over a weighted-average period of 2.4 years. Compensation expense attributable to option awards totaled approximately $43,000 and $37,000 for the three month periods ended September 30, 2014 and 2013, respectively, and approximately $114,000 and $110,000 for the nine months ended September 30, 2014 and 2013, respectively.   

Restricted Stock Units. The fair value of each restricted stock unit (“RSU”) award is determined based on the closing market price of the Company’s stock on the grant date and amortized to compensation expense on a straight-line basis over the vesting period. The vesting periods range from three to seven years.

	Restricted Stock Units			Weighted Average Grant Date Fair Value
Outstanding—January 1, 2014		65,500		$	8.97
Granted		130,100		$	8.21
Vested		(5,817	)	$	9.75
Forfeited		(2,034	)	$	8.50
Outstanding—September 30, 2014		187,749		$	8.42

As of September 30, 2014, there was $1.3 million of total unrecognized compensation costs related to nonvested RSUs under the 2011 Plan. The cost is expected to be recognized over a weighted-average period of 4.0 years. Compensation expense attributable to awards of RSUs totaled approximately $101,000 and $36,000 for the three months ended September 30, 2014 and 2013, respectively, and approximately $225,000 and $58,000 for the nine months ended September 30, 2014 and 2013, respectively.

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14.     EARNINGS PER SHARE

Basic earnings per share is computed by dividing reported earnings available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing reported earnings available to common stockholders by the weighted average number of common shares outstanding after consideration of the dilutive effect, if any, of the Company’s outstanding common stock options and warrants using the treasury stock method.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
Basic weighted average shares outstanding		30,027,791		20,013,343		24,066,438		19,779,684
Effect of dilutive securities		69,828		897,619		518,538		1,065,424
Diluted weighted average shares outstanding		30,097,619		20,910,962		24,584,976		20,845,108

The calculation of diluted earnings per share for the three and nine months ended September 30, 2014 excluded antidilutive stock options representing 42,500 shares. The calculation of diluted earnings per share for the three and nine months ended September 30, 2013 excluded antidilutive stock options representing approximately 7,000 shares.

15.      FAIR VALUE MEASUREMENTS

ASC 820, Fair Value Measurement, provides a framework for measuring fair value and defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 describes three levels of inputs that may be used to measure fair value: 

Level 1	Unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2	Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data at the measurement date for substantially the full term of the assets or liabilities.
Level 3	Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

Financial instruments are broken down by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that, due to an event or circumstance, were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.

The following is a description of inputs and valuation methodologies used for assets recorded at fair value on a recurring basis and recognized in the accompanying statements of financial condition at September 30, 2014 and December 31, 2013, as well as the general classification of such assets pursuant to the valuation hierarchy.

Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. The fair values used by the Company are obtained from an independent pricing service, which represent either quoted market prices for the identical asset or fair values determined by pricing models, or other model-based valuation techniques, that consider observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems. Recurring Level 2 securities include U.S. agency securities, mortgage-backed securities, municipal bonds and corporate debt securities. Inputs used for valuing Level 2 securities include observable data that may include dealer quotes, benchmark yields, market spreads, live trading levels and market consensus prepayment speeds, among other things. Additional inputs include indicative values derived from the independent pricing service’s proprietary computerized models. No securities were included in the Recurring Level 3 category at or for the periods ended September 30, 2014 or December 31, 2013.

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The following table presents major categories of assets measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 (in thousands):

	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2014
Available for sale investment securities:
U.S. Government agencies	$	106,505	$	--	$	106,505	$	--
Municipal securities		47,257		--		47,257		--
Mortgage-backed securities		36,614		--		36,614		--
Total	$	190,376	$	--	$	190,376	$	--
December 31, 2013
Available for sale investment securities:
Municipal securities	$	41,924	$	--	$	41,924	$	--
Mortgage-backed securities		28,904		--		28,904		--
Total	$	70,828	$	--	$	70,828	$	--

The following is a description of valuation methodologies used for significant assets measured at fair value on a nonrecurring basis.

Impaired Loans Receivable

Loans which meet certain criteria are evaluated individually for impairment. A loan is considered impaired when, based upon current information and events, it is probable the bank will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan agreement.  Substantially all of the Bank’s impaired loans at September 30, 2014 and December 31, 2013 are secured by real estate.  Impaired loans are individually measured for impairment by comparing the carrying value of the loan to the discounted cash flows or the fair value of the collateral, less estimated selling costs, as appropriate. Fair value is estimated through current appraisals, real estate brokers’ opinions or listing prices.  Fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3.   During the reported periods, collateral discounts ranged from 15% to 45% and selling costs were estimated at 8%. Fair value adjustments are made by partial charge-offs and adjustments to the allowance for loan and lease losses.

Real Estate Owned, net

REO represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is carried at the lower of cost or fair value less estimated selling costs.  Fair value is estimated through current appraisals, real estate brokers’ opinions or listing prices.  As these properties are actively marketed, estimated fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3.  During the reported periods, collateral discounts ranged from 0% to 25% and selling costs were typically estimated at 8%. Fair value adjustments are recorded in earnings during the period such adjustments are made. REO loss provisions recorded during the nine months ended September 30, 2014 and 2013 were $1.5 million and $533,000, respectively.

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The following table presents major categories of assets measured at fair value on a nonrecurring basis for the nine months ended September 30, 2014 and 2013 (in thousands). The assets disclosed in the following table represent REO properties or impaired loans that were remeasured at fair value during the period with a resulting valuation adjustment or fair value write-down.

	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2014
Impaired loans	$	6,540	$	--	$	--	$	6,540
REO, net		3,925		--		--		3,925
September 30, 2013
Impaired loans	$	16,043	$	--	$	--	$	16,043
REO, net		5,249		--		--		5,249

16.     FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair value of financial instruments has been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The estimated fair values of financial instruments that are reported at amortized cost in the Company’s statement of financial condition, segregated by the level of valuation inputs within the fair value hierarchy used to measure fair value, are as follows (in thousands):

	September 30, 2014				December 31, 2013
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
FINANCIAL ASSETS:
Level 1 inputs:
Cash and cash equivalents	$	87,586	$	87,586	$	23,970	$	23,970
Federal funds sold		10,250		10,250		--		--
Level 2 inputs:
Interest-bearing time deposits in banks		14,660		14,943		24,118		24,573
Other investment securities		7,104		7,104		457		457
Loans held for sale		7,539		7,539		4,205		4,205
Cash surrender value of life insurance		43,132		43,132		23,811		23,811
Accrued interest receivable		5,045		5,045		1,473		1,473
Level 3 inputs:
Loans receivable—net		1,049,867		1,063,266		371,149		377,851
FINANCIAL LIABILITIES:
Level 1 inputs:
Short term borrowings		12,081		12,081		--		--
Level 2 inputs:
Checking, money market and savings accounts		792,102		792,102		203,067		203,067
Other borrowings		69,302		70,581		5,941		6,017
Accrued interest payable		324		324		33		33
Level 3 inputs:
Certificates of deposit		485,204		485,538		266,658		266,495

For cash and cash equivalents and federal funds sold, the carrying amount approximates fair value (level 1). For other investment securities, loans held for sale, cash surrender value of life insurance and accrued interest receivable, the carrying value is a reasonable estimate of fair value, primarily because of the short-term nature of the instruments or, as to other investment securities, the ability to sell the stock back to the issuer at cost (level 2). Interest bearing time deposits in banks were valued using discounted cash flows based on current rates for similar types of deposits (level 2). Fair values of impaired loans are estimated as described in Note 9. Non-impaired loans were valued using discounted cash flows. The discount rates used to determine the present value of these loans were based on interest rates currently being charged by the Banks on comparable loans (level 3).

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For federal funds purchased and securities sold under agreements to repurchase, the carrying amount approximates fair value (level 1). The fair value of checking accounts, savings accounts and money market deposits is the amount payable on demand at the reporting date (level 2). The fair value of fixed-maturity certificates of deposit is estimated using the discount rates currently offered by the Banks for deposits of similar terms (level 3). The fair value of FHLB advances is estimated using the rates for advances of similar remaining maturities at the reporting date (level 2). For accrued interest payable the carrying value is a reasonable estimate of fair value, primarily because of the short-term nature of the instruments (level 2).

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

17. REGULATORY MATTERS

The Company and subsidiary banks are subject to various regulatory capital requirements administered by the federal and state banking agencies. The Office of the Comptroller of the Currency (“OCC”) is the primary regulator for First Federal Bank, First National Bank, Hot Springs and Heritage Bank. The Federal Reserve Bank is the primary regulator for the Company. Failure to meet minimum capital requirements can result in certain mandatory—and possible additional discretionary—actions by regulators that, if undertaken, could have a direct and material effect on the Company’s or the Banks’ financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Banks must meet specific capital guidelines that involve quantitative measures of the Company’s and the Banks’ assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Banks’ capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.  

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Banks to maintain minimum amounts and ratios (set forth in the following table) of tangible capital (as defined) to tangible assets (as defined) and core capital (as defined) to adjusted tangible assets (as defined), and of total risk-based capital (as defined) to risk-weighted assets (as defined). Tier 1 (core) capital includes common stockholders’ equity and qualifying preferred stock less certain other deductions. Total capital includes Tier 1 capital plus the allowance for loan and lease losses, subject to limitations.

As of the most recent notification from regulatory authorities, the Company and the Banks were all categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, tier 1 risk-based, and tier 1 (core) ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed any of the Banks’ categorizations.

The actual and required capital amounts (in thousands) and ratios of the Company (Consolidated) and First Federal Bank (“First Federal”), First National Bank (“FNB”) and Heritage Bank (“Heritage”) as of September 30, 2014 are presented in the following table:

	Actual					For Capital Adequacy Purposes					To be Categorized as Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Tangible Capital to Tangible Assets
First Federal	$	51,694		8.85	%	$	8,762		1.50	%		N/A		N/A
Tier 1 Capital to Average Assets
Consolidated	$	117,189		8.10	%	$	57,905		4.00	%		N/A		N/A
First Federal (1)		51,694		8.85	%		23,366		4.00	%	$	29,207		5.00	%
FNB		54,312		9.15	%		17,808		3.00	%		29,679		5.00	%
Heritage		28,433		9.69	%		8,802		3.00	%		14,670		5.00	%
Total Capital to Risk-Weighted Assets
Consolidated	$	130,153		11.43	%	$	91,077		8.00	%		N/A		N/A
First Federal		57,597		12.36	%		37,278		8.00	%	$	46,598		10.00	%
FNB		54,728		12.34	%		35,487		8.00	%		44,358		10.00	%
Heritage		28,834		12.78	%		18,051		8.00	%		22,563		10.00	%
Tier I Capital to Risk-Weighted Assets
Consolidated	$	117,189		10.29	%	$	45,539		4.00	%		N/A		N/A
First Federal		51,694		11.09	%		N/A		N/A		$	27,959		6.00	%
FNB		54,312		12.24	%		17,743		4.00	%		26,615		6.00	%
Heritage		28,433		12.60	%		9,025		4.00	%		13,538		6.00	%

(1) In the case of First Federal, the ratio is calculated based on adjusted assets at period end.

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First Federal’s actual and required capital amounts (in thousands) and ratios as of December 31, 2013, are presented in the following table:

	Actual					For Capital Adequacy Purposes					To be Categorized as Well Capitalized Under Prompt Corrective Action Provisions					Required Per Agreement With the OCC (1)
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2013, :
Tangible Capital to Tangible Assets	$	70,853		12.90	%	$	8,240		1.50	%		N/A		N/A			N/A		N/A
Core Capital to Adjusted Tangible Assets		70,853		12.90	%		21,972		4.00	%	$	27,465		5.00	%	$	43,944		8.00	%
Total Capital to Risk-Weighted Assets		76,036		18.68	%		32,570		8.00	%		40,713		10.00	%		48,855		12.00	%
Tier I Capital to Risk-Weighted Assets		70,853		17.40	%		N/A		N/A			24,428		6.00	%		N/A		N/A

(1) First Federal’s Bank Order, effective through January 15, 2013, required the bank to maintain a Tier 1 (core) capital ratio of at least 8% and a total risk-based capital ratio of at least 12%. After such date and through February 21, 2014, First Federal agreed with the OCC to maintain a minimum Tier 1 (core) capital ratio of at least 8% of adjusted total assets and a total risk-based capital ratio of at least 12% of risk-weighted assets. The required amounts presented reflect these ratios.

Private Placement. In connection with the merger with FNSC, on June 13, 2014 the Company sold 2,531,646 shares of Company common stock at a price per share equal to $7.90 in a private placement (the “Private Placement”) to its principal stockholder Bear State and certain of Bear State’s members in their individual capacity (the “Investors”) (including Richard N. Massey, the Company’s Chairman of the Board, President and Chief Executive Officer, and Scott T. Ford, a director of the Company). Additionally, the Company issued warrants (the “Investor Warrants”) to purchase 177,215 shares of common stock on the same terms as in the Private Placement to the Investors in exchange for their respective commitments to backstop the Private Placement. The pricing of the Private Placement and Investor Warrants was equal to the closing stock price for the Company’s common stock on June 28, 2013, which was the last business day prior to the execution of the merger agreement with FNSC. This price was also used to determine the number of shares issued to FNSC stockholders in the merger.

Authorized Shares. On March 21, 2014, the stockholders of the Company approved a proposal to amend the Company’s Articles of Incorporation to increase the number of authorized shares of common stock from 30,000,000 to 100,000,000. Effective June 3, 2014, the Company filed Amended and Restated Articles of Incorporation (the “Amended Articles”) with the Secretary of State of the State of Arkansas. The Amended Articles increased the number of authorized shares from 30,000,000 to 100,000,000.

Dividend Restrictions. The Banks may not declare or pay cash dividends on its shares of common stock if the effect thereof would cause the bank’s stockholders’ equity to be reduced below applicable regulatory capital maintenance requirements for insured institutions or, in the case of First Federal, below the special liquidation account established by First Federal in connection with the consummation of its conversion from the mutual holding company structure on May 3, 1996. In addition, federal regulations, as currently applied to the Banks, impose limitations upon payment of capital distributions to the Company.

The principal source of the Company’s revenues is dividends from the Banks. Our ability to pay dividends to our stockholders depends to a large extent upon the dividends we receive from the Banks.

Repurchase Program. On February 19, 2014, the Board of Directors of the Company approved a share repurchase program permitting the Company to repurchase up to $1,000,000 of its common stock over the next 12 months.

18. SUBSEQUENT EVENTS

On October 13, 2014, the board of directors of the Company authorized an additional term loan with an unaffiliated bank in the amount of $5 million with principal and interest payments due quarterly and a maturity date of May 30, 2019.

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

Management's discussion and analysis of financial condition and results of operations (“MD&A”) is intended to assist a reader in understanding the consolidated financial condition and results of operations of the Company for the periods presented. The information contained in this section should be read in conjunction with the Condensed Consolidated Financial Statements and the accompanying Notes to the Condensed Consolidated Financial Statements and the other sections contained herein. References to the Company and the Banks throughout MD&A are made using the first person notations of “we”, “us” or “our”.

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The Company is a bank holding company headquartered in Little Rock, Arkansas.  Its principal subsidiaries, First Federal Bank (“First Federal”), First National Bank (“First National”) and Heritage Bank, N.A. (“Heritage”) (collectively, the “Banks”), are community oriented financial institutions providing a broad line of financial products to individuals and business customers.  Collectively, the Banks operate 45 branch offices throughout Arkansas and Southeast Oklahoma.

The Company completed its acquisition of First National Security Company (“FNSC”) and its subsidiaries, including FNB and Heritage, on June 13, 2014. Accordingly, the Company’s results of operations for the nine months ended September 30, 2014 includes results of operations for FNB and Heritage for the period from June 14 through September 30, 2014.

The Company’s three banks continue to progress towards more highly efficient and integrated operations. The Company’s operational integration project includes conversion of all bank operations to a single technology platform, and, subject to regulatory approval, the consolidation of its three banking charters to a single charter.  The Company expects the bulk of this integration project to be completed by the second quarter of 2015. It also expects further public announcements regarding its management and key operations as the integration project nears completion. 

2014 THIRD QUARTER OVERVIEW

The Company’s net income was $22.7 million for the three months ended September 30, 2014 and $19.5 million for the nine months ended September 30, 2014, respectively, compared to net income of $143,000 and $530,000 for the same periods in 2013. The increase in net income for the comparative period was due to an increase in income tax benefit resulting from the reversal of $19.5 million of the Company’s valuation allowance on its net deferred tax asset during the third quarter, offset by increases in certain operating expenses, primarily related to salaries and employee benefits, real estate owned and acquisition related expenses.

CRITICAL ACCOUNTING POLICIES

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the Consolidated Financial Statements included herein. In particular, Note 1 to the Consolidated Financial Statements – “Summary of Significant Accounting Policies” generally describes our accounting policies. We believe that the judgments, estimates and assumptions used in the preparation of our Consolidated Financial Statements are appropriate given the factual circumstances at the time. However, given the sensitivity of our Consolidated Financial Statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition.

Determination of the adequacy of the allowance for loan and lease losses. In estimating the amount of credit losses inherent in our loan portfolio, various judgments and assumptions are made. For example, when assessing the condition of the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. In the event the economy were to sustain a prolonged downturn, the loss factors applied to our portfolios may need to be revised, which may significantly impact the measurement of the allowance for loan and lease losses. For impaired loans that are collateral dependent and for real estate owned, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold.

Acquired loan amounts deemed uncollectible at acquisition date become part of the fair value calculation and are excluded from the ALLL. Following acquisition, a regular review will be completed on acquired loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL. Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan and lease losses and related ALLL, if any, or prospective adjustment to the accretable yield if no provision for loan and lease losses had been recorded.

Acquired Loans. Acquired loans and leases are recorded at fair value at the date of acquisition. No allowance for loan and lease losses is recorded on the acquisition date as the fair value of the acquired assets incorporates assumptions regarding credit risk. The fair value adjustment on acquired loans without evidence of credit deterioration since origination will be accreted into earnings as a yield adjustment using the level yield method over the remaining life of the loan.

Acquired loans and leases with evidence of credit deterioration since origination such that it is probable at acquisition that the bank will be unable to collect all contractually required payments are accounted for under the guidance in ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. As of the acquisition date, the difference between contractually required payments and the cash flows expected to be collected is the nonaccretable difference, which is included as a reduction of the carrying amount of acquired loans and leases. If the timing and amount of the future cash flows is reasonably estimable, any excess of cash flows expected at acquisition over the estimated fair value is the accretable yield and is recognized in interest income over the asset's remaining life using a level yield method.

Goodwill and other intangible assets. The Company accounts for acquisitions using the acquisition method of accounting. Under acquisition accounting, if the purchase price of an acquired company exceeds the fair value of its net assets, the excess is carried on the acquirer's balance sheet as goodwill. An intangible asset is recognized as an asset apart from goodwill if it arises from contractual or other legal rights or if it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged. Intangible assets are identifiable assets, such as core deposit intangibles, resulting from acquisitions which are amortized on a straight-line basis over an estimated useful life and evaluated for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable.

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Goodwill is not amortized but is evaluated at least annually for impairment or more frequently if events occur or circumstances change that may trigger a decline in the value of the reporting unit or otherwise indicate that a potential impairment exists. Potential impairment of goodwill exists when the carrying amount of a reporting unit exceeds its fair value. To the extent the reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired, and implied fair value of the reporting unit's goodwill will be determined. If the implied fair value of the reporting unit's goodwill is lower than its carrying amount, goodwill is impaired and is written down to the implied fair value. The loss recognized is limited to the carrying amount of goodwill. Once an impairment loss is recognized, future increases in fair value will not result in the reversal of previously recognized losses.

Valuation of real estate owned. Fair value is estimated through current appraisals, real estate brokers’ opinions or listing prices.  As these properties are actively marketed, estimated fair values may be adjusted by management to reflect current economic and market conditions. The estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold.

Valuation of investment securities. The Company has classified all of its investment securities as available for sale. Accordingly, its investment securities are stated at estimated fair value in the consolidated financial statements with unrealized gains and losses, net of related income taxes, reported as a separate component of stockholders’ equity with any related changes included in accumulated other comprehensive income (loss). The Company utilizes independent third parties as its principal sources for determining fair value of its investment securities that are measured on a recurring basis. For investment securities traded in an active market, the fair values are based on quoted market prices if available. If quoted market prices are not available, fair values are based on market prices for comparable securities, broker quotes or comprehensive interest rate tables, pricing matrices or a combination thereof. For investment securities traded in a market that is not active, fair value is determined using unobservable inputs. The fair values of the Company’s investment securities traded in both active and inactive markets can be volatile and may be influenced by a number of factors including market interest rates, prepayment speeds, discount rates, credit quality of the issuer, general market conditions including market liquidity conditions and other factors. Factors and conditions are constantly changing and fair values could be subject to material variations that may significantly impact the Company’s financial condition, results of operations and liquidity.

Valuation of deferred tax assets. We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We evaluate our deferred tax assets for recoverability using a consistent approach that considers the relative impact of negative and positive evidence, including our historical profitability and projections of future taxable income. We are required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we estimate future taxable income based on management-approved business plans and ongoing tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between our projected operating performance, our actual results and other factors.

RESULTS OF OPERATIONS

Three and Nine Months Ended September 30, 2014 Compared to Three and Nine Months Ended September 30, 2013

Net Income. The Company recorded net income of $22.7 million for the three months ended September 30, 2014 compared to net income of $143,000 for the three months ended September 30, 2013. The Company recorded net income of $19.5 million for the nine months ended September 30, 2014 compared to net income of $530,000 for the nine months ended September 30, 2013.

The increase in net income for the comparative periods was due to an increase in income tax benefit, partially offset by increases in certain operating expenses, primarily related to salaries and employee benefits, real estate owned and acquisition related expenses. During the quarter ended September 30, 2014, the Company recorded a valuation allowance reversal of $19.5 million on the basis of management’s assessment of the amount of its deferred tax assets that are more likely than not to be realized. During the third quarter, the Company also paid approximately $3.0 million in termination fees related to the termination of current core and online banking contracts of FNSC. During the second quarter, the Company elected to retire certain pension liabilities of the Company’s multiemployer defined benefit plan resulting in a charge of $2.9 million.  This election improved the funded status of the plan resulting in a significant reduction of the Company’s pension expense beginning in the third quarter of 2014. Additionally, during the second and third quarters of 2014, the Company performed a review of its REO properties and made a decision to more aggressively market certain properties resulting in a $618,000 REO loss provision during the second quarter of 2014 and $653,000 in the third quarter of 2014. Finally, the Company incurred acquisition related charges in the second and third quarters of 2014 of approximately $392,000 and 82,000, respectively, related to the FNSC acquisition.

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Net Interest Income. The Company's results of operations depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Net interest income for the third quarter of 2014 was $14.7 million, compared to $3.8 million for the same period in 2013. Net interest income for the nine months ended September 30, 2014 was $24.0 million, compared to $11.1 million for the same period in 2013. The increase in net interest income for the three and nine month comparison periods resulted from changes in interest income and interest expense discussed below.

Interest Income. Interest income for the third quarter of 2014 was $16.2 million compared to $4.6 million for the same period in 2013. Interest income for the nine months ended September 30, 2014 was $27.5 million compared to $13.6 million for the same period in 2013. The increase in interest income for the three and nine months ended September 30, 2014 compared to the comparable periods in 2013 was primarily related to increases in the average balances of loans receivable and investment securities and yields earned on loans receivable as a result of the acquisition of FNSC. Interest income of the Company attributable to FNB and Heritage for the three and nine months ended September 30, 2014 amounted to $11.0 million and $12.6 million, respectively.

Interest Expense.   Interest expense for the third quarter of 2014 was $1.6 million compared to $825,000 for the same period in 2013. Interest expense for the nine months ended September 30, 2014 was $3.5 million compared to $2.5 million for the same period in 2013. The increase in interest expense for the three and nine months ended September 30, 2014 compared to the comparable periods in 2013 was primarily due to an increase in the average balance of deposit accounts, which balances substantially increased following the acquisition of FNSC. Interest expense of the Company attributable to FNB and Heritage for the three and nine months ended September 30, 2014 amounted to $509,000 and $589,000, respectively.

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Rate/Volume Analysis. The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided regarding changes attributable to (i) changes in volume (changes in average volume multiplied by prior rate); (ii) changes in rate (changes in rate multiplied by prior average volume); (iii) changes in rate-volume (changes in rate multiplied by the change in average volume); and (iv) the net change.

	Three Months Ended September 30,
	2014 vs. 2013
	Increase (Decrease) Due to
	Volume			Rate			Rate/ Volume			Total Increase (Decrease)
	(In Thousands)
Interest income:
Loans receivable	$	7,705		$	1,255		$	2,397		$	11,357
Investment securities		1,071			(226	)		(553	)		292
Other interest-earning assets		(5	)		--			--			(5	)
Total interest-earning assets		8,771			1,029			1,844			11,644
Interest expense:
Deposits		1,271			(299	)		(466	)		506
Other borrowings		855			(8	)		(611	)		236
Total interest-bearing liabilities		2,126			(307	)		(1,077	)		742
Net change in net interest income	$	6,645		$	1,336		$	2,921		$	10,902

	Nine Months Ended September 30,
	2014 vs. 2013
	Increase (Decrease) Due to
	Volume			Rate			Rate/ Volume			Total Increase (Decrease)
	(In Thousands)
Interest income:
Loans receivable	$	10,123		$	1,727		$	1,447		$	13,297
Investment securities		1,602			(380	)		(528	)		694
Other interest-earning assets		(103	)		58			(15	)		(60	)
Total interest-earning assets		11,622			1,405			904			13,931
Interest expense:
Deposits		1,600			(549	)		(354	)		697
Other borrowings		494			(13	)		(184	)		297
Total interest-bearing liabilities		2,094			(562	)		(538	)		994
Net change in net interest income	$	9,528		$	1,967		$	1,442		$	12,937

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Average Balance Sheets. The following table sets forth certain information relating to the Company's average balance sheets and reflects the average annualized yield on assets and average annualized cost of liabilities for the periods indicated. Such yields and costs are derived by dividing interest income or interest expense by the average balance of assets or liabilities, respectively, for the periods presented and are presented on an annualized basis. Average balances are based on daily balances during the periods. Interest rate spread represents the difference between the weighted average yield on average interest earning assets and the weighted average cost of average interest bearing liabilities. Net interest margin represents net interest income as a percentage of average interest earning assets.

	Three Months Ended September 30,
	2014							2013
	Average Balance		Interest		Average Yield/ Cost			Average Balance		Interest		Average Yield/ Cost
	(Dollars in Thousands)
Interest-earning assets:
Loans receivable(1)	$	1,045,076	$	15,390		5.84	%	$	359,071	$	4,033		4.46	%
Investment securities(2)		213,813		728		1.35			61,880		436		2.80
Other interest-earning assets		50,370		105		0.83			52,580		110		0.83
Total interest-earning assets		1,309,259		16,223		4.92			473,531		4,579		3.84
Noninterest-earning assets		184,268							50,232
Total assets	$	1,493,527						$	523,763
Interest-bearing liabilities:
Deposits	$	1,096,212		1,320		0.48		$	427,945		814		0.76
Other borrowings		76,997		247		1.27			978		11		4.29
Total interest-bearing liabilities		1,173,209		1,567		0.53			428,923		825		0.76
Noninterest-bearing deposits		170,310							21,747
Noninterest-bearing liabilities		4,271							2,122
Total liabilities		1,347,790							452,792
Stockholders' equity		145,737							70,971
Total liabilities and stockholders' equity	$	1,493,527						$	523,763
Net interest income			$	14,656						$	3,754
Net earning assets	$	136,050						$	44,608
Interest rate spread						4.39	%						3.08	%
Net interest margin						4.44	%						3.15	%
Ratio of interest-earning assets to Interest-bearing liabilities						111.60	%						110.40	%

(1) Includes nonaccrual loans. 

(2) Includes FHLB of Dallas and Federal Reserve Bank stock.

	Nine Months Ended September 30,
	2014							2013
	Average Balance		Interest		Average Yield/ Cost			Average Balance		Interest		Average Yield/ Cost
	(Dollars in Thousands)
Interest-earning assets:
Loans receivable(1)	$	653,780	$	25,381		5.19	%	$	355,757	$	12,084		4.54	%
Investment securities(2)		131,157		1,846		1.88			54,873		1,152		2.81
Other interest-earning assets		51,728		321		0.83			70,690		381		0.72
Total interest-earning assets		836,665		27,548		4.40			481,320		13,617		3.78
Noninterest-earning assets		99,541							51,393
Total assets	$	936,206						$	532,713
Interest-bearing liabilities:
Deposits	$	715,593		3,174		0.59		$	434,772		2,477		0.76
Other borrowings		32,971		334		1.35			2,296		37		2.12
Total interest-bearing liabilities		748,564		3,508		0.63			437,068		2,514		0.77
Noninterest-bearing deposits		83,145							22,300
Noninterest-bearing liabilities		3,326							2,351
Total liabilities		835,035							461,719
Stockholders' equity		101,171							70,994
Total liabilities and stockholders' equity	$	936,206						$	532,713
Net interest income			$	24,040						$	11,103
Net earning assets	$	88,101						$	44,252
Interest rate spread						3.78	%						3.01	%
Net interest margin						3.84	%						3.08	%
Ratio of interest-earning assets to Interest-bearing liabilities						111.77	%						110.12	%

(1) Includes nonaccrual loans. 

(2) Includes FHLB of Dallas and Federal Reserve Bank stock

36

The Company’s net interest margin increased primarily as a result of an increase in yields on loans receivable resulting from loans acquired in the FNSC transaction.

Provision for Loan Losses. The provision for loan losses represents the amount added to the allowance for loan and lease losses (“ALLL”) for the purpose of maintaining the ALLL at a level considered adequate to cover probable credit losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio that have been incurred as of the balance sheet date. The adequacy of the ALLL is evaluated quarterly by management of the Banks based on the Banks’ past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and other qualitative factors.

Management determined that provisions for loan losses of $600,000 and $830,000 were required for the three and nine months ended September 30, 2014, respectively, to maintain the ALLL at an adequate level. Management determined the necessity of the provisions and the amounts thereof taking into consideration (i) loans originated by FFB and FNB and Heritage during the period subsequent to the acquisition date, (ii) decreases in the overall portfolio of nonperforming and classified loans of the Banks, (iii) continued improvement in the credit quality of First Federal’s loan portfolio, and (iv) ALLL coverage of nonaccrual loans. The ALLL as a percentage of loans receivable was 1.2% at September 30, 2014, compared to 3.3% at December 31, 2013. The ALLL as a percentage of nonaccrual loans was 136.8% at September 30, 2014, compared to 106.5% at December 31, 2013. The ALLL as a percentage of classified loans was 52.3% at September 30, 2014, compared to 86.1% at December 31, 2013. See “Allowance for Loan and Lease Losses” in the “Asset Quality” section. A regular review will be completed on acquired loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL.

Noninterest Income. Noninterest income is generated primarily through deposit account fee income, profit on sale of loans, and earnings on life insurance policies. Total noninterest income of $3.6 million for the three months ended September 30, 2014 increased from $1.4 million for the same period in 2013. Total noninterest income of $6.7 million for the nine months ended September 30, 2014 increased from $4.0 million for the same period in 2013. The increase in the three and nine month comparison periods was primarily due to an increase in deposit fee income and gain on sale of loans. The increase in deposit fee income was attributable to the acquisition of FNB and Heritage deposit accounts, which, for the three and nine months ended September 30, 2014, amounted to $1.3 million and $1.5 million, respectively in deposit fee income. The increase in profit on loans held for sale was due to an increase in the number of loans sold and the average profit on loans held for sale. First Federal sold 401 loans in the secondary market during the nine month period ended September 30, 2014 compared to 274 loans during the nine month period ended September 30, 2013.

Noninterest Expense. Noninterest expense consists primarily of employee compensation and benefits, data processing expense, office occupancy expense, real estate owned expense, and other operating expense. Total noninterest expense increased $10.3 million or 205.3% during the third quarter of 2014 compared to the third quarter of 2013. Total noninterest expense increased $16.1 million or 110.5% during the nine months ended September 30, 2014 compared to the same period in 2013. The variances in certain noninterest expense items are further explained in the following paragraphs, with the aggregate expense increase for the three and nine month comparison periods being primarily related to the increase in employee compensation expense, data processing related expenses, loss provision on other real estate owned for the nine month comparison period, and expenses related to the acquisition of FNSC. Noninterest expense of the Company attributable to FNB and Heritage for the three and nine months ended September 30, 2014 amounted to $6.4 million and $7.2 million, respectively.

37

Salaries and Employee Benefits. Salaries and employee benefits increased $3.4 million and $7.6 million for the three and nine months ended September 30, 2014 compared to the same periods in 2013, respectively. The increase in the three and nine month comparison periods was primarily due to the merger with FNSC, the salaries and employee benefits for FNSC totaled $3.1 million and $3.5 million, respectively, for the three and nine months ended September 30, 2014. Additionally, the Company’s election in the second quarter of 2014 to retire certain pension liabilities of the Company’s multiemployer defined benefit plan resulted in a charge of $2.9 million.  This election improved the funded status of the plan resulting in a significant reduction of the Company’s pension expense beginning in the third quarter of 2014. The changes in the composition of this line item are presented below (in thousands):

	Three Months Ended September 30,									Nine Months Ended September 30,
	2014			2013			Change			2014			2013			Change
Salaries	$	5,291		$	2,368		$	2,923		$	10,758		$	6,843		$	3,915
Payroll taxes		360			163			197			887			596			291
Insurance		425			130			295			682			389			293
401(k) plan expenses		89			8			81			175			17			158
Defined benefit plan		42			151			(109	)		3,250			369			2,881
Stock compensation		143			73			70			340			168			172
Other		(89	)		(57	)		(32	)		(297	)		(150	)		(147	)
Total	$	6,261		$	2,836		$	3,425		$	15,795		$	8,232		$	7,563

Net Occupancy Expense. The increases in net occupancy expense during the three and nine months ended September 30, 2014 compared to the same periods in 2013 of $986,000 and $1.0 million, respectively, were primarily related to the merger with FNSC. Net occupancy expense of the Company attributable to FNB and Heritage for the three and nine months ended September 30, 2014 amounted to $885,000 and $952,000, respectively.

Real Estate Owned, net. The changes in the composition of this line item are presented below (in thousands):

	Three Months Ended September 30,									Nine Months Ended September 30,
	2014			2013			Change			2014			2013			Change
Loss provisions	$	653		$	358		$	295		$	1,513		$	533		$	980
Net gain on sales		(46	)		(316	)		270			(188	)		(690	)		502
Rental income		(28	)		(22	)		(6	)		(125	)		(85	)		(40	)
Taxes and insurance		32			53			(21	)		102			146			(44	)
Other		39			60			(21	)		156			178			(22	)
Total	$	650		$	133		$	517		$	1,458		$	82		$	1,376

During the second and third quarters of 2014, the Company performed a review of its REO properties and made a decision to more aggressively market certain properties, resulting in REO loss provisions of $618,000 and $653,000, respectively. The decrease in gains on sales of REO is due to a decrease in sales of REO in the nine months of 2014 compared to the same period in 2013 due to an overall continued decrease in REO balances during the periods. Real estate owned expenses such as taxes, insurance and maintenance as well as rental income are expected to continue to decline as the size of the REO portfolio decreases. Future levels of loss provisions and net gains or losses on sales of real estate owned will depend on market conditions. The acquisition of FNSC had no material impact on real estate owned, net.

Data Processing. The increases in data processing expenses during the three and nine months ended September 30, 2014 compared to the same periods in 2013 of $3.8 million and $4.1 million, respectively, were primarily related to termination fees of $3.0 million paid in the third quarter of 2014 associated with the conversion of FNB and Heritage to certain of the Company’s data processing platforms.

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Other Noninterest Expenses. The increases in other noninterest expenses during the three and nine months ended September 30, 2014 compared to the same periods in 2013 of $1.6 million and $2.1 million, respectively, were primarily due to expenses related to the acquisition of FNSC of approximately $474,000 recognized during the second and third quarters of 2014. The changes in other noninterest expenses are presented below (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2014		2013		Change		2014		2013		Change
FDIC insurance	$	249	$	139	$	110	$	494	$	480	$	14
Amortization of intangible assets		157		--		157		183		--		183
Professional fees		213		108		105		644		518		126
Advertising and public relations		494		71		423		795		215		580
Postage and supplies		263		91		172		466		308		158
Other		1,291		682		609		2,839		1,823		1,016
Total	$	2,667	$	1,091	$	1,576	$	5,421	$	3,344	$	2,077

Income Taxes. During the quarter ended September 30, 2014, the Company recorded a valuation allowance reversal of $19.5 million on the basis of management’s assessment of the amount of its deferred tax assets that are more likely than not to be realized.

LENDING ACTIVITIES

Loans Receivable. Changes in loan composition between September 30, 2014 and December 31, 2013, are presented in the following table (dollars in thousands).

	September 30,			December 31,			Increase
	2014			2013			(Decrease)			% Change
One- to four-family residential	$	318,673		$	129,308		$	189,365			146.4	%
Multifamily residential		44,365			25,773			18,592			72.1
Nonfarm nonresidential		379,560			168,902			210,658			124.7
Farmland		48,892			2,663			46,229			1,736.0
Construction and land development		89,165			23,891			65,274			273.2
Total real estate loans		880,655			350,537			530,118			151.2
Commercial		149,073			29,033			120,040			413.5
Consumer		33,268			4,368			28,900			661.6
Total loans receivable		1,062,996			383,938			679,058			176.9
Unearned discounts and net deferred loan costs		(165	)		(78	)		(87	)		111.5
Allowance for loan and lease losses		(12,964	)		(12,711	)		(253	)		2.0
Loans receivable, net	$	1,049,867		$	371,149		$	678,718			182.9	%

Total loans receivable increased $679.1 million to $1.1 billion at September 30, 2014, compared to $383.9 million at December 31, 2013. The increase in total loans receivable was primarily due to the acquisition of FNSC which increased the Company’s consolidated total loans receivable by $605.5 million at the date of acquisition. The remaining increase in the Company’s consolidated loan portfolio was due to an increase in originations by First Federal during the nine months and by FNB and Heritage since the date of acquisition of commercial, nonfarm nonresidential and multifamily loans.

39

ASSET QUALITY

Nonperforming Assets. The following table sets forth the amounts and categories of the Company’s nonperforming assets at the dates indicated (dollars in thousands).

	September 30, 2014					December 31, 2013
	Net (2)		% Total Assets			Net (2)		% Total Assets			Increase (Decrease)
Nonaccrual Loans:
One- to four-family residential	$	4,569		0.30	%	$	4,258		0.77	%	$	311
Nonfarm nonresidential		3,214		0.21	%		4,057		0.75	%		(843	)
Farmland		737		0.05	%		782		0.15	%		(45	)
Construction and land development		615		0.04	%		2,467		0.44	%		(1,852	)
Commercial		316		0.02	%		350		0.06	%		(34	)
Consumer		26		--			24		0.01	%		2
Total nonaccrual loans		9,477		0.62	%		11,938		2.18	%		(2,461	)
Accruing loans 90 days or more past due		--		--			--		--			--
Real estate owned		5,542		0.36	%		8,627		1.57	%		(3,085	)
Total nonperforming assets		15,019		0.98	%		20,565		3.75	%		(5,546	)
Performing restructured loans		571		0.04	%		494		0.09	%		77
Total nonperforming assets and performing restructured loans (1)	$	15,590		1.02	%	$	21,059		3.84	%	$	(5,469	)

(1) The table does not include substandard loans which were judged not to be impaired totaling $15.3 million at September 30, 2014 and $2.9 million at December 31, 2013 or acquired ASC 310-30 purchased credit impaired loans which are considered performing at September 30, 2014.

(2) Loan balances are presented net of undisbursed loan funds, partial charge-offs and interest payments recorded as reductions in principal balances for financial reporting purposes.

The decrease in nonperforming assets at September 30, 2014 compared to December 31, 2013, was primarily due to sales of real estate owned of $3.1 million and net cash payments on nonaccrual loans of $2.4 million during the nine months ended September 30, 2014.

Nonaccrual Loans. The composition of nonaccrual loans by status was as follows as of the dates indicated (dollars in thousands):

	September 30, 2014					December 31, 2013					Increase (Decrease)
	Balance		Percentage of Total			Balance		Percentage of Total			Balance			Percentage of Total
Bankruptcy or foreclosure	$	835		8.8	%	$	1,043		8.7	%	$	(208	)		0.1	%
Over 90 days past due		3,702		39.1			6,308		52.8			(2,606	)		(13.7	)
30-89 days past due		655		6.9			637		5.3			18			1.6
Not past due		4,285		45.2			3,950		33.2			335			12.0
	$	9,477		100.0	%	$	11,938		100.0	%	$	(2,461	)		--

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The following table presents nonaccrual loan activity for the nine months ended September 30, 2014 and 2013 (in thousands):

	Nine Months Ended September 30, 2014			Nine Months Ended September 30, 2013
Balance of nonaccrual loans—beginning of period	$	11,938		$	18,824
Loans added to nonaccrual status		2,248			2,942
Net cash payments		(2,428	)		(4,476	)
Loans returned to accrual status		(406	)		(537	)
Charge-offs to the ALLL		(473	)		(1,668	)
Transfers to REO		(1,402	)		(2,017	)
Balance of nonaccrual loans—end of period	$	9,477		$	13,068

Real Estate Owned. Changes in the composition of real estate owned between December 31, 2013 and September 30, 2014 are presented in the following table (dollars in thousands).

	December 31, 2013		Additions(1)		Fair Value Adjustments			Net Sales Proceeds			Net Gain (Loss)		September 30, 2014
One- to four-family residential	$	1,517	$	542	$	(93	)	$	(431	)	$	36	$	1,571
Land		4,688		756		(579	)		(1,987	)		69		2,947
Nonfarm nonresidential		2,422		80		(841	)		(720	)		83		1,024
Total	$	8,627	$	1,378	$	(1,513	)	$	(3,138	)	$	188	$	5,542

(1) Additions include $69,000 of real estate owned acquired in the FNSC acquisition in the second quarter of 2014.

Classified Assets. Federal regulations require that each financial institution risk rate their classified assets into three classification categories - substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that some loss will be sustained if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is generally considered uncollectible and of such little value that continuance as an asset is not warranted. As of September 30, 2014 and December 31, 2013, the Banks did not have any assets classified as doubtful or loss. 

The table below summarizes the Banks’ classified assets as of the dates indicated (dollars in thousands):

	September 30, 2014			December 31, 2013			September 30, 2013
Nonaccrual loans	$	9,477		$	11,938		$	13,068
Accruing classified loans		15,332			2,827			3,753
Classified loans		24,809			14,765			16,821
Real estate owned		5,542			8,627			9,835
Total classified assets	$	30,351		$	23,392		$	26,656
Texas Ratio (1)		11.5	%		24.8	%		27.4	%
Classified Assets Ratio (2)		23.3	%		28.0	%		31.9	%

(1) Defined as the ratio of nonaccrual loans and real estate owned to Tier 1 capital plus the allowance for loan and lease losses.

(2) Defined as the ratio of total classified assets to Tier 1 capital plus the allowance for loan and lease losses.

The increase in classified assets during the nine months ended September 30, 2014, was primarily due to loans acquired in the FNSC merger, partially offset by sales of real estate owned and net cash payments on nonaccrual loans. Classified assets in the acquired loan portfolios totaled approximately $13.3 million at September 30, 2014.

Allowance for Loan and Lease Losses. The Banks maintain an allowance for loan and lease losses for known and inherent losses determined by ongoing quarterly assessments of the loan portfolio. The estimated appropriate level of the ALLL is maintained through a provision for loan losses charged to earnings. Charge-offs are recorded against the ALLL when management believes the estimated loss has been confirmed. Subsequent recoveries, if any, are credited to the ALLL.

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The ALLL consists of general and allocated (also referred to as specific) loan loss components. For loans that are determined to be impaired that are troubled debt restructurings (“TDRs”) and impaired loans where the relationship totals $250,000 or more, a specific loan loss allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than its carrying value. The general loan loss allowance covers loans that are not impaired and those impaired relationships under $250,000 and is based on historical loss experience adjusted for qualitative factors.

The ALLL represents management’s estimate of incurred credit losses inherent in the Banks’ loan portfolios as of the balance sheet date. The estimation of the ALLL is based on a variety of factors, including past loan loss experience, the current credit profile of the Banks’ borrowers, adverse situations that have occurred that may affect the borrowers’ ability to repay, the estimated value of underlying collateral, and general economic conditions, including unemployment, bankruptcy trends, vacancy rates and the level and trend of home sales and prices. Losses are recognized when available information indicates that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or conditions change.

A loan is considered impaired when, based on current information and events, it is probable that the bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the note. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the short fall in relation to the principal and interest owed. Each quarter, classified loans where the borrower’s total loan relationship exceeds $250,000 are evaluated for impairment on a loan-by-loan basis. Nonaccrual loans and TDRs are considered to be impaired loans. TDRs are restructurings in which the bank, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that the bank would not otherwise consider. Impairment is measured quarterly on a loan-by-loan basis for all TDRs and impaired loans where the aggregate relationship balance exceeds $250,000 by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, if the loan is collateral dependent. Impaired loans under this threshold are aggregated and included in loan pools with their ALLL calculated as described in the following paragraph.

Groups of smaller balance homogeneous loans are collectively evaluated for impairment. Homogeneous loans are those that are considered to have common characteristics that provide for evaluation on an aggregate or pool basis. The bank considers the characteristics of (1) one- to four-family residential mortgage loans; (2) unsecured consumer loans; and (3) collateralized consumer loans to permit consideration of the appropriateness of the ALLL of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of the ALLL includes segregating impaired loans from the pools of loans, valuing these loans, and then applying a loss factor to the remaining pool balance based on several factors including past loss experience, inherent risks, and economic conditions in the primary market areas.

Acquired loan amounts deemed uncollectible at acquisition date become part of the fair value calculation and are excluded from the ALLL. Following acquisition, a regular review will be completed on acquired loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL. Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan and lease losses and related ALLL, if any, or prospective adjustment to the accretable yield if no provision for loan and lease losses had been recorded.

In estimating the amount of credit losses inherent in the loan portfolio, various judgments and assumptions are made. For example, when assessing the condition of the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. For impaired loans that are collateral dependent, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold in the event that the bank has to foreclose or repossess the collateral.

The Banks consider their consolidated ALLL totaling approximately $13.0 million to be appropriate based on evaluations of the management of the Banks of their respective loan portfolios and the losses inherent in those loan portfolios as of September 30, 2014. Actual losses may substantially differ from currently estimated losses. Adequacy of the ALLL is periodically evaluated, and the ALLL could be significantly decreased or increased, which could materially affect the Company’s financial condition and results of operations.

42

The following table summarizes changes in the allowance for loan and lease losses and other selected statistics for the periods indicated.

	Nine Months Ended September 30,
	2014			2013
	(Dollars in Thousands)
Total loans outstanding at end of period	$	1,062,996		$	362,029
Average loans outstanding	$	653,780		$	355,757
Allowance at beginning of period	$	12,711		$	15,676
Charge-offs:
One- to four-family residential		(70	)		(1,026	)
Multifamily residential		--			(876	)
Nonfarm nonresidential		(115	)		(1,009	)
Farmland		--			--
Construction and land development		(444	)		(115	)
Commercial		(29	)		(380	)
Consumer (1)		(122	)		(107	)
Total charge-offs		(780	)		(3,513	)
Recoveries:
One- to four-family residential		55			172
Multifamily residential		--			--
Nonfarm nonresidential		6			500
Farmland		--			--
Construction and land development		83			119
Commercial		10			77
Consumer (1)		49			47
Total recoveries		203			915
Net charge-offs		(577	)		(2,598	)
Total provisions for losses		830			--
Allowance at end of period	$	12,964		$	13,078
Allowance for loan and lease losses as a percentage of total loans outstanding at end of period		1.2%			3.6%
Net loans charged-off as a percentage of average loans outstanding		0.1%			1.0%
Allowance for loan and lease losses to nonaccrual loans		136.8%			100.1%

(1)      Consumer loan charge-offs include overdraft charge-offs of $100,000 and $90,000 for the nine months ended September 30, 2014 and 2013, respectively. Consumer loan recoveries include recoveries of overdraft charge-offs of $34,000 and $41,000 for the nine months ended September 30, 2014 and 2013, respectively.

43

The following table presents, on a consolidated basis, the allocation of the Banks’ ALLL by the type of loan at each of the dates indicated as well as the percentage of loans in each category to total loans receivable. These allowance amounts have been computed using the Banks’ internal models. The amounts shown are not necessarily indicative of the actual future losses that may occur within a particular category.

	September 30,
	2014					2013
	Amount		Percentage of Loans			Amount		Percentage of Loans
	(Dollars in Thousands)
One-to-four family residential	$	4,556		29.98	%	$	5,875		37.11	%
Multifamily residential		916		4.17			1,038		7.08
Nonfarm nonresidential		4,227		35.71			4,189		44.59
Farmland		290		4.60			280		0.69
Construction and land development		941		8.39			1,057		4.39
Commercial		1,933		14.02			552		4.81
Consumer		101		3.13			87		1.33
Total	$	12,964		100.00	%	$	13,078		100.00	%

INVESTMENT SECURITIES

The following table sets forth the carrying values of the Company's investment securities available for sale (dollars in thousands).

	September 30, 2014		December 31, 2013		Increase (Decrease)
U.S. Government agencies	$	106,505	$	--	$	106,505
Municipal securities		47,257		41,924		5,333
Mortgage-backed securities		36,614		28,904		7,710
Total	$	190,376	$	70,828	$	119,548

The increase is due to the acquisition of FNSC which held $138.1 million of investments at the time of the acquisition. The overall yield of the investment portfolio was 1.35% as of September 30, 2014 compared to 2.86% at December 31, 2013.

DEPOSITS

Changes in the composition of deposits between September 30, 2014 and December 31, 2013, are presented in the following table (dollars in thousands).

	September 30,		December 31,		Increase
	2014		2013		(Decrease)		% Change
Checking accounts	$	559,935	$	127,764	$	432,171		338.26	%
Money market accounts		117,018		45,153		71,865		159.16
Savings accounts		115,149		30,150		84,999		281.92
Certificates of deposit		485,204		266,658		218,546		81.96
Total deposits	$	1,277,306	$	469,725	$	807,581		171.93	%

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Total deposits increased in the comparison period primarily due to the acquisition of FNSC, with $761.3 million of the Company’s total deposits at September 30, 2014 being attributed to the FNSC acquisition. The remaining increase of $46.2 million in First Federal deposits was primarily due to an increase in certificates of deposit. The Banks manage the pricing of their deposits to maintain deposit balances commensurate with their overall balance sheet management and liquidity position.

OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS

In the normal course of business and to meet the needs of its customers, the Banks are a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments could involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Company’s consolidated statements of financial condition.

The Banks do not use financial instruments with off-balance sheet risk as part of their asset/liability management program or for trading purposes. The Banks’ exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. The Banks evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

The funding period for construction loans is generally six to eighteen months and commitments to originate mortgage loans are generally outstanding for no more than 60 days.

In the normal course of business, the Banks make commitments to buy or sell assets or to incur or fund liabilities. Commitments include, but are not limited to:

■ the origination, purchase or sale of loans; and

■ the fulfillment of commitments under letters of credit, extensions of credit on lines of credit, construction loans, and under predetermined overdraft protection limits.

At September 30, 2014, the Banks’ off-balance sheet arrangements principally included lending commitments, which are described below. At September 30, 2014, the Company had no interests in non-consolidated special purpose entities.

At September 30, 2014, commitments included:

■ total approved loan origination commitments outstanding amounting to $27.4 million, including approximately $4.7 million of loans committed to sell;

■ rate lock agreements with customers of $10.1 million, all of which have been locked with an investor;

■ funded mortgage loans committed to sell of $7.5 million;

■ unadvanced portion of construction loans of $45.1 million;

■ unused lines of credit of $92.3 million;

■ outstanding standby letters of credit of $4.0 million; and

■ total predetermined overdraft protection limits of $15.9 million.

Total unfunded commitments to originate loans for sale and the related commitments to sell of $10.1 million meet the definition of a derivative financial instrument. The related asset and liability are considered immaterial at September 30, 2014.

Historically, a very small percentage of predetermined overdraft limits have been used. At September 30, 2014, overdrafts of accounts with Bounce Protection™ represented usage of 3.16% of the limit.

Liquidity and Capital Resources

The primary source of funds for the Company is the receipt of dividends from its subsidiary banks, the receipt of management fees from its subsidiary banks, cash balances maintained, and borrowings from nonaffiliated sources. Payment of dividends by the Company’s subsidiary banks is subject to certain regulatory restrictions as set forth in banking laws and regulations.

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The Company’s primary uses of cash include injecting capital into subsidiaries, stock repurchases, debt service requirements, and paying for general operating expenses. The Company had a cash balance of $260,000 at September 30, 2014.

The Company's objective as it relates to liquidity is to ensure that its subsidiary banks have funding and access to sources of funding to ensure that cash flow requirements for deposit withdrawals and credit demands are met in an orderly and timely manner without unduly penalizing profitability. A major component of our overall asset/liability management efforts surrounds pricing of the liability side to ensure adequate liquidity and proper spread and interest margin management. Reliance on any one funding source is kept to a minimum by prioritizing those sources in terms of both availability and time to activation.

In order to maintain proper levels of liquidity, the subsidiary banks have several sources of funds available. Generally the subsidiary banks rely on cash on hand and due from banks, fed funds sold, cash flow generated by the repayment of principal and interest and loans and securities and deposits as its primary sources of funds. Commercial, consumer and public funds customers in our local markets are the principal deposit sources utilized. The subsidiary banks use those local market deposits, along with secondary sources of funding including FHLB Advances, federal funds purchased, FRB borrowings and other alternative funding sources to fund continuing operations, make loans and leases, acquire investment securities and other assets.

At September 30, 2014, the Company had substantial unused borrowing availability. This availability was primarily comprised of the following four options for its subsidiary banks: (1) $275.3 million of available blanket borrowing capacity with the FHLB-Dallas, (2) $47.1 million of investment securities available to pledge for federal funds or other borrowings, (3) $123.9 million of available unsecured federal funds borrowing lines and (4) up to $8.6 million of available borrowing capacity from borrowing programs of the FRB. In addition, at September 30, 2014, the Company had available borrowing capacity of $0.4 million with an unaffiliated bank.

At September 30, 2014, the Company’s and the Banks’ overall liquidity ratio was approximately 12.1% which represents liquid assets as a percent of deposits and borrowings. As of the same date, the Company’s overall adjusted liquidity ratio was 50.1%, which represents liquid assets plus borrowing capacity at the FHLB, FRB and correspondent banks as a percentage of deposit and borrowings. The Company anticipates it will continue to rely primarily on principal and interest repayments on loans and securities, and deposits to provide liquidity, as well as other funding sources as appropriate. Additionally, where appropriate, the secondary sources of borrowed funds described above will be used to augment the Company’s primary funding sources. We believe that we have sufficient liquidity to satisfy our current operations of the Company and the subsidiary banks.

At September 30, 2014, the Company’s core, tier 1 and total risk-based capital ratios amount to 8.10%, 10.29% and 11.43%, respectively, compared to capital adequacy requirements of 4%, 4% and 8%. See Note 17 to the Consolidated Financial Statements for more information about the Company’s and the Banks’ capital requirements and ratios.

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CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS

This Form 10-Q contains certain forward-looking statements and information relating to the Company and its subsidiary banks that are based on the beliefs of management as well as assumptions made by and information currently available to management. As used in this document, the words "anticipate," "believe," "estimate," "expect," "intend," "should" and similar expressions, or the negative thereof, as they relate to the Company, its subsidiary banks or the management thereof, are intended to identify forward-looking statements.

The statements presented herein with respect to, among other things, the Company’s or any of the Banks’ plans, objectives, expectations and intentions, anticipated changes in noninterest expenses in future periods (including changes as a result of the merger with FNSC and the continued evaluation of the fair value adjustments presented), changes in earnings, impact of outstanding off-balance sheet commitments, sources of liquidity and that we have sufficient liquidity, the sufficiency of the allowance for loan losses, expected loan, asset, and earnings growth, growth in new and existing customer relationships, our intentions with respect to our investment securities, and financial and other goals and plans are forward looking.

Such statements reflect the current views of the Company with respect to future looking events and are subject to certain risks, uncertainties and assumptions, including those risk factors described in Part I, Item 1A. of the Company’s Annual Report on Form 10-K filed with the SEC on March 28, 2014 and in Part II, Item 1A. hereof. Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. The Company cautions readers not to place undue reliance on any forward-looking statements. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause actual results for the remainder of fiscal 2014 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us and could negatively affect the Company’s operating and stock performance.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

MARKET RISK MANAGEMENT

Market risk arises from changes in interest rates.  We have risk management policies to monitor and limit exposure to market risk.  In asset and liability management activities, policies designed to minimize structural interest rate risk are in place.  The measurement of market risk associated with financial instruments is meaningful only when all related and offsetting on- and off-balance-sheet transactions are aggregated, and the resulting net positions are identified.

INTEREST RATE SENSITIVITY

Interest rate risk represents the potential impact of interest rate changes on net income and capital resulting from mismatches in repricing opportunities of assets and liabilities over a period of time.  A number of tools are used to monitor and manage interest rate risk, including simulation models and interest sensitivity gap analysis.  Management uses simulation models to estimate the effects of changing interest rates and various balance sheet strategies on the level of the Company’s net income and capital.  As a means of limiting interest rate risk to an acceptable level, management may alter the mix of floating and fixed-rate assets and liabilities, change pricing schedules on assets and liabilities and manage investment maturities during future security purchases.

The simulation model incorporates management’s assumptions regarding the level of interest rates or balance changes for indeterminate maturity deposits for a given level of market rate changes.  These assumptions have been developed through anticipated pricing behavior.  Key assumptions in the simulation models include the relative timing of prepayments, cash flows and maturities.  These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of a change in interest rates on net income or capital.  Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

As of September 30, 2014, the model simulations projected that 100 and 200 basis point increases in interest rates would result in positive variances in net interest income of 2.5% and 5.4%, respectively, relative to the base case over the next twelve months and decreases in interest rates of 100 basis points would result in a positive variance in net interest income of 0.5% relative to the base case over the next twelve months.  The likelihood of a decrease in interest rates as of September 30, 2014 is considered remote given current interest rate levels.  These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics of specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates.  We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude.  As interest-bearing assets and liabilities reprice in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion.  Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.

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Item 4. Controls and Procedures.

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are operating effectively.

The Company’s management, including the Company’s Chief Executive Officer and the Chief Financial Officer, regularly review our controls and procedures and make changes intended to ensure the quality of our financial reporting. On June 13, 2014, we completed the acquisition of FNSC, and as a result, we extended our oversight and monitoring processes that support our internal control over financial reporting during the second quarter of 2014 to include the operations of FNSC. No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II. Other Information

Item 1.      Legal Proceedings

Neither the Company nor the Banks are a party to or involved in any pending legal proceedings other than non-material legal proceedings occurring in the ordinary course of business.

Item 1A.     Risk Factors

The Company may fail to realize the anticipated cost savings or any other benefits from the acquisition of FNSC.

The Company pursued the acquisition of FNSC with the expectation that the merger would result in benefits to the Company, including cost savings. Although the Company estimates that it will realize cost savings of at least $500,000 annually (excluding one-time costs and expenses associated with the acquisition) from the merger, it is possible that the estimates of the potential cost savings could be incorrect. For example, future business developments may require the Company to continue to operate or maintain some facilities or support functions that are currently expected to be combined or reduced. The cost savings estimates also depend on the Company’s ability to combine the acquired businesses with the Company’s existing operations in a manner that permits those costs savings to be realized. If the estimates turn out to be incorrect or the Company is not able to combine the two companies successfully, the anticipated cost savings may not be fully or partially realized, or may take longer to realize than expected.

Integrating the operations of FNSC may be more difficult, costly or time-consuming than expected, and failure to do so quickly and efficiently could reduce the Company’s profitability, affect its stock price and either delay or prevent realization of many of the potential benefits of the merger.

If the Company is not able to integrate its existing business with the operations of FNSC efficiently and timely, the expected benefits of the merger may not be realized. It is possible that the integration process could result in the loss of key employees, disruption of each bank’s ongoing business or inconsistencies in standards, controls, procedures and policies, any of which could adversely affect the Company’s ability to maintain relationships with the Company’s or FNSC’s existing customers and employees or to achieve the anticipated benefits of the merger. As with any merger of banking institutions, there also may be business disruptions that cause the Company and FNSC to lose customers. The Company may be required to spend additional time and money on operating compatibility, which could otherwise be spent on developing the Company’s business. If the Company does not integrate the operations of FNSC effectively or efficiently, it could harm the Company’s business, financial condition and results of operations.

Item 6.     Exhibits

The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Exhibit Index attached hereto and are incorporated herein by reference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

BEAR STATE FINANCIAL, INC.

Date:	November 7, 2014	By:	/s/ Richard N. Massey
			Richard N. Massey
			Chief Executive Officer

Date:	November 7, 2014	By:	/s/ Matt Machen
			Matt Machen
			Chief Financial Officer

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Bear State Financial, Inc.

Exhibit Index

Exhibit No.	Description
2.1	Agreement and Plan of Merger by and between Bear State Financial, Inc. (formerly known as First Federal Bancshares of Arkansas, Inc.) and First National Security Company, dated July 1, 2013 (incorporated herein by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on July 3, 2013). (1)
2.2	List of Schedules to the Agreement and Plan of Merger (incorporated herein by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K filed with the SEC on July 3, 2013).
3.1	Amended and Restated Articles of Incorporation of Bear State Financial, Inc. (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed with the SEC on July 21, 2011).
3.2	Amended and Restated Bylaws of Bear State Financial, Inc. (incorporated herein by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K filed with the SEC on July 21, 2011).
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Section 906 Certification of the CEO
32.2	Section 906 Certification of the CFO
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema
101.CAL	XBRL Taxonomy Extension Calculation Linkbase
101.LAB	XBRL Taxonomy Extension Label Linkbase
101.PRE	XBRL Taxonomy Extension Presentation Linkbase
101.DEF	XBRL Taxonomy Extension Definition Linkbase

(1) Pursuant to Item 601(b)(2) of Regulation S-K, certain schedules to this Agreement have not been filed with this exhibit. The schedules contain various items related to the business of and the representations and warranties made by the Company and FNSC. The Registrant agrees to furnish supplementally any omitted schedule to the SEC upon request.

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