SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

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

For the fiscal year ended December 31, 2006

 

or

 

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

For the transition period from                                   to                                   

 

Commission file number:  0-24168

 

TF FINANCIAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

 

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

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

Common Stock, par value $.10 per share

(Title of Class)

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

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

The aggregate market value of the voting common equity held by non-affiliates of the registrant, based on the closing price of the registrant’s Common Stock as quoted on the Nasdaq System on June 30, 2006, was $58.5 million (2,870,485 shares at $28.85 per share).

As of March 19, 2007 there were outstanding 2,928,005 shares of the registrant’s Common Stock.

 

DOCUMENTS INCORPORATED BY REFERENCE

1.                  Portions of the Annual Report to Stockholders for the Fiscal Year Ended December 31, 2006. (Parts I, II and IV)

2.                  Portions of the Proxy Statement for the 2007 Annual Meeting of Stockholders. (Part III)

PART I

TF FINANCIAL CORPORATION (THE “COMPANY”) MAY FROM TIME TO TIME MAKE WRITTEN OR ORAL “FORWARD-LOOKING STATEMENTS”, INCLUDING STATEMENTS CONTAINED IN THE COMPANY’S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION (INCLUDING THIS ANNUAL REPORT ON FORM 10-K AND THE EXHIBITS HERETO), IN ITS REPORTS TO STOCKHOLDERS AND IN OTHER COMMUNICATIONS BY THE COMPANY, WHICH ARE MADE IN GOOD FAITH BY THE COMPANY PURSUANT TO THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.

THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF THE COMPANY’S PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS, THAT ARE SUBJECT TO CHANGE BASED ON VARIOUS IMPORTANT FACTORS (SOME OF WHICH ARE BEYOND THE COMPANY’S CONTROL).  THE FOLLOWING FACTORS, AMONG OTHERS, COULD CAUSE THE COMPANY’S FINANCIAL PERFORMANCE TO DIFFER MATERIALLY FROM THE PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS EXPRESSED IN SUCH FORWARD-LOOKING STATEMENTS: THE STRENGTH OF THE UNITED STATES ECONOMY IN GENERAL AND THE STRENGTH OF THE LOCAL ECONOMIES IN WHICH THE COMPANY CONDUCTS OPERATIONS; THE EFFECTS OF, AND CHANGES IN, MONETARY AND FISCAL POLICIES AND LAWS, INCLUDING INTEREST RATE POLICIES OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, INFLATION, INTEREST RATES, MARKET AND MONETARY FLUCTUATIONS; THE TIMELY DEVELOPMENT OF AND ACCEPTANCE OF NEW PRODUCTS AND SERVICES OF THE COMPANY AND THE PERCEIVED OVERALL VALUE OF THESE PRODUCTS AND SERVICES BY USERS, INCLUDING THE FEATURES, PRICING AND QUALITY COMPARED TO COMPETITORS’ PRODUCTS AND SERVICES; THE IMPACT OF CHANGES IN FINANCIAL SERVICES’ LAWS AND REGULATIONS (INCLUDING LAWS CONCERNING TAXES, BANKING, SECURITIES AND INSURANCE); TECHNOLOGICAL CHANGES; ACQUISITIONS; CHANGES IN CONSUMER SPENDING AND SAVING HABITS; AND THE SUCCESS OF THE COMPANY AT MANAGING THE RISKS INVOLVED IN THE FOREGOING.

THE COMPANY CAUTIONS THAT THE FOREGOING LIST OF IMPORTANT FACTORS IS NOT EXCLUSIVE.  THE COMPANY DOES NOT UNDERTAKE TO UPDATE ANY FORWARD-LOOKING STATEMENT, WHETHER WRITTEN OR ORAL, THAT MAY BE MADE FROM TIME TO TIME BY OR ON BEHALF OF THE COMPANY.

Item 1.                            Business

BUSINESS OF THE COMPANY

On July 13, 1994, the Company consummated its public offering for 5,290,000 shares of its common stock and acquired Third Federal Bank (the “Bank”) as part of the Bank’s mutual-to-stock conversion.  The Company was incorporated under Delaware law in March 1994.  The Company is a savings and loan holding company and is subject to regulation by the Office of Thrift Supervision (the “OTS”), the Federal Deposit Insurance Corporation (the “FDIC”) and the Securities and Exchange Commission (the “SEC”).  The Company does not transact any material business other than through its direct and indirect subsidiaries: Third Federal Bank, TF Investments Corporation, Teragon Financial Corporation, Penns Trail Development Corporation and Third Delaware Corporation. At December 31, 2006, the Company had total assets of $653 million, total liabilities of $587 million and stockholders’ equity of $66 million.

BUSINESS OF THE BANK

The Bank is a federally-chartered stock savings bank, which was originally chartered in 1921 as a Pennsylvania-chartered building and loan association.  The Bank’s deposits are insured up to the maximum amount allowable by the FDIC.

The Bank is a community oriented savings institution offering a variety of financial services to meet the needs of the communities it serves.  As of December 31, 2006 the Bank operated fifteen branch offices in Bucks and

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Philadelphia counties, Pennsylvania and in Mercer County, New Jersey.

The Bank attracts deposits from the general public and uses such deposits, together with borrowings and other funds primarily to originate or purchase loans secured by first mortgages on owner-occupied, one-to-four family residences in its market area and to invest in mortgage-backed and investment securities.  At December 31, 2006, one-to-four family residential mortgage loans totaled $268 million or 55% of the Bank’s total loan portfolio.  At that same date, the Bank had approximately $82 million or 13% of total assets invested in mortgage-backed securities and $35 million or 5% of total assets in investment securities. The Bank also originates commercial real estate and multi-family, construction and consumer loans. The Bank has two subsidiaries, Third Delaware Corporation, which was incorporated in 1998 for the purpose of holding and managing mortgage-backed securities and investment securities for the Bank, and Teragon Financial Corporation which holds a 75% limited partnership interest in a captive title insurance agency, Third Fed Abstract, L. P. During 2006, Teragon Financial Corporation was granted approval by the state of Pennsylvania to conduct business as an insurance agency.

Market Area

The Bank offers a wide range of consumer and business products at its fifteen full service branch offices located in Bucks and Philadelphia Counties in Pennsylvania, and Mercer County in New Jersey. Five of the branch offices are located in Bucks County, the third wealthiest county in Pennsylvania. Bucks County is a growing region offering opportunity for growth for the Bank. Seven branches are located in the northeast section of Philadelphia where the Bank was founded. Although Philadelphia County is experiencing population decline, the Bank’s branches in this section of Philadelphia represent a deposit stronghold. The remaining three branches are in Mercer County, New Jersey which has an expanding population and represents another growth area for the Bank.

Competition

The Bank faces varying degrees of competition from banks, thrift institutions and credit unions at its various branch locations.  Stronger competition has come from local and very large regional commercial banks based in and around the Philadelphia area.  Based upon the latest available data, at June 30, 2006 the Company’s share of deposits in each of the counties in which it operates was as follows:

County, State		Market Share for Entire County		Market Share for ZIP Codes Including Company Branches
Philadelphia, Pennsylvania		0.5	%	10.9	%
Bucks, Pennsylvania		1.6	%	6.2	%
Mercer, New Jersey		0.8	%	4.6	%

 

Lending Activities

General.  The Bank’s loan portfolio composition consists primarily of conventional adjustable-rate (“ARM”) and fixed-rate first mortgage loans secured by one-to-four family residences.  The Bank also makes commercial real estate and multi-family loans, construction loans and consumer and other loans.  At December 31, 2006, the Bank’s mortgage loans outstanding were $396 million, of which $268 million were secured by first mortgages on one-to-four family residential property.  Of the one-to-four family residential mortgage loans outstanding at that date, 19% were ARM’s and 81% were fixed-rate loans.  Total ARM loans in the Bank’s residential mortgage portfolio at December 31, 2006 amounted to $51 million or 11% of total loans.  At that same date, commercial real estate and multi-family residential loans totaled $94 million, and construction loans totaled $35 million. The construction loans are predominately floating-rate, prime-rate-based loans.

Consumer and other loans held by the Bank totaled $50 million or 10% of total loans outstanding at December 31, 2006, of which $47 million consisted of home equity and second mortgage loans. At that same date commercial business loans and leases totaled $40 million or 8% of total loans.

The following table sets forth the composition of the Bank’s loan portfolio and mortgage-backed and related securities portfolios in dollar amounts and in percentages of the respective portfolios at the dates indicated.

 

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		At December 31,
		2006					2005					2004					2003					2002
		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total
		(Dollars in thousands)
Loans held for investment:
Mortgage loans:
One-to-four family		$	266,789		54.91	%	$	289,678		58.76	%	$	283,965		64.08	%	$	276,849		68.22	%	$	227,953		61.33	%
Commercial real estate and multi-family		93,607			19.26		89,489			18.15		83,559			18.86		74,109			18.26		85,493			23.00
Construction		34,944			7.19		24,888			5.04		10,286			2.32		6,591			1.62		12,026			3.23
Total mortgage loans		395,340			81.36		404,055			81.95		377,810			85.26		357,549			88.10		325,472			87.56
Consumer loans:
Home equity and second mortgage		46,864			9.65		37,479			7.60		29,522			6.66		25,199			6.21		25,480			6.87
Other consumer		3,206			0.66		2,836			0.58		4,384			0.99		6,532			1.61		10,490			2.82
Total consumer and other loans		50,070			10.31		40,315			8.18		33,906			7.65		31,731			7.82		35,970			9.69
Commercial loans and leases:
Commercial loans		40,458			8.33		48,471			9.83		30,543			6.90		15,185			3.74		8,005			2.15
Commercial leases		36			—		186			0.04		857			0.19		1,371			0.34		2,246			0.60
Total commercial loans and leases		40,494			8.33		48,657			9.87		31,400			7.09		16,556			4.08		10,251			2.75
Total loans		485,904			100.00	%	493,027			100.00	%	443,116			100.00	%	405,836			100.00	%	371,693			100.00	%
Less:
Unearned discount, (premium), deferred loan fees, net		(531		)			(505		)			(706		)			(924		)			(446		)
Allowance for loan losses		2,865					2,641					2,307					2,111					2,047
Total loans, held for investment, net		$	483,570				$	490,891				$	441,515				$	404,649				$	370,092
Loans held for sale:
Mortgage loans:
One-to-four family		$	969		100.00	%	$	68		100.00	%	$	680		100.00	%	—			—	%	—			—	%
Total loans held for sale		$	969		100.00	%	$	68		100.00	%	$	680		100.00	%	—			—	%	—			—	%
Mortgage-backed securities held-to-maturity:
FHLMC		$	2,297		29.84	%	$	3,161		31.06	%	$	5,195		34.87	%	$	8,407		35.58	%	$	21,870		40.10	%
FNMA		3,084			40.07		3,969			39.00		5,182			34.77		7,205			30.49		11,781			21.60
GNMA		2,316			30.09		3,040			29.87		4,516			30.31		8,007			33.88		18,278			33.40
Real estate investment mortgage conduit		—			—		7			0.07		7			0.05		11			0.05		2,519			4.60
Other mortgage-backed securities		—			—		—			—		—			—		—			—		144			0.30
Total mortgage-backed and related securities held-to-maturity		$	7,697		100.00	%	$	10,177		100.00	%	$	14,900		100.00	%	$	23,630		100.00	%	$	54,592		100.00	%
Mortgage-backed securities available-for-sale:
FHLMC		$	7,888		10.61	%	$	9,686		11.60	%	$	6,614		6.38	%	$	8.525		7.98	%	$	699		0.60	%
FNMA		10,330			13.90		12,173			14.58		15,108			14.58		18,385			17.22		11,878			10.30
Real estate investment mortgage conduit		56,120			75.49		61,652			73.82		81,888			79.04		79,864			74.80		102,666			89.10
Total mortgage-backed and related securities available-for-sale		$	74,338		100.00	%	$	83,511		100.00	%	$	103,610		100.00	%	$	106,774		100.00	%	$	115,243		100.00	%

 

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Loan Maturity and Repricing Information.  The following table sets forth certain information at December 31, 2006, regarding the dollar amount of loans maturing in the Bank’s loan and mortgage-backed securities portfolios based on their maturity date.  Demand loans, loans having no stated schedule of repayments and no stated maturity, overdrafts and delinquent loans maturing prior to December 31, 2007, are reported as due in one year or less.  The table does not include prepayments or scheduled principal repayments.

 

The following table sets forth the dollar amount of all loans and mortgage-backed securities due after December 31, 2007, which have predetermined interest rates and which have floating or adjustable interest rates. Loans which have rate adjustments after ten years are considered to have predetermined rates.

 

One-to-Four Family Mortgage Lending.  The Bank offers first mortgage loans secured by one-to-four family residences in the Bank’s lending area.  Typically, such residences are single-family homes that serve as the primary residence of the owner.  The Bank generally originates and invests in one-to-four family residential mortgage loans in amounts up to 80% of the lesser of the appraised value or selling price of the mortgaged property.  Loans originated in amounts over 80% of the lesser of the appraised value or selling price of the mortgaged property, other than loans to facilitate the sale of real estate acquired through foreclosure, must be owner-occupied and private mortgage insurance is typically required.

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Loan originations are obtained from existing or past customers, members of the local community, and referrals from established builders and realtors within the Bank’s lending area using direct advertising in local newspapers, branch signage and promotions, and word of mouth referrals.

The Bank offers a variety of ARM loans with terms of 30 years which adjust at the end of 6 months, one, three, five, seven and ten years and adjust by a maximum of 3% to 5% per adjustment with a lifetime cap of 5% to 6% over the life of the loan.

The Bank offers fixed-rate mortgage loans with terms of 10 to 30 years, which are payable monthly.  Interest rates charged on fixed-rate mortgage loans are competitively priced based on market conditions.  The origination fees for fixed-rate loans range from 0% to 3% depending on the underlying loan coupon. Generally, the Bank’s standard underwriting guidelines for fixed-rate mortgage loans conform to the FHLMC and FNMA guidelines. The Bank sells a portion of its conforming fixed-rate mortgage loan originations in the secondary market to FHLMC and FNMA while retaining the servicing rights on these loans. The Bank also brokers a small portion of its loan closings to correspondents. However, the Bank is primarily a portfolio lender.  As of December 31, 2006, the Bank’s portfolio of loans serviced for FHLMC or FNMA totaled approximately $23 million.

The Bank has a mortgage lending department that is separate as to its sales efforts from the consumer lending area of the Bank. This department employs a lending manager and several commissioned loan officers. Through this department the Bank offers, in addition to its standard portfolio loan products, other types of mortgage loans that are originated in the name of, or sold on a servicing released basis to, third party investors. The mortgage loan officers support the Bank’s branches and customers, and additionally engage in calling efforts directed toward realtors, builders, and others that can be sources of lending business for the Bank.

Commercial Real Estate and Multi-Family Lending.  The Bank originates loans secured by commercial real estate including non-owner occupied residential multi-family dwelling units (more than four units) primarily secured by professional office buildings and apartment complexes. The Bank generally originates commercial real estate and multi-family loans up to 75% of the appraised value of the property securing the loan.  Currently, it is the Bank’s philosophy to originate commercial real estate and multi-family loans primarily on properties in its general market area.  The commercial real estate and multi-family loans in the Bank’s portfolio consist of fixed-rate, ARM and balloon loans originated at prevailing market rates for terms of up to 25 years.  The Bank’s current policy is to originate commercial real estate and multi-family loans as ARM’s that amortize over a 20 to 25 year period and either have a scheduled interest rate reset, or are callable by the Bank after a 5 to 10 year period.

Loans secured by commercial and multi-family real estate are generally larger and involve a greater degree of risk than one-to-four family residential mortgage loans.  Of primary concern in commercial and multi-family real estate lending is the borrower’s creditworthiness and the feasibility and cash flow potential of the project.  Loans secured by income properties are generally larger and involve greater risks than residential mortgage loans because payments on loans secured by income properties are often dependent on successful operation or management of the properties.  As a result, repayment of such loans may be subject to a greater extent than residential real estate loans to adverse conditions in the real estate market or the economy.  In order to monitor cash flows on income properties, the Bank requires borrowers and loan guarantors, if any, to provide annual financial statements and rent rolls on multi-family loans.  Similarly, on commercial office buildings and hotel properties, the Bank requires minimum debt service coverage and obtains operating statements of such properties. At December 31, 2006, the five largest commercial real estate and multi-family loans totaled $24 million with no single loan larger than $6 million.  At December 31, 2006, all such loans were current and the properties securing such loans are in the Bank’s market area.

Construction Lending.  At December 31, 2006, the Bank had $35 million of construction loans or 7% of the Bank’s total loan portfolio.  Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate.  Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development and the estimated cost (including interest) of construction.  During the construction phase, a number of factors could result in delays and cost overruns.  If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the

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construction.  If the estimate of value proves to be inaccurate, the Bank may be confronted, at or prior to the maturity of the loan, with a project having a value which is insufficient to assure full repayment. At December 31, 2006, the five largest construction loans totaled $18 million with no single loan larger than $5 million.

Consumer and Other Loans.  The Bank also offers consumer and other loans in the form of home equity and second mortgage loans (referred to hereinafter collectively as “second mortgage loans”), automobile loans and student loans.  These loans totaled $50 million or 10% of the Bank’s total loan portfolio at December 31, 2006.  The Bank originates consumer loans in order to provide a wide range of financial services to its customers and because the shorter terms and normally higher interest rates on such loans help maintain a profitable spread between its average loan yield and its cost of funds.

In connection with consumer loan applications, the Bank verifies the borrower’s income and reviews a credit bureau report.  In addition, the relationship of the loan to the value of the collateral is considered.  All automobile loan applications are reviewed and approved by the Bank.  The Bank reviews the credit report of the borrower as well as the value of the vehicle which secures the loan.

Consumer loans tend to be originated at higher interest rates than conventional residential mortgage loans and for shorter terms, thus facilitating the Bank’s interest rate risk management.  Consumer loans, however, tend to have a higher risk of default than residential mortgage loans.  At December 31, 2006, $68,000 or 0.1% of the Bank’s consumer loans were delinquent more than 90 days, compared to $141,000 or 0.05% of residential one-to-four family loans.

The Bank offers second mortgage loans on one-to-four family residences.  At December 31, 2006, second mortgage and home equity loans totaled $47 million, or 10% of the Bank’s total loan portfolio.  Second mortgage loans are offered as fixed-rate loans for a term not to exceed 15 years.  Such loans are only made on owner-occupied one-to-four family residences and are subject to a 90% combined loan to value ratio.  The underwriting standards for second mortgage loans are the same as the Bank’s standards applicable to one-to-four family residential loans.

Business Lending.  The Bank makes commercial business loans only on a secured or guaranteed basis.  The terms of these loans generally do not exceed five years. These loans can have floating interest rates which adjust with changes in market interest rates, usually the prime rate, or have a fixed rate related to their term to maturity.  The Bank’s commercial business loans primarily consist of short-term loans for equipment, working capital, business expansion and inventory financing.  The Bank customarily requires a personal guaranty of payment by the principals of any borrowing entity and reviews the financial statements and income tax returns of the guarantors.  At December 31, 2006, the Bank had approximately $40 million outstanding in commercial business loans, which represented approximately 8% of its total loan portfolio. At December 31, 2006, the five largest commercial business loans totaled $14 million with no single loan larger than $4 million.

Loan Approval Authority and Underwriting.  The Board of Directors of the Bank sets the authority to approve loans based on the amount, type of loan (i.e., secured or unsecured) and total exposure to the borrower.  Where there are one or more existing loans to a borrower, the level of approval required is governed by the proposed total exposure including the new loan.  The Board has approved loan authority and limits for certain of the Bank’s lending personnel and senior officers, including the president of the Bank.  Approval authority ranges from $5,000 to $750,000 for secured loans, and $5,000 to $100,000 for unsecured loans. Members of an in-house loan committee comprising four senior members of management approve all loans over $500,000. Any two members may combine their lending authority. The committee has the authority to approve secured loans up to $2.5 million and unsecured loans up to $200,000. All loans greater than $2.5 million through $5 million require the approval of a Board Loan Committee composed of four members of the Board of Directors of the Bank. All loans over $5 million or loans that cause the aggregate lending relationship to exceed $5 million must be approved by the Bank’s Board of Directors.

One-to-four family residential mortgage loans are generally underwritten according to FHLMC and FNMA guidelines.  For all loans originated by the Bank, upon receipt of a completed loan application from a prospective borrower, a credit report is ordered, income and certain other information is verified and, if necessary, additional financial information is requested.  An appraisal of the real estate intended to secure the proposed loan is required

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which currently is performed by an independent appraiser designated and approved by the Bank.  The Bank makes construction/permanent loans on individual properties.  Funds advanced during the construction phase are held in a loan-in-process account and disbursed based upon various stages of completion.  An independent appraiser or loan officer determines the stage of completion based upon a physical inspection of the construction and funds are advanced only for work in place.  It is the Bank’s policy to obtain title insurance or a title opinion on all real estate first mortgage loans in excess of $200,000.  Borrowers must also obtain hazard or flood insurance (for loans on property located in a flood zone) prior to closing the loan.  For loans in excess of 80% of the loan to value ratio, borrowers are generally required to advance funds on a monthly basis together with each payment of principal and interest to an escrow account from which the Bank makes disbursements for items such as real estate taxes and hazard insurance premiums. The Bank does not engage in sub-prime or “no-doc” style lending.

Loans to One Borrower.  Current regulations limit loans to one borrower in an amount equal to 15% of unimpaired capital and retained income on an unsecured basis and an additional amount equal to 10% of unimpaired capital and retained income if the loan is secured by readily marketable collateral (generally, financial instruments, not real estate) or $500,000, whichever is higher.  Penalties for violations of the loan-to-one borrower statutory and regulatory restrictions include cease and desist orders, the imposition of a supervisory agreement and civil money penalties.  The Bank’s maximum loan-to-one borrower limit was approximately $9.2 million as of December 31, 2006.

At December 31, 2006, the Bank’s five largest aggregate lending relationships had balances ranging from $6.3 to $7.4 million.  At December 31, 2006, all of these loans were current.

Mortgage-Backed Securities

To supplement lending activities, the Bank invests in residential mortgage-backed securities.  Although the majority of such securities are held to maturity, they can serve as collateral for borrowings and, through repayments, as a source of liquidity.

The mortgage-backed securities portfolio as of December 31, 2006, consisted of pass-through certificates issued by the Federal Home Loan Mortgage Corporation (“FHLMC”) ($10.2 million), Government National Mortgage Association (“GNMA”), ($2.3 million) Federal National Mortgage Association (“FNMA”) ($13.4 million), and real estate mortgage investment conduits formed by these same agencies (“REMICs”) ($56.1 million).

At December 31, 2006, the amortized cost of mortgage-backed securities totaled $83.9 million, or 13% of total assets, and the market value of such securities totaled approximately $82.1 million.

The Bank’s mortgage-backed securities are so-called “pass-throughs” which represent a participation interest in a pool of single-family or multi-family mortgages, the principal and interest payments on which are passed from the mortgage originators, through intermediaries (generally quasi-governmental agencies) that pool and repackage the participation interests in the form of securities, to investors such as the Bank.  Such quasi-governmental agencies, which guarantee the payment of principal and interest to investors, primarily include FHLMC, FNMA and GNMA. The REMIC securities are composed of the same loan types as the pass through certificates, but offer differing characteristics as to their expected cash flows depending on the class of such securities purchased. The Bank’s REMICs are primarily “planned amortization classes” and “very accurately defined maturity classes” that, when purchased, offered a high probability of predictable cash flows.

Mortgage-Backed Securities Carrying Value. The following table sets forth the carrying value of the Bank’s mortgage-backed securities held in portfolio at the dates indicated.

 

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Mortgage-Backed Securities Maturity.  The following table sets forth the maturity and the weighted average coupon (“WAC”) of the Bank’s mortgage-backed securities portfolio at December 31, 2006.  The table does not include estimated prepayments.  Adjustable-rate mortgage-backed securities are shown as maturing based on contractual maturities.

 

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Non-Performing and Problem Assets

Loan Collection.  When a borrower fails to make a required payment on a loan, the Bank takes a number of steps to have the borrower cure the delinquency and restore the loan to current status.  In the case of residential mortgage loans and consumer loans, the Bank generally sends the borrower a written notice of non-payment after the loan is 15 days past due.  In the event payment is not then received, additional letters and phone calls are made.  If the loan is still not brought current and it becomes necessary for the Bank to take legal action, which typically occurs after a loan is delinquent more than 90 days, the Bank will commence foreclosure proceedings against any real property that secures the loan and attempt to repossess any personal property that secures a consumer loan.  If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is obtained by the Bank at foreclosure.

In the case of commercial real estate and multi-family loans, and construction loans, the Bank generally attempts to contact the borrower by telephone after any loan payment is ten days past due and a senior loan officer reviews all collection efforts made if payment is not received after the loan is 30 days past due.  Decisions as to when to commence foreclosure actions for commercial real estate and multi-family loans and construction loans are made on a case by case basis.  The Bank may consider loan work-out arrangements with these types of borrowers in certain circumstances.

On mortgage loans or loan participations purchased by the Bank, the Bank receives monthly reports from its loan servicers with which it monitors the loan portfolio.  Based upon servicing agreements with the servicers of the loan, the Bank relies upon the servicer to contact delinquent borrowers, collect delinquent amounts and to initiate foreclosure proceedings, when necessary, all in accordance with applicable laws, regulations and the terms of the servicing agreements between the Bank and its servicing agents. At December 31, 2006 the Bank used third-party servicers to service $24.9 million in mortgage loans, including one servicer that serviced $17 million. Please see Item 3. Legal Proceedings for additional information regarding this servicer.  All of the Bank’s third-party mortgage loan servicers are regulated financial institutions or are approved by either HUD, FNMA, or FHLMC to service loans on their behalf.

Delinquent Loans.  Generally, the Bank reserves for uncollected interest on loans past due more than 90 days; these loans are included in the table of nonaccrual loans below.  Loans also are placed on a nonaccrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further collection.  When a loan is placed on nonaccrual status, previously accrued but unpaid interest is deducted from interest income and the further accrual of interest ceases unless the underlying facts that prompted a nonaccrual determination are deemed to have improved significantly.

Non-Performing Assets.  The following table sets forth information regarding non-accrual loans and real estate owned by the Bank at the dates indicated.  The Bank had no loans contractually past due more than 90 days for which accrued interest has been recorded.

Non-performing assets

		At December 31,
		2006			2005			2004			2003			2002
		(Dollars in thousands)
Loans accounted for on a non-accrual basis:
Mortgage loans:
One-to-four family		$	141		$	392		$	536		$	1,549		$	1,013
Commercial real estate and multi-family		61			877			23			296			1,677
Consumer and other		68			170			84			135			245
Commercial loans and leases		1,840			150			317			368			887
Total non-accrual loans		2,110			1,589			960			2,348			3,822
Real estate owned, net		—			700			700			868			84
Total non-performing assets		$	2,110		$	2,289		$	1,660		$	3,216		$	3,906
Total non-accrual loans to loans		0.43		%	0.32		%	0.22		%	0.58		%	1.03		%
Total non-accrual loans to total assets		0.32		%	0.24		%	0.15		%	0.39		%	0.53		%
Total non-performing assets to total assets		0.32		%	0.35		%	0.26		%	0.53		%	0.54		%

 

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At December 31, 2006, the Bank had no foreign loans and no loan concentrations exceeding 10% of total loans not disclosed in above the table. “Loan concentrations” are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions.  Loans recorded in the category of other real estate owned are valued at the lower of book value of loans outstanding or fair market value less cost of disposal.

At December 31, 2006, the Bank was not aware of any potential problem loans that are not otherwise included in the foregoing table.  “Potential problem loans” are loans where information about possible credit problems of borrowers has caused management to have serious doubts about the borrowers’ ability to comply with present repayment terms.

Classified Assets.  OTS regulations provide for a classification system for problem assets of insured institutions which covers all problem assets.  Under this classification system, problem assets of insured institutions are classified as “substandard,” “doubtful,” or “loss.”  An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected.  Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions and values, “highly questionable and improbable.”  Assets classified as “loss” are those considered “uncollectible” and of such little value that the establishment of a specific loss reserve is warranted.  Assets designated “special mention” by management are assets included on the Bank’s internal watchlist because of potential weakness but that do not currently warrant classification in one of the aforementioned categories.

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management.  General allowances for OTS purposes represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets.  However, when an insured institution classifies all or a portion of a problem asset as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount.  An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS, which may order the establishment of additional general or specific loss allowances.  A portion of general loss allowances established to cover possible losses related to assets classified as substandard or doubtful may be included in determining an institution’s regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital.

The following table provides further information in regard to the Bank’s classified assets as of December 31, 2006.

 

Real Estate Owned.  Real estate acquired by the Bank as a result of foreclosure, judgment or by deed in lieu of foreclosure is classified as real estate owned (“REO”) until it is sold.  When property is acquired it is

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recorded at the lower of fair value, minus estimated cost to sell, or cost.  If the property subsequently decreases in estimated value from the initial recorded amount, the Bank will provide a valuation allowance, through a charge to earnings, if the decrease is judged by management to be temporary. If the decrease is judged to be permanent, the Bank will reduce the recorded amount, through a charge to earnings, to the new estimated value.

Allowances for Loan Losses.  The Bank provides valuation allowances for estimated losses from uncollectible loans. Management determines the adequacy of the allowance on a quarterly basis to ensure that a provision for loan losses has been charged against earnings in an amount necessary to maintain the allowance at a level that is appropriate based upon management’s estimate of probable losses. Several sources of data are used in making the evaluation as to the appropriateness of the allowance.

In establishing reserves, a specific reserve is established for loans which because of past payment history, a review of recent financial information, or other facts regarding the credit, pose a higher than normal amount of perceived risk of collection. In addition, a reserve is assigned based upon qualitative and quantitative risk factors which are inherent in segments of the loan portfolio.

Although the allowance has been allocated to determine the appropriateness of the reserve, the total allowance is available to absorb any and all losses from any segment of the loan portfolio. At December 31, 2006, management believes that the allowance for loan loss is at an acceptable level.

The following table sets forth information with respect to the Bank’s allowance for loan losses at the dates and for the periods indicated:

		For the Years Ended December 31,
		2006			2005			2004			2003			2002
		(Dollars in thousands)
Balance at beginning of period		$	2,641		$	2,307		$	2,111		$	2,047		$	1,972
Provision for loan losses		150			540			600			330			988
Charge-offs:
One-to-four family		—			—			—			(16		)	(13		)
Commercial and multi-family real estate loans		—			—			(112		)	—			—
Consumer and other loans		(55		)	(122		)	(186		)	(219		)	(303		)
Commercial loans and leases		(1		)	(286		)	(161		)	(322		)	(625		)
Recoveries:
One-to-four family		—			—			—			—			3
Consumer and other loans		65			39			55			36			25
Commercial loans and leases		65			163			—			255			—
Balance at end of year		$	2,865		$	2,641		$	2,307		$	2,111		$	2,047
Ratio of net charge-offs during the period to average loans outstanding during the period		(0.01		)%	0.04		%	0.09		%	0.07		%	0.25		%
Ratio of allowance for loan losses to non-performing loans at the end of the period		135.8		%	166.3		%	240.3		%	89.9		%	53.6		%
Ratio of allowance for loan losses to loans receivable at the end of the period		0.59		%	0.54		%	0.52		%	0.52		%	0.55		%
Ratio of allowance for loan losses and foreclosed real estate to total non-performing assets at the end of the period		135.8		%	115.4		%	139.0		%	65.6		%	52.4		%

 

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The following table sets forth the allocation of the Bank’s allowance for loan losses by loan category and the percent of loans in each category to total loans receivable, gross, at the dates indicated.

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		At December 31,
		2006					2005					2004					2003					2002
		Amount			Percent of Loans to Total Loans		Amount			Percent of Loans to Total Loans		Amount			Percent of Loans to Total Loans		Amount			Percent of Loans to Total Loans		Amount			Percent of Loans to Total Loans
		(Dollars in thousands)
At end of period allocated to:
One-to-four family		$	332		54.9	%	$	154		58.8	%	$	176		64.1	%	$	277		68.2	%	$	119		61.3	%
Commercial real estate and multi-family		665			19.3		1,010			18.2		1,035			18.8		1,230			18.3		1,021			23.0
Construction		621			7.2		738			5.0		121			2.3		109			1.6		90			3.2
Consumer and other loans		248			10.3		115			8.2		554			7.7		246			7.8		271			9.7
Commercial loans and leases		999			8.3		624			9.8		421			7.1		249			4.1		546			2.8
Total allowance		$	2,865		100.0	%	$	2,641		100.0	%	$	2,307		100.0	%	$	2,111		100.0	%	$	2,047		100.0	%

 

Investment Activities

The investment policy of the Bank, which is established by the Board of Directors and implemented by the Asset Liability Committee, is designed primarily to provide and maintain liquidity, to generate a favorable return on investments without incurring undue interest rate and credit risk, and to complement the Bank’s lending activities.  In establishing its investment strategies, the Bank considers its business and growth plans, the economic environment, the types of securities to be held and other factors.  Federally chartered savings institutions have the authority to invest in various types of assets, including U.S. Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers acceptances, repurchase agreements, loans on federal funds, and, subject to certain limits, commercial paper and mutual funds.

The following table sets forth certain information regarding the amortized cost and fair values of the Bank’s investments at the dates indicated.

		At December 31,
		2006						2005						2004
		Amortized Cost			Fair Value			Amortized Cost			Fair Value			Amortized Cost			Fair Value
		(In thousands)
Interest-earning deposits		$	6,860		$	6,860		$	177		$	177		$	252		$	252
Investment securities held-to-maturity:
State and political subdivisions		$	677		$	681		$	1,015		$	1,036		$	1,326		$	1,395
Corporate debt securities		—			—			3,675			3,671			5,701			5,793
Total		$	677		$	681		$	4,690		$	4,707		$	7,027		$	7,188
Securities available-for-sale:
U.S. government and agency obligations		$	5,990		$	5,911		$	5,982		$	5,880		$	2,978		$	2,958
State and political subdivisions		24,406			24,429			20,844			20,563			13,704			13,675
Corporate debt securities		4,003			3,982			4,002			3,958			1,000			992
Equities		150			202			—			—			—			—
Total		$	34,549		$	34,524		$	30,828		$	30,401		$	17,682		$	17,625

 

Investment Portfolio Maturities

The following table sets forth certain information regarding the amortized cost, weighted average yields

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and maturities of the Bank’s investment securities portfolio, exclusive of interest-earning deposits, at December 31, 2006.  Yields on tax exempt obligations have been computed on a tax equivalent basis.

		One Year or Less					One to Five Years					Five to Ten Years					More than Ten Years					Total Investment Securities(1)
		Amortized Cost			Average Yield		Amortized Cost			Average Yield		Amortized Cost			Average Yield		Amortized Cost			Average Yield		Amortized Cost			Average Yield		Fair Value
		(Dollars in thousands)
Equities		$	150		—	%	$	—		—	%	$	—		—	%	$	—		—	%	$	150		—	%	$	202
U.S. government agency		3,000			4.27		2,990			3.40		—			—		—			—		5,990			3.83		5,911
Municipal obligations		—			—		1,923			5.59		12,008			5.11		11,152			5.61		25,083			5.37		25,110
Corporate obligations		3,003			3.91		1,000			4.64		—			—		—			—		4,003			4.09		3,982
Total		$	6,153		3.99	%	$	5,913		4.32	%	$	12,008		5.11	%	$	11,152		5.61	%	$	35,226		4.94	%	$	35,205

(1)             Includes $34.5 million of U.S. government agency, municipal and corporate obligations which are carried as available-for-sale at December 31, 2006.  Investment securities available-for-sale are carried at fair value.

Sources of Funds

General. Deposits, borrowings, loan repayments and cash flows generated from operations are the primary sources of the Bank’s funds for use in lending, investing and other general purposes.

Deposits. The Bank offers a variety of deposit accounts having a range of interest rates and terms. The Bank’s deposits consist of regular savings, non-interest bearing checking, NOW checking, money market, and certificate accounts. Of the deposit accounts, $32 million or 6.6% consist of IRA, Keogh or SEP retirement accounts at December 31, 2006.

The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition. The Bank’s deposits are primarily obtained from areas surrounding its offices, and the Bank relies primarily on customer service and long-standing relationships with customers to attract and retain these deposits. The Bank has maintained a high level of core deposits consisting of regular savings, money market, non-interest-bearing checking, and NOW checking, which has contributed to a low cost-of-funds. At December 31, 2006, core deposits amounted to 59% of total deposits.

During 2005, the Bank introduced a floating-rate certificate of deposit, which has an interest rate that adjusts according to adjustments in the prime rate. At December 31, 2006 there were $10.2 million of these floating rate certificates of deposit. In 2006, the Bank obtained $11.7 million in broker-originated deposits.

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The following table sets forth the distribution of the Bank’s deposit accounts at the dates indicated and the weighted average nominal interest rates on each category of deposits presented. The Bank does not have significant amount of deposits from outside its market area. Management does not believe that the use of year end balances instead of average balances resulted in any material difference in the information presented.

		At December 31,
		2006							2005							2004
		Amount			Percent of Total Deposits		Weighted Average Nominal Rate		Amount			Percent of Total Deposits		Weighted Average Nominal Rate		Amount			Percent of Total Deposits		Weighted Average Nominal Rate
		(Dollars in thousands)
Transaction Accounts
Interest-bearing checking accounts		$	51,272		10.72		0.48	%	$	52,319		11.12		0.47	%	$	54,887		11.93		0.47	%
Money market accounts		62,914			13.16		3.21		79,666			16.93		2.72		42,496			9.24		1.00
Non-interest-bearing checking accounts		36,991			7.74		0.00		37,138			7.89		0.00		32,636			7.10		0.00
Total transaction accounts		151,177			31.62				169,123			35.94				130,019			28.27
Passbook accounts		131,359			27.48		2.21		151,725			32.25		1.11		182,945			39.78		0.98
Certificates of deposit		195,551			40.90		4.35		149,673			31.81		3.29		146,939			31.95		2.42
Total deposits		$	478,087		100.00	%	2.86	%	$	470,521		100.00	%	2.39	%	$	459,903		100.00	%	1.31	%

 

At December 31, 2006, the Bank had outstanding certificates of deposit in amounts of $100,000 or more maturing as follows:

 

Borrowings

Deposits are the primary source of funds of the Bank’s lending and investment activities and for its general business purposes. The Bank may obtain advances from the FHLB of Pittsburgh to supplement its supply of lendable funds. Advances from the FHLB of Pittsburgh are typically secured by a pledge of the Bank’s stock in the FHLB of Pittsburgh and a portion of the Bank’s first mortgage loans and certain other assets. The Bank, if the need arises, may also access the Federal Reserve Bank discount window. The following tables set forth the maximum month-end balance, period ending balance, and weighted average balance of outstanding FHLB advances at the dates and for the periods indicated, together with the applicable weighted average interest rates.

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Subsidiary Activity

The Bank is permitted to invest up to 2% of its assets in the capital stock of, or secured or unsecured loans to, subsidiary corporations, with an additional investment of 1% of assets when such additional investment is utilized primarily for community development purposes. Under such limitations, as of December 31, 2006, the Bank was authorized to invest up to approximately $13 million in the stock of, or loans to, service corporations (based upon the 2% limitation). In addition, the Bank can designate a subsidiary as an operating subsidiary, in which there is no percentage of assets investment limitation, if it engages only in activities in which it would be permissible for the Bank to engage. At December 31, 2006, the Bank had two wholly-owned subsidiaries, Third Delaware Corporation and Teragon Financial Corporation. Third Delaware Corporation was formed in 1998 for the purpose of investing in marketable securities. At December 31, 2006, the Bank had $128 million invested in Third Delaware Corporation. During 2004, Teragon Financial Corporation (“Teragon”) invested $7,500 in a limited partnership entitled Third Fed Abstract, L. P., whose purpose is to operate a title insurance agency, primarily to capture certain title insurance premiums generated by the Bank’s lending activities. At December 31, 2006 the Bank had an investment of $74,000 in Teragon. During 2006, Teragon Financial Corporation was granted approval by the state of Pennsylvania to conduct business as an insurance agency, and expects to receive a modest amount of insurance commissions in the future.

Personnel

As of December 31, 2006, the Company had 176 full-time and 26 part-time employees. None of the Company’s employees are represented by a collective bargaining group. The Company believes that its relationship with its employees is good.

REGULATION

Set forth below is a brief description of all material laws and regulations which relate to the regulation of the Bank and the Company. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.

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Company Regulation

General. The Company is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings association subsidiaries, should such subsidiaries be formed, which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association. This regulation and oversight is intended primarily for the protection of the depositors of the Bank and not for the benefit of stockholders of the Company. The Company is also required to file certain reports with, and otherwise comply with, the rules and regulations of the OTS and the SEC.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (the “Act”) implemented legislative reforms intended to address corporate and accounting fraud and improve public company reporting. The Securities and Exchange Commission (the “SEC”) has promulgated new regulations pursuant to the Act and may continue to propose additional implementing or clarifying regulations as necessary in furtherance of the Act. The passage of the Act by Congress and the implementation of new regulations by the SEC subject publicly-traded companies to additional and more cumbersome reporting regulations and disclosure. Compliance with the Act and corresponding regulations may increase the Company’s expenses.

Financial Modernization. The Gramm-Leach-Bliley Act (“GLB”) permits qualifying bank holding companies to become financial holding companies and thereby affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. GLB defines “financial in nature” to include securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal Reserve Board has determined to be closely related to banking. A qualifying national bank also may engage, subject to limitations on investment, in activities that are financial in nature, other than insurance underwriting, insurance company portfolio investment, real estate development, and real estate investment, through a financial subsidiary of the bank.

GLB also prohibits new unitary thrift holding companies from engaging in nonfinancial activities or from affiliating with a nonfinancial entity. As a grandfathered unitary thrift holding company, the Company has retained its authority to engage in nonfinancial activities.

QTL Test. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions, provided the Bank satisfies the QTL test. If the Company acquires control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company, and the activities of the Company and any of its subsidiaries (other than the Bank) would become subject to restrictions applicable to bank holding companies unless such other associations each also qualify as a QTL and were acquired in a supervisory acquisition.

Bank Regulation

General. As a federally chartered, FDIC-insured savings association, the Bank is subject to extensive regulation by the OTS and the FDIC. Lending activities and other investments must comply with various federal statutory and regulatory requirements. The Bank is also subject to certain reserve requirements promulgated by the Federal Reserve Board.

The OTS, in conjunction with the FDIC, regularly examines the Bank and prepares reports for the consideration of the Bank’s Board of Directors on any deficiencies that they find in the Bank’s operations. The Bank’s relationship with its depositors and borrowers is also regulated to a great extent by federal law, especially in such matters as the ownership of savings accounts and the form and content of the Bank’s mortgage documents.

The Bank must file reports with the OTS and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with or acquisitions of other savings institutions. This regulation and supervision establishes a comprehensive framework of

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activities in which an institution can engage and is intended primarily for the protection of the FDIC and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulations, whether by the OTS, the FDIC or the Congress could have a material adverse impact on the Company, the Bank and their operations. The Company is also required to file certain reports with, and otherwise comply with, the rules and regulations of the OTS and the SEC.

Loan Limitations.  Regulations limit the amount of non-residential mortgage loans a savings institution may hold as a percentage of assets or capital.  Separate from the qualified thrift lender test, regulations limit a savings institution to a maximum of 10% of its assets in large commercial loans (defined as loans in excess of $2 million), with another 10% of assets permissible in “small business loans.”  Commercial loans secured by real estate can be made in an amount up to four times an institution’s capital.  An institution can also have commercial leases, in addition to the above items, up to 10% of its assets. Commercial paper, corporate bonds, and consumer loans cannot collectively exceed 35% of an institution’s assets.  For this purpose, however, residential mortgage loans (including securities backed by such loans) and credit card loans are not considered consumer loans, and are both unlimited in amount.

Deposit Insurance. The Bank’s deposits are insured to applicable limits by the Federal Deposit Insurance Company. Although the FDIC is authorized to assess premiums under a risk-based system for such deposit insurance, most insured depository institutions have not been required to pay premiums for the last ten years. The Federal Deposit Insurance Reform Act of 2005, which was signed into law on February 15, 2006, has resulted in significant changes to the federal deposit insurance program: (i) effective March 31, 2006, the Bank Insurance Fund (which formerly insured the deposits of banks) and the Savings Association Insurance Fund (which formerly insured the deposits of savings associations like the Bank) were merged into a combined fund, called the Deposit Insurance Fund; (ii) the current $100 thousand deposit insurance coverage will be indexed for inflation (with adjustments every five years, commencing January 1, 2011); and (iii) deposit insurance coverage for retirement accounts has been increased to $250 thousand per participant subject to adjustment for inflation. The FDIC has been given greater latitude in setting the assessment rates for insured depository institutions, which could be used to impose minimum assessments.

The FDIC is authorized to set the reserve ratio for the Deposit Insurance Fund annually between 1.15% and 1.5% of estimated insured deposits. If the Deposit Insurance Fund’s reserves exceed the designated reserve ratio, the FDIC is required to pay out all or, if the reserve ratio is less than 1.5%, a portion of the excess as a dividend to insured depository institutions based on the percentage of insured deposits held on December 31, 1996 adjusted for subsequently paid premiums. Insured depository institutions that were in existence on December 31, 1996 and paid assessments prior to that date (or their successors) are entitled to a one-time credit against future assessments based on the amount of their assessable deposits on that date. The Bank anticipates that it will be able to offset its deposit insurance premium for 2007 with the special on-time assessment credit it will receive during 2007.

Pursuant to the Reform Act, the FDIC has determined to maintain the designated reserve ratio at its current 1.25%. The FDIC has also adopted a new risk-based premium system that provides for quarterly assessments based on an insured institution’s ranking in on of four risk categories based on their examination ratings and capital ratios. Beginning in 2007, well capitalized institutions with the CAMEL ratings of 1 or 2 will be grouped in Risk Category I and will be assessed for deposit insurance at an annual rate of between five and seven basis points with the assessment rate for an individual institution to be determined according to a formula based on a weighted average of the institution’s individual CAMEL component ratings plus either five financial ratios or the average ratings of it s long term debt. Institutions in Risk Categories II, III, and IV will be assessed at annual rates of 10, 28 and 43 basis points respectively.

In addition, all FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (“FICO”), an agency of the Federal government established to recapitalize the predecessor to the SAIF. The FICO assessment rates which are determined quarterly averaged 0.128% of insured deposits in fiscal 2006.  These assessments will continue until the FICO bonds mature in 2017.

Regulatory Capital Requirements. OTS capital regulations require savings institutions to meet three

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capital standards:  (1) tangible capital equal to 1.5% of total adjusted assets, (2) a leverage ratio (core capital) equal to at least 4% of total adjusted assets and (3) a risk-based capital requirement equal to 8.0% of total risk-weighted assets. In addition, the OTS prompt corrective action regulation provides that a savings institution that has a leverage capital ratio of less than 4% (3% for institutions receiving the highest examination rating) will be deemed to be “undercapitalized” and may be subject to certain restrictions.

At December 31, 2006, the Bank was in compliance with all of its regulatory capital requirements.

Dividend and Other Capital Distribution Limitations. The Bank may not declare or pay a cash dividend on its capital stock if the effect thereof would be to reduce the regulatory capital of the Bank below the amount required for the liquidation account established at the time of the Bank’s mutual-to-stock conversion.

Savings associations that would remain at least adequately capitalized following the capital distribution, and that meet other specified requirements, are not required to file a notice or application for capital distributions (such as cash dividends) declared below specified amounts. Savings associations which are eligible for expedited treatment under current OTS regulations are not required to file an application with the OTS if (i) the savings association would remain at least adequately capitalized following the capital distribution and (ii) the amount of capital distribution does not exceed an amount equal to the savings association’s net income for that year to date, plus the savings association’s retained net income for the previous two calendar years. Thus, only undistributed net income for the prior two years may be distributed in addition to the current year’s undistributed net income without the filing of an application with the OTS. Savings associations which do not qualify for expedited treatment or which desire to make a capital distribution in excess of the specified amount, must file an application with, and obtain the approval of, the OTS prior to making the capital distribution. A savings association such as the Bank that is a subsidiary of a savings and loan holding company, and under certain other circumstances, must file a notice with OTS prior to making the capital distribution.

Qualified Thrift Lender Test. The Home Owners’ Loan Act (“HOLA”), as amended, requires savings institutions to meet a QTL test. If the Bank maintains an appropriate level of Qualified Thrift Investments (primarily residential mortgages and related investments, including certain mortgage-backed securities) (“QTIs”) and otherwise qualifies as a QTL, it will continue to enjoy full borrowing privileges from the FHLB of Pittsburgh. The required percentage of QTIs is 65% of portfolio assets (defined as all assets minus intangible assets, property used by the institution in conducting its business and liquid assets equal to 10% of total assets). Certain assets are subject to a percentage limitation of 20% of portfolio assets. In addition, savings associations may include shares of stock of the FHLBs, FNMA and FHLMC as qualifying QTIs. The method for measuring compliance with the QTL test requires an institution to be in compliance nine out of every 12 months. As of December 31, 2006, the Bank was in compliance with its QTL requirement with 73% of its assets invested in QTIs.

Federal Home Loan Bank System. The Bank is a member of the FHLB of Pittsburgh, one of 12 regional FHLBs that administer the home financing credit function of savings associations. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the Board of Directors of the FHLB.

As a member, the Bank is required to purchase and maintain an investment in the capital stock of the FHLB of Pittsburgh in an amount equal to 4.55% of its advances outstanding from the FHLB plus 0.55% of its unused borrowing capacity. At December 31, 2006, the Bank had $7.1 million in FHLB stock, which was in compliance with this requirement.

Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts) and non-personal time deposits. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy the liquidity requirements that are imposed by the OTS. At December 31, 2006, the Bank’s total transaction accounts required a reserve level of $251,000 which was offset by the Bank’s vault cash on hand and cash on deposit at the Federal Reserve Bank of Philadelphia.

Savings associations have authority to borrow from the Federal Reserve Bank “discount window,” but

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Federal Reserve policy generally requires savings associations to exhaust all other sources before borrowing from the Federal Reserve System. The Bank had no such borrowings at December 31, 2006.

Item 1A.                 Risk Factors

If the allowance for loan losses is inadequate, earnings will be reduced as the reserve is replenished. The establishment of the allowance for loan losses is based on a high degree of judgment and estimation. At December 31, 2006 the allowance was $2.9 million or 0.59% of the loans receivable balance of $487 million. Several factors could render the reserve inadequate, possibly over a short period of time: a single large loss, a severe and sustained economic downturn in the markets in which the Company’s loans are located, and a general decline in real estate values. These factors could produce charges to the allowance in excess of the amount provided. Replenishing the reserve would reduce earnings.

If the Company must raise the interest rates it pays to attract or retain its deposits, earnings will be reduced. The Company’s assets are primarily funded with deposits. The Company faces intense competition, both to retain current deposits and to attract new deposits that can be used to fund the Company’s growth. If the Company raises the interest rates it pays on a significant amount of these deposits, its interest expense could be substantially higher and earnings substantially lower.

Failure to attract or retain key individuals could severely affect the Company’s business objectives. Because the Company is a relatively small community bank, it operates with a small number of key people in key positions such as in executive administration, loan production, branch administration, and operations. Replacing these individuals, or expanding the Company’s business with additional human resources, requires the Company to compete for talent against companies that are much larger and possess much greater resources. Failure to attract and retain key individuals could negatively affect the Company’s business and earnings.

The Company operates in a highly regulated industry, and changes to regulations can require costly adjustments to the Company’s practices and procedures. In addition to the rule-making bodies under which most public companies operate, the Company’s primary subsidiary is a bank and operates under rules promulgated by governmental or quasi-governmental regulatory bodies that oversee lending, deposit-taking, and the operations of a bank. These agencies can issue rules which can impose costly compliance procedures upon a bank, can require a bank to modify or discontinue certain of its business practices, or impose other requirements, any of which can serve to reduce the Company’s earnings or reduce its franchise value.

The Company is vulnerable to interest rate risk. Most of the Company’s assets and liabilities are interest rate sensitive, and changes in the level of market interest rates or the shape of the yield curve can have a substantial negative impact on the Company’s value and earnings.

The Company’s ability to pay dividends on its common stock can be negatively affected by regulation of its bank subsidiary. The Company is a thrift holding company and its bank subsidiary is the primary source of cash with which it pays the cash dividend on its common stock. Regulations require a bank that is a subsidiary of a thrift holding company to file either a notification or an application with its primary regulator when it seeks to pay a dividend to its parent company. If in the judgment of its primary regulator, the Office of Thrift Supervision, the payment of a dividend by the Company’s bank subsidiary presents safety and soundness concerns, or is otherwise not permitted by regulation, the notification or application can be denied, thereby eliminating the primary source of cash with which the Company pays its dividend to its shareholders.

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