SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(mark one)
 
x   QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2008
 
or
 
   o   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
 
For the transition period from _______to_______
 
Commission File Number 000-51876
 
MUTUAL FEDERAL BANCORP, INC.
(Exact name of registrant specified in its charter)
 
Federal
(State or other jurisdiction of incorporation or organization)
 
33-1135091
(I.R.S. Employer Identification Number)
 
2212 West Cermak Road
Chicago, Illinois 60608
(Address of principal executive offices)

(773) 847-7747
(Registrant’s telephone number, including area code)
 
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
Accelerated filer  o
Non-accelerated filer    o   (Do not check if a smaller reporting company)
Smaller reporting company  x

Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:
 
Class
Outstanding as of November 1, 2008
Common Stock, $0.01 par value
3,470,317
 
 

 
MUTUAL FEDERAL BANCORP, INC.
 
FORM 10-Q
 
For the quarterly period ended September 30, 2008
 
TABLE OF CONTENTS
 
 
Page
 
 
1
2
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5
15
30
30
   
 
31
31
31
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31
   
SIGNATURES                                                                                                                              
32
   
 

 
 
PART I.  – FINANCIAL INFORMATION
 
Item 1 .   Financial Statements
 
MUTUAL FEDERAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (unaudited)
(Dollar amounts in thousands except share data)
 
 
   
September 30,
2008
   
December 31,
2007
 
ASSETS
           
Cash and cash equivalents
  $ 4,024     $ 2,264  
Trading securities
    2,174        
Securities available-for-sale
    11,015       16,345  
Loans, net of allowance for loan losses of $700 at
September 30, 2008; $290 at December 31, 2007
    53,406       53,047  
Federal Home Loan Bank stock, at cost
    610       610  
Premises and equipment, net
    882       250  
Accrued interest receivable
    343       360  
Other assets
    772       135  
Total assets
  $ 73,226     $ 73,011  
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Liabilities
               
Non-interest-bearing deposits
  $ 345     $ 331  
Interest-bearing deposits
    39,035       39,388  
Total deposits
    39,380       39,719  
Advance payments by borrowers for taxes
and insurance
    722       236  
Advances from the Federal Home Loan Bank
    6,000       5,000  
Accrued interest payable and other liabilities
    1,307       1,037  
Common stock in ESOP subject to contingent repurchase
obligation
    137       108  
Total liabilities
    47,546       46,100  
Commitments and contingencies
               
Stockholders’ equity
               
Preferred stock, $0.01 par value, 1,000,000 shares
authorized at September 30, 2008 and December 31, 2007
           
Common stock, $0.01 par value, 12,000,000 shares
authorized, 3,636,875 shares issued at September 30, 2008
and December 31, 2007
    36       36  
Additional paid-in capital
    9,914       9,738  
Treasury stock, at cost, 166,558 shares at September 30, 2008
and 108,696 at December 31, 2007
    (1,925 )     (1,286 )
Retained earnings
    18,469       19,077  
Reclassification of ESOP shares
    (137 )     (108 )
Unearned ESOP shares
    (725 )     (768 )
Accumulated other comprehensive income
    48       222  
Total stockholders’ equity
    25,680       26,911  
Total liabilities and stockholders’ equity
  $ 73,226     $ 73,011  
 
 
 

 
See accompanying notes to unaudited consolidated financial statements.
 
 
MUTUAL FEDERAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME (LOSS) (unaudited)
(Dollar amounts in thousands except share data)
 

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2008
   
2007
   
2008
   
2007
 
Interest and dividend income
                       
Loans, including fees
  $ 829     $ 899     $ 2,462     $ 2,611  
Securities
    156       208       518       643  
Interest earning deposits
    11       10       42       27  
Federal Home Loan Bank stock dividends
          5             12  
Total interest and dividend income
    996       1,122       3,022       3,293  
                                 
Interest expense
                               
Deposits
    229       289       751       874  
Advances from Federal Home Loan Bank
    59       38       176       98  
        Total interest expense
    288       327       927       972  
Net interest income
    708       795       2,095       2,321  
Provision for loan losses
    285             553       10  
Net interest income after provision for loan losses
    423       795       1,542       2,311  
                                 
Non-interest income
                               
Gain on sale of securities
                152        
Impairment charge on securities available-for-sale
    (351 )           (382 )      
Changes in fair value of trading securities
    (147 )           (294 )      
Other income
    17       13       39       35  
Total non-interest income
    (481 )     13       (485 )     35  
                                 
Non-interest expense
                               
Compensation and benefits
    375       336       1,122       1,006  
Occupancy and equipment
    36       38       122       120  
Data processing
    34       26       85       81  
Professional fees
    74       125       285       386  
Other expense
    88       74       234       219  
Total non-interest expense
    607       599       1,848       1,812  
                                 
Income (loss) before income taxes
    (665 )     209       (791 )     534  
Income tax (benefit) expense
    (244 )     86       (282 )     216  
Net income (loss)
  $ (421 )   $ 123     $ (509 )   $ 318  
                                 
Earnings (loss) per share (basic and diluted)
  $ (0.12 )   $ 0.03     $ (0.15 )   $ 0.09  
                                 
Total comprehensive income (loss)
  $ (423 )   $ 238     $ (683 )   $ 367  

 

 
See accompanying notes to unaudited consolidated financial statements.
 
 
 
MUTUAL FEDERAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited)
(Dollar amounts in thousands)
 
   
Common
Stock
   
Additional Paid-in Capital
   
Treasury Stock
   
Retained Earnings
   
Amount Reclassified on ESOP Shares
   
Unearned ESOP Shares
   
Accumulated Other Comprehensive Income/(Loss)
   
Total
 
Balance at January 1, 2007
  $ 36     $ 10,175     $     $ 18,782     $ (66 )   $ (827 )   $ 133     $ 28,233  
 
Comprehensive income:
                                                               
Net income
                      318                         318  
Change in net unrealized gain on securities available-for-sale, net of taxes and reclassification adjustments
                                        49       49  
 
Total comprehensive income
                                                            367  
 
Treasury stock purchases, 83,444 shares at cost
                (1,106 )                             (1,106 )
MRP share grants, 52,748 shares at cost
          (699 )     699                                
MRP shares earned
          108                                     108  
Stock option shares earned
          74                                     74  
Adjustment to fair value of common stock in ESOP subject to contingent repurchase obligation of ESOP shares
                            (36 )                 (36 )
ESOP shares committed to be released
          14                         44             58  
Balance at September 30, 2007
  $ 36     $ 9,672     $ (407 )   $ 19,100     $ (102 )   $ (783 )   $ 182     $ 27,698  
 
 

 
See accompanying notes to unaudited consolidated financial statements.
 
 
 
 
   
Common
Stock
   
Additional Paid-in Capital
   
Treasury Stock
   
Retained
Earnings
   
Amount Reclassified on ESOP Shares
   
Unearned ESOP Shares
   
Accumulated
Other
Comprehensive
Income/(Loss)
   
Total
 
Balance at January 1, 2008
  $ 36     $ 9,738     $ (1,286 )   $ 19,077     $ (108 )   $ (768 )   $ 222     $ 26,911  
 
Comprehensive income:
                                                               
Net loss
                      (509 )                       (509 )
Change in net unrealized gain (loss) on securities available-for-sale, net of taxes and reclassification adjustments
                                        (174 )     (174 )
 
Total comprehensive income (loss)
                                                            (683 )
 
Dividends paid
                      (114 )                       (114 )
Treasury stock purchases, 60,000 shares at cost
                (664 )                             (664 )
MRP share grants, 2,138 shares at cost
          (25 )     25                                
MRP shares earned
          117             5                         122  
Stock option shares earned
          80                                     80  
Adjustment to fair value of common stock in ESOP subject to contingent repurchase obligation of ESOP shares
                            (29 )                 (29 )
ESOP shares committed to be released
          4             10             43             57  
Balance at September 30, 2008
  $ 36     $ 9,914     $ (1,925 )   $ 18,469     $ (137 )   $ (725 )   $ 48     $ 25,680  
 
 

 
See accompanying notes to unaudited consolidated financial statements.
 
 
 
MUTUAL FEDERAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(Dollar amounts in thousands)
 
   
Nine Months Ended
September 30,
 
   
2008
   
2007
 
Cash flows from operating activities
           
Net income (loss)
  $ (509 )   $ 318  
Adjustments to reconcile net income to net cash
from operating activities
               
Provision for loan losses
    553       10  
Depreciation
    38       44  
Net amortization of securities
    10       20  
Dividends reinvested on securities
    (46 )     (89 )
Gain on sale of securities
    (152 )      
Impairment charge on securities available-for-sale
    382        
Changes in fair value of trading securities 
    294        
ESOP expense
    57       58  
MRP expense
    122       108  
Option expense
    80       74  
Increase in accrued interest receivable and other assets
    (620 )     (175 )
Increase in accrued interest payable and other liabilities
    336       726  
Net cash provided by operating activities
    545       1,094  
                 
Cash flows from investing activities
               
Activity in securities available-for-sale:
               
Proceeds from maturities, calls, and principal repayments
    2,909       2,832  
Proceeds from sales
    160        
Purchases
    (641 )      
Purchase of FHLB stock
          (110 )
Loan originations and payments, net
    (912 )     (1,528 )
Proceeds from sale of real estate owned, acquired through foreclosure
          222  
Additions to premises and equipment
    (670 )     (16 )
Net cash provided by investing activities
    846       1,400  
                 
Cash flows from financing activities
               
Net increase (decrease) in deposits
    (339 )     (2,471 )
Net increase in advance payments by borrowers for taxes and insurance
    486       306  
Advances from the Federal Home Loan Bank
    4,000       4,500  
Repayment of advances from the Federal Home Loan Bank
    (3,000 )     (3,500 )
Dividends paid
    (114 )      
Purchases of treasury stock
    (664 )     (1,106 )
Net cash provided by (used in) financing activities
    369       (2,271 )
Net increase in cash and cash equivalents
    1,760       223  
Cash and cash equivalents at beginning of period
    2,264       2,268  
Cash and cash equivalents at end of period                                                                                           
  $ 4,024     $ 2,491  
 
 

 
See accompanying notes to unaudited consolidated financial statements.
 
 
 
 
   
Nine Months Ended
September 30,
 
   
2008
   
2007
 
Supplemental disclosure of cash flow information
           
Adoption of fair value option
           
  Securities transferred from available-for-sale to trading
  $ 2,423        
Loans transferred to real estate owned…………………………………….
        $ 222  
Cash paid during the year for:
               
Interest
  $ 950     $ 926  
Income taxes
    263       81  
 
 

 
See accompanying notes to unaudited consolidated financial statements.

 
Note 1 – Basis of Presentation
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with instructions to Form 10-Q (as applicable to smaller reporting companies) and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  In the opinion of management, all adjustments consisting of normal recurring accruals necessary for a fair presentation have been included.  The results of operations and other data for the three months and the nine months ended September 30, 2008, are not necessarily indicative of results that may be expected for the entire fiscal year ended December 31, 2008.
 
The consolidated financial statements include Mutual Federal Bancorp, Inc. (the “Company”), and its wholly owned subsidiary Mutual Federal Savings and Loan Association of Chicago and its wholly owned subsidiary, EMEFES Service Corporation, together referred to as “the Bank.”  Intercompany transactions and balances are eliminated in consolidation.  As of September 30, 2008, Mutual Federal Bancorp, MHC (the “MHC”) was the majority (73%) stockholder of the Company.  The MHC is owned by the depositors of the Bank.  The financial statements included in this Form 10-Q do not include the transactions and balances of the MHC.  EMEFES Service Corporation is an insurance agency that sells insurance products to the Bank’s customers.  The insurance products are underwritten and provided by a third party.
 
The Bank provides financial services through its office in Chicago.  Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage loans and loans on deposit accounts.  Substantially all loans are secured by specific items of collateral, including one- to four-family and multifamily residential real estate, and deposit accounts.  The Company does not originate or purchase nontraditional loans such as interest-only, negative amortization, or payment option ARMS.  The Company does not originate or purchase sub-prime or Alt-A loans. There are no significant concentrations of loans to any one customer.  However, the customers’ ability to repay their loans is dependent on the real estate and general economic conditions in the Chicago area.
 
Note 2 – Capital Resources
 
The Bank is subject to regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a material impact on the Bank’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated for regulatory accounting purposes.  The Bank’s 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 Bank to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets and of tangible capital to average assets.  As of September 30, 2008, the Bank met the capital adequacy requirements to which it is subject.  The Bank’s tangible capital ratio at September 30, 2008 was 31.09%.  The Tier 1 capital ratio was 31.09%, the Tier 1 risk-based capital ratio was 51.92%, and the total risk-based capital ratio was 52.73%.
 
The most recent notification from the federal banking agencies categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action.  To be well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios.  There are no conditions or events since that notification that have changed the Bank’s category.
 
 

Note 2 – Capital Resources (continued)
 
On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 (EESA), which provides the U. S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets.  One of the provisions resulting from the Act is the Treasury Capital Purchase Program (CPP), which provides direct equity investment of perpetual preferred stock by the Treasury in qualified financial institutions.  The program is voluntary and requires an institution to comply with a number of restrictions and provisions, including limits on executive compensation, stock redemptions and declaration of dividends.  Applications must be submitted by November 14, 2008 and are subject to approval by the Treasury.  The CPP provides for a minimum investment of  1% of Risk-Weighted Assets, with a maximum investment equal to the lesser of 3 percent of Total Risk-Weighted Assets or $25 billion.  The perpetual preferred stock investment will have a dividend rate of 5% per year, until the fifth anniversary of the Treasury investment, and a dividend of 9%, thereafter.  The CPP also requires the Treasury to receive warrants for common stock equal to 15% of the capital invested by the Treasury.  Participation in the program is not automatic and subject to approval by the Treasury.  After giving consideration to, among other things, the Company’s continued sound capital position, with tangible and Tier 1 core capital ratios of 31.09%, the Company has determined not to apply for participation in the Capital Purchase Program presently being implemented by the U. S. Treasury.

Note 3 – Commitments
 
At September 30, 2008, the Bank had no outstanding commitments to make loans.  At December 31, 2007, the Bank had outstanding commitments to make loans of $205,000.
 
Note 4 – Fair Value Option and Fair Value Measurements
 
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements .  This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset.  The standard was effective for fiscal years beginning after November 15, 2007.  The impact of adoption was not material.  In February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of FASB Statement No. 157 .  This FSP delays the effective date of FAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.  The impact of adoption was not material.

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities.   The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities.  The new standard was effective for the Company on January 1, 2008.  The Company elected the fair value option for various mutual funds included in trading securities as of January 1, 2008.  The impact of adoption was not material, as the Company recognized an impairment charge at December 31, 2007, resulting in the mutual funds being carried at fair value.
 
 

Note 5 – Fair Value
 
Fair Value Option
 
The Company has elected the fair value option for various mutual funds in order to make them more readily available for liquidity management.  The mutual funds are the only assets being designated as trading assets.  The Company’s investments in Federal Home Loan Mortgage Corporation preferred stock, and all debt securities, will continue to be held as available-for-sale, carried at fair value with unrealized gains and losses recorded through accumulated other comprehensive income.  Unrealized losses on securities held as available-for-sale that management considers other-than-temporary are recognized through income as write downs of the cost basis of the securities.
 
Fair Value Measurement.
 
Statement 157 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. Statement 157 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. The standard describes three levels of inputs that may be used to measure fair value:
 
Level 1: Quoted prices (unadjusted) of identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
 
Level 2: Significant other 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.
 
Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
 
The Company determines the fair values of trading securities and securities available-for-sale by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).  The Company determines the fair values of impaired loans by obtaining current appraisals of the collateral real estate properties (Level 2 or 3 inputs).
 
         
Fair Value Measurements at September 30, 2008 Using
 
   
September 30, 2008
   
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
         
Level 1
   
Level 2
   
Level 3
 
Trading securities
  $ 2,174     $ 2,174     $     $  
Securities available-for-sale
    11,015       20       10,995        
    $ 13,189     $ 2,194     $ 10,995     $  
 
 

Note 5 – Fair Value (continued)
 
Dividend income earned on trading securities was reinvested and used to purchase additional shares through May 31, 2008.  The Company discontinued reinvesting dividends in these securities as of June 1, 2008.  Changes in share price are recorded through the income statement as changes in fair value of trading securities.  During the nine months ended September 30, 2008, the Company recognized an unrealized loss of $294,000 on changes in fair value of trading securities.  Restrictions on redemption of these securities have been imposed by the manager of these funds, limiting cash redemptions to $250,000 per fund (there are three funds) per quarter.  The Company has not requested any redemptions, and although it currently does not anticipate  a need to request redemptions, it may do so in the future.
 
For the nine months ended September 30, 2008, the Company also recognized a $382,000 loss for other-than-temporary impairment of FHLMC preferred stock held as available-for-sale, because the fair value of the preferred stock has declined substantially due to the announcement on September 7, 2008, that its regulatory agency, the Federal Housing Finance Agency (“FHFA”), was appointed as conservator, and because dividends on previously issued preferred shares have been suspended.  We are uncertain as to what impact these actions will have on the future value of this security.  At September 30, 2008, we held 10,000 preferred shares valued at $2.00 per share.
 
         
Fair Value Measurements at September 30, 2008 Using
 
   
September 30, 2008
   
Quoted Prices in Active Markets for Identical Assets
   
Significant Other Observable Inputs
   
Significant Unobservable Inputs
 
         
Level 1
   
Level 2
   
Level 3
 
Impaired loans
  $ 1,813     $     $ 1,813     $  

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $2.2 million, with specific valuation allowances of $345,000.
 
 
Note 6 – Stock Based Compensation
 
On January 16, 2007, the Company awarded 52,748 shares of common stock, with a fair value of $14.41 per share, to the Company’s officers and directors under its 2006 Management Recognition and Retention Plan.  The Company also awarded 131,871 options to purchase the Company’s common stock at a strike price of $14.41 per share, to the Company’s officers and directors under its 2006 Stock Option Plan.
 
On March 18, 2008, the Company awarded 2,138 shares of common stock, with a fair value of $11.35 per share, to a director of the Company under its 2006 Management Recognition and Retention Plan.  The Company also awarded to this director options to purchase 5,346 shares of the Company’s common stock at a strike price of $11.35 per share under its 2006 Stock Option Plan.
 
The awards vest over a five year period.  Total compensation cost that has been charged against income for those plans for the nine months ended September 30, 2008 and 2007, was $202,000 and $182,000, respectively.  The total income tax benefits were estimated at $47,000 and $53,000, respectively.
 
Stock Option Plan
 
The Company’s 2006 Stock Option Plan, which is shareholder-approved, permits the grant of stock options to its officers, directors and employees for up to an aggregate 178,206 shares of common stock.  The Company believes that such awards better align the interests of its employees with those of its shareholders.  Option awards are granted with an exercise price that is no less than the market price of the Company’s common stock at the date of grant, have vesting periods of five years, and have ten year contractual terms.  The Company anticipates purchasing shares to satisfy share option exercises.
 
The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below.  Since the Company stock has only been trading since April 6, 2006, the Company has used the price volatility of similar entities to estimate volatility.  The Company has no historical data on which to base forfeiture estimates, and has assumed no forfeitures.  The expected term of options granted is based on the calculation for “plain vanilla options” permitted by Staff Accounting Bulletin No. 107, and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.
 
The fair value of options granted during 2008 and 2007 were determined using the following weighted-average assumptions as of grant date:
 

   
2008
   
2007
 
Risk-free interest rate
    3.47 %     4.50 %
Expected term
 
6.50 years
 
6.50 years
Expected stock price volatility
    13.51 %     9.40 %
Dividend yield
    0.00 %     0.00 %
 
 
Note 6 – Stock Based Compensation (continued)
 
A summary of the activity in the stock option plan for 2008 and 2007 follows:
 
 
   
Shares
   
Weighed Average Exercise Price
   
Weighted Average Remaining Contractual Term
   
Aggregate Intrinsic Value
 
                                 
Outstanding at January 1, 2008
    131,871     $ 14.41       9.0     $  
Granted
    5,346       11.35       10.0        
Exercised
                       
Forfeited or expired
                       
Outstanding at September 30, 2008
    137,217     $ 14.29       8.3     $  
                                 
Exercisable at September 30, 2008
    26,374     $ 14.41             $  
                                 
Outstanding at January 1, 2007
        $           $  
Granted
    131,871       14.41       10.0        
Exercised
                       
Forfeited or expired
                       
Outstanding at September 30, 2007
    131,871     $ 14.41       9.3     $  
 
There were no option exercises or forfeitures for the nine months ended September 30, 2008 and 2007.  The weighted average fair value of options granted in 2008 and 2007 were $2.83 and $3.96, respectively.  As of September 30, 2008, there was $357,000 of total unrecognized compensation cost related to non-vested stock options granted under the Plan.  The cost is expected to be recognized over a weighted-average remaining period of 3.3 years.  Options outstanding at September 30, 2008 and 2007 had an intrinsic value of zero as these options have a strike price that exceeds the stock price at those dates.
 
Stock Award Plan
 
The Company’s 2006 Management Recognition and Retention Plan (“MRP”), which is shareholder approved, permits awards of up to an aggregate 71,282 shares of the Company’s common stock to officers, directors and employees.  Compensation expense is recognized over the vesting period of the shares based on the market value of the shares at issue date.
 
A summary of changes in the Company’s non-vested shares for the nine months ended September 30, 2008 and 2007, follows:
 
 
Note 6 – Stock Based Compensation (continued)
 
   
Shares
   
Weighted Average Grant Price
   
Weighed Average Grant-Date Fair Value
 
                   
Non-vested at January 1, 2008
    52,748     $ 14.41     $ 760,000  
Granted
    2,138       11.35       24,000  
Vested
    (10,553 )     14.41       (152,000 )
Forfeited
                 
Non-vested at September 30, 2008
    44,333     $ 14.26     $ 632,000  
                         
Non-vested at January 1, 2007
        $     $  
Granted
    52,748       14.41       760,000  
Vested
                 
Forfeited
                 
Non-vested at September 30, 2007
    52,748     $ 14.41     $ 760,000  
 
As of September 30, 2008, there was $522,000 of total unrecognized compensation cost related to non-vested shares granted under the Plan.  The cost is expected to be recognized over a weighted-average remaining period of 3.3 years.

Note 7 – Earnings Per Share
 
Basic earnings per share are computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period.  Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company.  Both basic and fully diluted weighted average shares outstanding for the three months and the nine months ended September 30, 2008, are 3,397,097 and 3,428,679, respectively.  Both basic and fully diluted weighted average shares outstanding for the three months and the nine months ended September 30, 2007, are 3,527,271 and 3,544,315, respectively.  During the nine months ended September 30, 2008 and 2007, the average fair value of the Company’s common stock was less than the exercise price, and the stock option awards had no dilutive effect on earnings per share.
 
The factors used in the earnings per share computation for the three months and the nine months ended September 30, 2008 and 2007, follow:
 
 
Note 7 – Earnings Per Share (continued)
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2008
   
2007
   
2008
   
2007
 
Basic
                       
Net income (loss)
  $ (421 )   $ 123     $ (509 )   $ 318  
                                 
Weighted average common shares outstanding
    3,470,317       3,606,314       3,503,334       3,624,829  
Less: average unallocated ESOP shares
    (73,220 )     (79,043 )     (74,655 )     (80,514 )
                                 
Average shares
    3,397,097       3,527,271       3,428,679       3,544,315  
                                 
Basic earnings (loss) per common share
  $ (0.12 )   $ 0.03     $ (0.15 )   $ 0.09  
                                 
Diluted
                               
Net income (loss)
  $ (421 )   $ 123     $ (509 )   $ 318  
                                 
Weighted average common shares outstanding for basic earnings per common share
    3,397,097       3,527,271       3,428,679       3,544,315  
Add: dilutive effects of assumed exercises of stock options
                       
                                 
Average shares and dilutive potential common shares
    3,397,097       3,527,271       3,428,679       3,544,315  
                                 
Diluted earnings (loss) per common share
  $ (0.12 )   $ 0.03     $ (0.15 )   $ 0.09  
                                 
 
 
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations .
 
  General
 
This discussion and analysis reflects our consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial condition and results of operations.  You should read the information in this section in conjunction with our audited consolidated financial statements for the years ended December 31, 2007 and 2006, which are included in Form 10-KSB filed with the Securities and Exchange Commission on March 21, 2008.
 
  Forward-Looking Information
 
This report contains forward-looking statements, which can be identified by the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions.  These forward-looking statements include statements of our goals, intentions and expectations; statements regarding our business plans and prospects and growth and operating strategies; statements regarding the asset quality of our loan and investment portfolios; and estimates of our risks and future costs and benefits.  These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following important factors that could affect the actual outcome of future events:
 
·  
general economic conditions, either nationally or in our market area, continue to deteriorate or become worse than expected;
 
·  
adverse changes or continued volatility and disruption in the securities and credit markets;
 
·  
deterioration in asset quality due to adverse changes in the residential real estate market;
 
·  
inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;
 
·  
significantly increased competition among depository and other financial institutions;
 
·  
our ability to enter new markets successfully and take advantage of growth opportunities;
 
·  
our ability to successfully implement our business plan;
 
·  
legislative or regulatory changes that adversely affect our business;
 
·  
changes in consumer spending, borrowing and savings habits;
 
·  
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board and the PCAOB; and
 
·  
changes in our organization, compensation and benefit plans.
 
These risks and uncertainties should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements.  Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.
 
 
  Overview
 
Our results of operations depend primarily on our net interest income.  Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, U.S. government and agency securities, mortgage-backed securities and other interest earning assets (primarily cash and cash equivalents), and the interest we pay on our interest-bearing liabilities, consisting of savings accounts, time deposits, and advances from the Federal Home Loan Bank.  Our results of operations are also affected by our provisions for loan losses, non-interest income and non-interest expense.  Non-interest income consists primarily of miscellaneous fees and charges on loan and deposit accounts, gains and losses on securities and related impairment charges, and changes in the fair value of trading securities.  Non-interest expense currently consists primarily of salaries and employee benefits, occupancy, data processing, professional fees, and other operating expenses.  Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.
 
  Critical Accounting Policies
 
We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies.  We consider our critical accounting policies to be those related to our allowance for loan losses.
 
The allowance for loan losses is the estimated amount considered necessary to cover probable incurred losses in the loan portfolio at the balance sheet date.  The allowance is established through a provision for loan losses that is charged against income.  In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of our most critical.
 
Management performs a quarterly evaluation of the adequacy of the allowance for loan losses.  We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors.  This evaluation is inherently subjective as it requires material estimates that may be subject to significant change.
 
The analysis has two components: specific and general allocations.  Specific allocations are made for loans that are determined to be impaired.  Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent, the fair value of the collateral adjusted for market conditions and selling expenses.  The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history.  We also analyze historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations.  This analysis establishes factors that are applied to the loan groups to determine the amount of the general allowance for loan losses.  Actual loan losses may be significantly more than the allowances we have established which could have a material negative effect on our financial results.
 
Recent Events
 
During the past year, the banking industry has been under significant stress due to declining real estate values, asset impairment, eroding capital ratios and tightening liquidity.  The impact of these trends are briefly discussed below and more fully discussed in the quarterly and nine-month operating results comparisons that follow.
 
 
 
Loan Quality : As discussed in greater detail in the Management Discussion and Analysis, the Company has seen an increase in non-performing loans. During the nine months ended September 30, 2008, the Company recorded charge-offs totaling $143,000.  The combination of increased charge-offs and non-performing loans in conjunction with downturns in the economy and real estate environment has resulted in an increase in our allowance for loan losses.  At September 30, 2008, the allowance to loan losses was 1.29% of loans receivable as compared to 0.54% at December 31, 2007.  The increase in non-performing loans has been a result of economic and real estate softening and not a result of changes in underwriting standards.  As previously mentioned, the Company does not originate or purchase nontraditional loans, such as interest-only, negative amortization, or payment option ARM loans, and the Company does not originate or purchase sub-prime or Alt-A loans.  Management continues to enforce strict underwriting standards which generally require loan to value ratios not to exceed 80%.
 
Securities Portfolio: Our securities portfolio primarily consists of FHLB bonds and FNMA, FHLMC, and GNMA guaranteed mortgage backed securities.  At September 30, 2008, total unrealized gain on our security portfolio was approximately $48,000.  As further discussed in this document, during the nine months ended September 30, 2008, the Company recorded a gain of $152,000 on the sale of FHLMC common stock, an impairment charge of $382,000 due to other than temporary declines in fair value of FHLMC preferred stock, and a change in fair value of mutual funds (trading securities) resulting in an unrealized loss of $294,000.  Restrictions on redemption of these mutual funds have been imposed by the manager of these funds, limiting cash redemptions to $250,000 per fun d (there are three funds) per quarter.  The Company has not requested any redemptions, and although it currently does not anticipate a need to request redemptions, it may do so in the future. As of September 30, 2008, management has not identified any additional securities that we believe would be classified as other than temporarily impaired.
 
Capital Levels :  As previously detailed in Note 2 - Capital Resources, the Bank's capital levels exceed regulatory capital requirements.  As of September 30, 2008, the Bank is categorized as well capitalized under the regulatory framework for prompt corrective action. After giving consideration to, among other things, the Company’s continued sound capital position, with tangible and Tier 1 core capital ratios of 31.09%, the Company has determined not to apply for participation in the Capital Purchase Program presently being implemented by the U. S. Treasury.
 
Liquidity:   In recent months, certain banking institutions have encountered liquidity constraints.  As of the date of this filing, the Company has not encountered similar liquidity constraints. However, we actively monitor our liquidity and, if necessary, we presently have additional borrowing capacity with the Federal Home Loan Bank of Chicago that we could use to satisfy liquidity demands.  Please see the Liquidity section of Management’s Discussion and Analysis for additional details.
 
The Federal Depository Insurance Corporation (FDIC) has issued a proposed rule to raise current deposit insurance assessment rates uniformly for all financial institutions for the first quarter of 2009.  The proposed rule also provides for a new means of calculating deposit insurance beginning during the second quarter of 2009, and includes an assessment of the financial institution’s risk profile as determined by the FDIC.  Although final rules have not been published, the Company anticipates that its cost of insuring deposits will increase in 2009, when and if the final rules are adopted.
 
 
 
  Comparison of Financial Condition at September 30, 2008 and December 31, 2007
 
Our total assets increased $215,000, or 0.3%, to $73.2 million at September 30, 2008, compared to $73.0 million at December 31, 2007.  Loans receivable increased $359,000, or 0.7%, to $53.4 million at September 30, 2008, from $53.0 million at December 31, 2007, reflecting an decrease of $872,000, or 2.6%, in one-to-four family residential mortgage loans and an increase of $1.6 million, or 8.2%, in multi-family residential mortgage loans during the period, offset by a net increase of $410,000 in the allowance for loan losses.
 
Premises and equipment increased $632,000, to $882,000 at September 30, 2008, from $250,000 at December 31, 2007, primarily due to the acquisition of property adjacent to the current bank building for $660,000, for the purpose of adding a drive-up facility for added customer convenience.  Other assets increased $637,000, to $772,000 at September 30, 2008, from $135,000 at December 31, 2007, primarily due to increases in deferred income tax assets resulting from temporary differences in the recording of loan and security losses for book and income tax purposes.
 
Total deposits decreased $339,000, or 0.9%, to $39.4 million at September 30, 2008, from $39.7 million at December 31, 2007.  Mortgage escrow accounts increased by $486,000, or 205.9% during this period.  The Company borrowed an additional $4.0 million from the Federal Home Loan Bank in order to refinance $3.0 million in maturing advances, lock in lower interest rates, and fund loans.
 
Stockholders’ equity decreased $1.2 million, to $25.7 million at September 30, 2008,  from $26.9 million at December 31, 2007.  The decrease reflects a net loss of $509,000 for the nine months ended September 30, 2008, a $174,000 decrease in accumulated other comprehensive income from net unrealized gains on securities available-for-sale (a $152,000 in gain from the sale of FHLMC common stock before a conservator was appointed for FHLMC, was realized through earnings during the period), and $664,000 in repurchases of the Company’s common stock.  The Company paid dividends of $114,000 to minority shareholders.  Mutual Federal Bancorp, MHC, the majority shareholder, waived receipt of its dividends.  Stockholders’ equity also reflects a $259,000 increase from recognition of stock benefits earned under the Company’s Employee Stock Ownership Plan, Management Recognition and Retention Plan, and Stock Option Plan, offset by a $29,000 reclassification due to the commitment for release and change in fair value of common stock in the ESOP subject to the contingent repurchase obligation of ESOP shares.
 
  Comparison of Operating Results for the Three Months Ended September 30, 2008 and 2007
 
General .  The Company had a net loss of $421,000 for the three months ended September 30, 2008, compared to net income of $123,000 for the three months ended September 30, 2007.  The primary reasons for the decrease were a $351,000 charge for other-than-temporary impairment of FHLMC preferred stock and a $147,000 write down in the fair value of trading securities. Also contributing to the decrease was an $87,000, or 10.9% decrease in net interest income, to $708,000 for the three months ended September 30, 2008, from $795,000 for the three months ended September 30, 2007, and the increased provision for loan losses of $285,000 for the three months ended September 30, 2008, from none in the third quarter of 2007.
 
Compensation and benefits expense increased $39,000, or 11.6%, to $375,000 for the three months ended September 30, 2008, from $336,000 for the three months ended September 30, 2007, primarily due to new employees, ordinary - course salary increases, a $16,000 increase in health insurance costs, and a $2,000 increase in the amortization of stock awards and stock option expense.  The increase in compensation and benefits expense was offset by a $51,000, or 40.8% decrease in professional fees, to $74,000 for the current period, from $125,000 for the same period last year.  The decrease in professional fees was due primarily to legal, accounting and consulting fees in 2007 which were not repeated in 2008.
 
 
 
The annualized return on average assets was (2.27)% for the three months ended September 30, 2008, compared to 0.67% for the same period last year, and the annualized return on equity was (6.48)%  and 1.77%, respectively, for these two periods.
 
Interest Income .  Interest and dividend income decreased $126,000, or 11.2%, to $996,000 for the three months ended September 30, 2008, compared to $1.1 million for the three months ended September 30, 2007. The decrease resulted primarily from decrease of 68 basis points in the average yield on interest earning assets, to 5.61% in 2008, from 6.29% in 2007.  In addition, it is the Company’s policy to reserve all accrued interest on loans 90 days or more delinquent, which resulted in a $38,000 reduction in interest income on loans during the third quarter of 2008, compared to a $38,000 increase during the third quarter of 2007.
 
Interest income and fees from loans receivable decreased $70,000, or 7.8%, to $829,000 for the three months ended September 30, 2008, from $899,000 for the three months ended September 30, 2007.  The primary reason was the increase in the reserve for uncollected interest.  The decrease was partially offset by a $1.4 million, or 2.7%, increase in the average balance of loans receivable, to $54.2 million in the third quarter of 2008, compared to $52.8 million in the third quarter of 2007.  There was a net decrease of 69 basis points in the average yield on loans receivable, to 6.12% in 2008, from 6.81% in 2007.
 
Interest and dividend income from securities, FHLB stock, and interest-earning deposits decreased $56,000, or 25.1%, to $167,000 for the three months ended September 30, 2008, from $223,000 for the three months ended September 30, 2007.  The primary reasons for the decrease were a $1.6 million, or 9.1%, decrease in the average balances of  securities, FHLB stock, and interest-earning deposits, to $16.9 million in 2008, from $18.5 million in 2007, as well as an 85 basis point decrease in average yield to 3.96% in 2008, from 4.81% in 2007.  In addition, the FHLB of Chicago has suspended its dividend, which amounted to $5,000 of income during the third quarter of 2007, and the Federal Home Loan Mortgage Corporation suspended the dividend on its common and preferred stocks, resulting in a reduction of $11,000 in dividend income from this source during the third quarter of 2008, as compared to the third quarter of 2007.
 
 Interest Expense .  Interest expense on deposits decreased $60,000, or 20.8%, to $229,000 for the three months ended September 30, 2008, from $289,000 for the three months ended September 30, 2007.  The decrease in interest expense was due primarily to a $1.5 million decrease in the average balance of interest bearing deposits.  The average rate paid on deposits decreased 51 basis points, to 2.32% for the quarter ended September 30, 2008, from 2.83% for the quarter ended September 30, 2007.  Interest expense on certificates of deposit decreased $58,000, or 25.6%, to $169,000 in 2008, from $227,000 in 2007, because of a $827,000 decrease in the average balance of certificates of deposit, and a decrease in the average rate paid on certificates of deposit of 97 basis points, to 3.32% in 2008, from 4.29% in 2007.
 
Interest expense on FHLB advances increased $21,000, to $59,000 for the three months ended September 30, 2008, compared to $38,000 for the three months ended September 30, 2007.  The average balance of FHLB advances increased $3.4 million, to $6.3 million for the third quarter of 2008, from $2.9 million for the third quarter of 2007. The average rate paid on advances decreased 157 basis points, to 3.75% in 2008, from 5.32% in 2007.  The overall average cost of funds decreased 47 basis points, to 2.52% in 2008, from 2.99% in 2007.
 
Net Interest Income .  Net interest income decreased $87,000, or 10.9%, to $708,000 for the three months ended September 30, 2008, from $795,000 for the same quarter last year.  Our net interest margin decreased 47 basis points, to 3.99% in 2008, from 4.46% in 2007.  A 68 basis point decrease in the average yield on interest-earning assets, to 5.61% in 2008, from 6.29% in 2007, and a decrease of $283,000 in the average balance of interest-earning assets, both contributed to interest income decreasing
 
by $126,000.  The average rate paid on interest-bearing liabilities decreased 47 basis points, to 2.52% in 2008, from 2.99% in 2007, and the average balance of interest-bearing liabilities increased $2.0 million, with interest expense decreasing by $39,000.  The interest rate spread between interest earning assets and interest bearing liabilities decreased 21 basis points, to 3.09% in 2008, from 3.30% in 2007.
 
Provision for Loan Losses .  During the three months ended September 30, 2008, management made a $285,000 provision for losses on loans, based on its quarterly evaluation of the level of the allowance necessary to absorb probable incurred loan losses at September 30, 2008.  Management established $267,000 in specific allowances against $1.5 million of impaired loans, charged off $143,000 in realized losses against previously established specific reserves, and increased the general allowance for loan losses by $18,000.
 
  Management considers changes in delinquencies, changes in the composition and volume of loans, historical loan loss experience, general economic and real estate market conditions, as well as peer group data, when determining the level on the allowance for loan losses.  The increase in the general allowance resulted from increases in the factors used for delinquency trends, both in our portfolio and in the current economic environment, and declines in the value of real estate reflected in the current market.
 
During the three months ended September 30, 2008, non-performing (non-accrual) loans decreased $49,000, to $3.19 million, from $3.24 million at June 30, 2008.  Loans delinquent 60-89 days decreased  $743,000, to $1.4 million at September 30, 2008, compared to $2.1 million at June 30, 2008.  During this period, one- to four-family residential mortgage loans decreased $872,000, or 2.6%, and multi-family residential mortgage loans increased $1.6 million, or 8.2%.
 
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $2.2 million at September 30, 2008, with specific valuation allowances of $345,000, or 16.0% of the carrying amount.  All of the impaired loans were one- to four-family mortgage loans.
 
  At September 30, 2008, the allowance for loan losses, including specific allowances, was $700,000, or 1.29% of loans receivable, compared to $558,000, or 1.03% of loans receivable at June 30, 2008.  In a similar evaluation of the allowance for loan losses at September 30, 2007, management determined that there was no need for an additional loan loss provision for the three months then ended.
 
Non-interest Income .  Non-interest income decreased $494,000, to a loss of $481,000 for the three month period ended September 30, 2008, compared to $13,000 income for the three months ended September 30, 2007.  The Company recognized a $351,000 charge for other-than-temporary impairment of FHLMC preferred stock held as available-for-sale, because the fair value of the preferred stock has declined significantly since FHFA was appointed conservator for FHLMC, and we are unable to forecast a recovery.  The Company holds 10,000 shares of FHLMC preferred stock valued at $2.00 per share at September 30, 2008.
 
The Company also recognized a $147,000 fair value loss adjustment on various mutual funds carried as trading securities and accounted for under FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which was adopted for these mutual funds on January 1, 2008.
 
Non-interest Expense .  Non-interest expense increased $8,000, or 1.3%, to $607,000 for the three months ended September 30, 2008, from $599,000 for the same quarter last year, primarily as a result of increased compensation and employee benefits expense, partially offset by decreases in professional fees.  Compensation and employee benefits expense increased $39,000, or 11.6%, to $375,000 in 2008, from $336,000 in 2007, primarily due to new employees, ordinary - course salary increases, a $16,000 increase in health insurance costs, and a $2,000 increase in the amortization of stock awards and stock option expense.
 
Occupancy costs decreased $2,000, or 5.3%, to $36,000 in 2008, from $38,000 in 2007.  Data processing fees increased $8,000, or 30.8%, to $34,000, from $26,000 in 2007.  Professional fees, including legal, accounting and consulting fees, decreased $51,000, or 40.8%, to $74,000 in 2008, from $125,000 in 2007.  (Legal, accounting, and consulting expenses decreased $27,000, $19,000, and $5,000, respectively.)   Miscellaneous expenses increased $14,000, or 18.9%, to $88,000 for the third quarter of 2008, from $74,000 for the third quarter of 2007.
 
The Company’s ratio of non-interest expense to average assets increased to 3.28% in the third quarter of 2008, from 3.25% in 2007, and its efficiency ratio was 83.7% in 2008, compared to 74.1% in 2007.
 
Income Tax Expense .  The provision for income taxes decreased $330,000, to a benefit of $244,000 in 2008, from an expense of $86,000 in 2007, largely due to the $874,000 decrease in pre-tax income.  The effective tax rate for the quarter ended September 30, 2008, decreased to 36.7%, compared to 41.2% for this quarter last year.
 
  Average Balance Sheet
 
The following table sets forth average balance sheets, average annualized yields and costs, and certain other information for the three months ended September 30, 2008 and 2007.  No tax-equivalent yield adjustments were made, as their effects were not material.  All average balances are based on an average of daily balances.  Non-accrual loans are included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield.  The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
 
   
For the Three Months Ended September 30,
 
   
2008
   
2007
 
   
Average Outstanding Balance
   
Interest
   
Yield/Rate
   
Average Outstanding Balance
   
Interest
   
Yield/Rate
 
Interest-earning assets:
                                   
Loans
  $ 54,192     $ 829       6.12 %   $ 52,786     $ 899       6.81 %
Securities
    13,738       156       4.54       17,022       207       4.86  
Interest-earning deposits
    2,503       11       1.76       908       11       4.85  
Federal Home Loan Bank Stock
    610       -       0.00       610       5       3.28  
Total interest-earning assets
    71,043     $ 996       5.61 %     71,326     $ 1,122       6.29 %
Non-interest-earning assets
    2,999                       2,413                  
Total assets
  $ 74,042                     $ 73,739                  
Interest-Bearing Liabilities: (1)
                                               
Savings deposits
  $ 19,064     $ 60       1.26 %   $ 19,699     $ 62       1.26 %
Certificates of deposit
    20,342       169       3.32       21,169       227       4.29  
Total interest-bearing deposits
    39,406       229       2.32       40,868       289       2.83  
Federal Home Loan Bank advances
    6,293       59       3.75       2,859       38       5.32  
Total interest-bearing liabilities
    45,699       288       2.52 %     43,727       327       2.99 %
Non-interest-bearing liabilities
    2,346                       2,260                  
Total liabilities
    48,045                       45,987                  
Stockholders’ equity
    25,997                       27,752                  
Total liabilities and stockholders’ equity
  $ 74,042                     $ 73,739                  
Net interest income
          $ 708                     $ 795          
Net interest rate spread (2)
                    3.09 %                     3.30 %
Net interest-earning assets (3)
  $ 25,344                     $ 27,599                  
Net interest margin (4)
                    3.99 %                     4.46 %
Ratio of interest-earning assets to interest- bearing liabilities
                    155.46 %                     163.12 %
____________
(1)
Non-interest-bearing checking deposits are included in non-interest-bearing liabilities.
(2)
Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(3)
Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(4)
Net interest margin represents net interest income divided by average total interest-earning assets.
 
  Comparison of Operating Results for the Nine Months Ended September 30, 2008 and 2007
 
General .  The Company had a net loss of $509,000 for the nine months ended September 30, 2008, compared to net income of $318,000 for the nine months ended September 30, 2007.  The primary reasons for the decrease were a $382,000 charge for other-than-temporary impairment of FHLMC preferred stock, a $294,000 write down in the fair value of trading securities, partially offset by a $152,000 gain on the sale of FHLMC common stock prior to the appointment of a conservator for FHLMC, and the increased provision for loan losses, to $553,000 for the nine months ended September 30, 2008, from $10,000 in 2007.  The decrease also resulted from a $226,000, or 9.7% decrease in net
 
interest income, to $2.1 million for the nine months ended September 30, 2008, from $2.3 million for the nine months ended September 30, 2007.
 
Compensation and benefits expense increased $116,000, or 11.5%, to $1.1 million for the nine months ended September 30, 2008, from $1.0 million for the nine months ended September 30, 2007, primarily due to new employees, ordinary- course salary increases, a $54,000 increase in health insurance premiums, and a $14,000 increase in the amortization of stock awards and stock option expense.  The increase in compensation and benefits expense was partially offset by a $101,000, or 26.2% decrease in professional fees, to $285,000 for the current period, from $386,000 for the same period last year.  The decrease in professional fees was due primarily to legal, accounting and consulting fees in 2007 which were not repeated in 2008.
 
The annualized return on average assets was (0.92)% for the nine months ended September 30, 2008, compared to 0.57% for the same period last year, and the annualized return on equity was (2.55)%  and 1.51%, respectively, for these two periods.
 
Interest Income .  Interest and dividend income decreased $271,000, or 8.2%, to $3.0 million for the nine months ended September 30, 2008, compared to $3.3 million for the nine months ended September 30, 2007. The decrease resulted primarily from a decrease of 41 basis points in the average yield on interest earning assets, to 5.67% in 2008, from 6.08% in 2007.  In addition, it is the Company’s policy to reserve all accrued interest on loans 90 days or more delinquent, which resulted in a $135,000 reduction in interest income on loans during the first nine months of 2008, compared to a $23,000 increase during the first nine months of 2007.
 
Interest income and fees from loans receivable decreased $149,000, or 5.7%, to $2.5 million for the nine months ended September 30, 2008, from $2.6 million for the nine months ended September 30, 2007.  The primary reason was the increase in the reserve for uncollected interest.   There was a decrease of 39 basis points in the average yield on loans receivable, to 6.18% in 2008, from 6.57% in 2007.
 
Interest and dividend income from securities, FHLB stock, and interest-earning deposits decreased $122,000, or 17.9%, to $560,000 for the nine months ended September 30, 2008, from $682,000 for the nine months ended September 30, 2007.  The primary reasons for the decrease were a $210,000, or 1.1%,  decrease in average balances of securities, FHLB stock, and interest-earning deposits, to $19.0 million in 2008, from $19.2 million in 2007, as well as an 56 basis point decrease in average yield to 4.17% in 2008, from 4.73% in 2007.  In addition, the FHLB of Chicago has suspended its dividend, which amounted to $12,000 of income during the first nine months of 2007, and the Federal Home Loan Mortgage Corporation suspended the dividends on its common and preferred stock, resulting in a reduction of $15,000 in dividend income from this source during the first nine months of 2008.
 
 Interest Expense .  Interest expense on deposits decreased $123,000, or 14.1%, to $751,000 for the nine months ended September 30, 2008, from $874,000 for the nine months ended September 30, 2007.  The decrease in interest expense was due primarily to a $2.5 million decrease in the average balance of interest bearing deposits and to a decrease in the average rate paid on deposits of 24 basis points, to 2.54% for the nine months ended September 30, 2008, from 2.78% for the nine months ended September 30, 2007.  Interest expense on certificates of deposit decreased $112,000, or 16.3%, to $576,000 in 2008, from $688,000 in 2007, because of a $1.3 million decrease in the average balance of certificates of deposit, and a decrease in the average rate paid on certificates of deposit of 45 basis points, to 3.75% in 2008, from 4.20% in 2007.
 
Interest expense on FHLB advances increased $78,000, to $176,000 for the nine months ended September 30, 2008, compared to $98,000 for the nine months ended September 30, 2007.  The average balance of FHLB advances increased $3.4 million, to $5.8 million for the first nine months of 2008, from
 
$2.4 million for the first nine months of 2007. The average rate paid on advances decreased 132 basis points, to 4.02% in 2008, from 5.34% in 2007.  The overall average cost of funds decreased 19 basis points, to 2.73% in 2008, from 2.92% in 2007.
 
Net Interest Income .  Net interest income decreased $226,000, or 9.7%, to $2.1 million for the nine months ended September 30, 2008, from $2.3 million for the same period last year.  Our net interest margin decreased 35 basis points, to 3.93% in 2008, from 4.28% in 2007.  A 41 basis point decrease in the average yield on interest-earning assets, to 5.67% in 2008, from 6.08% in 2007, and the increase in non-accrual loans, both contributed to interest income decreasing by $271,000.  The average rate paid on interest-bearing liabilities decreased 19 basis points, to 2.73% in 2008, from 2.92% in 2007, with interest expense decreasing by $45,000.  The interest rate spread between interest earning assets and interest bearing liabilities decreased 22 basis points, to 2.94% in 2008, from 3.16% in 2007.
 
Provision for Loan Losses .  During the nine months ended September 30, 2008, management made an additional $553,000 provision for losses on loans, based on its quarterly evaluation of the level of the allowance necessary to absorb probable incurred loan losses at September 30, 2008.  Management established $488,000 in specific allowances, charged off $143,000 in realized losses against previously established specific reserves, and increased the general allowance for loan losses by $65,000.
 
  Management considers changes in delinquencies, changes in the composition and volume of loans, historical loan loss experience, general economic and real estate market conditions, as well as peer group data, when determining the level on the allowance for loan losses.  The increase in the general allowance resulted from increases in the factors used for delinquency trends, both in our portfolio and in the current economic environment, and declines in the value of real estate reflected in the current market.
 
During the nine months ended September 30, 2008, non-performing (non-accrual) loans increased to $3.2 million, from $259,000 at December 31, 2007.  Loans delinquent 60-89 days were $1.4 million at September 30, 2008, decreasing $1.2 million, from $2.6 million at December 31, 2007.  The loan portfolio increased $359,000, or 0.7%, to $53.4 million at September 30, 2008, from $53.0 million at December 31, 2007.  During this period, one- to four-family residential mortgage loans decreased $872,000, or 2.6%, and multi-family residential mortgage loans increased $1.6 million, or 8.2%.
 
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $2.2 million at September 30, 2008, with specific valuation allowances of $345,000, or 16.0% of the carrying amount.  All of the impaired loans were one- to four-family mortgage loans.
 
At September 30, 2008, the allowance for loan losses, including specific allowances, was $700,000, or 1.29% of loans receivable, compared to $290,000, or 0.54% of loans receivable at December 31, 2007.  In a similar evaluation of the allowance for loan losses at September 30, 2007, management determined that there was a need for a provision of $10,000 for the nine months then ended.
 
Non-interest Income .  Non-interest income decreased $520,000, to a loss of $485,000 for the nine months ended September 30, 2008, compared to $35,000 income for the nine months ended September 30, 2007.  The Company recognized a $382,000 loss for other-than-temporary impairment of FHLMC preferred stock held as available-for-sale, because the fair value of the preferred stock has continued to decline since FHFA was appointed conservator for FHLMC, and we are unable to forecast a recovery.   Partially offsetting this loss, and prior to the conservator appointment, the Company sold its remaining shares of FHLMC common stock and realized a gain of $152,000.  The Company holds 10,000 shares of FHLMC preferred stock valued at $2.00 per share at September 30, 2008.
 
The Company also recognized a $294,000 fair value loss adjustment on various mutual funds carried as trading securities and accounted for under FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which was adopted for these mutual funds on January 1, 2008.
 
Non-interest Expense .  Non-interest expense increased $36,000, or 2.0%, to $1.8 million for the nine months ended September 30, 2008, approximately the same as last year.  Compensation and employee benefits increased $116,000, or 11.5%, to $1.1 million in 2008, from $1.0 million in 2007, primarily due to new employees, ordinary- course salary increases, a $54,000 increase in health insurance premiums, and to a $15,000 increase in the amortization of stock grant and stock option expense.
 
Occupancy costs increased $2,000, or 1.7%, to $122,000 in 2008, from $120,000 in 2007.  Data processing fees increased $4,000, or 4.9%, to $85,000, from $81,000 in 2007.  Professional fees, including legal, accounting and consulting fees, decreased $101,000, or 26.2%, to $285,000 in 2008, from $386,000 in 2007.  (Legal, accounting, and consulting expenses decreased $43,000, $38,000, and $20,000, respectively.)  Miscellaneous expenses increased $15,000, or 6.9%, to $234,000 in 2008, from $219,000 in 2007.
 
The Company’s ratio of non-interest expense to average assets increased to 3.33% in the first nine months of 2008, from 3.24% for the first nine months of 2007, and the efficiency ratio increased to 86.6% in 2008, from 76.9% in 2007.
 
Income Tax Expense .  The provision for income taxes decreased $498,000, to a tax benefit of $282,000 in 2008, from a tax expense of $216,000 in 2007, largely due to the $1.3 million decrease in pre-tax income to a loss of $791,000 in 2008, from income of $534,000 in 2007.  The effective tax rate for the nine months ended September 30, 2008, decreased to 35.7%, compared to 40.5% for this period last year.
 
  Average Balance Sheet
 
The following table sets forth average balance sheets, average annualized yields and costs, and certain other information for the nine months ended September 30, 2008 and 2007.  No tax-equivalent yield adjustments were made, as their effects were not material.  All average balances are based on an average of daily balances.  Non-accrual loans are included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield.  The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
 
   
For the Nine Months Ended September 30,
 
   
2008
   
2007
 
   
Average Outstanding Balance
   
Interest
   
Yield/Rate
   
Average Outstanding Balance
   
Interest
   
Yield/Rate
 
Interest-earning assets:
                                   
Loans
  $ 53,106     $ 2,462       6.18 %   $ 53,024     $ 2,611       6.57 %
Securities
    14,718       518       4.69       17,947       643       4.78  
Interest-earning deposits
    2,578       42       2.17       728       27       4.95  
Federal Home Loan Bank Stock
    610       -       0.00       570       12       2.81  
Total interest-earning assets
    71,012     $ 3,022       5.67 %     72,269     $ 3,293       6.08 %
Non-interest-earning assets
    2,986                       2,269                  
Total assets
  $ 73,998                     $ 74,538                  
Interest-Bearing Liabilities: (1)
                                               
Savings deposits
  $ 18,918     $ 175       1.23 %   $ 20,126     $ 186       1.23 %
Certificates of deposit
    20,502       576       3.75       21,818       688       4.20  
Total interest-bearing deposits
    39,420       751       2.54       41,944       874       2.78  
Federal Home Loan Bank advances
    5,832       176       4.02       2,448       98       5.34  
Total interest-bearing liabilities
    45,252       927       2.73 %     44,392       972       2.92 %
Non-interest-bearing liabilities
    2,151                       2,096                  
Total liabilities
    47,403                       46,488                  
Stockholders’ equity
    26,595                       28,050                  
Total liabilities and stockholders’ equity
  $ 73,998                     $ 74,538                  
Net interest income
          $ 2,095                     $ 2,321          
Net interest rate spread (2)
                    2.94 %                     3.16 %
Net interest-earning assets (3)
  $ 25,760                     $ 27,877                  
Net interest margin (4)
                    3.93 %                     4.28 %
Ratio of interest-earning assets to interest- bearing liabilities
                    156.93 %                     162.80 %
____________
(1)
Non-interest-bearing checking deposits are included in non-interest-bearing liabilities.
(2)
Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(3)
Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(4)
Net interest margin represents net interest income divided by average total interest-earning assets.
 
  Liquidity
 
We maintain liquid assets at levels we consider adequate to meet our liquidity needs.  We adjust our liquidity levels to fund deposit outflows, pay real estate taxes on mortgage loans, repay our borrowings and to fund loan commitments.  We also adjust liquidity as appropriate to meet asset and liability management objectives.
 
Our primary sources of liquidity are deposits, amortization and prepayment of loans, maturities of investment securities and other short-term investments, and earnings and funds provided from operations.  
 
While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition.  We set the interest rates on our deposits to maintain a desired level of total deposits.  In addition, we invest excess funds in short-term interest-earning assets, which provide liquidity to meet lending requirements.
 
A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities.  At September 30, 2008, $4.0 million of our assets were invested in cash and cash equivalents.  Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of investment securities, increases in deposit accounts, and FHLB advances.  Our cash flows are derived from operating activities, investing activities and financing activities as reported in our consolidated statements of cash flows.
 
Our primary investing activities are the origination of loans and the purchase of investment securities.  During the nine months ended September 30, 2008, net loan originations totaled $913,000.  During the nine months ended September 30, 2007, net loan originations totaled $1.5 million.  We do not sell loans.  Cash received from principal repayments, calls and maturities of securities totaled $2.9 million and $2.8 million for the nine months ended September 30, 2008 and 2007, respectively.  We purchased $641,000 in securities during the nine months ended September 30, 2008, and sold $160,000 in securities during this period.  We purchased $110,000 in Federal Home Loan Bank common stock during the first nine months of 2007 to meet our minimum required for membership in  the FHLB of Chicago.
 
Deposit flows are generally affected by the level of interest rates, the interest rates and products offered by us and by local competitors, and other factors.  There was a net decrease in total deposits of $338,000 for the nine months ended September 30, 2008, and a net decrease of $2.5 million for the same period in 2007.
 
Liquidity management is both a daily and long-term function of business management.  If we require funds beyond our ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank of Chicago, which provide an additional source of funds.  During the nine months ended September 30, 2008, the Company borrowed $4.0 million in advances from the Federal Home Loan Bank, and repaid $3.0 million.  Our available borrowing limit was $12.2 million, an additional $6.2 million over the $6.0 million borrowed at September 30, 2008.
 
During the nine months ended September 30, 2008, we repurchased 60,000 shares of our common stock for $664,000, under a share repurchase program.  During the same period last year, we repurchased 83,300 shares for $1.1 million.
 
 At September 30, 2008, the Company had no outstanding commitments to originate loans, primarily due to a lack of recent applications and the current economic environment.  At September 30, 2008, certificates of deposit scheduled to mature in less than one year totaled $18.1 million.  Based on prior experience, management believes that a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case.  In the event we do not retain a significant portion of our maturing certificates of deposit, we will have to utilize other funding sources, such as Federal Home Loan Bank of Chicago advances, in order to maintain our level of assets.  Alternatively, we would reduce our level of liquid assets, such as our cash and cash equivalents, or securities.  In addition, the cost of such deposits may be significantly higher if market interest rates are higher at the time of renewal.
 
  Off-Balance-Sheet Arrangements
 
In the ordinary course of business, the Company is a party to credit-related financial instruments with off-balance-sheet risk to meet the financing needs of its customers.  These financial instruments include commitments to extend credit.  The Company follows the same credit policies in making commitments as it does 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 and may require payment of a fee.  Therefore, the total commitment amounts do not necessarily represent future cash requirements.
 
The Company had no outstanding commitments to make loans at September 30, 2008.  At December 31, 2007, the Company had outstanding commitments to make loans of $205,000.
 
  Impact of Inflation and Changing Prices
 
Our financial statements and related notes have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).  GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation.  The impact of inflation is reflected in the increased cost of our operations.  Unlike industrial companies, our assets and liabilities are primarily monetary in nature.  As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
 
  Management of Market Risk
 
General .  The majority of our assets and liabilities are monetary in nature.  Consequently, our most significant form of market risk is interest rate risk.  Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, which consist primarily of deposits.  As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates.   Our board of directors has approved a series of policies for evaluating interest rate risk inherent in our assets and liabilities; for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives; and for managing this risk consistent with these policies.  Senior management regularly monitors the level of interest rate risk and reports to the board of directors on our compliance with our asset/liability policies and on our interest rate risk position.
 
We have sought to manage our interest rate risk in order to control the exposure of our earnings and capital to changes in interest rates.  During the low interest rate environment that has existed in recent years, we have managed our interest rate risk by maintaining a high equity-to-assets ratio and building and maintaining portfolios of shorter-term fixed rate residential loans and second mortgage loans.  By maintaining a high equity-to-assets ratio, we believe that we are better positioned to absorb more interest rate risk in order to improve our net interest margin.  However, maintaining high equity balances reduces our return on equity ratio, and investments in shorter-term assets generally bear lower yields than longer-term investments.
 
Net Portfolio Value .  In past years, many savings institutions have measured interest rate sensitivity by computing the “gap” between the assets and liabilities that are expected to mature or reprice within certain time periods, based on assumptions regarding loan prepayment and deposit decay rates formerly provided by the OTS.  However, the OTS now requires the computation of amounts by which the net present value of an institution’s cash flow from assets, liabilities and off balance sheet items (the
 
 
 
institution’s net portfolio value or “NPV”) would change in the event of a range of assumed changes in market interest rates.  The OTS provides all institutions that file a Consolidated Maturity/Rate Schedule as a part of their quarterly Thrift Financial Report with an interest rate sensitivity report of net portfolio value.  The OTS simulation model uses a discounted cash flow analysis and an option-based pricing approach to measuring the interest rate sensitivity of net portfolio value.  Historically, the OTS model estimated the economic value of each type of asset, liability and off-balance sheet contract under the assumption that the United States Treasury yield curve increases or decreases instantaneously by 100 to 300 basis points in 100 basis point increments.  A basis point equals one-hundredth of one percent, and 100 basis points equals one percent.  An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below.  The OTS provides us the results of the interest rate sensitivity model, which is based on information we provide to the OTS to estimate the sensitivity of our net portfolio value.
 
The table below sets forth, as of June 30, 2008, the latest date available, the estimated changes in our NPV and our net interest income that would result from the designated instantaneous changes in the U.S. Treasury yield curve.  Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
 
 
Change In
   
NPV
   
Net Portfolio Value as a
Percentage of Present Value of
Assets
 
Interest Rates
(Basis Points)
   
Estimated
NPV
   
Amount
of Change
   
Percentage
Change
   
NPV Ratio
   
Change in
Basis Points
 
(dollars in thousands)
 
 
+300
    $ 19,699     $ (6,380 )     -24 %     27.82 %     -571 bp
 
+200
      21,819       (4,259 )     -16       29.84       -368  
 
+100
      23,993       (2,086 )     -8       31.79       -174  
 
+50
      25,075       (1,004 )     -4       32.70       -82  
Unchanged
      26,079                   33.52        
 
-50
      27,010       931       +4       34.26       +73  
 
-100
      27,905       1,826       +7       34.94       +141  
 
The table above indicates that at June 30, 2008, in the event of a 100 basis point decrease in interest rates, we would experience a 7% increase in net portfolio value.  (The OTS model did not report a calculation for a 200 basis point decrease in interest rates at June 30, 2008.)  In the event of a 200 basis point increase in interest rates, we would experience a 16% decrease in net portfolio value.
 
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement.  Modeling changes in net portfolio value requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates.  In this regard, the net portfolio value table presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities.  Accordingly, although the net portfolio value table provides an indication of our interest rate risk exposure at a particular point in time, such measurements do not provide a precise forecast of the effect of changes in market interest rates on net interest income and will differ from actual results.
 
Item 3 .   Quantitative and Qualitative Disclosures About Market Risk
 
Disclosure for this item is currently not required for smaller reporting companies on an interim basis.
 
Item 4 .   Controls and Procedures
 
As of the end of the period covered by this report, we carried out an evaluation, under the supervision, and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as contemplated by Exchange Act Rule 13a-15.  Based upon, and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective, in all material respects, in timely alerting them to material information relating to the Company (and its consolidated subsidiaries) required to be included in the periodic reports the Company is required to file and submit to the Securities and Exchange Commission under the Exchange Act.
 
There have been no changes in the Company’s internal controls during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
 
 
 
PART II . – OTHER INFORMATION
 
Item 1A is currently not required for smaller reporting companies and has been omitted.
 
Item 1 .   Legal Proceedings .
 
The Company and the Bank are not involved in any pending proceedings other than the legal proceedings occurring in the ordinary course of business.  Such legal proceedings in the aggregate are believed by management to be immaterial to the Company’s business, financial condition, results of operations and cash flows.
 
Item 2 .   Unregistered Sales of Equity Securities and Use of Proceeds .
 
 
Period
 
Total number of shares purchased
   
Average price paid per share
   
Total number of shares purchased as part of publicly announced plans or programs
   
Maximum number of shares that may yet be purchased under the plans or programs (1)
 
                                 
7/1/08–7/31/08
                      136,044  
8/1/08–8/31/08
                      136,044  
9/1/08–9/30/08
                      136,044  
____________
(1)  
On May 29, 2008 the Company announced that its Board of Directors had approved a stock repurchase program that authorized the purchase of up to 5%, or 175,500 shares, of the Company’s then outstanding shares of common stock, from time to time in open market or privately negotiated transactions. Unless terminated or amended earlier by the Board of Directors, the stock repurchase program will end when the Company has repurchased all 175,500 shares authorized for repurchase.

Item 3 .   Defaults Upon Senior Securities .
 
None
 
Item 4 .   Submission of Matters to a Vote of Security Holders .
 
None

Item 5 .   Other Information .
 
None
 
Item 6.   Exhibits .
 
The exhibits filed as part of this Form 10-Q are listed in the Exhibit Index, which is incorporated herein by reference.
 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
  MUTUAL FEDERAL BANCORP, INC.  
       
Date:  November  13 , 2008
By:
/s/Stephen M. Oksas   
    Stephen M. Oksas  
   
President and Chief Executive Officer
 
       
 
       
Date:  November 13, 2008
By:
/s/John L. Garlanger   
     John L. Garlanger  
    Chief Financial Officer  
       
 
 
 
EXHIBIT INDEX
 
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
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