Guaranty Federal Bancshares, Inc September 30, 2006 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

OR

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

For the transition period from _______ to _______

Commission number 0-23325

Guaranty Federal Bancshares, Inc.
(Exact name of registrant as specified in its charter)

Delaware
43-1792717
   
(State or other jurisdiction of
(IRS Employer Identification No.)
incorporation or organization)
  
1341 West Battlefield
  
Springfield, Missouri
65807
(Address of principal executive offices)
(Zip Code)

Telephone Number: (417) 520-4333

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [  ] Accelerated filer [  ]
Non-accererated filer [X]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b-2 of the Exchange Act). Yes [ ] No [X]

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

Class
Outstanding as of November 14, 2006
Common Stock, Par Value $0.10 per share
2,916,560 Shares

 
GUARANTY FEDERAL BANCSHARES, INC.
       
TABLE OF CONTENTS
     
Page
PART I. FINANCIAL INFORMATION
       
Item 1. Financial Statements
Consolidated Financial Statements (Unaudited):
  
 
Statements of Financial Condition
3
 
Statements of Income
  
4
 
Statements of Stockholders’ Equity
5
 
Statements of Cash Flows
  
7
 
Notes to Consolidated Financial Statements
8
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
11
       
Item 3. Quantitative and Qualitative Disclosures about Market Risk
17
       
Item 4. Control and Procedures
  
19
       
PART II. OTHER INFORMATION
       
Item 1. Legal Proceedings
 
20
       
Item 1A. Risk Factors
20
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
20
       
Item 3. Defaults Upon Senior Securities
  
20
       
Item 4. Submission of Matters to a Vote of Security Holders
20
       
Item 5. Other Information
  
20
       
Item 6. Exhibits
 
21
       
Signatures
      
       
   
       
   

2

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

GUARANTY FEDERAL BANCSHARES, INC.
  
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
  
SEPTEMBER 30, 2006 (UNAUDITED) AND DECEMBER 31, 2005
  
           
ASSETS
  
9/30/06
  
12/31/05
  
Cash
 
$
15,070,804
    
17,990,774
 
Interest-bearing deposits in other financial institutions
   
4,995,260
   
2,515,704
 
Cash and cash equivalents
   
20,066,064
   
20,506,478
 
Available-for-sale securities
   
9,331,152
   
6,757,147
 
Held-to-maturity securities
   
791,123
   
944,724
 
Stock in Federal Home Loan Bank, at cost
   
6,322,700
   
4,978,800
 
Mortgage loans held for sale
   
2,489,050
   
2,092,279
 
Loans receivable, net of allowance for loan losses of
         
September 30, 2006 - $5,618,872 - December 31, 2005 - $5,399,654
   
465,209,114
   
433,435,429
 
Accrued interest receivable:
         
Loans
   
2,495,998
   
2,040,872
 
Investments
   
104,265
   
48,255
 
Prepaid expenses and other assets
   
1,320,999
   
2,604,425
 
Foreclosed assets held for sale
   
502,126
   
26,775
 
Premises and equipment
   
8,019,953
   
7,452,798
 
Refundable income taxes
   
475,469
    
-
 
Deferred income taxes
   
851,194
   
112,686
 
   
$
517,979,207
    
481,000,668
 
             
LIABILITIES AND STOCKHOLDERS' EQUITY
              
LIABILITIES
             
               
Deposits
 
$
322,223,850
    
320,058,951
 
Federal Home Loan Bank advances
   
124,000,000
   
100,000,000
 
Securities sold under agreements to repurchase
   
8,923,196
   
1,594,258
 
Subordinated debentures
   
15,465,000
   
15,465,000
 
Advances from borrowers for taxes and insurance
   
815,733
   
212,320
 
Accrued expenses and other liabilities
   
509,536
   
288,587
 
Accrued interest payable
   
1,097,018
   
508,164
 
Dividend payable
   
469,062
   
459,074
 
Income taxes payable
   
-
   
322,165
 
     
473,503,395
   
438,908,519
 
               
COMMITMENTS AND CONTINGENCIES
             
               
STOCKHOLDERS' EQUITY
             
Common Stock:
             
$0.10 par value; authorized 10,000,000 shares;
             
issued September 30, 2006 - 6,645,225 shares;
             
December 31, 2005 - 6,571,348 shares
   
664,523
   
657,135
 
Additional paid-in capital
   
55,473,760
   
53,778,686
 
Unearned ESOP shares
   
(1,401,930
)
  
(1,572,930
)
Retained earnings, substantially restricted
   
39,912,147
   
36,533,338
 
Accumulated other comprehensive income
             
Unrealized appreciation on available-for-sale securities,
             
net of income taxes
    
1,611,096
   
1,971,925
 
     
96,259,596
   
91,368,154
 
               
Treasury stock, at cost; September 30, 2006 - 3,726,267 shares;
             
December 31, 2005 - 3,639,301 shares
   
(51,783,784
)
  
(49,276,005
)
     
44,475,812
   
42,092,149
 
   
$
517,979,207
    
481,000,668
 

See Notes to Condensed Consolidated Financial Statements
3
 
CONSOLIDATED STATEMENTS OF INCOME
 
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005 (UNAUDITED)
 
                   
                   
   
Three months ended
 
Nine months ended
 
   
9/30/2006
  
9/30/2005
  
9/30/2006
  
9/30/2005
  
INTEREST INCOME
                 
Loans
 
$
8,870,204
    
6,935,225
   
25,001,916
   
19,020,080
 
Investment securities
   
112,571
   
109,108
   
339,888
   
307,380
 
Other
   
71,830
   
47,155
   
176,985
   
225,861
 
     
9,054,605
   
7,091,488
   
25,518,789
   
19,553,321
 
INTEREST EXPENSE
                     
Deposits
   
2,638,877
   
1,904,836
   
7,383,588
   
5,162,510
 
Federal Home Loan Bank advances
   
1,610,387
   
1,215,982
   
4,197,026
   
3,188,553
 
Subordinated agreements
   
251,057
         
765,892
       
Other
   
42,774
   
8,869
   
91,187
   
19,211
 
     
4,543,095
   
3,129,687
   
12,437,693
   
8,370,274
 
NET INTEREST INCOME
   
4,511,510
   
3,961,801
   
13,081,096
   
11,183,047
 
PROVISION FOR LOAN LOSSES
   
150,000
   
240,000
   
600,000
   
705,000
 
NET INTEREST INCOME AFTER
                     
PROVISION FOR LOAN LOSSES
   
4,361,510
   
3,721,801
   
12,481,096
   
10,478,047
 
NONINTEREST INCOME
                     
Service charges
   
337,621
   
434,380
   
987,543
   
1,227,851
 
Late charges and other fees
   
36,136
   
37,672
   
186,408
   
178,384
 
Gain on sale of investment securities
   
176,958
   
180,669
   
551,879
   
563,572
 
Gain on sale of loans
   
172,827
   
210,015
   
452,792
   
469,136
 
Income (loss) on foreclosed assets
   
(2,062
)
  
(502
)
  
(2,327
)
  
3,688
 
Other income
   
199,570
   
95,558
   
525,445
   
240,275
 
     
921,050
   
957,792
   
2,701,740
   
2,682,906
 
NONINTEREST EXPENSE
                     
Salaries and employee benefits
   
1,588,921
   
1,184,666
   
4,515,725
   
3,621,048
 
Occupancy
   
417,946
   
366,371
   
1,105,809
   
1,031,119
 
SAIF deposit insurance premiums
   
9,801
   
9,935
   
30,033
   
29,926
 
Data processing
   
77,415
   
97,719
   
202,556
   
277,042
 
Advertising
   
101,039
   
59,395
   
303,293
   
109,965
 
Other expense
   
435,072
   
439,170
   
1,383,672
   
1,334,246
 
     
2,630,194
   
2,157,256
   
7,541,088
   
6,403,346
 
INCOME BEFORE INCOME TAXES
   
2,652,366
   
2,522,337
   
7,641,748
   
6,757,607
 
PROVISION FOR INCOME TAXES
   
1,028,044
   
935,076
   
2,871,711
   
2,506,857
 
NET INCOME
 
$
1,624,322
    
1,587,261
   
4,770,037
   
4,250,750
 
                     
BASIC EARNINGS PER SHARE
 
$
0.58
    
0.57
   
1.71
   
1.53
 
DILUTED EARNINGS PER SHARE
 
$
0.56
    
0.55
   
1.64
   
1.48
 

See Notes to Condensed Consolidated Financial Statements
4


 
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
 
NINE MONTHS ENDED SEPTEMBER 30, 2006 (UNAUDITED)
 
           
 
      
 
          
   
Common Stock
 
Additional Paid-In Capital
 
Unearned ESOP Shares
 
Treasury Stock
 
Retained Earnings
 
Accumulated Other Comprehensive Income
 
Total
 
Balance, January 1, 2006
 
$
657,135
    
53,778,686
   
(1,572,930
)
  
(49,276,005
)
  
36,533,338
   
1,971,925
   
42,092,149
 
Comprehensive income
                                           
Net income
   
-
   
-
   
-
   
-
   
4,770,037
   
-
   
4,770,037
 
Change in unrealized appreciation
                                           
on available-for-sale securities, net
                                           
of income taxes
   
-
   
-
   
-
   
-
   
-
   
(360,829
)
  
(360,829
)
Total comprehensive income
                                     
4,409,208
 
Dividends ($0.495 per share)
   
-
   
-
   
-
   
-
   
(1,391,228
)
  
-
   
(1,391,228
)
Stock award plans
   
-
   
355,596
   
-
   
-
   
-
   
-
   
355,596
 
Stock options exercised
   
7,388
   
1,020,556
   
-
   
-
   
-
   
-
   
1,027,944
 
Release of ESOP shares
   
-
   
318,922
   
171,000
   
-
   
-
   
-
   
489,922
 
Treasury stock purchased
   
-
   
-
   
-
   
(2,507,779
)
  
-
   
-
   
(2,507,779
)
Balance, September 30, 2006
 
$
664,523
    
55,473,760
   
(1,401,930
)
  
(51,783,784
)
  
39,912,147
   
1,611,096
   
44,475,812
 
 
See Notes to Condensed Consolidated Financial Statements
5

 
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
 
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
 
           
 
      
 
          
   
Common Stock
 
Additional Paid-In Capital
 
Unearned ESOP Shares
 
Treasury Stock
 
Retained Earnings
 
Accumulated Other Comprehensive Income
 
Total
 
Balance, January 1, 2005
 
$
649,386
    
52,384,842
   
(1,800,930
)
  
(45,712,994
)
  
32,437,131
   
2,815,828
   
40,773,263
 
Comprehensive income
                                           
Net income
   
-
   
-
   
-
   
-
   
4,250,750
   
-
   
4,250,750
 
Change in unrealized appreciation
                                           
on available-for-sale securities, net
                                           
of income taxes of ($235,200)
   
-
   
-
   
-
   
-
   
-
   
(1,034,421
)
  
(1,034,421
)
Total comprehensive income
                                     
3,216,329
 
Dividends ($0.48 per share)
   
-
   
-
   
-
   
-
   
(1,343,689
)
  
-
   
(1,343,689
)
Stock award plans
   
-
   
22,397
   
-
   
-
   
-
   
-
   
22,397
 
Stock options exercised
   
7,466
   
986,829
   
-
   
-
   
-
   
-
   
994,295
 
Release of ESOP shares
   
-
   
236,351
   
171,000
   
-
   
-
   
-
   
407,351
 
Treasury stock purchased
   
-
   
-
   
-
   
(2,721,144
)
  
-
   
-
   
(2,721,144
)
Balance, September 30, 2005
 
$
656,852
    
53,630,419
   
(1,629,930
)
  
(48,434,138
)
  
35,344,192
   
1,781,407
   
41,348,802
 
 
                                  

 
See Notes to Condensed Consolidated Financial Statements
6
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005 (UNAUDITED)
 
   
9/30/2006
  
9/30/2005
  
CASH FLOWS FROM OPERATING ACTIVITIES
         
Net income
 
$
4,770,037
    
4,250,750
 
Items not requiring (providing) cash:
             
Deferred income taxes
   
(526,593
)
  
(353,743
)
Depreciation
   
569,646
   
575,243
 
Provision for loan losses
   
600,000
   
705,000
 
Gain on loans and investment securities
   
(1,004,671
)
  
(1,032,708
)
(Gain) loss on sale of premises and equipment and other assets
    
(110,766
)
  
1,925
 
(Gain) loss on sale of foreclosed assets
   
(1,023
)
  
(6,003
)
Amortization of deferred income, premiums and discounts
   
32,072
   
(101,496
)
Stock award plan expense
   
355,596
   
34,879
 
Origination of loans held for sale
   
(36,495,543
)
  
(33,023,273
)
Proceeds from sale of loans held for sale
   
36,551,565
   
33,872,947
 
Release of ESOP shares
   
489,922
   
407,351
 
Changes in:
         
Accrued interest receivable
   
(511,136
)
  
(372,663
)
Prepaid expenses and other assets
   
1,308,417
   
106,360
 
Accounts payable and accrued expenses
   
828,086
   
348,545
 
Income taxes payable
   
-
   
226,608
 
Net cash provided by operating activities
   
6,855,609
   
5,639,722
 
CASH FLOWS FROM INVESTING ACTIVITIES
         
Net increase in loans
   
(32,912,403
)
  
(49,452,917
)
Principal payments on held-to-maturity securities
   
158,120
   
210,353
 
Principal payments on available-for-sale securities
   
124,756
   
-
 
Proceeds from maturities of available-for-sale securities
   
500,000
   
6,000,000
 
Purchase of tax credit investments
    
(657,412
)
  
-
  
Proceeds from sale of originated mortgage servicing rights
    
742,757
    
-
  
Purchase of premises and equipment
   
(1,142,298
)
  
(794,779
)
Proceeds from sale of premises and equipment
   
5,927
   
4,200
 
Purchase of available-for-sale securities
   
(3,780,316
)
  
(6,444,433
)
Proceeds from sale of available-for-sale securities
   
560,690
   
572,383
 
Purchase of FHLB stock
   
(1,343,900
)
  
(1,078,300
)
Proceeds from sale of foreclosed assets
   
27,798
   
337,653
 
Net cash used in investing activities
   
(37,716,281
)
  
(50,645,840
)
CASH FLOWS FROM FINANCING ACTIVITIES
             
Stock options exercised
   
1,027,944
   
994,295
 
Cash dividends paid
   
(2,197,157
)
  
(1,351,151
)
Net increase (decrease) in demand deposits,
         
NOW accounts and savings accounts
   
(7,137,394
)
  
(700,424
)
Net increase (decrease) in certificates of deposit and securities sold
             
under agreements to repurchase
   
16,631,231
   
22,229,395
 
Proceeds from FHLB advances
   
1,337,414,000
   
897,050,000
 
Repayments of FHLB advances
   
(1,313,414,000
)
  
(869,050,000
)
Advances from borrowers for taxes and insurance
   
603,413
   
667,629
 
Treasury stock purchased
   
(2,507,779
)
  
(2,721,144
)
Net cash provided by financing activities
   
30,420,258
   
47,118,600
 
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
   
(440,414
)
  
2,112,482
 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
   
20,506,478
   
15,896,458
 
CASH AND CASH EQUIVALENTS, END OF PERIOD
 
$
20,066,064
    
18,008,940
 

See Notes to Condensed Consolidated Financial Statements
7
 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1: Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included.

The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K annual report for 2005 filed with the Securities and Exchange Commission. The condensed consolidated statement of financial condition of the Company as of December 31, 2005, has been derived from the audited consolidated balance sheet of the Company as of that date. Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.

Note 2: Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Guaranty Federal Bancshares, Inc. (the “Company”), its wholly owned subsidiary, Guaranty Bank (the “Bank”) and the wholly-owned subsidiary of the Bank, Guaranty Financial Services of Springfield, Inc. All significant intercompany transactions and balances have been eliminated in consolidation.
 
Note 3: Benefit Plans

Stock Award Plans

The Company has established stock award plans for the benefit of certain directors, officers and employees of the Bank and its subsidiary. The plans provide a proprietary interest in the Company in a manner designed to encourage these individuals to remain with the Bank. A committee of the Bank’s Board of Directors administers the plans. The Company accounts for the cost of share purchases under the plans as a reduction of stockholders' equity. The awards vest at the rate of 20% per year over a five-year period. Compensation expense is recognized based on the Company’s stock price on the date the shares are awarded to employees.

As of September 30, 2006 all shares in stock award plans have vested. The Bank recognized $4,266 and $18,537 and $10,815 and $34,879 of expense under these stock award plans in the three month and nine month periods ended September 30, 2006 and 2005, respectively.

Stock Option Plans

The Company has established stock option plans for the benefit of certain directors, officers and employees of the Bank and its subsidiary. A committee of the Company’s Board of Directors administers the plans. The stock options under these plans may be either incentive stock options or nonqualified stock options. Incentive stock options can be granted only to participants who are employees of the Bank or its subsidiary. The option price must not be less than the market value of the Company stock on the date of grant. All options expire no later than ten years from the date of grant. The options vest at the rate of 20% per year over a five-year period.


8
The table below summarizes transactions under the Company’s stock option plans for the nine months ended September 30, 2006:

   
Number of shares
      
   
Incentive Stock Option
 
Non-Incentive Stock Option
 
Weighted Average Exercise Price
 
               
Balance outstanding as of December 31, 2005
   
164,785
   
175,091
   
15.65
 
Granted
   
10,000
   
10,000
   
28.06
 
Exercised
   
(24,294
)
  
(49,583
)
  
13.91
 
Forfeited
   
(5,000
)
  
-
   
27.90
 
Balance outstanding as of September 30, 2006
   
142,991
   
138,008
   
16.78
 
Options exercisable as of September 30, 2006
   
102,993
   
81,508
   
14.04
 
 
In December, 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment” (SFAS 123R). SFAS 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options and restricted stock, based on the fair value of those awards at the date of grant and eliminates the choice to account for employee stock options under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), which is how the Company previously accounted for its stock options. The Company adopted SFAS 123R effective January 1, 2006 using the modified prospective method and, as such, results for prior periods have not been restated. Stock-based compensation expense will be recognized for all stock option granted or modified after January 1, 2006. In addition, unvested options existing at January 1, 2006, will be recognized in expense over the remaining vesting period. The fair value of all stock options has been estimated using the Black-Scholes option pricing model using various assumptions, some of which are highly subjective.
 
As a result of adopting SFAS 123R on January 1, 2006, incremental stock-based compensation expense recognized was $15,185 and $49,017 during the three months and nine months ended September 30, 2006, respectively. As of September 30, 2006, there was $194,162 of unrecognized compensation expense related to nonvested stock options, which will be recognized over the remaining vesting period.
 
Prior to January 1, 2006, no compensation expense was recognized for stock option grants, as all such grants had an exercise price equal to the fair market value on the date of grant. The following illustrates the effect on net income and earnings per share if the Company had applied the fair value method of SFAS No. 123, “Accounting for Stock-Based Compensation,” prior to January 1, 2006:

 
9
   
Three Months ended
 
Nine Months ended
 
   
September 30, 2005
  
September 30, 2005
  
           
Net income, as reported
  
$
1,587,261
    
4,250,750
 
Less: Total stock-based employee compensation
              
cost determined under the fair value-based
              
method, net of income taxes
    
(9,361
)
  
(27,218
)
               
Pro forma net income
  
$
1,577,900
    
4,223,502
 
               
Earnings per share:
              
Basic - as reported
  
$
0.57
    
1.53
 
Basic - pro forma
  
$
0.57
    
1.52
 
Diluted - as reported
  
$
0.55
    
1.47
 
Diluted - pro forma
  
$
0.54
    
1.46
 

Note 4: Earnings Per Share
   
For three months ended September 30, 2006
 
For nine months ended September 30, 2006
 
   
Income Available to Stockholders
 
Average Shares Outstanding
 
Per-share
 
Income Available to Stockholders
 
Average Shares Outstanding
 
Per-share
 
Basic Earnings per Share
 
$
1,624,322
    
2,782,887
 
$
0.58
  
$
4,770,037
    
2,792,040
 
$
1.71
  
Effect of Dilutive Securities:
                             
Stock Options
         
111,721
             
109,448
     
Diluted Earnings per Share
 
$
1,624,322
    
2,894,608
 
$
0.56
  
$
4,770,037
    
2,901,488
 
$
1.64
  
                                       
For three months ended September 30, 2005
   
For nine months ended September 30, 2005
Income Available to Stockholders
         
Average Shares Outstanding
   
Per-share
   
Income Available to Stockholders
   
Average Shares Outstanding
   
Per-share
 
Basic Earnings per Share
 
$
1,587,261
    
2,764,303
 
$
0.57
  
$
4,250,750
    
2,777,946
 
$
1.53
  
Effect of Dilutive Securities:
                             
Stock Options
         
134,696
             
121,263
     
Diluted Earnings per Share
 
$
1,587,261
    
2,898,999
 
$
0.55
  
$
4,250,750
    
2,899,209
 
$
1.47
  
 
10
Note 5: Other Comprehensive Income

   
9/30/2006
  
9/30/2005
  
Unrealized gains (losses) on
 
$
(20,865
)
  
(1,078,366
)
available-for-sale securities
             
Less: Reclassification adjustment for
             
realized (gains) losses included in income
   
(551,879
)
  
(563,572
)
Other comprehensive income (loss),
             
before tax effect
   
(572,744
)
  
(1,641,938
)
Tax expense (benefit)
   
(211,915
)
  
(607,517
)
OTHER COMPREHENSIVE INCOME (LOSS)
 
$
(360,829
)
  
(1,034,421
)

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

General

The primary function of the Company is to monitor its investment in the Bank. As a result, the results of operations of the Company are derived primarily from the operations of the Bank. The Bank’s results of operations are primarily dependent on net interest margin, which is the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. The Bank’s income is also affected by the level of its noninterest expenses, such as employee salaries and benefits, occupancy expenses and other expenses. The following discussion reviews the Company’s financial condition as of September 30, 2006, and the results of operations for the three months and nine months ended September 30, 2006 and 2005.

The discussion set forth below, as well as other portions of this Form 10-Q, may contain forward-looking comments. Such comments are based upon the information currently available to management of the Company and management’s perception thereof as of the date of this Form 10-Q. When used in this Form 10-Q, words such as “anticipates,” “estimates,” “believes,” “expects,” and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Such statements are subject to risks and uncertainties. Actual results of the Company’s operations could materially differ from those forward-looking comments. The differences could be caused by a number of factors or combination of factors including, but not limited to: changes in demand for banking services; changes in portfolio composition; changes in management strategy; increased competition from both bank and non-bank companies; changes in the general level of interest rates; and other factors set forth in reports and other documents filed by the Company with the Securities and Exchange Commission from time to time, including the risk factors described under Item 1A. of the Company’s Form 10-K for the fiscal year ended December 31, 2005.

Financial Condition

Assets

The Company’s total assets increased $36,978,539 (8%) from $481,000,668 as of December 31, 2005, to $517,979,207 as of September 30, 2006.

Cash and cash equivalents decreased $440,414 (2%) from $20,506,478 as of December 31, 2005, to $20,066,064 as of September 30, 2006. The decrease is primarily due to a smaller amount of uncollected funds on deposit with a correspondent bank as of September 30, 2006, compared to December 31, 2005.
 
Securities available-for-sale increased $2,574,005, (38%) from $6,757,147 as of December 31, 2005, to $9,331,152 as of September 30, 2006. The increase was primarily due to the purchase of various government agency securities during the period totaling approximately $3,500,000. The Bank currently holds 39,600 shares of Federal Home Loan Mortgage Corporation (“FHLMC”) stock with an amortized cost of $38,784 in the available-for-sale category. As of September 30, 2006, the gross unrealized gain on the FHLMC stock was $2,587,884, a decrease from $3,176,010 as of December 31, 2005.

11
Securities held-to-maturity decreased primarily due to principal repayments of such securities by $153,601 (16%) from $944,724 as of December 31, 2005, to $791,123 as of September 30, 2006.

Stock in Federal Home Loan Bank of Des Moines (“FHLB”) increased $1,343,900 (27%) from $4,978,800 as of December 31, 2005 to $6,322,700 as of September 30, 2006, due to the purchase of additional stock necessary to meet FHLB requirements. The Bank is required to own FHLB stock in an amount equal to the sum of 0.12% of assets and 4.45% of advances.
 
Net loans receivable increased $31,773,685 (7%) from $433,435,429 as of December 31, 2005, to $465,209,114 as of September 30, 2006. Commercial real estate loans increased $42,601,580 (35%) from $122,884,052 as of December 31, 2005, to $165,485,632 as of September 30, 2006. The Bank plans to continue its emphasis on commercial lending, while selling the majority of conforming single family loan production on the secondary market. As a result, permanent mortgage loans secured by both owner and non-owner occupied residential real estate decreased by $17,794,656 (18%). Loans held for sale which consists primarily of permanent residential mortgage loans increased $396,771 (19%) to $2,489,050 as of September 30, 2006, compared to $2,092,279 at December 31, 2005. The Bank also continued to be active in construction lending. Construction loans increased by $9,205,325 (13%) to $79,595,228 as of September 30, 2006, compared to $70,389,903 as of December 31, 2005. Loan growth is anticipated to continue and represents a major part of the Bank’s planned asset growth. See also discussion under “Quantitative and Qualitative Disclosure about Market Risk - Asset/Liability Management.”
 
Allowance for loan losses increased $219,218 (4%) from $5,399,654 as of December 31, 2005 to $5,618,872 as of September 30, 2006. The allowance increased primarily due to the provision for loan losses of $600,000 recorded during this period exceeding net loan charge-offs of $380,782 during this period. Management of the Company decided to increase the allowance for loan losses by this provision charge primarily as a result of the continued growth of the Bank’s loan portfolio, particularly its commercial loan portfolio. See discussion under “Results of Operations - Comparison of Three Month and Nine Months Periods Ended September 30, 2006 and 2005 - Provision for Loan Losses.” The allowance for loan losses as of September 30, 2006 and December 31, 2005 was 1.26% and 1.29%, respectively, of average net loans outstanding. As of September 30, 2006, the allowance for loan losses was 45% of impaired loans compared to 75% as of December 31, 2005.

Premises and equipment increased $567,155 (8%) from $7,452,798, as of December 31, 2005 to $8,019,953 as of September 30, 2006, due to purchases of equipment less the depreciation recognized on these assets during the nine month period ended September 30, 2006. 

Liabilities

Deposits increased $2,164,899 (1%) from $320,058,951 as of December 31, 2005, to $322,223,850 as of September 30, 2006. For the nine months ended September 30, 2006, checking and savings accounts decreased $7,137,394 (6%) and certificates of deposits increased $9,302,293 (5%). The decrease in checking and savings was primarily due to activity in commercial demand accounts. Due to the nature of the businesses of these commercial account holders, there are large fluctuations in account balances. The increase in certificates of deposit was primarily due to the Company’s decision to increase rates paid on retail certificates of deposit. As a result retail certificates of deposits increased $30,048,007 (23%) during the period. During the same period brokered certificates of deposit decreased $20,745,715 (36%). See also the discussion under “Quantitative and Qualitative Disclosure about Market Risk - Asset/Liability Management.”

FHLB advances increased $24,000,000 (24%), from $100,000,000 as of December 31, 2005, to $124,000,000 as of September 30, 2006, due to new advances exceeding repayments. These funds were primarily used to fund new loans.
 
On December 15, 2005, the Company completed an offering of $15 million of “Trust Preferred Securities” (defined hereinafter). The Company formed two wholly-owned subsidiaries, each a Delaware statutory trust (each a “Trust”, and collectively, the “Trusts”), for the purpose of issuing the $15 million of Trust Preferred Securities. The proceeds of the sale of Trust Preferred Securities, together with the proceeds of the Trusts’ sale of their common securities to the Company for $465,000, were used by each Trust to purchase certain debentures from the Company. The Company issued 30-year junior subordinated deferrable interest debentures to the Trusts in the principal amount of $5,155,000 (“Trust I Debentures”) and $10,310,000 (“Trust II Debentures”, and together with the Trust I Debentures, the “Debentures”) pursuant to the terms of Indentures dated December 15, 2005 by and between the Company and Wilmington Trust Company, as trustee. The Trust I Debentures bear interest at a fixed rate of 6.92%, payable quarterly. The Trust II Debentures bear interest at a fixed rate of 6.47% for 5 years, payable quarterly, after issuance and thereafter at a floating rate equal to the three month LIBOR plus 1.45%. The interest payments by the Company to the Trusts will be used to pay the dividends payable by the Trusts to the holders of the Trust Preferred Securities. The Company has not issued additional debentures since December 15, 2005.

12
As a part of management’s review of available funding, management continually evaluates the cost associated with FHLB advances, issuing junior subordinated debentures, and utilizing brokered certificates of deposit in the national market versus retail certificates of deposit in the local market. The aggregate cost of brokered certificates of deposit includes both the interest paid to the depositor and the broker fee paid to the broker. At times, the all-inclusive cost of brokered certificates of deposit is less than the marginal cost of increasing local retail certificate of deposits. Management believes a combination of these sources of funds will provide the lowest cost long-term funding.

Advances from borrowers for taxes and insurance increased $603,413 (284%) from $212,320 as of December 31, 2005, to $815,733 as of September 30, 2006 which was due to the timing of collection and payment of real estate taxes.

Stockholders’ Equity
 
    Stockholders’ equity (including unrealized appreciation on securities available-for-sale, net of tax) increased $2,383,663 (6%) from $42,092,149 as of December 31, 2005, to $44,475,812 as of September 30, 2006. This increase was due to several factors. The Company’s net income during this period was $4,770,037 which was partially offset by dividends in the amount of $461,397 which were declared on March 16, 2006 and paid on April 14, 2006, to stockholders’ of record as of March 30, 2006 and $467,809 which were declared on June 23, 2006 and paid on July 14, 2006, to stockholders’ of record as of July 3, 2006 and $469,062 where were delared on September 22, 2006, to stockholders’ of record October 2, 2006, and paid on October 16, 2006. In addition, the increase in stockholders’ equity was further offset as the Company repurchased 87,066 shares of treasury stock at an aggregate cost of $2,507,779 (an average cost of $28.80 per share) and a decrease in unrealized appreciation on available for sale securities, net of taxes, of $360,829 during this period. As of September 30, 2006, 201,477 shares of the Company’s common stock remain to be repurchased under the repurchase plan announced by the Company on July 25, 2006. On a per share basis, stockholders’ equity increased from $15.17 as of December 31, 2005 to $16.01 as of September 30, 2006.

Average Balances, Interest and Average Yields

The Company’s profitability is primarily dependent upon net interest income, which represents the difference between interest and fees earned on loans and debt and equity securities, and the cost of deposits, junior subordinate debentures and other borrowings. Net interest income is dependent on the difference between the average balances and rates earned on interest-earning assets and the average balances and rates paid on interest-bearing liabilities. Non-interest income, non-interest expense, and income taxes also impact the Company’s net income.

The following table sets forth certain information relating to the Company’s average consolidated statements of financial condition and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense annualized by the average balance of assets or liabilities, respectively, for the periods shown. Average balances were derived from average daily balances. The average balance of loans includes loans on which the Company has discontinued accruing interest. The yields and costs include fees which are considered adjustments to yields. All dollar amounts are in thousands.


13

   
Nine months ended 9/30/2006
  
Nine months ended 9/30/2005
  
   
Average Balance
 
Interest
 
Yield / Cost
 
Average Balance
 
Interest
 
Yield / Cost
 
ASSETS
                         
Interest-earning:
 
 
          
 
          
Loans
 
$
445,594
    
25,002
   
7.48
%
$
413,648
    
19,020
   
6.13
%
Investment securities
   
7,277
   
340
   
6.23
%
  
9,963
   
307
   
4.11
%
Other assets
   
9,836
   
177
   
2.40
%
  
12,189
   
226
   
2.47
%
Total interest-earning
   
462,707
   
25,519
   
7.35
%
  
435,800
   
19,553
   
5.98
%
Noninterest-earning
   
20,968
               
19,329
             
   
$
483,675
              
$
455,129
              
LIABILITIES AND STOCKHOLDERS’ EQUITY
                             
Interest-bearing:
                                   
Savings accounts
 
$
14,692
    
259
   
2.35
%
$
15,117
    
141
   
1.25
%
Transaction accounts
   
76,283
   
1,169
   
2.04
%
  
86,668
   
966
   
1.49
%
Certificates of deposit
   
191,856
   
5,956
   
4.14
%
  
174,199
   
4,055
   
3.10
%
FHLB Advances
   
110,293
   
4,197
   
5.07
%
  
109,576
   
3,189
   
3.88
%
Subordinated agreements
   
15,465
   
766
   
6.60
%
  
-
   
-
   
0.00
%
Other borrowed funds
   
4,271
   
91
   
2.84
%
  
1,239
   
19
   
2.04
%
Total interest-bearing
   
412,860
   
12,438
   
4.02
%
  
386,799
   
8,370
   
2.89
%
Noninterest-bearing
   
26,763
               
27,568
             
Total liabilities
   
439,623
               
414,367
             
Stockholders’ equity
   
44,052
               
40,762
             
   
$
483,675
              
$
455,129
              
Net earning balance
 
$
49,847
              
$
49,001
              
Earning yield less costing rate
               
3.34
%
              
3.09
%
Net interest income, and net yield spread
                             
on interest earning assets
       
$
13,081
    
3.77
%
      
$
11,183
    
3.42
%
Ratio of interest-earning assets to
                                     
interest-bearing liabilities
         
112
%
              
113
%
      

Results of Operations - Comparison of Three Month and Nine Month Periods Ended September 30,
2006 and 2005

Net income for the three months and nine months ended September 30, 2006 was $1,624,322 and $4,770,037, respectively, as compared to $1,587,261 and $4,250,750, respectively, for the three months and nine months ended September 30, 2005, which represents an increase in earnings of $37,061 (2%) for the three month period, and an increase in earnings of $519,287 (12%) for the nine month period.

Interest Income

Total interest income for the three months and nine months ended September 30, 2006, increased
$1,963,117 (28%) and $5,965,468 (31%), respectively, as compared to the three months and nine months ended September 30, 2005. For the three month and nine month periods ended September 30, 2006 compared to the same periods in 2005, the average yield on interest earning assets increased 140 basis points to 7.70% and increased 137 basis points to 7.35%, respectively, while the average balance of interest earning assets increased $20,281,000 and $26,907,000, respectively.

14
Interest Expense

Total interest expense for the three months and nine months ended September 30, 2006, increased $1,413,408 (45%) and $4,067,419 (49%), respectively, when compared to the three months and nine months ended September 30, 2005. For the three month and nine month periods ended September 30, 2006 compared to the same periods in 2005, the average cost of interest bearing liabilities increased 117 basis points to 4.31% and 113 basis points to 4.02%, respectively, while the average balance increased $22,163,000 and $26,061,000, respectively. The increase in interest expense is attributed, in part, to the issuance by the Company of $15,465,000 of 30-year junior subordinated debentures on December 15, 2005, as explained previously.

Net Interest Income

As a result of the interest income and interest expense for the three months and nine months ended September 30, 2006 as discussed above, net interest income for the three months and nine months ended September 30, 2006 increased $549,709 (14%) and $1,898,049 (17%), respectively, when compared to the same periods in 2005.

Provision for Loan Losses

Based primarily on the continued growth of the commercial loan portfolio and increases in non-performing loans during the period, management decided to record a provision for loan losses of $150,000 and $600,000 for the three months and nine months ended September 30, 2006, respectively, compared to $240,000 and $705,000 for the same periods in 2005. The Bank will continue to monitor its allowance for loan losses and make future additions based on economic and regulatory conditions. Although the Bank maintains its allowance for loan losses at a level which it considers to be sufficient to provide for potential losses, there can be no assurance that future loan losses will not exceed internal estimates. In addition, the amount of the allowance for loan losses is subject to review by regulatory agencies which can order the establishment of additional loan loss provisions. See also the discussion under “Nonperforming assets”.

Noninterest Income

Noninterest income changed only marginally for the three months and nine months ended September 30, 2006, respectively, when compared to the three months and nine months ended September 30, 2005.

Service charges on transaction accounts decreased by $96,759 (22%) and $240,308 (20%) during the three months and nine months ended September 30, 2006, respectively, when compared to the same periods in 2005. This is a result of a decrease in the amount of “non-sufficient funds” and overdraft fees collected during this three month and nine month period when compared to the same period in 2005. This decrease is a result of fewer “non-sufficient funds” checks being presented per account during the three month and nine month period ended September 30, 2006, compared to the same periods in 2005.

Gain on sale of loans decreased $37,188 (18%) and $16,344 (3%) for the three months and nine months ended September 30, 2006, respectively, when compared to the same periods in 2005, which was a result of a decrease in mortgage loans sold on the secondary market, due to higher interest rate and less demand during these periods.

Other income increased $104,012 (109%) and $285,170 (119%) for the three months and nine months ended September 30, 2006, respectively when compared to the same periods in 2005. This increase was primarily due to profit on the sale of mortgage servicing rights that occurred during the three months and nine months ended September 30, 2006. During these periods the Bank recorded $110,336 profit from the sale of mortgage servicing rights. In addition, there was increase in the amount of ATM fees collected during the three months and nine months ended September 30, 2006, compared to the same period in 2005.

15
Noninterest Expense

Noninterest expense increased $472,939 (22%) and $1,137,743 (18%) for the three months and nine months ended September 30, 2006, respectively when compared to the three months and nine months ended September 30, 2005. The increases for the three months and six months ended June 30, 2006 were primarily due to increases in salaries and employee benefits and advertising, which were partially offset by decreases in data processing as discussed below.

Salaries and employee benefits increased $404,255 (34%) and $894,677 (25%) for the three months and nine months ended September 30, 2006, respectively when compared to the same periods in 2005. This increase was due to several factors, including additions in executive and staff positions, pay increases to existing employees and increases in employee benefit costs during the three month and nine month periods ended September 30, 2006 when compared to the same periods in 2005.

Advertising expense increased $41,644 (70%) and $193,328 (176%) for the three months and nine months ended September 30, 2006, respectively when compared to the same periods in 2005. This increase was primarily due to the Bank’s decision to increase its exposure through the use of several different advertising mediums.

Data processing expense decreased $20,304 (21%) and $74,486 (27%) for the three months and nine months ended September 30, 2006 when compared to the same periods in 2005. This decrease was primarily due to the Bank’s decision to terminate its relationship with a third-party vendor that provided data processing services during the three month and nine month periods ended September 30, 2006.

Provision for Income Taxes

There was an increase of $92,968 (10%) and $364,854 (15%) in the provision for income taxes for the three months and six months ended September 30, 2006, respectively, as compared to the same periods in 2005. These increases were due to an increases in before tax income of $130,029 (5%) and $884,141 (13%) for the three months and nine months ended September 30, 2006, respectively, compared to the same periods in 2005.
 
Nonperforming Assets

The allowance for loan losses is calculated based upon an evaluation of pertinent factors underlying the various types and quality of the Bank’s existing loan portfolio. When making such evaluation, management considers such factors as the repayment status of its loans, the estimated net realizable value of the underlying collateral, borrowers’ intent (to the extent known by the Bank) and ability to repay the loan, local economic conditions and the Bank’s historical loss ratios. The Bank’s allowance for loan losses as of September 30, 2006, was $5,618,872 or 1.27% of average net loans receivable. Total assets classified as substandard, doubtful or loss as of September 30, 2006, were $6,642,987 or 1.3% of total assets. Management considered nonperforming and total classified assets in evaluating the adequacy of the Bank’s allowance for loan losses.
 
16
The ratio of nonperforming assets to total assets is another useful tool in evaluating exposure to credit risk. Nonperforming assets of the Bank include nonperforming loans (nonaccruing loans) and assets which have been acquired as a result of foreclosure or deed-in-lieu of foreclosure. All dollar amounts are in thousands.

   
9/30/2006
  
12/31/2005
  
12/31/2004
  
Nonperforming loans
 
$
3,099
    
721
   
1,007
 
Real estate acquired in settlement of loans
   
508
   
27
   
78
 
Total nonperforming assets
 
$
3,607
    
748
   
1,085
 
                     
Total nonperforming assets as a percentage of total assets
   
0.70
%
  
0.17
%
  
0.25
%
Allowance for loan losses
 
$
5,619
    
5,400
   
4,537
 
Allowance for loan losses as a percentage of average net loans
   
1.27
%
  
1.29
%
  
1.16
%

The increase in nonperforming loans from December 31, 2005 to September 30, 2006 was primarily due to one borrower who has a total of seventeen loans that were placed on non-accrual status during this period. The total amount outstanding is approximately $2.3 million. These loans are secured by six patio homes and nine building lots, along with two unsecured loans. The Bank believes that the established allowance on this credit is adequate at this time. During this period the Bank also acquired three properties through foreclosure with an estimated fair value of $502,000.

Liquidity and Capital Resources

The Bank’s primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed securities, proceeds from maturing investment securities, issuances of junior subordinated debentures and extensions of credit from FHLB. While scheduled loan and security repayments and the maturity of short-term investments are somewhat predictable sources of funding, deposit flows are influenced by many factors, which make their cash flows difficult to anticipate.

The Bank uses its liquidity resources principally to satisfy its ongoing commitments which include funding loan commitments, funding maturing certificates of deposit as well as deposit withdrawals, maintaining liquidity, purchasing investments, and meeting operating expenses. As of September 30, 2006, the Bank had approximately $2,940,000 in commitments to originate mortgage and commercial loans. These commitments will be funded through existing cash balances, cash flow from operations and, if required, FHLB advances. Management believes that anticipated cash flows and deposit growth will be adequate to meet the Bank’s liquidity needs.

During the three months ended September 30, 2006, the Company procured a revolving line of credit with U. S. Bancorp in the amount of $2,500,000, with an initial maturity of 364 days. To date there have been no funds drawn against this line. The purpose of the line of credit is to provide an additional liquidity source for the Company.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Asset/Liability Management

The goal of the Bank’s asset/liability policy is to manage interest rate risk so as to maximize net interest income over time in changing interest rate environments. Management monitors the Bank’s net interest spreads (the difference between yields received on assets and paid on liabilities) and, although constrained by market conditions, economic conditions, and prudent underwriting standards, the Bank offers deposit rates and loan rates designed to maximize net interest income. Management also attempts to fund the Bank’s assets with liabilities of a comparable duration to minimize the impact of changing interest rates on the Bank’s net interest income. Since the relative spread between financial assets and liabilities is constantly changing, the Bank’s current net interest income may not be an indication of future net interest income.

17
As a part of its asset and liability management strategy and throughout the past several years, the Bank has continued to emphasize the origination of adjustable-rate, one- to four-family residential loans and adjustable-rate or relatively short-term commercial real estate, commercial business and consumer loans, while originating fixed-rate, one- to four-family residential loans primarily for immediate resale in the secondary market on either a service-retained basis or service-released basis. This allows the Bank to serve the customer’s needs and retain a banking relationship with respect to such fixed-rate residential loans, while limiting its exposure to the risk associated with carrying a long-term fixed-rate loan in its loan portfolio.

The Bank is also managing interest rate risk by the origination of construction loans. As of September 30, 2006, such loans represented 17% of the net loans receivable and continue to account for a larger portion of the Bank’s existing portfolio. In general, these loans have higher yields, shorter maturities and greater interest rate sensitivity than other real estate loans.

The Bank constantly monitors its deposits in an effort to decrease their interest rate sensitivity. Rates of interest paid on deposits at the Bank are priced competitively in order to meet the Bank’s asset/liability management objectives and spread requirements. As of December 31, 2005, the Bank’s savings accounts, checking accounts, and money market deposit accounts totaled $130,252,633 or 41% of its total deposits. As of September 30, 2006, these accounts totaled $123,115,239 or 38% of the Bank’s total deposits. The Bank believes, based on historical experience, that a substantial portion of such accounts represents non-interest rate sensitive core deposits.

Interest Rate Sensitivity Analysis

The following table sets forth as of September 30, 2006 management’s estimates of the projected changes in net portfolio value (“NPV”) in the event of 100, 200, and 300 basis point (“bp”) instantaneous and permanent increases and 100, 200 and 300 basis point instantaneous and permanent decreases in market interest rates. Dollar amounts are expressed in thousands.

 
Estimated Net Portfolio Value
 
NPV as % of PV of Assets
 
in Rates
 
$ Amount
 
$ Change
 
% Change
 
NPV Ratio
 
Change
 
+300
  
$
38,872
  
$
(3,092
)
  
-7
%
  
7.45
%
  
-0.73
%
+200
    
40,664
   
(1,300
)
  
-3
%
  
7.84
%
  
-0.34
%
+100
    
41,826
   
(138
)
  
0
%
  
8.10
%
  
-0.07
%
NC
    
41,964
   
-
   
-
   
8.18
%
  
-
 
-100
    
41,136
   
(828
)
  
-2
%
  
8.07
%
  
-0.10
%
-200
    
39,716
   
(2,248
)
  
-5
%
  
7.86
%
  
-0.31
%
-300
    
37,727
   
(4,237
)
  
-10
%
  
7.54
%
  
-0.64
%

Computations of prospective effects of hypothetical interest rate changes are based on an internally generated model using actual maturity and repricing schedules for the Bank’s loans and deposits, and are based on numerous assumptions, including relative levels of market interest rates, loan repayments and deposit run-offs, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Bank may undertake in response to changes in interest rates.

Management cannot predict future interest rates or their effect on the Bank’s NPV in the future. Certain shortcomings are inherent in the method of analysis presented in the computation of NPV. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in differing degrees to changes in market interest rates. Additionally, certain assets, such as adjustable-rate loans, have an initial fixed rate period typically from one to five years, and over the remaining life of the asset changes in the interest rate are restricted. In addition, the proportion of adjustable-rate loans in the Bank’s portfolio could decrease in future periods due to refinancing activity if market interest rates remain steady in the future. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in the table. Finally, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase.

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The Bank’s Board of Directors (the “Board”) is responsible for reviewing the Bank’s asset and liability policies. The Board meets quarterly to review interest rate risk and trends, as well as liquidity and capital ratios and requirements. The Bank’s management is responsible for administering the policies and determinations of the Board with respect to the Bank’s asset and liability goals and strategies.

Item 4. Controls and Procedures
 
(a) The Company maintains disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
The Company conducted an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2006. 
 
(b) There have been no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
 
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PART II. OTHER INFORMATION

Item 1. Legal Proceedings
Not applicable

Item 1A. Risk Factors
 Not applicable

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

The following table summarizes the repurchase activity of the Company’s common stock during the Company’s third quarter ended September 30, 2006.

ISSUER PURCHASES OF EQUITY SECURITIES

Period
  
(a) Total Number of Shares Purchased
 
(b) Average Price Paid per Share
  
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)
  
(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
  
July 1, 2006 to July 31, 2006
    
8,400
   
27.52
   
8,400
   
241,602
 
August 1, 2006 to August 31, 2006
    
35,100
   
28.94
   
35,100
   
206,502
 
September 1, 2006 to September 30, 2006
    
5,025
   
28.66
   
5,025
   
201,477
 
Total
    
48,525
   
28.94
   
48,525
     


(1)  
The Company has a repurchase plan which was announced by the Company on July 25, 2006. This plan authorizes the purchase by the Company of up to 250,000 shares of the Company’s common stock. There is no expiration date for this plan. There are no other repurchase plans in effect at this time. During the period ended September 30, 2006, the remaining shares under the repurchases plan which was announced by the Company on November 22, 2006 were repurchased by the Company, and such repurchases are reflected in this table.

Item 3. Defaults Upon Senior Securities
Not applicable.

Item 4. Submission of Matters to a Vote of Common Security Holders
Not applicable.
 
Item 5. Other Information
None.

Item 6. Exhibits
    11. Statement re computation of per share earnings (set forth in “Note 4: Earnings Per Share” of
    the Notes to Condensed Consolidated Financial Statements (unaudited))
    31(i).1 Certification of the Principal Executive Officer pursuant to Rule 13a -14(a) of the Exchange Act
    31(i).2 Certification of the Principal Financial Officer pursuant to Rule 13a - 14(a) of the Exchange Act
    32.1  CEO certification pursuant to 18 U.S.C. Section 1350   
    32.2  CFO certification pursuant to 18 U.S.C. Section 1350
 
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SIGNATURES

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

 
Signature and Title                             Date

/s/ Shaun A. Burke         November 14, 2006  
Shaun A. Burke
President and Chief Executive Officer
(Principal Executive Officer and Duly Authorized Officer)



/s/ Bruce Winston                             November 14, 2006  
Bruce Winston  
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

21