BankFinancial CORP - Quarter Report: 2007 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the Quarterly Period ended March 31, 2007

or

For transition period from              to             

Commission File Number 0-51331

BANKFINANCIAL CORPORATION

(Exact Name of Registrant as Specified in Charter)

Registrant’s telephone number, including area code:  (800) 894-6900

Not Applicable

(Former name or former address, 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 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 shell company (as defined in Rule 12b-2 of the Exchange Act.    Yes  ¨    No  x.

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  x    Non-accelerated filer  ¨

Indicate the number of shares outstanding of each of the Issuer’s classes of common stock as of the latest practicable date. 23,175,176 shares of Common Stock, par value $0.01 per share, were issued and outstanding as of May 4, 2007

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BANKFINANCIAL CORPORATION

Form 10-Q Quarterly Report

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PART I

BANKFINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

March 31, 2007 (Unaudited) and December 31, 2006

(In thousands, except share and per share data)

See accompanying notes to consolidated financial statements.

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BANKFINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

Three months ended March 31, 2007 and 2006

(In thousands, except per share data) - (Unaudited)

See accompanying notes to consolidated financial statements.

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BANKFINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND

COMPREHENSIVE INCOME

Three months ended March 31, 2007 and 2006

(In thousands, except share and per share data) - (Unaudited)

See accompanying notes to consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

Three months ended March 31, 2007 and 2006

(In thousands) - (Unaudited)

(Continued)

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BANKFINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOW

Three months ended March 31, 2007 and 2006

(In thousands) - (Unaudited)

See accompanying notes to consolidated financial statements.

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Table amounts in thousands, except share and per share data)

(unaudited)

Note 1 – Basis of Presentation.

BankFinancial Corporation, a Maryland corporation headquartered in Burr Ridge, Illinois, (the “Company”) became the owner of all of the issued and outstanding capital stock of BankFinancial, F.S.B. (the “Bank”) on June 23, 2005, when the Company consummated a plan of conversion and reorganization that the Bank and its predecessor holding companies, BankFinancial MHC, Inc. (“BankFinancial MHC”) and BankFinancial Corporation, a federal corporation, adopted on August 25, 2004. BankFinancial Corporation, the Maryland corporation, was organized in 2004 to facilitate the mutual-to-stock conversion and to become the holding company for the Bank upon its completion.

As part of the mutual-to-stock conversion, BankFinancial Corporation, the Maryland corporation, sold 24,466,250 shares of common stock in a subscription offering for $10.00 per share. The separate corporate existences of BankFinancial MHC and BankFinancial Corporation, the federal corporation, ceased upon the completion of the mutual-to-stock conversion. For a further discussion of the mutual-to-stock conversion, see our Prospectus as filed on April 29, 2005 with the Securities and Exchange Commission pursuant to Rule 424(b)(3) of the Rules and Regulations of the Securities Act of 1933 (File Number 333-119217).

As used in this Quarterly Report on Form 10-Q, the words “Company,” “we” and “our” are intended to refer to BankFinancial Corporation, the Maryland corporation, and the above subsidiary, with respect to matters and time periods occurring thereafter, including the information presented for the three-month period ended March 31, 2007.

The interim unaudited consolidated financial statements reflect all normal and recurring adjustments that are, in the opinion of management, considered necessary for a fair presentation of the financial condition and results of operations for the periods presented. All significant intercompany accounts and transactions have been eliminated. The results of operations for the three-month period ended March 31, 2007, are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2007.

Certain information and note disclosures normally included in financial statements and prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission.

To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, mortgage loan servicing rights, impairment of securities and the fair value of investment securities and financial instruments are particularly subject to change.

Certain reclassifications have been made in the prior period’s financial statements to conform with the current period’s presentation.

These unaudited consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, and all amendments thereto, as filed with the Securities and Exchange Commission.

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Table amounts in thousands, except share and per share data)

(unaudited)

Note 2 – Earnings per share

Amounts reported in earnings per share reflect earnings available to common stockholders for the period divided by the weighted average number of shares of common stock outstanding during the period, exclusive of unearned ESOP shares and unvested restricted stock shares. Stock options and restricted stock are regarded as potential common stock and are considered in the diluted earnings per share calculations to the extent that they would have a dilutive effect if converted to common stock computed using the “treasury stock” method.

N.A. – not applicable

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Table amounts in thousands, except share and per share data)

(unaudited)

Note 3 – Securities

The fair value of securities available-for-sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income are as follows:

At March 31, 2007, our debt securities consisted of mortgage-backed pass-through securities issued or sponsored by Fannie Mae, Freddie Mac or Ginnie Mae, collateralized mortgage obligations and real estate mortgage investment conduits guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae, SBA guaranteed loan participation certificates, corporate and municipal securities. Our equity securities consisted entirely of shares of two floating rate and one fixed rate preferred stocks issued by a government-sponsored entity, Freddie Mac. All of our investment securities reflected in the preceding table were classified as available-for-sale at March 31, 2007.

Interest income on securities is recognized under the interest method, and includes amortization of purchase premium and discount. Gains and losses on sales of securities are based on the amortized cost of the securities sold.

Securities with significant declines in fair value are evaluated on a quarterly basis to determine whether they should be considered other-than-temporarily impaired under Securities and Exchange Commission Staff Accounting Bulletin No. 59, which provides that if a marketable security is in an unrealized loss position, whether due to general market conditions or industry or issuer specific factors, the holder must assess whether the impairment is other-than-temporary. The Company evaluated the securities in our investment portfolio at March 31, 2007 and December 31, 2006, and concluded that the declines were either not significant or were primarily attributable to increases in interest rates rather than credit quality or other issuer-specific factors. Since the Company had the ability and intent at March 31, 2007, to hold these investments until a recovery occurred or the securities matured, and the carrying cost of any of these securities with any significant declines in value was expected to recover as market interest rates change, the Company did not consider the declines in fair value to be other-than-temporary impairments. No unrealized losses existed at March 31, 2007 and December 31, 2006 with respect to our marketable equity securities, including our Freddie Mac floating rate preferred stocks.

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Table amounts in thousands, except share and per share data)

(unaudited)

Note 4 – Loans Receivable

Loans originated are identified as either held for sale or held for investment and are accounted for accordingly upon their origination. Loans that are classified as held for sale are recorded at the lower of their aggregate cost or market value. The Company sells a portion of its mortgage loan production in the secondary market. The Company obtains sales commitments on certain of these loans immediately prior to making the origination commitment. Net unrealized losses are recognized by charges to income. Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the cost allocated to the servicing rights. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the loan sold.

Premiums and discounts associated with loans purchased are amortized over the expected life of the loan using the level-yield method.

Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the contractual loan term, adjusted for prepayments. Interest income is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not received for loans on nonaccrual status is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Loans receivable are as follows:

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Table amounts in thousands, except share and per share data)

(unaudited)

Note 4 – Loans Receivable (Continued)

Activity in the allowance for loan losses is as follows:

Impaired loans are as follows:

Interest income received on impaired loans was approximately $1.2 million and $235,000 for the three-month periods ended March 31, 2007 and 2006, respectively.

Nonperforming loans are as follows:

Nonperforming loans and impaired loans are defined differently. Some loans may be included in both categories, and some may only be included in one category. Nonperforming loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

As of March 31, 2007, the Company has approximately $15.5 million of one- to four-family residential mortgages and $4.3 million of commercial real estate loans being serviced by a loan servicing company that filed a Chapter 11 bankruptcy petition in late December, 2006. The Bankruptcy Court appointed a Trustee on January 22, 2007, and the case was converted to a Chapter 7 bankruptcy proceeding on March 2, 2007. The Bank terminated its loan servicing arrangements with the debtor effective March 2, 2007, and thereafter transferred the servicing of these loans to a substitute loan servicing company. The Trustee has completed an accounting of all funds and loan documents in the Trustee's possession and has filed a motion with the Bankruptcy Court proposing to distribute all

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Table amounts in thousands, except share and per share data)

(unaudited)

Note 4 – Loans Receivable (Continued)

loan payments that the Trustee collected following his appointment on January 22, 2007 to the owners of the loans, including loan payments aggregating $824,559 that the Trustee collected between the date of his appointment and March 2, 2007, on loans owned by the Bank. The Trustee has also filed a motion requesting the Bankruptcy Court to authorize and direct the debtor’s former loan subservicers to remit loan payments that they collected to the respective owners of the loans. The Trustee has reported to the Bankruptcy Court that the loan servicing trust accounts utilized by the debtor prior to January 22, 2007, are substantially out of balance and are insufficient to pay all of the debtor’s obligations to its former loan servicing clients, including $633,000 that the debtor collected prior to January 22, 2007, on loans owned by the Bank. The Bank made a specific reserve allocation to its allowance for loan and leases for $428,000 on uncollected principal, $104,000 for uncollected interest and $101,000 for uncollected escrow funds. At March 31, 2007 there were $1.6 million of these loans classified as nonperforming, compared to $507,000 at December 31, 2006. The $1.6 million includes $1.1 million in principal payments that were made to the debtor or the Trustee prior to the date that the Company terminated its loan servicing arrangements with the Trustee. The Trustee is proposing a partial distribution of the principal payments due. The Bankruptcy Court has not yet ruled on the Trustee’s motion and one or more creditors may oppose it, leaving the outcome uncertain.

The allowance for loan losses is a valuation allowance for probable incurred credit losses inherent in the loan portfolio. In determining the level of the allowance for loan losses, management considers past and current loss experience, evaluations of collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan, the levels of nonperforming and other classified loans, and other relevant factors. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available, or as later events occur or circumstances change. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers nonclassified loans and is based on historical loss experience adjusted for current factors.

A loan is impaired when full payment under the loan terms is not expected. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.

Note 5 – Deposits

Deposits are as follows:

Certificates of deposit at March 31, 2007 include brokered deposits of $6.4 million, including $2.5 million of brokered internet certificates of deposit, and at December 31, 2006 include $10.4 million including $4.2 million of brokered internet certificates of deposit.

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Table amounts in thousands, except share and per share data)

(unaudited)

Note 5 – Deposits (Continued)

Interest expense on deposit accounts is summarized as follows for the periods indicated:

Note 6 – Other Comprehensive Income

Other comprehensive income components were as follows:

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Table amounts in thousands, except share and per share data)

(unaudited)

Note 7 – New Accounting Standards

In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements,” to provide guidance on how to measure fair value, which would apply broadly to financial and non-financial assets and liabilities that are measured at fair value under other authoritative accounting pronouncements. The statement defines fair value, provides a hierarchy that prioritizes inputs that should be used in valuation techniques used to measure fair value, and expands current disclosures about the use of fair value to measure assets and liabilities. The disclosures focus on the methods used for the measurements and their effect on earnings and would apply whether the assets were measured at fair value in all periods, such as trading securities, or in only some periods, such as for impaired assets. A transition adjustment would be recognized as a cumulative-effect adjustment to beginning retained earnings for the fiscal year in which statement is initially adopted. This adjustment is measured as the difference between the carrying amounts and the fair values of those financial instruments at the date of adoption. The statement is effective January 1, 2008 for calendar-year companies and interim periods within those fiscal years. The Company will adopt the statement on January 1, 2008. The fair value disclosures required by this statement will be effective for the first interim period in which the statement is adopted. The Company is currently evaluating the impact of the statement on its financial position, results of operations, and liquidity.

The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1, 2007. A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The adoption had no material effect on the Company’s financial statements.

The Company and its subsidiary are subject to U.S. federal income tax as well as income tax of the State of Illinois. The Company is no longer subject to examination by these taxing authorities for years before 2003. The Company does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months.

The Company recognizes interest and/or penalties related to income tax matters in income tax expense. At March 31, 2007, the Company had recorded a cumulative accrual of $47,700 pursuant to FIN 48 for potential interest and penalties.

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Cautionary Statement Regarding Forward-Looking Information

Forward Looking Statements

This Quarterly Report on Form 10-Q, including this Item 2, contains, and other periodic reports and press releases of BankFinancial Corporation may contain, forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, that involve significant risks and uncertainties. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of invoking these safe harbor provisions. These forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “plan,” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain and actual results may differ from those predicted. We undertake no obligation to update these forward-looking statements in the future. Factors that could have a material adverse effect on operations and could affect management’s outlook or our future prospects include, but are not limited to: higher than expected overhead, infrastructure and compliance costs, changes in market interest rates, a flattening or inversion of the yield curve, less than anticipated balance sheet growth, lack of demand for loan products, unanticipated changes in secondary mortgage market conditions, deposit flows, pricing, underwriting and other forms of competition, adverse federal or state legislative or regulatory developments, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and Federal Reserve Board, deteriorating economic conditions that could result in increased delinquencies in our loan portfolio, the quality or composition of our loan or investment portfolios, demand for financial services and multi-family, commercial and residential real estate loans in our market area, the possible short-term dilutive effect of potential acquisitions or de novo branches, if any, changes in accounting principles, policies and guidelines, and future adverse developments concerning Freddie Mac or the Federal Home Loan Bank of Chicago. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. We do not undertake any obligation to update any forward-looking statement to reflect circumstances and events that occur after the date on which the forward-looking statement was made.

Critical Accounting Policies

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that the critical accounting policies upon which our financial condition and results of operation depend, and which involve the most complex subjective decisions or assessments, are included in the discussion entitled “Critical Accounting Policies” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in the Company’s Annual Report on Form 10-K, and all amendments thereto, as filed with the Securities and Exchange Commission. There are no material changes to the risk factors disclosed in the Annual Report on Form 10-K filed for the fiscal year ended December 31, 2006.

Overview

This Overview focuses on the first quarter of 2007 and changes from the prior quarter. Comparisons to the first quarter of 2006 are discussed in subsequent sections of this Management’s Discussion and Analysis. Business conditions were consistent with our expectations for the first quarter of 2007. Demand for all types of loans was muted, though there were signs of increasing activity towards the end of the quarter for refinances of residential loans and multi-family loans. Repayments on construction loans (primarily due to project sales activity) significantly outpaced new construction loan originations and draws on existing construction loans. We expect demand for construction loans to continue at a materially reduced pace, and accordingly, do not expect the Company’s construction loan portfolio to return to its recent average balance levels given current market conditions. Originations of commercial leases are traditionally lowest at the beginning of each year, and consequently, principal

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amortizations of our commercial lease portfolio exceeded lease originations during the quarter.

Our asset quality improved during the quarter and we continue to vigorously pursue resolutions of classified assets, particularly in the health care portfolio. Overall portfolio quality trends remained relatively constant. National and local economic risk factors increased slightly during the quarter as measured by our SFAS No. 5 loan loss reserve model; however, we noted that effective occupancies in the multi-family real estate market are stable to increasing and it is thus possible that future increases to effective rents will offset the substantial recent expense increases (primarily real estate taxes and utilities) experienced by some multi-family property investors. Due to the lower levels of overall loan activity in the market, particularly for commercial real estate loans, pressures on underwriting standards continued to intensify, but we believe adherence to our historical loan underwriting standards remains appropriate.

The $581,000 increase in our provision for losses on loans and leases was due primarily to a $428,000 reserve established in connection with the bankruptcy filing by a loan servicing company servicing a portfolio of purchased residential and commercial real estate loans. Excluding this reserve, the Company’s required loan loss reserves increased slightly due to the increase in national and local economic risk factors and the impact of these increased risks on our SFAS No. 5 loan loss reserve model.

Competition for deposits stabilized to some extent during the quarter. Deposit balances declined during the quarter consistent with expected seasonal activity, though we noted that the deposit balances maintained by our title insurance operations declined by $2.1 million, reflecting the lower overall levels of residential mortgage activity in the market.

Though our net interest margin and net interest spread exhibited stable to positive behavior during the past quarter, we believe that narrowing commercial credit spreads, coupled with future deposit migration risk, make it likely that the Company will experience some compression in these vital measurements. The principal drivers of any such compression will be the steadily intensifying pressures on pricing for high-quality organic loan growth, reductions in the risk profile of the loan portfolio due to lower construction loan balances and actions needed to retain valuable commercial credit customers and deposit customers. We also noted that the cumulative effects of the Company’s share repurchase program on the overall level of net interest income will require the Company to further intensify its efforts to increase non-interest bearing deposits.

Non-interest income declined during the quarter consistent with our expectations, reflecting lower activity in deposit-related fees, title insurance sales and Wealth Management operations. Some of this decline appears to be seasonal in nature, but changes in the residential mortgage loan market and expectations concerning interest rates will be among the principal factors affecting title insurance and Wealth Management revenues in future quarters. Future product development activities have the potential to gradually improve deposit-related fee income during the remainder of the year.

Non-interest expense remained well contained. We continue to reduce expenses and staffing levels consistent with the results of our functional reviews, which we expect to complete by the end of the next quarter. We expect expenses for marketing (especially retail deposits and small business customers), commercial business development personnel and audit/compliance functions to increase during the year as we respond to market conditions and changes in applicable laws and regulations.

On February 1, 2007, our Board of Directors declared a quarterly cash dividend of $0.07 per share. The dividend was paid on March 2, 2007 to stockholders of record at the close of business on February 14, 2007.

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Selected Financial Data

The following tables summarize the major components of the changes in our balance sheet at March 31, 2007 and December 31, 2006, and in our income statement for the three-month periods ended March 31, 2007 and March 31, 2006.

N.M. – not meaningful

Footnotes for tables on following page

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Selected Financial Data (Continued)

(Footnotes for tables on previous page)

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Comparison of Financial Condition at March 31, 2007 and December 31, 2006

Total assets decreased $46.2 million, or 2.9%, to $1.567 billion at March 31, 2007, from $1.613 billion at December 31, 2006, due primarily to the combined effect of a $31.6 million net decrease in loans, the maturity of investment securities, and cash expenditures to fund stock repurchases and dividends.

Net loans receivable decreased by $31.6 million, or 2.4%, to $1.298 billion at March 31, 2007, from $1.330 billion at December 31, 2006, primarily due to construction loan repayments resulting from project sales activities. Construction and land loans decreased $16.5 million, or 19.3%, affected in part by a decreased emphasis on originating new loans in this loan category. We received pay downs of $27.9 million on construction and land loans during the current year quarter, compared to $12.2 million during the same period in 2006. Non-residential real estate loans decreased $6.5 million, or 2.0%. One- to four-family residential mortgage loans decreased by $5.8 million, or 1.5%, with the impact of rising interest rates lessening the demand for one- to four-family residential mortgage loans. We continue to concentrate our efforts to originate new loans in targeted loan categories. Multi-family mortgage loans increased $2.4 million, or 0.8% and commercial loans increased $757,000, or 0.9%. Commercial leases decreased $4.8 million, or 3.5%, but commercial lease originations are traditionally lowest at the beginning of each year.

Net securities available for sale decreased by $11.0 million, or 9.3%, to $106.9 million at March 31, 2007, from $117.9 million at December 31, 2006, primarily due to the maturity of a $12 million federal agency discount note. We continue to evaluate the securities available for sale portfolio for opportunities to improve yields and reduce liquidity volatility.

Cash and cash equivalents decreased $1.0 million to $66.3 million at March 31, 2007, from $67.3 million at December 31, 2006.

Other assets decreased by $1.6 million, or 23.3%, to $5.4 million at March 31, 2007, from $7.0 million at December 31, 2006. The decrease in other assets was primarily due to a $927,000 decrease in deferred tax assets that related in part to an increase in the fair value of our investment portfolio during the three months ended March 31, 2007.

Deposits decreased $23.7 million, or 2.1%, to $1.106 billion at March 31, 2007, from $1.230 billion at December 31, 2006. Total core deposits (savings, money market, noninterest bearing demand and NOW accounts) increased slightly as a percentage of total deposits, representing 69.9% of total deposits at March 31, 2007, compared to 69.4% of total deposits at December 31, 2006.

Consistent with our planning, we repaid borrowings in the first quarter of 2007. Borrowings decreased $3.8 million, or 2.8%, to $134.3 million at March 31, 2007, from $138.1 million at December 31, 2006.

Total stockholders’ equity decreased $16.4 million to $309.6 million at March 31, 2007, compared to $326.0 million at December 31, 2006. Retained earnings decreased $37,000 due to our declaration of $1.688 million in cash dividends in February of 2007, which was partially offset by net income of $1.651 million for the first quarter of 2007. Total stockholders’ equity at March 31, 2007, reflected an unrealized gain on securities available for sale of $4.5 million, net of tax, compared to $3.0 million, net of tax, at December 31, 2006. We repurchased and retired 1,131,974 shares of common stock at an aggregate cost of $19.3 million during the first quarter of 2007. The unallocated shares of common stock that are owned by our Employee Stock Ownership Plan (ESOP) were reflected as an $17.9 million reduction to stockholders’ equity at March 31, 2007, compared to an $18.1 million reduction to equity at December 31, 2006.

Comparison of Operating Results for the Three Months Ended March 31, 2007 and 2006

Net Income. We had net income of $1.7 million for the three months ended March 31, 2007, compared to net income of $3.1 million for the three months ended March 31, 2006. Our operating results for the first quarter of

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2007 reflected $1.4 million in expenses for equity-based compensation and benefits, compared to $385,000 for the first quarter of 2006, relating to the ESOP that we established in connection with our mutual-to-stock conversion in June of 2005 and awards granted under the 2006 Equity Incentive Plan that our stockholders approved in June of 2006. Our earnings per share of common stock for the three months ended March 31, 2007 were $0.08 per share, compared to $0.14 per share for the three-month period ending March 31, 2006.

Net Interest Income. Net interest income increased by $216,000, or 1.6%, to $14.0 million for the three months ended March 31, 2007, from $13.8 million for the three months ended March 31, 2006. Our net interest rate spread increased by six basis points to 2.98% for the three months ended March 31, 2007, from 2.92% for the same period in 2006. Factors contributing to the increase in net interest income included a 19 basis point increase in our net interest margin to 3.84% for the three months ended March 31, 2007, a $62.5 million increase in average loans to $1.323 billion from $1.261 billion during the same period in 2006, a $133.3 million decrease in average investment securities available-for-sale to $112.2 million from $245.5 million during the same period in 2006, and a $36.6 million decrease in average interest-bearing liabilities to $1.120 billion, which included a 38.3% decrease in average borrowings, from $1.156 billion during the same period in 2006. Interest income increased $1.5 million, or 6.7%, to $23.8 million for the three months ended March 31, 2007, from $22.3 million for the three months ended March 31, 2006. The increase in interest income reflected a 62 basis point improvement in the average yield on interest-earning assets to 6.51% at March 31, 2007, from 5.89% at March 31, 2006, which was partially offset by $52.5 million, or 3.4%, decrease in total average interest-earning assets, to $1.481 billion for the three months ended March 31, 2007, from $1.534 billion for the same period in 2006.

Interest income from loans, the most significant portion of interest income, increased $2.2 million, or 11.0%, to $21.7 million for the three months ended March 31, 2007, from $19.6 million for the three months ended March 31, 2006. The increase in interest income on loans resulted primarily from a 36 basis point increase in the average yield on loans to 6.66% for the three months ended March 31, 2007, from 6.30% for the same period in 2006, due to higher market interest rates, and a $62.5 million, or 5.0%, increase in the average balance of loans outstanding to $1.323 billion for the three months ended March 31, 2007, from $1.261 billion for the same period in 2006.

Interest income from securities available for sale decreased by $972,000, or 38.9%, to $1.5 million for the three months ended March 31, 2007, from $2.5 million for the three months ended March 31, 2006, due in part to a decrease of $133.3 million, or 54.3%, in the average outstanding balance of securities available for sale to $112.2 million for the three months ended March 31, 2007, from $245.5 million for the same period in 2006. We decided to reduce our portfolio of investment securities available-for-sale throughout 2006 to eliminate certain lower yielding securities and configure our balance sheet in a way that was better positioned for a flat or inverted yield curve environment. Partially offsetting the decrease in average balances in securities available-for-sale was a 139 basis point increase in the yield on securities available-for-sale to 5.51% for the three months ended March 31, 2007, from 4.12% for the same period in 2006.

Income from cash dividends on our Federal Home Loan Bank of Chicago common stock totaled $143,000 for the three months ended March 31, 2007, compared to cash dividends of $192,000 for the three months ended March 31, 2006. The decrease was primarily attributable to the redemption of $9.8 million of our excess Federal Home Loan Bank of Chicago common stock since March 31, 2006.

Interest income from cash that we maintained in interest bearing deposits totaled $385,000 for the three months ended March 31, 2007, compared to $22,000 for the three months ended March 31, 2006. The increase was primarily due to a $28.2 million increase in the average balances of cash maintained in interest bearing deposits and a 97 basis point increase in the yield on interest bearing deposits to 5.15% for the three months ended March 31, 2007, from 4.18% for the same period in 2006.

Interest expense increased $1.3 million, or 15.2%, to $9.8 million for the three months ended March 31, 2007, from $8.5 million for the three months ended March 31, 2006. This increase reflected an increase in the weighted average interest rates that we paid on deposit accounts, and an increase in the average interest rates that we paid on our Federal Home Loan Bank advances, which together resulted in an overall increase of 57 basis points in

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the cost of average interest-bearing liabilities to 3.54% for the three months ended March 31, 2007, from 2.97% for the same period in 2006. The effect of the increase in interest expense was mitigated by a $36.6 million, or 3.1%, decrease in our average interest bearing liabilities to $1.120 billion for the three months ended March 31, 2007, from $1.156 billion for the same period in 2006.

Interest expense on deposits increased $2.0 million, or 32.0%, to $8.3 million for the three months ended March 31, 2007, from $6.3 million for the three months ended March 31, 2006. The increase reflected a 69 basis point increase in the average rate paid on deposits to 3.42% for the three months ended March 31, 2007, from 2.73% for same period in 2006. This increase in interest expense also reflected a $49.0 million, or 5.3%, increase in average interest-bearing deposits to $982.0 million for the three months ended March 31, 2007, from $932.9 million for the same period in 2006. Interest expense on deposits increased for all categories of interest bearing deposits other than savings deposits. The increase in interest expense in non-savings deposits was primarily due to increases in short-term market interest rates and the effect of those increases on the interest rates paid on deposits, including competitive market conditions and increased average balances for money market deposits.

Interest expense on money market account deposits increased $547,000, or 24.8%, reflecting an increase of $11.2 million, or 4.5%, in the average balance of money market account deposits to $258.4 million for the three months ended March 31, 2007, from $247.3 million for the same period in 2006, and a 70 basis point increase in the interest rate paid on money market account deposits to 4.32%, from 3.62% for same period in 2006. Indexed money market accounts deposits had average balances totaling $183.9 million during the three months ended March 31, 2007, compared to $155.8 million for the same period in 2006. The interest rates paid on money market account deposits, certain NOW account deposits and savings account deposits have increased due to increasing short-term market interest rates, changes in applicable indices and increases in rates paid by our competitors. Rates on other selected money market account deposits and certificates of deposit also increased due to market conditions and competitive factors.

Interest expense on NOW account deposits increased $785,000, or 107.4%, reflecting a 93 basis point increase in the interest rates paid on NOW account deposits to 2.28% for the three months ended March 31, 2007, from 1.35% for the same period in 2006, and an increase of $49.1 million, or 22.3%, in the average balance of NOW account deposits to $269.4 million for the three months ended March 31, 2007, from $220.3 million for the same period in 2006.

Interest expense on certificates of deposit increased $708,000, or 23.0%, reflecting a 89 basis point increase in the interest rates paid on certificates of deposit to 4.51% for the three months ended March 31, 2007, from 3.62% for the same period in 2006. The increase in interest expense on certificates of deposit was partially offset by a decrease of $4.3 million, or 1.3%, in the average balance of certificates of deposit to $340.4 million for the three months ended March 31, 2007, from $344.7 million for the same period in 2006. Average balances of wholesale certificates of deposits declined by $20.6 million, or 53.1%, in the first quarter of 2007, compared to the same period in 2006, while average balances for retail certificates of deposit increased by $16.3 million, or 5.3%, for the first quarter of 2007, compared to the same period in 2006.

Interest expense on borrowings decreased by $721,000, or 32.6%, to $1.5 million for the three months ended March 31, 2007, from $2.2 million for the three months ended March 31, 2006. The decrease was due to a $85.6 million, or 38.3%, reduction of our average borrowings to $137.7 million for the three months ended March 31, 2007, from $223.4 million for the same period in 2006, which was partially offset by a 37 basis point increase in interest rates paid on borrowings to 4.38% for the three months ended March 31, 2007, from 4.01% for the same period in 2006.

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Average Balances and Net Interest Margin

The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect of these adjustments would not be material. Average balances are daily average balances. Nonaccrual loans have been 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, where applicable, the effect of deferred fees and expenses, discounts and premiums, purchase accounting adjustments and Federal Home Loan Bank advance prepayment penalties that are amortized or accreted to interest income or expense.