BankFinancial CORP - Quarter Report: 2009 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, 2009

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨     No  ¨.

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

Indicate the number of shares outstanding of each of the Issuer’s classes of common stock as of the latest practicable date. 21,448,377 shares of Common Stock, par value $0.01 per share, were issued and outstanding as of April 27, 2009.

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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, 2009 and December 31, 2008

(In thousands, except share and per share data)

(Unaudited)

See accompanying notes to consolidated financial statements.

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BANKFINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

Three months ended March 31, 2009 and 2008

(In thousands, except share and 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, 2009 and 2008

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

See accompanying notes to consolidated financial statements.

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BANKFINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOW

Three months ended March 31, 2009 and 2008

(In thousands) - (Unaudited)

(Continued)

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BANKFINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOW

Three months ended March 31, 2009 and 2008

(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”), is the owner of all of the issued and outstanding capital stock of BankFinancial, F.S.B. (the “Bank”). On March 15, 2008, Financial Assurance Services, Inc. (“Financial Assurance”), a wholly-owned subsidiary of the Bank, completed the sale of its title insurance agency business to a newly formed, third-party title insurance agency. The sale of the title insurance agency business does not affect the Bank’s other insurance businesses, such as the property, casualty and life insurance and fixed annuity products that the Bank sells through Financial Assurance. The transaction had no material impact on the Company’s total assets, stockholders’ equity or net income.

As used in this Quarterly Report on Form 10-Q, the words “Company,” “we” and “our” are intended to refer to the Company, the Bank, and the Bank’s subsidiaries, with respect to information presented for the three-month period ended March 31, 2009.

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, 2009, are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2009.

Certain information and note disclosures normally included in financial statements 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 them to 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, 2008, 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.

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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 (loss) are as follows:

Mortgage-backed securities and collateralized mortgage obligations consisted of Freddie Mac, Fannie Mae and Ginnie Mae issues at March 31, 2009 and December 31, 2008. Equity securities consisted of Freddie Mac preferred stock at March 31, 2009 and December 31, 2008. All of our investment securities reflected in the preceding table were classified as available-for-sale at March 31, 2009.

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.

The Company evaluates marketable investment securities with significant declines in fair value on a quarterly basis to determine whether they should be considered other-than-temporarily impaired under the current accounting guidance, 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 of the securities must assess whether the impairment is other-than-temporary.

The shares of Freddie Mac preferred stock that the Company holds in its investment portfolio experienced significant declines in fair value (as measured by quoted market prices for these securities) during the year ended December 31, 2008 and the three months ended March 31, 2009 due to a variety of market conditions and issuer-specific factors, including the placing of Freddie Mac into a conservatorship, Freddie Mac’s issuance of new shares of preferred stock that are senior to all previously issued preferred shares, and Freddie Mac’s suspension of dividends on all previously issued preferred shares. The Company evaluated its shares of Freddie Mac preferred stocks at March 31, 2009 for impairment, and concluded that the unrealized losses that existed at that date did not constitute an other-than-temporary impairment under the current accounting guidance.

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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 aggregate cost or estimated fair market value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the fair value of the servicing right. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

Premiums and discounts associated with loans purchased are amortized over the contractual term 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 a loan is 90 days delinquent unless the loan is well-secured and there are no asserted or pending legal barriers to its 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 placed 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 status. 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:

Cash basis interest income received on impaired loans was approximately $251,000 and $390,000 for the three-month periods ended March 31, 2009 and 2008, respectively.

Nonaccrual loans and loans past due 90 days still on accrual are as follows:

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

The $2.4 million in loans reflected in the above table as “90 days delinquent, still accruing,” represent four well-secured loans in the process of collection. Generally, the Bank does not utilize this category of loan classification unless: (1) the loan is repaid in full shortly after the period end date; (2) the loan is well secured and there are no asserted or pending legal barriers to its collection; or (3) the borrower has remitted all scheduled payments and is otherwise in substantial compliance with the terms of the loan, but the processing of payments actually received or the renewal of a loan has not occurred for administrative reasons.

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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)

The allowance for loan losses is a valuation allowance for probable incurred credit losses inherent in the loan portfolio. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience; the nature and volume of the portfolio; information about specific borrower situations; and estimated collateral values, economic conditions, and other 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. Multi-family, nonresidential real estate, construction, land, and commercial loans and leases 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:

Interest expense on deposit accounts is summarized 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 6 – Fair Values of Financial Instruments

Financial Accounting Standards Board (“FASB”) Statement No. 157 Fair Value Measurements establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The fair values of marketable equity securities available-for-sale are generally determined by quoted prices, in active markets, for each specific security (Level 1 measurement inputs). If Level 1 measurement inputs are not available for a marketable equity security, the fair value is determined based on the quoted price of a similar security traded in an active market (Level 2 measurement inputs). The fair values of debt securities available-for-sale are generally determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 measurement inputs).

The fair values of loans held for sale are generally determined by quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets (Level 2 measurement inputs).

Impaired loans are evaluated at the time the loan is identified as impaired, and are recorded at the lower of carrying value or fair value. Fair value is measured based on the value of the collateral securing these loans and is classified at a Level 2 in the fair value hierarchy. Collateral may be real estate and/or business assets, including equipment, inventory and/or accounts receivable, and its fair value is generally determined based on real estate appraisals or other independent evaluations by qualified professionals. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

The fair values of mortgage servicing rights are based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 measurement inputs).

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(unaudited)

Note 6 – Fair Values of Financial Instruments (continued)

The following table sets forth the Company’s financial assets that were accounted for at fair value and are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

The following table sets forth the Company’s assets that were measured at fair value on a non-recurring basis:

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral-dependent loans, had a carrying amount of $11.8 million, with a valuation allowance of $2.0 million at March 31, 2009, compared to a carrying amount of $10.1 million, with a valuation allowance of $2.7 million December 31, 2008, resulting in a credit to the provision for specific loan losses related to SFAS No. 114, Accounting by Creditors for Impairment of a Loan of $661,000 for the three months ended March 31, 2009.

Mortgage servicing rights, which are carried at lower of cost or fair value, had a carrying amount of $1.7 million at March 31, 2009, comprised of $1.1 million on fixed rate loans and $565,000 on adjustable rate loans, including a valuation allowance of $183,000 on mortgage servicing rights of the fixed rate loans. A pre-tax charge of $73,000 was included in net income as an additional reserve on our mortgage servicing rights portfolio for the three month period ended March 31, 2009, compared to $194,000 recorded for the same period 2008. Mortgage servicing rights had a carrying amount of $1.8 million at December 31, 2008, comprised of $1.2 million on fixed rate loans and $629,000 on adjustable rate loans, including a valuation allowance of $110,000 on mortgage servicing rights of the fixed rate loans.

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(unaudited)

Note 7 – Other Comprehensive Income (Loss)

Other comprehensive income (loss) components were as follows:

Note 8 – Adoption of New Accounting Standards

In December 2007, the FASB issued SFAS No. 141R (revised 2007), Business Combinations (“SFAS 141R”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. SFAS No. 141R is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of this standard is not applicable unless the Company enters into a business combination.

On October 10, 2008, the FASB issued FASB Staff Position (“FSP”) 157-3, Determining the Fair Value of a Financial Assets When the Market for that Asset is Not Active, which provides an example that illustrates key considerations in determining the fair value of a financial asset when the market for that asset is not active. The FSP does not change existing U.S. generally accepted accounting principles. The FSP provides clarification on how to consider various inputs in determining fair value under current market conditions consistent with the principles of FSP 157. The FSP includes only one example, as the FASB emphasized the need to apply reasonable judgment to each specific fact pattern. Several additional concepts addressed in the FSP include distressed sales, the use of third party pricing information, the use of internal assumptions and the relevance of observable data, among others. This FSP was effective upon issuance, including prior periods for which financial statements have not been issued. The impact of adoption did not have a material impact on the Company’s consolidated financial position or results of operations.

In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities an Amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 amends Statement 133 by requiring expanded disclosures about an entity’s derivative instruments and hedging activities, but does not change Statement 133’s scope or accounting. This statement requires increased qualitative, quantitative, and credit-risk disclosures. SFAS 161 also amends Statement No. 107 to clarify that derivative instruments are subject to Statement 107’s concentration-of-credit-risk disclosures. SFAS 161 is effective for fiscal years beginning on or after November 15, 2008. The impact of adoption did not have a material impact on the Company’s consolidated financial position or results of operations.

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BANKFINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(unaudited)

Note 8 – Adoption of New Accounting Standards (continued)

In June 2008, the FASB issued FASB Staff Position EITF 03-6-1—Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. (FSP EITF 03-6-1). This FASB Staff Position (FSP) addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (EPS) under the two-class method of FASB Statement No. 128, Earnings Per Share. FSP EITF 03-6-1 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. This FSP was effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period EPS data presented were to be adjusted retrospectively (including interim financial statements, summaries of earnings, and selected financial data) to conform with the provisions of this FSP. The Company’s unvested restricted stock awards do not contain nonforfeitable rights to dividends, they are not included under the scope of this pronouncement, and therefore, the impact of adoption was not material.

Note 9 – Newly Issued But Not Yet Effective Accounting Standards

In April 2009 the FASB issued FSP 115-2 & 124-2 Recognition and Presentation of Other-Than Temporary Impairments. The FSP eliminates the requirement for the issuer to evaluate whether it has the intent and ability to hold an impaired investment until maturity. Conversely, the new FSP requires the issuer to recognize an OTTI in the event that the issuer intends to sell the impaired security or in the event that it is more likely than not that the issuer will sell the security prior to recovery. In the event that the sale of the security in question prior to its maturity is not probable but the entity does not expect to recover its amortized cost basis in that security, then the entity will be required to recognize an OTTI. In the event that the recovery of the security’s cost basis prior to maturity is not probable and an OTTI is recognized, the FSP provides that any component of the OTTI relating to a decline in the creditworthiness of the debtor should be reflected in earnings, with the remainder being recognized in Other Comprehensive Income. Conversely, in the event that the issuer determines that sale of the security in question prior to recovery is probable, then the entire OTTI will be recognized in earnings. The FSP is effective for interim and annual reporting periods ending after June 15, 2009. The Company does not expect the adoption to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In April 2009 the FASB issued FSP 157-4 Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. The FSP provides additional guidance for determining fair value based on observable transactions. The FSP provides that if evidence suggests that an observable transaction was not executed orderly that little, if any, weight should be assigned to this indication of an Asset or Liability’s fair value. Conversely, if evidence suggests that the observable transaction was executed orderly that the transaction price of the observable transaction may be appropriate to use in determining the fair value of the Asset/Liability in question, with appropriate weighting given to this indication based on facts and circumstances. Finally, if there is no way for the entity to determine whether the observable transaction was executed orderly, relatively less weight should be ascribed to this indicator of fair value. The FSP is effective for interim and annual reporting periods ending after June 15, 2009. The Company does not expect the adoption to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In April 2009 the FASB issued FSP 107-1 & APB 28-1 Interim Disclosures about Fair Value of Financial Instruments. The FSP provides that publicly traded companies shall provide information concerning the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. In periods after initial adoption this FSP requires comparative disclosures only for periods ending after initial adoption. The FSP is effective for interim reporting periods ending after June 15, 2009.

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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 and special 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 the purpose of invoking these safe harbor provisions. Forward-looking statements are based on certain assumptions or describe our future plans, strategies and expectations, and 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 plans or strategies is inherently uncertain, and actual results may differ from those predicted. 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, changes in the yield curve, balance sheet shrinkage or less than anticipated balance sheet growth, lack of demand for loan products, illiquidity and changes in financial markets, including the market for mortgage backed securities and other debt obligations, declining demand for real estate and real estate valuations, increasing unemployment levels, 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, adverse economic conditions that could result in increased delinquencies in our loan portfolio or a decline in the value of our investment securities and the collateral for our loans, 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 areas, the possible short-term dilutive effect of potential acquisitions or de novo branches, if any, changes in accounting principles, policies and guidelines, increased costs of federal deposit insurance, and future adverse developments concerning 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 in the future, or 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 for the fiscal year ended December 31, 2008, and all amendments thereto, as filed with the Securities and Exchange Commission. There are no material changes to the critical accounting policies disclosed in the Annual Report on Form 10-K.

Overview

Business conditions continued to exhibit significantly divergent characteristics in the first quarter of 2009. New loan and lease opportunities are increasingly available at quite attractive pricing, but uncertainties regarding forward corporate earnings and, in particular, concerns about investment real estate valuations, caused us to be even more conservative than our underwriting standards would otherwise dictate. Similarly, the competitive environment for deposits is more favorable than at any time in the recent past, but the unpredictability of future net loan growth and the very low returns on investment securities limited our interest in more aggressive deposit growth. Local economic conditions remain fragile, with rising unemployment affecting the retail sales and service sectors to a greater degree than in the previous quarter.

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Multi-family loan balances increased modestly due to favorable competitive conditions and a broader geographic market territory. Commercial real estate loan balances were stable as fewer real estate investors are willing to enter or exit the market. Commercial leasing activity increased materially, but net balance growth remained limited because of the short amortization periods generally applicable to the existing commercial lease portfolio. Commercial loan balances declined slightly due to lower working capital usage by some borrowers; this trend could accelerate if the State of Illinois improves the frequency of remittances to certain health-care borrowers.

Residential loan balances increased due to a larger quantity of loans held for sale in the secondary market and increased home equity line of credit usage resulting primarily from seasonal factors. Construction loans balances declined due to project sales, as we continued to pursue prudent inventory liquidation avenues with borrowers where necessary.

Deposits increased during the quarter, principally due to increased marketing efforts and a considerably more favorable competitive environment, especially for retail certificates of deposit. Our focus on retaining core deposit relationships within current FDIC insurance limits resulted in the stabilization of such deposit balances within product lines that are not indexed to current market rates. Given these conditions, we reduced wholesale deposit and other borrowing balances during the quarter and we expect to continue doing so as conditions further permit.

Overall trends in our owner-occupied residential and multi-family loan portfolios remained stable. A modest negative trend emerged in investor-owned single-family buildings, but in at least two of the three situations encountered, the borrowers failed to remit rental income they received from occupied properties due to unrelated cash flow issues. The current and anticipated supply of single-family residences on the market will likely result in longer holding periods for some of these properties following the conclusion of formal collection action, but we do not expect any material negative financial impact from these trends at present.

The significantly extended absorption periods for new single-family construction and individual building sites resulted in a total of $8.8 million in loans being placed on non-accrual status during the quarter due to the exhaustion of the borrowers’ ability to continue debt service on a cash basis. Of the total $9.4 million in non-accrual loans within this segment, approximately $5.2 million is secured by three completed single-family homes in the northern suburbs of Chicago, and the remaining balance is secured by several individual building sites for single-family homes, one small single-family attached development parcel and two small commercial parcels located in similar markets. Given our extensive real estate development management experience, we are prepared to retain certain improved development sites for future disposition if the underlying facts and circumstances make it materially financially advantageous for us to do so.

We began to see some signs of stress in the commercial real estate portfolio, both with respect to investment and owner-occupied real estate. Some retail tenants are requesting and receiving rental reductions and office space absorption remains weak due to the contraction of economic activity generally. During the quarter, we placed $3.8 million of commercial real estate loans on non-accrual status, including a $2.7 million loan secured by a northwest suburban Chicago industrial / office building for which the borrower had exhausted family financial resources to pay debt service and leasing agency services. The remaining increase in non-accruing commercial real estate loans is due to two situations where the borrower’s business cash flow difficulties resulted in the borrower’s failure to remit existing rental income or were simply insufficient to continue debt service payments as scheduled. In general, we pursue both informal and formal collection actions designed to maximize occupancy or locate an alternative user or investor for the collateral or the business itself on an expedited basis wherever possible.

It should also be noted that the Circuit Court of Cook County, Illinois, in which a substantial majority of our real estate collateral is located, recently issued an order suspending the entry of judgments and orders of sale in any mortgage foreclosure suit filed in 2009 and default judgments in previously filed suits until at least September 1, 2009, subject to certain limited exceptions. We are unable to predict the impact of this action on borrower behavior and its effect on market inventory and valuation levels at this time, but we anticipate that, at the very least, the inability to promptly pursue all available collection remedies will delay the full realization of real estate collateral proceeds and thus the reduction of non-accrual credit exposures.

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Overall trends in our commercial lease and commercial loan portfolios remained stable; however, we anticipate that economic conditions will place increasing stress on smaller businesses in general and any business relating to domestic automobile manufacturing or construction services. Our largest exposure to the automotive sector is a $1.2 million commercial lease exposure to Daimler-Chrysler LLC, originated in 2006-2007, which is secured by manufacturing equipment with a remaining weighted-average term to maturity of 30.7 months. The material uncertainties regarding both the company and any related U.S. Government action make it at least reasonably foreseeable that some or all of this exposure may become uncollectable in the future depending on the timing of any interruption in payments and the net realizable value of the collateral.

Our net interest margin and net interest spread declined modestly, principally due to the effects of the increase in loans on nonaccrual status offsetting growth in loan interest income during the quarter. Given the volatility in market interest rates, prospective loan and deposit balances and other factors, we believe that it is not presently possible to reliably make accurate statements concerning net interest margin and net interest spread trends for the immediate future.

Our non-interest income decreased during the quarter due in part to reduced deposit-related fee income related to reductions in retail spending. Other factors affecting non-interest income included our decision to move our Bank-Owned Life Insurance investment into a low-yielding money-market sub-account at the end of 2008 as a means to protect its underlying value, a required valuation allowance that we recorded on our mortgage loan servicing rights based on market conditions, and higher management or disposition costs for real estate owned.

Our non-interest expenses remained well-contained, with increases in compensation related to seasonal payroll tax factors and certain benefit costs related to terminated employees. Continued discipline on operating expenses, including the completion of all remaining functional reviews, remains a key focus for the balance of 2009.

Selected Financial Data

The following tables summarize the major components of the changes in our balance sheet at March 31, 2009 and December 31, 2008, and in our income statement for the three-month periods ended March 31, 2009 and March 31, 2008.

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Selected Financial Data (continued)