SOUTHERN MISSOURI BANCORP, INC. - Quarter Report: 2006 September (Form 10-Q)

Generally accepted accounting principles are complex and require management to apply significant judgments to various accounting, reporting and disclosure matters. Management of the Company must use assumptions and estimates to apply these principles where actual measurement is not possible or practical. For a complete discussion of the Company's significant accounting policies, see "Notes to the Consolidated Financial Statements" in the Company's 2006 Annual Report. Certain policies are considered critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements. Management has reviewed the application of these policies with the Audit Committee of the Company's Board of Directors. For a discussion of applying critical accounting policies, see "Critical Accounting Policies" beginning on page 11 in the Company's 2006 Annual Report.

Executive Summary

Our results of operations depend primarily on our net interest margin, which is directly impacted by the interest rate environment. The net interest margin is the difference between the average yield earned on average interest-earning assets, primarily mortgage loans, commercial loans and the investment portfolio, and the average rate paid on average interest-bearing liabilities, primarily certificates of deposit, savings, interest-bearing demand accounts and borrowed funds. Net interest margin is directly impacted by the spread between long-term interest rates and short-term interest rates, as our interest-earning assets, particularly those with initial terms to maturity or repricing greater than one year, generally price off longer term rates while our interest-bearing liabilities generally price off shorter term interest rates.

Our net interest income is also impacted by the shape of the market yield curve. A steep yield curve - in which the difference in interest rates between short term and long term periods is relatively large - could be beneficial to our net interest income, as the interest rate spread between our additional interest-earning assets and interest-bearing liabilities would be larger. Conversely, a flat or flattening yield curve, in which the difference in rates between short term and long term periods is relatively small or shrinking, or an inverted yield curve, in which short term rates exceed long term rates, could have an adverse impact on our net interest income, as our interest rate spread could decrease.

Our results of operations may also be affected significantly by general and local economic and competitive conditions, particularly those with respect to changes in market interest rates, government policies and actions of regulatory authorities.

During the first three months of fiscal 2007, we grew our balance sheet by $9.2 million, which was consistent with the growth initiatives we have employed during recent periods. This additional growth reflected a $10.1 million increase in total net loans, a $10.7 million decrease in deposits, and a $19.9 million increase in borrowed funds. The growth in loans was primarily due to commercial loan originations and advances. The increase in borrowed funds was in the form of short-term borrowings from the Federal Home Loan Bank of Des Moines (FHLB).

Our net income for the first quarter of 2007 increased 8.6% to $740,000, as compared to $681,000 earned during the same period of the prior year. The increase in net income was primarily due to a 6.0% increase in net interest income, partially offset by a 3.8% increase in non-interest expense and a 13.7% increase in income tax provisions. During the prior period, the FHLB changed its dividend policy, reducing income by approximately $30,000. Diluted earnings per share for the first quarter of fiscal 2007 was $0.33, as compared to $0.30 for the first quarter of fiscal 2006. For the three month period ended September 30, 2006, our growth in interest income was derived primarily from the overall growth in our balance sheet and the increase in yields earned; the increase in interest expense reflected the growth in our interest-bearing liabilities and increases in prevailing interest rates.

Short-term market interest rates were steady during the first three months of fiscal 2007, following increases during the previous two fiscal years. The Federal Open Market Committee of the Federal Reserve Bank increased the overnight lending rate 25 basis points at each of the regularly scheduled meetings from June 2004 to June 2006, and held the rate steady following meetings in August and September, 2006, at the current rate of 5.25%. Intermediate- and long-term market interest rates have decreased from 20 to 40 basis points during the first three months of fiscal 2007. The result was a continued inversion of the yield curve during the first three months of fiscal 2007. In this rate environment, our net interest margin decreased seven basis points when comparing the first quarter of fiscal 2007 with the corresponding period in 2006, as our interest income, in general, is reflective of long-term rates, while our interest expense, in general, is reflective of short-term rates. The $140,000 increase in net interest income for the first quarter of 2007, when compared to the corresponding period in 2006, reflected growth of 6.2% in our average interest-earning assets, compared to the prior period.

The Company's net income is also affected by the level of non-interest income and operating expenses. Non-interest income consists primarily of service charges, ATM and loan fees, and other general operating income. Operating expenses consist primarily of salaries and employee benefits, occupancy-related expenses, postage, insurance, advertising, professional fees, office expenses, and other general operating expenses. In the three months ended September 30, 2006, compared to the three months ended September 30, 2005, non-interest income increased primarily due to increased collections of loan fees, charges for NSF activity, and income from ATM and check card transactions. In the three months ended September 30, 2006, compared to the three months ended September 30, 2005, non-interest expense increased primarily in the categories of compensation and benefits, as well as occupancy expenses, partially as a result of the Company's opening of a new banking facility in January 2006. Absent the non-interest expenses attributed to that location, non-interest expense would have declined compared to the same period of the prior year.

We expect to continue to grow our assets modestly through the origination and occasional purchase of loans and investment securities. A portion of the current period's loan growth is attributed to the seasonal nature of agricultural lending, and growth for the remainder of the fiscal year is not expected to continue at the same pace. The primary funding for our asset growth is expected to come from retail deposits, short- and long-term FHLB borrowings, and brokered certificates of deposit. We intend to grow deposits by offering desirable deposit products for our existing customers and by attracting new depository relationships. We will continue to explore branch expansion opportunities in market areas that we believe present attractive opportunities for our strategic business model.

Comparison of Financial Condition at September 30, 2006, and June 30, 2006

The Company's total assets increased by $9.2 million, or 2.6%, to $359.9 million at September 30, 2006, as compared to $350.7 million at June 30, 2006. Loans, net of the allowance for loan losses, increased $10.2 million, or 3.6%, to $291.1 million, as compared to $280.9 million at June 30, 2006. The Company continues to focus on origination of commercial loans, resulting in growth of $9.6 million in commercial loan balances. Cash balances decreased $2.0 million, or 31.6%, to $4.4 million, as compared to $6.4 million at June 30, 2006.

Asset growth during the first three months of fiscal 2007 has been funded primarily with short-term FHLB borrowings. At June 30, 2006, the Company had no short-term FHLB borrowings; at September 30, 2006, short-term FHLB borrowings totaled $22.9 million. During the first three months of fiscal 2007, one FHLB advance of $3.0 million was called, and the Company replaced this funding with short-term borrowings. The remaining $19.9 million increase in short-term borrowings was due to asset growth and decreases in deposit balances. FHLB advances totaled $65.9 at September 30, 2006, compared to $46.0 million at June 30, 2006. At September 30, 2005, FHLB advances totaled $67.8 million. Deposits decreased $10.8 million, or 4.2%, to $247.3 million at September 30, 2006, as compared to $258.1 million at June 30, 2006. At September 30, 2005, deposits totaled $231.5 million. The decrease in total deposits was primarily due to the net maturity of $4.6 million in brokered certificates of deposit, along with a $4.3 million decrease in money market passbook deposits. Securities sold under agreements to repurchase decreased $1.5 million, or 12.9%; the decrease was attributed primarily to normal balance fluctuations with customers holding the agreements.

Total stockholders' equity increased $830,000, or 3.1%, to $27.4 million at September 30, 2006, as compared to $26.6 million at June 30, 2006. The increase was primarily due to retention of net income and an increase in the market value of the available-for-sale investment portfolio, partially offset by cash dividends paid.

Average Balance Sheet for the Three Months Ended September 30, 2006 and 2005

The table on the following page presents certain information regarding Southern Missouri Bancorp, Inc.'s financial condition and net interest income for the three-month periods ending September 30, 2006 and 2005. The table presents the annualized average yield on interest-earning assets and the annualized average cost of interest-bearing liabilities. We derived the yields and costs by dividing annualized income or expense by the average balance of interest-earning assets and interest-bearing liabilities, respectively, for the periods shown. Yields on tax-exempt obligations were not computed on a tax equivalent basis.

Results of Operations - Comparison of the three month periods ended September 30, 2006 and 2005

General. Net income for the three month period ended September 30, 2006, was $740,000, as compared to net income of $681,000 earned during the same period of the prior year. Basic and diluted earnings per share were $0.33 for the first quarter of fiscal 2007, compared to $0.31 and $0.30, respectively, for the first quarter of fiscal 2006. Our annualized return on average assets was .83% for the first three months of fiscal 2007 compared to .81% for the first three months of fiscal 2006. Our return on average stockholders' equity was 10.96% for the first three months of fiscal 2007, compared to 10.81% for the first three months of fiscal 2006.

Net Interest Income. Net interest income for the three months ended September 30, 2006 increased $140,000 as compared to the same period of the prior year. This increase primarily reflected our growth initiatives that resulted in increases in the average balances of both interest-earning assets and interest-bearing liabilities, and was partially offset by a decrease in our net interest rate spread. Our net interest rate spread was 2.67% for the three-month period ended September 30, 2006, as compared to 2.74% for the same period of the prior year. For the first quarter of fiscal 2007, our net interest margin, determined by dividing the annualized net interest income by total average interest-earning assets, was 2.98%, equal to our net interest margin for the same period of the prior year. The decrease in net interest rate spread for the three-month period ended September 30, 2006, resulted from an 85 basis point increase in the weighted-average cost of funds, partially offset by a 78 basis point increase in the weighted-average yield on interest-earning assets. Net interest rate spread compression during the last twelve months was attributed to repricing of liabilities at relatively higher short-term rates, while asset repriced at a slower pace and based on relatively lower longer-term interest rates. Absent the Company's recent focus on origination of commercial and commercial real estate loans, spread compression likely would have been more pronounced.

Interest Income. Total interest income for the three-month period ended September 30, 2006, increased by $936,000, or 19.7%, to $5.7 million. The increase was due to a $19.4 million, or 6.2%, increase in the average balance of interest-earning assets, to $333.7 million, and a 78 basis point increase in the yield earned on those assets. For the three month period ended September 30, 2006, the average interest rate on interest-earning assets was 6.82%, as compared to 6.04% for the same period of the prior year.

Interest Expense. Total interest expense for the three-month period ended September 30, 2006, increased by $796,000, or 33.1%, to $3.2 million. The increase was due to a $16.5 million, or 5.7%, increase in the average balance of interest-bearing liabilities, to $308.0 million, and the increase in the weighted average cost of funds of 85 basis points. The increase in the average balance of interest-bearing liabilities was primarily due to funding needed to provide for asset growth.

Provision for Loan Losses. The provision for loan losses for the three-month period ended September 30, 2006, was $125,000, as compared to $120,000 for the same period of the prior year. The Company's recent growth in its commercial and commercial real estate loan balances has required increased provisions for loan losses, as those loan types generally carry additional risk. Although we believe that we have established and maintained the allowance for loan losses at adequate levels, additions will be necessary as the loan portfolio grows, as economic conditions change, and as other conditions differ from the current operating environment. Even though we use the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short-term change. (See "Critical Accounting Policies", "Allowance for Loan Loss Activity" and "Nonperforming Assets").

Non-interest Income. Non-interest income increased $37,000, or 6.9%, to $577,000 for the three-month period ended September 30, 2006, as compared to $540,000 for the same period of the prior year. The increase was primarily due to increased collections of loan fees, charges for NSF activity, and income from ATM and check card transactions.

Non-interest Expense. Non-interest expense increased $65,000, or 3.8%, to $1.8 million for the three-month period ended September 30, 2006, as compared to $1.7 million for the same period of the prior year. The increase in non-interest expense was primarily due to increased salaries and benefits, as well as increased occupancy expenses. The Company opened a new banking facility in January 2006. Absent the non-interest expenses attributed to that location, non-interest expense would have declined by 2.5%, compared to the same period of the prior year. As the Company continues to grow its balance sheet, non-interest expense will continue to increase due to compensation, expenses related to expansion, and inflation. Our efficiency ratio, determined by dividing total non-interest expense by the sum of net interest income and non-interest income, was 58.6% for the first quarter of fiscal 2007, as compared to 60.0% for the same period of the prior year.

Income Taxes. Provisions for income taxes for the three-month period ended September 30, 2006, increased $49,000, or 13.7%, to $404,000, as compared to $356,000 for the same period of the prior year. The increase in provisions for income taxes was primarily due to increased net income before income taxes. Our effective tax rate for the first three months of fiscal 2007 was 35.3%, as compared to 34.3% for the same period of the prior year. The increase in the effective tax rate was primarily due to a decrease in the amount of net loan charge offs.

Allowance for Loan Loss Activity

The Company regularly reviews its allowance for loan losses and makes adjustments to its balance based on management's analysis of the loan portfolio, the amount of non-performing and classified assets, as well as general economic conditions. Although the Company maintains its allowance for loan losses at a level that it considers sufficient to provide for losses, there can be no assurance that future 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 loss provisions. The following table summarizes changes in the allowance for loan losses over the three months ended September 30, 2006 and 2005:

The allowance for loan losses has been calculated based upon an evaluation of pertinent factors underlying the various types and quality of the Company's loans. Management considers such factors as the repayment status of a loan, the estimated net fair value of the underlying collateral, the borrower's intent and ability to repay the loan, local economic conditions, and the Company's historical loss ratios. We maintain the allowance for loan losses through the provisions for loan losses that we charge to income. We charge losses on loans against the allowance for loan losses when we believe the collection of loan principal is unlikely. The allowance for loan losses increased $100,000 to $2.2 million at September 30, 2006, from $2.1 million at June 30, 2006. At September 30, 2006, the Bank had $1.0 million, or .28% of total assets adversely classified (substandard, doubtful, or loss) as compared to adversely classified assets of $1.6 million, or .48% of assets at September 30, 2005. At September 30, 2006, the Company had classified assets as substandard and doubtful in the amount of $991,000 and $11,000, respectively.

PART I: Item 4: Controls and Procedures
SOUTHERN MISSOURI BANCORP, INC.

An evaluation of Southern Missouri Bancorp's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended, (the "Act")) as of September 30, 2006, was carried out under the supervision and with the participation of our Chief Executive and Financial Officer, and several other members of our senior management. The Chief Executive and Financial Officer concluded that, as of September 30, 2006, the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to management (including the Chief Executive and Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Act) that occurred during the quarter ended September 30, 2006, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The Company does not expect that its disclosures and procedures will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies evaluate and annually report on their systems of internal control over financial reporting. In addition, our independent accountants must report on management's evaluation of its internal control over financial reporting. We are in the process of reviewing our options regarding documentation and testing of internal control over financial reporting to provide the basis for our report that will, for the first time, be a required part of our annual report on Form 10-K for the fiscal year ending June 30, 2008. Due to the ongoing evaluation and testing of our internal controls, there can be no assurance that, if any control deficiencies are identified, they will be remediated before the end of the 2008 fiscal year, or that there may not be significant deficiencies or material weaknesses that would be required to be reported. In addition, we expect the evaluation process and any required remediation, if applicable, to increase our accounting, legal and other costs and divert management resources from core business operations.

PART II: Other Information
SOUTHERN MISSOURI BANCORP, INC.

Item 1: Legal Proceedings

Except as set forth below, in the opinion of management, the Bank is not a party to any pending claims or lawsuits that are expected to have a material effect on the Bank's financial condition or operations. Periodically, there have been various claims and lawsuits involving the Bank mainly as a defendant, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank's business. Aside from such pending claims and lawsuits, which are incident to the conduct of the Bank's ordinary business, the Bank is not a party to any material pending legal proceedings that would have a material effect on the financial condition or operations of the Bank.

In April 2005, the Bank discovered there had been an adverse development with respect to a substandard loan that resulted from allegedly fraudulent activities on the part of the borrower. To date, we have liquidated all assets of the borrower of which we were able to take possession, and have incurred charge-offs of $4.7 million. At September 30, 2006, the Bank no longer reports any amount of this loan relationship, or any collateral related thereto, as an asset. The resolution of the borrower's assets has resulted in litigation between the Bank and another financial institution with non-performing loans to the same borrower, as well as several other entities, including the accounting firm which performed audits on said borrower. The litigation is based on who was the rightful lien holder of various assets of the borrower. To the extent this litigation is settled or resolved in favor of the Bank, a portion of the amounts charged off could be recovered. The Company cannot predict whether or to what extent such a recovery may occur.

Item 1a: Risk Factors

There have been no material changes to the risk factors set forth in Part I, Item 1A of the Company's Annual Report on Form 10-K for the year ended June 30, 2006.

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

Item 3: Defaults upon Senior Securities

Not applicable

Item 4: Submission of Matters to a Vote of Security Holders

On October 16, 2006, the Company held its Annual Meeting of Stockholders.

At the meeting Mr. Greg A. Steffens, Mr. Samuel H. Smith, and Mr. L. Douglas Bagby were elected to three-year terms to expire in 2009, and the Company's proposal to appoint BKD, LLP as the Company's auditors for the fiscal year ending June 30, 2007, was also approved.

The results of the voting on each of the proposals were as follows:

Item 5 - Other Information

None

Item 6 - Exhibits

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.

		SOUTHERN MISSOURI BANCORP, INC. Registrant
Date:	November 13, 2006	/s/ James W. Tatum James W. Tatum Chairman of the Board of Directors
Date:	November 13, 2006	/s/ Greg A. Steffens Greg A. Steffens President (Principal Executive, Financial and Accounting Officer)

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