10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2011

OR

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

For the transition period from _____________ to ____________

Commission File Number 00-50347

JEFFERSON BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Tennessee		45-0508261
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)
120 Evans Avenue, Morristown, Tennessee		37814
(Address of principal executive offices)		(Zip code)
	(423) 586-8421
	(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 90days.      Yes x  No  o

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 (Section 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 x    No o

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

Large Accelerated Filer ¨	Accelerated Filer  ¨
Non-Accelerated Filer ¨	Smaller Reporting Company x
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   o    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

At February 14, 2012, the registrant had 6,632,039 shares of common stock, $0.01 par value per share, outstanding.

INDEX

PART I.  FINANCIAL INFORMATION

Item 1.	Financial Statements	Page
	Consolidated Statements of Condition - Unaudited
	Six months ended December 31, 2011 and year ended June 30, 2011	3
	Consolidated Statements of Earnings - Unaudited
	Three and six months ended December 31, 2011 and 2010	4
	Consolidated Statements of Changes in Stockholders’ Equity – Unaudited
	Six months ended December 31, 2011 and 2010	5
	Consolidated Statements of Cash Flows - Unaudited
	Six months ended December 31, 2011 and 2010	6
	Notes to Consolidated Financial Statements - Unaudited	7
Item 2.	Management’s Discussion and Analysis of
	Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	35
Item 4.	Controls and Procedures	35
	PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	36
Item 1A.	Risk Factors	36
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 3.	Defaults Upon Senior Securities	36
Item 4.	Mine Safety Disclosures	37
Item 5.	Other Information	37
Item 6.	Exhibits	37

SIGNATURES

2

PART I.   FINANCIAL INFORMATION

Item 1.  Financial Statements

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY
Consolidated Balance Sheets
(Dollars in Thousands)
	December 31,			June 30,
	2011			2011
Assets	(Unaudited)
Cash and cash equivalents	$	5,419		$	5,327
Interest-earning deposits		30,328			35,221
Investment securities classified as available for sale, net		77,990			74,780
Federal Home Loan Bank stock		4,735			4,735
Bank owned life insurance		6,744			6,625
Loans receivable, net of allowance for loan losses of $10,880 and $8,181		351,827			378,587
Loans held-for-sale	916				-
Premises and equipment, net		26,102			26,617
Foreclosed real estate, net		8,902			9,498
Accrued interest receivable:
Investments		352			311
Loans receivable		1,500			1,521
Deferred tax asset		11,479			9,009
Core deposit intangible		1,748			1,978
Other assets		2,357			6,980
Total Assets	$	530,399		$	561,189
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing	$	51,696		$	54,340
Interest-bearing		380,250			399,922
Repurchase agreements		820			945
Federal Home Loan Bank advances		37,903			37,942
Subordinated debentures		7,189			7,133
Other liabilities		936			4,988
Total liabilities		478,794			505,270
Commitments and contingent liabilities		-			-
Stockholders' equity:
Preferred stock, $.01 par value; 10,000,000 shares
authorized; no shares issued or outstanding
Common stock, $.01 par value; 30,000,000 shares authorized;
9,182,372 shares issued and 6,632,039 shares outstanding at
December 31, 2011 and 6,634,523 shares outstanding at June 30, 2011		92			92
Additional paid-in capital		78,740			78,895
Unearned ESOP shares		(3,025	)		(3,241	)
Unearned compensation		(1,046	)		(1,019	)
Accumulated other comprehensive income		743			459
Retained earnings		7,442			12,067
Treasury stock, at cost (2,550,333 and 2,547,849 shares)		(31,341	)		(31,334	)
Total stockholders' equity		51,605			55,919
Total liabilities and stockholders' equity	$	530,399		$	561,189

See accompanying notes to financial statements.

3

Jefferson Bancshares, Inc. and Subsidiary
Consolidated Statements of Earnings (Unaudited)
(Dollars in Thousands, Except Net Earnings Per Share)
	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2011			2010			2011			2010
Interest income:
Interest on loans receivable	$	5,265		$	6,112		$	10,837		$	12,394
Interest on investment securities		450			409			934			891
Other interest		60			109			124			201
Total interest income		5,775			6,630			11,895			13,486
Interest expense:
Deposits		800			1,534			1,756			3,197
Repurchase agreements		1			2			3			4
Advances from FHLB		320			582			640			1,343
Subordinated debentures		82			80			159			162
Total interest expense		1,203			2,198			2,558			4,706
Net interest income		4,572			4,432			9,337			8,780
Provision for loan losses		5,687			950			8,673			950
Net interest income after provision for loan losses		(1,115	)		3,482			664			7,830
Noninterest income:
Mortgage origination fee income		101			224			196			364
Service charges and fees		284			315			576			671
Gain on investments		13			743			39			752
Gain (loss) on sale of fixed assets		-			-			(19	)		-
Gain (loss) on sale of foreclosed real estate, net		(63	)		(58	)		(79	)		(405	)
BOLI increase in cash value		60			59			119			119
Other		183			161			349			333
Total noninterest income		578			1,444			1,181			1,834
Noninterest expense:
Compensation and benefits		1,525			1,703			3,131			3,444
Occupancy expense		351			358			713			722
Equipment and data processing expense		605			610			1,207			1,262
DIF premiums		201			163			403			325
Advertising		115			59			135			105
Valuation adjustment and expenses on OREO		1,467			573			1,871			1,104
Loss on early extinguishment of debt		-			190			-			190
Other		831			731			1,655			1,588
Total noninterest expense		5,095			4,387			9,115			8,740
Earnings before income taxes		(5,632	)		539			(7,270	)		924
Income taxes:
Current		-			3			-			3
Deferred		(1,965	)		177			(2,645	)		303
Total income taxes		(1,965	)		180			(2,645	)		306
Net earnings	$	(3,667	)	$	359		$	(4,625	)	$	618
Net earnings per share, basic	$	(0.59	)	$	0.06		$	(0.74	)	$	0.10
Net earnings per share, diluted	$	(0.59	)	$	0.06		$	(0.74	)	$	0.10

See accompanying notes to financial statements.

4

Jefferson Bancshares, Inc. and Subsidiary Consolidated Statements of Changes in Stockholders' Equity Six Months Ended December 31, 2011 and 2010 (Dollars in Thousands)
						Unallocated						Accumulated
			Additional			Common						Other									Total
	Common		Paid-in			Stock in			Unearned			Comprehensive			Retained			Treasury			Stockholders'
	Stock		Capital			ESOP			Compensation			Income			Earnings			Stock			Equity
Balance at June 30, 2011	$	92	$	78,895		$	(3,241	)	$	(1,019	)	$	459		$	12,067		$	(31,334	)	$	55,919
Comprehensive income:
Net earnings		-		-			-			-			-			(4,625	)		-			(4,625	)
Change in net unrealized gain (loss)
on securities available for sale, net
of taxes of $176		-		-			-			-			284			-			-			284
Total comprehensive income		-		-			-			-			-			-			-			(4,341	)
Dividends used for ESOP payment		-		-			-			-			-			-						-
Shares committed to be released by the ESOP		-		(155	)		216			(27	)		-			-			-			34
Purchase of common stock (2,484 shares)		-		-			-			-			-			-			(7	)		(7	)
Balance at December 31, 2011	$	92	$	78,740		$	(3,025	)	$	(1,046	)	$	743		$	7,442		$	(31,341	)	$	51,605
						Unallocated						Accumulated
			Additional			Common						Other									Total
	Common		Paid-in			Stock in			Unearned			Comprehensive			Retained			Treasury			Stockholders'
	Stock		Capital			ESOP			Compensation			Income			Earnings			Stock			Equity
Balance at June 30, 2010	$	92	$	79,175		$	(3,673	)	$	(1,053	)	$	1,206		$	12,023		$	(31,247	)	$	56,523
Comprehensive income:
Net earnings		-		-			-			-			-			618			-			618
Change in net unrealized gain (loss)
on securities available for sale, net
of taxes of ($452)		-		-			-			-			(728	)		-			-			(728	)
Total comprehensive income		-		-			-			-			-			-			-			(110	)
Dividends used for ESOP payment		-		-			-			-			-			13						13
Shares committed to be released by the ESOP		-		(142	)		216			-			-			-			-			74
Earned portion of stock grants		-		-			-			33			-			-			-			33
Purchase of common stock (22,718 shares)		-		-			-			-			-			-			(79	)		(79	)
Balance at December 31, 2010	$	92	$	79,033		$	(3,457	)	$	(1,020	)	$	478		$	12,654		$	(31,326	)	$	56,454

See accompanying notes to the financial statements.

5

Jefferson Bancshares, Inc. and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)
(Dollars in Thousands)
	Six Months Ended			Six Months Ended
	December 31,			December 31,
	2011			2010
Cash flows from operating activities:
Net earnings	$	(4,625	)	$	618
Adjustments to reconcile net earnings to net cash provided by (used for) operating activities:
Allocated ESOP shares		61			74
Depreciation and amortization expense		950			678
Amortization of premiums (discounts), net on investment securities		35			218
Provision for loan losses		8,673			950
Amortization of deferred loan fees, net		(78	)		(146	)
(Gain) loss on sale of investment securities		(39	)		5
(Gain) loss on sale of foreclosed real estate, net		79			405
(Gain) loss on sale of fixed assets, net		19			-
Deferred tax benefit		(2,646	)		303
Originations of mortgage loans held for sale		(9,494	)		(13,487	)
Proceeds from sale of mortgage loans		8,578			14,432
Increase in cash value of life insurance		(119	)		(119	)
Earned portion of MRP		(27	)		34
Decrease (increase) in:
Accrued interest receivable		(20	)		243
Other assets		4,622			(776	)
Increase (decrease) in other liabilities and accrued income taxes		(4,051	)		1,205
Net cash provided by (used for) operating activities		1,918			4,637
Cash flows used for investing activities:
Loan originations, net of principal collections		17,545			21,551
Investment securities classifed as available-for-sale:		-
Proceeds from maturities, calls and prepayments		38,341			38,536
Proceeds from sale		501			756
Purchase of securities		(41,726	)		(23,127	)
Proceeds from sale of premises and equipment, construction overpayments		26			-
Purchase of premises and equipment		(46	)		(80	)
Proceeds from sale of (additions to) foreclosed real estate, net		1,079			1,915
Net cash provided by (used for) investing  activities		15,720			39,551
Cash flows from financing activities:
Net increase (decrease) in deposits		(22,294	)		8,964
Net increase in repurchase agreements		(125	)		(650	)
Proceeds from advances from FHLB		-			309
Repayment of FHLB advances		(13	)		(26,619	)
Purchase of treasury stock		(7	)		(79	)
Dividends paid		-			-
Net cash provided by (used for) financing activities		(22,439	)		(18,075	)
Net increase (decrease) in cash, cash equivalents and interest-earning deposits		(4,801	)		26,113
Cash, cash equivalents and interest-earning deposits at beginning of period		40,548			69,303
Cash, cash equivalents and interest-earning deposits at end of period	$	35,747		$	95,416
Supplemental disclosures of cash flow information:
Cash paid during period for:
Interest on deposits	$	1,806		$	3,205
Interest on borrowed funds	$	526		$	1,543
Interest on subordinated debentures	$	103		$	106
Income taxes		-			-
Real estate acquired in settlement of loans	$	2,229		$	8,635

See accompanying notes to financial statements.

6

Notes To Consolidated Financial Statements

(1)   Basis of Presentation

The condensed consolidated financial statements include the accounts of Jefferson Bancshares, Inc. (the “Company” or “Jefferson Bancshares”) and its wholly-owned subsidiary, Jefferson Federal Bank (the “Bank” or “Jefferson Federal”).  The accompanying interim condensed consolidated financial statements, presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”), are unaudited and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of financial condition and results of operations for the interim periods. The results of operations for the six months ended December 31, 2011 are not necessarily indicative of the results which may be expected for the entire fiscal year or any other period. These unaudited consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended June 30, 2011, which was filed with the Securities and Exchange Commission on September 27, 2011.  All dollar amounts, other than per-share amounts, are in thousands unless otherwise noted.  The Company has adopted FASB ASC Topic 855 for Subsequent Events which did not significantly change the subsequent events the Company reports either through recognition or disclosure.  

(2)   Principles of Consolidation

The consolidated financial statements include the accounts of Jefferson Bancshares, Inc. and its wholly-owned subsidiary, Jefferson Federal Bank.  All significant intercompany balances and transactions have been eliminated in consolidation.

(3)   Use of Estimates

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the statement of condition dates and revenues and expenses for the periods shown.  Actual results could differ from the estimates and assumptions used in the consolidated financial statements.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate and deferred tax assets.

(4)   Limitation on Capital Distributions

Jefferson Federal may not pay dividends on its capital stock if its regulatory capital would thereby be reduced below the amount then required for the liquidation account established for the benefit of certain depositors of Jefferson Federal at the time of its conversion to stock form.

Under applicable regulations, Jefferson Federal is prohibited from making any capital distributions if, after making the distribution, the Bank would have: (i) total risk-based capital ratio of less than 8.0%; (ii) Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.

Under the banking laws of the State of Tennessee, a Tennessee chartered savings bank may not declare dividends in any calendar year in which the dividend would exceed the total of its net income for that year, combined with its retained net income for the preceding two years, without the prior approval of the Commissioner of the Tennessee Department of Financial Institutions.

(5)   Earnings Per Common Share

Earnings per common share and diluted earnings per common share have been computed on the basis of dividing net earnings by the weighted-average number of shares of common stock outstanding, exclusive of unallocated employee stock ownership plan (“ESOP”) shares.  Diluted earnings per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued.  Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method.  For the three and six months ended December 31, 2011, stock options to purchase 340,638 shares were not included in the computation of diluted net income per share as their effect would have been anti-dilutive.  The following table illustrates the number of weighted-average shares of common stock used in each corresponding earnings per common share calculation:

7

	Weighted-Average Shares				Weighted-Average Shares
	Outstanding for the				Outstanding for the
	Three Months Ended				Six Months Ended
	December 31,				December 31,
	2011		2010		2011		2010
Weighted average number of common shares used
in computing basic earnings per common share		6,219,673		6,197,757		6,224,970		6,201,670
Effect of dilutive stock options		-		-		-		-
Weighted average number of common shares and
dilutive potential common shares used in
computing earnings per common share
assuming dilution		6,219,673		6,197,757		6,224,970		6,201,670

(6)   Accounting for Allowance for Loan Losses and Impairment of a Loan

The allowance for loan and lease losses is an estimate of the losses that are inherent in the loan and lease portfolio.  The allowance is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  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.  The Bank’s charge-off policy is consistent with bank regulatory standards.  Generally, loans are charged off when the loan becomes over 120 days delinquent.  Real estate acquired as a result of foreclosure is initially recorded at the lower of the amount of the loan or the fair value, less estimated selling costs. Any writedown to fair value is charged to the allowance for loan and lease losses.  Any subsequent writedown of foreclosed real estate is charged against earnings.

The allowance consists of specific and general components.  The specific component relates to loans that are classified as doubtful, substandard or special mention.  The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.  

In connection with assessing the allowance, we have established a systematic methodology for determining the adequacy of the allowance for loan losses.  Loans are grouped into pools based on loan type and further segregated by loan grade.  Loan pools include residential mortgage loans, multi-family loans, construction and land development loans, non-residential real estate loans (owner occupied and non-owner occupied), commercial loans and consumer loans.  Commercial business loans and loans secured by commercial real estate are generally larger and involve a greater degree of risk than residential mortgage loans.  In addition, loans secured by commercial real estate are more likely to be negatively impacted by adverse conditions in the real estate market or the economy.  Management utilizes a loan grading system and assigns a loan grade of “Pass”, “Watch”, “Special Mention”, “Substandard”, “Doubtful” or “Loss” based on risk characteristics of loans.  Lending staff reviews the loan grades of customers on a regular basis and makes changes as needed given that the creditworthiness of customers may change over time.  

Descriptions of loan grades are as follows:

Pass - loans in this category represent an acceptable risk and do not require heightened levels of monitoring by lending staff.

8

Watch - loans in this category represent an acceptable risk; however, require monitoring by lending staff due to potential weakness for any number of reasons.  

Special Mention - loans in this category have potential weaknesses that may result in deteriorating prospects for the asset or in the Bank’s credit position at some future date.  

Substandard - loans in this category are inadequately protected by the sound worth and paying capacity of the borrower or the collateral pledged. Borrowers in this category have a well-defined weakness(es) that jeopardize the proper liquidation of the debt.

Doubtful - loans classified as doubtful have a clear and defined weakness making the ultimate repayment of the loan, or portions thereof, highly improbable.

Loss - loans classified as “loss” are those of such little value that their continuance as bank assets is not warranted, even though partial recovery may be affected in the future.  Charge off is required in the month this grade is assigned.

Specific valuation allowances are established for impaired loans.  The Company considers a loan to be impaired when, based on current information and events, it is probable that the company will be unable to collect all amounts due according to the contractual terms of the loan agreement on a timely basis.  A specific reserve represents the difference between the recorded value of the loan and either its estimated fair value less estimated disposition costs, or the net present value as determined by a discounted cash flow analysis.  On a quarterly basis, management evaluates individual loans and lending relationships which have outstanding principal balances of $500,000 or more and which are classified as either substandard, doubtful or loss according to the loan grading policy for impairment.  Troubled debt restructurings (“TDRs”) are also considered to be impaired, except for those that have been performing under the new terms for at least six consecutive months.  

A TDR occurs when the Bank grants a concession to a borrower with financial difficulties that it would not otherwise consider. The Bank has adopted the guidance and definitions found in ASU 2011-02  in determining if a borrower is experiencing financial difficulties and if a concession has been granted.  The majority of the Bank’s TDRs involve a modification in loan terms such as a temporary period of interest only or extension of the maturity date.  A TDR may be non-accruing or it may accrue interest.  A nonaccrual TDR will be returned to accruing status at such time when the borrower successfully performs under the new terms for six consecutive months.  

The accrual of interest on all loans is discontinued at the time the loan is 90 days delinquent.  All interest accrued but not collected for loans considered impaired, placed on non-accrual or charged off is reversed against interest income.  The interest on these loans is accounted for on the cash basis or cost-recovery method until the loan is returned to accrual status.  Loans are returned to accrual status when future payments are reasonably assured.  Payments received on non-accrual loans are applied to the remaining principal balance of the loans.

The evaluation of the allowance for loan and lease losses is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.  The Company is subject to periodic examination by regulatory agencies, which may require the Company to record increases in the allowances based on the regulator’s evaluation of available information.  There can be no assurance that the Company’s regulators will not require further increases to the allowances.

9

The following table summarizes the activity in the allowance for loan losses for the six months ended December 31, 2011:

	Residential Mortgage			Multi-family		Construction and land development			Non-residential real estate			Owner occupied			Commercial			Consumer			Total
Allowance for Credit Losses:
Balance at June 30, 2011	$	1,543		$	1,858	$	803		$	1,934		$	803		$	1,197		$	43		$	8,181
Charge Offs		(127	)		-		(115	)		(191	)		(142	)		(5,406	)		(75	)		(6,056	)
Recoveries		7			-		-			-			-			67			8			82
Provision		(345	)		827		34			610			(300	)		7,798			49			8,673
Balance at December 31, 2011	$	1,078		$	2,685	$	722		$	2,353		$	361		$	3,656		$	25		$	10,880
Ending balance, Individually Evaluated	$	554		$	2,634	$	446		$	2,165		$	101		$	2,494		$	-		$	8,394
Ending balance, Collectively Evaluated	$	524		$	51	$	276		$	188		$	260		$	1,162		$	25		$	2,486
Loans:
Balance at December 31, 2011	$	126,159		$	13,411	$	34,462		$	51,309		$	75,541		$	56,880		$	5,185		$	362,947
Ending balance, Individually Evaluated	$	2,519		$	8,411	$	1,244		$	5,932		$	471		$	5,883		$	-		$	24,460
Ending balance, Collectively Evaluated	$	123,640		$	5,000	$	33,218		$	45,377		$	75,070		$	50,997		$	5,185		$	338,487

10

The following table is an aging analysis of the loan portfolio at December 31, 2011:

	30-59 days past due		60-89 days past due		Greater than 90 days		Total past due		Total Current		Total loans receivable
Residential Mortgage	$	4,088	$	594	$	4,874	$	9,556	$	116,603	$	126,159
Multi-family		7,774		96		-		7,870		5,541		13,411
Construction/land development		253		-		653		906		33,556		34,462
Non-residential real estate		349		3,025		622		3,996		47,313		51,309
Owner occupied		1,082		1,394		828		3,304		72,237		75,541
Commercial		153		99		2,543		2,795		54,085		56,880
Consumer		53		3		41		97		5,088		5,185
Total	$	13,752	$	5,211	$	9,561	$	28,524	$	334,423	$	362,947

The following table summarizes the credit risk profile by internally assigned grade at December 31, 2011:

	Residential Mortgage		Multi-family		Construction and land development		Non-residential real estate		Owner occupied		Commercial		Consumer		Total
Grade:
Pass	$	112,423	$	4,900	$	29,750	$	36,589	$	70,400	$	50,075	$	5,120	$	309,257
Watch		4,091		-		2,006		7,994		2,758		1,190		12		18,051
Special mention		-		-		-		1,255		-		-		-		1,255
Substandard		9,645		8,511		2,706		5,472		2,383		5,614		53		34,384
Doubtful		-		-		-		-		-		-		-		-
Loss		-		-		-		-		-		-		-		-
Total:	$	126,159	$	13,411	$	34,462	$	51,310	$	75,541	$	56,879	$	5,185	$	362,947

11

The following table summarizes the composition of impaired loans, the associated specific reserves, and interest income recognized on impaired loans at December 31, 2011:

	Recorded investment		Unpaid principal balance		Specific allowance		Interest income recognized
With an allowance recorded:
Residential Mortgage	$	2,519	$	2,519	$	554	$	33
Multi-family		8,411		8,411		2,634		152
Construction and land development		1,244		1,244		446		25
Non-residential real estate		5,932		5,932		2,165		82
Owner occupied		471		471		101		-
Commercial		5,883		5,883		2,494		104
Consumer		-		-		-		-
Total	$	24,460	$	24,460	$	8,394	$	396
With no related allowance:
Residential Mortgage	$	2,854	$	2,854	$	-	$	70
Multi-family		-		-		-		-
Construction and land development		1,152		1,152		-		38
Non-residential real estate		1,752		1,752		-		52
Owner occupied		1,034		1,034		-		29
Commercial		-		-		-		-
Consumer		-		-		-		-
Total	$	6,792	$	6,792	$	-	$	189
Total:
Residential Mortgage	$	5,373	$	5,373	$	554	$	103
Multi-family		8,411		8,411		2,634		152
Construction and land development		2,396		2,396		446		63
Non-residential real estate		7,684		7,684		2,165		134
Owner occupied		1,505		1,505		101		29
Commercial		5,883		5,883		2,494		104
Consumer		-		-		-		-
Total	$	31,252	$	31,252	$	8,394	$	585
Average impaired loans for the
Six months ended December 31, 2011	$	33,012

(7)   Financial Instruments With Off-Balance Sheet Risk

Jefferson Bancshares is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company’s maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount and related accrued interest receivable of those instruments. The Company minimizes this risk by evaluating each borrower’s creditworthiness on a case-by-case basis. Collateral held by the Company consists of a first or second mortgage on the borrower’s property. The amount of collateral obtained is based upon an appraisal of the property.

At December 31, 2011, we had approximately $6.1 million in commitments to extend credit, consisting of commitments to fund real estate loans.  In addition to commitments to originate loans, we had $4.7 million in unused letters of credit and approximately $29.8 million in unused lines of credit.

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(8)   Dividends

On February 2, 2010, the Company announced that the Board of Directors had voted to suspend the payment of the quarterly cash dividend on the Company’s common stock in an effort to conserve capital.

(9)   Stock Incentive Plans

The Company maintains stock-based benefit plans under which certain employees and directors are eligible to receive stock grants or options.  Under the 2004 Stock-Based Benefit Plan, a maximum of 279,500 shares may be granted as restricted stock and a maximum of 698,750 shares may be issued through the exercise of nonstatutory or incentive stock options.  The exercise price of each option equals the market price of the Company’s stock on the date of grant and an option’s maximum term is ten years.  

In connection with the Company’s acquisition of State of Franklin Bancshares, Inc. (“State of Franklin”) on October 31, 2008, each outstanding State of Franklin non-qualified option with an exercise price of $13.50 or less was converted into an option to purchase shares of Jefferson Bancshares common stock with an expiration date of October 31, 2011.

The table below summarizes the status of the Company’s stock option plans as of December 31, 2011.

	Three Months Ended
	December 31, 2011
				Weighted-
				average
	Shares			exercise price
Outstanding at beginning of period		525,287		$	12.69
Granted during the three-month period		-			-
Options forfeited		(184,649	)	$	10.85
Options exercised		-
Outstanding at December 31, 2011		340,638		$	13.69
Options exercisable at December 31, 2011		340,638		$	13.69

The following information applies to options outstanding at December 31, 2011:

Number outstanding		340,638
Range of exercise prices	$	13.69
Weighted-average exercise price	$	13.69
Weighted-average remaining contractual life		2.08
Number of options remaining for future issuance		358,112

The estimated fair value of stock options at grant date was determined using the Black-Scholes option-pricing model based on market data as of January 29, 2004.  An expected dividend yield of 1.17% and expected volatility of 7.01% were used to model the value.  The risk free rate of return equaled 4.22%, which was based on the yield of a U.S. Treasury note with a term of ten years. The estimated time remaining before the expiration of the options equaled ten years.

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(10)    Investment Securities

Investment securities are summarized as follows:

At December 31, 2011
	Amortized			Unrealized		Unrealized			Fair
	Cost			Gains		Losses			Value
	(Dollars in thousands)
Securities available-for-sale
Debt securities:
Federal agency	$	21,224		$	292	$	-		$	21,516
Mortgage-backed		50,516			1,200		(240	)		51,476
Municipals		4,437			283		-			4,720
Other Securities		609			-		(331	)		278
Total securities available-
for-sale	$	76,786		$	1,775	$	(571	)	$	77,990
Weighted-average rate		2.40	%
Pledged at December 31, 2011	$	13,600
At June 30, 2011
	Amortized			Unrealized		Unrealized			Fair
	Cost			Gains		Losses			Value
	(Dollars in thousands)
Securities available-for-sale
Debt securities:
Federal agency	$	43,721		$	228	$	-		$	43,949
Mortgage-backed		24,551			861		(56	)		25,356
Municipals		5,150			112		(25	)		5,237
Other Securities		613			-		(375	)		238
Total securities available-
for-sale	$	74,035		$	1,201	$	(456	)	$	74,780
Weighted-average rate		2.35	%
Pledged at June 30, 2011	$	19,389

Securities with unrealized losses not recognized in income are as follows:

	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
	(Dollars in thousands)
December 31, 2011
Federal agency securities	$	-	$	-		$	-	$	-		$	-	$	-
Mortgage-backed securities		3,510		(133	)		600		(107	)		4,110		(240	)
Municipal securities		-		-			-		-			-		-
Other securities		-		-			278		(331	)		278		(331	)
	$	3,510	$	(133	)	$	878	$	(438	)	$	4,388	$	(571	)

The Company evaluates its securities with significant declines in fair value on a quarterly basis to determine whether they should be considered temporarily or other than temporarily impaired.  The Company has recognized all of the unrealized losses reflected in the foregoing table in other comprehensive income.  The Company neither has the intent to sell nor is forecasting the need or requirement to sell the securities before their anticipated recovery.

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GSE Residential Mortgage-Backed Securities – The unrealized losses of $133,000 for these five GSE mortgage-backed securities was caused by changes in market interest rates. The contractual cash flows of these investments are guaranteed by an agency of the U.S. Government. Accordingly it is expected that the securities would not be settled at a price less than the amortized bases of the Company’s investments. Because the decline in market value is attributable to changes in market interest rates and not credit quality, and because the Company does not intend to sell the investments before recovery of their amortized cost bases and it is not more likely than not the Company does not intend to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2011.

Private-Label Residential Mortgage-Backed Securities - The unrealized losses of $107,000 for this private-label mortgage-backed security is primarily driven by higher projected collateral losses, wider credit spreads and changes in interest rates as indicated by the annual independent valuation of the investment. The valuation methodology used is a future cash flow analysis which is built upon a model based on collateral-specific assumptions as they relate to the underlying loans. Given the expected improvement in the future performances of the expected cash flow, the unrealized losses are not deemed to be attributable to credit quality. Accordingly it is expected that the security would not be settled at a price less than the amortized bases of the Company’s investment. Because the decline in market value is attributable to higher projected collateral losses, wider credit spreads and changes in interest rates and not credit quality, the Company expects to recover the entire amortized cost bases of this security.

Other Securities – The unrealized loss of $331,000 on this CDO was a result of updated variables and inputs that comprise the model used in the annual independent valuation of this security. The collateral for the CDO investment is comprised of trust preferred securities and senior and subordinated debt issued by banks, insurance companies, REIT’s, real estate operating companies and homebuilding companies. The CDO security is valued using three different scenarios as a predictor of future collateral performance and the fair market value determined accordingly. Given the expected improvement in the future performance of the collateral, the unrealized loss is not deemed to be attributable to credit quality. Since the Company does not intend to sell this investment before recovery of its amortized cost basis, which may be maturity, the Company does not consider this investment to be other-than-temporarily impaired at December 31, 2011.

Maturities of debt securities at December 31, 2011, are summarized as follows:

					Weighted
	Amortized		Fair		Average
	Cost		Value		Yield
Within 1 year	$	498	$	500		2.34	%
Over 1 year through 5 years		12,611		12,802		1.47	%
After 5 years through 10 years		11,658		11,897		1.79	%
Over 10 years		52,019		52,791		2.77	%
	$	76,786	$	77,990		2.40	%

(11)   Fair Value Disclosures

Fair value is defined as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. When measuring fair value, the Company uses valuation techniques that are appropriate and consistently applied.  A hierarchy is also established under the standard and is used to prioritize valuation inputs into the following three levels used to measure fair value:

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Level 1

Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as certain U.S. Treasury, other U.S. Government and agency mortgage-backed debt securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2

Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain U.S. Government and agency mortgage-backed debt securities, corporate debt securities, derivative contracts and residential mortgage loans held-for-sale.

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights, and highly structured or long-term derivative contracts.

The following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities Available for Sale

Level 2 investment securities classified as “available-for-sale” are recorded at fair value on a recurring basis. Fair value measurements are based upon independent pricing models or other model-based valuation techniques with inputs that are observable in the market or that can be derived principally from or corroborated by observable market data. Level 2 securities include mortgage-backed securities issued by government-sponsored entities, municipal bonds, bonds issued by government agencies, and corporate debt securities. Level 3 investment securities classified as “available-for-sale” are recorded at fair value on at least a semi-annual basis. Fair value measurements are based upon independent pricing models based upon unobservable inputs which require significant management judgment or estimation. Level 3 includes certain mortgage-backed securities and other debt securities.  

Impaired Loans

The Company records loans at fair value on a non-recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows.

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Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2011, substantially all of the total impaired loans were evaluated based on either the fair value of the collateral or its liquidation value. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Below is a table that presents information about certain assets and liabilities measured at fair value:   

	December 31, 2011
				Total Carrying
				Amount in	Assets/Liabilities
				Statement of	Measured at
Description	Level 1	Level 2	Level 3	Financial Condition	Fair Value
Securities available for sale	-	$74,997	$2,993	$77,990	$77,990

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below.

	December 31, 2011
				Total Carrying
				Amount in	Assets/Liabilities
				Statement of	Measured at
Description	Level 1	Level 2	Level 3	Financial Condition	Fair Value
Impaired Loans	-	$22,859	-	$22,859	$22,859

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The carrying value and estimated fair value of the Company’s financial instruments are as follows:

	December 31, 2011						June 30, 2011
	Carrying			Fair			Carrying			Fair
	Amount			Value			Amount			Value
Financial assets:
Cash and due from banks and	$	35,747		$	35,747		$	40,548		$	40,548
interest-earning deposits
with banks
Available-for-sale securities		77,990			77,990			74,780			74,780
Federal Home Loan Bank stock		4,735			4,735			4,735			4,735
Loans receivable, net		351,827			359,841			378,587			379,787
Accrued interest receivable		1,852			1,852			1,832			1,832
Loans held-for-sale		916			916			-			-
Financial liabilities:
Deposits		(431,946	)		(425,888	)		(454,262	)		(446,115	)
Borrowed funds		(38,723	)		(40,783	)		(38,887	)		(40,718	)
Subordinated debentures		(7,189	)		(5,119	)		(7,133	)		(6,277	)
Off-balance sheet assets (liabilities):
Commitments to extend credit		-			6,146			-			11,932
Unused letters of credit		-			4,729			-			4,809
Unused lines of credit		-			29,805			-			34,362

(12)   Subordinated Debt

As part of the State of Franklin acquisition, the Company acquired State of Franklin Statutory Trust II (the “Trust”) and assumed the Trust’s obligation with respect to certain capital securities described below.  On December 13, 2006, State of Franklin issued $10.3 million of junior subordinated debentures to the Trust, a Delaware business trust wholly owned by State of Franklin.  The Trust (a) sold $10.0 million of capital securities through its underwriters to institutional investors and upstreamed the proceeds to State of Franklin and (b) issued $310,000 of common securities to State of Franklin.  The sole assets of the Trust are the $10.3 million of junior subordinated debentures issued by State of Franklin. The securities are redeemable at par after January 30, 2012, and have a final maturity of January 30, 2037.  The interest is payable quarterly at a floating rate equal to 3-month LIBOR plus 1.7%.

On January 11, 2012, the Company notified the Trustee for the Trust that, beginning with the January 30, 2012 interest payment period, the Company has elected to defer all payments of interest on the Company’s junior subordinated debentures for an indefinite period of time (but no longer than 20 consecutive quarterly periods).  Under the terms of the indenture, the Company is prohibited from paying dividends on its common stock during the period that interest is deferred on the debentures.

(13)   Subsequent Events

The company has evaluated subsequent events for potential recognition and disclosure for the three months ended December 31, 2011.  No items were identified during this evaluation that required adjustment to or disclosure in the accompanying financial statements.

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

Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of Jefferson Bancshares. The information contained in this section should be read in conjunction with the financial statements and accompanying notes thereto. For further information, refer to the financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2011, which was filed with the Securities and Exchange Commission on September 27, 2011.

General

Jefferson Bancshares, Inc. (also referred to as the “Company” or “Jefferson Bancshares”) is the holding company for Jefferson Federal Bank (the “Bank” or “Jefferson Federal”).

Management of the Company and the Bank are substantially similar and the Company neither owns nor leases any property, but instead uses the premises, equipment and furniture of the Bank.  Accordingly, the information set forth in this report, including the consolidated financial statements and related financial data, relates primarily to the Bank.

Jefferson Federal is a community oriented financial institution offering traditional financial services to its local communities. The Bank is engaged primarily in the business of attracting deposits from the general public and using such funds to originate loans secured by first mortgages on owner-occupied, one-to four- family residential properties, as well as originate commercial real estate and multi-family mortgage loans, construction loans, consumer loans, commercial non-real estate loans and make other investments permitted by applicable laws and regulations.

The Bank’s savings accounts are insured up to the applicable legal limits by the Federal Deposit Insurance Corporation (“FDIC”) through the Deposit Insurance Fund. Jefferson Federal is a member of the Federal Home Loan Bank (“FHLB”) System.

Private Securities Litigation Reform Act Safe Harbor Statement

This Quarterly Report may contain forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts; but rather, are statements based on Jefferson Bancshares’ current expectations regarding its business strategies and their intended results and the Company’s future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.

Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain.  These factors include, but are not limited to, general economic conditions, changes in the interest rate environment, legislative or regulatory changes that may adversely affect our business, changes in accounting policies and practices, changes in competition and demand for financial services, adverse changes in the securities markets and changes in the quality or composition of the Company’s loan or investment portfolios. Additional factors that may affect our results are discussed in the reports we file with the SEC, including our Annual Report on Form 10-K for the year ended June 30, 2011 under “Item 1A. Risk Factors.”  These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements.  Jefferson Bancshares assumes no obligation to update any forward-looking statements.

Results of Operations for the Three Months Ended December 31, 2011 and 2010

Net Income

For the three months ended December 31, 2011, the Company reported a net loss of $3.7 million, or $0.59 per diluted share, compared to net income of $359,000, or $0.06 per diluted share, for the corresponding period in 2010.  Financial results for the quarter ended December 31, 2011 were negatively impacted by a $5.7 million provision for loan losses compared to a provision of $950,000 for the quarter ended December 31, 2010.  The increase in the provision for loan losses was attributable to higher realized and estimated losses.

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	Three Months Ended
	December 31,
	2011			2010
	(Dollars in thousands,
	except per share data)
Net earnings	$	(3,667	)	$	359
Net earnings per share, basic	$	(0.59	)	$	0.06
Net earnings per share, diluted	$	(0.59	)	$	0.06
Return on average assets (annualized)		(2.71	%)		0.23	%
Return on average equity (annualized)		(26.37	%)		2.51	%

Net Interest Income

Net interest income increased $140,000, or 3.2%, to $4.6 million for the three months ended December 31, 2011 compared to $4.4 million for the same period in 2010.   The interest rate spread and net interest margin for the quarter ended December 31, 2011 were 3.64% and 3.77%, respectively, compared to 2.99% and 3.11%, respectively, for the same period in 2010.

The following table summarizes changes in interest income and expense for the three month periods ended December 31, 2011 and 2010:

	Three Months
	Ended
	December 31,
	2011		2010		$ Change			% Change
	(Dollars in thousands)
Interest income:
Loans	$	5,265	$	6,112	$	(847	)		(13.9	%)
Investment securities		450		409		41			10.0	%
Interest-earning deposits		12		61		(49	)		(80.3	%)
FHLB stock		48		48		-			0.0	%
Total interest income		5,775		6,630		(855	)		(12.9	%)
Interest expense:
Deposits		800		1,534		(734	)		(47.8	%)
Repurchase Agreements		1		2		(1	)		(50.0	%)
Borrowings		320		582		(262	)		(45.0	%)
Subordinated Notes & Debentures		82		80		2			2.5	%
Total interest expense		1,203		2,198		(995	)		(45.3	%)
Net interest income	$	4,572	$	4,432	$	140			3.2	%

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The following table summarizes average balances and average yields and costs for the three months ended December 31, 2011 and 2010.  

	Three Months Ended December 31,
	2011					2010
	Average		Yield/			Average		Yield/
	Balance		Cost			Balance		Cost
	(Dollars in thousands)
Loans	$	374,931		5.57	%	$	420,860		5.76	%
Investment securities		79,761		2.32	%		43,718		3.90	%
Interest-earning deposits		23,770		0.20	%		97,945		0.25	%
FHLB stock		4,735		4.02	%		4,735		4.02	%
Deposits		383,132		0.83	%		449,999		1.35	%
FHLB advances		37,916		3.35	%		67,067		3.44	%
Repurchase agreements		981		0.40	%		1,142		0.69	%
Subordinated debentures		7,171		4.54	%		7,059		4.50	%

The following table sets forth the effects of changing rates and volumes on our net interest income.  The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume).  The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate).  The net column represents the sum of the prior columns.  For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

	Three Months Ended December 31, 2011 Compared to 2010
	Increase (Decrease)
	Due To
	Volume			Rate			Net
	(In thousands)
Interest income:
Loans receivable	$	(638	)	$	(209	)	$	(847	)
Investment securities		(9	)		50			41
Daily interest-earning deposits
and other interest-earning assets		(39	)		(10	)		(49	)
Total interest-earning assets		(686	)		(169	)		(855	)
Interest expense:
Deposits		(203	)		(531	)		(734	)
FHLB advances		(246	)		(16	)		(262	)
Repurchase agreements		-			(1	)		(1	)
Subordinatd debentures		1			1			2
Total interest-bearing liabilities		(448	)		(547	)		(995	)
Net change in interest income	$	(238	)	$	378		$	140

Total interest income decreased $855,000, or 12.9%, to $5.8 million for the three months ended December 31, 2011 primarily due to a lower volume of interest-earning assets and a lower average yield.  The average balance of interest-earning assets declined $84.1 million, or 14.8%, to $483.2 million for the three months ended December 31, 2011 compared to $567.3 million for the same period in 2010, due primarily to declines in average loan balances and interest-earning deposits.  The average yield on interest-earning assets was 4.76% for the three months ended December 31, 2011 compared to 4.65% for the same period in 2010.

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Interest on loans decreased $847,000, or 13.9%, to $5.3 million for the three months ended December 31, 2011 due to a lower average balance of loans.  The average balance of loans decreased $45.9 million, or 10.9%, to $374.9 million for the three months ended December 31, 2011, due to the combination of reduced loan demand, normal paydowns on existing loans, transfers to OREO and charge-offs.  Reduced loan demand has resulted from continued economic weakness in the Bank’s market areas.  The average yield on loans was 5.57% for the three months ended December 31, 2011 compared to 5.76% for the same period in 2010.  

Interest on investment securities was $450,000 for the three months ended December 31, 2011 compared to $409,000 for the same period in 2010.  The average balance of investment securities increased $36.0 million to $79.8 million for the three months ended December 31, 2011 compared to $43.7 million for the corresponding period in 2010.  The average yield on investment securities decreased to 2.32% for the three months ended December 31, 2011 compared to 3.90% for the same period in 2010 due to proceeds from called securities reinvested at lower interest rates and changes in the composition of the portfolio.

Total interest expense decreased $995,000 to $1.2 million for the three months ended December 31, 2011 compared to $2.2 million for the corresponding period in 2010 primarily due to lower interest rates on deposits and a lower average balance of both deposits and FHLB borrowings.   The average rate paid on deposits was 0.83% for the three months ended December 31, 2011, compared to 1.35% for the same period in 2010 due to downward repricing of interest bearing deposits in the current low interest rate environment.  Average FHLB borrowings decreased $29.2 million to $37.9 million for the three months ended December 31, 2011 compared to $67.1 million for the comparable period in 2010, while the average rate paid on borrowings decreased 9 basis points to 3.35%.  Excess liquidity was used to repay FHLB advances during the prior fiscal year.

Provision for Loan Losses

The provision for loan losses for the three months ended December 31, 2011 was $5.7 million, compared to a provision of $950,000 for the comparable period in 2010.  The increase in the provision for loan losses was attributable to higher realized and estimated losses. Net charge-offs for the three months ended December 31, 2011 were $5.0 million compared to $1.8 million for the comparable period in 2010.   Management reviews the level of the allowance for loan losses on a monthly basis and establishes the provision for loan losses based on changes in the nature and volume of the loan portfolio, the amount of impaired and classified loans, historical loan loss experience and other qualitative factors.  In addition, the Federal Deposit Insurance Corporation and Tennessee Department of Financial Institutions, as an integral part of their examination process, periodically review our allowance for loan losses and may require the Company to recognize adjustments to the allowance for loan losses based on their judgments about information available to them at the time of their examination.

Noninterest Income

Noninterest income decreased $866,000, or 60.0%, to $578,000 for the three months ended December 31, 2011 compared to $1.4 million for the same period in 2010, due to a decrease in gain on sale of investment securities and a decrease in mortgage origination fee income. Gain on sale of investment securities was $13,000 for the quarter ended December 31, 2011 compared to $743,000 for the same period in 2010.  Mortgage origination fee income decreased $123,000, or 54.9%, to $101,000 for the three months ended December 31, 2011 due to lower demand for residential mortgage refinancing. Service charges and fees declined $31,000, or 9.8%, to $284,000 for the three months ended December 31, 2011 compared to the prior year period.

The following table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent changes for the three months ended December 31, 2011 compared to the same period in 2010.

22

	Three Months Ended
	December 31,						$			%
	2011			2010			Change			Change
	(Dollars in thousands)
Noninterest income:
Mortgage origination fee income	$	101		$	224		$	(123	)		(54.9	%)
Service charges and fees		284			315			(31	)		(9.8	%)
(Loss) gain on investment securities		13			743			(730	)		(98.3	%)
Gain (loss) on sale of foreclosed real estate, net		(63	)		(58	)		(5	)		8.6	%
BOLI increase in cash value		60			59			1			1.7	%
Other		183			161			22			13.7	%
Total noninterest income	$	578		$	1,444		$	(866	)		(60.0	%)

Noninterest Expense

Total noninterest expense increased $708,000, or 16.1%, to $5.1 million for the three months ended December 31, 2011 compared to $4.4 million for the corresponding period in 2010.   Compensation expense decreased $178,000, or 10.5%, to $1.5 million for the three months ended December 31, 2011 compared to $1.7 million for the same period in 2010 as the Bank has reduced its number of employees through attrition.  Valuation adjustments and expenses on other real estate owned increased $894,000 to $1.5 million for the three months ended December 31, 2011 compared to $573,000 for the same period in 2010.

The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the three months ended December 31, 2011 compared to the same period in 2010.  

	Three Months Ended
	December 31,				$			%
	2011		2010		Change			Change
	(Dollars in thousands)
Noninterest expense:
Compensation and benefits	$	1,525	$	1,703	$	(178	)		(10.5	%)
Occupancy expense		351		358		(7	)		(2.0	%)
Equipment and data processing expense		605		610		(5	)		(0.8	%)
Deposit insurance premiums		201		163		38			23.3	%
Advertising		115		59		56			94.9	%
Valuation adjustment and expenses on OREO		1,467		573		894			156.0	%
Loss on early extinguishment of debt		-		190		(190	)		(100.0	%)
Other		831		731		100			13.7	%
Total noninterest expense	$	5,095	$	4,387	$	708			16.1	%

Income Taxes

Income tax benefit for the three months ended December 31, 2011 was $2.0 million compared to income tax expense of $180,000 for the same period in 2010 due to lower taxable income.  

Results of Operations for the Six Months Ended December 31, 2011 and 2010

Net Income

For the six months ended December 31, 2011, the Company reported a net loss of $4.6 million, or $0.74 per diluted share, compared to net income of $618,000, or $0.10 per diluted share, for the corresponding period in 2010.  Financial results for the six months ended December 31, 2011 included a provision for loan losses totaling $8.7 million compared to a  provision of $950,000 for the six months ended December 31, 2010.  The increase in the provision for loan losses was attributable to higher realized and estimated losses.

23

	Six Months Ended
	December 31,
	2011			2010
	(Dollars in thousands,
	except per share data)
Net earnings	$	(4,625	)	$	618
Net earnings per share, basic	$	(0.74	)	$	0.10
Net earnings per share, diluted	$	(0.74	)	$	0.10
Return on average assets (annualized)		(1.69	%)		0.20	%
Return on average equity (annualized)		(16.48	%)		2.17	%

Net Interest Income

Net interest income increased $557,000, or 6.3%, to $9.3 million for the six months ended December 31, 2011 compared to $8.8 million for the same period in 2010.   The interest rate spread and net interest margin for the six months ended December 31, 2011 were 3.67% and 3.80%, respectively, compared to 2.91% and 3.05%, respectively, for the same period in 2010.

The following table summarizes changes in interest income and expense for the six month periods ended December 31, 2011 and 2010:

	Six Months
	Ended
	December 31,
	2011		2010		$ Change			% Change
	(Dollars in thousands)
Interest income:
Loans	$	10,837	$	12,394	$	(1,557	)		(12.6	%)
Investment securities		934		891		43			4.8	%
Interest-earning deposits		29		100		(71	)		(71.0	%)
FHLB stock		95		101		(6	)		(5.9	%)
Total interest income		11,895		13,486		(1,591	)		(11.8	%)
Interest expense:
Deposits		1,756		3,197		(1,441	)		(45.1	%)
Repurchase Agreements		3		4		(1	)		(25.0	%)
Borrowings		640		1,343		(703	)		(52.3	%)
Subordinated Notes & Debentures		159		162		(3	)		(1.9	%)
Total interest expense		2,558		4,706		(2,148	)		(45.6	%)
Net interest income	$	9,337	$	8,780	$	557			6.3	%

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The following table summarizes average balances and average yields and costs for the six months ended December 31, 2011 and 2010.  

	Six Months Ended December 31,
	2011					2010
	Average		Yield/			Average		Yield/
	Balance		Cost			Balance		Cost
	(Dollars in thousands)
Loans	$	378,202		5.68	%	$	429,217		5.73	%
Investment securities		80,666		2.38	%		49,171		3.76	%
Interest-earning deposits		25,795		0.22	%		91,198		0.22	%
FHLB stock		4,735		3.98	%		4,735		4.23	%
Deposits		389,525		0.89	%		446,588		1.42	%
FHLB advances		37,926		3.35	%		76,061		3.50	%
Repurchase agreements		995		0.60	%		1,193		0.67	%
Subordinated debentures		7,157		4.41	%		7,045		4.56	%

The following table sets forth the effects of changing rates and volumes on our net interest income.  The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume).  The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate).  The net column represents the sum of the prior columns.  For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

	Six Months Ended December 31, 2011 Compared to 2010
	Increase (Decrease)
	Due To
	Volume			Rate			Net
	(In thousands)
Interest income:
Loans receivable	$	(1,311	)	$	(246	)	$	(1,557	)
Investment securities		(45	)		88			43
Daily interest-earning deposits
and other interest-earning assets		(74	)		(3	)		(77	)
Total interest-earning assets		(1,430	)		(161	)		(1,591	)
Interest expense:
Deposits		(370	)		(1,071	)		(1,441	)
FHLB advances		(646	)		(57	)		(703	)
Repurchase agreements		(1	)		-			(1	)
Subordinatd debentures		3			(6	)		(3	)
Total interest-bearing liabilities		(1,014	)		(1,134	)		(2,148	)
Net change in interest income	$	(416	)	$	973		$	557

Total interest income decreased $1.6 million, or 11.8%, to $11.9 million for the six months ended December 31, 2011 primarily due to a lower volume of interest-earning assets.  The average balance of interest-earning assets declined $84.9 million, or 14.8%, to $489.4 million for the six months ended December 31, 2011 compared to $574.3 million for the same period in 2010, due primarily to declines in average loan balances.  The average yield on interest-earning assets was 4.84% for the six months ended December 31, 2011 compared to 4.67% for the same period in 2010.

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Interest on loans decreased $1.6 million, or 12.6%, to $10.8 million for the six months ended December 31, 2011 primarily due to a lower average balance of loans and a lower average yield.  The average balance of loans decreased $51.0 million, or 11.9%, to $378.2 million for the six months ended December 31, 2011, due to the combination of reduced loan demand, normal paydowns on existing loans, transfers to OREO and charge-offs.  The average yield on loans was 5.68% for the six months ended December 31, 2011 compared to 5.73% for the same period in 2010.  

Interest on investment securities increased to $934,000 for the six months ended December 31, 2011 compared to $891,000 for the same period in 2010.  The average balance of investment securities increased $31.5 million to $80.7 million for the six months ended December 31, 2011 compared to $49.2 million for the corresponding period in 2010.  The average yield on investment securities decreased to 2.38% for the six months ended December 31, 2011 compared to 3.76% for the same period in 2010 due to proceeds from called securities reinvested at lower interest rates and changes in the composition of the portfolio.

Total interest expense decreased $2.1 million to $2.6 million for the six months ended December 31, 2011 compared to $4.7 million for the corresponding period in 2010 primarily due to lower interest rates on deposits and a lower average balance of both deposits and FHLB borrowings.   The average rate paid on deposits was 0.89% for the six months ended December 31, 2011, compared to 1.42% for the same period in 2010 due to downward repricing of interest bearing deposits in the current low interest rate environment.  Average FHLB borrowings decreased $38.1 million to $37.9 million for the six months ended December 31, 2011 compared to $76.1 million for the comparable period in 2010, while the average rate paid on borrowings decreased 16 basis points to 3.35%.  Excess liquidity was used to repay FHLB advances during the prior fiscal year.

Provision for Loan Losses

The provision for loan losses for the six months ended December 31, 2011 was $8.7 million, compared to a provision of $950,000 for the comparable period in 2010.  The increase in the provision for loan losses was attributable to higher realized and estimated losses. Net charge-offs for the six months ended December 31, 2011 were $6.0 million compared to $2.7 million for the comparable period in 2010.   

Noninterest Income

Noninterest income decreased $653,000, or 35.6%, to $1.2 million for the six months ended December 31, 2011 compared to $1.8 million for the same period in 2010, due to a decrease in gain on sale of investment securities and a decrease in mortgage origination fee income. Gain on sale of investment securities was $39,000 for the six months ended December 31, 2011 compared to $752,000 for the same period in 2010.  Mortgage origination fee income decreased $168,000, or 46.2%, to $196,000 for the six months ended December 31, 2011 due to lower demand for residential mortgage refinancing. Service charges and fees declined $95,000, or 14.2%, to $576,000 for the six months ended December 31, 2011 compared to the prior year period.  

26

The following table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent changes for the six months ended December 31, 2011 compared to the same period in 2010.

 

	Six Months Ended
	December 31,						$			%
	2011			2010			Change			Change
	(Dollars in thousands)
Noninterest income:
Mortgage origination fee income	$	196		$	364		$	(168	)		(46.2	%)
Service charges and fees		576			671			(95	)		(14.2	%)
Gain (loss) on sale of fixed assets		(19	)		-			(19	)		-
(Loss) gain on investment securities		39			752			(713	)		(94.8	%)
Gain (loss) on sale of foreclosed real estate, net		(79	)		(405	)		326			(80.5	%)
BOLI increase in cash value		119			119			-			0.0	%
Other		349			333			16			4.8	%
Total noninterest income	$	1,181		$	1,834		$	(653	)		(35.6	%)

Noninterest Expense

Total noninterest expense increased $375,000, or 4.3%, to $9.1 million for the six months ended December 31, 2011 compared to $8.7 million for the corresponding period in 2010.   Compensation expense totaled $3.1 million for the six months ended December 31, 2011 compared to $3.4 million for the same period in 2010 due to employee attrition.  The number of full-time equivalent employees was 122 at December 31, 2011 compared to 130 at December 31, 2010. Valuation adjustments and expenses on other real estate owned increased $767,000 to $1.9 million for the six months ended December 31, 2011 compared to $1.1 million for the same period in 2010.  

The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the six months ended December 31, 2011 compared to the same period in 2010.  

	Six Months Ended
	December 31,				$			%
	2011		2010		Change			Change
	(Dollars in thousands)
Noninterest expense:
Compensation and benefits	$	3,131	$	3,444	$	(313	)		(9.1	%)
Occupancy expense		713		722		(9	)		(1.2	%)
Equipment and data processing expense		1,207		1,262		(55	)		(4.4	%)
Deposit insurance premiums		403		325		78			24.0	%
Advertising		135		105		30			28.6	%
Valuation adjustment and expenses on OREO		1,871		1,104		767			69.5	%
Loss on early extinguishment of debt		-		190		(190	)		(100.0	%)
Other		1,655		1,588		67			4.2	%
Total noninterest expense	$	9,115	$	8,740	$	375			4.3	%

Income Taxes

Income tax benefit for the six months ended December 31, 2011 was $2.6 million compared to income tax expense of $306,000 for the same period in 2010 due to lower taxable income.  

Financial Condition

Cash, Cash Equivalents and Interest-Earning Deposits

Cash, cash equivalents, and interest-earning deposits decreased $4.8 million to $35.7 million at December 31, 2011 compared to $40.5 million at June 30, 2011.

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 Investments

The Company’s investment security portfolio primarily consists of U.S. Government agency obligations, mortgage-backed securities issued by government-sponsored entities, and municipal bonds.  Investment securities increased to $78.0 million at December 31, 2011 compared to $74.8 million at June 30, 2011.  Investments classified as available-for-sale are carried at fair market value and reflect an unrealized gain of $1.2 million, or $743,000 net of taxes, at December 31, 2011. The $3.2 million increase in the investment portfolio is primarily due to new purchases exceeding calls and paydowns of securities.  

Loans

Net loans decreased $26.8 million to $351.8 million at December 31, 2011 compared to $378.6 million at June 30, 2011 due primarily to reduced loan demand combined with normal paydowns on existing loans, transfers to OREO and charge-offs.  Reduced loan demand has resulted from continued economic weakness in the Bank’s market areas.  

28

Loans receivable, net, are summarized as follows:

	At						At
	December 31,						June 30,
	2011						2011
				Percent						Percent			$			%
	Amount			of Portfolio			Amount			of Portfolio			Change			Change
	(Dollars in thousands)
Real estate loans:
Residential one-to four-family	$	102,520			28.2	%	$	110,046			28.4	%	$	(7,526	)		(6.8	%)
Home equity line of credit		19,376			5.3	%		20,029			5.2	%		(653	)		(3.3	%)
Commercial		141,186			38.9	%		144,519			37.3	%		(3,333	)		(2.3	%)
Multi-family		13,411			3.7	%		14,062			3.6	%		(651	)		(4.6	%)
Construction		4,653			1.3	%		2,171			0.6	%		2,482			114.3	%
Land		28,773			7.9	%		30,053			7.8	%		(1,280	)		(4.3	%)
Total real estate loans		309,919			85.4	%		320,880			82.9	%		(10,961	)		(3.4	%)
Commercial business loans		47,974			13.2	%		60,497			15.6	%		(12,523	)		(20.7	%)
Consumer loans:
Automobile loans		1,040			0.3	%		1,237			0.3	%		(197	)		(15.9	%)
Mobile home loans		8			0.0	%		13			0.0	%		(5	)		(38.5	%)
Loans secured by deposits		1,234			0.3	%		1,268			0.3	%		(34	)		(2.7	%)
Other consumer loans		2,902			0.8	%		3,235			0.8	%		(333	)		(10.3	%)
Total consumer loans		5,184			1.4	%		5,753			1.5	%		(569	)		(9.9	%)
Total gross loans		363,077			100.0	%		387,130			100.0	%		(24,053	)		(6.2	%)
Less:
Deferred loan fees, net		(370	)					(362	)					(8	)		2.2	%
Allowance for losses		(10,880	)					(8,181	)					(2,699	)		33.0	%
Loans receivable, net	$	351,827					$	378,587					$	(26,760	)		(7.1	%)

Loan Loss Allowance

The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio.  We evaluate the need to establish reserves against losses on loans on a monthly basis.  When additional reserves are necessary, a provision for loan losses is charged to earnings.  

In connection with assessing the allowance, we have established a systematic methodology for determining the adequacy of the allowance for loan losses.  The methodology utilizes a loan grading system which segments loans with similar risk characteristics.  Management performs a monthly assessment of the allowance for loan losses based on the nature and volume of the loan portfolio, the amount of impaired and classified loans and historical loan loss experience.  In addition, management considers other qualitative factors, including delinquency trends, economic conditions and loan considerations.

The FDIC and the Tennessee Department of Financial Institutions, as an integral part of their examination process, periodically review our allowance for loan losses.  The FDIC and/or the Tennessee Department of Financial Institutions may require us to make additional provisions for loan losses based on judgments different from ours.  

29

The allowance for loan losses was $10.9 million at December 31, 2011 compared to $8.2 million at June 30, 2011.  Our allowance for loan losses represented 3.00% of total loans and 113.86% of nonperforming loans at December 31, 2011 compared to 2.11% of total loans and 99.19% of nonperforming loans at June 30, 2011.

	Three Months Ended						Six Months Ended
	December 31,						December 31,
	2011			2010			2011			2010
	(Dollars in thousands)						(Dollars in thousands)
Balance at beginning of period	$	10,204		$	8,748		$	8,181		$	9,649
Provision for loan losses		5,687			950			8,673			950
Recoveries		42			94			82			102
Charge-offs		(5,053	)		(1,847	)		(6,056	)		(2,756	)
Net charge-offs		(5,011	)		(1,753	)		(5,974	)		(2,654	)
Allowance at end of period	$	10,880		$	7,945		$	10,880		$	7,945
Net charge-offs to average outstanding
loans during the period, annualized		5.35	%		1.67	%		3.16	%		1.24	%

Nonperforming Assets

We consider repossessed assets and nonaccrual loans to be nonperforming assets.  Loans are reviewed on a monthly basis and are generally placed on nonaccrual status when the loan becomes more than 90 days delinquent.  Nonaccrual loans totaled $9.6 million at December 31, 2011 compared to $8.2 million at June 30, 2011.  Troubled debt restructuring (“TDR”) loans were $14.3 million at December 31, 2011 compared to $15.8 million at June 30, 2011.  In general, a TDR exists when we grant a concession to a borrower experiencing financial difficulty that we normally would not otherwise consider.  These concessions can result in avoidance of foreclosure proceedings and can result in the full repayment of the loan principal amount.  The majority of the Bank’s TDRs involve a modification in loan terms such as a temporary period of interest only or extension of the maturity date.    The amount of accruing TDR loans totaled $12.9 million at December 31, 2011.  Foreclosed real estate amounted to $8.9 million at December 31, 2011 compared to $9.5 million at June 30, 2011.  Foreclosed real estate is initially recorded at the lower of the amount of the loan or the fair value of the foreclosed real estate, less estimated selling costs.  Any initial writedown to fair value is charged to the allowance for loan losses.  Any subsequent writedown of foreclosed real estate is charged against earnings.  Foreclosed real estate at December 31, 2011 consisted of vacant land totaling $1.7 million, residential property totaling $1.8 million, subdivision developments totaling $3.0 million and commercial real estate totaling $2.4 million.

30

	December 31,			June 30,
	2011			2011
	(Dollars in thousands
Nonaccrual loans:
Real estate	$	6,002		$	5,401
Commercial business		2,166			848
Consumer		41			41
Total nonaccrual loans		8,209			6,290
Nonaccrual restructured loans:
Real estate		975			1,531
Commercial business		377			427
Consumer		-			-
Total nonaccrual restructured loans		1,352			1,958
Total nonperforming loans		9,561			8,248
Nonaccrual investments		276			464
Real estate owned		8,902			9,498
Other nonperforming assets		1			1
Total nonperforming assets	$	18,740		$	18,211
Accruing restructured loans	$	12,972		$	13,821
Accruing restructured loans and nonperforming loans	$	22,533		$	22,069
Total nonperforming loans to total loans		2.63	%		2.13	%
Total nonperforming loans to total assets		1.80	%		1.47	%
Total nonperforming assets to total assets		3.53	%		3.25	%

The following table summarizes activity in OREO during the six months ended December 31, 2011:

OREO balance at beginning of period	$	9,498
OREO acquired		2,229
OREO sold		(1,154	)
Initial valuation adjustments		(341	)
Subsequent valuation adjustments		(1,330	)
OREO ending balance	$	8,902

Bank Owned Life Insurance

We hold bank owned life insurance (“BOLI”) to help offset the cost of employee benefit plans.  BOLI provides earnings from accumulated cash value growth and provides tax advantages inherent in a life insurance contract.  The cash surrender value of the BOLI at December 31, 2011 was $6.7 million.  

Deposits

Total deposits decreased $22.3 million to $431.9 million at December 31, 2011 due to the planned runoff of certificates of deposit resulting from the offering of lower interest rates.  Time deposits decreased $31.1 million, or 14.8%, to $179.8 million at December 31, 2011.  Transaction accounts increased $8.8 million, or 3.6%, to $252.2 million at December 31, 2011.

31

	December 31,		June 30,
	2011		2011		$ Change			% Change
	(Dollars in thousands)
Noninterest-bearing accounts	$	51,696	$	54,340	$	(2,644	)		(4.9	%)
NOW accounts		48,390		46,134		2,256			4.9	%
Savings accounts		98,113		91,637		6,476			7.1	%
Money market accounts		53,956		51,252		2,704			5.3	%
Certificates of deposit		179,791		210,899		(31,108	)		(14.8	%)
Total	$	431,946	$	454,262	$	(22,316	)		(4.9	%)

Advances

FHLB advances remained unchanged at $37.9 million at December 31, 2011 compared to June 30, 2011. Additional FHLB advances may be utilized in the future to manage daily liquidity needs and to support loan growth.

Stockholders’ Equity

Stockholders’ equity was $51.6 million at December 31, 2011 compared to $55.9 million at June 30, 2011. Unrealized gains and losses, net of taxes, in the available-for-sale investment portfolio are reflected as an adjustment to stockholders’ equity.  At December 31, 2011, the adjustment to stockholders’ equity was a net unrealized gain of $743,000 compared to a net unrealized gain of $459,000 at June 30, 2011.  On November 13, 2008, the Company announced its third stock repurchase program pursuant to which up to 620,770 shares of the Company’s outstanding common stock may be repurchased.  At December 31, 2011, 437,802 shares remained eligible for repurchase under the current stock repurchase program.

Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations of a short-term nature.  Primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and borrowings from the FHLB of Cincinnati.  While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

Investments in liquid assets are regularly adjusted based on our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program.  Excess liquid assets are invested generally in interest-earning deposits and short- and intermediate-term U.S. Government agency obligations.  

Our most liquid assets are cash and cash equivalents and marketable investment securities that are not pledged as collateral.  The levels of these assets are dependent on operating, financing, lending and investing activities during any given period.  At December 31, 2011, cash and cash equivalents totaled $35.7 million compared to $40.5 million at June 30, 2011.  Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $78.0 million at December 31, 2011 compared to $74.8 million at June 30, 2011.   At December 31, 2011, approximately $13.6 million of the investment portfolio was pledged as collateral for municipal deposits, FHLB borrowings and repurchase agreements.   The Company’s external sources of liquidity include borrowing capacity with the Federal Home Loan Bank of Cincinnati, the Federal Reserve, and other correspondent banks.  FHLB advances remained unchanged at $37.9 million at December 31, 2011 compared to June 30, 2011.   At December 31, 2011, borrowing capacity with the FHLB totaled $62.4 million based on pledged collateral, of which $24.8 million was unused.  Additional eligible collateral may be transferred to the FHLB to increase borrowing capacity.  The Company can borrow from the Federal Reserve Bank of Atlanta’s discount window to meet short-term liquidity requirements.   At December 31, 2011, the Company had approximately $19.6 million of unused borrowing capacity based on pledged collateral with the Federal Reserve Bank discount window.  In addition, the Company also maintains federal funds lines with two correspondent banks totaling $18.5 million under which no borrowings were outstanding. These federal funds lines may be terminated at any time and may not be outstanding for more than 14 consecutive days.

32

The Company anticipates that it will have sufficient funds available to meet current loan commitments.  At December 31, 2011, we had approximately $6.1 million in loan commitments, consisting of commitments to fund real estate loans.  In addition to commitments to originate loans, we had $4.7 million in unused letters of credit and approximately $29.8 million in unused lines of credit. At December 31, 2011, we had approximately $121.8 million in certificates of deposit due within one year and $252.2 million in other deposits without specific maturities.  We believe, based on past experience, that a significant portion of those deposits will remain with us. Deposit flows are affected by the overall level of interest rates and products offered by us and our local competitors and other factors.  We generally manage the pricing of our deposits to be competitive and to increase core deposits.    Occasionally, we offer promotional rates on certain deposit products in order to attract deposits. We experienced a net decrease in total deposits of $22.3 million during the six-month period ended December 31, 2011.

Jefferson Bancshares is a separate entity and apart from Jefferson Federal and must provide for its own liquidity.  In addition to its operating expenses, Jefferson Bancshares is responsible for the payment of dividends declared for its shareholders, and interest and principal on outstanding debt.  At times, Jefferson Bancshares has repurchased and retired outstanding shares of its stock pursuant to share repurchase programs adopted by the Board of Directors.  Payment of dividends to Jefferson Bancshares by Jefferson Federal is limited under Tennessee law.  The amount that can be paid in any calendar year, without prior approval from the Tennessee Department of Financial Institutions, cannot exceed the total of Jefferson Federal’s net income for the year combined with its retained net income for the preceding two years.  Jefferson Bancshares believes that such restriction will not have an impact on its ability to meet its ongoing cash obligations.

Off-Balance Sheet Arrangements

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements.  These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk.  Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, unused lines of credit, amounts due mortgagors on construction loans, amounts due on commercial loans and commercial letters of credit.

For the three months ended December 31, 2011, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

33

Capital Compliance

The Bank is subject to various regulatory capital requirements administered by the banking regulatory agencies. As of December 31, 2011, Jefferson Federal met each of its capital requirements.  The following table presents our capital position relative to our regulatory capital requirements at December 31, 2011 and June 30, 2011:

												To Be Well
												Capitalized Under
						For Capital						Prompt Corrective
	Actual					Adequacy Purposes						Action Provisions
	Amount		Ratio			Amount			Ratio			Amount			Ratio
	(Dollars in thousands)
At December 31, 2011
Total Risk-Based Capital
(To Risk Weighted Assets)	$	45,396		11.97	%	$	30,337	>		8.0	%	$	37,921	>		10.0	%
Tier 1 Capital
(To Risk Weighted Assets)		40,580		10.70	%		15,168	>		4.0	%		22,752	>		6.0	%
Tier 1 Capital
(To Average Assets)		40,580		7.69	%		21,115	>		4.0	%		26,394	>		5.0	%
At June 30, 2011
Total Risk-Based Capital
(To Risk Weighted Assets)	$	52,254		13.00	%	$	32,168	>		8.0	%	$	40,210	>		10.0	%
Tier 1 Capital
(To Risk Weighted Assets)		47,189		11.74	%		16,084	>		4.0	%		24,126	>		6.0	%
Tier 1 Capital
(To Average Assets)		47,189		8.50	%		22,208	>		4.0	%		27,760	>		5.0	%

Under the capital regulations of the FDIC, Jefferson Federal must satisfy various capital requirements. Banks supervised by the FDIC must maintain a minimum leverage ratio of core (“Tier I”) capital to average adjusted assets of at least 3.00% if a particular institution has the highest examination rating and at least 4.00% for all others. At December 31, 2011, Jefferson Federal’s leverage capital ratio was 7.69%. The FDIC’s risk-based capital rules require banks supervised by the FDIC to maintain a ratio of risk-based capital to risk-weighted assets of at least 8.00%. Risk-based capital for Jefferson Federal is defined as Tier 1 capital plus Tier 2 capital. At December 31, 2011, Jefferson Federal had a ratio of total capital to risk-weighted assets of 11.97%. At December 31, 2011, the Bank met the minimum regulatory capital requirements, and the Bank was “well-capitalized” within the meaning of federal regulatory requirements.

34

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

For a discussion of the Company’s asset and liability management policies, as well as the potential impact of interest rate changes upon the market value of the Company’s portfolio equity, see Item 7A in the Company’s Annual Report on Form 10-K for the year ended June 30, 2011.  Management, as part of its regular practices, performs periodic reviews of the impact of interest rate changes upon net interest income and the market value of the Company’s portfolio equity.  Based on, among other factors, such reviews, management believes that there have been no material changes in the market risk of the Company’s asset and liability position since June 30, 2011.  

Item 4.   Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”)  (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and  (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.  In addition, based on that evaluation, no change in the Company’s internal control over financial reporting occurred during the quarter ended December 31, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

35

PART II.  OTHER INFORMATION

Item 1.   Legal Proceedings

Jefferson Bancshares is not a party to any pending legal proceedings.  Periodically, there have been various claims and lawsuits involving Jefferson Federal, such as claims to enforce liens, condemnation proceedings on properties in which Jefferson Federal holds security interests, claims involving the making and servicing of real property loans and other issues incident to Jefferson Federal’s business.  Jefferson Federal is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company or the Bank.

Item 1A.  Risk Factors

There have been no material changes to the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended June 30, 2011.

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

							( d )
							Maximum Number
					( c )		(or Approximate
					Total Number of		Dollar Value)
	(a)		(b)		Shares (or Units)		of Shares (or
	Total Number		Average		Purchased as		Units) That May
	of Shares		Price Paid		Part of Publicly		Yet Be Purchased
	(or units)		per Share		Announced Plans		Under the Plans
Period	Purchased		(or Unit)		or Progams		or Programs
Month #1
October 1, 2011		—	$	—		—		438,153	(1	)
through
October 31, 2011
Month #2
November 1, 2011		—	$	—		—		438,153	(1	)
through
November 30, 2011
Month #3
December 1, 2011		351	$	2.49		351		437,802	(1	)
through
December 31, 2011
Total		351	$	2.49		351		437,802

(1)  On November 13, 2008, the Company announced a stock repurchase program under which the Company mayrepurchase up to 620,770 shares of the Company's common stock, from time to time, subject to market conditions. The repurchase program will continue until completed or terminated by the Board of Directors.

Item 3.  Defaults Upon Senior Securities

None.

36

Item 4.  Mine Safety Disclosures

               Not applicable.

Item 5.  Other Information

None.

Item 6.  Exhibits   

31.1 Rule 13a-14(a)/15d-14(a) certification of the principal executive officer

31.2 Rule 13a-14(a)/15d-14(a) certification of the principal financial officer

32.0 Section 1350 certification

101.0* The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2011, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Condition, (ii) the Consolidated Statements of Earnings, (iii) the Consolidated Statement of Changes in Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements, tagged as blocks of text.

*  Furnished, not filed.

37

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.

	JEFFERSON BANCSHARES, INC.
February 14, 2012	/s/ Anderson L. Smith
	Anderson L. Smith President and Chief Executive Officer
	/s/ Jane P. Hutton
February 14, 2012	Jane P. Hutton
	Chief Financial Officer, Treasurer and Secretary

38

EX-31.1

Jefferson Bancshares, Inc. 10-Q

EXHIBIT 31.1

CERTIFICATION

I, Anderson L. Smith, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Jefferson Bancshares, Inc.;

2. Based on my knowledge, this  report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 (e) and 15d-15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15 (f) and 15d-15 (f))  for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and in preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

February 14, 2012	/s/ Anderson L. Smith
	Anderson L. Smith President and Chief Executive Officer

EX-31.2

Jefferson Bancshares, Inc. 10-Q

EXHIBIT 31.2

CERTIFICATION

I, Jane P. Hutton, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Jefferson Bancshares, Inc.;

2. Based on my knowledge, this  report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 (e) and 15d-15 (e))  and internal control over financial reporting (as defined in Exchange Act Rules 13a-15 (f) and 15d-15 (f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and in preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

	/s/ Jane P. Hutton
February 14, 2012	Jane P. Hutton
	Chief Financial Officer, Treasurer and Secretary

EX-32.1

Jefferson Bancshares, Inc. 10-Q

EXHIBIT 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADDED BY

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the QuarterlyReport of Jefferson Bancshares, Inc. (the “Company”) on Form 10-Q for the quarter ended December 31, 2011as filed with the Securities and Exchange Commission (the “Report”), the undersigned hereby certify, pursuant to 18 U.S.C.§ 1350, as added by § 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report.

February 14, 2012	/s/ Anderson L. Smith
	Anderson L. Smith President and Chief Executive Officer
	/s/ Jane P. Hutton
February 14, 2012	Jane P. Hutton
	Chief Financial Officer, Treasurer and Secretary

XML

Principles of Consolidation

6 Months Ended

Dec. 31, 2011

Principles Of Consolidation

Principles of Consolidation

(2)   Principles of Consolidation

The consolidated financial statements include the accounts of Jefferson Bancshares, Inc. and its wholly-owned subsidiary, Jefferson Federal Bank.  All significant intercompany balances and transactions have been eliminated in consolidation.

XML

Basis of Presentation

6 Months Ended

Dec. 31, 2011

Basis Of Presentation

Basis of Presentation

(1)   Basis of Presentation

The condensed consolidated financial statements include the accounts of Jefferson Bancshares, Inc. (the “Company” or “Jefferson Bancshares”) and its wholly-owned subsidiary, Jefferson Federal Bank (the “Bank” or “Jefferson Federal”).  The accompanying interim condensed consolidated financial statements, presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”), are unaudited and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of financial condition and results of operations for the interim periods. The results of operations for the six months ended December 31, 2011 are not necessarily indicative of the results which may be expected for the entire fiscal year or any other period. These unaudited consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended June 30, 2011, which was filed with the Securities and Exchange Commission on September 27, 2011.  All dollar amounts, other than per-share amounts, are in thousands unless otherwise noted.  The Company has adopted FASB ASC Topic 855 for Subsequent Events which did not significantly change the subsequent events the Company reports either through recognition or disclosure.  

XML

Consolidated Balance Sheets (Unaudited) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2011	Jun. 30, 2011
Assets
Cash and cash equivalents	$ 5,419	$ 5,327
Interest-earning deposits	30,328	35,221
Investment securities classified as available for sale, net	77,990	74,780
Federal Home Loan Bank stock	4,735	4,735
Bank owned life insurance	6,744	6,625
Loans receivable, net of allowance for loan losses of $10,880 and $8,181	351,827	378,587
Loans held-for-sale	916
Premises and equipment, net	26,102	26,617
Foreclosed real estate, net	8,902	9,498
Accrued interest receivable:
Investments	352	311
Loans receivable	1,500	1,521
Deferred tax asset	11,479	9,009
Core deposit intangible	1,748	1,978
Other assets	2,357	6,980
Total Assets	530,399	561,189
Deposits
Noninterest-bearing	51,696	54,340
Interest-bearing	380,250	399,922
Repurchase agreements	820	945
Federal Home Loan Bank advances	37,903	37,942
Subordinated debentures	7,189	7,133
Other liabilities	936	4,988
Total liabilities	478,794	505,270
Commitments and contingent liabilities
Stockholders' equity
Common stock, $.01 par value; 30,000,000 shares authorized; 9,182,372 shares issued and 6,632,039 shares outstanding at December 31, 2011 and 6,634,523 shares outstanding at June 30, 2011	92	92
Additional paid-in capital	78,740	78,895
Unearned ESOP shares	(3,025)	(3,241)
Unearned compensation	(1,046)	(1,019)
Accumulated other comprehensive income	743	459
Retained earnings	7,442	12,067
Treasury stock, at cost (2,550,333 and 2,547,849 shares)	(31,341)	(31,334)
Total stockholders' equity	51,605	55,919
Total liabilities and stockholders' equity	$ 530,399	$ 561,189

XML

Consolidated Statements of Changes in Stockholders' Equity (Parenthetical) (USD $) In Thousands, except Share data, unless otherwise specified	6 Months Ended
	Dec. 31, 2011	Dec. 31, 2010
Accumulated Other Comprehensive Income
Taxes of the change in net unrealized gain (loss) on securities available for sale	$ 176	$ (452)
Treasury Stock
Purchase of common stock, shares	2,484	22,718

XML

Consolidated Statements of Cash Flows (Unaudited) (USD $) In Thousands, unless otherwise specified	6 Months Ended
	Dec. 31, 2011	Dec. 31, 2010
Cash flows from operating activities:
Net earnings	$ (4,625)	$ 618
Adjustments to reconcile net earnings to net cash provided by (used for) operating activities:
Allocated ESOP shares	61	74
Depreciation and amortization expense	950	678
Amortization of premiums (discounts), net on investment securities	35	218
Provision for loan losses	8,673	950
Amortization of deferred loan fees, net	(78)	(146)
(Gain) loss on sale of investment securities	(39)	5
(Gain) loss on sale of foreclosed real estate, net	79	405
(Gain) loss on sale of fixed assets, net	19
Deferred tax benefit	(2,646)	303
Originations of mortgage loans held for sale	(9,494)	(13,487)
Proceeds from sale of mortgage loans	8,578	14,432
Increase in cash value of life insurance	(119)	(119)
Earned portion of MRP	(27)	34
Decrease (increase) in:
Accrued interest receivable	(20)	243
Other assets	4,622	(776)
Increase (decrease) in other liabilities and accrued income taxes	(4,051)	1,205
Net cash provided by (used for) operating activities	1,918	4,637
Cash flows used for investing activities:
Loan originations, net of principal collections	17,545	21,551
Investment securities classified as available-for-sale:
Proceeds from maturities, calls and prepayments	38,341	38,536
Proceeds from sale	501	756
Purchase of securities	(41,726)	(23,127)
Proceeds from sale of premises and equipment, construction overpayments	26
Purchase of premises and equipment	(46)	(80)
Proceeds from sale of (additions to) foreclosed real estate, net	1,079	1,915
Net cash provided by (used for) investing activities	15,720	39,551
Cash flows from financing activities:
Net increase (decrease) in deposits	(22,294)	8,964
Net increase in repurchase agreements	(125)	(650)
Proceeds from advances from FHLB		309
Repayment of FHLB advances	(13)	(26,619)
Purchase of treasury stock	(7)	(79)
Dividends paid
Net cash provided by (used for) financing activities	(22,439)	(18,075)
Net increase (decrease) in cash, cash equivalents and interest-earning deposits	(4,801)	26,113
Cash, cash equivalents and interest-earning deposits at beginning of period	40,548	69,303
Cash, cash equivalents and interest-earning deposits at end of period	35,747	95,416
Cash paid during period for:
Interest on deposits	1,806	3,205
Interest on borrowed funds	526	1,543
Interest on subordinated debentures	103	106
Income taxes
Real estate acquired in settlement of loans	$ 2,229	$ 8,635

XML

Consolidated Balance Sheets (Parenthetical) (USD $) In Thousands, except Share data, unless otherwise specified	Dec. 31, 2011	Jun. 30, 2011
Consolidated Balance Sheets
Allowance for loan losses	$ 10,880	$ 8,181
Preferred stock, par value	$ 0.01	$ 0.01
Preferred stock, shares authorized	10,000,000	10,000,000
Preferred stock, shares issued	0	0
Preferred stock, shares outstanding	0	0
Common stock, par value	$ 0.01	$ 0.01
Common stock, shares authorized	30,000,000	30,000,000
Common stock, shares issued	9,182,372	9,182,372
Common stock, shares outstanding	6,632,039	6,634,523
Treasury stock, shares	2,550,333	2,547,849

XML

Investment Securities

6 Months Ended

Dec. 31, 2011

Investment Securities

Investment Securities

(10)    Investment Securities

Investment securities are summarized as follows:

At December 31, 2011
	Amortized			Unrealized		Unrealized			Fair
	Cost			Gains		Losses			Value
	(Dollars in thousands)
Securities available-for-sale
Debt securities:
Federal agency	$	21,224		$	292	$	-		$	21,516
Mortgage-backed		50,516			1,200		(240	)		51,476
Municipals		4,437			283		-			4,720
Other Securities		609			-		(331	)		278
Total securities available-
for-sale	$	76,786		$	1,775	$	(571	)	$	77,990
Weighted-average rate		2.40	%
Pledged at December 31, 2011	$	13,600
At June 30, 2011
	Amortized			Unrealized		Unrealized			Fair
	Cost			Gains		Losses			Value
	(Dollars in thousands)
Securities available-for-sale
Debt securities:
Federal agency	$	43,721		$	228	$	-		$	43,949
Mortgage-backed		24,551			861		(56	)		25,356
Municipals		5,150			112		(25	)		5,237
Other Securities		613			-		(375	)		238
Total securities available-
for-sale	$	74,035		$	1,201	$	(456	)	$	74,780
Weighted-average rate		2.35	%
Pledged at June 30, 2011	$	19,389

Securities with unrealized losses not recognized in income are as follows:

	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
	(Dollars in thousands)
December 31, 2011
Federal agency securities	$	-	$	-		$	-	$	-		$	-	$	-
Mortgage-backed securities		3,510		(133	)		600		(107	)		4,110		(240	)
Municipal securities		-		-			-		-			-		-
Other securities		-		-			278		(331	)		278		(331	)
	$	3,510	$	(133	)	$	878	$	(438	)	$	4,388	$	(571	)

The Company evaluates its securities with significant declines in fair value on a quarterly basis to determine whether they should be considered temporarily or other than temporarily impaired.  The Company has recognized all of the unrealized losses reflected in the foregoing table in other comprehensive income.  The Company neither has the intent to sell nor is forecasting the need or requirement to sell the securities before their anticipated recovery.

GSE Residential Mortgage-Backed Securities – The unrealized losses of $133,000 for these five GSE mortgage-backed securities was caused by changes in market interest rates. The contractual cash flows of these investments are guaranteed by an agency of the U.S. Government. Accordingly it is expected that the securities would not be settled at a price less than the amortized bases of the Company’s investments. Because the decline in market value is attributable to changes in market interest rates and not credit quality, and because the Company does not intend to sell the investments before recovery of their amortized cost bases and it is not more likely than not the Company does not intend to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2011.

Private-Label Residential Mortgage-Backed Securities - The unrealized losses of $107,000 for this private-label mortgage-backed security is primarily driven by higher projected collateral losses, wider credit spreads and changes in interest rates as indicated by the annual independent valuation of the investment. The valuation methodology used is a future cash flow analysis which is built upon a model based on collateral-specific assumptions as they relate to the underlying loans. Given the expected improvement in the future performances of the expected cash flow, the unrealized losses are not deemed to be attributable to credit quality. Accordingly it is expected that the security would not be settled at a price less than the amortized bases of the Company’s investment. Because the decline in market value is attributable to higher projected collateral losses, wider credit spreads and changes in interest rates and not credit quality, the Company expects to recover the entire amortized cost bases of this security.

Other Securities – The unrealized loss of $331,000 on this CDO was a result of updated variables and inputs that comprise the model used in the annual independent valuation of this security. The collateral for the CDO investment is comprised of trust preferred securities and senior and subordinated debt issued by banks, insurance companies, REIT’s, real estate operating companies and homebuilding companies. The CDO security is valued using three different scenarios as a predictor of future collateral performance and the fair market value determined accordingly. Given the expected improvement in the future performance of the collateral, the unrealized loss is not deemed to be attributable to credit quality. Since the Company does not intend to sell this investment before recovery of its amortized cost basis, which may be maturity, the Company does not consider this investment to be other-than-temporarily impaired at December 31, 2011.

Maturities of debt securities at December 31, 2011, are summarized as follows:

					Weighted
	Amortized		Fair		Average
	Cost		Value		Yield
Within 1 year	$	498	$	500		2.34	%
Over 1 year through 5 years		12,611		12,802		1.47	%
After 5 years through 10 years		11,658		11,897		1.79	%
Over 10 years		52,019		52,791		2.77	%
	$	76,786	$	77,990		2.40	%

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Document and Entity Information	6 Months Ended
	Dec. 31, 2011	Feb. 14, 2012
Document And Entity Information
Entity Registrant Name	JEFFERSON BANCSHARES INC
Entity Central Index Key	0001222915
Document Type	10-Q
Document Period End Date	Dec. 31, 2011
Amendment Flag	false
Current Fiscal Year End Date	--06-30
Is Entity a Well-known Seasoned Issuer?	No
Is Entity a Voluntary Filer?	No
Is Entity's Reporting Status Current?	Yes
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding		6,632,039
Document Fiscal Period Focus	Q2
Document Fiscal Year Focus	2012

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Fair Value Disclosures

6 Months Ended

Dec. 31, 2011

Fair Value Disclosures [Abstract]

Fair Value Disclosures

(11)   Fair Value Disclosures

Fair value is defined as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. When measuring fair value, the Company uses valuation techniques that are appropriate and consistently applied.  A hierarchy is also established under the standard and is used to prioritize valuation inputs into the following three levels used to measure fair value:

Level 1

Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as certain U.S. Treasury, other U.S. Government and agency mortgage-backed debt securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2

Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain U.S. Government and agency mortgage-backed debt securities, corporate debt securities, derivative contracts and residential mortgage loans held-for-sale.

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights, and highly structured or long-term derivative contracts.

The following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities Available for Sale

Level 2 investment securities classified as “available-for-sale” are recorded at fair value on a recurring basis. Fair value measurements are based upon independent pricing models or other model-based valuation techniques with inputs that are observable in the market or that can be derived principally from or corroborated by observable market data. Level 2 securities include mortgage-backed securities issued by government-sponsored entities, municipal bonds, bonds issued by government agencies, and corporate debt securities. Level 3 investment securities classified as “available-for-sale” are recorded at fair value on at least a semi-annual basis. Fair value measurements are based upon independent pricing models based upon unobservable inputs which require significant management judgment or estimation. Level 3 includes certain mortgage-backed securities and other debt securities.  

Impaired Loans

The Company records loans at fair value on a non-recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows.

Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2011, substantially all of the total impaired loans were evaluated based on either the fair value of the collateral or its liquidation value. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Below is a table that presents information about certain assets and liabilities measured at fair value:   

	December 31, 2011
				Total Carrying
				Amount in	Assets/Liabilities
				Statement of	Measured at
Description	Level 1	Level 2	Level 3	Financial Condition	Fair Value
Securities available for sale	-	$74,997	$2,993	$77,990	$77,990

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below.

	December 31, 2011
				Total Carrying
				Amount in	Assets/Liabilities
				Statement of	Measured at
Description	Level 1	Level 2	Level 3	Financial Condition	Fair Value
Impaired Loans	-	$22,859	-	$22,859	$22,859

The carrying value and estimated fair value of the Company’s financial instruments are as follows:

	December 31, 2011						June 30, 2011
	Carrying			Fair			Carrying			Fair
	Amount			Value			Amount			Value
Financial assets:
Cash and due from banks and	$	35,747		$	35,747		$	40,548		$	40,548
interest-earning deposits
with banks
Available-for-sale securities		77,990			77,990			74,780			74,780
Federal Home Loan Bank stock		4,735			4,735			4,735			4,735
Loans receivable, net		351,827			359,841			378,587			379,787
Accrued interest receivable		1,852			1,852			1,832			1,832
Loans held-for-sale		916			916			-			-
Financial liabilities:
Deposits		(431,946	)		(425,888	)		(454,262	)		(446,115	)
Borrowed funds		(38,723	)		(40,783	)		(38,887	)		(40,718	)
Subordinated debentures		(7,189	)		(5,119	)		(7,133	)		(6,277	)
Off-balance sheet assets (liabilities):
Commitments to extend credit		-			6,146			-			11,932
Unused letters of credit		-			4,729			-			4,809
Unused lines of credit		-			29,805			-			34,362

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Consolidated Statements of Earnings (Unaudited) (USD $) In Thousands, except Per Share data, unless otherwise specified	3 Months Ended		6 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2011	Dec. 31, 2010
Interest income:
Interest on loans receivable	$ 5,265	$ 6,112	$ 10,837	$ 12,394
Interest on investment securities	450	409	934	891
Other interest	60	109	124	201
Total interest income	5,775	6,630	11,895	13,486
Interest expense:
Deposits	800	1,534	1,756	3,197
Repurchase agreements	1	2	3	4
Advances from FHLB	320	582	640	1,343
Subordinated debentures	82	80	159	162
Total interest expense	1,203	2,198	2,558	4,706
Net interest income	4,572	4,432	9,337	8,780
Provision for loan losses	5,687	950	8,673	950
Net interest income after provision for loan losses	(1,115)	3,482	664	7,830
Noninterest income:
Mortgage origination fee income	101	224	196	364
Service charges and fees	284	315	576	671
Gain on investments	13	743	39	752
Gain (loss) on sale of fixed assets			(19)
Gain (loss) on sale of foreclosed real estate, net	(63)	(58)	(79)	(405)
BOLI increase in cash value	60	59	119	119
Other	183	161	349	333
Total noninterest income	578	1,444	1,181	1,834
Noninterest expense:
Compensation and benefits	1,525	1,703	3,131	3,444
Occupancy expense	351	358	713	722
Equipment and data processing expense	605	610	1,207	1,262
DIF premiums	201	163	403	325
Advertising	115	59	135	105
Valuation adjustment and expenses on OREO	1,467	573	1,871	1,104
Loss on early extinguishment of debt		190		190
Other	831	731	1,655	1,588
Total noninterest expense	5,095	4,387	9,115	8,740
Earnings before income taxes	(5,632)	539	(7,270)	924
Income taxes:
Current		3		3
Deferred	(1,965)	177	(2,645)	303
Total income taxes	(1,965)	180	(2,645)	306
Net earnings	$ (3,667)	$ 359	$ (4,625)	$ 618
Net earnings per share, basic	$ (0.59)	$ 0.06	$ (0.74)	$ 0.10
Net earnings per share, diluted	$ (0.59)	$ 0.06	$ (0.74)	$ 0.10

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Earnings Per Common Share

6 Months Ended

Dec. 31, 2011

Earnings Per Common Share

Earnings Per Common Share

(5)   Earnings Per Common Share

Earnings per common share and diluted earnings per common share have been computed on the basis of dividing net earnings by the weighted-average number of shares of common stock outstanding, exclusive of unallocated employee stock ownership plan (“ESOP”) shares.  Diluted earnings per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued.  Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method.  For the three and six months ended December 31, 2011, stock options to purchase 340,638 shares were not included in the computation of diluted net income per share as their effect would have been anti-dilutive.  The following table illustrates the number of weighted-average shares of common stock used in each corresponding earnings per common share calculation:

	Weighted-Average Shares				Weighted-Average Shares
	Outstanding for the				Outstanding for the
	Three Months Ended				Six Months Ended
	December 31,				December 31,
	2011		2010		2011		2010
Weighted average number of common shares used
in computing basic earnings per common share		6,219,673		6,197,757		6,224,970		6,201,670
Effect of dilutive stock options		-		-		-		-
Weighted average number of common shares and
dilutive potential common shares used in
computing earnings per common share
assuming dilution		6,219,673		6,197,757		6,224,970		6,201,670

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Limitation on Capital Distributions

6 Months Ended

Dec. 31, 2011

Limitation On Capital Distributions

Limitation on Capital Distributions

(4)   Limitation on Capital Distributions

Jefferson Federal may not pay dividends on its capital stock if its regulatory capital would thereby be reduced below the amount then required for the liquidation account established for the benefit of certain depositors of Jefferson Federal at the time of its conversion to stock form.

Under applicable regulations, Jefferson Federal is prohibited from making any capital distributions if, after making the distribution, the Bank would have: (i) total risk-based capital ratio of less than 8.0%; (ii) Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.

Under the banking laws of the State of Tennessee, a Tennessee chartered savings bank may not declare dividends in any calendar year in which the dividend would exceed the total of its net income for that year, combined with its retained net income for the preceding two years, without the prior approval of the Commissioner of the Tennessee Department of Financial Institutions.

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Subordinated Debt

6 Months Ended

Dec. 31, 2011

Subordinated Debt

Subordinated Debt

(12)   Subordinated Debt

As part of the State of Franklin acquisition, the Company acquired State of Franklin Statutory Trust II (the “Trust”) and assumed the Trust’s obligation with respect to certain capital securities described below.  On December 13, 2006, State of Franklin issued $10.3 million of junior subordinated debentures to the Trust, a Delaware business trust wholly owned by State of Franklin.  The Trust (a) sold $10.0 million of capital securities through its underwriters to institutional investors and upstreamed the proceeds to State of Franklin and (b) issued $310,000 of common securities to State of Franklin.  The sole assets of the Trust are the $10.3 million of junior subordinated debentures issued by State of Franklin. The securities are redeemable at par after January 30, 2012, and have a final maturity of January 30, 2037.  The interest is payable quarterly at a floating rate equal to 3-month LIBOR plus 1.7%.

On January 11, 2012, the Company notified the Trustee for the Trust that, beginning with the January 30, 2012 interest payment period, the Company has elected to defer all payments of interest on the Company’s junior subordinated debentures for an indefinite period of time (but no longer than 20 consecutive quarterly periods).  Under the terms of the indenture, the Company is prohibited from paying dividends on its common stock during the period that interest is deferred on the debentures.

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Dividends

6 Months Ended

Dec. 31, 2011

Dividends [Abstract]

Dividends

(8)   Dividends

On February 2, 2010, the Company announced that the Board of Directors had voted to suspend the payment of the quarterly cash dividend on the Company’s common stock in an effort to conserve capital.

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Accounting for Allowance for Loan Losses and Impairment of a Loan

6 Months Ended

Dec. 31, 2011

Accounting For Allowance For Loan Losses And Impairment Of Loan

Accounting for Allowance for Loan Losses and Impairment of a Loan

(6)   Accounting for Allowance for Loan Losses and Impairment of a Loan

The allowance for loan and lease losses is an estimate of the losses that are inherent in the loan and lease portfolio.  The allowance is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  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.  The Bank’s charge-off policy is consistent with bank regulatory standards.  Generally, loans are charged off when the loan becomes over 120 days delinquent.  Real estate acquired as a result of foreclosure is initially recorded at the lower of the amount of the loan or the fair value, less estimated selling costs. Any writedown to fair value is charged to the allowance for loan and lease losses.  Any subsequent writedown of foreclosed real estate is charged against earnings.

The allowance consists of specific and general components.  The specific component relates to loans that are classified as doubtful, substandard or special mention.  The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.  

In connection with assessing the allowance, we have established a systematic methodology for determining the adequacy of the allowance for loan losses.  Loans are grouped into pools based on loan type and further segregated by loan grade.  Loan pools include residential mortgage loans, multi-family loans, construction and land development loans, non-residential real estate loans (owner occupied and non-owner occupied), commercial loans and consumer loans.  Commercial business loans and loans secured by commercial real estate are generally larger and involve a greater degree of risk than residential mortgage loans.  In addition, loans secured by commercial real estate are more likely to be negatively impacted by adverse conditions in the real estate market or the economy.  Management utilizes a loan grading system and assigns a loan grade of “Pass”, “Watch”, “Special Mention”, “Substandard”, “Doubtful” or “Loss” based on risk characteristics of loans.  Lending staff reviews the loan grades of customers on a regular basis and makes changes as needed given that the creditworthiness of customers may change over time.  

Descriptions of loan grades are as follows:

Pass - loans in this category represent an acceptable risk and do not require heightened levels of monitoring by lending staff.

Watch - loans in this category represent an acceptable risk; however, require monitoring by lending staff due to potential weakness for any number of reasons.  

Special Mention - loans in this category have potential weaknesses that may result in deteriorating prospects for the asset or in the Bank’s credit position at some future date.  

Substandard - loans in this category are inadequately protected by the sound worth and paying capacity of the borrower or the collateral pledged. Borrowers in this category have a well-defined weakness(es) that jeopardize the proper liquidation of the debt.

Doubtful - loans classified as doubtful have a clear and defined weakness making the ultimate repayment of the loan, or portions thereof, highly improbable.

Loss - loans classified as “loss” are those of such little value that their continuance as bank assets is not warranted, even though partial recovery may be affected in the future.  Charge off is required in the month this grade is assigned.

Specific valuation allowances are established for impaired loans.  The Company considers a loan to be impaired when, based on current information and events, it is probable that the company will be unable to collect all amounts due according to the contractual terms of the loan agreement on a timely basis.  A specific reserve represents the difference between the recorded value of the loan and either its estimated fair value less estimated disposition costs, or the net present value as determined by a discounted cash flow analysis.  On a quarterly basis, management evaluates individual loans and lending relationships which have outstanding principal balances of $500,000 or more and which are classified as either substandard, doubtful or loss according to the loan grading policy for impairment.  Troubled debt restructurings (“TDRs”) are also considered to be impaired, except for those that have been performing under the new terms for at least six consecutive months.  

A TDR occurs when the Bank grants a concession to a borrower with financial difficulties that it would not otherwise consider. The Bank has adopted the guidance and definitions found in ASU 2011-02  in determining if a borrower is experiencing financial difficulties and if a concession has been granted.  The majority of the Bank’s TDRs involve a modification in loan terms such as a temporary period of interest only or extension of the maturity date.  A TDR may be non-accruing or it may accrue interest.  A nonaccrual TDR will be returned to accruing status at such time when the borrower successfully performs under the new terms for six consecutive months.  

The accrual of interest on all loans is discontinued at the time the loan is 90 days delinquent.  All interest accrued but not collected for loans considered impaired, placed on non-accrual or charged off is reversed against interest income.  The interest on these loans is accounted for on the cash basis or cost-recovery method until the loan is returned to accrual status.  Loans are returned to accrual status when future payments are reasonably assured.  Payments received on non-accrual loans are applied to the remaining principal balance of the loans.

The evaluation of the allowance for loan and lease losses is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.  The Company is subject to periodic examination by regulatory agencies, which may require the Company to record increases in the allowances based on the regulator’s evaluation of available information.  There can be no assurance that the Company’s regulators will not require further increases to the allowances.

The following table summarizes the activity in the allowance for loan losses for the six months ended December 31, 2011:

	Residential Mortgage			Multi-family		Construction and land development			Non-residential real estate			Owner occupied			Commercial			Consumer			Total
Allowance for Credit Losses:
Balance at June 30, 2011	$	1,543		$	1,858	$	803		$	1,934		$	803		$	1,197		$	43		$	8,181
Charge Offs		(127	)		-		(115	)		(191	)		(142	)		(5,406	)		(75	)		(6,056	)
Recoveries		7			-		-			-			-			67			8			82
Provision		(345	)		827		34			610			(300	)		7,798			49			8,673
Balance at December 31, 2011	$	1,078		$	2,685	$	722		$	2,353		$	361		$	3,656		$	25		$	10,880
Ending balance, Individually Evaluated	$	554		$	2,634	$	446		$	2,165		$	101		$	2,494		$	-		$	8,394
Ending balance, Collectively Evaluated	$	524		$	51	$	276		$	188		$	260		$	1,162		$	25		$	2,486
Loans:
Balance at December 31, 2011	$	126,159		$	13,411	$	34,462		$	51,309		$	75,541		$	56,880		$	5,185		$	362,947
Ending balance, Individually Evaluated	$	2,519		$	8,411	$	1,244		$	5,932		$	471		$	5,883		$	-		$	24,460
Ending balance, Collectively Evaluated	$	123,640		$	5,000	$	33,218		$	45,377		$	75,070		$	50,997		$	5,185		$	338,487

The following table is an aging analysis of the loan portfolio at December 31, 2011:

	30-59 days past due		60-89 days past due		Greater than 90 days		Total past due		Total Current		Total loans receivable
Residential Mortgage	$	4,088	$	594	$	4,874	$	9,556	$	116,603	$	126,159
Multi-family		7,774		96		-		7,870		5,541		13,411
Construction/land development		253		-		653		906		33,556		34,462
Non-residential real estate		349		3,025		622		3,996		47,313		51,309
Owner occupied		1,082		1,394		828		3,304		72,237		75,541
Commercial		153		99		2,543		2,795		54,085		56,880
Consumer		53		3		41		97		5,088		5,185
Total	$	13,752	$	5,211	$	9,561	$	28,524	$	334,423	$	362,947

The following table summarizes the credit risk profile by internally assigned grade at December 31, 2011:

	Residential Mortgage		Multi-family		Construction and land development		Non-residential real estate		Owner occupied		Commercial		Consumer		Total
Grade:
Pass	$	112,423	$	4,900	$	29,750	$	36,589	$	70,400	$	50,075	$	5,120	$	309,257
Watch		4,091		-		2,006		7,994		2,758		1,190		12		18,051
Special mention		-		-		-		1,255		-		-		-		1,255
Substandard		9,645		8,511		2,706		5,472		2,383		5,614		53		34,384
Doubtful		-		-		-		-		-		-		-		-
Loss		-		-		-		-		-		-		-		-
Total:	$	126,159	$	13,411	$	34,462	$	51,310	$	75,541	$	56,879	$	5,185	$	362,947

The following table summarizes the composition of impaired loans, the associated specific reserves, and interest income recognized on impaired loans at December 31, 2011:

	Recorded investment		Unpaid principal balance		Specific allowance		Interest income recognized
With an allowance recorded:
Residential Mortgage	$	2,519	$	2,519	$	554	$	33
Multi-family		8,411		8,411		2,634		152
Construction and land development		1,244		1,244		446		25
Non-residential real estate		5,932		5,932		2,165		82
Owner occupied		471		471		101		-
Commercial		5,883		5,883		2,494		104
Consumer		-		-		-		-
Total	$	24,460	$	24,460	$	8,394	$	396
With no related allowance:
Residential Mortgage	$	2,854	$	2,854	$	-	$	70
Multi-family		-		-		-		-
Construction and land development		1,152		1,152		-		38
Non-residential real estate		1,752		1,752		-		52
Owner occupied		1,034		1,034		-		29
Commercial		-		-		-		-
Consumer		-		-		-		-
Total	$	6,792	$	6,792	$	-	$	189
Total:
Residential Mortgage	$	5,373	$	5,373	$	554	$	103
Multi-family		8,411		8,411		2,634		152
Construction and land development		2,396		2,396		446		63
Non-residential real estate		7,684		7,684		2,165		134
Owner occupied		1,505		1,505		101		29
Commercial		5,883		5,883		2,494		104
Consumer		-		-		-		-
Total	$	31,252	$	31,252	$	8,394	$	585
Average impaired loans for the
Six months ended December 31, 2011	$	33,012

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Financial Instruments With Off-Balance Sheet Risk

6 Months Ended

Dec. 31, 2011

Financial Instruments With Off-Balance Sheet Risk

Financial Instruments With Off-Balance Sheet Risk

(7)   Financial Instruments With Off-Balance Sheet Risk

Jefferson Bancshares is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company’s maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount and related accrued interest receivable of those instruments. The Company minimizes this risk by evaluating each borrower’s creditworthiness on a case-by-case basis. Collateral held by the Company consists of a first or second mortgage on the borrower’s property. The amount of collateral obtained is based upon an appraisal of the property.

At December 31, 2011, we had approximately $6.1 million in commitments to extend credit, consisting of commitments to fund real estate loans.  In addition to commitments to originate loans, we had $4.7 million in unused letters of credit and approximately $29.8 million in unused lines of credit.

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Stock Incentive Plans

6 Months Ended

Dec. 31, 2011

Stock Incentive Plans

Stock Incentive Plans

(9)   Stock Incentive Plans

The Company maintains stock-based benefit plans under which certain employees and directors are eligible to receive stock grants or options.  Under the 2004 Stock-Based Benefit Plan, a maximum of 279,500 shares may be granted as restricted stock and a maximum of 698,750 shares may be issued through the exercise of nonstatutory or incentive stock options.  The exercise price of each option equals the market price of the Company’s stock on the date of grant and an option’s maximum term is ten years.  

In connection with the Company’s acquisition of State of Franklin Bancshares, Inc. (“State of Franklin”) on October 31, 2008, each outstanding State of Franklin non-qualified option with an exercise price of $13.50 or less was converted into an option to purchase shares of Jefferson Bancshares common stock with an expiration date of October 31, 2011.

The table below summarizes the status of the Company’s stock option plans as of December 31, 2011.

	Three Months Ended
	December 31, 2011
				Weighted-
				average
	Shares			exercise price
Outstanding at beginning of period		525,287		$	12.69
Granted during the three-month period		-			-
Options forfeited		(184,649	)	$	10.85
Options exercised		-
Outstanding at December 31, 2011		340,638		$	13.69
Options exercisable at December 31, 2011		340,638		$	13.69

The following information applies to options outstanding at December 31, 2011:

Number outstanding		340,638
Range of exercise prices	$	13.69
Weighted-average exercise price	$	13.69
Weighted-average remaining contractual life		2.08
Number of options remaining for future issuance		358,112

The estimated fair value of stock options at grant date was determined using the Black-Scholes option-pricing model based on market data as of January 29, 2004.  An expected dividend yield of 1.17% and expected volatility of 7.01% were used to model the value.  The risk free rate of return equaled 4.22%, which was based on the yield of a U.S. Treasury note with a term of ten years. The estimated time remaining before the expiration of the options equaled ten years.

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Consolidated Statements of Changes in Stockholders' Equity (USD $) In Thousands, unless otherwise specified	Common Stock	Additional Paid-In Capital	Unallocated Common Stock in ESOP	Unearned Compensation	Accumulated Other Comprehensive Income	Retained Earnings	Treasury Stock	Total
Balance, beginning at Jun. 30, 2010	$ 92	$ 79,175	$ (3,673)	$ (1,053)	$ 1,206	$ 12,023	$ (31,247)	$ 56,523
Comprehensive income:
Net earnings						618		618
Change in net unrealized gain (loss) on securities available for sale, net of taxes					(728)			(728)
Total comprehensive income								(110)
Dividends used for ESOP payment						13		13
Shares committed to be released by the ESOP		(142)	216					74
Earned portion of stock grants				33				33
Purchase of common stock							(79)	(79)
Balance, ending at Dec. 31, 2010	92	79,033	(3,457)	(1,020)	478	12,654	(31,326)	56,454
Balance, beginning at Jun. 30, 2011	92	78,895	(3,241)	(1,019)	459	12,067	(31,334)	55,919
Comprehensive income:
Net earnings						(4,625)		(4,625)
Change in net unrealized gain (loss) on securities available for sale, net of taxes					284			284
Total comprehensive income								(4,341)
Dividends used for ESOP payment
Shares committed to be released by the ESOP		(155)	216	(27)				34
Purchase of common stock							(7)	(7)
Balance, ending at Dec. 31, 2011	$ 92	$ 78,740	$ (3,025)	$ (1,046)	$ 743	$ 7,442	$ (31,341)	$ 51,605

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Use of Estimates

6 Months Ended

Dec. 31, 2011

Use Of Estimates

Use of Estimates

(3)   Use of Estimates

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the statement of condition dates and revenues and expenses for the periods shown.  Actual results could differ from the estimates and assumptions used in the consolidated financial statements.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate and deferred tax assets.

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Subsequent Events

6 Months Ended

Dec. 31, 2011

Subsequent Events [Abstract]

Subsequent Events

(13)   Subsequent Events

The company has evaluated subsequent events for potential recognition and disclosure for the three months ended December 31, 2011.  No items were identified during this evaluation that required adjustment to or disclosure in the accompanying financial statements.