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 March 31, 2012

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)

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY

(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 90 days. 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 o	Accelerated Filer o
Non-Accelerated Filer o	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 May 15, 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 Nine months ended March 31, 2012 and year ended June 30, 2011	3
	Consolidated Statements of Earnings - Unaudited Three and nine months ended March 31, 2012 and 2011	4
	Consolidated Statements of Changes in Stockholders’ Equity – Unaudited Nine months ended March 31, 2012 and 2011	5
	Consolidated Statements of Cash Flows - Unaudited Nine months ended March 31, 2012 and 2011	6
	Notes to Consolidated Financial Statements - Unaudited	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	37
Item 4.	Controls and Procedures	37
	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	38
Item 1A.	Risk Factors	38
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 3.	Defaults Upon Senior Securities	39
Item 4.	Mine Safety Disclosures	39
Item 5.	Other Information	39
Item 6.	Exhibits	39
SIGNATURES

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

JEFFERSON BANCSHARES, INC. AND SUBSIDIARY

Consolidated Balance Sheets

(Dollars in Thousands)

	March 31,			June 30,
	2012			2011
Assets	(Unaudited)
Cash and cash equivalents	$	3,956		$	5,327
Interest-earning deposits		34,661			35,221
Investment securities classified as available for sale, net		89,260			74,780
Federal Home Loan Bank stock		4,735			4,735
Bank owned life insurance		6,802			6,625
Loans receivable, net of allowance for loan losses of $6,807 and $8,181		341,524			378,587
Loans held-for-sale		243			-
Premises and equipment, net		26,501			26,617
Foreclosed real estate, net		7,823			9,498
Accrued interest receivable:
Investments		404			311
Loans receivable		1,279			1,521
Deferred tax asset		11,405			9,009
Core deposit intangible		1,642			1,978
Other assets		3,795			6,980
Total Assets	$	534,030		$	561,189
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing	$	55,247		$	54,340
Interest-bearing		378,575			399,922
Repurchase agreements		890			945
Federal Home Loan Bank advances		37,883			37,942
Subordinated debentures		7,217			7,133
Other liabilities		2,185			4,988
Total liabilities		481,997			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 March 31, 2012 and 6,634,523 shares outstanding at June 30, 2011		92			92
Additional paid-in capital		78,657			78,895
Unearned ESOP shares		(2,916	)		(3,241	)
Unearned compensation		(1,046	)		(1,019	)
Accumulated other comprehensive income		811			459
Retained earnings		7,776			12,067
Treasury stock, at cost (2,550,333 and 2,547,849 shares)		(31,341	)		(31,334	)
Total stockholders’ equity		52,033			55,919
Total liabilities and stockholders’ equity	$	534,030		$	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						Nine Months Ended
	March 31,						March 31,
	2012			2011			2012			2011
Interest income:
Interest on loans receivable	$	4,758		$	6,049		$	15,595		$	18,443
Interest on investment securities		478			411			1,412			1,302
Other interest		66			105			190			306
Total interest income		5,302			6,565			17,197			20,051
Interest expense:
Deposits		671			1,293			2,427			4,490
Repurchase agreements		2			1			5			5
Advances from FHLB		316			445			956			1,788
Subordinated debentures		84			79			243			241
Total interest expense		1,073			1,818			3,631			6,524
Net interest income		4,229			4,747			13,566			13,527
Provision for loan losses		600			1,400			9,273			2,350
Net interest income after provision for loan losses		3,629			3,347			4,293			11,177
Noninterest income:
Mortgage origination fee income		68			66			264			430
Service charges and fees		265			286			841			957
Gain on investments		-			1,279			39			2,031
Gain (loss) on sale of fixed assets		-			-			(19	)		-
Gain (loss) on sale of foreclosed real estate, net		(61	)		(186	)		(140	)		(591	)
BOLI increase in cash value		58			58			177			177
Other		178			194			527			527
Total noninterest income		508			1,697			1,689			3,531
Noninterest expense:
Compensation and benefits		1,494			1,620			4,625			5,064
Occupancy expense		334			309			1,047			1,031
Equipment and data processing expense		591			638			1,798			1,900
DIF premiums		203			165			606			490
Advertising		155			62			290			167
Legal and professional services		72			144			383			387
Valuation adjustment and expenses on OREO		273			371			2,144			1,475
Amortization of intangible assets		106			120			336			377
Loss on early extinguishment of debt		-			585			-			775
Other		544			621			1,658			1,709
Total noninterest expense		3,772			4,635			12,887			13,375
Earnings before income taxes		365			409			(6,905	)		1,333
Income taxes:
Current		-			2			-			5
Deferred		31			147			(2,614	)		450
Total income taxes		31			149			(2,614	)		455
Net earnings	$	334		$	260		$	(4,291	)	$	878
Net earnings per share, basic	$	0.05		$	0.04		$	(0.69	)	$	0.14
Net earnings per share, diluted	$	0.05		$	0.04		$	(0.69	)	$	0.14

See accompanying notes to financial statements.

4

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders’ Equity

Nine Months Ended March 31, 2012 and 2011

(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		-		-			-			-			-		(4,291	)		-			(4,291	)
Change in net unrealized gain (loss) on securities available for sale, net of taxes of $218		-		-			-			-			352		-			-			352
Total comprehensive income		-		-			-			-			-		-			-			(3,939	)
Dividends used for ESOP payment		-		-			-			-			-		-						-
Shares committed to be released by the ESOP		-		(238	)		325			(27	)		-		-			-			60
Purchase of common stock (2,484 shares)		-		-			-			-			-		-			(7	)		(7	)
Balance at March 31, 2012	$	92	$	78,657		$	(2,916	)	$	(1,046	)	$	811	$	7,776		$	(31,341	)	$	52,033

						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		-		-			-			-			-			878		-			878
Change in net unrealized gain (loss) on securities available for sale, net of taxes of ($1,030)		-		-			-			-			(1,659	)		-		-			(1,659	)
Total comprehensive income		-		-			-			-			-			-		-			(781	)
Dividends used for ESOP payment		-		-			-			-			-			13					13
Shares committed to be released by the ESOP		-		(209	)		324			-			-			-		-			115
Earned portion of stock grants		-		-			-			34			-			-		-			34
Purchase of common stock (24,453 shares)		-		-			-			-			-			-		(86	)		(86	)
Balance at March 31, 2011	$	92	$	78,966		$	(3,349	)	$	(1,019	)	$	(453	)	$	12,914	$	(31,333	)	$	55,818

See accompanying notes to the financial statements.

5

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)

	Nine Months Ended
	March 31,
	2012			2011
Cash flows from operating activities:
Net earnings	$	(4,291	)	$	878
Adjustments to reconcile net earnings to net cash provided by (used for) operating activities:
Allocated ESOP shares		87			115
Depreciation and amortization expense		1,404			812
Amortization of premiums (discounts), net on investment securities		228			88
Provision for loan losses		9,273			2,350
Amortization of deferred loan fees, net		(112	)		(209	)
(Gain) loss on sale of investment securities		(39	)		(2,031	)
(Gain) loss on sale of foreclosed real estate, net		140			591
(Gain) loss on sale of fixed assets, net		19			-
Deferred tax benefit		(2,614	)		450
Originations of mortgage loans held for sale		(11,391	)		(16,708	)
Proceeds from sale of mortgage loans		11,148			17,535
Increase in cash value of life insurance		(177	)		(177	)
Earned portion of MRP		(27	)		35
Decrease (increase) in:
Accrued interest receivable		149			186
Other assets		3,185			(4,432	)
Increase (decrease) in other liabilities and accrued income taxes		(2,803	)		4,145
Net cash provided by (used for) operating activities		4,179			3,628
Cash flows used for investing activities:
Loan originations, net of principal collections		27,235			30,045
Investment securities classifed as available-for-sale:		-			-
Proceeds from maturities, calls and prepayments		42,132			41,899
Proceeds from sale		501			11,778
Purchase of securities		(56,771	)		(45,371	)
Proceeds from sale of premises and equipment		26			-
Purchase of premises and equipment		(707	)		(183	)
Proceeds from sale of (additions to) foreclosed real estate, net		1,962			3,363
Net cash provided by (used for) investing activities		14,378			41,531
Cash flows from financing activities:
Net decrease in deposits		(20,407	)		(9,907	)
Net increase (decrease) in repurchase agreements		(55	)		48
Proceeds from advances from FHLB		-			309
Repayment of FHLB advances		(19	)		(46,625	)
Purchase of treasury stock		(7	)		(86	)
Dividends paid		-			-
Net cash provided by (used for) financing activities		(20,488	)		(56,261	)
Net increase (decrease) in cash, cash equivalents and interest-earning deposits		(1,931	)		(11,102	)
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	$	38,617		$	58,201
Supplemental disclosures of cash flow information:
Cash paid during period for:
Interest on deposits	$	2,361		$	4,470
Interest on borrowed funds	$	786		$	1,788
Interest on subordinated debentures	$	159		$	162
Income taxes		-		$	50
Real estate acquired in settlement of loans	$	2,495		$	11,897

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 nine months ended March 31, 2012 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.
(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.

7

(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 nine months ended March 31, 2012, 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				Nine Months Ended
	March 31,				March 31,
	2012		2011		2012		2011
Weighted average number of common shares used in computing basic earnings per common share		6,261,939		6,231,452		6,237,203		6,211,295
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		6,261,939		6,231,452		6,237,203		6,211,295

(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 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, HELOC and junior lien, 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.

8

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 involving changes in amortization terms, reductions in interest rates, interest only payments and, in limited cases, concessions to outstanding loan balances. 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 at least six consecutive months. The Bank’s TDRs totaled $11.3 million at March 31, 2012 compared to $15.8 million at June 30, 2011.

9

The following table presents the Bank’s loans classified as TDRs by loan type and accrual status as of March 31, 2012:

	March 31, 2012
	Accrual		Non-accrual		Total
	Status		Status		TDRs
Residential Mortgage	$	904	$	523	$	1,427
Multi-family		632		5,284		5,916
Construction and land development		153		33		186
Non-residential real estate		-		2,000		2,000
Owner occupied		-		402		402
Commercial		836		338		1,174
HELOC and Junior Lien		172		-		172
Total	$	2,697	$	8,580	$	11,277

The following table presents newly restructured loans with concessions related to loan balances that occurred during the three- and nine-month periods ended March 31, 2012:

	Nine Months Ended March 31, 2012
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
	Loans		Investment		Investment
Multi-family		2	$	7,775	$	5,284
Non-residential real estate		1		3,025		2,000
Total		3	$	10,800	$	7,284

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.

10

The following table summarizes the activity in the allowance for loan losses for the nine months ended March 31, 2012:

	Residential Mortgage			Multi-family			Construction and land development			Non-residential real estate			Owner occupied			Commercial			HELOC and junior Lien			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		(261	)		(2,491	)		(147	)		(1,102	)		(220	)		(6,617	)		(53	)		(13	)		(10,904	)
Recoveries		5			-			-			-			-			230			3			19			257
Provision		(755	)		1,182			(118	)		228			(305	)		8,842			225			(26	)		9,273
Balance at March 31, 2012	$	532		$	549		$	538		$	1,060		$	278		$	3,652		$	175		$	23		$	6,807
Ending balance, Individually Evaluated	$	114		$	139		$	294		$	753		$	8		$	2,358		$	66		$	-		$	3,732
Ending balance, Collectively Evaluated	$	418		$	410		$	244		$	307		$	270		$	1,294		$	109		$	23		$	3,075
Loans:
Balance at March 31, 2012	$	101,968		$	10,836		$	31,327		$	50,419		$	75,405		$	53,511		$	20,191		$	4,909		$	348,566
Ending balance, Individually Evaluated	$	593		$	632		$	1,042		$	5,282		$	393		$	5,378		$	172		$	-		$	13,492
Ending balance, Collectively Evaluated	$	101,375		$	10,204		$	30,285		$	45,137		$	75,012		$	48,133		$	20,019		$	4,909		$	335,074

11

The following table is an aging analysis of the loan portfolio at March 31, 2012:

	30-59 days past due		60-89 days past due		Greater than 90 days		Total past due		Total Current		Total loans receivable
Residential Mortgage	$	2,609	$	-	$	5,597	$	8,206	$	93,762	$	101,968
Multi-family		-		-		5,284		5,284		5,552		10,836
Construction/land development		341		1,396		976		2,713		28,614		31,327
Non-residential real estate		1,790		-		2,915		4,705		45,714		50,419
Owner occupied		242		-		1,875		2,117		73,288		75,405
Commercial		111		1,234		1,579		2,924		50,587		53,511
HELOC and Junior Lien		2		-		204		206		19,985		20,191
Consumer		37		3		38		78		4,831		4,909
Total	$	5,132	$	2,633	$	18,468	$	26,233	$	322,333	$	348,566

The following table summarizes the credit risk profile by internally assigned grade at March 31, 2012:

	Residential Mortgage		Multi-family		Construction and land development		Non-residential real estate		Owner occupied		Commercial		HELOC and Junior Lien		Consumer		Total
Grade:
Pass	$	89,997	$	4,821	$	26,358	$	28,731	$	66,679	$	46,657	$	18,312	$	4,443	$	285,998
Watch		2,984		-		1,976		15,563		6,527		1,450		622		420		29,542
Special mention		-		-		-		1,256		-		-		-		-		1,256
Substandard		8,987		6,015		2,993		4,869		2,199		5,404		1,257		46		31,770
Doubtful		-		-		-		-		-		-		-		-		-
Loss		-		-		-		-		-		-		-		-		-
Total:	$	101,968	$	10,836	$	31,327	$	50,419	$	75,405	$	53,511	$	20,191	$	4,909	$	348,566

12

The following table summarizes the composition of impaired loans, the associated specific reserves, and interest income recognized on impaired loans at March 31, 2012:

	Recorded investment		Unpaid principal balance		Specific allowance		Interest income recognized
With an allowance recorded:
Residential Mortgage	$	593	$	593	$	114	$	19
Multi-family		632		632		139		34
Construction and land development		1,042		1,042		294		68
Non-residential real estate		5,282		5,282		753		131
Owner occupied		393		393		8		27
Commercial		5,378		5,378		2,358		192
HELOC and Junior Lien		172		172		66		-
Consumer		-		-		-		-
Total	$	13,492	$	13,492	$	3,732	$	471
With no related allowance:
Residential Mortgage	$	3,021	$	3,021	$	-	$	133
Multi-family		5,284		5,284		-		98
Construction and land development		1,688		1,688		-		48
Non-residential real estate		3,098		3,098		-		132
Owner occupied		947		947		-		78
Commercial		396		396		-		31
HELOC and Junior Lien		703		703		-		15
Consumer		-		-		-		-
Total	$	15,137	$	15,137	$	-	$	535
Total:
Residential Mortgage	$	3,614	$	3,614	$	114	$	152
Multi-family		5,916		5,916		139		132
Construction and land development		2,730		2,730		294		116
Non-residential real estate		8,380		8,380		753		263
Owner occupied		1,340		1,340		8		105
Commercial		5,774		5,774		2,358		223
HELOC and Jr Lien		875		875		66		15
Consumer		-		-		-		-
Total	$	28,629	$	28,629	$	3,732	$	1,006
Average impaired loans for the nine months ended March 31, 2012	$	31,917

(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.

13

	At March 31, 2012, we had approximately $7.4 million in commitments to extend credit, consisting of commitments to fund real estate loans. In addition to commitments to originate loans, we had $4.5 million in unused letters of credit and approximately $29.9 million in unused lines of credit.
(8)	Dividends
	On February 2, 2011, 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.
	The table below summarizes the status of the Company’s stock option plans as of March 31, 2012.

	Three Months Ended
	March 31, 2012
			Weighted-
			average
	Shares		exercise price
Outstanding at beginning of period		340,638	$	3.69
Granted during the three-month period		-		-
Options forfeited		-		-
Options exercised		-		-
Outstanding at March 31, 2012		340,638	$	3.69
Options exercisable at March 31, 2012		340,638	$	3.69

The following information applies to options outstanding at March 31, 2012:

Number outstanding		340,638
Range of exercise prices	$	13.69
Weighted-average exercise price	$	13.69
Weighted-average remaining contractual life		1.83
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.

14

(10)	Investment Securities
	Investment securities are summarized as follows:

At March 31, 2012
	Amortized			Unrealized		Unrealized			Fair
	Cost			Gains		Losses			Value
	(Dollars in thousands)
Securities available-for-sale
Debt securities:
Federal agency	$	24,217		$	242	$	(160	)	$	24,299
Mortgage-backed		58,683			1,534		(247	)	$	59,970
Municipals		4,436			276		-			4,712
Other Securities		609			-		(330	)		279
Total securities available-for-sale	$	87,945		$	2,052	$	(737	)	$	89,260
Weighted-average rate		2.32	%
Pledged at March 31, 2012	$	13,186

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

15

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)
March 31, 2012
Federal agency securities	$	7,837	$	(160	)	$	-	$	-		$	7,837	$	(160	)
Mortgage-backed securities		8,607		(141	)		629		(106	)		9,236		(247	)
Municipal securities		-		-			-		-			-		-
Other securities		-		-			279		(330	)		279		(330	)
	$	16,444	$	(301	)	$	908	$	(436	)	$	17,352	$	(737	)

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.

Federal Agency Securities – The unrealized losses of $160,000 for these six federal agency securities were caused by changes in market interest rates. The contractual cash flows of these investments are guaranteed by an agency of the U.S. Government. 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 March 31, 2012.

GSE Residential Mortgage-Backed Securities – The unrealized losses of $141,000 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 March 31, 2012.

Private-Label Residential Mortgage-Backed Securities - The unrealized losses of $106,000 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.

16

Other Securities – The unrealized loss of $330,000 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 March 31, 2012.

Maturities of debt securities at March 31, 2012, are summarized as follows:

					Weighted
	Amortized		Fair		Average
	Cost		Value		Yield
Within 1 year	$	391	$	392		2.50	%
Over 1 year through 5 years		12,795		12,979		1.67	%
After 5 years through 10 years		14,070		14,308		2.71	%
Over 10 years		60,689		61,581		3.12	%
	$	87,945	$	89,260		2.32	%

(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.

17

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 March 31, 2012, 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.

18

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:

	March 31, 2012
						Total Carrying
						Amount in
						Statement of		Assets/Liabilities
						Financial		Measured at
Description	Level 1	Level 2		Level 3		Condition		Fair Value
Securities available for sale	-	$	86,244	$	3,016	$	89,260	$	89,260

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.

	March 31, 2012
					Total Carrying
					Amount in
					Statement of		Assets/Liabilities
					Financial		Measured at
Description	Level 1	Level 2	Level 3		Condition		Fair Value
Impaired Loans	-	-	$	24,897	$	24,897	$	24,897

19

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

	March 31, 2012						June 30, 2011
	Carrying			Fair			Carrying			Fair
	Amount			Value			Amount			Value
Financial assets:
Cash and due from banks and interest-earning deposits with banks	$	38,617		$	38,617		$	40,548		$	40,548
Available-for-sale securities		89,260			89,260			74,780			74,780
Federal Home Loan Bank stock		4,735			4,735			4,735			4,735
Loans receivable, net		341,524			348,309			378,587			379,787
Accrued interest receivable		1,683			1,683			1,832			1,832
Loans held-for-sale		243			243			-			-
Financial liabilities:
Deposits		(433,822	)		(426,261	)		(454,262	)		(446,115	)
Borrowed funds		(38,773	)		(40,684	)		(38,887	)		(40,718	)
Subordinated debentures		(7,217	)		(4,500	)		(7,133	)		(6,277	)
Off-balance sheet assets (liabilities):
Commitments to extend credit		-			7,394			-			11,932
Unused letters of credit		-			4,453			-			4,809
Unused lines of credit		-			29,934			-			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 March 31, 2012. No items were identified during this evaluation that required adjustment to or disclosure in the accompanying financial statements.

20

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.

21

Results of Operations for the Three Months Ended March 31, 2012 and 2011

Net Income

For the three months ended March 31, 2012, the Company reported net income for the quarter ended March 31, 2012 of $334,000, or $0.05 per diluted share, compared to net income of $260,000, or $0.04 per diluted share, for the quarter ended March 31, 2011. The increase in net income is primarily the result of a reduced loan loss provision and lower noninterest expense, partially offset by a reduction in both net interest income and noninterest income.

	Three Months Ended
	March 31,
	2012			2011
	(Dollars in thousands,
	except per share data)
Net earnings	$	334		$	260
Net earnings per share, basic	$	0.05		$	0.04
Net earnings per share, diluted	$	0.05		$	0.04
Return on average assets (annualized)		0.25	%		0.17	%
Return on average equity (annualized)		2.56	%		1.83	%

Net Interest Income

Net interest income decreased $518,000, or 10.9%, to $4.2 million for the quarter ended March 31, 2012 compared to $4.7 million for the same period in 2011. The interest rate spread and net interest margin for the quarter ended March 31, 2012 were 3.49% and 3.60%, respectively, compared to 3.43% and 3.58%, respectively, for the same period in 2011.

The following table summarizes changes in interest income and expense for the three month periods ended March 31, 2012 and 2011:

	Three Months
	Ended
	March 31,
	2012		2011		$ Change			% Change
	(Dollars in thousands)
Interest income:
Loans	$	4,758	$	6,049	$	(1,291	)	(21.3	%)
Investment securities		478		411		67		16.3	%
Interest-earning deposits		54		51		3		5.9	%
FHLB stock		12		54		(42	)	(77.8	%)
Total interest income		5,302		6,565		(1,263	)	(19.2	%)
Interest expense:
Deposits		671		1,293		(622	)	(48.1	%)
Repurchase Agreements		2		1		1		100.0	%
Borrowings		316		445		(129	)	(29.0	%)
Subordinated Notes & Debentures		84		79		5		6.3	%
Total interest expense		1,073		1,818		(745	)	(41.0	%)
Net interest income	$	4,229	$	4,747	$	(518	)	(10.9	%)

22

The following table summarizes average balances and average yields and costs for the three months ended March 31, 2012 and 2011.

	Three Months Ended March 31,
	2012				2011
	Average		Yield/		Average		Yield/
	Balance		Cost		Balance		Cost
	(Dollars in thousands)
Loans	$	358,261	5.34	%	$	410,128	5.98	%
Investment securities		83,698	2.38	%		52,101	3.37	%
Interest-earning deposits		28,202	0.17	%		72,591	0.28	%
FHLB stock		4,735	4.59	%		4,735	4.63	%
Deposits		380,949	0.71	%		426,378	1.23	%
FHLB advances		37,895	3.35	%		51,757	3.49	%
Repurchase agreements		858	0.94	%		836	0.49	%
Subordinated debentures		7,200	4.69	%		7,087	4.52	%

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 March 31,
	2012 Compared to 2011
	Increase (Decrease)
	Due To
	Volume			Rate			Net
	(In thousands)
Interest income:
Loans receivable	$	(722	)	$	(569	)	$	(1,291	)
Investment securities		53			14			67
Daily interest-earning deposits and other interest-earning assets		(24	)		(15	)		(39	)
Total interest-earning assets		(693	)		(570	)		(1,263	)
Interest expense:
Deposits		(126	)		(496	)		(622	)
FHLB advances		(116	)		(13	)		(129	)
Repurchase agreements		-			1			1
Subordinatd debentures		1			4			5
Total interest-bearing liabilities		(241	)		(504	)		(745	)
Net change in interest income	$	(452	)	$	(66	)	$	(518	)

Total interest income decreased $1.3 million, or 19.2%, to $5.3 million for the three months ended March 31, 2012 primarily due to a lower volume of interest-earning assets and a lower average yield. The average balance of interest-earning assets declined $64.7 million, or 12.0%, to $474.9 million for the three months ended March 31, 2012 compared to $539.6 million for the same period in 2011, due primarily to declines in average loan balances and interest-earning deposits. The average yield on interest-earning assets was 4.50% for the three months ended March 31, 2012 compared to 4.95% for the same period in 2011.

23

Interest on loans decreased $1.3 million, or 21.3%, to $4.8 million for the three months ended March 31, 2012 due to a lower average balance of loans and a lower average yield. The average balance of loans decreased $51.9 million, or 12.7%, to $358.3 million for the three months ended March 31, 2012, 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 5.34% for the three months ended March 31, 2012 compared to 5.98% for the same period in 2011.

Interest on investment securities was $478,000 for the three months ended March 31, 2012 compared to $411,000 for the same period in 2011. The average balance of investment securities increased $31.6 million to $83.7 million for the three months ended March 31, 2012 compared to $52.1 million for the corresponding period in 2011 as excess liquidity was deployed into the investment portfolio. The average yield on investment securities decreased to 2.38% for the three months ended March 31, 2012 compared to 3.37% for the same period in 2011 due to lower interest rates.

Total interest expense decreased $745,000 to $1.1 million for the three months ended March 31, 2012 compared to $1.8 million for the corresponding period in 2011 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 0.71% for the three months ended March 31, 2012, compared to 1.23% for the same period in 2011 due to downward repricing of interest bearing deposits in the current low interest rate environment. Average FHLB borrowings decreased $13.9 million to $37.9 million for the three months ended March 31, 2012 compared to $51.8 million for the comparable period in 2011, while the average rate paid on borrowings decreased 14 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 March 31, 2012 was $600,000, compared to a provision of $1.4 million for the comparable period in 2011. Net charge-offs for the three months ended March 31, 2012 were $4.7 million compared to $1.5 million for the comparable period in 2011. Net charge-offs for the three ended March 31, 2012 were primarily attributable to problem loans previously identified and reserved for in our allowance for loan losses. 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 $1.2 million to $508,000 for the three months ended March 31, 2012 compared to $1.7 million for the same period in 2011, due primarily to gains realized on the sale of investment securities during the prior year period totaling $1.3 million. Loss on sale of foreclosed real estate declined $125,000 to $61,000 for the three months ended March 31, 2012 compared to $186,000 for the prior year period.

24

The following table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent changes for the three months ended March 31, 2012 compared to the same period in 2011.

	Three Months Ended
	March 31,						$			%
	2012			2011			Change			Change
	(Dollars in thousands)
Noninterest income:
Mortgage origination fee income	$	68		$	66		$	2			3.0	%
Service charges and fees		265			286			(21	)		(7.3	%)
(Loss) gain on investment securities		-			1,279			(1,279	)		(100.0	%)
Gain (loss) on sale of foreclosed real estate, net		(61	)		(186	)		125			(67.2	%)
BOLI increase in cash value		58			58			-			0.0	%
Other		178			194			(16	)		(8.2	%)
Total noninterest income	$	508		$	1,697		$	(1,189	)		(70.1	%)

Noninterest Expense

Total noninterest expense decreased $863,000, or 18.6%, to $3.8 million for the three months ended March 31, 2012 compared to $4.6 million for the corresponding period in 2011. Noninterest expense for the three months ended March 31, 2011 included prepayment penalties of $585,000 incurred on the early payoff of FHLB advances. Compensation expense decreased $126,000, or 7.8%, to $1.5 million for the three months ended March 31, 2012 compared to $1.6 million for the same period in 2011 as the Bank has reduced its number of employees through attrition. Valuation adjustments and expenses on other real estate owned decreased $98,000 to $273,000 for the three months ended March 31, 2012 compared to $371,000 for the same period in 2011.

The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the three months ended March 31, 2012 compared to the same period in 2011.

	Three Months Ended
	March 31,				$			%
	2012		2011		Change			Change
	(Dollars in thousands)
Noninterest expense:
Compensation and benefits	$	1,494	$	1,620	$	(126	)		(7.8	%)
Occupancy expense		334		309		25			8.1	%
Equipment and data processing expense		591		638		(47	)		(7.4	%)
Deposit insurance premiums		203		165		38			23.0	%
Advertising		155		62		93			150.0	%
Professional services		72		144		(72	)		(50.0	%)
Valuation adjustment and expenses on OREO		273		371		(98	)		(26.4	%)
Amortization of intangible assets		106		120		(14	)		(11.7	%)
Loss on early extinguishment of debt		-		585		(585	)		(100.0	%)
Other		544		621		(77	)		(12.4	%)
Total noninterest expense	$	3,772	$	4,635	$	(863	)		(18.6	%)

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Income Taxes

Income tax expense for the three months ended March 31, 2012 was $31,000 compared to $149,000 for the same period in 2011 due to lower taxable income.

Results of Operations for the Nine Months Ended March 31, 2012 and 2011

Net Income

For the nine months ended March 31, 2012, the Company reported a net loss of $4.3 million, or $0.69 per diluted share, compared to net income of $878,000, or $0.14 per diluted share, for the corresponding period in 2011. Financial results for the nine months ended March 31, 2012 included aprovision for loan losses totaling $9.3 million compared to a provision of $2.4 million for the nine months ended March 31, 2011. The increase in the provision for loan losses was attributable to higher realized and estimated losses in the commercial loan portfolio.

	Nine Months Ended
	March 31,
	2012			2011
	(Dollars in thousands,
	except per share data)
Net earnings	$	(4,291	)	$	878
Net earnings per share, basic	$	(0.69	)	$	0.14
Net earnings per share, diluted	$	(0.69	)	$	0.14
Return on average assets (annualized)		(1.05	%)		0.19	%
Return on average equity (annualized)		(10.44	%)		2.05	%

Net Interest Income

Net interest income remained relatively stable at $13.6 million compared to $13.5 million for the nine months ended March 31, 2011. The interest rate spread and net interest margin for the nine months ended March 31, 2012 were 3.62% and 3.74%, respectively, compared to 3.08% and 3.21%, respectively, for the same period in 2011.

26

The following table summarizes changes in interest income and expense for the nine month periods ended March 31, 2012 and 2011:

	Nine Months
	Ended
	March 31,
	2012		2011		$ Change			% Change
	(Dollars in thousands)
Interest income:
Loans	$	15,595	$	18,443	$	(2,848	)	(15.4	%)
Investment securities		1,412		1,302		110		8.4	%
Interest-earning deposits		149		151		(2	)	(1.3	%)
FHLB stock		41		155		(114	)	(73.5	%)
Total interest income		17,197		20,051		(2,854	)	(14.2	%)
Interest expense:
Deposits		2,427		4,490		(2,063	)	(45.9	%)
Repurchase Agreements		5		5		-		0.0	%
Borrowings		956		1,788		(832	)	(46.5	%)
Subordinated Notes & Debentures		243		241		2		0.8	%
Total interest expense		3,631		6,524		(2,893	)	(44.3	%)
Net interest income	$	13,566	$	13,527	$	39		0.3	%

The following table summarizes average balances and average yields and costs for the nine months ended March 31, 2012 and 2011.

	Nine Months Ended March 31,
	2012				2011
	Average		Yield/		Average		Yield/
	Balance		Cost		Balance		Cost
	(Dollars in thousands)
Loans	$	371,555	5.59	%	$	422,854	5.81	%
Investment securities		81,676	2.38	%		50,147	3.63	%
Interest-earning deposits		26,597	0.21	%		84,995	0.24	%
FHLB stock		4,735	4.19	%		4,735	4.36	%
Deposits		386,666	0.84	%		439,852	1.36	%
FHLB advances		37,916	3.36	%		67,960	3.50	%
Repurchase agreements		949	0.70	%		1,074	0.62	%
Subordinated debentures		7,171	4.51	%		7,059	4.55	%

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.

27

	Nine Months
	Ended March 31,
	2012 Compared to 2011
	Increase (Decrease)
	Due To
	Volume			Rate			Net
	(In thousands)
Interest income:
Loans receivable	$	(2,173	)	$	(675	)	$	(2,848	)
Investment securities		26			84			110
Daily interest-earning deposits and other interest-earning assets		(92	)		(24	)		(116	)
Total interest-earning assets		(2,239	)		(615	)		(2,854	)
Interest expense:
Deposits		(493	)		(1,570	)		(2,063	)
FHLB advances		(760	)		(72	)		(832	)
Repurchase agreements		-			-			-
Subordinatd debentures		4			(2	)		2
Total interest-bearing liabilities		(1,249	)		(1,644	)		(2,893	)
Net change in interest income	$	(990	)	$	1,029		$	39

Total interest income decreased $2.9 million, or 14.2%, to $17.2 million for the nine months ended March 31, 2012 primarily due to a lower volume of interest-earning assets and lower market interest rates. The average balance of interest-earning assets declined $78.2 million, or 13.9%, to $484.6 million for the nine months ended March 31, 2012 compared to $562.7 million for the same period in 2011, due primarily to declines in average loan balances and interest-earning deposits. The average yield on interest-earning assets was 4.74% for the nine months ended March 31, 2012 compared to 4.76% for the same period in 2011.

Interest on loans decreased $2.8 million, or 15.4%, to $15.6 million for the nine months ended March 31, 2012 primarily due to a lower average balance of loans and a lower average yield. The average balance of loans decreased $51.3 million, or 12.1%, to $371.6 million for the nine months ended March 31, 2012, 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 5.59% for the nine months ended March 31, 2012 compared to 5.81% for the same period in 2011.

Interest on investment securities increased to $1.4 million for the nine months ended March 31, 2012 compared to $1.3 million for the same period in 2011. The average balance of investment securities increased $31.5 million to $81.7 million for the nine months ended March 31, 2012 compared to $50.1 million for the corresponding period in 2011 as excess liquidity has been deployed into the investment portfolio. The average yield on investment securities decreased to 2.38% for the nine months ended March 31, 2012 compared to 3.64% for the same period in 2011 due to lower market interest rates.

Total interest expense decreased $2.9 million to $3.6 million for the nine months ended March 31, 2012 compared to $6.5 million for the corresponding period in 2011 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 0.84% for the nine months ended March 31, 2012, compared to 1.36% for the same period in 2011 due to downward repricing of interest bearing deposits in the current low interest rate environment. Average FHLB borrowings decreased $30.0 million to $37.9 million for the nine months ended March 31, 2012 compared to $68.0 million for the comparable period in 2011, while the average rate paid on borrowings decreased 15 basis points to 3.36%. Excess liquidity was used to repay FHLB advances during the prior fiscal year.

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Provision for Loan Losses

The provision for loan losses for the nine months ended March 31, 2012 was $9.3 million, compared to a provision of $2.4 million for the comparable period in 2011. The increase in the provision for loan losses was attributable to higher realized and estimated losses. Net charge-offs for the nine months ended March 31, 2012 were $10.6 million compared to $4.1 million for the comparable period in 2011.

Noninterest Income

Noninterest income decreased $1.8 million to $1.7 million for the nine months ended March 31, 2012 compared to $3.5 million for the same period in 2011, due primarily to gains realized on the sale of investment securities during the prior year period. Gain on sale of investment securities was $39,000 for the nine months ended March 31, 2012 compared to $2.0 million for the same period in 2011. Mortgage origination fee income decreased $166,000, or 38.6%, to $264,000 for the nine months ended March 31, 2012 due to lower demand for residential mortgage refinancing. Service charges and fees declined $116,000, or 12.1%, to $841,000 for the nine months ended March 31, 2012 compared to the prior year period. Loss on sale of foreclosed real estate was $140,000 for the nine months ended March 31, 2012 compared to $591,000 for the comparable period in 2011.

The following table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent changes for the nine months ended March 31, 2012 compared to the same period in 2011.

	Nine Months Ended
	March 31,						$			%
	2012			2011			Change			Change
	(Dollars in thousands)
Noninterest income:
Mortgage origination fee income	$	264		$	430		$	(166	)		(38.6	%)
Service charges and fees		841			957			(116	)		(12.1	%)
Gain (loss) on sale of fixed assets		(19	)		-			(19	)		-
(Loss) gain on investment securities		39			2,031			(1,992	)		(98.1	%)
Gain (loss) on sale of foreclosed real estate, net		(140	)		(591	)		451			(76.3	%)
BOLI increase in cash value		177			177			-			0.0	%
Other		527			527			-			0.0	%
Total noninterest income	$	1,689		$	3,531		$	(1,842	)		(52.2	%)

Noninterest Expense

Total noninterest expense decreased $488,000, or 3.6%, to $12.9 million for the nine months ended March 31, 2012 compared to $13.4 million for the corresponding period in 2011. Noninterest expense for the nine months ended March 31, 2011 included prepayment penalties of $775,000 incurred on the early payoff of FHLB advances. Compensation expense decreased $439,000 to $4.6 million for the nine months ended March 31, 2012 compared to $5.1 million for the same period in 2011 due to employee attrition. Valuation adjustments and expenses on other real estate owned increased $669,000 to $2.1 million for the nine months ended March 31, 2012 compared to $1.5 million for the same period in 2011.

29

The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the nine months ended March 31, 2012 compared to the same period in 2011.

	Nine Months Ended
	March 31,				$			%
	2012		2011		Change			Change
	(Dollars in thousands)
Noninterest expense:
Compensation and benefits	$	4,625	$	5,064	$	(439	)	(8.7	%)
Occupancy expense		1,047		1,031		16		1.6	%
Equipment and data processing expense		1,798		1,900		(102	)	(5.4	%)
Deposit insurance premiums		606		490		116		23.7	%
Advertising		290		167		123		73.7	%
Professional services		383		387		(4	)	(1.0	%)
Valuation adjustment and expenses on OREO		2,144		1,475		669		45.4	%
Amortization of intangible assets		336		377		(41	)	(10.9	%)
Loss on early extinguishment of debt		-		775		(775	)	(100.0	%)
Other		1,658		1,709		(51	)	(3.0	%)
Total noninterest expense	$	12,887	$	13,375	$	(488	)	(3.6	%)

Income Taxes

Income tax benefit for the nine months ended March 31, 2012 was $2.6 million compared to income tax expense of $455,000 for the same period in 2011 due to lower taxable income.

Financial Condition

Cash, Cash Equivalents and Interest-Earning Deposits

Cash, cash equivalents, and interest-earning deposits decreased $1.9 million to $38.6 million at March 31, 2012 compared to $40.5 million at June 30, 2011.

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 $89.3 million at March 31, 2012 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 $1.3 million, or $811,000 net of taxes, at March 31, 2012. The $14.5 million increase in the investment portfolio is the result of excess liquidity deployed into the investment portfolio.

Loans

Net loans decreased $37.1 million to $341.5 million at March 31, 2012 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.

30

Loans receivable, net, are summarized as follows:

	At						At
	March 31,						June 30,
	2012						2011
				Percent						Percent			$			%
	Amount			of Portfolio			Amount			of Portfolio			Change			Change
	(Dollars in thousands)
Real estate loans:
Residential one-to four-family	$	99,494			28.5	%	$	110,046			28.4	%	$	(10,552	)		(9.6	%)
Home equity line of credit		19,050			5.5	%		20,029			5.2	%		(979	)		(4.9	%)
Commercial		139,373			40.0	%		144,519			37.3	%		(5,146	)		(3.6	%)
Multi-family		10,836			3.1	%		14,062			3.6	%		(3,226	)		(22.9	%)
Construction		2,241			0.6	%		2,171			0.6	%		70			3.2	%
Land		28,485			8.2	%		30,053			7.8	%		(1,568	)		(5.2	%)
Total real estate loans		299,479			85.9	%		320,880			82.9	%		(21,401	)		(6.7	%)
Commercial business loans		44,377			12.7	%		60,497			15.6	%		(16,120	)		(26.6	%)
Consumer loans:
Automobile loans		875			0.3	%		1,237			0.3	%		(362	)		(29.3	%)
Mobile home loans		7			0.0	%		13			0.0	%		(6	)		(46.2	%)
Loans secured by deposits		1,070			0.3	%		1,268			0.3	%		(198	)		(15.6	%)
Other consumer loans		2,876			0.8	%		3,235			0.8	%		(359	)		(11.1	%)
Total consumer loans		4,828			1.4	%		5,753			1.5	%		(925	)		(16.1	%)
Total gross loans		348,684			100.0	%		387,130			100.0	%		(38,446	)		(9.9	%)
Less:
Deferred loan fees, net		(353	)					(362	)					9			(2.5	%)
Allowance for losses		(6,807	)					(8,181	)					1,374			(16.8	%)
Loans receivable, net	$	341,524					$	378,587					$	(37,063	)		(9.8	%)

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.

31

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.

The allowance for loan losses was $6.8 million at March 31, 2012 compared to $8.2 million at June 30, 2011. Our allowance for loan losses represented 1.95% of total loans and 36.86% of nonperforming loans at March 31, 2012 compared to 2.11% of total loans and 99.19% of nonperforming loans at June 30, 2011.

	Three Months Ended						Nine Months Ended
	March 31,						March 31,
	2012			2011			2012			2011
	(Dollars in thousands)						(Dollars in thousands)
Balance at beginning of period	$	10,880		$	7,945		$	8,181		$	9,649
Provision for loan losses		600			1,400			9,273			2,350
Recoveries		175			11			257			113
Charge-offs		(4,848	)		(1,475	)		(10,904	)		(4,231	)
Net charge-offs		(4,673	)		(1,464	)		(10,647	)		(4,118	)
Allowance at end of period	$	6,807		$	7,881		$	6,807		$	7,881
Net charge-offs to average outstanding loans during the period, annualized		5.22	%		1.43	%		3.82	%		1.30	%

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. Nonperforming assets totaled $26.7 million, or 5.00% of total assets, at March 31, 2012, compared to $18.2 million, or 3.25% of total assets, at June 30, 2011 and $22.2 million, or 3.85% of total assets, at March 31, 2011. Nonaccrual loans totaled $18.5 million at March 31, 2012 compared to $8.2 million at June 30, 2011. Troubled debt restructuring (“TDR”) loans were $11.3 million at March 31, 2012 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 involving changes in amortization terms, reductions in interest rates, interest only payments and, in limited cases, concessions to outstanding loan balances. The amount of accruing TDR loans totaled $2.7 million at March 31, 2012. Foreclosed real estate amounted to $7.8 million at March 31, 2012 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 March 31, 2012 consisted of vacant land totaling $1.2 million, residential property totaling $1.2 million, subdivision developments totaling $3.0 million and commercial real estate totaling $2.4 million.

32

	March 31,			June 30,
	2012			2011
	(Dollars in thousands
Nonaccrual loans:
Real estate	$	8,609		$	5,401
Commercial business		1,241			848
Consumer		38			41
Total nonaccrual loans		9,888			6,290
Nonaccrual restructured loans:
Real estate		8,242			1,531
Commercial business		338			427
Consumer		-			-
Total nonaccrual restructured loans		8,580			1,958
Total nonperforming loans		18,468			8,248
Nonaccrual investments		277			464
Real estate owned		7,823			9,498
Other nonperforming assets		147			1
Total nonperforming assets	$	26,715		$	18,211
Accruing restructured loans	$	2,697		$	13,821
Accruing restructured loans and nonperforming loans	$	21,165		$	22,069
Total nonperforming loans to total loans		5.30	%		2.13	%
Total nonperforming loans to total assets		3.46	%		1.47	%
Total nonperforming assets to total assets		5.00	%		3.25	%

The following table summarizes activity in OREO during the nine months ended March 31, 2012:

OREO balance at beginning of period	$	9,498
OREO acquired		2,495
OREO sold		(2,188	)
Initial valuation adjustments		(598	)
Subsequent valuation adjustments		(1,384	)
OREO ending balance	$	7,823

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 March 31, 2012 was $6.8 million.

Deposits

Total deposits decreased $20.4 million to $433.8 million at March 31, 2012 due to the planned runoff of higher cost certificates of deposit. Time deposits decreased $33.1 million, or 15.7%, to $177.8 million at March 31, 2012. Transaction accounts increased $12.6 million, or 5.2%, to $256.0 million at March 31, 2012.

33

	March 31,		June 30,
	2012		2011		$ Change			% Change
	(Dollars in thousands)
Noninterest-bearing accounts	$	54,636	$	54,340	$	296		0.5	%
NOW accounts		46,974		46,134		840		1.8	%
Savings accounts		100,589		91,637		8,952		9.8	%
Money market accounts		53,812		51,252		2,560		5.0	%
Certificates of deposit		177,811		210,899		(33,088	)	(15.7	%)
Total	$	433,822	$	454,262	$	(20,440	)	(4.5	%)

Advances

FHLB advances remained unchanged at $37.9 million at March 31, 2012 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 $52.0 million at March 31, 2012 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 March 31, 2012, the adjustment to stockholders’ equity was a net unrealized gain of $811,000 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 March 31, 2012, 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 March 31, 2012, cash and cash equivalents totaled $38.6 million compared to $40.5 million at June 30, 2011. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $89.3 million at March 31, 2012 compared to $74.8 million at June 30, 2011. At March 31, 2012, approximately $13.2 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 March 31, 2012 compared to June 30, 2011. At March 31, 2012, borrowing capacity with the FHLB totaled $54.9 million based on pledged collateral, of which $17.0 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 March 31, 2012, the Company had approximately $17.3 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.

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The Company anticipates that it will have sufficient funds available to meet current loan commitments. At March 31, 2012, we had approximately $7.4 million in loan commitments, consisting of commitments to fund real estate loans. In addition to commitments to originate loans, we had $4.5 million in unused letters of credit and approximately $29.9 million in unused lines of credit. At March 31, 2012, we had approximately $115.1 million in certificates of deposit due within one year and $256.0 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 $20.4 million during the nine-month period ended March 31, 2012.

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 March 31, 2012, 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.

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Capital Compliance

The Bank is subject to various regulatory capital requirements administered by the banking regulatory agencies. As of March 31, 2012, Jefferson Federal met each of its capital requirements. The following table presents our capital position relative to our regulatory capital requirements at March 31, 2012 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 March 31, 2012
Total Risk-Based Capital
(To Risk Weighted Assets)	$	46,387	12.37	%	$	29,998	>	8.0	%	$	37,498	>	10.0	%
Tier 1 Capital
(To Risk Weighted Assets)		41,674	11.11	%		14,999	>	4.0	%		22,499	>	6.0	%
Tier 1 Capital
(To Average Assets)		41,674	8.03	%		20,762	>	4.0	%		25,952	>	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 March 31, 2012, Jefferson Federal’s leverage capital ratio was 8.03%. 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 March 31, 2012, Jefferson Federal had a ratio of total capital to risk-weighted assets of 12.37%. At March 31, 2012, the Bank met the minimum regulatory capital requirements, and the Bank was “well-capitalized” within the meaning of federal regulatory requirements.

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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 March 31, 2012 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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
January 1, 2012 through January 31, 2012	-	$	-	-	437,802	(1)
Month #2
February 1, 2012 through February 29, 2012	-	$	-	-	437,802	(1)
Month #3
March 1, 2012 through March 31, 2012	-	$	-	-	437,802	(1)
Total	-	$	-	-	437,802

(1) On November 13, 2008, the Company announced a stock repurchase program under which the Company may repurchase 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.

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Item 3. Defaults Upon Senior Securities

None.

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 March 31, 2012, 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.

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SIGNATURES

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

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

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