UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

T       Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2013

OR

o      Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number 000-51507

WATERSTONE FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

Federal	20-3598485
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
11200 W. Plank Court Wauwatosa, Wisconsin	53226
(Address of principal executive offices)	(Zip Code)

(414) 761-1000

(Registrant's telephone number, including area code)

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      T            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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes      T            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 definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer T	Non-accelerated filer o	Smaller reporting company o
	(Do not check if 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      T

The number of shares outstanding of the issuer's common stock, $0.01 par value per share, was 31,349,317 at July 31, 2013.

WATERSTONE FINANCIAL, INC.

10-Q INDEX

	Page No.
PARTI. FINANCIAL INFORMATION	3
Item l. Financial Statements	3
Consolidated Statements of Financial Condition as of June 30, 2013 (unaudited) and December 31, 2012	3
Consolidated Statements of Income for the three and six months ended June 30, 2013 and 2012 (unaudited)	4
Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2013 and 2012 (unaudited)	5
Consolidated Statements of Changes in Shareholders' Equity for the six months ended June 30, 2013 and 2012 (unaudited)	6
Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012 (unaudited)	7
Notes to Consolidated Financial Statements (unaudited)	8 - 41
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	42 - 67
Item 3. Quantitative and Qualitative Disclosures about Market Risk	68 - 69
Item 4. Controls and Procedures	69
PART II. OTHER INFORMATION	70
Item 1. Legal Proceedings	70
Item 1A. Risk Factors	70
Item 6. Exhibits	70
Signatures	70

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

	(Unaudited)
	June 30, 2013			December 31, 2012
Assets	(In Thousands, except share data)
Cash	$	40,319			37,129
Federal funds sold		13,803			28,576
Interest-earning deposits in other financial institutions and other short term investments		246			5,764
Cash and cash equivalents		54,368			71,469
Securities available for sale (at fair value)		216,253			205,017
Loans held for sale (at fair value)		132,045			133,613
Loans receivable		1,106,915			1,133,672
Less: Allowance for loan losses		27,767			31,043
Loans receivable, net		1,079,148			1,102,629
Office properties and equipment, net		27,781			26,935
Federal Home Loan Bank stock (at cost)		20,193			20,193
Cash surrender value of life insurance		38,642			38,061
Real estate owned		29,983			35,974
Prepaid expenses and other assets		34,463			27,185
Total assets	$	1,632,876			1,661,076
Liabilities and Shareholders' Equity
Liabilities:
Demand deposits	$	91,496			84,140
Money market and savings deposits		119,620			118,453
Time deposits		681,891			736,920
Total deposits		893,007			939,513
Short-term borrowings		56,046			45,888
Long-term borrowings		434,000			434,000
Advance payments by borrowers for taxes		15,556			1,672
Other liabilities		24,922			37,369
Total liabilities		1,423,531			1,458,442
Shareholders' equity:
Preferred stock (par value $.01 per share)
Authorized - 20,000,000 shares, no shares issued		-			-
Common stock (par value $.01 per share)
Authorized - 200,000,000 shares in 2013 and 2012
Issued - 34,074,450 in 2013 and 34,072,909 in 2012
Outstanding - 31,349,317 in 2013 and 31,348,556 in 2012		341			341
Additional paid-in capital		110,438			110,490
Retained earnings		146,039			136,487
Unearned ESOP shares		(1,280	)		(1,708	)
Accumulated other comprehensive (loss) income, net of taxes		(932	)		2,285
Treasury shares (2,724,353 shares), at cost		(45,261	)		(45,261	)
Total shareholders' equity		209,345			202,634
Total liabilities and shareholders' equity	$	1,632,876			1,661,076

See Accompanying Notes to Unaudited Consolidated Financial Statements.

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WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three months ended June 30,					Six months ended June 30,
	2013		2012			2013			2012
	(In Thousands, except per share amounts)
Interest income:
Loans	$	14,862		16,319			30,075			32,892
Mortgage-related securities		419		921			856			1,784
Debt securities, federal funds sold and short-term investments		617		548			1,153			1,255
Total interest income		15,898		17,788			32,084			35,931
Interest expense:
Deposits		1,353		2,663			2,819			5,866
Borrowings		4,624		4,497			9,198			9,010
Total interest expense		5,977		7,160			12,017			14,876
Net interest income		9,921		10,628			20,067			21,055
Provision for loan losses		1,200		1,425			2,960			5,100
Net interest income after provision for loan losses		8,721		9,203			17,107			15,955
Noninterest income:
Service charges on loans and deposits		348		382			713			631
Increase in cash surrender value of life insurance		261		264			401			409
Total other-than-temporary investment losses		—		(471	)		—			(475	)
Portion of loss recognized in other comprehensive income (before income taxes)		—		371			—			371
Net impairment losses recognized in earnings		—		(100	)		—			(104	)
Mortgage banking income		25,455		22,507			47,443			36,708
(Loss) gain on sale of available for sale securities		—		—			(9	)		241
Other		643		199			1,192			368
Total noninterest income		26,707		23,252			49,740			38,253
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		19,944		14,965			36,426			25,602
Occupancy, office furniture, and equipment		1,862		1,688			3,778			3,409
Advertising		796		769			1,620			1,324
Data processing		484		334			961			726
Communications		342		306			750			603
Professional fees		730		533			1,135			959
Real estate owned		12		2,838			153			4,273
FDIC insurance premiums		380		873			1,053			1,814
Other		2,897		3,930			5,442			7,041
Total noninterest expenses		27,447		26,236			51,318			45,751
Income before income taxes		7,981		6,219			15,529			8,457
Income tax expense		3,054		41			5,977			71
Net income	$	4,927		6,178			9,552			8,386
Income per share:
Basic	$	0.16		0.20			0.31			0.27
Diluted	$	0.16		0.20			0.30			0.27
Weighted average shares outstanding:
Basic		31,144		31,045			31,134			31,035
Diluted		31,368		31,136			31,351			31,069

See Accompanying Notes to Unaudited Consolidated Financial Statements.

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WATERSONE FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

	Three months ended June 30,					Six months ended June 30,
	2013			2012		2013			2012
	(In Thousands)
Net income	$	4,927			6,178		9,552			8,386
Other comprehensive income, net of tax:
Net unrealized holding (loss) gain on available for sale securities:
Net unrealized holding (loss) gain arising during the period, net of tax benefit (expense) of $1,895, ($320), $2,120, ($420), respectively		(2,881	)		582		(3,222	)		922
Reclassification adjustment for net loss (gain) included in net income during the period, net of tax (benefit) expense of $0, ($41),($4), $55, respectively		-			63		5			(81	)
Total other comprehensive (loss) income		(2,881	)		645		(3,217	)		841
Comprehensive income	$	2,046			6,823		6,335			9,227

See Accompanying Notes to Unaudited Consolidated Financial Statements.

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WATERSONE FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

													Accumulated
					Additional					Unearned			Other						Total
	Common Stock				Paid-In			Retained		ESOP			Comprehensive			Treasury			Shareholders'
	Shares		Amount		Capital			Earnings		Shares			Income (Loss)			Shares			Equity
	(In Thousands)
Balances at December 31, 2011		31,250	$	340		110,894			101,573		(2,562	)		1,388			(45,261	)		166,372
Comprehensive income:
Net income		—		—		—			8,386		—			—			—			8,386
Other comprehensive income		—		—		—			—		—			841			—			841
Total comprehensive income																				9,227
ESOP shares committed to be released to Plan participants		—		—		(317	)		—		427			—			—			110
Stock based compensation		100		—		75			—		—			—			—			75
Balances at June 30, 2012		31,350	$	340		110,652			109,959		(2,135	)		2,229			(45,261	)		175,784
Balances at December 31, 2012		31,348	$	341		110,490			136,487		(1,708	)		2,285			(45,261	)		202,634
Comprehensive income:
Net income		—		—		—			9,552		—			—			—			9,552
Other comprehensive loss		—		—		—			—		—			(3,217	)		—			(3,217	)
Total comprehensive income																				6,335
ESOP shares committed to be released to Plan participants		—		—		(117	)		—		428			—			—			311
Stock based compensation		1		—		65			—		—			—			—			65
Balances at June 30, 2013		31,349	$	341		110,438			146,039		(1,280	)		(932	)		(45,261	)		209,345

See Accompanying Notes to Unaudited Consolidated Financial Statements.

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WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six months ended June 30,
	2013			2012
	(In Thousands)
Operating activities:
Net income	$	9,552			8,386
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		2,960			5,100
Provision for depreciation		1,226			985
Deferred income taxes		3,624			(2,160	)
Stock based compensation		65			75
Net amortization of premium/discount on debt and mortgage related securities		1,233			576
Amortization of unearned ESOP shares		311			110
Gain on sale of loans held for sale		(43,399	)		(37,304	)
Loans originated for sale		(978,327	)		(767,092	)
Proceeds on sales of loans originated for sale		1,023,294			770,190
(Increase) decrease in accrued interest receivable		(395	)		508
Increase in cash surrender value of life insurance		(401	)		(409	)
Decrease in accrued interest on deposits and borrowings		(135	)		(318	)
Increase in other liabilities		1,754			3,862
Decrease in accrued tax payable		(2,190	)		(257	)
Loss (gain) on sale of available for sale securities		9			(241	)
Impairment of securities		-			104
Net (gain) loss related to real estate owned		(802	)		2,670
Other		(7,660	)		(2,887	)
Net cash provided by (used in) operating activities		10,719			(18,102	)
Investing activities:
Net decrease in loans receivable		12,117			33,609
Purchases of:
Debt securities		(34,555	)		-
Mortgage related securities		(7,160	)		(77,252	)
Certificates of deposit		(980	)		(1,470	)
Premises and equipment, net		(2,093	)		(741	)
Bank owned life insurance		(180	)		(180	)
Proceeds from:
Principal repayments on mortgage-related securities		21,902			16,182
Maturities of debt securities		2,060			11,908
Sales of debt securities		921			44,868
Calls of structured notes		-			2,648
Sales of real estate owned		14,466			16,247
Redemption of FHLB stock		-			1,146
Net cash provided by investing activities		6,498			46,965
Financing activities:
Net decrease in deposits		(46,506	)		(65,094	)
Net increase in short-term borrowings		10,158			17,893
Net increase in advance payments by borrowers for taxes		2,030			2,833
Net cash used in financing activities		(34,318	)		(44,368	)
Decrease in cash and cash equivalents		(17,101	)		(15,505	)
Cash and cash equivalents at beginning of period		71,469			80,380
Cash and cash equivalents at end of period		54,368			64,875
Supplemental information:
Cash paid or credited during the period for:
Income tax payments		4,573			2,488
Interest payments		12,151			15,195
Noncash investing activities:
Loans receivable transferred to real estate owned		8,404			11,002

See Accompanying Notes to Unaudited Consolidated Financial Statements.

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WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 — Basis of Presentation

The unaudited interim consolidated financial statements include the accounts of Waterstone Financial, Inc. (the "Company") and the Company's subsidiaries.

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information, Rule 10-01 of Regulation S-X and the instructions to Form 10-Q. The financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position, results of operations, changes in shareholders' equity, and cash flows of the Company for the periods presented.

The accompanying unaudited consolidated financial statements and related notes should be read in conjunction with the Company's December 31, 2012 Annual Report on Form 10-K. Operating results for the six and three months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013 or for any other period.

The preparation of the unaudited consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Significant items subject to such estimates and assumptions include the allowance for loan losses, deferred income taxes and real estate owned. Actual results could differ from those estimates.

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Note 2— Securities Available for Sale

The amortized cost and fair values of the Company's investment in securities available for sale follow:

	June 30, 2013
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
	(In Thousands)
Mortgage-backed securities	$	107,683		1,229		(694	)		108,218
Collateralized mortgage obligations:
Government sponsored enterprise issued		22,465		329		—			22,794
Mortgage-related securities		130,148		1,558		(694	)		131,012
Government sponsored enterprise bonds		14,517		3		(175	)		14,345
Municipal securities		61,173		1,072		(2,677	)		59,568
Other debt securities		5,000		168		—			5,168
Debt securities		80,690		1,243		(2,852	)		79,081
Certificates of Deposit		6,125		43		(8	)		6,160
	$	216,963		2,844		(3,554	)		216,253

	December 31, 2012
	Amortized cost		Gross unrealized gains		Gross Unrealized losses			Fair value
	(In Thousands)
Mortgage-backed securities	$	116,813		2,349		(106	)		119,056
Collateralized mortgage obligations:
Government sponsored enterprise issued		29,207		373		(1	)		29,579
Mortgage-related securities		146,020		2,722		(107	)		148,635
Government sponsored enterprise bonds		8,000		17		—			8,017
Municipal securities		35,493		2,043		(165	)		37,371
Other debt securities		5,000		70		—			5,070
Debt securities		48,493		2,130		(165	)		50,458
Certificates of Deposit		5,880		45		(1	)		5,924
	$	200,393		4,897		(273	)		205,017

The Company's mortgage-backed securities and collateralized mortgage obligations issued by government sponsored enterprises are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. At June 30, 2013, $989,000 of the Company's government sponsored enterprise bonds and $100.5 million of the Company's mortgage related securities were pledged as collateral to secure repurchase agreement obligations of the Company.

- 9 -

The amortized cost and fair values of investment securities by contractual maturity at June 30, 2013 are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized Cost		Fair Value
	(In Thousands)
Debt and other securities
Due within one year	$	2,355		2,359
Due after one year through five years		28,704		29,341
Due after five years through ten years		20,792		19,866
Due after ten years		34,964		33,675
Mortgage-related securities		130,148		131,012
	$	216,963		216,253

Gross unrealized losses on securities available for sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position were as follows:

	June 30, 2013
	Less than 12 months					12 months or longer					Total
	Fair value		Unrealized loss			Fair value		Unrealized loss			Fair value		Unrealized loss
	(In Thousands)
Mortgage-backed securities	$	49,739		(694	)		—		—			49,739		(694	)
Government sponsored enterprise bonds		10,842		(175	)		—		—			10,842		(175	)
Municipal securities		41,912		(2,535	)		337		(142	)		42,249		(2,677	)
Certificates of Deposit		1,216		(8	)		—		—			1,216		(8	)
	$	103,709		(3,412	)		337		(142	)		104,046		(3,554	)

	December 31, 2012
	Less than 12 months					12 months or longer					Total
	Fair value		Unrealized loss			Fair value		Unrealized loss			Fair value		Unrealized loss
	(In Thousands)
Mortgage-backed securities	$	19,382		(106	)		—		—			19,382		(106	)
Collateralized mortgage obligations:
Government sponsored enterprise issued		1,419		(1	)		—		—			1,419		(1	)
Municipal securities		9,009		(94	)		398		(71	)		9,407		(165	)
Certificates of Deposit		244		(1	)		—		—			244		(1	)
	$	30,054		(202	)		398		(71	)		30,452		(273	)

The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment. In evaluating whether a security's decline in market value is other-than-temporary, management considers the length of time and extent to which the fair value has been less than cost, financial condition of the issuer and the underlying obligors, quality of credit enhancements, volatility of the fair value of the security, the expected recovery period of the security and ratings agency evaluations. In addition the Company may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds and the value of any underlying collateral. For certain securities in unrealized loss positions, the Company prepares cash flow analyses to compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.

- 10 -

As of June 30, 2013, the Company identified two municipal securities that were deemed to be other-than-temporarily impaired. Both securities were issued by a tax incremental district in a municipality located in Wisconsin. During the year ended December 31, 2012, the Company received audited financial statements with respect to the municipal issuer that called into question the ability of the underlying taxing district that issued the securities to operate as a going concern. During the year ended December 31, 2012, the Company's analysis of these securities resulted in $100,000 in credit losses that were charged to earnings with respect to these two municipal securities. No additional credit loss was recognized during the six months ended June 30, 2013. As of June 30, 2013, these securities had a combined amortized cost of $215,000 and a combined estimated fair value of $189,000. As of June 30, 2013, the Company had one municipal security which had been in an unrealized loss position for twelve months or longer. This security was determined not to be other-than-temporarily impaired as of June 30, 2013. During the year ended December 31, 2012, two private-label collateralized mortgage obligations, that had been identified as other than temporarily impaired, were sold at a combined gain of $282,000. At the time of sale, these securities had a combined amortized cost of $18.0 million.

The following table presents the change in other-than-temporary credit related impairment charges on securities available for sale for which a portion of the other-than-temporary impairments related to other factors was recognized in other comprehensive loss.

	(In Thousands)
Credit-related impairments on securities as of December 31, 2011	$	2,096
Credit-related impairments related to securities for which an other- than-temporary impairment was not previously recognized		100
Increase in credit-related impairments related to securities for which an other-than-temporary impairment was previously recognized		113
Reduction for sales of securities for which other-than-temporary was previously recognized		(2,209	)
Credit-related impairments on securities as of December 31, 2012		100
Credit-related impairments related to securities for which an other- than-temporary impairment was not previously recognized		—
Increase in credit-related impairments related to securities for which an other-than-temporary impairment was previously recognized		—
Credit-related impairments on securities as of June 30, 2013	$	100

Exclusive of the aforementioned securities, the Company has determined that the decline in fair value of the remaining securities is not attributable to credit deterioration. Based on the foregoing evaluation criteria, and as the Company does not intend to sell nor is it more likely than not that it will be required to sell these securities before recovery of the amortized cost basis, these securities are not considered other-than-temporarily impaired.

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Continued deterioration of general economic market conditions could result in the recognition of future other-than-temporary impairment losses within the investment portfolio and such amounts could be material to our consolidated financial statements.

During the six months ended June 30, 2013, proceeds from the sale of securities totaled $921,000 and resulted in losses totaling $9,000. The $9,000 loss included in(loss) gain on sale of available for sale securities in the consolidated statements of income during the six months ended June 30, 2013 was reclassified from accumulated other comprehensive income. During the six months ended June 30, 2012, proceeds from the sale of securities totaled $11.9 million and resulted in gains totaling $241,000. The $241,000 gain included in (loss) gain on sale of available for sale securities in the consolidated statements of income during the six months ended June 30, 2012 was reclassified from accumulated other comprehensive income.

Note 3 - Loans Receivable

Loans receivable at June 30, 2013 and December 31, 2012 are summarized as follows:

	June 30, 2013		December 31, 2012
	(In Thousands)
Mortgage loans:
Residential real estate:
One- to four-family	$	425,693		460,821
Over four-family		518,745		514,363
Home equity		35,382		36,494
Construction and land		36,981		33,818
Commercial real estate		70,960		65,495
Consumer		134		132
Commercial loans		19,020		22,549
	$	1,106,915		1,133,672

The Company provides several types of loans to its customers, including residential, construction, commercial and consumer loans. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to one borrower or to multiple borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. While credit risks are geographically concentrated in the Company's Milwaukee metropolitan area, and while 88.5% of the Company's loan portfolio involves loans that are secured by residential real estate, there are no concentrations with individual or groups of related borrowers. While the real estate collateralizing these loans is residential in nature, it ranges from owner-occupied single family homes to large apartment complexes. In addition, real estate collateralizing $74.6 million, or 6.7% of total loans, is located outside of the state of Wisconsin.

During the six months ended June 30, 2013, $978.3 million in residential loans were originated for sale. During the same period, sales of loans held for sale totaled $1.0 billion, generating mortgage banking income of $47.4 million. The unpaid principal balance of loans serviced for others was $943.6  million and $635.8 million at June 30, 2013 and December 31, 2012, respectively. These loans are not reflected in the consolidated statements of financial condition.

Qualifying loans receivable totaling $792.8 million and $801.6 million at June 30, 2013 and December 31, 2012, respectively, are pledged as collateral against $350.0 million in outstanding Federal Home Loan Bank of Chicago advances under a blanket security agreement.

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An analysis of past due loans receivable as of June 30, 2013 and December 31, 2012 follows:

	As of June 30, 2013
	1-59 Days Past Due (1)			60-89 Days Past Due (2)		Greater Than 90 Days		Total Past Due		Current (3)		Total Loans
	(In Thousands)
Mortgage loans:
Residential real estate:
One- to four-family		$	8,371		6,126		20,971		35,468		390,225		425,693
Over four-family			1,691		1,200		8,427		11,318		507,427		518,745
Home equity			1,471		143		206		1,820		33,562		35,382
Construction and land			5,476		1,995		3,170		10,641		26,340		36,981
Commercial real estate			576		—		272		848		70,112		70,960
Consumer			—		—		—		—		134		134
Commercial loans			—		—		511		511		18,509		19,020
Total		$	17,585		9,464		33,557		60,606		1,046,309		1,106,915

	As of December 31, 2012
Mortgage loans:
Residential real estate:
One- to four-family	$	11,745	5,402	29,259	46,406	414,415	460,821
Over four-family		3,543	1,498	18,336	23,377	490,986	514,363
Home equity		416	111	404	931	35,563	36,494
Construction and land		87	—	2,180	2,266	31,552	33,818
Commercial real estate		290	—	668	959	64,536	65,495
Consumer		—	—	—	—	132	132
Commercial loans		—	—	511	511	22,038	22,549
Total	$	16,081	7,011	51,358	74,450	1,059,222	1,133,672

⁽¹⁾ Includes $3.6 million and $2.4 million for June 30, 2013 and December 31, 2012, respectively, which are on non-accrual status.

⁽²⁾ Includes $6.2 million and $2.8 million for June 30, 2013 and December 31, 2012, respectively, which are on non-accrual status.

⁽³⁾ Includes $9.9 million and $18.2 million for June 30, 2013 and December 31, 2012, respectively, which are on non-accrual status.

As of June 30, 2013 and December 31, 2012, there are no loans that are 90 or more days past due and still accruing interest.

- 13 -

A summary of the activity for the six months ended June 30, 2013 and 2012 in the allowance for loan losses follows:

	One- to Four- Family			Over Four-Family			Home Equity			Construction and Land			Commercial Real Estate			Consumer			Commercial			Total
	(In Thousands)
Six months ended June 30, 2013
Balance at beginning of period	$	17,819			7,734			2,097			1,323			1,259			30			781			31,043
Provision (credit) for loan losses		2,115			(335	)		163			926			110			3			(22	)		2,960
Charge-offs		(5,686	)		(732	)		(524	)		(134	)		(95	)		—			—			(7,171	)
Recoveries		608			201			70			51			—			2			3			935
Balance at end of period	$	14,856			6,868			1,806			2,166			1,274			35			762			27,767
Six months ended June 30, 2012
Balance at beginning of period	$	17,475			8,252			1,998			2,922			941			28			814			32,430
Provision (credit) for loan losses		2,943			1,396			374			(137	)		817			(1	)		(292	)		5,100
Charge-offs		(4,133	)		(612	)		(158	)		(192	)		(43	)		—			(59	)		(5,197	)
Recoveries		252			11			22			15			—			—			25			325
Balance at end of period	$	16,537			9,047			2,236			2,608			1,715			27			488			32,658

A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of June 30, 2013 follows:

	One- to Four- Family		Over Four Family		Home Equity		Construction and Land		Commercial Real Estate		Consumer		Commercial		Total
	(In Thousands)
Allowance related to loans individually evaluated for impairment	$	3,850		786		863		377		218		—		376		6,470
Allowance related to loans collectively evaluated for impairment		11,006		6,082		943		1,789		1,056		35		386		21,297
Balance at end of period	$	14,856		6,868		1,806		2,166		1,274		35		762		27,767
Loans individually evaluated for impairment	$	46,925		25,940		1,885		6,689		436		20		1,352		83,247
Loans collectively evaluated for impairment		378,768		492,805		33,497		30,292		70,524		114		17,668		1,023,668
Total gross loans	$	425,693		518,745		35,382		36,981		70,960		134		19,020		1,106,915

- 14 -

A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of the year ended December 31, 2012 follows:

	One- to Four- Family		Over Four Family		Home Equity		Construction and Land		Commercial Real Estate		Consumer		Commercial		Total
	(In Thousands)
Allowance related to loans individually evaluated for impairment	$	7,058		3,268		1,033		377		341		—		331		12,408
Allowance related to loans collectively evaluated for impairment		10,761		4,466		1,064		946		918		30		450		18,635
Balance at end of period	$	17,819		7,734		2,097		1,323		1,259		30		781		31,043
Loans individually evaluated for impairment	$	57,467		28,281		2,127		4,470		1,250		24		1,352		94,971
Loans collectively evaluated for impairment		403,354		486,082		34,367		29,348		64,245		108		21,197		1,038,701
Total gross loans	$	460,821		514,363		36,494		33,818		65,495		132		22,549		1,133,672

The following table presents information relating to the Company's internal risk ratings of its loans receivable as of June 30, 2013 and December 31, 2012:

	One- to Four- Family		Over Four Family		Home Equity		Construction and Land		Commercial Real Estate		Consumer		Commercial		Total
	(In Thousands)
At June 30, 2013
Substandard	$	42,846		10,468		2,263		6,689		437		20		1,364		64,087
Watch		12,937		26,836		985		2,015		1,997		—		1,294		46,064
Pass		369,910		481,441		32,134		28,277		68,526		114		16,362		996,764
	$	425,693		518,745		35,382		36,981		70,960		134		19,020		1,106,915
At December 31, 2012
Substandard	$	53,242		24,767		2,913		3,705		1,251		23		1,365		87,266
Watch		17,082		14,157		606		2,803		1,234		—		964		36,846
Pass		390,497		475,439		32,975		27,310		63,010		109		20,220		1,009,560
	$	460,821		514,363		36,494		33,818		65,495		132		22,549		1,133,672

- 15 -

Factors that are important to managing overall credit quality include sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, an allowance for loan losses, and sound non-accrual and charge-off policies. Our underwriting policies require an officers' loan committee review and approve all loans in excess of $500,000. In addition, an independent loan review function exists for all loans. Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans. To do so, we maintain a loan review system under which our credit management personnel review non-owner occupied one- to four-family, over four-family, construction and land, commercial real estate and commercial loans that individually, or as part of an overall borrower relationship, exceed $1.0 million in potential exposure. Loans meeting these criteria are reviewed on an annual basis, or more frequently if the loan renewal is less than one year. With respect to this review process, management has determined that pass loans include loans that exhibit acceptable financial statements, cash flow and leverage. Watch loans have potential weaknesses that deserve management's attention and, if left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credit. Substandard loans are considered inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged. These loans generally have a well-defined weakness that may jeopardize liquidation of the debt and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Finally, a loan is considered to be impaired when it is probable that the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. Management has determined that all non-accrual loans and loans modified under troubled debt restructurings meet the definition of an impaired loan.

The Company's procedures dictate that an updated valuation must be obtained with respect to underlying collateral at the time a loan is deemed impaired. Updated valuations may also be obtained upon transfer from loans receivable to real estate owned based upon the age of the prior appraisal, changes in market conditions or known changes to the physical condition of the property.

Estimated fair values are reduced to account for sales commissions, broker fees, unpaid property taxes and additional selling expenses to arrive at an estimated net realizable value. The adjustment factor is based upon the Company's actual experience with respect to sales of real estate owned over the prior two years. An additional adjustment factor is applied by appraisal vintage to account for downward market pressure since the date of appraisal. The additional adjustment factor is based upon relevant sales data available for our general operating market as well as company-specific historical net realizable values as compared to the most recent appraisal prior to disposition.

With respect to over-four family income-producing real estate, appraisals are reviewed and estimated collateral values are adjusted by updating significant appraisal assumptions to reflect current real estate market conditions. Significant assumptions reviewed and updated include the capitalization rate, rental income and operating expenses. These adjusted assumptions are based upon recent appraisals received on similar properties as well as on actual experience related to real estate owned and currently under Company management.

- 16 -

The following tables present data on impaired loans at June 30, 2013 and December 31, 2012.

	As of or for the Six Months Ended June 30, 2013
	Recorded Investment		Unpaid Principal		Reserve		Cumulative Charge-Offs		Average Recorded Investment		Interest Paid
	(In Thousands)
Total Impaired with Reserve
One- to four-family	$	19,634		20,299		3,850		665		20,513		373
Over four-family		22,570		22,955		786		385		24,054		254
Home equity		1,353		1,353		863		—		1,440		25
Construction and land		1,551		1,551		377		—		1,551		23
Commercial real estate		349		759		218		409		758		5
Consumer		—		—		—		—		—		—
Commercial		1,352		1,352		376		—		1,352		18
		46,809		48,269		6,470		1,459		49,668		698
Total Impaired with no Reserve
One- to four-family		27,291		32,111		—		4,819		31,856		608
Over four-family		3,370		3,859		—		489		3,880		59
Home equity		532		532		—		—		542		8
Construction and land		5,138		6,603		—		1,465		6,605		47
Commercial real estate		87		163		—		76		175		2
Consumer		20		20		—		—		22		—
Commercial		—		—		—		—		—		—
		36,438		43,288		—		6,849		43,080		724
Total Impaired
One- to four-family		46,925		52,410		3,850		5,484		52,369		981
Over four-family		25,940		26,814		786		874		27,934		313
Home equity		1,885		1,885		863		—		1,982		33
Construction and land		6,689		8,154		377		1,465		8,156		70
Commercial real estate		436		922		218		485		933		7
Consumer		20		20		—		—		22		—
Commercial		1,352		1,352		376		—		1,352		18
	$	83,247		91,557		6,470		8,308		92,748		1,422

- 17 -

	As of or for the Year Ended December 31, 2012
	Recorded Investment		Unpaid Principal		Reserve		Cumulative Charge-Offs		Average Recorded Investment		Interest Paid
	(In Thousands)
Total Impaired with Reserve
One- to four-family	$	29,057		29,456		7,058		399		29,768		874
Over four-family		17,397		17,642		3,268		245		18,073		722
Home equity		1,544		1,544		1,033		—		1,615		74
Construction and land		2,316		2,316		377		—		2,316		78
Commercial real estate		813		1,179		341		366		1,748		50
Consumer		—		—		—		—		—		—
Commercial		1,352		1,352		331		—		1,352		42
		52,479		53,489		12,408		1,010		54,872		1,840
Total Impaired with no Reserve
One- to four-family		28,410		31,315		—		2,905		31,358		1,175
Over four-family		10,884		11,179		—		295		11,649		549
Home equity		583		749		—		166		755		14
Construction and land		2,154		3,655		—		1,501		3,656		5
Commercial real estate		437		461		—		24		473		12
Consumer		24		24		—		—		24		1
Commercial		—		—		—		—		—		—
		42,492		47,383		—		4,891		47,915		1,756
Total Impaired
One- to four-family		57,467		60,771		7,058		3,304		61,126		2,049
Over four-family		28,281		28,821		3,268		540		29,722		1,271
Home equity		2,127		2,293		1,033		166		2,370		88
Construction and land		4,470		5,971		377		1,501		5,972		83
Commercial real estate		1,250		1,640		341		390		2,221		62
Consumer		24		24		—		—		24		1
Commercial		1,352		1,352		331		—		1,352		42
	$	94,971		100,872		12,408		5,901		102,787		3,596

The difference between a loan's recorded investment and the unpaid principal balance represents a partial charge-off resulting from a confirmed loss due to the value of the collateral securing the loan being below the loan balance and management's assessment that the full collection of the loan balance is not likely.

When a loan is considered impaired, interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower's financial condition and prospects for repayment, including consideration of the borrower's sustained historical repayment performance and other relevant factors.

- 18 -

The determination as to whether an allowance is required with respect to impaired loans is based upon an analysis of the value of the underlying collateral and/or the borrower's intent and ability to make all principal and interest payments in accordance with contractual terms. The evaluation process is subject to the use of significant estimates and actual results could differ from estimates. This analysis is primarily based upon third party appraisals and/or a discounted cash flow analysis. In those cases in which no allowance has been provided for an impaired loan, the Company has determined that the estimated value of the underlying collateral exceeds the remaining outstanding balance of the loan. Of the total $36.4 million of impaired loans as of June 30, 2013 for which no allowance has been provided, $6.8 million in charge-offs have been recorded to reduce the unpaid principal balance to an amount that is commensurate with the loan's net realizable value, using the estimated fair value of the underlying collateral. To the extent that further deterioration in property values continues, the Company may have to reevaluate the sufficiency of the collateral servicing these impaired loans resulting in additional provisions to the allowance for loans losses or charge-offs.

At June 30, 2013, total impaired loans includes $47.1 million of troubled debt restructurings. Troubled debt restructurings involve granting concessions to a borrower experiencing financial difficulty by modifying the terms of the loan in an effort to avoid foreclosure. The vast majority of debt restructurings include a modification of terms to allow for an interest only payment and/or reduction in interest rate. The restructured terms are typically in place for six to twelve months. At December 31, 2012, total impaired loans included $59.6 million of troubled debt restructurings.

The following presents data on troubled debt restructurings:

		As of June 30, 2013
		Accruing				Non-accruing					Total
		Amount		Number		Amount			Number		Amount			Number
	(dollars in thousands)
One- to four-family		$	8,420		16		$	12,842		73		$	21,262		89
Over four-family			16,340		8			5,962		4			22,302		12
Home equity			-		-			1,007		4			1,007		4
Construction and land			1,408		1			840		2			2,248		3
Commercial real estate			-		-			272		2			272		2
Commercial loans			9		1			-		-			9		1
		$	26,177		26		$	20,923		85		$	47,100		111

		As of December 31, 2012
		Accruing				Non-accruing					Total
		Amount		Number		Amount			Number		Amount			Number
	(dollars in thousands)
One- to four-family		$	9,921		17		$	21,847		95		$	31,768		112
Over four-family			3,917		4			20,030		13			23,947		17
Home equity			-		-			986		3			986		3
Construction and land			2,173		2			79		1			2,252		3
Commercial real estate			-		-			668		2			668		2
		$	16,011		23		$	43,610		114		$	59,621		137

At June 30, 2013, $47.1 million in loans had been modified in troubled debt restructurings and $20.9 million of these loans were included in the non-accrual loan total. The remaining $26.2 million, while meeting the internal requirements for modification in a troubled debt restructuring, were current with respect to payments under their original loan terms at the time of the restructuring and thus, continued to be included with accruing loans. Provided these loans perform in accordance with the modified terms, they will continue to be accounted for on an accrual basis.

- 19 -

All loans that have been modified in a troubled debt restructuring are considered to be impaired. As such, an analysis has been performed with respect to all of these loans to determine the need for a valuation reserve. When a loan is expected to perform in accordance with the restructured terms and ultimately return to and perform under contract terms, a valuation allowance is established for an amount equal to the excess of the present value of the expected future cash flows under the original contract terms as compared with the modified terms, including an estimated default rate. When there is doubt as to the borrower's ability to perform under the restructured terms or ultimately return to and perform under market terms, a valuation allowance is established equal to the impairment when the carrying amount exceeds fair value of the underlying collateral. As a result of the impairment analysis, a $2.4 million valuation allowance has been established as of June 30, 2013 with respect to the $47.1 million in troubled debt restructurings. As of December 31, 2012, a $6.4 million valuation allowance had been established with respect to the $59.6 million in troubled debt restructurings.

After a troubled debt restructuring reverts to market terms, a minimum of six consecutive contractual payments must be received prior to consideration for a return to accrual status. If an updated credit department review indicates no other evidence of elevated credit risk, the loan is returned to accrual status at that time.

The following presents troubled debt restructurings by concession type:

		As of June 30, 2013
	Performing in accordance with modified terms					In Default				Total
	Amount			Number		Amount		Number		Amount		Number
	(dollars in thousands)
Interest reduction and principal forbearance		$	20,373		47	$	3,522		18	$	23,895		65
Principal forbearance			16,126		9		1,229		2		17,355		11
Interest reduction			3,423		11		2,427		24		5,850		35
		$	39,922		67	$	7,178		44	$	47,100		111

		As of December 31, 2012
	Performing in accordance with modified terms					In Default				Total
	Amount			Number		Amount		Number		Amount		Number
	(dollars in thousands)
Interest reduction and principal forbearance		$	26,051		77	$	2,770		11	$	28,821		88
Principal forbearance			17,574		11		348		1		17,922		12
Interest reduction			11,984		35		894		2		12,878		37
		$	55,609		123	$	4,012		14	$	59,621		137

- 20 -

The following presents data on troubled debt restructurings as of June 30, 2013:

	For the Three Months Ended June 30, 2013				For the Three Months Ended June 30, 2012
	Amount		Number		Amount		Number
	(dollars in thousands)
Loans modified as a troubled debt restructure
One- to four-family	$	474		2	$	3,533		4
Over four-family		-		-		1,004		2
Home equity		39		1		105		1
	$	513		3	$	4,642		7
Troubled debt restructuring modified within the past twelve months for which there was a default
One- to four-family	$	-		-	$	135		0
	$	-		-	$	135		0

	For the Six Months Ended June 30, 2013				For the Six Months Ended June 30, 2012
	Amount		Number		Amount		Number
	(dollars in thousands)
Loans modified as a troubled debt restructure
One- to four-family	$	817		5	$	6,500		11
Over four-family		-		-		1,004		2
Home equity		39		1		117		2
	$	856		6	$	7,621		15
Troubled debt restructuring modified within the past twelve months for which there was a default
One- to four-family	$	-		-	$	655		2
	$	-		-	$	655		2

The following table presents data on non-accrual loans as of June 30, 2013 and December 31, 2012:

	June 30, 2013			December 31, 2012
	(Dollars in Thousands)
Non-accrual loans:
Residential
One- to four-family	$	36,664			46,467
Over four-family		9,259			23,205
Home equity		1,328			1,578
Construction and land		5,199			2,215
Commercial real estate		272			668
Consumer		20			24
Commercial		511			511
Total non-accrual loans	$	53,253			74,668
Total non-accrual loans to total loans receivable		4.81	%		6.59	%
Total non-accrual loans and performing troubled debt restructurings to total loans receivable		7.18	%		8.00	%
Total non-accrual loans to total assets		3.26	%		4.50	%

- 21 -

Note 4— Real Estate Owned

Real estate owned is summarized as follows:

	June 30, 2013		December 31, 2012
	(In Thousands)
One- to four-family	$	15,458		17,353
Over four-family		7,514		9,890
Construction and land		5,200		7,029
Commercial real estate		1,811		1,702
	$	29,983		35,974

The following table presents the activity in the Company's real estate owned:

	Six months ended June 30,
	2013			2012
	(In Thousands)
Real estate owned at beginning of the period	$	35,974			56,670
Transferred from loans receivable		8,404			11,002
Sales (net of gains / losses)		(13,475	)		(16,247	)
Write downs		(950	)		(3,439	)
Other		30			(171	)
Real estate owned at the end of the period	$	29,983			47,815

- 22 -

Note 5— Mortgage Servicing Rights

The following table presents the activity in the Company's mortgage servicing rights:

	Six months ended June 30,
	2013			2012
	(In Thousands)
Mortgage servicing rights at beginning of the period	$	3,220			198
Additions		2,111			982
Amortization		(569	)		(77	)
Mortgage servicing rights at end of the period		4,762			1,103
Valuation allowance at end of period		—			—
Mortgage servicing rights at the end of the period, net	$	4,762			1,103

The following table shows the estimated future amortization expense for mortgage servicing rights for the periods indicated:

		(In Thousands)
Estimate for the period ended December 31:	2013	$	571
2014			981
2015			1,030
2016			891
2017			752
Thereafter			537
Total		$	4,762

- 23 -

Note 6— Deposits

A summary of the contractual maturities of time deposits at June 30, 2013 is as follows:

	(In Thousands)
Within one year	$	463,336
More than one to two years		168,350
More than two to three years		12,553
More than three to four years		15,653
More than four through five years		21,986
After five years		13
	$	681,891

- 24 -

Note 7— Borrowings

Borrowings consist of the following:

		June 30, 2013					December 31, 2012
		Balance		Weighted Average Rate			Balance		Weighted Average Rate
		(Dollars in Thousands)
Short term:
Short-term repurchase agreements		$	56,046		3.43	%		45,888		3.09	%
Long term:
Federal Home Loan Bank, Chicago advances maturing:
2016			220,000		4.34	%		220,000		4.34	%
2017			65,000		3.19	%		65,000		3.19	%
2018			65,000		2.97	%		65,000		2.97	%
Repurchase agreements maturing	2017		84,000		3.96	%		84,000		3.96	%
		$	490,046		3.84	%		479,888		3.82	%

The short-term repurchase agreements represent the outstanding portion of a total $90.0 million commitment with two unrelated banks. The short-term repurchase agreements are utilized by Waterstone Mortgage Corporation to finance loans originated for sale. These agreements are secured by the underlying loans being financed. Related interest rates are based upon the note rate associated with the loans being financed. The first of the two short-term repurchase agreements has an outstanding balance of $31.9 million, a rate of 3.19% and a total commitment of $40.0 million at June 30, 2013. The second short-term repurchase agreement has an outstanding balance of $24.1 million, a rate of 3.75% and a total commitment of $50.0 million at June 30, 2013.

The $220.0 million in advances due in 2016 consist of eight advances with fixed rates ranging from 4.01% to 4.82% callable quarterly until maturity.

The $65.0 million in advances due in 2017 consist of three advances with fixed rates ranging from 3.09% to 3.46% callable quarterly until maturity.

The $65.0 million in advances due in 2018 consist of three advances with fixed rates ranging from 2.73% to 3.11% callable quarterly until maturity.

The $84.0 million in repurchase agreements have fixed rates ranging from 2.89% to 4.31% callable quarterly until their maturity in 2017. The repurchase agreements are collateralized by securities available for sale with an estimated fair value of $100.2 million at June 30, 2013 and $101.9 million at December 31, 2012.

The Company selects loans that meet underwriting criteria established by the Federal Home Loan Bank Chicago (FHLBC) as collateral for outstanding advances. The Company's borrowings at the FHLBC are limited to 75% of the carrying value of unencumbered one- to four-family mortgage loans, 40% of the carrying value of home equity loans and 60% of the carrying value of over four-family loans. In addition, these advances are collateralized by FHLBC stock of $20.2 million at both June 30, 2013 and December 31, 2012. In the event of prepayment, the Company is obligated to pay all remaining contractual interest on the advance.

- 25 -

Note 8 – Regulatory Capital

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements, or overall financial performance deemed by the regulators to be inadequate, can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items, as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). As of June 30, 2013, the Bank meets all capital adequacy requirements to which it is subject.

Effective December 11, 2012, the WDFI and the Federal Deposit Insurance Corporation terminated a consent order originally agreed to by WaterStone Bank on November 25, 2009 and replaced it with a memorandum of understanding.  The memorandum of understanding requires, among other things, maintenance of a minimum Tier I capital ratio of 8.0 % and a minimum Total risk based cpaital ratio of 12.0 %.

As of June 30, 2013 the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as quantitatively "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized," the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios, as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank's category.

As a state-chartered savings bank, the Bank is required to meet minimum capital levels established by the state of Wisconsin in addition to federal requirements. For the state of Wisconsin, regulatory capital consists of retained income, paid-in-capital, capital stock equity and other forms of capital considered to be qualifying capital by the Federal Deposit Insurance Corporation.

- 26 -

The actual and required capital amounts and ratios for the Bank as of June 30, 2013 and December 31, 2012 are presented in the table below:

	June 30, 2013
	Actual						For Capital Adequacy Purposes					To Be Well-Capitalized Under Prompt Corrective Action Provisions
	Amount			Ratio			Amount		Ratio			Amount			Ratio
	(Dollars In Thousands)
Total capital (to risk-weighted assets)		$	211,222		18.87	%		89,555		8.00	%		111,943			10.00	%
Tier I capital (to risk-weighted assets)			197,060		17.60	%		44,777		4.00	%		67,166			6.00	%
Tier I capital (to average assets)			197,060		12.17	%		64,771		4.00	%		80,964			5.00	%
State of Wisconsin (to total assets)			197,060		12.10	%		97,710		6.00	%		N/	A		N/	A
	December 31, 2012
	(Dollars In Thousands)
Total capital (to risk-weighted assets)		$	199,098		17.34	%		91,844		8.00	%		114,806			10.00	%
Tier I capital (to risk-weighted assets)			184,542		16.07	%		45,922		4.00	%		68,883			6.00	%
Tier I capital (to average assets)			184,542		11.13	%		66,312		4.00	%		82,890			5.00	%
State of Wisconsin (to total assets)			184,542		11.15	%		99,305		6.00	%		N/	A		N/	A

Note 9 – Income Taxes

Income tax expense increased from $71,000 during the six months ended June 30, 2012 to $6.0 million for the six months ended June 30, 2013. This increase was partially due to the increase in our income before income taxes, which increased from $8.5 million during the six months ended June 30, 2012 to $15.5 million during the six months ended June 30, 2013. During the third quarter of 2008, we established a valuation allowance against our net deferred tax assets. That valuation allowance effectively resulted in no income tax expense being recognized during the six months ended June 30, 2012 other than state income taxes for states in which separate company returns are filed. During the fourth quarter of 2012, we released the valuation allowance against our net deferred tax assets. Income tax expense is recognized on the statement of income during the six months ended June 30, 2013 at an effective rate of 38.5% of pretax book income.

As of June 30, 2013, net deferred tax assets totaled $15.3 million, which, in the judgment of management, will more-likely-than-not be fully realized. The largest components of the deferred tax asset are associated with the allowance for loan losses and basis adjustments on real estate owned. We are largely relying on earnings generated in the current year and forecasted earnings in future years in making the determination that we will more-likely-than-not realize our deferred tax asset.

- 27 -

Note 10 – Offsetting of Assets and Liabilities

The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. In addition, the Company enters into agreements under which it sells loans held for sale subject to an obligation to repurchase the same loans. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as a sale and subsequent repurchase of assets. The obligation to repurchase the assets is reflected as a liability in the Company's consolidated statements of condition, while the securities and loans held for sale underlying the repurchase agreements remain in the respective investment securities and loans held for sale asset accounts. In other words, there is no offsetting or netting of the investment securities or loans held for sale assets with the repurchase agreement liabilities. One of the Company's two short-term repurchase agreements and all of the Company's long-term repurchase agreements are subject to master netting agreements, which sets for the rights and obligations for repurchase and offset. Under the master netting agreement, the Company is entitled to set off the collateral placed with a single counterparty against obligations owed to that counterparty.

The following table presents the liabilities subject to an enforceable master netting agreement as of June 30, 2013 and December 31, 2012.

	Gross Recognized Liabilities		Gross Amounts Offset		Net Amounts Presented		Gross Amounts Not Offset		Net Amount
	(In Thousands)
June 30, 2013
Repurchase Agreements
Short-term	$	31,943		—		31,943		31,943		—
Long-term		84,000		—		84,000		84,000		—
	$	115,943		—		115,943		115,943		—
December 31, 2012
Repurchase Agreements
Short-term	$	38,090		—		38,090		38,090		—
Long-term		84,000		—		84,000		84,000		—
	$	122,090		—		122,090		122,090		—

- 28 -

Note 11– Financial Instruments with Off-Balance Sheet Risk

The Company 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 include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

	June 30, 2013		December 31, 2012
	(In Thousands)
Financial instruments whose contract amounts represent potential credit risk:
Commitments to extend credit under amortizing loans (1)	$	$22,466		20,836
Commitments to extend credit under home equity lines of credit		16,405		17,628
Unused portion of construction loans		4,879		5,502
Unused portion of business lines of credit		10,308		10,967
Standby letters of credit		1,119		736

____________

⁽¹⁾ Excludes commitments to originate loans held for sale, which are discussed in the following footnote.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements of the Company. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral obtained generally consists of mortgages on the underlying real estate.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds mortgages on the underlying real estate as collateral supporting those commitments for which collateral is deemed necessary.

The Company has determined that there are no probable losses related to commitments to extend credit or the standby letters of credit as of June 30, 2013 and December 31, 2012.

Residential mortgage loans sold to others are predominantly conventional residential first lien mortgages. The Company's agreements to sell residential mortgage loans in the normal course of business usually require certain representations and warranties on the underlying loans sold related to credit information, loan documentation and collateral, which if subsequently are untrue or breached, could require the Company to repurchase certain loans affected. The Company has only been required to make insignificant repurchases as a result of its representations and warranties. The Company's agreements to sell residential mortgage loans also contain limited recourse provisions. The recourse provisions are limited in that the recourse provision ends after certain payment criteria have been met. With respect to these loans, repurchase could be required if defined delinquency issues arose during the limited recourse period. Given that the underlying loans delivered to buyers are predominantly conventional first lien mortgages and that historical experience shows negligible losses and insignificant repurchase activity, management believes that losses and repurchases under the limited recourse provisions will continue to be insignificant.

- 29 -

Note 12 – Derivative Financial Instruments

In connection with its mortgage banking activities, the Company enters into derivative financial instruments as part of its strategy to manage its exposure to changes in interest rates. Mortgage banking derivatives include interest rate lock commitments provided to customers to fund mortgage loans to be sold in the secondary market and forward commitments for the future delivery of such loans to third party investors. It is the Company's practice to enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on its commitments to fund the loans as well as on its portfolio of mortgage loans held for sale. The Company's mortgage banking derivatives have not been designated as being in hedge relationships. These instruments are used to manage the Company's exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements of ASC 815. Changes in the fair value of derivatives not designated in hedging relationships are recorded as a component of mortgage banking income in the Company's consolidated statements of operations. The Company does not use derivatives for speculative purposes.

Forward commitments to sell mortgage loans represent commitments obtained by the Company from a secondary market agency to purchase mortgages from the Company at specified interest rates and within specified periods of time. Commitments to sell loans are made to mitigate interest rate risk on interest rate lock commitments to originate loans and loans held for sale. At June 30, 2013, the Company had forward commitments to sell mortgage loans with an aggregate notional amount of approximately $322.9 million and interest rate lock commitments with an aggregate notional amount of approximately $186.6 million. The fair value of the mortgage derivatives at June 30, 2013 included a gain of $7.5 million that is reported as a component of other assets on the Company's consolidated statements of financial condition.

In determining the fair value of its derivative loan commitments, the Company considers the value that would be generated by the loan arising from exercise of the loan commitment when sold in the secondary mortgage market. That value includes the price that the loan is expected to be sold for in the secondary mortgage market. The fair value of these commitments is recorded on the consolidated statements of financial condition with the changes in fair value recorded as a component of mortgage banking income.

- 30 -

Note 13 – Earnings per share

Earnings per share are computed using the two-class method. Basic earnings per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities have the right to receive dividends at the same rate as holders of the Company's common stock. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding adjusted for the dilutive effect of all potential common shares. Unvested restricted stock and stock options are considered outstanding for diluted earnings per share only. Unvested restricted stock totaling 81,000 and 105,000 shares are considered outstanding for dilutive earnings per share for the six months ended June 30, 2013 and June 30, 2012, respectively. Unvested stock options totaled 220,000 and 289,000 shares for the six months ended June 30, 2013 and June 30, 2012, respectively.

Presented below are the calculations for basic and diluted earnings per share:

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
	(In Thousands, except per share amounts)
Net income	$	4,927		6,178		9,552		8,386
Net income available to unvested restricted shares		12		21		25		28
Net income available to common stockholders	$	4,915		6,157		9,527		8,358
Weighted average shares outstanding	$	31,144		31,045		31,134		31,035
Effect of dilutive potential common shares		224		91		217		34
Diluted weighted average shares outstanding	$	31,368		31,136		31,351		31,069
Basic earnings per share	$	0.16		0.20		0.31		0.27
Diluted earnings per share	$	0.16		0.20		0.30		0.27

Note 14 – Fair Value Measurements

The FASB issued an accounting standard (subsequently codified into ASC Topic 820, "Fair Value Measurements and Disclosures") which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This accounting standard applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements. The standard also emphasizes that fair value (i.e., the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. When considering the assumptions that market participants would use in pricing the asset or liability, this accounting standard establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity's own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

The fair value hierarchy prioritizes inputs used to measure fair value into three broad levels.

Level 1 inputs - In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that we have the ability to access.

Level 2 inputs - Fair values determined by Level 2 inputs use inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets where there are few transactions and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs - Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability.

In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

- 31 -

The following table presents information about our assets recorded in our consolidated statement of financial position at their fair value on a recurring basis as of June 30, 2013 and December 31, 2012, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

			Fair Value Measurements Using
	June 30, 2013		Level 1		Level 2		Level 3
	(In Thousands)
Available for sale securities
Mortgage-backed securities	$	108,218		—		108,218		—
Collateralized mortgage obligations
Government sponsored enterprise issued		22,794		—		22,794		—
Government sponsored enterprise bonds		14,345		—		14,345		—
Municipal securities		59,568		—		59,568		—
Other debt securities		5,168		5,168		—		—
Certificates of deposit		6,160		—		6,160		—
Loans held for sale		132,045		—		132,045		—
Mortgage banking derivative assets		7,455		—		—		7,455

			Fair Value Measurements Using
	December 31, 2012		Level 1		Level 2		Level 3
	(In Thousands)
Available for sale securities
Mortgage-backed securities	$	119,056		—		119,056		—
Collateralized mortgage obligations
Government sponsored enterprise issued		29,579		—		29,579		—
Government sponsored enterprise bonds		8,017		—		8,017		—
Municipal securities		37,371		—		37,371		—
Other debt securities		5,070		5,070		—		—
Certificates of deposit		5,924		—		5,924		—
Loans held for sale		133,613		—		133,613		—
Mortgage banking derivative assets		1,668		—		—		1,668
Mortgage banking derivative liabilities		249		—		—		249

The following summarizes the valuation techniques for assets recorded in our consolidated statements of financial condition at their fair value on a recurring basis:

Available for sale securities – The Company's investment securities classified as available for sale include: mortgage-backed securities, collateralized mortgage obligations, government sponsored enterprise bonds, municipal securities and other debt securities. The fair value of mortgage-backed securities, collateralized mortgage obligations and government sponsored enterprise bonds are determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricing model. Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmark securities, prepayment models and bid/offer market data. For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuer spread. These model and matrix measurements are classified as Level 2 and Level 3 in the fair value hierarchy. The fair value of municipal securities is determined by a third party valuation source using observable market data utilizing a multi-dimensional relational pricing model. Standard inputs to this model include observable market data such as benchmark yields, reported trades, broker quotes, rating updates and issuer spreads. These model measurements are classified as Level 2 in the fair value hierarchy. The fair value of other debt securities, which includes a trust preferred security issued by a financial institution, is determined through quoted prices in active markets and is classified as Level 1 in the fair value hierarchy.

- 32 -

Loans held for sale – The Company carries loans held for sale at fair value under the fair value option model. Fair value is generally determined by estimating a gross premium or discount, which is derived from pricing currently observable in the secondary market, principally from observable prices for forward sale commitments. Loans held-for-sale are considered to be Level 2 in the fair value hierarchy of valuation techniques.

Mortgage banking derivatives - Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors. The Company relies on a valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the current interest rate environment and then multiplying by quoted investor prices. The Company also relies on a valuation model to estimate the fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available. While there are Level 2 and 3 inputs used in the valuation models, the Company has determined that one or more of the inputs significant in the valuation of both of the mortgage banking derivatives fall within Level 3 of the fair value hierarchy.

The table below presents reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during 2013 and 2012.

	Available for sale securities			Mortgage banking derivatives, net
	(In Thousands)
Balance at December 31, 2011	$	18,451			527
Unrealized holding losses arising during the period:
Included in other comprehensive income		1,023			-
Other than temporary impairment included in net loss		(113	)		-
Principal repayments		(1,352	)		-
Sales of available for sale securities		(18,009	)
Mortgage derivative gain, net		-			892
Balance at December 31, 2012		-			1,419
Mortgage derivative gain, net		-			6,036
Balance at June 30, 2013	$	-			7,455

There were no transfers in or out of Level 1, 2 or 3 measurements during the periods.

- 33 -

Assets Recorded at Fair Value on a Non-recurring Basis

The following table presents information about our assets recorded in our consolidated statement of financial position at their fair value on a non-recurring basis as of June 30, 2013 and December 31, 2012, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

			Fair Value Measurements Using
	June 30, 2013		Level 1		Level 2		Level 3
	(In Thousands)
Impaired loans, net (1)	$	$40,339		-		-		40,339
Real estate owned		29,983		-		-		29,983

			Fair Value Measurements Using
	December 31, 2012		Level 1		Level 2		Level 3
	(In Thousands)
Impaired loans, net (1)	$	$40,071		-		-		40,071
Real estate owned		35,974		-		-		35,974

_________

(1) Represents collateral-dependent impaired loans, net, which are included in loans.

Loans – We do not record loans at fair value on a recurring basis. On a non-recurring basis, loans determined to be impaired are analyzed to determine whether a collateral shortfall exists, and if such a shortfall exists, are recorded on our consolidated statements of financial condition at net realizable value of the underlying collateral. Fair value is determined based on third party appraisals. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal. Given the significance of the adjustments made to appraised values necessary to estimate the fair value of impaired loans, loans that have been deemed to be impaired are considered to be Level 3 in the fair value hierarchy of valuation techniques. At June 30, 2013, loans determined to be impaired with an outstanding balance of $46.8 million were carried net of specific reserves of $6.5 million for a fair value of $40.3 million. At December 31, 2012, loans determined to be impaired with an outstanding balance of $52.5 million were carried net of specific reserves of $12.4 million for a fair value of $40.1 million. Impaired loans collateralized by assets which are valued in excess of the net investment in the loan do not require any specific reserves.

Real estate owned – On a non-recurring basis, real estate owned, is recorded in our consolidated statements of financial condition at the lower of cost or fair value. Fair value is determined based on third party appraisals and, if less than the carrying value of the foreclosed loan, the carrying value of the real estate owned is adjusted to the fair value. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal. Given the significance of the adjustments made to appraised values necessary to estimate the fair value of the properties, real estate owned is considered to be Level 3 in the fair value hierarchy of valuation techniques. Changes in the value of real estate owned totaled $950,000 and $3.4 million during the six months ended June 30, 2013 and 2012, respectively and are recorded in real estate owned expense. At June 30, 2013 and December 31, 2012, real estate owned totaled $30.0 million and $36.0 million, respectively.

Mortgage servicing rights - The Company utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of mortgage servicing rights.  The model utilizes prepayment assumptions to project cash flows related to the mortgage servicing rights based upon the current interest rate environment, which is then discounted to estimate an expected fair value of the mortgage servicing rights.   The model considers characteristics specific to the underlying mortgage portfolio, such as: contractually specified servicing fees, prepayment assumptions, delinquency rates, late charges and costs to service.  Given the significance of the unobservable inputs utilized in the estimation process, mortgage servicing rights are classified as Level 3 within the fair value hierarchy.  The Company records the mortgage servicing rights at the lower of amortized cost or fair value.  At June 30, 2013 and December 31, 2012, there was no impairment identified for mortgage servicing rights, therefore mortgage servicing rights were not recorded at fair value on a non-recurring basis.

- 34 -

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of June 30, 2013, the significant unobservable inputs used in the fair value measurements were as follows:

					Significant Unobservable Input Value
	Fair Value at June 30, 2013		Valuation Technique	Significant Unobservable Inputs	Minimum Value			Maximum Value
Mortgage banking derivatives	$	7,455	Pricing models	Pull through rate		68.30	%		100.00	%
Impaired loans		40,339	Market approach	Discount rates applied to appraisals		15.00	%		30.00	%
Real estate owned		29,983	Market approach	Discount rates applied to appraisals		4.00	%		89.40	%
Mortgage servicing rights		9,248	Pricing models	Prepayment rate		8.48	%		18.56	%
				Note rate		3.00	%		3.97	%

___________

The significant unobservable inputs used in the fair value measurement of the Company's mortgage banking derivatives, including interest rate lock commitments is the loan pull through rate. This represents the percentage of loans currently in a lock position which the Company estimates will ultimately close. Generally, the fair value of an interest rate lock commitment will be positively (negatively) impacted when the prevailing interest rate is lower (higher) than the interest rate lock commitment. Generally, an increase in the pull through rate will result in the fair value of the interest rate lock increasing when in a gain position, or decreasing when in a loss position. The pull through rate is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. The pull through rate is computed using historical data and the ratio is periodically reviewed by the Company.

The significant unobservable inputs used in the fair value measurement of collateral for collateral-dependent impaired loans and real estate owned included in the above table primarily relate to discounting criteria applied to independent appraisals received with respect to the collateral. Discounts applied to the appraisals are dependent on the vintage of the appraisal as well as the marketability of the property. The discount factor is computed using actual realization rates on properties that have been foreclosed upon and liquidated in the open market.

The significant unobservable inputs used in the fair value measurement or mortgage servicing rights include the prepayment rate and note rate.  The prepayment rate represents the assumed rate of prepayment of the outstanding principal balance of the underlying mortgage notes.  Generally, the fair value of mortgage servicing rights will be positively (negatively) impacted when the prepayment rate (decreases) increases.  The note rate represents the contractual rate on the underlying mortgages.

Fair value information about financial instruments follows, whether or not recognized in the consolidated statements of financial condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

- 35 -

The carrying amounts and fair values of the Company's financial instruments consist of the following:

	June 30, 2013										December 31, 2012
	Carrying amount		Fair Value								Carrying amount		Fair Value
			Total		Level 1		Level 2		Level 3				Total		Level 1		Level 2		Level 3
	(In Thousands)
Financial Assets
Cash and cash equivalents	$	54,368		54,368		54,368		-		-		71,649		71,469		71,469		-		-
Securities available-for-sale		216,253		216,253		5,168		211,085		-		205,017		205,017		5,070		199,947		-
Loans held for sale		132,045		132,045		-		132,045		-		133,613		133,613		-		133,613		-
Loans receivable		1,106,915		1,112,490		-		-		1,112,490		1,133,672		1,148,107		-		-		1,148,107
FHLB stock		20,193		20,193		-		20,193		-		20,193		20,193		-		20,193		-
Cash surrender value of life insurance		38,642		38,642		38,642		-		-		38,061		38,061		38,061		-		-
Real estate owned		29,983		29,983		-		-		29,983		35,974		35,974		-		-		35,974
Accrued interest receivable		3,846		3,846		3,846		-		-		3,452		3,452		3,452		-		-
Mortgage servicing rights		4,762		9,248		-		-		9,248		3,220		4,070		-		-		4,070
Mortgage banking derivative assets		7,455		7,455		-		-		7,455		1,668		1,668		-		-		1,668
Financial Liabilities
Deposits		893,007		895,158		211,116		684,042		-		939,513		942,118		202,593		739,525		-
Advance payments by borrowers for taxes		15,556		15,556		15,556		-		-		1,672		1,672		1,672		-		-
Borrowings		490,046		530,885		-		530,885		-		479,888		537,299		-		537,299		-
Accrued interest payable		1,581		1,581		1,581		-		-		1,715		1,715		1,715		-		-
Mortgage banking derivative liabilities		-		-		-		-		-		249		249		-		-		249
Other Financial Instruments
Stand-by letters of credit		7		7		-		-		7		5		5		-		-		5

- 36 -

The following methods and assumptions were used by the Company in determining its fair value disclosures for financial instruments.

Cash and Cash Equivalents

The carrying amount reported in the consolidated statements of financial condition for cash and cash equivalents is a reasonable estimate of fair value.

 Securities

The fair value of securities is determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricing model. Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmark securities and bid/offer market data. For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuer spread. Prepayment models are used for mortgage related securities with prepayment features.

Loans Held for Sale

Fair value is estimated using the prices of the Company's existing commitments to sell such loans and/or the quoted market price for commitments to sell similar loans.

Loans Receivable

Loans determined to be impaired are analyzed to determine whether a collateral shortfall exists, and if such a shortfall exists, are recorded on our consolidated statements of financial condition at fair value. Fair value is determined based on third party appraisals. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal. With respect to loans that are not considered to be impaired, fair value is estimated by discounting the future contractual cash flows using discount rates that reflect a current rate offered to borrowers of similar credit standing for the remaining term to maturity. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC 820-10 and generally produces a higher fair value.

FHLBC Stock

For FHLBC stock, the carrying amount is the amount at which shares can be redeemed with the FHLBC and is a reasonable estimate of fair value.

Cash Surrender Value of Life Insurance

The carrying amounts reported in the consolidated statements of financial condition for the cash surrender value of life insurance approximate those assets' fair values.

Deposits and Advance Payments by Borrowers for Taxes

The fair values for interest-bearing and noninterest-bearing negotiable order of withdrawal accounts, savings accounts, and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar remaining maturities to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit. The advance payments by borrowers for taxes are equal to their carrying amounts at the reporting date.

Borrowings

Fair values for borrowings are estimated using a discounted cash flow calculation that applies current interest rates to estimated future cash flows of the borrowings.

- 37 -

Accrued Interest Payable and Accrued Interest Receivable

For accrued interest payable and accrued interest receivable, the carrying amount is a reasonable estimate of fair value.

Commitments to Extend Credit and Standby Letters of Credit

Commitments to extend credit and standby letters of credit are generally not marketable. Furthermore, interest rates on any amounts drawn under such commitments would be generally established at market rates at the time of the draw. Fair values for the Company's commitments to extend credit and standby letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparty's credit standing, and discounted cash flow analyses. The fair value of the Company's commitments to extend credit is not material at June 30, 2013 and December 31, 2012.

Mortgage Banking Derivative Assets and Liabilities

Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors. The Company relies on a valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the current interest rate environment, and then multiplying by quoted investor prices. The Company also relies on a valuation model to estimate the fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available. On the Company's Consolidated Statements of Condition, instruments that have a positive fair value are included in prepaid expenses and other assets, and those instruments that have a negative fair value are included in other liabilities.

Note 15 – Segment Reporting

Selected financial and descriptive information is required to be provided about reportable operating segments, considering a "management approach" concept as the basis for identifying reportable segments. The management approach is based on the way that management organizes the segments within the enterprise for making operating decisions, allocating resources, and assessing performance. Consequently, the segments are evident from the structure of the enterprise's internal organization, focusing on financial information that an enterprise's chief operating decision-makers use to make decisions about the enterprise's operating matters. The Company has determined that it has two reportable segments: community banking and mortgage banking. The Company's operating segments are presented based on its management structure and management accounting practices. The structure and practices are specific to the Company and therefore, the financial results of the Company's business segments are not necessarily comparable with similar information for other financial institutions.

Community Banking

The Community Banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin. Consumer products include loan and deposit products: mortgage, home equity loans and lines, personal term loans, demand deposit accounts, interest bearing transaction accounts and time deposits. Business banking products include secured and unsecured lines and term loans for working capital, inventory and general corporate use, commercial real estate construction loans, demand deposit accounts, interest bearing transaction accounts and time deposits.

- 38 -

Mortgage Banking

The Mortgage Banking segment provides residential mortgage loans for the purpose of sale on the secondary market. Mortgage banking products and services are provided by offices in: Wisconsin, Arizona, Florida, Idaho, Illinois, Indiana, Iowa, Maryland, Minnesota, Ohio and Pennsylvania.

	Three months ended June 30, 2013
	Community Banking		Mortgage Banking		Holding Company and Other			Consolidated
	(In Thousands)
Net interest income	$	9,724		73		124			9,921
Provision for loan losses		1,200		-		-			1,200
Net interest income after provision for loan losses		8,524		73		124			8,721
Noninterest income		811		25,974		(78	)		26,707
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		3,577		16,434		(67	)		19,944
Occupancy, office furniture and equipment		765		1,163		(66	)		1,862
FDIC insurance premiums		380		-		-			380
Real estate owned		12		-		-			12
Other		1,107		4,057		85			5,249
Total noninterest expenses		5,841		21,654		(48	)		27,447
Income before income taxes		3,494		4,393		94			7,981
Income tax expense		1,245		1,759		50			3,054
Net income	$	2,249		2,634		44			4,927
Total Assets	$	1,545,771		156,019		(68,914	)		1,632,876

- 39 -

	Three months ended June 30, 2012
	Community Banking			Mortgage Banking			Holding Company and Other			Consolidated
	(In Thousands)
Net interest income	$	10,335			168			125			10,628
Provision for loan losses		1,500			(75	)		-			1,425
Net interest income after provision for loan losses		8,835			243			125			9,203
Noninterest income		670			22,582			-			23,252
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		3,086			12,052			(173	)		14,965
Occupancy, office furniture and equipment		758			930			-			1,688
FDIC insurance premiums		873			-			-			873
Real estate owned		2,838			-			-			2,838
Other		1,322			4,462			88			5,872
Total noninterest expenses		8,877			17,444			(85	)		26,236
Income before income taxes (benefit)		628			5,381			210			6,219
Income tax expense (benefit)		(2,313	)		2,159			195			41
Net income	$	2,941			3,222			15			6,178
Total Assets	$	1,611,757			137,374			(67,950	)		1,681,181

	Six months ended June 30, 2013
	Community Banking		Mortgage Banking		Holding Company and Other			Consolidated
	(In Thousands)
Net interest income	$	19,660		159		248			20,067
Provision for loan losses		2,900		60		-			2,960
Net interest income after provision for loan losses		16,760		99		248			17,107
Noninterest income		1,450		48,380		(90	)		49,740
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		6,868		29,704		(146	)		36,426
Occupancy, office furniture and equipment		1,598,000		2,246		(66	)		3,778
FDIC insurance premiums		1,053		-		-			1,053
Real estate owned		153		-		-			153
Other		2,066		7,714		128			9,908
Total noninterest expenses		11,738		39,664		(84	)		51,318
Income before income taxes		6,472		8,815		242			15,529
Income tax expense		2,361		3,541		75			5,977
Net income	$	4,111		5,274		167			9,552

- 40 -

	Six months ended June 30, 2012
	Community Banking			Mortgage Banking		Holding Company and Other			Consolidated
	(In Thousands)
Net interest income	$	20,582			223		250			21,055
Provision for loan losses		5,100			-		-			5,100
Net interest income after provision for loan losses		15,482			223		250			15,955
Noninterest income		1,444			36,809		-			38,253
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		6,213			19,779		(390	)		25,602
Occupancy, office furniture and equipment		1,548			1,861		-			3,409
FDIC insurance premiums		1,814			-		-			1,814
Real estate owned		4,273			-		-			4,273
Other		2,540			7,959		154			10,653
Total noninterest expenses		16,388			29,599		(236	)		45,751
Income before income taxes (benefit)		538			7,433		486			8,457
Income tax expense (benefit)		(3,107	)		2,983		195			71
Net income	$	3,645			4,450		291			8,386

Note 16 – Other Matters

On June 6, 2013, the Boards of Directors of Lamplighter Financial, MHC (the "Mutual Holding Company"), Waterstone Financial, Inc. (the "Company"), and WaterStone Bank SSB (the "Bank") each unanimously adopted the Plan of Conversion and Reorganization of the Mutual Holding Company (the "Plan") pursuant to which the Mutual Holding Company will undertake a "second-step" conversion and cease to exist.

The Company will merge into a new Maryland corporation named Waterstone Financial, Inc. As part of the conversion, the MHC's ownership interest of the Company will be offered for sale in a public offering. The existing publicly held shares of the Company, which represents the remaining ownership interest in the Company, will be exchanged for new shares of common stock of Waterstone Financial, Inc., the new Maryland corporation. The exchange ratio will ensure that immediately after the conversion and public offering, the public shareholders of the Company will own the same aggregate percentage of Waterstone Financial, Inc. common stock that they owned immediately prior to that time (excluding shares purchased in the stock offering and cash received in lieu of fractional shares). When the conversion and public offering are completed, all of the capital stock of WaterStone Bank will be owned by Waterstone Financial, Inc., the Maryland corporation.

The Plan provides for the establishment, upon the completion of the conversion, of special "liquidation accounts" for the benefit of certain depositors of WaterStone Bank in an amount equal to the greater of the MHC's ownership interest in the retained earnings of the Company as of the date of the latest balance sheet contained in the prospectus or the retained earnings of WaterStone Bank at the time it reorganized into the MHC. Following the completion of the conversion, under the rules of the Board of Governors of the Federal Reserve System, WaterStone Bank will not be permitted to pay dividends on its capital stock to Waterstone Financial, Inc., its sole shareholder, if WaterStone Bank's shareholder's equity would be reduced below the amount of the liquidation accounts. The liquidation accounts will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder's interest in the liquidation accounts.

Direct costs of the conversion and public offering will be deferred and reduce the proceeds from the shares sold in the public offering. Costs of $487,000 have been incurred related to the conversion as of June 30, 2013.

- 41 -

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations Cautionary Statements Regarding Forward-Looking Information

This report contains various forward-looking statements concerning the Company's financial condition, business plans, growth, operating strategies and prospects that are based on the current expectations and beliefs of management.  Forward-looking statements may also be made by the Company from time to time in other reports and documents as well as in oral presentations.  When used in written documents or oral statements, the words "anticipate," "believe," "estimate," "expect," "objective" and similar expressions and verbs in the future tense, are intended to identify forward-looking statements.  The statements contained herein and such future statements involve or may involve certain assumptions, risks and uncertainties, many of which are beyond the Company's control, that could cause the Company's actual results and performance to differ materially from what is expected.  In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Company:

• our ability to maintain higher regulatory capital levels as imposed by federal and state regulators;

• adverse changes in the real estate markets;

• adverse changes in the securities markets;

• general economic conditions, either nationally or in its market areas, that are worse than expected;

• inflation and changes in the interest rate environment that reduce its margins or reduce the fair value of financial instruments;

• changes in interest rates that reduce loan origination volumes and, ultimately, income from its mortgage banking operations;

• modification/cessation of governmental programs offered to current and prospective homeowners that reduce loan origination volumes and, ultimately, income from our mortgage banking operations;

• changes in the level of government support for housing finance;

• legislative or regulatory changes that adversely affect its business;

• our ability to enter new markets successfully and take advantage of growth opportunities;

• significantly increased competition among depository and other financial institutions;

• changes in accounting policies and practices, as may be adopted by the bank regulatory agencies and the Financial Accounting Standards Board; and

• changes in consumer spending, borrowing and savings habits.

See also the factors referred to in reports filed by the Company with the Securities and Exchange Commission (particularly those under the caption "Risk Factors" in Item 1A of the Company's 2012 Annual Report on Form 10-K).

Overview

The following discussion and analysis is presented to assist the reader in the understanding and evaluation of the Company's financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Form 10-Q and should be read in conjunction therewith. The detailed discussion focuses on the results of operations for the three and six months ended June 30, 2013 and 2012 and the financial condition as of June 30, 2013 compared to the financial condition as of December 31, 2012.

- 42 -

Our profitability is highly dependent on our net interest income, mortgage banking income and provision for loan losses.  Net interest income is the difference between the interest income we earn on our interest earning assets which are loans receivable, investment securities and cash and cash equivalents, and the interest we pay on deposits and other borrowings.  The Company's banking subsidiary, WaterStone Bank SSB ("WaterStone Bank" or the "Bank") is primarily a mortgage lender with loans secured by real estate comprising 98.3% of total loans receivable on June 30, 2013.  Further, 88.5% of loans receivable are residential mortgage loans with over four-family loans comprising 46.9% of all loans on June 30, 2013.  WaterStone Bank funds loan production primarily with retail deposits and Federal Home Loan Bank advances.  The Bank's mortgage banking subsidiary, Waterstone Mortgage Corporation, utilizes a line of credit provided by the Bank as a primary source of funding loans held for sale.  In addition, Waterstone Mortgage Corporation utilizes short-term repurchase agreements with external banks as needed.  On June 30, 2013, deposits comprised 62.7% of total liabilities.  Time deposits, also known as certificates of deposit, accounted for 76.4% of total deposits at June 30, 2013.  Federal Home Loan Bank advances outstanding on June 30, 2013 totaled $350.0 million, or 24.6% of total liabilities.  During the current prolonged period of low interest rates and economic weakness, we have determined that an investment philosophy emphasizing short-term liquid investments including cash and cash equivalents is prudent and positions the Company to take advantage of the investment, lending and interest rate risk management opportunities that should exist as the local and national economies recover from the recession.  Our high level of time deposits, relative to total deposits, will result in an increase in our cost of funds when market interest rates begin to increase.

During the six months ended June 30, 2013, our results of operations were positively impacted by an increase in income from our mortgage banking segment and from decreases in our provision for loans losses and in real estate owned expense, both of which resulted from an improvement in our asset quality.  A significant increase in the volume of mortgage loans sold in the secondary market yielded a $1.4 million increase in pre-tax earnings from our mortgage banking segment during the six months ended June 30, 2013 compared to the six months ended June 30, 2012.

Our provision for loan losses decreased $2.1 million to $3.0 million for six months ended June 30, 2013 as compared to $5.1 million for the six months ended June 30, 2012.  The decrease in provision for loan losses reflects a stabilization in both the quality of our loan portfolio and the overall local real estate market.  The Company has experienced a stabilization or improvement in a number of key loan-related loan quality metrics compared to December 31, 2012, including impaired loans, loans contractually past due and non-accrual loans.  In addition, the turnover of loans in each of the three aforementioned metrics has slowed during the six months ended June 30, 2013 compared to the six months ended June 30, 2012, which has resulted in fewer loans requiring a specific collateral analysis to determine a potential collateral shortfall and subsequent loan loss reserve.  Furthermore, as a result of stabilization in the local real estate market, those loans that have required a specific collateral review to assess the level of impairment have experienced less significant collateral shortfalls when compared to the prior year.  This is also reflected in the $4.1 million decrease in real estate owned expense from $4.3 million during the six months ended June 30, 2012 to $153,000 for the six months ended June 30, 2013.  Additional information regarding loan quality and its impact on our financial condition and results of operations can be found in the "Asset Quality" discussion.

Offsetting the positive impact of the increase in income from mortgage banking operations and a reduction of the provision for loan losses and real estate owned expense, net interest income decreased $988,000 to $20.1 million during the six months ended June 30, 2013 compared to $21.1 million during the six months ended June 30, 2012.

Income tax expense increased from $71,000 during the six months ended June 30, 2012 to $6.0 million during the six months ended June 30, 2013.  During the third quarter of 2008, we established a valuation allowance against our net deferred tax assets. That valuation allowance effectively resulted in no income tax expense being recognized during the six months ended June 30, 2012 other than state income taxes for states in which separate company returns are filed.  During the fourth quarter of 2012, we released the valuation allowance against our net deferred tax assets.  Income tax expense was recognized during the six months ended June 30, 2013 at an effective rate of 38.5% of pretax book income.

- 43 -

Comparison of Operating Results for the Three Months Ended June 30, 2013 and 2012

General - Net income for the three months ended June 30, 2013 totaled $4.9 million, or $0.16 for both basic and diluted income per share, compared to net income of $6.2 million, or $0.20 for both basic and diluted income per share, for the three months ended June 30, 2012.  The three months ended June 30, 2013 generated an annualized return on average assets of 1.21% and an annualized return on average equity of 9.42%, compared to an annualized return on average assets of 1.45% and an annualized return on average equity of 14.12% for the comparable period in 2012.  Income before income taxes increased $1.8 million to $8.0 million during the three months ended June 30, 2013, compared to $6.2 million during the three months ended June 30, 2012.  The pre-tax results of operations for the three months ended June 30, 2013 as compared to the three months ended June 30, 2012 reflect a $2.8 million decrease in real estate owned expense, partially offset by a $988,000 decrease in pre-tax income from the mortgage banking segment.  Income taxes totaled $3.1 million during the three months ended June 30, 2013, compared to $41,000 during the three months ended June 30, 2012.

Segment Review – As described in the notes to consolidated financial statements, the Company has two reportable segments: community banking and mortgage banking.  Community banking consists of lending and deposit gathering (as well as other banking-related products and services) to consumers and businesses and the support to deliver, fund, and manage such banking services. The Company's mortgage banking segment originates residential mortgage products for sale in the secondary market.

Mortgage banking segment assets (which consist predominantly of loans held for sale) increased $8.3 million, or 5.6%, to $156.0 million as of June 30, 2013 compared to $147.7 million as of December 31, 2012.  Additional details are provided in the "Loans Held for Sale" section.  Mortgage banking revenues increased $3.4 million, or 15.0%, to $26.0 million for the three months ended June 30, 2013 compared to $22.6 million during the three months ended June 30, 2012.   The $3.4 million increase in mortgage banking revenues was attributable to an increase in loan origination volume.  Loans originated for sale on the secondary market totaled $548.2 million during the three months ended June 30, 2013, which represents a $108.0 million, or 24.5%, increase in originations from the three months ended June 30, 2012, which totaled $440.2 million.  The increase in mortgage banking income attributable to an increase in loan origination and sales volume was partially offset by a decrease in margins.  The major components of mortgage banking revenues include fees and premiums associated with the sale of residential loans held for sale. The major expenses for the mortgage banking segment are compensation, payroll taxes and other employee benefits, as well as occupancy, office furniture and equipment and other expenses, which are covered generally in the consolidated discussion in section "Noninterest Expense."

Average Balance Sheets, Interest and Yields/Costs

The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated.  No tax-equivalent yield adjustments were made, as the effect thereof was not material.  Non-accrual loans were included in the computation of average balances.  The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

- 44 -

	Three Months Ended June 30,
	2013							2012
	Average Balance		Interest		Yield/Cost			Average Balance		Interest		Yield/Cost
	(Dollars in Thousands)
Assets
Interest-earning assets:
Loans receivable and held for sale(1)	$	1,235,782		14,862		4.82	%	$	1,275,192		16,319		5.13	%
Mortgage related securities(2)		134,985		419		1.25			140,792		921		2.62
Debt securities, federal funds sold and short-term investments(2)(6)		159,956		617		1.54			195,179		548		1.13
Total interest-earning assets		1,530,723		15,898		4.17			1,611,163		17,788		4.43
Noninterest-earning assets		98,244							96,858
Total assets	$	1,628,967						$	1,708,021
Liabilities and equity
Interest-bearing liabilities:
Demand accounts	$	45,705		3		0.03		$	40,258		6		0.06
Money market and savings accounts		129,250		36		0.11			124,151		77		0.25
Time deposits		696,610		1,314		0.76			844,806		2,580		1.23
Total interest-bearing deposits		871,565		1,353		0.62			1,009,215		2,663		1.06
Borrowings		485,199		4,624		3.82			472,052		4,497		3.82
Total interest-bearing liabilities		1,356,764		5,977		1.77			1,481,267		7,160		1.94
Noninterest-bearing liabilities
Non interest-bearing deposits		43,502							32,697
Other noninterest-bearing liabilities		19,002							18,520
Total noninterest-bearing liabilities		62,504							51,217
Total liabilities		1,419,268							1,532,484
Equity		209,699							175,537
Total liabilities and equity	$	1,628,967						$	1,708,021
Net interest income			$	9,921						$	10,628
Net interest rate spread (3)						2.40	%						2.49	%
Net interest-earning assets (4)	$	173,959						$	129,896
Net interest margin (5)						2.60	%						2.65	%
Average interest-earning assets to average interest-bearing liabilities						112.82	%						108.77	%

________

⁽¹⁾  Interest income includes net deferred loan fee amortization income of $183,000 and $146,000 for the three months ended June 30, 2013 and 2012, respectively.

⁽²⁾  Average balance of mortgage related and debt securities are based on amortized historical cost.

⁽³⁾  Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of  average interest-bearing liabilities.

⁽⁴⁾  Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

⁽⁵⁾  Net interest margin represents net interest income divided by average total interest-earning assets.

⁽⁶⁾  Interest income from tax exempt securities is not significant to total interest income, therefore, interest yield on interest earning assets are not stated on a tax equivalent basis.  The average balance of tax exempt securities totaled $51.0 million and $15.0 million for the three months ended June 30, 2013 and 2012, respectively.

- 45 -

Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated.  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 June 30,
	2013 versus 2012
	Increase (Decrease) due to
	Volume			Rate			Net
	(In Thousands)
Interest income:
Loans receivable and held for sale(1) (2)	$	(494	)		(963	)		(1,457	)
Mortgage related securities(3)		(36	)		(466	)		(502	)
Other earning assets(3)		(111	)		180			69
Total interest-earning assets		(641	)		(1,249	)		(1,890	)
Interest expense:
Demand accounts		1			(4	)		(3	)
Money market and savings accounts		3			(44	)		(41	)
Time deposits		(398	)		(868	)		(1,266	)
Total interest-bearing deposits		(394	)		(916	)		(1,310	)
Borrowings		126			1			127
Total interest-bearing liabilities		(268	)		(915	)		(1,183	)
Net change in net interest income	$	(373	)		(334	)		(707	)

______________

⁽¹⁾     Interest income includes net deferred loan fee amortization income of $183,000 and $146,000 for the three months ended June 30, 2013 and 2012, respectively.

⁽²⁾     Non-accrual loans have been included in average loans receivable balance.

⁽³⁾     Includes available for sale securities.  Average balance of available for sale securities is based on amortized historical cost.

Total Interest Income - Total interest income decreased $1.9 million, or 10.6%, to $15.9 million during the three months ended June 30, 2013 from $17.8 million during the three months ended June 30, 2012.

Interest income on loans decreased $1.5 million, or 8.9%, to $14.9 million during the three months ended June 30, 2013 from $16.3 million during the three months ended June 30, 2012.  The decrease in interest income was primarily due to a 31 basis point decrease in the average yield on loans to 4.82% for the three months ended June 30, 2013 from 5.13% for the three months ended June 30, 2012.  The decrease in interest income on loans also reflects a $39.4 million, or 3.1%, decrease in the average balance of loans outstanding to $1.24 billion during the three months ended June 30, 2013 from $1.28 billion during the three months ended June 30, 2012.

Interest income from mortgage-related securities decreased $502,000, or 54.5%, to $419,000 during the three months ended June 30, 2013 from $921,000 during the three months ended June 30, 2012.  The decrease in interest income was due to a 138 basis point decrease in the average yield on mortgage-related securities to 1.25% for the three months ended June 30, 2013 from 2.62% for the three months ended June 30, 2012.  The decrease in interest income on mortgage-related securities also reflects a $5.8 million, or 4.1%,  decrease in the average balance of mortgage-related securities to $135.0 million for the three months ended June 30, 2013 from $140.8 million during the three months ended June 30, 2012. The decrease in average yield resulted from a general turnover of the investment security portfolio in which cash flow from higher yielding securities was reinvested in securities at lower yields due to the low interest rate environment.

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Interest income from other interest earning assets (comprised of debt securities, federal funds sold and short-term investments) increased $69,000, or 12.6%, to $617,000 for the three months ended June 30, 2013 compared to $548,000 for the three months ended June 30, 2012.  Interest income on other interest earning assets increased due to a 41 basis point increase in the average yield on other interest earning assets to 1.54% for the three months ended June 30, 2013 from 1.13% for the three months ended June 30, 2012.The average balance of higher yielding, tax-exempt municipal securities increased to $51.0 million for the three months ended June 30, 2013 from $15.0 million for the three months ended June 30, 2012, accounting for the increase in the average yield for the period.  The increase in interest income due to the increase in average yield on other interest earning assets was partially offset by a decrease of $35.2 million, or 18.0%, in the average balance of other earning assets to $160.0 million during the three months ended June 30, 2013 from $195.2 million during the three months ended June 30, 2012.

Total Interest Expense - Total interest expense decreased by $1.2 million, or 16.5%, to $6.0 million during the three months ended June 30, 2013 from $7.2 million during the three months ended June 30, 2012.  This decrease was the result of both a decrease in the average cost of funds as well as a decrease in the average balance of interest-bearing deposits and borrowings.  The average cost of funds decreased 17 basis points to 1.77% for the three months ended June 30, 2013 from 1.94% for the three months ended June 30, 2012.  Total average interest bearing deposits and borrowings outstanding decreased $124.5 million, or 8.4%, to $1.36 billion for the three months ended June 30, 2013 compared to an average balance of $1.48 billion for the three months ended June 30, 2012.

Interest expense on deposits decreased $1.3 million, or 49.2%, to $1.4 million during the three months ended June 30, 2013 from $2.7 million during the three months ended June 30, 2012.  The decrease in interest expense on deposits was primarily due to a decrease in the cost of average deposits of 44 basis points to 0.62% for the three months ended June 30, 2013 compared to 1.06% for the three months ended June 30, 2012.  The decrease in the cost of deposits reflects the current low interest rate environment due to the Federal Reserve's low short-term interest rate policy.  These rates are typically used by financial institutions in pricing deposit products.  The decrease in the cost of deposits also reflects a shift in the composition of deposits from higher cost time deposits to lower cost demand, money market and savings accounts.  The decrease in interest expense attributable to the decrease in the cost of deposits was compounded by a decrease of $137.7 million, or 13.6%, in the average balance of interest bearing deposits to $871.6 million during the three months ended June 30, 2013 from $1.01 billion during the three months ended June 30, 2012.  The decrease in average interest-bearing deposits was exclusively the result of a decrease in time deposits, which carry a higher cost than demand, money market or savings accounts.  The decrease in time deposits was consistent with the Bank's liquidity needs and funding obligations.

Interest expense on borrowings increased $127,000, or 2.8%, to $4.6 million during the three months ended June 30, 2013 from $4.5 million during the three months ended June 30, 2012.  The increase primarily resulted from a $13.1 million, or 2.8%, increase in average borrowings outstanding to $485.2 million during the three months ended June 30, 2013 from $472.1 million during the three months ended June 30, 2012.  The increased use of borrowings as a funding source during the three months ended June 30, 2013 reflects an increased use of short-term repurchase agreements within our mortgage banking segment to fund loan originations to be sold in the secondary market.  The average cost of borrowings remained consistent at 3.82% during the three months ended June 30, 2013 and 2012.

Net Interest Income - Net interest income decreased by $707,000, or 6.7%, to $9.9 million during the three months ended June 30, 2013 as compared to $10.6 million during the three months ended June 30, 2012.  The decrease in net interest income resulted primarily from a 9 basis point decrease in our net interest rate spread to 2.40% during the three months ended June 30, 2013 from 2.49% during the three months ended June 30, 2012.  The 9 basis point decrease in the net interest rate spread resulted from a 26 basis point decrease in the average yield on interest earning assets, which was partially offset by a 17 basis point decrease in the average cost of interest bearing liabilities.

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Provision for Loan Losses – Our provision for loan losses decreased $225,000, or 15.8%, to $1.2 million during the three months ended June 30, 2013, from $1.4 million during the three months ended June 30, 2012.  The decrease in the provision for loan losses resulted from a decrease in loans exhibiting risk characteristics that require estimated loan loss provisions in excess of our historical average experience rates.  While the provision for loan losses has decreased from the prior year, it remains at historically elevated levels.  These levels remain elevated due to continued general economic stress resulting in reduced levels of income earned by many of our borrowers combined with loan collateral values, primarily real estate, that remain at levels below those estimated at the time the loans were originally made.  These factors result in higher levels of actual loss experience which, when applied to the portfolio in general, require higher loan loss provisions.  See the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions.

Noninterest Income - Total noninterest income increased $3.5 million, or 14.9%, to $26.7 million during the three months ended June 30, 2013 from $23.3 million during the three months ended June 30, 2012.  The increase resulted primarily from an increase in mortgage banking income.

Mortgage banking income increased $2.9 million, or 13.1%, to $25.5 million for the three months ended June 30, 2013, compared to $22.5 million during the three months ended June 30, 2012.  The $2.9 million increase in mortgage banking income was the result of an increase in origination and sales volumes, partially offset by a decrease in average sales margins.  The decrease in average sales margin reflects a decrease in pricing and fees on all products in all geographic markets.

Loan origination volumes increased significantly compared to the prior year which reflects the continued strong demand for fixed-rate loans due in large part to historically low interest rates on these products.  Loans originated for sale in the secondary market totaled $548.2 million during the three months ended June 30, 2013, which represents a $108.0 million, or 24.5%, increase in originations from the three months ended June 30, 2012, which totaled $440.2 million.

Our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance).  Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan.  During the three months ended June 30, 2013, the growth in loan origination volume resulted in a shift towards conventional loans and loans made to purchase real estate.  Loans originated for the purchase of a residential property comprised 66.1% of total originations during the three months ended June 30, 2013, compared to 63.8% during the three months ended June 30, 2012.  The mix of loan type also changed slightly with conventional loans and governmental loans comprising 68.7% and 31.3% of all loan originations, respectively, during the three months ended June 30, 2013.  During the three months ended June 30, 2012 conventional loans and governmental loans comprised 65.3% and 34.7% of all loan originations, respectively.

Noninterest Expense - Total noninterest expense increased $1.2 million, or 4.6%, to $27.4 million during the three months ended June 30, 2013 from $26.2 million during the three months June 30, 2012.  The increase was primarily attributable to increased compensation, partially offset by a decrease in real estate owned expense.

Compensation, payroll taxes and other employee benefit expense increased $5.0 million, or 33.3%, to $19.9 million during the three months ended June 30, 2013 compared to $15.0 million during the three months ended June 30, 2012.  Due primarily to an increase in loan origination activity, total compensation, payroll taxes and other benefits at our mortgage banking subsidiary increased $4.4 million, or 36.4%, to $16.4 million for the three months ended June 30, 2013 compared to $12.1 million during the three months ended June 30, 2012.  The increase in compensation at our mortgage banking subsidiary correlates to the increase in mortgage banking transaction volume due to the commission-based compensation structure in place for our mortgage banking loan officers.  The increase in compensation also reflects an increase in staffing levels necessary to support the increase in loan origination volumes.

Real estate owned expense decreased $2.8 million, or 99.6%, to $12,000 during the three months ended June 30, 2013 from $2.8 million during the three months ended June 30, 2012.  Real estate owned expense includes the operating costs related to the properties, net of rental income.  In addition, it includes net gains or losses recognized upon the sale of a foreclosed property, as well as write-downs recognized to maintain the properties at the lower of cost or estimated fair value.  The decrease in real estate owned expense results from a decrease in net property management expense and an increase in net gains recognized upon the sale of properties.  During the three months ended June 30, 2013, net operating expense, which primarily relates to property taxes, maintenance and management fees, net of rental income, decreased $211,000, or 31.3%, to $463,000 from $674,000 during the three months ended June 30, 2012.  The decrease in net operating expense compared to the prior period resulted from both an improvement in the operating results of income producing properties as well as a decrease in the number and average balance of properties owned.  The average balance of real estate owned totaled $30.8 million for the three months ended June 30, 2013 compared to $53.3 million for the three months ended June 30, 2012.  Sales and write-downs of real estate owned resulted in a net gain of $450,000 during the three months ended June 30, 2013.  During the three months ended June 30, 2012, sales and write downs of real estate owned resulted in a net loss of $2.2 million.

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Income Taxes – Income tax expense increased from $41,000 during the three months ended June 30, 2012 to $3.1 million for the three months ended June 30, 2013. This increase was partially due to the increase in our income before income taxes, which increased from $6.2 million during the three months ended June 30, 2012 to $8.0 million during the three months ended June 30, 2013.  During the third quarter of 2008, we established a valuation allowance against our net deferred tax assets. That valuation allowance effectively resulted in no income tax expense being recognized during the three months ended June 30, 2012 other than state income taxes for states in which separate company returns are filed.  During the fourth quarter of 2012, we released the valuation allowance against our net deferred tax assets. Therefore, income tax expense is recognized during the three months ended June 30, 2013 at an effective rate of 38.3% of pretax book income.

As of June 30, 2013, net deferred tax assets totaled $15.3 million, which, in the judgment of management, will more-likely-than-not be fully realized. The largest components of the deferred tax assets are associated with the allowance for loan losses and basis adjustments on real estate owned. We are largely relying on earnings generated in the current year and forecasted earnings in future years in making the determination that we will more-likely-than-not realize our deferred tax assets.

Comparison of Operating Results for the Six Months Ended June 30, 2013 and 2012

General - Net income for the six months ended June 30, 2013 totaled $9.6 million, or $0.31 for basic and $0.30 for diluted income per share, compared to net income of $8.4 million, or $0.27 for both basic and diluted income per share, for the six months ended June 30, 2012.  The six months ended June 30, 2013 generated an annualized return on average assets of 1.18% and an annualized return on average equity of 9.28%, compared to an annualized return on average assets of 0.99% and an annualized return on average equity of 9.61% for the comparable period in 2012.  Income before income taxes increased $7.1 million to $15.5 million during the six months ended June 30, 2013, compared to $8.5 million during the six months ended June 30, 2012. The pre-tax results of operations for the six months ended June 30, 2013 as compared to the six months ended June 30, 2012 reflect a $1.4 million increase in pre-tax income from our mortgage banking operations, a $4.1 million decrease in real estate owned expense, a $2.1 million decrease in the provision for loan losses, partially offset by an $988,000 decrease in net interest income.  Income taxes totaled $6.0 million during the six months ended June 30, 2013, compared to $71,000 during the six months ended June 30, 2012.  The provision for loan losses totaled $3.0 million during the six months ended June 30, 2013, compared to $5.1 million for the six months ended June 30, 2012.  Loan charge-off activity and specific loan loss reserves are discussed in additional detail in the "Asset Quality" section.

Segment Review – As described in the notes to consolidated financial statements, the Company has two reportable segments: community banking and mortgage banking.  Community banking consists of lending and deposit gathering (as well as other banking-related products and services) to consumers and businesses and the support to deliver, fund, and manage such banking services. The Company's mortgage banking segment originates residential mortgage products for sale in the secondary market.

Mortgage banking segment assets (which consist predominantly of loans held for sale) increased $8.3 million, or 5.6%, to $156.0 million as of June 30, 2013 compared to $147.7 million as of December 31, 2012.  Additional details are provided in the "Loans Held for Sale" section.  Mortgage banking revenues increased $11.6 million, or 31.4%, to $48.4 million for the six months ended June 30, 2013 compared to $36.8 million during the six months ended June 30, 2012.   The $11.6 million increase in mortgage banking revenues was attributable to an increase in loan origination volume.  Loans originated for sale on the secondary market totaled $978.3 million during the six months ended June 30, 2013, which represents a $211.2 million, or 27.5%, increase in originations from the six months ended June 30, 2012, which totaled $767.1 million.  The increase in mortgage banking income attributable to an increase in loan origination and sales volume was partially offset by a decrease in margins.  The major components of mortgage banking revenues include fees and premiums associated with the sale of residential loans held for sale, which are discussed in below. The major expenses for the mortgage banking segment are compensation, payroll taxes and other employee benefits, as well as occupancy, office furniture and equipment and other expenses, which are covered generally in the consolidated discussion in section "Noninterest Expense."

Average Balance Sheets, Interest and Yields/Costs

The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated.  No tax-equivalent yield adjustments were made, as the effect thereof was not material.  Non-accrual loans were included in the computation of average balances.  The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

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	Six Months Ended June 30,
	2013							2012
	Average Balance		Interest		Yield/Cost			Average Balance		Interest		Yield/Cost
	(Dollars in Thousands)
Assets
Interest-earning assets:
Loans receivable and held for sale(1)	$	1,239,390		30,075		4.89	%	$	1,284,612		32,892		5.13	%
Mortgage related securities(2)		139,283		856		1.24			121,915		1,784		2.93
Debt securities, federal funds sold and short-term investments(2)(6)		156,906		1,153		1.48			196,728		1,255		1.28
Total interest-earning assets		1,535,579		32,084		4.21			1,603,255		35,931		4.49
Noninterest-earning assets		98,053							96,856
Total assets	$	1,633,632						$	1,700,111
Liabilities and equity
Interest-bearing liabilities:
Demand accounts	$	44,959		6		0.03		$	30,445		13		0.09
Money market and savings accounts		124,436		73		0.12			117,419		163		0.28
Time deposits		709,969		2,740		0.78			857,086		5,690		1.33
Total interest-bearing deposits		879,364		2,819		0.65			1,004,950		5,866		1.17
Borrowings		485,229		9,198		3.82			464,855		9,010		3.89
Total interest-bearing liabilities		1,364,593		12,017		1.78			1,469,805		14,876		2.03
Noninterest-bearing liabilities
Non interest-bearing deposits		41,694							39,411
Other noninterest-bearing liabilities		19,772							15,447
Total noninterest-bearing liabilities		61,466							54,858
Total liabilities		1,426,059							1,524,663
Equity		207,573							175,448
Total liabilities and equity	$	1,633,632						$	1,700,111
Net interest income			$	20,067						$	21,055
Net interest rate spread (3)						2.43	%						2.46	%
Net interest-earning assets (4)	$	170,986						$	133,450
Net interest margin (5)						2.64	%						2.63	%
Average interest-earning assets to average interest-bearing liabilities						112.53	%						109.08	%

_________

⁽¹⁾  Interest income includes net deferred loan fee amortization income of $339,000 and $296,000 for the six months ended June 30, 2013 and 2012, respectively.

⁽²⁾  Average balance of mortgage related and debt securities are based on amortized historical cost.

⁽³⁾  Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of  average interest-bearing liabilities.

⁽⁴⁾  Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

⁽⁵⁾  Net interest margin represents net interest income divided by average total interest-earning assets.

⁽⁶⁾  Interest income from tax exempt securities is not significant to total interest income, therefore, interest yield on interest earning assets are not stated on a tax equivalent basis.  The average balance of tax exempt securities totaled $43.8 million and $20.7 million for the six months ended June 30, 2013 and 2012, respectively.

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Rate/Volume Analysis

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

	Six Months Ended June 30,
	2013 versus 2012
	Increase (Decrease) due to
	Volume			Rate			Net
	(In Thousands)
Interest income:
Loans receivable and held for sale(1) (2)	$	(1,206	)		(1,611	)		(2,817	)
Mortgage related securities(3)		225			(1,153	)		(928	)
Other earning assets(3)		(280	)		178			(102	)
Total interest-earning assets		(1,261	)		(2,586	)		(3,847	)
Interest expense:
Demand accounts		5			(11	)		(6	)
Money market and savings accounts		9			(99	)		(90	)
Time deposits		(863	)		(2,088	)		(2,951	)
Total interest-bearing deposits		(849	)		(2,198	)		(3,047	)
Borrowings		353			(165	)		188
Total interest-bearing liabilities		(496	)		(2,363	)		(2,859	)
Net change in net interest income	$	(765	)		(223	)		(988	)

______________

⁽¹⁾     Interest income includes net deferred loan fee amortization income of $339,000 and $296,000 for the six months ended June 30, 2013 and 2012, respectively.

⁽²⁾     Non-accrual loans have been included in average loans receivable balance.

⁽³⁾     Includes available for sale securities.  Average balance of available for sale securities is based on amortized historical cost.

Total Interest Income - Total interest income decreased $3.8 million, or 10.7%, to $32.1 million during the six months ended June 30, 2013 from $35.9 million during the six months ended June 30, 2012.

Interest income on loans decreased $2.8 million, or 8.6%, to $30.1 million during the six months ended June 30, 2013 from $32.9 million during the six months ended June 30, 2012.  The decrease in interest income was primarily due to a 24 basis point decrease in the average yield on loans to 4.89% for the six months ended June 30, 2013 from 5.13% for the six months ended June 30, 2012.  The decrease in interest income on loans also reflects a $45.2 million, or 3.5%, decrease in the average balance of loans outstanding to $1.24 billion during the six months ended June 30, 2013 from $1.28 billion during the six months ended June 30, 2012.

Interest income from mortgage-related securities decreased $928,000, or 52.0%, to $856,000 during the six months ended June 30, 2013 from $1.8 million during the six months ended June 30, 2012.  The decrease in interest income was due to a 169 basis point decrease in the average yield on mortgage-related securities to 1.24% for the six months ended June 30, 2013 from 2.93% for the six months ended June 30, 2012.  The decrease in average yield was partially offset by a $17.4 million, or 14.3%, increase in the average balance of mortgage-related securities to $139.3 million for the six months ended June 30, 2013 from $121.9 million during the six months ended June 30, 2012. The decrease in average yield resulted from a general turnover of the investment security portfolio in which cash flows from higher yielding securities were reinvested in lower yielding securities due to the low interest rate environment.

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Interest income from other interest earning assets (comprised of debt securities, federal funds sold and short-term investments) decreased $102,000, or 8.1%, to $1.2 million for the six months ended June 30, 2013 compared to $1.3 million for the six months ended June 30, 2012.  Interest income decreased due to a decrease of $39.8 million, or 20.2%, in the average balance of other earning assets to $156.9 million during the six months ended June 30, 2013 from $196.7 million during the six months ended June 30, 2012.  The average balance of higher yielding, tax-exempt municipal securities increased to $43.8 million for the six months ended June 30, 2013 from $20.7 million for the six months ended June 30, 2012, accounting for the increase in the average yield for the period.  The decrease in interest income from other earning assets due to a decrease in average balance was partially offset by a 20 basis point increase in the average yield on other earning assets to 1.48% for the six months ended June 30, 2013 from 1.28% for the six months ended June 30, 2012.

Total Interest Expense - Total interest expense decreased by $2.9 million, or 19.2%, to $12.0. million during the six months ended June 30, 2013 from $14.9 million during the six months ended June 30, 2012.  This decrease was the result of both a decrease in the average cost of funds as well as a decrease in the average balance of interest-bearing deposits and borrowings.  The average cost of funds decreased 25 basis points to 1.78% for the six months ended June 30, 2013 from 2.03% for the six months ended June 30, 2012.  Total average interest bearing deposits and borrowings outstanding decreased $105.2 million, or 7.2%, to $1.36 billion for the six months ended June 30, 2013 compared to an average balance of $1.47 billion for the six months ended June 30, 2012.

Interest expense on deposits decreased $3.0 million, or 52.0%, to $2.8 million during the six months ended June 30, 2013 from $5.9 million during the six months ended June 30, 2012.  The decrease in interest expense on deposits was primarily due to a decrease in the cost of average deposits of 52 basis points to 0.65% for the six months ended June 30, 2013 compared to 1.17% for the six months ended June 30, 2012.  The decrease in the cost of deposits reflects the current low interest rate environment due to the Federal Reserve's low short-term interest rate policy.  These rates are typically used by financial institutions in pricing deposit products.  The decrease in the cost of deposits also reflects a shift in the composition of deposits from higher cost time deposits to lower cost demand, money market and savings accounts.  The decrease in interest expense attributable to the decrease in the cost of deposits was compounded by a decrease of $125.6 million, or 12.5%, in the average balance of interest bearing deposits to $879.4 million during the six months ended June 30, 2013 from $1.0 billion during the six months ended June 30, 2012.  The decrease in average interest-bearing deposits was exclusively the result of a decrease in time deposits, which carry a higher cost than demand, money market or savings accounts.  The decrease in time deposits was consistent with the Bank's liquidity needs and funding obligations.

Interest expense on borrowings increased $188,000, or 2.1%, to $9.2 million during the six months ended June 30, 2013 from $9.0 million during the six months ended June 30, 2012.  The increase primarily resulted from a $20.4 million, or 4.4%, increase in average borrowings outstanding to $485.2 million during the six months ended June 30, 2013 from $464.9 million during the six months ended June 30, 2012.  The increased use of borrowings as a funding source during the six months ended June 30, 2013 reflects an increased use of short-term repurchase agreements within our mortgage banking segment to fund loan originations to be sold in the secondary market.  The increase in average balance was partially offset by a 7 basis point decrease in the average cost of borrowings to 3.82% during the six months ended June 30, 2013 compared to 3.89% during the six months ended June 30, 2012.

Net Interest Income - Net interest income decreased by $988,000, or 4.7%, to $20.1 million during the six months ended June 30, 2013 as compared to $21.1 million during the six months ended June 30, 2012.  The decrease in net interest income resulted primarily from a $67.7 million, or 4.2%, decrease in the average balance of interest earning assets to $1.54 billion during the six months ended June 30, 2013 from $1.60 billion during the six months ended June 30, 2012, together with a $105.2 million, or 7.2%, decrease in the average balance of interest-bearing liabilities to $1.36 billion from $1.47 billion.  The 28 basis point decrease in the average yield on interest earning assets was largely offset by a 25 basis point decrease in the average cost of interest-bearing liabilites.

Provision for Loan Losses – Our provision for loan losses decreased $2.1 million, or 42.0%, to $3.0 million during the six months ended June 30, 2013, from $5.1 million during the six months ended June 30, 2012.  The decrease in the provision for loan losses resulted from a decrease in loans exhibiting risk characteristics that require estimated loan loss provisions in excess of our historical average experience rates.  While the provision for loan losses has decreased from the prior year, it remains at historically elevated levels.  These levels remain elevated due to continued general economic stress resulting in reduced levels of income earned by many of our borrowers combined with loan collateral values, primarily real estate, that remain at levels below those estimated at the time the loans were originally made.  These factors result in higher levels of actual loss experience which, when applied to the portfolio in general, require higher loan loss provisions.  See the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions.

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Noninterest Income - Total noninterest income increased $11.5 million, or 30.0%, to $49.7 million during the six months ended June 30, 2013 from $38.3 million during the six months ended June 30, 2012.  The increase resulted primarily from an increase in mortgage banking income.

Mortgage banking income increased $10.7 million, or 29.2%, to $47.4 million for the six months ended June 30, 2013, compared to $36.7 million during the six months ended June 30, 2012.  The $10.7 million increase in mortgage banking income was the result of an increase in origination and sales volumes, partially offset by a decrease in average sales margins.  The decrease in average sales margin reflects an increase in pricing and fees on all products in all geographic markets.

Loan origination volumes increased significantly compared to the prior year which reflects the continued strong demand for fixed-rate loans due in large part to historically low interest rates on these products.  Loans originated for sale in the secondary market totaled $978.3 million during the six months ended June 30, 2013, which represents a $211.2 million, or 27.5%, increase in originations from the six months ended June 30, 2012, which totaled $767.1 million.

Our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance).  Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan.  During the six months ended June 30, 2013, the growth in loan origination volume resulted in a shift towards conventional loans and loans made for the purpose of a refinancing.  Loans originated for the purchase of a residential property comprised 57.9% of total originations during the six months ended June 30, 2013, compared to 60.2% during the six months ended June 30, 2012.  The mix of loan type also changed slightly with conventional loans and governmental loans comprising 68.0% and 32.0% of all loan originations, respectively, during the six months ended June 30, 2013.  During the six months ended June 30, 2012 conventional loans and governmental loans comprised 64.6% and 35.4% of all loan originations, respectively.

Noninterest Expense - Total noninterest expense increased $5.6 million, or 12.2%, to $51.3 million during the six months ended June 30, 2013 from $45.8 million during the six months June 30, 2012.  The increase was primarily attributable to increased compensation, partially offset by a decrease in real estate owned expense.

Compensation, payroll taxes and other employee benefit expense increased $10.8 million, or 42.23%, to $36.4 million during the six months ended June 30, 2013 compared to $25.6 million during the six months ended June 30, 2012.  Due primarily to an increase in loan origination activity, total compensation, payroll taxes and other benefits at our mortgage banking subsidiary increased $9.9 million, or 50.2%, to $29.7 million for the six months ended June 30, 2013 compared to $19.8 million during the six months ended June 30, 2012.  The increase in compensation at our mortgage banking subsidiary correlates to the increase in mortgage banking transaction volume due to the commission-based compensation structure in place for our mortgage banking loan officers.  The increase in compensation also reflects an increase in staffing levels necessary to support the increase in loan origination volumes.

Real estate owned expense decreased $4.1 million, or 96.4%, to $153,000 during the six months ended June 30, 2013 from $4.3 million during the six months ended June 30, 2012.  Real estate owned expense includes the operating costs related to the properties, net of rental income.  In addition, it includes net gain or loss recognized upon the sale of a foreclosed property, as well as write-downs recognized to maintain the properties at the lower of cost or estimated fair value.  The decrease in real estate owned expense results from a decrease in net property management expense and a decrease in net losses recognized upon the sale or write-downs of properties.  During the six months ended June 30, 2013, net operating expense, which primarily relates to property taxes, maintenance and management fees, net of rental income, decreased $648,000, or 40.4%, to $955,000 from $1.6 million during the six months ended June 30, 2012.  The decrease in net operating expense compared to the prior period resulted from both an improvement in the operating results of income producing properties as well as a decrease in the number and average balance of properties owned.  The average balance of real estate owned totaled $32.4 million for the six months ended June 30, 2013 compared to $54.9 million for the six months ended June 30, 2012.  Sales and write-downs of real estate owned resulted in a net gain of $802,000 during the six months ended June 30, 2013.  During the six months ended June 30, 2012, sales and write downs of real estate owned resulted in a net loss of $2.7 million.

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Income Taxes – Income tax expense increased from $71,000 during the six months ended June 30, 2012 to $6.0 million for the six months ended June 30, 2013. This increase was partially due to the increase in our income before income taxes, which increased from $8.5 million during the six months ended June 30, 2012 to $15.5 million during the six months ended June 30, 2013.  During the third quarter of 2008, we established a valuation allowance against our net deferred tax assets. That valuation allowance effectively resulted in no income tax expense being recognized during the six months ended June 30, 2012 other than state income taxes for states in which separate company returns are filed.  During the fourth quarter of 2012, we released the valuation allowance against our net deferred tax assets. Therefore, income tax expense is recognized during the six months ended June 30, 2013 at an effective rate of 38.5% of pretax book income.

As of June 30, 2013, net deferred tax assets totaled $15.3 million, which, in the judgment of management, will more-likely-than-not be fully realized. The largest components of the deferred tax assets are associated with the allowance for loan losses and basis adjustments on real estate owned. We are largely relying on earnings generated in the current year and forecasted earnings in future years in making the determination that we will more-likely-than-not realize our deferred tax assets.

Comparison of Financial Condition at June 30, 2013 and December 31, 2012

Total Assets - Total assets decreased by $28.2 million, or 1.7%, to $1.63 billion at June 30, 2013 from $1.66 billion at December 31, 2012.  The decrease in total assets reflects decreases in loans receivable of $26.8 million and real estate owned of $6.0 million.  Cash and cash equivalents in addition to funds received from the repayment of loans held in portfolio and from escrow deposits were combined with cash and used to reduce deposits by $46.5 million and increase available for sale securities by $11.2 million during the six months ended June 30, 2013.

Cash and Cash Equivalents – Cash and cash equivalents decreased $17.1 million, or 23.9%, to $54.4 million at June 30, 2013, compared to $71.5 million at December 31, 2012.  Despite the decrease, the overall level of cash and cash equivalents continues to reflect the Company's plan to maintain higher than usual liquidity given the current economic environment and relatively low rates of return available on securities and other investments.

Securities Available for Sale – Securities available for sale increased by $11.2 million, or 5.5%, to $216.3 million at June 30, 2013 from $205.0 million at December 31, 2012.  This increase reflects a $22.2 million increase in municipal securities and a $6.3 million increase in government sponsored enterprise bonds, partially offset by a $10.8 million decrease in mortgage-backed securities and a $6.8 million decrease in government sponsored enterprise issue collateralized mortgage obligations.  During the six months ended June 30, 2013, the proceeds from principal repayments on mortgage-related securities were reinvested in municipal securities deemed to provide a better risk-adjusted return.  As of June 30, 2013, the Company holds two municipal securities with a total fair value of $189,000 and amortized cost of $215,000 that were determined to be other than temporarily impaired.  During the year ended December 31, 2012, $100,000 was recognized as additional other than temporary impairment with respect to these municipal securities which was charged against earnings.  There was no additional other than temporary impairment recorded during the six months ended June 30, 2013.

Loans Held for Sale - Loans held for sale decreased $1.6 million, or 1.2%, to $132.0 million at June 30, 2013 from $133.6 million at December 31, 2012.  During the six months ended June 30, 2013, $978.3 million in residential loans were originated for sale.  During the same period, sales of loans held for sale totaled $979.9 million.

Loans Receivable - Loans receivable held for investment decreased $26.8 million, or 2.4%, to $1.11 billion at June 30, 2013 from $1.13 billion at December 31, 2012.  The decrease in total loans receivable was primarily attributable to a $35.1 million decrease in one- to four-family loans, partially offset by a $5.5 million increase in commercial real estate loans and a $4.4 million increase in over four-family real estate loans.  The decrease in one- to four-family loans reflects a decline in loan demand for variable-rate real estate mortgage loans as borrowers continue to prefer long-term fixed-rate products that the Company does not generally retain in its portfolio.  As a result of the low interest rate environment with respect to long-term fixed-rate real estate mortgage products, the Company continued to experience a shift in the composition of loan originations during 2013 and 2012 from one- to four-family residential variable-rate loans to residential real estate loans collateralized by over four-family properties and commercial real estate, as these categories of borrowers displayed relatively stable levels of demand for our existing products.  During the six months ended June 30, 2013, $8.4 million in loans were transferred to real estate owned and $6.2 million were charged-off, net of recoveries.

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The following table shows loan origination, loan purchases, principal repayment activity, transfers to real estate owned, charge-offs and sales during the periods indicated.

	As of or for the						As of or for the
	Six Months Ended June 30,						Year Ended
	2013			2012			December 31, 2012
	(In Thousands)
Total gross loans receivable and held for sale at beginning of period	$	1,267,285		$	1,304,947			1,304,947
Real estate loans originated for investment:
Residential
One- to four-family		9,187			10,352			17,088
Over four-family		37,190			22,930			51,816
Home equity		2,882			1,915			3,112
Construction and land		2,372			238			2,695
Commercial real estate		9,637			10,900			14,572
Total real estate loans originated for investment		61,268			46,335			89,283
Consumer loans originated for investment		-			35			35
Commerical business loans originated for investment		2,401			3,013			9,857
Total loans originated for investment		63,669			49,383			99,175
Real estate loans purchased for investment:
One- to four-family		-			-			12,148
Home equity		-			-			3,338
Total real estate loans purchased for investment		-			-			15,486
Principal repayments		(75,861	)		(82,992	)		(165,683	)
Transfers to real estate owned		(8,404	)		(11,002	)		(22,282	)
Loan principal charged-off, net of recoveries		(6,161	)		(4,872	)		(9,687	)
Net activity in loans held for investment		(26,757	)		(49,483	)		(82,991	)
Loans originated for sale		978,327			767,092			1,749,426
Loans sold		(979,895	)		(732,886	)		(1,704,097	)
Net activity in loans held for sale		(1,568	)		34,206			45,329
Total gross loans receivable and held for sale at end of period	$	1,238,960		$	1,289,670			1,267,285

Allowance for Loan Losses - The allowance for loan losses decreased $3.3 million, or 10.6%, to $27.8 million at June 30, 2013 from $31.0 million at December 31, 2012.  The $3.3 million decrease in the allowance for loan losses during the six months ended June 30, 2013 reflects a stabilization in both the quality of the loan portfolio as well as the overall local real estate market.  We have experienced a stabilization or improvement in a number of key loan quality metrics compared to December 31, 2012, including impaired loans, substandard loans, loans contractually past due and non-accrual loans.  In addition, the decrease in the allowance for loan losses reflects a decrease in the balance of loans outstanding.   As of June 30, 2013, the allowance for loan losses to total loans receivable was 2.51% and was equal to 52.14% of non-performing loans, compared to 2.74% and 41.58%, respectively, at December 31, 2012.  The overall $3.3 million decrease in the allowance for loan losses during the six months ended June 30, 2013 was primarily the result of a $3.0 million decrease in the allowance for loan losses related to the one- to four-family category.  The decrease related to this category resulted from the charge-off of specific reserves, a stabilization or improvement of key loan quality metrics, as well as a decrease in the overall balance of loans outstanding.  While the local real estate market has stabilized during the current fiscal year, the risk of loss on loans secured by residential real estate remains at an elevated level.  That portion of the allowance for loan losses attributable to mortgage loans secured by residential real estate comprised 84.7% of the total allowance for loan losses at June 30, 2013 and 89.1% at December 31, 2012.

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Real Estate Owned – Total real estate owned decreased $6.0 million, or 16.7%, to $30.0 million at June 30, 2013 from $36.0 million at December 31, 2012.  During the six months ended June 30, 2013, $8.4 million was transferred from loans to real estate owned upon completion of foreclosure.  Declines in property values evidenced by updated appraisals, responses to list prices on properties held for sale and/or deterioration in the condition of properties resulted in write downs totaling $950,000 during the six months ended June 30, 2013.  During the same period, sales of real estate owned totaled $13.5 million.

Prepaid Expenses and Other Assets – Prepaid expenses and other assets increased by $7.3 million or 26.8%, to $34.5 million at June 30, 2013 from $27.2 million at December 31, 2012.  The increase is primarily due to an increase in mortgage banking derivative assets, as well as an increase in the mortgage servicing rights intangible asset that relates to an increase in loans sold on a servicing retained basis.  The increase in prepaid expenses and other assets was partially offset by a decrease in net deferred tax assets.

Deposits – Total deposits decreased $46.5 million, or 5.0%, to $893.0 million at June 30, 2013 from $939.5 million at December 31, 2012.  The reduction in deposits reflects management's decision to accept a certain level of deposit run-off during a period of diminished loan demand.  Total time deposits decreased $55.0 million, or 7.5%, to $681.9 million at June 30, 2013 from $736.9 million at December 31, 2012.  The decrease in time deposits was partially offset by an increase in money market and savings deposits and demand deposits.  Total money market and savings deposits increased $1.2 million, or 1.0%, to $119.6 million at June 30, 2013 from $118.5 million at December 31, 2012.  Total demand deposits increased $7.4 million, or 8.8%, to $91.5 million at June 30, 2013 from $84.1 million at December 31, 2012.

Borrowings – Total borrowings increased $10.2 million, or 2.1%, to $490.0 million at June 30, 2013 from $479.9 million at December 31, 2012.  The increase in borrowings relates to a increase in the use of short-term repurchase agreements to finance loans held for sale.  The balance of these lines of credit increased by $10.2 to $56.0 million at June 30, 2013, from $45.9 million at December 31, 2012.

Advance Payments by Borrowers for Taxes - Advance payments by borrowers for taxes increased $13.9 million to $15.6 million at June 30, 2013 from $1.7 million at December 31, 2012.  The increase was the result of payments received from borrowers for their real estate taxes and is seasonally normal, as balances increase during the course of the calendar year until real estate tax obligations are paid out in the fourth quarter.

Other Liabilities - Other liabilities decreased $12.4 million, or 33.3%, to $24.9 million at June 30, 2013 from $37.4 million at December 31, 2012.  The decrease resulted primarily from a seasonal decrease in outstanding escrow checks.  The Company receives payments from borrowers for their real estate taxes during the course of the calendar year until real estate tax obligations are paid out in the fourth quarter.  These amounts remain classified as other liabilities until settled.  The decrease related to escrow checks was partially offset by an increase in amounts due to third parties related to the origination of loans held for sale.

Shareholders' Equity – Shareholders' equity increased by $6.7 million, or 3.3%, to $209.3 million at June 30, 2013 from $202.6 million at December 31, 2012.  The increase in shareholders' equity was primarily due to a $9.6 million increase in retained earnings reflecting net income for the six months ended June 30, 2013.  In addition to the increase in retained earnings, shareholders' equity was positively impacted by a $427,000 decrease in unearned ESOP shares.  Partially offsetting the increases was a $3.2 million decrease in accumulated other comprehensive income.

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ASSET QUALITY

NONPERFORMING ASSETS

	At June 30,			At December 31,
	2013			2012
	(Dollars in Thousands)
Non-accrual loans:
Residential
One- to four-family	$	36,664			46,467
Over four-family		9,259			23,205
Home equity		1,328			1,578
Construction and land		5,199			2,215
Commercial real estate		272			668
Consumer		20			24
Commercial		511			511
Total non-accrual loans		53,253			74,668
Real estate owned
One- to four-family		15,458			17,353
Over four-family		7,514			9,890
Construction and land		5,200			7,029
Commercial real estate		1,811			1,702
Total real estate owned		29,983			35,974
Total nonperforming assets	$	83,236			110,642
Total non-accrual loans to total loans, net		4.81	%		6.59	%
Total non-accrual loans and performing troubled debt restructurings     to total loans receivable restructurings to total loans receivable		7.18	%		8.00	%
Total non-accrual loans to total assets		3.26	%		4.50	%
Total nonperforming assets to total assets		5.10	%		6.66	%

All loans that exceed 90 days past due with respect to principal and interest are recognized as non-accrual.  Troubled debt restructurings that are non-accrual either due to being past due greater than 90 days or which have not yet performed under the modified terms for a reasonable period of time, are included in the table above.  In addition, loans that are past due less than 90 days are evaluated to determine the likelihood of collectability given other credit risk factors such as early stage delinquency, the nature of the collateral or the results of a borrower review.  When the collection of all contractual principal and interest is determined to be unlikely, the loan is moved to non-accrual status and an updated appraisal of the underlying collateral is ordered.  This process generally takes place between contractual past due dates 60 to 90 days.  Upon determining the updated estimated value of the collateral, a loan loss provision is recorded to establish a specific reserve to the extent that the outstanding principal balance exceeds the updated estimated net realizable value of the collateral.  When a loan is determined to be uncollectible, typically coinciding with the initiation of foreclosure action, the specific reserve is reviewed for adequacy, adjusted if necessary, and charged-off.

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The following table sets forth activity in our non-accrual loans for the periods indicated.

	At or for the Six Months Ended June 30,
	2013			2012
	(In Thousands)
Balance at beginning of period	$	74,668			78,218
Additions		17,608			31,340
Transfers to real estate owned		(8,404	)		(11,002	)
Charge-offs		(6,766	)		(3,443	)
Returned to accrual status		(20,000	)		(8,043	)
Principal paydowns and other		(3,853	)		(2,318	)
Balance at end of period	$	53,253			84,752

Total non-accrual loans decreased by $21.4 million, or 28.7%, to $53.3 million as of June 30, 2013 compared to $74.7 million as of December 31, 2012.  The ratio of non-accrual loans to total loans receivable was 4.81% at June 30, 2013 compared to 6.59% at December 31, 2012.  During the six months ended June 30, 2013, $20.0 million in loans were returned to accrual status, $8.4 million  were transferred to real estate owned (net of charge-offs), $6.8 million in loan principal was charged off and $3.9 million in principal payments were received.  Offsetting this activity, $17.6 million in loans were placed on non-accrual status during the six months ended June 30, 2013.

Of the $53.3 million in total non-accrual loans as of June 30, 2013, $37.9 million in loans have been specifically reviewed to assess whether a specific valuation allowance is necessary.  A specific valuation allowance is established for an amount equal to the impairment when the carrying value of the loan exceeds the present value of expected future cash flows, discounted at the loan's original effective interest rate or the fair value of the underlying collateral with an adjustment made for costs to dispose of the asset.  Based upon these specific reviews, a total of $7.5 million in partial charge-offs have been recorded with respect to these loans as of June 30, 2013.  Partially charged-off loans measured for impairment based upon net realizable collateral value are maintained in a "non-performing" status and are disclosed as impaired loans.  In addition, specific reserves totaling $4.1 million have been recorded as of June 30, 2013.  The remaining $15.4 million of non-accrual loans were reviewed on an aggregate basis and $4.0 million in general valuation allowance was deemed necessary related to those loans as of June 30, 2013.   The $4.0 million in general valuation allowance is based upon a migration analysis performed with respect to similar non-accrual loans in prior periods.

There were no accruing loans past due 90 days or more during the six months ended June 30, 2013 or 2012.

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TROUBLED DEBT RESTRUCTURINGS

The following table summarizes troubled debt restructurings:

	At June 30,		At December 31,
	2013		2012
	(Dollars in Thousands)
Troubled debt restructurings
Substandard	$	24,853		48,449
Watch		22,247		11,172
Total troubled debt restructurings	$	47,100		59,621

All troubled debt restructurings are considered to be impaired and are risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in the notes to the financial statements.  Specific reserves have been established to the extent that collateral-based impairment analyses indicate that a collateral shortfall exists.

Information with respect to the accrual status of our troubled debt restructurings is provided in the following table.

	As of June 30, 2013
	Accruing		Non-accruing		Total
	(In Thousands)
One- to four-family	$	8,420		12,842		21,262
Over four-family		16,340		5,962		22,302
Home equity		-		1,007		1,007
Construction and land		1,408		840		2,248
Commercial real estate		-		272		272
Commercial		9		-		9
	$	26,177		20,923		47,100
	As of December 31, 2012
	Accruing		Non-accruing		Total
One- to four-family	$	9,921		21,847		31,768
Over four-family		3,917		20,030		23,947
Home equity		-		986		986
Construction and land		2,173		79		2,252
Commercial real estate		-		668		668
	$	16,011		43,610		59,621

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The following table sets forth activity in our troubled debt restructurings for the periods indicated.

	At or for the Six Months Ended June 30, 2013
	Accrual			Non-accrual
	(In Thousands)
Balance at beginning of period	$	16,011			43,609
Additions		98			620
Change in accrual status		16,146			(16,146	)
Charge-offs		(63	)		(1,970	)
Returned to contractual/market terms		(5,721	)		(2,845	)
Transferred to real estate owned		-			(1,625	)
Principal paydowns and other		(294	)		(720	)
Balance at end of period	$	26,177			20,923

LOAN DELINQUENCY

The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio:

	At June 30,			At December 31,
	2013			2012
	(Dollars in Thousands)
Loans past due less than 90 days	$	27,049			23,092
Loans past due 90 days or more		33,557			51,358
Total loans past due	$	60,606			74,450
Total loans past due to total loans receivable		5.48	%		6.57	%

Past due loans decreased by $13.8 million, or 18.6%, to $60.6 million at June 30, 2013 from $74.5 million at December 31, 2012.  Loans past due 90 days or more decreased by $17.8 million, or 34.7%, during the six months ended June 30, 2013 while loans past due less than 90 days increased by $4.0 million, or 17.1%.  The $17.8 million decrease in loans past due 90 days or more was primarily due to an $11.0 million lending relationship that was brought current under the terms of a troubled debt restructuring during the three months ended June 30, 2013.  The $4.0 million increase in loans past due less than 90 days or more was primarily attributable to a $7.4 million increase in loans collateralized by construction and land loans, partially offset by a $2.6 million decrease in loans collateralized by one- to four-family residential real estate.

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REAL ESTATE OWNED

Total real estate owned decreased by $6.0 million, or 16.7%, to $30.0 million at June 30, 2013, compared to $36.0 million at December 31, 2012.  During the six months ended June 30, 2013, $8.4 million was transferred from loans to real estate owned upon completion of foreclosure.  Declines in property values evidenced by updated appraisals, responses to list prices on properties held for sale and/or deterioration in the condition of properties resulted in write-downs totaling $950,000 during the six months ended June 30, 2013.  During the same period, sales of real estate owned totaled $15.2 million, resulting in a net gain of $1.8 million.  New appraisals received on real estate owned and collateral dependent impaired loans are based upon an "as is value" assumption.  During the period of time in which we are awaiting receipt of an updated appraisal, loans evaluated for impairment based upon collateral value are measured by the following:

• Applying an updated adjustment factor (as described previously) to an existing appraisal;

• Confirming that the physical condition of the real estate has not significantly changed since the last valuation date;

• Comparing the estimated current value of the collateral to that of updated sales values experienced on similar collateral;

• Comparing the estimated current value of the collateral to that of updated values seen on current appraisals of similar collateral; and

• Comparing the estimated current value to that of updated listed sales prices on our real estate owned and that of similar properties (not owned by the Company).

Virtually all habitable real estate owned is managed with the intent of attracting a lessee to generate revenue.  Foreclosed properties are recorded at the lower of carrying value or fair value, less costs to sell, with charge-offs, if any, charged to the allowance for loan losses upon transfer to real estate owned.  The fair value is primarily based upon updated appraisals in addition to an analysis of current real estate market conditions.

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ALLOWANCE FOR LOAN LOSSES

	At or for the Six Months
	Ended June 30,
	2013			2012
	(Dollars in Thousands)
Balance at beginning of period	$	31,043			32,430
Provision for loan losses		2,960			5,100
Charge-offs:
Mortgage
One- to four-family		5,686			4,133
Over four-family		732			612
Home Equity		524			158
Commercial real estate		95			43
Construction and land		134			192
Consumer		-			-
Commercial		-			59
Total charge-offs		7,171			5,197
Recoveries:
Mortgage
One- to four-family		608			252
Over four-family		201			11
Home Equity		70			22
Construction and land		51			15
Consumer		2			-
Commercial		3			25
Total recoveries		935			325
Net charge-offs		6,236			4,872
Allowance at end of period	$	27,767		$	32,658
Ratios:
Allowance for loan losses to non-accrual loans at end of period		52.14	%		38.53	%
Allowance for loan losses to loans receivable at end of period		2.51	%		2.80	%
Net charge-offs to average loans outstanding (annualized)		1.01	%		0.76	%
Current year provision for loan losses to net charge-offs		47.47	%		104.68	%
Net charge-offs (annualized) to beginning of the year allowance		40.51	%		15.02	%

_______________

At June 30, 2013, the allowance for loan losses was $27.8 million, compared to $31.0 million at December 31, 2012.  As of June 30, 2013, the allowance for loan losses represented 2.51% of total loans receivable and was equal to 52.14% of non-performing loans, compared to 2.74% and 41.58%, respectively, at December 31, 2012.  The $3.3 million decrease in the allowance for loan losses during the six months ended June 30, 2013 reflects a stabilization in both the quality of the loan portfolio as well as the overall local real estate market.  The Company has experienced a stabilization or improvement in a number of key loan-related loan quality metrics compared to June 30, 2012, including impaired loans, substandard loans, loans contractually past due and non-accrual loans.  In addition, the decrease in the allowance for loan losses reflects a decrease in the overall balance of loans outstanding.

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Net charge-offs totaled $6.2 million, or an annualized 1.01% of average loans for the six months ended June 30, 2013, compared to $4.9 million, or an annualized 0.76% of average loans for the six months ended June 30, 2012.  Of the $6.2 million in net charge-offs during the six months ended June 30, 2013, substantially all of the activity related to loans secured by one- to four-family residential loans.  Weakness in the residential real estate market continues and the risk of loss on loans secured by residential real estate remains at an elevated level.

Our underwriting policies and procedures emphasize the fact that credit decisions must rely on both the credit quality of the borrower and the estimated value of the underlying collateral.  Credit quality is assured only when the estimated value of the collateral is objectively determined and is not subject to significant fluctuation.  The quantified deterioration of the credit quality of our loan portfolio as described above is the direct result of borrowers who were not financially strong enough to make regular interest and principal payments or maintain their properties when the economic environment no longer allowed them the option of converting estimated real estate value increases into short-term cash flow.

The allowance for loan losses has been determined in accordance with GAAP. We are responsible for the timely and periodic determination of the amount of the allowance required. Future provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and the underlying collateral, trends in nonperforming loans, current economic conditions and other relevant factors. To the best of management's knowledge, all probable losses have been provided for in the allowance for loan losses.

The establishment of the amount of the loan loss allowance inherently involves judgments by management as to the appropriateness of the allowance, which ultimately may or may not be correct. Higher than anticipated rates of loan default would likely result in a need to increase provisions in future years. See "Critical Accounting Policies" above for a discussion on the use of judgment in determining the amount of the allowance for loan losses.

Liquidity and Capital Resources

We maintain liquid assets at levels we consider adequate to meet our liquidity needs.  Our liquidity ratio averaged 3.87% and 5.10% for the six months ended June 30, 2013 and 2012, respectively.  The liquidity ratio is equal to average daily cash and cash equivalents for the period divided by average total assets.  We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans.  We also adjust liquidity as appropriate to meet asset and liability management objectives.  The operational adequacy of our liquidity position at any point in time is dependent upon the judgment of the senior management as supported by the Asset/Liability Committee.  Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators.

Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations.  While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors.  We set the interest rates on our deposits to maintain a desired level of total deposits.  In addition, we invest excess funds in short-term, interest-earning assets, which provide liquidity to meet lending requirements.  Additional sources of liquidity used for the purpose of managing long- and short-term cash flows include advances from the FHLBC.

A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities.  At June 30, 2013 and 2012, respectively, $54.4 million and $64.9 million of our assets were invested in cash and cash equivalents.  At June 30, 2013 cash and cash equivalents are comprised of the following: $40.3 million in cash held at the Federal Reserve Bank and other depository institutions and $14.1 million in federal funds sold and short-term investments.  Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage-related securities, increases in deposit accounts and advances from the FHLBC.

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During the six months ended June 30, 2013, the collection of principal payments on loans, net of loan originations, provided cash flows of $12.1 million, compared to $33.6 million for the six months ended June 30, 2012.  The decrease in loans receivable is reflective of the general decline in loan demand for variable-rate residential real estate mortgage loans combined with the Company's tightened underwriting standards given the current economic environment.  The decrease in total loans receivable was primarily attributable to a $35.1 million decrease in one- to four-family loans, partially offset by a $5.5 million increase in commercial real estate loans and a $4.4 million increase in over four-family real estate loans.  The decrease in one- to four-family loans reflects a decline in loan demand for variable-rate real estate mortgage loans as borrowers continue to prefer long-term fixed-rate products that the Company does not generally retain in its portfolio.

Deposit flows are generally affected by the level of interest rates, the interest rates and products offered by local competitors, and other factors.  Deposits decreased by $46.5 million for the six months ended June 30, 2013 compared to a $65.1 million decrease during the six months ended June 30, 2012.  The 2013 decrease in deposits was driven by a $55.0 million decrease in time deposits, partially offset by a $1.2 million decrease in money market and savings deposits and a $7.4 million increase in demand deposits.

Liquidity management is both a daily and longer-term function of business management.  If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLBC which provide an additional source of funds.  At June 30, 2013, we had $350.0 million in advances from the FHLBC with contractual maturity dates in 2016, 2017 or 2018.  All advances are callable quarterly until maturity.  As an additional source of funds, we also enter into repurchase agreements.  At June 30, 2013, we had $84.0 million in repurchase agreements.  The repurchase agreements mature at various times in 2017, however, all are callable quarterly until maturity.

At June 30, 2013, we had outstanding commitments to originate loans receivable of $22.5 million.  In addition, at June 30, 2013 we had unfunded commitments under construction loans of $4.9 million, unfunded commitments under business lines of credit of $10.3 million and unfunded commitments under home equity lines of credit and standby letters of credit of $17.5 million.  At June 30, 2013 certificates of deposit scheduled to mature in one year or less totaled $463.3 million.  Based on prior experience, management believes that, subject to the Bank's funding needs, a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case.  In the event a significant portion of our deposits is not retained by us, we will have to utilize other funding sources, such as FHLBC advances, in order to maintain our level of assets.  However, we cannot assure that such borrowings would be available on attractive terms, or at all, if and when needed.  Alternatively, we could reduce our level of liquid assets, such as our cash and cash equivalents and securities available-for-sale in order to meet funding needs.  In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal.

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Capital

Waterstone Financial, Inc. is the mid-tier stock holding company subsidiary of Lamplighter Financial, MHC, formed as part of the reorganization of WaterStone Bank into mutual holding company form.  WaterStone Bank was converted from a mutual to a stock savings bank as part of our reorganization.  At June 30, 2013, 74% of Waterstone Financial, Inc. outstanding shares were held by Lamplighter Financial, HMC and 26% were held by public shareholders.

Shareholders' equity increased by $6.7 million, or 3.3%, to $209.3 million at June 30, 2013 from $202.6 million at December 31, 2012.  The increase in shareholders' equity was primarily due to a $9.6 million increase in retained earnings reflecting net income for the six months ended June 30, 2013.  In addition to the increase in retained earnings, shareholders' equity was positively impacted by a $428,000 decrease in unearned ESOP shares.  Partially offsetting the increases was a $3.2 million decrease in accumulated other comprehensive income.

Basel III

On July 2, 2013, the Board of Governors of the Federal Reserve Board (Reserve Board) approved the final rules implementing the Basel Committee on Banking Supervision's capital guidelines for U.S. banks. Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by the Company. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%. On July 9, 2013, the FDIC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the Reserve Board. The FDIC's rule is identical in substance to the final rules issued by the Reserve Board.

The phase-in period for the final rules will begin for the Company and WaterStone Bank on January 1, 2015, with full compliance with all of the final rule's requirements phased in over a multi-year schedule. While management is currently evaluating the provisions of the final rules and their expected impact to the Company and WaterStone Bank, we anticipate that the capital ratios for the Company and WaterStone Bank under Basel III will continue to exceed the well capitalized minimum capital requirements.

Also see "Notes to Consolidated Financial Statements - Regulatory Capital."

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Contractual Obligations, Commitments and Contingent Liabilities

The following tables present information indicating various contractual obligations and commitments of the Company as of June 30, 2013 and the respective maturity dates.

					More than		More than
					One Year		Three Years		Over
			One Year		Through		Through		Five
	Total		or Less		Three Years		Five Years		Years
	(In Thousands)
Demand deposits (4)	$	91,496		91,496		-		-		-
Money market and savings deposits (4)		119,620		119,620		-		-		-
Time deposit (4)		681,891		463,336		180,903		37,639		13
Short-term borrowings (4)		56,046		56,046		-		-		-
Federal Home Loan Bank advances (1)		350,000		-		70,000		280,000		-
Repurchase agreements (2)(4)		84,000		-		-		84,000		-
Operating leases (3)		3,321		1,621		1,346		354		-
Salary continuation agreements		680		170		340		170		-
	$	1,387,054		732,289		252,589		402,163		13

_____________

⁽¹⁾  Secured under a blanket security agreement on qualifying assets, principally, mortgage loans.  Excludes interest which will accrue on the advances.

     All Federal Home Loan Bank advances with maturities exceeding one year are callable on a quarterly basis.

⁽²⁾  The repurchase agreements are callable on a quarterly basis until maturity.

⁽³⁾  Represents non-cancelable operating leases for offices and equipment.

⁽⁴⁾  Excludes interest.

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Off-Balance Sheet Commitments

The following table details the amounts and expected maturities of significant off-balance sheet commitments as of June 30, 2013.

					More than		More than
					One Year		Three Years		Over
			One Year		Through		Through		Five
	Total		or Less		Three Years		Five Years		Years
	(In Thousands)
Real estate loan commitments (1)	$	22,466	$	22,466		-		-		-
Unused portion of home equity lines of credit (2)		16,405		16,405		-		-		-
Unused portion of construction loans (3)		4,879		4,879		-		-		-
Unused portion of business lines of credit		10,308		10,308		-		-		-
Standby letters of credit		1,119		1,119		-		-		-
Total Other Commitments	$	55,177		55,177		-		-		-

______________

General:  Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract and generally have fixed expiration dates or other termination clauses.

⁽¹⁾  Commitments for loans are extended to customers for up to 90 days after which they expire.

⁽²⁾  Unused portions of home equity loans are available to the borrower for up to 10 years.

⁽³⁾  Unused portions of construction loans are available to the borrower for up to 1 year.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Management of Market Risk

General. The majority of our assets and liabilities are monetary in nature.  Consequently, our most significant form of market risk is interest rate risk.  Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits.  As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates.  Accordingly, WaterStone Bank's board of directors has established an Asset/Liability Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors.  Management monitors the level of interest rate risk on a regular basis and the Asset/Liability Committee meets at least weekly to review our asset/liability policies and interest rate risk position, which are evaluated quarterly.

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates.  We have implemented the following strategies to manage our interest rate risk: (i) emphasizing variable rate loans including variable rate one- to four-family, and commercial real estate loans as well as six to five year commercial real estate balloon loans; (ii) reducing and shortening the expected average life of the investment portfolio; and (iii) whenever possible, lengthening the term structure of our deposit base and our borrowings from the FHLBC.  These measures should reduce the volatility of our net interest income in different interest rate environments.

Income Simulation.  Simulation analysis is an estimate of our interest rate risk exposure at a particular point in time.  At least quarterly we review the potential effect changes in interest rates may have on the repayment or repricing of rate sensitive assets and funding requirements of rate sensitive liabilities.  Our most recent simulation uses projected repricing of assets and liabilities at June 30, 2013 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments.  Prepayment rate assumptions may have a significant impact on interest income simulation results.  Because of the large percentage of loans and mortgage-backed securities we hold, rising or falling interest rates may have a significant impact on the actual prepayment speeds of our fixed-rate mortgage related assets that may in turn affect our interest rate sensitivity position.  When interest rates rise, prepayment speeds slow and the average expected lives of our fixed-rate assets would tend to lengthen more than the expected average lives of our liabilities and therefore would most likely have a negative impact on net interest income and earnings.  This effect is offset by the impact that variable-rate assets have on net interest income as interest rates rise and fall.

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	Percentage Increase (Decrease)  in Estimated Annual Net Interest  Income Over 12 Months
300 basis point gradual rise in rates		3.16
200 basis point gradual rise in rates		2.26
100 basis point gradual rise in rates		1.47
Unchanged rate scenario		0.43
100 basis point gradual decline in rates (1)		(1.02)

____________

⁽¹⁾ Given the current low point in the interest rate cycle, down scenarios in excess of 100 basis points are not meaningful.

WaterStone Bank's Asset/Liability policy limits projected changes in net average annual interest income to a maximum decline of 25% for various levels of interest rate changes measured over a 12-month period when compared to the flat rate scenario.  In addition, projected changes in the economic value of equity are limited to a maximum decline of 35% for interest rate movements of up to 300 basis points when compared to the flat rate scenario.  These limits are re-evaluated on a periodic basis and may be modified, as appropriate.  At June 30, 2013, a 100 basis point gradual increase in interest rates had the effect of increasing forecast net interest income by 1.47% while a 100 basis point decrease in rates had the effect of decreasing net interest income by 1.02%.  At June 30, 2013, a 100 basis point gradual increase in interest rates had the effect of decreasing the economic value of equity by 7.57% while a 100 basis point decrease in rates had the effect of increasing the economic value of equity by 6.46 %.  While we believe the assumptions used are reasonable, there can be no assurance that assumed prepayment rates will approximate actual future mortgage-backed security and loan repayment activity.

Item 4. Controls and Procedures

Disclosure Controls and Procedures : Company management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective.

Internal Control Over Financial Reporting : There have been no changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are 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

The Company is not involved in any pending legal proceedings as a defendant other than routine legal proceedings occurring in the ordinary course of business.  At June 30, 2013, the Company believes that any liability arising from the resolution of any pending legal proceedings will not be material to its financial condition or results of operations.

Item 1A. Risk Factors

See "Risk Factors" in Item 1A of the Company's annual report on Form 10-K for the year ended December 31, 2012.

Item 6. Exhibits

    (a) Exhibits: See Exhibit Index, which follows the signature page hereof.

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.

	WATERSTONE FINANCIAL, INC. (Registrant)
Date:  August 9, 2013
	/s/  Douglas S. Gordon
	Douglas S. Gordon
	Chief Executive Officer Principal Executive Officer
Date:  August 9, 2013
	/s/  Richard C. Larson
	Richard C. Larson
	Chief Financial Officer Principal Financial and Accounting Officer

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EXHIBIT INDEX

WATERSTONE FINANCIAL, INC.

Form 10-Q for Quarter Ended June 30, 2013

Exhibit No.	Description	Filed Herewith
31.1	Sarbanes-Oxley Act Section 302 Certification signed by the Chief Executive Officer of Waterstone Financial, Inc.	X
31.2	Sarbanes-Oxley Act Section 302 Certification signed by the Chief Financial Officer of Waterstone Financial, Inc.	X
32.1	Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Executive Officer of Waterstone Financial, Inc.	X
32.2	Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Financial Officer of Waterstone Financial, Inc.	X
101.INS*	XBRL Instance Document	X
101.SCH*	XBRL Taxonomy Extension Schema Document	X
101.CAL*	XBRL Taxonomy Extension Calculation Linkbase Document	X
101.LAB*	XBRL Extension Labels Linkbase Document	X
101.PRE*	XBRL Taxonomy Extension Presentation Linkbase Document	X
101.DEF*	XBRL Taxonomy Extension Definition Lankbase Document	X

*In accordance with SEC rules, this interactive data file is deemed "furnished" and not "filed" for purposes of Sections 11 or 12 of the Securities Act of 1933 and Section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under those sections or Acts.

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