UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

(Mark One)

(x) 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

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period of _________ to _________

Commission File Number   000-53935

Harvard Illinois Bancorp, Inc.

(Exact name of Registrant as specified in its charter)

Maryland	27-2238553
(State or other jurisdiction of incorporation)	(I.R.S. Employer Identification Number)

58 N. Ayer Street
Harvard, IL	60033
(Address of principal executive office)	(Zip Code)

Registrant’s telephone number, including area code:  (815) 943-5261

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Sections 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.

(x)  Yes ( )  No

Indicate by check mark whether the Registrant has submitted electronic and posted on its corporate website, 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 the registrant was required to submit and post such filings).

(x) Yes ( )  No

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 the definitions of large accelerated filer”, “accelerated filer” and “smaller reporting Company” in Rule 12b-2 of the Exchange Act.

( )  Large Accelerated Filer	( ) Accelerated Filer
( )  Non-Accelerated Filer	(x)  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 (x)  No

As of August 14, 2013, 829,850 shares of the Registrant’s common stock, par value $0.01 per share, were issued and outstanding.

1

HARVARD ILLINOIS BANCORP, INC.

FORM 10-Q FOR THE QUARTERLY PERIOD ENDED June 30, 2013

TABLE OF CONTENTS

		Page
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets	3
	Consolidated Statements of Income	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Stockholders’ Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to the Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	42
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	61
Item 4.	Controls and Procedures	61
PART II	OTHER INFORMATION	62
Item 1.	Legal Proceedings	62
Item 1A.	Risk Factors	62
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	62
Item 3.	Defaults Upon Senior Securities	62
Item 4.	Mine Safety Disclosures	62
Item 5.	Other Information	62
Item 6.	Exhibits	62
	Signatures	63

2

PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

HARVARD ILLINOIS BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

	(Unaudited)
	June 30, 2013			December 31, 2012
Assets
Cash and due from banks	$	1,237		$	1,102
Interest-bearing demand deposits in banks		2,512			2,743
Securities purchased under agreements to resell		20,909			19,014
Cash and cash equivalents		24,658			22,859
Interest-bearing deposits with other financial institutions		8,126			9,126
Available-for-sale securities		6,119			7,879
Held-to-maturity securities, at amortized cost (estimated fair value of $966 and $1,314 at June 30, 2013 and December 31, 2012, respectively)		940			1,263
Loans, net of allowance for loan losses $2,563 and $2,550 at June 30, 2013 and December 31, 2012, respectively		115,950			114,976
Premises and equipment, net		3,319			3,395
Federal Home Loan Bank stock, at cost		870			1,404
Foreclosed assets held for sale		954			886
Accrued interest receivable		738			612
Deferred income taxes		1,994			1,859
Bank-owned life insurance		4,415			4,357
Loan servicing rights		529			412
Other		263			339
Total assets	$	168,875		$	169,367
Liabilities and Equity
Liabilities
Deposits
Demand	$	5,711		$	6,278
Savings, NOW and money market		52,448			51,571
Certificates of deposit		73,327			76,136
Total deposits		131,486			133,985
Federal Home Loan Bank advances		12,890			12,357
Advances from borrowers for taxes and insurance		391			382
Deferred compensation		2,382			2,338
Accrued interest payable		27			29
Other		1,684			659
Total liabilities		148,860			149,750
Commitments and Contingencies		—			—
Stockholders’ Equity
Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued or outstanding		—			—
Common stock, $.01 par value, 30,000,000 shares authorized; 829,850 and 816,076 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively		8			8
Additional paid-in capital		7,153			6,976
Unearned ESOP shares, at cost		(481	)		(502	)
Amount reclassified on ESOP shares		(201	)		(163	)
Retained earnings		13,562			13,291
Accumulated other comprehensive income (loss), net of tax		(26	)		7
Total stockholders’ equity		20,015			19,617
Total liabilities and stockholders’ equity	$	168,875		$	169,367

See accompanying notes to the consolidated financial statements.

3

HARVARD ILLINOIS BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME      

(Dollars in thousands)

	(Unaudited) Three Months Ended June 30,					(Unaudited) Six Months Ended June 30,
	2013		2012			2013		2012
Interest and Dividend Income
Interest and fees on loans	$	1,491	$	1,721		$	3,036	$	3,444
Securities
Taxable		22		46			56		91
Tax-exempt		9		2			18		2
Securities purchased under agreements to resell		45		26			89		68
Other		20		25			41		50
Total interest and dividend income		1,587		1,820			3,240		3,655
Interest Expense
Deposits		317		352			638		733
Federal Home Loan Bank advances		67		89			139		178
Total interest expense		384		441			777		911
Net Interest Income		1,203		1,379			2,463		2,744
Provision for Loan Losses		49		135			193		308
Net Interest Income After Provision for Loan Losses		1,154		1,244			2,270		2,436
Noninterest Income
Customer service fees		73		62			147		131
Brokerage commission income		—		11			1		20
Net realized gains (losses) on loan sales		130		(25	)		222		91
Losses on other than temporary impairment of equity securities		—		—			—		(1	)
Loan servicing fees		56		51			105		104
Bank-owned life insurance income, net		29		30			57		62
Other		2		3			4		6
Total noninterest income		290		132			536		413
Noninterest Expense
Compensation and benefits		626		627			1,266		1,303
Occupancy		124		121			251		244
Data processing		77		82			157		183
Professional fees		130		151			244		287
Marketing		22		14			52		28
Office supplies		8		14			18		27
Federal deposit insurance		43		37			76		74
Indirect automobile loan servicing fee		30		29			53		54
Foreclosed assets, net		25		52			84		171
Other		101		142			174		237
Total noninterest expense		1,186		1,269			2,375		2,608
Income Before Income Taxes		258		107			431		241
Provision for Income Taxes		64		22			78		5
Net Income	$	194	$	85		$	353	$	236
Earnings Per Share
Basic (Note 4)	$	.25	$	.12		$	.45	$	.32
Diluted		.25		.11			.45		.32

See accompanying notes to the consolidated financial statements.

4

HARVARD ILLINOIS BANCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

	(Unaudited) Three Months Ended June 30,						(Unaudited) Six Months Ended June 30,
	2013			2012			2013			2012
Net Income	$	194		$	85		$	353		$	236
Other Comprehensive Income
Unrealized depreciation on available-for-sale securities, net of taxes of $(14) and $(4) for the three months ended June 30, 2013 and 2012, respectively and $17 and $0 for the six months ended June 30, 2013 and 2012, respectively		(27	)		(7	)		(33	)		—
Less: reclassification adjustment for loss on other-than-temporary impairment of equity securities included in net income, net of taxes of $0 for the three and six months ended June 30, 2013 and 2012, respectively		—			—			—			(1	)
Comprehensive Income	$	167		$	78		$	320		$	235

See accompanying notes to the consolidated financial statements.

5

HARVARD ILLINOIS BANCORP, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Dollars in thousands)

	Common Stock		Additional Paid-in Capital		Unearned ESOP Shares			Amount Reclassified On ESOP Shares			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
For the Six Months Ended June 30, 2013 (unaudited)
Balance, January 1, 2013	$	8	$	6,976	$	(502	)	$	(163	)	$	13,291		$	7		$	19,617
Net income		—		—		—			—			353			—			353
Other comprehensive loss		—		—		—			—			—			(33	)		(33	)
ESOP shares earned, 2,092 shares		—		8		21			—			—			—			29
Stock-based compensation expense		—		57		—			—			—			—			57
Reclassification due to change in fair value of common stock in ESOP subject to contingent repurchase obligation		—		—		—			(38	)		—			—			(38	)
Exercise of stock options, 13,774 shares		—		112		—			—			—			—			112
Dividends on common stock, $.10 per share		—		—		—			—			(82	)		—			(82	)
Balance, June 30, 2013	$	8	$	7,153	$	(481	)	$	(201	)	$	13,562		$	(26	)	$	20,015
For the Six Months Ended June 30, 2012 (unaudited)
Balance, January 1, 2012	$	8	$	6,852	$	(544	)	$	(80	)	$	12,403		$	23		$	18,662
Net income		—		—		—			—			236			—			236
Other comprehensive loss		—		—		—			—			—			(1	)		(1	)
ESOP shares earned, 2,092 shares		—		2		21			—			—			—			23
Stock-based compensation expense		—		66		—			—			—			—			66
Reclassification due to change in fair value of common stock in ESOP subject to contingent repurchase obligation		—		—		—			(26	)		—			—			(26	)
Balance, June 30, 2012	$	8	$	6,920	$	(523	)	$	(106	)	$	12,639		$	22		$	18,960

See accompanying notes to consolidated financial statements.

6

HARVARD ILLINOIS BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

	(Unaudited) Six Months Ended June 30,
	2013			2012
Operating Activities
Net income	$	353		$	236
Items not requiring (providing) cash
Depreciation		101			102
Provision for loan losses		193			308
Amortization (accretion) of premiums and discounts on securities		13			(16	)
Deferred income taxes		(118	)		(142	)
Net realized gains on loan sales		(222	)		(91	)
Loss on other than temporary impairment of equity securities		—			1
Losses and write down on foreclosed assets held for sale		79			171
Bank-owned life insurance income, net		(58	)		(64	)
Originations of loans held for sale		(11,783	)		(6,999	)
Proceeds from sales of loans held for sale		11,888			7,082
ESOP compensation expense		29			23
Stock-based compensation expense		57			66
Changes in
Accrued interest receivable		(126	)		105
Other assets		76			159
Accrued interest payable		(2	)		1
Deferred compensation		44			40
Other liabilities		987			354
Net cash provided by operating activities		1,511			1,336
Investing Activities
Net (increase) decrease in interest-bearing deposits		1,000			(2,392	)
Purchases of available-for-sale securities		(1,080	)		(6,367	)
Proceeds from maturities and pay-downs of available-for-sale securities		2,764			2,007
Proceeds from maturities and pay-downs of held-to-maturity securities		336			308
Net change in loans		(1,443	)		(7,456	)
Purchase of premises and equipment		(25	)		(34	)
Purchases of Federal Home Loan Bank stock		(426	)		—
Proceeds from redemption of Federal Home Loan Bank stock		960			3,889
Proceeds from sale of foreclosed assets		129			160
Net cash provided by (used in) investing activities		2,215			(9,885	)
Financing Activities
Net increase in demand deposits, money market, NOW and savings accounts		310			993
Net decrease in certificates of deposit, including brokered certificates		(2,809	)		(4,274	)
Net increase in advances from borrowers for taxes and insurance		9			37
Proceeds from Federal Home Loan Bank advances		9,500			7,000
Repayments of Federal Home Loan Bank advances		(8,967	)		(3,145	)
Dividends paid		(82	)		—
Stock options exercised		112			—
Net cash provided by (used in) financing activities		(1,927	)		611
Net Increase (Decrease) in Cash and Cash Equivalents		1,799			(7,938	)
Cash and Cash Equivalents, Beginning of Period		22,859			22,227
Cash and Cash Equivalents, End of Period	$	24,658		$	14,289
Supplemental Cash Flows Information
Interest paid	$	779		$	910
Income taxes paid		176			86
Foreclosed assets acquired in settlement of loans		267			125

See accompanying notes to unaudited consolidated financial statements.

7

HARVARD ILLINOIS BANCORP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED) (Dollar amounts in thousands)

Note 1:        Basis of Financial Statement Presentation

The consolidated financial statements include the accounts of Harvard Illinois Bancorp, Inc. (Company) and its wholly-owned subsidiary, Harvard Savings Bank (Bank). All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial reporting and with instructions for Form 10–Q and Rule 10–01 of Regulation S–X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ from these estimates. In the opinion of management, the preceding unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the financial condition of the Company as of June 30, 2013 and December 31, 2012, and the results of its operations for the three and six month periods ended June 30, 2013 and 2012. These consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company for the year ended December 31, 2012 included as part of Harvard Illinois Bancorp, Inc.’s Form 10-K (File No. 000-53935) (2012 Form 10-K) filed with the Securities and Exchange Commission on March 22, 2013.

The results of operations for the six month period ended June 30, 2013 are not necessarily indicative of the results that may be expected for the entire year. For further information, refer to the consolidated financial statements and footnotes thereto included in the 2012 Form 10–K.

Note 2:        New Accounting Pronouncements

Recent and Future Accounting Requirements

In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This ASU improves the transparency of reporting of amounts reclassified out of accumulated other comprehensive income. The amendments in ASU 2013-02 do not change the current requirements for reporting net income or other comprehensive income in financial statements. The new amendments will require the Company to present (either on the face of the statements where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. It will also require a cross-reference to other disclosures currently required. For public entities, the amendments are effective for reporting periods beginning after December 15, 2012. The Company adopted the ASU during the first quarter of 2013.

8

Note 3:        Stock-based Compensation

In connection with the conversion to stock form, the Bank established an ESOP for the exclusive benefit of eligible employees (all salaried employees who have completed at least 1,000 hours of service in a twelve-month period and have attained the age of 18). The ESOP borrowed funds from the Company in an amount sufficient to purchase 62,775 shares (approximately 8% of the common stock issued in the stock offering). The loan is secured by the shares purchased and is being repaid by the ESOP with funds from contributions made by the Bank and dividends received by the ESOP, with funds from any contributions on ESOP assets. Contributions are being applied to repay interest on the loan first, then the remainder are being applied to principal. The loan is expected to be repaid over a period of up to 15 years. Shares purchased with the loan proceeds are being held in a suspense account for allocation among participants as the loan is repaid. Contributions to the ESOP and shares released from the suspense account are allocated among participants in proportion to their compensation, relative to total compensation of all active participants. Participants vest 100% in their accrued benefits under the employee stock ownership plan after three vesting years, with no prorated vesting prior to reaching three vesting years. Vesting is accelerated upon retirement, death or disability of the participant or a change in control of the Bank. Forfeitures will be reallocated to remaining plan participants. Benefits may be payable upon retirement, death, disability, separation from service, or termination of the ESOP. Since the Bank’s annual contributions are discretionary, benefits payable under the ESOP cannot be estimated.

Participants receive the shares at the end of employment. Because the Company’s stock is not traded on an established market, as of June 30, 2013, it is required to provide the participants in the Plan with a put option to repurchase their shares. This repurchase obligation is reflected in the Company’s financial statements in other liabilities and reduces shareholders’ equity by the estimated fair value of the earned shares.

The Company is accounting for its ESOP in accordance with ASC Topic 718, Employers Accounting for Employee Stock Ownership Plans. Accordingly, the debt of the ESOP is eliminated in consolidation and the shares pledged as collateral are reported as unearned ESOP shares in the consolidated balance sheet. Contributions to the ESOP shall be sufficient to pay principal and interest currently due under the loan agreement. As shares are committed to be released from collateral, the Company reports compensation expense equal to the average market price of the shares for the respective period, and the shares become outstanding for earnings per shares computations. Dividends, if any, on unallocated ESOP shares are recorded as a reduction of debt and accrued interest. ESOP compensation expense for the six months ended June 30, 2013 and 2012 was $29 and $23, respectively.

A summary of ESOP shares is as follows:

	June 30, 2013		December 31, 2012
Allocated shares		12,556		8,370
Shares released for allocation		2,092		4,185
Unearned shares		48,127		50,220
Total ESOP shares		62,775		62,775
Fair value of unearned ESOP shares	$	637	$	452

The Company is obligated at the option of each beneficiary to repurchase shares of the ESOP upon the beneficiary’s termination or after retirement. At June 30, 2013, the fair value of the 14,648 allocated shares held by the ESOP is $201. The fair value of all shares subject to the repurchase obligation is $201.

On May 26, 2011, the stockholders approved the Harvard Illinois Bancorp, Inc. 2011 Equity Incentive Plan (the “Equity Incentive Plan”) for employees and directors of the Company. The Equity Incentive Plan authorizes the issuance of up to 109,856 shares of the Company’s common stock, with no more than 31,387 of shares as restricted stock awards and 78,469 as stock options, either incentive stock options or non-qualified stock options. The exercise price of options granted under the Equity Incentive Plan may not be less than the fair market value on the date the stock option is granted. The compensation committee of the board of directors has sole discretion to determine the amount and to whom equity incentive awards are granted. Certain option awards provide for accelerated vesting if there is a change of control (as defined in the Equity Incentive Plan).

9

On June 23, 2011, the compensation committee of the board of directors approved the awards of 73,761 options to purchase Company stock and 31,387 shares of restricted stock. Of the 73,761 stock options granted, 63,167 were qualified stock options and 10,594 were nonqualified. The remaining 4,708 shares were awarded on November 29, 2012. Stock options and restricted stock vest over a five year period, and stock options expire ten years after issuance. Apart from the vesting schedule for both stock options and restricted stock, there are no performance-based conditions or any other material conditions applicable to the awards issued.

A summary of the option activity under the Equity Incentive Plan as of June 30, 2013, and changes for the six months then ended, is presented below:

	June 30, 2013
	Shares			Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding, January 1, 2013		78,469		$	8.27
Granted		—			—
Exercised		(13,774	)		8.10
Forfeited or expired		—			—
Outstanding, June 30, 2013		64,695		$	8.31		8.09	$	352
Exercisable, June 30, 2013		15,730		$	8.10		7.98	$	89

Stock-based compensation expense for stock options for the six month periods ended June 30, 2013 and 2012 was $33 and $30, respectively.

As of June 30, 2013, total unrecognized compensation costs related to nonvested stock options amounted to $205. That cost is expected to be recognized over a weighted-average period of 3.09 years.   

A summary of the status of the Company’s nonvested stock options as of June 30, 2013, and changes during the six month period then ended, is presented below:

	Shares		Weighted- Average Grant-Date  Fair Value
Nonvested, January 1, 2013		63,717	$	4.20
Granted		—		—
Vested		14,752		4.11
Forfeited		—		—
Nonvested, June 30, 2013		48,965	$	4.23

10

The following table summarizes the nonvested restricted stock activity for the six months ended June 30, 2013:

	Shares		Weighted Average Grant-Date Fair Value
Nonvested at December 31, 2012		23,854	$	8.10
Granted		—		—
Vested		5,964		8.10
Forfeited		—		—
Nonvested at June 30, 2013		17,890	$	8.10

The fair value of the restricted stock awards is amortized to compensation expense over the vesting period (five years) and is based on the market price of the Company’s common stock at the date of grant multiplied by the number of shares granted that are expected to vest. At the date of grant the par value of the shares granted was recorded in equity as a credit to common stock and a debit to paid-in capital. Stock-based compensation expense for restricted stock for the six month periods ended June 30, 2013 and 2012 was $24 and $36, respectively. Unrecognized compensation expense for nonvested restricted stock awards was $145 at June 30, 2013 and is expected to be recognized over a weighted average period of 3.0 years.

Total compensation expense under the Equity Incentive Plan for the six month periods ended June 30, 2013 and 2012 was $57 and $66, respectively.

Note 4: Earnings Per Common Share (“EPS”)

Basic and diluted earnings per common share are presented for the three-month and six-month periods ended June 30, 2013 and 2012. The factors used in the earnings per common share computation follow:

	Three Months Ended June 30, 2013			Three Months Ended June 30, 2012			Six Months Ended June 30, 2013			Six Months  Ended June 30, 2012
Net income	$	194		$	85		$	353		$	236
Net income allocated to participating securities		(4	)		—			(8	)		—
Net income allocated to common stock	$	190		$	85		$	345		$	236
Basic weighted average shares outstanding		811,035			790,966			806,443			790,966
Less: Average unallocated ESOP shares		(48,476	)		(52,661	)		(48,999	)		(53,184	)
Basic average shares outstanding		762,559			738,305			757,444			737,782
Diluted effect of stock options		6,145			—			5,167			—
Diluted effect of restricted stock awards		2,569			4,533			2,654			3,689
Diluted average shares outstanding		771,273			742,838			765,265			741,471
Basic earnings per share	$	.25		$	.12		$	.45		$	.32
Diluted earnings per share	$	.25		$	.11		$	.45		$	.32

Options to purchase 73,761 shares at a weighted-average exercise price of $8.10 were outstanding at June 30, 2012, but were not included in the computation of diluted earnings per share as the options were considered antidilutive for the periods ended June 30, 2012.

11

Note 5:         Securities Purchased Under Agreements to Resell

The Company enters into purchases of securities under agreements to resell. The amounts advanced under these agreements were $20,909 and $19,014 at June 30, 2013 and December 31, 2012, respectively, and represent short-term cash investment alternatives. These agreements are over-collateralized by 103% with collateral consisting of securities guaranteed by the “full faith and credit” of the United States government, typically SBA securities. During the period, the securities were delivered by appropriate entry into the third-party custodian’s account designated by the Company under a written custodial agreement that explicitly recognizes the Company’s interest in the securities. At June 30, 2013 and December 31, 2012, these agreements mature by notice by the Company or 30 days by the custodian.

At June 30, 2013 and December 31, 2012, agreements to resell securities purchased were outstanding with the following entities:

	June 30, 2013		December 31, 2012
BCM High Income Fund, LP	$	9,450	$	8,053
Coastal Securities		5,898		10,508
First Farmers Financial		5,561		—
HEC Opportunity Fund		—		453
Total	$	20,909	$	19,014

Note 6:        Securities

The amortized cost and approximate fair value of securities, together with gross unrealized gains and losses, of securities are as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available-for-sale Securities:
June 30, 2013:
U.S. government agencies	$	989	$	—	$	(14	)	$	975
State and political subdivisions		4,019		1		(69	)		3,951
Mortgage-backed:
Government-sponsored enterprises (GSE) – residential		699		17		—			716
Equity securities		452		25		—			477
	$	6,159	$	43	$	(83	)	$	6,119
December 31, 2012:
U.S. Government and federal agency	$	3,194	$	5	$	(14	)	$	3,185
Mortgage-backed:
Government-sponsored enterprises (GSE) – residential		758		21		—			779
State and political subdivisions		3,467		5		(23	)		3,449
Equity securities		450		16		—			466
	$	7,869	$	47	$	(37	)	$	7,879

12

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Held-to-maturity Securities:
June 30, 2013:
U.S. government agencies	$	500	$	12	$	—	$	512
Mortgage-backed:
Government-sponsored enterprises (GSE) – residential		15		—		—		15
Private-label residential		425		14		—		439
	$	940	$	26	$	—	$	966
December 31, 2012:
U.S. Government agencies	$	500	$	21	$	—	$	521
Mortgage-backed:
Government-sponsored enterprises (GSE) – residential		17		1		—		18
Private-label residential		746		29		—		775
	$	1,263	$	51	$	—	$	1,314

The Company held no securities of a single issuer at June 30, 2013 or December 31, 2012 with a book value that exceeded 10% of total equity, with the exception of obligations of U.S. Treasury and other U.S. government agencies and corporations.

Available for sale equity securities consist of shares in the Shay Asset Management mutual funds, shares of FHLMC common stock, and shares in other financial institutions. Other than temporary impairments recorded for the six month periods ended June 30, 2013 and 2012 totaled $0 and $1, respectively.

As of June 30, 2013 and December 31, 2012, the Company held investments in Shay Asset Management mutual funds with a fair value of $444 and $447. The investments in mutual funds are valued using available market prices. Management performed an analysis and deemed the remaining investment in the mutual funds was not other than temporarily impaired as of June 30, 2013 and December 31, 2012.

As of June 30, 2013 and December 31, 2012, the Company held investments in FHLMC common stock with a fair value of $10 and $2, respectively. The investments in FHLMC common stock is valued using available market prices. Management performed an analysis and deemed the remaining investment in FHLMC common stock was not other than temporarily impaired as of June 30, 2013 and December 31, 2012.

As of June 30, 2013 and December 31, 2012, the Company held investments in other equity securities with a fair value of $23 and $17, respectively. The Company recorded other-than-temporary impairments on other equity securities of $0 and $1 for the six month periods ended June 30, 2013 and 2012, respectively. Management performed an analysis and deemed the remaining investment in other equity securities was not other than temporarily impaired as of June 30, 2013 and December 31, 2012.

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes was $1,136 and $934 as of June 30, 2013 and December 31, 2012, respectively.

There were no sales of available-for-sale securities for the six months ended June 30, 2013 and 2012.

13

The amortized cost and fair value of available-for-sale securities and held-to-maturity securities at June 30, 2013, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available-for-sale				Held-to-maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Within one year	$	533	$	533	$	500	$	512
One to five years		3,043		3,010		—		—
Five to ten years		1,432		1,383		—		—
After ten years		—		—		—		—
		5,008		4,926		500		512
Mortgage-backed securities		699		716		440		454
Equity securities		452		477		—		—
Totals	$	6,159	$	6,119	$	940	$	966

Certain investments in debt and marketable equity securities are reported in the financial statements at amounts less than their historical cost. Total fair value of these investments at June 30, 2013 and December 31, 2012 was $4,411 and $2,846, respectively, which is approximately 62% and 31% of the Company’s available-for-sale and held-to-maturity investment portfolio. These declines primarily resulted from recent increases in market interest rates. Management believes the declines in fair value for these securities are not other-than-temporary.

The following table shows the Company’s securities’ gross unrealized losses and fair value of the Company’s securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2013 and December 31, 2012:

	June 30, 2013
	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Available-for-sale:
U.S. government and federal agency	$	500	$	(1	)	$	475	$	(13	)	$	975	$	(14	)
State and political subdivisions		2,931		(64	)		505		(5	)		3,436		(69	)
Total temporarily impaired securities	$	3,431	$	(65	)	$	980	$	(18	)	$	4,411	$	(83	)

	December 31, 2012
	Less than 12 Months					12 Months or More				Total
Description of Securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available-for-sale:
U.S. government and federal agency	$	472	$	(14	)	$	—	$	—	$	472	$	(14	)
State and political subdivisions		2,374		(23	)		—		—		2,374		(23	)
Total temporarily impaired securities	$	2,846	$	(37	)	$	—	$	—	$	2,846	$	(37	)

14

Note 7:        Loans

Classes of loans include:

	June 30, 2013			December 31, 2012
Mortgage loans on real estate
One-to-four family	$	40,194		$	41,842
Home equity lines of credit and other 2nd mortgages		8,539			9,431
Multi-family residential		120			51
Commercial		19,107			19,989
Farmland		12,661			11,765
Construction and land development		855			1,837
Total mortgage loans on real estate		81,476			84,915
Commercial and industrial		5,814			5,407
Agricultural		23,130			20,096
Purchased indirect automobile, net of dealer reserve		7,976			6,987
Other consumer		110			117
		118,506			117,522
Less
Net deferred loan fees and costs		(7	)		(4	)
Allowance for loan losses		2,563			2,550
Net loans	$	115,950		$	114,976

The Company believes that sound loans are a necessary and desirable means of employing funds available for investment. Recognizing the Company’s obligations to its depositors and to the communities it serves, authorized personnel are expected to seek to develop and make sound, profitable loans that resources permit and that opportunity affords. The Company maintains lending policies and procedures in place designed to focus our lending efforts on the types, locations, and duration of loans most appropriate for our business model and markets. The Company’s principal lending activity is the origination of one-to four-family residential mortgage loans but also includes commercial real estate loans, farmland loans, commercial and industrial, home equity, construction, agricultural and other loans. The primary lending market is McHenry, Grundy and to a lesser extent Boone Counties in Illinois and Walworth County in Wisconsin. Generally, loans are collateralized by assets, primarily real estate, of the borrowers and guaranteed by individuals.  The loans are expected to be repaid from cash flows of the borrowers or from proceeds from the sale of selected assets of the borrowers.

Pursuant to applicable law, the aggregate amount of loans that the Company is permitted to make to any one borrower or a group of related borrowers is generally limited to 25% of our total capital plus the allowance for loan losses.

Our lending is subject to written underwriting standards and origination procedures. Decisions on loan applications are made on the basis of detailed applications submitted by the prospective borrower and property valuations (consistent with our appraisal policy) prepared by outside independent licensed appraisers approved by our board of directors as well as internal evaluations, where permitted by regulations. The loan applications are designed primarily to determine the borrower’s ability to repay the requested loan, and the more significant items on the application are verified through use of credit reports, financial statements and tax returns.

Under our loan policy, the individual processing an application is responsible for ensuring that all documentation is obtained prior to the submission of the application to an officer for approval. An officer then reviews these materials and verifies that the requested loan meets our underwriting guidelines described below.

All one-to-four family residential loans up to $500,000, vacant land loans up to $250,000, and any consumer loans require approval of a quorum of our retail loan committee consisting of five officers. All such loan approvals are reported at the next board meeting following said approval. All secured commercial loans, including agricultural loans, up to $1,500,000 and unsecured loans up to $250,000 must be approved by our commercial credit management committee, which currently consists of our Chief Executive Officer, Executive Vice President, Secretary – Treasurer and our Vice President – Commercial Loan Officer. These approvals are reported at the next board meeting following said approval. All other loans must be approved by the board.

15

Generally, title insurance or title searches on our mortgage loans are required as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property, depending on the type of loan.

One-to-Four Family Residential Mortgage Loans

The cornerstone of our lending program has long been the origination of long-term permanent loans secured by mortgages on owner-occupied one-to-four family residences. Virtually all of the residential loans originated are secured by properties located in our market area.

Due to consumer demand in the current low market interest rate environment, many of our recent originations are 10- to 30-year fixed-rate loans secured by one-to-four family residential real estate. The Company generally originates fixed-rate one-to-four family residential loans in accordance with secondary market standards to permit their sale. During the last several years, consistent with our asset-liability management strategy, most of the fixed rate one-to-four family residential loans we originated with original terms to maturity in excess of ten years were sold in the secondary market.

During recent years, as a part of our asset/liability management policy, seven-year balloon loans with up to 30-year amortization schedules secured by one-to-four family real estate have been originated.

In order to reduce the term to repricing of the loan portfolio, adjustable-rate one-to-four family residential mortgage loans were originated. However, our ability to originate such loans is limited in the current low interest rate environment due to low consumer demand. Our current adjustable-rate mortgage loans carry interest rates that adjust annually at a margin over the one year U.S. Treasury index. Many of our adjustable-rate one-to-four family residential mortgage loans have fixed rates for initial terms of three to five years. Such loans carry terms to maturity of up to 30 years. The adjustable-rate mortgage loans currently offered by the Company generally provide for a 200 basis point annual interest rate change cap and a lifetime cap of 600 basis points over the initial rate.

Although adjustable-rate mortgage loans may reduce to an extent our vulnerability to changes in market interest rates because they periodically reprice as interest rates increase, the required payments due from the borrower also increase (subject to rate caps), increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustments of the contractual interest rate are also limited by the maximum periodic and lifetime rate adjustments permitted by our loan documents. Moreover, the interest rates on many of our adjustable-rate loans do not adjust for the first three to five years. As a result, the effectiveness of adjustable-rate mortgage loans may be limited during periods of rapidly rising interest rates.

The Company evaluates both the borrower’s ability to make principal, interest and escrow payments and the value of the property that will secure the loan. One-to-four family residential mortgage loans do not currently include prepayment penalties, are non-assumable and do not produce negative amortization. One-to-four family residential mortgage loans customarily include due-on-sale clauses giving the Company the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells the property subject to the mortgage. Residential mortgage loans are originated for our portfolio with loan-to-value ratios of up to 75% for one-to-four family homes, with higher limits applicable to loans with private mortgage insurance on owner-occupied residences.

Commercial Real Estate Loans

In an effort to enhance the yield and reduce the term to maturity of our loan portfolio, the Company has sought to increase its commercial real estate loans. Most of the commercial real estate loans have balloon loan terms of three to ten years with amortization terms of 15 to 25 years and fixed interest rates. The maximum loan-to-value ratio of the commercial real estate loans is generally 75%.

The Company considers a number of factors in originating commercial real estate loans. The qualifications and financial condition of the borrower are evaluated, including credit history, profitability and expertise, as well as the value and condition of the property securing the loan. When evaluating the qualifications of the borrower, the financial resources of the borrower, the borrower’s experience in owning or managing similar property and the borrower’s payment history with the Company and other financial institutions are considered. In evaluating the property securing the loan, the factors considered include the net operating income of the mortgaged property before debt service and depreciation, the ratio of the loan amount to the appraised value of the mortgaged property and the debt service coverage ratio (the ratio of net operating income to debt service). All commercial real estate loans are appraised by outside independent appraisers approved by the board of directors or by internal evaluations, where permitted by regulation. Personal guarantees are generally obtained from the principals of commercial real estate loans.

16

Loans secured by commercial real estate generally are larger than one-to-four family residential loans and involve greater credit risk. Commercial real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Repayment of these loans depends to a large degree on the results of operations and management of the properties securing the loans or the businesses conducted on such property, and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of these loans makes them more difficult for management to monitor and evaluate.

Multi-Family Real Estate Loans

The Company has a limited number of loans on multi-family residences in our market area. Such loans have terms and are underwritten similarly to our commercial real estate loans and are subject to similar risks.

Home Equity Loans

The Company originates variable-rate home equity lines-of-credit and, to a lesser extent, fixed-rate loans secured by junior liens on the borrower’s primary residence. Home equity lines-of-credit are generally limited to 70% of the property value less any other mortgages. Fixed rate other second mortgages are generally limited to 75% of the property value less any other mortgages. Prior to 2009, home equity loans were originated up to 90% of the property value to our customers where we serviced their first lien mortgage loan. The same underwriting standards are used for home equity lines-of-credit and loans as used for one-to-four family residential mortgage loans. The home equity line-of-credit product carries an interest rate tied to the prime rate published in the Wall Street Journal. The product has a rate ceiling of 18%. Home equity loans with fixed-rate terms typically amortize over a period of up to 20 years. Home equity lines-of-credit provide for an initial draw period of up to five years, with monthly payments of interest calculated on the outstanding balance. At the end of the initial five years, the line may be paid in full or restructured at our then current home equity program.

Construction and Land Development Loans

The Company has construction loans to builders and developers for the construction of one- to four- and multi-family residential units and to individuals for the construction of their primary or secondary residence. The Company has a limited amount of land loans to developers, primarily for the purpose of developing residential subdivisions.

The application process includes a submission of plans, specifications, and costs of the project to be constructed or developed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current appraised value and/or the cost of construction (land plus building). Construction loan agreements generally provide that loan proceeds are disbursed in increments as construction progresses. Outside independent licensed appraisers or title company representatives under a construction loan escrow agreement inspect the progress of the construction of the dwelling before disbursements are made.

The Company has construction loans for commercial development projects such as multi-family, apartment and other commercial buildings. These loans generally have an interest-only phase during construction then convert to permanent financing. Disbursements of construction loan funds are at our discretion based on the progress of construction. The maximum loan-to-value ratio limit applicable to these loans is generally 75%.

The Company has loans to builders and developers for the development of one-to-four family lots in our market area. These loans have terms of five years or less. Land loans are generally made in amounts up to a maximum loan-to-value ratio of 65% on raw land and up to 75% on developed building lots based upon an independent appraisal. Personal guarantees are obtained for land loans.

Loans to individuals for the construction of their residences typically run for up to twelve months and then convert to permanent loans. These construction loans have rates and terms comparable to one-to-four family residential loans offered. During the construction phase, the borrower pays interest only at a fixed rate. The maximum loan-to-value ratio of owner-occupied single-family construction loans is 75%, 80% if the permanent loan has been approved to be sold in the secondary market. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential loans.

17

Construction and land lending generally affords the Company an opportunity to receive higher origination and other loan fees. In addition, such loans are generally made for relatively short terms. Nevertheless, construction and land lending to persons other than owner-occupants is generally considered to involve a higher level of credit risk than one-to-four family residential lending due to the concentration of principal in a limited number of loans and borrowers and the effects of general economic conditions on construction projects, real estate developers and managers. In addition, the nature of these loans is such that they are more difficult to evaluate and monitor. Risk of loss on a construction or land loan is dependent largely upon the accuracy of the initial estimate of the property’s value upon completion of the project and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, the Company may be confronted, at or prior to the maturity of the loan, with a project with a value which is insufficient to assure full repayment and/or the possibility of having to make substantial investments to complete and sell the project. Because defaults in repayment may not occur during the construction period, it may be difficult to identify problem loans at an early stage. When loan payments become due, the cash flow from the property may not be adequate to service the debt. In such cases, the Company may be required to modify the terms of the loan.

Farmland Loans

These loans are primarily secured by farmland located in our market area. Adjustable rate farmland loans have interest rates that generally adjust every one, three or five years in accordance with a designated index and are generally amortized over 15-25 years. Fixed-rate farmland loans generally are for terms of up to 15 years, although many are amortized over longer periods, and include a balloon payment at maturity. Lending policies on such loans generally limit the maximum loan-to-value ratio to 75% of the lesser of the appraised value or purchase price of the property.

While earning higher yields on agricultural mortgage loans than on single-family residential mortgage loans, agricultural-related lending involves a greater degree of risk than single-family residential mortgage loans because of the typically larger loan amounts and potential volatility in the market. In addition, repayments on agricultural loans are substantially dependent on the successful operation of the underlying business and the value of the property collateralizing the loan, both of which are affected by many factors, such as weather and changing market prices, outside the control of the borrower. Finally, some commentators believe that the recent sharp increases in farm land prices could make a price correction more likely.

Substantially all farmland loans are underwritten to conform to agency guidelines to qualify for a government guarantee of up to 90% of the original loan amount, which in turn qualifies them to be sold to a variety of investors in the secondary market. Once the government guarantee is secured from Farmers Home Loan Administration, the guarantee covers up to 90% of any loss on the loan. Longer-term fixed-rate agricultural mortgage loans may be sold in the secondary market, which the Company services for the secondary market purchaser.

Commercial and Industrial Loans

Commercial and industrial loans and lines of credit are originated to small and medium-sized companies in our primary market area. Commercial and industrial loans are generally used for working capital purposes or for acquiring equipment, inventory or furniture. Commercial and industrial loans generally carry a floating-rate indexed to the prime rate as published in The Wall Street Journal and a one-year term. All commercial and industrial loans are secured.

When making commercial and industrial loans, the financial statements of the borrower, the lending history of the borrower, the debt service capabilities of the borrower, the projected cash flows of the business, the value of the collateral, if any, and whether the loan is guaranteed by the principals of the borrower are considered. Commercial and industrial loans are generally secured by accounts receivable, inventory, equipment and personal guarantees.

Commercial and industrial loans generally have a greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial and industrial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial and industrial loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. These risks are minimized through underwriting standards and personal guarantees.

18

Agricultural Loans

Agricultural operating lines of credit generally have terms of one year and are secured by growing crops, livestock and equipment, and mortgages on the farmland. Intermediate-term loans have terms of 2-7 years and will be secured by machinery and equipment. Generally these loans are extended to farmers in our market area for the purchase of equipment, seed, fertilizer, insecticide and other purposes in connection with agricultural production. The maximum term for equipment secured loans is tied to the useful life of the underlying collateral but generally does not exceed 10 years. The interest rate is generally increased with respect to the longer terms loans due to the rate exposure of these loans. The amount of the commitment is based on management’s review of the borrower’s business plan, prior performance, marketability of crops, and current market prices. Recent financial statements are examined and evaluate cash flow analysis and debt-to-net worth, and liquidity ratios. Loans for crop production generally require 75% or more crop insurance coverage.

The repayment of agricultural business loans generally is dependent on the successful operation of a farm and can be adversely affected by fluctuations in crop prices, increase in interest rates, and changes in weather conditions. These developments may result in smaller harvests and less income for farmers which may adversely affect such borrower’s ability to repay a loan. Many borrowers also have more than one agricultural business loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose the Company to significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan. Finally, if the Company forecloses on an agricultural commercial loan, our holding period for the collateral, if any, typically is longer than for one-to-four family residential mortgage loans because there are fewer potential purchasers of the collateral.

Consumer Loans

The Company has secured and unsecured loans to consumers. However, during recent years, most consumer lending efforts were focused on purchases of indirect automobile loans.

In an effort to expand and diversify our loan portfolio and increase the overall yield on our loan portfolio, since 1999 the Company has purchased indirect loans on new and used automobiles located primarily in Cook County, Illinois. Although we do not separately underwrite each purchased loan, we thoroughly review the knowledge and experience of the originators’ management teams, their underwriting standards, and their historical loss rates.

Under the loan purchase arrangement, on a monthly basis the seller aggregates indirect automobile loans into separate loan pools. The pools are then segregated into risk categories with each category having predefined limits as to the maximum amounts allowed. Generally, the pools are sold without recourse. The Company receives a listing of the individual loans in the pool, including loan and borrower information prior to funding the purchase but the Company is not generally permitted to substitute loans in a pool or purchase part of a pool.

The seller is responsible for dealer relationships and the monitoring of their performance. The seller performs all servicing functions including the collection of principal, interest, and fees as well as repossessions and recoveries. Thus, the Company is not involved in the sale of repossessed vehicles.

The Company performs semi-annual reviews of newly purchased loan files and review operational procedures as part of our internal audit function.

Consumer loans may entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances as well as the economy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

19

The following tables present the activity in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method for the three and six months ended June 30, 2013 and 2012, and the year ended December 31, 2012:

	Three Months Ended June 30, 2013
	Mortgage Loans on Real Estate
	1-4 Family			HELOC and 2nd Mortgage			Multi-Family Residential		Commercial		Farmland		Construction and Land Development
Allowance for loan losses:
Balance, beginning of period	$	739		$	332		$	3	$	654	$	181	$	62
Provision charged to expense		(53	)		(20	)		3		73		9		1
Losses charged off		(23	)		(6	)		—		—		—		—
Recoveries		—			—			—		—		—		—
Balance, end of period	$	663		$	306		$	6	$	727	$	190	$	63
Ending balance: individually evaluated for impairment	$	70		$	44		$	—	$	320	$	—	$	16
Ending balance: collectively evaluated for impairment	$	593		$	262		$	6	$	407	$	190	$	47
Loans:
Ending balance	$	40,194		$	8,539		$	120	$	19,107	$	12,661	$	855
Ending balance: individually evaluated for impairment	$	1,998		$	119		$	—	$	2,630	$	—	$	388
Ending balance: collectively evaluated for impairment	$	38,196		$	8,420		$	120	$	16,477	$	12,661	$	467

	Three Months Ended June 30, 2013 (Continued)
	Commercial and Industrial		Agricultural		Purchased Indirect Automobile, Net			Other Consumer			Unallocated		Total
Allowance for loan losses:
Balance, beginning of period	$	128	$	337	$	113		$	1		$	—	$	2,550
Provision charged to expense		6		10		22			(2	)		—		49
Losses charged off		—		—		(9	)		—			—		(38	)
Recoveries		—		—		—			2			—		2
Balance, end of period	$	134	$	347	$	126		$	1		$	—	$	2,563
Ending balance: individually evaluated for impairment	$	4	$	—	$	5		$	—		$	—	$	459
Ending balance: collectively evaluated for impairment	$	130	$	347	$	121		$	1		$	—	$	2,104
Loans:
Ending balance	$	5,814	$	23,130	$	7,976		$	110		$	—	$	118,506
Ending balance: individually evaluated for impairment	$	4	$	—	$	17		$	—		$	—	$	5,156
Ending balance: collectively evaluated for impairment	$	5,810	$	23,130	$	7,959		$	110		$	—	$	113,350

	Three Months Ended June 30, 2012
	Mortgage Loans on Real Estate
	1-4 Family			HELOC and 2nd Mortgage			Multi-Family Residential			Commercial		Farmland		Construction and Land Development
Allowance for loan losses:
Balance, beginning of period	$	602		$	193		$	311		$	603	$	141	$	304
Provision charged to expense		104			(13	)		(23	)		6		—		31
Losses charged off		(63	)		—			—			—		—		—
Recoveries		—			—			—			—		—		—
Balance, end of period	$	643		$	180		$	288		$	609	$	141	$	335
Ending balance: individually evaluated for impairment	$	128		$	56		$	233		$	36	$	—	$	255
Ending balance: collectively evaluated for impairment	$	515		$	124		$	55		$	573	$	141	$	80
Loans:
Ending balance	$	44,217		$	9,829		$	1,999		$	25,292	$	9,429	$	2,581
Ending balance: individually evaluated for impairment	$	2,457		$	167		$	905		$	1,390	$	—	$	971
Ending balance: collectively evaluated for impairment	$	41,760		$	9,662		$	1,094		$	23,902	$	9,429	$	1,610

20

	Three Months Ended June 30, 2012 (Continued)
	Commercial and Industrial			Agricultural		Purchased Indirect Automobile, Net			Other Consumer		Unallocated		Total
Allowance for loan losses:
Balance, beginning of period	$	127		$	270	$	123		$	1	$	—	$	2,675
Provision charged to expense		(3	)		15		17			1		—		135
Losses charged off		—			—		(27	)		—		—		(90	)
Recoveries		—			—		5			—		—		5
Balance, end of period	$	124		$	285	$	118		$	2	$	—	$	2,725
Ending balance: individually evaluated for impairment	$	—		$	—	$	5		$	—	$	—	$	713
Ending balance: collectively evaluated for impairment	$	124		$	285	$	113		$	2	$	—	$	2,012
Loans:
Ending balance	$	5,383		$	19,032	$	7,522		$	162	$	—	$	125,446
Ending balance: individually evaluated for impairment	$	50		$	—	$	16		$	—	$	—	$	5,956
Ending balance: collectively evaluated for impairment	$	5,333		$	19,032	$	7,506		$	162	$	—	$	119,490

	Six Months Ended June 30, 2013
	Mortgage Loans on Real Estate
	1-4 Family			HELOC and 2nd Mortgage			Multi-Family Residential		Commercial		Farmland		Construction and Land Development
Allowance for loan losses:
Balance, beginning of period	$	668		$	333		$	3	$	530	$	176	$	275
Provision charged to expense		97			(21	)		3		197		14		(152	)
Losses charged off		(102	)		(6	)		—		—		—		(60	)
Recoveries		—			—			—		—		—		—
Balance, end of period	$	663		$	306		$	6	$	727	$	190	$	63
Ending balance: individually evaluated for impairment	$	70		$	44		$	—	$	320	$	—	$	16
Ending balance: collectively evaluated for impairment	$	593		$	262		$	6	$	407	$	190	$	47
Loans:
Ending balance	$	40,194		$	8,539		$	120	$	19,107	$	12,661	$	855
Ending balance: individually evaluated for impairment	$	1,998		$	119		$	—	$	2,630	$	—	$	388
Ending balance: collectively evaluated for impairment	$	38,196		$	8,420		$	120	$	16,477	$	12,661	$	467

	Six Months Ended June 30, 2013 (Continued)
	Commercial and Industrial			Agricultural		Purchased Indirect Automobile, Net			Other Consumer			Unallocated		Total
Allowance for loan losses:
Balance, beginning of period	$	151		$	301	$	112		$	1		$	—	$	2,550
Provision charged to expense		(17	)		46		29			(3	)		—		193
Losses charged off		—			—		(17	)		—			—		(185	)
Recoveries		—			—		2			3			—		5
Balance, end of period	$	134		$	347	$	126		$	1		$	—	$	2,563
Ending balance: individually evaluated for impairment	$	4		$	—	$	5		$	—		$	—	$	459
Ending balance: collectively evaluated for impairment	$	130		$	347	$	121		$	1		$	—	$	2,104
Loans:
Ending balance	$	5,814		$	23,130	$	7,976		$	110		$	—	$	118,506
Ending balance: individually evaluated for impairment	$	4		$	—	$	17		$	—		$	—	$	5,156
Ending balance: collectively evaluated for impairment	$	5,810		$	23,130	$	7,959		$	110		$	—	$	113,350

21

	Six Months Ended June 30, 2012
	Mortgage Loans on Real Estate
	1-4 Family			HELOC and 2nd Mortgage			Multi-Family Residential		Commercial		Farmland			Construction and Land Development
Allowance for loan losses:
Balance, beginning of period	$	549		$	248		$	287	$	533	$	143		$	374
Provision charged to expense		167			(66	)		1		76		(2	)		16
Losses charged off		(73	)		(2	)		—		—		—			(55	)
Recoveries		—			—			—		—		—			—
Balance, end of period	$	643		$	180		$	288	$	609	$	141		$	335
Ending balance: individually evaluated for impairment	$	128		$	56		$	233	$	36	$	—		$	255
Ending balance: collectively evaluated for impairment	$	515		$	124		$	55	$	573	$	141		$	80
Loans:
Ending balance	$	44,217		$	9,829		$	1,999	$	25,292	$	9,429		$	2,581
Ending balance: individually evaluated for impairment	$	2,457		$	167		$	905	$	1,390	$	—		$	971
Ending balance: collectively evaluated for impairment	$	41,760		$	9,662		$	1,094	$	23,902	$	9,429		$	1,610

	Six Months Ended June 30, 2012 (Continued)
	Commercial and Industrial			Agricultural		Purchased Indirect Automobile, Net			Other Consumer			Unallocated		Total
Allowance for loan losses:
Balance, beginning of period	$	125		$	215	$	95		$	6		$	—	$	2,575
Provision charged to expense		(1	)		70		51			(4	)		—		308
Losses charged off		—			—		(34	)		—			—		(164	)
Recoveries		—			—		6			—			—		6
Balance, end of period	$	124		$	285	$	118		$	2		$	—	$	2,725
Ending balance: individually evaluated for impairment	$	—		$	—	$	5		$	—		$	—	$	713
Ending balance: collectively evaluated for impairment	$	124		$	285	$	113		$	2		$	—	$	2,012
Loans:
Ending balance	$	5,383		$	19,032	$	7,522		$	162		$	—	$	125,446
Ending balance: individually evaluated for impairment	$	50		$	—	$	16		$	—		$	—	$	5,956
Ending balance: collectively evaluated for impairment	$	5,333		$	19,032	$	7,506		$	162		$	—	$	119,490

	Year Ended December 31, 2012
	Mortgage Loans on Real Estate
	1-4 Family			HELOC and 2nd Mortgage			Multi-Family Residential			Commercial			Farmland		Construction and Land Development
Allowance for loan losses:
Balance, beginning of year	$	549		$	248		$	287		$	533		$	143	$	374
Provision charged to expense		484			109			(284	)		(3	)		33		73
Losses charged off		(365	)		(24	)		—			—			—		(172	)
Recoveries		—			—			—			—			—		—
Balance, end of year	$	668		$	333		$	3		$	530		$	176	$	275
Ending balance: individually evaluated for impairment	$	112		$	48		$	—		$	81		$	—	$	176
Ending balance: collectively evaluated for impairment	$	556		$	285		$	3		$	449		$	176	$	99
Loans:
Ending balance	$	41,842		$	9,431		$	51		$	19,989		$	11,765	$	1,837
Ending balance: individually evaluated for impairment	$	2,484		$	166		$	—		$	1,482		$	—	$	851
Ending balance: collectively evaluated for impairment	$	39,358		$	9,265		$	51		$	18,507		$	11,765	$	986

22

	Year Ended December 31, 2012 (Continued)
	Commercial and Industrial			Agricultural		Purchased Indirect Automobile, Net			Other Consumer			Unallocated		Total
Allowance for loan losses:
Balance, beginning of year	$	125		$	215	$	95		$	6		$	—	$	2,575
Provision charged to expense		42			86		66			(7	)		—		599
Losses charged off		(16	)		—		(59	)		—			—		(636	)
Recoveries		—			—		10			2			—		12
Balance, end of year	$	151		$	301	$	112		$	1		$	—	$	2,550
Ending balance: individually evaluated for impairment	$	7		$	—	$	7		$	—		$	—	$	431
Ending balance: collectively evaluated for impairment	$	144		$	301	$	105		$	1		$	—	$	2,119
Loans:
Ending balance	$	5,407		$	20,096	$	6,987		$	117		$	—	$	117,522
Ending balance: individually evaluated for impairment	$	7		$	—	$	25		$	—		$	—	$	5,015
Ending balance: collectively evaluated for impairment	$	5,400		$	20,096	$	6,962		$	117		$	—	$	112,507

Management’s opinion as to the ultimate collectability of loans is subject to estimates regarding future cash flows from operations and the value of property, real and personal, pledged as collateral.  These estimates are affected by changing economic conditions and the economic prospects of borrowers.

Allowance for Loan Losses

Our allowance for loan losses is the estimated amount considered necessary to reflect probable incurred credit losses in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged against income. In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of the most critical for the Company. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions utilized, and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses.

Since a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans and discounted cash flow valuations of properties are critical in determining the amount of the allowance required for specific loans. Assumptions for appraisals and discounted cash flow valuations are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly impact the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals and discounted cash flow valuations are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans.

Management performs a quarterly evaluation of the allowance for loan losses. Consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the value of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision based on changes in economic and real estate market conditions.

The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment loss is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating classified loans from the remaining loans, and then categorizing each group by type of loan. Loans within each type exhibit common characteristics including terms, collateral type, and other risk characteristics. The Company also analyzes historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allocations.

Although the Company’s policy allows for a general valuation allowance on certain smaller-balance, homogenous pools of loans classified as substandard, the Company has historically evaluated every loan classified as substandard, regardless of size for impairment as part of the review for establishing specific allowances. The Company’s policy also allows for general valuation allowance on certain smaller-balance homogenous pools of loans which are loans criticized as special mention or watch. A separate general allowance calculation is made on these loans based on historical measured weakness, and which is no less than twice the amount of the general allowance calculated on the non-classified loans.

23

There have been no changes to the Company’s accounting policies or methodology from the prior periods.

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. All commercial, agricultural and land development loans are graded at inception of the loan. Subsequently, analyses are performed on an annual basis and grade changes are made as necessary. Interim grade reviews may take place if circumstances of the borrower warrant a more timely review. The Company utilizes an internal asset classification system as a means of reporting problem and potential problem loans. Under the Company’s risk rating system, the Company classifies problem and potential problem loans as “Watch,” “Substandard,” “Doubtful,” and “Loss.” The Company uses the following definitions for risk ratings:

Pass – Loans classified as pass are well protected by the ability of the borrower to pay or by the value of the asset or underlying collateral.

Watch – Loans classified as watch represent loans with the minimum level of acceptable credit risk and servicing requirements and the borrower has the capacity to perform according to the terms and repayment is expected. However, one or more elements of uncertainty exist.

Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

Loss – Loans classified as loss are the portion of the loan that is considered uncollectible so that its continuance as an asset is not warranted. The amount of the loss determined will be charged-off.

The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of June 30, 2013 and December 31, 2012, respectively:

	June 30, 2013
	Mortgage Loans on Real Estate
	1-4 Family		HELOC and 2nd Mortgage		Multi-Family Residential		Commercial		Farmland		Construction and Land Development
Pass	$	34,759	$	8,234	$	120	$	14,031	$	12,634	$	467
Watch		2,137		89		—		2,362		27		—
Special Mention		1,300		97		—		84		—		—
Substandard		1,998		119		—		2,630		—		388
Total	$	40,194	$	8,539	$	120	$	19,107	$	12,661	$	855

	June 30, 2013 (Continued)
	Commercial and Industrial		Agricultural		Purchased  Indirect Automobile, Net		Other Consumer		Total
Pass	$	4,720	$	23,121	$	7,959	$	110	$	106,155
Watch		988		9		—		—		5,612
Special Mention		102		—		—		—		1,583
Substandard		4		—		17		—		5,156
Total	$	5,814	$	23,130	$	7,976	$	110	$	118,506

24

	December 31, 2012
	Mortgage Loans on Real Estate
	1-4 Family		HELOC and 2nd Mortgage		Multi-Family Residential		Commercial		Farmland		Construction and Land Development
Pass	$	37,027	$	9,012	$	51	$	16,036	$	11,765	$	986
Watch		1,460		218		—		2,386		—		—
Special Mention		871		35		—		85		—		—
Substandard		2,484		166		—		1,482		—		851
Total	$	41,842	$	9,431	$	51	$	19,989	$	11,765	$	1,837

	December 31, 2012 (Continued)
	Commercial and Industrial		Agricultural		Purchased Indirect Automobile, Net		Other Consumer		Total
Pass	$	3,761	$	20,096	$	6,962	$	117	$	105,813
Watch		1,526		—		—		—		5,590
Special Mention		113		—		—		—		1,104
Substandard		7		—		25		—		5,015
Total	$	5,407	$	20,096	$	6,987	$	117	$	117,522

The accrual of interest on loans is generally discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off at the earlier date if collection of principal and interest is considered doubtful.

All interest accrued but not collected for loans that are placed on non-accrual or charged-off are reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. 

The following tables present the Company’s loan portfolio aging analysis as of June 30, 2013 and December 31, 2012, respectively:

	June 30, 2013
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days & Accruing
Real estate loans:
One-to-four family	$	1,545	$	542	$	1,428	$	3,515	$	36,679	$	40,194	$	162
Home equity lines of credit and other 2nd mortgages		76		—		35		111		8,428		8,539		—
Multi-family		—		—		—		—		120		120		—
Commercial		—		—		—		—		19,107		19,107		—
Farmland		—		—		—		—		12,661		12,661		—
Construction and land development		—		—		388		388		467		855		—
Total real estate loans		1,621		542		1,851		4,014		77,462		81,476		162
Commercial and industrial		—		—		—		—		5,814		5,814		—
Agriculture		—		—		—		—		23,130		23,130		—
Consumer loans:
Purchased indirect automobile		15		—		2		17		7,959		7,976		—
Other		—		—		—		—		110		110		—
Total consumer loans		15		—		2		17		8,069		8,086		—
Total	$	1,636	$	542	$	1,853	$	4,031	$	114,475	$	118,506	$	162

25

	December 31, 2012
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days & Accruing
Real estate loans:
One-to-four family	$	1,464	$	808		1,122	$	3,394	$	38,448	$	41,842	$	—
Home equity lines of credit and other 2nd mortgages		51		14		35		100		9,331		9,431		—
Multi-family		—		—		—		—		51		51		—
Commercial		—		—		—		—		19,989		19,989		—
Farmland		—		—		—		—		11,765		11,765		—
Construction and land development		—		—		—		—		1,837		1,837		—
Total real estate loans		1,515		822		1,157		3,494		81,421		84,915		—
Commercial and industrial		—		—		7		7		5,400		5,407		—
Agriculture		—		—		—		—		20,096		20,096		—
Consumer loans:
Purchased indirect automobile		25		—		—		25		6,962		6,987		—
Other		—		—		—		—		117		117		—
Total consumer loans		25		—		—		25		7,079		7,104		—
Total	$	1,540	$	822	$	1,164	$	3,526	$	113,996	$	117,522	$	—

At June 30, 2013 and December 31, 2012, the Company held $23,130 and $20,096 in agricultural production loans and $12,661 and $11,765, respectively in farmland loans in the Company’s geographic lending area. Generally, those loans are collateralized by assets of the borrower. The loans are expected to be repaid from cash flows or from proceeds of sale of related assets of the borrower. Declines in prices for corn, beans, livestock and farmland could significantly affect the repayment ability for many agricultural and farmland loan customers.

At June 30, 2013 and December 31, 2012, the Company held $19,107 and $19,989 in commercial real estate loans and $855 and $1,837 in loans collateralized by construction and development real estate primarily in the Company’s geographic lending area. Due to national, state and local economic conditions, values for commercial and development real estate have declined significantly, and the market for these properties is depressed.

Loans contractually delinquent 60-89 days or more decreased $280 from December 31, 2012 to $542 at June 30, 2013, and loans contractually delinquent 90 days or more increased $689 from December 31, 2012 to $1,853 at June 30, 2013, primarily as a result of similar movement in delinquent one-to-four family real estate loans and one commercial land development loan, a troubled debt restructuring that is now greater than 90 days past due.

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loans and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Impairment is measured on a loan-by-loan basis by either the present value of the expected future cash flows, the loan’s observable market value, or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. Significant restructured loans are considered impaired in determining the adequacy of the allowance for loan losses.

The Company actively seeks to reduce its investment in impaired loans. The primary tools to work through impaired loans are settlement with the borrowers or guarantors, foreclosure of the underlying collateral, or restructuring.

26

The Company will restructure loans when the borrower demonstrates the inability to comply with the terms of the loan, but can demonstrate the ability to meet acceptable restructured terms. Restructurings generally include one or more of the following restructuring options; reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance, or other actions intended to maximize collection. Restructured loans in compliance with modified terms are initially classified as impaired.

The following tables present impaired loans at June 30, 2013, June 30, 2012 and December 31, 2012, respectively:

	Six Months Ended June 30, 2013
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized		Interest Income Recognized Cash Basis
Loans without a specific allowance
Real estate loans:
One-to-four family	$	1,375	$	1,829	$	—	$	1,572	$	7	$	7
Home equity lines of credit and other 2nd mortgages		34		61		—		70		—		—
Multi-family		—		—		—		—		—		—
Commercial		—		—		—		—		—		—
Farmland		—		—		—		—		—		—
Construction and land development		—		—		—		—		—		—
Total real estate loans		1,409		1,890		—		1,642		7		7
Commercial and industrial		—		—		—		—		—		—
Agriculture		—		—		—		—		—		—
Consumer loans:
Purchased indirect automobile		—		—		—		—		—		—
Other		—		—		—		—		—		—
Total consumer loans		—		—		—		—		—		—
Total loans	$	1,409	$	1,890	$	—	$	1,642	$	7	$	7
Loans with a specific allowance
Real estate loans:
One-to-four family	$	623	$	655	$	70	$	669	$	3	$	3
Home equity lines of credit and other 2nd mortgages		85		87		44		73		1		1
Multi-family		—		—		—		—		—		—
Commercial		2,630		3,056		320		2,056		9		9
Farmland		—		—		—		—		—		—
Construction and land development		388		451		16		619		3		3
Total real estate loans		3,726		4,249		450		3,417		16		16
Commercial and industrial		4		21		4		5		—		—
Agriculture		—		—		—		—		—		—
Consumer loans:
Purchased indirect automobile		17		17		5		21		—		—
Other		—		20		—		—		—		—
Total consumer loans		17		37		5		21		—		—
Total loans		3,747		4,307		459		3,443		16		16
Total	$	5,156	$	6,197	$	459	$	5,085	$	23	$	23

27

	Six Months Ended June 30, 2012
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized		Interest Income Recognized Cash Basis
Loans without a specific allowance
Real estate loans:
One-to-four family	$	943	$	1,021	$	—	$	1,026	$	12	$	12
Home equity lines of credit and other 2nd mortgages		108		110		—		109		1		1
Multi-family		—		—		—		—		—		—
Commercial		—		—		—		695		8		8
Farmland		—		—		—		—		—		—
Construction and land development		—		—		—		—		—		—
Total real estate loans		1,051		1,131		—		1,830		21		21
Commercial and industrial		50		50		—		25		—		—
Agriculture		—		—		—		—		—		—
Consumer loans:
Purchased indirect automobile		—		—		—		—		—		—
Other		—		—		—		—		—		—
Total consumer loans		—		—		—		—		—		—
Total loans	$	1,101	$	1,181	$	—	$	1,855	$	21	$	21
Loans with a specific allowance
Real estate loans:
One-to-four family	$	1,514	$	1,538	$	128	$	2,090	$	24	$	24
Home equity lines of credit and other 2nd mortgages		59		59		56		108		1		1
Multi-family		905		965		233		911		10		10
Commercial		1,390		1,390		36		695		8		8
Farmland		—		—		—		—		—		—
Construction and land development		971		1,106		255		999		11		11
Total real estate loans		4,839		5,058		708		4,803		54		54
Commercial and industrial		—		—		—		25		1		1
Agriculture		—		—		—		—		—		—
Consumer loans:
Purchased indirect automobile		16		16		5		12		—		—
Other		—		—		—		3		—		—
Total consumer loans		16		16		5		15		—		—
Total loans		4,855		5,074		713		4,843		55		55
Total	$	5,956	$	6,255	$	713	$	6,698	$	76	$	76

28

	Three Months Ended June 30, 2013						Three Months Ended June 30, 2012
	Average Investment in Impaired Loans		Interest Income Recognized		Interest Income Recognized Cash Basis		Average Investment in Impaired Loans		Interest Income Recognized		Interest Income Recognized Cash Basis
Loans without a specific allowance
Real estate loans:
One-to-four family	$	1,429	$	3	$	3	$	967	$	3	$	3
Home equity lines of credit and other 2nd mortgages		53		—		—		108		—		—
Multi-family		—		—		—		—		—		—
Commercial		344		1		1		—		—		—
Farmland		—		—		—		—		—		—
Construction and land development		188		—		—		—		—		—
Total real estate loans		2,014		4		4		1,075		3		3
Commercial and industrial		—		—		—		45		—		—
Agriculture		—		—		—		—		—		—
Consumer loans:
Purchased indirect automobile		—		—		—		—		—		—
Other		—		—		—		—		—		—
Total consumer loans		—		—		—		—		—		—
Total loans	$	2,014	$	4	$	4	$	1,120	$	3	$	3
Loans with a specific allowance
Real estate loans:
One-to-four family	$	896	$	2	$	2	$	2,057	$	6	$	6
Home equity lines of credit and other 2nd mortgages		89		—		—		69		—		—
Multi-family		—		—		—		908		2		2
Commercial		2,010		—		—		1,390		4		4
Farmland		—		4		4		—		—		—
Construction and land development		401		1		1		972		3		3
Total real estate loans		3,396		7		7		5,396		15		15
Commercial and industrial		4		—		—		25		—		—
Agriculture		—		—		—		—		—		—
Consumer loans:
Purchased indirect automobile		18		—		—		13		—		—
Other		—		—		—		—		—		—
Total consumer loans		18		—		—		13		—		—
Total loans		3,418		7		7		5,434		15		15
Total	$	5,432	$	11	$	11	$	6,554	$	18	$	18

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	December 31, 2012
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized		Interest Income Recognized Cash Basis
Loans without a specific allowance
Real estate loans:
One-to-four family	$	1,770	$	2,130	$	—	$	1,439	$	24	$	24
Home equity lines of credit and other 2nd mortgages		106		127		—		109		2		2
Multi-family		—		—		—		—		—		—
Commercial		—		—		—		695		11		11
Farmland		—		—		—		—		—		—
Construction and land development		—		—		—		—		—		—
Total real estate loans		1,876		2,257		—		2,243		37		37
Commercial and industrial		—		17		—		—		—		—
Agriculture		—		—		—		—		—		—
Consumer loans:
Purchased indirect automobile		—		—		—		—		—		—
Other		—		23		—		—		—		—
Total consumer loans		—		23		—		—		—		—
Total	$	1,876	$	2,297	$	—	$	2,243	$	37	$	37
Loans with a specific allowance
Real estate loans:
One-to-four family	$	714	$	722	$	112	$	1,690	$	28	$	28
Home equity lines of credit and other 2nd mortgages		60		60		48		108		2		2
Multi-family		—		—		—		459		8		8
Commercial		1,482		1,482		81		741		12		12
Farmland		—		—		—		—		—		—
Construction and land development		851		1,103		176		939		15		15
Total real estate loans		3,107		3,367		417		3,937		65		65
Commercial and industrial		7		7		7		29		1		1
Agriculture		—		—		—		—		—		—
Consumer loans:
Purchased indirect automobile		25		25		7		17		—		—
Other		—		—		—		2		—		—
Total consumer loans		25		25		7		19		—		—
Total loans		3,139		3,399		431		3,985		66		66
Total	$	5,015	$	5,696	$	431	$	6,228	$	103	$	103

Interest income recognized on impaired loans includes interest accrued and collected on the outstanding balances of accruing impaired loans as well as interest cash collections on non-accruing impaired loans for which the ultimate collectability of principal is not uncertain.

Included in certain loan categories in the impaired loans are troubled debt restructurings (“TDR”), where economic concessions have been granted to borrowers who have experienced financial difficulties that were classified as impaired. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  TDRs are considered impaired at the time of restructuring and typically are returned to accrual status after considering the borrower’s sustained repayment performance for a reasonable period of at least twelve months.

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When loans and leases are modified into a TDR, the Company evaluates any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan or lease agreement, or based on the current fair value of the collateral, less selling costs for collateral dependent loans.  If the Company determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance.  In periods subsequent to modification, the Company evaluates all TDRs, including those that have payment defaults, for possible impairment and recognizes impairment through the allowance.

Given the current adverse economic environment and negative outlook in the residential real estate market, the Company includes in its methodology for the valuation of loans in its real estate portfolio a methodology that applies downward “qualitative” adjustments to the real estate appraised values for residential loans that are deemed impaired. We believe that these qualitative appraisal adjustments more accurately reflect real estate values in light of the sales experience and economic conditions that we have recently observed.

The following table presents the recorded balance of troubled debt restructurings as of June 30, 2013 and December 31, 2012:

	June 30, 2013		December 31, 2012
Real estate loans:
One-to-four family	$	1,992	$	1,814
Home equity lines of credit and other 2nd mortgages		—		6
Multi-family		—		—
Commercial		—		1,482
Farmland		—		—
Construction and land development		388		851
Total real estate loans		2,380		4,153
Commercial and industrial		—		—
Agriculture		—		—
Consumer loans:
Purchased indirect automobile		—		—
Other		—		—
Total consumer loans		—		—
Total	$	2,380	$	4,153

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The following table represents loans modified as troubled debt restructures during the three and six month periods ended June 30, 2013 and 2012:

	Three Months Ended				Three Months Ended
	June 30, 2013				June 30, 2012
	Number of		Recorded		Number of		Recorded
	Modifications		Investment		Modifications		Investment
Real estate loans:
One-to-four family		—	$	—		—	$	—
Home equity lines of credit and other 2nd mortgages		—		—		—		—
Multi-family		—		—		—		—
Commercial		—		—		—		—
Farmland		—		—		—		—
Construction and land development		—		—		—		—
Total real estate loans		—		—		—		—
Commercial and industrial		—		—		—		—
Agriculture		—		—		—		—
Consumer loans:
Purchased indirect automobile		—		—		—		—
Other		—		—		—		—
Total consumer loans		—		—		—		—
Total		—	$	—		—	$	—

	Six Months Ended				Six Months Ended
	June 30, 2013				June 30, 2012
	Number of		Recorded		Number of		Recorded
	Modifications		Investment		Modifications		Investment
Real estate loans:
One-to-four family		1	$	245		1	$	65
Home equity lines of credit and other 2nd mortgages		—		—		—		—
Multi-family		—		—		—		—
Commercial		—		—		1		1,390
Farmland		—		—		—		—
Construction and land development		—		—		—		—
Total real estate loans		1		245		2		1,455
Commercial and industrial		—		—		—		—
Agriculture		—		—		—		—
Consumer loans:
Purchased indirect automobile		—		—		—		—
Other		—		—		—		—
Total consumer loans		—		—		—		—
Total		1	$	245		2	$	1,455

During the six month period ended June 30, 2013, the Company modified one residential real estate loan, with a recorded investment of $245 prior to modification, which was deemed a TDR. The modification involved both an interest rate and maturity concession, which resulted in an impairment loss of $16 based upon the present value of expected future cash flows.

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During the six month period ended June 30, 2012, the Company modified one residential real estate loan, with a recorded investment of $65 prior to modification, which was deemed a TDR. The modification involved both an interest rate and maturity concession, which resulted in an impairment loss of $1 based upon the present value of the expected future cash flows. During the six months ended June 30, 2012, the Company modified one commercial real estate loan totaling $1,390 involving a maturity concession only, which resulted in no impairment loss and specific allowances of $36 based upon the fair value of the collateral.

As of June 30, 2013 and 2012 there were no loans in default that had been modified within the previous 12 months as TDR. As of June 30, 2013, there were two TDRs secured by one-to-four family real estate totaling $487 and one TDR secured by commercial land for development of $388, in default.

The following table presents the Company’s nonaccrual loans at June 30, 2013 and December 31, 2012. Nonaccrual loans include troubled debt restructurings of $1,267 and $3,219 at June 30, 2013 and December 31, 2012, respectively.

	June 30, 2013		December 31, 2012
Mortgages on real estate:
One-to-four family	$	1,896	$	2,484
Home equity lines of credit and other 2nd mortgages		119		166
Multi-family residential		—		—
Commercial		2,630		1,482
Construction and land development		388		851
Commercial and industrial		4		7
Consumer Loans:
Purchased indirect automobile		2		—
Other consumer		—		—
Total	$	5,039	$	4,990

Note 8:        Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss), included in stockholders’ equity at June 30, 2013 and December 31, 2012, are summarized as follows:

	June 30, 2013			December 31, 2012
Net unrealized gain (loss) on securities available-for-sale	$	(40	)	$	10
Tax effect		14			(3	)
Net-of-tax amount	$	(26	)	$	7

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Note 9: Income Taxes

A reconciliation of the income tax expense at the statutory rate to the Company’s actual income tax expense for the six months ended June 30, 2013 and 2012 is shown below:

	Six Months Ended June 30,
	2013			2012
Computed at the statutory rate (34%)	$	147		$	82
Decrease resulting from
Tax exempt interest		(5	)		(1	)
Changes in deferred tax valuation allowance		(59	)		(40	)
Cash surrender value of life insurance		(19	)		(21	)
Other		14			(15	)
Actual expense	$	78		$	5
Tax expense as a percentage of pre-tax income		18.10	%		2.07	%

The decreases in the valuation allowance of $59 and $40 in 2013 and 2012 are due to the reversals of a portion of the previous valuation allowance related to capital losses incurred in prior periods. Management believes the Company has capital gains to enable a portion of the capital losses to be utilized prior to expiration.

Note 10:        Disclosures About Fair Value of Assets and Liabilities

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities

Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

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Recurring Measurements

The following table presents the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2013 and December 31, 2012:

			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
June 30, 2013:
Available-for-sale securities:
US Government and federal agency	$	975	$	—	$	975	$	—
Mortgage-backed securities – GSE residential		716		—		716		—
State and political subdivisions		3,951		—		3,951		—
Equity securities		477		33		444		—
Loan servicing rights		529		—		—		529

			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2012:
Available-for-sale securities:
US Government and federal agency	$	3,185	$	—	$	3,185	$	—
Mortgage-backed securities – GSE residential		779		—		779		—
State and political subdivisions		3,449		—		3,449		—
Equity securities		466		18		448		—
Loan servicing rights		412		—		—		412

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the period ended June 30, 2013. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Available-for-sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows, the inputs of which are market-based or independently

35

sourced market parameters, including, but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows. Such securities are classified in Level 2 of the valuation hierarchy. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

Loan Servicing Rights

Loan servicing rights do not trade in an active, open market with readily observable prices. Accordingly, fair value is estimated using discounted value of estimated future cash flows utilizing contractual cash flows, servicing rate, constant prepayment rate, servicing cost, and discount rate factors. Accordingly, the fair value is estimated based on a valuation model that calculates the present value of estimated future net servicing income. Due to the nature of the valuation inputs, loan servicing rights are classified within Level 3 of the hierarchy.

Level 3 Reconciliation

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs:

	Loan Servicing Rights
Balance, January 1, 2013	$	412
Total realized and unrealized gains and losses included in net income		86
Servicing rights that result from asset transfers		97
Loans refinanced		(66	)
Balance, June 30, 2013	$	529
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date	$	—

Realized and unrealized gains and losses for items reflected in the table above are included in net income in the consolidated statements of income as noninterest income.

Nonrecurring Measurements

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2013 and December 31, 2012:

			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
June 30, 2013:
Impaired loans (collateral dependent)	$	4,697	$	—	$	—	$	4,697
Foreclosed assets		626		—		—		626
December 31, 2012:
Impaired loans (collateral dependent)	$	2,570	$	—	$	—	$	2,570
Foreclosed assets		616		—		—		616

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Following is a description of the valuation methodologies used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Collateral-dependent Impaired Loans, Net of ALLL 

The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell. Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.

The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value. Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Company. Appraisals are reviewed for accuracy and consistency by the Company. Appraisers are selected from the list of approved appraisers maintained by management. The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral. These discounts and estimates are developed by the Company by comparison to historical results. Fair value adjustments on impaired loans were $(126) and $(65) at June 30, 2013 and December 31, 2012.

Foreclosed Assets

Foreclosed assets consist primarily of real estate owned. Real estate owned (OREO) is carried at the lower of fair value at acquisition date or current estimated fair value, less estimated cost to sell when the real estate is acquired. Estimated fair value of OREO is based on appraisals or evaluations. OREO is classified within Level 3 of the fair value hierarchy.

Appraisals of OREO are obtained when the real estate is acquired and subsequently as deemed necessary by management. Appraisals are reviewed for accuracy and consistency by the Company. Appraisers are selected from the list of approved appraisers maintained by management.

Fair value adjustments on foreclosed assets were $(52) at June 30, 2013 compared to $(209) at December 31, 2012.

Unobservable (Level 3) Inputs

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements (dollars in thousands).

	Fair Value at June 30, 2013		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Foreclosed assets	$	626	Market comparable properties	Comparability adjustments (%)	Not available
Collateral-dependent impaired loans		4,697	Market comparable properties	Marketability discount	10%	-	30%	(25%)
Loan servicing rights		529	Discounted cash flow	Discount rate PSA standard prepayment model rate	9%	-	11%	(10%) 476

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	Fair Value at December 31, 2012		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Collateral-dependent impaired loans	$	2,570	Market comparable properties	Marketability discount	10%	-	30%	(22%)
Foreclosed assets		616	Market comparable properties	Comparability adjustments (%)	10%	-	40%	(27%)
Mortgage servicing rights		412	Discounted cash flow	Discount rate PSA standard prepayment model rate	9%	-	11%	(10%) 421

Fair Value of Financial Instruments

The following table presents estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2013.

				Fair Value Measurements Using
		Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant  Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
June 30, 2013:
Financial assets
Cash and cash equivalents	$	24,658	$	24,658	$	—	$	—
Interest-bearing deposits with other financial institutions		8,126		—		8,126		—
Held-to-maturity securities		940		—		966		—
Loans, net of allowance for loan losses		115,950		—		117,697		—
Federal Home Loan Bank stock		870		—		870		—
Accrued interest receivable		738		—		738		—
Financial liabilities
Deposits		131,486		—		129,341		—
Federal Home Loan Bank advances		12,890		—		12,994		—
Advances from borrowers for taxes and insurance		391		—		391		—
Accrued interest payable		27		—		27		—
Unrecognized financial instruments (net of contract amount)
Commitments to originate loans		—		—		—		—
Letters of credit		—		—		—		—
Lines of credit		—		—		—		—

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				Fair Value Measurements Using
		Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
December 31, 2012:
Financial assets
Cash and cash equivalents	$	22,859	$	22,859	$—	$—
Interest-bearing deposits with other financial institutions		9,126		—	9,126	—
Held-to-maturity securities		1,263		—	1,314	—
Loans, net of allowance for loan losses		114,976		—	117,099	—
Federal Home Loan Bank stock		1,404		—	1,404	—
Accrued interest receivable		612		—	612	—
Financial liabilities
Deposits		133,985		—	136,816	—
Federal Home Loan Bank advances		12,357		—	12,682	—
Advances from borrowers for taxes and insurance		382		—	382	—
Accrued interest payable		29		—	29	—
Unrecognized financial instruments (net of contract amount)
Commitments to originate loans		—		—	—	—
Letters of credit		—		—	—	—
Lines of credit		—		—	—	—

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The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying consolidated balance sheets at amounts other than fair value.

Cash and Cash Equivalents, Interest-Bearing Deposits with Other Financial Institutions, Federal Home Loan Bank Stock, Accrued Interest Receivable, Accrued Interest Payable and Advances from Borrowers for Taxes and Insurance

The carrying amount approximates fair value.

Held-to-maturity Securities

Fair value is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans

The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans with similar characteristics were aggregated for purposes of the calculations.

Deposits

Deposits include demand deposits, savings accounts, NOW accounts and certain money market deposits. The carrying amount of these types of deposits approximates fair value. The fair value of fixed-maturity time deposits is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Federal Home Loan Bank Advances

Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt.

Commitments to Originate Loans, Letters of Credit and Lines of Credit

The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements, or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.

Note 11:        Commitments

Commitments to Originate Loans

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 a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.

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Standby Letters of Credit

Standby letters of credit are irrevocable conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Financial standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Performance standby letters of credit are issued to guarantee performance of certain customers under non-financial contractual obligations. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to customers. Should the Company be obligated to perform under the standby letters of credit, the Company may seek recourse from the customer for reimbursement of amounts paid.

Lines of Credit

Lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Lines of credit generally have fixed expiration dates. Since a portion of the line may expire without being drawn upon, the total unused lines do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate. Management uses the same credit policies in granting lines of credit as it does for on-balance-sheet instruments. 

Note 12:        Regulatory Matters

Effective September 2, 2010, the Board of Directors of the Company entered into a memorandum of understanding (the “MOU”) with the Office of Thrift Supervision (the “OTS”). Effective July 21, 2011, the Board of Governors of the Federal Reserve System (the “FRB”) assumed supervisory authority with respect to the MOU.   The MOU, which is an informal enforcement action, requires the Company to take a number of actions, including among other things:

1. review the business plan of its subsidiary, Harvard Savings Bank, and provide the OTS with a written compliance report identifying any instances of Bank’s material non-compliance with its business plan and establishing a target date for correcting any such non-compliance or indicating that a new business plan will be submitted;

2. submit a capital plan (the “Capital Plan”) which shall include, among other things, a minimum tangible capital ratio commensurate with the Company’s consolidated risk profile, capital preservation strategies to achieve and maintain the Board-established minimum tangible equity capital ratio, operating strategies to achieve net income levels that will result in adequate cash flow throughout the term of the Capital Plan, and quarterly pro forma consolidated and unconsolidated financial statements for the period covered by the Capital Plan;

3. submit any material modifications to the Capital Plan to the OTS for its non-objection;

4. update the Capital Plan on an annual basis;

5. prepare and submit quarterly reports comparing projected operating results contained in the Capital Plan to actual results;

6. implement a risk management program which shall, among other things, appoint one or more individuals responsible for implementing and maintaining the program, clearly define the duties of the appointed individual(s), and identify the means and methods to be used to identify and monitor significant risks and trends impacting the Company’s consolidated risk and compliance profile;

7. to not declare or pay any dividends or purchase, repurchase, or redeem, or commit to purchase, repurchase, or redeem any Company stock without the prior written non-objection of the OTS; and

8. to not incur any additional debt at the holding company without the prior written non-objection of the OTS.

The Company has taken the relevant actions to comply with the terms of the agreement and believes it will be able to maintain compliance, although compliance will be determined by the FRB and not by the Company. The requirements of the MOU will remain in effect until the FRB decides to terminate, suspend or modify it.

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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of the Company. The information contained in this section should be read in conjunction with the unaudited consolidated financial statements and accompanying notes thereto.

FORWARD-LOOKING STATEMENTS

This Form 10-Q contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:

● statements of our goals, intentions and expectations;

● statements regarding our business plans, prospects, growth and operating strategies;

● statements regarding the asset quality of our loan and investment portfolios; and

● estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this Form 10-Q.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

● our ability to manage our operations under the current adverse economic conditions (including real estate values, loan demand, inflation, commodity prices and employment levels) nationally and in our market areas;

● adverse changes in the financial industry, securities, credit and national and local real estate markets (including real estate values);

● significant increases in our loan losses, including as a result of our inability to resolve delinquent loans and non-performing and classified assets, changes in the underlying cash flows of our borrowers, and management’s assumptions in determining the adequacy of the allowance for loan losses;

● credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and in our allowance for loan losses and provision for loan losses;

● our ability to comply with the terms of the Memorandum of Understanding with our regulators, including business and capital plans submitted to our regulators, and our ability to successfully conduct our operations while subject to regulatory restrictions on our activities;

● increased competition among depository and other financial institutions;

● our ability to successfully diversify our loan portfolio without experiencing a significant decrease in asset quality;

● our ability to attract and maintain deposits;

● expenses and diversion of management’s time and attention resulting from our efforts to oppose stockholder nominations that we do not believe are in the best interests of stockholders;

● changes interest rates generally, including changes in the relative differences between short-term and long-term interest rates, that may affect our interest margins, reduce the fair value of our financial instruments, or affect our access to funding sources;

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● declines in the yield on our assets resulting from the current low interest rate environment;

● fluctuations in the demand for loans, which may be affected by the number of unsold homes, land and other properties in our market areas and by declines in the value of real estate in our market area;

● risks related to high concentration of loans secured by real estate located in our market areas;

● the results of examinations by our regulators, including the possibility that our regulators may, among other things, require us to increase our reserve for loan losses, write down assets, change our regulatory capital position, limit our ability to borrow funds or maintain or increase deposits, or prohibit us from paying dividends, which could adversely affect our dividends and earnings;

● changes in laws or government regulations or policies affecting financial institutions, including the Dodd-Frank Act, which could result in, among other things, increased deposit premiums and assessments, capital requirements, regulatory fees and compliance costs, and changes in the level of government support of housing finance;

● our ability to enter new markets successfully and capitalize on growth opportunities;

● our reliance on a small executive staff;

● changes in consumer spending, borrowing and savings habits;

● changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission and the Public Company Accounting Oversight Board;

● risks and costs related to operating as a publicly traded company;

● changes in our organization, compensation and benefit plans;

● changes in our financial condition or results of operations that reduce capital available to pay dividends;

● changes in the financial condition or future prospects of issuers of securities that we own; and

● other economic, competitive, governmental, regulatory and operational factors affecting our operations, pricing, products and services

Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

OVERVIEW

Harvard Illinois Bancorp, Inc. (the “Company”) is a savings and loan holding company and is subject to regulation by the Board of Governors of the Federal Reserve System. The Company’s business activities are limited to oversight of its investment in Harvard Savings Bank (the “Bank”).

The Bank is primarily engaged in providing a full range of banking and mortgage services to consumer and business customers in McHenry County, Grundy County, and to a lesser extent Boone County, Illinois and Walworth County in Wisconsin. The Bank is subject to regulation by the Federal Deposit Insurance Corporation and the Illinois Department of Financial and Professional Regulation.

Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, investment securities and other interest-earning assets, and the interest paid on our interest-bearing liabilities, consisting primarily of savings and transaction accounts, certificates of deposit, and Federal Home Loan Bank of Chicago advances. Our results of operations also are affected by our provision for loan losses, noninterest income and noninterest expense. Noninterest income consists primarily of customer service fees, brokerage commission income, net realized gains on loan sales, loan servicing fees, and net income on bank-owned life insurance, offset by impairment charges on securities. Noninterest expense consists primarily of compensation and benefits, occupancy, data processing, professional fees, marketing, office supplies, federal deposit insurance premiums, indirect automobile loan servicing fees, and management of foreclosed assets.

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The Company discontinued its securities brokerage activities in 2013.

As further discussed in Note 12 to the financial statements included herein, the Company entered into a memorandum of understanding (the “MOU”) with the Office of Thrift Supervision (the “OTS”). Effective July 21, 2011, supervisory authority with respect to the MOU was transferred from the OTS to the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). Among other provisions, this informal enforcement action prohibits the Company from declaring or paying dividends or repurchasing any Company stock without the prior written consent of the Federal Reserve Board. The Company has taken the relevant actions to comply with the terms of the agreement and believes it will be able to maintain compliance. The requirements of the MOU will remain in effect until the Federal Reserve Board decides to terminate, suspend or modify it.

Business Strategy

Our long-term business strategy is to operate Harvard Savings Bank as a community-oriented financial institution, offering one- to four-family residential real estate, commercial real estate, farmland, commercial and industrial, home equity, agricultural and purchased indirect automobile loans, and to a lesser extent, multi-family, construction and land development, and other consumer loans along with a diversified platform of deposit and other products and services to individuals and agricultural and other businesses in our market areas. In order to offset the rising overhead costs related to community banking, we intend to grow our assets and liabilities in a disciplined manner, subject to market conditions. We believe that execution of our long-term business strategy will create long-term shareholder value.

We intend to accomplish this strategy by:

● Leveraging our established name and franchise, capital strength and loan production capability and knowledge of our market areas to deliver a consistent high quality level of professional banking service to our retail and business customers, attracting new customers and expanding our presence in the geographical area we serve;

● Offering a complete platform of deposit products at competitive rates and terms, focusing on growing deposits, in particular lower-cost core deposits, and diversifying the deposit mix, in order to provide for replacing long-term FHLB advances as they mature and providing lower cost funding for lending activities;

● Managing our loan portfolio to minimize concentrations and diversify the types of loans in the portfolio;

● Managing the credit risk within our loan portfolio to minimize the risk of loss;

● Managing interest rate risk to optimize our net interest margin; and

● Improving our overall efficiency and profitability.

At June 30, 2013, the Bank was categorized as “well capitalized” under regulatory capital requirements.

During the three and six months ended June 30, 2013, in accordance with the MOU, the Bank paid the Company dividends totaling $0 and $373,000, respectively, to fund expenses of the Company.

On February 20, 2013, with the consent of the Federal Reserve Board, the Company paid a special cash dividend of $0.10 per share of the Company’s common stock to stockholders of record as of February 6, 2013.

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The following discussion compares the financial condition of Harvard Illinois Bancorp, Inc. and its wholly owned subsidiary, Harvard Savings Bank, at June 30, 2013 to its financial condition at December 31, 2012, and the results of operations for the three months and six months ended June 30, 2013 to the same periods in 2012. This discussion should be read in conjunction with the interim financial statements and footnotes included herein.

CRITICAL ACCOUNTING POLICIES AND USE OF SIGNIFICANT ESTIMATES

There are no material changes to the critical accounting policies disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

FINANCIAL CONDITION

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

Total assets at June 30, 2013 decreased $492,000, or 0.3%, to $168.9 million from $169.4 million at December 31, 2012. Total liabilities decreased $890,000, or 0.6%, to $148.9 million at June 30, 2013 from $149.8 million at December 31, 2012. The modest changes in total assets and liabilities were consistent with our strategy to limit growth of our balance sheet in the current economic environment.

Cash and cash equivalents increased $1.8 million to $24.7 million at June 30, 2013 from $22.9 million at December 31, 2012. Cash and cash equivalents includes securities purchased under agreements to resell, which increased $1.9 million to $20.9 million at June 30, 2013 from $19.0 million at December 31, 2012. These agreements to resell securities represent short-term cash investment alternatives that are over-collateralized with collateral that is guaranteed by the “full faith and credit” of the United States government. Interest-bearing deposits with other financial institutions decreased $1.0 million to $8.1 million at June 30, 2013 from $9.1 million at December 31, 2012. These deposits are certificates of deposit we have placed with other financial institutions with terms from three months to five years and are fully covered by FDIC deposit insurance. Available-for-sale securities decreased $1.8 million to $6.1 million at June 30, 2013 from $7.9 million at December 31, 2012. This decrease was primarily due to maturities and pay-downs on those securities, offset partially by purchases of debt securities totaling $1.1 million. Held-to-maturity securities totaled $940,000 at June 30, 2013, a decrease of $323,000 from $1.3 million at December 31, 2012 as a result of maturities and pay-downs on those securities and no purchases. The investments in those deposits and securities were based on liquidity, yield and credit quality considerations.

Loans, net increased $974,000 to $116.0 million at June 30, 2013 from $115.0 million at December 31, 2012. During the six months ended June 30, 2013, loan originations, advances and purchases were $52.9 million, which were offset by $11.8 million in loans sold, $39.7 million of loan repayments and payoffs, net of $185,000 in charge offs and transfers to foreclosed assets of $267,000. The increase in loans during the first half of 2013 was due primarily to increases of $896,000, $407,000, $3.0 million and $989,000, respectively, in the farmland, commercial and industrial, agricultural, and purchased indirect automobile loan portfolios, offset partially by decreases of $1.6 million, $892,000, $882,000 and $982,000, respectively, in the one-to-four family, home equity lines of credit and other second mortgage, commercial, construction and land development real estate loan portfolios, respectively. The increases in farmland, commercial and industrial, agricultural loan and purchased indirect automobile loan portfolios reflect the implementation of our strategy to reduce asset duration and loan concentrations by expanding our lending activity in those portfolios. Substantially all of our farmland, agricultural, and commercial and industrial loans originated during 2013 were in our market area.

The decrease in our one- to four-family loans during 2013 was primarily due to repayments, early payoffs and $7.0 million in loans sold to Fannie Mae, which generated $105,000 in net gains on loan sales, partially offset by loan originations of $10.2 million. The decrease in the one- to four-family loan portfolio reflects our strategy to sell substantially all our conforming one-to four-family loans based on yield and duration considerations. The decreases in home equity line of credit and other second mortgage, commercial, and construction and land development real estate loan portfolios were primarily due to tighter underwriting guidelines and weak loan demand in those categories.

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All other assets, consisting of premises and equipment, Federal Home Loan Bank stock, foreclosed assets held for sale, accrued interest receivable, deferred income taxes, bank-owned life insurance, loan servicing rights and other assets decreased $182,000 to $13.1 million at June 30, 2013 from $13.3 million at December 31, 2012. The largest component of other assets was our investment in bank-owned life insurance, which increased $58,000 to $4.4 million at June 30, 2013. The largest change was in Federal Home Loan Bank stock, which decreased $534,000 to $870,000 at June 30, 2013 from $1.4 million at December 31, 2012 resulting from the Company’s redemption of a substantial portion of its remaining excess stock at its carrying amount. At June 30, 2013, the Company’s deferred tax asset relating to unused capital loss carryovers and unrealized capital losses on other than temporary impairment of equity securities totaled $159,000. Management has established a valuation allowance for the deferred tax asset related to those capital losses of $159,000 at June 30, 2013, a non-recurring decrease of $59,000 from the December 31, 2012 balance of $218,000. The decrease in the valuation allowance in the six months ended June 30, 2013 was due to the reversal of a previous valuation allowance related to capital losses. The Company now believes it has capital gains to enable a portion of those capital losses to be utilized prior to expiration.

Total deposits decreased $2.5 million to $131.5 million at June 30, 2013 from $134.0 million at December 31, 2012. Decreases in demand and certificate accounts of $567,000 and $2.8 million, respectively, were partially offset by an increase in savings, NOW and money market accounts of $877,000. The net decrease in deposits was due to our strategy to control growth in this economic environment as well as the typical seasonal fluctuation in deposits. Federal Home Loan Bank advances increased $533,000 to $12.9 million at June 30, 2013 from $12.4 million at December 31, 2012, as short-term advances increased $500,000 due to liquidity considerations. Noninterest bearing liabilities increased $1.1 million to $4.5 million at June 30, 2013 from $3.4 million at December 31, 2012. The largest component of noninterest bearing liabilities is deferred compensation which increased $44,000 in 2013 to $2.4 million at June 30, 2013 from $2.3 million at December 31, 2012. The largest change was in other noninterest liabilities which increased $1.0 million to $1.7 million at June 30, 2013 from $659,000 at December 31, 2012, primarily due to an increase of $779,000 in unremitted collections on loans sold to Farmer Mac.

Total stockholders’ equity increased by $398,000 or 2.0% to $20.0 million at June 30, 2013 from $19.6 million at December 31, 2012. The increase in stockholders’ equity for the six months ended June 30, 2013 resulted primarily from net income of $353,000, the recognition of ESOP compensation expense of $29,000, the recognition of stock – based compensation expense related to the 2011 Incentive Equity Plan of $57,000 and proceeds from common stock issued of $112,000, offset partially by the decrease in other accumulated comprehensive income of $33,000, dividends paid of $82,000 and the increase in the contingent repurchase obligation for the ESOP of $38,000.

RESULTS OF OPERATIONS

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 was $194,000 compared to net income of $85,000 for the three months ended June 30, 2012, an increase in net income of $109,000 or 128.2%. The increase in net income was due to an increase in noninterest income of $158,000, and decreases in the provision for loan losses, interest expense and noninterest expense of $86,000, $57,000 and $83,000, respectively, partially offset by an increase in the provision for income taxes of $42,000 and a decrease in interest income of $233,000.

Interest and Dividend Income. Total interest and dividend income decreased $233,000 or 12.8% to $1.6 million for the three months ended June 30, 2013 from $1.8 million for the same period in 2012. Although average interest-earning assets increased $904,000 to $158.6 million for the three months ended June 30, 2013 from $157.7 million for the three months ended June 30, 2012, the average yield decreased 62 basis points to 4.00% from 4.62%. This decrease reflected a decline in the interest rate environment for most asset categories during the period. Interest income on securities and other interest-earning assets decreased $3,000 or 3.0% to $96,000 for the three months ended June 30, 2013 compared to $99,000 for the three months ended June 30, 2012, as the average yield on those assets decreased 21 basis points to 0.96% from 1.17%, due to the lower interest rate environment, offset partially by an increase in the average balances of those assets of $6.3 million to $40.2 million from $33.9 million. Interest and fees on loans decreased $230,000 or 13.4% to $1.5 million for the three months ended June 30, 2013 from $1.7 million for the same period in 2012, as the average balance of loans decreased $5.4 million, or 4.4%, to $118.5 million from $123.9 million primarily due to repayments and sales of loans outpacing originations and purchases of loans, and by a decrease in the average yield on loans of 53 basis points to 5.03% from 5.56%.

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Interest Expense. Total interest expense decreased $57,000 or 12.9% to $384,000 for the three months ended June 30, 2013 from $441,000 for the same period in 2012. Interest expense on deposit accounts decreased $35,000 or 9.9% to $317,000 for the three months ended June 30, 2013 from $352,000 for the same period in 2012. This decrease was primarily due to a decrease in interest expense on certificates of deposit and brokered certificates of deposit of $41,000. The average balance in certificates of deposits and brokered certificates of deposit decreased $2.4 million with the cost of these deposits decreasing 16 basis points to 1.56% from 1.72%. The decrease in interest expense on certificates of deposit and brokered certificates of deposit accounts was partially offset by an increase in interest expense on savings, NOW and money market accounts of $6,000, or 30.0%, to $26,000 for the three months ended June 30, 2013 from $20,000 for the same period in 2012. The average balances of savings, NOW and money market accounts increased $1.2 million, or 2.3%, to $53.0 million from $51.8 million and the cost of these deposits increased 5 basis points to 0.20% during the three months ended June 30, 2013 from 0.15% during the three months ended June 30, 2012. The reduction in the average cost of certificate accounts was the result of our competitive pricing and the declining market interest rates for deposits. The increase in the average cost of core deposits was primarily due to the execution of our business strategy to focus on growth of our lower-cost core deposits.

Interest expense on Federal Home Loan Bank advances decreased $22,000, or 24.7%, to $67,000 for the three months ended June 30, 2013 from $89,000 for the three months ended June 30, 2012. The average cost of advances decreased 83 basis points to 2.16% for the three months ended June 30, 2013 from 2.99% for the comparable period in 2012, offset partially by an increase in the average balances of advances of $472,000. The decrease in the cost of these funds was a reflection of the lower market interest rate environment in 2013 compared to 2012.

Net Interest Income. Net interest income decreased $176,000 or 12.8% to $1.2 million for the three months ended June 30, 2013 from $1.4 million for the three months ended June 30, 2012, primarily as a result of a decrease in our net interest rate spread of 47 basis points to 2.90% from 3.37%. Our net interest margin decreased to 3.03% for the three months ended June 30, 2013 from 3.50% for the three months ended June 30, 2012. The decreases in our net interest rate spread and net interest margin reflected the decreases in market interest rates and average balance for loans in 2013 compared to 2012. The decreases in our net interest rate spread and net interest margin were offset partially by the ratio of our average interest-earning assets to average interest-bearing liabilities which increased to 113.31% for the three months ended June 30, 2013 from 112.07% for the same period in 2012.

Provision for Loan Losses. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when we believe the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

We evaluate the allowance for loan losses on a regular basis and the provision is based upon our periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The factors we considered in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans by either the present value of expected future cash flows discounted at the loans effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Groups of loans with similar loan characteristics, including individually evaluated loans not determined to be impaired, are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, we do not separately identify individual consumer and residential loans for impairment measurements.

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Based upon our evaluation of these factors, a provision of $49,000 was recorded for the three months ended June 30, 2013, a decrease of $86,000 or 63.7% from $135,000 for the three months ended June 30, 2012. The provision for loan losses reflected net charge offs of $36,000 for the three months ended June 30, 2013, compared to $85,000 for the three months ended June 30, 2012. The allowance for loan losses was $2.6 million, or 2.16% of total loans at June 30, 2013, compared to $2.6 million, or 2.17% of total loans at December 31, 2012. At June 30, 2013, we had identified substandard loans totaling $5.2 million, all of which were considered impaired, and maintained an allowance for loan losses of $459,000 allocated to these loans. At December 31, 2012, we considered all substandard loans totaling $5.0 million impaired and maintained an allowance for loan losses of $431,000 allocated to these loans. We used the same methodology in assessing the allowance for each period.

The allowance as a percent of nonperforming loans increased to 49.28% at June 30, 2013 from 46.21% at June 30, 2012. Nonperforming loans totaled $5.2 million at June 30, 2013, compared to $5.9 million at June 30, 2012, a decrease of $696,000 or 13.4%. All nonperforming loans were considered impaired at June 30, 2013 and 2012, and allowances for impaired loans decreased $254,000 or 35.6% to $459,000 at June 30, 2013 from $713,000 at June 30, 2012. Net charge-offs as a percent of average total loans outstanding decreased to 0.12% for the quarter ended June 30, 2013 from 0.27% for the same quarter in 2012, due to a decrease in net charge-offs of $49,000 to $36,000, partially offset by a $5.4 million decrease in average loans outstanding to $118.5 million.

To the best of our knowledge, we have recorded all losses that are both probable and reasonably estimable for the three months ended June 30, 2013 and 2012, respectively.

The following table sets forth the allowance for loan losses allocated by loan category, the percent of allowance in each loan category to the total allowance, and the percent of loans in each loan category to total loans as of June 30, 2013 and December 31, 2012 (dollars in thousands).

	June 30, 2013								December 31, 2012
			Percent of			Percent of					Percent of			Percent of
			Allowance			Loans in					Allowance			Loans in
			to Total			Category to					to Total			Category to
	Amount		Allowance			Total Loans			Amount		Allowance			Total Loans
Real estate loans:
One-to-four-family	$	663		25.87	%		33.92	%	$	668		26.20	%		35.61	%
Home equity line of credit and other 2nd mortgage		306		11.94			7.21			333		13.06			8.02
Multi-family		6		0.23			0.10			3		0.12			0.04
Commercial		727		28.37			16.12			530		20.78			17.01
Farmland		190		7.41			10.68			176		6.90			10.01
Construction and land development		63		2.46			0.72			275		10.78			1.56
Total real estate loans		1,955		76.28			68.75			1,985		77.84			72.25
Commercial and industrial		134		5.23			4.91			151		5.93			4.60
Agriculture		347		13.53			19.52			301		11.80			17.10
Consumer loans:
Purchased indirect automobile		126		4.92			6.73			112		4.39			5.95
Other		1		0.04			0.09			1		0.04			0.10
Total consumer loans		127		4.96			6.82			113		4.43			6.05
Unallocated		—		—			—			—		—			—
Total allowance for loan losses	$	2,563		100.00	%		100.00	%	$	2,550		100.00	%		100.00	%

The increase in the allowance for loan losses allocated to commercial real estate loans was primarily due to an increase in the balance and required reserves for impaired loans of $1.1 million and $239,000, respectively, from December 31, 2012 to June 30, 2013, partially offset by a decrease in loans collectively evaluated for impairment of $2.0 million. The decrease in the allowance for loan losses allocated to construction and land development real estate loans was primarily due to the payoff of a troubled debt restructuring secured by a residential subdivision in our market area during the three months ended June 30, 2013, that was deemed impaired with a required reserve of $157,000 at December 31, 2012. The increase in the allowance for loan losses allocated to agriculture loans was primarily due to the increase in the balance of performing loans of $3.0 million.

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The following table sets forth information regarding nonperforming assets at the dates indicated (dollars in thousands):

	At June 30, 2013			At December 31, 2012
Non-accrual loans:
Real estate loans:
One-to-four family	$	1,896		$	2,484
Home equity lines of credit and other 2nd mortgage		119			166
Farmland loans		—			—
Commercial		2,630			1,482
Construction and land development		388			851
Total real estate loans		5,033			4,983
Commercial and industrial		4			7
Agricultural loans		—			—
Consumer loans:
Purchased indirect automobile		2			—
Other		—			—
Total consumer loans		2			—
Total non-accrual loans		5,039			4,990
Accruing loans past due 90 days or more:
One-to four-family		162			—
Total accruing loans past due 90 days or more		162			—
Total of nonaccrual and 90 days or more past due loans		5,201			4,990
Other real estate owned:
One-to four family		320			187
Commercial		584			616
Total other real estate owned		904			803
Repossessed automobiles		50			83
Total non-performing assets		6,155			5,876
Troubled debt restructurings (not included in nonaccrual loans above)		1,113			934
Total non-performing assets and troubled debt restructurings	$	7,268		$	6,810
Total non-performing loans to total loans		4.39	%		4.25	%
Total non-performing assets to total assets		3.64	%		3.47	%
Total non-performing loans and troubled debt restructurings to total loans		5.33	%		5.04	%
Total non-performing assets and troubled debt restructurings to total assets		4.30	%		4.02	%

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Total non-performing assets, including troubled debt restructurings, increased $458,000 or 6.7% to $7.3 million at June 30, 2013, compared to $6.8 million at December 31, 2012. Total non-performing assets, including troubled debt restructurings, to total assets were 4.3% and 4.0% at June 30, 2013 and December 31, 2012, respectively. Troubled debt restructurings included in nonaccrual loans totaled $1.3 million at June 30, 2013, compared to $3.2 million at December 31, 2012.

Non-performing one- to four-family real estate loans totaled $2.1 million at June 30, 2013 and consisted of 19 loans secured by properties located in our market area. Those loans included four loans that totaled $879,000 that are troubled debt restructurings, which resulted in charge-offs of $45,000 during the six months ended June 30, 2013, including two loans totaling $487,000 that were in the process of foreclosure. Non-performing one- to four-family real estate loans at June 30, 2013 included six other loans totaling $675,000 that were in the process of foreclosure, and resulted in charge-offs of $46,000 during the six months ended June 30, 2013. Non-performing one- to four-family real estate loans at June 30, 2013 included nine other loans totaling $504,000 that were in the process of collection. We maintained impairment allowances of $70,000 on the non-performing one- to four-family real estate loans at June 30, 2013.

Non-accrual home equity lines of credit and other second mortgage loans totaled $119,000 at June 30, 2013 and consisted of seven loans secured by properties located in our market area. Non-accrual home equity lines of credit and other second mortgage loans included one loan that totaled $6,000 that was a troubled debt restructuring and charged-off during the six months ended June 30, 2013. Non-accrual home equity lines of credit and other second mortgage loans included six other loans in the process of collection totaling $119,000. We maintained impairment allowances of $44,000 on the non-performing home equity lines of credit and other second mortgage loans at June 30, 2013.

Non-accrual commercial real estate loans totaled $2.6 million at June 30, 2013 and consisted of one loan, secured by a non-owner occupied property located in our market area. The property was reappraised in 2013. We maintained an impairment allowance of $320,000 on the non-performing commercial real estate loan at June 30, 2013.

Non-accrual construction and land development loans totaled $388,000 at June 30, 2013 and consisted of one troubled debt restructuring, a commercial land development loan secured by property in our market area that was refinanced in a troubled debt restructuring in 2011 which provided for both interest rate and maturity concessions. At June 30, 2013, the loan was more than 90 days past due. We maintained an impairment allowance of $16,000 on that non-accrual commercial land development loan at June 30, 2013.

Other non-performing loans, which consisted of two commercial and industrial loans and one purchased indirect automobile loan, totaled $6,000 at June 30, 2013. We maintained impairment allowances of $4,000 on those loans at June 30, 2013.

Other real estate owned totaled $904,000 at June 30, 2013, net of $46,000 in write-downs during the six months ended June 30, 2013, and consisted of four residential real estate properties totaling $320,000 and two commercial real estate properties totaling $584,000. All the properties are located in our market area. The properties are carried at estimated fair value less costs to sell. The two commercial real estate properties were reappraised in 2012.

In addition, we had $50,000 of repossessed automobiles at June 30, 2013.

The following table shows the aggregate principal amount of potential problem loans on the Company’s watch list at June 30, 2013 and December 31, 2012.  Substantially all non-accruing loans, troubled debt restructurings and loans past due 60 days or more are placed on the watch list (in thousands).

	June 30, 2013		December 31, 2012
Watch loans	$	5,612	$	5,590
Special Mention loans		1,583		1,104
Substandard loans		5,156		5,015
Total watch list loans	$	12,351	$	11,709

50

The $642,000 net increase in watch list loans during the six months ended June 30, 2013 is primarily due to three loans to one borrower, all secured by residential real estate, totaling $498,000 that were classified special mention after the borrower filed for Chapter 13 bankruptcy protection in 2013.

Noninterest Income. Noninterest income increased $158,000 or 119.7% to $290,000 for the three months ended June 30, 2013 from $132,000 for the three months ended June 30, 2012. The increase was primarily due to an increase in net realized gains on loan sales of $155,000 to $130,000 for the three months ended June 30, 2013, from a loss of $(25,000) for the same period in 2012. Net realized gains of $50,000 and $22,000 were recognized on loans sold of $6.9 million and $1.3 million for the three months ended June 30, 2013 and 2012, respectively. Net realized gains on loans sales also included the net increase (decrease) in fair value of loan servicing rights of $80,000 and $(47,000) for the three months ended June 30, 2013 and 2012, respectively. Brokerage commission income decreased $11,000 to $0 for the three months ended June 30, 2013 compared to the same period in 2012, primarily due to the Company exiting that line of business in 2013.

Noninterest Expense. Noninterest expense decreased $83,000 or 6.5% to $1.2 million for the three months ended June 30, 2013 from $1.3 million for the three months ended June 30, 2012. Decreases in compensation and benefits, data processing, professional fees, office supplies, foreclosed assets, net, and other expenses in the three months ended June 30, 2013 compared to the three months ended June 30, 2012 of $1,000, $5,000, $21,000, $6,000, $27,000 and $41,000, respectively, were partially offset by increases in occupancy, marketing, federal deposit insurance and indirect automobile loan servicing fees of $3,000, $8,000, $6,000 and $1,000, respectively. The decrease in professional fees and other expenses is primarily due to lower fees incurred to support the Board of Director’s nominees for director in a contested election. The decrease in foreclosed assets, net, was due primarily to lower losses and write-downs on foreclosed assets held for sale of $29,000 for the three months ended June 30, 2013, compared to $51,000 for the same period in 2012. The increase in marketing expense was primarily due to the promotion of a new checking product in the three months ended June 30, 2013.

Provision (Benefit) for Income Taxes. The provision for income taxes increased $42,000 or 190.9% to $64,000 for the three months ended June 30, 2013 from $22,000 for the same period in 2012. The effective tax provision as a percent of pre-tax income was 24.8% and 20.6% for the three months ended June 30, 2013 and 2012, respectively. The provision for income taxes in 2013 reflects the impact of a $151,000 increase in pre-tax income for the three months ended June 30, 2013 compared to the same period in 2012, offset partially by a $19,000 non-recurring decrease in valuation allowances recorded for deferred tax assets related to capital losses on equity securities compared to an increase of $7,000 in 2012.

51

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 was $353,000 compared to net income of $236,000 for the six months ended June 30, 2012, an increase in net income of $117,000 or 49.6%. The increase in net income was due to an increase in noninterest income of $123,000, and decreases in the provision for loan losses, interest expense and noninterest expense of $115,000, $134,000 and $233,000, respectively, partially offset by an increase in the provision for income taxes of $73,000 and a decrease in interest income of $415,000.

Interest and Dividend Income. Total interest and dividend income decreased $415,000, or 11.4%, to $3.2 million for the three months ended June 30, 2013 from $3.7 million for the same period in 2012. Although average interest-earning assets increased $927,000 to $159.3 million for the six months ended June 30, 2013 from $158.4 million for the six months ended June 30, 2012, the average yield decreased 55 basis points to 4.07% from 4.62%. This decrease reflected a decline in the interest rate environment for most asset categories during the period. Interest income on securities and other interest-earning assets decreased $7,000, or 3.3%, to $204,000 for the six months ended June 30, 2013 compared to $211,000 for the six months ended June 30, 2012, as the average yield on those assets decreased 17 basis points to 0.99% from 1.16%, due to the lower interest rate environment, offset partially by an increase in the average balances of those assets of $4.6 million to $41.0 million from $36.4 million. Interest and fees on loans decreased $408,000, or 11.8%, to $3.0 million for the six months ended June 30, 2013 from $3.4 million for the same period in 2012, as the average balance of loans decreased $3.7 million, or 3.0%, to $118.3 million from $122.0 million primarily due to repayments and sales of loans outpacing originations and purchases of loans, and by a decrease in the average yield on loans of 52 basis points to 5.13% from 5.65%.

Interest Expense. Total interest expense decreased $134,000 or 14.7% to $777,000 for the six months ended June 30, 2013 from $911,000 for the same period in 2012. Interest expense on deposit accounts decreased $95,000 or 13.0% to $638,000 for the six months ended June 30, 2013 from $733,000 for the same period in 2012. This decrease was primarily due to a decrease in interest expense on certificates of deposit and brokered certificates of deposit of $105,000. The average balance in certificates of deposits and brokered certificates of deposit decreased $3.1 million with the cost of these deposits decreasing 21 basis points to 1.56% from 1.77%. The decrease in interest expense on certificates of deposit and brokered certificates of deposit accounts was partially offset by an increase in interest expense on savings, NOW and money market accounts of $10,000, or 25.0%, to $50,000 for the six months ended June 30, 2013 from $40,000 for the same period in 2012. The average balances of savings, NOW and money market accounts increased $1.6 million, or 3.1%, to $52.7 million from $51.1 million and the cost of these deposits increased 3 basis points to 0.19% during the six months ended June 30, 2013 from 0.16% during the six months ended June 30, 2012. The reduction in the average cost of these funds was the result of our competitive pricing and the declining market interest rates for deposits, and execution of our business strategy to focus on growth of our lower-cost core deposits.

Interest expense on Federal Home Loan Bank advances decreased $39,000, or 21.9%, to $139,000 for the six months ended June 30, 2013 from $178,000 for the six months ended June 30, 2012. The average cost of advances decreased 67 basis points to 2.18% for the six months ended June 30, 2013 from 2.85% for the comparable period in 2012, offset partially by an increase in the average balances of advances of $279,000. The decrease in the cost of these funds was a reflection of the lower market interest rate environment in 2013 compared to 2012.

Net Interest Income. Net interest income decreased $281,000, or 10.2%, to $2.5 million for the six months ended June 30, 2013 from $2.7 million for the six months ended June 30, 2012, primarily as a result of a decrease in our net interest rate spread of 37 basis points to 2.97% from 3.34%. Our net interest margin decreased to 3.09% for the six months ended June 30, 2013 from 3.46% for the six months ended June 30, 2012. The decreases in our net interest rate spread and net interest margin reflected the decreases in market interest rates and average balance for loans in 2013 compared to 2012. The decreases in our net interest rate spread and net interest margin were offset partially by the ratio of our average interest-earning assets to average interest-bearing liabilities which increased to 113.15% for the six months ended June 30, 2013 from 111.59% for the same period in 2012.

52

Provision for Loan Losses. 

The following table shows the activity in the allowance for loan losses for the six months ended June 30, 2013 and 2012 (dollars in thousands):

	2013			2012
Allowance at beginning of period	$	2,550		$	2,575
Provision for loan losses		193			308
Charge-offs:
Real estate loans:
One-to four family		102			73
Home equity line of credit and other 2nd mortgage		6			2
Construction and land development		60			55
Total charge-offs, real estate loans		168			130
Consumer loans:
Purchased indirect automobile		17			34
Other		—			—
Total charge-offs, consumer loans		17			34
Total charge-offs		185			164
Recoveries:
Real estate loans:
One-to four family		—			—
Commercial		—			—
Total recoveries, real estate loans		—			—
Consumer loans:
Purchased indirect automobile		2			6
Other		3			—
Total recoveries, consumer loans		5			6
Total recoveries		5			6
Net charge-offs		(180	)		(158	)
Allowance at end of period	$	2,563		$	2,725
Allowance to non-performing loans		49.28	%		46.21	%
Allowance to total loans outstanding at the end of the period		2.16	%		2.17	%
Net charge-offs to average total loans outstanding during the period		0.30	%		0.26	%

53

A provision of $193,000 was recorded for the six months ended June 30, 2013, a decrease of $115,000 or 37.3% from $308,000 for the same period in 2012. The provision for loan losses reflected net charge offs of $180,000 or 0.30% of average total loans for the six months ended June 30, 2013, compared to $158,000 or 0.26% of average total loans for the six months ended June 30, 2012. Substandard loans increased $141,000 to $5.2 million during the six months ended June 30, 2013, while the related specific loss allowances for those loans increased $28,000 to $459,000. Substandard loans decreased $1.5 million to $6.0 million during the six months ended June 30, 2012, while the related specific loss allowances for those loans decreased $262,000 to $713,000. The larger provision in 2012 was impacted by the $7.2 million growth in total loans, primarily agricultural loans, during the six months ended June 30, 2012 compared to the $984,000 increase in total loans during the same period in 2013.

To the best of our knowledge, we have recorded all losses that are both probable and reasonably estimable for the six months ended June 30, 2013 and 2012, respectively. We used the same methodology in assessing the allowance for each period.

Noninterest Income. Noninterest income increased $123,000 or 29.8% to $536,000 for the six months ended June 30, 2013 from $413,000 for the six months ended June 30, 2012. The increase was primarily due to an increase in net realized gains on loan sales of $131,000 to $222,000 for the six months ended June 30, 2013, from $91,000 for the same period in 2012. Net realized gains of $105,000 and $83,000 were recognized on loans sold of $11.8 million and $7.0 million for the six months ended June 30, 2013 and 2012, respectively. Net realized gains on loans sales also included the net increase in fair value of loan servicing rights of $117,000 and $8,000 for the six months ended June 30, 2013 and 2012, respectively. Brokerage commission income decreased $19,000 to $1,000 for the six months ended June 30, 2013 compared to the same period in 2012, primarily due to the Company exiting that line of business in 2013.

Noninterest Expense. Noninterest expense decreased $233,000 or 8.9% to $2.4 million for the six months ended June 30, 2013 from $2.6 million for the six months ended June 30, 2012. Decreases in compensation and benefits, data processing, professional fees, office supplies, indirect automobile servicing fees, foreclosed assets, net, and other expenses in the six months ended June 30, 2013 compared to the six months ended June 30, 2012 of $37,000, $26,000, $43,000, $9,000, $1,000, $87,000 and $63,000, respectively, were partially offset by increases in occupancy, marketing, and federal deposit insurance of $7,000, $24,000, and $2,000, respectively. The decrease in compensation and benefits was primarily due to lower benefit plan costs. The decrease in data processing was due primarily to lower costs associated with the long-term contract renewal with our data center in 2012.The decrease in professional fees and other expenses is primarily due to lower fees incurred to support the Board of Director’s nominees for director in a contested election. The decrease in foreclosed assets, net, was due primarily to lower losses and write-downs on foreclosed assets held for sale of $79,000 for the six months ended June 30, 2013, compared to $171,000 for the same period in 2012. The increase in marketing expense was primarily due to the promotion of a new checking product in the six months ended June 30, 2013.

Provision (Benefit) for Income Taxes. The provision for income taxes increased $73,000 to $78,000 for the six months ended June 30, 2013 from $5,000 for the same period in 2012. The effective tax provision as a percent of pre-tax income was 18.1% and 2.1% for the six months ended June 30, 2013 and 2012, respectively. The provision for income taxes in 2013 reflects the impact of a $190,000 increase in pre-tax income for the six months ended June 30, 2013 compared to the same period in 2012, offset partially by a decrease of $59,000 in valuation allowances recorded for deferred tax assets related to capital losses on equity securities in 2013 compared to $40,000 in 2012.

54

Liquidity and Capital Resources

Our primary sources of funds are deposits, principal and interest payments on loans and securities, proceeds from maturities and calls of securities, and Federal Home Loan Bank advances. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and short-term investments including securities repurchase agreements. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities was $1.5 million and $1.3 million for the six months ended June 30, 2013 and 2012, respectively. Net cash provided by (used in) investing activities consisted primarily of disbursements for loan originations and the purchase of securities, Federal Home Loan Bank stock and interest-bearing deposits, offset by net cash provided by principal collections on loans, and proceeds from maturing securities and interest-bearing deposits, pay downs on mortgage-backed securities, and redemptions of excess Federal Home Loan Bank stock. Net cash provided by (used in) investing activities was $2.2 million and $(9.9) million for the six months ended June 30, 2013 and 2012, respectively. Net cash provided by (used in) financing activities consisted primarily of the activity in deposit accounts and Federal Home Loan Bank borrowings. The net cash provided by (used in) financing activities was $(1.9) million and $611,000 for the six months ended June 30, 2013 and 2012, respectively.

The Bank is required to maintain regulatory capital requirements imposed by the Federal Deposit Insurance Corporation.  The Bank’s actual ratios at June 30, 2013 and the required minimums to be considered adequately capitalized are shown in the table below.  In order to be considered well-capitalized, the Bank must maintain: (i) Tier 1 Capital to Average Assets of 5.0%, (ii) Tier 1 Capital to Risk-Weighted Assets of 6.0%, and (iii) Total Capital to Risk-Weighted Assets of 10.0%. Accordingly, Harvard Savings Bank was categorized as well capitalized at June 30, 2013. Management is not aware of any conditions or events since the most recent notification that would change our category.

	June 30, 2013 Actual			December 31, 2012 Actual			Minimum Required
Tier 1 capital to average assets		9.9	%		10.2	%		4.0	%
Tier 1 capital to risk-weighted assets		13.0	%		13.3	%		4.0	%
Total capital to risk-weighted assets		14.2	%		14.5	%		8.0	%

The Company must also maintain adequate levels of liquidity to ensure the availability of funds to satisfy loan commitments.  The Company anticipates that it will have sufficient funds available to meet its current commitments principally through the use of current liquid assets and through its borrowing capacity discussed above.  The following table summarizes these commitments at June 30, 2013 and December 31, 2012 (in thousands).

	June 30, 2013		December 31, 2012
Commitments to fund loans	$	16,139	$	18,584
Standby letters of credit		6		6

Certificates of deposit that are scheduled to mature in less than one year from June 30, 2013 totaled $25.7 million. Management expects that a substantial portion of the maturing certificates of deposit will be renewed. However, if a substantial portion of these deposits is not retained, we may utilize Federal Home Loan Bank advances or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.

55

In July 2013, the Federal Deposit Insurance Corporation and the other federal bank regulatory agencies issued a final rule that will revise their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-in or opt-out is exercised. The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.

The final rule becomes effective for the Bank on January 1, 2015. The capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective. The final rule also implements consolidated capital requirements for savings and loan holding companies, such as the Company, effective January 1, 2015.

56

Analysis of Net Interest Income and Average Balance Sheet

The following table sets forth average balance sheets, average yields and costs, and certain other information at or for the periods indicated (dollars in thousands):

	Three Months Ended June 30,
	2013							2012
	Average Balance		Interest Income/ Expense		Yield/Cost			Average Balance		Interest Income/ Expense		Yield/Cost
Assets
Interest- earning assets:
Interest -earning deposits	$	9,391	$	19		0.81	%	$	10,490	$	22		0.84	%
Securities purchased under agreements to resell		21,809		45		0.83	%		12,356		26		0.84	%
Securities, tax-exempt		3,712		9		0.97	%		916		2		0.87	%
Securities, taxable		4,479		22		1.96	%		6,997		46		2.63	%
Loans		118,470		1,491		5.03	%		123,894		1,721		5.56	%
Federal Home Loan Bank stock		787		1		0.51	%		3,091		3		0.39	%
Total interest earning assets		158,648		1,587		4.00	%		157,744		1,820		4.62	%
Non-interest earning assets		11,230							11,142
Total assets	$	169,878						$	168,886
Liabilities and equity
Interest-bearing liabilities:
Savings accounts	$	17,684		6		0.14	%	$	17,340		5		0.12	%
NOW and money market accounts		35,325		20		0.23	%		34,463		15		0.17	%
Certificates of deposit		74,613		291		1.56	%		75,535		313		1.66	%
Brokered certificates of deposit		—		—		0.00	%		1,499		19		5.07	%
Federal Home Loan Bank advances		12,391		67		2.16	%		11,919		89		2.99	%
Total interest-bearing liabilities		140,013		384		1.10	%		140,756		441		1.25	%
Non-interest-bearing deposits		5,845							5,121
Other non-interest-bearing liabilities		4,041							3,762
Total liabilities		149,899							149,639
Equity		19,979							19,247
Total liabilities and equity	$	169,878						$	168,886
Net interest income			$	1,203						$	1,379
Interest rate spread						2.90	%						3.37	%
Net interest margin						3.03	%						3.50	%
Average interest earning assets to average interest-bearing liabilities						113.31	%						112.07	%

57

The following table sets forth the changes in interest income and interest expense resulting from the changes in interest rate and changes in volume of the Company’s interest-earning assets and interest-earning liabilities (in thousands).

	Three Months Ended June 30,
	2013 Compared to Three Months
	Ended June 30, 2012
	Increase (Decrease) Due to
	Rate			Volume			Net
Interest income:
Interest-earning deposits	$	(1	)	$	(2	)	$	(3	)
Securities purchased under agreements to resell		(1	)		20			19
Securities, tax-exempt		—			7			7
Securities, taxable		(10	)		(14	)		(24	)
Loans		(157	)		(73	)		(230	)
Federal Home Loan Bank stock		1			(3	)		(2	)
Total		(168	)		(65	)		(233	)
Interest Expense:
Savings accounts		1			—			1
NOW and money market accounts		5			—			5
Certificates of deposit		(18	)		(4	)		(22	)
Brokered certificates of deposit		—			(19	)		(19	)
Federal Home Loan Bank advances		(25	)		3			(22	)
Total		(37	)		(20	)		(57	)
Increase in net interest income	$	(131	)	$	(45	)	$	(176	)

58

The following table sets forth average balance sheets, average yields and costs, and certain other information at or for the periods indicated (dollars in thousands):

	Six Months Ended June 30,
	2013							2012
			Interest							Interest
	Average		Income/					Average		Income/
	Balance		Expense		Yield/Cost			Balance		Expense		Yield/Cost
Assets
Interest- earning assets:
Interest -earning deposits	$	9,622	$	39		0.81	%	$	9,601	$	45		0.94	%
Securities purchased under agreements to resell		21,836		89		0.82	%		15,931		68		0.85	%
Securities, tax-exempt		3,588		18		1.00	%		458		2		0.87	%
Securities, taxable		5,025		56		2.23	%		6,313		91		2.88	%
Loans		118,290		3,036		5.13	%		122,006		3,444		5.65	%
Federal Home Loan Bank stock		950		2		0.42	%		4,075		5		0.25	%
Total interest earning assets		159,311		3,240		4.07	%		158,384		3,655		4.62	%
Non-interest earning assets		11,199							11,219
Total assets	$	170,510						$	169,603
Liabilities and equity
Interest-bearing liabilities:
Savings accounts	$	17,401		11		0.13	%	$	17,028		10		0.12	%
NOW and money market accounts		35,337		39		0.22	%		34,070		30		0.18	%
Certificates of deposit		75,300		588		1.56	%		76,859		655		1.70	%
Brokered certificates of deposit		—		—		0.00	%		1,499		38		5.07	%
Federal Home Loan Bank advances		12,755		139		2.18	%		12,476		178		2.85	%
Total interest-bearing liabilities		140,793		777		1.10	%		141,932		911		1.28	%
Non-interest-bearing deposits		6,040							4,983
Other non-interest-bearing liabilities		3,890							3,530
Total liabilities		150,723							150,445
Equity		19,787							19,158
Total liabilities and equity	$	170,510						$	169,603
Net interest income			$	2,463						$	2,744
Interest rate spread						2.97	%						3.34	%
Net interest margin						3.09	%						3.46	%
Average interest earning assets to average interest-bearing liabilities						113.15	%						111.59	%

59

The following table sets forth the changes in rate and changes in volume of the Company’s interest earning assets and liabilities (in thousands).

	Six Months Ended June 30, 2013 Compared to Six Months Ended June 30, 2012 Increase (Decrease) Due to
	Rate			Volume			Net
Interest income:
Interest-earning deposits	$	(6	)	$	—		$	(6	)
Securities purchased under agreements to resell		(3	)		24			21
Securities, tax-exempt		—			16			16
Securities, taxable		(18	)		(17	)		(35	)
Loans		(305	)		(103	)		(408	)
Federal Home Loan Bank stock		2			(5	)		(3	)
Total		(330	)		(85	)		(415	)
Interest Expense:
Savings accounts		1			—			1
NOW and money market accounts		8			1			9
Certificates of deposit		(54	)		(13	)		(67	)
Brokered certificates of deposit		—			(38	)		(38	)
Federal Home Loan Bank advances		(43	)		4			(39	)
Total		(88	)		(46	)		(134	)
Increase (decrease) in net interest income	$	(242	)	$	(39	)	$	(281	)

Off-Balance Sheet Arrangements

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

For the three months ended June 30, 2013, we did not engage in any off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.

60

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required for smaller reporting companies.

ITEM 4 - CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Disclosure Controls and Procedures. An evaluation was performed under the supervision and with the participation of the Company’s management, including the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of June 30, 2013. Based on that evaluation, the Company’s management, including the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.

Internal Control Over Financial Reporting. During the quarter ended June 30, 2013, there have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Securities and Exchange Act of 1934, as amended) that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

61

PART II – OTHER INFORMATION

Item 1.        Legal Proceedings

The Company and its subsidiaries are subject to various legal actions that are considered ordinary routine litigation incidental to the business of the Company, and no claim for money damages exceeds ten percent of the Company’s consolidated assets. In the opinion of management, based on currently available information, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s results of operations.

Item 1A.     Risk Factors

Not required for smaller reporting companies

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

 None.

Item 3.         Defaults Upon Senior Securities

None.

Item 4.         Mine Safety Disclosures

None.

Item 5.         Other Information

None.

Item 6.          Exhibits

31.1 – Certification of the Chief Executive Officer Pursuant to Rule 13a-15(e)/15d-15(e)

31.2 – Certification of the Chief Financial Officer Pursuant to Rule 13a-15(e)/15d-15(e)

32.1 – Certification of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2003

101 Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012, (ii) the Consolidated Statements of Income for the three and six months ended June 30, 2013 and 2012, (iii) the Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2013 and 2012, (iv) the Consolidated Statements of Stockholders’ Equity for the six months ended June 30, 2013 and 2012, (v) the Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012, and (vi) the Notes to the Consolidated Financial Statements.(1)

(1) Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

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SIGNATURES

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

	HARVARD ILLINOIS BANCORP, INC.
	Registrant
Date: August 14, 2013	/s/ Duffield J. Seyller III
	Duffield Seyller III
	President and Chief Executive Officer
	/s/ Donn L. Claussen
	Donn L. Claussen
	Executive Vice President and Chief Financial Officer

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