10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended December 31, 2007

OR

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

For the transition period from                      to                     

Commission File Number: 000-25328

FIRST KEYSTONE FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

Pennsylvania	23-2576479
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification Number)
22 West State Street
Media, Pennsylvania	19063
(Address of principal executive office)	(Zip Code)

Registrant’s telephone number, including area code: (610) 565-6210

Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No o

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

Large accelerated filer o	Accelerated filer o	Non-accelerated filer þ	Smaller reporting company o
	(Do not check if a smaller reporting company)

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     No þ

Number of shares of Common Stock outstanding as of February 11, 2008: 2,432,998

FIRST KEYSTONE FINANCIAL, INC.

Contents

		Page
PART I	FINANCIAL INFORMATION:
Item 1.	Financial Statements
	Unaudited Consolidated Statements of Financial Condition as of December 31, 2007 and September 30, 2007		1
	Unaudited Consolidated Statements of Income for the Three Months Ended December 31, 2007 and 2006		2
	Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the Three Months Ended December 31, 2007 and 2006		3
	Unaudited Consolidated Statements of Cash Flows for the Three Months Ended December 31, 2007 and 2006		4
	Notes to Unaudited Consolidated Financial Statements		5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		20
Item 4.	Controls and Procedures		20
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings		22
Item 1A.	Risk Factors		22
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		22
Item 3.	Defaults Upon Senior Securities		22
Item 4.	Submission of Matters to a Vote of Security Holders		22
Item 5.	Other Information		22
Item 6.	Exhibits		23
SIGNATURES			25

-i-

FIRST KEYSTONE FINANCIAL, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(dollars in thousands)

	December 31,			September 30,
	2007			2007
ASSETS
Cash and amounts due from depository institutions	$	8,658		$	4,642
Interest-bearing deposits with depository institutions		35,726			48,293
Total cash and cash equivalents		44,384			52,935
Investment securities available for sale		31,091			29,284
Mortgage-related securities available for sale		91,912			79,178
Investment securities held to maturity — at amortized cost (approximate fair value of $3,312 at December 31, 2007 and $3,266 at September 30, 2007)		3,256			3,256
Mortgage-related securities held to maturity — at amortized cost (approximate fair value of $29,636 at December 31, 2007 and $30,511 at September 30, 2007)		29,872			31,294
Loans receivable (net of allowance for loan losses of $3,376 and $3,322 at December 31, 2007 and September 30, 2007, respectively)		280,520			292,418
Accrued interest receivable		2,357			2,702
FHLBank stock, at cost		6,239			6,338
Office properties and equipment, net		4,698			4,762
Deferred income taxes		2,174			2,505
Cash surrender value of life insurance		17,416			17,234
Prepaid expenses and other assets		3,128			2,975
TOTAL ASSETS	$	517,047		$	524,881
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits:
Non-interest-bearing	$	16,178		$	18,404
Interest-bearing		329,689			335,304
Total deposits		345,867			353,708
Advances from FHLBank and other borrowings		113,208			115,384
Junior subordinated debentures		15,264			15,264
Accrued interest payable		2,410			2,324
Advances from borrowers for taxes and insurance		1,947			870
Accounts payable and accrued expenses		2,755			2,637
Total liabilities		481,451			490,187
Commitments and contingencies (see Note 13)		—			—
Stockholders’ Equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized; none issued
Common stock, $.01 par value, 20,000,000 shares authorized; issued 2,712,556 shares; outstanding at December 31, 2007 and September 30, 2007, 2,432,998 shares		27			27
Additional paid-in capital		12,597			12,598
Employee stock ownership plan		(2,958	)		(2,985	)
Treasury stock at cost: 279,558 shares at December 31, 2007 and at September 30, 2007		(4,244	)		(4,244	)
Accumulated other comprehensive loss		(579	)		(1,223	)
Retained earnings — partially restricted		30,753			30,521
Total stockholders’ equity		35,596			34,694
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	517,047		$	524,881

See notes to unaudited consolidated financial statements.

-1-

FIRST KEYSTONE FINANCIAL, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share data)

	Three months ended
	December 31,
	2007		2006
INTEREST INCOME:
Interest and fees on loans	$	4,671	$	5,355
Interest and dividends on:
Mortgage-related securities		1,380		1,207
Investment securities:
Taxable		395		310
Tax-exempt		42		151
Dividends		86		87
Interest-bearing deposits		162		63
Total interest income		6,736		7,173
INTEREST EXPENSE:
Interest on:
Deposits		2,678		2,704
FHLB advances and other borrowings		1,225		1,505
Junior subordinated debentures		367		502
Total interest expense		4,270		4,711
Net interest income		2,466		2,462
PROVISION FOR LOAN LOSSES		42		75
Net interest income after provision for loan losses		2,424		2,387
NON-INTEREST INCOME:
Service charges and other fees		422		387
Net gain on sales of loans held for sale		—		116
Net gain on sales of investments		69		—
Increase in cash surrender value of life insurance		182		147
Other income		89		97
Total non-interest income		762		747
NON-INTEREST EXPENSE:
Salaries and employee benefits		1,430		1,498
Occupancy and equipment		400		396
Professional fees		283		337
Federal deposit insurance premium		51		38
Operations of real estate owned		—		50
Data processing		137		138
Advertising		100		107
Deposit processing		145		154
Other		395		419
Total non-interest expense		2,941		3,137
Income (loss) before income tax expense (benefit)		245		(3	)
Income tax expense (benefit)		13		(91	)
Net income	$	232	$	88
Earnings per common share:
Basic	$	0.10	$	0.04
Diluted	$	0.10	$	0.04
Weighted average shares — basic		2,314,908		1,992,453
Weighted average shares — diluted		2,314,908		2,011,731

See notes to unaudited consolidated financial statements.

-2-

FIRST KEYSTONE FINANCIAL, INC.

UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(dollars in thousands)

						Employee						Accumulated			Retained
			Additional			stock						other			earnings-		Total
	Common		paid-in			ownership			Treasury			comprehensive			partially		stockholders’
	stock		capital			plan			stock			(loss) gain			restricted		equity
BALANCE AT OCTOBER 1, 2006	$	27	$	12,974		$	(3,089	)	$	(10,522	)	$	(787	)	$	30,056	$	28,659
Net income		—		—			—			—			—			88		88
Other comprehensive income, net of tax:
Net unrealized loss on securities net of reclassification adjustment, net of tax benefit of $134(1)		—		—			—			—			(261	)		—		(261	)
Comprehensive loss		—		—			—			—			—			—		(173	)
ESOP shares committed to be released		—		—			25			—			—			—		25
Share-based compensation		—		15			—			—			—			—		15
Excess of fair value above cost of ESOP shares committed to be released		—		10			—			—			—			—		10
Release of treasury shares for equity offering		—		(412	)		—			6,200			—			—		5,788
BALANCE AT DECEMBER 31, 2006	$	27	$	12,587		$	(3,064	)	$	(4,322	)	$	(1,048	)	$	30,144	$	34,324
BALANCE AT OCTOBER 1, 2007	$	27	$	12,598		$	(2,985	)	$	(4,244	)	$	$(1,223	)	$	30,521	$	34,694
Net income		—		—			—			—			—			232		232
Other comprehensive income, net of tax:
Net unrealized gain on securities net of reclassification adjustment, net of taxes of $332(1)		—		—			—			—			644			—		644
Comprehensive income		—		—			—			—			—			—		876
ESOP shares committed to be released		—		—			27			—			—			—		27
Excess of fair value above cost of ESOP shares committed to be released		—		(1	)		—			—			—			—		(1	)
BALANCE AT DECEMBER 31, 2007	$	27	$	12,597		$	(2,958	)	$	(4,244	)	$	(579	)	$	30,753	$	35,596

⁽¹⁾ Disclosure of reclassification amount, net of tax:

	December 31,
	2007		2006
Net unrealized appreciation (depreciation) arising during the period	$	644	$	(261	)
Less: reclassification adjustment for net gains included in net income (net of tax)		—		—
Net unrealized gain (loss) on securities	$	644	$	(261	)

See notes to unaudited consolidated financial statements.

-3-

FIRST KEYSTONE FINANCIAL, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

	Three months ended
	December 31,
	2007			2006
OPERATING ACTIVITIES:
Net income	$	232		$	88
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for depreciation and amortization		141			137
Amortization of premiums and discounts		15			59
Increase in cash surrender value of life insurance		(182	)		(147	)
Net gain on sales of loans held for sale		—			(116	)
Net gain on sales of investments		(69	)		—
Provision for loan losses		42			75
Amortization of ESOP		26			35
Share-based compensation		—			15
Changes in assets and liabilities which provided (used) cash:
Origination of loans held for sale		—			(152	)
Loans sold in the secondary market		—			1,099
Accrued interest receivable		345			125
Prepaid expenses and other assets		(153	)		151
Accrued interest payable		86			218
Accrued expenses		118			(817	)
Net cash provided by operating activities		601			770
INVESTING ACTIVITIES:
Loans originated		(14,652	)		(26,297	)
Purchases of:
Mortgage-related securities available for sale		(14,895	)		(2,026	)
Investment securities available for sale		(2,948	)		(113	)
Redemption of FHLB stock		1,179			1,017
Purchase of FHLB stock		(1,080	)		(725	)
Principal collected on loans		26,516			32,545
Proceeds from sales of investments		69			—
Proceeds from maturities, calls, or repayments of:
Investment securities available for sale		1,039			55
Mortgage-related securities available for sale		3,232			3,092
Mortgage-related securities held to maturity		1,405			1,780
Purchase of property and equipment		(77	)		(13	)
Net cash (used in) provided by investing activities		(212	)		9,315
FINANCING ACTIVITIES:
Net decrease in deposit accounts		(7,841	)		(2,045	)
Net decrease in FHLBank advances and other borrowings		(2,176	)		(6,715	)
Net increase in advances from borrowers for taxes and insurance		1,077			1,033
Net proceeds from equity offering		—			5,788
Net cash used in financing activities		(8,940	)		(1,939	)
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(8,551	)		8,146
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		52,935			12,787
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	44,384		$	20,933
SUPPLEMENTAL DISCLOSURE OF CASH FLOW AND NON-CASH INFORMATION:
Cash payments for interest on deposits and borrowings	$	4,184		$	4,493

See notes to unaudited consolidated financial statements.

-4-

FIRST KEYSTONE FINANCIAL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)

1.	BASIS OF PRESENTATION
	The accompanying unaudited consolidated financial statements have been prepared in accordance with instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. However, such information reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the periods.
	The results of operations for the three month period ended December 31, 2007 are not necessarily indicative of the results to be expected for the fiscal year ending September 30, 2008 or any other period. The consolidated financial statements presented herein should be read in conjunction with the audited consolidated financial statements and related notes thereto included in the First Keystone Financial, Inc. (the “Company”) Annual Report on Form 10-K for the year ended September 30, 2007.
2.	INVESTMENT SECURITIES
	The amortized cost and approximate fair value of investment securities available for sale and held to maturity, by contractual maturities, are as follows:

	December 31, 2007
			Gross		Gross
	Amortized		Unrealized		Unrealized			Approximate
	Cost		Gain		Loss			Fair Value
Available for Sale:
U.S. Government and agency bonds:
1 to 5 years	$	2,000	$	1	$	—		$	2,001
Over 10 years		2,963		37		—			3,000
Municipal obligations:
5 to 10 years		1,130		3		—			1,133
Over 10 years		2,824		79		—			2,903
Corporate bonds:
Less than 1 year		1,000		19		—			1,019
1 to 5 years		1,070		26		—			1,096
5 to 10 years		2,000		—		(385	)		1,615
Over 10 years		7,598		—		(339	)		7,259
Mutual funds		10,327		15		(293	)		10,049
Other equity investments		1,040		37		(61	)		1,016
Total	$	31,952	$	217	$	(1,078	)	$	31,091
Held to Maturity:
Municipal obligations:
5 to 10 years	$	3,256	$	56	$	—		$	3,312

-5-

Provided below is a summary of investment securities available for sale and held to maturity which were in an unrealized loss position at December 31, 2007.

	Loss Position					Loss Position
	Less than 12 Months					12 Months or Longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Corporate bonds	$	5,398	$	(180	)	$	3,475	$	(544	)	$	8,873	$	(724	)
Equity securities		274		(61	)		—		—			274		(61	)
Mutual funds		—		—			9,522		(293	)		9,522		(293	)
Total	$	5,672	$	(241	)	$	12,997	$	(837	)	$	18,669	$	(1,078	)

At December 31, 2007, investment securities in a gross unrealized loss position for twelve months or longer consisted of three securities and investments in two mutual funds having an aggregate depreciation of 6.0% from the Company’s amortized cost basis. Management believes that the estimated fair value of the securities disclosed above is primarily dependent upon the movement in market interest rates. These investment securities are comprised of securities that are rated investment grade by at least one bond credit rating service. Although the fair value will fluctuate as the market interest rates move, management believes that these fair values will recover as the underlying portfolios mature and are reinvested in yielding market rates of interest investments. Mutual funds in an unrealized loss position for 12 months or longer consist of two funds primarily invested in asset-backed securities and have an aggregate depreciation of 3.0%. Corporate bonds in an unrealized loss position for 12 months or longer consisted of three debt securities and had an aggregate depreciation of 13.5%. The Company has the ability and intent to hold all of these securities until such time as the value recovers. Management does not believe any individual unrealized loss as of December 31, 2007 represents an other-than-temporary impairment.

The amortized cost and approximate fair value of investment securities available for sale and held to maturity, by contractual maturities, are as follows:

	September 30, 2007
			Gross		Gross
	Amortized		Unrealized		Unrealized			Approximate
	Cost		Gain		Loss			Fair Value
Available for Sale:
U.S. Government bonds:
1 to 5 years	$	2,000	$	—	$	—		$	2,000
Over 10 years		3,950		10		(9	)		3,951
Municipal obligations:
5 to 10 years		1,130		—		(14	)		1,116
Corporate bonds:
1 to 5 years		2,074		50		—			2,124
5 to 10 years		2,000		—		(560	)		1,440
Over 10 years		7,654		61		(42	)		7,673
Mutual funds		10,203		7		(322	)		9,888
Other equity investments		1,040		60		(8	)		1,092
Total	$	30,051	$	188	$	(955	)	$	29,284
Held to Maturity:
Municipal obligations:
5 to 10 years	$	3,256	$	10	$	—		$	3,266

-6-

Provided below is a summary of investment securities available for sale and held to maturity which were in an unrealized loss position at September 30, 2007.

	Loss Position					Loss Position
	Less than 12 Months					12 Months or Longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
U.S. Government bonds	$	2,954	$	(9	)	$	—	$	—		$	2,954	$	(9	)
Corporate bonds		—		—			3,420		(602	)		3,420		(602	)
Municipal bonds		—		—			986		(14	)		986		(14	)
Mutual funds		—		—			9,374		(322	)		9,374		(322	)
Equity securities		327		(8	)		—		—			327		(8	)
Total	$	3,281	$	(17	)	$	13,780	$	(938	)	$	17,061	$	(955	)

3.	MORTGAGE-RELATED SECURITIES
	Mortgage-related securities available for sale and mortgage-related securities held to maturity are summarized as follows:

	December 31, 2007
			Gross		Gross
	Amortized		Unrealized		Unrealized			Approximate
	Cost		Gain		Loss			Fair Value
Available for Sale:
FHLMC pass-through certificates	$	26,051	$	195	$	(14	)	$	26,232
FNMA pass-through certificates		34,210		300		(65	)		34,445
GNMA pass-through certificates		2,117		12		—			2,129
Collateralized mortgage obligations		29,551		19		(464	)		29,106
Total	$	91,929	$	526	$	(543	)	$	91,912
Held to Maturity:
FHLMC pass-through certificates	$	11,426	$	9	$	(112	)	$	11,323
FNMA pass-through certificates		18,412		6		(139	)		18,279
Collateralized mortgage obligations		34		—		—			34
Total	$	29,872	$	15	$	(251	)	$	29,636

Provided below is a summary of mortgage-related securities available for sale and held to maturity which were in an unrealized loss position at December 31, 2007.

	Loss Position					Loss Position
	Less than 12 Months					12 Months or Longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Pass-through certificates	$	5,296	$	(17	)	$	29,966	$	(313	)	$	35,262	$	(330	)
Collateralized mortgage obligations		4,776		(17	)		23,671		(447	)		28,447		(464	)
Total	$	10,072	$	(34	)	$	53,637	$	(760	)	$	63,709	$	(794	)

-7-

At December 31, 2007, mortgage-related securities in a gross unrealized loss position for twelve months or longer consisted of forty securities that at such date had an aggregate depreciation of 1.4% from the Company’s amortized cost basis. Management does not believe any individual unrealized loss as of December 31, 2007 represents an other-than-temporary impairment. The unrealized losses reported for mortgage-related securities relate primarily to securities issued by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and private institutions. The majority of the unrealized losses associated with mortgage-related securities are attributable to changes in interest rates and not due to the deterioration of the creditworthiness of the issuer. The Company has the ability and intent to hold these securities until the securities mature or recover in value.

Mortgage-related securities available for sale and mortgage-related securities held to maturity are summarized as follows:

	September 30, 2007
			Gross		Gross
	Amortized		Unrealized		Unrealized			Approximate
	Cost		Gain		Loss			Fair Value
Available for Sale:
FHLMC pass-through certificates	$	15,647	$	1	$	(137	)	$	15,511
FNMA pass-through certificates		31,744		80		(320	)		31,504
GNMA pass-through certificates		2,185		3		(7	)		2,181
Collateralized mortgage obligations		30,689		19		(726	)		29,982
Total	$	80,265	$	103	$	(1,190	)	$	79,178
Held to Maturity:
FHLMC pass-through certificates	$	11,957	$	5	$	(316	)	$	11,646
FNMA pass-through certificates		19,289		4		(476	)		18,817
Collateralized mortgage obligations		48		—		—			48
Total	$	31,294	$	9	$	(792	)	$	30,511

Provided below is a summary of mortgage-related securities available for sale and held to maturity which were in an unrealized loss position at September 30, 2007.

	Loss Position					Loss Position
	Less than 12 Months					12 Months or Longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Pass-through certificates	$	21,075	$	(176	)	$	47,185	$	(1,080	)	$	68,260	$	(1,256	)
Collateralized mortgage obligations		2,754		(20	)		26,392		(706	)		29,146		(726	)
Total	$	23,829	$	(196	)	$	73,577	$	(1,786	)	$	97,406	$	(1,982	)

-8-

4.	LOANS RECEIVABLE
	Loans receivable consist of the following:

	December 31,			September 30,
	2007			2007
Real estate loans:
Single-family	$	140,151		$	139,888
Construction and land		23,500			23,501
Multi-family and commercial		55,320			60,026
Home equity and lines of credit		56,352			57,808
Consumer loans		1,191			1,204
Commercial loans		15,887			19,044
Total loans		292,401			301,471
Loans in process		(8,801	)		(6,008	)
Allowance for loan losses		(3,376	)		(3,322	)
Deferred loan costs		296			277
Loans receivable — net	$	280,520		$	292,418

At December 31, 2007 and September 30, 2007, non-performing loans (which include loans in excess of 90 days delinquent) amounted to approximately $1,785 and $4,685, respectively. At December 31, 2007, non-performing loans consisted of seven single-family residential mortgage loans aggregating $466, four non-residential mortgage loans aggregating $1,072, three commercial business loans aggregating $219 and four consumer loans aggregating $28.

At December 31, 2007 and September 30, 2007, the Company had impaired loans with a total recorded investment of $245 and $1,173, respectively. No interest income was recognized on these impaired loans during the three months ended December 31, 2007. Interest income of approximately $9 was not recognized as interest income due to the non-accrual status of such loans for the three months ended December 31, 2007.

Loans collectively evaluated for impairment include residential real estate, home equity (including lines of credit) and consumer loans and are not included in the data that follow:

	December 31,		September 30,
	2007		2007
Impaired loans with related allowance for loan losses under SFAS No. 114	$	220	$	1,148
Impaired loans with no related allowance for loan losses under SFAS No. 114		25		25
Total impaired loans	$	245	$	1,173
Valuation allowance related to impaired loans	$	110	$	271

The following is an analysis of the allowance for loan losses:

	Three Months Ended
	December 31,
	2007		2006
Balance beginning of period	$	3,322	$	3,367
Provisions charged to income		42		75
Charge-offs		—		(12	)
Recoveries		12		25
Total	$	3,376	$	3,455

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5.	DEPOSITS
	Deposits consist of the following major classifications:

	December 31,					September 30,
	2007					2007
	Amount		Percent			Amount		Percent
Non-interest bearing	$	16,178		4.7	%	$	18,404		5.2	%
NOW		73,643		21.3			75,194		21.2
Passbook		35,979		10.4			37,369		10.6
Money market demand		34,646		10.0			34,252		9.7
Certificates of deposit		185,421		53.6			188,489		53.3
Total	$	345,867		100.0	%	$	353,708		100.0	%

6.	EARNINGS PER SHARE
	Basic net income per share is based upon the weighted average number of common shares outstanding, while diluted net income per share is based upon the weighted average number of common shares outstanding and common share equivalents that would arise from the exercise of dilutive securities. All dilutive shares consist of options the exercise price of which is lower than the market price of the common stock covered thereby at the dates presented. At December 31, 2007 and 2006, anti-dilutive shares consisted of options covering 50,956 and 2,221 shares, respectively.
	The calculation of basic and diluted earnings per share (“EPS”) is as follows:

	Three Months Ended
	December 31,
	2007		2006
Numerator	$	232	$	88
Denominators:
Basic shares outstanding		2,314,908		1,992,453
Effect of dilutive securities		—		19,278
Dilutive shares outstanding		2,314,908		2,011,731
Earnings per share:
Basic	$	0.10	$	0.04
Diluted	$	0.10	$	0.04

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7.	REGULATORY CAPITAL REQUIREMENTS
	The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum regulatory capital requirements can result in certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and other factors.
	Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth below) of tangible and core capital (as defined in the regulations) to adjusted assets (as defined), and of Tier I and total capital (as defined) to average assets (as defined). Management believes, as of December 31, 2007, that the Bank meets all regulatory capital adequacy requirements to which it is subject.
	The Bank’s actual capital amounts and ratios are presented in the following table.

						Required for					Well Capitalized
						Capital Adequacy					Under Prompt
	Actual					Purpose					Corrective Action
	Amount		Ratio			Amount		Ratio			Amount		Ratio
At December 31, 2007:
Core Capital (to Adjusted Tangible Assets)	$	49,628		9.63	%	$	20,621		4.0	%	$	25,777		5.0	%
Tier I Capital (to Risk-Weighted Assets)		49,628		16.24			N/A		N/A			18,331		6.0
Total Capital (to Risk-Weighted Assets)		53,004		17.35			24,441		8.0			30,552		10.0
Tangible Capital (to Tangible Assets)		49,551		9.61			7,732		1.5			N/A		N/A
At September 30, 2007:
Core Capital (to Adjusted Tangible Assets)	$	49,207		9.38	%	$	20,975		4.0	%	$	26,219		5.0	%
Tier I Capital (to Risk-Weighted Assets)		49,207		15.44			N/A		N/A			19,118		6.0
Total Capital (to Risk-Weighted Assets)		52,529		16.49			25,491		8.0			31,864		10.0
Tangible Capital (to Tangible Assets)		49,126		9.37			7,864		1.5			N/A		N/A

On February 13, 2006, the Bank entered into a supervisory agreement with the Office of Thrift Supervision (“OTS.”) The supervisory agreement requires the Bank, among other things, to maintain minimum core capital and total risk-based capital ratios of 7.5% and 12.5%, respectively. At December 31, 2007, the Bank was in compliance with such requirement, the Bank has been deemed to be “well-capitalized” for purposes of the prompt corrective action regulations by the OTS.

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8.	RECENT ACCOUNTING PRONOUNCEMENTS
	In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. SFAS No. 141(R) is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.
	In September 2007, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value. SFAS No. 157 clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability. The definition focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted. The Company is evaluating the impact of this pronouncement but does not expect that the guidance will have a material effect on the Company’s financial position or results of operations.
	In September 2007, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post-retirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R).” For defined benefit post-retirement plans, SFAS 158 requires that the funded status be recognized in the statement of financial position, that assets and obligations that determine funded status be measured as of the end of the employer’s fiscal year, and that changes in funded status be recognized in comprehensive income in the year the changes occur. SFAS 158 does not change the amount of net periodic benefit cost included in net income or address measurement issues related to defined benefit post-retirement plans. This requirement is effective for fiscal years ending after December 15, 2008. The other provisions of the Statement were effective as of the end of the fiscal year ending after December 15, 2006, for public companies. The Company has determined that the guidance provided by SFAS No. 158 does not have an impact on its stockholders’ equity or on the Company’s financial position or results of operations.
	In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51.” SFAS No. 160 amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Among other requirements, this statement requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.

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The Company adopted the provisions of FIN No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109,” effective October 1, 2007. FIN No. 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. FIN No. 48 also provides guidance on the accounting for and disclosure of unrecognized tax benefits, interest and penalties. Adoption of FIN No. 48 did not have a significant impact on the Company’s financial statements.

In June 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-11 (“EITF 06-11”), “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” EITF 06-11 applies to share-based payment arrangements with dividend protection features that entitle employees to receive (a) dividends on equity-classified nonvested shares, (b) dividend equivalents on equity-classified nonvested share units, or (c) payments equal to the dividends paid on the underlying shares while an equity-classified share option is outstanding, when those dividends or dividend equivalents are charged to retained earnings under SFAS No. 123R, Share-Based Payment, and result in an income tax deduction for the employer. A consensus was reached that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity-classified nonvested equity shares, nonvested equity share units, and outstanding equity share options should be recognized as an increase in additional paid-in capital. EITF 06-11 is effective for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s results of operations.

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

     In addition to historical information, this Quarterly Report on Form 10-Q includes certain “forward-looking statements” based on management’s current expectations. The Company’s actual results could differ materially, as such term is defined in the Securities Act of 1933 and the Securities Exchange Act of 1934, from management’s expectations. Such forward-looking statements include statements regarding management’s current intentions, beliefs or expectations as well as the assumptions on which such statements are based. These forward-looking statements are subject to significant business, economic and competitive uncertainties and contingencies, many of which are not subject to the Company’s control. Stockholders and potential stockholders are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Factors that could cause future results to vary from current management expectations include, but are not limited to, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal, state and local tax authorities, changes in interest rates, deposit flows, the cost of funds, demand for loan products, demand for financial services, competition, changes in the quality or composition of the Company’s loan and investment portfolios, changes in accounting principles, policies or guidelines, availability and cost of energy resources and other economic, competitive, governmental and technological factors affecting the Company’s operations, markets, products, services and fees.

     The Company undertakes no obligation to update or revise any forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results that occur subsequent to the date such forward-looking statements are made.

General

     The Company is a Pennsylvania corporation and the sole stockholder of the Bank, a federally chartered stock savings bank, which converted to the stock form of organization in January 1995. The Bank is a community-oriented bank emphasizing customer service and convenience. The Bank’s primary business is attracting deposits from the general public and using those funds, together with other available sources of funds, primarily borrowings, to originate loans. The Bank’s management remains focused on its long-term strategic plan to continue to shift the Bank’s loan composition towards increased investment in commercial, construction and home equity loans and lines of credit in order to provide a higher yielding loan portfolio with generally shorter contractual terms. In view of the Company’s recent reduction in criticized and classified commercial loans combined with the implementation of an enhanced loan administration infrastructure, as well as underwriting standards with respect to the origination of commercial loans, the Company expects to renew its emphasis on the origination of commercial loans. In furtherance of such goal, the Company expects to engage experienced commercial loan officers during fiscal 2008.

Critical Accounting Policies

     Accounting policies involving significant judgments and assumptions by management, which have, or could have, a material impact on the carrying value of certain assets or comprehensive income, are considered critical accounting policies. In management’s opinion, the most critical accounting policy affecting the Company’s financial statements is the evaluation of the allowance for loan losses. The Company maintains an allowance for loan losses at a level management believes is sufficient to provide for known and inherent losses in the loan portfolio that were both probable and reasonable to estimate. The allowance for loan losses is considered a critical accounting estimate because there is a large degree of judgment in (i) assigning individual loans to specific risk levels (pass, substandard, doubtful and loss), (ii) valuing the underlying collateral securing the loans, (iii) determining the appropriate reserve factor to be applied to specific risk levels for criticized and classified loans (special mention, substandard, doubtful and loss) and (iv) determining reserve factors to be applied to pass loans based upon loan type. Accordingly, there is a likelihood that materially different amounts would be reported under different, but reasonably plausible conditions or assumptions.

     The determination of the allowance for loan losses requires management to make significant estimates with respect to the amounts and timing of losses and market and economic conditions. Accordingly, a decline in the economy could increase loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss allowances in future periods. The Bank will continue to monitor and adjust its

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allowance for loan losses through the provision for loan losses as economic conditions and other factors dictate. Management reviews the allowance for loan losses generally on a monthly basis, but at a minimum at least quarterly. Although the Bank maintains its allowance for loan losses at levels considered adequate to provide for the inherent risk of loss in its loan portfolio, there can be no assurance that future losses will not exceed estimated amounts or that additional provisions for loan losses will not be required in future periods. In addition, the Bank’s determination as to the amount of its allowance for loan losses is subject to review by its primary federal banking regulator, the OTS, as part of its examination process, which may result in additional provisions to increase the allowance based upon the judgment and review of the OTS.

Supervisory Agreements

     On February 13, 2006, the Company and the Bank each entered into a supervisory agreement with the OTS which primarily addressed issues identified in the OTS’ reports of examination of the Company’s and the Bank’s operations and financial condition conducted in 2005.

     Under the terms of the supervisory agreement between the Company and the OTS, the Company agreed to, among other things, (i) develop and implement a three-year capital plan designed to support the Company’s efforts to maintain prudent levels of capital and to reduce its debt-to-equity ratio below 50%; (ii) not incur any additional debt without the prior written approval of the OTS; and (iii) not repurchase any shares of or pay any cash dividends on its common stock until the Company complied with certain conditions. Upon reducing its debt-to-equity below 50%, the Company may resume the payment of quarterly cash dividends at the lesser of the dividend rate in effect immediately prior to entering into the supervisory agreement ($0.11 per share) or 35% of its consolidated net income (on an annualized basis), provided that the OTS, upon review of prior written notice from the Company of the proposed dividend, does not object to such payment.

     The Company has submitted to and received from the OTS approval of a capital plan, which calls for an equity infusion in order to reduce the Company’s debt-to-equity ratio below 50%. As part of its capital plan, the Company conducted a private placement of 400,000 shares of common stock, raising gross proceeds of approximately $6.5 million. In June 2007, the net proceeds of approximately $5.8 million were used to reduce the amount of its outstanding debt through the redemption of $6.2 million of its junior subordinated debentures. As a result of such redemption, the Company’s debt-to-equity ratio is less than 50%. Although the Company’s debt-to-equity ratio is below 50%, it does not anticipate resuming the payment of dividends until such time as the Company’s operating results materially improve.

     Under the terms of the supervisory agreement between the Bank and the OTS, the Bank agreed to, among other things, (i) not grow in any quarter in excess of the greater of 3% of total assets (on an annualized basis) or net interest credited on deposit liabilities during such quarter; (ii) maintain its core capital and total risk-based capital in excess of 7.5% and 12.5%, respectively; (iii) adopt revised policies and procedures governing commercial lending; (iv) conduct periodic reviews of its commercial loan department; (v) conduct periodic internal loan reviews; (vi) adopt a revised asset classification policy and (vii) not amend, renew or enter compensatory arrangements with senior executive officers and directors, subject to certain exceptions, without the prior approval of the OTS. As a result of the growth restriction imposed on the Bank, the Company’s growth is currently and will continue to be substantially constrained unless and until the supervisory agreements are terminated or modified. As of March 31, 2006 and June 30, 2006, the Bank exceeded the growth limitation contained in the supervisory agreement with the OTS described above. Subsequent to June 30, 2006, the Bank reduced its assets sufficiently to be below the June 30, 2006 limitation. The OTS advised the Bank that it would not take any regulatory action against the Bank provided it was in compliance with the growth limitation as of September 30, 2006. The Bank has continued to comply with the growth restriction as of each quarter since and including September 30, 2006.

     As a result of the supervisory agreement, the Bank hired a Chief Credit Officer (“CCO”) who, under the direction of the Board and the CEO, has taken steps to enhance the Bank’s credit review analysis, develop loan administrative procedures and adopt an asset classification system. The Bank continues to address these areas and to reduce the level of classified and criticized assets in order to be in full compliance with the terms of the supervisory agreements. At December 31, 2007, the Company believes it and the Bank are in compliance with all the operative provisions of both supervisory agreements.

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Comparison of Financial Condition at December 31, 2007 and September 30, 2007

     Total assets of the Company decreased by $7.8 million from $524.8 million at September 30, 2007 to $517.0 million at December 31, 2007. Loans receivable decreased by $11.9 million, or 4.1%, from $292.4 million at September 30, 2007 to $280.5 million at December 31, 2007 primarily as a result of the Company experiencing repayments within the commercial real estate and business loan portfolios while only originating a limited amount of such loans. This resulted from the Company’s self-imposed curtailment of such lending activity while implementing substantially enhanced credit review and administration infrastructure. Cash and cash equivalents decreased by $8.6 million, or 16.2%, to $44.4 million at December 31, 2007 from $53.0 million at September 30, 2007 primarily due to investing the cash in municipal obligations and mortgage-backed securities. As a result of the additional cash flows from the loan portfolio, mortgage-related securities available for sale increased by $12.7 million, or 16.1%, to $91.9 million. Deposits decreased $7.8 million, or 2.2%, from $353.7 million at September 30, 2007 to $345.9 million at December 31, 2007. The decrease in deposits resulted from a $4.8 million, or 2.9%, decrease in core deposits (which consist of passbook, money market, NOW and non-interest bearing accounts) combined with a $3.0 million, or 1.6%, decrease in certificates of deposit. The decline in deposits reflected the effects of competition as local competitors offered higher rates on these products.

Comparison of Results of Operations for the Three Months Ended December 31, 2007 and 2006

Net Income. Net income was $232,000 for the three months ended December 31, 2007 as compared to $88,000 for the same period in 2006. The $144,000, or 163.6%, increase in net income for the three months ended December 31, 2007 was primarily due to a $36,000 increase in net interest income after provision for loan losses combined with a $196,000 decrease in non-interest expense, partially offset by a $104,000 decrease in income tax benefit.

Net Interest Income. Net interest income increased slightly to $2.5 million for the three months ended December 31, 2007 as compared to the same period in 2006. The increase was primarily due to a $441,000, or 9.4%, decrease in interest expense which was the result of a $34.8 million, or 7.2%, decrease in average interest-bearing liabilities combined with a 9 basis point decrease in the weighted average rate paid on interest-bearing liabilities for the three months ended December 31, 2007 as compared to the same period in 2006. The decrease in interest expense was almost fully offset by a $437,000, or 6.1%, decrease in interest income which was the result of a $25.7 million decrease in average interest-earning assets, combined with a 4 basis point decrease in the weighted average rate earned on interest-earning assets for the three months ended December 31, 2007 as compared to the same period in 2006.

     The interest rate spread and net interest margin were 2.10% and 2.16%, respectively, for the three months ended December 31, 2007 as compared to 2.05% and 2.04%, respectively, for the same period in 2006. The increase in the net interest margin was due to a decline in the cost of funds primarily as result of the $6.2 million redemption of the junior subordinated debentures during fiscal 2007 which bore an interest rate of 9.1% at time of their redemption. As a result of the Federal Reserve’s actions with the recent reductions in the prime rate, the Company has experienced a reduction in the yield earned on our interest-earning assets.

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     The following table presents the average balances for various categories of assets and liabilities, and income and expense related to those assets and liabilities for the three months ended December 31, 2007 and 2006.

	For the three months ended
	December 31, 2007               December 31, 2006
					Average								Average
	Average				Yield/			Average					Yield/
(Dollars in thousands)	Balance		Interest		Cost			Balance			Interest		Cost
Interest-earning assets:
Loans receivable(1) (2)	$	286,475	$	4,671		6.52	%	$	321,525		$	5,355		6.66	%
Mortgage-related securities(2)		114,775		1,380		4.81			106,734			1,207		4.52
Investment securities		38,034		523		5.50			43,904			548		4.99
Other interest-earning assets		17,806		162		3.64			10,658			63		2.37
Total interest-earning assets		457,090		6,736		5.90			482,821			7,173		5.94
Non-interest-earning assets		34,602							37,911
Total assets	$	491,692						$	520,732
Interest-bearing liabilities:
Deposits	$	347,017		2,678		3.09		$	355,631			2,704		3.04
FHLB advances and other borrowings		87,704		1,225		5.59			107,661			1,505		5.59
Junior subordinated debentures		15,264		367		9.64			21,480			502		9.35
Total interest-bearing liabilities		449,985		4,270		3.80			484,772			4,711		3.89
Interest rate spread(3)						2.10	%							2.05	%
Non-interest-bearing liabilities		6,671							7,048
Total liabilities		456,656							491,820
Stockholders’ equity		35,036							28,912
Total liabilities and stockholders’ equity	$	491,692						$	520,732
Net interest-earning assets	$	7,105						$	(1,951	)
Net interest income			$	2,466							$	2,462
Net interest margin(3)						2.16	%							2.04	%
Ratio of average interest-earning assets to average interest-bearing liabilities						101.58	%							99.60	%

(1)	Includes non-accrual loans.
(2)	Includes assets classified as either available for sale or held for sale.
(3)	Net interest income divided by average interest-earning assets.

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Provision for Loan Losses. Provisions for loan losses are charged to earnings to maintain the total allowance for loan losses at a level believed by management sufficient to cover all known and inherent losses in the loan portfolio which are both probable and reasonably estimable. Management’s analysis includes consideration of the Company’s historical experience, the volume and type of lending conducted by the Company, the amount of the Company’s classified assets, the status of past due principal and interest payments, general economic conditions, particularly as they relate to the Company’s primary market area, and other factors related to the collectibility of the Company’s loan portfolio. For the three months ended December 31, 2007 and 2006, the provision for loan losses amounted to $42,000 and $75,000, respectively. The provision for loan losses was based on the Company’s monthly review of the credit quality of its loan portfolio, the net charge-offs during the first quarter of fiscal 2008 as well as the other factors referenced above.

     At December 31, 2007, non-performing assets decreased $2.9 million to $1.8 million, or 0.4%, of total assets, from $4.7 million at September 30, 2007. The decrease in non-performing assets was primarily the result of $1.7 million and $488,000 of non-performing commercial business loans and construction loans, respectively, being renewed that were in the 90 days delinquent and still accruing category because the loans had exceeded their contractual maturity. In addition, non-accrual loans decreased $886,000 primarily as a result of a repayment in full of a $1.1 million non-performing commercial loan credit secured by a bakery along with rental units located above the establishment. Of the $1.8 million in non-performing assets, $1.0 million represents commercial loans that are 90 days delinquent and still accruing because the loans exceeded their contractual maturity. The loans continue to pay in accordance with their terms otherwise. The principal balance of the loans is included in the accruing loans past due 90 days or more category of non-performing assets. The coverage ratio, which is the ratio of the allowance for loan losses to non-performing loans, was 189.1% and 70.9% at December 31, 2007 and September 30, 2007, respectively.

     At December 31, 2007, the Bank decreased its classified assets by $2.3 million to $9.7 million compared to $12.0 million at September 30, 2007. All the assets were classified as substandard and consisted primarily of commercial business and real estate loans.

     Management continues to review its loan portfolio to determine the extent, if any, to which additional loss provisions may be deemed necessary. There can be no assurance that the allowance for losses will be adequate to cover losses which may in fact be realized in the future and that additional provisions for losses will not be required.

Non-interest Income. Non-interest income increased $15,000, or 2.0%, to $762,000 for the three months ended December 31, 2007 as compared to the same period in 2006. The increase was due to increases of $69,000, $35,000 and $35,000 in gains on sale of investments, service charges and other fees, and increases in cash surrender value of bank owned life insurance, respectively. The gain on sale of investments was primarily the receipt of a final distribution of an equity investment. The increase in service charges and other fees is due to additional volume in fees being assessed. These increases in non-interest income were partially offset by an $116,000 decrease in gains on sale of loans. The Company elected to originate and sell SBA loans in fiscal 2007; it was not involved in such activity in fiscal 2008.

Non-interest Expense. Non-interest expense decreased $196,000, or 6.2%, during the three months ended December 31, 2007 compared to the same period in 2006. The decrease was primarily due to decreases of $68,000, $54,000, and $24,000 in salary and employee benefits, professional fees, and other operating expenses, respectively. Salaries and employee benefits decreased primarily due to the reduction in the number of employees employed by the Bank and in the costs related to the employee stock ownership plan. The decrease in professional fees was related to legal and audit services. In addition, non-interest expense was $50,000 higher in the first quarter of fiscal 2007 due to real estate owned expenditures in such period related to the maintenance of commercial real estate located in Chesapeake City, Maryland, which property was sold in January 2007.

Income Tax Expense. The Company recognized an income tax expense of $13,000 for the three months ended December 31, 2007 as compared to recognition of an income tax benefit of $91,000, for the same period in 2006. The primary reason for the recognition of an income tax expense for the three months ended December 31, 2007 was the increase in income before income taxes combined with the reduced effects of non-taxable earning assets.

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Liquidity and Capital Resources

     The Company’s liquidity, represented by cash and cash equivalents, is a product of its operating, investing and financing activities. The Company’s primary sources of funds are deposits, amortization, prepayment and maturities of outstanding loans and mortgage-related securities, sales of loans, maturities of investment securities and other short-term investments, borrowing and funds provided from operations. While scheduled payments from the amortization of loans and mortgage-related securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. In addition, the Company invests excess funds in overnight deposits and other short-term interest-earning assets which provide liquidity to meet lending requirements. The Company has been able to generate sufficient cash through its deposits as well as borrowings to satisfy its funding commitments. At December 31, 2007, the Company had short-term borrowings (due within one year or currently callable by the FHLBank Pittsburgh (“FHLB”)) outstanding of $113.0 million, all of which consisted of advances from the FHLB. At December 31, 2007, the Company had committed to borrow an additional $12.0 million in long-term advances from the FHLB.

     Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in short-term investments such as overnight deposits. On a longer term basis, the Company maintains a strategy of investing in various lending products, mortgage-related securities and investment securities. The Company uses its sources of funds primarily to meet its ongoing commitments, to fund maturing certificates of deposit and savings withdrawals, fund loan commitments and maintain a portfolio of mortgage-related and investment securities. At December 31, 2007, total approved loan commitments outstanding amounted to $1.3 million, not including loans in process. At the same date, commitments under unused lines of credit amounted to $33.8 million. Certificates of deposit scheduled to mature in one year or less at December 31, 2007 totaled $162.3 million. Based upon the Company’s historical experience, management believes that a significant portion of maturing deposits will remain with the Company.

     The Bank is required under applicable federal banking regulations to maintain tangible capital equal to at least 1.5% of its adjusted total assets, core capital equal to at least 4.0% of its adjusted total assets and total capital equal to at least 8.0% of its risk-weighted assets. At December 31, 2007, the Bank had tangible capital and core capital equal to 9.6% of adjusted total assets and total capital equal to 16.2% of risk-weighted assets. However, as a result of the supervisory agreement discussed in Item 2 of Part I hereof, the Bank is required to maintain core and risk-based capital in excess of 7.5% and 12.5%, respectively. The Bank is in compliance with such requirements imposed by the supervisory agreement.

Impact of Inflation and Changing Prices

     The Consolidated Financial Statements of the Company and related notes presented herein have been prepared in accordance with generally accepted accounting principles which requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.

     Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services, since such prices are affected by inflation to a larger extent than interest rates. In the current interest rate environment, liquidity and the maturity structure of the Company’s assets and liabilities are critical to the maintenance of acceptable performance levels.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

     For a discussion of the Company’s asset and liability management policies, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation” in the Company’s Annual Report for the year ended September 30, 2007.

     The Company utilizes reports prepared by the OTS to measure interest rate risk. Using data from the Bank’s quarterly thrift financial reports, the OTS models the net portfolio value (“NPV”) of the Bank over a variety of interest rate scenarios. The NPV is defined as the present value of expected cash flows from existing assets less the present value of expected cash flows from existing liabilities plus the present value of net expected cash inflows from existing off-balance sheet contracts. The model assumes instantaneous, parallel shifts in the U.S. Treasury Securities yield curve up to 300 basis points, and a decline of 200 basis points.

     The interest rate risk measures used by the OTS include an “Exposure Measure” or “Post-Shock” NPV ratio and a “Sensitivity Measure”. The “Post-Shock” NPV ratio is the net present value as a percentage of assets over the various yield curve shifts. A low “Post-Shock” NPV ratio indicates greater exposure to interest rate risk and can result from a low initial NPV ratio or high sensitivity to changes in interest rates. The “Sensitivity Measure” is the decline in the NPV ratio, in basis points, caused by a 2% increase or decrease in rates, whichever produces a larger decline. The following sets forth the Bank’s NPV as of December 31, 2007.

Net Portfolio Value
(Dollars in thousands)
Changes in											Net
Rates in					Dollar			Percentage			Portfolio Value As
Basis Points			Amount		Change			Change			a % of Assets			Change
	300		$	44,795	$	(22,203	)		(33	)%		8.86	%	(370) bp
	200			53,096		(13,902	)		(21	)		10.30		(226) bp
	100			60,769		(6,229	)		(9	)		11.58		(98) bp
	50			64,064		(2,934	)		(4	)		12.10		(46) bp
	0			66,998		—			—			12.56		— bp
	(50	)		68,436		1,437			2			12.77		20 bp
	(100	)		70,062		3,063			5			13.00		43 bp
	(200			70,622		3,624			5			13.01		45 bp

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As of December 31, 2007, the Company’s NPV was $67.0 million or 12.56% of the market value of assets. Following a 200 basis point increase in interest rates, the Company’s “post shock” NPV would be $53.1 million or 10.30% of the market value of assets. The change in the NPV ratio or the Company’s sensitivity measure was a decline of 226 basis points.

Item 4. Controls and Procedures

     Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and (ii) accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure and that such disclosure controls and procedures are operating in an effective manner.

     No change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II

Item 1. Legal Proceedings

No material changes have occurred in the legal proceedings previously disclosed in Item 3 of the Company’s Form 10-K for the year ended September 30, 2007.

Item 1A. Risk Factors

There were no material changes from the risk factors described in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2007.

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

(a) — (b) Not applicable.

(c) Not applicable. No shares were repurchased by the Company during the quarter.

Item 3. Defaults Upon Senior Securities

Not applicable.

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

On February 6, 2008, the Annual Meeting of Stockholders of the Company was held to obtain approval for three proxy proposals submitted on behalf of the Company’s Board of Directors: the election of two nominees for directors, amending the amended and restated Articles of Incorporation, and the ratification of the appointment of S.R. Snodgrass, A.C. as the Company’s independent registered public accounting firm for the fiscal year ended September 30, 2008. With respect to the election of directors, the following directors were elected by the requisite plurality of the votes cast at the Annual Meeting on the matter:

	Votes
Nominee	For		Withheld
Bruce C. Hendrixson		1,750,222		466,072
Thomas M. Kelly		1,750,747		465,547

The directors whose terms continued are: Donald S. Guthrie, Donald G. Hosier, Jr., Edmund Jones, Jerry A. Naessens, William J. O’Donnell, Marshall J. Soss and Nedret Vidinli.

A proposal was submitted for approval by the shareholders to amend the amended and restated articles of incorporation to permit the Company to issue shares in “book-entry” form. The results were as follows: 2,020,251 votes for, 181,980 votes against and 14,063 votes abstaining.

With respect to the ratification of S.R. Snodgrass, A.C. as the Company’s independent registered public accounting firm for the fiscal year ending September 30, 2008, the results were as follows: 2,199,211 votes for, 5,669 votes against and 11,414 votes abstaining.

Item 5. Other Information

(a) Not applicable

(b) No changes in procedures.

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Item 6. Exhibits

List of Exhibits

Exhibit
No	Description
3.1	Amended and Restated Articles of Incorporation of First Keystone Financial, Inc. 1
3.2	Amended and Restated Bylaws of First Keystone Financial, Inc. 1
4.1	Specimen Stock Certificate of First Keystone Financial, Inc. 2
4.2	Instrument defining the rights of security holders **
10.1	Employment Agreement between First Keystone Financial, Inc. and Thomas M. Kelly dated December 1, 2004 3,*
10.2	Severance Agreement between First Keystone Financial, Inc. and Carol Walsh dated December 1, 2004 3,*
10.3	1995 Stock Option Plan 4, *
10.4	1995 Recognition and Retention Plan and Trust Agreement 5,*
10.5	1998 Stock Option Plan 5, *
10.6	Employment Agreement between First Keystone Bank and Thomas M. Kelly dated December 1, 2004 3, *
10.7	Severance Agreement between First Keystone Bank and Carol Walsh dated December 1, 2004 3, *
10.8	First Keystone Bank Supplemental Executive Retirement Plan 6,*
10.9	Amendment No. 1 to the Employment Agreement between First Keystone Financial, Inc. and Thomas M. Kelly 7,*
10.10	Amendment No. 1 to the Employment Agreement between First Keystone Bank and Thomas M. Kelly 7,*
10.11	Transition, Consulting, Noncompetition and Retirement Agreement by and between First Keystone Financial, Inc., First Keystone Bank and Donald S. Guthrie 8,*
10.12	Letter dated December 11, 2006 with respect to appointment to Board 9
10.13	Form of Registration Rights Agreement 10
11	Statement re: computation of per share earnings. See Note 2 to the Consolidated Financial Statements included in Item 8 hereof.
23.1	Consent of S.R. Snodgrass, A.C.
23.2	Consent of Deloitte & Touche LLP
31.1	Section 302 Certification of Chief Executive Officer
31.2	Section 302 Certification of Chief Financial Officer
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1	Codes of Ethics 11
99.2	Supervisory Agreement between First Keystone Financial, Inc. and the Office of Thrift Supervision dated February 13, 2006. 12
99.3	Supervisory Agreement between First Keystone Bank and the Office of Thrift Supervision dated February 13, 2006. 12

(1)	Incorporated by reference from Exhibit 3.1(with respect to the Articles) and Exhibit 3.2 (with respect to the Bylaws) on Form 8-K filed by the Registrant with the SEC on February 12, 2008.
(2)	Incorporated by reference from the Registration Statement on Form S-1 (Registration No. 33-84824) filed by the Registrant with the SEC on October 6, 1994, as amended.

-23-

(3)	Incorporated by reference from Exhibits 10.5, 10.8, 10.14, and 10.16, respectively, in the Form 8-K filed by the Registrant with the SEC on December 7, 2004 (File No. 000-25328).
(4)	Incorporated by reference from Exhibit 10.9 in the Form 10-K filed by the Registrant with SEC on December 29, 1995 (File No. 000-25328).
(5)	Incorporated from Appendix A of the Registrant=s definitive proxy statement dated December 24, 1998 (File No. 000-25328).
(6)	Incorporated by reference from Exhibit 10.17 in the Form 10-Q filed by the Registrant with the SEC on May 17, 2004.
(7)	Incorporated by reference from Exhibits 10.19 and 10.20, respectively, in the Form 8-K filed by the Registrant with the SEC on March 29, 2005.
(8)	Incorporated by reference from Exhibit 10.21 in the Form 8-K filed by the Registrant with the SEC on March 29, 2005.
(9)	Incorporated by reference from Exhibit 10.1 in the Form 8-K filed by the Registrant with the SEC on December 20, 2006.
(10)	Incorporated by reference from the Form 10-K filed by the Registrant with the SEC on December 23, 2003.
(11)	Incorporated by reference from the Form 10-Q for the quarter ended December 31, 2005 filed by the Registrant with the SEC on February 14, 2006.
(12)	Incorporated by reference from the Form 10-K filed by the Registrant with the SEC on December 29, 2006.
(*)	Consists of a management contract or compensatory plan
(**)	The Company has no instruments defining the rights of holders of long-term debt where the amount of securities authorized under such instrument exceeds 10% of the total assets of the Company and its subsidiaries on a consolidated basis. The Company hereby agrees to furnish a copy of any such instrument to the SEC upon request.

-24-

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.

	FIRST KEYSTONE FINANCIAL, INC.
Date: February 14, 2008	By:	/s/ Thomas M. Kelly
		Thomas M. Kelly
		President and Chief Executive Officer
Date: February 14, 2008	By:	/s/ Rose M. DiMarco
		Rose M. DiMarco
		Chief Financial Officer

-25-

EX-31.1

EXHIBIT 31.1

CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER
PURSUANT TO RULES 13a-14 AND 15d-14 OF THE SECURITIES EXCHANGE ACT OF
1934 AND SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

     I, Thomas M. Kelly certify that:

1. I have reviewed this quarterly report on Form 10-Q of First Keystone Financial, Inc. (the “Registrant”);

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

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

4. The Registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and have:

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

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

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

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

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

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

Date: February 14, 2008	/s/ Thomas M. Kelly
	Thomas M. Kelly
	President and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATION OF THE CHIEF FINANCIAL OFFICER
PURSUANT TO RULES 13a-14 AND 15d-14 OF THE SECURITIES EXCHANGE ACT
OF 1934 AND SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

     I, Rose M. DiMarco, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of First Keystone Financial, Inc. (the “Registrant”);
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;
4.	The Registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and have:

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

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

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

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

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

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

Date: February 14, 2008	/s/ Rose M. DiMarco
	Rose M. DiMarco
	Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

     The undersigned Chief Executive Officer of First Keystone Financial, Inc. (the “Registrant”) hereby certifies that the Registrant’s Form 10-Q for the quarter ended December 31, 2007 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained therein fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

/s/ Thomas M. Kelly
Name:	Thomas M. Kelly
Title:	President and Chief Executive Officer

Date: February 14, 2008

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act has been provided to First Keystone Financial, Inc. and will be retained by First Keystone Financial, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2

Exhibit 32.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350)

     The undersigned Chief Financial Officer of First Keystone Financial, Inc. (the “Registrant”) hereby certifies that the Registrant’s Form 10-Q for the quarter ended December 31, 2007 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained therein fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

/s/ Rose M. DiMarco
Name:	Rose M. DiMarco
Title:	Chief Financial Officer

Date: February 14, 2008

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act has been provided to First Keystone Financial, Inc. and will be retained by First Keystone Financial, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.