News Column

BEAR STATE FINANCIAL, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

August 14, 2014

Management's discussion and analysis of financial condition and results of operations ("MD&A") is intended to assist a reader in understanding the consolidated financial condition and results of operations of the Company for the periods presented. The information contained in this section should be read in conjunction with the Condensed Consolidated Financial Statements and the accompanying Notes to the Condensed Consolidated Financial Statements and the other sections contained herein. References to the Company and the Banks throughout MD&A are made using the first person notations of "we", "us" or "our". The Company owns First Federal Bank ("First Federal"), and two bank holding companies, First Community Banking Corporation ("FCBC") and Heritage Capital Corporation ("HCC"), which own First National Bank ("FNB") and Heritage Bank, NA ("Heritage"), respectively (collectively referred to as "the Banks"). First Federal is a federally chartered stock savings and loan association that conducts business from its home office in Harrison, Arkansas, a full-service branch office in Pulaski County, Arkansas, ten full-service branch offices and one limited service office located in a five county area in Northwest and Northcentral Arkansas and a mortgage production office in Bentonville, Arkansas. FNB offers banking services from its home office in Hot Springs, Arkansas, eighteen full service branch offices and three limited service offices located in Central and Southwest Arkansas and two full service offices in Southeast Oklahoma. Heritage has five branches in Jonesboro, Arkansas, including its home office, as well as four additional full service branches in Northeast Arkansas. The Banks are community oriented financial institutions providing a broad line of financial products to individuals and business customers. The Banks offer a wide range of retail and business deposit accounts, including noninterest bearing and interest bearing checking accounts, savings and money market accounts, certificates of deposit, and individual retirement accounts. Loan products offered by the Banks include residential real estate, consumer, construction, lines of credit, commercial real estate and commercial business loans. Other financial services include automated teller machines; 24-hour telephone banking; online banking, including account access, bill payment, and e-statements; mobile banking, including remote deposit capture and funds transfer; Bounce ProtectionTM overdraft service; debit cards; and safe deposit boxes.



2014 SECOND QUARTER OVERVIEW

Effective June 3, 2014, the Company changed its name from First Federal Bancshares of Arkansas, Inc. to Bear State Financial, Inc.

On June 13, 2014, the Company completed its previously-announced acquisition of First National Security Company ("FNSC") whereby FNSC merged with and into the Company in a transaction valued at approximately $124.4 million. In connection with the merger, former FNSC stockholders received in the aggregate 6,252,400 shares of Company common stock, valued at approximately $50.4 million and $74 million in cash in exchange for 100% of the outstanding shares of FNSC common stock. The Company paid $50 million of the total cash consideration and FNSC paid $24 million of the total cash consideration to its stockholders from funds it received immediately prior to the closing of the acquisition from its subsidiary bank, First National Bank. The acquisition expanded the Company's market into Northeast and Southwest Arkansas and further diversified the Company's loan, customer and deposit base. The Company's results of operations for the three and six months ended June 30, 2014 includes results of operations for FNB and Heritage for the period from June 14 through June 30, 2014. The Company's net loss was $2.9 million and $3.2 million for the three and six months ended June 30, 2014, respectively, compared to net income of $84,000 and $387,000 for the same periods in 2013. The decrease in net income for the comparative period was due to increases in operating expenses, primarily related to salaries and employee benefits, real estate owned and acquisition related expenses. 28

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CRITICAL ACCOUNTING POLICIES Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of this Management's Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the Consolidated Financial Statements included herein. In particular, Note 1 to the Consolidated Financial Statements - "Summary of Significant Accounting Policies" generally describes our accounting policies. We believe that the judgments, estimates and assumptions used in the preparation of our Consolidated Financial Statements are appropriate given the factual circumstances at the time. However, given the sensitivity of our Consolidated Financial Statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition. Determination of the adequacy of the allowance for loan and lease losses. In estimating the amount of credit losses inherent in our loan portfolio, various judgments and assumptions are made. For example, when assessing the condition of the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. In the event the economy were to sustain a prolonged downturn, the loss factors applied to our portfolios may need to be revised, which may significantly impact the measurement of the allowance for loan and lease losses. For impaired loans that are collateral dependent and for real estate owned, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold. Acquired loan amounts deemed uncollectible at acquisition date become part of the fair value calculation and are excluded from the ALLL. Following acquisition, a regular review will be completed on acquired loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL. Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan and lease losses and related ALLL, if any, or prospective adjustment to the accretable yield if no provision for loan and lease losses had been recorded. Acquired Loans. Acquired loans and leases are recorded at fair value at the date of acquisition. No allowance for loan and lease losses is recorded on the acquisition date as the fair value of the acquired assets incorporates assumptions regarding credit risk. The fair value adjustment on acquired loans without evidence of credit deterioration since origination will be accreted into earnings as a yield adjustment using the level yield method over the remaining life of the loan. Acquired loans and leases with evidence of credit deterioration since origination such that it is probable at acquisition that the bank will be unable to collect all contractually required payments are accounted for under the guidance in ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. As of the acquisition date, the difference between contractually required payments and the cash flows expected to be collected is the nonaccretable difference, which is included as a reduction of the carrying amount of acquired loans and leases. If the timing and amount of the future cash flows is reasonably estimable, any excess of cash flows expected at acquisition over the estimated fair value is the accretable yield and is recognized in interest income over the asset's remaining life using a level yield method. Goodwill and other intangible assets. The Company accounts for acquisitions using the acquisition method of accounting. Under acquisition accounting, if the purchase price of an acquired company exceeds the fair value of its net assets, the excess is carried on the acquirer's balance sheet as goodwill. An intangible asset is recognized as an asset apart from goodwill if it arises from contractual or other legal rights or if it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged. Intangible assets are identifiable assets, such as core deposit intangibles, resulting from acquisitions which are amortized on a straight-line basis over an estimated useful life and evaluated for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. Goodwill is not amortized but is evaluated at least annually for impairment or more frequently if events occur or circumstances change that may trigger a decline in the value of the reporting unit or otherwise indicate that a potential impairment exists. Potential impairment of goodwill exists when the carrying amount of a reporting unit exceeds its fair value. To the extent the reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired, and implied fair value of the reporting unit's goodwill will be determined. If the implied fair value of the reporting unit's goodwill is lower than its carrying amount, goodwill is impaired and is written down to the implied fair value. The loss recognized is limited to the carrying amount of goodwill. Once an impairment loss is recognized, future increases in fair value will not result in the reversal of previously recognized losses. Valuation of real estate owned. Fair value is estimated through current appraisals, real estate brokers' opinions or listing prices. As these properties are actively marketed, estimated fair values may be adjusted by management to reflect current economic and market conditions. The estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold. 29

-------------------------------------------------------------------------------- Valuation of investment securities. The Company has classified all of its investment securities as available for sale. Accordingly, its investment securities are stated at estimated fair value in the consolidated financial statements with unrealized gains and losses, net of related income taxes, reported as a separate component of stockholders' equity with any related changes included in accumulated other comprehensive income (loss). The Company utilizes independent third parties as its principal sources for determining fair value of its investment securities that are measured on a recurring basis. For investment securities traded in an active market, the fair values are based on quoted market prices if available. If quoted market prices are not available, fair values are based on market prices for comparable securities, broker quotes or comprehensive interest rate tables, pricing matrices or a combination thereof. For investment securities traded in a market that is not active, fair value is determined using unobservable inputs. The fair values of the Company's investment securities traded in both active and inactive markets can be volatile and may be influenced by a number of factors including market interest rates, prepayment speeds, discount rates, credit quality of the issuer, general market conditions including market liquidity conditions and other factors. Factors and conditions are constantly changing and fair values could be subject to material variations that may significantly impact the Company's financial condition, results of operations and liquidity. Valuation of deferred tax assets. We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We evaluate our deferred tax assets for recoverability using a consistent approach that considers the relative impact of negative and positive evidence, including our historical profitability and projections of future taxable income. We are required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we estimate future taxable income based on management-approved business plans and ongoing tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between our projected operating performance, our actual results and other factors. RESULTS OF OPERATIONS



Three and Six Months Ended June 30, 2014 Compared to Three and Six Months Ended June 30, 2013

Net Income. The Company recorded a net loss of $2.9 million for the three months ended June 30, 2014 compared to net income of $84,000 for the three months ended June 30, 2013. The Company recorded a net loss of $3.2 million for the six months ended June 30, 2014 compared to net income of $387,000 for the six months ended June 30, 2013. The decrease in net income for the comparative periods was due to increases in operating expenses, primarily related to salaries and employee benefits, real estate owned and acquisition related expenses, partially offset by an increase in net interest income. During the second quarter, the Company elected to retire certain pension liabilities of the Company's multiemployer defined benefit plan resulting in a charge of $2.9 million. This election will improve the funded status of the plan and is expected to result in a significant reduction of the Company's annual pension expense. Additionally, during the second quarter, the Company performed a review of its REO properties and made a decision to more aggressively market certain properties. This review resulted in a $618,000 REO loss provision during the second quarter of 2014. Finally, the Company incurred acquisition related charges in the second quarter of 2014 of approximately $392,000. Net Interest Income. The Company's results of operations depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Net interest income for the second quarter of 2014 was $5.3 million, compared to $3.6 million for the same period in 2013. Net interest income for the six months ended June 30, 2014 was $9.2 million, compared to $7.3 million for the same period in 2013. The increase in net interest income for the three and six month comparison periods resulted from changes in interest income and interest expense discussed below. Interest Income. Interest income for the second quarter of 2014 was $6.6 million compared to $4.5 million for the same period in 2013. Interest income for the six months ended June 30, 2014 was $11.3 million compared to $9.0 million for the same period in 2013. The increase in interest income for the three and six months ended June 30, 2014 compared to the comparable period in 2013 was primarily related to increases in the average balances of loans receivable and investment securities and yields earned on loans receivable and other investments as a result of the acquisition of FNSC. Interest income of the Company attributable to FNB and Heritage for the three and six months ended June 30, 2014 amounted to $1.6 million. Interest Expense. Interest expense for the second quarter of 2014 was $1.1 million compared to $830,000 for the same period in 2013. Interest expense for the six months ended June 30, 2014 was $1.9 million compared to $1.7 million for the same period in 2013. The increase in interest expense for the three and six months ended June 30, 2014 compared to the comparable period in 2013 was primarily due to an increase in the average balance of deposit accounts, which balances substantially increased following the acquisition of FNSC. Interest expense of the Company attributable to FNB and Heritage for the three and six months ended June 30, 2014 amounted to $80,000. 30 -------------------------------------------------------------------------------- Rate/Volume Analysis. The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided regarding changes attributable to (i) changes in volume (changes in average volume multiplied by prior rate); (ii) changes in rate (changes in rate multiplied by prior average volume); (iii) changes in rate-volume (changes in rate multiplied by the change in average volume); and (iv) the net change. Three Months Ended June 30, 2014 vs. 2013 Increase (Decrease) Due to Total Rate/ Increase Volume Rate Volume (Decrease) (In Thousands) Interest income: Loans receivable $ 1,741$ 98$ 43$ 1,882 Investment securities 357 (50 ) (51 ) 256 Other interest-earning assets (45 ) 27 (9 ) (27 ) Total interest-earning assets 2,053 75 (17 ) 2,111 Interest expense: Deposits 274 (80 ) (27 ) 167 Other borrowings 56 (1 ) (2 ) 53 Total interest-bearing liabilities 330 (81 ) (29 ) 220 Net change in net interest income $ 1,723$ 156$ 12$ 1,891 Six Months Ended June 30, 2014 vs. 2013 Increase (Decrease) Due to Total Rate/ Increase Volume Rate Volume (Decrease) (In Thousands) Interest income: Loans receivable $ 2,289$ (276 )$ (78 )$ 1,935 Investment securities 493 (54 ) (38 ) 401 Other interest-earning assets (110 ) 93 (38 ) (55 ) Total interest-earning assets 2,672 (237 ) (154 ) 2,281 Interest expense: Deposits 319 (108 ) (21 ) 190 Other borrowings 67 (1 ) (4 ) 62



Total interest-bearing liabilities 386 (109 ) (25 )

252

Net change in net interest income $ 2,286$ (128 )$ (129 ) $

2,029 31

-------------------------------------------------------------------------------- Average Balance Sheets. The following table sets forth certain information relating to the Company's average balance sheets and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing interest income or interest expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are based on daily balances during the periods. Interest rate spread represents the difference between the weighted average yield on average interest earning assets and the weighted average cost of average interest bearing liabilities. Net interest margin represents net interest income as a percentage of average interest earning assets. Three Months Ended June 30, 2014 2013 Average Average Average Yield/ Average Yield/ Balance Interest Cost Balance Interest Cost (Dollars in Thousands) Interest-earning assets: Loans receivable(1) $ 505,754$ 5,852 4.64% $ 351,591$ 3,970 4.54% Investment securities(2) 101,562 605 2.39 50,225 349 2.80 Other interest-earning assets 58,220 111 0.76 86,287 138 0.64 Total interest-earning assets 665,536 6,568 3.96 488,103 4,457 3.67 Noninterest-earning assets 83,431 51,625 Total assets $ 748,967$ 539,728 Interest-bearing liabilities: Deposits $ 587,429 984 0.67 $ 439,927 817 0.75 Other borrowings 15,209 66 1.74 2,862 13 1.77 Total interest-bearing liabilities 602,638 1,050 0.70 442,789 830 0.75



Noninterest-bearing

deposits 56,988



23,046

Noninterest-bearing

liabilities 2,728



2,146

Total liabilities 662,354



467,981

Stockholders' equity 86,613



71,747

Total liabilities and stockholders' equity $ 748,967 $



539,728

Net interest income $ 5,518$ 3,627 Net earning assets $ 62,898 $



45,314

Interest rate spread 3.26% 2.92% Net interest margin 3.33% 2.98% Ratio of interest-earning assets to Interest-bearing liabilities 110.44% 110.23%



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(1) Includes nonaccrual loans. (2) Includes FHLB of Dallas and Federal Reserve Bank stock. Six Months Ended June 30, 2014 2013 Average Average Average Yield/ Average Yield/ Balance Interest Cost Balance Interest Cost (Dollars in Thousands) Interest-earning assets: Loans receivable(1) $ 454,757$ 9,986 4.43% $ 354,072$ 8,051 4.59% Investment securities(2) 86,625 1,117 2.60 51,311 716 2.81 Other interest-earning assets 47,340 216 0.92 79,896 271 0.68 Total interest-earning assets 588,722 11,319 3.88 485,279 9,038 3.76 Noninterest-earning assets 64,461 51,983 Total assets $ 653,183$ 537,262 Interest-bearing liabilities: Deposits $ 522,214 1,853 0.72 $ 438,243 1,663 0.77 Other borrowings 10,592 88 1.68 2,966 26 1.77 Total interest-bearing liabilities 532,806 1,941 0.74 441,209 1,689 0.77 Noninterest-bearing deposits 38,752



22,581

Noninterest-bearing

liabilities 2,417



2,467

Total liabilities 573,975



466,257

Stockholders' equity 79,208



71,005

Total liabilities and stockholders' equity $ 653,183 $



537,262

Net interest income $ 9,378$ 7,349 Net earning assets $ 55,916 $



44,070

Interest rate spread 3.14% 2.99% Net interest margin 3.21% 3.05% Ratio of interest-earning assets to Interest-bearing liabilities 110.49% 109.99%



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(1) Includes nonaccrual loans. (2) Includes FHLB of Dallas and Federal Reserve Bank stock. 32

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The Company's net interest margin increased primarily as a result of an increase in yields on loans receivable resulting from loans acquired in the FNSC transaction.

Provision for Loan Losses. The provision for loan losses represents the amount added to the allowance for loan and lease losses ("ALLL") for the purpose of maintaining the ALLL at a level considered adequate to cover probable credit losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio that have been incurred as of the balance sheet date. The adequacy of the ALLL is evaluated quarterly by management of the Banks based on the Banks' past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral and other qualitative factors. Management determined that a provision for loan losses of $230,000 was required for the three and six months ended June 30, 2014, primarily due to loans originated during the period subsequent to the acquisition date by FNB and Heritage offset by decreases in nonperforming and classified loans and continued improvement in First Federal's loan portfolio and ALLL coverage of nonaccrual loans. The ALLL as a percentage of loans receivable was 1.2% at June 30, 2014, compared to 3.3% at December 31, 2013. The ALLL as a percentage of nonaccrual loans was 134.7% at June 30, 2014, compared to 106.5% at December 31, 2013. The ALLL as a percentage of classified loans was 53.4% at June 30, 2014, compared to 86.1% at December 31, 2013. See "Allowance for Loan and Lease Losses" in the "Asset Quality" section. No provision was made for any loans acquired in the acquisition of FNSC. Rather, such acquired loans are carried at fair value as of the date of acquisition on the Company's balance sheet. In the coming months, a regular review will be completed on acquired loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL. Noninterest Income. Noninterest income is generated primarily through deposit account fee income, profit on sale of loans, and earnings on life insurance policies. Total noninterest income of $1.8 million for the three months ended June 30, 2014 increased from $1.3 million for the same period in 2013. Total noninterest income of $3.0 million for the six months ended June 30, 2014 increased from $2.6 million for the same period in 2013. The increase in the three and six month comparison periods was primarily due to an increase in the number of loans sold and the average profit on loans held for sale. First Federal sold 234 loans in the secondary market during the six month period ended June 30, 2014 compared to 184 loans during the six month period ended June 30, 2013. Noninterest income of the Company attributable to FNB and Heritage for the three and six months ended June 30, 2014 amounted to $270,000. Noninterest Expense. Noninterest expense consists primarily of employee compensation and benefits, office occupancy expense, data processing expense, real estate owned expense, and other operating expense. Total noninterest expense increased $5.1 million or 105.2% during the second quarter of 2014 compared to the second quarter of 2013. Total noninterest expense increased $5.8 million or 60.7% during the six months ended June 30, 2014 compared to the same period in 2013. The variances in certain noninterest expense items are further explained in the following paragraphs, with the aggregate expense increase for the three and six month comparison periods being primarily related to the increase in employee compensation expense, an increase in loss provision on other real estate owned for the three and six month comparison periods, and expenses related to the acquisition of FNSC. Noninterest expense of the Company attributable to FNB and Heritage for the three and six months ended June 30, 2014 amounted to $757,000. Salaries and Employee Benefits. Salaries and employee benefits increased $3.7 million and $4.1 million for the three and six months ended June 30, 2014 compared to the same periods in 2013, respectively. The increase in the three and six month comparison periods was primarily due to the Company's election in the second quarter of 2014 to retire certain pension liabilities of the Company's multiemployer defined benefit plan resulting in a charge of $2.9 million. This election will improve the funded status of the plan and is expected to result in a significant reduction of the Company's annual pension expense. Additionally, the increase in the salaries and benefits of employees related to the merger with FNSC totaled $465,000 for the three and six months ended June 30, 2014. The changes in the composition of this line item are presented below (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change Salaries $ 3,015$ 2,327$ 688$ 5,465$ 4,475$ 990 Payroll taxes 241 191 50 527 433 94 Insurance 127 131 (4 ) 258 259 (1 ) 401(k) plan expenses 47 4 43 86 8 78 Defined benefit plan 3,055 110 2,945 3,208 218 2,990 Stock compensation 110 53 57 196 96 100 Other (55 ) (12 ) (43 ) (138 ) (7 ) (131 ) Total $ 6,540$ 2,804$ 3,736$ 9,602$ 5,482$ 4,120 33

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Real estate owned, net. The changes in the composition of this line item are presented below (in thousands):

Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change Loss provisions $ 618$ 33$ 585$ 860$ 176$ 684 Net gain on sales (62 ) (43 ) (19 ) (142 ) (374 ) 232 Rental income (44 ) (26 ) (18 ) (96 ) (63 ) (33 ) Taxes and insurance 33 25 8 69 93 (24 ) Other 46 56 (10 ) 117 117 -- Total $ 591$ 45$ 546$ 808$ (51 )$ 859 During the second quarter of 2014, the Company performed a review of its REO properties and made a decision to more aggressively market certain properties, resulting in a $618,000 REO loss provision. The decrease in gains on sales of REO is due to a decrease in sales of REO in the six months of 2014 compared to the same period in 2013 due to an overall continued decrease in REO balances during the periods. Real estate owned expenses such as taxes, insurance and maintenance as well as rental income are expected to continue to decline as the size of the REO portfolio decreases. Future levels of loss provisions and net gains or losses on sales of real estate owned will depend on market conditions. The acquisition of FNSC had no material impact on real estate owned, net. Other Noninterest Expenses. The increases in other noninterest expenses during the three and six months ended June 30, 2014 compared to the same periods in 2013 of $758,000 and $762,000, respectively, were primarily related to expenses related to the acquisition of FNSC of approximately $392,000 recognized during the second quarter of 2014. On July 31, 2014, the Company, through its subsidiary banks, executed contracts with its data processing service provider which provided for a termination fee of $2.4 million related to converting FNB and Heritage to the Company's data processing platform. The Company also expects to negotiate a termination fee of approximately $630,000 with one of its other data processing providers in the third quarter of 2014. These termination fees are expected to be recorded as noninterest expenses in the third quarter of 2014. Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change FDIC insurance $ 125$ 170$ (45 )$ 245$ 341$ (96 ) Data processing 563 397 166 982 733 249 Professional fees 235 151 84 430 410 20 Advertising and public relations 198 74 124 301 144 157 Postage and supplies 119 108 11 210 217 (7 ) Other 944 526 418 1,492 1,053 439 Total $ 2,184$ 1,426$ 758$ 3,660$ 2,898$ 762



Income Taxes. The Company had no taxable income for the three or six months ended June 30, 2014 or 2013 and recorded a valuation allowance for the full amount of its net deferred tax asset as of June 30, 2014 and December 31, 2013, respectively.

LENDING ACTIVITIES



Loans Receivable. Changes in loan composition between June 30, 2014 and December 31, 2013, are presented in the following table (dollars in thousands).

June 30, December 31, Increase 2014 2013 (Decrease) % Change One- to four-family residential $ 303,517$ 129,308$ 174,209 134.7 % Multifamily residential 44,679 25,773 18,906 73.4 Nonfarm nonresidential 346,169 168,902 177,267 105.0 Farmland 48,710 2,663 46,047 1,729.1 Construction and land development 94,084 23,891 70,193 293.8 Total real estate loans 837,159 350,537 486,622 138.8 Commercial 142,058 29,033 113,025 389.3 Consumer 32,171 4,368 27,803 636.5 Total loans receivable 1,011,388 383,938 627,450 163.4 Unearned discounts and net deferred loan costs (104 ) (78 ) (26 ) 33.3 Allowance for loan and lease losses (12,392 ) (12,711 ) 319 (2.5 ) Loans receivable, net $ 998,892$ 371,149$ 627,743 169.1 % Total loans receivable increased $627.5 million to $1.0 billion at June 30, 2014, compared to $383.9 million at December 31, 2013. The increase in total loans receivable was primarily due to the acquisition of FNSC which increased the Company's consolidated total loans receivable by $605.9 million. The remaining increase in the Company's consolidated loan portfolio was due to an increase in loan originations by First Federal of commercial, nonfarm nonresidential and multifamily loans. 34 --------------------------------------------------------------------------------

ASSET QUALITY Nonperforming Assets. The following table sets forth the amounts and categories of the Company's nonperforming assets at the dates indicated (dollars in thousands). June 30, 2014 December 31, 2013 % Total % Total Increase Net (2) Assets Net (2) Assets (Decrease)

Nonaccrual Loans: One- to four-family residential $ 4,273 0.30 % $ 4,258 0.77 % $ 15 Nonfarm nonresidential 3,209 0.23 % 4,057 0.75 % (848 ) Farmland 752 0.05 % 782 0.15 % (30 ) Construction and land development 622 0.04 % 2,467 0.44 % (1,845 ) Commercial 321 0.02 % 350 0.06 % (29 ) Consumer 24 -- 24 0.01 % -- Total nonaccrual loans 9,201 0.64 % 11,938



2.18 % (2,737 )

Accruing loans 90 days or more past due -- -- -- -- -- Real estate owned 6,226 0.43 % 8,627 1.57 % (2,401 ) Total nonperforming assets 15,427 1.07 % 20,565 3.75 % (5,138 ) Performing restructured loans 574 0.03 % 494 0.09 % 80 Total nonperforming assets and performing restructured loans (1) $ 16,001 1.10 % $ 21,059 3.84 % $ (5,058 )



(1) The table does not include substandard loans which were judged not to be

impaired totaling $13.6 million at June 30, 2014 and $2.9 million at

December 31, 2013 or acquired ASC 310-30 purchased credit impaired loans

which are considered performing at June 30, 2014. (2) Loan balances are presented net of undisbursed loan funds, partial charge-offs and interest payments recorded as reductions in principal balances for financial reporting purposes. The decrease in nonperforming assets at June 30, 2014 compared to December 31, 2013, was primarily due to sales of real estate owned of $2.4 million and net cash payments on nonaccrual loans of $2.2 million during the six months ended June 30, 2014.



Nonaccrual Loans. The composition of nonaccrual loans by status was as follows as of the dates indicated (dollars in thousands):

June 30, 2014 December 31, 2013 Increase (Decrease) Percentage of Percentage of Percentage of Balance Total Balance Total Balance Total Bankruptcy or foreclosure $ 751 8.1 % $ 1,043 8.7 % $ (292 ) (0.6 )% Over 90 days past due 3,520 38.3 6,308 52.8 (2,788 ) (14.5 ) 30-89 days past due 670 7.3 637 5.3 33 2.0 Not past due 4,260 46.3 3,950 33.2 310 13.1 $ 9,201 100.0 % $ 11,938 100.0 % $ (2,737 ) --



The following table presents nonaccrual loan activity for the six months ended June 30, 2014 and 2013 (in thousands):

Six Months Ended Six Months Ended June 30, 2014 June 30, 2013 Balance of nonaccrual loans-beginning of period $ 11,938 $ 18,824 Loans added to nonaccrual status 1,277 1,663 Net cash payments (2,220 ) (3,644 ) Loans returned to accrual status (403 ) (296 ) Charge-offs to the ALLL (444 ) (1,597 ) Transfers to REO (947 ) (1,223 ) Balance of nonaccrual loans-end of period $ 9,201 $ 13,727 35

-------------------------------------------------------------------------------- Real Estate Owned. Changes in the composition of real estate owned between December 31, 2013 and June 30, 2014 are presented in the following table (dollars in thousands). December Fair Value Net Sales 31, 2013 Additions(1) Adjustments Proceeds Net Gain (Loss) June 30, 2014 One- to four-family residential $ 1,517 $ 30 $ (90 ) $ (355 ) $ 34 $ 1,136 Land 4,688 746 (499 ) (1,731 ) 55 3,259 Nonfarm nonresidential 2,422 80 (271 ) (453 ) 53 1,831 Total $ 8,627 $ 856 $ (860 ) $ (2,539 ) $ 142 $ 6,226



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(1) Additions include $69,000 of real estate owned acquired in the FNSC acquisition in the second quarter of 2014. Classified Assets. Federal regulations require that each financial institution risk rate their classified assets into three classification categories - substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that some loss will be sustained if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is generally considered uncollectible and of such little value that continuance as an asset is not warranted. As of June 30, 2014 and December 31, 2013, the Banks did not have any assets classified as doubtful or loss. The table below summarizes the Banks' classified assets as of the dates indicated (dollars in thousands): June 30, 2014 December 31, 2013 June 30, 2013 Nonaccrual loans $ 9,201$ 11,938$ 13,727 Accruing classified loans 13,646 2,827 4,543 Classified loans 22,847 14,765 18,270 Real estate owned 6,226 8,627 11,967 Total classified assets $ 29,073$ 23,392$ 30,237 Texas Ratio (1) 12.7% 24.8% 30.9% Classified Assets Ratio (2) 24.0% 28.0% 36.3%



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(1) Defined as the ratio of nonaccrual loans and real estate owned to Tier 1

capital plus the allowance for loan and lease losses.

(2) Defined as the ratio of total classified assets to Tier 1 capital plus the

allowance for loan and lease losses. The increase in classified assets during the three and six months ended June 30, 2014, was primarily due to loans acquired in the FNSC merger, partially offset by sales of real estate owned and net cash payments on nonaccrual loans. Allowance for Loan and Lease Losses. The Banks maintain an allowance for loan and lease losses for known and inherent losses determined by ongoing quarterly assessments of the loan portfolio. The estimated appropriate level of the ALLL is maintained through a provision for loan losses charged to earnings. Charge-offs are recorded against the ALLL when management believes the estimated loss has been confirmed. Subsequent recoveries, if any, are credited to the ALLL. The ALLL consists of general and allocated (also referred to as specific) loan loss components. For loans that are determined to be impaired that are troubled debt restructurings ("TDRs") and impaired loans where the relationship totals $250,000 or more, a specific loan loss allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than its carrying value. The general loan loss allowance covers loans that are not impaired and those impaired relationships under $250,000 and is based on historical loss experience adjusted for qualitative factors. The ALLL represents management's estimate of incurred credit losses inherent in the Banks' loan portfolios as of the balance sheet date. The estimation of the ALLL is based on a variety of factors, including past loan loss experience, the current credit profile of the Banks' borrowers, adverse situations that have occurred that may affect the borrowers' ability to repay, the estimated value of underlying collateral, and general economic conditions, including unemployment, bankruptcy trends, vacancy rates and the level and trend of home sales and prices. Losses are recognized when available information indicates that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or conditions change. 36 -------------------------------------------------------------------------------- A loan is considered impaired when, based on current information and events, it is probable that the bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the note. 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 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 short fall in relation to the principal and interest owed. Each quarter, classified loans where the borrower's total loan relationship exceeds $250,000 are evaluated for impairment on a loan-by-loan basis. Nonaccrual loans and TDRs are considered to be impaired loans. TDRs are restructurings in which the bank, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that the bank would not otherwise consider. Impairment is measured quarterly on a loan-by-loan basis for all TDRs and impaired loans where the aggregate relationship balance exceeds $250,000 by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral, if the loan is collateral dependent. Impaired loans under this threshold are aggregated and included in loan pools with their ALLL calculated as described in the following paragraph. Groups of smaller balance homogeneous loans are collectively evaluated for impairment. Homogeneous loans are those that are considered to have common characteristics that provide for evaluation on an aggregate or pool basis. The bank considers the characteristics of (1) one- to four-family residential mortgage loans; (2) unsecured consumer loans; and (3) collateralized consumer loans to permit consideration of the appropriateness of the ALLL of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of the ALLL includes segregating impaired loans from the pools of loans, valuing these loans, and then applying a loss factor to the remaining pool balance based on several factors including past loss experience, inherent risks, and economic conditions in the primary market areas. Acquired loan amounts deemed uncollectible at acquisition date become part of the fair value calculation and are excluded from the ALLL. Following acquisition, a regular review will be completed on acquired loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL. Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan and lease losses and related ALLL, if any, or prospective adjustment to the accretable yield if no provision for loan and lease losses had been recorded. In estimating the amount of credit losses inherent in the loan portfolio, various judgments and assumptions are made. For example, when assessing the condition of the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. For impaired loans that are collateral dependent, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold in the event that the bank has to foreclose or repossess the collateral. The Banks consider their consolidated ALLL totaling approximately $12.4 million to be appropriate based on evaluations of the management of the Banks of their respective loan portfolios and the losses inherent in those loan portfolios as of June 30, 2014. Actual losses may substantially differ from currently estimated losses. Adequacy of the ALLL is periodically evaluated, and the ALLL could be significantly decreased or increased, which could materially affect the Company's financial condition and results of operations. 37 --------------------------------------------------------------------------------



The following table summarizes changes in the allowance for loan and lease losses and other selected statistics for the periods indicated.

Six Months Ended June 30, 2014 2013 (Dollars in Thousands) Total loans outstanding at end of period $ 1,011,388 $



345,005

Average loans outstanding $ 454,757 $



354,072

Allowance at beginning of period $ 12,711 $



15,676

Charge-offs:

One- to four-family residential (8 ) (747 ) Multifamily residential -- (876 ) Nonfarm nonresidential (115 ) (1,008 ) Farmland -- -- Construction and land development (444 ) (115 ) Commercial (27 ) (380 ) Consumer (1) (68 ) (76 ) Total charge-offs (662 ) (3,202 ) Recoveries: One- to four-family residential 21 53 Multifamily residential -- -- Nonfarm nonresidential 10 500 Farmland -- -- Construction and land development 44 107 Commercial 2 74 Consumer (1) 36 41 Total recoveries 113 775 Net charge-offs (549 ) (2,427 ) Total provisions for losses 230 -- Allowance at end of period $ 12,392$ 13,249 Allowance for loan and lease losses as a percentage of total loans outstanding at end of period 1.2 %



3.8 %

Net loans charged-off as a percentage of average loans outstanding 0.2 %



1.4 %

Allowance for loan and lease losses to nonaccrual loans 134.7 % 96.5 %

-------------------------------------------------------------------------------- (1) Consumer loan charge-offs include overdraft charge-offs of $53,000 and $58,000 for the six months ended June 30, 2014 and 2013, respectively. Consumer loan recoveries include recoveries of overdraft charge-offs of $24,000 and $33,000 for the six months ended June 30, 2014 and 2013, respectively. The following table presents, on a consolidated basis, the allocation of the Banks' ALLL by the type of loan at each of the dates indicated as well as the percentage of loans in each category to total loans receivable. These allowance amounts have been computed using the Banks' internal models. The amounts shown are not necessarily indicative of the actual future losses that may occur within a particular category. June 30, 2014 2013 Percentage Percentage Amount of Loans Amount of Loans (Dollars in Thousands) One-to-four family residential $ 4,490 30.00 % $ 6,151 40.33 % Multifamily residential 1,030 4.42 580 5.73 Nonfarm nonresidential 3,910 34.27 4,435 43.75 Farmland 282 4.81 273 0.66 Construction and land development 868 9.31 940 3.47 Commercial 1,721 14.02 662 4.61 Consumer 91 3.17 208 1.45 Total $ 12,392 100.00 % $ 13,249 100.00 % 38

-------------------------------------------------------------------------------- The decrease in the allowance for loan and lease losses from $13.2 million as of June 30, 2013 to $12.4 million as of June 30, 2014 was primarily related to a decrease in specific allowances primarily due to an improvement in the credit quality of the loan portfolio as well as a decrease in the overall historical net charge-off rate. The allowance for loan and lease losses remains at an elevated level due to the level of nonperforming loans and estimated inherent losses remaining in First Federal's loan portfolio as the Company continues its efforts to reduce nonperforming assets. INVESTMENT SECURITIES



The following table sets forth the carrying values of the Company's investment securities available for sale (dollars in thousands).

June 30, December 31, Increase 2014 2013 (Decrease) U.S. Government agencies $ 122,740 $ -- $ 122,740 Municipal securities 49,140 41,924 7,216 Mortgage-backed securities 37,844 28,904 8,940 Corporate debt securities 3,833 -- 3,833 Total $ 213,557$ 70,828$ 142,729



The increase is due to the acquisition of FNSC which held $138.1 million of investments at the time of the acquisition. The overall yield of the investment portfolio was 1.56% as of June 30, 2014 compared to 2.86% at December 31, 2013.

DEPOSITS



Changes in the composition of deposits between June 30, 2014 and December 31, 2013, are presented in the following table (dollars in thousands).

June 30, December 31, Increase 2014 2013 (Decrease) % Change Checking accounts $ 538,312$ 127,764$ 410,548 321.33% Money market accounts 108,033 45,153 62,880



139.26

Savings accounts 114,096 30,150 83,946



278.43

Certificates of deposit 470,973 266,658 204,315 76.62 Total deposits $ 1,231,414$ 469,725$ 761,689 162.16% Total deposits increased in the comparison period primarily due to the acquisition of FNSC, with $740.1 million of the Company's total deposits at June 30, 2014 being attributed to the FNSC acquisition. The remaining increase of $21.5 million in First Federal deposits was primarily in certificates of deposit ("CDs") due to an increase in new CDs opened in the period. The Banks manage the pricing of their deposits to maintain deposit balances commensurate with their overall balance sheet management and liquidity position.



OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS

In the normal course of business and to meet the needs of its customers, the Banks are a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments could involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Company's consolidated statements of financial condition. The Banks do not use financial instruments with off-balance sheet risk as part of their asset/liability management program or for trading purposes. The Banks' exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. 39 -------------------------------------------------------------------------------- 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. The Banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the bank upon extension of credit, is based on management's credit evaluation of the counterparty. Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The funding period for construction loans is generally six to eighteen months and commitments to originate mortgage loans are generally outstanding for no more than 60 days.



In the normal course of business, the Banks make commitments to buy or sell assets or to incur or fund liabilities. Commitments include, but are not limited to:

? the origination, purchase or sale of loans; and

? the fulfillment of commitments under letters of credit, extensions of credit on

lines of credit, construction loans, and under predetermined overdraft protection limits. At June 30, 2014, the Banks' off-balance sheet arrangements principally included lending commitments, which are described below. At June 30, 2014, the Company had no interests in non-consolidated special purpose entities.



At June 30, 2014, commitments included:

? total approved loan origination commitments outstanding amounting to $76.9

million, including approximately $2.5 million of loans committed to sell;

? rate lock agreements with customers of $11.4 million, all of which have been

locked with an investor;

? funded mortgage loans committed to sell of $8.9 million;

? unadvanced portion of construction loans of $29.9 million;

? unused lines of credit of $93.4 million;

? outstanding standby letters of credit of $3.9 million; and

? total predetermined overdraft protection limits of $16.0 million.

Total unfunded commitments to originate loans for sale and the related commitments to sell of $11.4 million meet the definition of a derivative financial instrument. The related asset and liability are considered immaterial at June 30, 2014.

Historically, a very small percentage of predetermined overdraft limits have been used. At June 30, 2014, overdrafts of accounts with Bounce Protection™ represented usage of 2.96% of the limit.



LIQUIDITY AND CAPITAL RESOURCES

The primary source of funds for the Company is the receipt of dividends from its subsidiary banks, the receipt of management fees from its subsidiary banks, cash balances maintained, and borrowings from nonaffiliated sources. Payment of dividends by the Company's subsidiary banks is subject to certain regulatory restrictions as set forth in banking laws and regulations. The Company's primary uses of cash include injecting capital into subsidiaries, stock repurchases, debt service requirements, and paying for general operating expenses. The Company had a cash balance of $1.2 million at June 30, 2014. The Company's objective as it relates to liquidity is to ensure that its subsidiary banks have funding and access to sources of funding to ensure that cash flow requirements for deposit withdrawals and credit demands are met in an orderly and timely manner without unduly penalizing profitability. A major component of our overall asset/liability management efforts surrounds pricing of the liability side to ensure adequate liquidity and proper spread and interest margin management. Reliance on any one funding source is kept to a minimum by prioritizing those sources in terms of both availability and time to activation. In order to maintain proper levels of liquidity, the subsidiary banks have several sources of funds available. Generally the subsidiary banks rely on cash on hand and due from banks, fed funds sold, cash flow generated by the repayment of principal and interest and loans and securities and deposits as its primary sources of funds. Commercial, consumer and public funds customers in our local markets are the principal deposit sources utilized. The subsidiary banks use those local market deposits, along with secondary sources of funding including FHLB Advances, federal funds purchased, FRB borrowings and other alternative funding sources to fund continuing operations, make loans and leases, acquire investment securities and other assets. At June 30, 2014, the Company had substantial unused borrowing availability. This availability was primarily comprised of the following four options for its subsidiary banks: (1) $283.8 million of available blanket borrowing capacity with the FHLB-Dallas, (2) $112.3 million of investment securities available to pledge for federal funds or other borrowings, (3) $117.9 million of available unsecured federal funds borrowing lines and (4) up to $9 million of available borrowing capacity from borrowing programs of the FRB. In addition, at June 30, 2014, the Company had available borrowing capacity of $1.25 million with an unaffiliated bank. 40

-------------------------------------------------------------------------------- At June 30, 2014, the Company's and the Banks' overall liquidity ratio was approximately 14.3% which represents liquid assets as a percent of deposits and borrowings. As of the same date, the Company's overall adjusted liquidity ratio was 45.8%, which represents liquid assets plus borrowing capacity at the FHLB, FRB and correspondent banks as a percentage of deposit and borrowings. The Company anticipates it will continue to rely primarily on principal and interest repayments on loans and securities, and deposits to provide liquidity, as well as other funding sources as appropriate. Additionally, where appropriate, the secondary sources of borrowed funds described above will be used to augment the Company's primary funding sources. We believe that we have sufficient liquidity to satisfy our current operations of the Company and the subsidiary banks. At June 30, 2014, the Company's core, tier 1 and total risk-based capital ratios amount to 7.54%, 10.31% and 10.85%, respectively, compared to capital adequacy requirements of 4%, 4% and 8%. See Note 16 to the Consolidated Financial Statements for more information about the Company's and the Banks' capital requirements and ratios.



CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS

This Form 10-Q contains certain forward-looking statements and information relating to the Company and its subsidieary banks that are based on the beliefs of management as well as assumptions made by and information currently available to management. As used in this document, the words "anticipate," "believe," "estimate," "expect," "intend," "should" and similar expressions, or the negative thereof, as they relate to the Company, its subsidiary banks or the management thereof, are intended to identify forward-looking statements. The statements presented herein with respect to, among other things, the Company's or any of the Banks' plans, objectives, expectations and intentions, anticipated changes in noninterest expenses in future periods (including changes as a result of the merger with FNSC and the continued evaluation of the fair value adjustments presented), changes in earnings, impact of outstanding off-balance sheet commitments, sources of liquidity and that we have sufficient liquidity, the sufficiency of the allowance for loan losses, expected loan, asset, and earnings growth, growth in new and existing customer relationships, our intentions with respect to our investment securities, and financial and other goals and plans are forward looking. Such statements reflect the current views of the Company with respect to future looking events and are subject to certain risks, uncertainties and assumptions, including those risk factors described in Part I, Item 1A. of the Company's Annual Report on Form 10-K filed with the SEC on March 28, 2014 and in Part II, Item 1A. hereof. Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. The Company cautions readers not to place undue reliance on any forward-looking statements. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause actual results for the remainder of fiscal 2014 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us and could negatively affect the Company's operating and stock performance.


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