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ALAMOGORDO FINANCIAL CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 29, 2014

This discussion and analysis reflects our consolidated financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section as of and for the years ended June 30, 2014 and 2013 has been derived from the audited consolidated financial statements that appear elsewhere in this annual report. You should read the information in this section in conjunction with the business and financial information regarding Alamogordo Financial Corp. and the financial statements provided in Part II, Item 8 of this annual report. Pending Merger On June 26, 2013, the Company and Bank 1440, headquartered in Phoenix, Arizona, jointly announced the execution of an agreement and plan of merger for the two community banks, with the Bank as the surviving entity. On April 1, 2014, they jointly announced an amendment of that agreement and plan of merger. Under the amended terms, common and preferred shareholders of Bank 1440 have the right to receive 0.17064 shares of Alamogordo Financial Corp. common stock and $0.94 of cash, for each share of Bank 1440 stock.



The necessary approvals of Bank 1440 shareholders and applicable banking regulators have been obtained and the transaction is expected to close on or about August 29, 2014.

Critical Accounting Policies

Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. Our critical accounting policies are those related to our allowance for loan losses, the evaluation of other-than-temporary impairment of securities, the valuation of and our ability to realize deferred tax assets and the measurement of fair values of financial instruments.

Allowance for Loan Losses. The allowance for loan losses is calculated with the objective of maintaining an allowance necessary to absorb probable credit losses inherent in the loan portfolio. Management's determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the losses for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of collateral. We have established a systematic method of periodically reviewing the credit quality of the loan portfolio in order to establish an allowance for loan losses. The allowance for loan losses is based on our current judgments about the credit quality of individual loans and segments of the loan portfolio. The allowance for loan losses is established through a provision for loan losses based on our evaluation of the probable losses inherent in the loan portfolio, and considers all known internal and external factors that affect loan collectability as of the reporting date. Our evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience, our knowledge of inherent losses in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance. Management believes this is a critical accounting policy because this evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters. The allowance for loan losses consists primarily of specific allocations and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral, including adjustments for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting and payment history. We also analyze delinquency trends, general economic conditions, trends in historical loss experience and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allowance. The principal assumption used in calculating the allowance for loan losses is the estimate of loss for each risk rating. Actual loan losses may be significantly more than the allowance we have established, which could have a material negative effect on our financial results. 21 Other-Than-Temporary Impairment. Securities are evaluated on at least a quarterly basis, to determine whether a decline in their value is other-than-temporary. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether or not we intend to sell or expect that it is more likely than not that we will be required to sell the investment security prior to an anticipated recovery in fair value. Once a decline in value for a debt security is determined to be other than temporary, the other-than-temporary impairment is separated in (a) the amount of total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to credit loss is recognized in operations. The amount of other-than-temporary impairment related to other factors is recognized in other comprehensive loss. Valuation of Deferred Tax Assets. In evaluating our ability to realize deferred tax assets, management considers all positive and negative information, including our past operating results and our forecast of future taxable income. In determining future taxable income, management utilizes a budget process that makes business assumptions and the implementation of feasible and prudent tax planning strategies. We also utilize a monthly forecasting tool to incorporate activity throughout the calendar year. These assumptions require us to make judgments about our future taxable income that are consistent with the plans and estimates we use to manage our business. The net deferred tax asset is offset by an equal valuation allowance. Any change in estimated future taxable income may result in a reduction of the valuation allowance against the deferred tax asset which would result in income tax benefit in the period. Fair Value Measurements.Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. A three-level of fair value hierarchy prioritizes the inputs used to measure fair value:



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

includes certain U.S. Treasury and other U.S. Government agency debt that is

highly liquid and actively traded in over-the-counter markets.



Level 2 - Inputs other than Level 1 that are observable, either directly or

indirectly, such as quoted prices for similar assets or liabilities, quoted

prices in markets that are not active or other inputs that are observable or

can be corroborated by observable market data for substantially the full term

of the assets or liabilities.



Level 3 - Unobservable inputs that are supported by little or no market

activity and that are significant to the fair value of the assets or

liabilities. Level 3 assets and liabilities include financial instruments

whose value is determined using pricing models, discounted cash flow

methodologies, or similar techniques, as well as instruments for which the

determination of fair value requires significant management judgment or estimation.



The asset or liability's fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Average Balance Sheet

The following table sets forth average balances, average yields and costs, and certain other information for the fiscal years indicated. Tax-equivalent yield adjustments have not been made for tax-exempt securities, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income. 22 For the Years Ended June 30, 2014 2013 Average Average Outstanding Average Outstanding Average Balance Interest Yield/Rate Balance Interest Yield/Rate (Dollars in thousands) Interest-earning assets: Loans $ 98,407$ 6,049 6.15 % $ 109,054$ 6,819 6.25 % Interest-earning deposits 6,414 12 0.19 3,563 15 0.42 Securities 46,844 873 1.86 48,307 663 1.37 Federal Home Loan Bank of Dallas stock 849 6 0.71 944 6 0.61 Total interest-earning assets 152,514 6,940 4.55 161,868 7,503 4.64 Non-interest-earning assets 17,005 17,597 Total assets $ 169,519$ 179,465 Interest-bearing liabilities: Checking, money market and savings accounts $ 51,773 237 0.46 $ 49,151 277 0.56 Certificates of deposit 69,674 722 1.04 77,805 973 1.25 Total interest-bearing deposits 121,447 959 0.79 126,956 1,250 0.98 Borrowings 11,309 404 3.57 14,415 581 4.03 Total interest-bearing liabilities 132,756 1,363 1.03 141,371 1,831 1.30

Non-interest-bearing deposits 12,372 12,514 Non-interest bearing liabilities 1,777 1,517 Total liabilities 146,905 155,402 Stockholders'equity 22,614 24,063 Total liabilities and total equity $ 169,519$ 179,465 Net interest income $ 5,577$ 5,672 Net interest rate spread (1) 3.52 % 3.34 % Net interest-earning assets (2) $ 19,758$ 20,497 Net interest margin (3) 3.66 % 3.50 % Average interest-earning assets to interest-bearing liabilities 114.88 % 114.50 %



(1) Net interest rate spread represents the difference between the weighted

average yield on interest-earning assets and the weighted average rate of interest-bearing liabilities.



(2) Net interest-earning assets represent total interest-earning assets less

total interest-bearing liabilities.

(3) Net interest margin represents net interest income divided by average total

interest-earning assets. Refer to Management's Discussion of Financial Condition and Results of Operations section, "Source of Funds - Deposits," for our average cost of all deposits, including non-interest bearing accounts, for the years ended June

30, 2014 and 2013. 23 Rate/Volume Analysis The following table presents the effects of changing rates and volumes on our net interest income for the years indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes

due to volume. Year Ended June 30, 2014 vs. 2013 Increase (Decrease) Due to Total Increase Volume Rate (Decrease) (In thousands) Interest-earning assets: Loans $ (656 )$ (114 )$ (770 ) Interest-earning deposits (10 ) 7 (3 ) Securities (19 ) 229 210 Other - - - Total interest-earning assets (685 ) 122 (563 ) Interest-bearing liabilities:

Checking, money market and savings accounts 16

(56 ) (40 ) Certificates of deposit (95 ) (156 ) (251 ) Total deposits (79 ) (212 ) (291 ) Borrowings (116 ) (61 ) (177 )

Total interest-bearing liabilities (195 )

(273 ) (468 ) Change in net interest income $ (490 ) $ 395 $ (95 )



Comparison of Financial Condition at June 30, 2014 and 2013

Total assets decreased $6.5 million, or 3.7%, to $167.8 million at June 30, 2014 from $174.3 million at June 30, 2013. The decrease in total assets was due primarily to a decrease in securities, partially offset by increases in cash and cash equivalents, loans held for sale and loans held for investment, each of which is discussed in more detail below. Cash and cash equivalents increased $5.7 million, or 135.9%, to $9.9 million at June 30, 2014 from $4.2 million at June 30, 2013. The increase resulted from maintaining higher levels of liquidity for funding loan originations and the cash portion of the upcoming merger with Bank 1440. Securities decreased $16.4 million, or 29.6%, to $38.9 million at June 30, 2014 from $55.3 million at June 30, 2013. Proceeds from sale and repayment of securities were used to fund loan originations for both loans held for sale and our loans held for investment, and for repayment of Federal Home Loan Bank advances. Loans held for investment, net, increased $1.6 million, or 1.8%, to $91.0 million at June 30, 2014 from $89.4 million at June 30, 2013. Commercial real estate loans, which include construction loans, increased $7.0 million, or 14.6%, to $55.1 million at June 30, 2014 from $48.1 million at June 30, 2013, reflecting our efforts to expand our commercial lending. Loans held for sale at June 30, 2014 totaled $10.3 million and included $7.7 million in residential mortgage loans and $2.6 million of SBA loans. We currently sell a significant majority of our residential mortgage loans in the secondary market. At June 30, 2013 we had $6.3 million of residential mortgage loans held for sale. The decreases in the other loan categories resulted from a combination of many factors, with the primary factor being our acute focus on improving and maintaining asset quality. Simultaneously, we remained cautious on pricing and underwriting risk despite significant competitive factors, especially from larger banks offering exceptionally low rates and very competitive longer terms on commercial and industrial loans. This conservative approach has limited our new loan growth and resulted in our losing some existing commercial and industrial loan clients who were targeted by our competition. Our residential loan portfolio is also experiencing a natural run-off as we continue to pursue our mortgage banking program, whereby loans are originated and sold for fee income as opposed to being held in our portfolio. Residential real estate loans decreased $4.4 million, or 11.5%, to $34.0 million at June 30, 2014 from $38.4 million at June 30, 2013. We have taken steps to enhance our commercial lending teams and bank-wide credit risk management processes consistent with our plans to grow our commercial loan portfolio. 24 Deposits decreased $844,000, or 0.6%, to $134.7 million at June 30, 2014 from $135.5 million at June 30, 2013. The decrease was caused primarily by a decrease in certificates of deposit of $5.8 million, or 7.9%, to $67.9 million at June 30, 2014 from $73.7 million at June 30, 2013, mostly offset by increases in savings and NOW accounts of $3.4 million, or 7.0%, and demand deposits of $1.5 million, or 12.5%. During the year we allowed non-core certificates of deposit to run off at maturity replacing them with savings, NOW and demand deposits

when possible.

Borrowings, consisting solely of Federal Home Loan Bank advances, decreased $4.5 million, or 33.9%, to $8.8 million at June 30, 2014 from $13.3 million at June 30, 2013. The decrease was due to contractual maturities of FHLB advances during the year, which were not replaced due to the available funds from the repayments, sales and contractual maturities in available-for-sale securities.



Total stockholders' equity decreased $1.4 million, or 6.0%, to $22.2 million at June 30, 2014 from $23.6 million at June 30, 2013. The decrease was due primarily to the net loss of $1.2 million for the 2014 fiscal year.

Comparison of Operating Results for the Fiscal Years Ended June 30, 2014 and 2013

Summary. We experienced a net loss of $1.2 million for fiscal year ended June 30, 2014, compared to a net loss of $133,000 for the fiscal year ended June 30, 2013. The change was due to a $513,000 decrease in noninterest income, a $409,000 increase in noninterest expense, a $95,000 decrease in net interest income and a $121,000 credit to the provision for loan losses in fiscal 2013, compared to none in fiscal 2014. Each of these changes is discussed in more detail below. Interest Income. Interest income decreased $563,000, or 7.5%, to $6.9 million for the fiscal year ended June 30, 2014 from $7.5 million for 2013. The decrease was caused by a decrease in interest and fees on loans, which decreased $771,000, or 11.3%, to $6.0 million for fiscal 2014 from $6.8 million for 2013, partially offset by an increase in interest income on securities of $210,000, or 31.8%, to $873,000 for 2014 from $663,000 for 2013. The decrease in interest and fees on loans was due primarily to a decrease in average balances, which decreased $10.6 million, or 9.8%, to $98.4 million for 2014 from $109.0 million for 2013. The average balance of loans decreased for the reasons described in "-Comparison of Financial Condition at June 30, 2014 and June 30, 2013." Our average loan yield decreased 10 basis points to 6.15% for 2014 from 6.25% for 2013 due primarily to a decrease in market rates on new originated loans and principal payments on older, higher yielding loans. Interest Expense. Interest expense decreased $468,000, or 25.5%, to $1.4 million for 2014 from $1.8 million for 2013. The decrease was caused primarily by a decrease in interest expense on deposits, which decreased $291,000, or 23.2%, to $959,000 for 2014 from $1.2 million for 2013. Interest expense on certificates of deposit decreased $251,000, or 25.8%, to $722,000 for 2014 from $973,000 for 2013. Our average rate on certificates of deposit decreased 21 basis points to 1.04% for 2014 from 1.25% for 2013 and the average balance decreased $8.1 million, or 10.5%, to $69.7 million for 2014 from $77.8 million for 2013. Interest expense on Federal Home Loan Bank advances decreased $177,000, or 30.5%, to $404,000 for 2014 from $581,000 for 2013. The average balance of Federal Home Loan Bank advances decreased $3.1 million, or 21.5%, to $11.3 million for 2014 from $14.4 million for 2013. In addition, the average rate paid on Federal Home Loan Bank advances decreased 46 basis points to 3.57% for 2014 from 4.03% for 2013. In 2014, we were able to decrease average Federal Home Loan Bank advances as our securities portfolio balances declined. Net Interest Income. Net interest income decreased $95,000, or 1.7%, to $5.6 million for 2014 from $5.7 million for 2013 due primarily to the decreases in average interest-earning assets and interest-bearing liabilities, partially offset by the increase in the net interest margin. 25 Provision for Loan Losses. We made no provision for loan losses for 2014, compared to a credit to the provision for loan losses of $121,000 in 2013. The credit to the provision in 2013 was due to both reduced loan portfolio balances and improving credit quality, including reductions in nonaccrual loans, impaired loans and total aggregate loans classified as special mention and substandard. In 2014, credit quality continued to improve and no increase in the allowance for loan losses was considered necessary as the reduction in the experience loss ratio offset the 1.6% increase in loans held for investment for the 2014 fiscal year. Net charge- offs to average loans were 0.18% for 2014, compared to 0.45% for 2013.



We had an allowance for loan losses of $1.6 million, or 1.77% of total loans held for investment and 371.33% of non-performing loans at June 30, 2014, compared to an allowance for loan losses of $1.8 million, or 2.00% of total loans held for investment and 242.23% of non-performing loans at June 30, 2013.

Noninterest Income. Noninterest income decreased $513,000, or 14.3%, to $3.1 million for 2014 from $3.6 million for 2013. Gain on sale of mortgage loans decreased $624,000, or 20.0%, to $2.5 million for 2014 from $3.1 million for 2013. We sold $91.1 million of mortgage loans during 2014, a decrease of 8.7%, compared to $99.7 million of sales during 2013. We realized a more attractive average premium for the 2013 period. Average premiums decreased to 2.7% of mortgage loans sold for 2014 compared to 3.0% for 2013. Premiums vary from period to period based upon the mix of government FHA and VA loans to conventional loans, geographic market differences and market interest rates, specifically changes in 10-year Treasury rates. Noninterest Expense. Noninterest expense increased $409,000, or 4.3%, to $9.9 million for 2014 from $9.5 million for 2013 due primarily to a $686,000 increase in merger-related expenses (including legal fees) related to our merger with Bank 1440. Salaries and benefits decreased $294,000 to $5.3 million for 2014 due primarily to reductions in retirement benefits and other employee benefits and incentive pay, partially offset by a 4% increase in base pay. Data processing fees increased $207,000 due primarily to higher core data processing fees and the completion of some special programming projects including the implementation of a secure web portal.



Income Tax Expense. Income tax expense was $0 for fiscal 2014, compared to $36,000 in 2013. No income tax expense was recorded in 2014 due to the pre-tax net loss of $1.2 million and no income tax benefit was recorded since the ability to receive a future tax benefit utilizing those losses was uncertain.

26 Loans Held for Investment We primarily originate residential real estate loans, including multi-family residential real estate loans, as well as commercial real estate loans, including construction loans, commercial and industrial loans and consumer and other loans. The following table sets forth the composition of our loans held for investment by type of loan at the dates indicated. At June 30, 2014 2013 Amount Percent Amount Percent (Dollars in thousands) Residential real estate loans $ 34,015 36.61 % $



38,432 42.07 %

Commercial real estate loans 55,103 59.31



48,081 52.64

Commercial and industrial loans 2,787 3.00



3,346 3.66

Consumer and other loans 1,007 1.08



1,487 1.63

Total gross loans held for investment 92,912 100.00 % 91,346 100.00 %

Less:

Unamortized loan fees (269 )



(132 )

Loans held for investment 92,643



91,214

Allowance for loan losses (1,645 )



(1,824 )

Loans held for investment, net $ 90,998$ 89,390

The following table sets forth the contractual maturities of our loans held for investment at June 30, 2014. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. The table presents contractual maturities and does not reflect repricing or the effect of prepayments. Actual maturities may differ. Commercial Residential Commercial and Consumer June 30, 2014 Real Estate Real Estate Industrial and other Total (In thousands) Amounts due in: One year or less $ 1,659$ 9,313$ 1,166$ 172$ 12,310 More than one to five years 5,922 27,922 1,459 821 36,124 More than five years 26,434 17,868 162 14 44,478 Total gross loans held for investment $ 34,015$ 55,103$ 2,787$ 1,007$ 92,912



The following table sets forth our fixed and adjustable-rate loans at June 30, 2014 that are contractually due after June 30, 2015.

Due After June 30, 2015 Fixed Adjustable Total (In thousands) Real estate loans: One- to four-family residential $ 32,356 $ - $ 32,356 Commercial 24,199 21,591 45,790 Commercial and industrial 1,524 97 1,621 Consumer and other loans 835 - 835 Total loans $ 58,914$ 21,688$ 80,602 27 Asset Quality We review loans on a regular basis, and place loans on nonaccrual status when either principal or interest is 90 days or more past due, or earlier if we do not expect to receive full payment of interest or principal. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is reversed from interest income. Once a loan is placed on nonaccrual status, the borrower must generally demonstrate at least six months of payment performance before the loan is eligible to return to accrual status. Non-Performing Assets.The following table sets forth information regarding our non-performing assets. At June 30, 2014 2013 (Dollars in thousands) Non-accrual loans: Real estate loans:

One- to four-family residential $ 99$ 120 Commercial 327 633 Commercial and industrial loans 17

- Consumer and other loans - - Total non-accrual loans 443 753

Accruing loans past due 90 days or more - - Total of nonaccrual loans and accruing loans past due 90 days or more 443 753 Other real estate owned ("ORE"): One- to four-family residential 17

297 Commercial 820 1,095 Total ORE 837 1,392 Total non-performing assets $ 1,280$ 2,145

Non-performing loans to gross loans held for investment 0.48 % 0.82 % Non-performing assets to total assets 0.76 % 1.23 % Non-performing assets to gross loans held for investment and ORE 1.37 % 2.31 %



The non-performing asset ratios decreased due primarily to reductions of 39.9% in other real estate and 41.2% in nonaccrual loans.

Interest income that would have been recorded for the year ended June 30, 2014, had nonaccruing loans been current according to their original terms amounted to $40,000. We recognized no interest income on these loans for the year ended June 30, 2014. Of such amount, $32,000 is related to troubled debt restructurings. We recognized no interest income on these loans for the year ended June 30, 2014. In addition to non-performing assets, as of June 30, 2014 and 2013 we had $489,000 and $505,000 of accruing troubled debt restructurings. Troubled debt restructurings include loans for which either a portion of interest or principal has been forgiven, or for loans modified at interest rates materially less than current market rates. The troubled debt restructurings as of June 30, 2014 consisted of three commercial real estate loans and one commercial and industrial loan and the troubled debt restructurings as of June 30, 2013 consisted of two commercial real estate loans and one commercial and industrial loan. As of June 30, 2014 and 2013 there were no specific reserves related to these loans, and at each date we had no commitments to lend additional amounts to the customers. 28



Delinquent Loans. The following table sets forth our loan delinquencies by type and amount at the dates indicated.

At June 30, 2014 2013 30-59 60-89 90 Days 30-59 60-89 90 Days Days Days or More Days Days or More Past Due Past Due Past Due Past Due Past Due Past Due (In thousands) Residential real estate loans $ - $ 43 $ - $ - $ 45$ 65 Commercial real estate loans 162 - - - - 137

Commercial and industrial loans - - -

- - - Consumer and other loans - - - - - - Total $ 162$ 43 $ - $ - $ 45$ 202

Classified Assets. Federal regulations provide that loans and other assets of lesser quality should be classified as "substandard", "doubtful" or "loss" assets. An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that we will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. We designate an asset as "special mention" if the asset has a potential weakness that warrants management's close attention.



The following table sets forth our amounts of classified assets and assets designated as special mention as of June 30, 2014 and 2013. The classified assets total at June 30, 2014 includes $443,000 of nonperforming loans.

At June 30, 2014 2013 (In thousands) Classified assets: Substandard (1) $ 3,274$ 3,575 Doubtful - - Loss - - Total classified assets $ 3,274$ 3,575 Special mention $ 854$ 2,031



(1) Includes other real estate at June 30, 2014 and 2013 of $837,000 and $1.4

million, respectively.

Allowance for Loan Losses. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb probable credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Because of uncertainties associated with regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management's estimate of probable credit losses inherent in the loan portfolio and the related allowance may change materially in the near-term. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by full and paryial charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Management's periodic evaluation of the adequacy of the allowance is based on the current level of net loan losses, 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 current economic conditions. 29

Adjustable-rate mortgage loans decrease the risk associated with changes in market interest rates by periodically repricing, but involve other risks as interest rates increase since the underlying payments by the borrower increase, thus increasing the potential for default. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustments permitted by our loan agreements and, therefore, the effectiveness of adjustable-rate mortgage loans may be limited during periods of rapidly rising interest rates. Loans secured by commercial real estate, including multi-family real estate generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate are often dependent on successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment or other income, and which are secured by real property that is generally more marketable and whose value tends to be more easily ascertainable, commercial and industrial loans generally are made on the basis of the borrower's ability to repay the loan from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial and industrial loans may depend substantially on the success of the business itself. Further, any collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. The following table sets forth activity in our allowance for loan losses for the years indicated. At or For the Years Ended June 30, 2014 2013 (Dollars in thousands)

Allowance at beginning of year $ 1,824$ 2,437 Provision for (credit to) loan losses - (121 ) Charge offs: Residential real estate loans (86 ) (111 ) Commercial real estate loans (76 ) (383 ) Commercial and industrial loans -

- Consumer and other loans (48 ) (187 ) Total charge-offs (210 ) (681 ) Recoveries: Residential real estate loans - 46 Commercial real estate loans 30 66

Commercial and industrial loans -

- Consumer and other loans 1 77 Total recoveries 31 189 Net (charge-offs) (179 ) (492 ) Allowance at end of year $ 1,645$ 1,824 Allowance for loan losses to non-performing loans at end of year 371.33 % 242.23 % Allowance for loan losses to gross loans held for investment at the end of the year 1.77 % 2.00 % Net (charge-offs) to average loans outstanding during the year (0.18 )% (0.45 )% The allowance for loan losses to non-performing loans ratio increased due to a decrease in non-performing loans. The allowance for loan losses to gross loans held for investment decreased as a result of charge-offs recognized during

2014. 30

Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category and the percent of loans in each category to total loans held for investment at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories. At June 30, 2014 2013 Percent of Percent of Loans in Loans in Each Each Allowance Category to Allowance Category to for Loan Total for Loan Total Losses Loans Losses Loans (Dollars in thousands)

Residential real estate loans $ 375 36.61 % $ 196 42.07 % Commercial real estate loans 1,126 59.31 1,568 52.64 Commercial and industrial loans 129 3.00

55 3.66 Consumer and other loans 15 1.08 5 1.63 Total allocated allowance 1,645 100.00 % 1,824 100.00 % Unallocated - - Total $ 1,645$ 1,824 Investments



Our investment policy is established by our Board of Directors. The policy emphasizes safety of the investment, liquidity requirements, potential returns, cash flow targets, and consistency with our interest rate risk management strategy.

The following table sets forth the amortized cost and estimated fair value of our available-for-sale securities portfolio at the dates indicated.

At June 30, 2014 2013 Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value (In thousands)



Mortgage-backed securities (1) $ 30,094$ 29,819 $

45,497 $ 45,306 Agency securities 9,106 8,831 10,385 10,034 Municipal obligations 309 309 - - Total $ 39,509$ 38,959$ 55,882$ 55,340



(1) Includes Freddie Mac, Fannie Mae and Ginnie Mae obligations.

At June 30, 2014 and 2013, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders' equity.

31 Portfolio Maturities and Yields. The composition and maturities of the securities portfolio at June 30, 2014, are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the effect of scheduled principal repayments, prepayments, or early redemptions that may occur. Tax-equivalent yield adjustments have not been made for tax-exempt securities, as the effect thereof was not material. More than One Year More than Five Years One Year or Less through Five Years through Ten Years More than Ten Years Total Weighted Weighted Weighted Weighted Weighted Amortized Average Amortized Average Amortized Average Amortized Average

Amortized Fair Average Cost Yield Cost Yield Cost Yield Cost Yield Cost Value Yield (Dollars in thousands) Mortgage-backed securities (1) $ 110 2.48 % $ 10,934 1.49 % $ 17,183 2.49 % $ 1,867 2.85 % $ 30,094$ 29,819 2.15 % Agency securities - - 2,300 1.35 6,806 2.20 - - 9,106 8,831 1.98 Municipal obligations - - 309 1.43 - - - - 309 309 1.43 Total $ 110 2.48 % $ 13,543 1.46 % $ 23,989 2.41 % $ 1,867 2.85 % $ 38,509$ 38,959 2.10 %



(1) Includes Freddie Mac, Ginnie Mae and Fannie Mae obligations.

32 Sources of Funds General. Deposits traditionally have been our primary source of funds for use in lending and investment activities. We also use Federal Home Loan Bank of Dallas advances, to supplement cash flow needs, lengthen the maturities of liabilities for interest rate risk purposes and to manage the cost of funds. Funds are derived from scheduled loan payments, securities maturities, loan prepayments, loan sales, and income on earning assets. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition. Deposits. Our deposits are generated mainly from residents within our primary deposit market area. We offer a selection of deposit accounts. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds must remain on deposit and the interest rate. Interest rates, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market rates, liquidity requirements, rates paid by competitors and growth goals. Personalized customer service and long-standing relationships with customers are relied upon to attract and retain deposits. The flow of deposits is influenced significantly by general economic conditions, changes in money market and other prevailing interest rates and competition. The variety of deposit accounts offered allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on experience, we believe that our deposits are relatively stable. However, the ability to attract and maintain deposits and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions.



The following table sets forth the distribution of total deposits by account type, for the years indicated.

For the Year Ended June 30, 2014 2013 Weighted Weighted Average Average Average Average Amount Percent Rate Amount Percent Rate (Dollars in thousands) Non-interest bearing $ 12,372 9.24 % - % $ 12,514 8.97 % - % Checking 12,783 9.55 0.20 % 12,038 8.63 0.22 % Money market 9,365 7.00 0.65 % 9,919 7.11 0.68 % Savings 29,625 22.14 0.51 % 27,194 19.50 0.67 % Certificates of deposit 69,674 52.07 1.04 % 77,805 55.79 1.25 % Total $ 133,819 100.00 % 0.72 % $ 139,470 100.00 % 0.90 % As of June 30, 2014, the aggregate amount of all our certificates of deposit in amounts greater than or equal to $100,000 was approximately $32.7 million. The following table sets forth the maturity of these certificates as of June 30, 2014. At June 30, 2014 (In thousands) Maturity Period: Three months or less $ 5,259 Over three through six months 2,443 Over six through twelve months 7,455 Over twelve months 17,528 Total $ 32,685 33 Borrowings. As of June 30, 2014 and 2013, our borrowings consisted solely of Federal Home Loan Bank of Dallas advances. The following table sets forth information concerning balances and interest rates on our Federal Home Loan Bank advances at the dates and for the years indicated. At or For the Years Ended June 30, 2014 2013 (Dollars in thousands)

Average amount outstanding during the year $ 11,309$ 14,415 Highest amount outstanding at any month end during the year $ 13,281$ 15,452 Weighted average interest rate during the year 3.57 % 4.03 % Balance outstanding at end of year $ 8,810$ 13,327 Weighted average interest rate at end of year 3.39

% 3.11 % Management of Market Risk

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



We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk:

offering a variety of adjustable rate loan products;

using alternate funding sources, such as advances from the Federal Home Loan

Bank of Dallas;



maintaining pricing strategies that encourage "core" deposits; and

selling longer-term, fixed rate loans into the secondary market.

By following these strategies, we believe that we are better positioned to react to increases in market interest rates.

Economic Value of Equity. We monitor interest rate risk through the use of a simulation model that estimates the amounts by which the fair value of our assets and liabilities (our economic value of equity or "EVE") would change in the event of a range of assumed changes in market interest rates. The quarterly reports developed in the simulation model assist us in identifying, measuring, monitoring and controlling interest rate risk to ensure compliance within the our policy guidelines. 34 The table below sets forth, as of June 30, 2014, the estimated changes in our EVE that would result from the designated instantaneous changes in market interest rates. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. At June 30, 2014 Change in Interest Estimated Increase (Decrease) Rates (Basis Points) in EVE (1) Estimated EVE (2) Amount Percent (Dollars in thousands) +300 $ 21,185 $ (2,529 ) (10.66 )% +200 22,725 (989 ) (4.17 )% +100 23,562 (152 ) (0.64 )% - 23,714 - - -100 24,835 1,121 4.73 %



(1) Assumes an instantaneous uniform change in interest rates at all maturities.

(2) EVE is the discounted present value of expected cash flows from assets,

liabilities and off-balance sheet contracts. The table above indicates that at June 30, 2014, in the event of a 100 basis point decrease in interest rates, we would experience a 4.73% increase in EVE. In the event of a 200 basis point increase in interest rates at June 30, 2014, we would experience a 4.17% decrease in EVE. Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in EVE require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the EVE table presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the EVE table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on EVE and will differ from actual results. EVE calculations also may not reflect the fair values of financial instruments. For example, decreases in market interest rates can increase the fair values of our loans, deposits and borrowings.



Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments and maturities and sales of securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits with other banks and short- and intermediate-term securities.



We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of June 30, 2014.

Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At June 30, 2014, cash and cash equivalents totaled $9.9 million. Additional cash is being carried to cover loan funding requirements, especially construction loan draws, and to cover the cash requirements for the upcoming merger with Bank 1440 which are expected to be in the $2.0 to $2.5 million range. Available-for-sale securities, which provide additional sources of liquidity, totaled $39.0 million at June 30, 2014. In addition, at June 30, 2014, we had $8.8 million of advances outstanding from the Federal Home Loan Bank of Dallas and the ability to borrow an additional $76.0 million from them. 35

At June 30, 2014, we had $19.3 million in loan commitments outstanding, and an additional $9.3 million in commitments to originate and sell mortgage loans. In addition to commitments to originate loans, we had $3.4 million in unused lines of credit and $145,000 of commitments issued under standby letters of credit. Certificates of deposit due within one year of June 30, 2014 totaled $31.4 million, or 23.3% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before June 30, 2015. We believe, however, based on past experience, that a significant portion of our certificates of deposit will remain with us, either as certificates of deposit or as other deposit products. We have the ability to attract and retain deposits by adjusting the interest rates offered. We have no material commitments or demands that are likely to affect our liquidity other than set forth above. In the event loan demand were to increase at a pace greater than expected, or any unforeseen demand or commitment were to occur, we would access our borrowing capacity with the Federal Home Loan Bank of Dallas. Our primary investing activities are the origination of loans and the purchase of securities. In the fiscal years ended June 30, 2014 and 2013, we originated $136.8 million and $125.9 million of loans, respectively, and purchased $6.9 million and $31.3 million of securities, respectively. We have not purchased any whole loans in recent periods. Financing activities consist primarily of activity in deposit accounts and Federal Home Loan Bank advances. We experienced net decreases in total deposits of $844,000 and $7.9 million during the fiscal years ended June 30, 2014 and 2013, respectively. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits so that we are competitive in our market area. Federal Home Loan Bank advances decreased by $4.5 million and $2.2 million during the fiscal years ended June 30, 2014 and 2013, respectively. Despite the increases in cash and cash equivalents, loans held for sale and loans held for investment in 2014, we were able to decrease our Federal Home Loan Bank advances due to a much larger decrease in our securities portfolio. BANK'34 is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At June 30, 2014, BANK'34 exceeded all regulatory capital requirements. BANK'34 is considered "well-capitalized" under regulatory guidelines.



Off-Balance Sheet Arrangements and Contractual Obligations

Commitments.As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our potential future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. In addition, we enter into commitments to sell mortgage loans. For additional information, see Note 10 of the Notes to the Consolidated Financial Statements. Contractual Obligations.In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include operating leases for premises and equipment, agreements with respect to borrowings and deposits and agreements with respect to securities.



Recent Accounting Pronouncements

For recent accounting pronouncements see Note 1 of the Notes to the Consolidated Financial Statements.

36



Impact of Inflation and Changing Prices

The consolidated financial statements and related notes of Alamogordo Financial Corp. have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). U.S. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.



ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk

For information regarding market risk, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations".


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