Edgar Filing: Cullman Bancorp, Inc.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Form 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

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

For the Fiscal Year ended December 31, 2011

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

For the transition period from to .

Commission File Number 000-53801

Cullman Bancorp, Inc.

(Exact Name of Registrant as Specified in Charter)


Federal		63-0052835
(State of Other Jurisdiction of Incorporation)		(I.R.S Employer Identification Number)

316 Second Avenue S.W., Cullman, Alabama		35055
(Address of Principal Executive Officer)		(Zip Code)

256-734-1740

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of March 9, 2012, there were issued and outstanding 2,564,458 shares of the Registrant’s Common Stock, par value $.01 per share.

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the last sales price on June 30, 2011 was $15.3 million.

Documents incorporated by reference:

Proxy statement for 2011 Annual Meeting of Shareholders of the Registrant (Part III).

Table of Contents


PART I.

Item 1.	Business	3

Item 1A.	Risk Factors	35

Item 1B.	Unresolved Staff Comments	35

Item 2.	Properties	35

Item 3.	Legal Proceedings	35

Item 4.	Mine Safety Disclosures	35

PART II.

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	36

Item 6.	Selected Financial Data	37

Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39

Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	46

Item 8.	Financial Statements and Supplementary Data	47

Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures	82

Item 9A.	Controls and Procedures	82

Item 9B.	Other Information	83

PART III.

Item 10.	Directors, Executive Officers and Corporate Governance	83

Item 11.	Executive Compensation	83

Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	83

Item 13.	Certain Relationships, Related Transaction and Director Independence	83

Item 14.	Principal Accountant Fees and Services	83

PART IV.

Item 15.	Exhibits	84

Item 16.	Signatures	85

PART I

Item 1. Business

Forward Looking Statements

This Annual Report (including information incorporated by reference) contains, and future oral and written statements of Cullman Bancorp, Inc. (“Cullman Bancorp” or the “Company”) and its management may contain, forward-looking statements as such term is defined in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of Cullman Bancorp. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of Cullman Bancorp’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions.

These forward-looking statements include, but are not limited to:

•

statements of our goals, intentions and expectations;

•

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

•

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

•

estimates of our risks and future costs and benefits.

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

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

•

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

•

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

•

increased competition among depository and other financial institutions;

•

our ability to improve our asset quality even as we increase our non-residential lending;

•

our success in increasing our commercial real estate and commercial business lending, including agricultural lending;

•

changes in the interest rate environment that reduce our margins or reduce the fair value of our financial instruments and real estate;

•

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

•

adverse changes in the local, national and international agricultural markets, including weather, pests and government regulation and support, which impact the value of our farmland and agricultural loans;

•

our ability to successfully implement our plan to increase our non-residential lending without significant decrease in asset quality;

•

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

•

increases in deposit and premium assessments;

•

legislative or regulatory changes, including increased compliance costs resulting from the recently enacted financial reform legislation, that adversely affect our business and earnings;

•

changes in the level of government support of housing finance;

•

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

•

our reliance on a small executive staff;

•

changes in consumer spending, borrowing and savings habits;

•

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

•

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

•

changes in our organization, compensation and benefit plans;

•

loan delinquencies and changes in the underlying cash flows of our borrowers resulting in increased loan losses;

•

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

•

changes in the financial condition or future prospects of issuers of securities that we own, including our stock in the FHLB of Atlanta.

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

Cullman Savings Bank, MHC

Cullman Savings Bank, MHC is our federally-chartered mutual holding company parent. As a mutual holding company, Cullman Savings Bank, MHC is a non-stock company. As of December 31, 2011, Cullman Savings Bank, MHC owned 54% of Cullman Bancorp’s common stock. As long as Cullman Savings Bank, MHC exists, it is required to own a majority of the voting stock of Cullman Bancorp and, through its board of directors, will be able to exercise voting control over most matters put to a vote of shareholders. Cullman Savings Bank, MHC does not engage in any business activity other than owning a majority of the common stock of Cullman Bancorp.

Cullman Bancorp, Inc.

Cullman Bancorp, Inc. is the federally-chartered mid-tier stock holding company formed by Cullman Savings Bank to be its holding company as part of its mutual holding company reorganization and initial public offering. Cullman Bancorp owns all of Cullman Savings Bank’s capital stock. Cullman Bancorp’s primary business activities, apart from owning the shares of Cullman Savings Bank, currently consist of loaning funds to the Cullman Savings Bank’s Employee Stock Ownership Plan (“ESOP”) and investing in checking and money market accounts at Cullman Savings Bank. For parent only financial statements, see Note 18 of the Notes to Consolidated Financial Statements.

Cullman Bancorp, as the holding company of Cullman Savings Bank, is authorized to pursue other business activities permitted by applicable laws and regulations, which may include the acquisition of banking and financial services companies. See “Supervision and Regulation—Holding Company Regulation” for a discussion of the activities that are permitted for savings and loan holding companies. We currently have no specific arrangements or understandings regarding any such other activities.

Our cash flow will depend on earnings from the investment of the net proceeds we retain, and any dividends received from Cullman Savings Bank. Cullman Bancorp, Inc. currently neither owns nor leases any property, but instead uses the premises, equipment and furniture of Cullman Savings Bank. At the present time, we employ only persons who are officers of

Cullman Savings Bank to serve as officers of Cullman Bancorp. However, we use the support staff of Cullman Savings Bank from time to time. These persons will not be separately compensated by Cullman Bancorp. Cullman Bancorp may hire additional employees, as appropriate, to the extent it expands its business in the future.

Cullman Savings Bank

Our principal business consists of attracting retail deposits from the general public in our market and investing those deposits, together with funds generated from operations and, to a lesser extent, borrowings in one-to-four family residential mortgage loans and commercial real estate loans, and, to a lesser extent, multi-family mortgage loans, construction loans, land loans, home equity loans, commercial loans and consumer loans. We also invest in U.S. Government and federal agency securities, mortgage-backed securities and, to a lesser extent, mutual funds that invest in those securities. Our revenues are derived principally from the interest on loans and securities, loan origination and servicing fees and fees levied on deposit accounts. Our primary sources of funds are principal and interest payments on loans and securities, deposits and advances from the Federal Home Loan Bank of Atlanta.

In 1999, we amended our business plan to increase significantly our commercial real estate lending in order to enhance the yield and interest rate sensitivity of our loan portfolio. In 2006, we appointed a new President and Chief Executive Officer from within our organization and hired a new Executive Vice President in charge of lending, both of whom have significant commercial lending experience. In the years since these management changes, our portfolio of commercial real estate loans has increased significantly. We expect this portfolio to continue to increase in the future, but at a more measured pace.

Reflecting our focus on our community, in 2002 we formed Cullman Savings Foundation, a private foundation. In connection with the stock offering, we formed another charitable foundation called Cullman Savings Bank Charitable Foundation. It was funded with 50,255 shares of common stock of Cullman Bancorp and $100,000 in cash. We formed a new foundation rather than making this contribution to Cullman Savings Foundation based on certain Internal Revenue Service regulations that may limit our ability to make a contribution of Cullman Bancorp common stock to an existing foundation. The corporate purpose of this new foundation is substantially the same as Cullman Savings Foundation.

Our website address is www.cullmansavingsbank.com. Information on our website should not be considered a part of this Annual Report.

Mutual Holding Company Reorganization

On October 8, 2009, the Bank completed its conversion and reorganization from a mutual savings bank into a two-tier mutual holding stock company. In accordance with the plan of reorganization, Cullman Bancorp (of which Cullman Savings Bank became a wholly-owned subsidiary) issued and sold shares of capital stock to eligible depositors of Cullman Savings Bank. A total of 1,080,483 shares were sold in the conversion at $10 per share, raising $10.8 million of gross proceeds. Approximately $900,000 of conversion expenses were offset against the gross proceeds. Cullman Bancorp, Inc.’s common stock began trading on the over-the-counter market under the symbol “CULL” on October 9, 2009.

The combination of shares sold to the public and contributed to the charitable foundation represents 46% of the common stock of Cullman Bancorp’s outstanding shares. Cullman Savings Bank, MHC owns 54% or 1,387,312 shares.

Market Area and Competition

We conduct business through our main office and one branch office located in Cullman, Alabama and an additional branch office located in Hanceville, Alabama. All three of our offices are located in Cullman County, which is centrally located between the Huntsville and Birmingham metropolitan areas, approximately 55 miles south of Huntsville and approximately 50 miles north of Birmingham.

Our primary market area, which consists of Cullman County and the contiguous surrounding counties, is mostly rural and suburban in nature. The regional economy is fairly diversified, with services, wholesale/retail trade, manufacturing and government providing the primary support for the area economy. Farming also continues to play a prominent role in the local economy, as Cullman County is ranked as one of the top sixty counties in the United States for total agricultural income. The largest employers in Cullman County include the Cullman County and Cullman City School Systems, the State and County Government, Wal-Mart, the Cullman Regional Medical Center, REHAU, Inc. (a polymer processing company) and Golden Rod Broilers (a poultry processor).

Competition for financial services in our primary market area is significant, particularly in light of the relatively modest population base of Cullman County and the relatively large number of institutions that maintain a presence in the county. Among our competitors are much larger and more diversified institutions, which have greater resources than we

maintain. Financial institution competitors in our primary market area include other locally based thrifts and banks, as well as regional, super-regional and money center banks. To meet our competition, we seek to emphasize our community orientation, local and timely decision making and superior customer service. As of June 30, 2011 our market share of deposits represented 10.36% of FDIC-insured deposits in Cullman County, Alabama.

Lending Activities

Historically our principal lending activity is the origination of one-to-four family residential mortgage loans and commercial real estate loans, and, to a lesser extent, multi-family mortgage loans, construction loans, land loans, home equity loans, commercial loans and consumer loans. In recent years we have expanded our commercial real estate loan portfolio in an effort to diversify our overall loan portfolio, increase the yield of our loans and shorten asset duration. We expect commercial real estate lending will continue to be an area of loan growth, and we have focused our efforts in this area on borrowers seeking loans in the $50,000 to $1.0 million range. As a long-standing community lender, we believe we can effectively compete for this business by emphasizing superior customer service and local underwriting, which differentiates us from larger commercial banks that have recently commenced operations in our primary market area.

Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.


	At December 31,
	2011						2010						2009						2008						2007
	Amount			Percent			Amount			Percent			Amount			Percent			Amount			Percent			Amount			Percent
	(Dollars In thousands)

One- to four-family (1)	$	78,869			47.61	%	$	83,721			46.88	%	$	81,436			46.79	%	$	80,454			48.34	%	$	84,925			51.59	%
Multi-family		5,184			3.13			4,837			2.71			5,780			3.32			3,722			2.24			3,272			1.99
Commercial real estate		63,336			38.23			63,443			35.53			60,602			34.82			59,655			35.85			56,609			34.39
Construction		1,667			1.01			8,936			5.00			6,235			3.59			3,263			1.97			6,701			4.08

Total real estate loans		149,056			89.98			160,937			90.12			154,053			88.52			147,094			88.39			151,507			92.05
Commercial loans		7,221			4.36			7,371			4.13			7,506			4.31			6,592			3.96			1,414			0.86
Consumer loans:					0.00
Home equity loans and lines of credit		5,286			3.19			6,165			3.45			7,543			4.33			7,321			4.40			5,539			3.37
Other consumer loans		4,097			2.47			4,111			2.30			4,936			2.84			5,411			3.25			6,141			3.73

Total consumer loans		9,383			5.66			10,276			5.75			12,479			7.17			12,732			7.65			11,680			7.10

Total loans	$	165,660			100.00	%	$	178,584			100.00	%	$	174,038			100.00	%	$	166,418			100.00	%	$	164,601			100.00	%

Net deferred loan fees		(337	)					(413	)					(544	)					(703	)					(874	)
Allowance for losses		(1,108	)					(854	)					(747	)					(472	)					(430	)

Loans, net	$	164,215					$	177,317					$	172,747					$	165,243					$	163,297

(1)	Excludes loans held for sale

Contractual Maturities and Interest Rate Sensitivity. The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2011. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.


	One-to-four Family Residential		Multi-family and Commercial Real Estate		Construction		Commercial		Home Equity Lines of Credit		Consumer and Other		Total
					(Dollars in thousands)

Amounts due in:
One year or less	$	2,923	$	8,353	$	1,667	$	4,341	$	813	$	2,235	$	20,332
More than one to two years		763		6,547		—		1,132		2,245		681		11,368
More than two to three years		1,747		5,308		—		264		1,043		758		9,120
More than three to five years		3,196		11,237		—		1,484		1,185		414		17,516
More than five to ten years		5,070		8,410		—		—		—		9		13,489
More than ten to fifteen years		8,309		14,085		—		—		—		—		22,394
More than fifteen years		56,861		14,580		—		—		—		—		71,441

Total	$	78,869	$	68,520	$	1,667	$	7,221	$	5,286	$	4,097	$	165,660


Interest rate terms on amounts due after one year:
Fixed-rate loans		64,159		38,148		—		2,880		63		1,862		107,112
Adjustable-rate loans		11,787		22,019		—		—		4,410		—		38,216

Total	$	75,946	$	60,167	$	—	$	2,880	$	4,473	$	1,862	$	145,328

Loan Approval Procedures and Authority. Pursuant to federal law, the aggregate amount of loans that we are permitted to make to any one borrower or a group of related borrowers is generally limited to 15% of our unimpaired capital and surplus (25% if the amount in excess of 15% is secured by “readily marketable collateral” or 30% for certain residential development loans). At December 31, 2011, based on the 15% limitation, our loans-to-one-borrower limit was approximately $5.0 million. On the same date, we had no borrowers with outstanding balances in excess of this amount. At December 31, 2011, our largest commercial real estate loan totaled $3.5 million and was secured by a mortgage on commercial real estate in our primary market area. At December 31, 2011, this loan was performing in accordance with its terms.

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

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

Our senior lending officers have approval authority for real estate loans of up to $300,000, secured vehicle loans (including farm equipment) of up to $100,000 and unsecured loans of up to $100,000. Loans above these amounts require approval by any two of the following three officers: President and Chief Executive Officer, Executive Vice President and Director of Lending and Vice President/Senior Loan Officer. An individual loan or an aggregate credit commitment in excess

of $1.5 million up to our legal lending limit requires the approval of all three of these officers and must be reported to our board of directors before the loan is closed. To ensure adequate liquidity, under our loan policy, aggregate loans outstanding should not exceed our total deposits and advances from the Federal Home Loan Bank of Atlanta.

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

One- to-Four Family Residential Real Estate Lending. The cornerstone of our lending program has long been the origination of long-term permanent loans secured by mortgages on owner-occupied one- to four-family residences. At December 31, 2011, $78.7 million, or 47.6% of our total loan portfolio consisted of permanent loans on one- to four-family residences. At that date, our average outstanding one- to four-family residential loan balance was $108,070 and our largest outstanding residential loan had a principal balance of $2.2 million. Virtually all of the residential loans we originate are secured by properties located in our market area. See “—Originations, Purchases and Sales of Loans.”

Due to consumer demand in the current low market interest rate environment, many of our recent originations are 15- to 30-year fixed-rate loans secured by one- to four-family residential real estate. We generally originate our fixed-rate one- to four-family residential loans in accordance with secondary market standards to permit their sale on a servicing-released basis. At December 31, 2011, we had $13.6 million of fixed-rate residential loans with original contractual maturities of 10 years or less, $9.2 million of fixed-rate residential loans with original contractual maturities between 10 and 20 years and $44.2 million of fixed-rate residential loans with original contractual maturities in excess of 20 years in our portfolio.

In order to reduce the term to repricing of our loan portfolio, we also originate adjustable-rate one- to four-family residential mortgage loans. Our current adjustable-rate mortgage loans carry interest rates that adjust annually at a margin (generally 300 basis points) over the Office of Thrift Supervision (“OTS”) Cost of Funds rate, which is a lagging index that generally adjusts more slowly than a U.S. Treasury index. Many of our adjustable-rate one- to four-family residential mortgage loans have fixed rates for initial terms of five or ten years. Such loans carry terms to maturity of up to 30 years. The adjustable-rate mortgage loans currently offered by us generally provide for a 100 basis point annual interest rate change cap and a lifetime cap of 400 basis points over the initial rate.

Although adjustable-rate mortgage loans may reduce to an extent our vulnerability to changes in market interest rates because they periodically reprice, as interest rates increase, the required payments due from the borrower also increase (subject to rate caps), increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustments of the contractual interest rate are also limited by the maximum periodic and lifetime rate adjustments permitted by our loan documents. Moreover, the interest rates on many of our adjustable-rate loans do not adjust for the first five to ten years. As a result, the effectiveness of adjustable-rate mortgage loans may be limited during periods of rapidly rising interest rates. At December 31, 2011, $11.8 million, or 14.9% of our one- to four-family residential loans, had adjustable rates of interest.

We evaluate both the borrower’s ability to make principal, interest and escrow payments and the value of the property that will secure the loan. Our one- to-four family residential mortgage loans do not currently include prepayment penalties, are non-assumable and do not produce negative amortization. Our one- to-four family residential mortgage loans customarily include due-on-sale clauses giving us the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells the property subject to the mortgage. We currently originate residential mortgage loans for our portfolio with loan-to-value ratios of up to 90% for owner-occupied one- to-four family homes and up to 80% for non-owner occupied homes.

At December 31, 2011, we had $252,000 of one- to-four family residential mortgage loans that were 60 days or more delinquent.

Commercial Real Estate Lending. In recent years, we have sought to increase our commercial real estate loans. Our commercial real estate loans are secured primarily by office buildings, farms, retail and mixed-use properties, churches, warehouses and restaurants located in our primary market area. At December 31, 2011, we had $63.3 million in commercial real estate loans, representing 38.2% of our total loan portfolio.

Most of our commercial real estate loans have a five-year balloon term with amortization periods of up to 20 years. The maximum loan-to-value ratio of our commercial real estate loans is generally 85%. At December 31, 2011, our largest commercial real estate loan totaled $3.5 million and was secured by a mortgage on a mixed use commercial building in our primary market area. At December 31, 2011, this loan was performing in accordance with its terms.

Classified within our commercial real estate loans are land loans. We also make a limited amount of land loans to complement our construction lending activities as such loans are generally secured by lots that will be used for residential development. Land loans also include loans secured by farm land and land purchased for investment purposes. Land loans are generally offered for terms of up to 15 years. The maximum loan-to-value ratio of land loans is 75%.

Set forth below is information regarding our commercial real estate loans:


Type of Loan	Number of Loans		Balance
	(Dollars in thousands)

Office		11	$	7,417
Farm		5		1,645
Retail		25		13,578
Mixed Use		25		12,005
Land		85		7,765
Church		10		8,979
Other		23		11,947


		184	$	63,336

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

Loans secured by commercial real estate generally are larger than one-to-four family residential loans and involve greater credit risk. Commercial real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Repayment of these loans depends to a large degree on the results of operations and management of the properties securing the loans or the businesses conducted on such property, and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general, including today’s economic recession. Accordingly, the nature of these loans makes them more difficult for management to monitor and evaluate. At December 31, 2011, we had no non-performing commercial real estate loans.

Multi-Family Real Estate Lending. At December 31, 2011, we had $5.2 million in multi-family real estate loans, representing 3.1% of our total loan portfolio. The multi-family real estate loans we originate generally have a maximum term of 20 years and are secured by apartment buildings located within our primary market area. The interest rates on these loans are generally fixed for an initial period of three to five years and then adjust every one to five years based on the relevant OTS Cost of Funds Rate, plus a margin. These loans are generally made in amounts of up to 80% of the lesser of the appraised value or the purchase price of the property with an appropriate projected debt service coverage ratio.

Appraisals on properties securing multi-family real estate loans are performed by an outside independent appraiser designated by us or internal evaluations, where permitted by regulation. All appraisals on multi-family real estate loans are reviewed by our management. Our underwriting procedures include considering the borrower’s expertise and require verification of the borrower’s credit history, income and financial statements, banking relationships, references and income projections for the property. We generally obtain personal guarantees on these loans.

The borrower’s financial information on multi-family loans is monitored on an ongoing basis by requiring periodic financial statement updates, payment history reviews and periodic face-to-face meetings with the borrower. We require such borrowers to provide annually updated financial statements and federal tax returns. These requirements also apply to the principals of our corporate borrowers.

At December 31, 2011, our largest multi-family loan had a balance of $1.3 million and was secured by a real estate mortgage on a 52-unit apartment complex in our primary market area. At December 31, 2011, this loan was performing in accordance with its terms.

Multi-family real estate loans generally present a higher level of risk than loans secured by one-to-four family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family residential real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower’s ability to repay the loan may be impaired. At December 31, 2011, we had no multi-family loans that were 60 days or more delinquent.

Construction Lending. We make construction loans to individuals for the construction of their primary residences and, to a limited extent, loans to builders and commercial borrowers for owner-occupied projects. At December 31, 2011, our construction loans totaled $1.7 million, representing 1.0% of our total loan portfolio.

Loans to individuals for the construction of their residences typically run for up to 12 months and then convert to permanent loans. These construction loans have rates and terms comparable to one-to-four family residential loans offered by us. During the construction phase, the borrower pays interest only. The maximum loan-to-value ratio of owner-occupied single-family construction loans is 85%. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential loans.

At December 31, 2011, our largest outstanding consumer construction loan was $446,250 of which $408,473 was outstanding. This loan was performing according to its terms at December 31, 2011. At December 31, 2011, there were no construction loans that were 60 days or more delinquent.

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

Construction loans generally are made for relatively short terms. However, to the extent our construction loans are not made to owner-occupants of single-family homes, they are more vulnerable to changes in economic conditions and the concentration of credit with a limited number of borrowers. Further, the nature of these loans is such that they are more difficult to evaluate and monitor. Our risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s value upon completion of the project and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project value, which is insufficient to assure full repayment and/or the possibility of having to make substantial investments to complete and sell the project. Because defaults in repayment may not occur during the construction period, it may be difficult to identify problem loans at an early stage.

Commercial Business Lending. We originate commercial business loans and lines of credit to small- and medium-sized companies in our primary market area. Our commercial business loans are generally used for working capital purposes or for acquiring equipment, inventory or furniture. The commercial business loans that we offer are floating-rate loans indexed to the prime rate as published in The Wall Street Journal and fixed-rate loans generally for a one-year term. Our commercial business loan portfolio consists primarily of secured loans, along with a small amount of unsecured loans.

At December 31, 2011, we had $7.2 million of commercial business loans outstanding, representing 4.4% of the total loan portfolio.

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

Commercial business loans generally have a greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment

from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. We seek to minimize these risks through our underwriting standards.

At December 31, 2011, our largest commercial business loan relationship was an $312,000 loan to a medical company secured by medical equipment and limited personal guarantees by several individuals, including one of our directors. At December 31, 2011, this loan was performing in accordance with its terms. At December 31, 2011, we had $25,000 of commercial business loans that were 60 days or more delinquent.

Home Equity Lending. We originate variable-rate and fixed-rate home equity lines-of-credit secured by a lien on the borrower’s primary residence. Our home equity products are limited to 90% of the property value less any other mortgages. We use the same underwriting standards for home equity lines-of-credit as we use for one-to-four family residential mortgage loans. Our variable-rate home equity line-of-credit product carries an interest rate tied to the prime rate published in The Wall Street Journal with a margin that ranges from (100) basis points to 250 basis points. Our home equity lines-of-credit provide for an initial draw period of up to five years, with monthly payments of 1.5% of the outstanding balance or interest only payments calculated on the outstanding balance. At the end of the initial five years, the line may be paid in full or restructured through our then current home equity program.

At December 31, 2011, we had $5.3 million or 3.2% of our total loans in home equity loans and outstanding advances under home equity lines and an additional $5.5 million of funds committed, but not advanced, under the home equity lines-of-credit.

Consumer Lending. To date, our consumer lending apart from home equity lines-of-credit has been quite limited. At December 31, 2011, we had $4.1 million of consumer loans outstanding, representing 2.5% of the total loan portfolio. Consumer loans consist of loans secured by deposits, auto loans and miscellaneous other types of installment loans.

Consumer loans may entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. At December 31, 2011, we had $2,000 of consumer loans that were 60 days or more delinquent.

Originations, Purchases and Sales of Loans

Lending activities are conducted primarily by our salaried loan personnel operating at our main and branch office locations and a commissioned loan officer. All loans originated by us are underwritten pursuant to our policies and procedures. We originate both fixed-rate and adjustable-rate loans. Our ability to originate fixed or adjustable-rate loans is dependent upon relative customer demand for such loans, which is affected by current and expected future levels of market interest rates. We originate real estate and other loans through our commissioned loan officer, marketing efforts, our customer base, walk-in customers and referrals from real estate brokers, builders and attorneys.

We may sell certain of the loans we originate into the secondary market. Additionally, we consider the current interest rate environment in making decisions as to whether to hold the mortgage loans we originate for investment or to sell such loans to investors, choosing the strategy that is most advantageous to us from a profitability and risk management standpoint. At December 31, 2011, we had $441,000 in loans held for sale. Generally, we have not retained the servicing rights on the mortgage loans sold in the secondary mortgage market.

From time to time, to diversify our risk, we will purchase or sell interests in loans. We underwrite our participation portion of the loan according to our own underwriting criteria and procedures. At December 31, 2011, we had $1.1 million in loan participation interests.

We generally do not purchase whole loans from third parties to supplement our loan production.

The following table shows our loan origination and principal repayment activity for loans originated for our portfolio during the periods indicated.


	Years Ended December 31,
	2011			2010
	(Dollars in thousands )
Total loans at beginning of period	$	178,584		$	174,038

Loans originated:
Real estate loans:
One- to four-family	$	4,850		$	13,198
Multi-family		—			—
Commercial real estate		3,187			11,158
Construction		2,570			8,421

Total real estate loans		10,607			32,777
Commercial loans		3,023			2,678
Consumer loans:
Home equity loans and lines of credit		806			445
Other consumer loans		2,320			1,989

Total loans originated		16,756			37,889


Deduct:
Principal repayments		(29,680	)		(33,343	)

Net loan activity		(12,924	)		4,546

Total loans at end of period	$	165,660		$	178,584

The following table shows loan origination and sale activity for one- to-four family residential mortgage loans originated for sale during the periods indicated. No other loans were originated for sale during the periods indicated.


	Years Ended December 31,
	2011			2010
	(Dollars in thousands )
Total mortgage loans at the beginning of the period	$	320		$	445
Mortgage loans originated for sale		10,536			15,020
Mortgage loans sold		(10,415	)		(15,145	)

Total mortgage loans at the end of the period	$	441		$	320

Delinquencies and Non-Performing Assets

Delinquency Procedures. When a borrower fails to make a required monthly loan payment by the last day of the month, a late notice is generated stating the payment and late charges due. Our policies provide borrowers that become 60 days or more delinquent are contacted by phone or mail to determine the reason for nonpayment and to discuss future payments, although in practice we generally contact such borrowers within 30 days. If repayment is not possible or doubtful, the loan will be brought to the board of directors for possible foreclosure. Once the board of directors declares a loan due and payable, a certified letter is sent to the borrower explaining the entire balance of the loan is due and payable. The borrower is permitted ten additional days to submit payment. If the loan is reinstated, foreclosure proceedings will be discontinued and the borrower will be permitted to continue to make payments. If the borrower does not respond, we will initiate foreclosure proceedings.

When we acquire real estate as a result of foreclosure or by deed in lieu of foreclosure, the real estate is classified as foreclosed real estate until it is sold. The real estate is recorded at estimated fair value at the date of acquisition less estimated costs to sell, and any write-down resulting from the acquisition is charged to the allowance for loan losses. Subsequent decreases in the value of the property are charged to operations through the creation of a valuation allowance. After acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized to the extent of estimated fair value less estimated costs to sell.

Delinquent Loans. The following table sets forth certain information with respect to our loan portfolio delinquencies by type and amount as of the date indicated:


	30-59 Days				60-89 Days				90 Days and Over				Total
	Number		Amount		Number		Amount		Number		Amount		Number		Amount
At December 31, 2011	(Dollars in thousands)
Real estate loans:
One- to four-family		12	$	2,157		2	$	130		1	$	122		15	$	2,409
Multi-family		—		—		—		—		—		—		—		—
Commercial real estate		1		32		—		—		—		—		1		32
Construction		—		—		—		—		—		—		—		—

Total real estate loans		13		2,189		2		130		1		122		16		2,441
Commercial loans		1		150		1		25		—		—		—		175
Consumer loans:														2
Home equity loans and lines of credit		—		—		—		—		—		—		—		—
Other consumer loans		6		84		1		2		—		—		7		86

Total		20	$	2,423		4	$	157		1	$	122		25	$	2,702


	30-59 Days				60-89 Days				90 Days and Over				Total
	Number		Amount		Number		Amount		Number		Amount		Number		Amount
At December 31, 2010	(Dollars in thousands)
Real estate loans:
One- to four-family		6	$	654		2	$	118		2	$	61		10	$	833
Multi-family		1		613				—		—		—		1		613
Commercial real estate		—		—		1		107		2		156		3		263
Construction		—		—		—		—		—		—		—		—

Total real estate loans		7		1,267		3		225		4		217		14		1,709
Commercial loans		—		—		—		—		—		—		—		—
Consumer loans:
Home equity loans and lines of credit		1		75		1		120		—		4		2		199
Other consumer loans		2		7		2		1		1		—		5		8

Total		10	$	1,349		6	$	346		5	$	221		21	$	1,916

Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered to be of lesser quality, as “substandard,” “doubtful” or “loss.” 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 the insured institution 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. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated as “special mention” by our management.

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances in an amount deemed prudent by management to cover probable incurred losses. General allowances represent loss allowances which have been established to cover probable incurred losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the regulatory authorities, which may require the establishment of additional general or specific loss allowances.

In connection with the filing of our periodic reports with our regulator and in accordance with our classification of assets policy, we regularly review the problem loans in our portfolio to determine whether any loans require classification in accordance with applicable regulations.

On the basis of this review, our classified or special mention assets at the dates indicated were as follows:


	At December 31,
	2011		2010
	(Dollars in thousands)
Special mention assets	$	8,289	$	7,942
Substandard assets		7,026		11,263
Doubtful assets		—		—
Loss assets		—		—
Foreclosed real estate		1,541		1,997

Total classified assets	$	16,856	$	21,202

Non-Performing Assets. We cease accruing interest on our loans when contractual payments of principal or interest have become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income is reversed. Interest received on nonaccrual loans generally is applied against principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

The table below sets forth the amounts and categories of our non-performing assets and troubled debt restructurings at the dates indicated.


	At December 31,
	2011			2010			2009			2008			2007
	(Dollars in thousands)
Non-Accrual:
Real estate loans:
One- to four-family	$	1,572		$	61		$	—		$	—		$	391
Multi-family		—			—			—			—			—
Commercial real estate		—			156			—			124			1,070
Construction		—			—			—			—			—

Total real estate loans		1,572			217			—			124			1,461
Commercial loans		—			—			—			—			—
Consumer loans:
Home equity loans and lines of credit		—			—			—			—			—
Other consumer loans		—			4			—			—			—

Total nonaccrual loans	$	1,572		$	221		$	—		$	124		$	1,461


Accruing loans past due 90 days or more:
Real estate loans:
One- to four-family	$	—		$	—		$	—		$	—		$	62
Multi-family		—			—			—			—			—
Commercial real estate		—			—			—			—			—
Construction		—			—			—			—			—

Total real estate loans		—			—			—			—			62
Commercial loans		—			—			—			—			—
Consumer loans:
Home equity loans and lines of credit		—			—			—			—			—
Other consumer loans		—			—			—			4			—

Total accruing loans past due 90 days or more		—			—			—			4			62

Total of nonaccrual and 90 days or more past due loans	$	1,572		$	221		$	—		$	128		$	1,523


Foreclosed real estate
One- to four-family	$	1,025		$	987		$	328		$	428		$	—
Commercial		516			1,010			603			432			151
Other nonperforming assets		—			—			—			—			—

Total nonperforming assets		3,113			2,218			931			988			1,674

Troubled debt restructurings		3,033			5,459			—			1,271			173

Troubled debt restructurings and total nonperforming assets	$	6,146		$	7,677		$	931		$	2,259		$	1,847


Total nonperforming loans to gross loans		0.95	%		0.12	%		0.00	%		0.08	%		0.93	%
Total nonperforming assets to total assets		1.40	%		0.99	%		0.43	%		0.45	%		0.82	%
Total nonperforming assets and troubled debt restructurings to total assets		2.76	%		3.43	%		0.43	%		1.04	%		0.91	%

At December 31, 2011, special mention, substandard and doubtful loans totaled $15.3 million. At December 31, 2011, there were $1.6 million in substandard loans that were non-accrual loans. There were no other loans that are not already disclosed where there is information about known credit problems of borrowers that caused us serious doubts about the ability of the borrowers to comply with present loan repayment terms and that may result in disclosure of such loans in the future.

For the years ended December 31, 2011 and 2010, gross interest income that would have been recorded had our non-accruing loans and troubled debt restructurings been current in accordance with their original terms was $36,162 and $4,457, respectively.

Allowance for Loan Losses

Analysis and Determination of the Allowance for Loan Losses. Our allowance for loan losses is the amount considered necessary to reflect probable incurred losses in our loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.

Our methodology for assessing the appropriateness of the allowance for loan losses consists of two key elements: (1) specific allowances for identified problem loans; and (2) a general valuation allowance on the remainder of the loan portfolio. Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available for the entire portfolio.

Specific Allowances for Identified Problem Loans. We establish a specific allowance when loans are determined to be impaired. Loss is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. Factors in identifying a specific problem loan include: (1) the strength of the customer’s personal or business cash flows; (2) the availability of other sources of repayment; (3) the amount due or past due; (4) the type and value of collateral; (5) the strength of our collateral position; (6) the estimated cost to sell the collateral; and (7) the borrower’s effort to cure the delinquency. In addition, for loans secured by real estate, we consider the extent of any past due and unpaid property taxes applicable to the property serving as collateral on the mortgage.

General Valuation Allowance on Certain Identified Problem Loans. Although our policy allows for a general valuation allowance on certain smaller balance, homogenous pools of loans classified as substandard, we have historically evaluated every loan classified as substandard, regardless of size, for impairment in establishing a specific allowance.

General Valuation Allowance on the Remainder of the Loan Portfolio. We establish a general allowance for loans that are not classified as substandard to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, has not been allocated to particular problem assets. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience, delinquency trends and management’s evaluation of the collectability of the loan portfolio. The allowance may be adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary market area, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are re-evaluated quarterly to ensure their relevance in the current real estate environment.

In addition, as an integral part of their examination process, our regulator will periodically review our allowance for loan losses. Such agency may require that we recognize additions to the allowance based on their judgments of information available to them at the time of their examination.

Allowance for Loan Losses. The following table sets forth activity in our allowance for loan losses for the periods indicated.


	At or For the Years Ended December 31,
	2011			2010			2009			2008			2007
	(Dollars in thousands)

Balance at beginning of period	$	854		$	747		$	472		$	430		$	457
Provision for loan losses		407			506			388			145			—
Charge offs:
Real estate loans:
One- to four-family		(33	)		(320	)		(57	)		(3	)		—
Multi-family		—			—			—			—			—
Commercial real estate		(78	)		(64	)		—			—			(23	)
Construction		—			—			—			(1	)		—
Commercial		—			(24	)		—			(85	)		(1	)
Home equity line of credit		—			—			(10	)		(19	)		(9	)
Consumer		(52	)		(14	)		(50	)		—			—

Total charge-offs		(163	)		(422	)		(117	)		(108	)		(33	)


Recoveries:
Real estate loans:
One- to four-family		—			—			—			4			3
Multi-family		—			—			—			—			—
Commercial real estate		—			—			—			—			—
Construction		—			—			—			—			—
Commercial		—			20			—			—			—
Home equity line of credit		—			—			—			—			—
Consumer		10			3			4			1			3

Total recoveries		10			23			4			5			6

Net (charge-offs) recoveries		(153	)		(399	)		(113	)		(103	)		(27	)


Allowance at end of period	$	1,108		$	854		$	747		$	472		$	430


Allowance to nonperforming loans		70.48	%		386.43	%		N/A			368.75	%		28.23	%
Allowance to total loans outstanding at the end of the period		0.67	%		0.48	%		0.43	%		0.28	%		0.26	%
Net (charge-offs) recoveries to average loans outstanding during the period		(0.09	)%		(0.23	)%		(0.07	)%		(0.06	)%		(0.02	)%

Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category, the total loan balances by category (excluding loans held for sale), and the percent of loans in each category to total loans 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 December 31,
	2011							2010							2009
	Allowance for Loan Losses		Loan Balances by Category		Loans in Each Category to Total Loans			Allowance for Loan Losses		Loan Balances by Category		Loans in Each Category to Total Loans			Allowance for Loan Losses		Loan Balances by Category		Loans in Each Category to Total Loans
								(Dollars in thousands)

Real estate loans:
One- to four-family	$	540	$	78,869		47.61	%	$	332	$	83,721		46.88	%	$	204	$	81,436		46.79	%
Multi-family		10		5,184		3.13			9		4,837		2.71			17		5,780		3.32
Commercial real estate		413		63,336		38.23			356		63,443		35.53			323		60,602		34.82
Construction		2		1,667		1.01			9		8,936		5.00			—		6,235		3.59

Total real estate loans		965		149,056		89.98			706		160,937		90.12			544		154,053		88.53
Commercial loans		18		7,221		4.36			47		7,371		4.13			59		7,506		4.31
Consumer loans:
Home equity loans and lines of credit		52		5,286		3.19			60		6,165		3.45			75		7,543		4.33
Other consumer loans		73		4,097		2.47			41		4,111		2.30			69		4,936		2.84

Total consumer loans
		125		9,383		5.66			101		10,276		5.75			144		12,479		7.17
Unallocated		—		—		—			—		—		—			—		—		—

Total loans	$	1,108	$	165,660		100.00	%	$	854	$	178,584		100.00	%	$	747	$	174,038		100.00	%



	2008							2007
	Allowance for Loan Losses		Loan Balances by Category		Loans in Each Category to Total Loans			Allowance for Loan Losses		Loan Balances by Category		Loans in Each Category to Total Loans
	(Dollars in thousands)

Real estate loans:
One- to four-family	$	199		80,454		48.34	%		214	$	84,925		51.59	%
Multi-family		9		3,722		2.24			8		3,272		1.99
Commercial real estate		196		59,655		35.85			142		56,609		34.39
Construction		8		3,263		1.96			18		6,701		4.08

Total real estate loans		412		147,094		88.39			382		151,507		92.05
Commercial loans		17		6,592		3.96			3		1,414		0.86
Consumer loans:
Home equity loans and lines of credit		20		7,321		4.40			12		5,539		3.37
Other consumer loans		13		5,411		3.25			15		6,141		3.73

Total consumer loans		33		12,732		7.65			27		11,680		7.10
Unallocated		10		—		—			18		—		—


Total loans	$	472		166,418		100.00	%		430	$	164,601		100.00	%

At December 31, 2011, our allowance for loan losses represented 0.67% of total loans. The allowance for loan losses increased to $1.1 million at December 31, 2011 from $854,000 at December 31, 2011, primarily due to the provision for loan losses of $407,000 less net charge-offs of $153,000.

Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with accounting principles generally accepted in the United States of America, regulators, in reviewing our loan portfolio, may request us to increase our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, the existing allowance for loan losses may not be adequate and increases may be necessary should the quality of any loan deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.

Investment Activities

General. The goals of our investment policy are to provide and maintain liquidity to meet deposit withdrawal and loan funding needs, to help mitigate our interest rate risk, and to generate a favorable return on idle funds within the context of our interest rate and credit risk objectives.

Our board of directors is responsible for adopting our investment policy. The investment policy is reviewed annually by management and any changes to the policy are recommended to and subject to the approval of the board of directors. Authority to make investments under the approved investment policy guidelines is delegated to our President and Chief Executive Officer and our Chief Financial Officer (all investment decisions require the approval of both investment officers). All investment transactions are reviewed at regularly scheduled quarterly meetings of the board of directors.

Our current investment policy permits investments in securities issued by the United States Government and its agencies or government sponsored enterprises. We also invest in mortgage-backed securities and, to a lesser extent, mutual funds that invest in mortgage-backed securities. Our investment policy also permits, with certain limitations, investments in bank-owned life insurance, collateralized mortgage obligations, asset-backed securities, real estate mortgage investment conduits, Alabama revenue bonds and municipal securities. While equity investments are generally not authorized by our investment policy, such investments are permitted on a case-by-case basis provided such investments are pre-authorized by action of our board of directors.

At December 31, 2011, we did not have an investment in the securities of any single non-government issuer that exceeded 10% of equity at that date.

Our current investment policy does not permit investment in stripped mortgage-backed securities, complex securities and derivatives as defined in federal banking regulations and other high-risk securities. As of December 31, 2011, we held no asset-backed securities other than mortgage-backed securities. Our current policies do not permit hedging activities, such as engaging in futures, options or swap transactions, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage backed securities.

At December 31, 2011, none of the collateral underlying our securities portfolio was considered subprime or Alt-A, and we did not hold any common or preferred stock issued by Freddie Mac or Fannie Mae as of that date. However, in September 2008, the Federal Housing Finance Agency placed Freddie Mac and Fannie Mae into conservatorship. The U.S. Treasury Department has established financing agreements to ensure that Freddie Mac and Fannie Mae meet their obligations to holders of mortgage-backed securities that they have issued or guaranteed. These actions have not affected the markets for mortgage-backed securities issued by Freddie Mac or Fannie Mae. Accounting guidance requires that, at the time of purchase, we designate a security as either held to maturity, available-for-sale, or trading, based upon our ability and intent. Securities available-for-sale and trading securities are reported at fair value and securities held to maturity are reported at amortized cost. A periodic review and evaluation of our available-for-sale and held-to-maturity securities portfolios is conducted to determine if the fair value of any security has declined below its carrying value and whether such decline is other-than-temporary. If such decline is deemed to be other-than-temporary, the security is written down to a new cost basis and the resulting loss is charged against earnings. The fair values of our securities are based on published or securities dealers’ market values. At December 31, 2011, all of our securities were classified as available-for-sale.

U.S. Government Sponsored Agencies. At December 31, 2011, our U.S. Government sponsored agencies securities portfolio totaled $20.0 million, all of which was classified as available-for-sale. While these securities generally provide lower yields than other investments in our securities investment portfolio, we maintain these investments, to the extent appropriate, for liquidity purposes, as collateral for borrowings and for prepayment protection.

Mortgage-Backed Securities. At December 31, 2011, our mortgage-backed securities portfolio totaled $2.7 million, all of which was classified as available-for-sale. Mortgage-backed securities are securities issued in the secondary market that are collateralized by pools of mortgages. Certain types of mortgage-backed securities are commonly referred to as “pass-through” certificates because the principal and interest of the underlying loans is “passed through” to investors, net of certain costs, including servicing and guarantee fees. Mortgage-backed securities typically are collateralized by pools of one- to four-family or multi-family mortgages, although we invest primarily in mortgage-backed securities backed by one-to-four family mortgages. The issuers of such securities pool and resell the participation interests in the form of securities to investors such as Cullman Savings Bank. The interest rate of the security is lower than the interest rates of the underlying loans to allow for payment of servicing and guaranty fees. Ginnie Mae, a United States Government agency, and government sponsored enterprises, such as Fannie Mae and Freddie Mac, either guarantee the payments or guarantee the timely payment of principal and interest to investors. Mortgage-backed securities are more liquid than individual mortgage loans since there is an active trading market for such securities. In addition, mortgage-backed securities may be used to collateralize our borrowings.

Investments in mortgage-backed securities involve a risk that actual payments will be greater or less than the prepayment rate estimated at the time of purchase, which may require adjustments to the amortization of any premium or accretion of any discount relating to such interests, thereby affecting the net yield on our securities. Current prepayment speeds determine whether prepayment estimates require modification that could cause amortization or accretion adjustments.

All of our mortgage-backed securities are issued by government-sponsored entities, except one, which had a fair value of approximately $631,000 at December 31, 2011. This security, issued by Wells Fargo, is “AAA” rated and is associated with the highest quality tranche of loans in the pool. Loans in this pool are all fully amortizing adjustable-rate mortgages secured by one-to-four family owner-occupied homes. Privately-issued mortgage-backed securities such as the security issued by Wells Fargo are subject to certain credit-related risks normally not associated with mortgage-backed securities that are issued by government-sponsored entities. However, management believes the higher yield available from the privately-issued mortgage-backed security offset the credit-related risk.

Mutual Funds. At December 31, 2011, our mutual fund portfolio totaled $1.5 million, all of which was classified as available-for-sale and all of which was invested in the AMF Ultra Short Mortgage Fund, a fund that invests primarily in mortgage-related securities.

Restricted Equity Securities. We invest in the common stock of the Federal Home Loan Bank of Atlanta, which is carried at cost and classified as restricted equity securities. We periodically evaluate the shares of common stock for impairment.

Bank-Owned Life Insurance. We invest in bank-owned life insurance to provide us with a funding source for our benefit plan obligations. Bank-owned life insurance also generally provides us non-interest income that is non-taxable. Federal regulations generally limit our investment in bank-owned life insurance to 25% of our Tier 1 capital plus our allowance for loan losses. At December 31, 2011, we had invested $2.5 million in bank-owned life insurance.

Securities Portfolio Composition. The following table sets forth the composition of our securities portfolio at the dates indicated.


	At December 31,
	2011				2010				2009
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(Dollars in thousands)

Securities available for sale:
U.S. Government sponsored agencies	$	19,989		19,993		13,997		13,532		9,745		9,710
Mutual fund		1,414		1,484		1,414		1,496		2,126		2,211
Municipal-taxable		5,146		5,473		5,154		5,055		506		484
Residential mortgage-backed, GSE		2,032		2,125		2,959		3,051		4,068		4,194
Residential mortgage-backed, private		623		631		961		983		1,531		1,481

Total	$	29,204		29,706		24,485		24,117		17,976		18,080

Securities Portfolio Maturities and Yields. The following table sets forth the contractual maturities and weighted average yields of our securities portfolio at December 31, 2011. Mortgage-backed securities are anticipated to be repaid in advance of their contractual maturities as a result of projected mortgage loan prepayments. The mutual fund does not have an actual maturity and can be redeemed by the Company at any time.


	One Year or Less					More than One Year to Five Years					More than Five Years to Ten Years
	Amortized Cost		Weighted Average Yield			Amortized Cost		Weighted Average Yield			Amortized Cost		Weighted Average Yield
	(Dollars in thousands)
Securities available-for-sale:
U.S. Government sponsored agencies	$	—		—	%	$	—		—	%	$	9,999		2.70	%
Mutual fund		—		—			—		—			—		—
Municipal-taxable		—		—			—		—			504		4.89
Residential mortgage-backed -GSE		—		—			163		3.75			449		5.15
Residential mortgage-backed -private label		—		—			—		—			—		—

Total	$	—		—	%	$	163		3.75	%	$	10,952		2.90	%


	More than Ten Years					Total
	Amortized Cost		Weighted Average Yield			Amortized Cost		Weighted Average Yield
	(Dollars in thousands)
Securities available-for-sale:
U.S. Government sponsored agencies	$	9,991		2.76	%	$	19,989		2.73	%
Mutual fund		1,414		—			1,414		—
Municipal-taxable		4,642		5.53			5,146		5.47
Residential mortgage-backed -GSE		1,420		1.99			2,032		2.83
Residential mortgage-backed -private label		623		4.69			623		4.69

Total	$	18,090		3.26	%	$	29,204		3.13	%

Sources of Funds

General. Deposits have traditionally been our primary source of funds for use in lending and investment activities. We also use borrowings, primarily Federal Home Loan Bank of Atlanta advances, to supplement cash flow needs, lengthen the maturities of liabilities for interest rate risk purposes and to manage the cost of funds. In addition, we receive funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings 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 primarily from residents within our primary market area. We offer a selection of deposit accounts, including demand accounts, NOW accounts, money market accounts, savings accounts and certificates of deposit. 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. We have not accepted brokered deposits in the past, although we have the authority to do so.

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, long-standing relationships with customers, and the favorable image of Cullman Savings Bank in the community are relied upon to attract and retain deposits.

The flow of deposits is influenced significantly by general economic conditions, changes in interest rates and competition. Our ability to gather deposits is impacted by the competitive market in which we operate which includes numerous financial institutions of varying sizes offering a wide range of products. We often use promotional rates to meet asset/liability and market segment goals.

The variety of deposit accounts offered allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on our experience, we believe that statement savings, demand and NOW accounts may be somewhat more stable sources of deposits than certificates of deposits. However, it can be difficult to attract and maintain such deposits at favorable interest rates under current market conditions.

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


	At December 31,
	2011								2010								2009
	Balance		Percent			Weighted Average Rate			Balance		Percent			Weighted Average Rate			Balance		Percent			Weighted Average Rate
	(Dollars in thousands)

NOW and demand deposits	$	37,423		27.09	%		0.14	%	$	30,950		22.69	%		0.43	%	$	30,289		24.21	%		0.80	%
Money market deposits		7,524		5.45			0.24			8,448		6.19			0.72			8,853		7.08			1.59
Regular savings and other deposits		16,620		12.03			0.24			17,099		12.54			0.65			13,296		10.62			1.17

Total transaction accounts		61,567		44.57			0.16			56,497		41.42			0.53			52,438		41.91			1.01

Certificates of deposit		76,580		55.43			1.41			79,902		58.58			1.94			72,681		58.09			3.19

Total deposits	$	138,147		100.00	%		0.82	%	$	136,399		100	%		1.33	%	$	125,119		100	%		2.28	%

The following table sets forth our deposit activities for the years indicated.


	Years Ended December 31,
	2011		2010
	(Dollars in thousands)
Beginning balance	$	136,399	$	125,119
Net deposits (withdrawals) before interest credited		194		9,223
Interest credited		1,554		2,057

Net increase (decrease) in deposits		1,748		11,280

Ending balance	$	138,147	$	136,399

As of December 31, 2011, the aggregate amount of our outstanding certificates of deposit in amounts greater than or equal to $100,000 was approximately $41.5 million. The following table sets forth the maturity of these certificates as of December 31, 2011:


	At December 31, 2011
	(Dollars in thousands)
Three months or less	$	6,977
Over three through six months		4,806
Over six through twelve months		13,594
Over twelve months		16,091

Total	$	41,468

The following table sets forth our time deposits classified by interest rate as of the dates indicated.


	At December 31,
	2011		2010
	(Dollars in thousands)

INTEREST RATE:
Less than 1.00%	$	26,640	$	14,088
1.00% - 1.99%		43,856		46,348
2.00% - 2.99%		2,855		11,278
3.00% - 3.99%		414		1,929
4.00% - 4.99%		1,064		2,484
5.00% - 5.99%		1,751		3,775

Total	$	76,580	$	79,902

The following table sets forth the amount and maturities of our time deposits at December 31, 2011.


	Less Than One Year		Over One to Two Years		Over Two to Three Years		Over Three Years		Total		Percentage of Total Certificate of Deposit Accounts
	(Dollars in thousands)

INTEREST RATE:
Less than 2%	$	43,943	$	18,615	$	510	$	7,428		70,496		92.06	%
2.00% - 2.99%		754		436		910		755		2,855		3.73
3.00% - 3.99%		14		400		—		—		414		0.54
4.00% - 4.99%		697		367		—		—		1,064		1.39
5.00% - 5.99%		1,751		—		—		—		1,751		2.29

Total	$	47,159	$	19,818	$	1,420	$	8,183		76,580		100.00	%

Borrowings

We may obtain advances from the Federal Home Loan Bank of Atlanta upon the security of our capital stock in the Federal Home Loan Bank of Atlanta and certain of our mortgage loans and mortgage-backed securities. Such advances may be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. To the extent such borrowings have different terms of repricing than our deposits, they can change our interest rate risk profile.

From time to time during recent years, we have utilized short-term borrowings to fund loan demand. To a limited extent, we have also used borrowings where market conditions permit to purchase securities of a similar duration in order to increase our net interest income by the amount of the spread between the asset yield and the borrowing cost. Finally, from time to time, we have obtained advances with terms of three years or more to extend the term of our liabilities.

Our borrowings currently consist primarily of advances from the Federal Home Loan Bank of Atlanta. At December 31, 2011, we had access to additional Federal Home Loan Bank advances of up to $51.0 million. The following table sets forth information concerning balances and interest rates on our Federal Home Loan Bank advances with terms of one year or less at the dates and for the periods indicated.


	Year Ended December 31,
	2011			2010			2009
	(Dollars in thousands)

Balance outstanding at end of period:
FHLB advances	$	42,000		$	47,000		$	51,107
Other borrowings		787			816			833
Average balance during the period:
FHLB advances	$	46,096		$	46,809		$	51,464
Other borrowings		802			825			847
Weighted average interest rate at end of period:
FHLB advances		3.48	%		3.61	%		4.01	%
Other borrowings		0.84			0.91			1.23
Weighted average interest rate during the period:
FHLB advances		3.52	%		4.25	%		4.37	%
Other borrowings		0.88			0.93			1.3

Subsidiary and Other Activities

Apart from Cullman Savings Bank, we have no subsidiaries. At December 31, 2011, we had a 99% limited partnership interest in Cullman Village Apartments of $596,000, which was acquired as an investment tax credit. The assets and liabilities of Cullman Village Apartments are consolidated into our financial statements.

Expense and Tax Allocation

Cullman Savings Bank has an agreement with Cullman Bancorp, Inc. and Cullman Savings Bank, MHC to provide them with certain administrative support services for compensation not less than the fair market value of the services provided. In addition, Cullman Savings Bank and Cullman Bancorp, Inc. have an agreement for allocating and for reimbursing the payment of their consolidated tax liability. During the year ended December 31, 2011, there were no expenses that were allocated between Cullman Savings Bank and Cullman Bancorp, Inc. and Cullman Savings Bank, MHC.

Personnel

As of December 31, 2011, we had 36 full-time employees and four part-time employees. Our employees are not represented by any collective bargaining group. Management believes that we have good relations with our employees.

FEDERAL, STATE AND LOCAL TAXATION

Federal Taxation

General. Cullman Bancorp, Inc. and Cullman Savings Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. Cullman Savings Bank’s tax returns have not been audited during the past five years. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to Cullman Bancorp, Inc. or Cullman Savings Bank.

Method of Accounting. For federal income tax purposes, Cullman Savings Bank currently reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its federal income tax returns.

Bad Debt Reserves. Cullman Savings Bank is permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions, within specified formula limits, are deducted in arriving at our taxable income. Should Cullman Savings Bank’s total assets exceed $500 million, it will be required to use the specific charge off method in computing its bad debt deduction.

Taxable Distributions and Recapture. Prior to the 1996 Act, federal tax bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income if the thrift institution failed to meet certain thrift asset and definitional tests. Federal legislation has eliminated these thrift-related recapture rules.

At December 31, 2011, our total federal and Alabama pre-1988 base year tax bad debt reserve was approximately $1.2 million. Under current law, pre-1988 federal base year reserves remain subject to recapture if a thrift institution makes certain non-dividend distributions, repurchases any of its stock, pays dividends in excess of tax earnings and profits, or ceases to maintain a thrift or bank charter.

Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended imposes an alternative minimum tax (“AMT”) at a rate of 20% on a base of regular taxable income plus certain tax preferences (“alternative minimum taxable income” or “AMTI”). The AMT is payable to the extent such AMTI is in excess of an exemption amount and the AMT exceeds the regular income tax. Net operating losses can offset no more than 90% of AMTI. Certain payments of AMT may be used as credits against regular tax liabilities in future years. Cullman Savings Bank has not been subject to the AMT and has no such amounts available as credits for carryover.

Net Operating Loss Carryovers. A financial institution generally may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years, although legislation passed during 2011 allows a limited carry back of five years. At December 31, 2011, Cullman Savings Bank had no net operating loss carry forwards for federal and state income tax purposes.

Corporate Dividends-Received Deduction. Cullman Bancorp, Inc. may exclude from its income 100% of dividends received from Cullman Savings Bank as a member of the same affiliated group of corporations. The corporate dividends-received deduction is 80% in the case of dividends received from corporations with which a corporate recipient does not file a consolidated return, and owns more than 20% of the stock of a corporation distributing a dividend and only 70% in the case of dividends received from less-than-20% owned corporations.

State and Local Taxation

Alabama State Taxation. Cullman Bancorp, Inc., and Cullman Savings Bank will be required to file Alabama income tax returns and pay tax at a stated tax rate of 6.5% of Alabama taxable income. For these purposes, Alabama taxable income generally means federal taxable income subject to certain modifications, primarily the exclusion of interest income on United States obligations and the deduction of federal income taxes paid.

SUPERVISION AND REGULATION

General

Cullman Savings Bank is examined and supervised by the Office of the Comptroller of the Currency (“OCC”). This regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the FDIC’s deposit insurance fund and depositors. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. Cullman Savings Bank also is a member of and owns stock in the Federal Home Loan Bank of Atlanta, which is one of the twelve regional banks in the Federal Home Loan Bank System. Cullman Savings Bank also is regulated, to a lesser extent, by the FDIC with respect to insurance of deposit accounts and the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), with respect to reserves to be maintained against deposits and other matters. Cullman Savings Bank’s relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters concerning the ownership of deposit accounts and the form and content of Cullman Savings Bank’s mortgage documents.

Any change in these laws or regulations, whether by the OCC, FDIC or Congress, could have a material adverse impact on Cullman Bancorp, Inc. and Cullman Savings Bank, and their operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) made extensive changes in the regulation of federal savings banks such as the Bank. Under the Dodd-Frank Act, the Office of Thrift Supervision (“OTS”), Cullman Savings Banks former regulator, was eliminated. Responsibility for the supervision and regulation of federal savings banks was transferred to the OCC, which is the agency that is currently primarily responsible for the regulation and supervision of national banks, on July 21, 2011. The OCC assumed responsibility for implementing and enforcing many of the laws and regulations applicable to federal savings banks on that date. At the same time, responsibility for the regulation and supervision of savings and loan holding companies, such as the Company and Cullman Savings Bank, MHC was transferred from the OTS to the Federal Reserve Board, which also supervises bank holding companies.

Additionally, the Dodd-Frank Act created a new Consumer Financial Protection Bureau as an independent bureau of the Federal Reserve Board. The Consumer Financial Protection Bureau has assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations, a function currently assigned to prudential regulators, and has authority to impose new requirements. However, institutions of less than $10 billion in assets, such as the Bank, will continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and be subject to the primary enforcement authority of, their prudential regulator rather than the Consumer Financial Protection Bureau.

In addition to eliminating the OTS and creating the Consumer Financial Protection Bureau, the Dodd-Frank Act, among other things, directed changes in the way that institutions are assessed for deposit insurance, mandated the imposition of consolidated capital requirements on savings and loan holding companies, requires originators of securitized loans to retain a percentage of the risk for the transferred loans, required rate-setting for certain debit card interchange fees, repealed restrictions on the payment of interest on commercial demand deposits and contained a number of reforms related to mortgage originations. Many of the provisions of the Dodd-Frank Act are subject to delayed effective dates and/or require the issuance of implementing regulations. Their impact on our operations cannot yet be fully assessed. However, there is significant possibility that the Dodd-Frank Act will, at a minimum, result in increased regulatory burden, compliance costs and interest expense for the Company.

Certain of the regulatory requirements that are or will be applicable to Cullman Savings Bank, Cullman Bancorp, Inc. and Cullman Savings Bank, MHC are described below. This description of statutes and regulations is not intended to be a complete explanation of such statutes and regulations and their effect on Cullman Savings Bank, Cullman Bancorp, Inc. and Cullman Savings Bank, MHC and is qualified in its entirety by reference to the actual statutes and regulations.

Federal Banking Regulation

Business Activities. A federal savings bank derives its lending and investment powers from the Home Owners’ Loan Act, as amended, and federal regulations. Under these laws and regulations, Cullman Savings Bank may originate mortgage loans secured by residential and commercial real estate, commercial business loans and consumer loans, and it may invest in certain types of debt securities and certain other assets. Certain types of lending, such as commercial and consumer loans, are

subject to an aggregate limit calculated as a specified percentage of Cullman Savings Bank’s capital assets. Cullman Savings Bank also may establish subsidiaries that may engage in activities not otherwise permissible for Cullman Savings Bank, including real estate investment and securities and insurance brokerage.

The Dodd-Frank Act removed federal statutory restrictions on the payment of interest on commercial demand deposit accounts, effective July 21, 2011.

Capital Requirements. Federal regulations require savings banks to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for savings banks receiving the highest regulatory rating) and an 8% risk-based capital ratio. The prompt corrective action standards discussed below, in effect, establish a minimum 2% tangible capital standard.

The risk-based capital standard for savings banks requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% assigned by the regulation based on the risks believed inherent in the type of asset. Core capital is defined as common stockholders’ equity (including retained earnings but excluding accumulated other comprehensive income), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. Additionally, a savings bank that retains credit risk in connection with an asset sale may be required to maintain additional regulatory capital because of the recourse back to the savings bank. In assessing an institution’s capital adequacy, the OCC takes into consideration not only these numeric factors but also qualitative factors as well, and has the authority to establish higher capital requirements for individual associations where necessary.

At December 31, 2011, Cullman Savings Bank’s capital exceeded all applicable requirements.

Loans to One Borrower. Generally, a federal savings bank generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2011, Cullman Savings Bank’s largest lending relationship with a single or related group of borrowers totaled $3.5 million, which represented 10.6% of unimpaired capital and surplus; therefore, Cullman Savings Bank was in compliance with the loans-to-one borrower limitations.

Qualified Thrift Lender Test. As a federal savings bank, Cullman Savings Bank is subject to a qualified thrift lender, or “QTL,” test. Under the QTL test, Cullman Savings Bank must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” in at least nine months of the most recent 12-month period. “Portfolio assets” generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings bank’s business.

“Qualified thrift investments” includes various types of loans made for residential housing purposes, investments related to such purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of portfolio assets. “Qualified thrift investments” also include 100% of an institution’s credit card loans, education loans and small business loans. Cullman Savings Bank also may satisfy the QTL test by qualifying as a “domestic building and loan association” as defined in the Internal Revenue Code.

A savings bank that fails the qualified thrift lender test must either convert to a commercial bank charter or operate under specified restrictions. The Dodd-Frank Act made noncompliance with the QTL Test potentially subject to agency enforcement action for violation of law. At December 31, 2011, Cullman Savings Bank maintained approximately 74.5% of its portfolio assets in qualified thrift investments and, therefore, satisfied the QTL test.

Capital Distributions. Federal regulations govern capital distributions by a federal savings bank, which include cash dividends, stock repurchases and other transactions charged to the capital account. A savings bank must file an application with the OCC for approval of a capital distribution if:

•

the total capital distributions for the applicable calendar year exceed the sum of the savings bank’s net income for that year to date plus the savings bank’s retained net income for the preceding two years;

•

the savings bank would not be at least adequately capitalized following the distribution;

•

the distribution would violate any applicable statute, regulation, agreement or regulatory condition; or

•

the savings bank is not eligible for expedited treatment of its filings.

Even if an application is not otherwise required, every savings bank that is a subsidiary of a holding company must still file a notice with the Federal Reserve Board at least 30 days before the board of directors declares a dividend or approves a capital distribution.

The Federal Reserve Board may disapprove a notice or application if:

•

the savings bank would be undercapitalized following the distribution;

•

the proposed capital distribution raises safety and soundness concerns; or

•

the capital distribution would violate a prohibition contained in any statute, regulation or agreement.

In addition, the Federal Deposit Insurance Act provides that an insured depository institution shall not make any capital distribution if, after making such distribution, the institution would be undercapitalized.

Liquidity. A federal savings institution is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation. We seek to maintain a ratio of liquid assets not subject to pledge as a percentage of deposits and borrowings of 10% or greater. At December 31, 2011, this ratio was 21.2%.

Community Reinvestment Act and Fair Lending Laws. All savings banks have a responsibility under the Community Reinvestment Act and related regulations of the OCC to help meet the credit needs of their communities, including low- and moderate-income borrowers. In connection with its examination of a federal savings bank, the OCC is required to assess the savings bank’s record of compliance with the Community Reinvestment Act. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. A savings bank’s failure to comply with the provisions of the Community Reinvestment Act could result in denial of certain corporate applications, such as branches or mergers, or in restrictions on its activities. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the OCC, as well as other federal regulatory agencies and the Department of Justice. Cullman Savings Bank received a “satisfactory” Community Reinvestment Act rating in its most recent federal examination.

Transactions with Related Parties. A federal savings bank’s authority to engage in transactions with its “affiliates” is limited by federal regulations and by Sections 23A and 23B of the Federal Reserve Act and its implementing Regulation W promulgated by the Board of Governors of the Federal Reserve System. The term “affiliate” for these purposes generally means any company that controls or is under common control with an insured depository institution such as Cullman Savings Bank. Cullman Bancorp, Inc. is an affiliate of Cullman Savings Bank. In general, transactions with affiliates must be on terms that are as favorable to the savings bank as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the savings bank’s capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the savings bank. In addition, federal regulations prohibit a savings bank from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. Finally, transactions with affiliates must be consistent with safe and sound banking practices and may not involve low-quality assets. The OCC requires savings banks to maintain detailed records of all transactions with affiliates.

Cullman Savings Bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Cullman Savings Bank’s capital. In addition, Cullman Savings Bank’s board of directors must approve extensions of credit in excess of certain limits.

Cullman Savings Bank is in compliance with Regulation O.

Enforcement. The OCC has primary enforcement responsibility over federal savings institutions and has the authority to bring enforcement action against all “institution-affiliated parties,” including stockholders, and attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution, receivership, conservatorship or the termination of deposit insurance. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1.0 million per day. The FDIC also has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings institution. If the OCC does not take action, the FDIC has authority to take action under specified circumstances.

The OCC assumed the OTS’ enforcement authority over federal savings associations as part of the Dodd-Frank Act regulatory restructuring.

Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan.

Prompt Corrective Action Regulations. Under the prompt corrective action regulations, the OCC is authorized and, under certain circumstances, required to take supervisory actions against undercapitalized savings banks. For this purpose, a savings bank is placed in one of the following five categories based on the savings bank’s capital:

•

well-capitalized (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total risk-based capital);

•

adequately capitalized (at least 4% leverage capital, 4% Tier 1 risk-based capital and 8% total risk-based capital);

•

undercapitalized (less than 8% total risk-based capital, 4% Tier 1 risk-based capital or 3% leverage capital);

•

significantly undercapitalized (less than 6% total risk-based capital, 3% Tier 1 risk-based capital or 3% leverage capital); and

•

critically undercapitalized (less than 2% tangible capital).

Generally, the OCC is required to appoint a receiver or conservator for a savings bank that is “critically undercapitalized” within specific time frames. The regulations also provide that a capital restoration plan must be filed with the OCC within 45 days of the date a savings bank receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Any holding company for the savings bank required to submit a capital restoration plan must guarantee the lesser of an amount equal to 5% of the savings bank’s assets at the time it was notified or deemed to be undercapitalized by the OCC, or the amount necessary to restore the savings bank to adequately capitalized status. This guarantee remains in place until the OCC notifies the savings bank that it has maintained adequately capitalized status for each of four consecutive calendar quarters, and the OCC has the authority to require payment and collect payment under the guarantee. Failure by a holding company to provide the required guarantee results in certain operating restrictions on the savings bank. Undercapitalized institutions are also subject to operating restrictions such as limitations on capital distributions and growth. The OCC may also take any one of a number of discretionary supervisory actions against undercapitalized savings banks, including the issuance of a capital directive and the replacement of senior executive officers and directors.

At December 31, 2011, Cullman Savings Bank met the criteria for being considered “well-capitalized.”

Insurance of Deposit Accounts. Cullman Savings Bank is a member of the Deposit Insurance Fund, which is administered by the FDIC. Deposit accounts in the Bank are insured by the FDIC. In view of the recent economic crisis, the FDIC temporarily increased the general individual deposit insurance available on deposit accounts from $100,000 to $250,000.

The Dodd-Frank Act made that level of coverage permanent. In addition, pursuant to a provision of the Dodd-Frank Act, certain non-interest-bearing transaction accounts are fully insured regardless of the dollar amount until December 31, 2012.

The FDIC imposes an assessment for deposit insurance on all depository institutions. Under the FDIC’s risk-based assessment system, insured institutions are assigned to risk categories based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned and certain adjustments specified by FDIC regulations, with institutions deemed less risky paying lower rates. Assessment rates (inclusive of possible adjustments) currently range from 2 ¹/2 to 45 basis points of each institution’s total assets less tangible capital. The FDIC may increase or decrease the scale uniformly, except that no adjustment can deviate more than two basis points from the base scale without notice and comment rulemaking. The FDIC’s current system represents a change, required by the Dodd-Frank Act, from its prior practice of basing the assessment on an institution’s volume of deposits.

In 2009, the FDIC, in response to pressures on the Deposit Insurance Fund caused by bank and savings association failures, required all insured depository institutions to prepay their estimated assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012. The estimated assessments were based on assumptions established by the FDIC, including an assumed 5% annual growth rate and certain assumed assessment rate increases. That pre-payment, which was due on December 30, 2009, was recorded as a prepaid expense at December 31, 2009 and is being amortized to expense over three years. Any unused prepaid assessments would be returned to the institution in June 2013.

On May 22, 2009, the FDIC issued a final rule that imposed a special five basis point assessment on each FDIC-insured depository institution’s assets, minus its Tier 1 capital on June 30, 2009. That was collected on September 30, 2009. The special assessment was capped at 10 basis points of an institution’s domestic deposits.

The Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC and the FDIC has exercised that discretion by establishing a long term fund ratio of 2%.

The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of Cullman Savings Bank. Management cannot predict what assessment rates will be in the future.

Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. Management of Cullman Savings Bank does not know of any practice, condition or violation that may lead to termination of our deposit insurance.

In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended December 31, 2011, the FICO assessment was equal to 0.68 basis points of total assets less tangible capital.

Prohibitions Against Tying Arrangements. Federal savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.

Federal Home Loan Bank System. Cullman Savings Bank is a member of the Federal Home Loan Bank System, which consists of twelve regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of the Federal Home Loan Bank of Atlanta, Cullman Savings Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank. As of December 31, 2011, Cullman Savings Bank was in compliance with this requirement.

Other Regulations

Interest and other charges collected or contracted for by Cullman Savings Bank are subject to state usury laws and federal laws concerning interest rates. Cullman Savings Bank’s operations are also subject to federal laws applicable to credit transactions, such as the:

•

Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

•

Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

•

Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

•

Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;

•

Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

•

Truth in Savings Act; and

•

Rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

The operations of Cullman Savings Bank also are subject to the:

•

Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

•

Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

•

Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;

•

Title III of The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT Act”), which significantly expanded the responsibilities of financial institutions, including savings and loan associations, in preventing the use of the United States financial system to fund terrorist activities. Among other provisions, the USA PATRIOT Act and the related federal regulations require savings banks operating in the United States to, among other things, establish broadened anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control Regulations; and

•

The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties.

Holding Company Regulation

General. Cullman Savings Bank, MHC and Cullman Bancorp, Inc. are savings and loan holding companies within the meaning of the Home Owners’ Loan Act. As such, Cullman Savings Bank, MHC and Cullman Bancorp, Inc. are registered with the Federal Reserve Board and are subject to Federal Reserve Board regulations, examinations, supervision and reporting requirements. In addition, the Federal Reserve Board has enforcement authority over Cullman Savings Bank, MHC and Cullman Bancorp, Inc., and their subsidiaries. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. As federal corporations, Cullman Savings Bank, MHC and Cullman Bancorp, Inc. are generally not subject to state business organization laws.

The Dodd-Frank Act transferred to the Federal Reserve Board from the OTS the responsibility for regulating and supervising savings and loan holding companies. The transfer was effective July 21, 2011.

Permitted Activities. Pursuant to Section 10(o) of the Home Owners’ Loan Act and Federal Reserve Board regulations and policy, a mutual holding company and a federally chartered mid-tier holding company such as Cullman Bancorp, Inc. may engage in the following activities:

(i)

investing in the stock of a savings institution;

(ii)

acquiring a mutual savings bank through the merger of such savings institution into a savings institution subsidiary of such holding company or an interim savings bank subsidiary of such holding company;

(iii)

merging with or acquiring another holding company, one of whose subsidiaries is a savings institution;

(iv)

investing in a corporation, the capital stock of which is available for purchase by a savings institution under federal law or under the law of any state where the subsidiary savings institution or savings institutions share their home offices;

(v)

furnishing or performing management services for a savings institution subsidiary of such company;

(vi)

holding, managing or liquidating assets owned or acquired from a savings subsidiary of such company;

(vii)

holding or managing properties used or occupied by a savings institution subsidiary of such company;

(viii)

acting as trustee under deeds of trust;

(ix)

any other activity (A) that the Federal Reserve Board, by regulation, has determined to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956, unless the Federal Reserve Board, by regulation, prohibits or limits any such activity for savings and loan holding companies; or (B) in which multiple savings and loan holding companies were authorized (by regulation) to directly engage on March 5, 1987;

(x)

any activity permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act, including securities and insurance underwriting; and

(xi)

purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such savings and loan holding company is approved by the Federal Reserve Board. If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company resulting from such merger or acquisition may only invest in assets and engage in activities listed in (i) through (xi) above, and has a period of two years to cease any nonconforming activities and divest of any nonconforming investments.

The Home Owners’ Loan Act prohibits a savings and loan holding company, including Cullman Bancorp, Inc. and Cullman Savings Bank, MHC, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior written approval of the Federal Reserve Board. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a nonsubsidiary company engaged in activities other than those permitted by the Home Owners’ Loan Act; or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Board must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.

The Federal Reserve Board is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies, and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions.

The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

Capital. Savings and loan holding companies are not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. That will eliminate from Tier 1 capital certain instruments that are currently includable for bank holding companies, such as trust preferred securities. There is a five-year transition period from the July 21, 2011 date of enactment of the Dodd-Frank Act before the capital requirements will apply to savings and loan holding companies.

Source of Strength. The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must promulgate regulations implementing the “source of strength” policy that requires holding companies act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.

The Federal Reserve Board has also issued a policy statement regarding the payment of dividends by bank holding companies that it has made applicable to savings and loan holding companies as well. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory review of capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of Cullman Bancorp, Inc. to pay dividends or otherwise engage in capital distributions.

Waivers of Dividends by Cullman Savings Bank, MHC. When Cullman Bancorp, Inc. pays dividends on its common stock to public shareholders, it is also required to pay dividends to Cullman Savings Bank, MHC, unless Cullman Savings Bank, MHC elects to waive the receipt of dividends. Under the Dodd-Frank Act, Cullman Savings Bank, MHC must receive the approval of the Federal Reserve Board before it may waive the receipt of any dividends from Cullman Bancorp, Inc., and there is no assurance that the Federal Reserve Board will approve future dividend waivers. In addition, any dividends waived by Cullman Savings Bank, MHC must be considered in determining an appropriate exchange ratio in the event of a conversion of the mutual holding company to stock form.

Conversion of Cullman Savings Bank, MHC to Stock Form. Federal regulations permit Cullman Savings Bank, MHC to convert from the mutual form of organization to the capital stock form of organization (a “Conversion Transaction”). There can be no assurance when, if ever, a Conversion Transaction will occur, and the board of directors has no current intention or plan to undertake a Conversion Transaction. In a Conversion Transaction, a new holding company would be formed as the successor to Cullman Bancorp, Inc. (the “New Holding Company”), Cullman Savings Bank, MHC’s corporate existence would end, and certain depositors of Cullman Savings Bank would receive the right to subscribe for shares of the New Holding Company. Each share of common stock held by stockholders other than Cullman Savings Bank, MHC (“Minority Stockholders”) would be automatically converted into a number of shares of common stock of the New Holding Company determined pursuant to an exchange ratio that ensures that Minority Stockholders own the same percentage of common stock in the New Holding Company as they owned in Cullman Bancorp, Inc. immediately prior to the Conversion Transaction. The total number of shares of common stock held by Minority Stockholders after a Conversion Transaction also would be increased by any purchases by Minority Stockholders in the stock offering conducted as part of the Conversion Transaction.

Any Conversion Transaction would require the approval of a majority of the outstanding shares of common stock of Cullman Bancorp, Inc. held by Minority Stockholders. Any Conversion Transaction also would require the approval of a majority of the eligible votes of members of Cullman Savings Bank, MHC.

Liquidation Rights. Each depositor of Cullman Savings Bank has both a deposit account in Cullman Savings Bank and a pro rata ownership interest in the net worth of Cullman Savings Bank, MHC based upon the deposit balance in his or her account. This ownership interest is tied to the depositor’s account and has no tangible market value separate from the deposit

account. This interest may only be realized in the unlikely event of a complete liquidation of Cullman Savings Bank. Any depositor who opens a deposit account obtains a pro rata ownership interest in Cullman Savings Bank, MHC without any additional payment beyond the amount of the deposit. A depositor who reduces or closes his or her account (including reductions to pay for shares of common stock in the stock offering) receives a portion or all, respectively, of the balance in the deposit account but nothing for his or her ownership interest in the net worth of Cullman Savings Bank, MHC, which is lost to the extent that the balance in the account is reduced or closed.

In the unlikely event of a complete liquidation of Cullman Savings Bank, all claims of creditors of Cullman Savings Bank, including those of depositors of Cullman Savings Bank (to the extent of their deposit balances), would be paid first. Thereafter, if there were any assets of Cullman Savings Bank remaining, these assets would be distributed to Cullman Bancorp, Inc. as Cullman Savings Bank’s sole stockholder. Then, if there were any assets of Cullman Bancorp, Inc. remaining, depositors of Cullman Savings Bank would receive those remaining assets, pro rata, based upon the deposit balances in their deposit account in Cullman Savings Bank immediately prior to liquidation.

Federal Securities Laws

Cullman Bancorp, Inc. common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. Cullman Bancorp, Inc. is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.

The registration under the Securities Act of 1933 of shares of the common stock in the stock offering does not cover the resale of the shares. Shares of the common stock purchased by persons who are not affiliates of Cullman Bancorp, Inc. may be resold without registration. Shares purchased by an affiliate of Cullman Bancorp, Inc. will be subject to the resale restrictions of Rule 144 under the Securities Act of 1933. If Cullman Bancorp, Inc. meets the current public information requirements of Rule 144 under the Securities Act of 1933, each affiliate of Cullman Bancorp, Inc. who complies with the other conditions of Rule 144, including those that require the affiliate’s sale to be aggregated with those of other persons, would be able to sell in the public market, without registration, a number of shares not to exceed, in any three month period, the greater of 1% of the outstanding shares of Cullman Bancorp, Inc., or the average weekly volume of trading in the shares during the preceding four calendar weeks. Provision may be made in the future by Cullman Bancorp, Inc. to permit affiliates to have their shares registered for sale under the Securities Act of 1933.

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act, our Chief Executive Officer and Chief Financial Officer will be required to certify that our quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the Securities and Exchange Commission under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal control over financial reporting; they have made certain disclosures to our auditors and the audit committee of the Board of Directors about our internal control over financial reporting; and they have included information in our quarterly and annual reports about their evaluation and whether there have been changes in our internal control over financial reporting or in other factors that could materially affect internal control over financial reporting.

Item 1A. Risk Factors

Not applicable to a smaller reporting company.

Item 1B. Unresolved Staff Comments

Not applicable to a smaller reporting company.

Item 2. Properties

As of December 31, 2011, the net book value of our properties was $9.5 million. The following is a list of our offices:


Location	Leased or Owned		Year Acquired or Leased		Square Footage		Net Book Value of Real Property
							(In thousands)

Main Office:
316 Second Avenue SW Cullman, Alabama		Owned		1970		44,000	$	6,839
Other Properties:
101 Main Street SW Hanceville, Alabama		Owned		1979		1,524		172
3201 Alabama Highway 157 Cullman, Alabama		Owned		2002		6,000		1,494
Highway 278 West Cullman, Alabama		Owned		2008		Land Only		399
1652 Second Avenue SW Cullman, Alabama		Owned		2010		2,531		592

							$	9,496

We believe that current facilities are adequate to meet our present and foreseeable needs, subject to possible future expansion.

Item 3. Legal Proceedings

From time to time, we are involved as plaintiff or defendant in various legal proceedings arising in the ordinary course of business. At December 31, 2011, we were not involved in any legal proceedings, the outcome of which would be material to our financial condition or results of operations.

Item 4. Mine Safety Disclosures

Not applicable

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our shares of common stock are traded on the OTC Bulletin Board under the symbol “CULL”. The approximate number of holders of record of Cullman Bancorp, Inc.’s common stock as of December 31, 2011 was 240. Certain shares of Cullman Bancorp, Inc. are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. The following table presents quarterly market information for Cullman Bancorp, Inc.’s common stock for each quarter for 2011 and 2010. The following information was provided by the OTC Bulletin Board:


Year ended December 31, 2011	High		Low		Cash Dividends Declared
First quarter	$	11.00	$	10.30	$	—
Second quarter	$	13.75	$	11.00	$	0.08
Third quarter	$	13.50	$	11.50	$	0.08
Fourth quarter	$	13.50	$	11.50	$	0.08


Year ended December 31, 2010	High		Low		Cash Dividends Declared
First quarter	$	10.35	$	10.06	$	—
Second quarter	$	10.40	$	10.00	$	—
Third quarter	$	10.65	$	9.50	$	—
Fourth quarter	$	10.60	$	9.50	$	—

The Board of Directors has the authority to declare cash dividends on shares of common stock, subject to statutory and regulatory requirements. As of December 31, 2011, the Company was paying quarterly cash dividends of $0.08 per share. In determining whether and in what amount to pay a cash dividend, the Board is expected to take into account a number of factors, including capital requirements, our consolidated financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions. No assurances can be given that any cash dividends will be paid or that, if paid, will not be reduced or eliminated in the future.

The available sources of funds for the payment of a cash dividend in the future are dividends from Cullman Savings Bank.

When Cullman Bancorp, Inc. pays dividends on its common stock to public shareholders, it will also be required to pay dividends to Cullman Savings Bank, MHC, unless Cullman Savings Bank, MHC elects to, and is permitted to, waive the receipt of dividends. The Dodd-Frank Act transferred the authority to review and approve mutual holding dividends waivers from the Office of Thrift Supervision to the Federal Reserve Board. The Federal Reserve Board historically has generally not allowed mutual holding companies to waive the receipt of dividends, and there can be no assurance that the Federal Reserve Board will approve dividend waiver requests by mutual holding companies such as Cullman Savings Bank, MHC.

In addition, our ability to pay dividends largely depends upon dividends we receive from Cullman Savings Bank, which are subject to regulatory restrictions on dividends. Applicable regulations limit dividends and other distributions from Cullman Savings Bank to us. See Item 1 Business – Supervision and Regulation – Capital Distributions. In addition, Cullman Savings Bank may not make a distribution that would constitute a return of capital during the three-year term of the business plan submitted in connection with the offering. No insured depository institution may make a capital distribution if, after making the distribution, the institution would be undercapitalized.

At December 31, 2011, there were no compensation plans under which equity securities of Cullman Bancorp, Inc. were authorized for issuance other than the Employee Stock Ownership Plan and the Equity Incentive Plan.

No shares were repurchased during 2011.

Item 6. Selected Financial Data

The following information is derived from the audited consolidated financial statements of Cullman Bancorp, Inc. For additional information, reference is made to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of Cullman Bancorp, Inc. and related notes included elsewhere in this Annual Report.


	At or For the Year Ended December 31,
	2011		2010		2009
			(In thousands)
Financial Condition Data:
Total assets	$	222,951	$	223,855	$	214,579
Investment securities		29,706		24,117		18,080
Loans receivable, net		164,215		177,317		172,747
Deposits		138,147		136,399		125,119
Federal Home Loan Bank advances		42,000		47,000		51,107
Other borrowings		787		816		833
Total shareholders’ equity		40,393		38,270		36,514
Operating Data:
Interest and dividend income	$	11,736	$	12,156	$	12,140
Interest expense		3,237		4,046		5,339


Net interest income		8,499		8,110		6,801
Provision for loan losses		407		506		388


Net interest income after provision for loan losses		8,092		7,604		6,413
Non-interest income		831		964		(210	)
Non-interest expenses		5,847		5,429		5,409


Income before income taxes		3,076		3,139		1,214
Income taxes		1,087		1,087		633


Net income	$	1,989	$	2,052	$	581


Basic earnings per share (1)	$	0.80	$	0.85	$	0.06
Dilutive earnings per share	$	0.80	$	0.85	$	0.06

(1)	Earnings per share for 2009 is based on earnings of Cullman Bancorp, Inc. for the period of October 8 to December 31, 2009.


	At or For the Year Ended December 31,
	2011			2010			2009
Performance Ratios:
Return on average assets		0.88	%		0.93	%		0.27	%
Return on average equity		4.86	%		5.51	%		2.08	%
Interest rate spread (1)		3.78	%		3.71	%		3.22	%
Net interest margin (2)		4.06	%		4.00	%		3.46	%
Noninterest expense to average assets		2.58	%		2.47	%		2.53	%
Efficiency ratio (3)		62.67	%		60.08	%		46.37	%
Average interest-earning assets to average interest-bearing liabilities		1.18	X		1.15	X		1.09	X
Average equity to average assets		18.03	%		16.94	%		13.12	%

Capital Ratios:
Total capital to risk weighted assets		22.25	%		21.21	%		22.03	%
Tier I capital to risk weighted assets		21.75	%		20.75	%		21.53	%
Tier I capital to average tangible assets		14.85	%		14.71	%		15.02	%

Asset Quality Ratios:

Allowance for loan losses as a percent of gross loans		0.67	%		0.48	%		0.43	%
Allowance for loan losses as a percent of nonperforming loans		70.48	%		386.43	%		N/A	%
Net (charge-offs) recoveries to average outstanding loans during the period		(0.09	)%		(0.23	)%		(0.07	)%
Non-performing loans as a percent of gross loans		0.95	%		0.12	%		0.00	%
Non-performing assets as a percent of total assets		1.40	%		0.99	%		0.43	%
Total non-performing assets and troubled debt as a percentage of total assets		2.76	%		3.43	%		0.43	%
Number of offices		3			3			3

(1)	Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities.

(2)	Represents net interest income as a percent of average interest-earning assets.

(3)	Represents noninterest expense divided by the sum of net interest income and noninterest income, excluding gains or losses on the sale of securities.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Since the entities are under common control, the reorganization was accounted for at historical cost and presented as if the transaction occurred at the beginning of the earliest period shown. A total of 1,080,483 shares were sold in the conversion at $10 per share, raising $10.8 million of gross proceeds. Approximately $900,000 of conversion expenses were offset against the gross proceeds. Cullman Bancorp, Inc.’s common stock began trading on the over-the-counter market under the symbol “CULL” on October 9, 2009. In addition, the Bank contributed $100,000 in cash and 50,255 shares of common stock to a charitable foundation that the Bank established in connection with the reorganization. The contribution of cash and shares of common stock totaled $603,000.

The combination of shares sold to the public and contributed to the charitable foundation represents 46% of the common stock of Cullman Bancorp, Inc. outstanding shares. Cullman Savings Bank, MHC owns 54% or 1,387,312 shares.

Our results of operations depend mainly on our net interest income, which is the difference between the interest income earned on our loan and investment portfolios and interest expense paid on our deposits and borrowed funds. Results of operations are also affected by fee income from banking operations, provisions for loan losses, gains (losses) on sales and other than temporary impairment charges of loans and securities and other miscellaneous income. Our noninterest expenses consist primarily of salaries and employee benefits, occupancy and equipment, data processing, advertising, bank examination fees, amortization of intangibles, general administrative expenses, deposit insurance fees and income tax expense. Our results of operations are also significantly affected by general economic and competitive conditions, particularly with respect to changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect our financial condition and results of operations.

Critical Accounting Policies

We consider accounting policies that require management to exercise significant judgment or discretion or make significant assumptions that have, or could have, a material impact on the carrying value of certain assets or on income, to be critical accounting policies. We consider the following to be our critical accounting policies:

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

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

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

The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment loss is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating classified loans from the remaining loans, and then categorizing each group by type of loan. Loans within each type exhibit common characteristics including terms,

collateral type, and other risk characteristics. We also analyze historical loss experience for the preceding four quarters, delinquency trends, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allocations. Actual loan losses may be significantly more than the allowance for loan losses we have established which could have a material negative effect on our financial results.

Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.

Securities Impairment. Accounting standards require us to perform periodic reviews of individual securities in our investment portfolios to determine whether a decline in the value of a security is other than temporary. We conduct a quarterly review and evaluation of our securities portfolio to make this determination and consider many factors, including the severity and duration of the impairment; our intent and ability to hold the security for a period of time sufficient for a recovery in value; and for debt securities, external credit ratings and recent downgrades. Securities on which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss. If such decline is deemed other-than-temporary, we would adjust the cost basis on the credit loss portion of the security by writing down the security to estimated fair market value through a charge to current period operations.

Business Strategy

We have focused primarily on improving the execution of our community oriented retail banking strategy. Highlights of our current business strategy include the following:

•

Continue to Focus on Residential Lending. We have been and will continue to be primarily a one-to-four family residential mortgage lender for borrowers in our market area. As of December 31, 2011, $78.7 million, or 47.6% of our total loan portfolio consisted of one- to four-family residential mortgage loans. We have developed a secondary mortgage capacity so that we can offer loans, including long-term fixed-rate loans, to our customers that we do not wish to retain in our loan portfolio from an asset/liability management standpoint. We consider the current interest rate environment in making decisions as to whether to hold our originated mortgage loans for investment or to sell the loans to investors, choosing the strategy that is most advantageous to us from a profitability and risk management standpoint.

•

Increase Commercial Real Estate Lending. While we will continue to emphasize one- to four-family residential mortgage loans, we also have increased and, subject to market conditions, intend to continue to increase our origination of commercial real estate loans in order to increase the yield of, and reduce the term to repricing of, our total loan portfolio. At December 31, 2011, $63.3 million, or 38.2% of our total loan portfolio consisted of commercial real estate loans.

•

Manage Interest Rate Risk While Maintaining or Enhancing to the Extent Practicable our Net Interest Margin. Subject to market conditions, we have sought to enhance net interest income by emphasizing controls on the cost of funds rather than attempting to maximize asset yields, as loans with high yields often involve greater credit risk or may be repaid during periods of decreasing market interest rates. We try to promote “core deposits” such as passbook and statement savings accounts, money market accounts and regular and commercial checking accounts, which generally are lower-cost sources of funds than certificates of deposit, and which are less sensitive to withdrawal when interest rates fluctuate. At December 31, 2011, 44.6% of our deposits were core deposits. We attempt to attract and retain core deposits by offering competitive products that meet the full-service banking needs of our customers, by emphasizing quality customer service, and through our convenient locations and advertising and promotions programs.

•

Expand Banking Relationships to a Larger Base of Customers. Our banking subsidiary, Cullman Savings Bank was established in 1887 and has been operating continuously in Cullman County since that time. Our share of FDIC-insured deposits in Cullman County as of June 30, 2011 (the latest date for which such information is available) was 10.4%. We will seek to expand our customer base and offer our products and services to the new base of customers, by using our recognized brand name and the goodwill developed over years of providing timely, efficient banking services.

•

Maintain Strong Asset Quality. We have emphasized maintaining strong asset quality by following conservative underwriting guidelines, sound loan administration, and focusing on loans secured by real estate located within our market area only. Our non-performing assets and troubled debt restructurings totaled $6.1 million, or 2.8% of total assets at December 31, 2011. Our total nonperforming loans to total loans ratio was 0.95% at December 31, 2011. Total loan delinquencies, greater than 30 days, as of December 31, 2011 were $2.7 million, or 1.6% of total loans

Comparison of Financial Condition at December 31, 2011 and December 31, 2010

Our total assets decreased $904,000, or 0.40%, to $222.9 million at December 31, 2011 from $223.9 million at December 31, 2010. The decrease was due to a decrease in loans of $13.1 million, or 7.4%, to $164.2 million at December 31, 2011 from $177.3 million at December 31, 2010. The decrease in total loans was partially offset by increases in cash and cash equivalents of $6.9 million to $9.5 million from $2.5 million and securities available for sales of $5.6 million to $29.7 million from $24.1 million at December 31, 2011 and 2010, respectively. The decrease in loans reflected the decreased demand for one-to-four family and real estate construction loans. Our portfolio of one-to-four family loans decreased $4.8 million to $78.9 million at December 31, 2011 from $83.7 million at December 31, 2010. Real estate construction loans decreased $7.3 million to $1.7 million from $8.9 million. Total real estate loans decreased $11.9 million to $149.1 at December 31, 2011 from $160.9 at December 31, 2010. Proceeds from loan repayments were used to fund purchases of securities available for sale and investment in federal funds sold.

Deposits increased to $138.1 million at December 31, 2011 from $136.4 million at December 31, 2010. The increase in deposits reflected a $6.5 million increase in NOW and demand accounts. This increase was offset partially by a decrease in certificates of deposit of $3.3 million to $76.6 million at December 31, 2011 from $79.9 million at December 31, 2010.

Federal Home Loan Bank of Atlanta advances decreased to $42.0 million at December 31, 2011 from $47.0 million at December 31, 2010. Our increase in deposits helped to offset the planned decrease in Federal Home Loan Bank advances.

Total equity increased to $40.4 million at December 31, 2011 from $38.3 million at December 31, 2010. The increase largely reflected net income of $2.0 million and an increase in accumulated other comprehensive income of $549,000, partially offset by dividends of $534,000.

Comparison of Operating Results for the Years Ended December 31, 2011 and December 31, 2010

General. Net income decreased to $2.0 million for the year ended December 31, 2011 from $2.1 million for the year ended December 31, 2010. The decrease reflected lower noninterest income and higher noninterest expenses. Noninterest income decreased by $134,000, or 13.9%, and noninterest expense increased by $399,000, or 7.4%, for the year ended December 31, 2011.

Interest Income. Interest income decreased $420,000, or 3.5%, to $11.7 million for the year ended December 31, 2011 from $12.1 million for the year ended December 31, 2010. The decrease reflected a decrease in the yields on interest earning assets to 5.6% during the year ended December 31, 2011 from 6.0% for the year ended December 31, 2010, which more than offset the modest increase in the average balances of interest earning assets of $6.8 million to $209.3 million from $202.5 million for the same periods ended.

Interest income on loans decreased $431,000 or 3.8%, to $10.8 million for the year ended December 31, 2011 from $11.2 million for the year ended December 31, 2010, reflecting a decrease in the average yield on loans to 6.2% from 6.4% and a decrease in the average balances of loans to $173.6 million from $174.5 million for the same periods ended. Interest income on investment securities decreased to $905,000 for the year ended December 31, 2011 from $911,000 for the year ended December 31, 2010, reflecting a decrease in the average yield of such securities to 3.6% in 2011 from 4.4% in 2010, which more than offset the increase in their average balances to $24.8 million from $20.8 million for the same periods ended.

Interest Expense. Interest expense decreased $809,000, or 20.2%, to $3.2 million for the year ended December 31, 2011 from $4.0 million for the year ended December 31, 2010. The decrease reflected a decrease in the yields on interest-bearing deposits to 1.20% for the year ended December 31, 2011 from 1.6% for the year ended December 31, 2010 and a decrease in the yield on Federal Home Loan Bank advances and other borrowings to 3.6% from 4.2% for the same periods ended. The decrease in the yields on interest-bearing deposits more than offset the increase in the average balances of deposits of $2.1 million to $130.9 million for the year ended December 31, 2011 from $128.8 million for the year ended December 31, 2010.

Interest expense on certificates of deposit decreased to $1.4 million for the year ended December 31, 2011 from $1.7 million for the year ended December 31, 2010. The decrease was due to a decrease in the yield on certificates of deposit to

1.7% from 2.2%, which more than offset the increase in their average balances of $2.4 million. Interest expense on money market deposits and NOW and demand deposits decreased to $203,000 for the year ended December 31, 2011 from $370,000 for the year ended December 31, 2010, due to both a decrease in the average yields on such deposits to 0.40% for the year ended December 31, 2011 from 0.72% for the year ended December 31, 2010 and a decrease in the average balances of such deposits of $282,000 to $51.3 million from $51.7 million for the same periods ended.

Interest expense on borrowings, primarily advances from the Federal Home Loan Bank of Atlanta, decreased $312,000, or 15.7% to $1.7 million for the year ended December 31, 2011 from $2.0 million for the year ended December 31, 2010. The decrease reflected a decrease in the average balance of such borrowings of $1.5 million to $46.1 million for the year ended December 31, 2011 coupled with a lower average rate paid on such borrowings of 3.6% for the year ended December 31, 2011 compared to 4.2% for the year ended December 31, 2010.

Net Interest Income. Net interest income increased to $8.5 million for the year ended December 31, 2011 from $8.1 million for the year ended December 31, 2010. The increase resulted from an increase in our interest rate spread to 3.8% from 3.7% and an increase in the ratio of our average interest earning assets to average interest bearing liabilities to 1.18X from 1.15X. Our net interest margin increased to 4.1% from 4.0%. The increases in our interest rate spread and net interest margin reflected a lower interest rate environment.

Provision for Loan Losses. The provision for loan losses decreased by $99,000 to $407,000 for the year ended December 31, 2011 from $506,000 for the year ended December 31, 2010. Net charge offs were $153,000 for the year ended December 31, 2011 compared to $399,000 for the year ended December 31, 2010. The allowance for loan losses was $1.1 million, or 0.67% of total loans at December 31, 2011 compared to $854,000, or 0.48%, of total loans at December 31, 2010. Nonperforming loans at December 31, 2011 were $1.6 million compared to $221,000 at December 31, 2010. Our foreclosed real estate was $1.5 million at December 31, 2011 compared to $2.0 million at December 31, 2010. To the best of our knowledge, we have recorded all losses that are both probable and reasonably estimable for the years ended December 31, 2011 and 2010.

Noninterest Income. Noninterest income decreased to $831,000 for the year ended December 31, 2011 from $964,000 for the year ended December 31, 2010. The decrease in noninterest income was primarily attributable to the decrease in service charges on deposit accounts of $36,000, the decrease in the net gain on sales of mortgage loans of $80,000, and the decrease in the net gain on the sale of securities of $38,000 to $409,000, $241,000, and $0, respectively for the year ended December 31, 2011. The decrease in the gain on sale of mortgage loans is reflective of lower volume in originations of these types of loans due to lower demand.

Noninterest Expense. Noninterest expense increased by $399,000 for the year ended December 31, 2011 to $5.8 million for the year ended December 31, 2011 from $5.4 million for the year ended December 31, 2010. The increase is largely reflective of the increase in salaries and other employee benefits of $290,000 and net losses on foreclosed real estate of $126,000. The increase in salaries and employee benefits reflected the increase in our stock based compensation expenses related to our ESOP and restricted stock programs. The total of these stock based compensation programs was $198,000 for the year ended December 31, 2011 from $49,000 for the year ended December 31, 2010. These increases were offset partially by a decrease in occupancy and equipment expense of $69,000 to $623,000 for the year ended December 31, 2011 and a decrease in the FDIC deposit insurance premium of $27,000 to $127,000 for the year ended December 31, 2011.

Income Tax Expense. The provision for income taxes remained the same at $1.1 million for both years ended December 31, 2011 and 2010. Our effective tax rate was 35.3% for the year ended December 31, 2011 compared to 34.6% for the year ended December 31, 2010.

Analysis of Net Interest Income

Net interest income represents the difference between the income we earn on interest-earning assets and the interest expense we pay on interest-bearing liabilities. Net interest income also depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them.

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the tables 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.


	For The Year Ended December 31,
	2011								2010								2009
	Average Balance			Interest and Dividends		Yield Cost			Average Balance			Interest and Dividends		Yield Cost			Average Balance			Interest and Dividends		Yield Cost
	(Dollars in thousands)
Assets:
Interest-earning assets:
Loans	$	173,655		$	10,799		6.22	%	$	174,881		$	11,230		6.42	%	$	169,540		$	11,080		6.54	%
Securities available for sale		24,790			905		3.65			20,762			911		4.39			21,172			1,046		4.94
Other interest-earning assets		10,873			32		0.29			6,895			15		0.22			6,017			14		0.23

Total interest-earning assets		209,318			11,736		5.61			202,538			12,156		6.00			196,729			12,140		6.17
Noninterest earning assets		17,492								17,335								16,496

Total average assets	$	226,810							$	219,873							$	213,225


Liabilities and equity:
Interest-bearing liabilities:
NOW and demand deposits	$	26,228			98		0.37		$	25,651			158		0.62		$	30,601			278		0.91
Regular savings and other deposits		17,171			69		0.40			15,763			119		0.75			12,356			148		1.20
Money market deposits		7,990			36		0.45			10,257			93		0.91			9,060			150		1.66
Certificates of deposit		79,541			1,351		1.70			77,108			1,688		2.19			76,926			2,512		3.27

Total interest-bearing deposits		130,930			1,554		1.19			128,779			2,058		1.60			128,943			3,088		2.39
FHLB advances and other borrowings		46,096			1,683		3.65			47,634			1,988		4.17			52,311			2,251		4.30

Total interest-bearing liabilities		177,026			3,237		1.83			176,413			4,046		2.29			181,254			5,339		2.95
Noninterest-bearing demand deposits		7,349								4,227								2,756
Other noninterest-bearing liabilities		1,548								1,986								1,235

Total liabilities		185,923								182,626								185,245
Equity		40,888								37,247								27,980

Total liabilities and equity	$	226,810							$	219,873							$	213,225


Net interest income				$	8,499							$	8,110							$	6,801

Interest rate spread							3.78	%							3.71	%							3.22	%
Net interest margin							4.06	%							4.00	%							3.46	%
Average interest-earning assets to average interest-bearing liabilities		1.18	X							1.15	X							1.09	X

Rate/Volume Analysis

The following table presents the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.


	Years Ended December 31, 2011 vs. 2010									Years Ended December 31, 2010 vs. 2009
	Increase (Decrease) Due to						Total Increase (Decrease)			Increase (Decrease) Due to						Total Increase (Decrease)
	Volume			Rate			Total Increase (Decrease)			Volume			Rate			Total Increase (Decrease)
	(Dollars In thousands)									(Dollars In thousands)
Interest-earning assets
Loans receivable	$	(79	)	$	(352	)	$	(431	)	$	345		$	(195	)	$	150
Investment securities		177			(183	)		(6	)		(20	)		(115	)		(135	)
Other interest-earning assets		9			8			17			(5	)		6			1

Total interest earning		107			(527	)		(420	)		320			(304	)		16

Interest-bearing liabilities
NOW and demand deposits		4			(64	)		(60	)