Edgar Filing: VSB BANCORP INC

UNITED STATES

SECURITY AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20849

FORM 10-Q

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

FOR THE QUARTER ENDED SEPTEMBER 30, 2012

£ TRANSITION REPORT PURSUANT TO SECTION 13 OF THE EXCHANGE ACT FOR THE TRANSITION PERIOD

COMMISSION FILE NUMBER 0-50237

VSB Bancorp, Inc.

(Exact name of registrant as specified in its charter)

New York

(State or other jurisdiction of incorporation or organization)

11 - 3680128

(I. R. S. Employer Identification No.)

4142 Hylan Boulevard, Staten Island, New York 10308

(Address of principal executive offices)

(718) 979-1100

Registrant's telephone number

Common Stock

(Title of Class)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 S No £

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 S No £

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

Large Accelerated Filer £ Accelerated Filer £ Non-Accelerated Filer £ Smaller Reporting Company S

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

Par Value: $0.0001 Class of Common Stock

The Registrant had 1,775,809 common shares outstanding as of November 9, 2012.

CROSS REFERENCE INDEX

PART I

		Page

Item 1	Consolidated Statements of Financial Condition as of September 30, 2012 and December 31, 2011 (unaudited)	4
	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2012 and 2011 (unaudited)	5
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2012 and 2011 (unaudited)	6
	Consolidated Statements of Changes in Stockholders’ Equity for Each of the Quarters in the Nine Months Period Ended September 30, 2012 and the Year Ended December 31, 2011 (unaudited)	7
	Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 2012 and 2011 (unaudited)	8
	Notes to Consolidated Financial Statements for the Three and Nine Months Ended September 30, 2012 and 2011 (unaudited)	9 to 27
Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	28 to 40
Item 3	Control and Procedures	40
	PART II

Item 1	Legal Proceedings	41

Signature Page		42

	Exhibit 31.1, 31.2, 32.1, 32.2	44 to 47

Forward-Looking Statements

When used in this periodic report , or in any written or oral statement made by us or our officers, directors or employees, the words and phrases “will result,” “expect,” “will continue,” “anticipate,” “estimate,” “project,” or similar terms are intended to identify “forward-looking statements.” A variety of factors could cause our actual results and experiences to differ materially from the anticipated results or other expectations expressed in any forward-looking statements. Some of the risks and uncertainties that may affect our operations, performance, development, and results, the interest rate sensitivity of our assets and liabilities, and the adequacy of our loan loss allowance, include, but are not limited to:

	•	deterioration in local, regional, national or global economic conditions which could result in, among other things, an increase in loan delinquencies, a decrease in property values, or a change in the real estate turnover rate;
	•	changes in market interest rates or changes in the speed at which market interest rates change;
	•	increases in inflation;
	•	technology changes requiring additional capital investment;
	•	breaches of security or other criminal acts affecting our operations;
	•	changes in laws and regulations affecting the financial service industry;
	•	changes in accounting rules;
	•	changes in the public’s perception of financial institutions in general and banks in particular;
	•	changes in borrowers’ attitudes towards their moral and legal obligations to repay their debts;
	•	the health and soundness of other financial institutions;
	•	changes in the securities or real estate markets;
	•	weather, geologic or climatic conditions;
	•	changes in government monetary or fiscal policy or other government political changes;
	•	changes in competition; and
	•	changes in consumer preferences by our customers or the customers of our business borrowers.

Please do not place undue reliance on any forward-looking statement, which speaks only as of the date made. There are many factors, including those described above, that could affect our future business activities or financial performance and could cause our actual future results or circumstances to differ materially from those we anticipate or project. We do not undertake any obligation to update any forward-looking statement after it is made.

VSB Bancorp, Inc.

Consolidated Statements of Financial Condition

(unaudited)

	September 30,			December 31,
	2012			2011

Assets:
Cash and due from banks	$	62,823,176		$	48,107,673
Investment securities, available for sale		112,293,648			108,500,489
Loans receivable		81,965,253			81,910,990
Allowance for loan loss		(1,666,916	)		(1,343,020	)
Loans receivable, net		80,298,337			80,567,970
Bank premises and equipment, net		2,183,842			2,332,727
Accrued interest receivable		556,014			582,942
Other assets		1,691,022			1,754,654
Total assets	$	259,846,039		$	241,846,455

Liabilities and stockholders' equity:
Liabilities:
Deposits:
Demand and checking	$	79,534,085		$	72,507,555
NOW		33,843,677			30,553,003
Money market		32,637,077			26,909,220
Savings		20,753,628			17,178,525
Time		63,864,539			65,894,536
Total deposits		230,633,006			213,042,839
Escrow deposits		321,841			180,066
Accounts payable and accrued expenses		1,178,733			1,521,290
Total liabilities		232,133,580			214,744,195

Stockholders' equity:
Common stock ($.0001 par value, 10,000,000 shares authorized, 1,989,509 issued, 1,775,809 outstanding at September 30, 2012 and 1,797,809 outstanding at December 31, 2011)		199			199
Additional paid in capital		9,313,979			9,304,789
Retained earnings		19,265,307			18,574,651
Treasury stock, at cost (213,700 shares at September 30, 2012 and 191,700 shares at December 31, 2011)		(2,170,073	)		(1,935,596	)
Unearned Employee Stock Ownership Plan shares		(267,707	)		(394,516	)
Accumulated other comprehensive income, net of taxes of $1,324,645 and $1,309,447, respectively		1,570,754			1,552,733

Total stockholders' equity		27,712,459			27,102,260

Total liabilities and stockholders' equity	$	259,846,039		$	241,846,455

See notes to consolidated financial statements.

VSB Bancorp, Inc.

Consolidated Statements of Operations

(unaudited)

	Three months			Three months			Nine months			Nine months
	ended			ended			ended			ended
	Sept. 30, 2012			Sept. 30, 2011			Sept. 30, 2012			Sept. 30, 2011
Interest and dividend income:
Loans receivable	$	1,484,891		$	1,537,598		$	4,489,089		$	4,357,917
Investment securities		736,733			939,250			2,319,168			2,949,689
Other interest earning assets		30,259			17,238			78,331			41,979
Total interest income		2,251,883			2,494,086			6,886,588			7,349,585

Interest expense:
NOW		19,414			18,965			62,972			75,237
Money market		59,187			59,240			174,058			179,720
Savings		16,493			11,508			35,693			37,482
Time		105,518			120,669			335,370			361,060
Total interest expense		200,612			210,382			608,093			653,499

Net interest income		2,051,271			2,283,704			6,278,495			6,696,086
Provision for loan loss		40,000			90,000			280,000			145,000
Net interest income after provision for loan loss		2,011,271			2,193,704			5,998,495			6,551,086

Non-interest income:
Loan fees		12,471			9,057			32,063			49,663
Service charges on deposits		524,766			533,256			1,626,041			1,591,641
Net rental income		18,327			10,795			42,605			32,513
Other income		52,264			49,397			156,075			159,684
Total non-interest income		607,828			602,505			1,856,784			1,833,501

Non-interest expenses:
Salaries and benefits		934,410			988,260			2,861,845			2,957,098
Occupancy expenses		367,248			403,650			1,095,729			1,141,878
Legal expense		59,292			57,035			209,276			156,995
Professional fees		84,819			65,900			253,880			218,401
Computer expense		66,463			64,298			183,131			202,867
Directors' fees		60,775			63,150			205,900			188,525
FDIC and NYSBD assessments		57,000			54,500			178,500			194,000
Other expenses		330,204			320,883			1,003,474			961,980
Total non-interest expenses		1,960,211			2,017,676			5,991,735			6,021,744

Income before income taxes		658,888			778,533			1,863,544			2,362,843

Provision/(benefit) for income taxes:
Current		329,410			421,989			1,058,329			1,402,370
Deferred		(27,982	)		(65,744	)		(205,730	)		(321,310	)
Total provision for income taxes		301,428			356,245			852,599			1,081,060

Net income	$	357,460		$	422,288		$	1,010,945		$	1,281,783

Earnings per share:
Basic	$	0.20		$	0.23		$	0.57		$	0.71

Diluted	$	0.20		$	0.23		$	0.57		$	0.71

Comprehensive income	$	547,112		$	673,802		$	1,028,966		$	1,776,586

Book value per common share	$	15.61		$	15.15		$	15.61		$	15.15

See notes to consolidated financial statements.

VSB Bancorp, Inc.

Consolidated Statements of Comprehensive Income

(unaudited)

	Three months		Three months		Nine months		Nine months
	ended		ended		ended		ended
	Sept. 30, 2012		Sept. 30, 2011		Sept. 30, 2012		Sept. 30, 2011

Net Income	$	357,460	$	422,288	$	1,010,945	$	1,281,783
Other comprehensive income:
Unrealized gains on securities:
Change in unrealized gain on securties available for sale		349,589		463,621		33,219		912,080
Tax effects		159,937		212,107		15,198		417,277
Net of tax		189,652		251,514		18,021		494,803
Comprehensive income	$	547,112	$	673,802	$	1,028,966	$	1,776,586

See notes to consolidated financial statements.

VSB Bancorp, Inc.

Consolidated Statements of Changes in Stockholders' Equity

Year Ended December 31, 2011 and For Each of the Quarters in the Nine Month Period Ended September 30, 2012

(unaudited)

	Number of																	Accumulated
	Common					Additional						Treasury			Unearned			Other			Total
	Shares			Common		Paid-In			Retained			Stock,			ESOP			Comprehensive			Stockholders'
	Outstanding			Stock		Capital			Earnings			at cost			Shares			Income			Equity

Balance at January 1, 2011		1,825,009		$	199	$	9,249,600		$	17,563,435		$	(1,643,797	)	$	(563,594	)	$	1,439,013		$	26,044,856

Stock-based compensation							95,952															95,952
Amortization of earned portion of ESOP common stock																169,078						169,078
Amortization of cost over fair value - ESOP							(40,763	)														(40,763	)
Cash dividends declared ($0.24 per share)										(433,235	)											(433,235	)
Purchase of treasury stock, at cost		(27,200	)										(291,799	)								(291,799	)
Comprehensive income:
Net income										1,444,451												1,444,451
Other comprehensive income, net:
Change in unrealized gain on securities available for sale, net of tax effects		—			—		—			—			—			—			113,720			113,720

Balance at December 31, 2011		1,797,809		$	199	$	9,304,789		$	18,574,651		$	(1,935,596	)	$	(394,516	)	$	1,552,733		$	27,102,260

Stock-based compensation							23,445															23,445
Amortization of earned portion of ESOP common stock																42,270						42,270
Amortization of cost over fair value - ESOP							(20,660	)														(20,660	)
Cash dividends declared ($0.06 per share)										(107,003	)											(107,003	)
Purchase of treasury stock, at cost		(10,000	)										(106,068	)								(106,068	)
Comprehensive income:
Net income										281,628												281,628
Other comprehensive income, net:
Change in unrealized gain on securities available for sale, net of tax effects		—			—		—			—			—			—			(91,552	)		(91,552	)

Balance at March 31, 2012		1,787,809		$	199	$	9,307,574		$	18,749,276		$	(2,041,664	)	$	(352,246	)	$	1,461,181		$	27,124,320

Stock-based compensation							23,446															23,446
Amortization of earned portion of ESOP common stock																42,269						42,269
Amortization of cost over fair value - ESOP							(20,230	)														(20,230	)
Cash dividends declared ($0.06 per share)										(107,003	)											(107,003	)
Comprehensive income:
Net income										371,857												371,857
Other comprehensive income, net:
Change in unrealized gain on securities available for sale, net of tax effects		—			—		—			—			—			—			(80,079	)		(80,079	)

Balance at June 30, 2012		1,787,809		$	199	$	9,310,790		$	19,014,130		$	(2,041,664	)	$	(309,977	)	$	1,381,102		$	27,354,580

Stock-based compensation							23,447															23,447
Amortization of earned portion of ESOP common stock																42,270						42,270
Amortization of cost over fair value - ESOP							(20,258	)														(20,258	)
Cash dividends declared ($0.06 per share)										(106,283	)											(106,283	)
Purchase of treasury stock, at cost		(12,000	)										(128,409	)								(128,409	)
Comprehensive income:
Net income										357,460												357,460
Other comprehensive income, net:
Change in unrealized gain on securities available for sale, net of tax effects		—			—		—			—			—			—			189,652			189,652

Balance at September 30, 2012		1,775,809		$	199	$	9,313,979		$	19,265,307		$	(2,170,073	)	$	(267,707	)	$	1,570,754		$	27,712,459

See notes to consolidated financial statements.

VSB Bancorp, Inc.

Consolidated Statements of Cash Flows

(unaudited)

	Three months			Three months			Nine months			Nine months
	ended			ended			ended			ended
	Sept. 30, 2012			Sept. 30, 2011			Sept. 30, 2012			Sept. 30, 2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	357,460		$	422,288		$	1,010,945		$	1,281,783
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		145,384			152,433			442,378			451,351
Accretion of income, net of amortization of premium		60,649			35,481			292,498			118,244
ESOP compensation expense		22,012			23,394			65,661			74,988
Stock-based compensation expense		23,447			23,445			70,338			72,506
Provision for loan losses		40,000			90,000			280,000			145,000
Decrease/(increase) in prepaid and other assets		121,195			(40,479	)		335,239			153,669
Decrease in accrued interest receivable		2,554			33,591			26,928			79,653
Decrease in deferred income taxes		(27,982	)		(65,744	)		(205,730	)		(321,310	)
Decrease in accrued expenses and other liabilities		(72,790	)		(99,171	)		(342,557	)		(26,236	)
Net cash provided by operating activities		671,929			575,238			1,975,700			2,029,648

CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in loan receivable		4,045,312			686,577			(36,363	)		(585,593	)
Proceeds from repayment and calls of investment securities, available for sale		9,050,698			7,657,492			27,734,440			24,605,813
Purchases of investment securities, available for sale		(3,941,875	)		—			(31,841,957	)		(15,614,398	)
Purchases of premises and equipment		(167,840	)		(29,077	)		(293,493	)		(114,376	)
Net cash provided by/(used in) investing activities		8,986,295			8,314,992			(4,437,373	)		8,291,446

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		7,225,994			(187,976	)		17,731,942			8,455,879
Purchase of treasury stock, at cost		(128,409	)		(1,145	)		(234,477	)		(1,145	)
Cash dividends paid		(106,283	)		(108,717	)		(320,289	)		(326,151	)
Net cash provided by/(used in) financing activities		6,991,302			(297,838	)		17,177,176			8,128,583

NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS		16,649,526			8,592,392			14,715,503			18,449,677

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		46,173,650			38,622,272			48,107,673			28,764,987

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	62,823,176		$	47,214,664		$	62,823,176		$	47,214,664

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest	$	197,554		$	211,920		$	612,222		$	659,024
Taxes	$	321,000		$	467,000		$	886,610		$	1,334,125

SUPPLEMENTAL NONCASH DISCLOSURE:
Transfer from loans to real estate owned	$	—		$	—		$	81,075		$	—

See notes to consolidated financial statements.

VSB BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011 (UNAUDITED)

1.	GENERAL

VSB Bancorp, Inc. (referred to using terms such as “we,” “us,” or the “Company”) is the holding company for Victory State Bank (the “Bank”), a New York chartered commercial bank. Our primary business is owning all of the issued and outstanding stock of the Bank. Our common stock is listed on the NASDAQ Global Market. We trade under the symbol “VSBN”.

Through the Bank, the Company is primarily engaged in the business of commercial banking, and to a lesser extent retail banking. The Bank gathers deposits from individuals and businesses primarily in Staten Island, New York and makes loans throughout that community. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the local Staten Island economic and real estate markets. The Bank invests funds that are not used for lending primarily in government securities, mortgage backed securities and collateralized mortgage obligations. Customer deposits are insured, up to the applicable limit, by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is supervised by the New York State Department of Financial Services (“NYDFS”) and the FDIC.

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The following is a description of the significant accounting and reporting policies followed in preparing and presenting the accompanying consolidated financial statements. These policies conform with accounting principles generally accepted in the United States of America (“GAAP”).

Principles of Consolidation - The consolidated financial statements of the Company include the accounts of the Company, including its subsidiary Victory State Bank. All significant inter-company accounts and transactions between the Company and Bank have been eliminated in consolidation.

Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting period. Actual results can differ from those estimates. The allowance for loan losses, prepayment estimates on the mortgage-backed securities and collateralized mortgage obligation portfolios, contingencies and fair values of financial instruments are particularly subject to change.

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation.

Cash and Cash Equivalents – Cash and cash equivalents consist of cash on hand, due from banks and interest-bearing deposits. Interest-bearing deposits with original maturities of 90 days or less are included in this category. Customer loan and deposit transactions are reported on a net cash basis. Regulation D of the Board of Governors of the Federal Reserve System requires that Victory State Bank maintain interest-bearing deposits or cash on hand as reserves against its demand deposits. The amount of reserves which Victory State Bank is required to maintain depends upon its level of transaction accounts. During the fourteen day period from September 20, 2012 through October 3, 2012, Victory State Bank was required to maintain reserves, after deducting vault cash, of $4,443,000. Reserves are required to be maintained on a fourteen day basis, so, from time to time, Victory State Bank may use available cash reserves on a day to day basis, so long as the fourteen day average reserves satisfy Regulation D requirements. Victory State Bank is required to report transaction account levels to the Federal Reserve on a weekly basis.

Interest-bearing bank balances – Interest-bearing bank balances mature overnight and are carried at cost.

Investment Securities, Available for Sale - Investment securities, available for sale, are to be held for an unspecified period of time and include securities that management intends to use as part of its asset/liability strategy. These securities may be sold in response to changes in interest rates, prepayments or other factors and are carried at estimated fair value. Gains or losses on the sale of such securities are determined by the specific identification method. Interest income includes amortization of purchase premium and accretion of purchase discount. Premiums and discounts are recognized in interest income using a method that approximates the level yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are estimated. Unrealized holding gains or losses, net of deferred income taxes, are excluded from earnings and reported as other comprehensive income in a separate component of stockholders’ equity until realized. For debt securities with other than temporary impairment (OTTI) that management does not intend to sell or expect to be required to sell, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

The Company invests primarily in agency collateralized mortgage-Backed obligations (“CMOs”) with estimated average lives primarily under 7 Years and mortgage-backed securities. These securities are primarily issued by the Federal National Mortgage Association (“FNMA”), the Government National Mortgage Association (“GNMA”) or the Federal Home Loan Mortgage Corporation (“FHLMC”) and are primarily comprised of mortgage pools guaranteed by FNMA, GNMA or FHLMC. The Company also invests in whole loan CMOs, collateralized loan obligations (“CLO”) and asset backed securities, all of which are AAA rated at the time of purchase. These securities expose the Company to risks such as interest rate, prepayment and credit risk and thus pay a higher rate of return than comparable treasury issues.

Loans Receivable - Loans receivable, that management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are stated at unpaid principal balances, adjusted for deferred net origination and commitment fees and the allowance for loan losses. Interest income on loans is credited as earned.

It is the policy of the Company to provide a valuation allowance for probable incurred losses on loans based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations which may affect the borrower’s ability to repay, estimated value of underlying collateral and current economic conditions in the Company’s lending area. The allowance is increased by provisions for loan losses charged to earnings and is reduced by charge-offs, net of recoveries. While management uses available information to estimate losses on loans, future additions to the allowance may be necessary based upon the expected growth of the loan portfolio and any changes in economic conditions beyond management’s control. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management. Management believes, based upon all relevant and available information, that the allowance for loan losses is appropriate.

The Company has a policy that all loans 90 days past due are placed on non-accrual status. It is the Company’s policy to cease the accrual of interest on loans to borrowers past due less than 90 days where a probable loss is estimated and to reverse out of income all interest that is due but has not been paid. The Company applies payments received on non-accrual loans to the outstanding principal balance due before applying any amount to interest, until the loan is restored to an accruing status. On a limited basis, the Company may apply a payment to interest on a non-accrual loan if there is no impairment or no estimated loss on these assets. The Company continues to accrue interest on construction loans that are 90 days past contractual maturity date if the loan is expected to be paid in full in the next 60 days and all interest is paid up to date.

Loan origination fees and certain direct loan origination costs are deferred and the net amount recognized over the contractual loan terms using the level-yield method, adjusted for periodic prepayments in certain circumstances.

The Company considers a loan to be impaired when, based on current information, it is probable that the Company will be unable to collect all principal and interest payments due according to the contractual terms of the loan agreement. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Impairment is measured on a loan by loan basis for commercial and construction loans. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral. The fair value of the collateral, as reduced by costs to sell, is utilized if a loan is collateral dependent. The fair value of the collateral is estimated by obtaining a new appraisal, if the loan amount exceeds $100,000, or by adjusting the most recent appraisal to reflect the current market if the loan is less than $100,000 or a more recent appraisal has yet to be received. Loans with modified terms that the Company would not normally consider, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Large groups of homogeneous loans are collectively evaluated for impairment.

Long-Lived Assets - The Company periodically evaluates the recoverability of long-lived assets, such as premises and equipment, to ensure the carrying value has not been impaired. In performing the review for recoverability, the Company would estimate the future cash flows expected to result from the use of the asset. If the sum of the expected future cash flows is less than the carrying amount, an impairment will be recognized. The Company reports these assets at the lower of the carrying value or fair value.

Premises and Equipment - Premises, leasehold improvements, and furniture and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are accumulated by the straight-line method over the estimated useful lives of the respective assets, which range from three to fifteen years. Leasehold improvements are amortized at the lesser of their useful life or the term of the lease.

Federal Home Loan Bank (FHLB) Stock - The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment. Because this stock is viewed as a long term investment, impairment is based on ultimate recovery of par value, which is the price the Bank pays for the FHLB Stock. Both cash and stock dividends are reported as income.

Income Taxes - The Company utilizes the liability method to account for income taxes. Under this method, deferred tax assets and liabilities are determined on differences between financial reporting and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws expected to be in effect when the differences are expected to reverse. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. As such, a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

Financial Instruments - In the ordinary course of business, the Company has entered into off-balance sheet financial instruments, primarily consisting of commitments to extend credit.

Basic and Diluted Net Income Per Common Share - The Company has stock compensation awards with non-forfeitable dividend rights which are considered participating securities. As such, earnings per share is computed using the two-class method. Basic earnings per common share is computed by dividing net income allocated to common stock by the weighted average number of common shares outstanding during the period which excludes the participating securities. Diluted earnings per common share includes the dilutive effect of additional potential common shares from stock-based compensation plans, but excludes awards considered participating securities. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.

Basic net income per share of common stock is based on 1,740,777 shares and 1,772,464 shares, the weighted average number of common shares outstanding for the three months ended September 30, 2012 and 2011, respectively. Diluted net income per share of common stock is based on 1,740,777 and 1,772,464, the weighted average number of common shares outstanding plus potentially dilutive common shares for the three months ended September 30, 2012 and 2011, respectively. The weighted average number of potentially dilutive common shares excluded in calculating diluted net income per common share due to the anti-dilutive effect is 48,267 and 43,065 shares for the three months ended September 30, 2012 and 2011, respectively. Common stock equivalents were calculated using the treasury stock method.

Basic net income per share of common stock is based on 1,744,379 shares and 1,767,607 shares, the weighted average number of common shares outstanding for the nine months ended September 30, 2012 and 2011, respectively. Diluted net income per share of common stock is based on 1,744,379 and 1,768,237, the weighted average number of common shares outstanding plus potentially dilutive common shares for the nine months ended September 30, 2012 and 2011, respectively. The weighted average number of potentially dilutive common shares excluded in calculating diluted net income per common share due to the anti-dilutive effect is 47,293 and 32,991 shares for the nine months ended September 30, 2012 and 2011, respectively. Common stock equivalents were calculated using the treasury stock method.

The reconciliation of the numerators and the denominators of the basic and diluted per share computations for the three and nine months ended September 30, are as follows:

Reconciliation of EPS
	Three months ended			Three months ended
	September 30, 2012			September 30, 2011
Basic
Distributed earnings allocated to common stock	$	104,447		$	106,348
Undistributed earnings allocated to common sock		248,552			309,119
Net earnings allocated to common stock	$	352,999		$	415,467

Weighted common shares outstanding including participating securities		1,762,777			1,801,564
Less: Participating securities		(22,000	)		(29,100	)
Weighted average shares		1,740,777			1,772,464

Basic EPS	$	0.20		$	0.23

Diluted
Net earnings allocated to common stock	$	352,999		$	415,467

Weighted average shares for basic		1,740,777			1,772,464
Dilutive effects of:
Stock Options		—			—
Unvested shares not considered particpating securtities		—			—
		1,740,777			1,772,464

Diluted EPS	$	0.20		$	0.23

Reconciliation of EPS
	Nine months ended			Nine months ended
	September 30, 2012			September 30, 2011
Basic
Distributed earnings allocated to common stock	$	313,988		$	318,169
Undistributed earnings allocated to common sock		682,823			940,948
Net earnings allocated to common stock	$	996,811		$	1,259,117

Weighted common shares outstanding including participating securities		1,769,112			1,799,426
Less: Participating securities		(24,733	)		(31,819	)
Weighted average shares		1,744,379			1,767,607

Basic EPS	$	0.57		$	0.71

Diluted
Net earnings allocated to common stock	$	996,811		$	1,259,117

Weighted average shares for basic		1,744,379			1,767,607
Dilutive effects of:
Stock Options		—			630
Unvested shares not considered particpating securtities		—			—
		1,744,379			1,768,237

Diluted EPS	$	0.57		$	0.71

Net earnings allocated to common stock for the period are distributed earnings during the period, such as dividends on common shares outstanding, plus a proportional amount of retained income for the period based on restricted shares granted but unvested compared to the total common shares outstanding.

Stock Based Compensation - The Company records compensation expense for stock options provided to employees in return for employment service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employment service period, which is normally the vesting period of the options.

Employee Stock Ownership Plan (“ESOP”) - The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of stockholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Cash dividends on allocated ESOP shares reduce retained earnings; cash dividends on unearned ESOP shares reduce debt and accrued interest.

Stock Repurchase Programs – On September 8, 2008, the Company announced that its Board of Directors had authorized a Rule 10b5-1 stock repurchase program for the repurchase of up to 100,000 shares of the Company’s common stock. On April 21, 2009, the Company announced that its Board of Directors had authorized a second Rule 10b5-1 stock repurchase program for the repurchase of up to an additional 100,000 shares of the Company’s common stock. The Company has repurchased a total of 200,000 shares of its common stock under these stock repurchase programs, which were completed by the end of 2010. On September 14, 2011, the Company announced that its Board of Directors had authorized a third Rule 10b5-1 stock repurchase program for the repurchase of up to an additional 100,000 shares of the Company’s common stock. At September 30, 2012, the Company had repurchased a total of 49,200 shares of its common stock under this third stock repurchase program. Stock repurchases under the programs have been accounted for using the cost method, in which the Company will reflect the entire cost of repurchased shares as a separate reduction of stockholders’ equity on its balance sheet.

Retention and Recognition Plan – At the April 27, 2010 Annual Meeting, the stockholders of VSB Bancorp, Inc. approved the adoption of the 2010 Retention and Recognition Plan (the “RRP”). The RRP authorizes the award of up to 50,000 shares of its common stock to directors, officers and employees. In conjunction with the approval the RRP, stockholders approved the award of 4,000 shares of stock to each of its eight directors who had at least five years of service. The director awards will vest over five years, with 20% vesting annually for each of the first five years after the award is made, subject to acceleration and forfeiture. On April 27, 2011, 6,400 shares or 20% of the 32,000 shares of stock awarded to its eight directors who had at least five years of service had vested. On April 27, 2012, an additional 6,400 shares or 20% of the 32,000 shares of stock awarded to its eight directors who had at least five years of service had vested. On June 8, 2010, an additional 3,500 shares of stock were awarded to the President and CEO of the Company, which will vest over a 65 month period, with 20% vesting annually for each of the first five years starting in November 2011, subject to acceleration and forfeiture. On November 16, 2011, 700 shares or 20% of the 3,500 shares of stock awarded to the President and CEO of the Company had vested. The recipient of an award will not be required to make any payment to receive the award or the stock covered by the award. The Company recognizes compensation expense for the shares awarded under the RRP gradually as the shares vest, based upon the market price of the shares on the date of the award. For the nine months ended September 30, 2012, the Company recognized $60,557 of compensation expense related to the shares awarded. The income tax benefit resulting from this expense was $27,705. As of September 30, 2012, there was approximately $192,738 of unrecognized compensation costs related to the shares awarded. These costs are expected to be recognized over the next 2.50 years.

A summary of the status of the Company’s non-vested plan shares as of September 30, 2012 is as follows:

For the Nine Months Ended September 30, 2012:

			Weighted Average
	Shares		Grant Date Share Value

Non vested at beginning of period		28,400	$	11.46
Granted		—
Vested		6,400	$	—
Non vested at end of period		22,000	$	11.46

Comprehensive Income - Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses, net of taxes, on securities available for sale which are also recognized as separate components of equity.

3.	INVESTMENT SECURITIES, AVAILABLE FOR SALE

The following table summarizes the amortized cost and fair value of the available-for-sale investment securities portfolio at September 30, 2012 and December 31, 2011 and the corresponding amounts of unrealized gains and losses herein:

	September 30, 2012
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value

FNMA MBS - Residential	$	29,761,097	$	811,289	$	(26,638	)	$	30,545,748
GNMA MBS - Residential		5,421,435		160,409		—			5,581,844
Whole Loan MBS - Residential		525,843		17,171		—			543,014
Collateralized mortgage obligations		69,747,334		1,929,318		—			71,676,652
Collateralized loan obligations		1,000,000		—		—			1,000,000
Other debt securities		2,942,540		3,850		—			2,946,390
	$	109,398,249	$	2,922,037	$	(26,638	)	$	112,293,648

	December 31, 2011
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value

FNMA MBS - Residential	$	5,080,697	$	109,069	$	—		$	5,189,766
GNMA MBS - Residential		6,748,239		228,105		—			6,976,344
Whole Loan MBS - Residential		786,085		20,531		—			806,616
Collateralized mortgage obligations		93,023,287		2,504,478		(2	)		95,527,763
	$	105,638,308	$	2,862,183	$	(2	)	$	108,500,489

There were no sales of investment securities for the nine months ended September 30, 2012 and 2011.

The amortized cost and fair value of the investment securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities, especially for collateralized mortgage obligations, if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

	September 30, 2012
	Amortized		Fair
	Cost		Value

Less than one year	$	—	$	—
Due after one year through five years		14,006,717		14,137,620
Due after five years through ten years		25,557,425		26,542,600
Due after ten years		69,834,107		71,613,428
	$	109,398,249	$	112,293,648

The following table summarizes the investment securities with unrealized losses at September 30, 2012 and December 31, 2011 by aggregated major security type and length of time in a continuous unrealized loss position:

September 30, 2012	Less than 12 months					More than 12 months				Total
	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
	Value		Loss			Value		Loss		Value		Loss

FNMA MBS	$	3,004,380	$	(26,638	)	$	—	$	—	$	3,004,380	$	(26,638	)
GNMA MBS		—		—			—		—		—		—
Whole Loan MBS		—		—			—		—		—		—
Collateralized mortgage obligations		—		—			—		—		—		—
Collateralized loan obligations		—		—			—		—		—		—
Other debt securities		—		—			—		—		—		—
	$	3,004,380	$	(26,638	)	$	—	$	—	$	3,004,380	$	(26,638	)

December 31, 2011	Less than 12 months					More than 12 months				Total
	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
	Value		Loss			Value		Loss		Value		Loss

FNMA MBS	$	—	$	—		$	—	$	—	$	—	$	—
GNMA MBS		—		—			—		—		—		—
Whole Loan MBS		—		—			—		—		—		—
Collateralized mortgage obligations		5,038		(2	)		—		—		5,038		(2	)
	$	5,038	$	(2	)	$	—	$	—	$	5,038	$	(2	)

The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.

At September 30, 2012, the unrealized loss on investment securities was caused by average life increases. We expect that these securities, at maturity, will be settled for at least the amortized cost of the investment. Because the decline in fair value is attributable to changes in average life and not credit quality, and because the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before recovery of the amortized cost basis less any current-period loss, these investments are not considered other-than-temporarily impaired. At September 30, 2012, there were no debt securities with unrealized losses with aggregate depreciation of 5% or more from the Company’s amortized cost basis.

Securities pledged had a fair value of $55,658,927 and $55,080,059 at September 30, 2012 and December 31, 2011, respectively and were pledged to secure public deposits and balances in excess of the deposit insurance limit on certain customer accounts.

4.	FAIR VALUE MEASUREMENTS

The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of FASB ASC 820, “Financial Instruments”. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The following methods and assumptions were used by the Company in estimating fair values of financial instruments:

Interest-bearing Bank Balances – Interest-bearing bank balances mature within one year and are carried at cost, which are estimated to be reasonably close to fair value.

Money Market Investments – The fair value of these securities approximates their carrying value due to the relatively short time to maturity

Investment Securities, Available For Sale – The estimated fair value of these securities is determined by using available market information and appropriate valuation methodologies. The estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.

Federal Home Loan Bank Stock - It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Loans Receivable - The fair value of commercial and construction loans is approximated by the carrying value as the loans are tied directly to the Prime Rate and are subject to change on a daily basis, subject to the applicable interest rate floors. The fair value of the remainder of the portfolio is determined by discounting the future cash flows of the loans using the appropriate discount rate.

Other Financial Assets - The fair value of these assets, principally accrued interest receivable, approximates their carrying value due to their short maturity.

Non-Interest Bearing and Interest Bearing Deposits - The fair value disclosed for non-interest bearing deposits is equal to the amount payable on demand at the reporting date. The fair value of interest bearing deposits is based upon the current rates for instruments of the same remaining maturity. Interest bearing deposits with a maturity of greater than one year are estimated using a discounted cash flow approach that applies interest rates currently being offered.

Other Liabilities - The estimated fair value of other liabilities, which primarily include accrued interest payable, approximates their carrying amount.

The carrying amounts and estimated fair values of financial instruments, at September 30, 2012 and December 31, 2011 are as follows:

	Fair Value Measurements at September 30, 2012 Using
	Carrying		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Value		(Level 1)		(Level 2)		(Level 3)		Total
Financial Assets:
Cash and cash equivalents	$	62,823,176	$	3,466,686	$	59,356,490	$	—	$	62,823,176
Investment securities, available for sale		112,293,648		—		111,293,648		1,000,000		112,293,648
Loans receivable		80,298,337		—		—		80,480,688		80,480,688
Accrued interest receivable		556,014		—		286,316		269,698		556,014
Total Financial Assets	$	255,971,175	$	3,466,686	$	170,936,454	$	81,750,386	$	256,153,526

Financial Liabilities:
Deposits	$	230,954,847	$	79,534,085	$	151,400,676	$	—	$	230,934,761
Accrued interest payable		12,882		—		12,882		—		12,882
Total Financial Liabilities	$	230,967,729	$	79,534,085	$	151,413,558	$	—	$	230,947,643

	Fair Value Measurements at December 31, 2011 Using
	Carrying		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Value		(Level 1)		(Level 2)		(Level 3)		Total
Financial Assets:
Cash and cash equivalents	$	48,107,673	$	3,384,186	$	44,723,487	$	—	$	48,107,673
Investment securities, available for sale		108,500,489		—		108,500,489		—		108,500,489
Loans receivable		80,567,970		—		—		81,722,136		81,722,136
Accrued interest receivable		582,942		—		315,760		267,182		582,942
Total Financial Assets	$	237,759,074	$	3,384,186	$	153,539,736	$	81,989,318	$	238,913,240

Financial Liabilities:
Deposits	$	213,222,905	$	72,687,621	$	140,454,934	$	—	$	213,142,555
Accrued interest payable		17,011		—		17,011		—		17,011
Total Financial Liabilities	$	213,239,916	$	72,687,621	$	140,471,945	$	—	$	213,159,566

ASC 820 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing and asset or liability.

The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or using matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

	Fair Value Measurements at September 30, 2012 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
FNMA MBS - Residential	$	30,545,748	$	—	$	30,545,748	$	—
GNMA MBS - Residential		5,581,844		—		5,581,844		—
Whole Loan MBS - Residential		543,014		—		543,014		—
Collateralized mortgage obligations		71,676,652		—		71,676,652		—
Collateralized loan obligations		1,000,000		—		—		1,000,000
Other debt securities		2,946,390		—		2,946,390		—
Total Available for sale Securities	$	112,293,648	$	—	$	111,293,648	$	1,000,000

	Fair Value Measurements at December 31, 2011 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
FNMA MBS - Residential	$	5,189,766	$	—	$	5,189,766	$	—
GNMA MBS - Residential		6,976,344		—		6,976,344		—
Whole Loan MBS - Residential		806,616		—		806,616		—
Collateralized mortgage obligations		95,527,763		—		95,527,763		—
Total Available for sale Securities	$	108,500,489	$	—	$	108,500,489	$	—

Certain financial assets are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

There were no transfers between levels from December 31, 2011 to September 30, 2012.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2012:

	Collateralized
	Loan
	Obligations
	2012

Balance of recurring Level 3 assets at January 1:
Total gains or losses for the period:	$	—
Included in earnings		—
Included in other comprehensive income		—
Purchases		1,000,000
Sales		—
Issuances		—

Settlements
Transfers into Level 3		—
Transfers out of Level 3		—

Balance of recurring Level 3 assets at September 30:	$	1,000,000

The following table presents quantitative information about recurring Level 3 fair value measurement at September 30, 2012:

Fair

Valuation

Unobservable

Value

Techniques

Inputs

Range

Collateralized loan

1,000,000

Discounted

Collateral default rate

0%-2%

obligations

cash flow

Recovery probability

70%-100%

Assets Measured on a Non-Recurring Basis

Assets measured at fair value on a non-recurring basis are summarized below:

Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 3 inputs based on internally customized discounting criteria and updated appraisals when received.

Other real estate owned measured at fair value less cost to sell, had a net carrying amount of $348,321.

	Fair Value Measurements at September 30, 2012 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs			Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)			(Level 3)
Assets:
Impaired loans
Commercial Real Estate	$	1,194,555		—		—	$	1,194,555

Other real estate owned		348,321		—		—		348,321

	Fair Value Measurements at December 31, 2011 Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Impaired loans
Commercial Real Estate	$	1,004,279		—		—	$	1,004,279

Other real estate owned		267,246		—		—		267,246

As of September 30, 2012, we had four impaired loans with specific reserves that were collateral dependent. Collateral dependent impaired loans, which are measured for impairment using the fair value of the collateral, had a carrying amount of $1,773,765, with a valuation allowance of $579,210 at that date. The valuation allowance increased $233,115 from December 31, 2011 to September 30, 2012.

As of December 31, 2011, we had four impaired loans with specific reserves that were collateral dependent. Collateral dependent impaired loans, which are measured for impairment using the fair value of the collateral, had a carrying amount of $1,350,374, with a valuation allowance of $346,095 at that date.

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2012.

	Fair		Valuation	Unobservable
	Value		Techniques	Inputs	Range
Impaired loans-
Commercial real estate	$	588,330	Third Party Appraisal	Discount adjustment for differences in various costs.		0.01	%

		85,886	Third Party Appraisal	Adjustments for differences between comparable sales.		2.7% - 12.6%

		183,125	Third Party Appraisal	Adjustments for differences in net operating income expectations		10% - 27%

		337,214	Third Party Appraisal	Adjustments for differences in net operating income expectations		0% - 49%

				Capitalization Rate		8.20	%

Other real estate owned - commercial		267,246	Third Party Appraisal	Adjustments for differences in net operating income expectations		17% - 26%

				Capitalization Rate		8.00	%

Other real estate owned - residential		81,075	Third Party Appraisal	Adjustments for differences between comparable sales		2% - 6%

5.	LOANS RECEIVABLE, NET

Loans receivable, net at September 30, 2012 and December 31, 2011 are summarized as follows:

	September 30,			December 31,
	2012			2011

Commercial loans (principally variable rate):
Secured	$	1,367,072		$	1,522,639
Unsecured		14,540,455			12,997,139
Total commercial loans		15,907,527			14,519,778

Real estate loans:
Commercial		59,959,077			59,376,008
Residential		2,291,320			2,309,899
Total real estate loans		62,250,397			61,685,907

Construction loans (net of undisbursed funds of $2,644,500 and $2,215,000, respectively)		2,867,482			4,610,000

Consumer loans		499,624			602,144
Other loans		677,077			717,261
		1,176,701			1,319,405

Total loans receivable		82,202,107			82,135,090

Less:
Unearned loans fees, net		(236,854	)		(224,100	)
Allowance for loan losses		(1,666,916	)		(1,343,020	)

Total	$	80,298,337		$	80,567,970

Nonaccrual loans outstanding at September 30, 2012 and December 31, 2011 are summarized as follows:

	September 30,		December 31,
	2012		2011
Nonaccrual loans:
Commercial real estate	$	6,090,240	$	8,265,397
Residential real estate		—		2,200,000
Construction		—		397,500

Total nonaccrual loans	$	6,090,240	$	10,862,897

	September 30,		December 31,
	2012		2011
Interest income that would have been recorded during the period on nonaccrual loans outstanding
in accordance with original terms	$	356,180	$	595,946

At September 30, 2012 and December 31, 2011, there were no loans 90 days past due and still accruing interest.

The following table presents the aging of the past due loan balances as of September 30, 2012 and December 31, 2011 by class of loans:

September 30, 2012			30-59 Days		60-89 Days		Greater than 90 Days		Total		Loans Not
	Total		Past Due		Past Due		Past Due		Past Due		Past Due

Commercial loans:
Unsecured	$	14,540,455	$	—	$	1,060	$	—	$	1,060	$	14,539,395
Secured		1,367,072		3,070		—		—		3,070		1,364,002
Real Estate loans
Commercial		59,959,077		—		—		6,090,240		6,090,240		53,868,837
Residential		2,291,320		—		—		—		—		2,291,320
Construction loans		2,867,482		467,500		—		—		467,500		2,399,982
Consumer loans		499,624		9,977		—		—		9,977		489,647
Other loans		677,077		—		—		—		—		677,077
Total loans	$	82,202,107	$	480,547	$	1,060	$	6,090,240	$	6,571,847	$	75,630,260

December 31, 2011			30-59 Days		60-89 Days		Greater than 90 Days		Total		Loans Not
	Total		Past Due		Past Due		Past Due		Past Due		Past Due

Commercial loans:
Unsecured	$	12,997,139	$	84,529	$	16,260	$	—	$	100,789	$	12,896,350
Secured		1,522,639		—		—		—		—		1,522,639
Real Estate loans
Commercial		59,376,008		997,740		359,620		8,265,397		9,622,757		49,753,251
Residential		2,309,899		—		—		2,200,000		2,200,000		109,899
Construction loans		4,610,000		—		—		397,500		397,500		4,212,500
Consumer loans		602,144		678		—		—		678		601,466
Other loans		717,261		—		—		—		—		717,261
Total loans	$	82,135,090	$	1,082,947	$	375,880	$	10,862,897	$	12,321,724	$	69,813,366

Nonaccrual loans include smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

Loans individually evaluated for impairment were as follows:

	September 30,		December 31,
	2012		2011

Loans with no allocated allowance for loan losses:
Commercial real estate	$	4,090,418	$	6,662,331
Construction		—		397,500
Residential real estate		—		2,200,000
Loans with allocated allowance for loan losses:
Commercial real estate		1,773,765		1,350,374
	$	5,864,183	$	10,610,205

Amount of the allowance for loan losses allocated:
Commercial real estate	$	579,210	$	346,095

	$	579,210	$	346,095

The following table sets forth certain information about impaired loans with a measured impairment:

	Three Months		Nine Months
	Ended		Ended
	September 30,		September 30,
	2012		2012

Average of individually impaired loans during period:
Commercial real estate	$	5,873,758	$	6,605,848
Construction		—		132,500
Residential real estate		—		488,889
	$	5,873,758	$	7,227,237

Interest income recognized during time period that loans were impaired, either using accrual or cash-basis method of accounting	$	304	$	304

Troubled Debt Restructurings:

The Company has allocated $43,864 and $3,412 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings (“TDRs”) as of September 30, 2012 and December 31, 2011, respectively. The Company has not committed to lend any additional amounts to customers with outstanding loans that are classified as TDRs.

The outstanding principal balance of trouble debt restructurings at September 30, 2012 was $4,746,266 and at December 31, 2011 was $4,576,997. None of the loans currently classified as TDRs have defaulted during this period. These TDRs are all current and are paying under the modified arrangements.

The terms of certain other loans were modified during the nine months ended September 30, 2012 that did not meet the definition of a TDR. These loans have a total recorded investment as of September 30, 2012 of $105,994. The modification of these loans involved either a modification of the terms of a loan to borrowers who were not experiencing financial difficulties or a delay in a payment that was considered to be insignificant.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification.

The following table presents loans by class modified as troubled debt restructurings that occurred during the nine months ending September 30, 2012:

Pre-Modification

Post-Modification

Number

Outstanding Recorded

of Loans

Investment

Troubled Debt Restructurings:

Commerical real estate

2,110,580

The troubled debt restructurings described above required an additional allowance of $5,244 during the period ending September 30, 2012.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debts such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:

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

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

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

The following table sets forth at September 30, 2012 and December 31, 2011, the aggregate carrying value of our assets categorized as Special Mention, Substandard and Doubtful according to asset type:

	At September 30, 2012
	Special						Not
	Mention		Substandard		Doubtful		Classified		Total

Commercial Loans:
Secured	$	—	$	—	$	—	$	1,367,072	$	1,367,072
Unsecured		62,086		—		—		14,478,369		14,540,455
Commercial Real Estate		5,822,769		6,494,976		—		47,641,332		59,959,077
Residential Real Estate		—		2,185,691		—		105,629		2,291,320
Construction		—		—		—		2,867,482		2,867,482
Consumer		10,623		—		—		489,001		499,624
Other		—		—		—		677,077		677,077
Total loans	$	5,895,478	$	8,680,667	$	—	$	67,625,962	$	82,202,107

Real estate owned		—		348,321		—		—		348,321
Total assets	$	5,895,478	$	9,028,988	$	—	$	67,625,962	$	82,550,428

	At December 31, 2011
	Special						Not
	Mention		Substandard		Doubtful		Classified		Total

Commercial Loans:
Secured	$	—	$	—	$	—	$	1,522,639	$	1,522,639
Unsecured		127,132		50,379		—		12,819,628		12,997,139
Commercial Real Estate		2,012,188		9,039,881		—		48,323,939		59,376,008
Residential Real Estate		—		2,200,000		—		109,899		2,309,899
Construction		—		397,500		—		4,212,500		4,610,000
Consumer		12,682		—		—		589,462		602,144
Other		5,306		—		—		711,955		717,261
Total loans	$	2,157,308	$	11,687,760	$	—	$	68,290,022	$	82,135,090

Real estate owned		—		267,246		—		—		267,246
Total assets	$	2,157,308	$	11,955,006	$	—	$	68,290,022	$	82,402,336

The following table presents the balance in the allowance for loan losses and the recorded balance in loans, by portfolio segment, and based on impairment method as of September 30, 2012 and December 31, 2011:

September 30, 2012

	Commercial		Commercial				Commerical		Residential		Other
	Unsecured		Secured		Construction		Real Estate		Real Estate		Loans		Total

Allowance for loan losses:
Ending allowance balance attributable to loans
Individually evaluated for impairment	$	—	$	—	$	—	$	588,317	$	—	$	—	$	588,317
Collectively evaluated for impairment		528,582		11,443		20,695		471,553		3,189		43,137		1,078,599
Total ending allowance balance	$	528,582	$	11,443	$	20,695	$	1,059,870	$	3,189	$	43,137	$	1,666,916

Loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	6,494,976	$	2,185,691	$	—	$	8,680,667
Collectively evaluated for impairment		14,540,455		1,367,072		2,867,482		53,464,101		105,629		1,176,701		73,521,440
Total ending loans balance	$	14,540,455	$	1,367,072	$	2,867,482	$	59,959,077	$	2,291,320	$	1,176,701	$	82,202,107

December 31, 2011

	Commercial		Commercial				Commerical		Residential		Other
	Unsecured		Secured		Construction		Real Estate		Real Estate		Loans		Total

Allowance for loan losses:
Ending allowance balance attributable to loans
Individually evaluated for impairment	$	6,664	$	—	$	—	$	363,520	$	—	$	—	$	370,184
Collectively evaluated for impairment		468,022		12,356		34,184		417,300		672		40,302		972,836
Total ending allowance balance	$	474,686	$	12,356	$	34,184	$	780,820	$	672	$	40,302	$	1,343,020

Loans:
Individually evaluated for impairment	$	50,379	$	—	$	397,500	$	9,039,881	$	2,200,000	$	—	$	11,687,760
Collectively evaluated for impairment		12,946,760		1,522,639		4,212,500		50,336,127		109,899		1,319,405		70,447,330
Total ending loans balance	$	12,997,139	$	1,522,639	$	4,610,000	$	59,376,008	$	2,309,899	$	1,319,405	$	82,135,090

The following table presents the activity in the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2012 and September 30, 2011.

Three months ended September 30, 2012

	Commercial			Commercial						Commerical		Residential		Other
	Unsecured			Secured			Construction			Real Estate		Real Estate		Loans			Total

Allowance for loan losses:
Beginning balance	$	547,621		$	13,678		$	37,186		$	930,883	$	2,190	$	50,839		$	1,582,397
Provision for loan losses		(29,818	)		(2,235	)		(16,491	)		86,237		999		1,308			40,000
Loans charged-off		—			—			—			—		—		(10,917	)		(10,917	)
Recoveries		10,779			—			—			42,750		—		1,907			55,436
Total ending allowance balance	$	528,582		$	11,443		$	20,695		$	1,059,870	$	3,189	$	43,137		$	1,666,916

Three months ended September 30, 2011

	Commercial		Commercial					Commerical		Residential			Other
	Unsecured		Secured		Construction			Real Estate		Real Estate			Loans			Total

Allowance for loan losses:
Beginning balance	$	542,558	$	11,701	$	37,517		$	564,952	$	5,173		$	30,729		$	1,192,630
Provision for loan losses		53,259		1,237		(1,985	)		32,917		(4,342	)		8,914			90,000
Loans charged-off		—		—		—			—		—			(1,942	)		(1,942	)
Recoveries		31,887		—		—			—		—			—			31,887
Total ending allowance balance	$	627,704	$	12,938	$	35,532		$	597,869	$	831		$	37,701		$	1,312,575

Nine months ended September 30, 2012

	Commercial			Commercial						Commerical			Residential			Other
	Unsecured			Secured			Construction			Real Estate			Real Estate			Loans			Total

Allowance for loan losses:
Beginning balance	$	474,686		$	12,356		$	34,184		$	780,820		$	672		$	40,302		$	1,343,020
Provision for loan losses		54,906			(913	)		(13,489	)		252,975			(25,124	)		11,645			280,000
Loans charged-off		(100,757	)		—			—			(16,675	)		—			(10,917	)		(128,349	)
Recoveries		99,747			—			—			42,750			27,641			2,107			172,245
Total ending allowance balance	$	528,582		$	11,443		$	20,695		$	1,059,870		$	3,189		$	43,137		$	1,666,916

Nine months ended September 30, 2011

	Commercial			Commercial						Commerical			Residential			Other
	Unsecured			Secured			Construction			Real Estate			Real Estate			Loans			Total

Allowance for loan losses:
Beginning balance	$	520,953		$	13,486		$	52,138		$	653,362		$	7,174		$	30,107		$	1,277,220
Provision for loan losses		223,618			(548	)		(16,606	)		(60,993	)		(6,343	)		5,872			145,000
Loans charged-off		(185,054	)		—			—			—			—			(1,943	)		(186,997	)
Recoveries		68,187			—			—			5,500			—			3,665			77,352
Total ending allowance balance	$	627,704		$	12,938		$	35,532		$	597,869		$	831		$	37,701		$	1,312,575

Many of our loans are made in the Borough of Staten Island and we are still assessing the impact of Hurricane Sandy on the allowance for loan loss and the loan portfolio.

6.	SUBSEQUENT EVENTS

Hurricane Sandy has had a devastating effect on the homes and businesses of New York City, especially Staten Island. We have been able to open four of five locations the day after the Hurricane and we are operating in a reasonable manner. We are still assessing the full impact of Hurricane Sandy, including the effects on the allowance for loan loss and the loan portfolio, and we will address any of the associated issues as they arise.

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Financial Condition at September 30, 2012

Total assets were $259,846,039 at September 30, 2012, an increase of $17,999,584, or 7.4%, from December 31, 2011. The increase resulted from the investment of funds available to us as the result of retained earnings and an increase in deposits. The deposit increase was caused generally by our efforts to grow our franchise and specifically by the deposit increases at our branch offices. We invested these funds primarily in the purchase of new investment securities and short term liquid funds. The principal changes resulting in the net increase in assets can be summarized as follows:

	•	a $14,715,503 net increase in cash and cash equivalents and
	•	a $3,793,159 net increase in investment securities available for sale.

In addition to these changes in major asset categories, we also experienced changes in other asset categories due to normal fluctuations in operations.

Our deposits (including escrow deposits) were $230,954,847 at September 30, 2012, an increase of $17,731,942 or 8.3%, from December 31, 2011 as a result of our active solicitation of retail deposits to increase funds for investment. The aggregate increase in deposits resulted from increases of $7,026,530 in non-interest demand deposits, $5,727,857 in money market accounts, $3,575,103 in savings accounts, $3,290,674 in NOW accounts, and $141,775 in escrow deposits, partially offset by a decrease of $2,029,997 in time deposits.

Total stockholders’ equity was $27,712,459 at September 30, 2012, an increase of $610,199, or 2.25%, from December 31, 2011. The increase reflected: (i) a $690,656 increase in retained earnings due to net income of $1,010,945 for the nine months ended September 30, 2012, partially offset by $320,289 of dividends paid in 2012; (ii) a reduction of $126,809 in Unearned ESOP shares reflecting the gradual payment of the loan we made to fund the ESOP’s purchase of our stock and (iii) an increase in the net unrealized gain on securities available for sale of $18,021. Additionally, there was a $234,477 increase in Treasury shares representing the cost of 22,000 shares of common stock we repurchased in the during the first nine months of 2012 under our Company’s third stock repurchase plan.

The unrealized gain on securities available for sale is excluded from the calculation of regulatory capital. Management does not anticipate selling securities in this portfolio, but changes in market interest rates or in the demand for funds may change management’s plans with respect to the securities portfolio. If there is a material increase in interest rates, the market value of the available for sale portfolio may decline. Management believes that the principal and interest payments on this portfolio, combined with the existing liquidity, will be sufficient to fund loan growth and potential deposit outflow.

The Current Economic Turmoil

The economy in the United States, including the economy in Staten Island, was and may still be in a recession. Although some analysts report that the economy is recovering, the extent and speed of the recovery is far from clear and some analysts predict a darker road ahead. There is substantial stress on many financial institutions and financial products. The federal government has intervened by making hundreds of billions of dollars in capital contributions to the banking industry. We draw a substantial portion of our customer base from local businesses, especially those in the building trades and related industries, and we believe that there continue to be substantial weaknesses in the business economy in our market area. Our customers have been adversely affected by the economic downturn, and if adverse conditions in the local economy continue, it will become more difficult for us to conduct prudent and profitable business in our community.

Making permanent residential mortgage loans is not a material part of our business, and our investments in mortgage-backed securities and collateralized mortgage obligations have been made with a view towards avoiding the types of securities that are backed by low quality mortgage-related assets. However, one of the primary focuses of our local business is receiving deposits from, and making loans to, businesses involved in the construction and building trades industry on Staten Island. Construction loans represented a significant component of our loan portfolio, reaching 39.8% of total loans at year end 2005. As we monitored the economy and the strength of the local construction industry, we elected to reduce our portfolio of construction loans. By September 30, 2012, the percentage had declined to 3.5%. However, developers and builders provide not only a source of loans, but they also provide us with deposits and other business. The weakness in the economy has had an adverse effect on some of our customers and potential customers, making it more difficult for us to find satisfactory loan opportunities. This compelled us to invest in lower yielding securities instead of higher-yielding loans. This has and may continue to reduce our net income.

Possible Adverse Effects on Our Net Income Due to Fluctuations in Market Rates

Our principal source of income is the difference between the interest income we earn on interest-earning assets, such as loans and securities, and our cost of funds, principally interest paid on deposits. These rates of interest change from time to time, depending upon a number of factors, including general market interest rates. However, the frequency of the changes varies among different types of assets and liabilities. For example, for a five-year loan with an interest rate based upon the prime rate, the interest rate may change every time the prime rate changes. In contrast, the rate of interest we pay on a five-year certificate of deposit adjusts only every five years, based upon changes in market interest rates.

In general, the interest rates we pay on deposits adjust more slowly than the interest rates we earn on loans because our loan portfolio consists primarily of loans with interest rates that fluctuate based upon the prime rate. In contrast, although many of our deposit categories have interest rates that could adjust immediately, such as interest checking accounts and savings accounts, changes in the interest rates on those accounts are at our discretion. Thus, the rates on those accounts, as well as the rates we pay on certificates of deposit, tend to adjust more slowly. As a result, the declines in market interest rates that occurred through the end of 2008 initially had an adverse effect on our net income because the yields we earn on our loans declined more rapidly than our cost of funds. However, many of our prime-based loans have minimum interest rates, or floors, below which the interest rate does not decline despite further decreases in the prime rate. As our loans reached their interest rate floors, our loan yields stabilized while our deposit costs continued to decline. This had a positive effect on our net interest income.

When market interest rates begin increasing, which we expect will occur at some point in the future, we anticipate an initial adverse effect on our net income. We anticipate that this will occur because our deposit rates should begin to rise, while loan yields remain relatively steady until the prime rate increases sufficiently that our loans begin to reprice above their interest rate floors. For most of our prime-rate based loans, this will not occur until the prime rate increases above 6%. Once our loan rates exceed the interest rate floors, increases in market interest rates should increase our net interest income because our cost of deposits should probably increase more slowly than the yields on our loans. However, customer preferences and competitive pressures may negate this positive effect because customers may choose to move funds into higher-earning deposit types as higher interest rates make them more attractive, or competitors offer premium rates to attract deposits. We also have a substantial portfolio of investment securities with fixed rates of interest, most of which are mortgage-backed securities with an estimated average life of not more than 7 years.

Delays in Foreclosure Proceedings

The length of time it takes to prosecute a foreclosure action and be able to sell real estate collateral in New York has substantially lengthened. It is not unusual for it to take more than a full year from the date a foreclosure action is commenced until the property is sold even in uncontested cases, and some uncontested cases can take as long as two years. This problem, if it continues or gets worse, could have a substantial adverse effect on the value of our collateral for loans in default. Especially in the case of construction loans, where property value deterioration during a lengthy foreclosure is more likely, the inability to realize upon collateral increases our loss in the event of a default.

Possible Effects of Hurricane Sandy

Results of Operations for the Three Months Ended September 30, 2012 and September 30, 2011

Our results of operations depend primarily on net interest income, which is the difference between the income we earn on our loan and investment portfolios and our cost of funds, consisting primarily of interest we pay on customer deposits. Our operating expenses principally consist of employee compensation and benefits, occupancy expenses, professional fees, advertising and marketing expenses and other general and administrative expenses. Our results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.

General. We had net income of $357,460 for the three months ended September 30, 2012, compared to net income of $422,288 for the comparable period in 2011. The principal categories which make up the 2012 net income are:

	•	Interest income of $2,251,883
	•	Reduced by interest expense of $200,612
	•	Reduced by a provision for loan losses of $40,000
	•	Increased by non-interest income of $607,828
	•	Reduced by non-interest expense of $1,960,211
	•	Reduced by income tax expense of $301,428

We discuss each of these categories individually and the reasons for the differences between the quarters ended September 30, 2012 and 2011 in the following paragraphs.

Interest Income. Interest income was $2,251,883 for the quarter ended September 30, 2012, compared to $2,494,086 for the quarter ended September 30, 2011, a decrease of $242,203 or 9.7%. The main reason for the decline was a 63 basis point decrease in the yield and a $2,089,124 decrease in average balance on investment securities between the periods, which combined to cause a $202,517 decline in interest income on investment securities. There was also a $52,707 decrease in interest income on loans

Interest income on loans decreased by $52,707 as a result of a decrease of $62,062 of interest collected on loans previously on non-accrual, from $100,523 for the third quarter of 2011 to $38,461 in the same period in 2012. There was a 12 basis point decrease in the average loan yield, partially offset by a $1,307,222 increase in the average balance of loans from the third quarter of 2011 to the third quarter of 2012. The increase in the average balance was the result of our efforts to increase our loan portfolio, which represents our highest yielding asset category. There was a $1,071,847 decrease in our average non-performing loans, from $7.2 million in the quarter ending September 30, 2011, to $6.1 million in the third quarter of 2012. During the period in which interest is not being paid, non-performing loans continue to be included in the calculation of average loan yield, but with an effective yield of zero. We estimate that if all non-performing loans were performing according to their contractual terms during the third quarter of 2012, our average loan yield would have been approximately 55 basis points higher. In contrast, we estimate that the comparable effect in 2011 period would have been approximately a 54 basis point increase in average loan yield. Substantially all of the non-accrual loans are secured by mortgages on real estate.

Interest rate floors on most of our loans have helped to stabilize interest income from the loan portfolio, but these floors will have the effect of limiting increases in our income until the prime rate rises above 6%.

We experienced a 63 basis point decrease in the average yield on our investment securities portfolio, from 3.18% to 2.55%, due to the purchase of new investment securities at lower market rates than the rates we had been earning on the investment securities previously purchased that were gradually being repaid. The average balance of our investment portfolio decreased by $2.1 million, or 1.8%, between the periods, as we limited our purchases of new investment securities due to the low yields available. The investment securities portfolio represented 68.1% of average non-loan interest earning assets in the 2012 period compared to 75.7% in the 2011 period.

Interest income from other interest earning assets (principally overnight investments) increased by $13,021 due to an increase in the yield of 4 basis points from 0.18% for the quarter ended September 30, 2011 to 0.22% for the quarter ended September 30, 2012. In addition, the average balance of our other interest earning assets (principally overnight investments) increased by $16.4 million between the periods because we elected to invest available funds in overnight investments rather than tie them up in longer term investment securities which were available only at relatively low yields.

Interest Expense. Interest expense was $200,612 for the quarter ended September 30, 2012, compared to $210,382 for the quarter ended September 30, 2011, a decrease of $9,770 or 4.6%. The decrease was primarily the result of a reduction in the rates we paid on deposits, principally time deposits, reflecting a 10 basis point decrease in the cost of time deposits between the periods, due to the continuing low market interest rates. As a result, our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 0.53% from 0.61% between the periods.

Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $2,051,271 for the quarter ended September 30, 2012, compared to $2,283,704 for the quarter ended September 30, 2011, a decrease of $232,433, or 10.2%. The decrease was primarily because the reduction in our interest income was greater than the reduction in our cost of funds when comparing the quarter ended September 30, 2012 to the same period ended 2011. The average yield on interest earning assets declined by 55 basis points, while the average cost of funds declined by 8 basis points. The reduction in the yield on assets was principally due to the 63 basis point drop in the yield on investment securities and the 12 basis point decrease in the yield on loans. The decline in the cost of funds was driven principally by the 10 basis point drop in the cost of time deposits. Overall, our interest rate spread declined 47 basis points, from 3.44% to 2.97% between the periods. Correspondingly, our net interest margin decreased to 3.18% for the quarter ended September 30, 2012 from 3.70% in the same period of 2011. The margin is higher than the spread because it takes into account the effect of interest free demand deposits and capital.

The spread and margin both decreased because of the combined effect of the decline in earnings we were able to obtain on our investments securities and the increase in the average balance of other interest earning assets, our lowest yielding asset class. These declines could not be offset by corresponding declines in the cost of deposits because the rates we paid on deposits were already low due to low markets rates so that we could not reduce them as much as the decline in the earnings on investment securities. In addition, we continued to incur interest expense on deposits that funded the non-performing loans that did not earn interest.

Provision for Loan Losses. The provision for loan losses in any period depends upon the amount necessary to bring the allowance for loan losses to the level management believes is appropriate, after taking into account charge offs and recoveries. We took a provision for loan losses of $40,000 for the quarter ended September 30, 2012 compared to a provision for loan losses of $90,000 for the quarter ended September 30, 2011. The $50,000 decrease in the provision was a result of increased level of recoveries on loans previously charged off.

Our allowance for loan losses is based on management's evaluation of the risks inherent in our loan portfolio and the general economy. We use the following framework each calendar quarter to evaluate the appropriateness of our allowance for loan losses. We conduct a loan by loan evaluation of credit losses in all non-performing or classified loans and we conduct a collective analysis of homogenous groups of performing loans to estimate credit losses in those loans on a group by group basis. Our individual evaluation of non-performing mortgage loans, which represent most of our non-performing loans, is based primarily upon updated appraisals. Our evaluation of homogenous groups of performing loans takes into account historical charge off rates we have experienced, as adjusted for pertinent current factors that may affect the extent to which we should rely upon our charge off history.

We experienced a decrease of $2,415,471 in non-performing loans from $8,505,711 at September 30, 2011 to $6,090,240 at September 30, 2012. All the non-performing loans at September 30, 2012 were secured by real estate. We individually evaluated the non-performing loans based primarily upon updated appraisals of the real estate collateral as part of our analysis of the appropriate level of our allowance for loan and lease losses. We had charge-offs of $10,917 for the quarter ended September 30, 2012 as compared to charge-offs of $1,942 for the quarter ended September 30, 2011. We also had recoveries (which are added back to the allowance for loan losses) of $55,436 for the quarter ended September 30, 2012 as compared to $31,887 in the same period of 2011. After decreasing the provision for loan losses for the quarter ended September 30, 2012 compared to the same period in 2011, and considering other matters that increased or decreased the allowance, we determined that the level of our allowance at September 30, 2012 was appropriate to address probable and incurred losses. We are aggressively collecting charged-off loans in an effort to recover the amounts charged off whenever we believe that collection efforts are likely to be fruitful.

Although management uses available information to assess the appropriateness of the allowance on a quarterly basis in consultation with outside advisors and the board of directors, changes in national or local economic conditions, the circumstances of individual borrowers, or other factors, may change, increasing the level of problem loans and requiring an increase in the level of the allowance. Overall, our allowance for loan losses increased from $1,312,575, or 1.59% of total loans, at September 30, 2011 to $1,666,916 or 2.03% of total loans, at September 30, 2012. There can be no assurance that a higher level, or a higher provision for loan losses, will not be necessary in the future.

Non-interest Income. Non-interest income was $607,828 for the quarter ended September 30, 2012, compared to $602,505 during the same period last year. The $5,323, or 0.9%, increase in non-interest income was a direct result of a $7,532 increase in net rental income and $3,414 increase in loans fees, partially offset by an $8,490 decrease in service charges on deposits. Service charges on deposits consist mainly of insufficient fund fees, which are inherently volatile, and are based upon the number of items being presented for payment against insufficient funds.

Non-interest Expense. Non-interest expense was $1,960,211 for the quarter ended September 30, 2012, compared to $2,017,676 for the quarter ended September 30, 2011, a decrease of $57,465 or 2.9%. The principal shifts in the individual categories were:

	•	a $53,850 decrease in salaries and benefits costs due to reduced staff;
	•	a $36,402 decrease in occupancy expense due to the one-time remediation costs at a branch damaged in the third quarter of 2011, partially offset by:
	•	an $18,919 increase in professional fees due to increased costs and the hiring of a consultant, and
	•	a $9,321 increase in other non-interest expenses due to an increase in the cost of holding real estate acquired in the collection of mortgage loans;

In addition to these changes, we also experienced changes in the various other non-interest expenses categories due to normal fluctuations in operations.

Income Tax Expense. Income tax expense was $301,428 for the quarter ended September 30, 2012, compared to income tax expense of $356,245 for the same period ended 2011. The decrease in income tax expense was due to the $119,645 decrease in income before income taxes in the 2012 period. Our effective tax rate for the quarters ended September 30, 2012 and 2011 was 45.8%.

Results of Operations for the Nine Months Ended September 30, 2012 and September 30, 2011

General. We had net income of $1,010,945 for the nine months ended September 30, 2012, compared to net income of $1,281,783 for the comparable period in 2011. The principal categories which make up the 2012 net income are:

	•	Interest income of $6,886,588
	•	Reduced by interest expense of $608,093
	•	Reduced by a provision for loan losses of $280,000
	•	Increased by non-interest income of $1,856,784
	•	Reduced by non-interest expense of $5,991,735
	•	Reduced by income tax expense of $852,599

We discuss each of these categories individually and the reasons for the differences between the nine months ended September 30, 2012 and 2011 in the following paragraphs.

Interest Income. Interest income was $6,886,588 for the nine months ended September 30, 2012, compared to $7,349,585 for the nine months ended September 30, 2011, a decrease of $462,997 or 6.3%. The main reason for the decline was a 62 basis point decrease in the yield and a $4,177,726 decrease in average balance on investment securities between the periods, which combined to cause a $630,521 decline in interest income on investment securities. This was partially offset by the $131,172 increase in interest income on loans.

Interest income on loans increased by $131,172 as a result of an increase of $68,366 of interest collected on loans previously on non-accrual, from $123,588 in the first nine months of 2011 to $191,954 in the same period in 2012. Also contributing to the increase in income on loans were a $1.8 million increase in the average balance of loans and a 2 basis point increase in the average yield, from the first nine months of 2011 to the first nine months of 2012. The increase in the average balance was the result of our efforts to increase our loan portfolio, which represents our highest yielding asset category. There was a $1,071,847 decrease in our average non-performing loans, from $7.2 million in the first nine months of 2011 to $6.1 million in the first nine months ended of 2012. During the period in which interest is not being paid, non-performing loans continue to be included in the calculation of average loan yield, but with an effective yield of zero. We estimate that if all non-performing loans were performing according to their contractual terms during the first nine months of 2012, our average loan yield would have been approximately 34 basis points higher. In contrast, we estimate that the comparable effect in 2011 period would have been approximately a 46 basis point increase in average loan yield. Substantially all of the non-accrual loans are secured by mortgages on real estate.

We experienced a 62 basis point decrease in the average yield on our investment securities portfolio, from 3.33% to 2.71%, due to the purchase of new investment securities at lower market rates than the rates we had been earning on the investment securities previously purchased that were gradually being repaid. The average balance of our investment portfolio decreased by $4.2 million, or 3.5%, between the periods. The investment securities portfolio represented 70.4% of average non-loan interest earning assets in the 2012 period compared to 77.9% in the 2011 period.

Interest income from other interest earning assets (principally overnight investments) increased by $36,352 due to an increase in the yield of 5 basis points from 0.17% for the nine months ended September 30, 2011 to 0.22% for the same period ended September 30, 2012. In addition, the average balance of our interest earning assets increased by $14.3 million between the periods because we elected to invest available funds in overnight investments rather than tie them up in longer term investment securities which were available only at relatively low yields.

Interest Expense. Interest expense was $608,093 for the nine months ended September 30, 2012, compared to $653,499 for the nine months ended September 30, 2011, a decrease of $45,406 or 7.0%. The decrease was primarily the result of a reduction in the rates we paid on deposits between the periods, principally a 10 basis point decrease in money market account rates and a 8 basis point decrease in the cost of Now account deposits, due to the continuing low market interest rates. As a result, our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 0.55% from 0.63% between the periods.

Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $6,278,495 for the nine months ended September 30, 2012, compared to $6,696,086 for the nine months ended September 30, 2011, a decrease of $417,591, or 6.2%. The decrease was primarily because the reduction in our interest income was greater than the reduction in our cost of funds when comparing the nine months ended September 30, 2012 to the same period ended 2011. The average yield on interest earning assets declined by 47 basis points, while the average cost of funds declined by 8 basis points. The reduction in the yield on assets was principally due to the 62 basis point drop in the yield on investment securities partially offset by the 2 basis point increase in the yield on loans. The decline in the cost of funds was driven principally by the 10 basis point decrease in money market accounts and the 8 basis point decrease in the cost of NOW account deposits. Overall, our interest rate spread declined 39 basis points, from 3.56% to 3.17% between the periods. Correspondingly, our net interest margin decreased to 3.39% for the nine months ended September 30, 2012 from 3.81% in the same period of 2011. The margin is higher than the spread because it takes into account the effect of interest free demand deposits and capital.

The spread and margin both decreased because of the combined effect of the decline in earnings we were able to obtain on our investments securities and the adverse effect of the decrease in interest received on problem loans. These declines could not be offset by corresponding declines in the cost of deposits because the rates we paid on deposits were already low due to low markets rates so that we could not reduce them as much as the decline in the earnings on investment securities. In addition, we continued to incur interest expense on deposits that funded the non-performing loans that did not earn interest and on other interest earning assets, our lowest yielding asset class.

Provision for Loan Losses. The provision for loan losses in any period depends upon the amount necessary to bring the allowance for loan losses to the level management believes is appropriate, after taking into account charge offs and recoveries. We took a provision for loan losses of $280,000 for the nine months ended September 30, 2012 compared to a provision for loan losses of $145,000 for the nine months ended September 30, 2011. The $135,000 increase in the provision was a result of increased write downs on impaired loans between the periods, due to the reduction in the fair value of underlying collateral, partially offset by the higher level of recoveries and a lower level of charge-offs between the periods.

We charged-off $128,349 of loans for the nine months ended September 30, 2012 as compared to charge-offs of $186,997 for the nine months ended September 30, 2011. We also had recoveries (which are added back to the allowance for loan losses) of $172,245 for the nine months ended September 30, 2012 as compared to $77,352 in the same period of 2011. After increasing the provision for loan losses for the nine months ended September 30, 2012 compared to the same period in 2011, and considering other matters that increased or decreased the allowance, we determined that the level of our allowance at September 30, 2012 was appropriate to address inherent losses.

Non-interest Income. Non-interest income was $1,856,784 for the nine months ended September 30, 2012, compared to $1,833,501 during the same period last year. The $23,283, or 1.3%, increase in non-interest income was a direct result of a $34,400 increase in service charges on deposits, partially offset by a $17,600 decrease in loan fees. Service charges on deposits consist mainly of insufficient fund fees, which are inherently volatile, and are based upon the number of items being presented for payment against insufficient funds.

Non-interest Expense. Non-interest expense was $5,991,735 for the nine months ended September 30, 2012, compared to $6,021,744 for the nine months ended September 30, 2011, a decrease of $30,009 or 0.5%. The principal shifts in the individual categories were:

	•	a $95,253 decrease in salaries and benefits due to reduced staff;
	•	a $46,149 decrease in occupancy expense due primarily to the 2011 remediation at a branch that flooded during Hurricane Irene;
	•	a $19,736 decrease in computer expenses due to reduced contract expense; and
	•	a $15,500 decrease in FDIC and NYSDFS assessments due to change in the FDIC’s methodology for calculating the FDIC assessment rate, partially offset by;
	•	a $52,281 increase in legal expense due to a higher level of collections and a recovery of legal fees in 2011 previously expensed on a settled lawsuit;
	•	a $41,494 increase in other non-interest expenses due to an increase in the cost of holding real estate acquired in the collection of mortgage loans and increased costs of preparing regulatory filings;
	•	a $35,479 increase in professional fees due to higher costs and the hiring of a consultant, and
	•	a $17,375 increase in director’s fee due to increased frequency of meetings.

In addition to these changes, we also experienced changes in the various other non-interest expenses categories due to normal fluctuations in operations.

Income Tax Expense. Income tax expense was $852,599 for the nine months ended September 30, 2012, compared to income tax expense of $1,081,060 for the same period ended 2011. The decrease in income tax expense was due to the $499,299 decrease in income before income taxes in the 2012 period. Our effective tax rate for the nine months ended September 30, 2012 and 2011 was 45.8%.

VSB Bancorp, Inc.

Consolidated Average Balance Sheets

(unaudited)

	Three								Three								Nine								Nine
	Months Ended								Months Ended								Months Ended								Months Ended
	September 30, 2012								September 30, 2011								September 30, 2012								September 30, 2011
	Average					Yield/			Average					Yield/			Average					Yield/			Average					Yield/
	Balance			Interest		Cost			Balance			Interest		Cost			Balance			Interest		Cost			Balance			Interest		Cost

Assets:
Interest-earning assets:
Loans receivable	$	83,624,556		$	1,484,891		6.93	%	$	82,317,334		$	1,537,598		7.05	%	$	83,609,088		$	4,489,089		7.09	%	$	81,769,965		$	4,357,917		7.07	%
Investment securities, afs		115,085,676			736,733		2.55			117,174,800			939,250		3.18			114,151,954			2,319,168		2.71			118,329,680			2,949,689		3.33
Other interest-earning assets		53,928,685			30,259		0.22			37,525,965			17,238		0.18			47,912,849			78,331		0.22			33,600,969			41,979		0.17
Total interest-earning assets		252,638,917			2,251,883		3.50			237,018,099			2,494,086		4.05			245,673,891			6,886,588		3.72			233,700,614			7,349,585		4.19

Non-interest earning assets		6,322,086								6,523,333								6,739,147								6,809,926
Total assets	$	258,961,003							$	243,541,432							$	252,413,038							$	240,510,540

Liabilities and equity:
Interest-bearing liabilities:
Savings accounts	$	20,524,056			16,493		0.32		$	17,213,314			11,508		0.27		$	18,582,998			35,693		0.26		$	16,788,227			37,482		0.30
Time accounts		64,522,535			105,518		0.65			63,961,120			120,669		0.75			64,900,066			335,370		0.69			63,709,504			361,060		0.76
Money market accounts		32,315,022			59,187		0.73			27,948,058			59,240		0.84			30,863,139			174,058		0.75			28,178,819			179,720		0.85
Now accounts		33,625,213			19,414		0.23			27,625,974			18,965		0.27			32,698,581			62,972		0.26			29,526,174			75,237		0.34
Total interest-bearing liabilities		150,986,826			200,612		0.53			136,748,466			210,382		0.61			147,044,784			608,093		0.55			138,202,724			653,499		0.63
Checking accounts		78,777,306								77,104,389								76,352,685								73,334,580
Escrow deposits		330,984								326,038								362,952								366,416
Total deposits		230,095,116								214,178,893								223,760,421								211,903,720
Other liabilities		1,250,885								1,860,120								1,229,445								1,827,782
Total liabilities		231,346,001								216,039,013								224,989,866								213,731,502
Equity		27,615,002								27,502,419								27,423,172								26,779,038
Total liabilities and equity	$	258,961,003							$	243,541,432							$	252,413,038							$	240,510,540

Net interest income/net interest rate spread				$	2,051,271		2.97	%				$	2,283,704		3.44	%				$	6,278,495		3.17	%				$	6,696,086		3.56	%

Net interest earning assets/net interest margin	$	101,652,091					3.18	%	$	100,269,633					3.70	%	$	98,629,107					3.39	%	$	95,497,890					3.81	%

Ratio of interest-earning assets to interest-bearing liabilities		1.67	x							1.73	x							1.67	x							1.69	x

Return on Average Assets (1)		0.53	%							0.62	%							0.52	%							0.70	%
Return on Average Equity (1)		4.92	%							5.50	%							4.80	%							6.32	%
Tangible Equity to Total Assets		10.66	%							11.27	%							10.66	%							11.27	%

(1) Ratios have been annualized.

Liquidity and Capital Resources

Our primary sources of funds are increases in deposits, proceeds from the repayment of investment securities, and the repayment of loans. We use these funds to purchase new investment securities and to fund new and renewing loans in our loan portfolio. Remaining funds are invested in short-term liquid assets such as overnight federal funds loans and bank deposits.

During the nine months ended September 30, 2012, we had a net increase in total deposits of $17,731,942 due to increases of $7,026,530 in non-interest demand deposits, $5,727,857 in money market accounts, $3,575,103 in savings accounts, $3,290,674 in NOW accounts, and $141,775 in escrow deposits partially offset by a decrease of $2,029,997 in time deposits. These are all what are commonly known as “retail” deposits that we obtain through the efforts of our branch network rather than “wholesale” deposits that some banks obtain from deposit brokers. We also received proceeds from repayment of investment securities of $27,734,440. We used $31,841,957 of available funds to purchase new investment securities and we had a net loan increase of $36,363. These changes resulted in an overall increase in cash and cash equivalents of $14,715,503. Total cash and cash equivalents at September 30, 2012 were $62,823,176.

In contrast, during the nine months ended September 30, 2011, we had a net increase in total deposits of $8,455,879 due to increases of $11,815,602 in non-interest demand deposits, $2,125,408 in savings accounts, $1,134,206 in time deposits, $446,903 in money market accounts, and $107,611 in escrow deposits partially offset by a decrease of $7,173,851 in NOW accounts. These are all what are commonly known as “retail” deposits that we obtain through the efforts of our branch network rather than “wholesale” deposits that some banks obtain from deposit brokers. We also received proceeds from repayment of investment securities of $24,605,813. We used $15,614,398 of available funds to purchase new investment securities and we had a net loan increase of $543,300. These changes resulted in an overall increase in cash and cash equivalents of $18,449,677.

At September 30, 2012, cash and cash equivalents represented 30.6% of total assets. Our cash and cash equivalents increased as we deployed more funds into short term overnight funds which will enable us to take advantage of future opportunities and investment securities. We maintain a higher level of cash and cash equivalents to help buffer the adverse effects of potential, future rising interest rates. We anticipate, based upon historical experience that these funds, combined with cash inflows we anticipate from payments on our loan and investment securities portfolios, will be sufficient to fund loan growth and unanticipated deposit outflows. The federal legal prohibition on paying interest on demand deposit accounts was repealed effective July 2011. Depending upon competitive pressures, we may need to implement interest-paying business checking in order to maintain demand deposits at historical levels or to increase such deposits.

As a secondary source of liquidity, at September 30, 2012 we had $112.3 million of investment securities classified available for sale. The disposition of these securities prior to maturity is an option available to us in the event, which we believe is unlikely, that our primary sources of liquidity and expected cash flows are insufficient to meet our need for funds. Additionally, we have the ability to borrow funds at the Federal Home Loan Bank of New York and the Federal Reserve Bank of New York using securities in our investment portfolio as collateral if the need arises. Based upon our assets size and the amount of our securities portfolio that qualifies as eligible collateral, we had more than $77.4 million of unused borrowing capability from the FHLBNY at September 30, 2012. Victory State Bank also has a $2 million unsecured credit facility with Atlantic Central Bankers Bank, which the Bank has not drawn upon. We do not anticipate a need for additional capital resources and do not expect to raise funds through a stock offering in the near future. We have sufficient resources to allow us to continue to make loans as appropriate opportunities arise without having to rely on government funds to support our lending activities.

Victory State Bank satisfied all capital ratio requirements of the Federal Deposit Insurance Corporation at September 30, 2012, with a Tier I Leverage Capital ratio of 9.94%, a Tier I Capital to Risk-Weighted Assets ratio of 26.50%, and a Total Capital to Risk-Weighted Assets ratio of 27.75%.

The following table sets forth our contractual obligations and commitments for future lease payments, time deposit maturities and loan commitments.

Contractual Obligations and Commitments at September 30, 2012

Contractual Obligations	Payment due by Period
	Less than		One to three		Four to five		After five		Total Amounts
	One Year		years		years		years		committed

Minimum annual rental payments under non-cancelable operating leases	$	427,940	$	762,047	$	527,083	$	605,436	$	2,322,506
Remaining contractual maturities of time
deposits		56,819,158		2,404,566		4,640,815		—		63,864,539
Total contractual cash obligations	$	57,247,098	$	3,166,613	$	5,167,898	$	605,436	$	66,187,045

Other commitments	Amount of commitment Expiration by Period
	Less than		One to three		Four to five		After five		Total Amounts
	One Year		years		years		years		committed

Loan commitments	$	20,217,819	$	5,420,738	$	572,000	$	—	$	26,210,557

Non-Performing Loans

Management closely monitors non-performing loans and other assets with potential problems on a regular basis. We had seventeen non-performing loans, totaling $6,090,240 at September 30, 2012, compared to twenty three non-performing loans, totaling $10,862,897 at December 31, 2011. Non-performing loans totaled 7.41% of total loans at September 30, 2012 compared to 13.23% at December 31, 2011. We have always followed a hands-on approach to dealing with our past due borrowers that we believe is sufficiently aggressive to maximize recovery.

As noted in the discussion below regarding specific loans, many of our non-performing loans are secured by real estate, and thus we expect substantial if not complete recovery of the loan amount. However, it is inevitable that we will experience some charge-offs of non-performing loans. All of the loans discussed individually below were evaluated separately for impairment under ASC 310 and we have included a component of our allowance for loan and lease losses representing our measurement of the impairment on those loans. However, the process by which we estimate the potential loss on those loans is necessarily imprecise and subject to changing future events, facts that may be unknown to us, and other uncertainties. Thus, although we believe that our allowance for loan losses is appropriate to address the weaknesses in those loans, we may be required to increase our provision for loan losses in the future if actual impairment exceeds our expectations.

The following is information about the seven largest non-performing loans and the associated relationships, totaling $4,676,103, or 76.8% of our non-performing loans, by outstanding principal balance at September 30, 2012. Management believes it has taken appropriate steps with a view towards maximizing recovery and minimizing loss, if any, on these loans.

	•	$1,362,648 in two commercial real estate loans. The real estate loans are secured by a second mortgage on property in Staten Island and by a first mortgage on property in Queens. The real estate property in Staten Island is being foreclosed upon by the first mortgagee. The loans are guaranteed personally by the principals of the borrowers. We commenced foreclosure proceedings on the property in Queens and the court granted our motion for summary judgment. On the loan secured by the second mortgage, we elected to seek a money judgment against the borrower and the guarantors because of the pending foreclosure action by the first mortgagee. We were granted summary judgment in that action for the full loan amount.
	•	$1,224,198 in two commercial real estate loans. The loans, made to two individuals, are secured by a first mortgage and second mortgage on two pieces of real estate in Staten Island. The borrowers signed a modified repayment agreement and confessions of judgment in July, 2012. In accordance with the modified repayment arrangement, we received a principal payment of $150,000 in July 2012 and agreed to hold foreclosure proceedings in abeyance for six months.
	•	$1,000,713 in a commercial real estate loan. The loan is secured by a first mortgage on the property in Staten Island. The loan is guaranteed personally by the principals of the borrower. The borrower signed a forbearance agreement which includes a modified payment arrangement. After the end of the quarter, we received a $145,000 upfront payment and the borrower agreed to make monthly payments. We have agreed to hold the previously commenced foreclosure proceedings in abeyance as long as there is performance under the forbearance agreement.
	•	$589,544 in a commercial real estate loan. The loan is secured by a second mortgage on the property in Staten Island. The loan is guaranteed personally by the principals of the borrower. The borrower signed a modified repayment agreement in April, 2012 and we are holding the previously commenced foreclosure action in abeyance as long as it performs under the terms of the modified repayment arrangement. We received a $125,000 upfront payment and the borrower has been making payments under the terms of the modified agreement since May 2012.
	•	$499,000 in a commercial real estate loan on property in Staten Island that is leased to a restaurant. The loan is secured by a first mortgage on the property and a second mortgage on other commercial real estate collateral. The loan is guaranteed personally by the principals of the borrower and we have a security interest in the business. We have commenced foreclosure proceedings.

From time to time, the Bank will enter into agreements with borrowers to modify the terms of their loans when we believe that a modification will maximize our recovery. In most cases, we do not agree to reduce the rate of interest or forgive the repayment of principal when we agree to the loan modification, and we did not do so in any of the modifications described above. Instead, we seek to modify terms on an interim basis to allow the borrower to reduce payments for a short duration and thus give the borrower an opportunity to get back on its feet. We prefer to develop repayment plans for our borrowers that provide them with cash flow relief while requiring that they ultimately pay all amounts that they owe. However, we are not averse to commencing legal action to foreclose on mortgages or obtain personal judgments against obligors when we perceive that as the appropriate strategy. Unfortunately, in recent years, many courts have taken a very pro-borrower stance in foreclosure actions, which has resulted in delays in our ability to realize upon real estate collateral.

If loans with modifications are on non-accrual status when they are modified, we do not immediately restore them to accruing status. For those loans, as well as other loans on non-accrual status when the borrower makes payments, we initially record payments received either as a reduction of principal or as interest received on a cash basis. The choice between those alternatives depends upon the magnitude of the concessions, if any, we have given to the borrower, the nature of the collateral and the related loan to value ratio, and other factors affecting the likelihood that we will continue to receive regular payments.

Once a loan is categorized as a non-accrual loan, the loan may be restored to accruing status after a period of consistent on-time performance. The length of on-time performance required to restore a loan to accruing status varies from a minimum of six months on loans with minor modifications or less-severe weaknesses to as long as a year or more on loans for which we have granted more significant concessions to the borrower or which otherwise have more significant weaknesses.

Critical Accounting Policies and Judgments

We are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting period. The allowance for loan losses, prepayment estimates on the mortgage-backed securities and Collateralized Mortgage Obligation portfolios, contingencies and fair values of financial instruments are particularly subject to change and to management’s estimates. Actual results can differ from those estimates and may have an impact on our financial statements.

Item 4 –Controls and Procedures

Evaluation of Disclosure Controls and Procedures: As of September 30, 2012, we undertook an evaluation of our disclosure controls and procedures under the supervision and with the participation of Raffaele M. Branca, President and CEO and Jonathan B. Lipschitz, Vice President and Controller. Disclosure controls are the systems and procedures we use that are designed to ensure that information we are required to disclose in the reports we file or submit under the Securities Exchange Act of 1934 (such as annual reports on Form 10-K and quarterly periodic reports on Form 10-Q) is recorded, processed, summarized and reported, in a manner which will allow senior management to make timely decisions on the public disclosure of that information. Mr. Branca and Mr. Lipschitz concluded that our current disclosure controls and procedures are effective in ensuring that such information is (i) collected and communicated to senior management in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Since our last evaluation of our disclosure controls, we have not made any significant changes in, or taken corrective actions regarding, either our internal controls or other factors that could significantly affect those controls.

We intend to continually review and evaluate the design and effectiveness of our disclosure controls and procedures and to correct any deficiencies that we may discover. Our goal is to ensure that senior management has timely access to all material financial and non-financial information concerning our business so that they can evaluate that information and make determinations as to the nature and timing of disclosure of that information. While we believe the present design of our disclosure controls and procedures is effective to achieve this goal, future events may cause us to modify our disclosure controls and procedures.

Part II

Item 1 – Legal Proceedings

VSB Bancorp, Inc. is not involved in any pending legal proceedings. The Bank, from time to time, is involved in routine collection proceedings in the ordinary course of business on loans in default. Management believes that such other routine legal proceedings in the aggregate are immaterial to our financial condition or results of operations.

Signature Page

In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	VSB Bancorp, Inc.

Date: November 13, 2012	/s/ Raffaele M. Branca
	Raffaele M. Branca
	President, CEO and Principal Executive Officer

Date: November 13, 2012	/s/ Jonathan B. Lipschitz
	Jonathan B. Lipschitz
	Vice President, Controller and Principal
	Accounting Officer

EXHIBIT INDEX

Exhibit Number		Description of Exhibit
31.1		Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer
31.2		Rule 13A-14(a)/15D-14(a) Certification of Principal Accounting Officer
32.1		Certification by CEO pursuant to 18 U.S.C. 1350.
32.2		Certification by Principal Accounting Officer pursuant to 18 U.S.C. 1350.
101.INS		XBRL Instance Document (furnished herewith)
101.SCH		XBRL Taxonomy Extension Schema Document (furnished herewith)
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document (furnished herewith)
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document (furnished herewith)
101.LAB		XBRL Taxonomy Extension Label Linkbase Document (furnished herewith)
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document (furnished herewith)

Item 6 - Exhibits

Exhibit Number		Description of Exhibit
31.1		Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer
31.2		Rule 13A-14(a)/15D-14(a) Certification of Principal Accounting Officer
32.1		Certification by CEO pursuant to 18 U.S.C. 1350.
32.2		Certification by Principal Accounting Officer pursuant to 18 U.S.C. 1350.
101.INS		XBRL Instance Document (furnished herewith)
101.SCH		XBRL Taxonomy Extension Schema Document (furnished herewith)
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document (furnished herewith)
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document (furnished herewith)
101.LAB		XBRL Taxonomy Extension Label Linkbase Document (furnished herewith)
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document (furnished herewith)