Edgar Filing: VSB BANCORP INC

UNITED STATES

SECURITY AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20849

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2013

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

COMMISSION FILE NUMBER 001-33250

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 x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No o

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 o Accelerated Filer o Non-Accelerated Filer o Smaller Reporting Company x

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

Par Value: $0.0001 Class of Common Stock

The Registrant had 1,782,309 common shares outstanding as of November 8, 2013.

CROSS REFERENCE INDEX

		Page
	PART I

Item 1	Consolidated Statements of Financial Condition as of September 30, 2013 and December 31, 2012 (unaudited)	4
	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2013 and 2012 (unaudited)	5
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2013 and 2012 (unaudited)	6
	Consolidated Statements of Changes in Stockholders’ Equity for Each of the Quarters in the Nine Months Period Ended September 30, 2013 and the Year Ended December 31, 2012 (unaudited)	6 to 7
	Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 2013 and 2012 (unaudited)	8
	Notes to Consolidated Financial Statements for the Three and Nine Months Ended September 30, 2013 and 2012 (unaudited)	9 to 29
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30 to 43
Item 3	Control and Procedures	43

PART II

Item 1	Legal Proceedings	43

Signature Page		44

	Exhibit 31.1, 31.2, 32.1, 32.2	46 to 49

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,
	2013			2012

Assets:
Cash and due from banks	$	63,257,198		$	77,728,426
Investment securities, available for sale		56,912,504			106,825,570
Investment securities, held to maturity (fair value 2013 - $99,128,515)		99,958,474			—
Loans receivable		76,520,302			81,971,571
Allowance for loan loss		(1,260,454	)		(1,753,521	)
Loans receivable, net		75,259,848			80,218,050
Bank premises and equipment, net		2,050,521			2,097,356
Accrued interest receivable		551,728			617,833
Other assets		1,926,974			2,217,136
Total assets	$	299,917,247		$	269,704,371

Liabilities and stockholders’ equity:
Liabilities:
Deposits:
Demand and checking	$	97,497,389		$	81,881,173
NOW		35,502,753			33,394,785
Money market		41,565,442			33,023,373
Savings		22,591,370			20,871,593
Time		73,828,624			71,452,704
Total deposits		270,985,578			240,623,628
Escrow deposits		104,885			77,578
Accounts payable and accrued expenses		1,291,551			1,249,194
Total liabilities		272,382,014			241,950,400

Stockholders’ equity:
Common stock ($.0001 par value, 10,000,000 shares authorized, 1,989,509 issued, 1,785,309 outstanding at September 30, 2013 and at December 31, 2012)		199			199
Additional paid in capital		9,321,312			9,257,167
Retained earnings		19,790,109			19,336,280
Treasury stock, at cost (204,200 shares at September 30, 2013 and at December 31, 2012)		(2,068,898	)		(2,068,898	)
Unearned Employee Stock Ownership Plan shares		(98,629	)		(225,438	)
Accumulated other comprehensive income, net of taxes of $498,519 and $1,226,742, respectively		591,140			1,454,661

Total stockholders’ equity		27,535,233			27,753,971

Total liabilities and stockholders’ equity	$	299,917,247		$	269,704,371

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, 2013			Sept. 30, 2012			Sept. 30, 2013			Sept. 30, 2012
Interest and dividend income:
Loans receivable	$	1,312,109		$	1,484,891		$	4,137,806		$	4,489,089
Investment securities		817,651			736,733			2,093,702			2,319,168
Other interest earning assets		39,722			30,259			123,781			78,331
Total interest income		2,169,482			2,251,883			6,355,289			6,886,588

Interest expense:
NOW		15,110			19,414			47,303			62,972
Money market		57,048			59,187			157,163			174,058
Savings		20,030			16,493			57,963			35,693
Time		113,503			105,518			359,326			335,370
Total interest expense		205,691			200,612			621,755			608,093

Net interest income		1,963,791			2,051,271			5,733,534			6,278,495
Provision for loan loss		45,000			40,000			180,000			280,000
Net interest income after provision for loan loss		1,918,791			2,011,271			5,553,534			5,998,495

Non-interest income:
Loan fees		13,399			12,471			37,132			32,063
Service charges on deposits		630,611			524,766			1,651,242			1,626,041
Net rental income		17,667			18,327			52,903			42,605
Other income		52,690			52,264			224,629			156,075
Total non-interest income		714,367			607,828			1,965,906			1,856,784

Non-interest expenses:
Salaries and benefits		947,829			934,410			2,898,913			2,861,845
Occupancy expenses		340,003			367,248			994,348			1,095,729
Legal expense		85,477			59,292			198,637			209,276
Professional fees		105,975			84,819			276,947			253,880
Computer expense		70,724			66,463			223,547			183,131
Directors’ fees		53,375			60,775			177,625			205,900
FDIC and NYSBD assessments		60,500			57,000			175,500			178,500
Other expenses		340,253			330,204			1,146,787			1,003,474
Total non-interest expenses		2,004,136			1,960,211			6,092,304			5,991,735
Income before income taxes		629,022			658,888			1,427,136			1,863,544

Provision/(benefit) for income taxes:

Current		323,092			329,410			424,715			1,058,329
Deferred		(35,308	)		(27,982	)		228,243			(205,730	)
Total provision for income taxes		287,784			301,428			652,958			852,599

Net income	$	341,238		$	357,460		$	774,178		$	1,010,945

Earnings per share:
Basic	$	0.19		$	0.20		$	0.44		$	0.57

Diluted	$	0.19		$	0.20		$	0.44		$	0.57

Comprehensive income/(loss)	$	294,391		$	547,112		$	(89,343	)	$	1,028,966

See notes to consolidated financial statements.

VSB Bancorp, Inc.
Consolidated Statements of Comprehensive Income/(Loss)
(unaudited)

	Three months			Three months		Nine months			Nine months
	ended			ended		ended			ended
	Sept. 30, 2013			Sept. 30, 2012		Sept. 30, 2013			Sept. 30, 2012

Net Income	$	341,238		$	357,460	$	774,178		$	1,010,945
Other comprehensive income:
Unrealized gains on securities, AFS:
Change in unrealized gain on securities, AFS		(59,153	)		349,589		(2,089,216	)		33,219
Unrealized gains on securities transferred from AFS to HTM		—			—		533,811			—
Accretion on unrealized gains on HTM securities		(27,201	)		—		(36,338	)		—
Tax effects		(39,507	)		159,937		(728,222	)		15,198
Net of tax		(46,847	)		189,652		(863,521	)		18,021
Comprehensive income/(loss)	$	294,391		$	547,112	$	(89,343	)	$	1,028,966

See notes to consolidated financial statements.

VSB Bancorp, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
Year Ended December 31, 2012 and For Each of the Quarters in the Nine Month Period Ended September 30, 2013
(unaudited)

	Number of
	Common					Additional						Treasury			Unearned			Other			Total
	Shares			Common		Paid-In			Retained			Stock,			ESOP			Comprehensive			Stockholders’
	Outstanding			Stock		Capital			Earnings			at cost			Shares			Gain/(Loss)			Equity

Balance at January 1, 2012		1,797,809		$	199	$	9,304,789		$	18,574,651		$	(1,935,596	)	$	(394,516	)	$	1,552,733		$	27,102,260

Stock-based compensation							101,672															101,672
Amortization of earned portion of ESOP common stock																169,078						169,078
Amortization of cost over fair value - ESOP							(48,119	)														(48,119	)
Cash dividends declared
($0.24 per share)										(426,571	)											(426,571	)
Purchase of treasury stock, at cost		(22,000	)										(234,477	)								(234,477	)
Contribution to RRP Trust from treasury shares		9,500					(101,175	)					101,175									—
Net income										1,188,200												1,188,200
Other comprehensive income		—			—		—			—			—			—			(98,072	)		(98,072	)

Balance at December 31, 2012		1,785,309		$	199	$	9,257,167		$	19,336,280		$	(2,068,898	)	$	(225,438	)	$	1,454,661		$	27,753,971

Stock-based compensation							36,185															36,185
Amortization of earned portion of ESOP common stock																42,270						42,270
Amortization of cost over fair value - ESOP							(21,552	)														(21,552	)
Cash dividends declared ($0.06 per share)										(106,783	)											(106,783	)
Net income										209,871												209,871
Other comprehensive income		—			—		—			—			—			—			(184,611	)		(184,611	)

Balance at March 31, 2013		1,785,309		$	199	$	9,271,800		$	19,439,368		$	(2,068,898	)	$	(183,168	)	$	1,270,050		$	27,729,351

VSB Bancorp, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
Year Ended December 31, 2012 and For Each of the Quarters in the Nine Month Period Ended September 30, 2013
(unaudited)

	Number of
	Common				Additional						Treasury			Unearned			Other			Total
	Shares		Common		Paid-In			Retained			Stock,			ESOP			Comprehensive			Stockholders’
	Outstanding		Stock		Capital			Earnings			at cost			Shares			Gain/(Loss)			Equity

Balance at March 31, 2013		1,785,309	$	199	$	9,271,800		$	19,439,368		$	(2,068,898	)	$	(183,168	)	$	1,270,050		$	27,729,351

Stock-based compensation						59,415															59,415
Amortization of earned portion
of ESOP common stock															42,269						42,269
Amortization of cost over
fair value - ESOP						(21,150	)														(21,150	)
Cash dividends declared
($0.06 per share)									(106,783	)											(106,783	)
Net income									223,069												223,069
Other comprehensive income		—		—		—			—			—			—			(632,063	)		(632,063	)

Balance at June 30, 2013		1,785,309	$	199	$	9,310,065		$	19,555,654		$	(2,068,898	)	$	(140,899	)	$	637,987		$	27,294,108

Stock-based compensation						32,544															32,544
Amortization of earned portion
of ESOP common stock															42,270						42,270
Amortization of cost over
fair value - ESOP						(21,297	)														(21,297	)
Cash dividends declared
($0.06 per share)									(106,783	)											(106,783	)
Net income									341,238												341,238
Other comprehensive income		—		—		—			—			—			—			(46,847	)		(46,847	)

Balance at September 30, 2013		1,785,309	$	199	$	9,321,312		$	19,790,109		$	(2,068,898	)	$	(98,629	)	$	591,140		$	27,535,233

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, 2013			Sept. 30, 2012			Sept. 30, 2013			Sept. 30, 2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	341,238		$	357,460		$	774,178		$	1,010,945
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		117,395			145,384			370,733			442,378
Accretion of income, net of amortization of premium		52,807			60,649			256,250			292,498
ESOP compensation expense		20,973			22,012			62,810			65,661
Stock-based compensation expense		32,544			23,447			128,144			70,338
Provision for loan losses		45,000			40,000			180,000			280,000
(Gain)/loss on sale of other real estate		—			—			(9,611	)		—
Write-down of other real estate owned		—			—			59,792			—
Decrease in prepaid and other assets		194,256			121,195			588,646			335,239
(Increase)/decrease in accrued interest receivable		(3,750	)		2,554			66,105			26,928
(Increase)decrease in deferred income taxes		(35,308	)		(27,982	)		228,243			(205,730	)
(Decrease)/increase in accrued expenses and other liabilities		(11,460	)		(72,790	)		42,357			(342,557	)
Net cash provided by operating activities		753,695			671,929			2,747,647			1,975,700

CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in loan receivable		280,068			4,045,312			4,637,604			(36,363	)
Available-for-sale securities:
Proceeds from repayment and calls of investment securities		3,519,874			9,050,698			20,505,835			27,734,440
Purchases of investment securities		(13,286,448	)		(3,941,875	)		(46,942,854	)		(31,841,957	)
Held-to-maturity securities:
Proceeds from repayment and calls of investment securities		3,565,344			—			3,571,244			—
Purchases of investment securities		(21,789,638	)		—			(29,087,028	)		—
Proceeds from sale of other real estate		202,000			—			492,686			—
Purchases of premises and equipment		(116,471	)		(167,840	)		(465,270	)		(293,493	)
Net cash (used in)/provided by investing activities		(27,625,271	)		8,986,295			(47,287,783	)		(4,437,373	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		2,364,841			7,225,994			30,389,257			17,731,942
Purchase of treasury stock, at cost		—			(128,409	)		—			(234,477	)
Cash dividends paid		(106,783	)		(106,283	)		(320,349	)		(320,289	)
Net cash provided by financing activities		2,258,058			6,991,302			30,068,908			17,177,176

NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS		(24,613,518	)		16,649,526			(14,471,228	)		14,715,503

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		87,870,716			46,173,650			77,728,426			48,107,673

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	63,257,198		$	62,823,176		$	63,257,198		$	62,823,176

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest	$	204,120		$	197,554		$	618,567		$	612,222
Taxes	$	175,000		$	321,000		$	330,849		$	886,610

SUPPLEMENTAL NONCASH DISCLOSURE:
Transfer from loans to real estate owned	$	—		$	—		$	200,000		$	81,075
Transfer from AFS to HTM investment securities	$	—		$	—		$	74,540,643		$	—

See notes to consolidated financial statements.

VSB BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012 (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 19, 2013 through October 2, 2013, Victory State Bank was required to maintain reserves, after deducting vault cash, of $5,574,000. 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, as well as corporate bonds, which are rated A or better 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.

Investment Securities, Held To Maturity – Investment securities, held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity. The Company invests in agency Collateralized Mortgage-Backed Obligations (“CMOs”) with average lives primarily under 7 years and balloon Mortgage-Backed Securities with a final maturity of ten years or less. 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.

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 1,756,670 shares and 1,740,777 shares, the weighted average number of common shares outstanding for the three months ended September 30, 2013 and 2012, respectively. Diluted net income per share of common stock is based on 1,756,670 and 1,740,777, the weighted average number of common shares outstanding plus potentially dilutive common shares for the three months ended September 30, 2013 and 2012, 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 48,452 and 48,267 shares for the three months ended September 30, 2013 and 2012, respectively. Common stock equivalents were calculated using the treasury stock method.

Basic net income per share of common stock is based on 1,750,777 shares and 1,744,379 shares, the weighted average number of common shares outstanding for the nine months ended September 30, 2013 and 2012, respectively. Diluted net income per share of common stock is based on 1,750,777 and 1,744,379, the weighted average number of common shares outstanding plus potentially dilutive common shares for the nine months ended September 30, 2013 and 2012, 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 48,615 and 47,293 shares for the nine months ended September 30, 2013 and 2012, 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
	Sept. 30, 2013			Sept. 30, 2012
Basic
Distributed earnings allocated to common stock	$	105,400		$	104,447
Undistributed earnings allocated to common sock		231,655			248,552
Net earnings allocated to common stock	$	337,055		$	352,999

Weighted common shares outstanding including participating securities		1,778,470			1,762,777
Less: Participating securities		(21,800	)		(22,000	)
Weighted average shares		1,756,670			1,740,777

Basic EPS	$	0.19		$	0.20

Diluted
Net earnings allocated to common stock	$	337,055		$	352,999

Weighted average shares for basic		1,756,670			1,740,777
Dilutive effects of:
Stock Options		—			—

Unvested shares not considered participating securities		—			—
		1,756,670			1,740,777

Diluted EPS	$	0.19		$	0.20

Reconciliation of EPS
	Nine months ended			Nine months ended
	Sept. 30, 2013			Sept. 30, 2012
Basic
Distributed earnings allocated to common stock	$	315,140		$	313,988
Undistributed earnings allocated to common sock		447,834			682,823
Net earnings allocated to common stock	$	762,974		$	996,811

Weighted common shares outstanding including participating securities		1,776,486			1,769,112
Less: Participating securities		(25,709	)		(24,733	)
Weighted average shares		1,750,777			1,744,379

Basic EPS	$	0.44		$	0.57

Diluted
Net earnings allocated to common stock	$	762,974		$	996,811

Weighted average shares for basic		1,750,777			1,744,379
Dilutive effects of:
Stock Options		—			—
Unvested shares not considered participating securities		—			—
		1,750,777			1,744,379

Diluted EPS	$	0.44		$	0.57

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, 2013, 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 April 29, 2013, 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 May 1, 2013, an additional 1,600 shares vested due to the retirement of a director. 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. On November 16, 2012, an additional 700 shares or 20% of the 3,500 shares of stock awarded to the President and CEO of the Company had vested. On November 13, 2012, an additional 2,500 shares of stock were awarded to the President and CEO of the Company on an equal two year vesting beginning November 13, 2013. Also, on November 13, 2012, an additional 1,000 shares were awarded to seven non-employee directors on an equal two year vesting beginning November 13, 2013. 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.

A summary of the status of the Company’s non-vested plan shares as of September 30, 2013 is as follows:

For the Nine Months Ended September 30, 2013:
			Weighted Average
	Shares		Grant Date Share Value

Non vested at beginning of period		30,800	$	11.25
Granted		—
Vested		9,000	$	—
Non vested at end of period		21,800	$	11.25

Comprehensive Income – Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses, net of taxes, on our securities’ portfolios which are also recognized as separate components of equity.

Recently-Adopted Accounting Standards – In February 2013, the FASB issued an Accounting Standards Update (“ASU”) to finalize the reporting requirements for reclassifications of amounts out of accumulated other comprehensive income (“AOCI”). Items reclassified out of AOCI to net income in their entirety must have the effect of the reclassification disclosed according to the respective income statement line item. This information must be provided either on the face of the financial statements by income statement line item, or in a footnote. For public companies, the amendments in the update became effective for interim and annual periods beginning on or after December 15, 2012. As of September 30, 2013, the Company’s adoption of this ASU had no impact on its results of operations.

3. INVESTMENT SECURITIES

The following table summarizes the amortized cost and fair value of securities available-for-sale and securities held-to-maturity at September 30, 2013 and December 31, 2012 and the corresponding amounts of unrealized gains and losses herein:


	September 30, 2013
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Available-for-Sale
FNMA MBS - Residential	$	1,259,522	$	63,600	$	—		$	1,323,122
Whole Loan MBS - Residential		138,646		3,007		—			141,653
Collateralized mortgage obligations		37,851,998		505,153		(239,821	)		38,117,330
Collateralized loan obligations		5,000,000		35,000		—			5,035,000
Corporate bonds		9,570,797		—		(264,988	)		9,305,809
Other debt securities		2,949,526		40,064		—			2,989,590
Total Available-for-Sale	$	56,770,489	$	646,824	$	(504,809	)	$	56,912,504

	September 30, 2013
			Gross		Gross
	Amortized		Unrecognized		Unrecognized			Fair
	Cost		Gains		Losses			Value
Held-to-Maturity
FNMA MBS - Residential	$	58,103,774	$	132,485	$	(475,584	)	$	57,760,675
GNMA MBS - Residential		3,953,859		—		(24,307	)		3,929,552
Collateralized mortgage obligations		37,900,841		8,341		(470,894	)		37,438,288
Total Held-to-Maturity	$	99,958,474	$	140,826	$	(970,785	)	$	99,128,515

	December 31, 2012
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Available-for-sale
FNMA MBS - Residential	$	34,168,335	$	869,590	$	(32,664	)	$	35,005,261
GNMA MBS - Residential		5,074,518		155,906		—			5,230,424
Whole Loan MBS - Residential		473,273		16,852		—			490,125
Collateralized mortgage obligations		60,483,873		1,597,293		(96	)		62,081,070
Collateralized loan obligations		1,000,000		—		—			1,000,000
Other debt securities		2,944,168		74,522		—			3,018,690
Total Available-for-Sale	$	104,144,167	$	2,714,163	$	(32,760	)	$	106,825,570

There were no sales of investment securities for the nine months ended September 30, 2013 and 2012.

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, 2013
	Amortized		Fair
Available-for-Sale	Cost		Value

Less than one year	$	—	$	—
Due after one year through five years		8,264,158		8,308,027
Due after five years through ten years		13,053,295		12,850,939
Due after ten years		35,453,036		35,753,538
Available-for-Sale	$	56,770,489	$	56,912,504

	September 30, 2013
	Amortized		Fair
Held-to-Maturity	Cost		Value

Less than one year	$	—	$	—
Due after one year through five years		29,465,277		29,237,950
Due after five years through ten years		29,722,179		29,596,276
Due after ten years		40,771,018		40,294,289
Held-to-Maturity	$	99,958,474	$	99,128,515

The following table summarizes the investment securities with unrealized losses at September 30, 2013 and December 31, 2012 by aggregated major security type and length of time in a continuous unrealized loss position:

September 30, 2013	Less than 12 months					More than 12 months				Total

	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
Available-for-Sale	Value		Loss			Value		Loss		Value		Loss

FNMA MBS	$	—	$	—		$	—	$	—	$	—	$	—
GNMA MBS		—		—			—		—		—		—
Whole Loan MBS		—		—			—		—		—		—
Collateralized mortgage obligations		15,981,110		(239,821	)		—		—		15,981,110		(239,821	)
Collateralized loan obligations		—		—			—		—		—		—
Corporate bonds		9,305,809		(264,988	)		—		—		9,305,809		(264,988	)
Other debt securities		—		—			—		—		—		—
Available-for-Sale	$	25,286,919	$	(504,809	)	$	—	$	—	$	25,286,919	$	(504,809	)

September 30, 2013	Less than 12 months					More than 12 months				Total

	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
Held-to-Maturity	Value		Loss			Value		Loss		Value		Loss

FNMA MBS	$	43,703,786	$	(475,584	)	$	—	$	—	$	43,703,786	$	(475,584	)
GNMA MBS		3,929,552		(24,307	)		—		—		3,929,552		(24,307	)
Collateralized mortgage obligations		30,454,114		(470,894	)		—		—		30,454,114		(470,894	)
Held-to-Maturity	$	78,087,452	$	(970,785	)	$	—	$	—	$	78,087,452	$	(970,785	)


December 31, 2012	Less than 12 months					More than 12 months				Total

	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
Available-for-Sale	Value		Loss			Value		Loss		Value		Loss

FNMA MBS	$	4,499,561	$	(32,664	)	$	—	$	—	$	4,499,561	$	(32,664	)
GNMA MBS		—		—			—		—		—		—
Whole Loan MBS		—		—			—		—		—		—
Collateralized mortgage obligations		101,543		(96	)		—		—		101,543		(96	)
Collateralized loan obligations		—		—			—		—		—		—
Other debt securities		—		—			—		—		—		—
Available-for-Sale	$	4,601,104	$	(32,760	)	$	—	$	—	$	4,601,104	$	(32,760	)

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, 2013, the unrealized loss on investment securities was caused by a rise in intermediate and long term market interest rates generally. 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 interest rates 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, 2013, 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 $62,090,144 and $66,043,504 at September 30, 2013 and December 31, 2012, respectively and were pledged to secure public deposits and balances in excess of the deposit insurance limit on certain customer accounts.

During the second quarter of 2013, $74,540,643 of securities was transferred from the available for sale portfolio to the held to maturity portfolio. These securities were transferred at fair value with the unrealized gain/loss remaining in accumulated other comprehensive income to be accreted or amortized through other comprehensive income over the remaining life of the securities.

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 and Held To Maturity – 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, 2013 and December 31, 2012 are as follows:

	Fair Value Measurements at September 30, 2013 Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)		Total
Financial Assets:
Cash and cash equivalents	$	63,257,198	$	6,495,284	$	56,761,914	$	—	$	63,257,198
Investment securities, available for sale		56,912,504		—		51,877,504		5,035,000		56,912,504
Investment securities, held to maturity		99,958,474		—		99,128,515		—		99,128,515
Loans receivable		75,259,848		—		—		76,117,619		76,117,619
Accrued interest receivable		551,728		—		305,953		245,775		551,728
Total Financial Assets	$	295,939,752	$	6,495,284	$	208,073,886	$	81,398,394	$	295,967,564

Financial Liabilities:
Deposits	$	271,090,463	$	97,497,389	$	173,425,360	$	—	$	270,922,749
Accrued interest payable		17,108		—		17,108		—		17,108
Total Financial Liabilities	$	271,107,571	$	97,497,389	$	173,442,468	$	—	$	270,939,857

	Fair Value Measurements at December 31, 2012 Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)		Total
Financial Assets:
Cash and cash equivalents	$	77,728,426	$	3,723,131	$	74,005,295	$	—	$	77,728,426
Investment securities, available for sale		106,825,570		—		105,825,570		1,000,000		106,825,570
Loans receivable		80,218,050		—		—		80,432,242		80,432,242
Accrued interest receivable		617,833		—		262,577		355,256		617,833
Total Financial Assets	$	265,389,879	$	3,723,131	$	180,093,442	$	81,787,498	$	265,604,071

Financial Liabilities:
Deposits	$	240,701,206	$	81,881,173	$	158,706,059	$	—	$	240,587,232
Accrued interest payable		13,920		—		13,920		—		13,920
Total Financial Liabilities	$	240,715,126	$	81,881,173	$	158,719,979	$	—	$	240,601,152

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 and held to maturity 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, 2013 Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Available for sale:
FNMA MBS - Residential	$	1,323,122	$	—	$	1,323,122	$	—
Whole Loan MBS-
Residential		141,653		—		141,653		—
Collateralized mortgage
obligations		38,117,330		—		38,117,330		—
Collateralized loan
obligations		5,035,000		—		—		5,035,000
Corporate bonds		9,305,809		—		9,305,809		—
Other debt securities		2,989,590		—		2,989,590		—
Total Available for sale Securities	$	56,912,504	$	—	$	51,877,504	$	5,035,000

	Fair Value Measurements at December 31, 2012 Using
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Available for sale:
FNMA MBS - Residential	$	35,005,261	$	—	$	35,005,261	$	—
GNMA MBS - Residential		5,230,424		—		5,230,424		—
Whole Loan MBS-
Residential		490,125		—		490,125		—
Collateralized mortgage
obligations		62,081,070		—		62,081,070		—
Collateralized loan
obligations		1,000,000		—		—		1,000,000
Other debt securities		3,018,690		—		3,018,690		—
Total Available for sale Securities	$	106,825,570	$	—	$	105,825,570	$	1,000,000

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, 2013:

	Collateralized
	Loan
	Obligations

	2013

Balance of recurring Level 3 assets at January 1:	$	1,000,000
Total gains or losses for the period:		—
Included in earnings		—
Included in other comprehensive income		35,000
Purchases		4,000,000
Sales		—
Issuances		—

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

Balance of recurring Level 3 assets at September 30:	$	5,035,000

The following table presents quantitative information about recurring Level 3 fair value measurement at September 30, 2013:

Fair

Valuation

Unobservable

Value

Techniques

Inputs

Range

Collateralized loan obligations

5,035,000

Discounted cash flow

Collateral default rate

0%-2%

Recovery probability

70%-100%

There were no transfers between levels from December 31, 2012 to September 30, 2013.

Assets Measured on a Non-Recurring

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).

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

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. There were no write downs for real estate owned for the three and nine months ended September 30, 2013 and 2012.

Fair Value Measurements at September 30, 2013 Using

Significant

Quoted Prices in

Other

Significant

Active Markets for

Observable

Unobservable

Identical Assets

Inputs

Total

(Level 1)

(Level 2)

(Level 3)

Assets:

Impaired loans

Commercial Real Estate

1,039,204

—

1,039,204

Other real estate owned

—

Fair Value Measurements at December 31, 2012 Using

Significant

Quoted Prices in

Other

Significant

Active Markets for

Observable

Unobservable

Identical Assets

Inputs

Total

(Level 1)

(Level 2)

(Level 3)

Assets:

Impaired loans

Commercial Real Estate

934,034

—

934,034

Other real estate owned

342,867

—

342,867

As of September 30, 2013, we had three 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 $1,373,021, with a valuation allowance of $ 333,817 at that date. The valuation allowance decreased $504,714 from December 31, 2012 to September 30, 2013. The unpaid principal balance on impaired loans at September 30, 2013 was $1,426,671.

As of December 31, 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 $1,772,565, with a valuation allowance of $838,531 at that date. The unpaid principal balance on impaired loans at December 31, 2012 was $1,792,790.

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, 2013.

Fair

Valuation

Unobservable

Value

Techniques

Inputs

Range

Impaired loans - Commercial real estate

521,844

Third Party Appraisal

Discount adjustment for differences in various costs.

0.01%

64,579

Third Party Appraisal

Adjustments for differences between comparable sales.

2% - 4%

452,781

Third Party Appraisal

Adjustments for differences in net operating income expectations

4% - 13%

Capitalization Rate

5.75%

Third Party Appraisal

Adjustments for differences between comparable sales.

2% - 6%

5. LOANS RECEIVABLE, NET

Loans receivable, net at September 30, 2013 and December 31, 2012 are summarized as follows:

	September 30,			December 31,
	2013			2012

Commercial loans (principally variable rate):
Secured	$	1,785,392		$	2,050,728
Unsecured		15,155,159			16,502,920
Total commercial loans		16,940,551			18,553,648

Real estate loans:
Commercial		52,674,057			56,698,844
Residential		2,460,097			2,498,603
Total real estate loans		55,134,154			59,197,447

Construction loans (net of undisbursed funds of $1,571,000 and $2,854,500, respectively)		3,254,000			3,112,477

Consumer loans		722,281			565,573
Other loans		668,214			768,790
		1,390,495			1,334,363

Total loans receivable		76,719,200			82,197,935

Less:
Unearned loans fees, net		(198,898	)		(226,364	)
Allowance for loan losses		(1,260,454	)		(1,753,521	)

Total	$	75,259,848		$	80,218,050

Nonaccrual loans outstanding at September 30, 2013 and December 31, 2012 are summarized as follows:

	September 30,		December 31,
	2013		2012
Nonaccrual loans:
Commercial real estate	$	4,334,938	$	5,923,090
Commercial secured		88,021		—
Commercial unsecured		245,913		—
Construction		467,500		467,500

Total nonaccrual loans	$	5,136,372	$	6,390,590

	September 30,		December 31,
	2013		2012
Interest income that would have been recorded during the period on nonaccrual loans outstanding in accordance with original terms	$	329,804	$	478,556

At September 30, 2013 and at December 31, 2012, 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, 2013 and December 31, 2012 by class of loans:

September 30, 2013			30-59		60-89		Greater				Loans
			Days		Days		than 90 Days		Total		Not
	Total		Past Due		Past Due		Past Due		Past Due		Past Due

Commercial loans:
Unsecured	$	15,155,159	$	216,553	$	—	$	245,913	$	462,466	$	14,692,693
Secured		1,785,392		—		—		88,021		—		1,785,392
Real Estate loans
Commercial		52,674,057		141,816		—		4,334,938		4,476,754		48,197,303
Residential		2,460,097		100,051		—		—		100,051		2,360,046
Construction loans		3,254,000		—		300,000		467,500		767,500		2,486,500
Consumer loans		722,281		—		—		—		—		722,281
Other loans		668,214		504		—		—		504		667,710
Total loans	$	76,719,200	$	458,924	$	300,000	$	5,136,372	$	5,807,275	$	70,911,925

December 31, 2012			30-59		60-89		Greater				Loans
			Days		Days		than 90 Days		Total		Not
	Total		Past Due		Past Due		Past Due		Past Due		Past Due

Commercial loans:
Unsecured	$	16,502,920	$	4,599	$	—	$	—	$	4,599	$	16,498,321
Secured		2,050,728		—		91,649		—		91,649		1,959,079
Real Estate loans
Commercial		56,698,844		1,946,281		150,000		5,923,090		8,019,371		48,679,473
Residential		2,498,603		—		—		—		—		2,498,603
Construction loans		3,112,477		—		—		467,500		467,500		2,644,977
Consumer loans		565,573		—		2,903		—		2,903		562,670
Other loans		768,790		—		—		—		—		768,790
Total loans	$	82,197,935	$	1,950,880	$	244,552	$	6,390,590	$	8,586,022	$	73,611,913

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,
	2013		2012

Loans with no allocated allowance
for loan losses:
Commercial real estate	$	2,753,935	$	3,924,469
Commercial secured		88,021		—
Construction		467,500		467,500
Loans with allocated allowance
for loan losses:
Commercial real estate		1,373,021		1,772,565
Commercial unsecured		245,913		—
	$	4,928,390	$	6,164,534

Amount of the allowance for loan losses allocated:
Commercial real estate	$	333,817	$	838,531
Commercial unsecured		49,182		—
	$	382,999	$	838,531

The following table sets forth certain information about impaired loans with a measured impairment for the three and nine months ended September 30, 2013 and 2012:

	Three Months		Three Months
	Ended		Ended
	September 30,		September 30,
	2013		2012

Average of individually impaired loans during period:
Commercial real estate	$	4,582,437	$	5,873,758
Construction		467,500		—
Commercial secured		88,716		—
Commercial unsecured		261,247		—
	$	5,399,900	$	5,873,758

Interest income recognized during time period that loans were impaired, either using accrual or cash-basis method of accounting	$	9,589	$	304

	Nine Months		Nine Months
	Ended		Ended
	September 30,		September 30,
	2013		2012

Average of individually impaired loans during period:
Commercial real estate	$	4,655,481	$	6,605,848
Construction		467,500		132,500
Commercial secured		59,651		—
Residential real estate		—		488,889
Commercial unsecured		155,041		—
	$	5,337,673	$	7,227,237

Interest income recognized during time period that loans were impaired, either using accrual or cash-basis method of accounting	$	62,269	$	304

Troubled Debt Restructurings:

The Company has allocated $105,062 and $63,329 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings (“TDRs”) as of September 30, 2013 and December 31, 2012, 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, 2013 was $5,431,492 and at December 31, 2012 was $5,826,633. None of the loans currently classified as TDRs have defaulted during the third quarter of 2013 and 2012. These TDRs are all current and are paying under the modified arrangements.

There was one loan that was modified during the nine months ended September 30, 2013 that did not meet the definition of a TDR. Modification of loans that do not meet the definition of a TDR involve 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 three and nine months ending September 30, 2013:

Pre-Modification

Post-Modification

Number

Outstanding Recorded

of Loans

Investment

Troubled Debt Restructurings:

Commercial real estate

245,913

The troubled debt restructurings described above required an additional allowance of $41,733 during the nine months ended September 30, 2013.

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, 2013 and December 31, 2012, the aggregate carrying value of our assets categorized as Special Mention, Substandard and Doubtful according to asset type:

	At September 30, 2013

	Special						Not
	Mention		Substandard		Doubtful		Classified		Total

Commercial Loans:
Secured	$	—	$	88,021	$	—	$	1,697,371	$	1,785,392
Unsecured		269,243		245,913		—		14,640,003		15,155,159
Commercial Real Estate		6,487,429		5,976,365		—		40,210,263		52,674,057
Residential Real Estate		—		2,140,047		—		320,050		2,460,097
Construction		300,000		467,500		—		2,486,500		3,254,000
Consumer		—		—		—		722,281		722,281
Other		2,889		—		—		665,325		668,214
Total loans	$	7,059,561	$	8,917,846	$	—	$	60,741,793	$	76,719,200

Real estate owned		—		—		—		—		—
Total assets	$	7,059,561	$	8,917,846	$	—	$	60,741,793	$	76,719,200

	At December 31, 2012

	Special						Not
	Mention		Substandard		Doubtful		Classified		Total

Commercial Loans:
Secured	$	91,649	$	—	$	—	$	1,959,079	$	2,050,728
Unsecured		63,032		—		—		16,439,888		16,502,920
Commercial Real Estate		5,820,246		6,570,971		—		44,307,627		56,698,844
Residential Real Estate		—		2,174,455		—		324,148		2,498,603
Construction		—		467,500		—		2,644,977		3,112,477
Consumer		—		—		—		565,573		565,573
Other		3,746		—		—		765,044		768,790
Total loans	$	5,978,673	$	9,212,926	$	—	$	67,006,336	$	82,197,935

Real estate owned		—		342,867		—		—		342,867
Total assets	$	5,978,673	$	9,555,793	$	—	$	67,006,336	$	82,540,802

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, 2013 and December 31, 2012:

September 30, 2013

	Commercial		Commercial				Commercial		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	$	49,183	$	—	$	—	$	372,103	$	—	$	—	$	421,286
Collectively evaluated for impairment		390,365		12,659		18,378		372,776		5,457		39,533		839,168
Total ending allowance balance	$	439,548	$	12,659	$	18,378	$	744,879	$	5,457	$	39,533	$	1,260,454

Loans:
Individually evaluated for impairment	$	245,913	$	88,021	$	467,500	$	5,976,365	$	2,140,047	$	—	$	8,917,846
Collectively evaluated for impairment		14,909,246		1,697,371		2,786,500		46,697,692		320,050		1,390,495		67,801,354
Total ending loans balance	$	15,155,159	$	1,785,392	$	3,254,000	$	52,674,057	$	2,460,097	$	1,390,495	$	76,719,200

December 31, 2012

	Commercial		Commercial				Commercial		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	$	—	$	—	$	—	$	853,108	$	—	$	—	$	853,108
Collectively evaluated for impairment		425,495		18,790		16,282		394,091		4,528		41,227		900,413
Total ending allowance balance	$	425,495	$	18,790	$	16,282	$	1,247,199	$	4,528	$	41,227	$	1,753,521

Loans:
Individually evaluated for impairment	$	—	$	—	$	467,500	$	6,570,971	$	2,174,455	$	—	$	9,212,926
Collectively evaluated for impairment		16,502,920		2,050,728		2,644,977		50,127,873		324,148		1,334,363		72,985,009
Total ending loans balance	$	16,502,920	$	2,050,728	$	3,112,477	$	56,698,844	$	2,498,603	$	1,334,363	$	82,197,935

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months and nine months ended September 30, 2013 and 2012.

Three months ended September 30, 2013

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

Allowance for loan losses:
Beginning balance	$	453,305		$	30,194		$	18,517		$	710,884	$	4,485		$	34,202		$	1,251,587
Provision for loan losses		(19,082	)		(17,535	)		(139	)		28,995		(2,420	)		55,181			45,000
Loans charged-off		—			—			—			—		—			(50,000	)		(50,000	)
Recoveries		5,325			—			—			5,000		3,392			150			13,867
Total ending allowance balance	$	439,548		$	12,659		$	18,378		$	744,879	$	5,457		$	39,533		$	1,260,454

Three months ended September 30, 2012

	Commercial			Commercial						Commercial		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

Nine months ended September 30, 2013

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

Allowance for loan losses:
Beginning balance	$	425,495		$	18,790		$	16,282	$	1,247,199		$	4,528		$	41,227		$	1,753,521
Provision for loan losses		(27,038	)		(6,131	)		2,096		173,081			(8,914	)		46,906			180,000
Loans charged-off		—			—			—		(680,401	)		—			(50,000	)		(730,401	)
Recoveries		41,091			—			—		5,000			9,843			1,400			57,334
Total ending allowance balance	$	439,548		$	12,659		$	18,378	$	744,879		$	5,457		$	39,533		$	1,260,454

Nine months ended September 30, 2012

	Commercial			Commercial						Commercial			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

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

Financial Condition at September 30, 2013

Total assets were $299,917,247 at September 30, 2013, an increase of $30,212,876, or 11.2%, from December 31, 2012. 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. The principal changes resulting in the net increase in assets can be summarized as follows:

	●	a $50,045,408 net increase in investment securities, partially offset by

	●	a $14,471,228 net decrease in cash and cash equivalents and

●

a $ 4,958,202 net decrease in loans receivable, net.

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 $271,090,463 at September 30, 2013, an increase of $30,389,257 or 12.6%, from December 31, 2012 as a result of our active solicitation of retail deposits to increase funds for investment. The aggregate increase in deposits resulted from increases of $15,616,216 in non-interest demand deposits, $8,542,069 in money market accounts, $2,375,920 in time deposits, $2,107,968 in NOW accounts, $1,719,777 in savings accounts and $27,307 in escrow deposits.

Total stockholders’ equity was $27,535,233 at September 30, 2013, a decrease of $218,738, or 0.79%, from December 31, 2012. The decrease reflected: (i) a $453,829 increase in retained earnings due to net income of $774,178 for the nine months ended September 30, 2013, partially offset by $320,349 of dividends paid in 2013; (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) a decrease in the net unrealized gain on securities of $863,521.

The unrealized gain or losses on the available for sale and held to maturity securities portfolios are excluded from the calculation of regulatory capital. Management does not anticipate selling securities in these portfolios, but changes in market interest rates or in the demand for funds may change management’s plans with respect to the securities portfolios. If there is a material increase in interest rates, the market value of the securities portfolios may decline.. Management believes that the principal and interest payments on these portfolios, 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, has recently come out of a recession, but the recovery has been slow and uneven. The extent and speed of the recovery is far from clear and the effects of low inflation, moderate job growth, and the Federal Reserve’s decision to taper their purchase of mortgage-backed securities have created uncertainty not only on the pace of economic growth but on its sustainability. Some analysts continue to predict a darker road ahead. Substantial stress remains on many financial institutions and financial products due to the artificially maintained low interest rate environment, which directly places negative pressure on interest rate margins. 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 significant weaknesses in the business economy in our market area. Our customers have been adversely affected by the economic downturn and Superstorm Sandy. 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, 2013, the percentage had declined to 4.2%. 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 and the uncertain pace of the recovery 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 have a substantial amount 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. We receive regular cash flows from the repayment of our securities portfolios. These repayments had averaged in excess of $8 million per quarter for over two years but declined to $7 million in the third quarter of 2013. As securities purchased in past years gradually repaid and were replaced with purchases of new investment securities, our cash flows from those securities did and will decline in the immediate future because prepayments tend to be lower on recently-issued securities. We also have a significant level of overnight and short term investments, The availability overnight funds and securities repayments should allow us to invest at higher yields as market rates increase, thus blunting the effect of the delay in repricing our loans with interest rate floors.

Transfer of Some Available For Sale Securities to Held to Maturity

During the second quarter of 2013, Senior Management and the Board decided to transfer some securities that we pledge to secure borrowings and deposits (GNMA MBS, GNMA CMOs, and FNMA balloon MBS with final maturities of ten years or less) from available for sale portfolio to the held to maturity portfolio to align those securities with the Bank’s ability and intent to hold until maturity. As the securities are backed by GNMA, FNMA or FHLMC, we will recover the recorded investment and thus realize no gains or losses when the issuer pays the amount promised through maturity. Each transfer was done at fair value and any unrealized gain or loss is being amortized or accreted as the security pays down.

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 two years from the date a foreclosure action is commenced until the property is sold even in uncontested cases, and some uncontested cases can take longer. This problem, if it continues or gets worse, could have a substantial adverse effect on the value of our collateral for loans in default. The inability to realize upon collateral promptly, increases our loss in the event of a default due to the property value deterioration during a lengthy foreclosure.

Effects of Superstorm Sandy

Superstorm Sandy has had a devastating effect on the homes and businesses of New York City, especially Staten Island. We opened four of five locations (all located in Richmond County) the day after the Hurricane and they are in full operation. We re-opened the fifth location in February 2013 and all retail banking services are fully operational. While Superstorm Sandy did not have a significant effect on our operations, we incurred expenses of approximately $300,000 to remediate and reconstruct one of our branches that suffered sewer backup, water and wind driven rain damage. We have received insurance proceeds of $275,333 to help defray those costs. In the aftermath of Sandy, we had waived deposit service charges and late fees to those affected customers.

After Superstorm Sandy, we immediately embarked an outreach program to determine the extent that our borrowers were affected by Superstorm Sandy. We contacted 58 customers that we identified as being located in areas affected by the Superstorm who sustained some of, or a combination of, the following issues: substantial water and sewage damage to the business’ physical plant, machinery and equipment; extended power loss causing business interruptions; displaced tenants due to the flood and sewage backup; employees unable to report to work due to the loss/damage of their personal homes or cars and the loss of mass transit. We individually assessed their condition and access to resources. The majority of our customers were able to restart their business with little assistance from us.

As we are primarily a commercial lender, we did not have residential loans that were negatively affected. We received 12 requests for either one or two month payment deferrals on commercial loans, which we granted. All twelve resumed their payments.

We operate primarily in Richmond County (Staten Island) and that is where we had the highest impact. We had one loan in Kings County that was affected but has since been current on payments. We had sufficient liquidity and resources to handle the effects of Superstorm Sandy. Our operations center was up and running the day Superstorm Sandy left the region and had full access to all of our resources.

We have assessed the short term impact of Superstorm Sandy, including the effects on the allowance for loan losses and the loan portfolio, but the sustainability and the viability of some businesses may take longer to evaluate. We will address any of the associated issues as they arise.

Results of Operations for the Three Months Ended September 30, 2013 and September 30, 2012

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 $341,238 for the three months ended September 30, 2013, compared to net income of $357,460 for the comparable period in 2012. The principal categories which make up the 2013 net income are:

	●	Interest income of $2,169,482

	●	Reduced by interest expense of $205,691

	●	Reduced by a provision for loan losses of $45,000

	●	Increased by non-interest income of $714,367

	●	Reduced by non-interest expense of $2,004,136

●

Reduced by income tax expense of $287,784

We discuss each of these categories individually and the reasons for the differences between the three months ended September 30, 2013 and 2012 in the following paragraphs.

Interest Income. Interest income was $2,169,482 for the three months ended September 30, 2013, compared to $2,251,883 for the three months ended September 30, 2012, a decrease of $82,401 or 3.7%. The main reason for the decline was a $7,764,984 decrease in the average loan balance and a 14 basis point decrease in the yield on loans, between the periods, which combined to cause a $172,782 decline in interest income on loans.

Interest income on loans decreased by $172,782 as a result of a decrease of $7.8 million in the average balance of loans and a 14 basis point decrease in the average yield, from the three months ended September 30, 2012 to the three months ended September 30, 2013. There was a $225,582 decrease in our average non-performing loans, from $6.1 million in the three months ended September 30, 2012 to $5.9 million in the same period ended 2013. 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 three months ended September 30, 2013, our average loan yield would have been approximately 41 basis points higher. In contrast, we estimate that the comparable effect in 2012 period would have been approximately a 55 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 had an increase of $80,918, or 11.0%, in income on investment securities when comparing the third quarter of 2012 to the third quarter of 2013. We experienced a 35 basis point decrease in the average yield on our investment securities portfolios, from 2.55% to 2.20%, 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 combined average balance of our investment portfolios increased by $32.4 million, or 28.2%, between the periods, as market conditions gave us opportunities to purchase investment securities at more favorable yields with terms similar to those we had purchased in the past. This increase in average balance was the reason for the overall increase in interest income on securities. The investment securities portfolios represented 68.9% of average non-loan interest earning assets in the 2013 period compared to 68.1% in the 2012 period.

Interest income from other interest earning assets (principally overnight investments) increased by $9,463 due to an increase in the yield of 2 basis point from 0.22% for the three months ended September 30, 2012 to 0.24% for the same period ended September 30, 2013. In addition, the average balance of our other interest earning assets increased by $12.6 million between the periods because we elected to invest most of the 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 $205,691 for the three months ended September 30, 2013, compared to $200,612 for the three months ended September 30, 2012, an increase of $5,079 or 2.5%. The principal reason for the increase was an increase in the average balance of interest-bearing deposits as we sought to increase our total deposits, partially offset by a decline in average cost of funds as we were able to reprice some deposits downward as market interest rates remained low. The components of this increase included a $7,985 increase in interest on time deposits due to a $10.3 million increase in the average balance between the periods, even as the average cost declined by 5 basis point, and a $3,537 increase in the cost of savings accounts due to 3 basis point increase in the average cost and the $2.5 million increase in the average balance between the periods. The increase in interest expense was partially offset by an $2,139 decrease in the cost of money market accounts, as the average cost declined by 16 basis points, while the average balance increased by $7.5 million and a $4,304 decrease in the cost of NOW accounts, as the average cost declined by 6 basis points, while the average balance increased by $1.5 million. We decided to reprice money market and NOW accounts downward due to a continuation of low market interest rates. As a result, our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 0.47% from 0.53% between the periods.

Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $1,963,791 for the three months ended September 30, 2013, compared to $2,051,271 for the three months ended September 30, 2012, a decrease of $87,480, or 4.3%. The decrease was because the reduction in our interest income was greater than the reduction in our cost of funds when comparing the three months ended September 30, 2013 to the same period ended 2012. The average yield on interest earning assets declined by 55 basis points, while the average cost of funds declined by 6 basis points. The reduction in the yield on assets was principally due to the 35 basis points drop in the yield on investment securities and the 14 basis points drop in the yield on loans, partially offset by an increase of 2 basis points in the low yielding overnight investments. In addition, loans, our highest yielding asset category, declined from 33.1% of earning assets in the 2012 quarter to 26.2% in the 2013 quarter, which also contributed to the decline in average yield. Overall, our interest rate spread declined 49 basis points, from 2.97% to 2.48% between the periods. Correspondingly, our net interest margin decreased to 2.67% for the three months ended September 30, 2013 from 3.18% in the same period of 2012. The margin is higher than the spread because it takes into account the effect of interest free demand deposits and capital. We are working to reverse the trend of declining spread by seeking to increase our loan portfolio and by taking advantage of opportunities to purchase investment securities at favorable yields that presented themselves during the third quarter of 2013.

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 larger average balances of our lowest yielding category, other interest earning assets. 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 $45,000 for the three months ended September 30, 2013 compared to a provision for loan losses of $40,000 for the same period in 2012. The $5,000 increase in the provision was a result of a higher level of charge-offs despite a lower level of non-performing loans and total loans.

We experienced a decrease of $953,866 in non-performing loans from $6,090,239 at September 30, 2012 to $5,136,373 at September 30, 2013. Most of those loans are secured by real estate. We individually evaluated the non-performing mortgage loans based primarily upon updated appraisals as part of our analysis of the appropriate level of our allowance for loan and lease losses. We charged-off $50,000 of loans for the three months ended September 30, 2013 as compared to charge-offs of $10,917 for the same period in 2012. We also had recoveries (which are added back to the allowance for loan losses) of $13,867 for the three months ended September 30, 2013 as compared to $55,436 in the same period of 2012.

After considering other matters that increased or decreased the allowance, we determined that the level of our allowance at September 30, 2013 was appropriate to address inherent losses. Overall, our allowance for loan losses decreased from $1,666,916 or 2.03% of total loans, at September 30, 2012 to $1,260,454 or 1.64% of total loans, at September 30, 2013. 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 $714,367 for the three months ended September 30, 2013, compared to $607,828 during the same period last year. The $106,539, or 17.5%, increase in non-interest income was a direct result of an increase of $105,845 in service charges on deposits primarily due to a recent increase in the per item insufficient fund fee we charge. 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 $2,004,136 for the three months ended September 30, 2013, compared to $1,960,211 for the three months ended September 30, 2012, an increase of $43,925 or 2.2%. The principal shifts in the individual categories were:

	●	a $26,185 increase in legal expense due to general corporate needs in 2013 and a recovery of legal expense on a past due loan in the third quarter of 2012 which legal fees had been previously expensed;

	●	a $21,156 increase in professional fees due to the engagement of a consulting firm;

	●	a $13,419 increase in salaries and benefits due to termination expenses;

	●	a $10,049 increase in other non-interest expenses due to a $4,255 increase in the costs of operating our ATM, a $2,571 increase in regulatory filing costs and increases other normal operating expenses;

	●	a $4,261 increase in computer expense due to a recent rise in software contract expense, partially offset by;

	●	a $27,245 decrease in occupancy expense due to reduced fixed asset costs; and

●

a $7,400 decrease in directors fees due to fewer meetings in 2013.

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 $287,784 for the three months ended September 30, 2013, compared to income tax expense of $301,428 for the same period ended 2012. The decrease in income tax expense was due to the $29,866 decrease in income before income taxes in the 2013 period. Our effective tax rate for the three months ended September 30, 2013 and 2012 was 45.8%.

Results of Operations for the Nine Months Ended September 30, 2013 and September 30, 2012

General. We had net income of $774,178 for the nine months ended September 30, 2013, compared to net income of $1,010,945 for the comparable period in 2012. The principal categories which make up the 2013 net income are:

	●	Interest income of $6,355,289

	●	Reduced by interest expense of $621,755

	●	Reduced by a provision for loan losses of $180,000

	●	Increased by non-interest income of $1,965,906

	●	Reduced by non-interest expense of $6,092,304

●

Reduced by income tax expense of $652,958

We discuss each of these categories individually and the reasons for the differences between the nine months ended September 30, 2013 and 2012 in the following paragraphs.

Interest Income. Interest income was $6,355,289 for the nine months ended September 30, 2013, compared to $6,886,588 for the nine months ended September 30, 2012, a decrease of $531,299 or 7.7%. The main reason for the decline was a $5,346,704 decrease in the average loan balance and a 9 basis point decrease in the yield on loans between the periods, which combined to cause a $351,283 decline in interest income on loans. There was also an increase of $225,466 in investment securities.

Interest income on loans decreased by $351,283 as a result of a decrease of $5.3 million in the average balance of loans and a 9 basis point decrease in the average yield, from the nine months ended September 30, 2012 to the nine months ended September 30, 2013. There was a $1,926,874 decrease in our average non-performing loans, from $7.7 million in the nine months ended September 30, 2012 to $5.8 million in the same period ended 2013. 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 nine months ended September 30, 2013, our average loan yield would have been approximately 37 basis points higher. In contrast, we estimate that the comparable effect in 2012 period would have been approximately a 34 basis point increase in average loan yield. Substantially all of the non-accrual loans are secured by mortgages on real estate.

We experienced a 56 basis point decrease in the average yield on our investment securities portfolios, from 2.71% to 2.15%, 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 aggregate average balance of our investment portfolios increased by $15.8 million, or 13.9%, between the periods. The investment securities portfolios represented 64.6% of average non-loan interest earning assets in the 2013 period compared to 70.4% in the 2012 period.

Interest income from other interest earning assets (principally overnight investments) increased by $45,450 due to an increase in the yield of 1 basis point from 0.22% for the nine months ended September 30, 2012 to 0.23% for the same period ended September 30, 2013. In addition, the average balance of our other interest earning assets increased by $23.1 million between the periods because we elected to invest most of the 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 $621,755 for the nine months ended September 30, 2013, compared to $608,093 for the nine months ended September 30, 2012, an increase of $13,662 or 2.3%. The principal reason for the increase was an increase in the average balance of interest-bearing deposits as we sought to increase our total deposits, partially offset by a decline in average cost of funds as we were able to reprice some deposits downward as market interest rates remained low. The increase was the result of a $23,956 increase in interest on time deposits due to a $9.8 million increase in the average balance between the periods, a $22,270 increase in the cost of savings accounts due to 8 basis point increase in the average cost and the $4.1 million increase in the average balance between the periods. The increase in interest expense was partially offset by an $16,895 decrease in the cost of money market accounts, as the average cost declined by 16 basis points and an $15,669 decrease in the cost of NOW accounts, as the average cost declined by 8 basis points, due to our decision to reprice those deposits downward during the continuation of low market interest rates. As a result, our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 0.50% from 0.55% between the periods.

Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $5,733,534 for the nine months ended September 30, 2013, compared to $6,278,495 for the nine months ended September 30, 2012, a decrease of $544,961, or 8.7%. The decrease was 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, 2013 to the same period ended 2012. The average yield on interest earning assets declined by 70 basis points, while the average cost of funds declined by 5 basis points. The reduction in the yield on assets was principally due to the 56 basis points drop in the yield on investment securities and the 9 basis points decrease in the yield on loans, partially offset by the increase in low yielding overnight investments as a percentage of total interest-earning assets. Overall, our interest rate spread declined 65 basis points, from 3.17% to 2.52% between the periods. Correspondingly, our net interest margin decreased to 2.73% for the nine months ended September 30, 2013 from 3.39% in the same period of 2012. The margin is higher than the spread because it takes into account the effect of interest free demand deposits and capital.

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 $180,000 for the nine months ended September 30, 2013 compared to a provision for loan losses of $280,000 for the same period in 2012. The $100,000 decrease in the provision was a result of a lower level of non-performing loans and total loans, despite a higher level of charge-offs.

We experienced a decrease of $953,866 in non-performing loans from $6,090,239 at September 30, 2012 to $5,136,373 at September 30, 2013. Most of those loans are secured by real estate. We individually evaluated the non-performing mortgage loans based primarily upon updated appraisals as part of our analysis of the appropriate level of our allowance for loan and lease losses. We charged-off $730,401 of loans for the nine months ended September 30, 2013 as compared to charge-offs of $128,349 for the same period in 2012. We also had recoveries (which are added back to the allowance for loan losses) of $57,334 for the nine months ended September 30, 2013 as compared to $172,245 in the same period of 2012.

Non-interest Income. Non-interest income was $1,965,906 for the nine months ended September 30, 2013, compared to $1,856,784 during the same period last year. The $109,122, or 5.9%, increase in non-interest income was a direct result of a $68,554 increase in other income, primarily due a reimbursement of $36,394 in expenses received from insurance proceeds as a result of Superstorm Sandy and a $17,571 gain on the sale of a fixed asset and an increase of $25,201 in service charges on deposits primarily due to a recent increase in the per-item insufficient fund fee assessed against deposit accounts. 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 $6,092,304 for the nine months ended September 30, 2013, compared to $5,991,735 for the nine months ended September 30, 2012, an increase of $100,569 or 1.7%. The principal shifts in the individual categories were:

	●	a $143,313 increase in other non-interest expenses due to a $66,477 increase in the cost of holding real estate acquired in foreclosure, principally writedowns of REO assets, and foreclosure costs; a $21,379 increase in the costs of operating our ATM’s; a $14,675 increases in marketing costs due to a new ad campaign, a $8,539 increase in forgery costs and increase in other normal operating expenses;

	●	a $40,416 increase in computer expense due to a recent rise in software acquisition and maintenance expenses

	●	a $37,068 increase in salaries and benefits due to severance payments and the acceleration of stock benefits upon retirement;

	●	a $23,067 increase in professional fees due to the engagement of a consulting firm to assist in identifying alternate revenue sources, partially offset by;

	●	a $101,381 decrease in occupancy expense due to a reimbursement by our insurance carrier on monies expensed in the remediation and rebuilding of our Dongan Hills branch, which sustained damage during Superstorm Sandy, and reduced fixed asset costs;

	●	a $28,275 decrease in director fees due to fewer meetings; and

●

a $10,639 decrease in legal expense, due to a recovery of legal expense on two past due loans, on which $15,992 in legal fees had been previously expensed.

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 $652,958 for the nine months ended September 30, 2013, compared to income tax expense of $852,599 for the same period ended 2012. The decrease in income tax expense was due to the $436,408 decrease in income before income taxes in the 2013 period. Our effective tax rate for the nine months ended September 30, 2013 and 2012 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, 2013								September 30, 2012								September 30, 2013								September 30, 2012
	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	$	75,859,572		$	1,312,109		6.79	%	$	83,624,556		$	1,484,891		6.93	%	$	78,262,384		$	4,137,806		7.00	%	$	83,609,088		$	4,489,089		7.09	%
Investment securities, afs & htm		147,493,695			817,651		2.20			115,085,676			736,733		2.55			129,974,164			2,093,702		2.15			114,151,954			2,319,168		2.71
Other interest-earning assets		66,517,357			39,722		0.24			53,928,685			30,259		0.22			71,086,253			123,781		0.23			47,912,849			78,331		0.22
Total interest-earning assets		289,870,624			2,169,482		2.95			252,638,917			2,251,883		3.50			279,322,801			6,355,289		3.02			245,673,891			6,886,588		3.72

Non-interest earning assets		7,791,484								6,322,086								7,349,027								6,739,147
Total assets	$	297,662,108							$	258,961,003							$	286,671,828							$	252,413,038

Liabilities and equity:
Interest-bearing liabilities:
Savings accounts	$	22,998,714			20,030		0.35		$	20,524,056			16,493		0.32		$	22,671,048			57,963		0.34		$	18,582,998			35,693		0.26
Time accounts		74,867,612			113,503		0.60			64,522,535			105,518		0.65			74,728,385			359,326		0.64			64,900,066			335,370		0.69
Money market accounts		39,813,966			57,048		0.57			32,315,022			59,187		0.73			35,673,688			157,163		0.59			30,863,139			174,058		0.75
Now accounts		35,170,903			15,110		0.17			33,625,213			19,414		0.23			34,271,100			47,303		0.18			32,698,581			62,972		0.26
Total interest-bearing liabilities		172,851,195			205,691		0.47			150,986,826			200,612		0.53			167,344,221			621,755		0.50			147,044,784			608,093		0.55
Checking accounts		96,186,019								78,777,306								90,497,422								76,352,685
Escrow deposits		110,760								330,984								214,946								362,952
Total deposits		269,147,974								230,095,116								258,056,589								223,760,421
Other liabilities		1,031,206								1,250,885								912,860								1,229,445
Total liabilities		270,179,180								231,346,001								258,969,449								224,989,866
Equity		27,482,928								27,615,002								27,702,379								27,423,172
Total liabilities and equity	$	297,662,108							$	258,961,003							$	286,671,828							$	252,413,038

Net interest income/net interest rate spread				$	1,963,791		2.48	%				$	2,051,271		2.97	%				$	5,733,534		2.52	%				$	6,278,495		3.17	%

Net interest earning assets/net interest margin	$	117,019,429					2.67	%	$	101,652,091					3.18	%	$	111,978,580					2.73	%	$	98,629,107					3.39	%

Ratio of interest-earning assets to interest-bearing liabilities		1.68	x							1.67	x							1.67	x							1.67	x

Return on Average Assets (1)		0.44	%							0.53	%							0.35	%							0.52	%
Return on Average Equity (1)		4.81	%							4.92	%							3.63	%							4.80	%
Tangible Equity to Total Assets		9.18	%							10.66	%							9.18	%							10.66	%

(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, 2013, we had a net increase in total deposits of $30,389,257 due to increases of $15,616,216 in non-interest demand deposits, $8,542,069 in money market accounts, $2,375,920 in time deposits, $2,107,968 in NOW accounts, $1,719,777 in savings accounts and $27,307 in escrow 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 $24,077,079. We used $76,029,882 of available funds to purchase new investment securities and we had a net loan decrease of $4,637,604. These changes resulted in an overall decrease in cash and cash equivalents of $14,471,228. Total cash and cash equivalents at September 30, 2013 were $63,257,198.

In contrast, 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 rather than “wholesale” deposits. 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.

At September 30, 2013, cash and cash equivalents represented 21.1% of total assets. Our cash and cash equivalents increased due to a recent influx of new deposits, which we have deployed into investment securities, which will enable us to generate higher interest income. We maintain a higher level of cash and cash equivalents to help buffer the adverse effects of potential, future rising interest rates but we anticipate that we will be purchasing more investment securities and seeking loan participations to reduce the current level of cash and cash equivalents. 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. 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, 2013 we had $56.9 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 all the securities in our investment portfolios as collateral if the need arises. Based upon our asset size and the amount of our securities portfolios that qualifies as eligible collateral, we had more than $122.1 million of unused borrowing capability from the FHLBNY at September 30, 2013. 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, 2013, with a Tier I Leverage Capital ratio of 8.86%, a Tier I Capital to Risk-Weighted Assets ratio of 25.17%, and a Total Capital to Risk-Weighted Assets ratio of 26.37%.

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, 2013

Contractual Obligations	Payment Due by Period

	Less than		One to three		Four to five		After		Total Amounts
	One Year		years		years		five years		committed

Minimum annual rental payments under
non-cancelable operating leases	$	436,010	$	793,382	$	508,330	$	410,019	$	2,147,741
Remaining contractual maturities of time
deposits		64,891,609		3,156,500		5,780,515		—		73,828,624
Total contractual cash obligations	$	65,327,619	$	3,949,882	$	6,288,845	$	410,019	$	75,976,365

Other Commitments	Amount of commitment Expiration by Period

	Less than		One to three		Four to five		After		Total Amounts
	One Year		years		years		five years		committed

Loan Commitments	$	15,515,624	$	1,612,000	$	—	$	—	$	17,127,624

Non-Performing Loans

Management closely monitors non-performing loans and other assets with potential problems on a regular basis. We had twenty four non-performing loans, totaling $5,136,373 at September 30, 2013, compared to nineteen non-performing loans, totaling $6,390,590 at December 31, 2012. Non-performing loans totaled 6.70% of total loans at September 30, 2013 compared to 7.77% of total loans at December 31, 2012. 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 $3,796,752, or 73.9% of our non-performing loans, by outstanding principal balance at September 30, 2013. Management believes it has taken appropriate steps with a view towards maximizing recovery and minimizing loss, if any, on these loans.

●

$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 are actively pursuing the sale of these properties. We commenced a foreclosure proceeding and we have obtained a money judgment on one of the loans that is a lien on their personal residence.

	●	$826,054 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 during the fourth quarter of 2012 which includes a modified payment arrangement. We received a $145,000 upfront payment and the borrower agreed to make monthly payments. We agreed to hold the previously commenced foreclosure proceedings in abeyance as long as there is performance under the forbearance agreement. The borrower has defaulted on the payments according to the forbearance agreement and we have resumed the foreclosure action.

	●	$780,000 in a commercial real estate loan, which is secured by a first mortgage on property in Queens. We have commenced a foreclosure action and we are at the stage of getting final court approval of the referee’s report on the amount due so we can hold the foreclosure sale of the property. A guarantor of the loan filed a bankruptcy petition, which temporarily delayed the foreclosure action. We had another second mortgage loan to the same and related borrowers and guarantors. The first mortgagor foreclosed and we charged-off that loan. We have a money judgment on that loan for $764,226.65, including principal, interest and costs, and have been aggressively pursuing collection but collection proceedings against the principal individual guarantor remains stayed due to the same bankruptcy.

	●	$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 and we have obtained a foreclosure judgment.

●

$467,500 in two construction loans. The loans are secured by a first and second mortgage on property in Staten Island. The loans are guaranteed personally by the principals of the borrower. The borrower signed a forbearance agreement in October, 2012 and has received a certificate of occupancy on the property. The borrowers executed a second forbearance agreement in April 2013 and payments are current.

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 3 – Controls and Procedures

Evaluation of Disclosure Controls and Procedures: As of September 30, 2013, 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. Victory State 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 12, 2013	/s/ Raffaele M. Branca
	Raffaele M. Branca
	President, CEO and Principal Executive Officer

Date: November 12, 2013	/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)