Quarterly Report (10-q)

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the Quarterly Period ended December 31, 2012

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

For transition period from to

Commission File Number 001-35295

Poage Bankshares, Inc.

(Exact Name of Registrant as Specified in Charter)

Maryland

45-3204393

(State of Other Jurisdiction

Of Incorporation

(I.R.S Employer

Identification Number)


1500 Carter Avenue, Ashland, KY 41101		41101
(Address of Principal Executive Officer)		(Zip Code)

606-324-7196

Registrant’s telephone number, including area code

Not Applicable

(Former name or former address, if changed since last report)

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

Indicate by check mark 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

As of February 8, 2013, 3,367,374 shares of the Registrant’s common stock, par value $.01 per share, were outstanding.

POAGE BANKSHARES, INC.

Form 10-Q Quarterly Report

Table of Contents


	PART I. FINANCIAL INFORMATION

ITEM 1.	CONSOLIDATED FINANCIAL STATEMENTS – POAGE BANKSHARES, INC.	1

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	21

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	27

ITEM 4.	CONTROLS AND PROCEDURES	27

	PART II. OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS	30

ITEM 1A.	RISK FACTORS	30

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	30

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	30

ITEM 4.	MINE SAFETY DISCLOSURES	30

ITEM 5.	OTHER INFORMATION	30

ITEM 6.	EXHIBITS	30

SIGNATURES		31

PART I

ITEM 1.

FINANCIAL STATEMENTS

POAGE BANKSHARES, INC.

UNAUDITED CONSOLIDATED BALANCE SHEETS


	December 31,			September 30,
	2012			2012
	(in thousands)
ASSETS
Cash and due from financial institutions	$	17,778		$	23,430
Securities available for sale		100,027			94,456
Loans held for sale		619			719
Loans, net of allowance of $1,991, and $2,004		177,831			179,998
Federal Home Loan Bank stock, at cost		1,953			1,953
Other real estate owned, net		775			1,001
Premises and equipment, net		6,033			6,078
Company owned life insurance		6,738			6,685
Accrued interest receivable		1,146			1,255
Other assets		1,550			1,584


	$	314,450		$	317,159


LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non-interest bearing	$	6,280		$	6,422
Interest bearing		229,024			230,050

Total deposits		235,304			236,472
Federal Home Loan Bank advances		16,748			17,672
Accrued interest payable		43			376
Other liabilities		1,683			2,057

Total liabilities		253,778			256,577

Commitments and contingent liabilities		—			—

Shareholders’ equity
Common stock, $.01 par value, 30,000,000 shares authorized, 3,372,375 issued and outstanding		34			34
Additional paid-in-capital		32,030			31,979
Retained earnings		29,715			29,416
Unearned Employee Stock Ownership Plan (ESOP) shares		(2,529	)		(2,563	)
Accumulated other comprehensive income		1,422			1,716


Total shareholders’ equity		60,672			60,582


	$	314,450		$	317,159

See notes to unaudited consolidated financial statements.

POAGE BANKSHARES, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME


	Three months ended
	December 31,
	2012		2011
			(Revised)
	(in thousands)

Interest and dividend income
Loans, including fees	$	2,554	$	2,728
Taxable securities		310		335
Tax exempt securities		146		228
Federal funds sold and other		33		35

		3,043		3,326

Interest expense
Deposits		582		775
Federal Home Loan Bank advances and other		126		176

		708		951


Net interest income		2,335		2,375

Provision for loan losses		—		38


Net interest income after provision for loan losses		2,335		2,337

Non-interest income
Service charges on deposits		152		104
Other service charges		8		6
Net gains on sales of loans		161		138
Net gains on securities activity		—		10
Income from company owned life insurance		53		56
Other		1		4

		375		318

Non-interest expense
Salaries and employee benefits		1,088		968
Occupancy and equipment		209		193
Data processing		171		157
Federal deposit insurance		47		51
Foreclosed assets, net		77		42
Advertising		30		72
Professional fees		174		137
Other taxes		61		51
Loss on fictitious loans		10		—
Other		248		197

		2,115		1,868


Income before income taxes		595		787

Income tax expense		161		179


Net income	$	434	$	608

Earnings per share:
Basic	$	0.14	$	0.20
Diluted	$	0.14	$	0.20
Dividend per share	$	0.04	$	—

See notes to unaudited consolidated financial statements.

POAGE BANKSHARES, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)


	Three months ended
	December 31,
	2012			2011
				(Revised)
	(in thousands)

Net income	$	434		$	608

Other comprehensive income (loss):
Unrealized holding gains (losses) on available for sale securities		(446	)		17
Reclassification adjustments for (gains) losses included in net income		—			(10	)

Net unrealized holding gains (losses) on available for sale securities		(446	)		7
Tax effect		152			(2	)

Other comprehensive income (loss):		(294	)		5


Comprehensive income	$	140		$	613

See notes to unaudited consolidated financial statements.

POAGE BANKSHARES, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY


											Accumulated
			Additional					Unearned			Other			Total
	Common		Paid-In		Retained			ESOP			Comprehensive			Shareholders’
	Stock		Capital		Earnings			Shares			Income			Equity
	(in thousands)

Balances, October 1, 2012	$	34	$	31,979	$	29,416		$	(2,563	)	$	1,716		$	60,582

Net income		—		—		434			—			—			434
Dividends paid		—		—		(135	)		—			—			(135	)
ESOP compensation earned		—		51		—			34			—			85
Change in unrealized gain (loss) on securities available for sale, net of taxes		—		—		—			—			(294	)		(294	)


Balances, December 31, 2012	$	34	$	32,030	$	29,715		$	(2,529	)	$	1,422		$	60,672

See notes to unaudited consolidated financial statements.

POAGE BANKSHARES, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS


	Three months ended
	December 31,
	2012			2011
				(Revised)
	(in thousands)
OPERATING ACTIVITY
Net income	$	434		$	608
Adjustments to reconcile net income to net cash from operating activities:
Depreciation		94			95
Provision for loan losses		—			38
ESOP compensation expense		85			—
Loss (gain) on sale of securities		—			(10	)
Loss (gain) on sale of other real estate owned		36			—
Net amortization on securities		257			144
Deferred income tax (benefit) expense		63			63
Net gain on sale of loans		(161	)		(138	)
Origination of loans held for sale		(1,950	)		(3,013	)
Proceeds from loans held for sale		2,317			3,894
Increase in cash value of life insurance		(53	)		(56	)
Decrease (increase) in:
Accrued interest receivable		110			(20	)
Other assets		122			(64	)
Increase (decrease) in:
Accrued interest payable		(333	)		(365	)
Other liabilities		(374	)		(1,193	)

Net cash from (used in) operating activities		647			(17	)


INVESTING ACTIVITIES
Securities available for sale:
Proceeds from sales		—			—
Proceeds from calls		4,370			8,757
Proceeds from maturities		100			—
Purchases		(14,271	)		(33,780	)
Principal payments received		3,527			700
Loan originations and principal payments on loans, net		1,942			1,450
Proceeds from the sale of other real estate owned		309			—
Purchase of office properties and equipment		(49	)		(62	)

Net cash used in investing activities		(4,072	)		(22,935	)


FINANCING ACTIVITIES
Net change in deposits		(1,168	)		(6,589	)
Payments on Federal Home Loan Bank borrowings		(924	)		(1,130	)
Cash dividends paid		(135	)		—

Net cash used in financing activities		(2,227	)		(7,719	)


DECREASE IN CASH AND CASH EQUIVALENTS		(5,652	)		(30,671	)

Cash and cash equivalents at beginning of year		23,430			48,440


CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	17,778		$	17,769


Additional cash flows and supplementary information:
Cash paid during the year for:
Interest on deposits and advances	$	1,041		$	1,316
Income taxes		—			—
Real estate acquired in settlement of loans	$	119		$	606

See notes to unaudited consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited consolidated financial statements of Poage Bankshares, Inc. (the “Company”) and its wholly owned subsidiary Home Federal Savings and Loans Association (the “Association”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates used in the preparation of the financial statements are based on various factors including the current interest rate environment and the general strength of the local economy. Changes in the overall interest rate environment can significantly affect the Company’s net interest income and the value of its recorded assets and liabilities. Actual results could differ from those estimates used in the preparation of the financial statements.

In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the Company’s financial position as of December 31, 2012 and September 30, 2012 and the results of operations and cash flows for the interim periods ended December 31, 2012 and 2011. All interim amounts have not been audited, and the results of operations for the interim periods herein are not necessarily indicative of the results of operations to be expected for the year. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto filed as part of the Company’s 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

NOTE 2 – ADJUSTMENT FOR FICTITIOUS LOANS

The Company is applying relevant guidance from the SEC and FASB to adjust for the cumulative effect of immaterial errors relating to prior years in the carrying amount of assets and liabilities as of the beginning of the current fiscal year, with an offsetting adjustment to the opening balance of retained earnings in the year of adoption. The guidance also requires the adjustment of any prior quarterly financial statements within the fiscal year of adoption for the effects of such errors on the quarters when the information is next presented. Such adjustments do not require previously filed reports with the SEC to be amended. In accordance with the relevant guidance, the Company has adjusted its opening retained earnings for 2011 for the item described below. The Company considers these adjustments to be immaterial to prior periods.

On November 26, 2012, the Company determined that it was required to record a loss for certain fraudulent loans in the aggregate amount of $950,000 including accrued interest of $127,000 which, net of tax, is a loss of $627,000. The loss relates to the creation of fictitious loans by a former employee of the Company’s subsidiary and was discovered by management while in the process of upgrading the Company’s lending controls and procedures.

The Company has reported this event to its blanket bond insurance provider and is working with the provider to determine the extent of any coverage. No amount has been recorded related to potential recoveries from the blanket bond coverage. That amount, if any, will be recorded when it can be accurately measured and collectability can be reasonably ascertained.

The applicable effect on the prior year statement of income related to these fictitious loans is as follows (in thousands):


	For the three months ended December 31, 2011
Statement of Income:
Interest and dividend income as previously reported	$	3,331
Interest income fictitious loans		(5	)

Interest and dividend income as adjusted	$	3,326


Net interest income as previously reported	$	2,380
Interest income fictitious loans		(5	)

Net interest income as adjusted	$	2,375


Net interest income after provision for loan loss as previously reported	$	2,342
Interest income fictitious loans		(5	)

Net interest income after provision for loan loss as adjusted	$	2,337


Income before income taxes previously reported	$	792
Interest income fictitious loans		(5	)

Income before income tax as adjusted	$	787


Income tax expense as previously reported	$	181
Tax impact of fictitious loans and related interest		(2	)

Income tax expense as adjusted	$	179


Net income as previously reported	$	611
Fictitious loans interest adjustment, net of tax		(3	)

Net income as adjusted	$	608

NOTE 3 – SECURITIES AVAILABLE FOR SALE

The amortized cost and fair value of securities available for sale at December 31, 2012 and September 30, 2012 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows (in thousands):


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value

December 31, 2012
States and political subdivisions	$	23,952	$	1,589	$	—		$	25,541
U.S. Government agencies and sponsored entities		32,490		47		(27	)		32,510
Government sponsored entities residential mortgage-backed:
FHLMC		23,218		249		—			23,467
FNMA		18,213		296		—			18,509

Total securities	$	97,873	$	2,181	$	(27	)	$	100,027


September 30, 2012
States and political subdivisions	$	24,445	$	1,743	$	—		$	26,188
U.S. Government agencies and sponsored entities		22,250		16		(9	)		22,257
Government sponsored entities residential mortgage-backed:
FHLMC		25,330		444					25,774
FNMA		19,831		406		—			20,237

Total securities	$	91,856	$	2,609	$	(9	)	$	94,456

The proceeds from calls of securities and the associated gross gains and losses are listed below (in thousands):


	Three months ended December 31,
	2012		2011
Proceeds	$	—	$	8,757
Gross gains		—		10
Gross losses		—		—

The provision for income taxes related to net realized gains for the three months ended December 31, 2011 was $3,400 based on an income tax rate of 34%.

The amortized cost and fair value of the securities portfolio at December 31, 2012 are shown in the following table by expected maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties (in thousands). Securities not due at a single maturity, mortgage-backed securities, are shown separately.


	December 31, 2012
	Amortized Cost		Fair Value

Within one year	$	11,878	$	11,956
One to five years		22,117		22,443
Five to ten years		22,447		23,652
Beyond ten years		—		—
Mortgage-backed securities		41,431		41,976

Total	$	97,873	$	100,027

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


	Less Than 12 Months					12 Months or Longer				Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

December 31, 2012
U.S. Government agencies and sponsored entities	$	9,230	$	(27	)	$	—	$	—	$	9,230	$	(27	)

Total securities	$	9,230	$	(27	)	$	—	$	—	$	9,230	$	(27	)


September 30, 2012
U.S. Government agencies and sponsored entities	$	10	$	(9	)	$	—	$	—	$	10	$	(9	)

Total securities	$	10	$	(9	)	$	—	$	—	$	10	$	(9	)

Unrealized losses on bonds have not been recognized into income because the issuers of the bonds are of high credit quality, management does not intend to sell and it is not more likely than not that management would be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates. The fair value is expected to recover as the bonds approach maturity.

Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, 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. For equity securities, the entire amount of impairment is recognized through earnings.

NOTE 3 – LOANS

Loans at December 31, 2012 and September 30, 2012 were as follows (in thousands):


	December 31, 2012		September 30, 2012

Real estate:
One to four family	$	137,873	$	141,307
Multi-family		925		985
Commercial real estate		16,340		16,333
Construction and land		4,473		3,095

		159,611		161,720

Commercial and Industrial		5,464		4,895

Consumer
Home equity lines of credit		5,674		5,911
Motor vehicle		6,780		6,968
Other		2,371		2,592

		14,825		15,471


Total		179,900		182,086
Less: Net deferred loan fees		78		84
Allowance for loan losses		1,991		2,004


	$	177,831	$	179,998

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of December 31, 2012 and September 30, 2012. Accrued interest receivable of $665,000 and $746,000 at December 31, 2012 and September 30, 2012, respectively, and net deferred loans fees of $78,000 at December 31, 2012 and $84,000 at September 30, 2012, are not considered significant and therefore are not included in the loan balances presented in the table below (in thousands):


December 31, 2012:
	Allowance for Loan Losses						Loan Balances
Loan Segment	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total

Real estate	$	—	$	1,876	$	1,876	$	—	$	159,611	$	159,611
Commercial and industrial		—		38		38		—		5,464		5,464
Consumer		—		77		77		—		14,825		14,825


Total	$	—	$	1,991	$	1,991	$	—	$	179,900	$	179,900


September 30, 2012:
	Allowance for Loan Losses						Loan Balances
Loan Segment	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total

Real estate	$	—	$	1,824	$	1,824	$	—	$	161,720	$	161,720
Commercial and industrial		—		47		47		—		4,895		4,895
Consumer		—		133		133		—		15,471		15,471


Total	$	—	$	2,004	$	2,004	$	—	$	182,086	$	182,086

The following table sets forth an analysis of our allowance for loan losses for the three months ended December 31, 2012 and 2011 (in thousands):


	Three months ended December 31,
	2012			2011
Balance at beginning of period	$	2,004		$	1,658
Provision for loan losses:
Commercial and Industrial		(9	)		—
Real Estate:
Commercial		(490	)		4
Residential		546			34
Consumer		(47	)		—

Total provision		—			38

Amounts charged off:
Commercial and Industrial		—			—
Real Estate:
Commercial		—			—
Residential		(19	)		(148	)
Consumer		(9	)		(20	)

Total loans charged off		(28	)		(168	)
Recoveries of amounts previously charged off:
Commercial and Industrial		—			—
Real Estate:
Commercial		12			—
Residential		3			1
Consumer		—			4

Total recoveries		15			5
Net charge-offs		(13	)		(163	)

Balance at end of period	$	1,991		$	1,533

There were no impaired loans as of or during the three months ended December 31, 2012 or 2011, or as of or during the year ended September 30, 2012.

Nonaccrual loans and loans past due 90 days still on accrual consist of smaller balance homogeneous loans that are collectively evaluated for impairment.

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of December 31, 2012 and September 30, 2012 (in thousands):


	As of December 31, 2012				As of September 30, 2012
	Nonaccrual		Loans Past Due Over 90 Days Still Accruing		Nonaccrual		Loans Past Due Over 90 Days Still Accruing
Real estate:
One to four family	$	851	$	—	$	976	$	—
Multi-family		—		—		—		—
Commercial real estate		—		—		—		307
Construction and land		—		—		—		—
Commercial and industrial		—		—		—		14
Consumer:
Home equity loans and lines of credit		—		—		15		—
Motor vehicle		14		—		—		—
Other		—		—		4		—


Total	$	865	$	—	$	995	$	321

The following table presents the aging of the recorded investment in past due loans as of December 31, 2012 and September 30, 2012 by class of loans. Non-accrual loans of $864,000 as of December 31, 2012 and $995,000 at September 30, 2012 are included in the tables below and have been categorized based on their payment status (in thousands).


	30 - 59 Days Past Due		60 - 89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Loans Not Past Due		Total
December 31, 2012
Real estate:
One to four family	$	939	$	593	$	850	$	2,382	$	135,491	$	137,873
Multi-family		—		—		—		—		925		925
Commercial real estate		—		—		—		—		16,340		16,340
Construction and land		—		—		—		—		4,473		4,473
Commercial and industrial		—		—		—		—		5,464		5,464
Consumer:
Home equity loans and lines of credit		299		—		—		299		5,375		5,674
Motor vehicle		87		47		14		148		6,632		6,780
Other		9		—		—		9		2,362		2,371

Total	$	1,334	$	640	$	864	$	2,838	$	177,062	$	179,900


	30 - 59 Days Past Due		60 - 89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Loans Not Past Due		Total
September 30, 2012
Real estate:
One to four family	$	1,117	$	169	$	803	$	2,089	$	139,218	$	141,307
Multi-family		—		—		—		—		985		985
Commercial real estate		139		—		307		446		15,887		16,333
Construction and land		525		—		—		525		2,570		3,095
Commercial and industrial		4		135		14		153		4,742		4,895
Consumer:
Home equity loans and lines of credit		—		—		15		15		5,896		5,911
Motor vehicle		87		28		—		115		6,853		6,968
Other		2		—		—		2		2,590		2,592

Total	$	1,874	$	332	$	1,139	$	3,345	$	178,741	$	182,086

CREDIT QUALITY INDICATORS:

Beginning in the fiscal year ended September 30, 2012, the Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt 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 includes all non-homogeneous loans, such as commercial and commercial real estate loans. The analysis for residential real estate and consumer loans primarily includes review of past due status. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:

Special Mention. Loans classified 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 at 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 characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

Based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):


	Pass		Special Mention		Substandard		Doubtful		Not Rated

December 31, 2012
One to four family	$	135,673	$	862	$	1,338	$	—	$	—
Multi family		925		—		—		—		—
Commercial Real Estate		13,429		876		2,035		—		—
Construction and land		4,473		—		—		—		—
Commercial and industrial		5,464		—		—		—		—
Home equity loans and lines of credit		5,674		—		—		—		—
Motor vehicle		6,698		35		47		—		—
Other		2,371		—		—		—		—


Total	$	174,707	$	1,773	$	3,420	$	—	$	—


September 30, 2012
One to four family	$	137,968	$	954	$	2,385	$	—	$	—
Multi family		985		—		—		—		—
Commercial Real Estate		14,654		810		869		—		—
Construction and land		3,095		—		—		—		—
Commercial and industrial		4,895		—		—		—		—
Home equity loans and lines of credit		5,874		15		22		—		—
Motor vehicle		6,907		20		41		—		—
Other		2,592		—		—		—		—


Total	$	176,970	$	1,799	$	3,317	$	—	$	—

The Company had no troubled debt restructuring at December 31, 2012 or September 30, 2012.

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For all loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity on a quarterly basis.

NOTE 4: FEDERAL HOME LOAN BANK ADVANCES

Advances from the FHLB at December 31, 2012 and September 30, 2012 were as follows: (in thousands)


	December 31, 2012		September 30, 2012

Maturities February 2016 through June 2024, fixed rate at rates from 2.16% to 6.70%, weighted average rate of 2.94% at December 31, 2012 and 2.95% at September 30, 2012	$	16,748	$	17,676

Payments contractually required over the next five years are as follows (in thousands):


December 31,
2013	$	4,821
2014		3,394
2015		2,763
2016		2,222
2017		1,779
Thereafter		1,769

Total	$	16,748

NOTE 5: FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

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 company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate fair value:

Securities : The fair values for securities are determined by quoted market prices, if available (Level 1). If quoted market prices are not available, fair values are based on quoted market prices of similar securities (Level 2). This includes the use of “matrix pricing” used to value debt securities absent the exclusive use of quoted prices. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows (Level 3).

Other Real Estate Owned : Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Assets and liabilities measured at fair value on a recurring basis, including financial assets and liabilities for which the Company has elected the fair value option, are summarized below (in thousands):


			Fair Value Measurements at December 31, 2012 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Financial Assets
Securities:

States and political subdivisions	$	25,541	$	—	$	25,541	$	—
U.S. Government agencies and sponsored entitites		32,510		—		32,510		—
Mortgage backed securities: residential		41,976		—		41,976		—

Total securities	$	100,027	$	—	$	100,027	$	—


			Fair Value Measurements at September 30, 2012 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Financial Assets
Securities:
States and political subdivisions	$	26,188	$	—	$	26,188	$	—
U.S. Government agencies and sponsored entitites		22,257		—		22,257		—
Mortgage backed securities: residential		46,011		—		46,011		—

Total securities	$	94,456	$	—	$	94,456	$	—

There were no transfers between Level 1 and Level 2.

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


			Fair Value Measurements at December 31, 2012 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Other real estate owned
(One to four family), net	$	22	$	—	$	—	$	22
(Commercial Real Estate), net		147		—		—		147

	$	169	$	—	$	—	$	169


			Fair Value Measurements at September 30, 2012 Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Other real estate owned (one to four family), net	$	268	$	—	$	—	$	268

Commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use 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. Appraisals for real estate properties classified as other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Association’s management. The appraisal values are discounted to allow for selling expenses and fees, and the discounts range from 5% to 10%.

At December 31, 2012, other real estate owned had a net carrying amount of $169,000 made up of the outstanding balance of $210,000 net of a valuation allowance of $41,000, which resulted in a write-down of $18,000 for the three months ended December 31, 2012. At September 30, 2012, other real estate owned had a net carrying amount of $268,000 made up of the outstanding balance of $336,000, net of a valuation allowance of $68,000. There was no write-down for the three months ended December 31, 2011.

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


			Fair Value Measurements
	Carrying Value		Level 1		Level 2		Level 3		Total
December 31, 2012
Financial assets
Cash and cash equivalents	$	17,778	$	17,778	$	—	$	—	$	17,778
Securities		100,027		—		100,027		—		100,027
Federal Home Loan Bank stock		1,953		N/A		N/A		N/A		N/A
Loans held for sale		619		—		636		—		636
Loans, net		177,831		—		—		196,890		196,890
Accrued interest receivable		1,146		—		481		665		1,146

Financial liabilities
Deposits	$	235,304	$	93,641	$	143,883	$	—	$	237,524
Federal Home Loan Bank advances		16,748		—		17,714		—		17,714
Accrued interest payable		43		—		43		—		43


	Carrying Amount		Level 1		Level 2		Level 3		Total
September 30, 2012
Financial assets
Cash and cash equivalents	$	23,430	$	23,430	$	—	$	—	$	23,430
Securities		94,456		—		94,456		—	$	94,456
Federal Home Loan Bank stock		1,953		N/A		N/A		N/A		N/A
Loans held for sale		719		—		739		—	$	739
Loans, net		179,998		—		—		202,153	$	202,153
Accrued interest receivable		1,255		—		509		746	$	1,255

Financial liabilities
Deposits	$	236,472	$	96,176	$	141,826	$	—	$	238,002
Federal Home Loan Bank advances		17,672		—		18,764		—	$	18,764
Accrued interest payable		376		—		376		—	$	376

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Loans

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are by definition equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level 1 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

Other Borrowings

The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value and are classified by level consistent with the level of the related assets or liabilities.

Off-balance Sheet Instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

NOTE 6 – ESOP PLAN

Employees participate in an Employee Stock Option Plan (ESOP). The ESOP borrowed from the Company to purchase 269,790 shares of the company’s common stock at $10 per share. The Company makes discretionary contributions to the ESOP, and pays dividends on unallocated shares to the ESOP, and the ESOP uses funds it receives to repay the loan. When loan payments are made, ESOP shares are allocated to participants based on relative compensation and expense is recorded. Dividends on allocated shares increase participant accounts.

Participants receive the shares at the end of employment. A participant may require stock received to be repurchased unless the stock is traded on an established market.

Contributions to the ESOP for the three months ended December 31, 2012 totaled $143,000 and $46,000 for the three months ended December 31, 2011.

Shares held by the ESOP at December 31, 2012 and September 30, 2012 was as follows:


	December 31, 2012		September 30, 2012
Allocated to participants		16,862		3,372
Unallocated		—		10,117
Unearned		252,928		256,301

Total ESOP shares		269,790		269,790


Fair value of unearned shares (in thousands)	$	3,225	$	3,158

NOTE 7 – EARNINGS PER SHARE

The factors used in the earnings per share computation for the three months ended December 31, 2012, were as follows (in thousands):


	Three months ended December 31,
	2012		2011
			(Revised)
Basic
Net income	$	434,000	$	608,000


Weighted average common shares outstanding		3,372,375		3,372,375
Less: Average unallocated ESOP shares		266,268		269,753


Average shares		3,106,107		3,102,622


Basic earnings per common share	$	0.14	$	0.20


Diluted
Net income	$	434,000	$	608,000


Weighted average common shares outstanding for basic earnings per common share		3,106,107		3,102,622
Add: Dilutive effects of assumed exercises of stock options		—		—


Average shares and dilutive potential common shares		3,106,107		3,102,622


Diluted earnings per common share	$	0.14	$	0.20

There were no potentially dilutive securities outstanding at December 31, 2012 or 2011; therefore, basic and diluted earnings per share are the same.

NOTE 8 – STOCK REPURCHASE PROGRAM

On December 18, 2012, the Board of Directors of Poage Bankshares, Inc. (the “Company”) authorized a stock repurchase program pursuant to which the Company intends to purchase up to 168,619 of its issued and outstanding shares of common stock, which represents approximately 5.0% of the Company’s issued and outstanding shares. The timing of the purchases will depend on certain factors, including but not limited to, market conditions and prices, available funds and alternative uses of capital. The stock repurchase program may be carried out through open-market purchases, block trades, negotiated private transactions and pursuant to a trading plan that will be adopted in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934. Any repurchased shares will be held by the Company as authorized but unissued shares. The Company has repurchased 5,001 of it’s common stock under the repurchase program at an average price of $13.21 per share, all after the December 31, 2012 reporting period.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report contains forward-looking statements, which can be identified by the use of such words as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may,” and similar expressions. These forward-looking statements include, but are not limited to:

•

statements of our goals, intentions and expectations;

•

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

•

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

•

estimates of our risks and future costs and benefits.

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

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

•

our ability to manage our operations during the current United States economic recession;

•

our ability to manage the risk from the growth of our commercial real estate lending;

•

significant increases in our loan losses, exceeding our allowance;

•

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

•

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

•

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

•

significant increases in our loan losses;

•

our ability to increase multi-family, commercial real estate and commercial loan portfolio while maintaining asset quality;

•

risks relating to acquisitions and an ability to integrate and operate profitably any financial institution that we may acquire;

•

our ability to pay dividends;

•

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

•

general economic conditions, either nationally or in our market area;

•

changes in consumer spending, borrowing and savings habits, including a lack of consumer confidence in financial institutions;

•

potential increases in deposit assessments;

•

significantly increased competition among depository and other financial institutions;

•

changes in accounting policies and practices, as may be adopted by the bank regulatory agencies and the authoritative accounting and auditing bodies;

•

legislative or regulatory changes, including increased deposit or premium assessments and increased compliance costs, that adversely affect our business and earnings;

•

changes in the level of government support of housing finance;

•

significantly increased competition with financial institutions;

•

risks and costs related to becoming a publicly traded company; and

•

changes in our organization, compensation and benefit plans.

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

Critical Accounting Policies

There are no material changes to the critical accounting policies disclosed in Poage Bankshares, Inc.’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on December 19, 2012.

Comparison of Financial Condition at December 31, 2012 and September 30, 2012

Our total assets decreased $2.7 million, or 0.9%, to $314.5 million at December 31, 2012 from $317.2 million at September 30, 2012. The decrease was primarily due to a decrease of cash and due from financial institutions of $5.6 million, or 23.9%, to $17.8 million at December 31, 2012 from $23.4 million at September 30, 2012, partially offset by an increase in securities available for sale of $5.5 million, or 5.8%, to $100.0 million at December 31, 2012 from $94.5 million at September 30, 2012.

Loans held for sale decreased $100,000, or 13.9% to $619,000 at December 31, 2012 from $719,000 at September 30, 2012. This decrease was largely due to reduced one-to-four family mortgage loan originations.

Loans receivable, net, decreased $2.1 million, or 1.2%, to $177.9 million at December 31, 2012 from $180.0 million at September 30, 2012. This decrease was largely due to reduced demand for one-to-four family loans in our market area, particularly with respect to refinancing. Non-performing loans decreased $440,000, or 33.6%, from $1.3 million at September 30, 2012 to $0.9 million at December 31, 2012.

Securities available for sale increased to $100.0 million at December 31, 2012 from $94.5 million at September 30, 2012. This increase was primarily due to the deployment of excess cash and cash equivalents for the purchase of higher-yielding U.S. Government Agencies.

Deposits decreased $1.2 million, or 0.5%, to $235.3 million at December 31, 2012 from $236.5 million at September 30, 2012. The decrease was primarily attributable to a decrease in savings and NOW accounts of $1.9 million, or 2.1%, offset by an increase of $0.9 million, or 0.6%, in certificates of deposit.

Federal Home Loan Bank advances decreased $1.0 million, or 5.6%, to $16.7 million at December 31, 2012 from $17.7 million at September 30, 2012. This decrease in borrowings was primarily the result of regular principal payments and maturities.

Total shareholders’ equity increased slightly to $60.7 million at December 31, 2012, compared to $60.6 million at September 30, 2012. The increase resulted primarily from net income of $434,000 for the three months ended December 30, 2012, partially offset by a decrease in other comprehensive income of $294,000 and cash dividends of $135,000.

Average Balance and Yields

The following tables set forth average balance sheets, average yields and costs, and certain other information at the dates and for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the tables as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income.


	For the Three Months Ended December 31,
	2012								2011
	Average Balance		Interest and Dividends			Yield/ Cost			Average Balance		Interest and Dividends			Yield/ Cost

Assets:
Interest-earning assets:
Loans	$	179,235	$	2,554			5.70	%	$	183,170	$	2,728			5.96	%
Investment securities		96,671		456			1.89	%		90,887		563			2.48	%
FHLB stock		1,953		23			4.71	%		1,906		19			3.99	%
Other interest-earning assets		19,825		10			0.20	%		8,069		16			0.79	%

Total interest-earning assets		297,684		3,043			4.09	%		284,032		3,326			4.68	%

Noninterest-earning assets		21,104								44,818

Total assets		318,788								328,850

Liabilities and equity:
Interest bearing liabilities:
Interest bearing deposits:
NOW, savings, money market, and other		88,063		107			0.49	%		108,129		127			0.47	%
Certificates of deposit		140,533		475			1.35	%		147,855		648			1.75	%

Total interest bearing deposits		228,596		582			1.02	%		255,984		775			1.21	%

FHLB advances		17,160		126			2.94	%		22,509		176			3.13	%

Total interest bearing liabilities		245,756		708			1.15	%		278,493		951			1.37	%

Non-interest bearing liabilities:
Non-interest bearing deposits		6,361								1,085
Accrued interest payable		481								551
Other liabilities		5,563								5,451

Total non-interest bearing liabilities		12,405								7,087

Total liabilities		258,161								285,580

Total equity		60,627								43,270

Total liabilities and equity	$	318,788							$	328,850

Net interest income				2,335								2,375
Interest rate spread							2.94	%							3.32	%
Net interest margin							3.12	%							3.34	%
Average interest-earning assets to average interest-bearing liabilities				121.13	%							101.99	%

Liquidity and Capital Resources

Our primary sources of funds are deposits and the proceeds from principal and interest payments on loans and investment securities. We also utilize Federal Home Loan Bank advances. While maturities and scheduled amortization of loans and securities are predicable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. We generally manage the pricing of our deposits to be competitive within our market and to increase core deposit relationships.

Liquidity management is both a daily and long-term responsibility of management. We adjust our investments in liquid assets based upon management’s assessment of (i) expected loan demand, (ii) expected deposit flows, (iii) yields available on interest-earning deposits and investment securities, and (iv) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning overnight deposits, federal funds sold, and short and intermediate-term investment securities. If we require funds beyond our ability to generate them internally we have additional borrowing capacity with the Federal Home Loan Bank of Cincinnati. At December 31, 2012, we had $16.7 million in advances from the Federal Home Loan Bank of Cincinnati and an additional borrowing capacity of $57.0 million.

Home Federal Savings and Loan Association (the “Association”) is subject to various regulatory capital requirements administered by its primary federal regulator, the Office of the Comptroller of the Currency (“OCC”). Failure to meet the minimum regulatory capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that if undertaken, could have a direct material effect on the Association and the consolidated financial statements. Under the regulatory capital adequacy guidelines and the regulatory framework for prompt corrective action, the Association must meet specific capital guidelines involving quantitative measures of the Association’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.

The Association’s capital amounts and classification under the prompt corrective action guidelines are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Association to maintain minimum amounts and ratios of: total risk-based capital and Tier I capital to risk-weighted assets (as defined in the regulations), Tier I capital to adjusted total assets (as defined), and tangible capital to adjusted total assets (as defined).

As of December 31, 2012, based on the most recent notification from the OCC, the Association was categorized as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since the most recent notification that management believes have changed the Association’s prompt corrective action category.

Actual and required capital amounts (in thousands) and ratios for the Association are presented below at December 31, 2012 and year-end:


	Actual						For Capital Adequacy Purposes						To Be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio				Amount			Ratio			Amount			Ratio
As of December 31, 2012:
Total Risk-Based Capital (to Risk-weighted Assets)	$	46,058		29.99	%	³	$	12,286	³		8.00	%	$	15,358	³		10.00	%
Tier I Capital (to Risk-weighted Assets)		44,137		28.74	%	³		6,143	³		4.00	%		9,215	³		6.00	%
Tier I Capital (to Adjusted Total Assets)		44,137		14.04	%	³		12,573	³		4.00	%		15,716	³		5.00	%


	Actual						For Capital Adequacy Purposes						To Be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio				Amount			Ratio			Amount			Ratio
As of September 30, 2012:
Total Risk-Based Capital (to Risk-weighted Assets)	$	45,499		29.29	%	³	$	12,429	³		8.00	%	$	15,388	³		10.00	%
Tier I Capital (to Risk-weighted Assets)		43,547		28.03	%	³		6,214	³		4.00	%		9,203	³		6.00	%
Tier I Capital (to Adjusted Total Assets)		43,547		13.78	%	³		12,644	³		4.00	%		16,346	³		5.00	%

Off-Balance Sheet Arrangements. In the normal course of operations, we engage in a variety of financial transactions that, in accordance with U.S. generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.

Comparison of Operating Results for the Three Months Ended December 31, 2012 and December 31, 2011

General. Net income decreased $174,000, or 3.5%, to $434,000 for the three months ended December 31, 2012 from $608,000 for the three months ended December 31, 2011. The decrease reflected an increase in net interest income of $74,000 for the three months ended December 31, 2012, offset by an increase in non-interest expense of $247,000 to $2.1 million for the three months ended December 31, 2012 from $1.9 million for the three months ended December 30, 2011.

Interest Income. Interest income decreased $169,000, or 5.1% to $3.2 million for the three months ended December 31, 2012 from $3.3 million and for the three months ended December 31, 2011.

Interest income on loans remained constant at $2.7 million for the three months ended December 31, 2012 and for the three months ended December 31, 2011. The average yields on loans decreased to 5.95% for the three months ended December 31, 2012, compared to 5.96% for the three months ended December 31, 2011 and the average balance of loans decreased to $179.2 million for the three months ended December 31, 2012 from $183.2 million for the three months ended December 31, 2011. Interest income on investment securities decreased $107,000, or 19.0%, to $456,000 for the three months ended December 31, 2012 from $563,000 for the three months ended December 31, 2011, reflecting an increase in the average balance of such securities to $96.7 million at December 31, 2012 from $90.9 million at December 31, 2011 offset by a decrease in the average yield to 1.89% for the three months ended December 31, 2012, from 2.48% for the three months ended December 31, 2011.

Interest Expense. Interest expense decreased $243,000, or 25.6%, to $708,000 for the three months ended December 31, 2012 from $951,000 for the three months ended December 31, 2011. The decrease reflected a decrease in the average rate paid on deposits to 1.02% for the three months ended December 31, 2012 from 1.21%

for the three months ended December 31, 2011, as well as a decrease in the average balance of such deposits to $228.6 million from $256.0 million for the same periods. Interest expense on Federal Home Loan Bank Advances decreased $50,000 or 28.4% to $126,000 for the three months ended December 31, 2012 from $176,000 for the three months ended December 31, 2011. This decrease was due to a decrease of $5.3 million in the average balance of these borrowings, and a 19 basis point decrease in the average rate paid on these borrowings.

Interest expense on certificates of deposit decreased $173,000, or 26.7%, to $475,000 for the three months ended December 31, 2012 from $648,000 for the three months ended December 31, 2011. This decrease reflected a decrease in the average rate paid on certificates of deposits to 1.35% for the three months ended December 31, 2012 from 1.75% for the three months ended December 31, 2011, as well as a decrease in the average balance of such certificates to $140.5 million from $147.9 million. Interest expense on money market deposits, savings, and NOW and demand deposits decreased $20,000, or 15.7%, to $107,000 for the three months ended December 31, 2012 from $127,000 for the three months ended December 31, 2011. The decrease was due to a slightly higher average rate paid on the NOW and demand deposits as well as savings and money market accounts to 0.49% for the three months ended December 31, 2012 from 0.47% for the three months ended December 31, 2011, offset by a decrease in the average balance of such deposits to $88.1 million from $108.0 million.

Net Interest Income. Net interest income remained constant at $2.4 million for the three months ended December 31, 2012 and 2011. The interest rate spread decreased to 2.94% from 3.32%, along with an increase in the ratio of our average interest earning assets to average interest bearing liabilities to 121.13% from 101.99%. Our net interest margin decreased slightly to 3.12% from 3.34%. The decrease in our interest rate spread and net interest margin were largely due to a reduction of interest earned on loans and investments.

Provision for Loan Losses. We recorded no provision for loan losses for the three months ended December 31, 2012 and $38,000 for the three months ended December 31, 2011, reflecting the minimal levels of nonperforming loans and charge-offs during the periods, as well as management’s conservative lending policies. The provisions for each period were based on management’s quarterly calculations and resulted primarily from increased subjective factors applied to its loan portfolio. Management reevaluated the residential subjective factors and has applied more emphasis on the residential real estate portfolio based upon historical losses, nonperforming loans and the level of rental property within the portfolio.

Noninterest Income. Noninterest income increased $57,000 or 17.9%, to $375,000 for the three months ended December 31, 2012 from $318,000 for the three months ended December 31, 2011. The increase in noninterest income was primarily attributable to an increase of $48,000 in service charges on deposits to $152,000 for the three months ended December 31, 2012 from $104,000 for the three months ended December 31, 2011, and an increase of net gains on sales of loans of $23,000 for the three months ended December 31, 2012 to $161,000 from $138,000 for the three months ended December 31, 2011.

Noninterest Expense. Noninterest expense increased $247,000, or 13.2%, to $2.1 million for the three months ended December 31, 2012, from $1.9 million for the three months ended December 31, 2011. This increase was due largely to an increase in salaries and employee benefits due to an increase in the number of employees to $1.1 million for the three months ended December 31, 2012 from $968,000 for the three months ended December 31, 2011 as well as an increase in professional fees and other costs related to being a public company.

Income Tax Expense. The provision for income taxes was $161,000 for the three months ended December 31, 2012, compared to $179,000 for the three months ended December 31, 2011. Our effective tax rates for the three months ended December 31, 2012 and 2011 were 27.1% and 22.7%, respectively. This decrease in income tax expense is largely due to reduced earnings during the three months ended December 31, 2012. The increase in the effective tax rate is largely due to a reduction in tax exempt income of $82,000 to $146,000 for the three months ended December 31, 2012 from $228,000 for the three months ended December 31, 2011.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Disclosures of quantitative and qualitative market risk are not required by smaller reporting companies, such as the Company.

ITEM 4.

CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the fiscal year (the “Evaluation Date”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were not effective, because of the material weakness described below, to enable us to provide that information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and to ensure that the information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Management’s Report on Internal Control over Financial Reporting.

Our management is responsible for establishing and maintaining an adequate system of internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Our internal control over financial reporting is intended to include those policies and procedures that:

•

pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets;

•

provide reasonable assurance that our transactions are recorded as necessary to permit preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America, and that our receipts and expenditures are being made only in accordance with authorizations of our management and our directors; and

•

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness as to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Further, because of changes in conditions, effectiveness of internal controls over financial reporting may vary over time. Our system contains self-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.

Our management and audit committee conducted an evaluation of the effectiveness of the system of internal control over financial reporting as of December 31, 2012 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework. A material weakness is a control deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. Based on our assessment, we believe that, as of December 31, 2012, the Company’s internal control over financial reporting was not effective based on those criteria because management identified the following material weaknesses.

Underwriting and Approval and Lack of Effective Supervision and Oversight by Management Over the Loan Approval Process With Respect to Certain Loans.

The Company has conducted an extensive internal review of our internal controls with the assistance of outside independent professional firms and its internal audit department, with specific focus on our loan underwriting, approval and review procedures. In the course of this review, management discovered that an employee had been using our share loan product to make fictitious loans and convert the proceeds to her own use, and, in connection with these fictitious loans, also had been improperly accessing branch cash drawers. This employee is no longer with the Company. As a result of the internal investigation, management discovered a material weakness in the operating effectiveness of procedures and documentation related to loan underwriting. Additionally, these processes lacked effective supervision and oversight by lending management personnel.

As a result of the internal investigations, management determined that we were required to record a charge for impairment of certain loans in the aggregate amount of $964,000 including accrued interest of $140,000. We have adjusted our opening retained earnings for 2011 for the item described above, which adjustment is reflected in the consolidated financial statements contained in the September 30, 2012 Annual Report on Form 10-K, and in this Quarterly Report on Form 10-Q and consider these adjustments to be immaterial to prior periods.

Management determined that these significant control deficiencies, combined with the material adjustment to the Company’s retained earnings, constitute a material weakness in the Company’s internal control over financial reporting.

Promptly following the identification of the material weakness related to the fraud described above, we began taking the following steps to remediate this material weakness, with a specific focus on enhancing oversight of loan origination, loan processing function, underwriting, branch management and cash control functions:

•

management reviewed this material weakness with our audit committee, senior management and independent public accounting firm;

•

management reviewed with the board of directors the policies introduced in August, 2012, which modified the loan product that the employee used to perpetrate fraud, and which resulted in the discovery of the fictitious loans;

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the board of directors approved modifications of such loan product and the administration of such loan product, which are intended to eliminate the possibility of future fraud; and

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management has centralized the dual control of cash collateral associated with each individual loan.

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management has engaged a third party accounting firm to peform a forensic investigation into the fictitious loans.

In addition to the steps management has taken, management intends to continue develop and improve our management oversight and loan approval process as our ongoing remediation efforts are pursued, including:

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continuing to review and monitor the material weakness and the effectiveness of our remedial actions with our audit committee and senior management;

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continuing to enhance loan documentation and underwriting procedures;

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reinforcing our loan review policies and procedures, including the engagement of a third party loan review firm to assist in our loan evaluations;

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continuing to enhance branch management policies and procedures, particularly with respect to access to cash on hand; and

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will review the report of the third party forensic audit for further areas of enhancement of internal controls.

Management believes that these changes will contribute significantly to the remediation of the material weakness in internal control over financial reporting that was in existence as of December 31, 2012. Additional changes will be implemented as determined necessary.

Although the Company’s remediation efforts are well underway and are expected to be completed in the near future, the Company’s weakness will not be considered remediated until new internal controls are operational for a period of time and are tested, and management and concludes that these controls are operating effectively.

Improper Accounting for a Third Party Contract.

During the conduct of our 2012 audit, we learned that we had not properly accounted for a contract with the FHLB—Cincinnati related to the sale of mortgage loans to the FHLB—Cincinnati, and that to account for this contract correctly, an asset and a corresponding gain on sale of loans should have been recorded. While this did not result in a material adjustment to our financial statements, we believe that our internal controls would not have identified this deficiency and that the matter could have become material in the future.

Management has designed controls, which were implemented during the first quarter of 2013, to ensure accounting for the contract is accurate.

Other than as discussed above, there were no significant changes made in our internal controls during the period covered by this report or, to our knowledge, in other factors that has materially affected or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II

OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company and its subsidiaries are subject to various legal actions that are considered ordinary routine litigation incidental to the business of the Company, and no claim for money damages exceeds ten percent of the Company’s consolidated assets. In the opinion of management, based on currently available information, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s results of operations.

ITEM 1A. RISK FACTORS

Disclosures of risk factors are not required by smaller reporting companies, such as the Company.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

The exhibits required by Item 601 of Regulation S-K are included with this Form 10-Q and are listed on the “Index to Exhibits” immediately following the Signatures.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Poage Bankshares, Inc.

Date: February 14, 2013

/s/ R. E. Coffman, Jr.

R. E. Coffman, Jr.

President & Chief Executive Officer

/s/ Jeffery W. Clark

Jeffery W. Clark,

Chief Financial Officer

INDEX TO EXHIBITS


Exhibit number		Description

31.1		Certification of R. E. Coffman, Jr., President, and Chief Executive Officer, Pursuant to Rule 13a-14(a) and Rule 15-d-14(a).

31.2		Certification of Jeffery W. Clark, Chief Financial Officer, Pursuant to Rule 13a-14(a) and Rule 15d-14(a).

32.1		Certification of R. E. Coffman, Jr., President and Chief Executive Officer, and Jeffery W. Clark, Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101		The following material from the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2012, formatted in XBRL (Extensible Business Reporting Language) :(i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Other Comprehensive Income (Loss), (iv) Consolidated Statements of Shareholders Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to the Consolidated Financial Statements. (*)