- Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________________________________________

FORM 10-Q

______________________________________________________

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

Commission file number 000-027307

(Exact name of registrant as specified in charter)



North Carolina (State or Other Jurisdiction of Incorporation or Organization)		56-1980549 (I.R.S. Employer Identification No.)

2634 Durham Chapel Hill Blvd. Durham, North Carolina (Address of Principal Executive Offices)		27707-2800 (Zip Code)

(919) 687-7800

(Registrant’s Telephone Number, Including Area Code)

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



Large accelerated filer o	Accelerated filer o	Non-accelerated filer o	Smaller reporting company x
		(Do not check here if a smaller reporting Company)

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

State the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

As of August 10, 2012, there were 2,031,337 shares outstanding of the issuer's common stock, no par value.

INDEX



PART I	1
FINANCIAL INFORMATION	1
Item 1 - Financial Statements (unaudited)	1
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 4 - Controls and Procedures	62
PART II	63
OTHER INFORMATION	63
Item 6 - Exhibits	64

Index

M&F BANCORP, INC.

PART I

FINANCIAL INFORMATION


Item 1 -	Financial Statements (unaudited)



CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)	September 30, 2012			December 31, 2011
	(Unaudited)			***
ASSETS
Cash and cash equivalents	$	51,516		$	61,296
Investment securities available for sale, at fair value	62,933			37,595
Other invested assets	489			638
Loans, net of unearned income and deferred fees	178,941			188,084
Allowances for loan losses	(3,498		)	(3,850		)
Loans, net	175,443			184,234
Interest receivable	850			764
Bank premises and equipment, net	4,661			4,654
Cash surrender value of bank-owned life insurance	5,926			5,768
Other real estate owned	3,072			3,215
Deferred tax assets and taxes receivable, net	4,329			4,703
Other assets	1,390			1,589
TOTAL ASSETS	$	310,609		$	304,456
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Interest-bearing deposits	$	212,874		$	209,291
Noninterest-bearing deposits	48,498			49,853
Total deposits	261,372			259,144
Other borrowings	2,987			2,939
Other liabilities	9,358			5,976
Total liabilities	273,717			268,059
COMMITMENTS AND CONTINGENCIES- NOTE 8
Stockholders' equity:
Series B Preferred Stock- $1,000 liquidation value per share, 11,735 shares issued and outstanding	11,725			11,724
Common stock, no par value 10,000,000 shares authorized; 2,031,337 shares issued and outstanding	8,732			8,732
Retained earnings	17,721			17,380
Accumulated other comprehensive loss	(1,286		)	(1,439		)
Total stockholders' equity	36,892			36,397
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	310,609		$	304,456

See notes to consolidated financial statements.

***Derived from audited financial statements.

Index

M&F BANCORP, INC.



CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands except for share and per share data)	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
(Unaudited)	2012		2011		2012			2011
Interest income:
Loans, including fees	$	2,775	$	2,783	$	7,969		$	8,524
Investment securities, including dividends
Taxable	229		186		636			472
Tax-exempt	23		73		91			204
Other	21		36		94			116
Total interest income	3,048		3,078		8,790			9,316
Interest expense:
Deposits	227		341		695			1,102
Borrowings	7		26		46			70
Total interest expense	234		367		741			1,172
Net interest income	2,814		2,711		8,049			8,144
Less provision for loan losses	122		264		166			437
Net interest income after provision for loan losses	2,692		2,447		7,883			7,707
Noninterest income:
Service charges	362		364		1,024			1,079
Rental income	92		88		273			261
Cash surrender value of life insurance	52		50		152			147
Realized gain on sale of securities	67		69		256			106
Realized (loss) gain on sale of other real estate owned	4		21		(42		)	162
Realized gain on disposal of assets	—		—		—			104
Other income	1		1		4			3
Total noninterest income	578		593		1,667			1,862
Noninterest expense:
Salaries and employee benefits	1,491		1,376		4,387			4,112
Occupancy and equipment	400		372		1,124			1,148
Directors fees	67		63		218			217
Marketing	75		55		164			198
Professional fees	166		335		627			818
Information technology	233		203		696			590
FDIC deposit insurance	131		144		395			468
OREO expense, net	61		35		190			185
Delivery expenses	48		46		150			180
Other	318		251		883			850
Total noninterest expense	2,990		2,880		8,834			8,766
Income before income taxes	280		160		716			803
Income tax expense	87		24		196			205
Net income	193		136		520			598
Less preferred stock dividends and accretion	59		59		179			176
Net income available to common stockholders	$	134	$	77	$	341		$	422

Basic and diluted earnings per share of common stock:	$	0.07	$	0.04	$	0.17		$	0.21
Weighted average shares of common stock outstanding:
Basic and diluted	2,031,337		2,031,337		2,031,337			2,031,337
Dividends per share of common stock	$	—	$	—	$	—		$	—

See notes to consolidated financial statements.

Index

M&F BANCORP, INC.



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
(Unaudited)	2012			2011			2012			2011
Net income	$	193		$	136		$	520		$	598

Items of other comprehensive income, before tax:
Unrealized gains on securities available for sale, net of taxes	408			295			523			800
Reclassification adjustments for gains included in income before income tax expense	(67		)	(69		)	(256		)	(106		)
Other comprehensive income before tax expense	341			226			267			694
Less: Changes in deferred income taxes related to change in unrealized gains on securities available for sale	120			33			114			160
Other comprehensive income, net of taxes	221			193			153			534

Total comprehensive income	$	414		$	329		$	673		$	1,132

See notes to consolidated financial statements

Index

M&F BANCORP, INC.



CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011
(Dollars in thousands except for share data) (Unaudited)	Number of Shares	Common Stock		Preferred Stock		Retained Earnings			Accumulated Other Comprehensive Loss			Total
Balances as of December 31, 2010	2,031,337	$	8,732	$	11,722	$	17,264		$	(1,308	)	$	36,410
Accretion of Series B preferred stock issuance costs				1		(1		)				—
Comprehensive income:
Net income						598						598
Other comprehensive income, net of tax expense of $160									534			534
Total comprehensive income, net of tax expense of $365												1,132
Dividends declared on preferred stock						(175		)				(175		)
Balances as of September 30, 2011	2,031,337	$	8.732	$	11.723	$	17.686		$	(774	)	$	37,367

Balances as of December 31, 2011	2,031,337	$	8,732	$	11,724	$	17,380		$	(1,439	)	$	36,397
Accretion of Series B preferred stock issuance costs				1		(1		)				—
Comprehensive income:
Net income						520						520
Other comprehensive loss, net of tax benefit of $114									153			153
Total comprehensive income, net of tax expense of $310												673
Dividends declared on preferred stock						(178		)				(178		)
Balances as of September 30, 2012	2,031,337	$	8,732	$	11,725	$	17,721		$	(1,286	)	$	36,892

See notes to consolidated financial statements

Index

M&F BANCORP, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30,

(Dollars in thousands)
(Unaudited)	2012			2011
Cash flows from operating activities:
Net income	$	520		$	598
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	166			437
Depreciation and amortization	256			260
Gain on disposition of asset	—			(104		)
Amortization of discounts/premiums on investments, net	75			18
Loan purchase accounting amortization, net	130			130
Deferred loan origination fees and costs, net	108			71
Gains on sale of available for sale securities	(256		)	(106		)
Increase in cash surrender value of bank owned life insurance	(152		)	(147		)
Loss (gain) on sale of other real estate owned	42			(162		)
Write-down of other real estate owned	38			80
Changes in:
Accrued interest receivable and other assets	374			(400		)
Other liabilities	3,382			(440		)
Net cash provided by operating activities	4,683			235
Cash flows from investing activities:
Activity in available-for-sale securities:
Sales	7,224			3,687
Maturities, prepayments and calls	819			1,723
Principal collections	7,478			2,407
Purchases	(40,263		)	(17,289		)
Net decrease in loans	8,050			5,392
Purchases of bank premises and equipment	(263		)	(46		)
Payment of BOLI premium	(6		)	(6		)
Proceeds from disposition of asset	—			110
Proceeds from sale of real estate owned	400			914
Net cash used in investing activities	(16,561		)	(3,108		)
Cash flows from financing activities:
Net increase (decrease) in deposits	2,228			(9,065		)
Net increase (decrease) in other borrowings	48			(14		)
Cash dividends	(178		)	(175		)
Net cash provided by (used in) financing activities	2,098			(9,254		)
Net decrease in cash and cash equivalents	(9,780		)	(12,127		)
Cash and cash equivalents as of the beginning of the period	61,296			74,575
Cash and cash equivalents as of the end of the period	$	51,516		$	62,448
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Increase in unrealized gains on available for sale securities	267			694
Net transfers in to other real estate owned from loans	337			1,326
Accretion of Series B preferred stock issuance costs	1			1
Cash paid during period for:
Interest	$	813		$	1,023
Income taxes	181			181

See notes to consolidated financial statements.

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements, September 30, 2012 (unaudited)


1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The Consolidated Financial Statements include the accounts and transactions of M&F Bancorp, Inc. (the “Company”) and its wholly-owned bank subsidiary, Mechanics and Farmers Bank (the “Bank”). All significant inter-company accounts and transactions have been eliminated in consolidation. The Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) under the Accounting Standards Codification ("ASC") for interim financial statements and in accordance with the instructions for Form 10-Q and Rule 8-03 of Regulation S-X. The accompanying Consolidated Financial Statements and Notes are unaudited except for the balance sheet and footnote information as of December 31, 2011 , which were derived from the Company’s audited consolidated Annual Report on Form 10-K for the year ended December 31, 2011 .

The Consolidated Financial Statements included herein do not include all the information and notes required by GAAP and should be read in conjunction with the Consolidated Financial Statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 .

In the opinion of management, the interim financial statements include all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the financial position, results of operations and cash flows in the Consolidated Financial Statements. The unaudited operating results for the periods presented may not be indicative of annual results.


2.	INVESTMENT SECURITIES

The main objectives of our investment strategy are to provide a source of liquidity while managing our interest rate risk, and to generate an adequate level of interest income without taking undue risks. Our investment policy permits investments in various types of securities, certificates of deposit and federal funds sold in compliance with various restrictions in the policy. As of September 30, 2012 , and December 31, 2011 , all investment securities were classified as available for sale.

Our available for sale securities totaled $62.9 million and $37.6 million as of September 30, 2012 and December 31, 2011 , respectively. Securities with a fair value of $1.1 million were pledged to the Federal Reserve Bank of Richmond (“FRB”), respectively, and an additional $5.4 million and $2.4 million in investments were pledged to public housing authorities in North Carolina and the North Carolina Department of State Treasurer as collateral for public deposits at September 30, 2012 . Securities with a fair value of $0.6 million were pledged to the FRB and an additional $5.3 million and $2.0 million in investments were pledged to public housing authorities in North Carolina and the North Carolina Department of State Treasurer as collateral for public deposits at December 31, 2011 .

As a consequence of recent decreases in the loan portfolio, the Company has started an investment purchase program, investing mainly in high-quality, variable rate U.S. Government sponsored mortgage backed securities with expected durations of five years or less.

Our investment portfolio consists of the following securities:


•	U.S. Government agency securities (“U.S. Agencies”)


•	U.S. Government sponsored residential mortgage backed securities (“MBS”),


•	Non-Government sponsored residential MBS, and


•	Municipal securities (“Municipals”)

The amortized cost, gross unrealized gains and losses and fair values of investment securities at September 30, 2012 and December 31, 2011 were:

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued



(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
(Unaudited)
September 30, 2012
U.S. Agencies	$	1,363	$	7	$	—		$	1,370
Government sponsored MBS
Residential	57,605		679		(5		)	58,279
Non-Government sponsored MBS
Residential	98		3		—			101
Municipal securities
North Carolina	2,969		214		—			3,183
Total at September 30, 2012	$	62,035	$	903	$	(5	)	$	62,933

December 31, 2011
U.S. Agencies	$	483	$	—	$	—		$	483
Government sponsored MBS
Residential	$	30,399	$	416	$	(26	)	$	30,789
Non-Government sponsored MBS
Residential	133		2		—			135
Municipals
North Carolina	3,505		197		—			3,702
Out of state	2,444		42		—			2,486
Total at December 31, 2011	$	36,964	$	657	$	(26	)	$	37,595

Sales and calls of securities available for sale for the nine months ended September 30, 2012 , and September 30, 2011 , resulted in aggregate gross realized gains of $263.8 thousand and $106.3 thousand , respectively, and realized losses of $8.2 thousand and $0.0 thousand , respectively. During the three months ended September 30, 2012 and September 30, 2011 the Company realized gross gains of $75.4 thousand and $68.7 thousand , respectively, from the sales of securities and realized losses of $8.2 thousand and $0.0 thousand , respectively.

In the first quarter of 2012, the Company sold all of its remaining non-North Carolina based municipal securities.

The amortized cost and estimated market value of securities as of September 30, 2012 by contractual maturities are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. MBS, which are not due at a single maturity date, are grouped based upon the final scheduled payment date. MBS may mature earlier because of principal prepayments.

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued



(Dollars in thousands)	September 30, 2012
(Unaudited)	Fair Value		Amortized Cost
U.S. Agencies
Due after one year through five years	$	1,007	$	1,000
Due after five years through ten years	363		363
Total US Agencies	$	1,370	$	1,363

Government sponsored MBS
Residential
Due after one year through five years	$	147	$	137
Due after five years through ten years	181		169
Due after ten years	57,951		57,299
Total government sponsored MBS	$	58,279	$	57,605

Non-Government sponsored MBS
Residential
Due after ten years	$	101	$	98

Municipals (all North Carolina)
Due within one year	492		466
Due after one year through five years	$	2,082	$	1,895
Due after five years through ten years	609		608
Total municipals	$	3,183	$	2,969

As of September 30, 2012 and December 31, 2011 , the fair value of securities with gross unrealized losses by length of time that the individual securities have been in an unrealized loss position is as follows:





(Dollars in thousands)	Less Than 12 Months					12 Months or Greater				Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
September 30, 2012
Government sponsored MBS
Residential	$	2,535	$	(5	)	$	—	$	—	$	2,535	$	(5	)
Municipals
Total at September 30, 2012	$	2,535	$	(5	)	$	—	$	—	$	2,535	$	(5	)





(Dollars in thousands)	Less Than 12 Months					12 Months or Greater				Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
December 31, 2011
Government sponsored MBS
Residential	$	9,669	$	(26	)	$	—	$	—	$	9,669	$	(26	)
Total at December 31, 2011	$	9,669	$	(26	)	$	—	$	—	$	9,669	$	(26	)

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

All securities owned as of September 30, 2012 , and December 31, 2011 ,were investment grade. At least quarterly, the Company evaluates securities for other-than-temporary impairment. Consideration is given to the financial condition and near-term prospects of the issuer, the length of time and extent to which the fair value has been less than cost, and our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. As of September 30, 2012 and December 31, 2011 , the Company held 2 and 12 investment positions, respectively, with unrealized losses of $5 thousand and $26 thousand , respectively. As of September 30, 2012 , these investments were in U.S. Government sponsored MBS as of both dates, and as of December 31, 2011 , U.S. Government sponsored MBS, Municipals and non-Government sponsored MBS. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and industry analysts’ reports. Management has determined that all declines in the market value of available for sale securities are not other-than-temporary, and the Company has the intent and ability to hold these securities until the market recovers.

The Company owns stock in the Federal Home Loan Bank of Atlanta ("FHLB"), classified on the Consolidated Balance Sheets as Other invested assets, which is evaluated on a quarterly basis for other-than-temporary impairment. The FHLB has been issuing dividends and repurchasing excess stock on a pro-rata basis for several quarters. The Company believes that the investment in FHLB stock is not impaired.


3.	RECONCILIATIONS OF BASIC AND DILUTED EARNINGS PER COMMON SHARE ("EPS")

Basic EPS is computed by dividing net income after preferred stock dividends by the weighted average number shares of common stock outstanding for the period. Basic EPS excludes the dilutive effect that could occur if any options or warrants to purchase shares of common stock were exercised. Diluted EPS is computed by dividing net income by the sum of the weighted average number of shares of common stock outstanding for the period plus the number of additional shares of common stock that would have been outstanding if the potentially dilutive common shares had been issued. There are no stock options or warrants outstanding for any of the periods being reported.


4.	LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans — Loans are stated at the amount of unpaid principal, net of deferred loan origination fees and costs. Nonrefundable loan fees, net of direct costs, associated with the origination or acquisition of loans are deferred and recognized as an adjustment of the loan yield over the life of the respective loan using the effective interest method. Loans (net) are reduced by the allowance for loan losses ("ALLL"). Interest on loans is accrued on the daily balances of unpaid principal outstanding. Interest income is accrued and credited to income only if deemed collectible. Other loan fees and charges, representing service charges for the prepayment of loans, for delinquent payments, or for miscellaneous loan services, are recorded in income when collected.

Non-Performing Loans and Leases - Generally, all classes of loans and leases are placed on non-accrual status upon becoming contractually past due 90 days or more as to principal or interest (unless loans are adequately secured by collateral, are in the process of collection, and are reasonably expected to result in repayment), or where substantial doubt about full repayment of principal or interest is evident.

When a loan is placed on non-accrual status, regardless of class, the accrued and unpaid interest receivable is reversed and the loan is accounted for on the cash or cost recovery method until qualifying for return to accrual status. All payments received on non-accrual loans and leases are applied against the principal balance of the loan or lease. Loans may be returned to accrual status when all principal and interest amounts contractually due (including any arrearages) are reasonably assured of repayment within a reasonable period, the borrower has demonstrated payment performance for a minimum of six months in accordance with the original or revised contractual terms of the loan, and when doubt about repayment is resolved.

Generally, for all classes of loans and leases, a charge-off is recorded when it is probable that a loss has been incurred and when it is possible to determine a reasonable estimate of the loss. For all classes of commercial loans and leases, a charge-off is determined on a judgmental basis after due consideration of the debtor's prospects for repayment and the fair value of collateral. For closed-end consumer loans, the entire outstanding balance of the loan is charged-off during the month that the loan becomes 120 days past due as to principal or interest. Consumer loans with non-real estate collateral are written down to the value of the collateral, less estimated costs to sell, if repossession of collateral is assured and in process. For residential mortgage and home equity loan classes, a partial charge-off is recorded at 120 days past due as to principal or interest for the amount that the loan balance exceeds the fair value of the collateral less estimated costs to sell.

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

Impaired Loans - A loan is considered impaired when, based on current information and events, it is probable that the Company will not be able to collect all amounts due from the borrower in accordance with the original contractual terms of the loan, including scheduled interest payments. Impaired loans include all classes of commercial non-accruing loans and Troubled Debt Restructurings ("TDRs"). Impaired loans exclude smaller balance homogeneous loans (consumer and small business non-accruing loans) not in the process of foreclosure that are collectively evaluated for impairment.

For all classes of commercial loans, a quarterly evaluation of specific individual commercial borrowers with identified weaknesses is performed to identify impaired loans. The identification of specific borrowers for review is based on a review of non-accrual loans as well as those loans specifically identified by management as exhibiting above average levels of risk.

When a loan has been identified as being impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral-dependent. If the measurement of the impaired loan is less than the recorded investment in the loan (net of deferred loan fees or costs and unamortized premiums or discounts), impairment is recognized by creating or adjusting an existing allocation of the ALLL, or by recording a partial charge-off of the loan to its estimated fair value. Interest payments made on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest income may be accrued or recognized on a cash basis.

Loans Modified as a TDR - Loans are considered to have been modified as a TDR when the Company makes certain concessions to a borrower experiencing financial difficulty. Concessions to the borrower at modification may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a TDR remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. Since the economic crisis began in 2008, management has elected to offer concessions to borrowers with identified financial weaknesses, even if the borrowers have continued making scheduled payments, working with the borrowers to enable them to continue meeting their obligations to repay the debt to the Company.

Income Recognition on Impaired and Nonaccrual Loans - Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity, or payment of principal or interest for a period of more than 90 days, unless such loans are well secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or is partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if full repayment of principal and/or interest is in doubt.

Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within a reasonable period of time, and the borrower has demonstrated payment performance for a minimum of six months in accordance with the contractual terms involving payments of cash or cash equivalents. During the nonaccrual period, all payments received will be applied to principal. After a loan is returned to accruing status, foregone interest will be accreted to interest income on a pro-rata basis over the remaining term of the loan if full repayment of principal and interest is reasonably assured.

In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the remaining loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the ALLL until prior charged off balances have been fully recovered.

Reserve for Credit Losses - The Company's reserve for credit losses is comprised of two components, the allowance for loan losses (the "ALLL") and the reserve for unfunded commitments (the "Unfunded Reserve").

Allowances for Loan Losses - The ALLL is a valuation allowance which is established through a provision for loan losses charged to expense. When management believes that the collectability of the principal is unlikely, loans are charged against the ALLL. Subsequent recoveries, if any, are credited to the ALLL.

The ALLL is management's estimate of probable losses that are inherent in the loan portfolio. The ALLL is based on regular quarterly assessments. The methodologies for measuring the appropriate level of the ALLL include the combination of a quantitative historical loss history by loan type and a qualitative analysis for loans not classified as impaired or TDRs ("ASC 450 reserve"), and a specific allowance method for impaired and TDR loans ("ASC 310 reserve"). The qualitative analysis for the ASC 450 reserve is patterned after the guidelines provided under the Securities Exchange Commission (“SEC”) Staff Accounting Bulletin

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Notes to Consolidated Financial Statements continued

102 and the Federal Financial Institutions Examination Council (“FFIEC”) Interagency Policy Statement on the Allowance for Loan and Lease Losses and include the following:


•	Changes in lending policies and procedures, including underwriting standards and collection practices, and charge-off and recovery experience;


•	Changes in national economic and business conditions and developments and the effect of unemployment on African Americans, who are the majority of our customers;


•	Changes in the nature and volume of the loan portfolio;


•	Changes in the experience, ability, and depth of lending management and staff;


•	Changes in trends of the volume and severity of past due and classified loans; and changes in trends in the volume of non-accrual loans, troubled debt restructurings and classified loans;


•	Changes in the quality of the loan review system and the degree of oversight by the Bank's Board of Directors;


•	The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and


•	The effect of external factors such as competition and legal and regulatory requirements.

Management has developed, from historical loan and economic information, quantitative drivers for most of the qualitative factors. The quantitative drivers of qualitative factors, to which different weights are assigned based on management's judgment, are reviewed and updated quarterly based on updated quarterly and eight quarter rolling data. For example, more weight is assigned to changes in Doubtful account balances than that assigned to changes in Substandard balances. Management has identified qualitative factors which, by nature, are subjective and for which no quantitative drivers have been established, such as lending policies, competition, and regulatory requirements.

The quantitative loss history is based on an eight quarter rolling history of net losses incurred by different loan types within the loan portfolio. For loans evaluated under the ASC 450 reserve, the qualitative factors are added to the quantitative loss factors by loan type and multiplied by the balances of each loan type to determine the ASC 450 reserve. The actual eight quarter loss history is 46 bps of average loans outstanding as of September 30, 2012 . The net qualitative factors applied to the ASC 450 calculations totaled 1.36% and the quantitative factors varied from net recoveries to 35.93% for overdrafts.

A specific ALLL is established for loans identified as impaired or TDRs, based on significant conditions or circumstances related to the specific credits. The specific allowance amounts are determined by a method prescribed by ASC 310, Receivables. Loans identified as impaired and non-accruing TDRs are accounted for in accordance with one of three valuations: (i) the present value of future cash flows discounted at the loan's effective interest rate; (ii) the loan's observable market price, or (iii) the fair value of the collateral, if the loan is collateral dependent, less estimated liquidation costs. A loan is considered impaired when it is probable that not all amounts due (principal and interest) will be collectible according to the original contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. The significance of payment delays and payment shortfalls are considered on a loan by loan basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

For commercial business, faith-based non-profit, real estate and certain consumer loans, the measurement of loan impairment is based on the present value of the expected future cash flows, discounted at the loan's effective interest rate, or on the fair value of the loan's collateral if the loan is collateral dependent. Most consumer loans are smaller balance and homogeneous, and are evaluated for impairment on a collective basis, applying the quantitative loss history and the qualitative factors. Impairment losses are included in the ALLL through a charge to the provision for loan losses.

The Company uses several credit quality indicators to manage credit risk on an ongoing basis. The Company's credit risk rating system was developed to aid in the risk management process by grouping credits with similar risk profiles into pass (which includes internal watch), special mention, or criticized categories, which includes substandard, doubtful, and loss. Credit risk ratings are applied individually to all classes of loans. Internal credit reviews and external contracted credit review examinations are used to determine and validate loan risk grades. The credit review system takes into consideration factors such as: borrower's background and experience; historical and current financial condition; credit history and payment performance; economic conditions and their

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Notes to Consolidated Financial Statements continued

impact on various industries; type, market value and volatility of the market value of collateral; lien position; and the financial strength of guarantors.

The process of assessing the adequacy of the ALLL is necessarily subjective. Further, and particularly in periods of economic downturns, it is reasonably possible that future credit losses may exceed historical loss levels and may also exceed management's current estimates of incurred losses inherent within the loan portfolio. As such, there can be no assurance that future loan charge-offs will not exceed management's current estimate of what constitutes a reasonable ALLL.

The Company and the Bank are subject to periodic examination by their federal and state regulators, and may be required by such regulators to recognize additions to the allowance for loan losses based on the regulators' assessment of credit information available to them at the time of their examinations.

Reserve for Unfunded Commitments - The Unfunded Reserve is a component of other liabilities and represents the estimate for probable credit losses inherent in unfunded commitments to extend credit. Unfunded commitments to extend credit include loans with drawable balances available, new commitments to lend that are not yet funded, and standby and commercial letters of credit. The process used to determine the Unfunded Reserve is consistent with the process for determining the quantitative portion of the ASC 450 reserve, as adjusted for estimated funding probabilities and historical eight quarter rolling quantitative loan loss factors. The level of the Unfunded Reserve is adjusted by recording an expense or recovery in other noninterest expense. The balances of $51.3 thousand and $23.7 thousand for September 30, 2012 and December 31, 2011 , respectively, were reflected in other liabilities on the Consolidated Balance Sheets.

The composition of the loan portfolio, net of deferred fees and costs, by loan classification as of September 30, 2012 and December 31, 2011 was as follows:



	September 30, 2012			December 31, 2011
(Dollars in thousands)
Commercial	$	5,540		$	7,688
Commercial real estate:
Construction	1,726			1,871
Owner occupied	20,051			20,352
Other	26,628			24,831
Faith-based non-profit:
Construction	1,910			2,287
Owner occupied	77,137			78,161
Other	6,861			8,703
Residential real estate:
First mortgage	25,120			27,896
Multifamily	5,904			7,207
Home equity	3,420			4,457
Construction	381			—
Consumer	1,455			1,667
Other loans	2,808			2,964
Loans, net of deferred fees	178,941			188,084
Allowance for loan losses	(3,498		)	(3,850		)
Loans, net of allowance for losses	$	175,443		$	184,234

The Bank has a concentration of loans to faith-based non-profit organizations, in which the Bank has specialized lending experience. As of September 30, 2012 , the percentage of loans in this niche, which included construction, owner occupied real estate secured, and other loans, comprised approximately 48.01% of the total loan portfolio The reserve allocated for these loans is 29.47% of the total allowance. Historically the Bank has experienced low levels of loan losses in this niche; however, repayment of these loans is generally dependent on voluntary contributions, some of which have been adversely affected by the Great Recession and continued economic downturn.

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Notes to Consolidated Financial Statements continued

A portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its ALLL. The following table presents the ALLL and the reported investment in loans, net of deferred fees and costs, by portfolio segment. The first column shows the ALLL and loans classified as impaired or TDRs, and the second column presents all other loans, not classified as impaired or TDRs as of September 30, 2012 :



Allowance for loan losses:	Individually evaluated for impairment		Collectively evaluated for impairment		Outstanding as of September 30, 2012
(Dollars in thousands)
Commercial	$	—	$	25	$	25
Commercial real estate	$	313	$	856	$	1,169
Faith-based non-profit	$	52	$	979	$	1,031
Residential real estate	$	342	$	832	$	1,174
Consumer	$	—	$	52	$	52
Other loans	$	—	$	47	$	47
Total	$	707	$	2,791	$	3,498
Loans:
(Dollars in thousands)
Commercial	$	590	$	4,950	$	5,540
Commercial real estate	9,134		39,271		48,405
Faith-based non-profit	13,557		72,351		85,908
Residential real estate	2,186		32,639		34,825
Consumer	—		1,455		1,455
Other loans	—		2,808		2,808
Total	$	25,467	$	153,474	$	178,941

The following table presents the ALLL and the reported investment in loans, net of deferred fees and costs, by portfolio segment and based on impairment method as of December 31, 2011 :

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Notes to Consolidated Financial Statements continued



Allowance for loan losses:	Individually evaluated for impairment		Collectively evaluated for impairment		Outstanding as of December 31, 2011
(Dollars in thousands)
Commercial	$	—	$	348	$	348
Commercial real estate	119		852		971
Faith-based non-profit	56		1,072		1,128
Residential real estate	543		756		1,299
Consumer	2		60		62
Other loans	—		42		42
Total	$	720	$	3,130	$	3,850
Loans:
(Dollars in thousands)
Commercial	$	590	$	7,098	$	7,688
Commercial real estate	6,828		40,226		47,054
Faith-based non-profit	13,816		75,335		89,151
Residential real estate	2,180		37,380		39,560
Consumer	2		1,665		1,667
Other loans	—		2,964		2,964
Total	$	23,416	$	164,668	$	188,084

Total impaired loans, including TDRs, was $25.5 million as of September 30, 2012 and $23.4 million as of December 31, 2011 . One loan to a faith-based non-profit was restructured as a TDR in the quarter ended September 30, 2012 . Two commercial real estate secured loans, totaling $1.4 million were restructured as TDRs during the nine months ended September 30, 2012 in addition to the TDR in the quarter ended September 30, 2012 . Of the 38 TDRs at September 30, 2012 , 29 loans totaling $17.7 million were in compliance with the restructured terms.

The following tables show impaired loans, excluding TDRs, with and without allocated allowances for loan losses as of September 30, 2012 and December 31, 2011 , as well as average balances by loan classification for the three and nine months ended September 30, 2012 and September 30, 2011:



(Dollars in thousands)	September 30, 2012		December 31, 2011
Loans with no allocated allowance for loan losses	$	490	$	3,214
Loans with allocated allowance for loan losses	2,809		1,545
Total	$	3,299	$	4,759
Amount of the allowance for loan losses allocated	$	493	$	600

The following table shows average impaired balances by portfolio segment for the three and nine month periods shown:

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Notes to Consolidated Financial Statements continued



(Dollars in thousands)	For the Nine Months Ended		For the Three Months Ended		For the Nine Months Ended		For the Three Months Ended
Average of impaired loans during the periods ended	September 30, 2012				September 30, 2011
Commercial	$	—	$	—	$	15	$	15
Commercial real estate:
Owner occupied	296		44		1,051		1,042
Other	874		1,653		109		117
Faith-based non-profit:
Owner occupied	2,522		2,522		5,948		6,057
Residential real estate:
First mortgage	1,202		1,222		799		1,071
Multifamily	—		—		547		629
Home equity	274		267		190		278
Consumer	2				5		5
Average impaired loans	$	5,170	$	5,708	$	8,712	$	9,214

The following table shows TDRs with and without allocated allowances for loan losses as of the periods ending September 30, 2012 and December 31, 2011 as well as average balances by loan classification for the three and nine months ended September 30, 2012 and September 30, 2011:



(Dollars in thousands)	September 30, 2012		December 31, 2011
Loans with no allocated allowance for loan losses	$	21,004	$	16,919
Loans with allocated allowance for loan losses	1,163		1,738
Total	$	22,167	$	18,657
Amount of the allowance for loan losses allocated	$	214	$	120

The following table shows average TDR balances by portfolio segment for the three and nine month periods shown:



	For the Nine Months Ended		For the Three Months Ended		For the Nine Months Ended		For the Three Months Ended
(Dollars in thousands)	September 30, 2012				September 30, 2011
Commercial	$	590	$	590	$	1,180	$	1,180
Commercial real estate:
Construction	687		374		1,029		1,021
Owner occupied	998		856		609		606
Other	5,433		6,195		3,039		3,045
Faith-based non-profit:
Owner occupied	11,792		12,342		5,798		7,080
Residential real estate:
First mortgage	618		598		345		401
Average TDR loans	$	20,118	$	20,955	$	12,000	$	13,333

The following table presents loans individually evaluated for impairment, excluding TDRs, by class of loans as of September 30, 2012 :

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Notes to Consolidated Financial Statements continued



	September 30, 2012
(Dollars in thousands)	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Interest Earned Nine Months		Interest Earned Three Months
Without allowance recorded:
Commercial real estate:
Owner occupied	$	42	$	42	$	—	$	—	$	—
Other	50		50		—		—		—
Residential real estate:
First mortgage	398		398		—		6		—
Total impaired loans without allowance recorded	$	490	$	490	$	—	$	6	$	—
With an allowance recorded:
Commercial real estate:
Other	1,591		1,591		156		65		—
Residential real estate:
First mortgage	1,218		1,218		337		40		11
Total impaired loans with allowance recorded	$	2,809	$	2,809	$	493	$	105	$	11
Total impaired loans	$	3,299	$	3,299	$	493	$	111	$	11

The following table presents loans individually evaluated for impairment, excluding TDRs, by class of loans, as of December 31, 2011 , and interest earned during the three and nine months ended September 30, 2011:

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Notes to Consolidated Financial Statements continued



	December 31, 2011				September 30, 2011
	Unpaid Principal Balance		Allowance for Loan Losses Allocated		Interest Earned Nine Months		Interest Earned Three Months
(Dollars in thousands)
With no related allowance recorded:
Commercial real estate:
Owner occupied	322		—		17		17
Other	56		—		—		—
Faith-based non-profit:
Owner occupied	2,522		—		61		61
Residential real estate:
First mortgage	402		—		—		—
Total impaired loans without allowance recorded	$	3,302	$	—	$	78	$	78
With an allowance recorded:
Commercial real estate:
Owner occupied	$	279	$	47	$	—	$	—
Other	40		10		—		—
Residential real estate:
First mortgage	763		290		26		9
Home equity	462		251		—		—
Consumer	2		2		—		—
Total impaired loans with allowance recorded	$	1,546	$	600	$	26	$	9
Total impaired loans	$	4,848	$	600	$	104	$	87

The recorded investment in loan balance is net of deferred fees and costs, and partial charge-offs where applicable.

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Notes to Consolidated Financial Statements continued

The following table presents TDRs by class of loans as of September 30, 2012 :



	September 30, 2012
(Dollars in thousands)	Impaired Balance		Liquid Collateral		Total Exposure		Recorded Investment		Allowance for Loan Losses Allocated		Interest Earned Nine Months		Interest Earned Three Months

Without related allowance recorded:
Commercial	$	1,567	$	—	$	1,567	$	590	$	—	$	—	$	—
Commercial real estate:
Construction	374		—		374		374		—		24		7
Owner occupied	509		—		509		509		—		28		6
Other	4,912		—		4,912		5,914		—		143		58
Faith-based non-profit:
Owner occupied	13,133		103		13,030		13,126		—		331		69
Residential real estate:
First mortgage	491		—		491		491		—		12		4
Total TDRs without allowance recorded	$	20,986	$	103	$	20,883	$	21,004	$	—	$	538	$	144
With an allowance recorded:
Commercial real estate:
Owner occupied	239		—		239		239		102		12		3
Other	414		—		414		414		55		26		6
Faith-based non-profit
Owner occupied	430		—		430		430		52		22		5
Residential real estate:
First mortgage	80		6		74		80		5		4		1
Total TDRs with allowance recorded	$	1,163	$	6	$	1,157	$	1,163	$	214	$	64	$	15
Total TDRs	$	22,149	$	109	$	22,040	$	22,167	$	214	$	602	$	159

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Notes to Consolidated Financial Statements continued

The following table presents TDRs by class of loans as of December 31, 2011 and interest earning during the nine and three months ended September 30, 2011:



	December 31, 2011											September 30, 2011
	Impaired Balance		Liquid Collateral			Total Exposure		Recorded Investment		Allowance for Loan Losses Allocated		Interest Earned Nine Months			Interest Earned Three Months
(Dollars in thousands)
With no related allowance recorded:
Commercial	$	1,567	$	—		$	1,567	$	590	$	—	$	—		—
Commercial real estate:
Construction	628		—			628		628		—		—			—
Owner occupied	893		—			893		895		—		20			16
Other	5,112		—			5,112		3,814		—		4			—
Faith-based non-profit:
Owner occupied	10,391		(103		)	10,288		10,385		—		297			110
Residential real estate:
First mortgage	617		(9		)	608		607		—		4			1
Total TDRs with no allowance recorded	$	19,208	$	(112	)	$	19,096	$	16,919	$	—	$	325		$	127
With an allowance recorded:
Commercial real estate:
Construction	378		—			378		378		15		24			9
Owner occupied	416		—			416		416		47		—		—	—
Other	—		—			—		—		—		19			3
Faith-based non-profit:
Construction	—		—			—		—		—		—
Owner occupied	908		—			908		909		56		33			15
Other	—		—			—		—		—		—			—
Residential real estate:
First mortgage	35		—			35		35		2		—			—
Multifamily	—		—			—		—		—		—			—
Home equity	—		—			—		—		—		—			—
Construction	—		—			—		—		—		—			—
Consumer	—		—			—		—		—		—			—
Total TDRs with allowance recorded	$	1,737	$	—		$	1,737	$	1,738	$	120	$	76		$	27
Total TDRs	$	20,945	$	(112	)	$	20,833	$	18,657	$	120	$	401		$	154

The recorded investment in loan balance is net of deferred fees and costs, and partial charge-offs, where applicable.

The Bank modifies certain loans in a TDR where the borrowers are experiencing financial difficulties, and for which the Bank grants certain concessions which typically result from loss mitigation recommendations developed by the Bank's problem loan solutions team. Concessions could include reductions below market interest rates (that would be available to the particular

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Notes to Consolidated Financial Statements continued

borrower), payment extensions, forbearance from foreclosure, or other actions. Certain TDRs are classified as nonperforming at the time of restructuring and may only be returned to performing status after considering the borrower's sustained repayment performance for a reasonable period, generally six months. Management has proactively identified potential repayment issues developing, and has elected to offer concessions to borrowers prior to the borrowers actually failing to perform under the original terms of the loan. In such cases, when the borrower has continued to pay throughout the life of the loan, the loan will remain on accruing status after being modified as a TDR.

When loans are modified, the Bank evaluates each loan for any possible impairment based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the repayment source is the liquidation of underlying collateral, in which cases the Bank uses the fair value of the collateral, less selling costs, instead of discounted cash flows. If the Bank determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance allocation or a charge-off to the allowance.

The following tables set forth new TDRs made during the periods present as well as the concessions granted, and status of performance:



	For the Three Months Ended
	September 30, 2012
	Number of Loans		Recorded Investment		Unpaid Principal Balance		Allowance		Concession	Performing or not
(Dollars in thousands)
Faith-based non-profit
Owner occupied	1		$	2,522	$	2,522	—		Below market interest rate and extended repayment terms	Not yet due as of 9-30-12
Total TDR Loans	$	1	$	2,522	$	2,522	$	—


	For the Nine Months Ended
	September 30, 2012
	Number of Loans		Recorded Investment		Unpaid Principal Balance		Allowance		Concession	Performing or not
(Dollars in thousands)
Commercial real estate:
Owner occupied	1		$	80	$	80	—		Extended repayment terms	Performing
Other	1		1,353		1,353		—		Extended repayment terms	Performing
Faith-based non-profit
Owner occupied	1		2,522		2,522		—		Below market interest rate and extended repayment terms	Not yet due as of 9-30-12
Total TDR Loans	$	3	$	3,955	$	3,955	$	—

The following table presents the recorded investment in non-accrual and loans past due over 90 days still on accrual by class of loans as of September 30, 2012 :

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Notes to Consolidated Financial Statements continued



(Dollars in thousands)	Nonaccrual		Number	Loans Past Due Over 90 Days Still Accruing		Number

Commercial	$	590	1	$	—	—
Commercial real estate:
Owner occupied	42		1	170		3
Other	50		1	—		—
Faith-based non-profit:
Owner occupied	5,600		4	145		1
Residential real estate:
First mortgage	3,400		42	89		2
Home equity	20		3	—		—
Consumer	18		3	—		—
Total	$	9,720	55	$	404	6

The following table presents the recorded investment in non-accrual and loans past due over 90 days still on accrual by class of loans as of December 31, 2011 :



	Nonaccrual		Number	Loans Past Due Over 90 Days Still Accruing		Number
(Dollars in thousands)
Commercial	$	590	1	$	—	—
Commercial real estate:
Construction	628		1	—		—
Owner occupied	772		4	52		1
Other	3,503		4	1		1
Faith-based non-profit:
Owner occupied	5,497		3	—		—
Residential real estate:
First mortgage	3,749		39	47		1
Multifamily	—		—	114		1
Home equity	582		8	—		—
Consumer	5		2	—		—
Total	$	15,326	62	$	214	4

Non-accrual loans and loans past due over 90 days still accruing interest include both smaller balance homogenous loans that are collectively evaluated for impairment and individually classified impaired loans. Loans for which principal or interest is in default for 90 days or more are classified as a nonaccrual unless they are well secured and in process of collection.

Unrecognized income on non-accrual loans as of September 30, 2012 and December 31, 2011 was $1.2 million and $1.9 million , respectively. In the quarter ended June 30, 2012 three TDRs to a single borrower were returned to accruing status. The interest foregone during the non-accrual period totaled approximately $0.9 million which will be accreted to income through the scheduled maturities of March 1, 2015. In the quarter ended September 30, 2012 , three TDR loans to one borrower were paid in full, including principal previously written down and unpaid interest.

Those loans over 90 days still accruing interest were in the process of modification. In these cases, the borrowers are still making payments. Borrowers have continued to make payments on these loans while administrative and legal due processes are proceeding which will enable the Bank to extend or modify maturity dates.

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Notes to Consolidated Financial Statements continued

The following table presents loans not past due, and the aging of the recorded investment in past due loans as of September 30, 2012 by class of loans:



(Dollars 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

Commercial	$	6	$	—	$	590	$	596	$	4,944	$	5,540
Commercial real estate:
Construction	—		—		—		—		1,726		1,726
Owner occupied	—		—		213		213		19,838		20,051
Other	—		353		50		403		26,225		26,628
Faith-based non-profit:
Construction	—		—		—		—		1,910		1,910
Owner occupied	833		51		2,930		3,814		73,323		77,137
Other	—		—		—		—		6,861		6,861
Residential real estate:
First mortgage	468		319		2,554		3,341		21,779		25,120
Multifamily	—		—		—		—		5,904		5,904
Home equity	157		—		7		164		3,256		3,420
Construction	—		—		—		—		381		381
Consumer	14		2		—		16		1,439		1,455
Other loans	—		—		—		—		2,808		2,808
Total	$	1,478	$	725	$	6,344	$	8,547	$	170,394	$	178,941

The following table presents loans not past due, and the aging of the recorded investment in past due loans as of December 31, 2011 by class of loans:



	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Loans Not Past Due		Total
(Dollars in thousands)
Commercial	$	2	$	—	$	590	$	592	$	7,096	$	7,688
Commercial real estate:
Construction	378		—		628		1,006		865		1,871
Owner occupied	343		—		824		1,167		19,185		20,352
Other	—		—		3,503		3,503		21,328		24,831
Faith-based and non-profit:
Construction	—		—		—		—		2,287		2,287
Owner occupied	—		—		2,522		2,522		75,639		78,161
Other	—		—		—		—		8,703		8,703
Residential real estate:
First mortgage	643		309		2,805		3,757		24,139		27,896
Multifamily	—		—		114		114		7,093		7,207
Home equity	—		127		567		694		3,763		4,457
Construction	—		—		—		—		—		—
Consumer	10		—		—		10		1,657		1,667
Other loans	—		—		—		—		2,964		2,964
Total	$	1,376	$	436	$	11,553	$	13,365	$	174,719	$	188,084

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

Non-accruals decreased $5.6 million in the period ending September 30, 2012 from the period ending December 31, 2011 , while the total loans past due

decreased by 36.05% , or $4.8 million , over the same period. The table below shows that the Bank has $3.4 million in non-accrual loans that are less than 30 days past due.

The following table displays all non-accrual loans and loans 90 or more days past due and still on accrual as of September 30, 2012 .



(Dollars in thousands)	September 30, 2012
	Amount		Number
Loans past due over 90 days still on accrual	$	404	6
Nonaccrual loans past due
Less than 30 days	$	3,436	12
30-59 days	308		3
60-89 days	35		1
90+ days	5,941		39
Nonaccrual loans	$	9,720	55

Changes in the allowance for loan losses for the three and nine months ended September 30, 2012 are as follows:



	For the Three Months Ended
	September 30, 2012
(Dollars in thousands)	June 30, 2012		Charge-offs			Recoveries		Provision/ (Recovery)			September 30, 2012
Commercial	$	61	$	—		$	—	$	(36	)	$	25
Commercial real estate	1,187		—			—		(18		)	1,169
Faith-based non-profit	1,091		—			—		(60		)	1,031
Residential real estate	1,243		(303		)	4		230			1,174
Consumer	46		—			4		2			52
Other	51		(8		)	—		4			47
Total	$	3,679	$	(311	)	$	8	$	122		$	3,498

	For the Nine Months Ended
	September 30, 2012
	December 31, 2011		Charge-offs			Recoveries		Provision/ (Recovery)			September 30, 2012
Commercial	$	348						$	(323	)	$	25
Commercial real estate	971		(56		)	1		253			1,169
Faith-based non-profit	1,128							(97		)	1,031
Residential real estate	1,299		(539		)	93		321			1,174
Consumer	62		(1		)	1		(10		)	52
Other	42		(26		)	9		22			47
Total	$	3,850	$	(622	)	$	104	$	166		$	3,498

Changes in the allowance for loan losses as of and for the three and nine months ended September 30, 2011 are as follows:

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued



	For the Three Months Ended
(Dollars in thousands)	June 30, 2011		Charge-offs			Recoveries		Provision/ (Recovery)			September 30, 2011
Commercial	$	582	$	(14	)	$	—	$	(10	)	$	558
Commercial real estate	840		(19		)	3		27			851
Faith-based non-profit	1,220		—			—		13			1,233
Residential real estate	1,457		(181		)	—		242			1,518
Consumer	43		(8		)	—		26			61
Other	103		(6		)	2		(34		)	65
Total	$	4,245	$	(228	)	$	5	$	264		$	4,286

	For the Nine Months Ended
	December 31, 2010		Charge-offs			Recoveries		Provision/ (Recovery)			September 30, 2011
Commercial	$	651	$	(14	)	$	95	$	(174	)	$	558
Commercial real estate	651		(19		)	129		90			851
Faith-based non-profit	1,289		—			—		(56		)	1,233
Residential real estate	1,045		(181		)	2		652			1,518
Consumer	105		(8		)	6		(42		)	61
Other	110		(23		)	11		(33		)	65
Total	$	3,851	$	(245	)	$	243	$	437		$	4,286

The Bank experienced $311 thousand in net loan charge offs for the three months ended September 30, 2012 compared to $228 thousand in net loan charge offs for the three months ended September 30, 2011 . On a rolling eight quarter basis, net loan charge-offs as a percent of average loan balances outstanding decreased from 62 bps as of September 30, 2011 to 57 bps as of December 31, 2011 , and 46 bps as of September 30, 2012 .

The Bank 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 Bank analyzes loans for reserves according to the loan's classification as to credit risk. This analysis includes non-homogenous loans, such as commercial, commercial real estate and faith-based non–profit entities, and mortgage loans in process of foreclosure for which the loan to value does not support repayment in full. This analysis is performed on at least a quarterly basis. The Bank 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. These loans exhibit a moderate likelihood of some loss related to those loans and leases.

•

Substandard. Loans classified as substandard are inadequately protected by the current sound 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 or repayment according to the original terms of the debt. Substandard loans include loans within the mortgage and consumer portfolio segments that are past due 90 days or more as to principal or interest if the loan to value does not support full repayment. Substandard loans are evaluated for impairment on an individual loan basis unless the substandard loan is a smaller balance homogenous loan that is not a TDR. These loans exhibit a distinct possibility that the Bank will sustain some loss if the deficiencies related to the loans are not corrected in a timely manner.


•	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.

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued


•	Loss. Based on current facts and circumstances, loans classified as loss are not expected to be repaid, or that collateral will be difficult to liquidate. Loans classified as loss are charged off to the ALLL with board approval.


•	Pass (includes internal watch). Loans are classified as pass in all classes within the portfolio that are not identified as special mention, substandard, doubtful, or loss, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. These loans exhibit a low likelihood of loss.

As of September 30, 2012 , and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:



(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Total

Commercial	$	4,941	$	—	$	9	$	590	$	5,540
Commercial real estate:
Construction	1,352		—		374		—		1,726
Owner occupied	14,492		3,730		1,829		—		20,051
Other	16,176		982		9,470		—		26,628
Faith-based and non-profit:
Construction	1,910		—		—		—		1,910
Owner occupied	56,091		5,829		15,217		—		77,137
Other	6,780		77		4		—		6,861
Residential real estate:
First mortgage	19,735		1,468		3,917		—		25,120
Multifamily	5,777		63		64		—		5,904
Home equity	3,125		—		295		—		3,420
Construction	381		—		—		—		381
Consumer	1,427		4		24		—		1,455
Other loans	2,808		—		—		—		2,808
Total	$	134,995	$	12,153	$	31,203	$	590	$	178,941

As of September 30, 2012 , the allowance for loan losses by class of loans, is as follows:

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued



(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Total

Commercial	$	24	$	—	$	1	$	—	$	25
Commercial real estate:
Construction	20		—		—		—		20
Owner occupied	294		89		127		—		510
Other	370		23		246		—		639
Faith-based and non-profit:
Construction	26		—		—		—		26
Owner occupied	751		113		48		—		912
Other	92		1		—		—		93
Residential real estate:
First mortgage	571		35		400		—		1,006
Multifamily	114		1		1		—		116
Home equity	38		—		9		—		47
Construction	5		—		—		—		5
Consumer	51		—		1		—		52
Other loans	47								47
Total	$	2,403	$	262	$	833	$	—	$	3,498

As of December 31, 2011 , the risk category of loans by class of loans was as follows:



	Pass		Special Mention		Substandard		Doubtful			Total
(Dollars in thousands)
Commercial	$	6,882	$	204	$	12	$	590		$	7,688
Commercial real estate:
Construction	857		—		1,014		—			1,871
Owner occupied	15,766		1,996		2,590		—			20,352
Other	14,938		1,004		8,889		—			24,831
Faith-based and non-profit:
Construction	2,287		—		—		—			2,287
Owner occupied	51,354		10,766		16,041		—			78,161
Other	8,125		572		6		—		8,703
Residential real estate:
First mortgage	21,938		1,363		4,595		—			27,896
Multifamily	6,661		42		504		—			7,207
Home equity	3,529		—		928		—			4,457
Construction	—		—		—		—			—
Consumer	1,644		14		7		2			1,667
Other loans	2,964		—		—		—			2,964
Total	$	136,945	$	15,961	$	34,586	$	592		$	188,084

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

As of December 31, 2011 , the allowance for loan losses by class of loans, is as follows:



	Pass		Special Mention		Substandard		Doubtful		Total
(Dollars in thousands)
Commercial	$	347	$	—	$	1	$	—	$	348
Commercial real estate:
Construction	12		—		16		—		28
Owner occupied	328		41		71		—		440
Other	322		23		158		—		503
Faith-based and non-profit:
Construction	32		—		—		—		32
Owner occupied	740		156		88		—		984
Other	104		8		—		—		112
Residential real estate:
First mortgage	444		31		347		—		822
Multifamily	128		1		11		—		140
Home equity	72		—		265		—		337
Construction	—		—		—		—		—
Consumer	56		—		—		6		62
Other loans	42		—		—		—		42
Total	$	2,627	$	260	$	957	$	6	$	3,850


5.	OTHER REAL ESTATE OWNED ("OREO")

At the time of foreclosure, real estate is recorded at fair market value based on appraised value less estimated costs to sell, such as realtor and recording fees. Subsequent to foreclosure, properties are appraised annually and adjusted to the lower of carrying amount or fair market value less estimated costs to sell.

The following table shows the activity in OREO properties for the three months ended September 30, 2012 .



(Dollars in thousands)	June 30, 2012		Sales (Cash)			Losses			Additions		September 30, 2012
Commercial real estate	$	2,447	$	(203	)	$	—		$	—	$	2,244
Faith-based non-profit	199		—			—			—		199
Residential	420		(56		)	(1		)	—		363
Land	307		(3		)	(38		)	—		266
Total	$	3,373	$	(262	)	$	(39	)	$	—	$	3,072

The following table shows the activity in OREO properties for the nine months ended September 30, 2012 .



(Dollars in thousands)	December 31, 2011		Sales (Cash)			Losses			Additions		September 30, 2012

Commercial	$	2,481	$	(203	)	$	(33	)			$	2,245
Faith-based and non-profit	253		(52		)	(3		)			198
Residential	174		(142		)	(6		)	337		363
Land	307		(3		)	(38		)			266
Total	$	3,215	$	(400	)	$	(80	)	$	337	$	3,072

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

There were foreclosures related to two borrowers during the nine months ended September 30, 2012 and no foreclosures that were taken into OREO during the three months ended September 30, 2012 . The losses recorded during the three months ended September 30, 2012 were related to three properties under contract for sale, the losses recorded during the nine months ended September 30, 2012 , related to five properties under contract for sale.


6.	FHLB ADVANCES

Borrowings as of September 30, 2012 and December 31, 2011 consisted of one FHLB fixed-term loan with a fixed rate of 0.50% , and a 2020 maturity date. The principal outstanding on this loan was $0.7 million as of both dates.



(Dollars in thousands)	September 30, 2012
	Amount		Maturity Date	Rate
Fixed Rate Note	$	708	2020	0.50	%



	December 31, 2011
	Amount		Maturity Date	Rate
Fixed Rate Note	$	725	2020	0.50	%

The Company has federal funds lines of credit with three correspondent banks totaling $10.0 million . The Company periodically tests its federal funds lines of credit with these correspondent banks. These lines were tested in the three and nine months ended September 30, 2012 . The Company had unused borrowing capacity with the FHLB of $7.3 million as of September 30, 2012 and $7.5 million as of December 31, 2011 , respectively. In addition, the Company has the ability to borrow from the Federal Reserve of Richmond to the extent of investment securities pledged to the Federal Reserve.


7.	EMPLOYEE BENEFIT PLANS

The Bank sponsors a noncontributory defined benefit cash balance pension plan (the “Cash Balance Plan”), covering all employees who qualify under length of service and other requirements. Under the Cash Balance Plan, retirement benefits are based on years of service and average earnings. The Bank’s funding policy is to contribute amounts to the Cash Balance Plan sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), plus such additional amounts as the Bank may determine to be appropriate. The contributions to the Cash Balance Plan paid during the nine months ended September 30, 2012 totaled $0.4 million . No contributions were made during the three months ended September 30, 2012 . The contributions paid during the three and nine months ended September 30, 2011 , totaled $0.6 million and $0.7 million . The Cash Balance Plan was not fully funded as of September 30, 2012 and December 31, 2011 . The Bank does not expect to provide any additional funding to the Cash Balance Plan in 2012. The annual measurement date for the Cash Balance Plan is as of December 31, and prior service costs and benefits are amortized on a straight-line basis over the average remaining service period of active participants.

The Bank sponsors a nonqualified Supplemental Executive Retirement Plan (“SERP”). The SERP, which is unfunded, provides certain individuals with pension benefits, outside the Bank’s noncontributory defined-benefit Cash Balance Plan, based on average earnings, years of service and age at retirement. Participation in the SERP is at the discretion of the Bank’s Board of Directors. The Bank purchased bank owned life insurance (“BOLI”) in 2002, with a face value of approximately $12.8 million covering all the participants in the SERP. Increases in the cash surrender value of the BOLI policies totaled $52 thousand and $152 thousand for the three and nine months ended September 30, 2012 . During the three and nine months periods ended September 30, 2011 the cash surrender value of the BOLI policies increased $50 thousand and $147 thousand , respectively. The cash surrender value of the BOLI owned by the Bank w as $5.926 million and $5.8 million as of September 30, 2012 and December 31, 2011 , respectively. The Bank has the ability and the intent to keep this life insurance in force indefinitely. The insurance proceeds may be used, at the sole discretion of the Bank, to fund the benefits payable under the SERP. The Bank does not expect to contribute to the SERP in 2012. In the second quarter of 2012, a Bank officer left before retirement age, forfeiting benefits under the SERP. This will reduce the service costs associated to this plan going forward.

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

The SERP and the Cash Balance Plan components of the net periodic benefit cost reflected in salaries and employee benefits expense for the nine months ended September 30, 2012 and September 30, 2011 were:



	Cash Balance Plan						SERP				Total
(Dollars in thousands)	2012			2011			2012		2011		2012			2011

Service cost	$	107		$	103		$	—	$	—	$	107		$	103
Interest cost	167			187			71		80		238			267
Expected return on plan assets	(199		)	(181		)	—		—		(199		)	(181		)
Amortization of prior service costs	1			1			—		3		1			4
Recognized net actuarial gain	159			114			13		3		172			117
Net periodic cost	$	235		$	224		$	84	$	86	$	319		$	310

The SERP and the Cash Balance Plan components of the net periodic benefit cost reflected in salaries and employee benefits expense for the three months ended September 30, 2012 and September 30, 2011 were:

(Dollars in thousands)	Cash Balance Plan						SERP				Total
	2012			2011			2012		2011		2012			2011
Service cost	$	36		$	34		$	—	$	—	$	36		$	34
Interest cost	56			62			23		27		79			89
Expected return on plan assets	(66		)	(60		)	—		—		(66		)	(60		)
Amortization of prior service costs	—			—			—		1		—			1
Recognized net actuarial gain	53			38			4		1		57			39
Net periodic cost	$	79		$	74		$	27	$	29	$	106		$	103

The Bank had a liability for the Cash Balance Plan of $1.5 million and $1.6 million for the periods ending September 30, 2012 and December 31, 2011 , respectively. The liability is included in Other Liabilities within the Consolidated Balance Sheets. The accrued liability and accumulated benefit obligations for the SERP was $2.3 million for the periods ending September 30, 2012 and December 31, 2011 . The balance is included in Other Liabilities within the Consolidated Balance Sheets. The September 30, 2012 fair value of the pension plan assets is immaterially different from what was reported for December 31, 2011 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 .

Retirement Plan Assets — In general, the Plan’s investment management organizations make reasonable efforts to control market fluctuations through appropriate techniques including, but not limited to, adequate diversification. The specific investment strategy adopted by the plan, referred to as the Long Term Growth of Capital Strategy attempts to achieve long-term growth of capital with little concern for current income. Typical investors in this portfolio have a relatively aggressive investment philosophy, seeking long term growth, and are not looking for current dividend income.

Prohibited investments include commodities and futures contracts, private placements, options, transactions which would result in unrelated business taxable income, and other investments prohibited by ERISA.

Equity investments must be listed on the New York, American, World, or other similar stock exchanges traded in the over-the-counter market with the requirement that such stocks have adequate liquidity relative to the size of the investment.

Fixed income investments must have a credit rating of B or better from Standard and Poor’s or Moody’s. The fixed income portfolio should be constructed so as to have an average maturity not exceeding 10 years. No more than 5% of the fixed income portfolio should be invested in any one issuer. (U.S. Treasury and Agency securities are exempt from this restriction.)

Cash and equivalent instruments that are acceptable are repurchase agreements, bankers’ acceptances, U.S. treasury bills, money market funds, and certificates of deposit.

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

The portfolio shall be structured to meet financial objectives over a period of 11 or more years. Over that time horizon, the total rate of return should equal at least 103% of the applicable blended benchmark returns and place in the top half of group performance. Benchmarks which may be used for portfolio performance comparison are as follows:


•	U.S. Large Cap Equities: S&P 500, Russell 1000, Russell 1000 Value, and Russell 1000 Growth


•	U.S. Mid Cap Equities: S&P 400 Mid Cap, Russell Mid Cap Value, and Russell Mid Cap Growth


•	U.S. Small Cap Equities: S&P 600 Small Cap, Russell 2000 Value, and Russell 2000 Growth


•	Non-U.S. Equities: MSCI EAFE IL


•	Fixed Income: Barclay's Capital Intermediate Government/Credit Index


•	Cash: U.S. 3-Month Treasury Bill

401(k) Plan —The Bank sponsors a 401(k) plan. Participation in the 401(k) plan is voluntary. Employees become eligible after completing 90 days of service and attaining age 21. Employees may elect to contribute up to 12% of their compensation to the 401(k) plan. The Bank matches 100% of each employee’s contribution, up to a maximum of 6% of compensation. The Bank’s contributions to the 401(k) plan were $55 thousand and $158 thousand , respectively, for the three and nine months ended September 30, 2012 . The Bank’s contributions to the 401(k) plan were $43 thousand and $137 thousand , respectively, for the three and nine months ended September 30, 2011 .

Deferred Compensation Plan —The Bank sponsors a nonqualified deferred compensation plan. The plan, which is unfunded, permits certain management employees to defer compensation in order to provide retirement and death benefits. The plan allows participants to receive the balance of the 6% Bank matching contribution on the 401(k) plan that would otherwise be forfeited to comply with the Internal Revenue Code. At September 30, 2012 and December 31, 2011 , the amount of the non-qualified deferred compensation plan liability was $0.3 million . A participant in this plan retired during the three months ended June 30, 2012, and will be paid out his balance in the first quarter of 2013.

Post-retirement Benefits —The Bank provides certain post-retirement benefits to select former executive officers. As of September 30, 2012 and December 31, 2011 , the amount of the liability for these benefits was approximately $0.2 million .

Split Dollar Benefits —In 2002, upon investing in BOLI policies, the Company granted certain executives a split dollar life benefit by which the beneficiaries of the executive would receive a portion of the death benefit, excluding any cash surrender value, of the BOLI upon the executive’s demise. Amounts are accrued by a charge to employee benefits. As of September 30, 2012 and December 31, 2011 , $0.2 million was recorded in other liabilities for the split dollar benefit. During the quarter ended June 30, 2012, a Bank officer left before retirement age, forfeiting his split dollar benefit. This will reduce the service costs associated with this plan going forward.


8.	COMMITMENTS AND CONTINGENCIES

To meet the financing needs of its customers, the Bank is a party to financial instruments, in the normal course of business, with off-balance sheet risk. These financial instruments include commitments to extend credit, and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk beyond the amount recognized on the Consolidated Balance Sheets. The contractual amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.

The Bank’s exposure to credit losses in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank utilizes the same credit policies in making commitments and conditional obligations as it does for balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is not a violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, upon extension of credit, is based on management’s credit evaluation of the counter parties. Collateral varies and may include real estate, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Bank as security for a customer's obligations to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

To the extent deemed necessary, collateral of varying types and amounts is held to secure customer performance under certain of those letters of credit outstanding.

Financial instruments whose contract amounts represent credit risk as of September 30, 2012 and December 31, 2011 , respectively, are commitments to extend credit (including availability of lines of credit), and standby letters of credit. Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral deemed necessary by the Bank is based on management’s credit evaluation and underwriting guidelines for the particular loan.

Commitments outstanding at September 30, 2012 are summarized in the following table:



(Dollars in thousands)	Commercial letters of credit		Other commercial loan commitments		Total commitments

Less than one year	$	435	$	17,290	$	17,725
One to three years	—		701		701
Three to five years	71		4,859		4,930
More than five years	—		2,150		2,150
Total	$	506	$	25,000	$	25,506


9.	FAIR VALUE MEASUREMENT

Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. Fair value measurements are required to be separately disclosed by level within the fair value hierarchy. The Company bases fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

For assets and liabilities recorded at fair value, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy.

Fair value measurements for assets and liabilities where there exists limited or no observable market data and, therefore, are based primarily upon estimates, are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment, other real estate owned ("OREO"), and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 — Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.

Level 2 — Valuations are obtained from readily available pricing sources via independent providers for market transactions involving similar assets or liabilities. The Company’s principal market for these securities is the secondary institutional markets and valuations are based on observable market data in those markets. Level 2 securities include U. S. Agencies, state and municipal bonds and MBS.

Index

M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets.

Assets and Liabilities Measured on a Recurring Basis:

Available for Sales ("AFS") Investment Securities: Investment securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using matrix pricing, which is a mathematical technique used widely 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 1 securities include those traded on nationally recognized securities exchanges, U.S. Treasury securities, and money market funds. Level 2 securities include U.S. Agencies, MBS issued by government sponsored entities, state and municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Mortgage Serving Rights: Mortgage servicing rights do not trade in an active market with readily observable market data. As a result, the Company estimates the fair value of mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income. The Company stratifies its mortgage servicing portfolio on the basis of loan type. The assumptions used in the discounted cash flow model are those that we believe market participants would use in estimating future net servicing income, including estimates of loan prepayment rates, servicing costs, ancillary income, impound account balances, and discount rates. Significant assumptions in the valuation of mortgage servicing rights include changes in interest rates, estimated loan repayment rates, and the timing of cash flows, among other factors. Mortgage servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation.

Assets measured at fair value on a recurring basis as of September 30, 2012 were:



(Dollars in thousands)
Description	September 30, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring:
US Agencies	$	1,370	$	—	$	1,370	$	—
Government sponsored MBS
Residential	58,279		—		58,279		—
Non-Government sponsored MBS
Residential	101		—		101		—
Municipal securities
North Carolina	3,183		—		3,183		—
Mortgage Servicing Rights	41		—		—		41
Total	$	62,974	$	—	$	62,933	$	41

Assets measured at fair value on a recurring basis as of December 31, 2011 were:

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M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued



(Dollars in thousands)
Description	December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring:
US Agencies	$	483	$	—	$	483	$	—
Government sponsored MBS
Residential	30,789		—		30,789		—
Non-Government sponsored MBS
Residential	135		—		135		—
Municipal securities
North Carolina	3,702		—		3,702		—
Out of state	2,486		—		2,486		—
Mortgage Servicing Rights	46		—		—		46
	$	37,641	$	—	$	37,595	$	46

The table below displays the change in all recurring Level 3 Assets between December 31, 2011 and September 30, 2012 :



(Dollars in thousands)	Mortgage Servicing Rights

Beginning balance (December 31, 2011)	$	46
Amortization	(3		)
Ending Balance (June 30, 2012)	$	43
Amortization	(2		)
Ending Balance (September 30, 2012)	$	41

Assets and Liabilities Measured on a Nonrecurring Basis:

Impaired loans: Impaired loans are evaluated and valued at the time the loan is identified as impaired, and are carried at the lower of cost or market value. Market value is measured based on the value of the collateral securing these loans or net present value of expected future cash flows discounted at the loan’s effective interest rate. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. The value of business equipment, inventory, and accounts receivable collateral is based on net book value on the business’ financial statements and, if necessary, discounted based on management’s review and analysis. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s selling costs and other expenses. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. The Company records impaired loans as nonrecurring Level 3, when Management believes the underlying collateral is less than the appraised value.

Other real estate owned (“OREO”): Foreclosed assets are adjusted to fair value, less estimated carrying costs and costs to sell, upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of the carrying value or the fair value, less estimated carry costs and costs to sell. Fair value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. The Company records foreclosed assets as nonrecurring Level 3.

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M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

Assets measured at fair value on a nonrecurring basis as of September 30, 2012 and December 31, 2011 were:



(Dollars in thousands)
Description	September 30, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Nonrecurring:
Other real estate owned	$	3,072	$	—	$	—	$	3,072
Impaired and TDR Loans:
Commercial	590		—		—		590
Commercial real estate	8,821		—		—		8,821
Faith-based non-profit	13,505		—		—		13,505
Residential real estate	1,844		—		—		1,844
Total	$	27,832	$	—	$	—	$	27,832

Description	December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Nonrecurring:
Other real estate owned	$	3,215	$	—	$	—	$	3,215
Impaired and TDR Loans:
Commercial	590		—		—		590
Commercial real estate	6,709		—		—		6,709
Faith-based non-profit	13,760		—		—		13,760
Residential real estate	1,637		—		—		1,637
Total	$	25,911	$	—	$	—	$	25,911

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M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

Quantitative Information about Level 3 Fair Value Measurements



Description	September 30, 2012		Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Value
Nonrecurring:
Other real estate owned	$	3,072	discounted appraisals	collateral discounts	6	-20%
Impaired and TDR loans	24,760		discounted appraisals	collateral discounts	6	-20%
Mortgage Servicing Rights	41		discounted cash flow	Public Securities Association ("PSA") speed	374	%
				cost to service	5.50	%
				investor yield	9.00	%
Total	$	27,873

Description	December 31, 2011		Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Value
Nonrecurring:
Other real estate owned	$	3,215	discounted appraisals	collateral discounts	6	-20%
Impaired and TDR loans	22,696		discounted appraisals	collateral discounts	6	-20%
Mortgage Servicing Rights	46		discounted cash flow	PSA speed	306	%
				cost to service	5.50	%
				investor yield	9.00	%
Total	$	25,957

The Company discloses estimated fair values for its significant financial instruments. The methodologies for estimating the fair value of financial assets and liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The methodologies for other financial assets and liabilities are discussed below.

The Company had no transfers between any of the three levels in 2011 or 2012.

Cash and Cash Equivalents : The carrying amount of cash, due from banks, and federal funds sold approximates fair value, and is therefore considered Level 1 input.

Loans (other than impaired), net of allowances for loan losses : Fair values are estimated for portfolios of loans with similar financial characteristics. The majority of the Company’s loans and lending-related commitments are not carried at fair value on a recurring basis on the Consolidated Balance Sheets, nor are they actively traded.

The fair value of performing loans is calculated by discounting scheduled cash flows through their individual contractual maturity, using discount rates that reflect the credit risk, overhead expenses, interest rate earned and again, contractual maturity of each loan. The maturity is based on contractual maturities for each loan, modified as required by an estimate of the effect of historical prepayments and current economic conditions.

For all loans, assumptions regarding the characteristics and segregation of loans, maturities, credit risk, cash flows, and discount rates are determined using specific borrower and other available information and are therefore considered a Level 3 input.

Accrued Interest Receivable and Payable : The fair value of interest receivable and payable is estimated to approximate the carrying amounts and is therefore considered a Level 1 input.

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M&F BANCORP, INC.

Notes to Consolidated Financial Statements continued

Deposits : The fair value of deposits with no stated maturity, such as demand deposits, checking accounts, savings and money market accounts, is equal to the carrying amount and is therefore considered a Level 1 input. The fair value of certificates of deposit is based on the discounted value of contractual cash flows, where the discount rate is estimated using the market rates currently offered for deposits of similar remaining maturities and is therefore considered a Level 2 input.

Borrowings : The fair value of borrowings is based on the discounted value of estimated cash flows. The discounted rate is estimated using market rates currently offered for similar advances or borrowings and is therefore considered a Level 3 input.

Off-Balance Sheet Instruments : Since the majority of the Company’s off-balance sheet instruments consist of non fee-producing variable rate commitments, the Company has determined they do not have a distinguishable fair value.

As of September 30, 2012 and December 31, 2011 , the carrying amounts and associated estimated fair value of financial assets and liabilities of the Company are as follows:



(Dollars in thousands)	September 30, 2012
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	51,516	$	51,516	$	51,516	$	—	$	—
Marketable securities	62,933		62,933		—		62,933		—
Loans, net of allowances for loan losses	175,443		177,389		—		—		177,389
Accrued interest receivable	850		850		850		—		—
Liabilities:
Non-maturity deposits	$	123,304	$	123,304	$	123,304	$	—	$	—
Maturity deposits	138,068		137,853		—		137,853		—
Other borrowings	2,987		2,879		—		—		2,879
Accrued interest payable	81		81		81		—		—
	December 31, 2011
Assets:	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Cash and cash equivalents	$	61,296	$	61,296	$	61,296	$	—	$	—
Marketable securities	37,595		37,595		—		37,595		—
Loans, net of allowances for loan losses	184,234		188,545		—		—		188,545
Accrued interest receivable	764		764		764		—		—
Liabilities:
Non-maturity deposits	$	123,488	$	123,488	$	123,488	$	—	$	—
Maturity deposits	135,656		135,348		—		135,348		—
Other borrowings	2,939		2,676		—		—		2,676
Accrued interest payable	196		196		196		—		—

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M&F BANCORP, INC.


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

SELECTED FINANCIAL DATA

The following tables set forth selected financial information for M&F Bancorp, Inc. (the "Company"), including balance sheets as of September 30, 2012 and December 31, 2011 and operational data as of and for the three and nine months ended September 30, 2012 and September 30, 2011 , portions of which have been derived from, are qualified by reference to, and should be read in conjunction with, the Consolidated Financial Statements and notes thereto included elsewhere in this report.



Selected Balance Sheet Data
(Dollars in thousands)	September 30, 2012			December 31, 2011

Cash and due from banks	$	51,516		$	61,296
Securities	62,933			37,595
Gross loans	178,941			188,084
Allowance for loan losses	(3,498		)	(3,850		)
Total assets	310,609			304,456
Deposits	261,372			259,144
Borrowings	2,987			2,939
Stockholders' equity	36,892			36,397



Summary of Operations	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
(Dollars in thousands)	2012		2011		2012		2011

Interest income	$	3,048	$	3,078	$	8,790	$	9,316
Interest expense	234		367		741		1,172
Net interest income	2,814		2,711		8,049		8,144
Provision for loan losses	122		264		166		437
Net interest income after provision for loan losses	2,692		2,447		7,883		7,707
Other operating income	578		593		1,667		1,862
Other operating expense	2,990		2,880		8,834		8,766
Pre-tax net income	280		160		716		803
Income tax expense	87		24		196		205
Less: Preferred dividends and accretion	59		59		179		176
Net income (1)	$	134	$	77	$	342	$	422

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M&F BANCORP, INC.



	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2012			2011			2012			2011
Per Share Data (1)
Net income-basic and diluted	$	0.07		$	0.04		$	0.17		$	0.21
Common stock dividends	$	—		$	—		$	—		$	—
Book value per share of common stock (2)	$	12.38		$	12.62		$	12.38		$	12.62
Average common shares outstanding	2,031,337			2,031,337			2,031,337			2,031,337
Selected Ratios (1)
Return on average assets	0.18		%	0.10		%	0.15		%	0.18		%
Return on average stockholders' equity	1.46			0.83			1.25			1.52
Dividend payout ratio	—			—			—			—
Average stockholders' equity to average total assets	12.35			12.26			12.23			12.11
Net interest margin (3)	4.10		%	3.76		%	3.87		%	3.81		%

(1) available to common stockholders

(2) stockholders equity reduced by liquidation value of preferred stock

(3) on a tax equivalent basis

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M&F BANCORP, INC. AND SUBSIDIARY

INTRODUCTION

The following discussion and analysis is intended to aid the reader in understanding and evaluating the Company’s consolidated results of operations and financial condition. This discussion is designed to provide more comprehensive information about the major components of the Company’s results of operations, financial condition, liquidity, and capital resources than may be obtained from reading the financial statements alone. This discussion should be read in conjunction with, and is qualified in its entirety by reference to, the Company’s Consolidated Financial Statements, including the related notes thereto presented under Item I in this Quarterly Report on Form 10-Q. All information presented is consolidated data unless otherwise specified.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements represent expectations and beliefs of the Company and Mechanics and Farmers Bank (the “Bank”), including but not limited to the Company’s operations, performance, financial condition, growth or strategies. These forward-looking statements are identified by words such as “expects”, “anticipates”, “should”, “estimates”, “believes” and variations of these words and other similar statements. For this purpose, any statements contained in this Form 10-Q that are not statements of historical fact may be deemed to be forward-looking statements. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. These forward-looking statements involve estimates, assumptions, risks and uncertainties that could cause actual results to differ materially from current projections depending on a variety of important factors, including but not limited to those risk factors identified in the section headed "Risk Factors", beginning on page 10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011, filed with the Securities and Exchange Commission (the "SEC") on March 30, 2012 (the "Annual Report"). The Company undertakes no obligation to updated any forward-looking statement, whether written or not, which may be made from time to time by or on behalf of the Company.

IMPACT OF RECENT DEVELOPMENTS ON THE BANKING INDUSTRY

Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") on July 21, 2010. This law significantly changed the current bank regulatory structure and affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act is a significant piece of legislation that will have major effects on the financial services industry, including the Company, and the financial condition and operations of banks and bank holding companies, including the Company and the Bank. The Dodd-Frank Act requires various federal agencies to adopt and implement a broad range of new rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting and implementing rules and regulations. Although some of these regulations have been promulgated or issued for comment, many of these required regulations are still being drafted. Consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

Many of the provisions of the Dodd-Frank Act are focused on financial institutions that are significantly larger than the Company and the Bank. As rules and regulations are promulgated by the federal agencies, the Bank will have to address each to ensure compliance with applicable provisions of the Act and compliance costs are expected to increase.

It is expected that the Dodd-Frank Act and the regulations it requires could increase the interest expense and compliance costs of the Bank and comparable financial institutions. Although neither the possible increase in the Bank’s interest expense and compliance costs, nor any one or more of the other aspects of Dodd-Frank Act discussed above, may have a material effect upon the Company’s future financial performance by themselves, the specific impact of the Dodd-Frank Act cannot be determined with specificity until after all required or otherwise proposed regulations are issued in final form. We believe that our operating income will be adversely affected, as will the operating expenses of other community financial institutions, in the future as a consequence of the implementation of the Dodd-Frank Act. Because of the current uncertainty about the schedule of implementation, the breadth of the regulations expected to be issued, and other similar factors, we cannot quantify the amount of any adverse impact.

The banking industry, including the Company, is operating in a challenging and volatile economic environment. The effects of the downturn in the housing market have adversely impacted credit markets, consumer confidence and the broader economy. Although the Bank remains profitable, it has not been immune to the impact of the recent recession or the increased focus of banking regulators upon capital and liquidity levels.

EXECUTIVE SUMMARY

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M&F BANCORP, INC. AND SUBSIDIARY

As discussed in more detail below, the following is an executive summary of the Company’s significant results for the three months ended September 30, 2012 .

•

Net income before preferred stock dividends was $193 thousand for the three months ended September 30, 2012 and $136 thousand for the three months ended September 30, 2011 . For the three months ended September 30, 2012 , net income available to common stockholders was $134 thousand , or $0.07 per common share. For the three months ended September 30, 2011 , net income available to common stockholders was $77 thousand , or $0.04 per common share.

•

Interest income on loans decreased by $8 thousand for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 , while interest income on investments and cash decreased $22 thousand resulting in total interest income being lower by $30 thousand in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 . Average loans outstanding for the three months ended September 30, 2012 decreased $17.6 million from the September 30, 2011 level of $199.0 million , and the rate for average loan interest earned increased 53 basis points ("bps") compared to September 30, 2011 . The three months ended September 30, 2012 benefited from interest income from a significant loan relationship that was returned to accrual status in June 2012, partially offsetting the loss of interest income caused by the decrease in average loans outstanding.

•

Interest expense on deposits decreased $114 thousand and interest expense on borrowings decreased $19 thousand , resulting in total interest expense being $133.0 thousand less in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 . Average interest-bearing deposits outstanding decreased $22.7 million during the three months ended September 30, 2012 from the September 30, 2011 level of $220.4 million ; and the average cost of those deposits decreased 16 bps in the three months ended September 30, 2012 compared to the same period ending September 30, 2011 . Average borrowings in the three months ended September 30, 2012 decreased slightly compared to the September 30, 2011 balance, and the average rate paid on borrowings decreased to 0.92% .


•	Due to the above factors, net interest income increased $103 thousand , or 3.80% in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 . The net interest margin, on a tax equivalent (“TE”) basis for the three months ended September 30, 2012 was 4.10% compared to 3.76% for the three months ended September 30, 2011 , an increase of 34 bps.

•

The ending balance of the Allowance for Loan Losses ("ALLL") as a percentage of loans outstanding decreased in the three months ended September 30, 2012 to 1.95% compared to 2.05% as of December 31, 2011 . The provision for loan losses decreased by $142 thousand in the three months ended September 30, 2012 compared from $264 thousand for the three months ended September 30, 2011 to $122 thousand for the three months ended September 30, 2012 . Net loans outstanding as of September 30, 2011 totaled $194.8 million million, decreasing 15.9 million to the balance as of September 30, 2012 . The quantitative loss history decreased from 62 basis points as of September 30, 2011 to 46 basis points as of September 30, 2012 . The combination of the decrease in loans outstanding and the loss history were the main contributors to the decrease in the coverage of allowance to loans.


•	Noninterest income was relatively flat in the quarter ended September 30, 2012 compared to the same period in 2011.


•	Noninterest expense increased $110 thousand in the three months ended September 30, 2012 over the same period in 2011. Increases in salaries and employees benefits, marketing, directors' fees, and information technology, and miscellaneous expenses were partially offset by declines in professional fees, and Federal Deposit Insurance Corporation ("FDIC") deposit insurance expenses.


•	Preferred stock dividends in the quarters ended September 30, 2012 and September 30, 2011 were $59 thousand .

As discussed in more detail below, the following is an executive summary of the Company’s significant results for the nine months ended September 30, 2012 .

•

Net income before preferred stock dividends was $520 thousand for the nine months ended September 30, 2012 and $598 thousand for the nine months ended September 30, 2011 . For the nine months ended September 30, 2012 , net income available to common stockholders was $342 thousand , or $0.17 per common share. For the nine months ended September 30, 2011 , net income available to common stockholders was $422 thousand , or $0.21 per common share.

•

Interest income on loans decreased by $555 thousand or 6.51% while interest income on investments and cash increased $29 thousand resulting in total interest income declining $526 thousand in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 . Average loans outstanding for the nine months ended September 30, 2012 decreased $18.5 million from the September 30, 2011 level, and the rate for average loan interest increased 17 bps compared to the nine months ended September 30, 2011 . The rate for the nine months ended September 30, 2012 benefited from interest income from a significant loan relationship that was returned to accrual status in June 2012.

•

Interest expense on deposits decreased $407 thousand and interest expense on borrowings decreased $24 thousand , resulting in total interest expense being $24 thousand less in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 . Average interest-bearing deposits outstanding decreased $17.3 million during the nine months ended September 30, 2012 from September 30, 2011 ; and the average cost of those deposits decreased

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M&F BANCORP, INC. AND SUBSIDIARY

21 bps in the nine months ended September 30, 2012 compared to the same period in September 30, 2011 . Average borrowings in the nine months ended September 30, 2012 increased $248.0 thousand compared to the September 30, 2011 balance due to a capital lease that began in September of 2011, however, the cost of those borrowings decreased 1 bps during the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 .


•	Net interest income, due to the above factors, decreased $95 thousand in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 . The net interest margin, on a TE basis for the nine months ended September 30, 2012 was 3.87% compared to 3.81% for the nine months ended September 30, 2011 , a increase of 6 bps.

•

The ending balance of the ALLL as a percentage of loans outstanding decreased to 1.95% as of September 30, 2012 compared to 2.05% as of December 31, 2011 . The $15.9 million decrease in loans outstanding compared to September 30, 2011 , and net charge offs of $518 thousand during the nine months ended September 30, 2012 compared to net charge offs of $245 thousand in the nine months ended September 30, 2011 , caused the Company to record a loan loss provision of $166 thousand for the nine months ended September 30, 2012 , and $437.0 thousand for the nine months ended September 30, 2011 based on management's estimate of inherent losses in the loan portfolio.

•

Noninterest income decreased by $195 thousand in the nine months ended September 30, 2012 over the same period in 2011, mainly due to net realized losses on the sales of Other real estate owned ("OREO") in nine months ended September 30, 2012 compared to net realized gains in the nine months ended September 30, 2011 resulting in a net decrease of $204 thousand . Decreases in service charge fees of $55 thousand and the decline in OREO was partially offset with an increase in the realized gains from available for sale securities of $150 thousand in the nine months ended September 30, 2012 over the same period in 2011.


•	Noninterest expense increased by $68 thousand in the nine months ended September 30, 2012 over the same period in 2011. Increases in salaries and employees benefits and information technology expense were partially offset by declines in marketing, professional fees, and delivery expenses.


•	Preferred stock dividends in the nine months ended September 30, 2012 and September 30, 2011 were $0.2 million .

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The following discussion and analysis of the Company’s financial condition and results of operations are based on the Company’s Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires the Company to make estimates and judgments regarding uncertainties that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to the allowance for loan losses, investment values, income taxes, contingencies, and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. However, because future events and their effects cannot be determined with certainty, actual results may differ from these estimates under different assumptions or conditions, and the Company may be exposed to gains or losses that could be material.

The Company’s significant accounting policies are discussed below and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Management believes that the following accounting policies are the most critical to aid in fully understanding and evaluating the Company’s reported financial results, and they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting policies and related disclosures with the Audit Committee of the Board of Directors.

•

Allowance for Loan Losses – The Company records an estimated ALLL based on known problem loans and estimated risks inherent within the existing loan portfolio. The allowance calculation takes into account historical loss trends and current market and economic conditions. If economic conditions were to decline significantly or the financial condition of the Company’s customers were to deteriorate further, resulting in an impairment of their ability to make payments, additional increases to the allowance may be required.

•

Investments – The Company records an investment impairment charge when it believes an investment has experienced a decline in value that is other-than-temporary. Future adverse changes in market conditions and associated market values of investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby possibly requiring an impairment charge in the future.


•	Deferred Taxes – The Company assesses the need to record a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. The Company considers anticipated future taxable income and ongoing

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M&F BANCORP, INC. AND SUBSIDIARY

prudent and feasible tax planning strategies in determining the need for the valuation allowance. In the event the Company were to determine that it would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

•

Foreclosed Assets– Foreclosed assets (also known as "Other real estate owned", or "OREO") represent properties acquired through foreclosure or physical possession. Write-downs to fair value of foreclosed assets at the time of transfer are charged to allowance for loan losses. Subsequent to foreclosure, the Company periodically evaluates the value of foreclosed assets held for sale and records an impairment charge for any subsequent declines in fair value less selling costs. Subsequent declines in value are charged to operations. Fair value is based on an assessment of information available at the end of a reporting period and depends upon a number of factors, including historical experience, economic conditions, and issues specific to individual properties. The evaluation of these factors involves subjective estimates and judgments that may change.

•

Fair Value Estimates– Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market inputs. For financial instruments that are traded actively and have quoted market prices or observable market inputs, there is minimal subjectivity involved in measuring fair value. However, when quoted market prices or observable market inputs are not fully available, significant management judgment may be necessary to estimate fair value. In developing our fair value measurements, we maximize the use of observable inputs and minimize the use of unobservable inputs.

•

The fair value hierarchy defines Level 1 and 2 valuations as those that are based on quoted prices for identical instruments traded in active markets and quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 3 valuations are based on model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that we believe market participants would use in pricing the asset or liability. Financial assets that are recorded at fair value on a recurring basis include available-for-sale investment securities, and mortgage servicing rights.

RESULTS OF OPERATIONS

Three months ended September 30, 2012 compared with three months ended September 30, 2011

•

Net income before preferred stock dividends was $193 thousand and $136 thousand for the three months ended September 30, 2012 and September 30, 2011 , respectively. Net income available to common stockholders for the three months ended September 30, 2012 was $134 thousand or $0.07 per share. Net income available to common stockholders for the three months ended September 30, 2011 was $77 thousand or $0.04 per share.


•	Net operating income before income taxes and preferred dividends for the three months ended September 30, 2012 and September 30, 2011 was $280 thousand and $160 thousand , respectively.


◦	Net interest margin on a TE basis increased from 3.76% for the three months ended September 30, 2011 to 4.10% for the three months ended September 30, 2012 due to:

▪

Average loans outstanding decreased $17.6 million in 2012 over 2011 , while yields on average loans increased from 5.59% for the three months ending September 30, 2011 to 6.12% for the three months ending September 30, 2012 , resulting in $8 thousand lower interest income from loans. Income from loans decreased mainly due to the decrease in average loans outstanding offset by the increase in average yields. The three months ended September 30, 2012 benefited from interest income from a significant loan relationship that was returned to accrual status in June 2012, making up for the loss of interest income from the decrease in average loans outstanding.


▪	Average interest bearing deposits outstanding decreased $22.7 million in 2012 over 2011 . The decrease in average deposits led to a decline in interest expense of $114 thousand in the three months ended September 30, 2012 compared to the same period in 2011 due to a the lower average deposits and the reduction in our average yield on deposits.


▪	Average borrowings outstanding decreased $34.0 thousand from the 2011 to the 2012 average balance, and the average rate paid on borrowings decreased from 3.37% to 0.92% .


◦	Noninterest income was relatively flat when comparing 2012 and 2011 .

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M&F BANCORP, INC. AND SUBSIDIARY


◦	Noninterest expense increased in 2012 by $110 thousand . Increases in salaries and employees benefits, marketing, board fees, and information technology expense were partially offset by declines in professional fees, and FDIC deposit insurance expenses.


◦	The above increase in the net interest income was offset by a decrease in the loan loss provision from $264 thousand to $122 thousand for the three months ended September 30, 2011 , and September 30, 2012 , respectively.

Net Interest Income. Net interest income, the difference between total interest income from loans and investments, and total interest expense from deposits and borrowings, is the Company’s principal source of earnings. The amount of net interest income is determined by the volume of interest-earning assets, the level of rates earned on those assets, and the volume and cost of underlying funding from deposits and borrowings. Net interest income before the provision for loan losses increased $103 thousand , or 3.80% , for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 . Net interest spread is the difference between rates earned on interest-earning assets and the interest paid on deposits and borrowed funds. Net interest margin is the total of net interest income divided by average earning assets. Average earning assets for the three months ended September 30, 2012 was $276.0 million , down 5.86% compared to $293.2 million for the three months ended September 30, 2011 . On a fully TE basis, net interest margin was 4.10% and 3.76% for the three months ended September 30, 2012 and September 30, 2011 , respectively. The net interest spread increased 40 basis points ("bps") to 3.97% for the three months ended September 30, 2012 , from 3.57% for the three months ended September 30, 2011 . The yield on average interest-earning assets was 4.44% and 4.23% for the three months ended September 30, 2012 and September 30, 2011 , respectively, a decrease of 21 bps, while the interest rate on average interest-bearing liabilities for those periods was 0.47% and 0.66% , respectively, a decrease of 19 bps due to the ongoing low interest rate environment and large low yielding cash holdings at the Federal Reserve Bank of Richmond (the "FRB").

The Company’s balance sheet remains asset sensitive and, as a result, interest-earning assets are repricing faster than interest-bearing liabilities. As loans and time deposits mature and reprice, the margin may be negatively impacted based on competitive pricing to retain these loans and deposits.

Interest income decreased 0.97% or $30 thousand for the three months ended September 30, 2012 from the three months ended September 30, 2011 . The average balances of loans, which had overall yields of 6.12% for the three months ended September 30, 2012 and 5.59% for the three months ended September 30, 2011 , respectively, decreased from $199.0 million for the three months ended September 30, 2011 to $181.4 million for the three months ended September 30, 2012 . The average balance of investment securities increased $33.1 million , from $27.9 million for the three months ended September 30, 2011 to $61.0 million for the three months ended September 30, 2012 . The Tax Equivalent ("TE") yield on investment securities decreased from 4.37% for the three months ended September 30, 2011 to 1.74% for the three months ended September 30, 2012 . In the low interest rate environment, higher yielding investments that are amortizing or being called are not being replaced by the same yields on new investments. The average balances of federal funds and other short-term investments decreased from $66.3 million for the three months ended September 30, 2011 to $33.6 million for the three months ended September 30, 2012 as management redeployed cash into the Available for sale investment portfolio, while the average yield in this category remained relatively unchanged.

Interest expense decreased 36.24% for the three months ended September 30, 2012 , to $234 thousand , from $367 thousand for the three months ended September 30, 2011 . Average total interest-bearing deposits, including savings, interest-bearing demand deposits and time deposits increased from $223.5 million for the three months ended September 30, 2011 , to $200.7 million for the three months ended September 30, 2012 . The average rate paid on interest-bearing deposits decreased 19 bps from 0.66% for the three months ended September 30, 2011 to 0.47% for the three months ended September 30, 2012 , primarily caused by the decreases in rates paid on time deposits.

The average borrowings outstanding decreased $34.0 thousand from the three months ended September 30, 2011 to the three months ended September 30, 2012 . The average rate on borrowings decreased from 3.37% to 0.92% for the three months ended September 30, 2012 .

The following table, Average Balances, Interest Earned or Paid, and Interest Yields/Rates reflects the Company’s effective yield on earning assets and cost of funds. Yields and costs are computed by dividing income or expense for the year by the respective daily average asset or liability balance. Changes in net interest income from year to year can be explained in terms of fluctuations in volume and rate. In the table, the amount earned on nontaxable securities is reflected as actual, whereas the rate on nontaxable securities is stated at the TE rate.

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M&F BANCORP, INC. AND SUBSIDIARY

Average Balances, Interest Earned or Paid, and Interest Yields/Rates For the Three Months Ended September 30, 2012 and 2011

(Dollars in thousands)	2.012							2.011
	Average Balance			Amount Earned/Paid		Average Rate		Average Balance			Amount Earned/Paid		Average Rate
Assets
Loans receivable (1):	$	181,376		$	2,775	6.12	%	$	199,006		$	2,783	5.59	%
Taxable securities	58,616			229		1.56		21,306			186		3.49
Nontaxable securities(2)	2,362			23		3.90		6,584			73		4.43
Federal funds sold and other interest on short-term investments	33,636			21		0.25		66,263			36		0.22
Total interest earning assets	275,990			3,048		4.44	%	293,159			3,078		4.26	%
Cash and due from banks	3,518							2,133
Other assets	20,854							19,340
Allowance for loan losses	(3,728		)					(3,847		)
Total assets	$	296,634						$	310,785
Liabilities and Equity
Savings deposits	$	51,322		$	26	0.20	%	$	61,136		$	45	0.29	%
Interest-bearing demand deposits	22,572			7		0.12		24,534			14		0.23
Time deposits	123,785			194		0.63		134,716			282		0.84
Total interest-bearing deposits	197,679			227		0.46		220,386			341		0.62
Borrowed funds	3,048			7		0.92		3,082			26		3.37
Total interest-bearing liabilities	200,727			234		0.47	%	223,468			367		0.66	%
Non-interest-bearing deposits	53,155							44,730
Other liabilities	6,103							5,549
Total liabilities	259,985							273,747
Stockholders' equity	36,649							37,038
Total liabilities and stockholders' equity	$	296,634						$	310,785
Net interest income				$	2,814						$	2,711
Non-taxable securities				23							73
Tax equivalent adjustment (3)				14							46
Tax equivalent net interest income				$	2,828						$	2,757
Net interest spread (4)						3.97	%						3.60	%
Net interest margin (5)				4.10		%					3.76		%

(1) Loans receivable include nonaccrual loans for which accrual of interest income has not been recorded.

(2) The tax equivalent rate is computed using a blended federal and state tax rate of 38.55%

(3) The tax equivalent adjustment is computed using a blended tax rate of 38.55%.

(4) Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(5) Net interest margin represents net interest income divided by average interest-earning assets.

Noninterest Income . Noninterest income was relatively unchanged in the quarter ended September 30, 2012 compared to the same period in 2011.

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M&F BANCORP, INC. AND SUBSIDIARY

ended September 30, 2011 . Increases in salaries and employees benefits, marketing and information technology expense were partially offset by declines in professional fees, and FDIC deposit insurance expenses.

Salary and employee benefits expenses were $1.5 million for the three months ended September 30, 2012 and $1.4 million for the three months ended September 30, 2011 . The $115 thousand increase in salaries and employee benefits was mainly due to the affect of raises given mid-year each year, as well as increases in benefit costs in July of 2012.

Occupancy expense was relatively flat at $0.4 million in the three months ended September 30, 2012 and the same period in 2011.

Data processing and communications costs were $233 thousand and $203 thousand , in the three months ended September 30, 2012 and September 30, 2011 , respectively, an increase of $30 thousand . The majority of the change was a $20 thousand increase in data processing services in the three months ended September 30, 2012 over the same period in 2011.

Directors and advisory board fees were $67 thousand and $63 thousand for each of the three month periods ended September 30, 2012 and 2011. Professional fees decreased $169.0 thousand in the three months ended September 30, 2012 compared to the same period in 2011, a majority of which is a decrease in accounting and consulting fees. OREO expense, net, increased $26 thousand , due to a decrease in OREO write-downs for the three months ended September 30, 2012 . All other noninterest expense remained relatively unchanged over these two periods.

Provision for Income Taxes . The Company recorded an income tax expense of $87 thousand and $24 thousand for the three months ended September 30, 2012 and September 30, 2011 , respectively. The overall effective rate decreased from a tax expense of 15.00% in the three months ended September 30, 2011 to a tax expense of 31.07% in the three months ended September 30, 2012 , due to a decrease in tax exempt interest income and permanent tax to book differences increasing.

Nine months ended September 30, 2012 compared with nine months ended September 30, 2011

•

Net income before preferred stock dividends was $520 thousand and $598 thousand for the nine months ended September 30, 2012 and September 30, 2011 , respectively. Net income available to common stockholders for the nine months ended September 30, 2012 was $342 thousand or $0.17 per share. Net income available to common stockholders for the nine months ended September 30, 2011 was $422 thousand or $0.21 per share.


•	Net operating income before income taxes and preferred dividends for the nine months ended September 30, 2012 and September 30, 2011 was $716 thousand and $803 thousand , respectively


◦	Net interest margin on a TE basis increased from 3.81% for the nine months ended September 30, 2011 to 3.87% % for the nine months ended September 30, 2012 due to:


▪	Average loans outstanding decreased $18.5 million in 2012 from the the same period in 2011 and average yields increased from 5.68% for the nine months ended September 30, 2011 to 5.85% for the nine months ended September 30, 2012 , resulting in $555 thousand less interest income from loans. Interest income from loans decreased mainly due to the decrease in average loans outstanding.


▪	Average interest bearing deposits outstanding decreased $17.3 million in 2012 from 2011. Due to the decrease in average deposits, interest expense declined by $407 thousand in the nine months ended September 30, 2012 compared to the same period in 2011 due to a reduction in our average yield on deposits.


▪	Average borrowings outstanding increased $248.0 thousand from the 2011 average balance, and the average rate paid on borrowings decreased from 3.49% in 2011 to 2.10% in 2012. The cause of the borrowing rate decrease was mainly due to a decline in the effective yield on participations sold (that do not qualify for "sale" treatment under GAAP).

◦

Noninterest income decreased $195 thousand in 2012 from 2011, mainly due to net realized losses on the sale of OREO in the nine months ended September 30, 2012 compared to net realized gains in the nine months ended September 30, 2011 . The decline in OREO realized gains along with declines in service charge fees was partially offset with an increase in the realized gains in available for sale securities and rental income for the nine months ended September 30, 2012 over the same period in 2011.


◦	Noninterest expense increased in 2012 by $68 thousand . An increase in salaries and employee benefits was partially offset by declines in FDIC deposit insurance expense, and professional fees.

◦

The loan loss provision decreased to $166 thousand for the nine months ended September 30, 2012 from $437 thousand for the nine months ended September 30, 2011 , mainly due to total loans outstanding decreasing from $196.6 million as of September 30, 2011 to $178.9 million as of September 30, 2012 . In addition, the quantitative loss history for the eight quarters ended September 30, 2012 decreased to 46 bps from 62 bps as of September 30, 2011 , resulting in a lower provision for loans collectively evaluated under ASC 450.

Index

M&F BANCORP, INC. AND SUBSIDIARY

Net Interest Income. Net interest income, the difference between total interest income from loans and investments, and total interest expenses from deposits and borrowings, is the Company’s principal source of earnings. The amount of net interest income is determined by the volume of interest-earning assets, the level of rates earned on those assets, and the volume and cost of underlying funding from deposits and borrowings. Net interest income before the provision for loan losses decreased $95 thousand , or 1.17% , from $8.1 million for the nine months ended September 30, 2011 , to $8.0 million for the nine months ended September 30, 2012 . Net interest spread is the difference between rates earned on interest-earning assets and the interest paid on deposits and borrowed funds. Net interest margin represents net interest income divided by average earning assets. Average earning assets for the nine months ended September 30, 2012 was $279.3 million , down 3.60% compared to $289.7 million for the nine months ended September 30, 2011 . On a fully TE basis, net interest margin was 3.87% and 3.81% for the nine months ended September 30, 2012 and September 30, 2011 , respectively. The net interest spread remained flat at 3.74% for the nine months ended September 30, 2012 , and September 30, 2011 . The yield on average interest-earning assets was 4.22% and 4.35% for the nine months ended September 30, 2012 and September 30, 2011 , respectively, a decrease of 13 bps, while the interest rate on average interest-bearing liabilities for those periods was 0.48% and 0.71% , respectively, a decrease of 23 bps due to the ongoing low interest rate environment.

Interest income decreased 5.65% for the nine months ended September 30, 2012 to $8.8 million , from $9.3 million for the nine months ended September 30, 2011 . The average balances of loans, which had overall yields of 5.85% for the nine months ended September 30, 2012 and 5.68% for the nine months ended September 30, 2011 , respectively, decreased from $200.0 million for the nine months ended September 30, 2011 to $181.5 million for the nine months ended September 30, 2012 . The average balance of investment securities increased $23.9 million from $24.5 million for the nine months ended September 30, 2011 to $48.4 million for the nine months ended September 30, 2012 . The TE yield on investment securities decreased from 4.38% for the nine months ended September 30, 2011 to 2.16% for the nine months ended September 30, 2012 . In the low interest rate environment, higher yield investments that are amortizing or being called are not being replaced by the same yields on new investments. The average balances of federal funds and other short-term investments decreased from $65.3 million for the nine months ended September 30, 2012 to $49.4 million for the nine months ended September 30, 2012 , and the average yield in this category remained relatively flat over the same time period. The decrease in the average balances year over year for loans outstanding had a negative impact on net interest margin. Management has begun purchasing short duration 0% and 20% risk weighted government backed bonds to help mitigate the effects of the decline in the Bank's loan portfolio.

Interest expense decreased in the nine months ended September 30, 2012 , to $741 thousand , from $1.2 million for the nine months ended September 30, 2011 . Average total interest-bearing deposits, including savings, interest-bearing demand deposits and time deposits decreased from $218.2 million for the nine months ended September 30, 2011 , to $200.9 million for the nine months ended September 30, 2012 . The average rate paid on interest-bearing deposits decreased 21 bps from 0.67% for the nine months ended September 30, 2011 to 0.46% for the nine months ended September 30, 2012 , primarily caused by the decreases in rates paid on time deposits.

The average rate on borrowings decreased from 3.49% for the nine months ended September 30, 2011 to 2.10% for the nine months ended September 30, 2012 . The average borrowings outstanding increased $0.2 million from the nine months ended September 30, 2011 to the nine months ended September 30, 2012 , mainly due to a capital lease that began late in 2011. The interest expense on borrowed funds decreased to $46.0 thousand in the nine months ended September 30, 2012 from the same period in 2011.

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M&F BANCORP, INC. AND SUBSIDIARY

Average Balances, Interest Earned or Paid, and Interest Yields/Rates For the Nine Months Ended September 30, 2012 and 2011

(Dollars in thousands)	2012							2011
	Average Balance			Amount Earned/Paid		Average Rate		Average Balance			Amount Earned/Paid		Average Rate
Assets
Loans receivable (1):	$	181,493		$	7,969	5.85	%	$	199,964		$	8,524	5.68	%
Taxable securities	45,318			636		1.87		18,032			472		3.49
Nontaxable securities (2)	3,081			91		3.94		6,461			204		4.21
Federal funds sold and other interest on short-term investments	49,415			94		0.25		65,287			116		0.24
Total interest earning assets	279,307			8,790		4.20	%	289,744			9,316		6.52	%
Cash and due from banks	2,545							2,217
Other assets	20,739							19,246
Allowance for loan losses	(3,793		)					(3,864		)
Total assets	$	298,798						$	307,343
Liabilities and Equity
Savings deposits	$	54,104		$	86	0.21	%	$	61,598		$	146	0.32	%
Interest-bearing demand deposits	23,881			24		0.13		25,138			47		0.25
Time deposits	122,935			585		0.63		131,513			909		0.92
Total interest-bearing deposits	200,920			695		0.46		218,249			1,102		0.67
Borrowed funds	2,921			46		2.10		2,673			70		3.49
Total interest-bearing liabilities	203,841			741		0.48	%	220,922			1,172		0.71	%
Non-interest-bearing deposits	52,730							44,108
Other liabilities	5,681							5,556
Total liabilities	262,252							270,586
Stockholders' equity	36,546							36,757
Total liabilities and stockholders' equity	$	298,798						$	307,343
Net interest income				$	8,049						$	8,144
Non-taxable securities				91							204
Tax equivalent adjustment (3)				57							128
Tax equivalent net interest income				$	8,106						$	8,272
Net interest spread (4)						3.72	%						5.81	%
Net interest margin (5)				3.87		%					3.81		%

(1) Loans receivable include nonaccrual loans for which accrual of interest income has not been recorded.

(2) The tax equivalent rate is computed using a blended federal and state tax rate of 38.55%

(3) The tax equivalent adjustment is computed using a blended tax rate of 38.55%.

(4) Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(5) Net interest margin represents net interest income divided by average interest-earning assets.

Noninterest Income . Noninterest income decreased 10.47% , or $195 thousand , for the nine months ended September 30, 2012 , mainly due to net realized losses on the sale of other real OREO in nine months ended September 30, 2012 compared to net realized gains in the nine months ended September 30, 2011 . The decline in OREO realized gains along with declines in service charge fees was partially offset with an increase in the realized gains of $150 thousand in available for sale securities for the nine months ended September 30, 2012 over the same period in 2011.

Index

M&F BANCORP, INC. AND SUBSIDIARY

Noninterest Expense. Noninterest expense represents the costs of operating the Company and the Bank. Management regularly monitors all categories of noninterest expense with the goal of improving productivity and operating performance. Noninterest expense increased $68 thousand for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 . Increases in salaries and employees benefits, OREO expenses, and information technology expense were partially offset by declines in marketing, professional fees, and delivery expenses.

Salary and employee benefits expenses for the nine months ended September 30, 2012 and September 30, 2011 were $4.4 million and $4.1 million , respectively. Salary increases were given mid-year in both years, the the full effect of the 2011 increases is reflected in the nine months ended September 30, 2012 . Benefits were increased to $1.1 million in the nine months ended September 30, 2012 from $961 thousand compared to the nine months ended September 30, 2011 .

Data processing and communications costs increased by 17.97% , or $106 thousand , to $696 thousand in the nine months ended September 30, 2012 , mainly due to increased core processing charges.

Professional fees decreased by $191.0 thousand to $627 thousand in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 , due to a decrease in legal, accounting, and consultant fees.

In the nine months ended September 30, 2012 , FDIC insurance premiums decreased $73.0 thousand to $395 thousand in the nine months ended September 30, 2011 from the same period in 2011. The main cause of the decline was due to a decrease in our average deposits and specifically the Bank's brokered deposits.

Other expenses increased $33.0 thousand for the nine months ended September 30, 2012 from the nine months ended September 30, 2011 . The increase in other expenses was driven by a increase in miscellaneous fees and services.

Provision for Income Taxes . The Company recorded an income tax expense of $196 thousand for the nine months ended September 30, 2012 and $205 thousand for the nine months ended September 30, 2011 . The overall effective rate increased from 25.53% in the nine months ended September 30, 2011 to 27.37% in the nine months ended September 30, 2012 due to an decrease in tax exempt interest income and permanent tax to book differences increasing.

ASSET QUALITY

Allowances for Loan Losses ("ALLL") - The ALLL is a valuation allowance which is established through a provision for loan losses charged to expense. When management believes that the collectability of the principal is unlikely, loans are charged against the ALLL. Subsequent recoveries, if any, are credited to the ALLL.


•	Changes in lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices;


•	Changes in national economic and business conditions and developments and the effect of unemployment on African Americans, who are the majority of our customers;


•	Changes in the nature and volume of the loan portfolio;


•	Changes in the experience, ability, and depth of lending management and staff;


•	Changes in trends of the volume and severity of past due and classified loans; and changes in trends in the volume of non-accrual loans, troubled debt restructurings and classified loans;


•	Changes in the quality of the loan review system and the degree of oversight by the Bank's Board of Directors;


•	The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and

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M&F BANCORP, INC. AND SUBSIDIARY


•	The effect of external factors such as competition and legal and regulatory requirements.

The quantitative loss history is based on an eight quarter rolling history of net losses incurred by different loan types within the loan portfolio. For loans evaluated under the ASC 450 reserve, the qualitative factors by loan type are added to the quantitative loss factors and multiplied by the balances of each loan type to determine the ASC 450 reserve. The actual eight quarter loss history is 46 bps of average loans outstanding as of September 30, 2012 . The net qualitative factors applied to the ASC 450 calculations totaled 1.36% and the quantitative factors varied from net recoveries to 35.93% for overdrafts.

A specific ALLL is established for loans identified as impaired or TDRs, based on significant conditions or circumstances related to the specific credits. The specific allowance amounts are determined by a method prescribed by Accounting Standards Codification (“ASC”) 310, Receivables. Loans identified as impaired and non-accruing TDRs are accounted for in accordance with one of three valuations: (i) the present value of future cash flows discounted at the loan's effective interest rate; (ii) the loan's observable market price, or (iii) the fair value of the collateral, if the loan is collateral dependent, less estimated liquidation costs. A loan is considered impaired when it is probable that not all amounts due (principal and interest) will be collectible according to the original contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. The significance of payment delays and payment shortfalls are considered on a loan by loan basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

For commercial, commercial real estate, faith-based non-profit, residential real estate and certain consumer loans, the measurement of loan impairment is based on the present value of the expected future cash flows, discounted at the loan's effective interest rate, or on the fair value of the loan's collateral if the loan is collateral dependent. Most consumer loans have smaller balances and are homogeneous, and are evaluated for impairment on a collective basis, applying the quantitative loss history and the qualitative factors. Impairment losses are included in the ALLL through a charge to the provision for loan losses.

The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company's credit risk rating system was developed to aid in the risk management process by grouping credits with similar risk profiles into pass, internal watch, special mention, or criticized categories, which includes substandard, doubtful, and loss. Credit risk ratings are applied individually to all classes of loans and leases. Internal credit reviews and external contracted credit review examinations are used to determine and validate loan risk grades. The credit review system takes into consideration factors such as: borrower's background and experience; historical and current financial condition; credit history and payment performance; economic conditions and their impact on various industries; type, market value and volatility of the market value of collateral; lien position; and the financial strength of guarantors.

The process of assessing the adequacy of the ALLL is necessarily subjective. Further, and particularly in periods of economic downturns, it is reasonably possible that future credit losses may exceed historical loss levels and may also exceed management's current estimates of incurred credit losses inherent within the loan portfolio. As such, there can be no assurance that future loan charge-offs will not exceed management's current estimate of what constitutes a reasonable ALLL.

The Company and the Bank are subject to periodic examination by their federal and state regulators, and may be required by such regulators to recognize additions to the allowance for loan losses based on their assessment of credit information available to them at the time of their examinations.

As of September 30, 2012 and December 31, 2011 , the ALLL was $3.5 million and $3.9 million , respectively, which represented approximately 1.95% and 2.05% of loans outstanding, net of unearned income and deferred costs ("net loans outstanding"), on those respective dates. The 10 bps decrease in the percentage of ALLL to gross loans outstanding is attributable to both decreasing qualitative factors and the $13 thousand decrease in ALLL related to impaired and TDR loans. Loans evaluated under the ASC 310 reserve increased $2.1 million or 8.76% , as of September 30, 2012 compared to December 31, 2011 . Loans evaluated under the ASC 450 reserve decreased $11.2 million or 6.80% , and the reserve allocated to those loans decreased $339 thousand or 10.8% . The eight quarter rolling quantitative loss history for loans evaluated under ASC 450 decreased from 57 bps as of December 31,

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M&F BANCORP, INC. AND SUBSIDIARY

2011 to 46 bps as of September 30, 2012 , and the qualitative factors decreased from 1.40% as of December 31, 2011 , to 1.36% as of September 30, 2012 .

Of the non-accruing loans totaling $9.7 million at September 30, 2012 , 93.74% of the outstanding balances are secured by real estate, which management believes mitigates the risk of loss. GAAP does not provide specific guidance on when a loan may be returned to accrual status. Federal banking regulators have provided guidance that interest on impaired loans, including TDRs, should only be recorded when there has been a sustained period of repayment performance, the loan is well secured, and collection under any revised terms is assessed as probable. The Company evaluates impaired loan and TDR performance under the applicable regulatory guidelines and returns loans to accruing after a sustained period of repayment performance.

Loans are generally placed on non-accrual status when the scheduled payments reach 90 days past due. Loans are charged-off, with Board approval, when the Chief Credit Officer and his staff determine that all reasonable means of collection of the outstanding balances, except foreclosure, have been exhausted. The Company continues its collection efforts subsequent to charge-off, which historically has resulted in some recoveries each year.

Loans at September 30, 2012 and December 31, 2011 were as follows:



(Dollars in thousands)	September 30, 2012			December 31, 2011

Commercial	$	5,540		$	7,688
Commercial real estate:
Construction	1,726			1,871
Owner occupied	20,051			20,352
Other	26,628			24,831
Faith-based non-profit:
Construction	1,910			2,287
Owner occupied	77,137			78,161
Other	6,861			8,703
Residential real estate:
First mortgage	25,120			27,896
Multifamily	5,904			7,207
Home equity	3,420			4,457
Construction	381			—
Consumer	1,455			1,667
Other loans	2,808			2,964
Loans, net of deferred fees	178,941			188,084
Allowance for loan losses	(3,498		)	(3,850		)
Loans, net of allowance for losses	$	175,443		$	184,234

Activity in the allowance for loan losses for the three and nine months ending September 30, 2012 and September 30, 2011 were as follows:

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	For the Three Months Ended
	September 30, 2012
(Dollars in thousands)	June 30, 2012		Charge-offs			Recoveries		Provision/ (Recovery)			September 30, 2012
Commercial	$	61	$	—		$	—	$	(36	)	$	25
Commercial real estate	1,187		—			—		(18		)	1,169
Faith-based non-profit	1,091		—			—		(60		)	1,031
Residential real estate	1,243		(303		)	4		230			1,174
Consumer	46		—			4		2			52
Other	51		(8		)	—		4			47
Unallocated	—										—
Total	$	3,679	$	(311	)	$	8	$	122		$	3,498


	For the Nine Months Ended
	September 30, 2012
	December 31, 2011		Charge-offs			Recoveries		Provision/ (Recovery)			September 30, 2012
Commercial	$	348						$	(323	)	$	25
Commercial real estate	971		(56		)	1		253			1,169
Faith-based non-profit	1,128							(97		)	1,031
Residential real estate	1,299		(539		)	93		321			1,174
Consumer	62		(1		)	1		(10		)	52
Other	42		(26		)	9		22			47
Unallocated	—							—			—
Total	$	3,850	$	(622	)	$	104	$	166		$	3,498

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M&F BANCORP, INC. AND SUBSIDIARY



	For the Three Months Ended
	September 30, 2011
(Dollars in thousands)	June 30, 2011		Charge-offs			Recoveries		Provision/ (Recovery)			September 30, 2011
Commercial	582		(14		)	—		(10		)	558
Commercial real estate	840		(19		)	3		27			851
Faith-based non-profit	1,220		—			—		13			1,233
Residential real estate	1,457		(181		)	—		242			1,518
Consumer	43		(8		)	—		26			61
Other	103		(6		)	2		(34		)	65
Total	$	4,245	$	(228	)	$	5	$	264		$	4,286

	For the Nine Months Ended
	September 30, 2011
	December 31, 2010		Charge-offs			Recoveries		Provision/ (Recovery)			September 30, 2011
Commercial	$	651	$	(14	)	$	95	$	(174	)	$	558
Commercial real estate	651		(19		)	129		90			851
Faith-based non-profit	1,289		—			—		(56		)	1,233
Residential real estate	1,045		(181		)	2		652			1,518
Consumer	105		(8		)	6		(42		)	61
Other	110		(23		)	11		(33		)	65
Total	$	3,851	$	(245	)	$	243	$	437		$	4,286

The Company experienced $518 thousand in net loan charge offs for the nine months ended September 30, 2012 compared to $245 thousand in net loan charge offs for the nine months ended September 30, 2011 . The Company experienced $311 thousand in net loan charge offs for the three months ended September 30, 2012 compared to $223 thousand in net loan charge offs for the three months ended September 30, 2011 . On a rolling eight quarter basis, net loan charge-offs as a percent of average loan balances outstanding decreased from 62 basis points (“bps”) as of September 30, 2011 to 57 bps as of December 31, 2011 , and decreased 11 bps to 46 bps as of September 30, 2012 .

The following table presents the allowance for loan losses and the reported investment in loans by portfolio segment and based on impairment method. The first column represents loans identified as impaired and TDRs, the second column represents all other loans as of September 30, 2012 :

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Allowance for loan losses:	Individually evaluated for impairment		Collectively evaluated for impairment		Outstanding as of September 30, 2012
(Dollars in thousands)
Commercial	$	—	$	25	$	25
Commercial real estate	313		856		1,169
Faith-based non-profit	52		979		1,031
Residential real estate	342		832		1,174
Consumer	—		52		52
Other loans	—		47		47
Total	$	707	$	2,791	$	3,498
Loans:
(Dollars in thousands)
Commercial	$	590	$	4,950	$	5,540
Commercial real estate	9,134		39,271		48,405
Faith-based non-profit	13,557		72,351		85,908
Residential real estate	2,186		32,639		34,825
Consumer	—		1,455		1,455
Other loans	—		2,808		2,808
Total	$	25,467	$	153,474	$	178,941

Total impaired loans including TDR loans was $25.5 million as of September 30, 2012 and $23.4 million as of December 31, 2011 .

Impaired loan balances at September 30, 2012 and December 31, 2011 were as follows:



	September 30, 2012
(Dollars in thousands)	Unpaid Principal Balance		Total Exposure		Recorded Investment		Allowance for Loan Losses Allocated		Interest Earned Nine Months		Interest Earned Three Months

Without related allowance recorded:
Commercial real estate:
Owner occupied	42		42		42		—		—		—
Other	50		50		50		—		—		—
Residential real estate:
First mortgage	398		398		398		—		6		—
Total impaired loans without allowance recorded	$	490	$	490	$	490	$	—	$	6	$	—
With an allowance recorded:
Commercial real estate:
Other	1,591		1,591		1,591		156		65		—
Residential real estate:
First mortgage	1,218		1,218		1,218		337		40		11
Total impaired loans with allowance recorded	$	2,809	$	2,809	$	2,809	$	493	$	105	$	11
Total impaired loans	$	3,299	$	3,299	$	3,299	$	493	$	111	$	11

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	December 31, 2011						September 30, 2011
	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Interest Earned Nine Months		Interest Earned Three Months
(Dollars in thousands)
With no related allowance recorded:
Commercial real estate:
Owner occupied	322		322		—		17		17
Other	56		56		—		—		—
Faith-based non-profit:
Owner occupied	2,522		2,522		—		61		61
Residential real estate:
First mortgage	402		314		—		—		—
Total impaired loans without allowance recorded	$	3,302	$	3,214	$	—	$	78	$	78
With an allowance recorded:
Commercial real estate:
Owner occupied	279		279		47		—		—
Other	40		40		10		—		—
Residential real estate:
First mortgage	763		762		290		26		9
Home equity	462		462		251		—		—
Consumer	2		2		2		—		—
Total impaired loans with allowance recorded	$	1,546	$	1,545	$	600	$	26	$	9
Total impaired loans	$	4,848	$	4,759	$	600	$	104	$	87



(Dollars in thousands)	For the Nine Months Ended		For the Three Months Ended		For the Nine Months Ended		For the Three Months Ended
Average of impaired loans during the periods ended	September 30, 2012				September 30, 2011
Commercial	$	—	$	—	$	15	$	15
Commercial real estate:
Owner occupied	296		44		1,051		1,042
Other	874		1,653		109		117
Faith-based non-profit:
Owner occupied	2,522		2,522		5,948		6,057
Other					48		—
Residential real estate:
First mortgage	1,202		1,222		799		1,071
Multifamily					547		629
Home equity	274		267		190		278
Consumer	2				5		5
Average impaired loans	$	5,170	$	5,708	$	8,712	$	9,214

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M&F BANCORP, INC. AND SUBSIDIARY

TDRs balances at September 30, 2012 were as follows:



	September 30, 2012
(Dollars in thousands)	Impaired Balance		Liquid Collateral		Total Exposure		Recorded Investment		Allowance for Loan Losses Allocated		Interest Earned Nine Months		Interest Earned Three Months

Without related allowance recorded:
Commercial	$	1,567	$	—	$	1,567	$	590	$	—	$	—	$	—
Commercial real estate:
Construction	374		—		374		374		—		24		7
Owner occupied	509		—		509		509		—		28		6
Other	4,912		—		4,912		5,914		—		143		58
Faith-based non-profit:
Owner occupied	13,133		103		13,030		13,126		—		331		69
Residential real estate:
First mortgage	491		—		491		491		—		12		4
Total TDRs without allowance recorded	$	20,986	$	103	$	20,883	$	21,004	$	—	$	538	$	144
With an allowance recorded:
Commercial real estate:
Owner occupied	$	239	$	—	$	239	$	239	$	102	$	12	$	3
Other	414		—		414		414		55		26		6
Faith-based non-profit
Owner occupied	430		—		430		430		52		22		5
Residential real estate:
First mortgage	80		6		74		80		5		4		1
Total TDRs with allowance recorded	$	1,163	$	6	$	1,157	$	1,163	$	214	$	64	$	15
Total TDRs	$	22,149	$	109	$	22,040	$	22,167	$	214	$	602	$	159

The following table presents TDRs by class of loans as of December 31, 2011 :

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	December 31, 2011											September 30, 2011
	Impaired Balance		Liquid Collateral			Total Exposure		Recorded Investment		Allowance for Loan Losses Allocated		Interest Earned Nine Months			Interest Earned Three Months
(Dollars in thousands)
With no related allowance recorded:
Commercial	$	1,567	$	—		$	1,567	$	590	$	—	$	—		—
Commercial real estate:
Construction	628		—			628		628		—		—			—
Owner occupied	893		—			893		895		—		20			16
Other	5,112		—			5,112		3,814		—		4			—
Faith-based non-profit:
Owner occupied	10,391		(103		)	10,288		10,385		—		297			110
Residential real estate:
First mortgage	617		(9		)	608		607		—		4			1
Total TDRs with no allowance recorded	$	19,208	$	(112	)	$	19,096	$	16,919	$	—	$	325		$	127
With an allowance recorded:
Commercial real estate:
Construction	$	378	$	—		$	378	$	378	$	15	$	24		$	9
Owner occupied	416		—			416		416		47		—		—	—
Other	—		—			—		—		—		19			3
Faith-based non-profit:
Owner occupied	908		—			908		909		56		33			15
Residential real estate:
First mortgage	35		—			35		35		2		—			—
Total TDRs with allowance recorded	$	1,737	$	—		$	1,737	$	1,738	$	120	$	76		$	27
Total TDRs	$	20,945	$	(112	)	$	20,833	$	18,657	$	120	$	401		$	154

Loans for which payment of principal or interest is in default for 90 days or more, are classified as a nonaccrual unless they are well secured and in process of collection. Loans over 90 days still accruing were matured loans that were well secured and in process of collection. Borrowers have continued to make payments on these loans while administrative and legal due processes are proceeding which will enable the Bank to extend or modify maturity dates.

The following table presents the recorded investment in non-accrual and loans past due over 90 days still on accrual by class of loans as of September 30, 2012 :

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(Dollars in thousands)	Nonaccrual		Number	Loans Past Due Over 90 Days Still Accruing		Number

Commercial	$	590	1	$	—	—
Commercial real estate:
Owner occupied	42		1	170		3
Other	50		1	—		—
Faith-based non-profit:
Owner occupied	5,600		4	145		1
Residential real estate:
First mortgage	3,400		42	89		2
Home equity	20		3	—		—
Consumer	18		3	—		—
Total	$	9,720	55	$	404	6

The following table presents the recorded investment in non-accrual and loans past due over 90 days still on accrual by class of loans as of December 31, 2011 :



	Nonaccrual		Number	Loans Past Due Over 90 Days Still Accruing		Number
(Dollars in thousands)
Commercial	$	590	1	$	—	—
Commercial real estate:
Construction	628		1	—		—
Owner occupied	772		4	52		1
Other	3,503		4	1		1
Faith-based non-profit:
Owner occupied	5,497		3	—		—
Residential real estate:
First mortgage	3,749		39	47		1
Multifamily	—		—	114		1
Home equity	582		8	—		—
Consumer	5		2	—		—
Total	$	15,326	62	$	214	4

The following table presents the aging of the recorded investment in loans as of September 30, 2012 by class of loans:

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(Dollars 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

Commercial	$	6	$	—	$	590	$	596	$	4,944	$	5,540
Commercial real estate:
Construction	—		—		—		—		1,726		1,726
Owner occupied	—		—		213		213		19,838		20,051
Other	—		353		50		403		26,225		26,628
Faith-based non-profit:
Construction	—		—		—		—		1,910		1,910
Owner occupied	833		51		2,930		3,814		73,323		77,137
Other	—		—		—		—		6,861		6,861
Residential real estate:
First mortgage	468		319		2,554		3,341		21,779		25,120
Multifamily	—		—		—		—		5,904		5,904
Home equity	157		—		7		164		3,256		3,420
Construction	—		—		—		—		381		381
Consumer	14		2		—		16		1,439		1,455
Other loans	—		—		—		—		2,808		2,808
Total	$	1,478	$	725	$	6,344	$	8,547	$	170,394	$	178,941

The Company has allocated $214.0 thousand and $120.0 thousand of specific reserves to customers whose loan terms have been modified in TDRs as of September 30, 2012 and December 31, 2011 , respectively. The Company has not committed to lend additional amounts as of September 30, 2012 and December 31, 2011 to customers with outstanding loans that are classified as TDRs.

Credit Quality Indicators:


•	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. These loans exhibit a moderate likelihood of some loss related to those loans and leases.

•


•	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.


•	Loss. Based on current facts and circumstances, loans classified as loss are not expected to be repaid, or that collateral will be difficult to liquidate.

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•	Pass. (includes internal watch) Loans are classified as pass in all classes within the portfolio that are not identified as special mention, substandard, or doubtful, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. These loans exhibit a low likelihood of loss.

The loans assigned to these ratings by portfolio class as of September 30, 2012 is as follows:



	Pass		Special Mention		Substandard		Doubtful		Total
(Dollars in thousands)
Commercial	$	4,941	$	—	$	9	$	590	$	5,540
Commercial real estate:
Construction	1,352		—		374		—		1,726
Owner occupied	14,492		3,730		1,829		—		20,051
Other	16,176		982		9,470		—		26,628
Faith-based and non-profit:
Construction	1,910		—		—		—		1,910
Owner occupied	56,091		5,829		15,217		—		77,137
Other	6,780		77		4		—		6,861
Residential real estate:
First mortgage	19,735		1,468		3,917		—		25,120
Multifamily	5,777		63		64		—		5,904
Home equity	3,125		—		295		—		3,420
Construction	381		—		—		—		381
Consumer	1,427		4		24		—		1,455
Other loans	2,808		—		—		—		2,808
Total	$	134,995	$	12,153	$	31,203	$	590	$	178,941

The provision for loan losses assigned to these ratings by portfolio class as of September 30, 2012 is as follows:



(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Total
Commercial	$	24	$	—	$	1	$	—	$	25
Commercial real estate:
Construction	20		—		—		—		20
Owner occupied	294		89		127		—		510
Other	370		23		246		—		639
Faith-based and non-profit:
Construction	26		—		—		—		26
Owner occupied	751		113		48		—		912
Other	92		1		—		—		93
Residential real estate:
First mortgage	571		35		400		—		1,006
Multifamily	114		1		1		—		116
Home equity	38		—		9		—		47
Construction	5		—		—		—		5
Consumer	51		—		1		—		52
Other loans	47								47
Total	$	2,403	$	262	$	833	$	—	$	3,498

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M&F BANCORP, INC. AND SUBSIDIARY

Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans. To do so, we operate a credit risk rating system under which our credit management personnel assign a numeric credit risk rating to each loan at the time of origination and review loans on a regular basis.

Each loan officer is responsible for monitoring his or her loan portfolio, recommending a credit risk rating for each loan in his or her portfolio and ensuring the credit risk ratings are appropriate. These credit risk ratings are then ratified by our Chief Credit Officer or the Directors’ Loan Committee. Credit risk ratings are determined by evaluating a number of factors including, a borrower’s financial strength, cash flow coverage, collateral protection and guarantees. The credit risk ratings and methodology applied are reviewed annually by management and the board of directors.

FINANCIAL CONDITION

The Company’s financial condition is measured in terms of its asset and liability composition, asset quality, capital resources and liquidity. While gross loans were down for the period ending September 30, 2012 , versus December 31, 2011 , the Bank continues to develop relationships and business in the commercial, and faith-based non-profit organizations operating within its footprint.

Total assets increased from $304.5 million as of December 31, 2011 to $310.6 million as of September 30, 2012 . The increase in assets was tempered by a $9.1 million decline in loans. The largest component of assets that increased was in investment securities available for sale, which increased $25.3 million from December 31, 2011 to September 30, 2012 . The increase in investment securities available for sale was impacted by the management decision to move low yielding cash into higher yielding, low risk bonds. Cash and cash equivalents declined $9.8 million to $51.5 million from December 31, 2011 . Gross loans decreased $9.1 million and OREO decreased $0.1 million in 2012. Total liabilities increased from $268.1 million as of December 31, 2011 to $273.7 million as of September 30, 2012 , although there was a decline in total deposits of $2.2 million .

Total consolidated stockholders’ equity increased from $36.4 million as of December 31, 2011 to $36.9 million as of September 30, 2012 . For the nine months ended September 30, 2012 , the net increase in retained earnings was comprised of $0.5 million of net income, offset by dividends declared to preferred stockholders of $0.2 million . The Company did not declare or pay a common stock dividend in the first nine months of 2012. Accumulated other comprehensive loss represents the unrealized gain or loss on available for sale securities and the unrealized gain or loss related to the deferred pension liability, net of deferred taxes. Accumulated other comprehensive loss was in a net unrealized loss position of $1.3 million at September 30, 2012 , a decrease of $0.2 million from the net unrealized loss of $1.4 million as of December 31, 2011 .

ASSETS

Cash and Cash Equivalents . Cash and cash equivalents, including noninterest-bearing and interest-bearing cash, fed funds sold and short-term investments, decreased $9.8 million from $61.3 million as of December 31, 2011 to $51.5 million as of September 30, 2012 . The decrease in cash was the result of the purchases in investment securities of $40.3 million and the $2.2 million decrease in deposits.

Loan Portfolio . Gross loans were $178.9 million and $188.1 million as of September 30, 2012 and December 31, 2011 , respectively. The commercial loan portfolio is comprised mainly of loans to small- and mid-sized businesses. A significant portion of the loan portfolio is collateralized by owner-occupied real estate. An adverse change in the economy affecting real estate values generally, or in our primary markets in particular, could impair the value of underlying collateral and/or our ability to sell such collateral.

The Bank has a concentration of loans to faith-based non-profit organizations, in which the Bank has specialized lending experience. As of September 30, 2012 , the percentage of loans in this niche, which included construction, real estate secured, and lines of credit, totaled approximately 48.01% of the total loan portfolio and the reserve for these loans is 29.47% of the total allowance. Historically the Bank has experienced low levels of loan losses in this specialty; however, repayment of loans is primarily dependent on voluntary contributions, which appears to have been adversely affected by the Great Recession. Management monitors the loan portfolio for changes in trends of past due loans and has seen a recent increase in the past due status of some loans in this concentration. The Bank has implemented policies and procedures to help manage this concentration risk and track the performance of the loans.

Traditionally, the Bank has not issued high-risk mortgage products such as Adjustable Rate Mortgages (“ARM”), interest only residential mortgages and other sub-prime mortgages. While the Bank does not engage in sub-prime lending, a small balance of loans may be deemed sub-prime based on borrowers’ credit scores. No loans in the portfolio have terms that permit the borrower

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to pay less than the interest due on the loan balance. Historically, the Bank has made very few acquisition and development loans or construction development loans with interest reserves built into the loans.

Of the loan balances outstanding at September 30, 2012 , 94.52% or $169.1 million is secured by real estate, and 1.47% or $2.6 million, is secured by cash deposits. Junior liens at September 30, 2012 , constituted $3.4 million , or 1.91% of the loan balances outstanding.

The Bank’s market areas are the Research Triangle (Raleigh and Durham, North Carolina), the Piedmont Triad (Greensboro and Winston-Salem, North Carolina) and Charlotte, North Carolina. The economic trends of the areas in North Carolina served by the Bank are influenced by the significant industries within these regions. The ultimate collectability of the Bank’s loan portfolio is susceptible to changes in the market conditions of these geographic regions.

Liquidity and Capital Resources

Liquidity, Interest Rate Sensitivity and Market Risks

The objectives of the Company’s liquidity management policy include providing adequate funds to meet the needs of depositors and borrowers at all times, providing funds to meet the basic needs for on-going operations of the Company, and to meet regulatory requirements. The 33.64% liquidity ratio is the sum of cash, overnight funds, and un-pledged, marketable U.S. Government and U.S. Agency securities, divided by the sum of deposits and short-term borrowings (less the full amount of pledged deposits). Management believes that core deposit activity, $7.3 million in available borrowing capacity from the Federal Home Loan Bank of Atlanta ("FHLB") at September 30, 2012 , and Fed Funds accommodations of $10.0 million will be adequate to meet the short-term and long-term liquidity needs of the Company. The Company had $0.7 million outstanding from the FHLB as of September 30, 2012 . The maximum outstanding balance from FHLB at any time during the second quarter quarter of 2012 was $0.8 million, of which $0.1 million was borrowed over night to test the borrowing capacity. The Company periodically draws on its Fed Funds accommodations to test the lines' availability.

The Company participates in the Certificate of Deposit Account Registry Service (“CDARS”) program, which enables depositors to receive FDIC insurance coverage for deposits otherwise exceeding the maximum insurable amount. Through the CDARS program, deposits in excess of the maximum insurable amount are placed with multiple participating financial institutions. All of the Bank’s CDARS deposits are reciprocal, relationship-based deposits. There are several large depositors in the CDARS program, and the largest depositor has renewed $20 million in deposits annually for several years. There is no guarantee, however that this trend will continue. In management’s opinion, the large depositors have stable and long-term relationships with the Bank.

Capital Resources

The Company and the Bank are subject to various regulatory capital requirements administered by their federal and state banking regulators. Failure to satisfy minimum capital requirements may result in certain mandatory and additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s Consolidated Financial Statements. The Bank is required to obtain the non-objection of its regulators before engaging in any transactions that would materially change the composition of the Bank’s balance sheet. Also, the Bank Memorandum of Understanding with its regulators requires the Bank to maintain a tier 1 leverage capital ratio of not less than 8.00%, and a total risk based capital ratio of not less than 10.00%.

The September 30, 2012 and December 31, 2011 regulatory capital levels of the Company and Bank compared to the regulatory standards were:

Index

M&F BANCORP, INC. AND SUBSIDIARY



	September 30, 2012
(Dollars in thousands)	Actual				For Capital Adequacy Purposes				To Be Well Capitalized
	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total capital (to risk weighted assets)
Company	$	36,494	21.45	%	$	13,608	8.00	%	$	17,010	10.00	%
Bank	34,750		18.99		14,639		8.00		18,299		10.00
Tier 1 (to risk weighted assets)
Company	$	34,356	20.20	%	$	6,804	4.00	%	$	10,206	6.00	%
Bank	32,454		17.74		7,319		4.00		10,979		6.00
Tier 1 (to average total assets)
Company	$	34,356	11.76	%	$	11,687	4.00	%	$	14,609	5.00	%
Bank	32,454		11.21		11,582		4.00		1,477		5.00



	December 31, 2011
(Dollars in thousands)	Actual				For Capital Adequacy Purposes				To Be Well Capitalized
	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total capital (to risk weighted assets)
Company	$	36,476	18.86	%	$	15,469	8.00	%	$	19,336	10.00	%
Bank	34,282		17.96		15,269		8.00		19,086		10.00
Tier 1 (to risk weighted assets)
Company	$	34,047	17.61	%	$	7,735	4.00	%	$	11,602	6.00	%
Bank	31,884		16.71		7,635		4.00		11,452		6.00
Tier 1 (to average total assets)
Company	$	34,047	11.21	%	$	12,151	4.00	%	$	15,189	5.00	%
Bank	31,884		10.64		11,992		4.00		14,990		5.00


Item 4 -	Controls and Procedures

The Company’s management, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer (its principal executive officer and principal financial officer, respectively), has concluded, based on its evaluation as of the end of the period covered by this report, that the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, (“the Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms.

There were no changes in internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Index

M&F BANCORP, INC. AND SUBSIDIARY

PART II

OTHER INFORMATION


Item 6.	Exhibits

Exhibits and Index of Exhibits

The following exhibits are filed with or incorporated by reference into this report.



Exhibit No.		Exhibit Description

Exhibit 3(i)(a)		Amended and Restated Articles of Incorporation of the Company, incorporated by reference to Exhibit 3(i) to the Form 10-QSB, filed with the SEC on November 15, 1999.

Exhibit 3(i)(b)		Articles of Amendment, adopted by the shareholders of the Company on May 3, 2000, filed with the North Carolina Department of the Secretary of State on July 12, 2000, and incorporated by reference to Exhibit 3(v) to the Form 10-KSB, filed with the SEC on March 31, 2006.

Exhibit 3(i)(c)		Articles of Amendment, adopted by the shareholders of the Company on June 9, 2009, filed with the North Carolina Department of the Secretary of State on June 11, 2009, and incorporated by reference to Exhibit 4.1 to the Form 8-K filed with the SEC on June 26, 2009.

Exhibit 3(i)(d)		Articles of Amendment, adopted by the Board of Directors of the Company on June 10, 2009, filed with the North Carolina Department of the Secretary of State on June 25, 2009, and incorporated by reference to Exhibit 4.2 to the Form 8-K filed with the SEC on June 26, 2009.

Exhibit 3(i)(e)		Articles of Amendment, adopted by the Board of Directors of the Company on July 27, 2010, filed with the North Carolina Department of the Secretary of State on August 20, 2010, and incorporated by reference to Exhibit 4.1 to the Form 8-K filed with the SEC on August 23, 2010.

Exhibit 3(ii)		Restated Bylaws of the Company, incorporated by reference to Exhibit 99.1 to the Form 8K filed with the SEC on April 6, 2009.

Exhibit 4(i)		Specimen Stock Certificate, incorporated by reference to Exhibit 4 to the Form 10-KSB, filed with the SEC on April 2, 2001.

Exhibit 4(ii)		Form of Certificate for the Fixed Rate Cumulative Perpetual Preferred Stock, Series B, incorporated by reference to Exhibit 4.2 to the Form 8-K filed with the SEC on August 23, 2010.

Exhibit 10(i) *		Employment Agreement dated January 12, 2007 by and among Kim D. Saunders, the Company and the Bank, incorporated by reference to Exhibit 99.1 to the Form 8-K filed with the SEC on January 18, 2007.

Exhibit 10(ii)		Letter Agreement and certain side letters, all dated August 20, 2010, between the Company and the United States Department of the Treasury, with respect to the issuance and sale of the Fixed Rate Cumulative Perpetual Preferred Stock, Series B, incorporated by reference to Exhibit 10.1 to the Form 8-K filed with the SEC on August 23, 2010.

Exhibit 10(iii) *		Employment Agreement Amendment, dated June 26, 2009, among the Company, the Bank and Kim D. Saunders, incorporated by reference to Exhibit 10.2 to the Form 8-K filed with the SEC on June 26, 2009.

Index

M&F BANCORP, INC. AND SUBSIDIARY



Exhibit 31(i)		Certification of Kim D. Saunders.

Exhibit 31(ii)		Certification of Lyn Hittle.

Exhibit 32		Certification pursuant to 18 U.S.C. Section 1350.

Exhibit 101		Financial Statements filed in XBRL format

*management contracts and compensatory arrangements

SIGNATURES

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



		M&F Bancorp, Inc.

Date:	November 13, 2012	By:	/s/ Kim D. Saunders
			Kim D. Saunders
			President, Chief Executive Officer

		By:	/s/ Lyn Hittle
			Lyn Hittle
			Senior Vice President, Chief Financial Officer

INDEX TO EXHIBITS



Exhibit 31(i)		Certification of Kim D. Saunders.

Exhibit 31(ii)		Certification of Lyn Hittle.

Exhibit 32		Certification pursuant to 18 U.S.C. Section 1350.

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