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Estate Planning Failures of the Rich and Famous V
 

ESSA BANCORP, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

Our business strategy is to grow and improve our profitability by:. •Increasing customer relationships through the offering of excellent service and the distribution of that service through effective delivery systems;• Continuing to transform into a full service community bank by meeting the financial services needs of our customers;.

Edgar Online, Inc.

Business Strategy

Our business strategy is to grow and improve our profitability by:



       •     Increasing customer relationships through the offering of excellent
             service and the distribution of that service through effective
             delivery systems;




       •     Continuing to transform into a full service community bank by meeting
             the financial services needs of our customers;



• Continuing to develop into a high performing financial institution, in

             part by increasing interest revenue and fee income;




  •   Remaining within our risk management parameters; and



• Employing affordable technology to increase profitability and improve

             customer service.


We intend to continue to pursue our business strategy, subject to changes necessitated by future market conditions and other factors. We also intend to focus on the following:

• Increasing customer relationships through a continued commitment to

             service and enhancing products and delivery systems. We will continue
             to increase customer relationships by focusing on customer
             satisfaction with regard to service, products, systems and operations.
             We have upgraded and expanded certain of our facilities,

including our

             corporate center and added additional branches to provide additional
             capacity to manage future growth and expand our delivery systems.




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• Continuing to develop into a high performing financial institution. We

             will continue to enhance profitability by focusing on

increasing

             non-interest income as well as increasing commercial products,
             including commercial real estate lending, which often have a higher
             profit margin than more traditional products. We also will pursue
             lower-cost commercial deposits as part of this strategy.



• Remaining within our risk management parameters. We place significant

             emphasis on risk management and compliance training for all of 

our

             directors, officers and employees. We focus on establishing 

regulatory

             compliance programs to determine the degree of such compliance and to
             maintain the trust of our customers and community.



• Employing cost-effective technology to increase profitability and

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             improve customer service. We will continue to upgrade our technology
             in an efficient manner. We have implemented new software for marketing
             purposes and have upgraded both our internal and external
             communication systems.




       •     Continuing our emphasis on commercial real estate lending to improve
             our overall performance. We intend to continue to emphasize the
             origination of higher interest rate margin commercial real estate
             loans as market conditions, regulations and other factors permit. We
             have expanded our commercial banking capabilities by adding
             experienced commercial bankers, and enhancing our direct marketing
             efforts to local businesses.



• Expanding our banking franchise through branching and acquisitions. We

             will continue to integrate the nine former First Star Branches that we
             acquired during 2012. The most significant event in that integration
             is the conversion of the computer banking system used by the former
             First Star branches to the computer banking system used by ESSA Bank &
             Trust. The conversion is planned for January, 2013. Post conversion,
             all 26 ESSA Bank & Trust branches will be using the same computer
             banking system. We will attempt to use our stock holding company
             structure, to expand our market footprint through de

novobranching as

             well as through additional acquisitions of banks, savings 

institutions

             and other financial service providers in our primary market area. We
             will also consider establishing de novo branches or acquiring
             additional financial institutions in contiguous counties. We will
             continue to review and assess locations for new branches both within
             Monroe County and the contiguous counties around Monroe. There can be
             no assurance that we will be able to consummate any new

acquisitions

             or establish any additional new branches. We may continue to explore
             acquisition opportunities involving other banks and thrifts, and
             possibly financial service companies, when and as they arise, as a
             means of supplementing internal growth, filling gaps in our current
             geographic market area and expanding our customer base,

product lines

             and internal capabilities, although we have no current plans,
             arrangements or understandings to make any acquisitions.




       •     Maintaining the quality of our loan portfolio. Maintaining the quality
             of our loan portfolio is a key factor in managing our growth. We will
             continue to use customary risk management techniques, such as
             independent internal and external loan reviews, risk-focused portfolio
             credit analysis and field inspections of collateral in

overseeing the

             performance of our loan portfolio.




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Critical Accounting Policies


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

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

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

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

The analysis of the allowance for loan losses has two components: specific and
general allocations. Specific allocations are made for loans that are determined
to be impaired. Impairment is measured by determining the present value of
expected future cash flows or, for collateral-dependent loans, the fair value of
the collateral adjusted for market conditions and selling expenses. The general
allocation is determined by segregating the remaining loans by type of loan,
risk weighting (if applicable) and payment history. We also analyze historical
loss experience, delinquency trends, general economic conditions and geographic
and industry concentrations. This analysis establishes factors that are applied
to the loan groups to determine the amount of the general allocations. Actual
loan losses may be significantly more than the allowance for loan losses we have
established which could have a material negative effect on our financial
results.

Other-than-Temporary Investment Security Impairment. Securities are evaluated
periodically to determine whether a decline in their value is
other-than-temporary. Management utilizes criteria such as the magnitude and
duration of the decline, in addition to the reasons underlying the decline, to
determine whether the loss in value is other-than-temporary. The term
"other-than-temporary" is not intended to indicate that the decline is
permanent, but indicates that the prospect for a near-term recovery of value is
not necessarily favorable, or that there is a lack of evidence to support a
realizable value equal to or greater than the carrying value of the investment.
Once a decline in value is determined to be other-than-temporary, the value of
the security is reduced and a corresponding charge to earnings is recognized.

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



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determination of this valuation allowance to be a critical accounting policy
because of the need to exercise significant judgment in evaluating the amount
and timing of recognition of deferred tax liabilities and assets, including
projections of future taxable income. These judgments and estimates are reviewed
on a continual basis as regulatory and business factors change. A valuation
allowance for deferred tax assets may be required if the amount of taxes
recoverable through loss carryback declines, or if we project lower levels of
future taxable income. Such a valuation allowance would be established through a
charge to income tax expense which would adversely affect our operating results.



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Comparison of Financial Condition at September 30, 2012 and September 30, 2011


Total Assets. Total assets increased $321.3 million, or 29.3%, to $1.4 billion
at September 30, 2012, compared to $1.10 billion at September 30, 2011. This
increase was primarily due to the acquisition of First Star Bank which was
completed on July 31, 2012. Increases in investment securities available for
sale, loans receivable, goodwill, deferred income taxes and other assets were
partially offset by a decrease in interest-bearing deposits with other
institutions.

Interest-Bearing Deposits with Other Institutions. Interest-bearing deposits
with other institutions decreased $27.4 million, or 85.8%, to $4.5 million at
September 30, 2012 from $31.9 million at September 30, 2011. The primary reason
for the decrease was a decrease in the Company's interest bearing demand deposit
account at the FHLB-Pittsburgh of $27.5 million. This decrease was primarily due
to the prepayment of approximately $52.0 million of former First Star FHLBank
Pittsburgh advances shortly after the completion of the First Star acquisition
on July 31, 2012. The funds used to complete the prepayment came from the sale
of approximately $26.0 million of former First Star investment securities
available for sale and approximately $26.0 million from cash. In addition, the
Company prepaid approximately $8.2 million of former First Star junior
subordinated debt, $10.0 million of its own repurchase agreements and $27.0
million of its own FHLB advances during September, 2012.

Investment Securities Available for Sale. Investment securities available for
sale increased $84.2 million, or 34.3% to $329.6 million at September 30, 2012
from $245.4 million at September 30, 2011. The increase was due primarily to the
First Star merger. The Company acquired approximately $113.0 million of
investment securities available for sale from the First Star acquisition.
Approximately $26.0 million of these securities were promptly sold and the
proceeds used to help fund the prepayment of $52.0 million of FHLBank Pittsburgh
advances.

Net Loans. Net loans increased $211.7 million, or 28.7%, to $950.4 million at
September 30, 2012 from $738.6 million at September 30, 2011. The primary
reasons for the increase were increases in residential and commercial real
estate loans. Residential real estate loans increased by $113.1 million to
$696.7 million at September 30, 2012 from $583.6 million at September 30, 2011.
Residential real estate loans acquired as part of the First Star acquisition
were $113.7 million. Commercial real estate loans increased by $80.8 million to
$160.2 million at September 30, 2012 from $79.4 million at September 30, 2011.
Commercial and commercial real estate loans acquired from First Star were $87.3
million.

Goodwill and Deferred Income Taxes. Goodwill increased to $8.5 million at September 30, 2012 from $40,000 at September 30, 2011. For the same period, deferred income taxes increased $8.3 million to $11.3 million from $3.0 million. Both of these increases were due primarily to the acquisition of First Star Bank. Please refer to Footnote 18 of the Company's consolidated financial statements for additional details regarding the acquisition.


Other Assets. Other assets increased $16.9 million, or 130.7% to $29.8 million
at September 30, 2012 from $12.9 million at September 30, 2011. The primary
reasons for the increase were increases in accounts receivable of $6.7 million
at September 30, 2012 compared to September 30, 2011 and in the Company's
investment in low income tax credits of $5.0 million for the same period.
Accounts receivable increased primarily due to $6.0 million of brokered deposits
that the Company contracted for prior to September 30, 2012 but for which the
funds were not received until October 1, 2012. As previously disclosed, the
Company has committed approximately $8.0 to a low income housing project of
which $7.4 million had been disbursed at September 30, 2012.

Deposits. Deposits increased by $357.7 million, or 56.1%, to $995.6 million at
September 30, 2012 from $637.9 million at September 30, 2011. The Company
acquired $340.1 million of deposits as a result of the First Star merger.
Overall, the increases in deposits at September 30, 2012 compared to
September 30, 2011 included increases in non-interest bearing demand accounts of
$8.5 million or 25.4%, NOW accounts of $44.8 million or 68.9%, money market
accounts of $41.0 million or 35.8%, savings and club accounts of $29.1 million
or 39.8% and certificates of deposit of $234.3 million or 66.6%. Included in the
certificates of deposit was an increase of $36.0 million or 29.7% in brokered
certificates of deposit. The increase in brokered certificates of deposit was
the result of the Company's decision to purchase brokered certificates based on
cost compared to other available funding sources. At September 30, 2012, the
Company had $156.8 million of brokered certificates of deposit outstanding.



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Borrowed Funds. Borrowed funds, short term and other, decreased $53.7 million or
18.6% to $234.7 million at September 30, 2012 from $288.4 million at
September 30, 2011. Included in borrowed funds at September 30, 2012 were $45.0
million of repurchase agreements with various financial institution third
parties. Except for these borrowings, all borrowed funds are from the FHLB. The
decrease in borrowed funds was primarily due to the use of cheaper funding
sources to replace maturing FHLB borrowings. Additionally, as previously
announced the Company prepaid $10.0 million of longer term, higher costing
repurchase agreements and $27.0 million of FHLB borrowings during September,
2012.

Stockholders' Equity. Stockholders' equity increased by $13.7 million, or 8.5%
to $175.4 million at September 30, 2012 from $161.7 million at September 30,
2011. The primary reason for the increase was the issuance of approximately
1.2 million additional shares of ESSA Bancorp common stock as a result of the
merger with First Star. As previously disclosed, the total purchase price of the
First Star acquisition was $24.6 million. As per the merger agreement, one half
of the purchase price, or $12.3 million, was paid for with ESSA Bancorp common
stock.

Comparison of Operating Results for the Years Ended September 30, 2012 and September 30, 2011


Net Income. Net income decreased $5.0 million, or 95.9%, to $215,000 for the
fiscal year ended September 30, 2012 from $5.3 million for the fiscal year ended
September 30, 2011. The decrease was primarily due to $1.4 million in merger
related costs and $4.6 million in prepayment penalties incurred on borrowings
during the year ended September 30, 2012.

Net Interest Income. Net interest income increased by $172,000, or 0.60%, to $29.1 million for fiscal year 2012 from $28.9 million for fiscal year 2011.


Interest Income. Interest income decreased $2.0 million or 4.2% to $45.2 million
for fiscal year 2012 from $47.2 million for fiscal year 2011. The decrease
resulted from a 41 basis point decrease in the overall yield on interest earning
assets to 4.13% for fiscal year 2012 from 4.54% for fiscal year 2011 which
decreased interest income by $4.1 million. This decrease was partially offset by
a $55.2 million increase in average interest earning assets which had the effect
of increasing interest income by $2.1 million. The increase in average interest
earning assets during 2012 compared to 2011 included increases in average loans
of $34.7 million, average investments of $18.2 million and average other
interest earning assets of $6.6 million. These increases were partially offset
by decreases in average mortgage-backed securities of $2.2 million and
regulatory stock of $2.1 million. The average yield on loans decreased to 4.90%
for the fiscal year 2012, from 5.2% for the fiscal year 2011. The average yields
on investment securities decreased to 2.13% from 2.56% and the average yields on
mortgage backed securities decreased to 2.61% from 3.36% for the 2012 and 2011
periods, respectively.

Interest Expense. Interest expense decreased $2.1 million, or 11.8% to $16.1
million for fiscal year 2012 from $18.3 million for fiscal year 2011. The
decrease resulted from a 36 basis point decrease in the overall cost of
interest-bearing liabilities to 1.71% for fiscal 2012 from 2.07% for fiscal 2011
which decreased interest expense by $2.4 million. A $57.5 million increase in
average interest-bearing liabilities had the effect of increasing interest
expense by $287,000 as borrowed funds matured and were replaced by lower cost
alternatives. Average savings and club accounts increased by $9.2 million,
average NOW accounts increased $7.0 million, average money market accounts
decreased $828,000 and average certificates of deposit increased $75.5 million.
For fiscal 2012, average borrowed funds decreased $33.3 million over 2011. The
cost of money market accounts decreased to 0.28% for fiscal year 2012 from 0.47%
for fiscal year 2011. The cost of savings and club accounts decreased to 0.10%
for fiscal 2012 from 0.22% for fiscal 2011. The cost of certificates of deposit
decreased to 1.71% from 2.01% and the cost of borrowed funds decreased to 3.24%
from 3.60% for fiscal 2012 and 2011, respectively.

Provision for Loan Losses. The Company establishes provisions for loan losses,
which are charged to earnings, at a level necessary to absorb known and inherent
losses that are both probable and reasonably estimable at the date of the
financial statements. In evaluating the level of the allowance for loan losses,
management considers historical loss experience, the types of loans and the
amount of loans in the loan portfolio, adverse situations that may affect the
borrower's ability to repay, the estimated value of any underlying collateral,
peer group information and prevailing economic conditions. This evaluation is
inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available or as future events
occur. After an



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evaluation of these factors, the Company made a provision of $2.6 million for
fiscal year 2012 compared to a $2.1 million provision for the 2011 fiscal year.
The allowance for loan losses was $7.3 million or 0.76% of loans outstanding at
September 30, 2012, compared to $8.2 million, or 1.09% of loans outstanding at
September 30, 2011.

Determining the amount of the allowance for loan losses necessarily involves a
high degree of judgment. Management reviews the level of the allowance on a
quarterly basis, and establishes the provision for loan losses based on the
factors set forth in the preceding paragraph. Historically, the Bank's loan
portfolio has consisted primarily of one-to four-family residential mortgage
loans. However, our current business plan calls for increases in commercial real
estate loan originations. As management evaluates the allowance for loan losses,
the increased risk associated with larger non-homogenous commercial real estate
may result in large additions to the allowance for loan losses in future
periods. Loans secured by commercial real estate generally expose a lender to
greater risk of non-payment and loss than one-to-four family residential
mortgage loans because repayment of the loans often depends on the successful
operation of the property and the income stream of the underlying property.
Additionally, such loans typically involve larger loan balances to single
borrowers or groups of related borrowers compared to one-to-four family
residential mortgage loans. Accordingly, an adverse development with respect to
one loan or one credit relationship can expose us to greater risk of loss
compared to an adverse development with respect to a one-to-four family
residential mortgage loan.

Although we believe that we use the best information available to establish the
allowance for loan losses, future additions to the allowance may be necessary,
based on estimates that are susceptible to change as a result of changes in
economic conditions and other factors. In addition, the Federal Reserve Board,
as an integral part of its examination process, will periodically review our
allowance for loan losses. This agency may require us to recognize adjustments
to the allowance, based on its judgments about information available to it at
the time of its examination.

Non-Interest Income. Non-interest income increased $410,000 or 6.5%, to $6.7
million for the year ended September 30, 2012, from $6.3 million for the
comparable 2011 period. The increase was primarily due to increases in earnings
on bank-owned life insurance of $168,000 and insurance commissions of $387,000
which were partially offset by a decrease in the gains on the sales of loans and
investments of $156,000. Earnings on bank-owned life insurance increased during
fiscal 2012 as a result of the purchase of $7.0 million of additional bank-owned
life insurance during fiscal 2011. Insurance commissions increased in fiscal
2012 because the Company's insurance subsidiary was not purchased until the
third quarter of fiscal 2011.

Non-Interest Expense. Non-interest expense increased $7.0 million, or 26.7%, to
$33.0 million for fiscal year 2012 from $26.0 million for the comparable period
in 2011. The primary reasons for the increase were the increases in merger
related costs of $1.4 million and prepayment penalties on borrowings of $4.6
million.

Income Taxes. Income tax expense of $33,000 was recognized for fiscal year 2012
compared to an income tax expense of $1.9 million recognized for fiscal year
2011. The primary reason for the decline was the decline in income before income
taxes of $6.9 million.



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Comparison of Operating Results for the Years Ended September 30, 2011 and September 30, 2010


Net Income. Net income increased $746,000, or 16.5%, to $5.3 million for the
fiscal year ended September 30, 2011 from $4.5 million for the fiscal year ended
September 30, 2010. The increase was primarily the result of an increase in net
interest income. This increase was partially offset by a decrease in
non-interest income.

Net Interest Income. Net interest income increased by $945,000, or 3.4%, to
$28.9 million for fiscal year 2011 from $28.0 million for fiscal year 2010. The
increase was primarily attributable to an increase of 13 basis points in the
interest rate spread to 2.47% for fiscal year 2010 from 2.34% for fiscal year
2010, offset in part by a decrease in the Company's net average interest-earning
assets of $17.2 million.

Interest Income. Interest income decreased $2.1 million or 4.2% to $47.2 million
for fiscal year 2011 from $49.3 million for fiscal year 2010. The decrease
resulted from a 37 basis point decrease in the overall yield on interest earning
assets to 4.54% for fiscal year 2011 from 4.91% for fiscal year 2010 which
decreased interest income by $4.7 million. This decrease was partially offset by
a $35.4 million increase in average interest earning assets which had the effect
of increasing interest income by $2.6 million. The average balance of loans
during 2011 increased $12.2 million over the average balance during 2010, along
with decreases in the average balance of investment securities of $2.0 million
and increases in mortgage-backed securities of $24.6 million. In addition,
average FHLB stock decreased $2.1 million and the average balance of other
interest earning assets increased $2.7 million. The primary reason for the
increase in mortgage backed securities was the investment of deposit and loan
proceeds in excess of those needed to fund loan growth. As a member of the FHLB
system, the Bank maintains an investment in the capital stock of the FHLB in an
amount not less than 45 basis points of the outstanding FHLB member asset value
plus 4.6% of its outstanding FHLB borrowings, as calculated throughout the year.
On December 23, 2008, the FHLB notified its members, including the Company, that
it was suspending the payment of dividends on its capital stock and the
repurchase of excess capital stock until further notice. The FHLB began
repurchasing capital stock in February 2011. The increase in average other
interest earning assets was the result of an increase in the average balance of
interest earning deposits held by the Company in its FHLB demand account of $2.7
million. The average yield on loans decreased to 5.2% for the fiscal year 2011,
from 5.51% for the fiscal year 2010. The average yields on investment securities
decreased to 2.56% from 2.72% and the average yields on mortgage backed
securities decreased to 3.36% from 3.97% for the 2011 and 2010 periods,
respectively.

Interest Expense. Interest expense decreased $3.0 million, or 14.2% to $18.3
million for fiscal year 2011 from $21.3 million for fiscal year 2010. The
decrease resulted from a 50 basis point decrease in the overall cost of
interest-bearing liabilities to 2.07% for fiscal 2011 from 2.57% for fiscal 2010
which decreased interest expense by $2.6 million. A $52.6 million increase in
average interest-bearing liabilities had the effect of decreasing interest
expense by $466,000 as borrowed funds matured and were replaced by lower cost
alternatives. Average savings and club accounts increased by $2.2 million,
average NOW accounts increased $3.0 million, average money market accounts
increased $2.4 million and average certificates of deposit increased $139.8
million. For fiscal 2011, average borrowed funds decreased $94.7 million over
2010. The cost of money market accounts decreased to 0.47% for fiscal year 2011
from 1.07% for fiscal year 2010. The cost of certificates of deposit decreased
to 2.01% from 2.49% and the cost of borrowed funds decreased to 3.60% from 3.78%
for fiscal 2011 and 2010, respectively.

Provision for Loan Losses. The Company establishes provisions for loan losses,
which are charged to earnings, at a level necessary to absorb known and inherent
losses that are both probable and reasonably estimable at the date of the
financial statements. In evaluating the level of the allowance for loan losses,
management considers historical loss experience, the types of loans and the
amount of loans in the loan portfolio, adverse situations that may affect the
borrower's ability to repay, the estimated value of any underlying collateral,
peer group information and prevailing economic conditions. This evaluation is
inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available or as future events
occur. After an evaluation of these factors, the Company made a provision of
$2.1 million for fiscal year 2011 compared to a $2.2 million provision for the
2010 fiscal year. At September 30, 2011, the Company had 52 commercial loan
relationships whose loans were judged by management to be impaired. Of these 52
relationships, five commercial real estate relationships with combined
outstanding loans of $2.4 million had an allocation of the allowance for loan
loss amounting to $466,000. Three commercial business relationships with
combined loans of $265,000 had an allocation of the allowance for loan loss
amounting to $101,000. These specific allowance allocations were also considered
in the Company's evaluation for its provision for loan losses for the fiscal
year ended September 30, 2011. The allowance for loan losses was $8.2 million or
1.09% of loans outstanding at September 30, 2011, compared to $7.4 million, or
1.01% of loans outstanding at September 30, 2010.



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Determining the amount of the allowance for loan losses necessarily involves a
high degree of judgment. Management reviews the level of the allowance on a
quarterly basis, and establishes the provision for loan losses based on the
factors set forth in the preceding paragraph. Historically, the Bank's loan
portfolio has consisted primarily of one-to four-family residential mortgage
loans. However, our current business plan calls for increases in commercial real
estate loan originations. As management evaluates the allowance for loan losses,
the increased risk associated with larger non-homogenous commercial real estate
may result in large additions to the allowance for loan losses in future
periods. Loans secured by commercial real estate generally expose a lender to
greater risk of non-payment and loss than one-to-four family residential
mortgage loans because repayment of the loans often depends on the successful
operation of the property and the income stream of the underlying property.
Additionally, such loans typically involve larger loan balances to single
borrowers or groups of related borrowers compared to one-to-four family
residential mortgage loans. Accordingly, an adverse development with respect to
one loan or one credit relationship can expose us to greater risk of loss
compared to an adverse development with respect to a one-to-four family
residential mortgage loan.

Although we believe that we use the best information available to establish the
allowance for loan losses, future additions to the allowance may be necessary,
based on estimates that are susceptible to change as a result of changes in
economic conditions and other factors. In addition, the Federal Reserve Board,
as an integral part of its examination process, will periodically review our
allowance for loan losses. This agency may require us to recognize adjustments
to the allowance, based on its judgments about information available to it at
the time of its examination.

Non-Interest Income. Non-interest income decreased $383,000 or 5.7%, to $6.3
million for the year ended September 30, 2011, from $6.7 million for the
comparable 2010 period. The decrease was primarily due to decreases in gain on
sale of investments, net of $442,000 and gains on sales of loans net of $351,000
for fiscal 2011 compared to fiscal 2010. These decreases were offset, in part,
by an increase in insurance commissions of $361,000.

Non-Interest Expense. Non-interest expense decreased $83,000, or 0.32%, to $26.0
million for fiscal year 2011 from $26.1 million for the comparable period in
2010. The primary reason for the decrease was a decrease in loss on foreclosed
real estate of $1.2 million. This decrease was offset, in part, by increases in
compensation and employee benefits of $884,000 and amortization of intangible
assets of $135,000. The increase in compensation and employee benefits primarily
related to new branches opened during the second and third quarters of 2010. The
increase in amortization expense was due to the purchase of a benefits
consulting business in the third quarter of 2011.

Income Taxes. Income tax expense of $1.9 million was recognized for fiscal year
2011 compared to an income tax expense of $1.8 million recognized for fiscal
year 2010. The effective tax rate was 26.2% for the year ended September 30,
2011, compared to 29.0% for the 2010 period.



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Average Balances and Yields. The following table sets forth average balance
sheets, average yields and costs, and certain other information for the periods
indicated. All average balances are monthly average balances. The yields set
forth below include the effect of deferred fees and discounts and premiums that
are amortized or accreted to interest income.



                                                                                        For the Years Ended September 30,
                                                         2012                                         2011                                         2010
                                                         Interest                                     Interest                                     Interest
                                          Average         Income/       Yield/         Average         Income/       Yield/         Average         Income/       Yield/
                                          Balance         Expense        Cost          Balance         Expense        Cost          Balance         Expense        Cost
                                                                                             (Dollars in thousands)

Interest-earning assets:
Loans(1) (2)                            $   783,444      $  38,384         4.90 %    $   748,765      $  38,949         5.20 %    $   736,540      $  40,598         5.51 %
Investment securities
Taxable(3)                                   58,643          1,116         1.90 %         43,629            869         1.99 %         44,148            916         2.07 %
Exempt from federal income tax(3) (4)         8,731            209         3.63 %          5,516            258         7.09 %          7,025            315         6.79 %

Total investment securities                  67,374          1,325         2.13 %         49,145          1,127         2.56 %         51,173          1,231         2.72 %
Mortgage-backed securities                  209,161          5,467         2.61 %        211,382          7,095         3.36 %        186,748          7,421         3.97 %
Regulatory stock                             16,521             -          0.00 %         18,626             -          0.00 %         20,727             -          0.00 %
Other                                        19,917             24         0.12 %         13,315              5         0.04 %         10,633              7         0.07 %

Total interest-earning assets             1,096,417         45,200         4.13 %      1,041,233         47,176         4.54 %      1,005,821         49,257         4.91 %
Allowance for loan losses                    (7,899 )                                     (7,967 )                                     (6,547 )
Noninterest-earning assets                   69,458                                       58,031                                       50,609

Total assets                            $ 1,157,976                                  $ 1,091,297                                  $ 1,049,883


Interest-bearing liabilities:
NOW accounts                            $    65,747             25         0.04 %    $    58,795             25         0.04 %    $    55,796             42         0.08 %
Money market accounts                       117,118            327         0.28 %        117,946            552         0.47 %        115,545          1,235         1.07 %
Savings and club accounts                    78,943             80         0.10 %         69,732            156         0.22 %         67,549            213         0.32 %
Certificates of deposit                     412,207          7,054         1.71 %        336,668          6,754         2.01 %        196,863          4,896         2.49 %
Borrowed funds                              266,691          8,646         3.24 %        300,024         10,793         3.60 %        394,772         14,920         3.78 %

Total interest-bearing liabilities 940,706 16,132 1.71 % 883,165 18,280 2.07 % 830,525 21,306 2.57 % Non-interest bearing demand accounts 37,064

              30,236                                       27,703
Noninterest-bearing liabilities              14,618                                       11,280                                       10,473

Total liabilities                           992,388                                      924,681                                      868,701
Equity                                      165,588                                      166,616                                      181,182

Total liabilities and equity            $ 1,157,976                                  $ 1,091,297                                  $ 1,049,883


Net interest income                                      $  29,068                                    $  28,896                                    $  27,951

Interest rate spread                                                       2.42 %                                       2.47 %                                       2.34 %
Net interest-earning assets             $   155,711                                  $   158,068                                  $   175,296

Net interest margin(5)                                                     2.65 %                                       2.78 %                                       2.78 %
Average interest-earning assets to
average interest-bearing liabilities                        116.55 %                                     117.90 %                                     121.11 %



(1) Non-accruing loans are included in the outstanding loan balances.

(2) Interest income on loans includes net amortized revenues (costs) on loans

totaling $1,000 in 2012, $35,000 for 2011, and $95,000 for 2010.

(3) Held to maturity securities are reported as amortized cost. Available for

sale securities are reported at fair value.

(4) Yields on tax exempt securities have been calculated on a fully tax

equivalent basis assuming a tax rate of 34%.

(5) Represents the difference between interest earned and interest paid, divided

    by average total interest earning assets.




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Rate/Volume Analysis


The following table presents the effects of changing rates and volumes on our
net interest income for the years indicated. The rate column shows the effects
attributable to changes in rate (changes in rate multiplied by prior volume).
The volume column shows the effects attributable to changes in volume (changes
in volume multiplied by prior rate). The net column represents the sum of the
prior columns. For purposes of this table, changes attributable to both rate and
volume, which cannot be segregated, have been allocated proportionately based on
the changes due to rate and the changes due to volume.



                                                      For the                                     For the
                                             Years Ended  September 30,                  Years Ended  September 30,
                                                   2012 vs. 2011                               2011 vs. 2010
                                         Increase (Decrease)                         Increase (Decrease)
                                                Due to                                      Due to
                                         Volume          Rate          Net           Volume          Rate          Net
                                                                         (In thousands)

Interest-earning assets:
Loans                                  $    1,754      $ (2,319 )    $   

(565 ) $ 690 $ (2,339 ) $ (1,649 ) Investment securities

                         470          (272 )         198             (83 )         (21 )        (104 )
Mortgage-backed securities                    (77 )      (1,551 )      

(1,628 ) 1,978 (2,304 ) (326 ) Other

                                           1            18            19               2            (4 )          (2 )

Total interest-earning assets               2,148        (4,124 )      

(1,976 ) 2,587 (4,668 ) (2,081 )


Interest-bearing liabilities:
NOW accounts                                   -             -             -               (2 )         (15 )         (17 )
Money market accounts                          (4 )        (221 )        (225 )            25          (708 )        (683 )
Savings and club accounts                      24          (100 )         (76 )             7           (64 )         (57 )
Certificates of deposit                     1,397        (1,097 )         300           2,948        (1,090 )       1,858
Borrowed funds                             (1,130 )      (1,017 )      (2,147 )        (3,444 )        (683 )      (4,127 )

Total interest-bearing liabilities            287        (2,435 )      

(2,148 ) (466 ) (2,560 ) (3,026 )

Net change in interest income $ 1,861 $ (1,689 ) $ 172$ 3,053 $ (2,108 ) $ 945

Management of Market Risk


General. The majority of our assets and liabilities are monetary in nature.
Consequently, our most significant form of market risk is interest rate risk.
Our assets, consisting primarily of mortgage loans, have longer maturities than
our liabilities, consisting primarily of deposits and borrowings. As a result, a
principal part of our business strategy is to manage interest rate risk and
reduce the exposure of our net interest income to changes in market interest
rates. Accordingly, our Board of Directors has approved guidelines for managing
the interest rate risk inherent in our assets and liabilities, given our
business strategy, operating environment, capital, liquidity and performance
objectives. Senior management monitors the level of interest rate risk on a
regular basis and the asset/liability committee meets quarterly to review our
asset/liability policies and interest rate risk position. We have sought to
manage our interest rate risk in order to minimize the exposure of our earnings
and capital to changes in interest rates.

Net interest income, which is the primary source of the Company's earnings, is
impacted by changes in interest rates and the relationship of different interest
rates. To manage the impact of the rate changes, the balance sheet should be
structured so that repricing opportunities exist for both assets and liabilities
at approximately the same time intervals. The Company uses net interest
simulation to assist in interest rate risk management. The process includes
simulating various interest rate environments and their impact on net interest
income. As of September 30, 2012, the level of net interest income at risk in a
200 basis points increase was within the Company's policy limit of a decline
less than 10% of net interest income. Due to the inability to reduce many
deposit rates by the full 200 basis points, the Company's net interest income at
risk in a 100 basis point decline was within the Company's policy limit of a
decline of less than 10% of net interest income.



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Liquidity and Capital Resources


We maintain liquid assets at levels we consider adequate to meet both our
short-term and long-term liquidity needs. We adjust our liquidity levels to fund
deposit outflows, repay our borrowings and to fund loan commitments. We also
adjust liquidity as appropriate to meet asset and liability management
objectives.

Our primary sources of liquidity are deposits, amortization and prepayment of
loans and mortgage-backed securities, maturities of investment securities and
other short-term investments, and earnings and funds provided from operations,
as well as access to FHLB advances and other borrowings. While scheduled
principal repayments on loans and mortgage-backed securities are a relatively
predictable source of funds, deposit flows and loan prepayments are greatly
influenced by market interest rates, economic conditions, and rates offered by
our competition. We set the interest rates on our deposits to maintain a desired
level of total deposits.

A portion of our liquidity consists of cash and cash equivalents and borrowings,
which are a product of our operating, investing and financing activities. At
September 30, 2012, $15.6 million of our assets were invested in cash and cash
equivalents. Our primary sources of cash are principal repayments on loans,
proceeds from the maturities of investment securities, principal repayments of
mortgage-backed securities and increases in deposit accounts. Short-term
investment securities (maturing in one year or less) totaled $3.5 million at
September 30, 2012. As of September 30, 2012, we had $189.7 million in
borrowings outstanding from the FHLB-Pittsburgh and $45.0 million in repurchase
agreements. We have access to FHLB advances of up to approximately $577 million.

At September 30, 2012, we had $63.5 million in loan commitments outstanding,
which included $5.6 million in undisbursed construction loans, $32.6 million in
unused home equity lines of credit and $6.2 million in commercial lines of
credit. Certificates of deposit due within one year of September 30, 2012
totaled $270.3 million, or 46.1% of certificates of deposit. If these maturing
deposits do not remain with us, we will be required to seek other sources of
funds, including other certificates of deposit and borrowings. Depending on
market conditions, we may be required to pay higher rates on such deposits or
other borrowings than we currently pay on the certificates of deposit due on or
before September 30, 2012. We believe, however, based on past experience that a
significant portion of our certificates of deposit will remain with us. We have
the ability to attract and retain deposits by adjusting the interest rates
offered.

As reported in the Consolidated Statements of Cash Flows, our cash flows are
classified for financial reporting purposes as operating, investing or financing
cash flows. Net cash provided by operating activities was $5.3 million, $10.2
million and $7.4 million for the years ended September 30, 2012, 2011 and 2010,
respectively. These amounts differ from our net income because of a variety of
cash receipts and disbursements that did not affect net income for the
respective periods. Net cash provided by/(used) in investing activities was
$75.4 million, $4.1 million and $(38.7) million in fiscal years 2012, 2011 and
2010, respectively, principally reflecting our loan and investment security
activities in the respective periods along with our acquisition of First Star
Bank in 2012. Investment security cash flows had the most significant effect, as
net cash utilized in purchases amounted to $92.0 million, $96.8 million and
$143.0 million in the years ended September 30, 2012, 2011 and 2010,
respectively. Cash proceeds from principal repayments, maturities and sales of
investment securities amounted to $117.5 million, $120.9 million and $112.0
million in the years ended September 30, 2012, 2011 and 2010, respectively.
Deposit and borrowing cash flows have traditionally comprised most of our
financing activities which resulted in net cash (used)/provided of $(106.9)
million in fiscal year 2012, $16.5 million in fiscal year 2011 and $23.6 million
in fiscal year 2010. In addition, during fiscal 2011 we used $16.9 million and
in fiscal 2010 we used $17.0 million to repurchase our stock as part of
previously disclosed stock repurchase plans.



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The following table summarizes our significant fixed and determinable contractual principal obligations and other funding needs by payment date at September 30, 2012. The payment amounts represent those amounts due to the recipient and do not include any unamortized premiums or discounts or other similar carrying amount adjustments.



                                                                        Payments Due by Period
                                           Less than       One to Three       Three to Five       More than
Contractual Obligations                    One  Year          Years               Years           Five Years        Total
                                                                            (In thousands)

Long-term debt                             $  130,281     $       42,010     $        46,550     $     15,900     $ 234,741
Operating leases                                  575              1,018                 718            1,350         3,661
Certificates of deposit                       270,280            209,239              94,435           12,181       586,135

Total                                      $  401,136     $      252,267     $       141,703     $     29,431     $ 824,537

Commitments to extend credit               $   24,705     $           -      $            -      $     38,750     $  63,455



We also have obligations under our post retirement plan as described in note 14
to the Consolidated Financial Statements. The post retirement benefit payments
represent actuarially determined future payments to eligible plan participants.
We expect to contribute $600,000 to our post retirement plan in 2013.

Off-Balance Sheet Arrangements. In the normal course of operations, we engage in
a variety of financial transactions that, in accordance with generally accepted
accounting principles are not recorded in our financial statements. These
transactions involve, to varying degrees, elements of credit, interest rate and
liquidity risk. Such transactions are used primarily to manage customers'
requests for funding and take the form of loan commitments and lines of credit.
For information about our loan commitments, letters of credit and unused lines
of credit, see note 12 of the notes to the Consolidated Financial Statements.

For fiscal year 2012, we did not engage in any off-balance-sheet transactions
other than loan origination commitments and standby letters of credit in the
normal course of our lending activities.

Impact of Inflation and Changing Prices


The financial statements and related notes of ESSA Bancorp, Inc. have been
prepared in accordance with United States generally accepted accounting
principles ("GAAP"). GAAP generally requires the measurement of financial
position and operating results in terms of historical dollars without
consideration for changes in the relative purchasing power of money over time
due to inflation. The impact of inflation is reflected in the increased cost of
our operations. Unlike industrial companies, our assets and liabilities are
primarily monetary in nature. As a result, changes in market interest rates have
a greater impact on performance than the effects of inflation.



Item 7A. Quantitative and Qualitative Disclosures About Market Risk

For information regarding market risk, see "Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operation."

Wordcount: 7380



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