Summary of COLONIAL FINANCIAL SERVICES, INC.

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

Forward-Looking Statements

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about anticipated operating and financial performance, such as loan originations, operating efficiencies, loan sales, charge-offs and loan loss provision, growth opportunities, interest rates and deposit growth. Words such as "may," "could," "should," "would," "will," "will likely result," "believe," "expect," "plan," "will continue," "is anticipated," "estimate," "intend," "project," and similar expressions are intended to identify these forward-looking statements. We wish to caution readers not to place undue reliance on any such forward-looking statements, each of which speaks only as of the date made. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings than those presently anticipated or projected.

Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U. S. Government, including policies of the U. S. Treasury and the Federal Reserve Board, the quality and composition of our loan or investment portfolios, demand for our loan products, deposit flows, competition, demand for financial services in our market area, changes in real estate values in our area, and changes in relevant accounting principles and guidelines. Additional factors that could affect our results may be discussed in our Form 10-K under Part I, Item 1A-"Risk Factors" in other reports filed with the Securities and Exchange Commission.

Critical Accounting Policies

Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. Our critical accounting policies are those related to our allowance for loan losses, the evaluation of other-than-temporary impairment of investments securities, the valuation of and our ability to realize deferred tax assets and the measurement of fair value.

Allowance for Loan Losses. The allowance for loan losses is calculated with the objective of maintaining an allowance sufficient to absorb estimated probable loan losses inherent in the loan portfolio. Management's determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of collateral.

We have established a systematic method of periodically reviewing the credit quality of the loan portfolio in order to establish the allowance for loan losses. The allowance for loan losses is based on our current judgments about the credit quality of individual loans and segments of the loan portfolio. The allowance for loan losses is established through a provision for loan losses based on our evaluation of the losses inherent in the loan portfolio, and considers all known internal and external factors that affect loan collectability as of the reporting date.

The allowance for loan losses consists of specific, general and unallocated components. 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 allowance for losses on loans is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience, delinquency trends and management's evaluation of the collectability of the loan portfolio. The allowance is adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors may include changes in our lending policies and procedures, changes in current general economic conditions and business conditions affecting our primary lending areas, credit quality trends, collateral values, loans volumes and concentrations, seasoning of the loan portfolio, loss experience, and duration of the current business cycle. The applied loss factors are re-evaluated each reporting period to ensure their relevance in the current economic environment.

The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Future provisions for loan losses may include an unallocated component as we re-evaluate our estimates including, but not limited to changes in economic conditions in our market area, declines in local property values and concentrations of risk. Included in our estimate and evaluation is an analysis of our mortgage loans, both current and delinquent, that may have private mortgage insurance. With the recent downgrades of insurance companies, this is another factor management will review as it assesses its allowance for loan losses.

Management believes this is a critical accounting policy because this evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters. Historically, we believe our estimates and assumptions have proven to be relatively accurate. Nevertheless, because a small number of non-performing loans could result in net charge-offs significantly in excess of the estimated losses inherent in our loan portfolio, additional provisions to the allowance for loan losses may be required that would adversely impact earnings for future periods.

Other-Than-Temporary Impairment. Investment securities are evaluated on at least a quarterly basis, to determine whether a decline in their value is other-than-temporary. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether or not we intend to sell or expect that it is more likely than not that we will be required to sell the investment security prior to an anticipated recovery in fair value. Once a decline in value for a debt security is determined to be other than temporary, the other-than-temporary impairment is separated in (a) the amount of total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to credit loss is recognized in earnings. The amount of other-than-temporary impairment related to other factors is recognized in other comprehensive income (loss). For equity securities, the full amount of the other-than-temporary impairment is recognized in earnings.

Management's determination of whether FHLB stock is impaired is based on our assessment of the ultimate recoverability of the cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of the cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted,
(2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB. Management believes no impairment is necessary related to the FHLB stock at March 31, 2012.

Valuation of Deferred Tax Assets. In evaluating our ability to realize deferred tax assets, management considers all positive and negative information, including our past operating results and our forecast of future taxable income. In determining future taxable income, management utilizes a budget process that makes business assumptions and the implementation of feasible and prudent tax planning strategies. These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets which would result in additional income tax expense in the period.

Fair Value Measurements. The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. We estimate the fair value of financial instruments using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value. When observable market prices do not exist, we estimate fair value. Other factors such as model assumptions and market dislocations can affect estimates of fair value. Differences in the fair value and carrying value of certain financial instruments (including changes in the differences between the fair value and the carrying value from period to period), such as loans, securities held to maturity, deposits and borrowings do not affect our reported financial condition or results of operations, as such financial instruments are carried at cost.

Comparison of Financial Condition at March 31, 2012 and December 31, 2011

Total assets increased $35.1 million, or 5.8%, to $638.9 million at March 31, 2012, from $603.8 million at December 31, 2011. The increase was mainly the result of increases in cash and cash equivalents and investment securities available-for-sale offset by decreases in investment securities held-to-maturity and loans receivable.

Net loans receivable decreased $3.3 million, or 1.1%, to $294.3 million at March 31, 2012 from $297.6 million at December 31, 2011. Commercial real estate loans decreased $1.8 million to $100.3 million at March 31, 2012 from $102.1 million at December 31, 2011. Construction loans decreased $164,000 to $4.0 million at March 31, 2012 from $4.1 million at December 31, 2011. One- to four-family residential real estate loans decreased $491,000 to $140.1 million at March 31, 2012 from $140.6 million at December 31, 2011. Home equity loans and lines of credit decreased $1.5 million to $31.1 million at March 31, 2012 from $32.6 million at December 31, 2011. Commercial loans decreased by $1.5 million to $20.4 million at March 31, 2012 from $21.9 million at December 31, 2011. We currently have an internal limit for our loans (other than one- to four-family residential real estate loans) which is 275% of the sum of core capital (generally common stockholders' equity including retained earnings and minority interest in equity accounts of consolidated subsidiaries, less certain intangible assets) plus our allowance for loan losses. Included in the net loans receivable are nonaccrual loans which decreased to $5.9 million at March 31, 2012 from $6.2 million at December 31, 2011.

Real estate owned totaled $3.2 million and $3.1 million at March 31, 2012 and December 31, 2011, respectively. We completed the foreclosure process on three properties, one of which was a nonresidential property and two of which were residential one- to four-family properties and we sold two residential one- to four-family properties.

Securities available-for-sale increased $15.3 million, or 6.7%, to $243.8 million at March 31, 2012 from $228.5 at December 31, 2011. This increase was the result of purchases in the amount of $51.5 million offset by calls, maturities and sales in the amount of $24.0 million, $11.4 in principal amortization and a market value decrease of $807,000. Securities held-to-maturity decreased by $1.2 million, to $36.8 million at March 31, 2012 from $38.0 million at December 31, 2011. This decrease was the result of calls and maturities in the amount of $1.4 million and principal amortization of $59,000 offset by purchases in the amount of $290,000.

Deposits increased $43.2 million, or 8.3%, to $563.9 million at March 31, 2012 from $520.7 million at December 31, 2011. NOW accounts increased $21.0 million, or 15.9%, to $152.9 million at March 31, 2012 from $131.9 million at December 31, 2011. Savings accounts increased $3.7 million to $108.7 million at March 31, 2012 from $105.0 million at December 31, 2011. Super NOW accounts increased by $2.2 million to $41.4 million at March 31, 2012 from $39.2 million at December 31, 2011. Non-interest bearing demand accounts increased by $19.8 million to $45.7 million at March 31, 2012 from $25.9 million at December 31, 2011. Certificates of deposit decreased by $276,000 to $147.3 million at March 31, 2012 from $147.6 million at December 31, 2011. We did not aggressively price our certificates of deposit upon maturity, but some certificate of deposit customers remained with us by opening other types of deposit accounts.

Federal Home Loan Bank borrowings totaled $2.0 million at March 31, 2012 and $10.0 million at December 31, 2011.

Total stockholders' equity decreased $157,000 to $71.5 million at March 31, 2012 from $71.7 million at December 31, 2011. This decrease was mainly attributable to a decrease in the accumulated other comprehensive income of $513,000 offset by net income of $248,000.

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

General. Net income decreased $567,000 to $248,000 for the three months ended March 31, 2012 from $815,000 for the three months ended March 31, 2011. The principal reasons for the decrease in net income was a reduction in net interest income of $48,000, an increase in the provision for loan losses of $932,000 offset by a decrease in non-interest expense of $43,000, a decrease in income tax expense of $241,000 and an increase in non-interest income of $129,000.

Interest Income. Interest income decreased $505,000 for the three months ended March 31, 2012 from the three months ended March 31, 2011. The decrease in interest income resulted from a decrease of $427,000 in interest income on loans and a decrease of $78,000 in interest income on securities.

Interest income on loans decreased $427,000 to $4.1 million for the three months ended March 31, 2012 from $4.5 million for the three months ended March 31, 2011. The average balance of loans decreased $21.0 million to $296.8 million for the three months ended March 31, 2012 from $317.8 million for the three months ended March 31, 2011 and the average yield decreased to 5.49% for the three months ended March 31, 2012 from 5.66% for the three months ended March 31, 2011.

Interest income on securities decreased by $78,000 to $1.5 million for the three months ended March 31, 2012 from $1.6 million for the three months ended March 31, 2011. The decrease in interest income on securities was due to a decrease in the average yield on taxable and tax-exempt securities of 48 basis points to 2.30% for the three months ended March 31, 2012 from 2.78% for the three months ended March 31, 2011, offset by an increase in the average balance of taxable and tax-exempt securities to $262.3 million for the three months ended March 31, 2012 from $228.2 million for the three months ended March 31, 2011. The yields on tax-exempt securities are not tax-affected.

Interest Expense. Interest expense decreased $457,000 to $1.5 million for the three months ended March 31, 2012 from $1.9 million for the three months ended March 31, 2011.

Interest expense on interest-bearing deposits decreased by $420,000 to $1.5 million for the three months ended March 31, 2012 from $1.9 million for the three months ended March 31, 2011. The decrease in interest expense on interest-bearing deposits was due to a decrease in the average rate paid on interest-bearing deposits to 1.15% for the three months ended March 31, 2012 from 1.55% for the three months ended March 31, 2011, offset by an increase in the average balance of interest-bearing deposits to $504.2 million for the three months ended March 31, 2012 from $482.9 million for the three months ended March 31, 2011. We experienced increases in the average balances of savings accounts, money market deposit accounts, NOW and Super-NOW accounts. We experienced decreases in the average cost across all categories of interest-bearing deposits, except NOW accounts, for the three months ended March 31, 2012, reflecting lower market rates.

Interest expense on borrowings decreased $37,000 to $11,000 for the three months ended March 31, 2012 from $48,000 for the three months ended March 31, 2011. This decrease was primarily due to a $4.1 million decrease in the average balance of borrowings to $2.9 million for the three months ended March 31, 2012 from $7.0 million for the three months ended March 31, 2011 and a decrease in the average rate paid on borrowings to 1.52% for the three months ended March 31, 2012 from 2.74% for the three months ended March 31, 2011. We have decreased our outstanding borrowings because our net increase in deposits and the proceeds received from the sales, calls, maturities and amortization of securities, discussed above, exceeded our cash needs to fund loan originations and investment securities purchases.

Provision for Loan Losses. We establish provisions for loan losses, which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb probable credit losses inherent in the loan portfolio. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluation of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower's ability to repay a loan and the levels of nonperforming and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or later events change. We assess the allowance for loan losses on a quarterly basis and make provisions for loan losses in order to maintain the allowance.

During the three months ended March 31, 2012, the Company charged off $3.4 million in loans which includes $2.6 million in specific valuation allowances that were established in earlier quarters and approximately $800,000 in additional loans charged-off during this quarter. The increased write-offs during this quarter had an effect of increasing our provision charged to operations as we utilize our historical loss experience in our allowance for loan loss calculation.

Based on our evaluation of the above factors, we recorded a provision for loan losses of $1.2 million for the three months ended March 31, 2012 and a provision for loan losses of $316,000 for the three months ended March 31, 2011. The allowance for loan losses was $2.9 million, or 0.96% of total loans, at March 31, 2012, compared to $3.8 million, or 1.18% of total loans, at March 31, 2011. Our balance of loans we evaluated individually for impairment was $24.1 million at March 31, 2012 and $30.1 million at December 31, 2011, although we provided specific allowances on loans with principal balances of $1.3 million as of March 31, 2012 and $11.4 million as of December 31, 2011. At March 31, 2012 and 2011, we maintained unallocated allowances for loan losses of $500,000.

To the best of our knowledge, we have recorded all losses that are both probable and reasonable to estimate at March 31, 2012 and 2011. However, future changes in the factors described above, including, but not limited to, actual loss experience with respect to our loan portfolio (including residential and commercial real estate loans) could result in material increases in our provisions for loan losses.

Non-interest Income. Non-interest income was $546,000 for the three months ended March 31, 2012 and $417,000 for the three months ended March 31, 2011. Fees and service charges on deposit accounts increased by $13,000 to $291,000 for the three months ended March 31, 2012 from $278,000 for the three months ended March 31, 2011. Gains on the sale of loans totaled $31,000 for the three months ended March 31, 2011 and we had no such gains on loans during the three months ended March 31, 2012. For the three months ended March 31, 2012, there was a net gain on the sale and call of investment securities in the amount of $166,000 compared to a net gain of $22,000 for the three months ended March 31, 2011. Earnings on life insurance increased by $1,000 to $86,000 for the three months ended March 31, 2012 from $85,000 for the three months ended March 31, 2011.

Non-interest Expense. Non-interest expense decreased $43,000 to $3.1 million for the three months ended March 31, 2012 from $3.1 million for the three months ended March 31, 2011. Compensation and benefits expense increased by $80,000 to $1.7 million for the three months ended March 31, 2012 from $1.6 million for the three months ended March 31, 2011. Occupancy and equipment expense decreased $37,000 to $376,000 for the three months ended March 31, 2012 from $413,000 for the three months ended March 31, 2011. This decrease is mainly due to a reduction in repairs and maintenance on Company assets. Federal deposit insurance premiums decreased $130,000 to $110,000 for the three months ended March 31, 2012 from $240,000 for the three months ended March 31, 2011. Data processing fees decreased by $63,000 to $198,000 for the three months ended March 31, 2012 from $261,000 for the three months ended March 31, 2011. This reduction is due to a change in processors for some of the services offered by us. Professional fees increased $28,000 mainly due to an increase in legal fees due to increased collection efforts on loans.

Income Tax Expense. We recorded income tax expense of $78,000 for the three months ended March 31, 2012, compared to $319,000 for the three months ended March 31, 2011. Our effective tax rates for the three months ended March 31, 2012 and 2011 were 23.9% and 28.1%, respectively. The reason for the decrease in the percentage noted above is due to the increase in the percentage of tax-exempt income to net income for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011.

Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments and maturities and sales of securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short- and intermediate-term securities.

Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At March 31, 2012, cash and cash equivalents totaled $31.6 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $243.8 million at March 31, 2012. In addition, at March 31, 2012, we had the ability to borrow a total of $319.5 million from the Federal Home Loan Bank of New York (50% of our assets at that date with FHLB-NY Board of Directors approval). On that date, we had $2.0 million in advances outstanding.

At March 31, 2012, loan commitments outstanding totaled $4.9 million. In addition to commitments to originate loans, we had $15.0 million in unadvanced funds to borrowers. We had commitments to purchase securities in the amount of $4.0 million at March 31, 2012. Total certificates of deposit due within one year of March 31, 2012 totaled $82.9 million. Total certificates of deposit due within one year of March 31, 2012 represent 14.7% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and Federal Home Loan Bank advances. 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 March 31, 2013. We believe 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.

We have no material commitments or demands that are likely to affect our liquidity other than set forth above. In the event loan demand were to increase at a pace greater than expected, or any unforeseen demand or commitment were to occur, we could access our borrowing capacity with the Federal Home Loan Bank of New York or increase deposit rates to attract additional deposits.

Our primary investing activities are the origination of loans and the purchase of securities. For the three months ended March 31, 2012, we originated $9.6 million of loans and purchased $51.8 million of securities. For the three months ended March 31, 2011, we originated $12.7 million of loans and purchased $39.4 million of securities.

Financing activities consist primarily of activity in deposit accounts and Federal Home Loan Bank advances. We experienced net increases in total deposits of $43.2 million and $10.4 million for the three months ended March 31, 2012 and 2011, respectively. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors . . .