---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



---

FORM 10-Q



---



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

For the quarterly period ended March 31, 2006

OR



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

For the transition period from  to

Commission File Number 00-50347



---

JEFFERSON BANCSHARES, INC.

(Exact name of registrant as specified in its charter)



---



|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Tennessee                                                      |  | 45-0508261                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)
|                                                               | 
|120 Evans Avenue, Morristown, Tennessee                        |  | 37814                                  
|(Address of principal executive offices)                       |  | (Zip code)                             

(423) 586-8421

(Registrants telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)



---

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

Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated filer ̈Accelerated
filer  x            Non-accelerated filer ̈

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

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

At May 10, 2006, the registrant had 6,693,317 shares of common stock, $0.01 par value per share, outstanding.



---



---

INDEX



|           |  |                                                                                                                  |  |     
|---------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                                  |  | Page
|           |  | Part I. FINANCIAL INFORMATION                                                                                    |  |     
|Item 1.    |  | Financial Statements                                                                                             |  |     
|           |  |                                                                                                                 
|           |  | Consolidated Statements of Condition - Unaudited Nine months ended March 31, 2006 and year ended June 30, 2005   |  | 3   
|           |  |                                                                                                                 
|           |  | Consolidated Statements of Earnings - Unaudited Three and nine months ended March 31, 2006 and 2005              |  | 4   
|           |  |                                                                                                                 
|           |  | Consolidated Statements of Changes in Stockholders Equity - Unaudited Nine months ended March 31, 2006 and 2005 |  | 5   
|           |  |                                                                                                                 
|           |  | Consolidated Statements of Cash Flows - Unaudited Nine months ended March 31, 2006 and 2005                      |  | 6   
|           |  |                                                                                                                 
|           |  | Notes to Consolidated Financial Statements - Unaudited                                                           |  | 7   
|           |  |                                                                                                                 
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 11  
|           |  |                                                                                                                 
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                                       |  | 27  
|           |  |                                                                                                                 
|Item 4.    |  | Controls and Procedures                                                                                          |  | 27  
|           |  |                                                                                                                 
|           |  | Part II. OTHER INFORMATION                                                                                       |  |     
|           |  |                                                                                                                 
|Item 1.    |  | Legal Proceedings                                                                                                |  | 28  
|Item 1A.   |  | Risk Factors                                                                                                     |  | 28  
|Item 2.    |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                      |  | 29  
|Item 3.    |  | Defaults Upon Senior Securities                                                                                  |  | 29  
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                              |  | 29  
|Item 5.    |  | Other Information                                                                                                |  | 30  
|Item 6.    |  | Exhibits                                                                                                         |  | 30  
|           | 
|SIGNATURES |  |                                                                                                                 



2



---

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Condition

(Dollars in thousands)



|                                                                                                                            |  |               |         |   |              |   |         |  
|--------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | - | ------------ | - | ------- | -
|                                                                                                                            |  | March 31,2006 |         |   | June 30,2005 |  
|                                                                                                                            |  | (Unaudited)   |         |   |              |  
|Assets                                                                                                                      |  |               |         |   |              |   |         |  
|                                                                                                                            |  |              
|Cash and cash equivalents                                                                                                   |  | $             | 3,228   |   |              | $ | 3,799   |  
|Interest-earning deposits                                                                                                   |  |               | 5,531   |   |              |   | 7,228   |  
|Investment securities classified as available-for-sale, net                                                                 |  |               | 39,902  |   |              |   | 53,366  |  
|Federal Home Loan Bank stock                                                                                                |  |               | 1,720   |   |              |   | 1,652   |  
|Bank owned life insurance                                                                                                   |  |               | 5,440   |   |              |   | 5,285   |  
|Loans receivable, net of allowance for loan losses of $2,191 and $2,293                                                     |  |               | 240,860 |   |              |   | 208,438 |  
|Loans held-for-sale                                                                                                         |  |               | 1,105   |   |              |   | 3,137   |  
|Premises and equipment, net                                                                                                 |  |               | 10,280  |   |              |   | 7,073   |  
|Foreclosed real estate, net                                                                                                 |  |               | 161     |   |              |   | 914     |  
|Accrued interest receivable:                                                                                                |  |               |         |   |              |   |         |  
|Investments                                                                                                                 |  |               | 267     |   |              |   | 489     |  
|Loans receivable                                                                                                            |  |               | 1,287   |   |              |   | 1,059   |  
|Deferred tax asset                                                                                                          |  |               | 1,898   |   |              |   | 1,878   |  
|Other assets                                                                                                                |  |               | 682     |   |              |   | 723     |  
|                                                                                                                            |  |               |         |   |              |   |         |  
|Total assets                                                                                                                |  | $             | 312,361 |   |              | $ | 295,041 |  
|                                                                                                                            |  |               |         |   |              |   |         |  
|Liabilities and Stockholders Equity                                                                                        |  |               |         |   |              |   |         |  
|                                                                                                                            |  |              
|Deposits                                                                                                                    |  |               |         |   |              |   |         |  
|Noninterest-bearing                                                                                                         |  | $             | 10,340  |   |              | $ | 9,973   |  
|Interest-bearing                                                                                                            |  |               | 186,539 |   |              |   | 184,733 |  
|Federal Home Loan Bank advances                                                                                             |  |               | 39,000  |   |              |   | 17,000  |  
|Other liabilities                                                                                                           |  |               | 988     |   |              |   | 1,307   |  
|                                                                                                                            |  |               |         |   |              |   |         |  
|Total liabilities                                                                                                           |  |               | 236,867 |   |              |   | 213,013 |  
|                                                                                                                            |  |               |         |   |              |   |         |  
|Commitments and contingent liabilities                                                                                      |  |               |        |   |              |   |        |  
|                                                                                                                            |  |              
|Stockholders equity:                                                                                                       |  |               |         |   |              |   |         |  
|Preferred stock, $.01 par value; 10,000,000 shares authorized; no shares issued or outstanding                              |  |               |        |   |              |   |        |  
|Common stock, $.01 par value; 30,000,000 shares authorized; 8,385,517 shares issued and 6,694,917 and 7,289,284 outstanding |  |               | 84      |   |              |   | 84      |  
|Additional paid-in capital                                                                                                  |  |               | 72,071  |   |              |   | 71,694  |  
|Unearned ESOP shares                                                                                                        |  |               | (5,509  | ) |              |   | (5,833  | )
|Unearned compensation                                                                                                       |  |               | (2,873  | ) |              |   | (3,232  | )
|Accumulated other comprehensive income                                                                                      |  |               | (558    | ) |              |   | (155    | )
|Retained earnings                                                                                                           |  |               | 34,952  |   |              |   | 34,069  |  
|Treasury stock, at cost; 1,711,731 and 1,105,832 shares                                                                     |  |               | (22,673 | ) |              |   | (14,599 | )
|                                                                                                                            |  |               |         |   |              |   |         |  
|Total stockholders equity                                                                                                  |  |               | 75,494  |   |              |   | 82,028  |  
|                                                                                                                            |  |               |         |   |              |   |         |  
|Total liabilities and stockholders equity                                                                                  |  | $             | 312,361 |   |              | $ | 295,041 |  
|                                                                                                                            |  |               |         |   |              |   |         |  

See accompanying notes to financial statements



3



---

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Earnings (Unaudited)

(Dollars in Thousands, Except Net Earnings Per Share)



|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|--------------------------------------------------- |  | --------------------------- | ----- | - | -------------------------- | - | ----- | ---- |  | - | ------ | - |  | - | ------ | -
|                                                    |  | Three Months EndedMarch 31, |       |   | Nine Months EndedMarch 31, |  
|                                                    |  | 2006                        |       |   | 2005                       |   |       | 2006 |  |   | 2005   |  
|Interest income:                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Interest on loans receivable                        |  | $                           | 4,155 |   |                            | $ | 3,330 |      |  | $ | 11,669 |   |  | $ | 9,655  |  
|Interest on investment securities                   |  |                             | 373   |   |                            |   | 594   |      |  |   | 1,272  |   |  |   | 1,938  |  
|Other interest                                      |  |                             | 77    |   |                            |   | 76    |      |  |   | 250    |   |  |   | 193    |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Total interest income                               |  |                             | 4,605 |   |                            |   | 4,000 |      |  |   | 13,191 |   |  |   | 11,786 |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Interest expense:                                   |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Deposits                                            |  |                             | 1,470 |   |                            |   | 1,064 |      |  |   | 3,964  |   |  |   | 3,080  |  
|Advances from FHLB                                  |  |                             | 396   |   |                            |   | 101   |      |  |   | 833    |   |  |   | 292    |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Total interest expense                              |  |                             | 1,866 |   |                            |   | 1,165 |      |  |   | 4,797  |   |  |   | 3,372  |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Net interest income                                 |  |                             | 2,739 |   |                            |   | 2,835 |      |  |   | 8,394  |   |  |   | 8,414  |  
|Provision for loan losses                           |  |                             |      |   |                            |   |      |      |  |   |       |   |  |   |       |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Net interest income after provision for loan losses |  |                             | 2,739 |   |                            |   | 2,835 |      |  |   | 8,394  |   |  |   | 8,414  |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Noninterest income:                                 |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Dividends from investments                          |  |                             | 12    |   |                            |   | 20    |      |  |   | 29     |   |  |   | 46     |  
|Mortgage origination fee income                     |  |                             | 129   |   |                            |   | 40    |      |  |   | 446    |   |  |   | 40     |  
|Service charges and fees                            |  |                             | 131   |   |                            |   | 132   |      |  |   | 404    |   |  |   | 416    |  
|Loss on sale of investment securities, net          |  |                             | (46   | ) |                            |   |      |      |  |   | (90    | ) |  |   | (43    | )
|Gain on sale of foreclosed real estate, net         |  |                             | 8     |   |                            |   | 38    |      |  |   | 168    |   |  |   | 71     |  
|BOLI increase in cash value                         |  |                             | 49    |   |                            |   | 45    |      |  |   | 155    |   |  |   | 153    |  
|Other                                               |  |                             | 30    |   |                            |   | 52    |      |  |   | 70     |   |  |   | 106    |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Total noninterest income                            |  |                             | 313   |   |                            |   | 327   |      |  |   | 1,182  |   |  |   | 789    |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Noninterest expense:                                |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Compensation and benefits                           |  |                             | 1,483 |   |                            |   | 1,070 |      |  |   | 4,063  |   |  |   | 2,914  |  
|Occupancy expense                                   |  |                             | 108   |   |                            |   | 89    |      |  |   | 305    |   |  |   | 241    |  
|Equipment and data processing expense               |  |                             | 276   |   |                            |   | 273   |      |  |   | 735    |   |  |   | 710    |  
|DIF deposit insurance premiums                      |  |                             | 6     |   |                            |   | 7     |      |  |   | 19     |   |  |   | 22     |  
|Advertising                                         |  |                             | 28    |   |                            |   | 47    |      |  |   | 173    |   |  |   | 140    |  
|REO expense                                         |  |                             | 9     |   |                            |   | 26    |      |  |   | 46     |   |  |   | 58     |  
|Other                                               |  |                             | 376   |   |                            |   | 403   |      |  |   | 1,107  |   |  |   | 994    |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Total noninterest expense                           |  |                             | 2,286 |   |                            |   | 1,915 |      |  |   | 6,448  |   |  |   | 5,079  |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Earnings before income taxes                        |  |                             | 766   |   |                            |   | 1,247 |      |  |   | 3,128  |   |  |   | 4,124  |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Income taxes:                                       |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Current                                             |  |                             | 218   |   |                            |   | 389   |      |  |   | 926    |   |  |   | 1,339  |  
|Deferred                                            |  |                             | 72    |   |                            |   | (4    | )    |  |   | 231    |   |  |   | 89     |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Total income taxes                                  |  |                             | 290   |   |                            |   | 385   |      |  |   | 1,157  |   |  |   | 1,428  |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Net earnings                                        |  | $                           | 476   |   |                            | $ | 862   |      |  | $ | 1,971  |   |  | $ | 2,696  |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Net earnings per share, basic                       |  | $                           | 0.08  |   |                            | $ | 0.12  |      |  | $ | 0.31   |   |  | $ | 0.36   |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Net earnings per share, diluted                     |  | $                           | 0.08  |   |                            | $ | 0.12  |      |  | $ | 0.31   |   |  | $ | 0.36   |  
|                                                    |  |                             |       |   |                            |   |       |      |  |   |        |   |  |   |        |  

See accompanying notes to financial statements



4



---

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders Equity

Nine Months Ended March 31, 2006 and 2005 (Unaudited)

(Dollars in Thousands)



|                                                                                              |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------------------------------- |  | ----------- | -- | ------------------------ | - | ----------------------------- |  | - | -------------------- | - |  | ----------------------------------- | ------ | - | ---------------- | - | ---- | ------------- |  | - | ------------------------ | - |  | - | ------- | - |  | - | ------- | -
|                                                                                              |  | CommonStock |    | AdditionalPaid-inCapital |   | UnallocatedCommonStock inESOP |  |   | UnearnedCompensation |   |  | AccumulatedOtherComprehensiveIncome |        |   | RetainedEarnings |   |      | TreasuryStock |  |   | TotalStockholdersEquity |  
|Balance at June 30, 2005                                                                      |  | $           | 84 |                          | $ | 71,694                        |  | $ | (5,833               | ) |  | $                                   | (3,232 | ) |                  | $ | (155 | )             |  | $ | 34,069                   |   |  | $ | (14,599 | ) |  | $ | 82,028  |  
|                                                                                              |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  
|Comprehensive income:                                                                         |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  
|Net earnings                                                                                  |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | 1,971                    |   |  |   |        |   |  |   | 1,971   |  
|Change in net unrealized gain (loss) on securities available for sale, net of taxes of $(250) |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   | (403 | )             |  |   |                         |   |  |   |        |   |  |   | (403    | )
|                                                                                              |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  
|Total comprehensive income                                                                    |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 1,568   |  
|                                                                                              |  |             |    |                          |   |                               |  |  
|Dividends                                                                                     |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | (1,245                   | ) |  |   |        |   |  |   | (1,245  | )
|Dividends used for ESOP payment                                                               |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | 157                      |   |  |   |        |   |  |   | 157     |  
|Shares committed to be released by the employee stock ownership plan                          |  |             |   |                          |   | 104                           |  |   | 324                  |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 428     |  
|Stock options expensed                                                                        |  |             |   |                          |   | 199                           |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 199     |  
|Tax benefit from exercise of nonqualifying stock options                                      |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   |        |  
|Earned portion of stock grants                                                                |  |             |   |                          |   |                              |  |   |                     |   |  |                                     | 359    |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 359     |  
|Exercise of options                                                                           |  |             |   |                          |   | 49                            |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 49      |  
|Tax benefit from exercise of nonqualifying stock options                                      |  |             |   |                          |   | 25                            |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 25      |  
|Purchase of common stock (605,899 shares)                                                     |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   | (8,074  | ) |  |   | (8,074  | )
|                                                                                              |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  
|Balance at March 31, 2006                                                                     |  | $           | 84 |                          | $ | 72,071                        |  | $ | (5,509               | ) |  | $                                   | (2,873 | ) |                  | $ | (558 | )             |  | $ | 34,952                   |   |  | $ | (22,673 | ) |  | $ | 75,494  |  
|                                                                                              |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  
|Balance at June 30, 2004                                                                      |  | $           | 84 |                          | $ | 71,496                        |  | $ | (6,265               | ) |  | $                                   | (3,488 | ) |                  | $ | (793 | )             |  | $ | 32,349                   |   |  | $ |        |   |  | $ | 93,383  |  
|                                                                                              |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  
|Comprehensive income:                                                                         |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  
|Net earnings                                                                                  |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | 2,696                    |   |  |   |        |   |  |   | 2,696   |  
|Change in net unrealized gain (loss) on securities available for sale, net of taxes of $138   |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   | 221  |               |  |   |                         |   |  |   |        |   |  |   | 221     |  
|                                                                                              |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  
|Total comprehensive income                                                                    |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 2,917   |  
|                                                                                              |  |             |    |                          |   |                               |  |  
|Dividends                                                                                     |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | (1,173                   | ) |  |   |        |   |  |   | (1,173  | )
|Dividends used for ESOP payment                                                               |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | 143                      |   |  |   |        |   |  |   | 143     |  
|Shares committed to be released by the employee stock ownership plan                          |  |             |   |                          |   | 97                            |  |   | 324                  |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 421     |  
|Stock options expensed                                                                        |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   |        |  
|Earned portion of stock grants                                                                |  |             |   |                          |   |                              |  |   |                     |   |  |                                     | 330    |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 330     |  
|Exercise of options                                                                           |  |             |   |                          |   | 44                            |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 44      |  
|Purchase of stock for the 2004 Stock Incentive Plan                                           |  |             |   |                          |   |                              |  |   |                     |   |  |                                     | (184   | ) |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | (184    | )
|Tax benefit from exercise of nonqualifying stock options                                      |  |             |   |                          |   | 25                            |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 25      |  
|Purchase of common stock (828,552 shares)                                                     |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   | (10,948 | ) |  |   | (10,948 | )
|                                                                                              |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  
|Balance at March 31, 2005                                                                     |  | $           | 84 |                          | $ | 71,662                        |  | $ | (5,941               | ) |  | $                                   | (3,342 | ) |                  | $ | (572 | )             |  | $ | 34,015                   |   |  | $ | (10,948 | ) |  | $ | 84,958  |  
|                                                                                              |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |         |  



5



---

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)



|                                                                                              |  |                            |         |   |      |   |         |  
|--------------------------------------------------------------------------------------------- |  | -------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                              |  | Nine Months endedMarch 31, |        
|                                                                                              |  | 2006                       |         |   | 2005 |  
|Cash flows from operating activities:                                                         |  |                            |         |   |      |   |         |  
|Net earnings                                                                                  |  | $                          | 1,971   |   |      | $ | 2,696   |  
|Adjustments to reconcile net earnings to net cash provided by (used for) operating activities |  |                            |         |   |      |   |         |  
|Allocated ESOP shares                                                                         |  |                            | 428     |   |      |   | 422     |  
|Depreciation and amortization expense                                                         |  |                            | 202     |   |      |   | 196     |  
|Amortization of premiums (discounts), net on investment securities                            |  |                            | 23      |   |      |   | 11      |  
|(Gain) loss on sale of investment securities and mortgage-backed securities, net              |  |                            | 106     |   |      |   | 43      |  
|(Gain) on sale of equity investments                                                          |  |                            | (16     | ) |      |   |        |  
|FHLB stock dividends                                                                          |  |                            | (68     | ) |      |   | (52     | )
|Amortization of deferred loan fees, net                                                       |  |                            | (95     | ) |      |   | (97     | )
|Loss (gain) on sale of foreclosed real estate, net                                            |  |                            | (168    | ) |      |   | (70     | )
|Deferred tax benefit                                                                          |  |                            | 231     |   |      |   | 296     |  
|Tax benefit from stock options and MRP                                                        |  |                            | 25      |   |      |   |        |  
|Originations of mortgage loans held for sale                                                  |  |                            | (41,998 | ) |      |   | (5,279  | )
|Proceeds from sales of mortgage loans                                                         |  |                            | 44,030  |   |      |   | 3,900   |  
|Increase in cash value of life insurance                                                      |  |                            | (155    | ) |      |   | (153    | )
|Earned portion of MRP                                                                         |  |                            | 359     |   |      |   | 330     |  
|Stock options expensed                                                                        |  |                            | 199     |   |      |   |        |  
|Decrease (increase) in:                                                                       |  |                            |         |   |      |   |         |  
|Accrued interest receivable                                                                   |  |                            | (6      | ) |      |   | 376     |  
|Other assets                                                                                  |  |                            | 41      |   |      |   | 66      |  
|Increase (decrease) in other liabilities and accrued income taxes                             |  |                            | 8       |   |      |   | 117     |  
|                                                                                              |  |                            |         |   |      |   |         |  
|Net cash provided by (used for) operating activities                                          |  |                            | 5,117   |   |      |   | 2,802   |  
|                                                                                              |  |                            |         |   |      |   |         |  
|Cash flows used for investing activities:                                                     |  |                            |         |   |      |   |         |  
|Loan originations, net of principal collections                                               |  |                            | (31,579 | ) |      |   | (7,954  | )
|Investment securities classified as available for sale:                                       |  |                            |         |   |      |   |         |  
|Purchased                                                                                     |  |                            | (1,246  | ) |      |   |        |  
|Proceeds from sale                                                                            |  |                            | 11,527  |   |      |   | 20,378  |  
|Proceeds from maturity                                                                        |  |                            | 200     |   |      |   | 1,700   |  
|Return of principal on mortgage-backed securities                                             |  |                            | 2,201   |   |      |   | 3,152   |  
|Purchase of premises and equipment                                                            |  |                            | (3,410  | ) |      |   | (255    | )
|Proceeds from sale of (additions to) foreclosed real estate, net                              |  |                            | 345     |   |      |   | 430     |  
|                                                                                              |  |                            |         |   |      |   |         |  
|Net cash provided by (used for) investing activities                                          |  |                            | (21,962 | ) |      |   | 17,451  |  
|                                                                                              |  |                            |         |   |      |   |         |  
|Cash flows from financing activities:                                                         |  |                            |         |   |      |   |         |  
|Net increase (decrease) in deposits                                                           |  |                            | 2,173   |   |      |   | (8,292  | )
|Proceeds from advances from FHLB                                                              |  |                            | 40,000  |   |      |   | 15,000  |  
|Repayment of FHLB advances                                                                    |  |                            | (18,000 | ) |      |   | (9,000  | )
|Purchase of company stock for the 2004 Stock Based Incentive Plan                             |  |                            |        |   |      |   | (14     | )
|Purchase of treasury stock                                                                    |  |                            | (8,074  | ) |      |   | (10,948 | )
|Cash dividend paid on common stock                                                            |  |                            | (1,572  | ) |      |   | (1,550  | )
|Proceeds from exercise of stock options                                                       |  |                            | 50      |   |      |   | 44      |  
|                                                                                              |  |                            |         |   |      |   |         |  
|Net cash provided by (used for) financing activities                                          |  |                            | 14,577  |   |      |   | (14,760 | )
|                                                                                              |  |                            |         |   |      |   |         |  
|Net increase (decrease) in cash, cash equivalents and interest-earning deposits               |  |                            | (2,268  | ) |      |   | 5,493   |  
|Cash, cash equivalents and interest-earning deposits at beginning of period                   |  |                            | 11,027  |   |      |   | 6,411   |  
|                                                                                              |  |                            |         |   |      |   |         |  
|Cash, cash equivalents and interest-earning deposits at end of period                         |  | $                          | 8,759   |   |      | $ | 11,904  |  
|                                                                                              |  |                            |         |   |      |   |         |  
|Supplemental disclosures of cash flow information:                                            |  |                            |         |   |      |   |         |  
|Cash paid during period for:                                                                  |  |                            |         |   |      |   |         |  
|Interest on deposits                                                                          |  | $                          | 3,964   |   |      | $ | 3,080   |  
|Interest on FHLB advances                                                                     |  |                            | 833     |   |      |   | 292     |  
|Income taxes                                                                                  |  |                            | 1,135   |   |      |   | 1,390   |  
|Real estate acquired in settlement of loans                                                   |  |                            | 454     |   |      |   | 1,282   |  

See accompanying notes to financial statements



6



---

Notes To Consolidated Financial Statements



|(1) | Basis of Presentation
|--- | ---------------------

The accompanying
unaudited consolidated financial statements include the accounts of Jefferson Bancshares, Inc. (the Company or Jefferson Bancshares) and its wholly-owned subsidiary, Jefferson Federal Bank (the Bank or
Jefferson Federal). The unaudited financial statements of the Company were prepared with generally accepted accounting principles and with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete
presentation of financial condition, results of operations and cash flows. In the opinion of management, the accompanying unaudited financial statements contain all adjustments, which are normal and recurring in nature, necessary for a fair
presentation of the interim financial statements. The results of operations for the period ended March 31, 2006 are not necessarily indicative of the results which may be expected for the entire fiscal year. These unaudited consolidated
financial statements should be read in conjunction with the Companys Annual Report on Form 10-K for the year ended June 30, 2005.



|(2) | Principles of Consolidation
|--- | ---------------------------

The
consolidated financial statements include the accounts of Jefferson Bancshares, Inc. and its wholly-owned subsidiary, Jefferson Federal Bank. All significant intercompany balances and transactions have been eliminated in consolidation.



|(3) | Use of Estimates
|--- | ----------------

In preparing the
consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the statement of condition dates and revenues and expenses for the periods shown. Actual
results could differ from the estimates and assumptions used in the consolidated financial statements. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan
losses, the valuation of foreclosed real estate and deferred tax assets.



|(4) | Limitation on Capital Distributions
|--- | -----------------------------------

Office
of Thrift Supervision regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under
the regulations, an application to and the prior approval of the Office of Thrift Supervision is required prior to any capital distribution if the institution does not meet the criteria for expedited treatment of applications under
Office of Thrift Supervision regulations (i.e., generally, examination ratings in the top two categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the
preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with, or condition imposed by, the Office of Thrift Supervision. If an
application is not required, the institution must still provide prior notice to the Office of Thrift Supervision of the capital distribution if, like Jefferson Federal, it is a subsidiary of a holding company. In addition, the Office of Thrift
Supervision could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the Office of Thrift Supervision determined that such



7



---

distribution would constitute an unsafe or unsound practice. In the event Jefferson Federals
capital falls below its regulatory requirements or the Office of Thrift Supervision notifies it that it is in need of more than normal supervision, Jefferson Federals ability to make capital distributions could be restricted. Jefferson Federal
also may not make a capital distribution if the distribution would reduce its regulatory capital below the amount needed for the liquidation account established in connection with its conversion from the mutual holding company form of organization.



|(5) | Earnings Per Common Share
|--- | -------------------------

Earnings per
common share and earnings per common share-assuming dilution have been computed on the basis of dividing net earnings by the weighted-average number of shares of common stock outstanding, exclusive of unearned ESOP shares. Diluted earnings per
common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are
determined using the treasury stock method. The following table illustrates the number of weighted-average shares of common stock used in each corresponding earnings per common share calculation:



|                                                                                                                                            |  |                                                                        |  |                                                                       |  |           |  |          
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------- |  | --------------------------------------------------------------------- |  | --------- |  | ---------
|                                                                                                                                            |  | Weighted-Average SharesOutstanding for
the Three Months EndedMarch 31, |  | Weighted-Average SharesOutstanding for
the Nine Months EndedMarch 31,
|                                                                                                                                            |  | 2006                                                                   |  | 2005                                                                  |  | 2006      |  | 2005     
|Weighted average number of common shares used in computing basic earnings per common share                                                  |  | 6,227,668                                                              |  | 7,171,692                                                             |  | 6,422,164 |  | 7,443,856
|Effect of dilutive stock options                                                                                                            |  | 20,436                                                                 |  | 16,865                                                                |  | 18,193    |  | 18,459   
|                                                                                                                                            |  |                                                                        |  |                                                                       |  |           |  |          
|Weighted average number of common shares and dilutive potential common shares used in computing earnings per common share assuming
dilution |  | 6,248,104                                                              |  | 7,188,557                                                             |  | 6,440,357 |  | 7,462,315
|                                                                                                                                            |  |                                                                        |  |                                                                       |  |           |  |          



|(6) | Statements of Cash Flows
|--- | ------------------------

Dividends declared
but not paid have been recorded in other liabilities; however, their non-effect on cash and operations dictates their exclusion from the cash flows until actually paid.



|(7) | Accounting by Creditors for Impairment of a Loan
|--- | ------------------------------------------------

Impairment of loans having an average recorded investment of $62,000 during the nine-month period ended March 31, 2006 has been recognized in conformity with the Financial Accounting Standards Board (FASB) Statement
No. 118. There was no allowance for loan losses related to impaired loans at March 31, 2006. Other nonaccrual loans at March 31, 2006 were approximately $62,000. For the nine months ended March 31, 2006, gross income which would
have been recognized had impaired and nonaccrual loans been current in accordance with their original terms amounted to approximately $4,000. Interest income from impaired and non-accrual loans included in the Companys interest income amounted
to $2,000 for the nine months ended March 31, 2006.



8



---

The following table summarizes the activity in the allowance for loan losses for the three months ended
March 31, 2006:



|                             |  |                                                 |      |   |  |   |       |  
|---------------------------- |  | ----------------------------------------------- | ---- | - |  | - | ----- | -
|                             |  | Allowance for Loan Losses(Dollars in thousands) |     
|Balance at June 30, 2005     |  |                                                 |      |   |  | $ | 2,293 |  
|Provision for loan losses    |  |                                                 |      |   |  |   |      |  
|Charge-offs                  |  | $                                               | (227 | ) |  |   |       |  
|Recoveries                   |  |                                                 | 125  |   |  |   |       |  
|                             |  |                                                 |      |   |  |   |       |  
|Net (charge-offs)/recoveries |  |                                                 |      |   |  |   | (102  | )
|                             |  |                                                 |      |   |  |   |       |  
|Balance at March 31, 2006    |  |                                                 |      |   |  | $ | 2,191 |  
|                             |  |                                                 |      |   |  |   |       |  



|(8) | Financial Instruments With Off-Balance Sheet Risk
|--- | -------------------------------------------------

Jefferson Bancshares is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate
mortgage loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Companys maximum exposure to credit loss in the event of nonperformance by
the borrower is represented by the contractual amount and related accrued interest receivable of those instruments. The Company minimizes this risk by evaluating each borrowers creditworthiness on a case-by-case basis. Collateral held by the
Company consists of a first or second mortgage on the borrowers property. The amount of collateral obtained is based upon an appraisal of the property.

At March 31, 2006, we had approximately $8.6 million in loan commitments, consisting of $925,000 in commitments to originate residential loans and $7.6 million to originate commercial loans. In addition to
commitments to originate loans, we had $13.0 million in loans-in-process, $528,000 in unused standby letters of credit and approximately $12.0 million in unused lines of credit.



|(9) | Dividend Declaration
|--- | --------------------

On February 24,
2006, the Board of Directors of the Company approved a quarterly dividend of $0.06 per share to stockholders of record as of March 31, 2006 and payable on April 14, 2006.



|(10) | Stock Incentive Plans
|---- | ---------------------

Under the Banks
1995 Stock Option Plan and the 1995 Management Recognition and Development Plan (MRP), the Company issued a combined total of 179,176 shares to officers, employees and non-employee directors. Both plans vested pro-rata over a five-year
period, with the Stock Option Plan having an expiration date of April 1, 2007. As of March 31, 2006, there were 39,726 options outstanding and no remaining shares available for grant under the 1995 Stock Option Plan. During the three-month
period, 3,000 options were exercised.

The Companys 2004 Stock Incentive Plan authorizes the granting of 698,750 options and 279,500
restricted stock awards to employees and non-employee directors. As of March 31, 2006, there were 401,778 options and 206,711 restricted stock awards granted under this plan which will vest pro-rata over a five-year period. The 2004 plan has an
expiration date of January 30, 2014.



9



---

The table below summarizes the status of the Companys stock option plans as of March 31, 2006.



|                                      |  |                                 |  |                                |      
|------------------------------------- |  | ------------------------------- |  | ------------------------------ | -----
|                                      |  | Nine Months EndedMarch 31, 2006
|                                      |  | Shares                          |  | Weighted-averageexercise price
|Outstanding at beginning of period    |  | 453,036                         |  | $                              | 12.60
|Granted during the nine-month period  |  |                                |  |                                |     
|Options exercised                     |  | 11,532                          |  | $                              | 4.26 
|Outstanding at March 31, 2006         |  | 441,504                         |  | $                              | 12.82
|                                      |  |                                
|Options exercisable at March 31, 2006 |  | 200,448                         |  | $                              | 11.77

The following information applies to options outstanding at March 31, 2006:



|                                                |  |               
|----------------------------------------------- |  | --------------
|Number outstanding                              |  | 441,504       
|Range of exercise prices                        |  | $3.52 - $13.69
|Weighted-average exercise price                 |  | $12.82        
|Weighted-average remaining contractual life     |  | 7.21          
|Number of options remaining for future issuance |  | 296,972       

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 123R, Share Based Payment (SFAS 123R), an amendment of FASB Statement No. 123 (SFAS 123), Accounting for Stock-Based Compensation. SFAS 123R eliminates the ability to account for
share-based compensation transactions using Accounting Principles Board Opinion No. 25 (APB 25) and requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on
the grant-date fair value of the award. This statement is effective for public entities that do not file as small business issuers as of the beginning of the first interim or annual reporting period that begins after June 15, 2005.

Effective July 1, 2005, the Company adopted SFAS 123R using the modified prospective application transition method. This requires the Company to
expense the unvested portion of options granted in 2004, which reduces net earnings by approximately $217,000 in fiscal year 2006 and $542,500 in the remaining service period. SFAS 123R provides for the use of alternative models to determine
compensation cost related to stock option grants. The estimated fair value of stock options at grant date has been determined using the Black-Scholes option-pricing model based on market data as of January 29, 2004. The expected dividend yield
of 1.17% and expected volatility of 7.01% were used to model the value. The risk free rate of return equaled 4.22%, which was based on the yield of a U.S. Treasury note with a term of ten years. The estimated time remaining before the expiration of
the options equaled ten years.



10



---

Had compensation cost for the Companys stock option plan been determined based on the fair value at
the grant dates for awards under the plan consistent with the method prescribed by SFAS No. 123R, the Companys net income and earnings per share would have been adjusted to the pro forma amounts indicated below:



|                                                                                                                                      |  |                                |      |   |                               |   |       |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ---- | - | ----------------------------- | - | ----- | -
|                                                                                                                                      |  | Three monthsendedMarch 31,2005 |      |   | Nine monthsendedMarch 31,2005 |  
|Net Income:                                                                                                                           |  |                                |      |   |                               |   |       |  
|As reported                                                                                                                           |  | $                              | 862  |   |                               | $ | 2,696 |  
|Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax
effects |  |                                | (54  | ) |                               |   | (162  | )
|                                                                                                                                      |  |                                |      |   |                               |   |       |  
|Pro forma                                                                                                                             |  | $                              | 808  |   |                               | $ | 2,534 |  
|                                                                                                                                      |  |                                |      |   |                               |   |       |  
|Basic net earnings per share:                                                                                                         |  |                                |      |   |                               |   |       |  
|As reported                                                                                                                           |  | $                              | 0.12 |   |                               | $ | 0.36  |  
|Pro forma                                                                                                                             |  | $                              | 0.11 |   |                               | $ | 0.34  |  
|Earnings per common share assuming dilution:                                                                                          |  |                                |      |   |                               |   |       |  
|As reported                                                                                                                           |  | $                              | 0.12 |   |                               | $ | 0.36  |  
|Pro forma                                                                                                                             |  | $                              | 0.11 |   |                               | $ | 0.34  |  

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

Managements
discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of Jefferson Bancshares. The information contained in this section should be read in
conjunction with the financial statements and accompanying notes. For further information, refer to the financial statements and footnotes included in the Companys Annual Report on Form 10-K for the year ended June 30, 2005.

General

Jefferson
Bancshares, Inc. (also referred to as the Company or Jefferson Bancshares) is the holding company for Jefferson Federal Bank (the Bank or Jefferson Federal).

The Company has no significant assets, other than all of the outstanding shares of the Bank, and no significant liabilities. Management of the Company and the Bank are
substantially similar and the Company neither owns nor leases any property, but instead uses the premises, equipment and furniture of the Bank. Accordingly, the information set forth in this report, including the consolidated financial statements
and related financial data, relates primarily to the Bank.

Jefferson Federal is a community oriented financial institution offering traditional financial
services to its local communities. The Bank is engaged primarily in the business of attracting deposits from the general public and using such funds to originate loans secured by first mortgages on owner-occupied,



11



---

one-to four- family residential properties, as well as to originate commercial real estate and multi-family mortgage
loans, construction loans, consumer loans, commercial non-real estate loans and make other investments permitted by applicable laws and regulations.

The
Banks savings accounts are insured up to the applicable legal limits by the Federal Deposit Insurance Corporation (FDIC) through the Deposit Insurance Fund. Jefferson Federal Bank is a member of the Federal Home Loan Bank
(FHLB) System.

Private Securities Litigation Reform Act Safe Harbor Statement

This Quarterly Report may contain forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts; but rather, are
statements based on Jefferson Bancshares current expectations regarding its business strategies and their intended results and its future performance. Forward-looking statements are preceded by terms such as expects,
believes, anticipates, intends and similar expressions.

Managements ability to predict results or the effect of
future plans or strategies is inherently uncertain. These factors include, but are not limited to, general economic conditions, changes in the interest rate environment, legislative or regulatory changes that may adversely affect our business,
changes in accounting policies and practices, changes in competition and demand for financial services, adverse changes in the securities markets and changes in the quality or composition of the Companys loan or investment portfolios.
Additional factors that may affect our results are discussed in our Annual Report on Form 10-K for the year ended June 30, 2005 under Item 1. Business - Risk Factors. These factors should be considered in evaluating the
forward-looking statements and undue reliance should not be placed on such statements. Jefferson Bancshares assumes no obligation to update any forward-looking statements.

Results of Operations for the Three and Nine Months Ended March 31, 2006 and 2005

Net Income

Net income was $476,000, or $0.08 per diluted share, for the quarter ended March 31, 2006 compared to net income of $862,000, or $0.12 per
diluted share, for the comparable period in 2005. The decline in net income for the three-month period ended March 31, 2006 was primarily the result of an increase in noninterest expense combined with a decrease in net interest income. The
increase in noninterest expense was the result of our expansion activities, as well as our adoption of Financial Accounting Standards Boards (FASB) Statement 123R, which requires the expensing of stock options. For the nine months
ended March 31, 2006, net income was $2.0 million, or $0.31 per diluted share, compared to $2.7 million, or $0.36 per diluted share, for the comparable period in 2005. The decline in net income for the nine-months ended March 31, 2006 was
primarily the result of an increase in noninterest expense, partially offset by an increase in noninterest income.



12



---

|                                      |  |                                              |      |   |                                              |   |      |      |  |   |       |   |  |   |       |  
|------------------------------------- |  | -------------------------------------------- | ---- | - | -------------------------------------------- | - | ---- | ---- |  | - | ----- | - |  | - | ----- | -
|                                      |  | Three Months EndedMarch 31,                  |      |   | Nine Months EndedMarch 31,                   |  
|                                      |  | 2006                                         |      |   | 2005                                         |   |      | 2006 |  |   | 2005  |  
|                                      |  | (Dollars in thousands,except per share data) |      |   | (Dollars in thousands,except per share data) |  
|Net earnings                          |  | $                                            | 476  |   |                                              | $ | 862  |      |  | $ | 1,971 |   |  | $ | 2,696 |  
|Net earnings per share, basic         |  | $                                            | 0.08 |   |                                              | $ | 0.12 |      |  | $ | 0.31  |   |  | $ | 0.36  |  
|Net earnings per share, diluted       |  | $                                            | 0.08 |   |                                              | $ | 0.12 |      |  | $ | 0.31  |   |  | $ | 0.36  |  
|Return on average assets (annualized) |  |                                              | 0.61 | % |                                              |   | 1.16 | %    |  |   | 0.86  | % |  |   | 1.18  | %
|Return on average equity (annualized) |  |                                              | 2.49 | % |                                              |   | 3.98 | %    |  |   | 3.33  | % |  |   | 4.01  | %

Net Interest Income

Net interest income before loan loss provision decreased $96,000 to $2.7 million for the three months ended March 31, 2006 compared to the same period in 2005. The increase in short-term interest rates has
improved the yield on earning assets; however, our cost of funds has also been affected by the increase in rates. The interest rate spread and net interest margin for the quarter ended March 31, 2006 were 3.04% and 3.80%, respectively, compared
to 3.36% and 4.02% for the same period in 2005. The average yield on interest-earning assets increased 70 basis points to 6.38% and the average volume of earning assets increased $6.8 million, to $288.7 million for the three months ended
March 31, 2006 compared to the same period in 2005. The average rate paid on interest-bearing liabilities increased 103 basis points to 3.34%, while the average volume of interest-bearing liabilities increased $21.7 million, to $223.3 million
for the three months ended March 31, 2006 compared to the same period in 2005.

The following table summarizes changes in interest income and expense
for the three-month periods ended March 31, 2006 and 2005:



|                          |  |                            |       |          |   |       |          |   |      |   |  |       |   
|------------------------- |  | -------------------------- | ----- | -------- | - | ----- | -------- | - | ---- | - |  | ----- | --
|                          |  | Three MonthsEndedMarch 31, |       | $ Change |   |       | % Change |  
|                          |  | 2006                       |       | 2005     |   |      
|                          |  | (Dollars in thousands)     |       |          |   |       |          |  
|Interest income:          |  |                            |       |          |   |       |          |   |      |   |  |       |   
|Loans                     |  | $                          | 4,155 |          | $ | 3,330 |          | $ | 825  |   |  | 24.8  | % 
|Investment securities     |  |                            | 373   |          |   | 594   |          |   | (221 | ) |  | (37.2 | )%
|Interest-earning deposits |  |                            | 53    |          |   | 58    |          |   | (5   | ) |  | (8.6  | )%
|FHLB stock                |  |                            | 24    |          |   | 18    |          |   | 6    |   |  | 33.3  | % 
|                          |  |                            |       |          |   |       |          |   |      |   |  |       |   
|Total interest income     |  |                            | 4,605 |          |   | 4,000 |          |   | 605  |   |  | 15.1  | % 
|Interest expense:         |  |                            |       |          |   |       |          |   |      |   |  |       |   
|Deposits                  |  |                            | 1,470 |          |   | 1,064 |          |   | 406  |   |  | 38.2  | % 
|Borrowings                |  |                            | 396   |          |   | 101   |          |   | 295  |   |  | 292.1 | % 
|                          |  |                            |       |          |   |       |          |   |      |   |  |       |   
|Total interest expense    |  |                            | 1,866 |          |   | 1,165 |          |   | 701  |   |  | 60.2  | % 
|                          |  |                            |       |          |   |       |          |   |      |   |  |       |   
|Net interest income       |  | $                          | 2,739 |          | $ | 2,835 |          | $ | (96  | ) |  | (3.4  | )%
|                          |  |                            |       |          |   |       |          |   |      |   |  |       |   

Net interest income before loan loss provision decreased $20,000 to $8.4 million for the nine months ended
March 31, 2006 compared to the same period in 2005. The interest rate spread and net interest margin for the nine months ended March 31, 2006 were 3.24% and 3.96%, respectively, compared to 3.25% and 3.88% for the same period in 2005. The
average yield on interest-earning assets increased



13



---

79 basis points to 6.22% while the average volume of earning assets declined $6.5 million, to $282.8 million for the nine
months ended March 31, 2006 compared to the same period in 2005. The average rate paid on interest-bearing liabilities increased 80 basis points to 2.98%, while the average volume of interest-bearing liabilities increased $8.6 million, to
$214.8 million for the nine months ended March 31, 2006, compared to the same period in 2005.

The following table summarizes changes in interest
income and expense for the nine-month periods ended March 31, 2006 and 2005:



|                          |  |                           |        |          |   |        |          |   |       |   |  |       |   
|------------------------- |  | ------------------------- | ------ | -------- | - | ------ | -------- | - | ----- | - |  | ----- | --
|                          |  | Nine MonthsEndedMarch 31, |        | $ Change |   |        | % Change |  
|                          |  | 2006                      |        | 2005     |   |       
|                          |  | (Dollars in thousands)    |        |          |   |        |          |  
|Interest income:          |  |                           |        |          |   |        |          |   |       |   |  |       |   
|Loans                     |  | $                         | 11,669 |          | $ | 9,655  |          | $ | 2,014 |   |  | 20.9  | % 
|Investment securities     |  |                           | 1,272  |          |   | 1,938  |          |   | (666  | ) |  | (34.4 | )%
|Interest-earning deposits |  |                           | 182    |          |   | 141    |          |   | 41    |   |  | 29.1  | % 
|FHLB stock                |  |                           | 68     |          |   | 52     |          |   | 16    |   |  | 30.8  | % 
|                          |  |                           |        |          |   |        |          |   |       |   |  |       |   
|Total interest income     |  |                           | 13,191 |          |   | 11,786 |          |   | 1,405 |   |  | 11.9  | % 
|Interest expense:         |  |                           |        |          |   |        |          |   |       |   |  |       |   
|Deposits                  |  |                           | 3,964  |          |   | 3,080  |          |   | 884   |   |  | 28.7  | % 
|Borrowings                |  |                           | 833    |          |   | 292    |          |   | 541   |   |  | 185.3 | % 
|                          |  |                           |        |          |   |        |          |   |       |   |  |       |   
|Total interest expense    |  |                           | 4,797  |          |   | 3,372  |          |   | 1,425 |   |  | 42.3  | % 
|                          |  |                           |        |          |   |        |          |   |       |   |  |       |   
|Net interest income       |  | $                         | 8,394  |          | $ | 8,414  |          | $ | (20   | ) |  | (0.2  | )%
|                          |  |                           |        |          |   |        |          |   |       |   |  |       |   

The following table summarizes average balances and average yields and costs:



|                          |  |                              |         |            |                             |   |                |      |            |  |      |                |  |            |         |  |                |   |            |   |         |  |      |  
|------------------------- |  | ---------------------------- | ------- | ---------- | --------------------------- | - | -------------- | ---- | ---------- |  | ---- | -------------- |  | ---------- | ------- |  | -------------- | - | ---------- | - | ------- |  | ---- | -
|                          |  | Three Months Ended March 31, |         |            | Nine Months Ended March 31, |  
|                          |  | 2006                         |         |            | 2005                        |   |                | 2006 |            |  | 2005 |               
|                          |  | AverageBalance               |         | Yield/Cost |                             |   | AverageBalance |      | Yield/Cost |  |      | AverageBalance |  | Yield/Cost |         |  | AverageBalance |   | Yield/Cost |  
|                          |  | (Dollars in thousands)       |         |            | (Dollars in thousands)      |  
|Loans                     |  | $                            | 239,795 |            | 6.93                        | % |                | $    | 197,923    |  | 6.73 | %              |  | $          | 226,793 |  | 6.86           | % |            | $ | 198,856 |  | 6.47 | %
|Investment securities     |  |                              | 40,047  |            | 3.73                        | % |                |      | 70,887     |  | 3.35 | %              |  |            | 46,008  |  | 3.69           | % |            |   | 77,778  |  | 3.32 | %
|Interest-earning deposits |  |                              | 7,111   |            | 2.98                        | % |                |      | 11,392     |  | 2.04 | %              |  |            | 8,264   |  | 2.94           | % |            |   | 10,996  |  | 1.71 | %
|FHLB stock                |  |                              | 1,712   |            | 5.61                        | % |                |      | 1,625      |  | 4.43 | %              |  |            | 1,687   |  | 5.37           | % |            |   | 1,608   |  | 4.31 | %
|Deposits                  |  |                              | 185,588 |            | 3.17                        | % |                |      | 189,527    |  | 2.25 | %              |  |            | 186,122 |  | 2.84           | % |            |   | 194,344 |  | 2.11 | %
|Borrowings                |  |                              | 37,666  |            | 4.21                        | % |                |      | 12,000     |  | 3.37 | %              |  |            | 28,667  |  | 3.87           | % |            |   | 11,889  |  | 3.27 | %

The following table sets forth the effects of changing rates and volumes on our net interest income. 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 changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.



14



---

|                                   |  |                                   |      |   |                                  |   |      |                           |        |   |      |      |  |   |       |   |  |   |       |   |  |   |       |  
|---------------------------------- |  | --------------------------------- | ---- | - | -------------------------------- | - | ---- | ------------------------- | ------ | - | ---- | ---- |  | - | ----- | - |  | - | ----- | - |  | - | ----- | -
|                                   |  | Three Months2006 Compared to 2005 |      |   | Nine Months2006 Compared to 2005 |  
|                                   |  | Increase (Decrease)Due To         |      |   | Net                              |   |      | Increase (Decrease)Due To |        |   | Net  |     
|                                   |  | Volume                            |      |   | Rate                             |   |      |                           | Volume |   |      | Rate |  |  
|                                   |  | (In thousands)                    |      |   | (In thousands)                   |  
|Interest income:                   |  |                                   |      |   |                                  |   |      |                           |        |   |      |      |  |   |       |   |  |   |       |   |  |   |       |  
|Loans receivable                   |  | $                                 | 723  |   |                                  | $ | 102  |                           |        | $ | 825  |      |  | $ | 1,413 |   |  | $ | 601   |   |  | $ | 2,014 |  
|Investment securities              |  |                                   | (309 | ) |                                  |   | 88   |                           |        |   | (221 | )    |  |   | (935  | ) |  |   | 269   |   |  |   | (666  | )
|Other                              |  |                                   | (2   | ) |                                  |   | 3    |                           |        |   | 1    |      |  |   | (23   | ) |  |   | 80    |   |  |   | 57    |  
|                                   |  |                                   |      |   |                                  |   |      |                           |        |   |      |      |  |   |       |   |  |   |       |   |  |   |       |  
|Total interest-earning assets      |  |                                   | 412  |   |                                  |   | 193  |                           |        |   | 605  |      |  |   | 455   |   |  |   | 950   |   |  |   | 1,405 |  
|                                   |  |                                   |      |   |                                  |   |      |                           |        |   |      |      |  |   |       |   |  |   |       |   |  |   |       |  
|Interest expense:                  |  |                                   |      |   |                                  |   |      |                           |        |   |      |      |  |   |       |   |  |   |       |   |  |   |       |  
|Deposits                           |  |                                   | (22  | ) |                                  |   | 428  |                           |        |   | 406  |      |  |   | (124  | ) |  |   | 1,008 |   |  |   | 884   |  
|Borrowings                         |  |                                   | 264  |   |                                  |   | 31   |                           |        |   | 295  |      |  |   | 479   |   |  |   | 62    |   |  |   | 541   |  
|                                   |  |                                   |      |   |                                  |   |      |                           |        |   |      |      |  |   |       |   |  |   |       |   |  |   |       |  
|Total interest-bearing liabilities |  |                                   | 242  |   |                                  |   | 459  |                           |        |   | 701  |      |  |   | 355   |   |  |   | 1,070 |   |  |   | 1,425 |  
|                                   |  |                                   |      |   |                                  |   |      |                           |        |   |      |      |  |   |       |   |  |   |       |   |  |   |       |  
|Net change in interest income      |  | $                                 | 170  |   |                                  | $ | (266 | )                         |        | $ | (96  | )    |  | $ | 100   |   |  | $ | (120  | ) |  | $ | (20   | )
|                                   |  |                                   |      |   |                                  |   |      |                           |        |   |      |      |  |   |       |   |  |   |       |   |  |   |       |  

Total interest income increased $605,000, or 15.1%, to $4.6 million for the three months ended March 31,
2006, and increased $1.4 million, or 11.9%, to $13.2 million for the nine months ended March 31, 2006. The increase in interest income was primarily due to an increase in both the volume and yield on average loans more than offsetting a
decrease in the volume of investment securities.

Interest on loans increased $825,000, or 24.8%, to $4.2 million for the three months ended March 31,
2006 and increased $2.0 million, or 20.9%, to $11.7 million for the nine months ended March 31, 2006. The increase in interest on loans is the result of a higher average balance, primarily due to growth in the commercial and consumer loan
portfolio, combined with a higher average yield. The increase in the average yield on loans was primarily the result of increases in the prime lending rate. The average yield on loans increased 20 basis points, to 6.93%, for the three months and
increased 39 basis points, to 6.86%, for the nine months ended March 31, 2006 compared to the corresponding periods in 2005. Most of the commercial loans that have been originated have been tied to prime and will reprice quickly as interest
rates change.

Interest on investment securities decreased $221,000, or 37.2%, to $373,000 for the three months ended March 31, 2006 and decreased
$666,000, or 34.4%, to $1.3 million, for the nine months ended March 31, 2006. The decrease for both periods was the result of a decrease in the average balance of investment securities more than offsetting an increase in the average yield. The
average balance of investment securities decreased $30.8 million, to $40.0 million for the three months ended March 31, 2006 and decreased $31.8 million, to $46.0 million for the nine months ended March 31, 2006. Proceeds from the sale of
investment securities were used to fund stock repurchases and to fund growth in the loan portfolio. The average yield on investments increased 38 basis points to 3.73% for the three months ended March 31, 2006 and increased 37 basis points to
3.69% for the nine months ended March 31, 2006 compared to the same periods in 2005. Dividends on Federal Home Loan Bank (FHLB) stock were $24,000 and $68,000, respectively, for the three- and nine-month periods ended March 31,
2006, compared to $18,000 and $52,000 for the comparable periods in 2005. FHLB dividends are paid with additional shares of FHLB stock.



15



---

Total interest expense increased $701,000, or 60.2%, to $1.9 million for the three-month period ended March 31, 2006
compared to the same period in 2005. For the nine months ended March 31, 2006, total interest expense increased $1.4 million, or 42.3%, to $4.8 million compared to the same period in 2005. The increase in both periods was due to an increase in
the average rate paid on interest-bearing liabilities combined with an increase in the average balance of FHLB advances. Interest expense on deposits increased $406,000, or 38.2%, to $1.5 million for the three-month period ended March 31, 2006
and increased $884,000, or 28.7%, to $4.0 million for the nine-month period ended March 31, 2006. The increase for both periods was due to an increase in the average rate paid on deposits more than offsetting a decrease in the average balance
of deposits. The average rate paid on deposits increased 92 basis points to 3.17% for the three months ended March 31, 2006 and increased 73 basis points to 2.84% for the nine months ended March 31, 2006 due to higher rates paid on money
market accounts and time deposits. The increase in the rate paid on deposits reflects an increase in short-term market interest rates. Interest expense on FHLB advances was $396,000 for the three months ended March 31, 2006 compared to $101,000
for the same period in 2005. For the nine months ended March 31, 2006, interest expense on FHLB advances was $833,000 compared to $292,000 for the same period in 2005. The increase for both periods was due to a higher average balance and a
higher rate paid. FHLB advances were utilized as a funding source for supporting loan growth during the three- and nine-month periods ended March 31, 2006.

Provision for Loan Losses

We review the level of the loan loss allowance on a monthly basis and establish the provision for loan
losses based on the volume and types of lending, delinquency levels, loss experience, the amount of classified loans, economic conditions and other factors related to the collectibility of the loan portfolio. Net charge-offs for the three- and
nine-month periods ended March 31, 2006 amounted to $43,000 and $102,000, respectively, compared to $50,000 and $141,000 for the comparable periods in 2005. There were no additions to the allowance for loan losses for either nine-month period.
Nonperforming loans totaled $62,000 at March 31, 2006 compared to $342,000 at March 31, 2005.

Noninterest Income

Noninterest income decreased $14,000 to $313,000 for the three months ended March 31, 2006 compared to $327,000 for the corresponding period in 2005. A loss on sale
of investment securities totaling $46,000 was recorded in the three-month period ended March 31, 2006 and included as a component of noninterest income. Proceeds from the sale of investment securities were used to fund stock repurchases and to
fund growth in the loan portfolio. Gain on sale of foreclosed property was $8,000 for the three months ended March 31, 2006 compared to $38,000 for the same period in 2005. Mortgage origination fee income accounted for the largest increase in
noninterest income with $129,000 for the three months ended March 31, 2006 and $40,000 for the comparable period in 2005. For the three months ended March 31, 2006, we originated $11.7 million in non-portfolio loans that were sold in the
secondary market compared to $5.3 million for the three months ended March 31, 2005.

The following table summarizes the dollar amounts for each
category of noninterest income, and the dollar and percent changes for the three months ended March 31, 2006 compared to the same period in 2005.



16



---

|                                            |  |                             |     |         |      |   |         |  |   |     |   |  |       |   
|------------------------------------------- |  | --------------------------- | --- | ------- | ---- | - | ------- |  | - | --- | - |  | ----- | --
|                                            |  | Three Months EndedMarch 31, |     | $Change |      |   | %Change | 
|                                            |  | 2006                        |     |         | 2005 |   |        
|                                            |  | (Dollars in thousands)      |     |         |      |   |         | 
|Dividends from investments                  |  | $                           | 12  |         |      | $ | 20      |  | $ | (8  | ) |  | (0.4  | )%
|Mortgage origination fee income             |  |                             | 129 |         |      |   | 40      |  |   | 89  |   |  | 222.5 | % 
|Service charges and fees                    |  |                             | 131 |         |      |   | 132     |  |   | (1  | ) |  | (0.8  | )%
|Loss on sale of investment securities, net  |  |                             | (46 | )       |      |   |        |  |   | (46 | ) |  | NM    |   
|Gain on sale of foreclosed real estate, net |  |                             | 8   |         |      |   | 38      |  |   | (30 | ) |  | (78.9 | )%
|BOLI increase in cash value                 |  |                             | 49  |         |      |   | 45      |  |   | 4   |   |  | 8.9   | % 
|Other                                       |  |                             | 30  |         |      |   | 52      |  |   | (22 | ) |  | (43.3 | )%
|                                            |  |                             |     |         |      |   |         |  |   |     |   |  |       |   
|Total noninterest income                    |  | $                           | 313 |         |      | $ | 327     |  | $ | (14 | ) |  | (4.3  | )%
|                                            |  |                             |     |         |      |   |         |  |   |     |   |  |       |   

Noninterest income increased $393,000, or 49.8%, to $1.2 million for the nine months ended March 31, 2006
compared to $789,000 for the comparable period in 2005. Mortgage origination fee income accounted for the largest increase in noninterest income with $446,000 for the current nine-month period and $40,000 for the comparable period in 2005. In
January 2005, we began originating and selling loans in the secondary market. Loss on sale of investment securities amounted to $90,000 for the nine months ended March 31, 2006 compared to $43,000 for the corresponding period in 2005. Gain on
sale of foreclosed property was $168,000 for the nine months ended March 31, 2006 compared to $71,000 for the same period in 2005.

The following
table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent changes for the nine months ended March 31, 2006 compared to the same period in 2005.



|                                            |  |                            |       |   |         |   |     |         |  |   |     |   |  |        |   
|------------------------------------------- |  | -------------------------- | ----- | - | ------- | - | --- | ------- |  | - | --- | - |  | ------ | --
|                                            |  | Nine Months EndedMarch 31, |       |   | $Change |   |     | %Change | 
|                                            |  | 2006                       |       |   | 2005    |   |     |        
|                                            |  | (Dollars in thousands)     |       |   |         |   |     |         | 
|Dividends from investments                  |  | $                          | 29    |   |         | $ | 46  |         |  | $ | (17 | ) |  | (37.0  | )%
|Mortgage origination fee income             |  |                            | 446   |   |         |   | 40  |         |  |   | 406 |   |  | 1015.0 | % 
|Service charges and fees                    |  |                            | 404   |   |         |   | 416 |         |  |   | (12 | ) |  | (2.9   | )%
|Loss on sale of investment securities, net  |  |                            | (90   | ) |         |   | (43 | )       |  |   | (47 | ) |  | 109.3  | % 
|Gain on sale of foreclosed real estate, net |  |                            | 168   |   |         |   | 71  |         |  |   | 97  |   |  | 136.6  | % 
|BOLI increase in cash value                 |  |                            | 155   |   |         |   | 153 |         |  |   | 2   |   |  | 1.3    | % 
|Other                                       |  |                            | 70    |   |         |   | 106 |         |  |   | (36 | ) |  | (34.0  | )%
|                                            |  |                            |       |   |         |   |     |         |  |   |     |   |  |        |   
|Total noninterest income                    |  | $                          | 1,182 |   |         | $ | 789 |         |  | $ | 393 |   |  | 49.8   | % 
|                                            |  |                            |       |   |         |   |     |         |  |   |     |   |  |        |   

Noninterest Expense

Noninterest expense increased $371,000 or 19.4%, to $2.3 million for the three-month period ended March 31, 2006, primarily due to an increase in compensation and benefits expense. Compensation and benefits
expense increased $413,000, or 38.6%, to $1.5 million for the three-month period ended March 31, 2006, primarily due to staff additions for our future branch office in Morristown, Tennessee which is scheduled to open in 2006 and two future
branch offices in Knoxville, Tennessee which are anticipated to open in 2006 and early 2007. There were 95 bank employees at March 31, 2006 compared to 75 employees at March 31, 2005. Further, on July 1, 2005, we adopted FASB
Statement No. 123R, Share-Based Payment, using the modified prospective approach, which requires the expensing of unvested stock options granted prior to the adoption date. The expense will be based on



17



---

the grant-date fair value and will be recognized over the remaining vesting period. The cost of stock options that have
vested prior to the adoption of SFAS 123R is never recognized. Accordingly, for the three months ended March 31, 2006, compensation expense included $66,000 related to the expensing of stock options.

The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the three months ended March 31,
2006 compared to the same period in 2005.



|                                      |  |                             |       |         |   |       |         |   |     |   |  |       |   
|------------------------------------- |  | --------------------------- | ----- | ------- | - | ----- | ------- | - | --- | - |  | ----- | --
|                                      |  | Three Months EndedMarch 31, |       | $Change |   |       | %Change |  
|                                      |  | 2006                        |       | 2005    |   |      
|                                      |  | (Dollars in thousands)      |       |         |   |       |         |  
|Compensation and benefits             |  | $                           | 1,483 |         | $ | 1,070 |         | $ | 413 |   |  | 38.6  | % 
|Occupancy expense                     |  |                             | 108   |         |   | 89    |         |   | 19  |   |  | 21.3  | % 
|Equipment and data processing expense |  |                             | 276   |         |   | 273   |         |   | 3   |   |  | 1.1   | % 
|Deposit insurance premiums            |  |                             | 6     |         |   | 7     |         |   | (1  | ) |  | (14.3 | )%
|Advertising                           |  |                             | 28    |         |   | 47    |         |   | (19 | ) |  | (40.4 | )%
|REO expense                           |  |                             | 9     |         |   | 26    |         |   | (17 | ) |  | (65.4 | )%
|Other                                 |  |                             | 376   |         |   | 403   |         |   | (27 | ) |  | (6.7  | )%
|                                      |  |                             |       |         |   |       |         |   |     |   |  |       |   
|Total noninterest expense             |  | $                           | 2,286 |         | $ | 1,915 |         | $ | 371 |   |  | 19.4  | % 
|                                      |  |                             |       |         |   |       |         |   |     |   |  |       |   

For the nine months ended March 31, 2006, noninterest expense increased $1.4 million, or 27.0%, to $6.4
million due primarily to an increase in compensation and benefits expense. Compensation and benefits expense increased $1.1 million, or 39.4%, to $4.1 million for the nine months ended March 31, 2006 due to staff additions and stock option
expensing. Compensation and benefits expense related to stock option expense totaled $199,000 for the nine months ended March 31, 2006.

The following
table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the nine months ended March 31, 2006 compared to the same period in 2005.



|                                      |  |                            |       |         |   |       |         |   |       |   |  |       |   
|------------------------------------- |  | -------------------------- | ----- | ------- | - | ----- | ------- | - | ----- | - |  | ----- | --
|                                      |  | Nine Months EndedMarch 31, |       | $Change |   |       | %Change |  
|                                      |  | 2006                       |       | 2005    |   |      
|                                      |  | (Dollars in thousands)     |       |         |   |       |         |  
|Compensation and benefits             |  | $                          | 4,063 |         | $ | 2,914 |         | $ | 1,149 |   |  | 39.4  | % 
|Occupancy expense                     |  |                            | 305   |         |   | 241   |         |   | 64    |   |  | 26.6  | % 
|Equipment and data processing expense |  |                            | 735   |         |   | 710   |         |   | 25    |   |  | 3.5   | % 
|Deposit insurance premiums            |  |                            | 19    |         |   | 22    |         |   | (3    | ) |  | (13.6 | )%
|Advertising                           |  |                            | 173   |         |   | 140   |         |   | 33    |   |  | 23.6  | % 
|REO expense                           |  |                            | 46    |         |   | 58    |         |   | (12   | ) |  | (20.7 | )%
|Other                                 |  |                            | 1,107 |         |   | 994   |         |   | 113   |   |  | 11.4  | % 
|                                      |  |                            |       |         |   |       |         |   |       |   |  |       |   
|Total noninterest expense             |  | $                          | 6,448 |         | $ | 5,079 |         | $ | 1,369 |   |  | 27.0  | % 
|                                      |  |                            |       |         |   |       |         |   |       |   |  |       |   

Income Taxes

Income tax expense for the three months ended March 31, 2006 was $290,000 compared to $385,000 for the same period in 2005 due to lower taxable income. For the nine months ended March 31, 2006, income tax expense decreased
$271,000, or 19.0%, to $1.2 million due to lower taxable income.



18



---

Financial Condition

Assets

At March 31, 2006, total assets were $312.4 million, an increase of $17.3 million, or 5.9%, compared to $295.0 million
at June 30, 2005. The increase in assets was primarily attributable to an increase in loans, more than offsetting a decline in investment securities. Proceeds from sales and maturities of investment securities and repayments of mortgage-backed
securities were utilized to fund stock repurchases and to fund growth in the loan portfolio. Additional FHLB advances were used to fund asset growth.

Investments

Our investment portfolio consists primarily of federal agency securities with maturities of seven years or less,
municipal securities and mortgage-backed securities with stated final maturities of 30 years or less. Investment securities decreased $13.5 million, or 25.2%, to $39.9 million due primarily to sales of investment securities during the nine-month
period. Proceeds from the sale of investment securities were used to fund stock repurchases and to fund growth in the loan portfolio. Investment securities classified as available-for-sale are carried at fair market value and reflect an unrealized
loss of $905,000, or $558,000 net of taxes.

The following table sets forth the carrying values of our investment securities portfolio at the dates
indicated. All of our investment securities are classified as available-for-sale.



|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|------------------------------------ |  | ---------------------- | ------ | - | --------------- | - | ---------------- |  | - | --------- | - |  | - | ------
|At March 31, 2006                    |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|                                     |  | AmortizedCost          |        |   | UnrealizedGains |   | UnrealizedLosses |  |   | FairValue
|                                     |  | (Dollars in thousands)
|Securities available-for-sale        |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Debt securities:                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Federal agency                       |  | $                      | 31,322 |   |                 | $ |                 |  | $ | (786      | ) |  | $ | 30,536
|Municipals                           |  |                        | 4,507  |   |                 |   | 1                |  |   | (120      | ) |  |   | 4,388 
|Mortgage-backed                      |  |                        | 4,977  |   |                 |   | 14               |  |   | (13       | ) |  |   | 4,978 
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Total securities available- for-sale |  | $                      | 40,806 |   |                 | $ | 15               |  | $ | (919      | ) |  | $ | 39,902
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Weighted-average rate                |  |                        | 3.51   | % |                 |   |                  |  |   |           |   |  |   |       
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|                                     |  |                        |        |  
|At June 30, 2005                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|                                     |  | AmortizedCost          |        |   | UnrealizedGains |   | UnrealizedLosses |  |   | FairValue
|                                     |  | (Dollars in thousands)
|Securities available-for-sale        |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Debt securities:                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Federal agency                       |  | $                      | 42,447 |   |                 | $ | 83               |  | $ | (393      | ) |  | $ | 42,137
|Municipals                           |  |                        | 3,475  |   |                 |   | 2                |  |   | (60       | ) |  |   | 3,417 
|Mortgage-backed                      |  |                        | 7,695  |   |                 |   | 117              |  |   |          |   |  |   | 7,812 
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Total securities available- for-sale |  | $                      | 53,617 |   |                 | $ | 202              |  | $ | (453      | ) |  | $ | 53,366
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Weighted-average rate                |  |                        | 3.42   | % |                 |   |                  |  |   |           |   |  |   |       
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       



19



---

Loans

Net
loans increased $32.4 million, or 15.6%, to $240.9 million at March 31, 2006. Our expansion into the Knoxville, Tennessee market has generated additional lending opportunities, which has resulted in significant growth in our loan portfolio. Our
primary lending activity is the origination of loans secured by real estate. Real estate loans totaled $199.9 million, or 82.1% of gross loans, at March 31, 2006 compared to $168.8 million, or 80.0% of gross loans, at June 30, 2005. We
originate real estate loans secured by one- to four-family homes, commercial real estate, multi-family real estate and land. We also originate construction loans and home equity loans. The largest portion of loan growth occurred in commercial real
estate, due to our emphasis on this type of lending. Commercial real estate loans increased $20.0 million, or 37.0%, to $74.3 million at March 31, 2006.

Commercial business loans decreased $2.0 million, or 5.8%, to $32.6 million at March 31, 2006. Commercial business loans were 13.4% of gross loans at March 31, 2006 compared to 16.4% of gross loans at June 30, 2005. Most of
the commercial business loans that we have originated have been tied to prime and will reprice quickly as interest rates change.

We originate a variety of
consumer loans, including loans secured by automobiles, mobile homes and deposit accounts at Jefferson Federal. Consumer loans totaled $10.8 million and represented 4.5% of total loans at March 31, 2006 compared to $7.6 million, or 3.6% of
total loans at June 30, 2005. Consumer loans increased in the nine months ended March 31, 2006 due to an increase in indirect automobile loans.



20



---

Loans receivable, net, are summarized as follows:



|                                             |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|-------------------------------------------- |  | ---------------------- | ------- | - | ------------------- | ----- | - | ------ | - | ------- | ------------------- |  | ----- | ------- |  | - | ------- | - |  | ----- | --
|                                             |  | AtMarch 31,2006        |         |   | AtJune 30,2005      |       |   |        |   |         |                     | 
|                                             |  | Amount                 |         |   | Percentof Portfolio |       |   | Amount |   |         | Percentof Portfolio |  |       | $Change |  |   | %Change |  
|                                             |  | (Dollars in thousands) |         |   |                     |       |   |        |  
|Real estate loans:                           |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|Residential one-to four-family               |  | $                      | 78,036  |   |                     | 32.1  | % |        | $ | 79,652  |                     |  | 37.7  | %       |  | $ | (1,616  | ) |  | (2.0  | )%
|Multi-family                                 |  |                        | 7,258   |   |                     | 3.0   | % |        |   | 8,568   |                     |  | 4.1   | %       |  |   | (1,310  | ) |  | (15.3 | )%
|Construction                                 |  |                        | 11,486  |   |                     | 4.7   | % |        |   | 7,029   |                     |  | 3.3   | %       |  |   | 4,457   |   |  | 63.4  | % 
|Commercial                                   |  |                        | 74,301  |   |                     | 30.5  | % |        |   | 54,252  |                     |  | 25.7  | %       |  |   | 20,049  |   |  | 37.0  | % 
|Land                                         |  |                        | 22,782  |   |                     | 9.4   | % |        |   | 14,415  |                     |  | 6.8   | %       |  |   | 8,367   |   |  | 58.0  | % 
|Home equity line of credit                   |  |                        | 6,033   |   |                     | 2.5   | % |        |   | 4,898   |                     |  | 2.3   | %       |  |   | 1,135   |   |  | 23.2  | % 
|                                             |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|Total real estate loans                      |  |                        | 199,896 |   |                     | 82.1  | % |        |   | 168,814 |                     |  | 80.0  | %       |  |   | 31,082  |   |  | 18.4  | % 
|                                             |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|Commercial business loans                    |  |                        | 32,603  |   |                     | 13.4  | % |        |   | 34,603  |                     |  | 16.4  | %       |  |   | (2,000  | ) |  | (5.8  | )%
|                                             |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|Consumer loans:                              |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|Loans secured by deposit accounts            |  |                        | 953     |   |                     | 0.4   | % |        |   | 1,041   |                     |  | 0.5   | %       |  |   | (88     | ) |  | (8.5  | )%
|Other consumer loans                         |  |                        | 1,751   |   |                     | 0.7   | % |        |   | 1,705   |                     |  | 0.8   | %       |  |   | 46      |   |  | 2.7   | % 
|Loans secured by automobiles                 |  |                        | 7,870   |   |                     | 3.2   | % |        |   | 4,457   |                     |  | 2.1   | %       |  |   | 3,413   |   |  | 76.6  | % 
|Mobile home loans                            |  |                        | 264     |   |                     | 0.1   | % |        |   | 379     |                     |  | 0.2   | %       |  |   | (115    | ) |  | (30.3 | )%
|                                             |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|Total non-real estate loans                  |  |                        | 10,838  |   |                     | 4.5   | % |        |   | 7,582   |                     |  | 3.6   | %       |  |   | 3,256   |   |  | 42.9  | % 
|                                             |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|Total commercial business and consumer loans |  |                        | 43,441  |   |                     | 17.9  | % |        |   | 42,185  |                     |  | 20.0  | %       |  |   | 1,256   |   |  | 3.0   | % 
|                                             |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|Total gross loans                            |  |                        | 243,337 |   |                     | 100.0 | % |        |   | 210,999 |                     |  | 100.0 | %       |  |   | 32,338  |   |  | 15.3  | % 
|Less:                                        |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|Deferred loan fees, net                      |  |                        | (286    | ) |                     |       |   |        |   | (268    | )                   |  |       |         |  |   | (18     | ) |  | 6.7   | % 
|Allowance for losses                         |  |                        | (2,191  | ) |                     |       |   |        |   | (2,293  | )                   |  |       |         |  |   | 102     |   |  | (4.4  | ) 
|                                             |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   
|Loans receivable, net                        |  | $                      | 240,860 |   |                     |       |   |        | $ | 208,438 |                     |  |       |         |  | $ | 32,422  |   |  | 15.6  | % 
|                                             |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |         |  |   |         |   |  |       |   

Loan Loss Allowance

The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish reserves against losses on loans on a monthly basis. When additional
reserves are necessary, a provision for loan losses is charged to earnings. In connection with assessing the allowance, we consider the level of classified loans, delinquency levels and loss experience. In addition, we assess the allowance using
factors that cannot be associated with specific credit or loan categories. These factors include our subjective evaluation of local and national economic and business conditions, portfolio concentration and changes in the character and size of the
loan portfolio. The allowance methodology appropriately reflects a margin for the imprecision necessarily inherent in estimates of expected credit losses.



21



---

The Office of Thrift Supervision, as an integral part of its examination process, periodically reviews our allowance for
loan losses. The Office of Thrift Supervision may require us to make additional provisions for loan losses based on judgments different from ours.

Due to
net charge-offs, the allowance for loan losses decreased $102,000 to $2.2 million at March 31, 2006. There were no additions to the allowance for loan losses during the nine-month period ended March 31, 2006. Our allowance for loan losses
represented 0.90% of total gross loans at March 31, 2006 compared to 1.09% of total gross loans at June 30, 2005.



|                                                                           |  |                             |       |   |                            |   |       |      |  |   |       |   |  |   |       |  
|-------------------------------------------------------------------------- |  | --------------------------- | ----- | - | -------------------------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                                           |  | Three Months EndedMarch 31, |       |   | Nine Months EndedMarch 31, |  
|                                                                           |  | 2006                        |       |   | 2005                       |   |       | 2006 |  |   | 2005  |  
|                                                                           |  | (Dollars in thousands)      |       |   | (Dollars in thousands)     |  
|Balance at beginning of period                                             |  | $                           | 2,234 |   |                            | $ | 2,388 |      |  | $ | 2,293 |   |  | $ | 2,479 |  
|Provision for loan losses                                                  |  |                             |      |   |                            |   |      |      |  |   |      |   |  |   |      |  
|Recoveries                                                                 |  |                             | 49    |   |                            |   | 66    |      |  |   | 125   |   |  |   | 252   |  
|Charge-offs                                                                |  |                             | (92   | ) |                            |   | (116  | )    |  |   | (227  | ) |  |   | (393  | )
|                                                                           |  |                             |       |   |                            |   |       |      |  |   |       |   |  |   |       |  
|Net charge-offs                                                            |  |                             | (43   | ) |                            |   | (50   | )    |  |   | (102  | ) |  |   | (141  | )
|                                                                           |  |                             |       |   |                            |   |       |      |  |   |       |   |  |   |       |  
|Allowance at end of period                                                 |  | $                           | 2,191 |   |                            | $ | 2,338 |      |  | $ | 2,191 |   |  | $ | 2,338 |  
|                                                                           |  |                             |       |   |                            |   |       |      |  |   |       |   |  |   |       |  
|Net charge-offs to average outstanding loans during the period, annualized |  |                             | 0.07  | % |                            |   | 0.10  | %    |  |   | 0.06  | % |  |   | 0.09  | %

Nonperforming Assets

We consider repossessed assets and nonaccrual loans to be nonperforming assets. Loans are reviewed on a monthly basis and are generally placed on nonaccrual status when the loan becomes more than 90 days delinquent.
Nonperforming assets were $223,000 at March 31, 2006 compared to $1.3 million at June 30, 2005. Nonperforming loans were $62,000 and $426,000 at March 31, 2006 and June 30, 2005, respectively. Foreclosed real estate decreased
$753,000 to $161,000 at March 31, 2006 due to the disposition of several pieces of foreclosed property. Foreclosed real estate is initially recorded at the lower of the amount of the loan or the fair value, less estimated selling costs. Any
writedown to fair value is charged to the allowance for loan losses. Any subsequent writedown of foreclosed real estate is charged against earnings.



22



---

|                                                       |  |                        |         |   |              |   |        |  
|------------------------------------------------------ |  | ---------------------- | ------- | - | ------------ | - | ------ | -
|                                                       |  | March 31,2006          |         |   | June 30,2005 |  
|                                                       |  | (Dollars in thousands) |        
|Nonaccruing loans:                                     |  |                        |         |   |              |   |        |  
|Real estate                                            |  | $                      | 62      |   |              | $ | 426    |  
|Commercial business                                    |  |                        |        |   |              |   |       |  
|Consumer                                               |  |                        |        |   |              |   |       |  
|                                                       |  |                        |         |   |              |   |        |  
|Total nonaccrual loans                                 |  |                        | 62      |   |              |   | 426    |  
|                                                       |  |                       
|Real estate owned                                      |  |                        | 161     |   |              |   | 914    |  
|Other repossessed assets                               |  |                        |        |   |              |   |       |  
|                                                       |  |                        |         |   |              |   |        |  
|                                                       |  |                       
|Total nonperforming assets                             |  | $                      | 223     |   |              | $ | 1,340  |  
|                                                       |  |                        |         |   |              |   |        |  
|Total nonperforming assets to total assets             |  |                        | 0.07    | % |              |   | 0.45   | %
|Total nonperforming loans to total loans               |  |                        | 0.03    | % |              |   | 0.20   | %
|Allowance for loan losses to total nonperforming loans |  |                        | 3533.87 | % |              |   | 538.26 | %

Bank Owned Life Insurance

We hold bank owned life insurance (BOLI) to help offset the cost of employee benefit plans. BOLI provides earnings from accumulated cash value growth and provides tax advantages inherent in a life
insurance contract. The cash surrender value of the BOLI at March 31, 2006 was $5.4 million.

Deposits

Total deposits increased $2.2 million to $196.9 million at March 31, 2006. Transaction accounts increased $4.9 million, or 6.6%, to $78.4 million, while time
deposits decreased $2.7 million, or 2.2%, to $118.5 million at March 31, 2006. We have focused on attracting lower cost transaction accounts to manage our cost of funds. Transaction accounts represented 39.8% of total deposits at March 31,
2006 compared to 37.8% at June 30, 2005 and 35.9% at March 31, 2005. The decrease in time deposits is the result of our pricing strategy combined with strong competition for time deposits in our market.



|                              |  |                        |         |              |   |          |  |   |          |   |  |       |   
|----------------------------- |  | ---------------------- | ------- | ------------ | - | -------- |  | - | -------- | - |  | ----- | --
|                              |  | March 31,2006          |         | June 30,2005 |   | $ Change |  |   | % Change |  
|                              |  | (Dollars in thousands) |         |              |   |          |  |  
|Certificates of deposit       |  | $                      | 118,456 |              | $ | 121,130  |  | $ | (2,674   | ) |  | (2.2  | )%
|Savings accounts              |  |                        | 12,175  |              |   | 12,944   |  |   | (769     | ) |  | (5.9  | )%
|Money market accounts         |  |                        | 39,683  |              |   | 31,841   |  |   | 7,842    |   |  | 24.6  | % 
|NOW accounts                  |  |                        | 16,225  |              |   | 18,818   |  |   | (2,593   | ) |  | (13.8 | )%
|Non-interest bearing accounts |  |                        | 10,340  |              |   | 9,973    |  |   | 367      |   |  | 3.7   | % 
|                              |  |                        |         |              |   |          |  |   |          |   |  |       |   
|                              |  | $                      | 196,879 |              | $ | 194,706  |  | $ | 2,173    |   |  | 1.1   | % 
|                              |  |                        |         |              |   |          |  |   |          |   |  |       |   

Advances and Other Liabilities

FHLB advances increased $22.0 million to $39.0 million at March 31, 2006. We utilize FHLB cash management overnight advances as a funding source to manage daily liquidity needs. In addition, a combination of
fixed and variable rate FHLB advances, with maturities ranging from August 2006 to March 2011, have been used as a funding source for loan growth.



23



---

Stockholders Equity

Stockholders equity decreased $6.5 million, or 8.0%, to $75.5 million at March 31, 2006. Retained earnings increased $883,000 to $35.0 million at March 31, 2006 due to net earnings of $2.0 million
partially offset by the payment of dividends to shareholders in the amount of $1.2 million. Unrealized gains and losses, net of taxes, in the available-for-sale investment portfolio are reflected as an adjustment to stockholders equity. At
March 31, 2006, the adjustment to stockholders equity was an unrealized loss of $558,000 compared to a net unrealized loss of $155,000 at June 30, 2005. During the nine-month period ended March 31, 2006, there were 605,899
shares of treasury stock purchased at a cost of $8.1 million.

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 deposits, loan repayments,
maturities and sales of investment securities and borrowings from the Federal Home Loan Bank of Cincinnati. 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 on 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 U.S. Government agency obligations.

Our most liquid assets are cash and cash equivalents and interest-earning
assets. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At March 31, 2006, cash and cash equivalents totaled $3.2 million and interest-earning deposits totaled $5.5
million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $39.9 million at March 31, 2006. In addition, at March 31, 2006, we had arranged the ability to borrow a total of approximately
$63.4 million from the Federal Home Loan Bank of Cincinnati. In the nine-month period ended March 31, 2006, Federal Home Loan Bank advances increased $22.0 million to $39.0 million.

We anticipate that we will have sufficient funds available to meet current loan commitments. At March 31, 2006, we had approximately $8.6 million in loan commitments, consisting of $925,000 in commitments to
originate residential loans and $7.6 million to originate commercial loans. In addition to commitments to originate loans, we had $13.0 million in loans-in-process, $528,000 in unused standby letters of credit and approximately $12.0 million in
unused lines of credit. We had $73.8 million in certificates of deposit due within one year and $78.4 million in other deposits without specific maturities at March 31, 2006. We believe, based on past experience, that a significant portion of
those deposits will remain with us. Deposit flows are affected by the overall level of interest rates and products offered by us and our local competitors and other factors. We have the ability to attract and retain deposits by adjusting the
interest rates offered. We experienced a net increase in total deposits of $2.2 million during the nine-month period ended March 31, 2006.



24



---

At March 31, 2006, the average liquidity ratio was 18.55% compared to 32.29% at March 31, 2005. The level of
liquidity has been reduced as net proceeds from the stock offering have been used for lending, operational growth and expansion activities.

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, unused lines of credit, amounts due mortgagors on construction loans, amounts due on commercial loans and commercial letters of credit.

For the three months ended March 31, 2006, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.



25



---

Capital Compliance

The following table presents our capital position relative to our regulatory capital requirements at March 31, 2006 and June 30, 2005:



|                          |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|------------------------- |  | ---------------------- | ------ | ----- | ---------------------------- | - | ------ | ------------------------------------------------------------- | ------ |  | ----- |  |  | ------ | - |  | - | ------ |  | - |  |  | ---- | -
|                          |  | Actual                 |        |       | For CapitalAdequacy Purposes |   |        | To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                          |  | Amount                 |        | Ratio |                              |   | Amount |                                                               |        |  | Ratio |  |  | Amount |   |  |   | Ratio  | 
|                          |  | (Dollars in thousands) |       
|At March 31, 2006         |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|                          |  |                        |        |       |                              |   |        |                                                              
|Total Capital             |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|(To Risk Weighted Assets) |  | $                      | 67,461 |       | 30.0                         | % |        | $                                                             | 18,013 |  | 3     |  |  | 8.0    | % |  | $ | 22,517 |  | 3 |  |  | 10.0 | %
|                          |  |                        |        |       |                              |   |        |                                                              
|Core Capital              |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|(To Tangible Assets)      |  |                        | 65,455 |       | 21.2                         | % |        |                                                               | 12,367 |  | 3     |  |  | 4.0    | % |  |   | 15,459 |  | 3 |  |  | 5.0  | %
|                          |  |                        |        |       |                              |   |        |                                                              
|Tangible Capital          |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|(To Tangible Assets)      |  |                        | 65,455 |       | 21.2                         | % |        |                                                               | 4,638  |  | 3     |  |  | 1.5    | % |  |   | N/A    |  |   |  |  |      |  
|                          |  |                        |        |       |                              |   |        |                                                              
|Tier 1 Capital            |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|(To Risk Weighted Assets) |  |                        | 65,455 |       | 29.1                         | % |        |                                                               | N/A    |  |       |  |  |        |   |  |   | 13,510 |  | 3 |  |  | 6.0  | %
|                          |  |                        |        |       |                              |   |        |                                                              
|At June 30, 2005          |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|                          |  |                        |        |       |                              |   |        |                                                              
|Total Capital             |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|(To Risk Weighted Assets) |  | $                      | 67,648 |       | 35.4                         | % |        | $                                                             | 15,293 |  | 3     |  |  | 8.0    | % |  | $ | 19,116 |  | 3 |  |  | 10.0 | %
|                          |  |                        |        |       |                              |   |        |                                                              
|Core Capital              |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|(To Tangible Assets)      |  |                        | 65,539 |       | 22.7                         | % |        |                                                               | 11,539 |  | 3     |  |  | 4.0    | % |  |   | 14,424 |  | 3 |  |  | 5.0  | %
|                          |  |                        |        |       |                              |   |        |                                                              
|Tangible Capital          |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|(To Tangible Assets)      |  |                        | 65,539 |       | 22.7                         | % |        |                                                               | 4,327  |  | 3     |  |  | 1.5    | % |  |   | N/A    |  |   |  |  |      |  
|                          |  |                        |        |       |                              |   |        |                                                              
|Tier 1 Capital            |  |                        |        |       |                              |   |        |                                                               |        |  |       |  |  |        |   |  |   |        |  |   |  |  |      |  
|(To Risk Weighted Assets) |  |                        | 65,539 |       | 34.3                         | % |        |                                                               | N/A    |  |       |  |  |        |   |  |   | 11,470 |  | 3 |  |  | 6.0  | %



26



---

Item 3. Quantitative and Qualitative Disclosures About Market Risk

For a discussion of the Companys asset and
liability management policies, as well as the potential impact of interest rate changes upon the market value of the Companys portfolio equity, see Item 7A in the Companys Annual Report on Form 10-K for the year ended June 30,
2005. Management, as part of its regular practices, performs periodic reviews of the impact of interest rate changes upon net interest income and the market value of the Companys portfolio equity. Based on, among other factors, such reviews,
management believes that there have been no material changes in the market risk of the Companys asset and liability position since June 30, 2005.

Item 4. Controls and Procedures

The Companys management, including the Companys principal executive officer
and principal financial officer, have evaluated the effectiveness of the Companys disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the
Exchange Act). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Companys disclosure controls and procedures were
effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the SEC) (1) is recorded,
processed, summarized and reported within the time periods specified in the SECs rules and forms, and (2) is accumulated and communicated to the Companys management, including its principal executive and principal financial
officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Companys internal control over financial reporting occurred during the quarter ended March 31, 2006
that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.



27



---

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

Jefferson Bancshares is not a party to any pending legal proceedings. Periodically, there have
been various claims and lawsuits involving Jefferson Federal, such as claims to enforce liens, condemnation proceedings on properties in which Jefferson Federal holds security interests, claims involving the making and servicing of real property
loans and other issues incident to Jefferson Federals business. Jefferson Federal is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company.

Item 1A. Risk Factors

There have been no material changes to the risk factors previously disclosed in the Companys
Annual Report on Form 10-K for the year ended June 30, 2005.



28



---

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds



|                                           |  |                                             |  |                                        |       |                                                                                           |         |                                                                                                                     |         |    
|------------------------------------------ |  | ------------------------------------------- |  | -------------------------------------- | ----- | ----------------------------------------------------------------------------------------- | ------- | ------------------------------------------------------------------------------------------------------------------- | ------- | ---
|Period                                     |  | (a)Total Numberof Shares(or units)Purchased |  | (b)AveragePrice Paidper Share(or Unit) |       | (c)Total Number ofShares (or Units)Purchased asPart of PubliclyAnnounced Plansor
Programs |         | (d)Maximum Number(or ApproximateDollar Value)of Shares (orUnits) That MayYet Be PurchasedUnder the
Plansor Programs |        
|Month #1                                   |  |                                             |  |                                        |       |                                                                                           |         |                                                                                                                     |         |    
|January 1, 2006 through January 31, 2006   |  |                                            |  |                                        |      |                                                                                           |        |                                                                                                                     | 176,068 | (1)
|                                           |  |                                             |  |                                       
|Month #2                                   |  |                                             |  |                                        |       |                                                                                           |         |                                                                                                                     |         |    
|February 1, 2006 through February 28, 2006 |  | 180,587                                     |  | $                                      | 13.43 |                                                                                           | 180,587 |                                                                                                                     | 685,742 | (1)
|                                           |  |                                             |  |                                       
|Month #3                                   |  |                                             |  |                                        |       |                                                                                           |         |                                                                                                                     |         |    
|March 1, 2006 through March 31, 2006       |  | 30,108                                      |  | $                                      | 13.52 |                                                                                           | 30,108  |                                                                                                                     | 655,634 | (1)
|Total                                      |  | 210,695                                     |  | $                                      | 13.44 |                                                                                           | 210,695 |                                                                                                                     | 655,634 |    

---

|(1) | On July 30, 2004, the Company announced a Stock Repurchase Program under which the Company may repurchase up to an aggregate of 838,552 shares, or 10%, of the Companys
common stock, from time to time, subject to market conditions. On April 29, 2005, the Company announced a stock repurchase program under which the Company may repurchase an additional 838,552 shares of the Companys common stock, from time
to time, subject to market conditions. The 2004 and 2005 repurchase authorizations were completed during the three months ended March 31, 2006. On February 24, 2006, the Company announced a Stock Repurchase Program under which the Company
may repurchase an additional 690,261 shares of the Companys common stock, from time to time, subject to market conditions. The repurchase program will continue until completed or terminated by the Board of Directors.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.



29



---

Item 5. Other Information

None.

Item 6. Exhibits



|     |  |                                                                          
|---- |  | -------------------------------------------------------------------------
|     | 
|31.1 |  | Rule 13a-14(a)/15d-14(a) certification of the principal executive officer
|     | 
|31.2 |  | Rule 13a-14(a)/15d-14(a) certification of the principal financial officer
|     | 
|32.1 |  | Section 1350 certification                                               



30



---

SIGNATURES

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



|             |  |  |  |                            |  |                                                         |  | 
|------------ |  |  |  | -------------------------- |  | ------------------------------------------------------- |  | 
|             |  |  |  | JEFFERSON BANCSHARES, INC.
|             |  | 
|May 10, 2006 |  |  |  | /s/ Anderson L. Smith     
|             |  |  |  |                            |  | Anderson L. Smith President and Chief Executive Officer

|             |  |  |  |                    |  |                                                                 |  | 
|------------ |  |  |  | ------------------ |  | --------------------------------------------------------------- |  | 
|             |  |  |  |                   
|             |  | 
|May 10, 2006 |  |  |  | /s/ Jane P. Hutton
|             |  |  |  |                    |  | Jane P. Hutton Chief Financial Officer, Treasurer and Secretary