##### Table of Contents

---

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 September 30, 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 November 9, 2006, the registrant had 6,556,583 shares of common stock, $0.01 par value per share, outstanding.



---



---

##### Table of Contents

INDEX



|           |  |                                                                                                                      |  |     
|---------- |  | -------------------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                                      |  | Page
|           |  | PART I. FINANCIAL INFORMATION                                                                                        |  |     
|           |  |                                                                                                                     
|Item 1.    |  | Financial Statements                                                                                                 |  |     
|           |  |                                                                                                                     
|           |  | Consolidated Statements of Condition - UnauditedThree months ended September 30, 2006 and year ended June 30, 2006   |  | 3   
|           |  |                                                                                                                     
|           |  | Consolidated Statements of Earnings - UnauditedThree months ended September 30, 2006 and 2005                        |  | 4   
|           |  |                                                                                                                     
|           |  | Consolidated Statements of Changes in Stockholders Equity  UnauditedThree months ended September 30, 2006 and 2005 |  | 5   
|           |  |                                                                                                                     
|           |  | Consolidated Statements of Cash Flows - UnauditedThree months ended September 30, 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                                                           |  | 24  
|           |  |                                                                                                                     
|Item 4.    |  | Controls and Procedures                                                                                              |  | 24  
|           |  |                                                                                                                     
|           |  | PART II. OTHER INFORMATION                                                                                           |  |     
|           |  |                                                                                                                     
|Item 1.    |  | Legal Proceedings                                                                                                    |  | 25  
|Item 1A.   |  | Risk Factors                                                                                                         |  | 25  
|Item 2.    |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                          |  | 25  
|Item 3.    |  | Defaults Upon Senior Securities                                                                                      |  | 26  
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                                  |  | 26  
|Item 5.    |  | Other Information                                                                                                    |  | 26  
|Item 6.    |  | Exhibits                                                                                                             |  | 26  
|           | 
|SIGNATURES |  |                                                                                                                     



2



---

##### Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Condition

(Dollars in thousands)



|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ------------ | - | ------- | -
|                                                                                                                                                                                             |  | September 30,2006 |         |   | June 30,2006 |  
|                                                                                                                                                                                             |  | (Unaudited)       |         |   |              |  
|Assets                                                                                                                                                                                       |  |                   |         |   |              |   |         |  
|                                                                                                                                                                                             |  |                  
|Cash and cash equivalents                                                                                                                                                                    |  | $                 | 3,432   |   |              | $ | 3,146   |  
|Interest-earning deposits                                                                                                                                                                    |  |                   | 5,328   |   |              |   | 8,810   |  
|Investment securities classified as available-for-sale, net                                                                                                                                  |  |                   | 31,271  |   |              |   | 31,845  |  
|Federal Home Loan Bank stock                                                                                                                                                                 |  |                   | 1,770   |   |              |   | 1,745   |  
|Bank owned life insurance                                                                                                                                                                    |  |                   | 5,543   |   |              |   | 5,491   |  
|Loans receivable, net of allowance for loan losses of $2,144 at September 30, 2006 and $2,172 at June 30, 2006                                                                               |  |                   | 265,033 |   |              |   | 254,127 |  
|Loans held-for-sale                                                                                                                                                                          |  |                   | 2,379   |   |              |   | 1,645   |  
|Premises and equipment, net                                                                                                                                                                  |  |                   | 12,268  |   |              |   | 11,926  |  
|Foreclosed real estate, net                                                                                                                                                                  |  |                   | 66      |   |              |   | 74      |  
|Accrued interest receivable:                                                                                                                                                                 |  |                   |         |   |              |   |         |  
|Investments                                                                                                                                                                                  |  |                   | 262     |   |              |   | 330     |  
|Loans receivable                                                                                                                                                                             |  |                   | 1,404   |   |              |   | 1,342   |  
|Deferred tax asset                                                                                                                                                                           |  |                   | 1,809   |   |              |   | 1,986   |  
|Other assets                                                                                                                                                                                 |  |                   | 833     |   |              |   | 4,670   |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|Total assets                                                                                                                                                                                 |  | $                 | 331,398 |   |              | $ | 327,137 |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|Liabilities and Stockholders Equity                                                                                                                                                         |  |                   |         |   |              |   |         |  
|                                                                                                                                                                                             |  |                  
|Deposits                                                                                                                                                                                     |  |                   |         |   |              |   |         |  
|Noninterest-bearing                                                                                                                                                                          |  | $                 | 12,341  |   |              | $ | 10,806  |  
|Interest-bearing                                                                                                                                                                             |  |                   | 195,789 |   |              |   | 188,037 |  
|Federal Home Loan Bank advances                                                                                                                                                              |  |                   | 47,900  |   |              |   | 52,400  |  
|Other liabilities                                                                                                                                                                            |  |                   | 867     |   |              |   | 1,295   |  
|Accrued income taxes                                                                                                                                                                         |  |                   | 59      |   |              |   | 56      |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|Total liabilities                                                                                                                                                                            |  |                   | 256,956 |   |              |   | 252,594 |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|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; 8,414,148 shares issued and 6,573,706 shares outstanding at September 30,
2006 and 6,613,557 shares outstanding at June 30, 2006 |  |                   | 84      |   |              |   | 84      |  
|Additional paid-in capital                                                                                                                                                                   |  |                   | 72,297  |   |              |   | 72,171  |  
|Unearned ESOP shares                                                                                                                                                                         |  |                   | (5,293  | ) |              |   | (5,401  | )
|Unearned compensation                                                                                                                                                                        |  |                   | (2,594  | ) |              |   | (2,733  | )
|Accumulated other comprehensive income                                                                                                                                                       |  |                   | (344    | ) |              |   | (609    | )
|Retained earnings                                                                                                                                                                            |  |                   | 34,674  |   |              |   | 34,780  |  
|Treasury stock, at cost; 1,840,442 shares at September 30, 2006 and 1,793,091 shares at June 30, 2006                                                                                        |  |                   | (24,382 | ) |              |   | (23,749 | )
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|Total stockholders equity                                                                                                                                                                   |  |                   | 74,442  |   |              |   | 74,543  |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|Total liabilities and stockholders equity                                                                                                                                                   |  | $                 | 331,398 |   |              | $ | 327,137 |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  

See accompanying notes to financial statements.



3



---

##### Table of Contents

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Earnings (Unaudited)

(Dollars in Thousands, Except Net Earnings Per Share)



|                                                    |  |                                 |       |      |   |       |  
|--------------------------------------------------- |  | ------------------------------- | ----- | ---- | - | ----- | -
|                                                    |  | Three Months EndedSeptember 30, |      
|                                                    |  | 2006                            |       | 2005 |  
|Interest income:                                    |  |                                 |       |      |   |       |  
|Interest on loans receivable                        |  | $                               | 4,734 |      | $ | 3,644 |  
|Interest on investment securities                   |  |                                 | 313   |      |   | 468   |  
|Other interest                                      |  |                                 | 87    |      |   | 82    |  
|                                                    |  |                                 |       |      |   |       |  
|Total interest income                               |  |                                 | 5,134 |      |   | 4,194 |  
|                                                    |  |                                 |       |      |   |       |  
|Interest expense:                                   |  |                                 |       |      |   |       |  
|Deposits                                            |  |                                 | 1,735 |      |   | 1,201 |  
|Advances from FHLB                                  |  |                                 | 650   |      |   | 179   |  
|                                                    |  |                                 |       |      |   |       |  
|Total interest expense                              |  |                                 | 2,385 |      |   | 1,380 |  
|                                                    |  |                                 |       |      |   |       |  
|Net interest income                                 |  |                                 | 2,749 |      |   | 2,814 |  
|Provision for loan losses                           |  |                                 |      |      |   |      |  
|                                                    |  |                                 |       |      |   |       |  
|Net interest income after provision for loan losses |  |                                 | 2,749 |      |   | 2,814 |  
|                                                    |  |                                 |       |      |   |       |  
|Noninterest income:                                 |  |                                 |       |      |   |       |  
|Dividends from investments                          |  |                                 | 30    |      |   | 17    |  
|Mortgage origination fee income                     |  |                                 | 150   |      |   | 186   |  
|Service charges and fees                            |  |                                 | 123   |      |   | 139   |  
|Gain (loss) on sale of investment securities, net   |  |                                 | 1     |      |   | (44   | )
|Gain on sale of foreclosed real estate, net         |  |                                 | 13    |      |   | 77    |  
|BOLI increase in cash value                         |  |                                 | 52    |      |   | 53    |  
|Other                                               |  |                                 | 18    |      |   | 28    |  
|                                                    |  |                                 |       |      |   |       |  
|Total noninterest income                            |  |                                 | 387   |      |   | 456   |  
|                                                    |  |                                 |       |      |   |       |  
|Noninterest expense:                                |  |                                 |       |      |   |       |  
|Compensation and benefits                           |  |                                 | 1,543 |      |   | 1,281 |  
|Occupancy expense                                   |  |                                 | 157   |      |   | 107   |  
|Equipment and data processing expense               |  |                                 | 344   |      |   | 240   |  
|DIF premiums                                        |  |                                 | 6     |      |   | 6     |  
|Advertising                                         |  |                                 | 169   |      |   | 64    |  
|REO expense                                         |  |                                 | 8     |      |   | 26    |  
|Other                                               |  |                                 | 439   |      |   | 351   |  
|                                                    |  |                                 |       |      |   |       |  
|Total noninterest expense                           |  |                                 | 2,666 |      |   | 2,075 |  
|                                                    |  |                                 |       |      |   |       |  
|Earnings before income taxes                        |  |                                 | 470   |      |   | 1,195 |  
|                                                    |  |                                 |       |      |   |       |  
|Income taxes:                                       |  |                                 |       |      |   |       |  
|Current                                             |  |                                 | 168   |      |   | 302   |  
|Deferred                                            |  |                                 | 12    |      |   | 108   |  
|                                                    |  |                                 |       |      |   |       |  
|Total income taxes                                  |  |                                 | 180   |      |   | 410   |  
|                                                    |  |                                 |       |      |   |       |  
|Net earnings                                        |  | $                               | 290   |      | $ | 785   |  
|                                                    |  |                                 |       |      |   |       |  
|Net earnings per share, basic                       |  | $                               | 0.05  |      | $ | 0.12  |  
|                                                    |  |                                 |       |      |   |       |  
|Net earnings per share, diluted                     |  | $                               | 0.05  |      | $ | 0.12  |  
|                                                    |  |                                 |       |      |   |       |  

See accompanying notes to financial statements.



4



---

##### Table of Contents

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders Equity

Three Months Ended September 30, 2006 and 2005 (Unaudited)

(Dollars in Thousands)



|                                                                                            |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|------------------------------------------------------------------------------------------- |  | ----------- | -- | ------------------------ | - | ----------------------------- |  | - | -------------------- | - |  | ----------------------------------- | ------ | - | ---------------- | - | ---- | ------------- |  | - | ------------------------ | - |  | - | ------- | - |  | - | ------ | -
|                                                                                            |  | CommonStock |    | AdditionalPaid-inCapital |   | UnallocatedCommonStock inESOP |  |   | UnearnedCompensation |   |  | AccumulatedOtherComprehensiveIncome |        |   | RetainedEarnings |   |      | TreasuryStock |  |   | TotalStockholdersEquity |  
|Balance at June 30, 2006                                                                    |  | $           | 84 |                          | $ | 72,171                        |  | $ | (5,401               | ) |  | $                                   | (2,733 | ) |                  | $ | (609 | )             |  | $ | 34,780                   |   |  | $ | (23,749 | ) |  | $ | 74,543 |  
|                                                                                            |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Comprehensive income:                                                                       |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Net earnings                                                                                |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | 290                      |   |  |   |        |   |  |   | 290    |  
|Change in net unrealized gain (loss) on securities available for sale, net of taxes of $164 |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   | 265  |               |  |   |                         |   |  |   |        |   |  |   | 265    |  
|                                                                                            |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Total comprehensive income                                                                  |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 555    |  
|Dividends                                                                                   |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | (396                     | ) |  |   |        |   |  |   | (396   | )
|Shares committed to be released by the employee stock ownership plan                        |  |             |   |                          |   | 34                            |  |   | 108                  |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 142    |  
|Stock options expensed                                                                      |  |             |   |                          |   | 66                            |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 66     |  
|Earned portion of stock grants                                                              |  |             |   |                          |   |                              |  |   |                     |   |  |                                     | 139    |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 139    |  
|Exercise of options                                                                         |  |             |   |                          |   | 26                            |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 26     |  
|Purchase of common stock (47,351 shares)                                                    |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   | (633    | ) |  |   | (633   | )
|                                                                                            |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Balance at September 30, 2006                                                               |  | $           | 84 |                          | $ | 72,297                        |  | $ | (5,293               | ) |  | $                                   | (2,594 | ) |                  | $ | (344 | )             |  | $ | 34,674                   |   |  | $ | (24,382 | ) |  | $ | 74,442 |  
|                                                                                            |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  



|                                                                                             |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|-------------------------------------------------------------------------------------------- |  | ----------- | -- | ------------------------ | - | ----------------------------- |  | - | -------------------- | - |  | ----------------------------------- | ------ | - | ---------------- | - | ---- | ------------- |  | - | ------------------------ | - |  | - | ------- | - |  | - | ------ | -
|                                                                                             |  | 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                                                                                 |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | 785                      |   |  |   |        |   |  |   | 785    |  
|Change in net unrealized gain (loss) on securities available for sale, net of taxes of $(62) |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   | (100 | )             |  |   |                         |   |  |   |        |   |  |   | (100   | )
|                                                                                             |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Total comprehensive income                                                                   |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 685    |  
|Dividends                                                                                    |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | (429                     | ) |  |   |        |   |  |   | (429   | )
|Shares committed to be released by the employee stock ownership plan                         |  |             |   |                          |   | 32                            |  |   | 108                  |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 140    |  
|Stock options expensed                                                                       |  |             |   |                          |   | 66                            |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 66     |  
|Earned portion of stock grants                                                               |  |             |   |                          |   |                              |  |   |                     |   |  |                                     | 110    |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 110    |  
|Purchase of common stock (137,981 shares)                                                    |  |             |   |                          |   |                              |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   | (1,816  | ) |  |   | (1,816 | )
|                                                                                             |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Balance at September 30, 2005                                                                |  | $           | 84 |                          | $ | 71,792                        |  | $ | (5,725               | ) |  | $                                   | (3,122 | ) |                  | $ | (255 | )             |  | $ | 34,425                   |   |  | $ | (16,415 | ) |  | $ | 80,784 |  
|                                                                                             |  |             |    |                          |   |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  

See accompanying notes to financial statements.



5



---

##### Table of Contents

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)



|                                                                                              |  |                                 |         |   |      |   |         |  
|--------------------------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                              |  | Three Months endedSeptember 30, |        
|                                                                                              |  | 2006                            |         |   | 2005 |  
|Cash flows from operating activities:                                                         |  |                                 |         |   |      |   |         |  
|Net earnings                                                                                  |  | $                               | 290     |   |      | $ | 785     |  
|Adjustments to reconcile net earnings to net cash provided by (used for) operating activities |  |                                 |         |   |      |   |         |  
|Allocated ESOP shares                                                                         |  |                                 | 142     |   |      |   | 140     |  
|Depreciation and amortization expense                                                         |  |                                 | 127     |   |      |   | 64      |  
|Amortization of premiums (discounts), net on investment securities                            |  |                                 | 3       |   |      |   | 8       |  
|(Gain) loss on sale of investment securities and mortgage-backed securities, net              |  |                                 | (1      | ) |      |   | 60      |  
|(Gain) on sale of equity investments                                                          |  |                                 |        |   |      |   | (16     | )
|FHLB stock dividends                                                                          |  |                                 | (25     | ) |      |   | (20     | )
|Amortization of deferred loan fees, net                                                       |  |                                 | (23     | ) |      |   | (29     | )
|Loss (gain) on sale of foreclosed real estate, net                                            |  |                                 | (13     | ) |      |   | (77     | )
|Deferred tax benefit                                                                          |  |                                 | 12      |   |      |   | 108     |  
|Originations of mortgage loans held for sale                                                  |  |                                 | (19,659 | ) |      |   | (19,355 | )
|Proceeds from sales of mortgage loans                                                         |  |                                 | 18,925  |   |      |   | 20,761  |  
|Increase in cash value of life insurance                                                      |  |                                 | (52     | ) |      |   | (53     | )
|Earned portion of MRP                                                                         |  |                                 | 139     |   |      |   | 110     |  
|Stock options expensed                                                                        |  |                                 | 66      |   |      |   | 66      |  
|Decrease (increase) in:                                                                       |  |                                 |         |   |      |   |         |  
|Accrued interest receivable                                                                   |  |                                 | 6       |   |      |   | 48      |  
|Other assets                                                                                  |  |                                 | 3,837   |   |      |   | 193     |  
|Increase (decrease) in other liabilities and accrued income taxes                             |  |                                 | (259    | ) |      |   | 325     |  
|                                                                                              |  |                                 |         |   |      |   |         |  
|Net cash provided by (used for) operating activities                                          |  |                                 | 3,515   |   |      |   | 3,118   |  
|                                                                                              |  |                                 |         |   |      |   |         |  
|Cash flows used for investing activities:                                                     |  |                                 |         |   |      |   |         |  
|Loan originations, net of principal collections                                               |  |                                 | (10,860 | ) |      |   | (6,003  | )
|Investment securities classified as available for sale:                                       |  |                                 |         |   |      |   |         |  
|Purchased                                                                                     |  |                                 |        |   |      |   | (165    | )
|Proceeds from sale                                                                            |  |                                 |        |   |      |   | 5,022   |  
|Proceeds from maturity                                                                        |  |                                 | 1,000   |   |      |   |        |  
|Return of principal on mortgage-backed securities                                             |  |                                 |        |   |      |   | 827     |  
|Purchase of premises and equipment                                                            |  |                                 | (469    | ) |      |   | (754    | )
|Proceeds from sale of (additions to) foreclosed real estate, net                              |  |                                 |        |   |      |   | 178     |  
|                                                                                              |  |                                 |         |   |      |   |         |  
|Net cash provided by (used for) investing activities                                          |  |                                 | (10,329 | ) |      |   | (895    | )
|                                                                                              |  |                                 |         |   |      |   |         |  
|Cash flows from financing activities:                                                         |  |                                 |         |   |      |   |         |  
|Net increase (decrease) in deposits                                                           |  |                                 | 9,287   |   |      |   | 1,369   |  
|Proceeds from advances from FHLB                                                              |  |                                 | 25,400  |   |      |   | 11,000  |  
|Repayment of FHLB advances                                                                    |  |                                 | (29,900 | ) |      |   | (6,000  | )
|Purchase of treasury stock                                                                    |  |                                 | (633    | ) |      |   | (1,816  | )
|Dividends paid                                                                                |  |                                 | (562    | ) |      |   | (729    | )
|Proceeds from exercise of stock options                                                       |  |                                 | 26      |   |      |   |        |  
|                                                                                              |  |                                 |         |   |      |   |         |  
|Net cash provided by (used for) financing activities                                          |  |                                 | 3,618   |   |      |   | 3,824   |  
|                                                                                              |  |                                 |         |   |      |   |         |  
|Net increase (decrease) in cash, cash equivalents and interest-earning deposits               |  |                                 | (3,196  | ) |      |   | 6,047   |  
|Cash, cash equivalents and interest-earning deposits at beginning of period                   |  |                                 | 11,956  |   |      |   | 11,027  |  
|                                                                                              |  |                                 |         |   |      |   |         |  
|Cash, cash equivalents and interest-earning deposits at end of period                         |  | $                               | 8,760   |   |      | $ | 17,074  |  
|                                                                                              |  |                                 |         |   |      |   |         |  
|Supplemental disclosures of cash flow information:                                            |  |                                 |         |   |      |   |         |  
|Cash paid during period for:                                                                  |  |                                 |         |   |      |   |         |  
|Interest on deposits                                                                          |  | $                               | 1,735   |   |      | $ | 1,201   |  
|Interest on FHLB advances                                                                     |  |                                 | 650     |   |      |   | 179     |  
|Income taxes                                                                                  |  |                                 | 75      |   |      |   | 365     |  
|Real estate acquired in settlement of loans                                                   |  |                                 |        |   |      |   | 109     |  

See accompanying notes to financial statements.



6



---

##### Table of Contents

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 September 30, 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, 2006.



|(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



7



---

##### Table of Contents

capital distribution by any institution, which would otherwise be permitted by the regulation, if the
Office of Thrift Supervision determined that such 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 EndedSeptember 30,
|                                                                                                                                            |  | 2006                                                                       |  | 2005     
|Weighted average number of common shares used in computing basic earnings per common share                                                  |  | 6,041,551                                                                  |  | 6,620,320
|Effect of dilutive stock options                                                                                                            |  | 7,915                                                                      |  | 13,169   
|                                                                                                                                            |  |                                                                            |  |          
|Weighted average number of common shares and dilutive potential common shares used in computing earnings per common share assuming
dilution |  | 6,049,466                                                                  |  | 6,633,489
|                                                                                                                                            |  |                                                                            |  |          



|(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 is recognized in conformity with the Financial Accounting Standards Board (FASB) Statement No. 118. There was no impairment of loans or allowance for loan losses related to impaired loans at
September 30, 2006. Other nonaccrual loans at September 30, 2006 were approximately $205,000. For the three months ended September 30, 2006, gross income which would have been recognized had nonaccrual loans been current in accordance
with their original terms amounted to approximately $4,000. Interest income from non-accrual loans included in the Companys interest income amounted to $1,000 for the three months ended September 30, 2006.



8



---

##### Table of Contents

The following table summarizes the activity in the allowance for loan losses for the three months ended
September 30, 2006:



|                              |  |                                                 |   |  |   |       |  
|----------------------------- |  | ----------------------------------------------- | - |  | - | ----- | -
|                              |  | Allowance for Loan Losses(Dollars in thousands) |  
|Balance at June 30, 2006      |  |                                                 |   |  | $ | 2,172 |  
|Provision for loan losses     |  |                                                 |   |  |   |      |  
|Charge-offs                   |  | (53                                             | ) |  |   |       |  
|Recoveries                    |  | 25                                              |   |  |   |       |  
|                              |  |                                                 |   |  |   |       |  
|Net (charge-offs)/recoveries  |  |                                                 |   |  |   | (28   | )
|                              |  |                                                 |   |  |   |       |  
|Balance at September 30, 2006 |  |                                                 |   |  | $ | 2,144 |  
|                              |  |                                                 |   |  |   |       |  



|(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 September 30, 2006, we had approximately $1.7 million in loan commitments, consisting of $750,000 in commitments to originate residential loans and $939,000 to originate commercial loans. In addition to
commitments to originate loans, we had $18.1 million of loans-in-process, $6.2 million in unused standby letters of credit and approximately $10.6 million in unused lines of credit.



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

On August 31,
2006, the Board of Directors of the Company approved a quarterly dividend of $0.06 per share to stockholders of record as of September 30, 2006 and payable on October 13, 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 September 30, 2006, there were 32,226 options outstanding and no remaining shares available for grant under the 1995 Stock Option Plan. During the
three-month period, 7,500 options were exercised.



9



---

##### Table of Contents

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 September 30, 2006, there were 401,778 options and 205,711 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.

The table below summarizes the status of the Companys stock option plans as of
September 30, 2006.



|                                          |  |                                      |  |                                |      
|----------------------------------------- |  | ------------------------------------ |  | ------------------------------ | -----
|                                          |  | Three Months EndedSeptember 30, 2006
|                                          |  | Shares                               |  | Weighted-averageexercise price
|Outstanding at beginning of period        |  | 441,504                              |  | $                              | 12.82
|Granted during the three-month period     |  |                                     |  |                                |     
|Options exercised                         |  | 7,500                                |  | $                              | 3.52 
|Outstanding at September 30, 2006         |  | 434,004                              |  | $                              | 12.98
|Options exercisable at September 30, 2006 |  | 192,948                              |  | $                              | 12.09

The following information applies to options outstanding at September 30, 2006:



|                                                |  |              
|----------------------------------------------- |  | -------------
|Number outstanding                              |  | 434,004      
|Range of exercise prices                        |  | $3.52 -$13.69
|Weighted-average exercise price                 |  | $12.98       
|Weighted-average remaining contractual life     |  | 6.83 years   
|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 2007 and $326,000 during 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



---

##### Table of Contents

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, 2006.

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, one-to four- family residential
properties, as well as 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



11



---

##### Table of Contents

our results are discussed in our Annual Report on Form 10-K for the year ended June 30, 2006 under Item 1A.
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 Months Ended September 30, 2006 and 2005

Net Income

Net income was $290,000, or $0.05 per diluted share, for the quarter ended September 30, 2006
compared to net income of $785,000, or $0.12 per diluted share, for the comparable period in 2005. The decline in net income for the three-month period ended September 30, 2006 was primarily the result of a decrease in net interest income and
noninterest income combined with an increase in noninterest expense. The increase in noninterest expense was attributable to the staffing and operational costs of two new full-service offices and our future branch office scheduled to open in 2007.



|                                      |  |                                              |      |   |      |   |      |  
|------------------------------------- |  | -------------------------------------------- | ---- | - | ---- | - | ---- | -
|                                      |  | Three Months EndedSeptember 30,              |     
|                                      |  | 2006                                         |      |   | 2005 |  
|                                      |  | (Dollars in thousands,except per share data) |     
|Net earnings                          |  | $                                            | 290  |   |      | $ | 785  |  
|Net earnings per share, basic         |  | $                                            | 0.05 |   |      | $ | 0.12 |  
|Net earnings per share, diluted       |  | $                                            | 0.05 |   |      | $ | 0.12 |  
|Return on average assets (annualized) |  |                                              | 0.35 | % |      |   | 1.05 | %
|Return on average equity (annualized) |  |                                              | 1.55 | % |      |   | 3.87 | %

Net Interest Income

Net interest income decreased $65,000, or 2.3%, to $2.7 million for the three months ended September 30, 2006 compared to the same period in 2005. The interest rate spread and net interest margin for the quarter
ended September 30, 2006 were 2.86% and 3.65%, respectively, compared to 3.38% and 4.06% for the corresponding period in 2005.



12



---

##### Table of Contents

The following table summarizes changes in interest income and expense for the three-month periods ended
September 30, 2006 and 2005:



|                          |  |                                |       |      |   |          |  |   |          |   |  |       |   
|------------------------- |  | ------------------------------ | ----- | ---- | - | -------- |  | - | -------- | - |  | ----- | --
|                          |  | Three MonthsEndedSeptember 30, |       |      |   |          |  |  
|                          |  | 2006                           |       | 2005 |   | $ Change |  |   | % Change |  
|                          |  | (Dollars in thousands)         |       |      |   |          |  |  
|Interest income:          |  |                                |       |      |   |          |  |   |          |   |  |       |   
|Loans                     |  | $                              | 4,734 |      | $ | 3,644    |  | $ | 1,090    |   |  | 29.9  | % 
|Investment securities     |  |                                | 313   |      |   | 468      |  |   | (155     | ) |  | (33.1 | )%
|Interest-earning deposits |  |                                | 62    |      |   | 62       |  |   |         |   |  | 0.0   | % 
|FHLB stock                |  |                                | 25    |      |   | 20       |  |   | 5        |   |  | 25.0  | % 
|                          |  |                                |       |      |   |          |  |   |          |   |  |       |   
|Total interest income     |  |                                | 5,134 |      |   | 4,194    |  |   | 940      |   |  | 22.4  | % 
|Interest expense:         |  |                                |       |      |   |          |  |   |          |   |  |       |   
|Deposits                  |  |                                | 1,735 |      |   | 1,201    |  |   | 534      |   |  | 44.5  | % 
|Borrowings                |  |                                | 650   |      |   | 179      |  |   | 471      |   |  | 263.1 | % 
|                          |  |                                |       |      |   |          |  |   |          |   |  |       |   
|Total interest expense    |  |                                | 2,385 |      |   | 1,380    |  |   | 1,005    |   |  | 72.8  | % 
|                          |  |                                |       |      |   |          |  |   |          |   |  |       |   
|Net interest income       |  | $                              | 2,749 |      | $ | 2,814    |  | $ | (65      | ) |  | (2.3  | )%
|                          |  |                                |       |      |   |          |  |   |          |   |  |       |   

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



|                          |  |                                  |         |            |      |   |                |   |            |  |      |  
|------------------------- |  | -------------------------------- | ------- | ---------- | ---- | - | -------------- | - | ---------- |  | ---- | -
|                          |  | Three Months Ended September 30, |        
|                          |  | 2006                             |         |            | 2005 |  
|                          |  | AverageBalance                   |         | Yield/Cost |      |   | AverageBalance |   | Yield/Cost | 
|                          |  | (Dollars in thousands)           |        
|Loans                     |  | $                                | 261,635 |            | 7.24 | % |                | $ | 214,867    |  | 6.78 | %
|Investment securities     |  |                                  | 31,655  |            | 3.96 | % |                |   | 50,968     |  | 3.67 | %
|Interest-earning deposits |  |                                  | 6,208   |            | 3.99 | % |                |   | 10,003     |  | 2.48 | %
|FHLB stock                |  |                                  | 1,755   |            | 5.70 | % |                |   | 1,665      |  | 4.80 | %
|Deposits                  |  |                                  | 191,556 |            | 3.62 | % |                |   | 186,218    |  | 2.58 | %
|Borrowings                |  |                                  | 49,683  |            | 5.23 | % |                |   | 21,000     |  | 3.41 | %

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.



13



---

##### Table of Contents

|                                                                  |  |                                   |      |   |      |   |      |     |  |   |       |  
|----------------------------------------------------------------- |  | --------------------------------- | ---- | - | ---- | - | ---- | --- |  | - | ----- | -
|                                                                  |  | Three Months 2006Compared to 2005 |     
|                                                                  |  | Increase (Decrease) Due To        |      |   |      |  
|                                                                  |  | Volume                            |      |   | Rate |   |      | Net | 
|                                                                  |  | (In thousands)                    |     
|Interest income:                                                  |  |                                   |      |   |      |   |      |     |  |   |       |  
|Loans receivable                                                  |  | $                                 | 807  |   |      | $ | 283  |     |  | $ | 1,090 |  
|Mortgage-backed securities                                        |  |                                   | (76  | ) |      |   |     |     |  |   | (76   | )
|Investment securities                                             |  |                                   | (113 | ) |      |   | 26   |     |  |   | (87   | )
|Municipals                                                        |  |                                   | 6    |   |      |   | 2    |     |  |   | 8     |  
|Daily interest-earning deposits and other interest-earning assets |  |                                   | 20   |   |      |   | (15  | )   |  |   | 5     |  
|                                                                  |  |                                   |      |   |      |   |      |     |  |   |       |  
|Total interest-earning assets                                     |  |                                   | 644  |   |      |   | 296  |     |  |   | 940   |  
|                                                                  |  |                                   |      |   |      |   |      |     |  |   |       |  
|Interest expense:                                                 |  |                                   |      |   |      |   |      |     |  |   |       |  
|Deposits                                                          |  |                                   | 47   |   |      |   | 487  |     |  |   | 534   |  
|Borrowings                                                        |  |                                   | 294  |   |      |   | 177  |     |  |   | 471   |  
|                                                                  |  |                                   |      |   |      |   |      |     |  |   |       |  
|Total interest-bearing liabilities                                |  |                                   | 341  |   |      |   | 664  |     |  |   | 1,005 |  
|                                                                  |  |                                   |      |   |      |   |      |     |  |   |       |  
|Net change in interest income                                     |  | $                                 | 303  |   |      | $ | (368 | )   |  | $ | (65   | )
|                                                                  |  |                                   |      |   |      |   |      |     |  |   |       |  

Total interest income increased $940,000, or 22.4%, to $5.1 million for the three months ended September 30,
2006 compared to the same period in 2005. The average yield on interest-earning assets increased 77 basis points to 6.82% while the average volume of earning assets increased $23.8 million, to $301.3 million at September 30, 2006 compared to
the same period in 2005.

Interest on loans increased $1.1 million, or 29.9%, to $4.7 million for the three months ended September 30, 2006. The
increase in interest on loans is the result of a higher average balance, primarily due to growth in the commercial loan portfolio, combined with a higher average yield. The average balance of loans increased $46.8 million, or 21.8%, to $261.6
million for the three months ended September 30, 2006. 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 45 basis points, to 7.24%, for the three
months ended September 30, 2006 compared to the corresponding period in 2005.

Interest on investment securities decreased $155,000, or 33.1%, to
$313,000 for the three months ended September 30, 2006. The average balance of investment securities decreased $19.3 million, or 37.9%, to $31.7 million for the three months ended September 30, 2006 as proceeds from investment sales have
been used to fund growth in the loan portfolio. The average yield on investments increased 28 basis points to 3.96% for the three months ended September 30, 2006 compared to the same period in 2005. Dividends on Federal Home Loan Bank
(FHLB) stock were $25,000 for the three-month period ended September 30, 2006, compared to $20,000 for the comparable period in 2005. FHLB dividends are paid with additional shares of FHLB stock.

Total interest expense increased $1.0 million, or 72.8%, to $2.4 million for the three-month period ended September 30, 2006 compared to the same period in 2005.
The average rate paid on interest-bearing liabilities increased 129 basis points to 3.95% while the average volume of interest-earning liabilities increased $34.0 million, to $241.2 million at September 30, 2006 compared to the same period in
2005.



14



---

##### Table of Contents

Interest expense on deposits increased $534,000, or 44.5%, to $1.7 million for the three-month period ended
September 30, 2006 due to growth in the average balance of certificates of deposit combined with higher interest rates. The average balance of certificates of deposit increased $9.5 million, or 7.9%, to $129.0 million at September 30, 2006
and the rate paid increased 122 basis points to 4.26%. The average balance of certificates of deposit has increased due to promotional rates offered in connection with the opening of our two new full-service offices in addition to customer
preference for higher-yielding deposit accounts.

Interest expense on FHLB advances amounted to $650,000 for the three months ended September 30, 2006
compared to $179,000 for the corresponding period in 2005, due to a higher average balance and a higher rate paid. FHLB advances have been utilized as a funding source for supporting loan growth.

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 quarter ended September 30, 2006 were $28,000, or 0.04% of average loans, compared to $12,000, or 0.02% of average loans for the quarter ended September 30, 2005. There were no
additions to the allowance for loan losses for either three-month period. Nonperforming loans totaled $205,000 at September 30, 2006 compared to $221,000 at September 30, 2005.

Noninterest Income

Noninterest income decreased $69,000, or 15.1%, to $387,000 for the three months ended
September 30, 2006 compared to $456,000 for the corresponding period in 2005. A loss on sale of investment securities totaling $44,000 was recorded in the three-month period ended September 30, 2005 and included as a component of
noninterest income. Gain on sale of foreclosed property was $13,000 for the three months ended September 30, 2006 compared to $77,000 for the same period in 2005. Mortgage origination fee income decreased $36,000, or 19.4%, to $150,000 due to a
lower volume of loan originations. Service charge and fee income decreased $16,000, or 11.5%, to $123,000 for the three months ended September 30, 2006 primarily due to a decrease in late charge fee income.



15



---

##### Table of Contents

The following table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent
changes for the three months ended September 30, 2006 compared to the same period in 2005.



|                                                  |  |                                 |     |      |          |     |   |          |   |     |   |  |       |   
|------------------------------------------------- |  | ------------------------------- | --- | ---- | -------- | --- | - | -------- | - | --- | - |  | ----- | --
|                                                  |  | Three Months EndedSeptember 30, |     |      | $ Change |     |   | % Change |  
|                                                  |  | 2006                            |     | 2005 |          |     |  
|                                                  |  | (Dollars in thousands)          |     |      |          |     |   |          |  
|Noninterest income:                               |  |                                 |     |      |          |     |   |          |   |     |   |  |       |   
|Dividends from investments                        |  | $                               | 30  |      | $        | 17  |   |          | $ | 13  |   |  | 76.5  | % 
|Mortgage origination fee income                   |  |                                 | 150 |      |          | 186 |   |          |   | (36 | ) |  | (19.4 | )%
|Service charges and fees                          |  |                                 | 123 |      |          | 139 |   |          |   | (16 | ) |  | (11.5 | )%
|Gain (loss) on sale of investment securities, net |  |                                 | 1   |      |          | (44 | ) |          |   | 45  |   |  | 102.3 | % 
|Gain on sale of foreclosed real estate, net       |  |                                 | 13  |      |          | 77  |   |          |   | (64 | ) |  | (83.1 | )%
|BOLI increase in cash value                       |  |                                 | 52  |      |          | 53  |   |          |   | (1  | ) |  | (1.9  | )%
|Other                                             |  |                                 | 18  |      |          | 28  |   |          |   | (10 | ) |  | (35.7 | )%
|                                                  |  |                                 |     |      |          |     |   |          |   |     |   |  |       |   
|Total noninterest income                          |  | $                               | 387 |      | $        | 456 |   |          | $ | (69 | ) |  | (15.1 | )%
|                                                  |  |                                 |     |      |          |     |   |          |   |     |   |  |       |   

Noninterest Expense

Noninterest expense increased $591,000 or 28.5%, to $2.7 million for the three-month period ended September 30, 2006, primarily due to an increase in compensation and benefits expense. Compensation and benefits
expense increased $262,000, or 20.5%, to $1.5 million for the three-month period ended September 30, 2006 primarily due to staff additions for our two new branch offices in Hamblen and Knox Counties and our future branch office in Knox County
scheduled to open in 2007. There were 95 full-time employees at September 30, 2006 compared to 81 full-time employees at September 30, 2005. Advertising expense amounted to $169,000 for the three months ended September 30, 2006
compared to $64,000 for the corresponding period in 2005 as a result of marketing efforts and promotions associated with the opening of our two new branch offices. Occupancy expense increased $50,000, or 46.7%, to $157,000 and equipment and data
processing expense increased $104,000, or 43.3%, to $344,000. The increases in occupancy, equipment and data processing expenses were also the result of our recent expansion activities.

The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the three months ended September 30, 2006 compared to the same period in 2005.



|                                      |  |                                 |       |          |   |       |          |   |     |   |  |       |   
|------------------------------------- |  | ------------------------------- | ----- | -------- | - | ----- | -------- | - | --- | - |  | ----- | --
|                                      |  | Three Months EndedSeptember 30, |       | $ Change |   |       | % Change |  
|                                      |  | 2006                            |       | 2005     |   |      
|                                      |  | (Dollars in thousands)          |       |          |   |       |          |  
|Compensation and benefits             |  | $                               | 1,543 |          | $ | 1,281 |          | $ | 262 |   |  | 20.5  | % 
|Occupancy expense                     |  |                                 | 157   |          |   | 107   |          |   | 50  |   |  | 46.7  | % 
|Equipment and data processing expense |  |                                 | 344   |          |   | 240   |          |   | 104 |   |  | 43.3  | % 
|Deposit insurance premiums            |  |                                 | 6     |          |   | 6     |          |   |    |   |  | 0.0   | % 
|Advertising                           |  |                                 | 169   |          |   | 64    |          |   | 105 |   |  | 164.1 | % 
|REO expense                           |  |                                 | 8     |          |   | 26    |          |   | (18 | ) |  | (69.2 | )%
|Other                                 |  |                                 | 439   |          |   | 351   |          |   | 88  |   |  | 25.1  | % 
|                                      |  |                                 |       |          |   |       |          |   |     |   |  |       |   
|Total noninterest expense             |  | $                               | 2,666 |          | $ | 2,075 |          | $ | 591 |   |  | 28.5  | % 
|                                      |  |                                 |       |          |   |       |          |   |     |   |  |       |   



16



---

##### Table of Contents

Income Taxes

Income tax expense for the three months ended September 30, 2006 was $180,000 compared to $410,000 for the same period in 2005 due to lower taxable income.

Financial Condition

Assets

At September 30, 2006, total assets were $331.4 million, an increase of $4.3 million, or 1.3%, compared to $327.1 million at June 30, 2006. The increase in
assets was attributable to a $10.9 million increase in loans, funded primarily by a $9.3 million increase in deposits.

Cash, Cash Equivalents and
Interest-Earning Deposits

Cash, cash equivalents, and interest-earning deposits were $8.8 million at September 30, 2006 compared to $12.0
million at June 30, 2006. We manage the level of cash, cash equivalents and interest-earning deposits to meet loan demand and daily liquidity needs.

Investments

Our investment portfolio consists primarily of federal agency securities with maturities of seven years or less, and
municipal securities. Investment securities decreased $574,000, or 1.8%, to $31.3 million due primarily to maturities of investment securities during the three-month period. Investment securities classified as available-for-sale are carried at fair
market value and reflect an unrealized loss of $557,000, or $344,000 net of taxes.



17



---

##### Table of Contents

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 September 30, 2006



|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|------------------------------------ |  | ---------------------- | ------ | - | --------------- | - | ---------------- |  | - | --------- | - |  | - | ------
|                                     |  | AmortizedCost          |        |   | UnrealizedGains |   | UnrealizedLosses |  |   | FairValue
|                                     |  | (Dollars in thousands)
|Securities available-for-sale        |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Debt securities:                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Federal agency                       |  | $                      | 27,331 |   |                 | $ | 2                |  | $ | (468      | ) |  | $ | 26,865
|Municipals                           |  |                        | 4,497  |   |                 |   | 2                |  |   | (93       | ) |  |   | 4,406 
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Total securities available- for-sale |  | $                      | 31,828 |   |                 | $ | 4                |  | $ | (561      | ) |  | $ | 31,271
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Weighted-average rate                |  |                        | 3.82   | % |                 |   |                  |  |   |           |   |  |   |       
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       

At June 30, 2006



|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|------------------------------------ |  | ---------------------- | ------ | - | --------------- | - | ---------------- |  | - | --------- | - |  | - | ------
|                                     |  | AmortizedCost          |        |   | UnrealizedGains |   | UnrealizedLosses |  |   | FairValue
|                                     |  | (Dollars in thousands)
|Securities available-for-sale        |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Debt securities:                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Federal agency                       |  | $                      | 28,330 |   |                 | $ |                 |  | $ | (827      | ) |  | $ | 27,503
|Municipals                           |  |                        | 4,502  |   |                 |   |                  |  |   | (160      | ) |  |   | 4,342 
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Total securities available- for-sale |  | $                      | 32,832 |   |                 | $ |                 |  | $ | (987      | ) |  | $ | 31,845
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       
|Weighted-average rate                |  |                        | 3.36   | % |                 |   |                  |  |   |           |   |  |   |       
|                                     |  |                        |        |   |                 |   |                  |  |   |           |   |  |   |       

Loans

Net loans increased $10.9 million, or 4.3%, to $265.0 million at September 30, 2006. Our expansion into the Knoxville, Tennessee market has generated additional lending opportunities, which has resulted in growth in our loan portfolio.
Our primary lending activity is the origination of loans secured by real estate. Real estate loans totaled $219.3 million, or 81.9% of gross loans, at September 30, 2006 compared to $209.4 million, or 81.6% of gross loans, at June 30,
2006. 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 $8.1 million, or 10.5%, to $85.7 million at September 30, 2006.

Commercial business loans increased $747,000, or 2.1%, to $36.4 million at September 30, 2006. Commercial business loans were 13.6% of gross loans at September 30, 2006 compared to 13.9% of gross loans at
June 30, 2006. Most of the commercial business loans that we have originated have rates based on the prime interest rate and will therefore 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 $11.9 million and represented 4.4% of total loans at
September 30, 2006 compared to $11.5 million, or 4.5% of total loans at June 30, 2006.



18



---

##### Table of Contents

Loans receivable, net, are summarized as follows:



|                               |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|------------------------------ |  | ---------------------- | ------- | - | ------------------- | ----- | - | ------ | - | ------- | ------------------- |  | ----- | -------- |  | - | ------- | - |  | ----- | --
|                               |  | At September 30, 2006  |         |   | At June 30, 2006    |       |   |        |   |         |                     | 
|                               |  | Amount                 |         |   | Percent ofPortfolio |       |   | Amount |   |         | Percent ofPortfolio |  |       | $ Change |  |   | %Change |  
|                               |  | (Dollars in thousands) |         |   |                     |       |   |        |  
|Real estate loans:             |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|Residential one-to four-family |  | $                      | 77,270  |   |                     | 28.9  | % |        | $ | 77,415  |                     |  | 30.2  | %        |  | $ | (145    | ) |  | (0.2  | )%
|Home equity line of credit     |  |                        | 4,775   |   |                     | 1.8   | % |        |   | 5,954   |                     |  | 2.3   | %        |  |   | (1,179  | ) |  | (19.8 | )%
|Commercial                     |  |                        | 85,650  |   |                     | 32.0  | % |        |   | 77,519  |                     |  | 30.2  | %        |  |   | 8,131   |   |  | 10.5  | % 
|Multi-family                   |  |                        | 8,153   |   |                     | 3.0   | % |        |   | 7,929   |                     |  | 3.1   | %        |  |   | 224     |   |  | 2.8   | % 
|Construction                   |  |                        | 15,816  |   |                     | 5.9   | % |        |   | 13,454  |                     |  | 5.2   | %        |  |   | 2,362   |   |  | 17.6  | % 
|Land                           |  |                        | 27,621  |   |                     | 10.3  | % |        |   | 27,133  |                     |  | 10.6  | %        |  |   | 488     |   |  | 1.8   | % 
|                               |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|Total real estate loans        |  |                        | 219,285 |   |                     | 81.9  | % |        |   | 209,404 |                     |  | 81.6  | %        |  |   | 9,881   |   |  | 4.7   | % 
|                               |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|Commercial business loans      |  |                        | 36,412  |   |                     | 13.6  | % |        |   | 35,665  |                     |  | 13.9  | %        |  |   | 747     |   |  | 2.1   | % 
|                               |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|Consumer loans                 |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|Automobile loans               |  |                        | 8,337   |   |                     | 3.1   | % |        |   | 8,458   |                     |  | 3.3   | %        |  |   | (121    | ) |  | (1.4  | )%
|Mobile home loans              |  |                        | 211     |   |                     | 0.1   | % |        |   | 234     |                     |  | 0.1   | %        |  |   | (23     | ) |  | (9.8  | )%
|Loans secured by deposits      |  |                        | 870     |   |                     | 0.3   | % |        |   | 977     |                     |  | 0.4   | %        |  |   | (107    | ) |  | (11.0 | )%
|Other consumer loans           |  |                        | 2,488   |   |                     | 0.9   | % |        |   | 1,854   |                     |  | 0.7   | %        |  |   | 634     |   |  | 34.2  | % 
|                               |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|Total consumer loans           |  |                        | 11,906  |   |                     | 4.4   | % |        |   | 11,523  |                     |  | 4.5   | %        |  |   | 383     |   |  | 3.3   | % 
|                               |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|Total gross loans              |  |                        | 267,603 |   |                     | 100.0 | % |        |   | 256,592 |                     |  | 100.0 | %        |  |   | 11,011  |   |  | 4.3   | % 
|                               |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|Less:                          |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|Deferred loan fees, net        |  |                        | (426    | ) |                     |       |   |        |   | (293    | )                   |  |       |          |  |   | (133    | ) |  | 45.4  | % 
|Allowance for losses           |  |                        | (2,144  | ) |                     |       |   |        |   | (2,172  | )                   |  |       |          |  |   | 28      |   |  | (1.3  | )%
|                               |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   
|Loans receivable, net          |  | $                      | 265,033 |   |                     |       |   |        | $ | 254,127 |                     |  |       |          |  | $ | 10,906  |   |  | 4.3   | % 
|                               |  |                        |         |   |                     |       |   |        |   |         |                     |  |       |          |  |   |         |   |  |       |   

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.

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.



19



---

##### Table of Contents

Due to net charge-offs, the allowance for loan losses decreased $28,000 to $2.1 million at September 30, 2006. There
were no additions to the allowance for loan losses during the three-month period ended September 30, 2006. Our allowance for loan losses represented 0.80% of total gross loans at September 30, 2006 compared to 0.85% of total gross loans at
June 30, 2006.



|                                                                           |  |                                 |       |   |      |   |       |  
|-------------------------------------------------------------------------- |  | ------------------------------- | ----- | - | ---- | - | ----- | -
|                                                                           |  | Three Months EndedSeptember 30, |      
|                                                                           |  | 2006                            |       |   | 2005 |  
|                                                                           |  | (Dollars in thousands)          |      
|Balance at beginning of period                                             |  | $                               | 2,172 |   |      | $ | 2,293 |  
|Provision for loan losses                                                  |  |                                 |      |   |      |   |      |  
|Recoveries                                                                 |  |                                 | 25    |   |      |   | 36    |  
|Charge-offs                                                                |  |                                 | (53   | ) |      |   | (48   | )
|                                                                           |  |                                 |       |   |      |   |       |  
|Net charge-offs                                                            |  |                                 | (28   | ) |      |   | (12   | )
|                                                                           |  |                                 |       |   |      |   |       |  
|Allowance at end of period                                                 |  | $                               | 2,144 |   |      | $ | 2,281 |  
|                                                                           |  |                                 |       |   |      |   |       |  
|Net charge-offs to average outstanding loans during the period, annualized |  |                                 | 0.04  | % |      |   | 0.02  | %

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 $271,000 at September 30, 2006 compared to $435,000 at June 30, 2006. Nonperforming loans were $205,000 and $345,000 at September 30, 2006 and June 30, 2006, respectively. Foreclosed real estate amounted
to $66,000 at September 30, 2006 compared to $74,000 at June 30, 2006. 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.



|                                                       |  |                        |         |   |              |   |        |  
|------------------------------------------------------ |  | ---------------------- | ------- | - | ------------ | - | ------ | -
|                                                       |  | September 30,2006      |         |   | June 30,2006 |  
|                                                       |  | (Dollars in thousands) |        
|Nonaccruing loans:                                     |  |                        |         |   |              |   |        |  
|Real estate                                            |  | $                      | 138     |   |              | $ | 296    |  
|Commercial business                                    |  |                        | 50      |   |              |   | 49     |  
|Consumer                                               |  |                        | 17      |   |              |   |       |  
|                                                       |  |                        |         |   |              |   |        |  
|Total nonaccrual loans                                 |  |                        | 205     |   |              |   | 345    |  
|                                                       |  |                       
|Real estate owned                                      |  |                        | 66      |   |              |   | 74     |  
|Other repossessed assets                               |  |                        |        |   |              |   | 16     |  
|                                                       |  |                        |         |   |              |   |        |  
|Total nonperforming assets                             |  | $                      | 271     |   |              | $ | 435    |  
|                                                       |  |                        |         |   |              |   |        |  
|Total nonperforming assets to total assets             |  |                        | 0.08    | % |              |   | 0.13   | %
|Total nonperforming loans to total loans               |  |                        | 0.08    | % |              |   | 0.13   | %
|Allowance for loan losses to total nonperforming loans |  |                        | 1045.85 | % |              |   | 629.57 | %



20



---

##### Table of Contents

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 September 30, 2006 was $5.5 million.

Deposits

Total deposits increased $9.3 million, or 4.7%, to $208.1 million at September 30, 2006 primarily as a result of marketing efforts and promotions associated with the
opening of our two new full-service offices. Certificates of deposit increased $7.6 million, or 6.1%, to $132.2 million primarily due to promotions and customer preference for higher-yielding accounts. The increase in deposits has provided funding
for loan growth and reduced our reliance on FHLB advances during the quarter ended September 30, 2006.



|                              |  |                        |         |              |   |          |  |   |          |   |  |      |   
|----------------------------- |  | ---------------------- | ------- | ------------ | - | -------- |  | - | -------- | - |  | ---- | --
|                              |  | September 30,2006      |         | June 30,2006 |   | $ Change |  |   | % Change |  
|                              |  | (Dollars in thousands) |         |              |   |          |  |  
|Non-interest bearing accounts |  | $                      | 12,341  |              | $ | 10,806   |  | $ | 1,535    |   |  | 14.2 | % 
|NOW accounts                  |  |                        | 17,059  |              |   | 16,408   |  |   | 651      |   |  | 4.0  | % 
|Savings accounts              |  |                        | 10,817  |              |   | 11,524   |  |   | (707     | ) |  | (6.1 | )%
|Money market accounts         |  |                        | 35,726  |              |   | 35,502   |  |   | 224      |   |  | 0.6  | % 
|Certificates of deposit       |  |                        | 132,187 |              |   | 124,603  |  |   | 7,584    |   |  | 6.1  | % 
|                              |  |                        |         |              |   |          |  |   |          |   |  |      |   
|                              |  | $                      | 208,130 |              | $ | 198,843  |  | $ | 9,287    |   |  | 4.7  | % 
|                              |  |                        |         |              |   |          |  |   |          |   |  |      |   

Advances and Other Liabilities

FHLB advances decreased $4.5 million to $47.9 million at September 30, 2006. We utilize FHLB cash management overnight advances as a funding source to manage daily liquidity needs. Additional FHLB advances may be
utilized in the future to support loan growth.

Stockholders Equity

Stockholders equity totaled $74.4 million at September 30, 2006 compared to $74.5 million at June 30, 2006. Retained earnings decreased $106,000 to $34.7 million at September 30, 2006 due to net
earnings of $290,000 partially offset by the payment of dividends to shareholders in the amount of $396,000. Unrealized gains and losses, net of taxes, in the available-for-sale investment portfolio are reflected as an adjustment to
stockholders equity. At September 30, 2006, the adjustment to stockholders equity was an unrealized loss of $344,000 compared to a net unrealized loss of $609,000 at June 30, 2006. During the three-month period ended
September 30, 2006, the Company repurchased 47,351 shares of its common stock at a cost of $633,000.

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 FHLB 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.



21



---

##### Table of Contents

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 September 30, 2006, cash and cash equivalents totaled $3.4 million and interest-earning deposits totaled $5.3 million. Securities classified as
available-for-sale, which provide additional sources of liquidity, totaled $31.3 million at September 30, 2006. In addition, at September 30, 2006, we had arranged the ability to borrow a total of approximately $59.3 million from the FHLB
of Cincinnati. In the three-month period ended September 30, 2006, FHLB advances decreased $4.5 million to $47.9 million.

We anticipate that we will
have sufficient funds available to meet current loan commitments. At September 30, 2006, we had approximately $1.7 million in loan commitments, consisting of $750,000 in commitments to originate residential loans and $939,000 to originate
commercial loans. In addition to commitments to originate loans, we had $18.1 million in loans-in-process, $6.2 million in unused standby letters of credit and approximately $10.6 million in unused lines of credit. We had $94.3 million in
certificates of deposit due within one year and $75.9 million in other deposits without specific maturities at September 30, 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 $9.3 million during the three-month period ended September 30, 2006.

At September 30, 2006, the average liquidity
ratio was 13.59% compared to 25.88% at September 30, 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 September 30, 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.



22



---

##### Table of Contents

Capital Compliance

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



|                          |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|------------------------- |  | ---------------------- | ------ | ----- | ----------------------------- | - | ------ | ---------------------------------------------------------------- | ------ | ----- |  | --- | ------ |  | - | ------ | - |  | ---- | -
|                          |  | Actual                 |        |       | For Capital Adequacy Purposes |   |        | To Be Well Capitalized Under Prompt Corrective Action Provisions |       
|                          |  | Amount                 |        | Ratio |                               |   | Amount |                                                                  |        | Ratio |  |     | Amount |  |   | Ratio  |  
|                          |  | (Dollars in thousands) |       
|At September 30, 2006     |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|                          |  |                        |        |       |                               |  
|Total Capital             |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|(To Risk Weighted Assets) |  | $                      | 67,380 |       | 26.9                          | % |        | $                                                                | 20,071 | >     |  | 8.0 | %      |  | $ | 25,089 | > |  | 10.0 | %
|Core Capital              |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|(To Tangible Assets)      |  |                        | 65,508 |       | 19.9                          | % |        |                                                                  | 13,162 | >     |  | 4.0 | %      |  |   | 16,452 | > |  | 5.0  | %
|Tangible Capital          |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|(To Tangible Assets)      |  |                        | 65,508 |       | 19.9                          | % |        |                                                                  | 4,936  | >     |  | 1.5 | %      |  |   | N/A    |   |  |      |  
|Tier 1 Capital            |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|(To Risk Weighted Assets) |  |                        | 65,508 |       | 26.1                          | % |        |                                                                  | N/A    |       |  |     |        |  |   | 15,054 | > |  | 6.0  | %
|                          |  |                        |        |       |                               |  
|At June 30, 2006          |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|                          |  |                        |        |       |                               |  
|Total Capital             |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|(To Risk Weighted Assets) |  | $                      | 67,000 |       | 27.5                          | % |        | $                                                                | 19,523 | >     |  | 8.0 | %      |  | $ | 24,404 | > |  | 10.0 | %
|Core Capital              |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|(To Tangible Assets)      |  |                        | 65,100 |       | 20.1                          | % |        |                                                                  | 12,961 | >     |  | 4.0 | %      |  |   | 16,201 | > |  | 5.0  | %
|Tangible Capital          |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|(To Tangible Assets)      |  |                        | 65,100 |       | 20.1                          | % |        |                                                                  | 4,860  | >     |  | 1.5 | %      |  |   | N/A    |   |  |      |  
|Tier 1 Capital            |  |                        |        |       |                               |   |        |                                                                  |        |       |  |     |        |  |   |        |   |  |      |  
|(To Risk Weighted Assets) |  |                        | 65,100 |       | 26.7                          | % |        |                                                                  | N/A    |       |  |     |        |  |   | 14,643 | > |  | 6.0  | %



23



---

##### Table of Contents

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, 2006.
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, 2006.

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 September 30,
2006 that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.



24



---

##### Table of Contents

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, 2006.

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 Progams |        | ( d )Maximum Number(or ApproximateDollar
Value) of Shares (orUnits) That MayYet Be PurchasedUnder the Plans or Programs |        
|Month #1           |  |                                               |  |                                        |       |                                                                                             |        |                                                                                                                         |         |    
|July 1, 2006       |  |                                              |  |                                        |      |                                                                                             |       |                                                                                                                         | 574,274 | (1)
|through            |  |                                               |  |                                        |       |                                                                                             |        |                                                                                                                         |         |    
|July 31, 2006      |  |                                               |  |                                        |       |                                                                                             |        |                                                                                                                         |         |    
|                   |  |                                               |  |                                       
|Month #2           |  |                                               |  |                                        |       |                                                                                             |        |                                                                                                                         |         |    
|August 1, 2006     |  | 19,303                                        |  | $                                      | 13.42 |                                                                                             | 19,303 |                                                                                                                         | 554,971 | (1)
|through            |  |                                               |  |                                        |       |                                                                                             |        |                                                                                                                         |         |    
|August 31, 2006    |  |                                               |  |                                        |       |                                                                                             |        |                                                                                                                         |         |    
|                   |  |                                               |  |                                       
|Month #3           |  |                                               |  |                                        |       |                                                                                             |        |                                                                                                                         |         |    
|September 1, 2006  |  | 28,048                                        |  | $                                      | 13.34 |                                                                                             | 28,048 |                                                                                                                         | 526,923 | (1)
|through            |  |                                               |  |                                        |       |                                                                                             |        |                                                                                                                         |         |    
|September 30, 2006 |  |                                               |  |                                        |       |                                                                                             |        |                                                                                                                         |         |    
|                   |  |                                               |  |                                       
|Total              |  | 47,351                                        |  | $                                      | 13.38 |                                                                                             | 47,351 |                                                                                                                         | 526,923 |    

---

|(1) | 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.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



25



---

##### Table of Contents

Item 3. Defaults Upon Senior Securities



| | None.
| | -----

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



| | None.
| | -----

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
| | ---- | --------------------------



26



---

##### Table of Contents

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.                      
|                 | 
|November 9, 2006 |  | /s/ Anderson L. Smith                           
|                 |  | Anderson L. Smith                               
|                 |  | President and Chief Executive Officer           
|                 | 
|November 9, 2006 |  | /s/ Jane P. Hutton                              
|                 |  | Jane P. Hutton                                  
|                 |  | Chief Financial Officer, Treasurer and Secretary