##### 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, 2008

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, a non-accelerated filer, or a smaller reporting company. See definition of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of
the Exchange Act. (Check one)



| |  |                                               |  |                             
| |  | --------------------------------------------- |  | ----------------------------
| |  | Large Accelerated Filer   ̈                    |  | Accelerated Filer  x        
| |  |                                              
| |  | Non-Accelerated Filer   ̈                      |  | Smaller Reporting Company  x
| |  | (Do not check if a smaller reporting company) |  |                             

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes   ̈    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, 2008, the registrant had 6,194,804 shares of common stock, $0.01 par value per share, outstanding.









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##### Table of Contents

INDEX



|                              |  |                                                                                                                       |  |     
|----------------------------- |  | --------------------------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                                       |  | Page
|PART I. FINANCIAL INFORMATION
|                              |  |                                                                                                                      
|Item 1.                       |  | Financial Statements                                                                                                  |  |     
|                              |  |                                                                                                                      
|                              |  | Consolidated Statements of Condition  Unaudited Three months ended September 30, 2008 and year ended June 30, 2008   |  | 3   
|                              |  |                                                                                                                      
|                              |  | Consolidated Statements of Earnings  Unaudited Three months ended September 30, 2008 and 2007                        |  | 4   
|                              |  |                                                                                                                      
|                              |  | Consolidated Statements of Changes in Stockholders Equity  Unaudited Three months ended September 30, 2008 and 2007 |  | 5   
|                              |  |                                                                                                                      
|                              |  | Consolidated Statements of Cash Flows  Unaudited Three months ended September 30, 2008 and 2007                      |  | 6   
|                              |  |                                                                                                                      
|                              |  | Notes to Consolidated Financial Statements  Unaudited                                                                |  | 7   
|                              |  |                                                                                                                      
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                 |  | 12  
|                              |  |                                                                                                                      
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                            |  | 25  
|                              |  |                                                                                                                      
|Item 4.                       |  | Controls and Procedures                                                                                               |  | 25  
|                             
|PART II. OTHER INFORMATION   
|                              |  |                                                                                                                      
|Item 1.                       |  | Legal Proceedings                                                                                                     |  | 26  
|                              |  |                                                                                                                      
|Item 1A.                      |  | Risk Factors                                                                                                          |  | 26  
|                              |  |                                                                                                                      
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                           |  | 26  
|                              |  |                                                                                                                      
|Item 3.                       |  | Defaults Upon Senior Securities                                                                                       |  | 27  
|                              |  |                                                                                                                      
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                                                   |  | 27  
|                              |  |                                                                                                                      
|Item 5.                       |  | Other Information                                                                                                     |  | 27  
|                              |  |                                                                                                                      
|Item 6.                       |  | Exhibits                                                                                                              |  | 27  
|                              | 
|SIGNATURES                    |  |                                                                                                                      



2



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##### Table of Contents

PART I. FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Condition

(Dollars in thousands)



|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ------------ | - | ------- | -
|                                                                                                                                                                                             |  | September 30,2008 |         |   | June 30,2008 |  
|                                                                                                                                                                                             |  | (Unaudited)       |         |   |              |  
|Assets                                                                                                                                                                                       |  |                   |         |   |              |   |         |  
|                                                                                                                                                                                             |  |                  
|Cash and cash equivalents                                                                                                                                                                    |  | $                 | 2,609   |   |              | $ | 2,398   |  
|Interest-earning deposits                                                                                                                                                                    |  |                   | 10,719  |   |              |   | 14,112  |  
|Fed funds sold                                                                                                                                                                               |  |                   | 349     |   |              |   | 1,106   |  
|Investment securities classified as available-for-sale, net                                                                                                                                  |  |                   | 3,458   |   |              |   | 3,478   |  
|Federal Home Loan Bank stock                                                                                                                                                                 |  |                   | 1,893   |   |              |   | 1,868   |  
|Bank owned life insurance                                                                                                                                                                    |  |                   | 5,986   |   |              |   | 5,926   |  
|Loans receivable, net of allowance for loan losses of $1,958 at September 30, 2008 and $1,836 at June 30, 2008                                                                               |  |                   | 286,547 |   |              |   | 282,483 |  
|Loans held-for-sale                                                                                                                                                                          |  |                   | 82      |   |              |   | 258     |  
|Premises and equipment, net                                                                                                                                                                  |  |                   | 15,138  |   |              |   | 15,200  |  
|Foreclosed real estate, net                                                                                                                                                                  |  |                   | 474     |   |              |   | 462     |  
|Accrued interest receivable:                                                                                                                                                                 |  |                   |         |   |              |   |         |  
|Investments                                                                                                                                                                                  |  |                   | 46      |   |              |   | 38      |  
|Loans receivable                                                                                                                                                                             |  |                   | 1,221   |   |              |   | 1,208   |  
|Deferred tax asset                                                                                                                                                                           |  |                   | 833     |   |              |   | 844     |  
|Other assets                                                                                                                                                                                 |  |                   | 991     |   |              |   | 884     |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|Total assets                                                                                                                                                                                 |  | $                 | 330,346 |   |              | $ | 330,265 |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|Liabilities and Stockholders Equity                                                                                                                                                         |  |                   |         |   |              |   |         |  
|                                                                                                                                                                                             |  |                  
|Deposits:                                                                                                                                                                                    |  |                   |         |   |              |   |         |  
|Noninterest-bearing                                                                                                                                                                          |  | $                 | 14,652  |   |              | $ | 17,517  |  
|Interest-bearing                                                                                                                                                                             |  |                   | 203,245 |   |              |   | 206,035 |  
|Federal Home Loan Bank advances                                                                                                                                                              |  |                   | 38,000  |   |              |   | 33,000  |  
|Other liabilities                                                                                                                                                                            |  |                   | 976     |   |              |   | 836     |  
|Accrued income taxes                                                                                                                                                                         |  |                   | 377     |   |              |   | 100     |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|Total liabilities                                                                                                                                                                            |  |                   | 257,250 |   |              |   | 257,488 |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|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; 8,446,375 shares issued and 6,194,804 shares outstanding at September 30,
2008 and 6,207,702 shares outstanding at June 30, 2008 |  |                   | 84      |   |              |   | 84      |  
|Additional paid-in capital                                                                                                                                                                   |  |                   | 73,014  |   |              |   | 72,959  |  
|Unearned ESOP shares                                                                                                                                                                         |  |                   | (4,429  | ) |              |   | (4,537  | )
|Unearned compensation                                                                                                                                                                        |  |                   | (1,534  | ) |              |   | (1,659  | )
|Accumulated other comprehensive income                                                                                                                                                       |  |                   | (28     | ) |              |   | (17     | )
|Retained earnings                                                                                                                                                                            |  |                   | 35,126  |   |              |   | 34,965  |  
|Treasury stock, at cost; 2,251,571 shares at September 30, 2008 and 2,238,673 shares at June 30, 2008                                                                                        |  |                   | (29,137 | ) |              |   | (29,018 | )
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|Total stockholders equity                                                                                                                                                                   |  |                   | 73,096  |   |              |   | 72,777  |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  
|Total liabilities and stockholders equity                                                                                                                                                   |  | $                 | 330,346 |   |              | $ | 330,265 |  
|                                                                                                                                                                                             |  |                   |         |   |              |   |         |  

See accompanying notes to financial statements.



3



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##### 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,
|                                                    |  | 2008                            |       | 2007
|Interest income:                                    |  |                                 |       |      |   |      
|Interest on loans receivable                        |  | $                               | 4,597 |      | $ | 5,047
|Interest on investment securities                   |  |                                 | 29    |      |   | 273  
|Other interest                                      |  |                                 | 42    |      |   | 91   
|                                                    |  |                                 |       |      |   |      
|Total interest income                               |  |                                 | 4,668 |      |   | 5,411
|                                                    |  |                                 |       |      |   |      
|Interest expense:                                   |  |                                 |       |      |   |      
|Deposits                                            |  |                                 | 1,325 |      |   | 2,069
|Advances from FHLB                                  |  |                                 | 356   |      |   | 441  
|                                                    |  |                                 |       |      |   |      
|Total interest expense                              |  |                                 | 1,681 |      |   | 2,510
|                                                    |  |                                 |       |      |   |      
|Net interest income                                 |  |                                 | 2,987 |      |   | 2,901
|Provision for loan losses                           |  |                                 | 160   |      |   | 68   
|                                                    |  |                                 |       |      |   |      
|Net interest income after provision for loan losses |  |                                 | 2,827 |      |   | 2,833
|                                                    |  |                                 |       |      |   |      
|Noninterest income:                                 |  |                                 |       |      |   |      
|Dividends from investments                          |  |                                 | 11    |      |   | 8    
|Mortgage origination fee income                     |  |                                 | 54    |      |   | 125  
|Service charges and fees                            |  |                                 | 245   |      |   | 154  
|Gain on sale of foreclosed real estate, net         |  |                                 |      |      |   | 46   
|BOLI increase in cash value                         |  |                                 | 60    |      |   | 55   
|Other                                               |  |                                 | 24    |      |   | 24   
|                                                    |  |                                 |       |      |   |      
|Total noninterest income                            |  |                                 | 394   |      |   | 412  
|                                                    |  |                                 |       |      |   |      
|Noninterest expense:                                |  |                                 |       |      |   |      
|Compensation and benefits                           |  |                                 | 1,318 |      |   | 1,444
|Occupancy expense                                   |  |                                 | 183   |      |   | 171  
|Equipment and data processing expense               |  |                                 | 358   |      |   | 359  
|DIF premiums                                        |  |                                 | 9     |      |   | 6    
|Advertising                                         |  |                                 | 3     |      |   | 95   
|Other                                               |  |                                 | 468   |      |   | 494  
|                                                    |  |                                 |       |      |   |      
|Total noninterest expense                           |  |                                 | 2,339 |      |   | 2,569
|                                                    |  |                                 |       |      |   |      
|Earnings before income taxes                        |  |                                 | 882   |      |   | 676  
|                                                    |  |                                 |       |      |   |      
|Income taxes:                                       |  |                                 |       |      |   |      
|Current                                             |  |                                 | 332   |      |   | 234  
|Deferred                                            |  |                                 | 17    |      |   | 8    
|                                                    |  |                                 |       |      |   |      
|Total income taxes                                  |  |                                 | 349   |      |   | 242  
|                                                    |  |                                 |       |      |   |      
|Net earnings                                        |  | $                               | 533   |      | $ | 434  
|                                                    |  |                                 |       |      |   |      
|Net earnings per share, basic                       |  | $                               | 0.09  |      | $ | 0.07 
|                                                    |  |                                 |       |      |   |      
|Net earnings per share, diluted                     |  | $                               | 0.09  |      | $ | 0.07 
|                                                    |  |                                 |       |      |   |      

See accompanying notes to financial statements.



4



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##### Table of Contents

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders Equity

Three Months Ended September 30, 2008 and 2007

(Dollars in Thousands)



|                                                                                            |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|------------------------------------------------------------------------------------------- |  | ----------- | -- | ------------------------ | - | ------ | ----------------------------- |  | - | -------------------- | - |  | ----------------------------------- | ------ | - | ---------------- | - | ---- | ------------- |  | - | ------------------------ | - |  | - | ------- | - |  | - | ------ | -
|                                                                                            |  | CommonStock |    | AdditionalPaid-inCapital |   |        | UnallocatedCommonStock inESOP |  |   | UnearnedCompensation |   |  | AccumulatedOtherComprehensiveIncome |        |   | RetainedEarnings |   |      | TreasuryStock |  |   | TotalStockholdersEquity |  
|Balance at June 30, 2008                                                                    |  | $           | 84 |                          | $ | 72,959 |                               |  | $ | (4,537               | ) |  | $                                   | (1,659 | ) |                  | $ | (17  | )             |  | $ | 34,965                   |   |  | $ | (29,018 | ) |  | $ | 72,777 |  
|                                                                                            |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Comprehensive income:                                                                       |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Net earnings                                                                                |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | 533                      |   |  |   |        |   |  |   | 533    |  
|Change in net unrealized gain (loss) on securities available for sale, net of taxes of ($7) |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   | (11  | )             |  |   |                         |   |  |   |        |   |  |   | (11    | )
|                                                                                            |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Total comprehensive income                                                                  |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 522    |  
|Dividends                                                                                   |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | (372                     | ) |  |   |        |   |  |   | (372   | )
|Shares committed to be released by the ESOP                                                 |  |             |   |                          |   | (10    | )                             |  |   | 108                  |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 98     |  
|Stock options expensed                                                                      |  |             |   |                          |   | 65     |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 65     |  
|Earned portion of stock grants                                                              |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     | 125    |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 125    |  
|Purchase of common stock (12,898 shares)                                                    |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   | (119    | ) |  |   | (119   | )
|                                                                                            |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Balance at September 30, 2008                                                               |  | $           | 84 |                          | $ | 73,014 |                               |  | $ | (4,429               | ) |  | $                                   | (1,534 | ) |                  | $ | (28  | )             |  | $ | 35,126                   |   |  | $ | (29,137 | ) |  | $ | 73,096 |  
|                                                                                            |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|                                                                                            |  |             |    |                          |   |        |                               | 
|                                                                                            |  | CommonStock |    | AdditionalPaid-inCapital |   |        | UnallocatedCommonStock inESOP |  |   | UnearnedCompensation |   |  | AccumulatedOtherComprehensiveIncome |        |   | RetainedEarnings |   |      | TreasuryStock |  |   | TotalStockholdersEquity |  
|Balance at June 30, 2007                                                                    |  | $           | 84 |                          | $ | 72,738 |                               |  | $ | (4,969               | ) |  | $                                   | (2,182 | ) |                  | $ | (246 | )             |  | $ | 35,082                   |   |  | $ | (26,863 | ) |  | $ | 73,644 |  
|                                                                                            |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Comprehensive income:                                                                       |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Net earnings                                                                                |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | 434                      |   |  |   |        |   |  |   | 434    |  
|Change in net unrealized gain (loss) on securities available for sale, net of taxes of $88  |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   | 141  |               |  |   |                         |   |  |   |        |   |  |   | 141    |  
|                                                                                            |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Total comprehensive income                                                                  |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 575    |  
|Dividends                                                                                   |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   | (384                     | ) |  |   |        |   |  |   | (384   | )
|Dividends used for ESOP payment                                                             |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   |       |  
|Shares committed to be released by the ESOP                                                 |  |             |   |                          |   | 16     |                               |  |   | 108                  |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 124    |  
|Stock options expensed                                                                      |  |             |   |                          |   | 66     |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 66     |  
|Earned portion of stock grants                                                              |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     | 136    |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   | 136    |  
|MRP vesting                                                                                 |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   |       |  
|Exercise of options                                                                         |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   |       |  
|Tax benefit from exercise of nonqualifying stock options                                    |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   |        |   |  |   |       |  
|Purchase of common stock (16,631 shares)                                                    |  |             |   |                          |   |       |                               |  |   |                     |   |  |                                     |       |   |                  |   |     |               |  |   |                         |   |  |   | (196    | ) |  |   | (196   | )
|                                                                                            |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  
|Balance at September 30, 2007                                                               |  | $           | 84 |                          | $ | 72,820 |                               |  | $ | (4,861               | ) |  | $                                   | (2,046 | ) |                  | $ | (105 | )             |  | $ | 35,132                   |   |  | $ | (27,059 | ) |  | $ | 73,965 |  
|                                                                                            |  |             |    |                          |   |        |                               |  |   |                      |   |  |                                     |        |   |                  |   |      |               |  |   |                          |   |  |   |         |   |  |   |        |  

See accompanying notes to financial statements.



5



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##### Table of Contents

Jefferson Bancshares, Inc. and Subsidiary

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)



|                                                                                               |  |                                 |         |   |      |   |         |  
|---------------------------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                               |  | Three Months EndedSeptember 30, |        
|                                                                                               |  | 2008                            |         |   | 2007 |  
|Cash flows from operating activities:                                                          |  |                                 |         |   |      |   |         |  
|Net earnings                                                                                   |  | $                               | 533     |   |      | $ | 434     |  
|Adjustments to reconcile net earnings to net cash provided by (used for) operating activities: |  |                                 |         |   |      |   |         |  
|Allocated ESOP shares                                                                          |  |                                 | 99      |   |      |   | 124     |  
|Depreciation and amortization expense                                                          |  |                                 | 152     |   |      |   | 164     |  
|Amortization of premiums (discounts), net on investment securities                             |  |                                 | 3       |   |      |   | 4       |  
|Provision for loan losses                                                                      |  |                                 | 160     |   |      |   | 68      |  
|FHLB stock dividends                                                                           |  |                                 | (25     | ) |      |   |        |  
|Amortization of deferred loan fees, net                                                        |  |                                 | (59     | ) |      |   | (58     | )
|(Gain) on sale of foreclosed real estate, net                                                  |  |                                 |        |   |      |   | (46     | )
|Deferred tax expense                                                                           |  |                                 | 17      |   |      |   | 8       |  
|Originations of mortgage loans held for sale                                                   |  |                                 | (3,375  | ) |      |   | (8,586  | )
|Proceeds from sale of mortgage loans                                                           |  |                                 | 3,551   |   |      |   | 10,496  |  
|Increase in cash value of life insurance                                                       |  |                                 | (60     | ) |      |   | (55     | )
|Earned portion of MRP                                                                          |  |                                 | 125     |   |      |   | 136     |  
|Stock options expensed                                                                         |  |                                 | 65      |   |      |   | 66      |  
|Decrease (increase) in:                                                                        |  |                                 |         |   |      |   |         |  
|Accrued interest receivable                                                                    |  |                                 | (21     | ) |      |   | 71      |  
|Other assets                                                                                   |  |                                 | (107    | ) |      |   | 41      |  
|Increase (decrease) in other liabilities and accrued income taxes                              |  |                                 | 417     |   |      |   | 98      |  
|                                                                                               |  |                                 |         |   |      |   |         |  
|Net cash provided by (used for) operating activities                                           |  |                                 | 1,475   |   |      |   | 2,965   |  
|                                                                                               |  |                                 |         |   |      |   |         |  
|Cash flows used for investing activities:                                                      |  |                                 |         |   |      |   |         |  
|Loan originations, net of principal collections                                                |  |                                 | (4,177  | ) |      |   | 2,543   |  
|Investment securities classified as available for sale:                                        |  |                                 |         |   |      |   |         |  
|Proceeds from maturities, calls and prepayments                                                |  |                                 |        |   |      |   | 2,000   |  
|Purchase of premises and equipment                                                             |  |                                 | (90     | ) |      |   | (54     | )
|Proceeds from sale of (additions to) foreclosed real estate, net                               |  |                                 | (1      | ) |      |   | 196     |  
|                                                                                               |  |                                 |         |   |      |   |         |  
|Net cash provided by (used for) investing activities                                           |  |                                 | (4,268  | ) |      |   | 4,685   |  
|                                                                                               |  |                                 |         |   |      |   |         |  
|Cash flows from financing activities:                                                          |  |                                 |         |   |      |   |         |  
|Net increase (decrease) in deposits                                                            |  |                                 | (5,655  | ) |      |   | 9,136   |  
|Proceeds from advances from FHLB                                                               |  |                                 | 16,500  |   |      |   | 6,500   |  
|Repayment of FHLB advances                                                                     |  |                                 | (11,500 | ) |      |   | (20,300 | )
|Purchase of treasury stock                                                                     |  |                                 | (119    | ) |      |   | (196    | )
|Dividends paid                                                                                 |  |                                 | (372    | ) |      |   | (385    | )
|                                                                                               |  |                                 |         |   |      |   |         |  
|Net cash provided by (used for) financing activities                                           |  |                                 | (1,146  | ) |      |   | (5,245  | )
|                                                                                               |  |                                 |         |   |      |   |         |  
|Net increase (decrease) in cash, cash equivalents and interest-earning deposits                |  |                                 | (3,939  | ) |      |   | 2,405   |  
|Cash, cash equivalents and interest-earning deposits at beginning of period                    |  |                                 | 17,616  |   |      |   | 7,734   |  
|                                                                                               |  |                                 |         |   |      |   |         |  
|Cash, cash equivalents and interest-earning deposits at end of period                          |  | $                               | 13,677  |   |      | $ | 10,139  |  
|                                                                                               |  |                                 |         |   |      |   |         |  
|Supplemental disclosures of cash flow information:                                             |  |                                 |         |   |      |   |         |  
|Cash paid during period for:                                                                   |  |                                 |         |   |      |   |         |  
|Interest on deposits                                                                           |  | $                               | 1,078   |   |      | $ | 2,069   |  
|Interest on FHLB advances                                                                      |  | $                               | 356     |   |      | $ | 441     |  
|Income taxes                                                                                   |  | $                               | 30      |   |      | $ | 85      |  
|Real estate acquired in settlement of loans                                                    |  | $                               | 12      |   |      | $ | 0       |  

See accompanying notes to financial statements.



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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, 2008 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, 2008, which was filed with the Securities and Exchange Commission on September 11, 2008. All dollar amounts,
other than per-share amounts, are in thousands unless otherwise noted.



|(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
|--- | -----------------------------------

Jefferson Federal may not pay dividends on its capital stock if its regulatory capital would thereby be reduced below the amount then required for the liquidation account established for the benefit of certain depositors of Jefferson
Federal at the time of its conversion to stock form.

Under applicable regulations, Jefferson Federal is prohibited from making any capital
distributions if after making the distribution, the Bank would have: (i) a total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.



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##### Table of Contents

Under the banking laws of the State of Tennessee, a Tennessee chartered savings bank may not declare
dividends in any calendar year that exceeds the total of its net income of that year combined with its retained net income for the preceding two years without the prior approval of the Commissioner of the Department of Financial Institutions.



|(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 unallocated 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 to outstanding stock options and are determined
using the treasury stock method. For the period ended September 30, 2008, stock options to purchase 400,032 shares were not included in the computation of diluted net income per share as their effect would have been anti-dilutive. 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 theThree Months
EndedSeptember 30,
|                                                                                                                                            |  | 2008                                                                      |  | 2007     
|Weighted average number of common shares used in computing basic earnings per common share                                                  |  | 5,638,175                                                                 |  | 5,879,990
|Effect of dilutive stock options                                                                                                            |  |                                                                          |  |         
|                                                                                                                                            |  |                                                                           |  |          
|Weighted average number of common shares and dilutive potential common shares used in computing earnings per common share assuming dilution |  | 5,638,175                                                                 |  | 5,879,990
|                                                                                                                                            |  |                                                                           |  |          



|(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 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, 2008. Other nonaccrual loans at September 30, 2008 were approximately $725,000. For the three months ended September 30, 2008, gross income which would have been recognized had nonaccrual



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##### Table of Contents

loans been current in accordance with their original terms amounted to approximately $14,000. Interest income from non-accrual loans included in the
Companys interest income amounted to $3,000 for the three months ended September 30, 2008.

The following table summarizes the
activity in the allowance for loan losses for the three months ended September 30, 2008:



|                              |  |                                                 |   |  |   |       |  
|----------------------------- |  | ----------------------------------------------- | - |  | - | ----- | -
|                              |  | Allowance for Loan Losses(Dollars in thousands) |  
|Balance at June 30, 2008      |  |                                                 |   |  | $ | 1,836 |  
|Provision for loan losses     |  |                                                 |   |  |   | 160   |  
|Charge-offs                   |  | (49                                             | ) |  |   |       |  
|Recoveries                    |  | 11                                              |   |  |   |       |  
|                              |  |                                                 |   |  |   |       |  
|Net (charge-offs)/recoveries  |  |                                                 |   |  |   | (38   | )
|                              |  |                                                 |   |  |   |       |  
|Balance at September 30, 2008 |  |                                                 |   |  | $ | 1,958 |  
|                              |  |                                                 |   |  |   |       |  



|(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, 2008, we had approximately $3.7 million in loan commitments, consisting of commitments to originate real estate loans. In addition to commitments to originate loans, we had $5.9 million of
loans-in-process, $3.5 million in unused standby letters of credit and approximately $19.9 million in unused lines of credit.



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

On August 28,
2008 the Board of Directors of the Company approved a quarterly dividend of $0.06 per share to stockholders of record as of September 30, 2008 and payable on October 10, 2008.



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

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 of Jefferson Federal and Jefferson Bancshares. As of September 30, 2008, there were 400,032 options
and 192,352 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.



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The table below summarizes the status of the Companys stock option plans as of September 30,
2008.



|                                          |  |                                      |  |                                |      
|----------------------------------------- |  | ------------------------------------ |  | ------------------------------ | -----
|                                          |  | Three Months EndedSeptember 30, 2008
|                                          |  | Shares                               |  | Weighted-averageexercise price
|Outstanding at beginning of period        |  | 401,778                              |  | $                              | 13.69
|Granted during the three-month period     |  |                                     |  |                                |     
|Options forfeited                         |  | 1,746                                |  | $                              | 13.69
|Options exercised                         |  |                                     |  |                                |     
|Outstanding at September 30, 2008         |  | 400,032                              |  | $                              | 13.69
|                                          |  |                                     
|Options exercisable at September 30, 2008 |  | 321,434                              |  | $                              | 13.69

The following information applies to options outstanding at September 30, 2008:



|                                                |  |   |        
|----------------------------------------------- |  | - | -------
|Number outstanding                              |  |   | 400,032
|Range of exercise prices                        |  | $ | 13.69  
|Weighted-average exercise price                 |  | $ | 13.69  
|Weighted-average remaining contractual life     |  |   | 5.33   
|Number of options remaining for future issuance |  |   | 298,718

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 $106,000 in fiscal year 2009. 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.



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##### Table of Contents

|(11) | Fair Value Disclosures
|---- | ----------------------

Effective
July 1, 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements and SFAS No. 159 The Fair Value Options for Financial Assets and Liabilities.
SFAS No. 159, which was issued in February 2007, generally permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. The statement also provides guidance on financial
assets and liabilities that are not subject to fair value measurement. Upon adoption of SFAS No. 159, the Company did not elect to adopt the fair value option for any financial instruments.

SFAS No. 157, which was issued in September 2006, defines fair value, provides a framework for measuring fair value under U.S. Generally Accepted
Accounting Principles and expands disclosures about fair value measurements. This Statement defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the most advantageous market for the asset or
liability in an orderly transaction between market participants on the measurement date. The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.

In accordance with SFAS No. 157, when measuring fair value, the Company uses valuation techniques that are appropriate and
consistently applied. A hierarchy is also established under the standard and is used to prioritize valuation inputs into the following three levels to determine fair value:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable inputs other than the quoted prices included in Level 1.

Level 3: Unobservable inputs.

Following is a description of valuation methodologies used for assets
recorded at fair value.

Investment Securities Available for Sale

Investment securities available-for-sale are recorded at fair value on at least a monthly basis. Fair value measurements are based upon independent
pricing models or other model-based valuation techniques with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. Level 2 securities include mortgage-backed securities issued by
government-sponsored entities, municipal bonds, bonds issued by government agencies, and corporate debt securities.

The fair value
measurements as of September 30, 2008, for investment securities available-for-sale are summarized below:



|                              |  |                              |  |         |       |         |   |       |   |      
|----------------------------- |  | ---------------------------- |  | ------- | ----- | ------- | - | ----- | - | -----
|                              |  | Fair Value Measurement Using |  |        
|Description                   |  | Level 1                      |  | Level 2 |       | Level 3 |   | Total
|Securities available for sale |  |                             |  | $       | 3,458 |         |  |       | $ | 3,458



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|(12) | Subsequent Event
|---- | ----------------

On October 31, 2008,
the Company completed its previously announced acquisition of State of Franklin Bancshares, Inc. (State of Franklin Bancshares). Pursuant to the terms of the Agreement and Plan of Merger by and between the Company and State of Franklin
Bancshares, shares of State of Franklin Bancshares will be converted into either $10.00 in cash or 1.1287 shares of Jefferson Bancshares common stock. The total merger consideration will consist of approximately $4.3 million in cash and 736,000
shares of Jefferson Bancshares stock. The acquisition provided the Company with total assets of approximately $670 million, including loans of approximately $509 million and total deposits of approximately $478 million.

In connection with the merger, on October 31, 2008, Jefferson Federal merged with and into State of Franklin Savings Bank, the wholly owned
subsidiary of State of Franklin Bancshares, Inc. The resulting institution will continue to operate as a Tennessee chartered savings bank under the name Jefferson Federal Bank. As a Tennessee chartered savings bank, Jefferson Federal
will be regulated by the Tennessee Department of Financial Institutions and the FDIC.



|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 thereto. 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, 2008, which was filed with the Securities and Exchange Commission on September 11, 2008.

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.



12



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##### Table of Contents

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 the Companys future performance. Forward-looking
statements are preceded by terms such as expects, believes, anticipates, intends and similar expressions.

Managements ability to predict results or the effect of future plans or strategies is inherently uncertain. These factors include, but are not limited to, general economic conditions, changes in the interest rate environment,
legislative or regulatory changes that may adversely affect our business, changes in accounting policies and practices, changes in competition and demand for financial services, adverse changes in the securities markets and changes in the quality or
composition of the Companys loan or investment portfolios. Additional factors that may affect our results are discussed in our Annual Report on Form 10-K for the year ended June 30, 2008 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, 2008 and 2007

Net Income

Net income was $533,000, or $0.09 per diluted share, for the quarter ended September 30, 2008
compared to net income of $434,000, or $0.07 per diluted share, for the corresponding quarter in 2007. The increase in net income for the three months ended September 30, 2008 was due to an increase in net interest income and a decrease in
noninterest expense, partially offset by an increase in the provision for loan losses.



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|                                      |  |                                              |      |   |      |   |      |  
|------------------------------------- |  | -------------------------------------------- | ---- | - | ---- | - | ---- | -
|                                      |  | Three Months EndedSeptember 30,              |     
|                                      |  | 2008                                         |      |   | 2007 |  
|                                      |  | (Dollars in thousands,except per share data) |     
|Net earnings                          |  | $                                            | 533  |   |      | $ | 434  |  
|Net earnings per share, basic         |  | $                                            | 0.09 |   |      | $ | 0.07 |  
|Net earnings per share, diluted       |  | $                                            | 0.09 |   |      | $ | 0.07 |  
|Return on average assets (annualized) |  |                                              | 0.65 | % |      |   | 0.52 | %
|Return on average equity (annualized) |  |                                              | 2.89 | % |      |   | 2.35 | %

Net Interest Income

Net interest income before loan loss provision increased $86,000, or 3.0%, to $3.0 million for the quarter ended September 30, 2008 from the corresponding period in 2007. The interest rate spread and net interest
margin for the quarter ended September 30, 2008 were 3.35% and 3.94%, respectively, compared to 2.91% and 3.72%, respectively, for the same period in 2007.

The following table summarizes changes in interest income and expense for the three-month periods ended September 30, 2008 and 2007:



|                          |      |                                |       |          |   |       |          |   |      |   |  |       |   
|------------------------- | ---- | ------------------------------ | ----- | -------- | - | ----- | -------- | - | ---- | - |  | ----- | --
|                          |      | Three MonthsEndedSeptember 30, |       | $ Change |   |       | % Change |  
|                          | 2008 |                                | 2007  |          |  
|                          |      | (Dollars in thousands)         |       |          |   |       |          |  
|Interest income:          |      |                                |       |          |   |       |          |   |      |   |  |       |   
|Loans                     |      | $                              | 4,597 |          | $ | 5,047 |          | $ | (450 | ) |  | (8.9  | )%
|Investment securities     |      |                                | 29    |          |   | 273   |          |   | (244 | ) |  | (89.4 | )%
|Interest-earning deposits |      |                                | 17    |          |   | 62    |          |   | (45  | ) |  | (72.6 | )%
|FHLB stock                |      |                                | 25    |          |   | 29    |          |   | (4   | ) |  | (13.8 | )%
|                          |      |                                |       |          |   |       |          |   |      |   |  |       |   
|Total interest income     |      |                                | 4,668 |          |   | 5,411 |          |   | (743 | ) |  | (13.7 | )%
|                          |      |                                |       |          |   |       |          |   |      |   |  |       |   
|Interest expense:         |      |                                |       |          |   |       |          |   |      |   |  |       |   
|Deposits                  |      |                                | 1,325 |          |   | 2,069 |          |   | (744 | ) |  | (36.0 | )%
|Borrowings                |      |                                | 356   |          |   | 441   |          |   | (85  | ) |  | (19.3 | )%
|                          |      |                                |       |          |   |       |          |   |      |   |  |       |   
|Total interest expense    |      |                                | 1,681 |          |   | 2,510 |          |   | (829 | ) |  | (33.0 | )%
|                          |      |                                |       |          |   |       |          |   |      |   |  |       |   
|Net interest income       |      | $                              | 2,987 |          | $ | 2,901 |          | $ | 86   |   |  | 3.0   | % 
|                          |      |                                |       |          |   |       |          |   |      |   |  |       |   

The following table summarizes average balances and average yields and costs for the three months ended
September 30, 2008 and September 30, 2007:



|                          |  |                                  |         |            |      |   |                |   |            |  |      |  
|------------------------- |  | -------------------------------- | ------- | ---------- | ---- | - | -------------- | - | ---------- |  | ---- | -
|                          |  | Three Months Ended September 30, |        
|                          |  | 2008                             |         |            | 2007 |  
|                          |  | AverageBalance                   |         | Yield/Cost |      |   | AverageBalance |   | Yield/Cost | 
|                          |  | (Dollars in thousands)           |        
|Loans                     |  | $                                | 287,869 |            | 6.34 | % |                | $ | 275,138    |  | 7.28 | %
|Investment securities     |  |                                  | 3,467   |            | 3.32 | % |                |   | 26,323     |  | 4.15 | %
|Interest-earning deposits |  |                                  | 7,707   |            | 0.88 | % |                |   | 6,317      |  | 3.89 | %
|FHLB stock                |  |                                  | 1,868   |            | 5.31 | % |                |   | 1,796      |  | 6.41 | %
|Deposits                  |  |                                  | 202,947 |            | 2.59 | % |                |   | 212,589    |  | 3.86 | %
|Borrowings                |  |                                  | 35,057  |            | 4.03 | % |                |   | 35,118     |  | 4.98 | %



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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.



|                                                                  |  |                                                      |      |   |      |   |      |   |  |   |      |  
|----------------------------------------------------------------- |  | ---------------------------------------------------- | ---- | - | ---- | - | ---- | - |  | - | ---- | -
|                                                                  |  | Three MonthsEnded September 30,2008 Compared to 2007 |     
|                                                                  |  | Increase(Decrease) Due To                            |      |   | Net  |  
|                                                                  |  | Volume                                               |      |   | Rate |   |     
|                                                                  |  | (In thousands)                                       |     
|Interest income:                                                  |  |                                                      |      |   |      |   |      |   |  |   |      |  
|Loans receivable                                                  |  | $                                                    | 250  |   |      | $ | (700 | ) |  | $ | (450 | )
|Investment securities                                             |  |                                                      | (240 | ) |      |   |     |   |  |   | (240 | )
|Municipals                                                        |  |                                                      | (7   | ) |      |   | 3    |   |  |   | (4   | )
|Daily interest-earning deposits and other interest-earning assets |  |                                                      | 19   |   |      |   | (68  | ) |  |   | (49  | )
|                                                                  |  |                                                      |      |   |      |   |      |   |  |   |      |  
|Total interest-earning assets                                     |  |                                                      | 22   |   |      |   | (765 | ) |  |   | (743 | )
|                                                                  |  |                                                      |      |   |      |   |      |   |  |   |      |  
|Interest expense:                                                 |  |                                                      |      |   |      |   |      |   |  |   |      |  
|Deposits                                                          |  |                                                      | (90  | ) |      |   | (654 | ) |  |   | (744 | )
|Borrowings                                                        |  |                                                      | (1   | ) |      |   | (84  | ) |  |   | (85  | )
|                                                                  |  |                                                      |      |   |      |   |      |   |  |   |      |  
|Total interest-bearing liabilities                                |  |                                                      | (91  | ) |      |   | (738 | ) |  |   | (829 | )
|                                                                  |  |                                                      |      |   |      |   |      |   |  |   |      |  
|Net change in interest income                                     |  | $                                                    | 113  |   |      | $ | (27  | ) |  | $ | 86   |  
|                                                                  |  |                                                      |      |   |      |   |      |   |  |   |      |  

Total interest income decreased $743,000, to $4.7 million for the three months ended September 30, 2008 due
to a lower average yield on interest-earning assets more than offsetting an increase in the average balance of interest-earning assets.

Interest on loans
decreased $450,000, or 8.9%, to $4.6 million for the three months ended September 30, 2008. The decrease in interest on loans was attributable to a decrease in the average yield partially offset by a higher average balance of loans. The average
balance of loans increased $12.7 million, or 4.6%, to $287.9 million for the three months ended September 30, 2008 primarily due to growth in the commercial loan portfolio. The average yield on loans decreased 94 basis points to 6.34%,
primarily as a result of decreases in the prime lending rate.



15



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##### Table of Contents

Interest on investment securities decreased $244,000 to $29,000 for the three months ended September 30, 2008
primarily due to a decline in the average balance of investment securities. The average balance of investment securities was $3.5 million for the three months ended September 30, 2008 compared to $26.3 million for the comparable period in 2007
due to securities being called.

Total interest expense decreased $829,000, or 33.0%, to $1.7 million for the three-month period ended September 30,
2008 primarily due to a 122 basis point decline in the rate paid on interest-bearing liabilities and a decrease in the average balance of interest-bearing liabilities.

Interest expense on deposits decreased $744,000, or 36.0%, to $1.3 million for the three-month period ended September 30, 2008 due to a decrease in the average rate paid on deposits and a decrease in the average
balance of deposits. The average rate paid on deposits decreased 127 basis points to 2.59% due to decreases in short term interest rates while the average balance of deposits declined $9.6 million to $202.9 million due to a decrease in the average
balance of certificates of deposit.

Interest expense on FHLB advances decreased $85,000, or 19.3%, to $356,000 for the three months ended
September 30, 2008 compared to the same period in 2007. The decrease was due to a lower average rate paid on borrowings.

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. The provision for loan losses for the three-month period ended
September 30, 2008 amounted to $160,000 compared to $68,000 for the comparable period in 2007. The increase in the provision for loan losses reflects growth in commercial loans, managements evaluation of credit quality and current
economic conditions. Nonperforming loans totaled $725,000 at September 30, 2008 compared to $1.4 million at September 30, 2007.

Noninterest Income

Noninterest income decreased $18,000, or 4.4%, to $394,000 for the three months ended September 30, 2008
compared to $412,000 for the corresponding period in 2007. Service charges and fee income increased $91,000, or 59.1%, to $245,000 for the three months ended September 30, 2008 due to the implementation of a new overdraft program. Mortgage
origination fee income decreased $71,000, or 56.8%, to $54,000 for the three months ended September 30, 2008 due to a lower volume of loan originations. There was no gain on sale of foreclosed assets for the quarter ended September 30,
2008 compared to a $46,000 gain on sale of foreclosed assets for the corresponding period in 2007.



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##### 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, 2008 compared to the same period in 2007.



|                                            |                        |                                 |      |         |   |     |         |   |     |   |  |         |  
|------------------------------------------- | ---------------------- | ------------------------------- | ---- | ------- | - | --- | ------- | - | --- | - |  | ------- | -
|                                            |                        | Three Months EndedSeptember 30, |      | $Change |   |     | %Change |  
|                                            | 2008                   |                                 | 2007 |         |  
|                                            | (Dollars in thousands) |                                 |      |         |   |     |        
|Noninterest income:                         |                        |                                 |      |         |   |     |         |   |     |   |  |         |  
|Dividends from investments                  |                        | $                               | 11   |         | $ | 8   |         | $ | 3   |   |  | 37.5    | %
|Mortgage origination fee income             |                        |                                 | 54   |         |   | 125 |         |   | (71 | ) |  | (56.8)  | %
|Service charges and fees                    |                        |                                 | 245  |         |   | 154 |         |   | 91  |   |  | 59.1    | %
|Gain on sale of foreclosed real estate, net |                        |                                 |     |         |   | 46  |         |   | (46 | ) |  | (100.0) | %
|BOLI increase in cash value                 |                        |                                 | 60   |         |   | 55  |         |   | 5   |   |  | 9.1     | %
|Other                                       |                        |                                 | 24   |         |   | 24  |         |   |    |   |  | 0.0     | %
|                                            |                        |                                 |      |         |   |     |         |   |     |   |  |         |  
|Total noninterest income                    |                        | $                               | 394  |         | $ | 412 |         | $ | (18 | ) |  | (4.4)   | %
|                                            |                        |                                 |      |         |   |     |         |   |     |   |  |         |  

Noninterest Expense

Noninterest expense decreased $230,000, or 9.0%, to $2.3 million for the three-month period ended September 30, 2008 compared to the corresponding 2007 period. Compensation and benefits expense decreased
$126,000, or 8.7%, to $1.3 million for the three months ended September 30, 2008 due in part to a lower number of employees. Advertising expense decreased $92,000 to $3,000 due to planned reductions in promotional advertising during the three
months ended September 30, 2008.

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, 2008 compared to the same period in 2007.



|                                      |                        |                                 |       |         |   |       |         |   |      |   |  |        |  
|------------------------------------- | ---------------------- | ------------------------------- | ----- | ------- | - | ----- | ------- | - | ---- | - |  | ------ | -
|                                      |                        | Three Months EndedSeptember 30, |       | $Change |   |       | %Change |  
|                                      | 2008                   |                                 | 2007  |         |  
|                                      | (Dollars in thousands) |                                 |       |         |   |       |        
|Compensation and benefits             |                        | $                               | 1,318 |         | $ | 1,444 |         | $ | (126 | ) |  | (8.7)  | %
|Occupancy expense                     |                        |                                 | 183   |         |   | 171   |         |   | 12   |   |  | 7.0    | %
|Equipment and data processing expense |                        |                                 | 358   |         |   | 359   |         |   | (1   | ) |  | (0.3)  | %
|Deposit insurance premiums            |                        |                                 | 9     |         |   | 6     |         |   | 3    |   |  | 50.0   | %
|Advertising                           |                        |                                 | 3     |         |   | 95    |         |   | (92  | ) |  | (96.8) | %
|Other                                 |                        |                                 | 468   |         |   | 494   |         |   | (26  | ) |  | (5.3)  | %
|                                      |                        |                                 |       |         |   |       |         |   |      |   |  |        |  
|Total noninterest expense             |                        | $                               | 2,339 |         | $ | 2,569 |         | $ | (230 | ) |  | (9.0)  | %
|                                      |                        |                                 |       |         |   |       |         |   |      |   |  |        |  

Income Taxes

Income tax expense for the three months ended September 30, 2008 was $349,000 compared to $242,000 for the same period in 2007 due to higher taxable income.



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##### Table of Contents

Financial Condition

Cash, Cash Equivalents and Interest-Earning Deposits

Cash, cash equivalents, and interest-earning deposits were $13.7 million at
September 30, 2008 compared to $17.6 million at June 30, 2008. 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
municipal securities with maturities of 20 years or less. We do not hold any Freddie Mac or Fannie Mae preferred or common stock in our investment portfolio. Investment securities amounted to $3.5 million at both September 30, 2008 and
June 30, 2008. Investment securities classified as available-for-sale are carried at fair market value and reflect an unrealized loss of $45,000, or $28,000 net of taxes.

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



|                                    |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|----------------------------------- |  | ---------------------- | ----- | - | --------------- | - | ---------------- |  | - | --------- | - |  | - | -----
|At September 30, 2008               |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|                                    |  |                        |       |  
|                                    |  | AmortizedCost          |       |   | UnrealizedGains |   | UnrealizedLosses |  |   | FairValue
|                                    |  | (Dollars in thousands)
|Securities available-for-sale       |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|Debt securities:                    |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|Federal agency                      |  | $                      |      |   |                 | $ |                 |  | $ |          |   |  | $ |     
|Municipals                          |  |                        | 3,503 |   |                 |   | 7                |  |   | (52       | ) |  |   | 3,458
|                                    |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|Total securities available-for-sale |  | $                      | 3,503 |   |                 | $ | 7                |  | $ | (52       | ) |  | $ | 3,458
|                                    |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|Weighted-average rate               |  |                        | 3.24  | % |                 |   |                  |  |   |           |   |  |   |      
|                                    |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|                                    |  |                        |       |  
|At June 30, 2008                    |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|                                    |  | AmortizedCost          |       |   | UnrealizedGains |   | UnrealizedLosses |  |   | FairValue
|                                    |  | (Dollars in thousands)
|Securities available-for-sale       |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|Debt securities:                    |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|Federal agency                      |  | $                      |      |   |                 | $ |                 |  | $ |          |   |  | $ |     
|Municipals                          |  |                        | 3,506 |   |                 |   | 7                |  |   | (35       | ) |  |   | 3,478
|                                    |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|Total securities available-for-sale |  | $                      | 3,506 |   |                 | $ | 7                |  | $ | (35       | ) |  | $ | 3,478
|                                    |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      
|Weighted-average rate               |  |                        | 3.62  | % |                 |   |                  |  |   |           |   |  |   |      
|                                    |  |                        |       |   |                 |   |                  |  |   |           |   |  |   |      

Loans

Net loans increased $4.1 million to $286.5 million at September 30, 2008 primarily due to an increase in real estate loans and commercial business loans. Our primary lending activity is the origination of loans secured by real estate.
Real estate loans totaled $228.8 million, or 79.2% of total loans, at September 30, 2008 compared to $224.6 million, or 78.9% of total loans, at June 30, 2008. Commercial business loans increased $562,000, or 1.1%, to $52.6 million at



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##### Table of Contents

September 30, 2008, while consumer loans decreased $581,000, or 7.3%, to $7.3 million at that date. The decline in consumer loans was largely
attributable to a decrease in indirect automobile loans.

Loans receivable, net, are summarized as follows:



|                               |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|------------------------------ | ---------------------- | ------------------- | ------- | ------------------- | -------------- | ----- | ------ | ------- | - | ------------------- | ------- |  | ----- | - |  | - | ----- | - |  | ------ | -
|                               |                        | AtSeptember 30,2008 |         |                     | AtJune 30,2008 |       |        | $Change |   |                     | %Change | 
|                               | Amount                 |                     |         | Percentof Portfolio |                |       | Amount |         |   | Percentof Portfolio |         |  |      
|                               | (Dollars in thousands) |                     |         |                     |                |       |        |        
|Real estate loans:             |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|Residential one-to four-family |                        | $                   | 64,099  |                     |                | 22.2  | %      |         | $ | 63,340              |         |  | 22.3  | % |  | $ | 759   |   |  | 1.2    | %
|Home equity line of credit     |                        |                     | 6,431   |                     |                | 2.2   | %      |         |   | 5,723               |         |  | 2.0   | % |  |   | 708   |   |  | 12.4   | %
|Commercial                     |                        |                     | 93,225  |                     |                | 32.3  | %      |         |   | 90,933              |         |  | 32.0  | % |  |   | 2,292 |   |  | 2.5    | %
|Multi-family                   |                        |                     | 4,877   |                     |                | 1.7   | %      |         |   | 4,219               |         |  | 1.5   | % |  |   | 658   |   |  | 15.6   | %
|Construction                   |                        |                     | 19,603  |                     |                | 6.8   | %      |         |   | 19,553              |         |  | 6.9   | % |  |   | 50    |   |  | 0.3    | %
|Land                           |                        |                     | 40,585  |                     |                | 14.1  | %      |         |   | 40,862              |         |  | 14.4  | % |  |   | (277  | ) |  | (0.7)  | %
|                               |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|Total real estate loans        |                        |                     | 228,820 |                     |                | 79.2  | %      |         |   | 224,630             |         |  | 78.9  | % |  |   | 4,190 |   |  | 1.9    | %
|                               |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|Commercial business loans      |                        |                     | 52,599  |                     |                | 18.2  | %      |         |   | 52,037              |         |  | 18.3  | % |  |   | 562   |   |  | 1.1    | %
|                               |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|Consumer loans:                |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|Automobile loans               |                        |                     | 3,472   |                     |                | 1.2   | %      |         |   | 3,973               |         |  | 1.4   | % |  |   | (501  | ) |  | (12.6) | %
|Mobile home loans              |                        |                     | 57      |                     |                | 0.0   | %      |         |   | 60                  |         |  | 0.0   | % |  |   | (3    | ) |  | (5.0)  | %
|Loans secured by deposits      |                        |                     | 939     |                     |                | 0.3   | %      |         |   | 930                 |         |  | 0.3   | % |  |   | 9     |   |  | 1.0    | %
|Other consumer loans           |                        |                     | 2,875   |                     |                | 1.0   | %      |         |   | 2,961               |         |  | 1.0   | % |  |   | (86   | ) |  | (2.9)  | %
|                               |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|Total consumer loans           |                        |                     | 7,343   |                     |                | 2.5   | %      |         |   | 7,924               |         |  | 2.8   | % |  |   | (581  | ) |  | (7.3)  | %
|                               |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|Total gross loans              |                        |                     | 288,762 |                     |                | 100.0 | %      |         |   | 284,591             |         |  | 100.0 | % |  |   | 4,171 |   |  | 1.5    | %
|                               |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|Less:                          |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|Deferred loan fees, net        |                        |                     | (257    | )                   |                |       |        |         |   | (272                | )       |  |       |   |  |   | 15    |   |  | (5.5)  | %
|Allowance for losses           |                        |                     | (1,958  | )                   |                |       |        |         |   | (1,836              | )       |  |       |   |  |   | (122  | ) |  | 6.6    | %
|                               |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  
|Loans receivable, net          |                        | $                   | 286,547 |                     |                |       |        |         | $ | 282,483             |         |  |       |   |  | $ | 4,064 |   |  | 1.4    | %
|                               |                        |                     |         |                     |                |       |        |         |   |                     |         |  |       |   |  |   |       |   |  |        |  

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.



19



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##### Table of Contents

In connection with assessing the allowance, we have established a systematic methodology for determining the adequacy of
the allowance for loan losses. The methodology utilizes a loan grading system which segments loans with similar risk characteristics. Management performs a monthly assessment of the allowance for loan losses based on the nature and volume of the
loan portfolio, the amount of impaired and classified loans and historical loan loss experience. In addition, management considers other qualitative factors, including delinquency trends, economic conditions and loan considerations.

The FDIC and/or the Tennessee Department of Financial Institutions, as an integral part of its examination process, periodically reviews our allowance for loan losses.
The FDIC and/or the Tennessee Department of Financial Institutions may require us to make additional provisions for loan losses based on judgments different from ours.

The allowance for loan losses was $2.0 million at September 30, 2008 compared to $1.8 million at June 30, 2008. Our allowance for loan losses represented 0.68% of total loans and 270.07% of nonperforming
loans at September 30, 2008 compared to 0.65% of total loans and 609.97% of nonperforming loans at June 30, 2008.



|                                                                           |  |                                 |       |   |      |   |       |  
|-------------------------------------------------------------------------- |  | ------------------------------- | ----- | - | ---- | - | ----- | -
|                                                                           |  | Three Months EndedSeptember 30, |      
|                                                                           |  | 2008                            |       |   | 2007 |  
|                                                                           |  | (Dollars in thousands)          |      
|Balance at beginning of period                                             |  | $                               | 1,836 |   |      | $ | 1,955 |  
|Provision for loan losses                                                  |  |                                 | 160   |   |      |   | 68    |  
|Recoveries                                                                 |  |                                 | 11    |   |      |   | 10    |  
|Charge-offs                                                                |  |                                 | (49   | ) |      |   | (78   | )
|                                                                           |  |                                 |       |   |      |   |       |  
|Net charge-offs                                                            |  |                                 | (38   | ) |      |   | (68   | )
|                                                                           |  |                                 |       |   |      |   |       |  
|Allowance at end of period                                                 |  | $                               | 1,958 |   |      | $ | 1,955 |  
|                                                                           |  |                                 |       |   |      |   |       |  
|Net charge-offs to average outstanding loans during the period, annualized |  |                                 | 0.05  | % |      |   | 0.10  | %

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 loans totaled $725,000 at September 30, 2008 compared to $301,000 at June 30, 2008. Foreclosed real estate amounted to $474,000 at September 30, 2008 compared to $462,000 at June 30, 2008. Foreclosed real estate is
initially recorded at the lower of the amount of the loan or the fair value of the foreclosed real estate, 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.



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##### Table of Contents

|                                                       |  |                        |        |   |              |   |        |  
|------------------------------------------------------ |  | ---------------------- | ------ | - | ------------ | - | ------ | -
|                                                       |  | September 30,2008      |        |   | June 30,2008 |  
|                                                       |  | (Dollars in thousands) |       
|Nonaccruing loans:                                     |  |                        |        |   |              |   |        |  
|Real estate                                            |  | $                      | 578    |   |              | $ | 139    |  
|Commercial business                                    |  |                        | 147    |   |              |   | 162    |  
|Consumer                                               |  |                        |       |   |              |   |       |  
|                                                       |  |                        |        |   |              |   |        |  
|Total nonaccrual loans                                 |  |                        | 725    |   |              |   | 301    |  
|                                                       |  |                       
|Real estate owned                                      |  |                        | 474    |   |              |   | 462    |  
|Other repossessed assets                               |  |                        | 5      |   |              |   | 5      |  
|                                                       |  |                        |        |   |              |   |        |  
|Total nonperforming assets                             |  | $                      | 1,204  |   |              | $ | 768    |  
|                                                       |  |                        |        |   |              |   |        |  
|Total nonperforming assets to total assets             |  |                        | 0.36   | % |              |   | 0.23   | %
|Total nonperforming loans to total loans               |  |                        | 0.25   | % |              |   | 0.11   | %
|Allowance for loan losses to total nonperforming loans |  |                        | 270.07 | % |              |   | 609.97 | %

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, 2008 was $6.0 million.

Deposits

Total deposits decreased $5.7 million, or 2.5%, to $217.9 million at September 30, 2008 due to a $7.6 million decrease in transaction accounts more than offsetting a
$2.0 million increase in certificates of deposit.



|                             |  |                        |         |              |   |          |  |   |          |   |  |       |   
|---------------------------- |  | ---------------------- | ------- | ------------ | - | -------- |  | - | -------- | - |  | ----- | --
|                             |  | September 30,2008      |         | June 30,2008 |   | $ Change |  |   | % Change |  
|                             |  | (Dollars in thousands) |         |              |   |          |  |  
|Noninterest-bearing accounts |  | $                      | 14,652  |              | $ | 17,517   |  | $ | (2,865   | ) |  | (16.4 | )%
|NOW accounts                 |  |                        | 19,334  |              |   | 20,352   |  |   | (1,018   | ) |  | (5.0  | )%
|Savings accounts             |  |                        | 9,032   |              |   | 9,153    |  |   | (121     | ) |  | (1.3  | )%
|Money market accounts        |  |                        | 46,141  |              |   | 49,781   |  |   | (3,640   | ) |  | (7.3  | )%
|Certificates of deposit      |  |                        | 128,738 |              |   | 126,749  |  |   | 1,989    |   |  | 1.6   | % 
|                             |  |                        |         |              |   |          |  |   |          |   |  |       |   
|                             |  | $                      | 217,897 |              | $ | 223,552  |  | $ | (5,655   | ) |  | (2.5  | )%
|                             |  |                        |         |              |   |          |  |   |          |   |  |       |   

Advances

FHLB advances increased $5.0 million to $38.0 million at September 30, 2008, compared to $33.0 million at June 30, 2008 due to an increase in short term borrowings to meet liquidity needs.

Stockholders Equity

Stockholders equity amounted
to $73.1 million at September 30, 2008 compared to $72.8 million at June 30, 2008. Stock repurchases for the three months ended September 30, 2008



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totaled 12,898 shares at an average cost of $9.29 per share. On February 24, 2006, the Company announced its third stock repurchase program pursuant to
which up to 690,261 shares of the Companys outstanding common stock may be repurchased. At September 30, 2008, 115,794 shares remained eligible for repurchase under the current stock repurchase program. 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, 2008, the adjustment to stockholders equity was a net unrealized loss of $28,000 compared to a net
unrealized loss of $17,000 at June 30, 2008. The Company declared a $0.06 per share dividend to shareholders of record at September 30, 2008 totaling $372,000 that was payable on October 10, 2008.

Liquidity and Capital Resources

Liquidity is the ability to meet
current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, 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.

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, 2008, cash and cash equivalents totaled $2.6 million and interest-earning deposits totaled $11.1 million, compared to $2.4 million and $15.2 million, respectively, at June 30,
2008. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $3.5 million at both September 30, 2008 and June 30, 2008. In addition, at September 30, 2008, our advance agreement with the
FHLB provided us with the ability to borrow a total of approximately $47.1 million from the FHLB of Cincinnati. In the three-month period ended September 30, 2008, FHLB advances increased $5.0 million to $38.0 million compared to $33.0 million
at June 30, 2008.

We anticipate that we will have sufficient funds available to meet current loan commitments. At September 30, 2008, we had
approximately $3.7 million in loan commitments outstanding. In addition to commitments to originate loans, we had $5.9 million in loans-in-process primarily related to undisbursed proceeds of construction loans, $3.5 million in unused standby
letters of credit and approximately $19.9 million in unused lines of credit. At September 30, 2008, we had $72.6 million in certificates of deposit due within one year and $89.2 million in other deposits without specific maturities. 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 generally



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manage the pricing of our deposits to be competitive and to increase deposits. Occasionally, we offer promotional rates on certain deposit products in order
to attract deposits. We experienced a net decrease in total deposits of $5.7 million during the three-month period ended September 30, 2008.

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, 2008, 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.



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Capital Compliance

The following table presents our capital position relative to our regulatory capital requirements at September 30, 2008 and June 30, 2008:



|                          |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|------------------------- | ---------------------- | ------ | ------ |  | ---------------------------- | ------ |  | ------------------------------------------------------------- | ------ |  | ------ |  | ----- | --- | - |  | - | ------ |  | - |  |  | ---- | -
|                          |                        | Actual |        |  | For CapitalAdequacy Purposes |        |  | To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                          | Amount                 |        | Ratio  |  |                              | Amount |  | Ratio                                                         |        |  | Amount |  | Ratio |    
|                          | (Dollars in thousands) |       
|At September 30, 2008     |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|Total Capital             |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|(To Risk Weighted Assets) |                        | $      | 66,178 |  | 23.6                         | %      |  | $                                                             | 22,444 |  | 3      |  |       | 8.0 | % |  | $ | 28,055 |  | 3 |  |  | 10.0 | %
|Core Capital              |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|(To Tangible Assets)      |                        |        | 64,277 |  | 19.5                         | %      |  |                                                               | 13,175 |  | 3      |  |       | 4.0 | % |  |   | 16,468 |  | 3 |  |  | 5.0  | %
|Tangible Capital          |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|(To Tangible Assets)      |                        |        | 64,277 |  | 19.5                         | %      |  |                                                               | 4,940  |  | 3      |  |       | 1.5 | % |  |   | N/A    |  |   |  |  |      |  
|Tier 1 Capital            |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|(To Risk Weighted Assets) |                        |        | 64,277 |  | 22.9                         | %      |  |                                                               | N/A    |  |        |  |       |     |   |  |   | 16,833 |  | 3 |  |  | 6.0  | %
|                          |                        |        |        |  |                              |        |  |                                                              
|At June 30, 2008          |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|Total Capital             |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|(To Risk Weighted Assets) |                        |        | 66,271 |  | 24.2                         | %      |  |                                                               | 21,941 |  | 3      |  |       | 8.0 | % |  |   | 27,426 |  | 3 |  |  | 10.0 | %
|Core Capital              |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|(To Tangible Assets)      |                        |        | 64,472 |  | 19.6                         | %      |  |                                                               | 13,175 |  | 3      |  |       | 4.0 | % |  |   | 16,469 |  | 3 |  |  | 5.0  | %
|Tangible Capital          |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|(To Tangible Assets)      |                        |        | 64,472 |  | 19.6                         | %      |  |                                                               | 4,941  |  | 3      |  |       | 1.5 | % |  |   | N/A    |  |   |  |  |      |  
|Tier 1 Capital            |                        |        |        |  |                              |        |  |                                                               |        |  |        |  |       |     |   |  |   |        |  |   |  |  |      |  
|(To Risk Weighted Assets) |                        |        | 64,472 |  | 23.5                         | %      |  |                                                               | N/A    |  |        |  |       |     |   |  |   | 16,455 |  | 3 |  |  | 6.0  | %



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|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, 2008. 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, 2008.



|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, 2008 that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.



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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 or the Bank.



|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, 2008.



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



|                                                      |  |                                             |  |                                        |      |                                                                                           |        |                                                                                                                     |         |    
|----------------------------------------------------- |  | ------------------------------------------- |  | -------------------------------------- | ---- | ----------------------------------------------------------------------------------------- | ------ | ------------------------------------------------------------------------------------------------------------------- | ------- | ---
|Period                                                |  | (a)Total Numberof Shares(or units)Purchased |  | (b)AveragePrice Paidper Share(or Unit) |      | (c)Total Number ofShares (or Units)Purchased asPart of PubliclyAnnounced Plansor Programs |        | (d)Maximum Number(or ApproximateDollar Value)of Shares (orUnits) That MayYet Be PurchasedUnder the
Plans orPrograms |        
|Month #1 July 1, 2008 through July 31, 2008           |  |                                            |  |                                        |     |                                                                                           |       |                                                                                                                     | 128,692 | (1)
|Month #2 August 1 2008 through August 31, 2008        |  | 12,770                                      |  | $                                      | 9.29 |                                                                                           | 12,770 |                                                                                                                     | 115,922 | (1)
|Month #3 September 1, 2008 through September 30, 2008 |  | 128                                         |  | $                                      | 9.23 |                                                                                           | 128    |                                                                                                                     | 115,794 | (1)
|Total                                                 |  | 12,898                                      |  |                                        | 9.29 |                                                                                           | 12,898 |                                                                                                                     | 115,794 |    



|(1) | On February 24, 2006, the Company announced a stock repurchase program under which the Company may repurchase up to 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.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------

None.



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

None.



|Item 5. | Other Information
|------- | -----------------

The following disclosures would
otherwise have been furnished on Form 8-K under the heading:

Item 2.02. Results of Operations and Financial Condition:

The information relating to the Companys results of operations for the quarter ended September 30, 2008, which was furnished to
the SEC via a Form 8-K on November 7, 2008, is incorporated herein by reference. The information being incorporated by reference herein shall not be deemed to be filed for purposes of Section 18 of the Exchange Act or otherwise
subject to the liabilities of that section.

Item 6. Exhibits



|     |  |                                                                                                                                           
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|2.1  |  | Agreement and Plan of Merger by and between Jefferson Bancshares, Inc. and State of Franklin Bancshares, Inc., dated September 4, 2008 (1)
|     | 
|10.1 |  | Employment Agreement by and among Jefferson Federal Bank, Jefferson Bancshares, Inc. and Randal R. Greene, dated October 31, 2008 (2)     
|     | 
|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                                                                                                                



|(1) | Incorporated by reference to the Current Report on Form 8-K filed with the Securities and Exchange Commission on September 5, 2008.
|--- | -----------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference to the Current Report on Form 8-K filed with the Securities and Exchange Commission on November 4, 2008.
|--- | ----------------------------------------------------------------------------------------------------------------------------------



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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 10, 2008 |  |  |  | /s/ Anderson L. Smith                           
|                  |  |  |  | Anderson L. Smith                               
|                  |  |  |  | President and Chief Executive Officer           
|                  |  | 
|November 10, 2008 |  |  |  | /s/ Jane P. Hutton                              
|                  |  |  |  | Jane P. Hutton                                  
|                  |  |  |  | Chief Financial Officer, Treasurer and Secretary