UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 
 FORM
10-K
 (Mark
One)
 
 T
              ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For the fiscal year ended December 31,
2009
 
 o
              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: 0-50876
 
 NAUGATUCK
VALLEY FINANCIAL CORPORATION
 (Exact
name of registrant as specified in its charter)
 
 United States
              
              65-1233977(State
      or other jurisdiction of incorporation or organization)
              
              (I.R.S.
      Employer Identification No.)
 
 333 Church Street, Naugatuck,
      Connecticut
              
              06770(Address
      of principal executive offices)
              
              (Zip
      Code)
 
 Registrant’s
telephone number, including area code:  (203) 720-5000
 
 Securities
registered pursuant to Section 12(b) of the Act:
  Title of each class
              
              Name of each exchange on which
      registeredCommon
      Stock, par value $0.01 per share
              
              Nasdaq
      Global Market
  Securities
registered pursuant to Section 12(g) of the Act:  None
 
 Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.  Yes  o    No  T
 
 Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act.  Yes  o    No  T
 
 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  T   No  o
 
 Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit
and post such files).
 Yes o    No
o
 
 Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of the registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K.
 x
 
 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 the definitions of
“accelerated filer,” “large accelerated filer” and “smaller reporting company”
in Rule 12b-2 of the Exchange Act.
  Large
      accelerated filer
              o
              Accelerated
      filer
              oNon-accelerated
      filer
              o (Do not check if
      a smaller reporting company)
              Smaller
      reporting company
              T
 
 Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the
Act).
 Yes  oNo  T
 
 The aggregate market value of the
voting and non-voting common equity held by non-affiliates as of June 30, 2009,
was $15,361,951.
  
 
  The number of shares outstanding of the
registrant’s common stock as of March 26, 2010 was 7,022,659. Of such
shares outstanding, 4,182,407 shares were held by Naugatuck Valley Mutual
Holding Company.
 
 DOCUMENTS
INCORPORATED BY REFERENCE
  Portions
of the Proxy Statement for the 2010 Annual Meeting of Stockholders are
incorporated by reference in Part III of this Form 10-K.
  
  INDEX
 
 Part
I
 PageItem
      1.
              
              Business
              
              2Item
      1A.
              
              Risk Factors
              
              18Item
      1B.
              
              Unresolved Staff Comments
              
              23Item
      2.
              
              Properties
              
              25Item
      3.
              
              Legal Proceedings
              
              25Item
      4.
              
              [Removed and Reserved]Part
      IIItem
      5.
              
              Market for Registrant’s Common Equity, Related Stockholder
      Matters and Issuer
      Purchases of Equity Securities
              
              26Item
      6.
              
              Selected Financial Data
              
              27Item
      7.
              
              Management’s Discussion and Analysis of Financial Condition and
      Results of Operation
              
              29Item
      7A.
              
              Quantitative and Qualitative Disclosures About Market
      Risk
              
              49Item
      8.
              
              Financial Statements and Supplementary Data
              
              49Item
      9.
              
              Changes in and Disagreements With Accountants on Accounting and
      Financial Disclosure
              
              49Item
      9A(T).
              
              Controls and Procedures
              
              49Item
      9B.
              
              Other Information
              
              49Part
      IIIItem
      10.
              
              Directors, Executive Officers and Corporate
      Governance
              
              50Item
      11.
              
              Executive Compensation
              
              50Item
      12.
              
              Security Ownership of Certain Beneficial Owners and Management
      and Related Stockholder
      Matters
              
              50Item
      13.
              
              Certain Relationships and Related Transactions, and Director
      Independence
              
              51Item
      14.
              
              Principal Accountant Fees and Services
              
              51Part
      IVItem
      15.
              
              Exhibits and Financial Statement Schedules
              
              52SIGNATURES
  Index
  This report contains certain
“forward-looking statements” within the meaning of the federal securities
laws.  These statements are not historical facts, rather statements
based on Naugatuck Valley Financial Corporation’s current expectations regarding
its business strategies, intended results and 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.  Factors which could affect actual results include interest
rate trends, the general economic climate in the market area in which Naugatuck
Valley Financial operates, as well as nationwide, Naugatuck Valley Financial’s
ability to control costs and expenses, competitive products and pricing, loan
delinquency rates and changes in federal and state legislation and regulation.Additional factors that
may affect our results are discussed in this Annual Report on Form 10-K 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.  Except as may be required by applicable
law or regulation, Naugatuck Valley Financial assumes no obligation to update
any forward-looking statements.
 
 PART
I
 
 ITEM1.
              BUSINESS.
 
 General
 
 Naugatuck Valley Financial Corporation
was organized as a federal corporation at the direction of Naugatuck Valley
Savings and Loan in connection with the mutual holding company reorganization of
Naugatuck Valley Savings.  The reorganization and initial public
offering of Naugatuck Valley Financial was completed on September 30,
2004.  In the offering, Naugatuck Valley Financial issued a majority
of its outstanding shares of common stock to Naugatuck Valley Mutual Holding
Company, the mutual holding company parent of Naugatuck Valley
Savings.  As long as Naugatuck Valley Mutual exists, it will own at
least a majority of Naugatuck Valley Financial’s common stock.
 
 Naugatuck Valley Financial’s business
activity is the ownership of the outstanding capital stock of Naugatuck Valley
Savings and management of the investment of offering proceeds retained from the
offering.  Naugatuck Valley Financial neither owns nor leases any
property but instead uses the premises, equipment and other property of
Naugatuck Valley Savings with the payment of appropriate rental fees, as
required by applicable law and regulations.  In the future, Naugatuck
Valley Financial may acquire or organize other operating subsidiaries, however,
there are no current plans, arrangements, agreements or understandings, written
or oral, to do so.  Naugatuck Valley Financial has no significant
assets, other than all of the outstanding shares of Naugatuck Valley Savings and
U.S. government and agency securities, and no significant
liabilities.  Accordingly, the information set forth in this report,
including the consolidated financial statements and related financial data,
relates primarily to Naugatuck Valley Savings.
 
 Naugatuck Valley Savings is a federally
chartered savings bank, and has served its customers in Connecticut since
1922.  We operate as a community-oriented financial institution
offering traditional financial services to consumers and businesses in our
market area.  We attract deposits from the general public and use
those funds to originate one- to four-family, multi-family and commercial real
estate, construction, commercial business, and consumer loans, which we
primarily hold for investment.
 
 Naugatuck Valley Mutual is our
federally chartered mutual holding company parent.  As a mutual
holding company, Naugatuck Valley Mutual is a non-stock company that has as its
members the depositors of Naugatuck Valley Savings.  Naugatuck Valley
Mutual does not engage in any business activity other than owning a majority of
the common stock of Naugatuck Valley Financial.
 
 Acquisition
of Southern Connecticut Bancorp, Inc. and Second-Step Conversion
Transaction
 
 On February 22, 2010, Naugatuck Valley
Financial and Southern Connecticut Bancorp, Inc. (“SCBI”), the holding company
for The Bank of Southern Connecticut, entered into a definitive agreement for
Naugatuck Valley Financial to acquire SCBI.  Naugatuck Valley Mutual
also adopted a Plan of Conversion and Reorganization to convert to a stock
holding company by selling to the public its approximate 60% ownership interest
in Naugatuck
  2
 Index
  Valley
Financial in a transaction commonly referred to as a “second step”
conversion.  Completion of the acquisition is contingent on the
completion of the second step conversion.
 
 The acquisition is expected to occur
immediately following the completion of the second step
conversion.  Upon completion of the second step conversion, Naugatuck
Valley Savings and Loan will become the wholly-owned subsidiary of a new stock
holding company (“Newco”).  It is expected that Newco will retain the
name “Naugatuck Valley Financial Corporation.”
  As a
result of the acquisition, SCBI will merge with and into Newco, with Newco as
the surviving entity. SCBI shareholders will be able to elect to receive $7.25
in cash, shares of Newco common stock, or a combination of cash and Newco common
stock, subject to proration if necessary, to assure that 50% of SCBI’s
outstanding shares are exchanged for Newco common stock and the remainder are
exchanged for cash. The exchange ratio for determining the number of shares of
Newco common stock to be exchanged for each share of SCBI common stock will
equal $7.25 divided by the initial offering price per share to be established
for Newco’s common stock in the second step conversion offering.
  As part of the transaction, The Bank of
Southern Connecticut will merge with and into Naugatuck Valley Savings and Loan,
with Naugatuck Savings and Loan as the surviving entity.  Naugatuck
Valley Savings and Loan intends to continue to operate the four acquired banking
offices of The Bank of Southern Connecticut, which are located in New Haven (two
offices), Branford and North Haven, Connecticut, under the name “The Bank of
Southern Connecticut”.
 
 In addition to the completion of the
second step conversion, the acquisition is contingent on the receipt of
regulatory approvals, the approval of SCBI’s stockholders, the approval of
Naugatuck Valley Financial stockholders and other customary
conditions.
 
 In the second step conversion, Newco
will offer and sell shares of its common stock in an amount representing
Naugatuck Valley Mutual’s approximate 60% ownership interest in Naugatuck Valley
Financial.  The amount will be based on an independent appraisal of
Newco that will take into account the proposed acquisition of
SCBI.  Newco will offer the shares for sale to Naugatuck Valley
Savings and Loan’s eligible account holders and tax qualified employee plans in
a subscription offering.  If any shares remain unsold after the
expiration of the subscription offering, the unsold shares will be offered for
sale to members of the general public in a community offering and, if necessary,
in a broker-assisted syndicated community offering.  The highest
offering priority will be depositors of Naugatuck Valley Savings and Loan with
qualifying deposits as of the close of business on December 31,
2008.
 
 Stockholders of Naugatuck Valley
Financial (other than Naugatuck Valley Mutual), who collectively own
approximately 40% of Naugatuck Valley Financial’s outstanding common stock, will
receive shares of Newco common stock based on an “exchange ratio” designed to
preserve their aggregate percentage ownership interest.  The exchange
ratio also will be determined based on an independent appraisal of Newco that
will take into account the proposed acquisition of SCBI.
 
 The second step conversion transaction
is subject to regulatory approval, the approval of NVSL’s depositors, and the
approval of Naugatuck Valley Financial’s stockholders (including the holders of
a majority of Naugatuck Valley Financial’s outstanding shares of common stock,
other than Naugatuck Valley Mutual).  The transaction is expected to
be completed in the third calendar quarter of 2010.
 
 Available
Information
 
 Naugatuck Valley Financial’s Annual
Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and any amendments to such reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made
available free of charge on our website, www.nvsl.com, as soon
as reasonably practicable after such reports are electronically filed with, or
furnished to, the Securities and Exchange Commission.  Information on
our website shall not be considered a part of this Form 10-K.
  3
 Index
  Market
Area
 
 We are headquartered in Naugatuck,
Connecticut, which is located in southwestern Connecticut approximately six
miles south of Waterbury and 26 miles north of Bridgeport.  In
addition to our main office, we operate nine branch offices in the Greater
Naugatuck Valley which we consider our market area.  The Greater
Naugatuck Valley encompasses the communities in the central and lower Naugatuck
Valley regions in New Haven and Fairfield Counties.  The economy in
our market area is primarily oriented to the service, retail, construction, and
manufacturing industries.
 
 Competition
 
 We face significant competition for the
attraction of deposits and origination of loans.  Our most direct
competition for deposits has historically come from the several financial
institutions operating in our market area and, to a lesser extent, from other
financial service companies, such as brokerage firms, credit unions and
insurance companies.  We also face competition for investors’ funds
from money market funds and other corporate and government
securities.  In addition, banks owned by Bank of America Corporation,
Wells Fargo & Company, J.P. Morgan Chase & Co. and TD Bank Financial
Group, all of which are large super-regional bank holding companies, also
operate in our market area.  These institutions are significantly
larger than us and, therefore, have significantly greater
resources.
 
 Our competition for loans comes from
financial institutions in our market area and from other financial service
providers, such as mortgage companies and mortgage
brokers.  Competition for loans also comes from the non-depository
financial service companies in the mortgage market, such as insurance companies,
securities companies and specialty finance companies.
 
 We expect competition to continue in
the future as a result of legislative, regulatory and technological changes and
the continuing trend of consolidation in the financial services
industry.  Technological advances, for example, have lowered the
barriers to enter new market areas, allowed banks to expand their geographic
reach by providing services over the internet and made it possible for
non-depository institutions to offer products and services that traditionally
have been provided by banks.  Changes in federal law permit
affiliation among banks, securities firms and insurance companies, which
promotes a competitive environment in the financial services
industry.  Banks that have received Federal Government assistance
under the Economic Stabilization Act of 2008 may be able to pay higher rates on
deposits and charge lower rates on loans due to their improved capital
position.  Competition for deposits and the origination of loans could
limit our growth in the future.
 
 Lending
Activities
 
 General.Our loan portfolio consists of one- to
four-family residential mortgage loans, multi-family and commercial real estate
loans, construction loans, commercial business loans and consumer
loans.  Substantially all of our loans are made to borrowers residing
within Connecticut.
 
 One-
to Four-Family Residential Loans.We
originate mortgage loans to enable borrowers to purchase or refinance existing
homes or to construct new residential dwellings in our market
area.  We generally offer fixed-rate and adjustable-rate mortgage
loans with terms up to 30 years.  Borrower demand for adjustable-rate
loans versus fixed-rate loans is a function of the level of interest rates, the
expectations of changes in the level of interest rates, the difference between
the interest rates and loan fees offered for fixed-rate mortgage loans and the
initial period interest rates and loan fees for adjustable-rate
loans.  The relative amount of fixed-rate mortgage loans and
adjustable-rate mortgage loans that can be originated at any time is largely
determined by the demand for each in a competitive environment and the effect
each has on our interest rate risk.  The loan fees charged, interest
rates and other provisions of mortgage loans are determined by us on the basis
of our own pricing criteria and competitive market conditions.
 
 We offer fixed-rate loans with terms of
either 10, 15, 20 or 30 years.  Our adjustable-rate mortgage loans are
based on either a 15, 20 or 30 year amortization schedule and interest rates and
payments on our adjustable-rate mortgage loans adjust annually after either a
one, three, five or seven year initial fixed period.  Interest rates
and
  4
 Index
  payments
on our adjustable-rate loans generally are adjusted to a rate typically equal to
2.75% above the one-year constant maturity Treasury index.  The
maximum amount by which the interest rate may be increased or decreased is
generally 2% per adjustment period and the lifetime interest rate cap is
generally 6% over the initial interest rate of the loan.
 
 Due to historically low interest rate
levels, borrowers generally have preferred fixed-rate loans in recent
years.  While we anticipate that our adjustable-rate loans will better
offset the adverse effects on our net interest income of an increase in interest
rates as compared to fixed-rate mortgages, the increased mortgage payments
required of adjustable-rate loans in a rising interest rate environment could
cause an increase in delinquencies and defaults.  The marketability of
the underlying property also may be adversely affected in a high interest rate
environment.  In addition, although adjustable-rate mortgage loans
help make our asset base more responsive to changes in interest rates, the
extent of this interest sensitivity is limited by the annual and lifetime
interest rate adjustment limits.
 
 While one- to four-family residential
real estate loans are normally originated with up to 30-year terms, such loans
typically remain outstanding for substantially shorter periods because borrowers
often prepay their loans in full upon sale of the property pledged as security
or upon refinancing the original loan.  Therefore, average loan
maturity is a function of, among other factors, the level of purchase and sale
activity in the real estate market, prevailing interest rates and the interest
rates payable on outstanding loans.  As interest rates declined and
remained low over the past few years, we have experienced high levels of loan
repayments and refinancings.
 
 We generally do not make conventional
loans with loan-to-value ratios exceeding 97% and generally make loans with a
loan-to-value ratio in excess of 80% only when secured by first liens on
owner-occupied one- to four-family residences.  Loans with
loan-to-value ratios in excess of 80% require private mortgage insurance or
additional collateral.  We require all properties securing mortgage
loans to be appraised by a Board-approved independent appraiser.  We
require title insurance on all first mortgage loans.  Borrowers must
obtain hazard insurance, or flood insurance for loans on property located in a
flood zone, before closing the loan.
 
 In an effort to provide financing for
first-time buyers, we offer a first-time home buyers program.  We
offer fixed-rate residential mortgage loans through this program to qualified
individuals and originate the loans using modified underwriting guidelines,
lower rates and terms of up to 40 years.
 
 Multi-Family
and Commercial Real Estate Loans.We
offer adjustable-rate mortgage loans secured by multi-family and commercial real
estate.  Our multi-family and commercial real estate loans are
generally secured by condominiums, apartment buildings, offices, retail and
other income producing properties, as well as owner-occupied properties used for
businesses.  We intend to continue to grow this segment of our loan
portfolio.
 
 We originate multi-family and
commercial real estate loans for terms generally up to 20
years.  Interest rates and payments on adjustable-rate loans adjust
every one, three, five or ten years.  Interest rates on our adjustable
rate loans generally are adjusted to a rate typically equal to 2.00% to 2.50%
above the one-year, three-year, five-year or ten-year Federal Home Loan Bank
classic advance rate.There are no adjustment
period or lifetime interest rate caps.  Loan amounts generally do not
exceed 80% of the appraised value.
 
 Loans secured by multi-family and
commercial real estate generally have larger balances and involve a greater
degree of risk than one- to four-family residential mortgage
loans.  Of primary concern in multi-family and commercial real estate
lending is the borrower’s creditworthiness and the feasibility and cash flow
potential of the project.  Payments on loans secured by income
properties often depend on successful operation and management of the
properties.  As a result, repayment of such loans may be subject to a
greater extent than residential real estate loans to adverse conditions in the
real estate market or the economy.  To monitor cash flows on income
properties, we require borrowers and loan guarantors, where applicable, to
provide annual financial statements on multi-family and commercial real estate
loans.  In reaching a decision on whether to make a multi-family or
commercial real estate loan, we consider the net operating income of the
property, the borrower’s expertise, credit history, profitability and the value
of the underlying property.  We require an environmental survey for
multi-family and commercial real estate loans.  The largest
outstanding multi-family or commercial real estate loan at December 31, 2009 was
$4.8 million, of which $4.8 million was outstanding.  This
loan is secured by land for retail development and was performing according
to its terms at December 31, 2009.
  5
 Index
  Construction
Loans.We
originate loans to individuals to finance the construction of residential
dwellings for personal use.  Our construction loans generally provide
for the payment of interest only during the construction phase, which is usually
nine months.  At the end of the construction phase, the loan converts
to a permanent mortgage loan.  Loans generally can be made with a
maximum loan to value ratio of 80% of the appraised value with a maximum term of
30 years. Our largest residential construction loan at December 31, 2009 was
$1.4 million, of which $356,000 was outstanding.  This loan was
performing according to its terms at December 31, 2009.  We also make
commercial construction loans for commercial development projects, including
condominiums, apartments buildings, and single family subdivisions as well as
office buildings, retail and other income producing properties.  These
loans provide for payment of interest only during the construction phase and
may, in the case of an apartment or commercial building, convert to a permanent
mortgage loan or, in the case of a single family subdivision or construction or
builder loan, be paid in full with the sale of the property after construction
is complete.  In the case of a commercial construction loan, the
construction period may be from nine months to two years.  Loans are
generally made to a maximum of 80% of the appraised value as determined by an
appraisal of the property made by an independent licensed
appraiser.  We also require an inspection of the property before
disbursement of funds during the term of the construction loan for both
residential and commercial construction loans.  Our largest commercial
construction loan at December 31, 2009 was $5.4 million, of which $2.6 million
was outstanding.    This loan is secured by real estate
for the construction of single family homes, and was performing according to its
terms at December 31, 2009.  Our largest commercial real estate loan
relationship at December 31, 2009 involved three loans totaling $6.4 million,
secured by land for commercial and retail development.  These loans
were performing according to their original terms at December 31,
2009.
 
 We originate land loans to individuals
on approved residential building lots for personal use for terms of up to 20
years and to a maximum loan-to-value ratio of 75% of the lower of the appraisal
value or purchase price.  Our land loans adjust annually after a
five-year initial fixed period.  Interest rates after adjustment are
equal to 2.75% above the one-year constant maturity Treasury index.
 
 We also originate loans to local
contractors and developers for the purpose of making improvements to, and on,
approved subdivisions and condominium projects within two years of the date of
the original loan.  Such loans generally are written with a maximum
loan-to-value ratio of 80% of the lower of the appraised value or purchase price
of the land.  These loans adjust when and as the index changes at a
rate that is generally equal to the prime rate as published in The Wall Street Journal plus
1%.  We require title insurance and, if applicable, a hazardous waste
survey reporting that the land is free of hazardous or toxic waste.
 
 Construction financing is generally
considered to involve a higher degree of risk of loss than long-term financing
on improved, occupied real estate.  Risk of loss on a construction
loan depends largely upon the accuracy of the initial estimate of the property’s
value at completion of construction or development and the estimated cost
(including interest) of construction.  During the construction phase,
a number of factors could result in delays and cost overruns.  If the
estimate of construction costs proves to be inaccurate, we may be required to
advance funds beyond the amount originally committed to permit completion of the
development.  If the estimate of value proves to be inaccurate, we may
be confronted, at or before the maturity of the loan, with a project having a
value which is insufficient to assure full repayment.  As a result of
the foregoing, construction lending often involves the disbursement of
substantial funds with repayment dependent, in part, on the success of the
ultimate project rather than the ability of the borrower or guarantor to repay
principal and interest.  If we are forced to foreclose on a project
before or at completion due to a default, there can be no assurance that we will
be able to recover all of the unpaid balance of, and accrued interest on, the
loan as well as related foreclosure and holding costs.
 
 Commercial
Business Loans.We
make commercial business loans to a variety of professionals, sole
proprietorships and small businesses primarily in our market area.  We
offer a variety of commercial lending products.  These loans are
typically secured, primarily by business assets.  These loans are
originated with maximum loan-to-value ratios of 75% of the value of the business
assets.  We originate one- to ten-year term loans for the acquisition
of equipment or business expansion, lines of credit for seasonal financing needs
and demand loans for short term financing needs with specific repayment
sources.  Commercial business loans are generally written at variable
rates which use the prime rate as published in The Wall Street Journal as an
index and, depending on the qualifications of the borrower, a zero to 3.0%
margin is added.  These rates will change when and as the index rate
changes without caps.  Fixed-rate loans are written at market rates
determined at the time the loan is granted and are
  6
 Index
  based on
the length of the term and the qualifications of the borrower.  Our
largest commercial business loan relationship at December 31, 2009 was a loan in
the amount of $1.2 million of which $1.2 million was outstanding and performing
according to the original terms at December 31, 2009.  This loan is
secured by assignment of receivables.
 
 When making commercial business loans,
we consider the financial statements of the borrower, the borrower’s payment
history of both corporate and personal debt, the debt service capabilities of
the borrower, the projected cash flows of the business, and viability of the
industry in which the customer operates and the value of the
collateral.
 
 Unlike residential mortgage loans,
which generally are made on the basis of the borrower’s ability to make
repayment from his or her employment or other income, and which are secured by
real property whose value tends to be more easily ascertainable, commercial
business loans are of higher risk and typically are made on the basis of the
borrower’s ability to make repayment from the cash flow of the borrower’s
business.  As a result, the availability of funds for the repayment of
commercial business loans may depend substantially on the success of the
business itself.  Further, any collateral securing such loans may
depreciate over time, may be difficult to appraise and may fluctuate in
value.
 
 Consumer
Loans.We
offer a variety of consumer loans, primarily second mortgage loans and home
equity lines of credit, and, to a much lesser extent, loans secured by passbook
or certificate accounts, automobiles, as well as unsecured personal loans and
overdraft protection accounts.  Unsecured loans generally have a
maximum borrowing limit of $5,000 and a maximum term of three
years.
 
 The procedures for underwriting
consumer loans include an assessment of the applicant’s payment history on other
debts and ability to meet existing obligations and payments on the proposed
loans.  Although the applicant’s creditworthiness is a primary
consideration, the underwriting process also includes a comparison of the value
of the collateral, if any, to the proposed loan amount.  Second
mortgage loans have fixed rates of interest for terms of up to 20
years.  These loans are originated with maximum combined loan-to-value
ratios of 75% of the appraised value of the property.  Home equity
lines of credit have adjustable rates of interest that are indexed to the prime
rate as published in The Wall
Street Journal for terms of up to 10 years.  These loans are
originated with maximum loan-to-value ratios of 75% of the appraised value of
the property and we require that we have a second lien position on the
property.
 
 Consumer loans may entail greater risk
than do residential mortgage loans, particularly in the case of consumer loans
that are unsecured or secured by assets that depreciate rapidly.  In
such cases, repossessed collateral for a defaulted consumer loan may not provide
an adequate source of repayment for the outstanding loan and the remaining
deficiency often does not warrant further substantial collection efforts against
the borrower.  In addition, consumer loan collections depend on the
borrower’s continuing financial stability, and therefore are more likely to be
adversely affected by job loss, divorce, illness or personal
bankruptcy.  Furthermore, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered on such loans.
 
 Loan
Originations, Purchases and Sales.Loan
originations come from a number of sources.  The primary source of
loan originations are our in-house loan originators, and to a lesser extent,
local mortgage brokers, advertising and referrals from customers.  We
occasionally purchase loans or participation interests in loans.
 
 We consider loan sales as a part of our
interest rate risk management efforts.  We have the ability to sell
longer-term fixed-rate loans in the secondary market based on prevailing market
interest rate conditions, an analysis of the composition and risk of the loan
portfolio, liquidity needs and interest rate risk management
goals.  Generally, loans are sold without recourse and with servicing
retained.  We did not sell any loans in the years ended December 31,
2009 or 2008.  We occasionally sell participation interests in
loans.
 
 Loan
Approval Procedures and Authority.Our
lending activities follow written, nondiscriminatory, underwriting standards and
loan origination procedures established by our Board of Directors and
management.
  7
 Index
  For one- to four-family loans and owner
occupied residential construction loans, two members of the mortgage loan
committee, one of which must be a vice president or above, may approve loans up
to $417,000 and a majority of the members of the Board loan committee must
approve loans over $417,000.  For unsecured commercial business loans,
a majority of the members of the Board must approve loans over $500,000 and two
members of the Board of Directors loan committee must approve loans over
$250,000 and up to $500,000.  Unsecured business loans of $250,000 or
less must be approved by two members of the officers’ loan
committee.  Loans of $100,000 or less which are unsecured can be
approved by one member of the officers’ loan committee and later presented to
the officers’ loan committee for ratification.  For secured commercial
loans and commercial construction loans, a majority of the members of the Board
must approve loans over $1.5 million and two members of the Board of Directors
loan committee must approve loans over $750,000 and up to $1.5
million.  Loans of $500,001 to $750,000, secured by real estate, where
the loan to value ratio is 80% or less supported by a conforming appraisal, can
be approved by the officers’ loan committee.  Loans of $500,000 or
less secured by real estate where the loan-to-value is 80% or less can be
approved by two members of the officers’ loan committee and for $100,000 or less
secured by real estate with an 80% loan-to-value one member of the officers’
loan committee can approve with a later ratification by the officers’ loan
committee.  The Board of Directors must approve all consumer loans
over $200,000.  Various bank personnel have been delegated authority
to approve smaller commercial loans and consumer loans.
 
 Loans
to One Borrower.The maximum amount that we may lend to
one borrower and the borrower’s related entities is limited, by regulation, to
generally 15% of our stated capital and reserves.  At December 31,
2009, our regulatory limit on loans to one borrower was$7.1 million.  At that date,
our largest lending relationship was$6.4 million and included loans secured
by land for commercial and retail development all of which were performing
according to the original repayment terms at December 31,
2009.
 
 Loan
Commitments.We issue commitments for fixed-rate and
adjustable-rate mortgage loans conditioned upon the occurrence of certain
events.  Commitments to originate mortgage loans are legally binding
agreements to lend to our customers and generally expire in 45 days or
less.
 
 Delinquencies.When
a borrower fails to make a required loan payment, we take a number of steps to
have the borrower cure the delinquency and restore the loan to current
status.  We make initial contact with the borrower when the loan
becomes 15 days past due.  If payment is not then received by the
30th day
of delinquency, additional letters and phone calls are made.  We send
a letter notifying the borrower that we will commence foreclosure proceedings if
the loan is not brought current within 91 days.  At this point, we may
consider loan workout arrangements with certain borrowers under certain
circumstances.  If our workout efforts are unsuccessful, we generally
commence foreclosure proceedings against any real property that secures the loan
or attempt to repossess any personal property that secures a consumer
loan.  If a foreclosure action is instituted and the loan is not
brought current, paid in full, or refinanced before the foreclosure sale, the
real property securing the loan generally is sold at foreclosure or taken by the
bank as other real estate owned.
 
 Management informs the Board of
Directors on a monthly basis of the amount of loans delinquent more than 30
days.  Management also provides detailed reporting of loans greater
than 90 days delinquent, all loans in foreclosure and all foreclosed and
repossessed property that we own.
 
 Investment
Activities
 
 We have legal authority to invest in
various types of liquid assets, including U.S. Treasury obligations, securities
of various federal agencies and of state and municipal governments,
mortgage-backed securities and certificates of deposit of federally insured
institutions.  Within certain regulatory limits, we also may invest a
portion of our assets in corporate securities and mutual funds.  We
also are required to maintain an investment in Federal Home Loan Bank of Boston
stock.
 
 At December 31, 2009, our investment
portfolio consisted of U.S. government and agency securities with maturities
primarily less than five years, mortgage-backed securities issued by Fannie Mae,
Freddie Mac and Ginnie Mae with stated final maturities of 30 years or less,
collateralized mortgage obligations with stated final maturities of 30 years or
less, and preferred money market securities with terms of primarily 91 days or
less.
  8
 Index
  Our investment objectives are to
provide and maintain liquidity, to maintain a balance of high quality,
diversified investments to minimize risk, to provide collateral for pledging
requirements, to establish an acceptable level of interest rate risk, to provide
an alternate source of low-risk investments when demand for loans is weak, and
to generate a favorable return.  During 2009 we enhanced our overall
interest rate risk position by selling our entire municipal bond portfolio,
using the majority of the funds to pay off Federal Home Loan Bank advances as
they came due.  Our Board of Directors has the overall responsibility
for our investment portfolio, including approval of our investment policy and
appointment of our Asset/Liability and Investment Committees.  The
Investment Committee meets regularly and is responsible for approval of
investment strategies and monitoring of investment performance.  Our
Controller is the designated investment portfolio manager and has the
responsibility for the daily investment activities and is authorized to make
investment decisions consistent with our investment policy.
 
 Deposit
Activities and Other Sources of Funds
 
 General.Deposits and loan repayments are the
major sources of our funds for lending and other investment
purposes.  Loan repayments are a relatively stable source of funds,
while deposit inflows and outflows and loan prepayments are significantly
influenced by general interest rates and money market
conditions.
 
 Deposit
Accounts.The vast majority of our depositors are
residents of the State of Connecticut.  Deposits are attracted from
within our primary market area through the offering of a broad selection of
deposit instruments, including NOW accounts, checking accounts, money market
accounts, regular savings accounts, club savings accounts, certificate accounts,
health savings accounts and various retirement accounts.Generally, we do not utilize brokered
funds.  Deposit account terms vary according to the minimum balance
required, the time periods the funds must remain on deposit and the interest
rate, among other factors.  In determining the terms of our deposit
accounts, we consider the rates offered by our competition, profitability to us,
matching deposit and loan products and customer preferences and
concerns.  We generally review our deposit mix and pricing
weekly.  Our current strategy is to offer competitive rates, but not
be the market leader in every type and maturity.
 
 Borrowings.We
borrow from the Federal Home Loan Bank of Boston to supplement our supply of
lendable funds and to meet deposit withdrawal requirements.  The
Federal Home Loan Bank functions as a central reserve bank providing credit for
member financial institutions.  As a member, we are required to own
capital stock in the Federal Home Loan Bank of Boston and are authorized to
apply for advances on the security of such stock and certain of our mortgage
loans and other assets (principally securities which are obligations of, or
guaranteed by, the United States), provided certain standards related to
creditworthiness have been met.  Advances are made under several
different programs, each having its own interest rate and range of
maturities.  Depending on the program, limitations on the amount of
advances are based either on a fixed percentage of an institution’s net worth or
on the Federal Home Loan Bank’s assessment of the institution’s
creditworthiness.  Under its current credit policies, the Federal Home
Loan Bank generally limits advances to 25% of a member’s assets, and short-term
borrowings of less than one year may not exceed 10% of the institution’s
assets.  The Federal Home Loan Bank determines specific lines of
credit for each member institution.
 
 We also use securities sold under
agreements to repurchase as a source of borrowings, and we occasionally borrow
short-term from correspondent banks tocover temporary cash
needs.
 
 Subsidiaries
 
 Naugatuck Valley Financial’s sole
subsidiary is Naugatuck Valley Savings.
 
 Naugatuck Valley Savings has one
subsidiary, Naugatuck Valley Mortgage Servicing
Corporation.  Naugatuck Valley Mortgage Servicing, established in 1999
under Connecticut law, is a passive investment corporation organized in order to
take advantage of certain state tax benefits.  Its primary business is
to service mortgage loans which we have originated and subsequently transferred
to Naugatuck Valley Mortgage Servicing.  At December 31, 2009,
Naugatuck Valley Mortgage Servicing had $267.0 million in
assets.
  9
 Index
  Personnel
 
 At December 31, 2009, we had 117
full-time employees and 16 part-time employees, none of whom are represented by
a collective bargaining unit.  We believe our relationship with our
employees is good.
 
 Regulation and
Supervision
 
 General
 
 Naugatuck Valley Savings is subject to
extensive regulation, examination and supervision by the Office of Thrift
Supervision, as its primary federal regulator, and the Federal Deposit Insurance
Corporation, as its deposits insurer.  Naugatuck Valley Savings is a
member of the Federal Home Loan Bank System and its deposit accounts are insured
up to applicable limits by the Deposit Insurance Fund managed by the Federal
Deposit Insurance Corporation.  Naugatuck Valley Savings must file
reports with the Office of Thrift Supervision and the Federal Deposit Insurance
Corporation concerning its activities and financial condition in addition to
obtaining regulatory approvals prior to entering into certain transactions such
as mergers with, or acquisitions of, other financial
institutions.  There are periodic examinations by the Office of Thrift
Supervision and, under certain circumstances, the Federal Deposit Insurance
Corporation to evaluate Naugatuck Valley Savings’ safety and soundness and
compliance with various regulatory requirements.  This regulation and
supervision establishes a comprehensive framework of activities in which an
institution can engage and is intended primarily for the protection of the
insurance fund and depositors.  The regulatory structure also gives
the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes.  Any change in
such policies, whether by the Office of Thrift Supervision, the Federal Deposit
Insurance Corporation or Congress, could have a material adverse impact on
Naugatuck Valley Financial, Naugatuck Valley Mutual and Naugatuck Valley Savings
and their operations.  Naugatuck Valley Financial and Naugatuck Valley
Mutual, as savings and loan holding companies, are required to file certain
reports with, are subject to examination by, and otherwise must comply with the
rules and regulations of the Office of Thrift Supervision.  Naugatuck
Valley Financial is also subject to the rules and regulations of the Securities
and Exchange Commission under the federal securities laws.
 
 Certain of the regulatory requirements
that are applicable to Naugatuck Valley Savings, Naugatuck Valley Financial and
Naugatuck Valley Mutual are described below.  This description of
statutes and regulations is not intended to be a complete explanation of such
statutes and regulations and their effects on Naugatuck Valley Savings,
Naugatuck Valley Financial and Naugatuck Valley Mutual and is qualified in its
entirety by reference to the actual statutes and regulations.
 
 Regulation
of Federal Savings Institutions
 
 Business
Activities. Federal law
and regulations govern the activities of federal savings banks, such as
Naugatuck Valley Savings.  These laws and regulations delineate the
nature and extent of the activities in which federal savings banks may
engage.  In particular, certain lending authority for federal savings
banks, e.g., commercial, non-residential real property loans and consumer loans,
is limited to a specified percentage of the institution’s capital or
assets.
 
 Capital
Requirements.The
Office of Thrift Supervision’s capital regulations require federal savings
institutions to meet three minimum capital standards: a 1.5% tangible capital to
total assets ratio; a 4% Tier 1 capital to total assets leverage ratio (3% for
institutions receiving the highest rating on the CAMELS examination rating
system); and an 8% risk-based capital ratio.  In addition, the prompt
corrective action standards discussed below also establish, in effect, a minimum
2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving
the highest rating on the CAMELS system) and, together with the risk-based
capital standard itself, a 4% Tier 1 risk-based capital standard.  The
Office of Thrift Supervision regulations also require that, in meeting the
tangible, leverage and risk-based capital standards, institutions must generally
deduct investments in and loans to subsidiaries engaged in activities as
principal that are not permissible for a national bank.
  10
 Index
  The risk-based capital standard for
savings institutions requires the maintenance of Tier 1 (core) and total
capital (which is defined as core capital and supplementary capital, less
certain specified deductions from total capital such as reciprocal holdings of
depository institution capital, instruments and equity investments) to
risk-weighted assets of at least 4% and 8%, respectively.  In
determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet activities, recourse obligations, residual interests and
direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%,
assigned by the Office of Thrift Supervision capital regulation based on the
risks believed inherent in the type of asset.  Core (Tier 1) capital
is generally defined as common stockholders’ equity (including retained
earnings), certain non-cumulative perpetual preferred stock and related surplus,
and minority interests in equity accounts of consolidated subsidiaries less
intangibles other than certain mortgage servicing rights and credit card
relationships.  The components of supplementary capital (Tier 2
capital) include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock, the allowance for loan and lease losses, limited to a maximum
of 1.25% of risk-weighted assets, and up to 45% of unrealized gains on
available-for-sale equity securities with readily determinable fair market
values.  Overall, the amount of supplementary capital included as part
of total capital cannot exceed 100% of core capital.
 
 The Office of Thrift Supervision also
has authority to establish individual minimum capital requirements in
appropriate cases upon a determination that an institution’s capital level is or
may become inadequate in light of the particular circumstances.  At
December 31, 2009 Naugatuck Valley Savings met each of its capital
requirements.
 
 Prompt
Corrective Regulatory Action.The Office of Thrift Supervision is
required to take certain supervisory actions against undercapitalized
institutions, the severity of which depends upon the
institution’s  degree of undercapitalization.  Generally, a
savings institution that has a ratio of total capital to risk weighted assets of
less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less
than 4% or a ratio of core capital to total assets of less than 4% (3% or less
for institutions with the highest examination rating) is considered to be
“undercapitalized.”  A savings institution that has a total risk-based
capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage
ratio that is less than 3% is considered to be “significantly undercapitalized”
and a savings institution that has a tangible capital to assets ratio equal to
or less than 2% is deemed to be “critically
undercapitalized.”  Subject to a narrow exception, the Office of
Thrift Supervision is required to appoint a receiver or conservator within
specified time frames for an institution that is “critically
undercapitalized.”  The regulation also provides that a capital
restoration plan must be filed with the Office of Thrift Supervision within 45
days of the date a savings institution is deemed to have received notice that it
is “undercapitalized,” “significantly undercapitalized” or “critically
undercapitalized.”  Compliance with the plan must be guaranteed by any
parent holding company up to the lesser of 5% of the savings institution’s total
assets when it was deemed to be undercapitalized or the amount necessary to
achieve compliance with applicable capital regulations.  In addition,
numerous mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion.  The Office of Thrift Supervision could also take any one
of a number of discretionary supervisory actions, including the issuance of a
capital directive and the replacement of senior executive officers and
directors.  Significantly and undercapitalized institutions are
subject to additional mandatory and discretionary restrictions.
 
 Loans
to One Borrower.
Federal law provides that savings institutions are generally subject to the
limits on loans to one borrower applicable to national banks.  Subject
to certain exceptions, a savings institution may not make a loan or extend
credit to a single or related group of borrowers in excess of 15% of its
unimpaired capital and surplus.  An additional amount may be lent,
equal to 10% of unimpaired capital and surplus, if secured by specified
readily-marketable collateral.
 
 Standards
for Safety and Soundness.The federal
banking agencies have adopted Interagency Guidelines prescribing Standards for
Safety and Soundness.  The guidelines set forth the safety and
soundness standards that the federal banking agencies use to identify and
address problems at insured depository institutions before capital becomes
impaired.  If the Office of Thrift Supervision determines that a
savings institution fails to meet any standard prescribed by the guidelines, the
Office of Thrift Supervision may require the institution to submit an acceptable
plan to achieve compliance with the standard.
 
 Limitation
on Capital Distributions.Office of Thrift Supervision
regulations impose limitations upon all capital distributions by a savings
institution, including cash dividends, payments to repurchase its shares
and
  11
 Index
  payments
to stockholders of another institution in a cash-out merger.  Under
the regulations, an application to and the prior approval of the Office of
Thrift Supervision is required before any capital distribution if the
institution does not meet the criteria for “expedited treatment” of applications
under Office of Thrift Supervision regulations (i.e., generally, examination and
Community Reinvestment Act ratings in the two top categories), the total capital
distributions for the calendar year exceed net income for that year plus the
amount of retained net income for the preceding two years, the institution would
be undercapitalized following the distribution or the distribution would
otherwise be contrary to a statute, regulation or agreement with the Office of
Thrift Supervision.  If an application is not required, the
institution must still provide prior notice to the Office of Thrift Supervision
of the capital distribution if, like Naugatuck Valley Savings, it is a
subsidiary of a holding company.  If Naugatuck Valley Savings’ capital
were ever to fall below its regulatory requirements or the Office of Thrift
Supervision notified it that it was in need of increased supervision, its
ability to make capital distributions could be restricted.  In
addition, the Office of Thrift Supervision could prohibit a proposed capital
distribution that would otherwise be permitted by the regulation, if the agency
determines that such distribution would constitute an unsafe or unsound
practice.
 
 Qualified
Thrift Lender Test.Federal
law requires savings institutions to meet a qualified thrift lender
test.  Under the test, a savings institution is required to either
qualify as a “domestic building and loan association” under the Internal Revenue
Code or maintain at least 65% of its “portfolio assets” (total assets less: (i)
specified liquid assets up to 20% of total assets; (ii) intangibles, including
goodwill; and (iii) the value of property used to conduct business) in certain
“qualified thrift investments” (primarily residential mortgages and related
investments, including certain mortgage-backed securities) in at least nine
months out of each twelve-month period.  Legislation has expanded the
extent to which education loans, credit card loans and small business loans may
be considered “qualified thrift investments.”
 
 A savings institution that fails the
qualified thrift lender test is subject to certain operating restrictions and
may be required to convert to a bank charter.  As of December 31,
2009, Naugatuck Valley Savings maintained 85.9% of its portfolio assets in
qualified thrift investments and, therefore, met the qualified thrift lender
test.
 
 Transactions
with Related Parties.Federal law
limits Naugatuck Valley Savings’ authority to make loans to, and engage in
certain other transactions with (collectively, “covered transactions”),
“affiliates” (i.e., generally, any company that controls or is under common
control with an institution), including Naugatuck Valley Financial and Naugatuck
Valley Mutual and their non-savings institution subsidiaries.  The
aggregate amount of covered transactions with any individual affiliate is
limited to 10% of the capital and surplus of the savings
institution.  The aggregate amount of covered transactions with all
affiliates is limited to 20% of the savings institution’s capital and
surplus.  Loans and other specified transactions with affiliates are
required to be secured by collateral in an amount and of a type described in
federal law.  The purchase of low quality assets from affiliates is
generally prohibited.  Transactions with affiliates must be on terms
and under circumstances that are at least as favorable to the institution as
those prevailing at the time for comparable transactions with non-affiliated
companies.  In addition, savings institutions are prohibited from
lending to any affiliate that is engaged in activities that are not permissible
for bank holding companies and no savings institution may purchase the
securities of any affiliate other than a subsidiary.
 
 The Sarbanes-Oxley Act generally
prohibits loans by Naugatuck Valley Financial to its executive officers and
directors.  However, the Sarbanes-Oxley Act contains a specific
exemption from such prohibition for loans by Naugatuck Valley Savings to its
executive officers and directors in compliance with federal banking
regulations.  Federal regulations impose certain quantitative limits
and require, among other things, that all loans or extensions of credit to
executive officers and directors of insured institutions must be made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons and must
not involve more than the normal risk of repayment or present other unfavorable
features.  Naugatuck Valley Savings is therefore generally prohibited
from making any new loans or extensions of credit to executive officers and
directors at different rates or terms than those offered to the general
public.  Notwithstanding this rule, federal regulations permit
Naugatuck Valley Savings to make loans to executive officers and directors at
reduced interest rates if the loan is made under a benefit program generally
available to all other employees and does not give preference to any executive
officer or director over any other employee.
 
 In addition, loans made to a director
or executive officer in an amount that, when aggregated with the amount of all
other loans to the person and his or her related interests, are in excess of the
greater of $25,000 or 5%
  12
 Index
  of
Naugatuck Valley Savings’ capital and surplus, or, in any event, greater than
$500,000, must be approved in advance by a majority of the disinterested members
of the board of directors.
 
 Loans to executive officers are subject
to additional restrictions based on the category of loan involved.
 
 Enforcement. The
Office of Thrift Supervision has primary enforcement responsibility over federal
savings institutions and has the authority to bring actions against the
institution and all institution-affiliated parties, including stockholders, and
any attorneys, appraisers and accountants who knowingly or recklessly
participate in wrongful action likely to have an adverse effect on an insured
institution.  Formal enforcement action may range from the issuance of
a capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance.  Civil penalties cover a wide range of violations
and can amount to $25,000 per day, or even $1 million per day in especially
egregious cases.  The Federal Deposit Insurance Corporation has
authority to recommend to the Director of the Office of Thrift Supervision that
enforcement action be taken with respect to a particular savings
institution.  If action is not taken by the Director, the Federal
Deposit Insurance Corporation has authority to take such action under certain
circumstances.  Federal law also establishes criminal penalties for
certain violations.
 
 Assessments. Federal
savings banks are required to pay assessments to the Office of Thrift
Supervision to fund its operations.  The general assessments, paid on
a semi-annual basis, are based upon the savings institution’s total assets,
including consolidated subsidiaries, financial condition and complexity of its
portfolio.  The Office of Thrift Supervision assessments paid by
Naugatuck Valley Savings for the year ended December 31, 2009 totaled
$130,459.
 
 Insurance
of Deposit Accounts.The deposits of
Naugatuck Valley Savings are insured up to applicable limits by the Deposit
Insurance Fund of the Federal Deposit Insurance Corporation.  The
Deposit Insurance Fund is the successor to the Bank Insurance Fund and the
Savings Association Insurance Fund, which were merged in 2006.
 
 Under the Federal Deposit Insurance
Corporation’s risk-based assessment system, insured institutions are assigned to
one of four risk categories based on supervisory evaluations, regulatory capital
levels and certain other factors, with less risky institutions paying lower
assessments.  An institution’s assessment rate depends upon the
category to which it is assigned.  For calendar 2008, assessments
ranged from five to forty-three basis points of each institution’s deposit
assessment base.  Due to losses incurred by the Deposit Insurance Fund
in 2008 from failed institutions, and anticipated future losses, the Federal
Deposit Insurance Corporation adopted an across the board seven basis point
increase in the assessment range for the first quarter of 2009.  The
Federal Deposit Insurance Corporation made further refinements to its risk-based
assessment system effective April 1, 2009 that effectively made the range seven
to 77 1/2 basis points.  The Federal Deposit Insurance Corporation may
adjust the scale uniformly from one quarter to the next, except that no
adjustment can deviate more than three basis points from the base scale without
notice and comment rulemaking.  No institution may pay a dividend if
it is in default of the federal deposit insurance assessment.
 
 The Federal Deposit Insurance
Corporation also imposed on all insured institutions a special emergency
assessment of five basis points of total assets minus tier 1 capital, as of June
30, 2009 (capped at ten basis points of an institution’s deposit assessment base
on the same date) in order to cover losses to the Deposit Insurance
Fund.  That special assessment was collected on September 30,
2009.  The Federal Deposit Insurance Corporation provided for similar
special assessments during the final two quarters of 2009, if deemed
necessary.  However, in lieu of further special assessments, the
Federal Deposit Insurance Corporation required insured institutions to prepay
estimated quarterly risk-based assessments for the fourth quarter of 2009
through the fourth quarter of 2012.  The estimated assessments, which
include an assumed annual assessment base increase of 5%, were recorded as a
prepaid expense asset as of December 30, 2009.  As of December 31,
2009, and each quarter thereafter, a charge to earnings will be recorded for
each regular assessment with an offsetting credit to the prepaid
asset.
 
 Due to the recent difficult economic
conditions, deposit insurance per account owner has been raised to $250,000 for
all types of accounts through December 31, 2013.  In addition, the
FDIC adopted an optional Temporary Liquidity Guarantee Program by which, for a
fee, noninterest bearing transaction accounts receive unlimited insurance
coverage until December 31, 2009, subsequently extended until June 30, 2010, and
certain senior
  13
 Index
  unsecured
debt issued by institutions and their holding companies during specified periods
would be guaranteed by the FDIC through June 30, 2012, or in certain cases, to
December 31, 2012.  Naugatuck Valley Savings made the business
decision to participate in the unlimited noninterest bearing transaction account
coverage and Naugatuck Valley Savings and its holding companies opted to
participate in the unsecured debt guarantee program.
 
 In addition to the assessment for
deposit insurance, institutions are required to make payments on bonds issued in
the late 1980s by the Financing Corporation to recapitalize a predecessor
deposit insurance fund.  That payment is established quarterly and
during the four quarters ending December 31, 2009 averaged 1.08 basis points of
assessable deposits.
 
 The Federal Deposit Insurance
Corporation has authority to increase insurance assessments.  A
significant increase in insurance premiums would likely have an adverse effect
on the operating expenses and results of operations of Naugatuck Valley
Savings.  Management cannot predict what insurance assessment rates
will be in the future.
 
 Insurance of deposits may be terminated
by the Federal Deposit Insurance Corporation upon a finding that the institution
has engaged in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations or has violated any applicable law, regulation, rule,
order or condition imposed by the Federal Deposit Insurance Corporation or the
Office of Thrift Supervision.  The management of Naugatuck Valley
Savings does not know of any practice, condition or violation that might lead to
termination of deposit insurance.
 
 Federal
Home Loan Bank System.Naugatuck
Valley Savings is a member of the Federal Home Loan Bank System, which consists
of twelve regional Federal Home Loan Banks.  The Federal Home Loan
Bank provides a central credit facility primarily for member
institutions.  Naugatuck Valley Savings, as a member of the Federal
Home Loan Bank of Boston, is required to acquire and hold shares of capital
stock in that Federal Home Loan Bank.  Naugatuck Valley Savings was in
compliance with this requirement with an investment in Federal Home Loan Bank
stock at December 31, 2009 of $6.3 million.
 
 The
Federal Home Loan Banks are required to provide funds for the resolution of
insolvent thrifts in the late 1980s and to contribute funds for affordable
housing programs.  These requirements could reduce the amount of
dividends that the Federal Home Loan Banks pay to their members and could also
result in the Federal Home Loan Banks imposing a higher rate of interest on
advances to their members.
 
 Federal
Reserve System
 
 The Federal Reserve Board regulations
require savings institutions to maintain non-interest earning reserves
against their transaction accounts (primarily Negotiable Order of Withdrawal
(NOW) and regular checking accounts).  For 2009, the regulations
generally provided that reserves be maintained against aggregate transaction
accounts as follows:  a 3% reserve ratio was assessed on net
transaction accounts up to and including $44.4 million; a 10% reserve ratio was
applied above $44.4 million.  The first $10.3 million of otherwise
reservable balances (subject to adjustments by the Federal Reserve Board) were
exempted from the reserve requirements.  The amounts are adjusted
annually and, for 2010, require a 3% ratio for up to $55.2 million and an
exemption of $10.7 million.  Naugatuck Valley Savings complies with
the foregoing requirements.
 
 Regulatory
Restructuring Legislation.The
Obama Administration has proposed, and the House of Representatives and Senate
are currently considering, legislation that would restructure the regulation of
depository institutions.  Proposals range from the merger of the
Office of Thrift Supervision with the Office of the Comptroller of the Currency,
which regulates national banks, to the creation of an independent federal agency
that would assume the regulatory responsibilities of the Office of Thrift
Supervision, Federal Deposit Insurance Corporation, Office of the Comptroller of
the Currency and Federal Reserve Board.  The federal
savings institution charter would be eliminated and
federal institutions required to become banks under some proposals,
although others would grandfather existing charters such as that of Naugatuck
Valley Savings.  Savings and loan holding companies would become
regulated as bank holding companies.  Also proposed is the creation of
a new federal agency to administer and enforce consumer and fair lending laws, a
function that is now performed by the depository institution
regulators.  The federal preemption of state laws currently accorded
federally chartered depository institutions would be reduced under certain
proposals as well.
  14
 Index
  Enactment of any of these proposals
would revise the regulatory structure imposed on Naugatuck Valley Savings, which
could result in more stringent regulation.  At this time, management
has no way of predicting the contents of any final legislation, or whether any
legislation will be enacted at all.
 
 Holding
Company Regulation
 
 General.
Naugatuck Valley Financial and Naugatuck Valley Mutual are savings and loan
holding companies within the meaning of federal law.  As such, they
are registered with the Office of Thrift Supervision and are subject to Office
of Thrift Supervision regulations, examinations, supervision, reporting
requirements and regulations concerning corporate governance and
activities.  In addition, the Office of Thrift Supervision has
enforcement authority over Naugatuck Valley Financial and Naugatuck Valley
Mutual and their non-savings institution subsidiaries.  Among other
things, this authority permits the Office of Thrift Supervision to restrict or
prohibit activities that are determined to be a serious risk to Naugatuck Valley
Savings.
 
 Restrictions
Applicable to Mutual Holding Companies.According to
federal law and Office of Thrift Supervision regulations, a mutual holding
company, such as Naugatuck Valley Mutual, may generally engage in the following
activities: (i) investing in the stock of a savings institution; (ii) acquiring
a mutual association through the merger of such association into a savings
institution subsidiary of such holding company or an interim savings institution
subsidiary of such holding company; (iii) merging with or acquiring another
holding company, one of whose subsidiaries is a savings institution; (iv)
investing in a corporation, the capital stock of which is available for purchase
by a savings institution under federal law or under the law of any state where
the subsidiary savings institution or institutions share their home offices; (v)
furnishing or performing management services for a savings institution
subsidiary of such company; (vi) holding, managing or liquidating assets owned
or acquired from a savings subsidiary of such company; (vii) holding or managing
properties used or occupied by a savings institution subsidiary of such company
properties used or occupied by a savings institution subsidiary of such company;
(viii) acting as trustee under deeds of trust; (ix) any other activity (A) that
the Federal Reserve Board, by regulation, has determined to be permissible for
bank holding companies under Section 4(c) of the Bank Holding Company Act,
unless the Office of Thrift Supervision, by regulation, prohibits or limits any
such activity for savings and loan holding companies; or (B) in which multiple
savings and loan holding companies were authorized (by regulation) to directly
engage on March 5, 1987; and (x) purchasing, holding, or disposing of stock
acquired in connection with a qualified stock issuance if the purchase of such
stock by such savings and loan holding company is approved by the Office of
Thrift Supervision.
 
 The Gramm-Leach Bliley Act of 1999 was
designed to modernize the regulation of the financial services industry by
expanding the ability of bank holding companies to affiliate with other types of
financial services companies such as insurance companies and investment banking
companies.  The legislation also expanded the activities permitted for
mutual savings and loan holding companies to also include any activity permitted
a “financial holding company” under the legislation, including a broad array of
insurance and securities activities.
 
 Federal law prohibits a savings and
loan holding company, including a federal mutual holding company, from, directly
or indirectly or through one or more subsidiaries, acquiring more than 5% of the
voting stock of another savings institution, or savings and loan holding company
thereof, without prior written approval of the Office of Thrift Supervision from
acquiring or retaining, with certain exceptions, more than 5% of a
non-subsidiary holding company or savings institution.  A savings and
loan holding company is also prohibited from acquiring more than 5% of a company
engaged in activities other than those authorized by federal law or acquiring or
retaining control of a depository institution that is not insured by the Federal
Deposit Insurance Corporation.   In evaluating applications by
holding companies to acquire savings institutions, the Office of Thrift
Supervision must consider, among other things, the financial and managerial
resources and future prospects of the company and institution involved, the
effect of the acquisition on the risk to the insurance funds, the convenience
and needs of the community and competitive factors.
 
 The Office of Thrift Supervision is
prohibited from approving any acquisition that would result in a multiple
savings and loan holding company controlling savings institutions in more than
one state, except:  (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies; and (ii) the acquisition of
a savings institution in another state if the laws of the state of the target
savings institution specifically permit such
  15
 Index
  acquisitions.  The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
 
 Although savings and loan holding
companies are not currently subject to regulatory capital requirements or
specific restrictions on the payment of dividends or other capital
distributions, federal regulations do prescribe such restrictions on subsidiary
savings institutions.  Naugatuck Valley Savings must notify the Office
of Thrift Supervision 30 days before declaring any dividend and comply with the
additional restrictions described below.  In addition, the financial
impact of a holding company on its subsidiary institution is a matter that is
evaluated by the Office of Thrift Supervision and the agency has authority to
order cessation of activities or divestiture of subsidiaries deemed to pose a
threat to the safety and soundness of the institution.
 
 Stock
Holding Company Subsidiary Regulation.The Office of
Thrift Supervision has adopted regulations governing the two-tier mutual holding
company form of organization and subsidiary stock holding companies that are
controlled by mutual holding companies.  Naugatuck Valley Financial is
the stock holding company subsidiary of Naugatuck Valley
Mutual.  Naugatuck Valley Financial is permitted to engage in
activities that are permitted for Naugatuck Valley Mutual subject to the same
restrictions and conditions.
 
 Waivers
of Dividends by Naugatuck Valley Mutual. Office of
Thrift Supervision regulations require Naugatuck Valley Mutual to notify the
Office of Thrift Supervision if it proposes to waive receipt of dividends from
Naugatuck Valley Financial.  The Office of Thrift Supervision reviews
dividend waiver notices on a case-by-case basis, and, in general, does not
object to any such waiver if: (i) the waiver would not be detrimental to the
safe and sound operation of the savings institution; and (ii) the mutual holding
company’s board of directors determines that such waiver is consistent with such
directors’ fiduciary duties to the mutual holding company’s
members.
 
 Conversion
of Naugatuck Valley Mutual to Stock Form.Office of
Thrift Supervision regulations permit Naugatuck Valley Mutual to convert from
the mutual form of organization to the capital stock form of
organization.  In a conversion transaction, a new holding company
would be formed as the successor to Naugatuck Valley Financial, Naugatuck Valley
Mutual’s corporate existence would end, and certain depositors of Naugatuck
Valley Savings would receive the right to subscribe for additional shares of the
new holding company.  In a conversion transaction, each share of
common stock held by stockholders other than Naugatuck Valley Mutual would be
automatically converted into a number of shares of common stock of the new
holding company based on an exchange ratio determined at the time of conversion
that ensures that stockholders other than Naugatuck Valley Mutual own the same
percentage of common stock in the new holding company as they owned in Naugatuck
Valley Financial immediately before conversion.  The total number of
shares held by stockholders other than Naugatuck Valley Mutual after a
conversion transaction would be increased by any purchases by such stockholders
in the stock offering conducted as part of the conversion
transaction.
 
 As set forth under “Acquisition of
Southern Connecticut Bancorp, Inc. and Second-Step Conversion Transaction”,
Naugatuck Valley Mutual adopted a Plan of Conversion and Reorganization to
convert to a stock holding company by selling to the public its approximate 60%
ownership interest in Naugatuck Valley Financial in a second step conversion
transaction.
 
 Acquisition
of Control.
Under the federal Change in Bank Control Act, a notice must be submitted to the
Office of Thrift Supervision if any person (including a company), or group
acting in concert, seeks to acquire “control” of a savings and loan holding
company or savings institution.  Under certain circumstances, a change
of control may occur, and prior notice is required, upon the acquisition of 10%
or more of the outstanding voting stock of the company or institution, unless
the Office of Thrift Supervision has found that the acquisition will not result
in a change of control of the company.  A change in control
definitively occurs upon the acquisition of 25% or more of a company’s
outstanding voting stock.  Under the Change in Bank Control Act, the
Office of Thrift Supervision has 60 days from the filing of a complete notice to
act, taking into consideration certain factors, including the financial and
managerial resources of the acquirer and the anti-trust effects of the
acquisition.  Any company that so acquires control would then be
subject to regulation as a savings and loan holding company.
  16
 Index
  Federal
Securities Laws
 
 Naugatuck Valley Financial’s common
stock is registered with the Securities and Exchange Commission under the
Securities Exchange Act of 1934.  Naugatuck Valley Financial is
subject to the information, proxy solicitation, insider trading restrictions and
other requirements under the Securities Exchange Act of 1934.
 
 Executive
Officers of the Registrant
 
 The executive officers of Naugatuck
Valley Financial, Naugatuck Valley Mutual Holding Company and Naugatuck Valley
Savings are elected annually by the Board of Directors and serve at the Board’s
discretion.  The executive officers of Naugatuck Valley Financial,
Naugatuck Valley Mutual Holding Company and Naugatuck Valley Savings
are:
 
 Name
              
              PositionJohn
      C. Roman
              
              President
      and Chief Executive Officer of Naugatuck Valley Financial, Naugatuck
      Valley Mutual and Naugatuck Valley SavingsDominic
      J. Alegi, Jr.
              
              Executive
      Vice President of Naugatuck Valley Financial, Naugatuck Valley Mutual and
      Naugatuck Valley SavingsLee
      R. Schlesinger
              
              Senior
      Vice President and Chief Financial Officer of Naugatuck Valley Financial,
      Naugatuck Valley Mutual and Naugatuck Valley SavingsWilliam
      C. Nimons
              
              Senior
      Vice President of Naugatuck Valley Financial, Naugatuck Valley Mutual and
      Naugatuck Valley SavingsMark
      S. Graveline
              
              Senior
      Vice President of Naugatuck Valley Financial and Naugatuck Valley Mutual;
      Senior Vice President and Chief Lending Officer of Naugatuck Valley
      Savings
 
 Below is information regarding the
executive officers who are not also directors.  Unless otherwise
stated, each executive officer has held his current position for at least the
last five years.  Ages presented are as of December 31,
2009.
 
 Dominic J. Alegi,
Jr. has served as Executive Vice President of Naugatuck Valley Financial
and Naugatuck Valley Mutual since September 2004 and has been Executive Vice
President of Naugatuck Valley Savings since 1989.  Mr. Alegi has
served with Naugatuck Valley Savings since 1970.  Age 63.
 
 Lee R.
Schlesingerwas appointed Senior Vice
President and Chief Financial Officer of Naugatuck Valley Mutual, Naugatuck
Valley Financial and Naugatuck Valley Savings in December,
2007.  Prior to that, he served as Vice President and Treasurer of
Naugatuck Valley Financial and Naugatuck Valley Mutual since September 2004, and
as Vice President and Treasurer of Naugatuck Valley Savings since August
2004.  Mr. Schlesinger served as Vice President and Controller of
Naugatuck Valley Savings from 2003 to 2004 and as Assistant Vice President and
Controller of Naugatuck Valley Savings from 2000 to 2003.  Mr.
Schlesinger has served with Naugatuck Valley Savings since 1983.  Age
49.
 
 William C.
Nimons has served as Senior Vice President of Naugatuck Valley Financial
and Naugatuck Valley Mutual since September 2004 and has been Senior Vice
President of Naugatuck Valley Savings since 2001.  Mr. Nimons
previously was the Manager-Network Management of Prudential Real Estate and
Relocation, a real estate and relocation firm and was an Executive Vice
President at Shelton Savings Bank.  Age 63.
 
 Mark S.
Graveline has served as Senior Vice President of Naugatuck Valley
Financial and Naugatuck Valley Mutual and as Senior Vice President and Chief
Lending Officer of Naugatuck Valley Savings since February 2005.  Mr.
Graveline previously was a Vice President of Banknorth-Connecticut and a Vice
President of North American Bank and Trust.  Age 53.
  17
 Index
  ITEM1A.
              RISK
      FACTORS.
 
 
 
 Risks
Related to our Business
 
 The
recent economic recession could result in increases in our level of
nonperforming loans and/or reduce demand for our products and services, which
would lead to lower revenue, higher loan losses and lower earnings.
 
 Our business activities and earnings
are affected by general business conditions in the United States and in our
local market area. These conditions include short-term and long-term interest
rates, inflation, unemployment levels, monetary supply, consumer confidence and
spending, fluctuations in both debt and equity capital markets, and the strength
of the economy in the United States generally and in our market area in
particular. The national economy has recently experienced a recession, with
rising unemployment levels, declines in real estate values and an erosion in
consumer confidence. Dramatic declines in the U.S. housing market over the past
few years, with falling home prices and increasing foreclosures, have negatively
affected the credit performance of mortgage loans and resulted in significant
write-downs of asset values by many financial institutions. Our local economy
has mirrored the overall economy. A prolonged or more severe economic downturn,
continued elevated levels of unemployment, further declines in the values of
real estate, or other events that affect household and/or corporate incomes
could impair the ability of our borrowers to repay their loans in accordance
with their terms.  Most of our loans are secured by real estate or
made to businesses in the Greater Naugatuck Valley. As a result of this
concentration, a prolonged or more severe downturn in the local economy could
result in significant increases in nonperforming loans, which would negatively
impact our interest income and result in higher provisions for loan losses,
which would hurt our earnings. The economic downturn could also result in
reduced demand for credit or fee-based products and services, which would
negatively impact our revenues.
 
 Changes
in interest rates could reduce our net interest income and
earnings.
 
 Our net interest income is the interest
we earn on loans and investments less the interest we pay on our deposits and
borrowings. Our net interest spread is the difference between the yield we earn
on our assets and the interest rate we pay for deposits and our other sources of
funding. Changes in interest rates—up or down—could adversely affect our net
interest spread and, as a result, our net interest income and net interest
margin. Although the yield we earn on our assets and our funding costs tend to
move in the same direction in response to changes in interest rates, one can
rise or fall faster than the other, causing our net interest margin to expand or
contract. Our liabilities tend to be shorter in duration than our assets, so
they may adjust faster in response to changes in interest rates. As a result,
when interest rates rise, our funding costs may rise faster than the yield we
earn on our assets, causing our net interest margin to contract. This
contraction could be more severe following a prolonged period of lower interest
rates, as a larger proportion of our fixed rate residential loan portfolio will
have been originated at those lower rates and borrowers may be more reluctant or
unable to sell their homes in a higher interest rate environment. Changes in the
slope of the “yield curve”—or the spread between short-term and long-term
interest rates—could also reduce our net interest margin. Normally, the yield
curve is upward sloping, meaning short-term rates are lower than long-term
rates. Because our liabilities tend to be shorter in duration than our assets,
when the yield curve flattens or even inverts, we could experience pressure on
our net interest margin as our cost of funds increases relative to the yield we
can earn on our assets.
 
 Our
emphasis on residential mortgage loans exposes us to a risk of loss due to a
decline in property values.
 
 At December 31, 2009, $229.6 million,
or 47.7%, of our loan portfolio consisted of one- to four-family residential
mortgage loans, and $37.3 million, or 7.8%, of our loan portfolio consisted of
home equity loans. We originate home equity lines of credit with maximum
combined loan-to-value ratios of up to 80%.  Recent declines in the
housing market have resulted in declines in real estate values in our market
area. These declines in real estate values could cause some of our mortgage and
home equity loans to be inadequately collateralized which would expose us to a
greater risk of loss in the event that we seek to recover on defaulted loans by
selling the real estate collateral.
  18
 Index
  Our
emphasis on commercial lending may expose us to increased lending
risks.
 
 At December 31, 2009, $166.3 million,
or 34.6%, of our loan portfolio consisted of multi-family and commercial real
estate loans and commercial business loans.  Commercial loans
generally expose a lender to greater risk of non-payment and loss than
residential mortgage loans because repayment of the loans often depends on the
successful operation of the borrower’s business. Such loans typically involve
larger loan balances to single borrowers or groups of related borrowers compared
to residential mortgage loans. Also, many of our commercial borrowers have more
than one loan outstanding with us. Consequently, an adverse development with
respect to one loan or one credit relationship can expose us to a significantly
greater risk of loss compared to an adverse development with respect to a
residential mortgage loan.
 
 Our
construction loan portfolio may expose us to increased credit risk.
 
 At December 31, 2009, our construction
portfolio was $46.3 million, of which $38.1 million represented loans to finance
the construction of condominiums, apartment buildings and residential
developments.  As a result of the deterioration in local economic
conditions in 2009, loans secured by residential real estate developments
experienced a slow down in absorption activity during 2009. Some construction
projects provide for an interest reserve that is utilized to pay the interest
for a period of time until the project is expected to produce positive cash
flows.  To the extent such economic conditions continue, construction
loan borrowers could fully utilize their interest reserve before the project is
able to generate cash flows.   If a borrower has insufficient
liquidity to pay interest on such projects, the loan could become impaired and
require an increase in the allowance for loan losses which would adversely
impact our results of operations.  This situation is exacerbated by
the shorter duration of our construction loan portfolio as $16.1 million, or
34.8%, of our construction loans mature in 2010.
 
 The
unseasoned nature of our commercial and construction loan portfolio may expose
us to increased lending risks.
 
 Our multi-family and commercial real
estate, commercial business and construction loan portfolio has increased $144.8
million, or 213.8%, from $67.7 million at December 31, 2005 to $212.6 million at
December 31, 2009.  Many of our multi-family, commercial real estate,
commercial business and construction loans are unseasoned, meaning that they
were originated recently.  Our limited experience with these loans
does not provide us with a significant payment history pattern with which to
judge future collectibility.  As a result, it may be difficult to
predict the future performance of this part of our loan
portfolio.  These loans may have delinquency or charge-off levels
above our expectations, which could negatively affect our future
performance.
 
 Turmoil
in the financial markets could have an adverse effect on our financial position
or results of operations.
 
 Beginning in 2008, United States and
global financial markets experienced severe disruption and volatility, and
general economic conditions have declined significantly. Adverse developments in
credit quality, asset values and revenue opportunities throughout the financial
services industry, as well as general uncertainty regarding the economic and
regulatory environment, have had a negative impact on the industry. The United
States and the governments of other countries have taken steps to try to
stabilize the financial system, including investing in financial institutions,
and have implemented programs intended to improve general economic conditions.
The U.S. Department of the Treasury created the Capital Purchase Program under
the Troubled Asset Relief Program, pursuant to which the Treasury Department
provided additional capital to participating financial institutions through the
purchase of preferred stock or other securities. Other measures include
homeowner relief that encourages loan restructuring and modification; the
establishment of significant liquidity and credit facilities for financial
institutions and investment banks; the lowering of the federal funds rate;
regulatory action against short selling practices; a temporary guaranty program
for money market funds; the establishment of a commercial paper funding facility
to provide back-stop liquidity to commercial paper issuers; and coordinated
international efforts to address illiquidity and other weaknesses in the banking
sector. Notwithstanding the actions of the United States and other governments,
there can be no assurances that these efforts will be successful in restoring
industry, economic or market conditions to their previous levels and that they
will not result in adverse unintended consequences. Factors that could continue
to pressure financial services companies, including FedFirst Financial, are
numerous and include
  19
 Index
  (1)
worsening credit quality, leading among other things to increases in loan losses
and reserves, (2) continued or worsening disruption and volatility in financial
markets, leading among other things to continuing reductions in asset values,
(3) capital and liquidity concerns regarding financial institutions generally,
(4) limitations resulting from or imposed in connection with governmental
actions intended to stabilize or provide additional regulation of the financial
system, or (5) recessionary conditions that are deeper or last longer than
currently anticipated.
 
 If
we conclude that the decline in value of any of our investment securities is
other than temporary, we are required to write down the value of that
security.
 
 Companies are required to record
other-than-temporary impairment if they have the intent to sell, or will more
likely than not be required to sell, an impaired debt security before recovery
of its amortized cost basis.  In addition, companies are required to
record other-than-temporary impairment for the amount of credit losses,
regardless of the intent or requirement to sell.  We evaluate
investments that have a fair value less than book value for other-than-temporary
impairment on a quarterly basis.  At December 31, 2009, we had one
corporate bond with a book value of $1.0 million and a fair market value of
$660,000.  Changes in the expected cash flows, credit enhancement
levels or credit ratings of these bonds and/or prolonged price declines may
result in our concluding in future periods that the impairment of these
securities is other-than temporary, which would require a charge to earnings to
write down the value of these securities.  Any charges for
other-than-temporary impairment would not impact cash flow, tangible capital or
liquidity.
 
 Higher
loan losses could require us to increase our allowance for loan losses through a
charge to earnings.
 
 When we loan money we incur the risk
that our borrowers will not repay their loans. We reserve for loan losses by
establishing an allowance through a charge to earnings. The amount of this
allowance is based on our assessment of loan losses inherent in our loan
portfolio. The process for determining the amount of the allowance is critical
to our financial results and condition. It requires subjective and complex
judgments about the future, including forecasts of economic or market conditions
that might impair the ability of our borrowers to repay their loans. We might
underestimate the loan losses inherent in our loan portfolio and have loan
losses in excess of the amount reserved. We might increase the allowance because
of changing economic conditions. For example, in a rising interest rate
environment, borrowers with adjustable-rate loans could see their payments
increase. There may be a significant increase in the number of borrowers who are
unable or unwilling to repay their loans, resulting in our charging off more
loans and increasing our allowance. In addition, when real estate values
decline, the potential severity of loss on a real estate-secured loan can
increase significantly, especially in the case of loans with high combined
loan-to-value ratios. The recent decline in the national economy and the local
economies of the areas in which our loans are concentrated could result in an
increase in loan delinquencies, foreclosures or repossessions resulting in
increased charge-off amounts and the need for additional loan loss provisions in
future periods. In addition, our determination as to the amount of our allowance
for loan losses is subject to review by our primary regulator, the Office of
Thrift Supervision, as part of its examination process, which may result in the
establishment of an additional allowance based upon the judgment of the Office
of Thrift Supervision after a review of the information available at the time of
its examination. Our allowance for loan losses amounted to 0.84% of total loans
outstanding and 66.6% of nonperforming loans at December 31, 2009. Our allowance
for loan losses at December 31, 2009, may not be sufficient to cover future loan
losses. A large loss could deplete the allowance and require increased
provisions to replenish the allowance, which would negatively affect
earnings.
 
 Increased
and/or special FDIC assessments will hurt our earnings.
 
 The recent economic recession has
caused a high level of bank failures, which has dramatically increased FDIC
resolution costs and led to a significant reduction in the balance of the
Deposit Insurance Fund. As a result, the FDIC has significantly increased the
initial base assessment rates paid by financial institutions for deposit
insurance. Increases in the base assessment rate have increased our deposit
insurance costs and negatively impacted our earnings. In addition, in May 2009,
the FDIC imposed a special assessment on all insured institutions. Our special
assessment, which was reflected in earnings for the quarter ended June 30, 2009,
was $246,793.   In lieu of imposing an additional special
assessment, the FDIC required all institutions to prepay their assessments for
the fourth quarter of 2009 and all of 2010, 2011 and 2012. Additional increases
in the base assessment rate or special assessments would negatively impact our
earnings.
  20
 Index
  Strong
competition within our market area could reduce our profits and slow
growth.
 
 We face intense competition both in
making loans and attracting deposits. This competition has made it more
difficult for us to make new loans and at times has forced us to offer higher
deposit rates. Price competition for loans and deposits might result in us
earning less on our loans and paying more on our deposits, which would reduce
net interest income. Competition also makes it more difficult to grow loans and
deposits. As of June 30, 2009, which is the most recent date for which
information is available, we held less than 2.0% of the deposits in each of the
counties in which our offices are located.  Several of the
institutions with which we compete have substantially greater resources and
lending limits than we have and may offer services that we do not provide. We
expect competition to increase in the future as a result of legislative,
regulatory and technological changes and the continuing trend of consolidation
in the financial services industry. Our profitability depends upon our continued
ability to compete successfully in our market area.
 
 We
operate in a highly regulated environment and we may be adversely affected by
changes in laws and regulations.
 
 We are subject to extensive regulation,
supervision and examination by the Office of Thrift Supervision, our primary
federal regulator, and by the Federal Deposit Insurance Corporation, as insurer
of our deposits. Such regulation and supervision governs the activities in which
an institution and its holding company may engage and are intended primarily for
the protection of the insurance fund and the depositors and borrowers of
Naugatuck Valley Savings and Loan rather than for holders of our common stock.
Regulatory authorities have extensive discretion in their supervisory and
enforcement activities, including the imposition of restrictions on our
operations, the classification of our assets and determination of the level of
our allowance for loan losses. Any change in such regulation and oversight,
whether in the form of regulatory policy, regulations, legislation or
supervisory action, may have a material impact on our operations.
 
 Proposed
regulatory reform may have a material impact on our operations.
 
 The Obama Administration has published
a comprehensive regulatory reform plan that is intended to modernize and protect
the integrity of the United States financial system and has offered proposed
legislation to accomplish these reforms. The U.S. House of Representatives has
passed financial regulatory reform legislation and the Senate Banking
Committee has passed its own version.  These various plans
contain several elements that would have a direct effect on Naugatuck Valley
Financial and Naugatuck Valley Savings and Loan. Under the legislation proposed
by the House of Representatives, the federal thrift charter and the Office of
Thrift Supervision would be eliminated and all companies that control an insured
depository institution must register as a bank holding company. Existing federal
thrifts, such as Naugatuck Valley Savings and Loan, would become a national bank
or could choose to adopt a state charter. Registration as a bank holding company
would represent a significant change, as there currently exist significant
differences between savings and loan holding company and bank holding company
supervision and regulation. For example, the Federal Reserve imposes leverage
and risk-based capital requirements on bank holding companies whereas the Office
of Thrift Supervision does not impose any capital requirements on savings and
loan holding companies. However, under the legislation proposed by the Senate,
existing federal thrift charters would be grandfathered in, but no new federal
thrift charters would be issued.The Administration has also proposed the
creation of a new federal agency, the Consumer Financial Protection Agency, that
would be dedicated to protecting consumers in the financial products and
services market. The creation of this agency could result in new regulatory
requirements and raise the cost of regulatory compliance. In addition,
legislation stemming from the reform plan could require changes in regulatory
capital requirements, loan loss provisioning practices, and compensation
practices. If implemented, the foregoing regulatory reforms may have a material
impact on our operations. However, because the final legislation may differ
significantly from the reform plan proposed by the President or passed by the
House of Representatives or the Senate, we cannot determine the specific impact
of regulatory reform at this time.
 
 Risks
Related to the Proposed Merger with SCBI
 
 Failure
to complete the merger could negatively impact the stock prices and the future
business and financial results of Naugatuck Valley Financial.
 
 If the
merger is not completed, the ongoing businesses of Naugatuck Valley Financial
may be adversely affected and Naugatuck Valley Financial will be subject to
several risks, including the following:
  21
 Index
  ·
              having
      to pay certain costs relating to the proposed merger, such as legal,
      accounting, financial advisor, filing, printing and mailing fees,
      and
 
 ·
              diverting
      the focus of management of each of the companies from pursuing other
      opportunities that could be beneficial to the companies, in each case,
      without realizing any of the benefits of having the merger
      completed.
 
 The
integration of the operations of Naugatuck Valley Financial and SCBI may be more
difficult than anticipated.
 
 The success of the merger will depend
on a number of factors, including, but not limited to, Naugatuck Valley
Financial’s ability to:
 
 ·
              timely
      and successfully integrate the operations of Naugatuck Valley Financial
      and SCBI;
 
 ·
              maintain
      existing relationships with The Bank of Southern Connecticut’s depositors
      and to minimize withdrawals of deposits subsequent to the
      merger;
 
 ·
              maintain
      and enhance existing relationships with borrowers to limit potential
      losses from loans made by The Bank of Southern
  Connecticut;
 
 ·
              control
      the incremental non-interest expense from Naugatuck Valley Financial to
      maintain overall operating
efficiencies;
 
 ·
              retain
      key personnel; and
 
 ·
              compete
      effectively in the communities served by The Bank of Southern
      Connecticut.
  The process of integrating operations
could cause an interruption of, or loss of momentum in, the activities of the
business and the loss of key personnel.  The integration of the two
companies will require the experience and expertise of certain key employees of
SCBI who are expected to be retained by Naugatuck Valley
Financial.  Naugatuck Valley Financial may not be successful in
retaining these employees for the time period necessary to successfully
integrate SCBI’s operations with those of Naugatuck Valley
Financial.  The diversion of management’s attention and any delays or
difficulties encountered in connection with the merger and the integration of
the two companies’ operations could have an adverse effect on the business and
results of operation of Naugatuck Valley Financial following the
merger.
  Naugatuck
Valley Financial and SCBI will be subject to business uncertainties while the
merger is pending that could adversely affect their businesses.
  Uncertainty among employees,
depositors, vendors and others about the effect of the merger may have an
adverse effect on Naugatuck Valley Financial and SCBI and, consequently, on the
combined company.  Although Naugatuck Valley Financial and SCBI intend
to take actions to reduce any adverse effects, these uncertainties may impair
their ability to attract, retain and motivate key personnel until the merger is
completed and for a period of time thereafter, and could cause depositors,
vendors and others that do business with Naugatuck Valley Financial and SCBI to
seek to change existing business relationships with either or both
companies.
  Naugatuck
Valley Financial and SCBI will incur significant transaction costs which may
diminish the anticipated benefits of the merger.
  Naugatuck Valley Financial and SCBI
expect to incur merger-related costs totaling approximately $1.8 million in
connection with completing the merger, including the expenses related to
integrating the operations of the two companies.  Substantially all
merger-related costs to be incurred by the two companies will be charged to
operations and will not be included as a component of the purchase price under
purchase accounting.  The amount of
  22
 Index
  merger-related
costs expected to be incurred by Naugatuck Valley Financial and SCBI are
preliminary estimates and are subject to change.
 
 Naugatuck Valley Financial and SCBI are
continuing to assess the magnitude of these costs, and, therefore, these
estimates may change substantially as additional unanticipated costs may be
incurred in the integration of the businesses of the two
companies.  Although Naugatuck Valley Financial and SCBI believe that
the elimination of duplicative costs, as well as the realization of other
efficiencies related to the integration of the businesses, will offset
merger-related costs over time, this net benefit may not be achieved in the near
term, or at all.
 
 ITEM1B.
              UNRESOLVED STAFF
      COMMENTS.
 
 None.
  23
 Index
  ITEM2.
              PROPERTIES.
 
 We conduct our business through our
main office and branch offices.  The following table sets forth
certain information relating to these facilities as of December 31,
2009.
 Location
              
              
              Year
                Opened/
                Acquired
              
              Net Book Value at
                December 31, 2009
              
              Square
                Footage
              
              Owned/
                Leased
              
              Date of Lease
                Expiration(Dollars
      in thousands)Main
      Office:333
      Church Street
                Naugatuck,
      CT  06770
              
              1996
              
              $2,481
              
              23,000
              
              Owned
              
              —Branches:1009
      New Haven Road
                Naugatuck,
      CT  06770
              
              2001
              
              1,207
              
              3,300
              
              Owned
              
              —127
      South Main Street
                Beacon
      Falls, CT  06403
              
              1997
              
              267
              
              960
              
              Owned
              
              —49
      Pershing Drive
                Derby,
      CT  06418
              
              2003
              
              95
              
              1,950
              
              Leased
              
              2013
      (1)249
      West Street (2)
                Seymour,
      CT  06483
              
              2002
              
              2,381
              
              9,500
              
              Owned
              
              —504
      Bridgeport Avenue
                Shelton,
      CT  06484
              
              2004
              
              435
              
              3,000
              
              Leased
              
              2020
      (3)1699
      Highland Avenue, Cheshire, CT  06410
              
              2006
              
              44
              
              3,000
              
              Leased
              
              2011
      (4)450
      Heritage Road, Suite 3C
                Southbury,
      CT  06488
              
              2008
              
              85
              
              3,000
              
              Leased
              
              2018
      (5)1570
      Southford Road (6)
                Southbury,
      CT  06488
              
              2006
              
              1,746
              
              4,823
              
              Owned
              
              —1030
      Hamilton Avenue Waterbury, CT  06706
              
              2006
              
              9
              
              1,239
              
              Leased
              
              2011
      (7)Other
      Properties:1007
      New Haven Road
                Naugatuck,
      CT  06770
              
              1974
              
              19
              
              1,725
              
              Leased
              
              2014
      (8)135
      South Main Street (9)
                Beacon
      Falls, CT  06403
              
              2003
              
              159
              
              N/A
              
              Owned
              
              —
 _________________________
 (1)
              We
      have an option to renew this lease for three additional five-year
      periods.
 (2)
              This
      branch occupies 3,500 square feet of this building and 1,465 square feet
      is utilized as a training facility for the bank.  The building
      also includes 4,535 square feet of rentable space which is currently
      leased until 2013.  The tenant has an option to renew this lease
      for three additional five year
periods.
 (3)
              We
      have an option to renew this lease for five additional five-year
      periods.
 (4)
              We
      have an option to renew this lease for three additional five-year
      periods.
 (5)
              We
      have an option to renew this lease for two additional five-year
      periods.
 (6)
              This
      branch occupies 3,383 square feet of this building.  The
      building also includes 1,440 square feet of rental space, none of which
      was rented as of December 31, 2009.
 (7)
              We
      have an option to renew this lease for four additional five-year
      periods.
 (8)
              Former
      branch site.  We have an option to renew this lease for two
      additional ten-year periods.  This property has been leased to a
      subtenant under a lease that expires in
2011.
 (9)
              This
      property is designated for future parking, additional access and possible
      future expansions of our Beacon Falls
branch.
  24
 Index
  ITEM3.
              LEGAL
      PROCEEDINGS.
 
 Periodically,
there have been various claims and lawsuits against us, such as claims to
enforce liens, condemnation proceedings on properties in which we hold security
interests, claims involving the making and servicing of real property loans and
other issues incident to our business.  We are not a party to any
pending legal proceedings that we believe would have a material adverse effect
on our financial condition, results of operations or cash flows.
 
 ITEM4.
              [REMOVED
      AND RESERVED].
 
 None.
  25
 Index
  PART
II
 
 ITEM5.
              MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES.
 
 Naugatuck Valley Financial’s common
stock is listed on the Nasdaq Global Market under the trading symbol
“NVSL.”  The following table sets forth the high and low sales prices
of the common stock, as reported on the Nasdaq Global Market, and the
dividend declared by Naugatuck Valley Financial during each quarter of 2008
and 2009.
  High
              
              
              Low
              
              
              Dividends2008:First
      Quarter
              
              $
              9.95
              
              
              $
              8.51
              
              
              $
              0.06Second
      Quarter
              
              
              9.69
              
              
              
              7.75
              
              
              
              0.06Third
      Quarter
              
              
              10.00
              
              
              
              7.75
              
              
              
              0.06Fourth
      Quarter
              
              
              8.25
              
              
              
              5.08
              
              
              
              0.062009:First
      Quarter
              
              $
              7.71
              
              
              $
              4.37
              
              
              $
              0.05Second
      Quarter
              
              
              7.24
              
              
              
              5.10
              
              
              
              0.03Third
      Quarter
              
              
              6.30
              
              
              
              4.11
              
              
              
              0.03Fourth
      Quarter
              
              
              7.42
              
              
              
              4.14
              
              
              
              0.03
 
 At March 23, 2010, there were 781
holders of record of Naugatuck Valley Financial common stock.
 
 Naugatuck Valley Financial’s ability to
pay dividends is dependent on dividends received from Naugatuck Valley
Savings.  For a discussion of restrictions on the payment of cash
dividends by Naugatuck Valley Savings, see “Business—Regulation and
Supervision—Regulation of Federal Savings Institutions—Limitation on Capital
Distributions” in this Annual Report on Form 10-K and note 14to the Consolidated
Financial Statements included in this Annual Report on Form 10-K.
 
 The following table presents
information regarding Naugatuck Valley Financial stock repurchases during the
three months ended December 31, 2009.
 
 Period
              Total Number of
                Shares Purchased
              Average Price Paid
                per Share
              Total Number of Shares Purchased as Part of
      Publicly Announced Plans or Programs
              Maximum Number of Shares that May Yet Be Purchased
      Under the Plans or ProgramsOctober
              --
              --
              --
              159,676November
              --
              --
              --
              159,676December
              --
              --
              --
              159,676Total
              --
              --
              --
              159,676
 
 On February 19, 2008, the Company
announced that the Board of Directors authorized the Company to repurchase up to
361,207 shares, or approximately 5%, of the outstanding shares of common stock,
including the shares held by Naugatuck Valley Mutual Holding
Company.  The repurchases will be conducted through open-market
purchases or privately negotiated transactions and will be made from time to
time depending on market conditions and other factors.  No time limit
was placed on the duration of the share repurchase program.  Any
repurchased shares will be held as treasury stock and will be available for
general corporate purposes.  The number of shares remaining to be
purchased under the plan in the table above does not reflect the number of
shares authorized in this repurchase plan.
  26
 Index
  ITEM6.
              SELECTED
      FINANCIAL DATA.
 
 The
following table sets forth certain consolidated summary historical financial
information concerning the financial position of Naugatuck Valley Financial and
its subsidiary, Naugatuck Valley Savings, at the dates and for the periods
indicated.  The financial data is derived in part from, and should be
read in conjunction with, the consolidated financial statements and related
notes of Naugatuck Valley Financial appearing later in this Annual Report on
Form 10-K.
 
 
 At December 31,2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005(In
      thousands)Financial
      Condition Data :Total
      assets
              
              $
              556,955
              
              
              $
              535,386
              
              
              $
              462,527
              
              
              $
              413,855
              
              
              $
              355,346Securities
      held to maturity
              
              
              1,451
              
              
              
              —
              
              
              
              1,190
              
              
              
              2,531
              
              
              
              5,002Securities
      available for sale
              
              
              37,623
              
              
              
              63,844
              
              
              
              65,264
              
              
              
              67,736
              
              
              
              58,047Loans
      receivable, net
              
              
              473,304
              
              
              
              431,976
              
              
              
              359,831
              
              
              
              308,376
              
              
              
              259,427Cash
      and cash equivalents
              
              
              12,146
              
              
              
              8,247
              
              
              
              8,370
              
              
              
              7,942
              
              
              
              8,951Deposits
              
              
              380,931
              
              
              
              363,026
              
              
              
              321,398
              
              
              
              289,198
              
              
              
              240,846Borrowed
      funds
              
              
              118,984
              
              
              
              119,148
              
              
              
              85,107
              
              
              
              68,488
              
              
              
              57,059Total
      capital
              
              
              50,308
              
              
              
              45,589
              
              
              
              50,457
              
              
              
              51,084
              
              
              
              50,964
 
 Year Ended December 31,2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005(In
      thousands, except per share data)Operating
      Data:Interest
      and dividend income
              
              $
              28,291
              
              
              $
              28,203
              
              
              $
              25,030
              
              
              $
              20,750
              
              
              $
              15,908Interest
      expense
              
              
              12,537
              
              
              
              13,904
              
              
              
              13,174
              
              
              
              9,350
              
              
              
              4,941Net
      interest income
              
              
              15,754
              
              
              
              14,299
              
              
              
              11,856
              
              
              
              11,400
              
              
              
              10,967Provision
      for loan losses
              
              
              1,144
              
              
              
              675
              
              
              
              151
              
              
              
              192
              
              
              
              32Net
      interest income after provision for loan losses
              
              
              14,610
              
              
              
              13,624
              
              
              
              11,705
              
              
              
              11,208
              
              
              
              10,935Noninterest
      income (loss)
              
              
              2,742
              
              
              
              (1,048
              )
              
              
              2,354
              
              
              
              1,948
              
              
              
              1,517Noninterest
      expense
              
              
              14,541
              
              
              
              13,454
              
              
              
              12,422
              
              
              
              11,504
              
              
              
              10,097Income
      (loss) before tax provision (benefit)
              
              
              2,811
              
              
              
              (878
              )
              
              
              1,637
              
              
              
              1,652
              
              
              
              2,355Income
      tax provision (benefit)
              
              
              818
              
              
              
              (566
              )
              
              
              217
              
              
              
              204
              
              
              
              450Net
      income (loss)
              
              $
              1,993
              
              
              $
              (312
              )
              
              $
              1,420
              
              
              $
              1,448
              
              
              $
              1,905Earnings
      (loss) per share, basic and diluted
              
              $
              0.29
              
              
              $
              (0.05
              )
              
              $
              0.20
              
              
              $
              0.20
              
              
              $
              0.26
  27
 Index
  
 At or For the Year Ended December
      31,2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005Performance
      Ratios:Return
      (loss) on average assets
              
              
              0.37
              %
              
              
              (0.06
              )%
              
              
              0.33
              %
              
              
              0.38
              %
              
              
              0.62
              %Return
      (loss) on average equity
              
              
              4.10
              
              
              
              (0.64
              )
              
              
              2.77
              
              
              
              2.79
              
              
              
              3.66Interest
      rate spread (1)
              
              
              3.00
              
              
              
              2.88
              
              
              
              2.76
              
              
              
              3.07
              
              
              
              3.68Net
      interest margin (2)
              
              
              3.09
              
              
              
              3.02
              
              
              
              2.95
              
              
              
              3.26
              
              
              
              3.87Noninterest
      expense to average assets
              
              
              2.68
              
              
              
              2.66
              
              
              
              2.86
              
              
              
              3.03
              
              
              
              3.27Efficiency
      ratio (3)
              
              
              78.43
              
              
              
              101.28
              
              
              
              87.18
              
              
              
              85.93
              
              
              
              80.61Dividend
      payout ratio (4)
              
              
              48.28
              
              
              
              N/M
              
              
              
              100.00
              
              
              
              100.00
              
              
              
              61.54Average
      interest-earning assets to average interest-bearing
      liabilities
              
              
              103.77
              
              
              
              104.46
              
              
              
              105.65
              
              
              
              107.18
              
              
              
              111.20Average
      equity to average assets
              
              
              8.97
              
              
              
              9.71
              
              
              
              11.80
              
              
              
              13.65
              
              
              
              16.87Capital
      Ratios:Total
      capital to risk-weighted assets
              
              
              11.10
              %
              
              
              11.09
              %
              
              
              12.88
              %
              
              
              14.29
              %
              
              
              17.88
              %Tier
      1 capital to risk-weighted assets
              
              
              10.16
              
              
              
              10.36
              
              
              
              12.22
              
              
              
              13.56
              
              
              
              17.07Tier
      1 capital to adjusted total assets
              
              
              7.76
              
              
              
              7.58
              
              
              
              8.81
              
              
              
              9.53
              
              
              
              11.42Total
      equity to total assets
              
              
              9.03
              
              
              
              8.52
              
              
              
              10.91
              
              
              
              12.34
              
              
              
              14.34Asset
      Quality Ratios:Allowance
      for loan losses as a percent of total loans
              
              
              0.84
              %
              
              
              0.66
              %
              
              
              0.60
              %
              
              
              0.67
              %
              
              
              0.72
              %Allowance
      for loan losses as a percent of nonperforming loans
              
              
              66.60
              
              
              
              107.13
              
              
              
              222.99
              
              
              
              103.03
              
              
              
              638.78Net
      charge-offs (recoveries) to average loans outstanding during the
      period
              
              
              0.00
              
              
              
              (0.01
              )
              
              
              0.02
              
              
              
              0.00
              
              
              
              0.01Nonperforming
      loans as a percent of total loans
              
              
              1.26
              
              
              
              0.62
              
              
              
              0.27
              
              
              
              0.65
              
              
              
              0.11Nonperforming
      assets as a percent of total assets
              
              
              1.10
              
              
              
              0.50
              
              
              
              0.21
              
              
              
              0.49
              
              
              
              0.10Other
      Data:Number
      of:Deposit
      accounts
              
              
              30,712
              
              
              
              30,721
              
              
              
              29,489
              
              
              
              27,385
              
              
              
              25,592Full
      service customer service facilities
              
              
              10
              
              
              
              10
              
              
              
              9
              
              
              
              9
              
              
              
              6
 
 (1)
              Represents
      the difference between the weighted average yield on average
      interest-earning assets and the weighted average cost of interest-bearing
      liabilities.
 (2)
              Represents
      net interest income as a percent of average interest-earning
      assets.
 (3)
              Represents
      noninterest expense (less intangible amortization) divided by the sum of
      net interest income and noninterest
income.
 (4)
              Represents
      dividends declared per share divided by basic net income per
      share.  Not meaningful for the 2008 period due to the net loss
      for the year.
  28
 Index
 
 ITEM7.
              MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATION.
 
 The objective of this section is to
help the reader understand our views on our financial condition and results of
operations.  You should read this discussion in conjunction with the
consolidated financial statements and notes to the financial statements that
appear at the end of this Annual Report on Form 10-K.
 
 Overview
 
 Income.  We
have two primary sources of income.  The first is net interest income,
which is the difference between interest income, the income that we earn on our
loans and investments, and interest expense, the interest that we pay on our
deposits and borrowings.
 
 To a lesser extent, we also recognize
income from fees and service charges, which is the compensation we receive from
providing products and services.  Our primary noninterest income comes
from fees and service charges on loan and deposit accounts.  We also
earn income from bank owned life insurance, sales of loans and investments and
investment advisory services.
 
 Expenses.The expenses
we incur in operating our business consist of compensation, taxes and benefits,
office occupancy, computer processing fees, advertising and professional fees
and other expenses.
 
 Compensation, taxes and benefits
consist primarily of the salaries and wages paid to our employees and directors,
payroll taxes and expenses for retirement and other employee
benefits.
 
 Occupancy expenses, which are the fixed
and variable costs of buildings and equipment, consist primarily of lease
payments, real estate taxes, depreciation charges, maintenance, and costs of
utilities.
 
 Computer processing fees includes fees
paid to our third-party data processing servicer and our network security
expenses.
 
 Professional fees include fees paid for
our attorneys, accountants and consultants.
 
 Other expenses include expenses for
insurance (including Federal Deposit Insurance Corporation insurance), postage,
expenses associated with being a public company, expenses related to checking
accounts, supervisory examinations and other miscellaneous operating
activities.
 
 Critical
Accounting Policies
 
 We consider accounting policies
involving significant judgments and assumptions by management that have, or
could have, a material impact on the carrying value of certain assets or on
income to be critical accounting policies.  We consider the following
to be critical accounting policies:  allowance for loan losses and
deferred income taxes.
 
 Allowance
for Loan Losses.  Determining
the amount of the allowance for loan losses necessarily involves a high degree
of judgment.  Management reviews the level of the allowance on a
quarterly basis, at a minimum, and establishes the provision for loan losses
based on the composition of the loan portfolio, delinquency levels, loss
experience, economic conditions, and other factors related to the collectability
of the loan portfolio.
 
 Although we believe that we use the
best information available to establish the allowance for loan losses, future
additions to the allowance may be necessary based on estimates that are
susceptible to change as a result of changes in economic conditions and other
factors.  We engage an independent review of our commercial loan
portfolio annually and adjust our loan ratings based in part upon this
review.  In addition, our banking regulators as an integral part of
their examination process, periodically review our allowance for loan
losses.  Such agencies may require us to recognize adjustments to the
allowance based on their judgments about information available to it at the time
of its examination.See
notes 3 and 5 of the notes to the financial statements included in this annual
report.
  29
 Index
  Deferred
Income Taxes.  We
use the asset and liability method of accounting for income
taxes.  Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases.  If current available information raises
doubt as to the realization of the deferred tax assets, a valuation allowance is
established.  Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or
settled.  We exercise significant judgment in evaluating the amount
and timing of recognition of the resulting tax liabilities and assets, including
projections of future taxable income.  These judgments and estimates
are reviewed periodically as regulatory and business factors
change.  See note 12 of the notes to the financial statements in this
annual report.
 
 Balance Sheet
 
 Loans.  Our
principal lending activity is the origination of loans secured by real estate
primarily located in our market area.  We originate real estate loans
secured by one- to four-family residential homes and multi-family and commercial
real estate and construction loans.  At December 31, 2009, real estate
loans totaled $410.9 million, or 85.4% of total loans compared to $372.8
million, or 85.4% of total loans at December 31, 2008.  Real estate
loans have increased due to favorable interest rates together with real estate
development continuing in our market area.
 
 The largest segment of our real estate
loan portfolio is one- to four-family residential loans.  At December
31, 2009, these loans totaled $229.7 million and represented 55.9% of real
estate loans and 47.7% of total loans compared to $216.2 million, which
represented 58.0% of real estate loans and 49.5% of total loans, at December 31,
2008.  One- to four-family residential loans increased $13.5 million,
or 6.2%, from December 31, 2008 to December 31, 2009, reflecting growth in the
mortgage portfolio from new borrowers and refinancing of existing
customers.
 
 Multi-family and commercial real estate
loans are the second largest segment of our real estate loan
portfolio.  These loans were $134.9 million and represented 32.8% of
real estate loans and 28.0% of total loans at December 31, 2009, compared to
$106.0 million, which represented 28.4% of real estate loans and 24.3% of total
loans, at December 31, 2008.  Multi-family and commercial real estate
loans increased $28.9 million, or 27.3%, for the year ended December 31, 2009
due to the efforts of our business development officers to grow market share and
attract new business.
 
 We also originate construction loans
secured by residential and commercial real estate.  These loans were
$46.3 million and represented 11.3% of real estate loans and 9.6% of total loans
at December 31, 2009, compared to $50.6 million, which represented 13.6% of real
estate loans and 11.6% of total loans at December 31,
2008.  Construction loans decreased $4.3 million, or 8.5%, for the
year ended December 31, 2009 primarily due to decreased loan demand by
contractors for construction loans.
 
 We originate commercial business loans
secured by business assets other than real estate, such as business equipment,
inventory and accounts receivable and letters of credit.  Commercial
business loans totaled $31.3 million, and represented 6.5% of total loans at
December 31, 2009, compared to $22.6 million, representing 5.2% of total loans,
at December 31, 2008.
 
 We also originate a variety of consumer
loans, including second mortgage loans, home equity lines of credit and loans
secured by savings accounts and automobiles.  Consumer loans totaled
$38.9 million and represented 8.1% of total loans at December 31, 2009, compared
to $41.3 million, which represented 9.4% of total loans at December 31,
2008.  The $2.4 million, or 5.8%, decrease for the year ended December
31, 2009 was due to declining demand for this type of product.
  30
 Index
  The following table sets forth the
composition of our loan portfolio at the dates indicated.
 
 At
      December 31,2009
              
              
              2008
              
              
              2007Amount
              
              
              Percent
              
              
              Amount
              
              
              Percent
              
              
              Amount
              
              
              Percent(Dollars
      in thousands)Real
      estate loans:One-
      to four-family
              
              $
              229,693
              
              
              
              47.74
              %
              
              $
              216,201
              
              
              
              49.51
              %
              
              $
              193,787
              
              
              
              53.24
              %Construction
              
              
              46,298
              
              
              
              9.62
              
              
              
              50,596
              
              
              
              11.59
              
              
              
              41,041
              
              
              
              11.27Multi-family
      and commercial real estate
              
              
              134,931
              
              
              
              28.05
              
              
              
              106,028
              
              
              
              24.28
              
              
              
              70,051
              
              
              
              19.25Total
      real estate loans
              
              
              410,922
              
              
              
              85.41
              
              
              
              372,825
              
              
              
              85.38
              
              
              
              304,879
              
              
              
              83.76Commercial
      business loans
              
              
              31,325
              
              
              
              6.51
              
              
              
              22,567
              
              
              
              5.17
              
              
              
              16,690
              
              
              
              4.59Consumer
      loans:Savings
      accounts
              
              
              1,113
              
              
              
              0.23
              
              
              
              1,093
              
              
              
              0.25
              
              
              
              1,272
              
              
              
              0.35Personal
              
              
              256
              
              
              
              0.05
              
              
              
              262
              
              
              
              0.06
              
              
              
              302
              
              
              
              0.08Automobile
              
              
              230
              
              
              
              0.05
              
              
              
              271
              
              
              
              0.06
              
              
              
              327
              
              
              
              0.09Home
      equity
              
              
              37,276
              
              
              
              7.75
              
              
              
              39,655
              
              
              
              9.08
              
              
              
              40,517
              
              
              
              11.13Total
      consumer loans
              
              
              38,875
              
              
              
              8.08
              
              
              
              41,281
              
              
              
              9.45
              
              
              
              42,418
              
              
              
              11.65Total
      loans
              
              
              481,122
              
              
              
              100.00
              %
              
              
              436,673
              
              
              
              100.00
              %
              
              
              363,987
              
              
              
              100.00
              %Less:Allowance
      for loan losses
              
              
              3,996
              
              
              
              
              
              
              
              2,869
              
              
              
              
              
              
              
              2,163Undisbursed
      construction loans
              
              
              3,336
              
              
              
              
              
              
              
              1,299
              
              
              
              
              
              
              
              1,532Deferred
      loan origination fees
              
              
              486
              
              
              
              
              
              
              
              529
              
              
              
              
              
              
              
              461Loans
      receivable, net
              
              $
              473,304
              
              
              
              
              
              
              $
              431,976
              
              
              
              
              
              
              $
              359,831
 
 
 At
      December 31,2006
              
              
              2005Amount
              
              
              Percent
              
              
              Amount
              
              
              Percent(Dollars
      in thousands)Real
      estate loans:One-
      to four-family
              
              $
              179,374
              
              
              
              57.27
              %
              
              $
              156,900
              
              
              
              59.44
              %Construction
              
              
              30,124
              
              
              
              9.62
              
              
              
              24,943
              
              
              
              9.45Multi-family
      and commercial real estate
              
              
              45,879
              
              
              
              14.65
              
              
              
              33,608
              
              
              
              12.73Total
      real estate loans
              
              
              255,377
              
              
              
              81.54
              
              
              
              215,451
              
              
              
              81.62Commercial
      business loans
              
              
              13,508
              
              
              
              4.31
              
              
              
              9,728
              
              
              
              3.69Consumer
      loans:Savings
      accounts
              
              
              634
              
              
              
              0.20
              
              
              
              785
              
              
              
              0.30Personal
              
              
              275
              
              
              
              0.09
              
              
              
              212
              
              
              
              0.08Automobile
              
              
              186
              
              
              
              0.06
              
              
              
              160
              
              
              
              0.06Home
      equity
              
              
              43,220
              
              
              
              13.80
              
              
              
              37,628
              
              
              
              14.25Total
      consumer loans
              
              
              44,315
              
              
              
              14.15
              
              
              
              38,785
              
              
              
              14.69Total
      loans
              
              
              313,200
              
              
              
              100.00
              %
              
              
              263,964
              
              
              
              100.00
              %Less:Allowance
      for loan losses
              
              
              2,071
              
              
              
              
              
              
              
              1,878Undisbursed
      construction loans
              
              
              2,343
              
              
              
              
              
              
              
              2,258Deferred
      loan origination fees
              
              
              410
              
              
              
              
              
              
              
              401Loans
      receivable, net
              
              $
              308,376
              
              
              
              
              
              
              $
              259,427
  31
 Index
  The
following table sets forth certain information at December 31, 2009 regarding
the dollar amount of loans repricing or maturing during the periods
indicated.  The table does not include any estimate of prepayments
which significantly shorten the average life of all loans and may cause our
actual repayment experience to differ from that shown below.  Demand
loans having no stated maturity are reported as due in one year or
less.
 
 At December 31, 2009Real Estate
                Loans
              
              
              Commercial
                Business
                Loans
              
              
              Consumer
                Loans
              
              
              Total
                Loans(In
      thousands)One
      year or less
              
              $
              54,992
              
              
              $
              17,553
              
              
              $
              22,387
              
              
              $
              94,932More
      than one year to five years
              
              
              92,609
              
              
              
              8,696
              
              
              
              3,615
              
              
              
              104,920More
      than five years
              
              
              263,321
              
              
              
              5,076
              
              
              
              12,873
              
              
              
              281,270Total
              
              $
              410,922
              
              
              $
              31,325
              
              
              $
              38,875
              
              
              $
              481,122
 
 The following table sets forth the
dollar amount of all loans at December 31, 2009 that are due after December 31,
2010 and have either fixed interest rates or floating or adjustable interest
rates.  The amounts shown below exclude applicable loans in process,
nonperforming loans and deferred loan fees, net.
 
 Fixed-Rates
              
              
              Floating or
                Adjustable-Rates
              
              
              Total(In
      thousands)Real
      estate loans:One-
      to four-family
              
              $
              213,925
              
              
              $
              19,791
              
              
              $
              233,716Construction
              
              
              7,612
              
              
              
              555
              
              
              
              8,167Multi-family
      and commercial
              
              
              5,214
              
              
              
              108,832
              
              
              
              114,046Commercial
      business loans
              
              
              10,378
              
              
              
              3,395
              
              
              
              13,773Consumer
      loans
              
              
              16,176
              
              
              
              312
              
              
              
              16,488Total
              
              $
              253,305
              
              
              $
              132,885
              
              
              $
              386,190
  The following table shows loan
origination activity during the periods indicated.
 
 Year Ended December 31,2009
              
              
              2008
              
              
              2007(In
      thousands)Total
      loans at beginning of period
              
              $
              436,673
              
              
              $
              363,987
              
              
              $
              313,200Loans
      originated:Real
      estate loans:One-
      to four-family
              
              
              48,387
              
              
              
              41,472
              
              
              
              30,172Construction
              
              
              24,518
              
              
              
              34,459
              
              
              
              32,913Multi-family
      and commercial
              
              
              24,547
              
              
              
              40,566
              
              
              
              30,009Commercial
      business loans
              
              
              21,598
              
              
              
              15,597
              
              
              
              10,714Consumer
      loans
              
              
              13,726
              
              
              
              13,235
              
              
              
              15,914Total
      loans originated
              
              
              132,776
              
              
              
              145,329
              
              
              
              119,722Deduct:Real
      estate loan principal repayments
              
              
              (59,355
              )
              
              
              (48,551
              )
              
              
              (43,595
              )Other
      repayments
              
              
              (28,972
              )
              
              
              (24,092
              )
              
              
              (25,340
              )Net
      loan activity
              
              
              44,449
              
              
              
              72,686
              
              
              
              50,787Total
      loans at end of period
              
              $
              481,122
              
              
              $
              436,673
              
              
              $
              363,987
 
 The Bank did not purchase or sell any
loans during the periods presented in the table above.
  32
 Index
  Allowance
for Loan Losses and Asset Quality.  The
allowance for loan losses is a valuation allowance for the probable losses
inherent in the loan portfolio.  We evaluate the need to establish
allowances against losses on loans on a quarterly basis.  When
additional allowances are needed a provision for loan losses is charged against
earnings.  The recommendations for increases or decreases to the
allowance are presented by management to the Board of Directors on a quarterly
basis.
 
 The allowance for loan losses is
established to recognize the inherent losses associated with lending
activities.  The methodology for assessing the appropriateness of the
allowance for loan losses consists of the following process.
 
 On a quarterly basis, or more often if
warranted, management analyzes the loan portfolio.  For individually
evaluated loans that are considered impaired, a reserve will be established
based on either the present value of expected future cash flows discounted at
the loan’s effective interest rate, the loan’s observable market price, or for
loans that are considered collateral dependant, the fair value of the
collateral.  (A loan is considered impaired when, based on current
information and events, it is probable that a creditor will be unable to collect
all amounts due under the contractual term of the loan agreement.)
 
 All other loans, including loans that
are individually evaluated but not considered impaired, are segregated into
groups based on similar risk factors.  Each of these groups is then
evaluated based on several factors to estimate credit
losses.  Management will determine for each category of loans with
similar risk characteristics the historical loss rate.  Historical
loss rates provide a reasonable starting point for the Bank’s analysis but
analysis and trends in losses do not form a sufficient basis to determine the
appropriate level of the loan loss reserve.  Management also considers
qualitative and environmental factors likely to cause losses.  These
factors include but are not limited to: changes in the amount and severity of
past due, non-accrual and adversely classified loans; changes in local,
regional, and national economic conditions that will affect the collectability
of the portfolio; changes in the nature and volume of loans in the portfolio;
changes in concentrations of credit, lending area, industry concentrations, or
types of borrowers; changes in lending policies, procedures, competition,
management, portfolio mix, competition, pricing, loan to value trends, extension
and modification requests; and loan quality trends.  This analysis
establishes factors that are applied to each of the segregated groups of loans
to determine an acceptable level of loan loss reserve.
 
 Our banking regulators, as an integral
part of their examination process, periodically review our allowance for loan
loss reserve.  The examination may require us to make additional
provision for loan losses based on judgments different from ours.  In
addition, we engage an independent consultant to review our commercial loan
portfolio and make recommendations based on their review as to the specific
credits in the portfolio.
 
 At December 31, 2009, our allowance for
loan losses represented 0.84% of total gross loans and 66.6% of nonperforming
loans compared to 0.66% of total gross loans and 107.13% of nonperforming loans
at December 31, 2008.  The allowance for loan losses increased $1.1
million from $2.9 million at December 31, 2008 to $4.0 million at December 31,
2009.  The increase in the allowance was largely the result of a $1.1
million provision for loan losses made during 2009.  This provision
was based on the increasing size of the loan portfolio and a change in the mix
of the portfolio towards commercial real estate loans which are generally
riskier than one-to-four family loans.  In addition, as discussed
below, nonperforming loans and classified loans increased during the 2009
year.  Total nonperforming loans increased from $2.7 million at
December 31, 2008, to $6.0 million at December 31, 2009.  The increase
was primarily in the commercial real estate and residential loan
portfolios.
 
 At December 31, 2008, our allowance for
loan losses represented 0.66% of total gross loans and 107.13% of nonperforming
loans.  The allowance for loan losses increased $706,000 from December
31, 2007 to December 31, 2008.  The increase in the allowance was
largely the result of a $675,000 provision for loan losses made during
2008.
 
 Although we believe that we use the
best information available to establish the allowance for loan losses, future
adjustments to the allowance for loan losses may be necessary and results of
operations could be adversely affected if circumstances differ substantially
from the assumptions used in making the determinations.  Furthermore,
while we believe we have established our allowance for loan losses in conformity
with generally accepted accounting principles, there can be no assurance that
regulators, in reviewing our loan portfolio, will not request
us
  33
 Index
  to
increase our allowance for loan losses.  In addition, because further
events affecting borrowers and collateral cannot be predicted with certainty,
there can be no assurance that the existing allowance for loan losses is
adequate or that increases will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed above.  Any material
increase in the allowance for loan losses may adversely affect our financial
condition and results of operations.
 
 Summary
of Loan Loss Experience.  The
following table sets forth an analysis of the allowance for loan losses for the
periods indicated.  Where specific loan loss allowances have been
established, any difference between the loss allowance and the amount of loss
realized has been charged or credited to current income.
 
 Year Ended December 31,2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005(Dollars
      in thousands)Allowance
      at beginning of period
              
              $
              2,869
              
              
              $
              2,163
              
              
              $
              2,071
              
              
              $
              1,878
              
              
              $
              1,829Provision
      for loan losses
              
              
              1,144
              
              
              
              675
              
              
              
              151
              
              
              
              192
              
              
              
              32Less:  Charge
      offs:Real
      estate loans
              
              
              —
              
              
              
              —
              
              
              
              46
              
              
              
              —
              
              
              
              —Commercial
      business loans
              
              
              12
              
              
              
              —
              
              
              
              5
              
              
              
              —
              
              
              
              3Consumer
      loans
              
              
              6
              
              
              
              7
              
              
              
              10
              
              
              
              2
              
              
              
              1Total
      charge-offs
              
              
              18
              
              
              
              7
              
              
              
              61
              
              
              
              2
              
              
              
              4Plus:  Recoveries:Real
      estate loans
              
              
              —
              
              
              
              38
              
              
              
              1
              
              
              
              3
              
              
              
              18Commercial
      business loans
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              3Consumer
      loans
              
              
              1
              
              
              
              —
              
              
              
              1
              
              
              
              —
              
              
              
              —Total
      recoveries
              
              
              1
              
              
              
              38
              
              
              
              2
              
              
              
              3
              
              
              
              21Net
      charge-offs (recoveries)
              
              
              17
              
              
              
              (31
              )
              
              
              59
              
              
              
              (1
              )
              
              
              (17
              )Allowance
      at end of period
              
              $
              3,996
              
              
              $
              2,869
              
              
              $
              2,163
              
              
              $
              2,071
              
              
              $
              1,878Allowance
      to nonperforming loans
              
              
              66.60
              %
              
              
              107.13
              %
              
              
              222.99
              %
              
              
              103.03
              %
              
              
              638.78
              %Allowance
      to total loans outstanding at the end of the period
              
              
              0.84
              %
              
              
              0.66
              %
              
              
              0.60
              %
              
              
              0.67
              %
              
              
              0.72
              %Net
      charge-offs (recoveries) to average loans outstanding during the
      period
              
              
              0.00
              %
              
              
              (0.01
              )%
              
              
              0.02
              %
              
              
              0.00
              %
              
              
              (0.01
              )%
  34
 Index
  The following table sets forth the
breakdown of the allowance for loan losses by loan category at the dates
indicated.
 
 At December 31,2009
              
              
              2008
              
              
              2007Amount
              
              
              % of
                Allowance
                to Total
                Allowance
              
              
              % of
                Loans in
                Category
                to Total
                Loans
              
              
              Amount
              
              
              % of
                Allowance
                to Total
                Allowance
              
              
              % of
                Loans in
                Category
                to Total
                Loans
              
              
              Amount
              
              
              % of
                Allowance
                to Total
                Allowance
              
              
              % of
                Loans in
                Category
                to Total
                Loans(Dollars
      in thousands)One-
      to four-family
              
              $
              1,044
              
              
              
              26.13
              %
              
              
              47.74
              %
              
              $
              762
              
              
              
              26.56
              %
              
              
              49.51
              %
              
              $
              661
              
              
              
              30.56
              %
              
              
              53.24
              %Construction
              
              
              632
              
              
              
              15.81
              
              
              
              9.62
              
              
              
              621
              
              
              
              21.65
              
              
              
              11.59
              
              
              
              473
              
              
              
              21.87
              
              
              
              11.27Multi-family
      and commercial real estate
              
              
              1,489
              
              
              
              37.26
              
              
              
              28.05
              
              
              
              903
              
              
              
              31.47
              
              
              
              24.28
              
              
              
              495
              
              
              
              22.88
              
              
              
              19.25Commercial
      business
              
              
              481
              
              
              
              12.04
              
              
              
              6.51
              
              
              
              251
              
              
              
              8.75
              
              
              
              5.17
              
              
              
              185
              
              
              
              8.55
              
              
              
              4.59Consumer
      loans
              
              
              350
              
              
              
              8.76
              
              
              
              8.08
              
              
              
              332
              
              
              
              11.57
              
              
              
              9.45
              
              
              
              349
              
              
              
              16.14
              
              
              
              11.65Unallocated
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Total
      allowance for loan losses
              
              $
              3,996
              
              
              
              100.00
              %
              
              
              100.00
              %
              
              $
              2,869
              
              
              
              100.00
              %
              
              
              100.00
              %
              
              $
              2,163
              
              
              
              100.00
              %
              
              
              100.00
              %
 
 
 At December 31,2006
              
              
              2005Amount
              
              
              % of Allowance to Total
      Allowance
              
              
              %
                of Loans in Category to Total
      Loans
              
              
              Amount
              
              
              % of
                Allowance
                to Total
                Allowance
              
              
              % of Loans in Category to Total
      Loans(Dollars
      in thousands)One-
      to four-family
              
              $
              718
              
              
              
              34.67
              %
              
              
              57.27
              %
              
              $
              724
              
              
              
              38.55
              %
              
              
              59.44
              %Construction
              
              
              464
              
              
              
              22.40
              
              
              
              9.62
              
              
              
              376
              
              
              
              20.02
              
              
              
              9.45Multi-family
      and commercial real estate
              
              
              347
              
              
              
              16.76
              
              
              
              14.65
              
              
              
              379
              
              
              
              20.18
              
              
              
              12.73Commercial
      business
              
              
              209
              
              
              
              10.09
              
              
              
              4.31
              
              
              
              113
              
              
              
              6.02
              
              
              
              3.69Consumer
      loans
              
              
              333
              
              
              
              16.08
              
              
              
              14.15
              
              
              
              283
              
              
              
              15.07
              
              
              
              14.69Unallocated
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              3
              
              
              
              0.16
              
              
              
              —Total
      allowance for loan losses
              
              $
              2,071
              
              
              
              100.00
              %
              
              
              100.00
              %
              
              $
              1,878
              
              
              
              100.00
              %
              
              
              100.00
              %
 
 Nonperforming
and Classified Assets.  When
a loan becomes more than 90 days delinquent, the loan is placed on nonaccrual
status at which time the accrual of interest ceases, the interest previously
accrued to income is reversed and the loan is placed on a cash
basis.  Payments on a nonaccrual loan are applied to the outstanding
principal and interest as determined at the time of collection of the
loan.
 
 We consider repossessed assets and
loans that are more than 90 days past due to be nonperforming
assets.  Real estate that we acquire as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as foreclosed real estate until it is
sold.  When property is acquired it is recorded at the lower of its
cost, which is the unpaid balance of the loan, or fair market value at the date
of foreclosure.  Holding costs and declines in fair value after
acquisition of the property are charged against income.
 
 Nonperforming
assets totaled $6.1 million, or 1.08% of total assets, at December 31, 2009,
which was an increase of approximately $3.5 million, or 129.3%, from December
31, 2008.  Nonaccrual loans accounted for 97.7% of the total
nonperforming assets at December 31, 2009.  This increase was
primarily due to increases in nonaccrual loans in the commercial real estate and
residential mortgage portfolios, along with smaller increases in consumer and
commercial business loan portfolios.
 
 Nonperforming
assets totaled $2.7 million, or 0.50% of total assets, at December 31, 2008,
which was an increase of approximately $1.7 million, or 176.1%, from December
31, 2007.  Nonaccrual loans accounted for 100% of the total
nonperforming assets at December 31, 2008. This increase was primarily due to
the transfer of three commercial loans secured by real estate in the amount of
$1.4 million to non-accrual status during this period.  Management
does not anticipate any losses on these loans due to the value of the real
estate securing the loans.
 
 Under current accounting guidelines, a
loan is defined as impaired when, based on current information and events, it is
probable that the creditor will be unable to collect all amounts due under the
contractual terms of the
  35
 Index
  loan
agreement.  We consider one- to four-family mortgage loans and
consumer loans to be homogeneous and only evaluate them for impairment
separately when they are delinquent or classified.  Other loans are
evaluated for impairment on an individual basis.  At December 31,
2009, nine loans were considered impaired.
 
 The following table provides
information with respect to our nonperforming assets at the dates
indicated.  We did not have any troubled debt restructurings or any
accruing loans past due 90 days or more at the dates presented.
 
 At December 31,2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005(Dollars
      in thousands)Nonaccrual
      loans:One-
      to four-family
              
              $
              1,826
              
              
              $
              1,100
              
              
              $
              422
              
              
              $
              423
              
              
              $
              165Multi-family
      and commercial real estate
              
              
              3,364
              
              
              
              1,371
              
              
              
              356
              
              
              
              1,388
              
              
              
              120Commercial
      business
              
              
              452
              
              
              
              142
              
              
              
              144
              
              
              
              142
              
              
              
              9Consumer
              
              
              358
              
              
              
              65
              
              
              
              48
              
              
              
              57
              
              
              
              —Total
              
              
              6,000
              
              
              
              2,678
              
              
              
              970
              
              
              
              2,010
              
              
              
              294Foreclosed
      real estate
              
              
              140
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              47Total
      nonperforming assets
              
              $
              6,140
              
              
              $
              2,678
              
              
              $
              970
              
              
              $
              2,010
              
              
              $
              341Total
      nonperforming loans to total loans
              
              
              1.26
              %
              
              
              0.62
              %
              
              
              0.27
              %
              
              
              0.65
              %
              
              
              0.11
              %Total
      nonperforming loans to total assets
              
              
              1.08
              %
              
              
              0.50
              %
              
              
              0.21
              %
              
              
              0.49
              %
              
              
              0.08
              %Total
      nonperforming assets to total assets
              
              
              1.10
              %
              
              
              0.50
              %
              
              
              0.21
              %
              
              
              0.49
              %
              
              
              0.10
              %
 
 Other than disclosed in the previous
table, there are no other loans at December 31, 2009 that we have serious doubts
about the ability of the borrowers to comply with the present loan repayment
terms.
 
 Interest income that would have been
recorded for the years ended December 31, 2009 and December 31, 2008 had
nonaccruing loans been current according to their original terms amounted to
$328,000 and $140,000, respectively.  Income related to nonaccrual
loans included in interest income for the years ended December 31, 2009 and
December 31, 2008 amounted to $238,000 and $118,000, respectively.
 
 Federal regulations require us to
regularly review and classify our assets.  In addition, our regulators
have the authority to identify problem assets and, if appropriate, require them
to be classified.  There are three classifications for problem assets:
substandard, doubtful and loss.  “Substandard assets” must have one or
more defined weaknesses and are characterized by the distinct possibility that
we will sustain some loss if the deficiencies are not
corrected.  “Doubtful assets” have the weaknesses of substandard
assets with the additional characteristic that the weaknesses make collection or
liquidation in full on the basis of currently existing facts, conditions and
values questionable, and there is a high possibility of loss.  An
asset classified “loss” is considered uncollectible and of such little value
that continuance as an asset of the institution is not warranted.  The
regulations also provide for a “special mention” category, described as assets
which do not currently expose us to a sufficient degree of risk to warrant
classification but do possess credit deficiencies or potential weaknesses
deserving our close attention.  If we classify an asset as loss, we
must charge off such amount.
  36
 Index
  The following table shows the aggregate
amounts of our classified assets at the dates indicated.
 
 At December 31,2009
              
              
              2008(In
      thousands)Special
      mention assets
              
              $
              43,539
              
              
              $
              30,268Substandard
      assets
              
              
              16,890
              
              
              
              10,274Doubtful
      assets
              
              
              37
              
              
              
              4Loss
      assets
              
              
              —
              
              
              
              —Total
      classified assets
              
              $
              60,466
              
              
              $
              40,546
 
 Special mention assets at December 31,
2009 included one loan in the amount of $70,000 that was
nonaccrual.  Special mention assets at December 31, 2008 did not
include any nonaccrual loans.  Substandard assets at December 31, 2009
and December 31, 2008 included nonaccrual loans of $5.8 million and $2.7
million, respectively.  Doubtful assets at December 31, 2009 and
December 31, 2008 included nonaccrual loans of $9,000 and zero, respectively.
The increase in loans classified as special mention in the 2009 period was due
in part to the timeliness of the borrower’s financial information and general
economic conditions.
 
 Delinquencies.  The
following table provides information about delinquencies in our loan portfolios
at the dates indicated.
 
 At December 31,2009
              
              
              2008
              
              
              200731-60 Days
                Past Due
              
              
              61-90 Days
                Past Due
              
              
              31-60 Days
                Past Due
              
              
              61-90 Days
                Past Due
              
              
              31-60 Days
                Past Due
              
              
              61-90 Days
                Past Due(In
      thousands)One-
      to four-family
              
              $
              2,634
              
              
              $
              328
              
              
              $
              1,000
              
              
              $
              724
              
              
              $
              99
              
              
              $
              950Multi-family
      and commercial real estate
              
              
              1,247
              
              
              
              2,713
              
              
              
              84
              
              
              
              --
              
              
              
              880
              
              
              
              678Commercial
      business
              
              
              373
              
              
              
              25
              
              
              
              568
              
              
              
              7
              
              
              
              31
              
              
              
              25Consumer
      loans
              
              
              364
              
              
              
              162
              
              
              
              2
              
              
              
              4
              
              
              
              11
              
              
              
              —Total
              
              $
              4,618
              
              
              $
              3,228
              
              
              $
              1,654
              
              
              $
              735
              
              
              $
              1,021
              
              
              $
              1,653
 
 Securities.  Our
securities portfolio consists primarily of mortgage-backed securities and
collateralized mortgage obligations with maturities of 30 years or less, money
market preferred obligations, as well as U.S. Government and agency
obligations.  Securities decreased by $24.8 million in the year ended
December 31, 2009 primarily due to the sale of our entire municipal bond
portfolio, combined with the sale of a portion of our mortgage-backed security
portfolio.
 
 Securities decreased by $2.6 million in
the year ended December 31, 2008 primarily due to the previously disclosed Other
Than Temporary Impairment (“OTTI”) write down on our auction rate pass through
certificates with Fannie Mae preferred stock as underlying collateral as a
result of the actions of the United States Treasury Department and the Federal
Housing Finance Agency, with respect to Fannie Mae and Freddie Mac, in the third
quarter of 2008.  Substantially all of our mortgage-backed securities
and collateralized mortgage obligations were issued either by Ginnie Mae, Fannie
Mae or Freddie Mac.  Our securities portfolio also includes a private
label collateralized mortgage obligation and a corporate
obligation.
  37
 Index
  The following table sets forth the
amortized costs and fair values of our securities portfolio at the dates
indicated.
 
 At December 31,2009
              
              
              2008
              
              
              2007Amortized
                Cost
              
              
              Fair
                Value
              
              
              Amortized
                Cost
              
              
              Fair
                Value
              
              
              Amortized
                Cost
              
              
              Fair
                Value(In
      thousands)Available-for-sale
      securities:U.S.
      Government and agency obligations
              
              $
              1,529
              
              
              $
              1,583
              
              
              $
              1,537
              
              
              $
              1,604
              
              
              $
              2,749
              
              
              $
              2,744Mortgage-backed
      securities
              
              
              23,561
              
              
              
              24,500
              
              
              
              42,297
              
              
              
              43,030
              
              
              
              31,352
              
              
              
              31,261Collateralized
      mortgage obligations
              
              
              3,091
              
              
              
              3,000
              
              
              
              3,339
              
              
              
              3,183
              
              
              
              3,547
              
              
              
              3,494Municipal
      obligations
              
              
              —
              
              
              
              —
              
              
              
              8,888
              
              
              
              8,993
              
              
              
              14,092
              
              
              
              14,075Money
      market preferred obligations
              
              
              8,200
              
              
              
              7,880
              
              
              
              9,273
              
              
              
              6,744
              
              
              
              12,700
              
              
              
              12,700Corporate
      obligations
              
              
              1,000
              
              
              
              660
              
              
              
              1,000
              
              
              
              290
              
              
              
              1,000
              
              
              
              990Held-to-maturity
      securities:U.S.
      Government and agency obligations
              
              
              1,451
              
              
              
              1,475
              
              
              
              —
              
              
              
              —
              
              
              
              1,000
              
              
              
              998Interest-bearing
      balances
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              190
              
              
              
              190Total
              
              $
              38,832
              
              
              $
              39,098
              
              
              $
              66,334
              
              
              $
              63,844
              
              
              $
              66,630
              
              
              $
              66,452
 
 At December 31, 2009, we did not own
any securities, other than U.S. Government and agency securities, that had an
aggregate book value in excess of 10% of our total capital at that
date.
  38
 Index
  The following table sets forth the
final maturities and weighted average yields of securities at December 31,
2009.  Mortgage-backed securities and collateralized mortgage
obligations are secured by mortgages and as a result produce monthly principal
repayments which are not reflected in the table below.  Certain
mortgage-backed securities, collateralized mortgage obligations and money market
preferred obligations have adjustable interest rates and reprice within the
various maturity ranges.  These repricing schedules are not reflected
in the table below.  At December 31, 2009, mortgage-backed securities
and collateralized mortgage obligations with adjustable rates totaled $10.9
million.  The auction markets for the money market preferred
obligations listed are not currently active.  As a result, the money
market preferred obligations are listed below based on their repricing schedule,
rather than their expected maturities.
 
 
 Less than
                One Year
              
              
              More than
                One Year to
                Five Years
              
              
              More than
                Five Years to
                Ten YearsCarrying
                Value
              
              
              Weighted
                Average
                Yield
              
              
              Carrying
                Value
              
              
              Weighted
                Average
                Yield
              
              
              Carrying
                Value
              
              
              Weighted
                Average
                Yield(Dollars
      n thousands)Available-for-sale
      securities:U.S.
      Government and agency obligations
              
              $
              —
              
              
              
              —
              
              
              $
              1,069
              
              
              
              4.39
              %
              
              $
              514
              
              
              
              5.55
              %Mortgage-backed
      securities
              
              
              —
              
              
              
              —
              
              
              
              690
              
              
              
              3.50
              %
              
              
              —
              
              
              
              —Collateralized
      mortgage obligations
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Money
      market preferred obligations
              
              
              7,880
              
              
              
              4.41
              %
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Corporate
      obligations
              
              
              —
              
              
              
              —
              
              
              
              660
              
              
              
              6.00
              %
              
              
              —
              
              
              
              —Total
      available-for-sale securities
              
              
              7,880
              
              
              
              4.41
              %
              
              
              2,419
              
              
              
              4.57
              %
              
              
              514
              
              
              
              5.55
              %Held-to-maturity
      securities:Mortgage-backed
      securities
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Total
      held-to-maturity securities
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Total
              
              $
              7,880
              
              
              
              4.41
              %
              
              $
              2,419
              
              
              
              4.57
              %
              
              $
              514
              
              
              
              5.55
              %
 
 
 More than
                Ten Years
              
              
              TotalCarrying
                Value
              
              
              Weighted
                Average
                Yield
              
              
              Carrying
                Value
              
              
              Weighted
                Average
                YieldAvailable-for-sale
      securities:U.S.
      Government and agency obligations
              
              $
              —
              
              
              
              —
              
              
              $
              1,583
              
              
              
              4.76
              %Mortgage-backed
      securities
              
              
              23,810
              
              
              
              4.96
              %
              
              
              24,500
              
              
              
              4.92
              %Collateralized
      mortgage obligations
              
              
              3,000
              
              
              
              3.19
              %
              
              
              3,000
              
              
              
              3.19
              %Money
      market preferred obligations
              
              
              —
              
              
              
              —
              
              
              
              7,880
              
              
              
              4.41
              %Corporate
      obligations
              
              
              —
              
              
              
              —
              
              
              
              660
              
              
              
              6.00
              %Total
      available-for-sale securities
              
              
              26,810
              
              
              
              4.76
              %
              
              
              37,623
              
              
              
              4.69
              %Held-to-maturity
      securities:Mortgage-backed
      securities
              
              
              1,475
              
              
              
              5.26
              %
              
              
              1,475
              
              
              
              5.26
              %Total
      held-to-maturity securities
              
              
              1,475
              
              
              
              5.26
              %
              
              
              1,475
              
              
              
              5.26
              %Total
              
              $
              28,285
              
              
              
              4.79
              %
              
              $
              39,098
              
              
              
              4.71
              %
  39
 Index
  Bank
Owned Life Insurance.During
2003, we purchased life insurance policies on certain key
executives.  We purchased $2.5 million of additional policies in the
fourth quarter of 2005.  Bank owned life insurance is recorded as an
asset at the lower of its cash surrender value or the amount that can be
realized.  Income earned on bank owned life insurance policies is
exempt from income taxes.
 
 Deposits.  Our
primary source of funds is retail deposit accounts held principally by
individuals and businesses within our market area.  The deposit base
is comprised of certificate accounts, regular savings accounts, checking and NOW
accounts, money market savings accounts and health savings
accounts.  At December 31, 2009, we had no brokered
deposits.  Total deposits increased $17.9 million or 4.9% in the year
ended December 31, 2009.  During that time period, certificate
accounts decreased1.6%, regular savings
accounts increased by 36.1%, checking and NOW accounts increased by 9.1% and
money market savings accounts decreased by1.9%.  Theincreasein deposits was
primarily due to competitive pricing in our market area, combined with the
opening of our 10th
office in the third quarter of 2008.  Theincrease in regular
savings accounts was primarily due to the inflow of funds into a more liquid
regular savings product with an attractive rate.
 
 The following table sets forth the
balances of our deposit products at the date indicated.
 
 At December 31,2009
              
              
              2008
              
              
              2007(In
      thousands)Certificate
      accounts
              
              $
              231,905
              
              
              $
              235,764
              
              
              $
              202,411Regular
      savings accounts
              
              
              65,916
              
              
              
              48,427
              
              
              
              41,480Checking
      and NOW accounts
              
              
              57,319
              
              
              
              52,537
              
              
              
              49,511Money
      market savings accounts
              
              
              25,791
              
              
              
              26,298
              
              
              
              27,996Total
              
              $
              380,931
              
              
              $
              363,026
              
              
              $
              321,398
 
 The following table indicates the
amount of jumbo certificate accounts by time remaining until maturity at
December 31, 2009.  Jumbo certificate accounts require minimum
deposits of $100,000.
 
 Maturity Period
              
              Certificate
                Accounts(In
      thousands)Three
      months or less
              
              $
              12,870Over
      three through six months
              
              
              16,955Over
      six through twelve months
              
              
              7,608Over
      twelve months
              
              
              45,507Total
              
              $
              82,940
  Borrowings.  We
borrow funds from the Federal Home Loan Bank of Boston during periods of low
liquidity to match fund increases in our fixed-rate mortgage portfolio and to
provide long-term fixed-rate funding with the goal of decreasing our exposure to
an increase in interest rates.  In addition, we occasionally borrow
short-term from correspondent banks to cover temporary cash needs.  At
December 31, 2009, we had the ability to borrow a total of $3.5 million from a
correspondent bank, none of which was borrowed at such date.  We also
use securities sold under agreements to repurchase as a source of
borrowings.
  40
 Index
  The following table presents certain
information regarding our Federal Home Loan Bank advances during the periods and
at the dates indicated.
 
 Year Ended December 31,2009
              
              
              2008
              
              
              2007(Dollars
      in thousands)Maximum
      amount of advances outstanding at any month end during the
      period
              
              $
              117,211
              
              
              $
              119,628
              
              
              $
              84,878Average
      advances outstanding during the period
              
              
              104,268
              
              
              
              107,182
              
              
              
              69,866Weighted
      average interest rate during the period
              
              
              3.77
              %
              
              
              4.31
              %
              
              
              4.89
              %Balance
      outstanding at end of period
              
              
              112,553
              
              
              $
              118,421
              
              
              $
              84,878Weighted
      average interest rate at end of period
              
              
              2.91
              %
              
              
              3.80
              %
              
              
              4.66
              %
 
 Equity.  Total
equity increased by $4.7 million, or 10.3%, to $50.3 million at December 31,
2009 from $45.6 million at December 31, 2008.  The increase in 2009
resulted from net income of $2.0 million, dividends of $447,000 paid to
stockholders, stock repurchases of $25,000, a net decrease to the unrealized
loss on available for sale securities of $2.5 million and $644,000 in capital
adjustments related to the Company’s 2005 Equity Incentive Plan.  Our
average equity to average assets ratio was 8.97% at December 31, 2009, compared
to 9.71% at December 31, 2008.
 
 Comparison
of Operating Results for the Years Ended December 31, 2009 and 2008
 
 Overview.
 
 2009
              
              
              2008
              
              
              % Change
                2009/2008(Dollars
      in thousands)Net
      income (loss)
              
              $
              1,993
              
              
              $
              (312
              )
              
              
              (738.78
              )%Return
      (loss) on average assets
              
              
              0.37
              %
              
              
              (0.06
              )%
              
              
              (716.67
              )%Return
      (loss) on average equity
              
              
              4.10
              %
              
              
              (0.64
              )%
              
              
              (740.63
              )%
 
 Net income for the year ended December
31, 2009 increased $2.3 million from net income in 2008.  The increase
was primarily due to the OTTI charge of $3.4 million on auction rate pass
through certificates with Fannie Mae preferred stock as underlying
collateralwhich was recorded in
2008.  The Company experienced an increase of $469,000 in the
provision for loan losses, an increase in noninterest expense of $1.1 million,
which was offset by a $1.5 million increase in net interest
income.  Excluding the OTTI charge, the Company experienced an
increase in noninterest income of $400,000.
 
 Net Interest Income.
 
 Net interest income for the year ended
December 31, 2009, totaled $15.8 million compared to $14.3 million for the year
ended December 31, 2008, an increase of $1.5 million, or 10.2%.  The
increase in net interest income was primarily due to a decrease in interest
expense.  Interest expense decreased by $1.4 million, or 9.8% during
this period, primarily due to a decrease in the average rates paid on interest
bearing liabilities.  The average rates paid on deposits and
borrowings decreased by 51 basis points in 2009.  The Company
experienced an increase in the average balances of deposits of 9.2% for the
twelve month periods, while the average balances of borrowings increased by 5.3%
in the twelve month period.  Increases in deposits were experienced in
all categories, except money market accounts where there was a small
decrease.
 
 The Company also experienced an
increase in the average balance of interest earning assets of 7.5%, partially
offset by a decrease in the average rate earned on these assets of 40 basis
points.  The increase in interest earning assets is attributed
primarily to an increase in the loan portfolio, partially offset by decreases in
the average balances of the investment portfolio over the same
periods.  The average balances in the loan portfolio increased by
13.0% in 2009.  The largest increases were in the commercial mortgage
portfolio followed by the residential mortgage portfolio, due in part to the
efforts of our business development officers to grow market share and attract
new customers.
  41
 Index
  Average
Balances and Yields.  The
following table presents information regarding average balances of assets and
liabilities, the total dollar amounts of interest income and dividends, the
total dollar amount of interest expense and the resulting average yields and
costs.  The yields and costs for the periods indicated are derived by
dividing income or expense by the average balances of assets or liabilities,
respectively, for the periods presented.  For purposes of this table,
average balances have been calculated using the average of daily balances and
nonaccrual loans are included in average balances only.  During the
2009, 2008 and 2007 periods, we held tax-exempt municipal securities with
average balances of $950,000, $9.9 million and $15.0 million, respectively, and
during the 2009, 2008 and 2007 periods we held preferred money market securities
with an average balance of $9.2 million, $11.9 million and $12.7 million
respectively which recognize a dividends received deduction.  The
yields below do not reflect the tax benefits of these
securities.
  42
 Index
 
 2009
              
              
              2008
              
              
              2007Average Balance
              
              
              Interest and
    Dividends
              
              
              Yield/
                Cost
              
              
              Average
                Balance
              
              
              Interest
                and
                Dividends
              
              
              Yield/
                Cost
              
              
              Average
                Balance
              
              
              Interest
                and
                Dividends
              
              
              Yield/
                Cost(Dollars
      in thousands)Interest-earning
      assets:Loans
              
              $
              448,131
              
              
              $
              25,954
              
              
              
              5.79
              %
              
              $
              396,524
              
              
              $
              24,556
              
              
              
              6.19
              %
              
              $
              331,490
              
              
              $
              21,681
              
              
              
              6.54
              %Fed
      Funds sold
              
              
              5,444
              
              
              
              5
              
              
              
              0.09
              
              
              
              2,391
              
              
              
              57
              
              
              
              2.38
              
              
              
              2,599
              
              
              
              143
              
              
              
              5.50Investment
      securities
              
              
              50,025
              
              
              
              2,332
              
              
              
              4.66
              
              
              
              69,498
              
              
              
              3,391
              
              
              
              4.88
              
              
              
              64,290
              
              
              
              2,938
              
              
              
              4.57Federal
      Home Loan Bank stock
              
              
              6,252
              
              
              
              --
              
              
              
              0.00
              
              
              
              5,735
              
              
              
              199
              
              
              
              3.47
              
              
              
              4,179
              
              
              
              268
              
              
              
              6.41Total
      interest-earning assets
              
              
              509,852
              
              
              
              28,291
              
              
              
              5.55
              
              
              
              474,148
              
              
              
              28,203
              
              
              
              5.95
              
              
              
              402,558
              
              
              
              25,030
              
              
              
              6.22Noninterest-earning
      assets
              
              
              32,484
              
              
              
              
              
              
              
              
              
              
              
              30,910
              
              
              
              
              
              
              
              
              
              
              
              31,629Total
      assets
              
              $
              542,336
              
              
              
              
              
              
              
              
              
              
              $
              505,058
              
              
              
              
              
              
              
              
              
              
              $
              434,187Interest-bearing
      liabilities:Certificate
      accounts
              
              $
              237,850
              
              
              $
              7,741
              
              
              
              3.25
              
              
              $
              216,595
              
              
              $
              8,297
              
              
              
              3.83
              
              
              $
              183,172
              
              
              $
              8,414
              
              
              
              4.59Regular savings accounts andescrow
              
              
              60,825
              
              
              
              390
              
              
              
              0.64
              
              
              
              48,130
              
              
              
              288
              
              
              
              0.60
              
              
              
              46,093
              
              
              
              258
              
              
              
              0.56Checking
      and NOW accounts
              
              
              53,258
              
              
              
              45
              
              
              
              0.08
              
              
              
              53,732
              
              
              
              159
              
              
              
              0.30
              
              
              
              56,915
              
              
              
              487
              
              
              
              0.86Money
      market savings accounts
              
              
              25,790
              
              
              
              301
              
              
              
              1.17
              
              
              
              27,607
              
              
              
              527
              
              
              
              1.91
              
              
              
              24,709
              
              
              
              591
              
              
              
              2.39Total
      interest-bearing deposits
              
              
              377,723
              
              
              
              8,477
              
              
              
              2.24
              
              
              
              346,064
              
              
              
              9,271
              
              
              
              2.68
              
              
              
              310,889
              
              
              
              9,750
              
              
              
              3.14FHLB
      advances
              
              
              104,268
              
              
              
              3,931
              
              
              
              3.77
              
              
              
              107,182
              
              
              
              4,615
              
              
              
              4.31
              
              
              
              69,866
              
              
              
              3,414
              
              
              
              4.89Other
      borrowings
              
              
              9,316
              
              
              
              129
              
              
              
              1.38
              
              
              
              654
              
              
              
              18
              
              
              
              2.75
              
              
              
              290
              
              
              
              10
              
              
              
              3.45Total
      interest-bearing liabilities
              
              
              491,307
              
              
              
              12,537
              
              
              
              2.55
              
              
              
              453,900
              
              
              
              13,904
              
              
              
              3.06
              
              
              
              381,045
              
              
              
              13,174
              
              
              
              3.46Noninterest-bearing
      liabilities
              
              
              2,391
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,899Total
      liabilities
              
              
              493,698
              
              
              
              
              
              
              
              
              
              
              
              2,138
              
              
              
              
              
              
              
              
              
              
              
              382,944Stockholders’
      equity
              
              
              48,638
              
              
              
              
              
              
              
              
              
              
              
              49,020
              
              
              
              
              
              
              
              
              
              
              
              51,243Total
      liabilities and stockholders’equity
              
              $
              542,336
              
              
              
              
              
              
              
              
              
              
              $
              505,058
              
              
              
              
              
              
              
              
              
              
              $
              434,187Net
      interest income
              
              
              
              
              
              $
              15,754
              
              
              
              
              
              
              
              
              
              
              $
              14,299
              
              
              
              
              
              
              
              
              
              
              $
              11,856Interest
      rate spread
              
              
              
              
              
              
              
              
              
              
              3.00
              %
              
              
              
              
              
              
              
              
              
              
              2.88
              %
              
              
              
              
              
              
              
              
              
              
              2.76
              %Net
      interest margin
              
              
              
              
              
              
              
              
              
              
              3.09
              %
              
              
              
              
              
              
              
              
              
              
              3.02
              %
              
              
              
              
              
              
              
              
              
              
              2.95
              %Average
      interest-earning assets to average interest-bearing
      liabilities
              
              
              
              
              
              
              
              
              
              
              103.77
              %
              
              
              
              
              
              
              
              
              
              
              104.46
              %
              
              
              
              
              
              
              
              
              
              
              105.65
              %
  43
 Index
  Rate/Volume
Analysis.  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).  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.  The net column represents the sum of the prior
columns.
 
 2009 Compared to 2008
              
              
              2008 Compared to 2007Increase (Decrease)
                Due to
              
              
              Increase (Decrease)
                Due toVolume
              
              
              Rate
              
              
              Net
              
              
              Volume
              
              
              Rate
              
              
              Net(In
      thousands)Interest
      income:Loans
              
              $
              2,784
              
              
              $
              (1,386
              )
              
              $
              1,398
              
              
              $
              3,943
              
              
              $
              (1,068
              )
              
              $
              2,875Fed
      Funds sold
              
              
              (211
              )
              
              
              159
              
              
              
              (52
              )
              
              
              (11
              )
              
              
              (75
              )
              
              
              (86
              )Investment
      securities
              
              
              (914
              )
              
              
              (145
              )
              
              
              (1,059
              )
              
              
              247
              
              
              
              206
              
              
              
              453Federal
      Home Loan Bank stock
              
              
              20
              
              
              
              (219
              )
              
              
              (199
              )
              
              
              297
              
              
              
              (366
              )
              
              
              (69
              )Total
      interest income
              
              
              1,679
              
              
              
              (1,591
              )
              
              
              88
              
              
              
              4,476
              
              
              
              (1,303
              )
              
              
              3,173Interest
      expense:Certificate
      accounts
              
              
              1,044
              
              
              
              (1,600
              )
              
              
              (556
              )
              
              
              (1,302
              )
              
              
              1,185
              
              
              
              (117
              )Regular
      savings accounts
              
              
              80
              
              
              
              22
              
              
              
              102
              
              
              
              12
              
              
              
              18
              
              
              
              30Checking
      and NOW accounts
              
              
              (1
              )
              
              
              (113
              )
              
              
              (114
              )
              
              
              (26
              )
              
              
              (302
              )
              
              
              (328
              )Money
      market savings accounts
              
              
              (33
              )
              
              
              (193
              )
              
              
              (226
              )
              
              
              89
              
              
              
              (153
              )
              
              
              (64
              )Total
      deposit expense
              
              
              1,090
              
              
              
              (1,884
              )
              
              
              (794
              )
              
              
              (1,227
              )
              
              
              748
              
              
              
              (479
              )FHLB
      advances
              
              
              (123
              )
              
              
              (561
              )
              
              
              (684
              )
              
              
              1,545
              
              
              
              (344
              )
              
              
              1,201Other
      borrowings
              
              
              115
              
              
              
              (4
              )
              
              
              111
              
              
              
              10
              
              
              
              (2
              )
              
              
              8Total
      interest expense
              
              
              1,082
              
              
              
              (2,449
              )
              
              
              (1,367
              )
              
              
              328
              
              
              
              402
              
              
              
              730Net
      interest income
              
              $
              597
              
              
              $
              858
              
              
              $
              1,455
              
              
              $
              4,148
              
              
              $
              (1,705
              )
              
              $
              2,443
 
 Provision for Loan Losses.
 
 During the year ended December 31,
2009, a $1.1 million provision was made to the allowance for loan
losses.   The provision was primarily due to the increased size
of the portfolio, a change in the mix of the portfolio towards commercial loans
which are generally riskier than one-to-four family loans, and general economic
conditions.
 
 During the year ended December 31,
2008, a $675,000 provision was made to the allowance for loan
losses.   The provision was primarily due to the increased size
of the loan portfolio, a change in the mix of the portfolio towards commercial
loans which are generally riskier than one-to-four family loans, and general
economic conditions.
  44
 Index
  Noninterest
Income.  The
following table shows the components of noninterest income and the percentage
changes from 2009 to 2008.
 
 2009
              
              
              2008
              
              
              % Change 2009/2008Fees
      for services related to deposit accounts
              
              $
              1,060
              
              
              $
              1,053
              
              
              
              0.66
              %Fees
      for other services
              
              
              574
              
              
              
              529
              
              
              
              8.51
              %Gain
      (loss) on investments
              
              
              388
              
              
              
              (3,398
              )
              
              
              -111.42
              %Income
      from bank owned life insurance
              
              
              341
              
              
              
              315
              
              
              
              8.25
              %Income
      from investment advisory services, net
              
              
              271
              
              
              
              299
              
              
              
              -9.36
              %Other
      income
              
              
              108
              
              
              
              154
              
              
              
              -29.87
              %Total
              
              $
              2,742
              
              
              $
              (1,048
              )
              
              
              -361.64
              %
 
 For the year ended December 31, 2009,
noninterest income increased 361.6% to $2.7 million, compared to $(1.0) million
for 2008.  The largest increase in noninterest income was the gain on
sale of investments. The 2008 period included the OTTI charge of $3.4 million on
auction rate pass through certificates with Fannie Mae preferred stock as
underlying collateral.
 
 Noninterest
Expense.The
following table shows the components of noninterest expense and the percentage
changes from 2009 to 2008.
 
 2009
              
              
              2008
              
              
              % Change 2009/2008Compensation,
      taxes and benefits
              
              $
              7,692
              
              
              $
              7,521
              
              
              
              2.27
              %Office
      occupancy
              
              
              2,151
              
              
              
              2,173
              
              
              
              -1.01
              %FDIC
      insurance premiums
              
              
              946
              
              
              
              132
              
              
              
              616.67
              %Computer
      processing
              
              
              916
              
              
              
              861
              
              
              
              6.39
              %Professional
      fees
              
              
              674
              
              
              
              518
              
              
              
              30.12
              %Directors
      compensation
              
              
              560
              
              
              
              493
              
              
              
              13.59
              %Advertising
              
              
              330
              
              
              
              534
              
              
              
              -38.20
              %Office
      supplies
              
              
              207
              
              
              
              195
              
              
              
              6.15
              %Loss
      on foreclosed real estate, net
              
              
              36
              
              
              
              1
              
              
              
              3,500.00
              %Other
      expenses (1)
              
              
              1,029
              
              
              
              1,026
              
              
              
              0.29
              %Total
              
              $
              14,541
              
              
              $
              13,454
              
              
              
              8.08
              %
 ____________________________
 (1)
              Other
      expenses for all periods include, among other items, insurance, postage
      and expenses related to checking
accounts.
 
 Noninterest expense was $14.5 million
for the year ended December 31, 2009, compared to $13.5 million for
2008.  The increase was primarily the result of increases in FDIC
insurance premiums.  In the second quarter of 2009, the FDIC announced
a special assessment of five basis points on each insured institution’s assets
minus Tier-1 capital.  This special assessment was paid on September
30, 2009.Additionally, the
increases in noninterest expense were due to increased professional fees,
primarily as a result of fees related to the announced acquisition of Southern
Connecticut Bancorp, Inc, and increases in compensation costs, primarily as a
result of filling two vacant positions.  These increases were
partially offset by a decrease in advertising expense and office occupancy
expenses.
  45
 Index
  Income Taxes
 
 During the year ended December 31,
2009, the effective tax rate for 2009 was 29.1%, compared with 23.5% for 2008,
excluding the tax benefit recorded for the OTTI charge in the 2008
period.  See note 12 to the financial statements in this Annual Report
on form 10-K.
 
 Market
Risk Analysis
 
 Qualitative
Aspects of Market Risk.Our
most significant form of market risk is interest rate risk.  We manage
the interest rate sensitivity of our interest-bearing liabilities and
interest-earning assets in an effort to minimize the adverse effects of changes
in the interest rate environment.  Deposit accounts typically react
more quickly to changes in market interest rates than mortgage loans because of
the shorter maturities of deposits.  As a result, sharp increases in
interest rates may adversely affect our earnings while decreases in interest
rates may beneficially affect our earnings.  To reduce the potential
volatility of our earnings, we have sought to improve the match between assets
and liability maturities (or rate adjustment periods), while maintaining an
acceptable interest rate spread, by originating adjustable-rate mortgage loans
for retention in our loan portfolio, variable-rate home equity lines and
variable-rate commercial loans and by purchasing variable-rate investments and
investments with expected maturities of less than 10 years.  In
2002-2004 we sold a small percentage of our originations of longer term
fixed-rate one- to four-family mortgage loans in the secondary market based on
prevailing market interest rate conditions, an analysis of the composition and
risk of the loan portfolio, liquidity needs and interest rate risk management
goals.  We have not sold any loans since 2004.  Generally,
loans are sold without recourse and with servicing retained.  We
currently do not participate in hedging programs, interest rate swaps or other
activities involving the use of off-balance sheet derivative financial
instruments.
 
 Our Asset/Liability Committee
communicates, coordinates and controls all aspects of asset/liability
management.  The committee establishes and monitors the volume and mix
of assets and funding sources with the objective of managing assets and funding
sources.
 
 Quantitative
Aspects of Market Risk.  We use an interest rate sensitivity
analysis prepared by the Office of Thrift Supervision to review our level of
interest rate risk.  This analysis measures interest rate risk by
computing changes in net portfolio value of our cash flows from assets,
liabilities and off-balance sheet items in the event of a range of assumed
changes in market interest rates.  Net portfolio value represents the
market value of portfolio equity and is equal to the market value of assets
minus the market value of liabilities, with adjustments made for off-balance
sheet items.  This analysis assesses the risk of loss in market risk
sensitive instruments in the event of a sudden and sustained 50 to 300 basis
point increase or a 50 to 100 basis point decrease in market interest rates with
no effect given to any steps that we might take to counter the effect of that
interest rate movement.  We measure interest rate risk by modeling the
changes in net portfolio value over a variety of interest rate
scenarios.  The following table, which is based on information that we
provide to the Office of Thrift Supervision, presents the change in net
portfolio value of Naugatuck Valley Savings at December 31, 2009 that would
occur in the event of an immediate change in interest rates based on Office of
Thrift Supervision assumptions, with no effect given to any steps that we might
take to counteract that change.
 
 Basis Point (“bp”)
                Change in Rates
              
              Net Portfolio Value
              
              
              Net Portfolio Value as %
      of
                Present Value of
    Assets$ Amount
              
              
              $ Change
              
              
              % Change
              
              
              NPV Ratio
              
              
              Change(Dollars
      in thousands)300bp
              
              $
              36,491
              
              
              $
              (20,597
              )
              
              
              (36
              )%
              
              
              6.74
              %
              
              
              (3.13
              )%200
              
              
              44,506
              
              
              
              (12,582
              )
              
              
              (22
              )%
              
              
              8.03
              %
              
              
              (1.84
              )%100
              
              
              51,817
              
              
              
              (5,271
              )
              
              
              (9
              )%
              
              
              9.13
              %
              
              
              (0.74
              )%50
              
              
              54,807
              
              
              
              (2,281
              )
              
              
              (4
              )%
              
              
              9.56
              %
              
              
              (0.31
              )%0
              
              
              57,088
              
              
              
              —
              
              
              
              —
              
              
              
              9.87
              %
              
              
              —(50)
              
              
              58,434
              
              
              
              1,346
              
              
              
              2
              %
              
              
              10.03
              %
              
              
              0.16
              %(100)
              
              
              58,348
              
              
              
              1,260
              
              
              
              2
              %
              
              
              9.96
              %
              
              
              0.09
              %
 
 The Office of Thrift Supervision uses
certain assumptions in assessing the interest rate risk of savings
institutions.  These assumptions relate to interest rates, loan
prepayment rates, deposit decay rates, and the market values of certain assets
under differing interest rate scenarios, among others.  As with any
method of measuring interest rate risk, certain shortcomings are inherent in the
method of analysis presented in the foregoing table.  For
  46
 Index
  example,
although certain assets and liabilities may have similar maturities or periods
to repricing, they may react in different degrees to changes in market interest
rates.  Also, the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market
rates.  Additionally, certain assets, such as adjustable-rate mortgage
loans, have features that restrict changes in interest rates on a short-term
basis and over the life of the asset.  Further, in the event of a
change in interest rates, expected rates of prepayments on loans and early
withdrawals from certificates could deviate significantly from those assumed in
calculating the table.
  Liquidity
and Capital Resources
 
 Liquidity is the ability to meet
current and future short-term financial obligations.  Our primary
sources of funds consist of deposit inflows, loan repayments, maturities and
sales of investment securities, and advances from the Federal Home Loan Bank of
Boston.  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.
 
 Each quarter we project liquidity
availability and demands on this liquidity for the next 90 days.  We
regularly adjust our investments in liquid assets based upon our assessment of
(1) expected loan demand, (2) expected deposit flows, (3) yields available on
interest-earning deposits and securities, and (4) the objectives of our
asset/liability management program.  Excess liquid assets are invested
generally in federal funds and short- and intermediate-term U.S. Government
agency obligations.
 
 Our most liquid assets are cash and
cash equivalents and interest-bearing deposits.  The levels of these
assets depend on our operating, financing, lending and investing activities
during any given period.  At December 31, 2009 and December 31, 2008,
cash and cash equivalents totaled approximately $12.1 million and $8.2 million
respectively, including federal funds of $3.1 million and $33,000,
respectively.  Securities classified as available for sale, which
provide additional sources of liquidity, totaled $37.6 million and $63.8 million
at December 31, 2009 and December 31, 2008, respectively.  At December
31, 2009 and December 31, 2008, we had the ability to borrow a total of $154.6
million and $152.0 million, respectively, from the Federal Home Loan Bank of
Boston, of which $112.6 million and $118.4 million, was outstanding,
respectively.  At December 31, 2009 and December 31, 2008, we had
arranged overnight lines of credit of $2.5 million with the Federal Home Loan
Bank of Boston for both periods.  We had no overnight advances
outstanding with the Federal Home Loan Bank of Boston on these
dates.  In addition, at December 31, 2009 and December 31, 2008, we
had the ability to borrow $3.5 million from a correspondent bank for both
periods, none of which was outstanding on this line at December 31, 2009, and
$1.3 million was outstanding at December 31, 2008.
 
 At December 31, 2009, we had $21.0
million in unused line availability on home equity lines of credit, $17.9
million in unadvanced commercial lines, $2.4 million in mortgage commitments,
$7.7 million in commercial mortgage loan commitments, $28.8 million in
unadvanced construction mortgage commitments, $4.3 million in letters of credit,
$460,000 in commercial business loan commitments and $99,000 in overdraft line
of credit availability.  Certificates of deposit due within one year
of December 31, 2009 totaled $115.6 million, or 30.4% of total
deposits.  If these deposits do not remain with us, we will be
required to seek other sources of funds, including other certificates of deposit
and lines of credit.  Depending on market conditions, we may be
required to pay higher rates on such deposits or other borrowings than we
currently pay on the certificates of deposit due on or before December 31,
2009.  We believe, however, based on past experience, that a
significant portion of our certificates of deposit will remain with
us.  We have the ability to attract and retain deposits by adjusting
the interest rates offered.
 
 Historically, we have remained highly
liquid.  We expect that all of our liquidity needs, including the
contractual commitments set forth in the table below, the estimated costs of our
branch expansion plans and increases in loan demand can be met by our currently
available liquid assets and cash flows.  If loan demand were to
increase at a pace greater than expected, or any unforeseen demand or commitment
were to occur, we would access our borrowing capacity with the Federal Home Loan
Bank of Boston.  We expect that our currently available liquid assets
and our ability to borrow from the Federal Home Loan Bank of Boston would be
sufficient to satisfy our liquidity needs without any material adverse effect on
our liquidity.  We are not aware of any trends and/or demands,
commitments, events or uncertainties that could result in a material decrease in
liquidity.
  47
 Index
  Our primary investing activities are
the origination of loans and the purchase of securities.  For the year
ended December 31, 2009 we originated $132.8 million of loans and purchased $1.6
million of securities. For the year ended December 31, 2008 we originated $145.3
million of loans and purchased $25.0 million of securities.  During
the year ended December 31, 2009, these activities were funded primarily by an
increase in deposits of $17.9 million, proceeds from sales and maturities of
available-for-sale securities of $29.3 million and proceeds from
held-to-maturity securities of $110,000.  During the year ended
December 31, 2008, these activities were funded primarily by an increase in
deposits of $41.6 million, net increase in borrowed funds of $34.0 million,
proceeds from sales and maturities of available-for-sale securities of $20.7
million and proceeds from held-to-maturity securities of $1.2
million.
 
 Historically, our investment portfolio
had been funded by excess liquidity when deposit inflows exceed loan
demand.In December
2008, we implemented a leverage strategy with the objective of enhancing
earnings by borrowing $13.5 million from the Federal Home Loan Bank of Boston on
an intermediate-term basis to fund the purchase of a like amount of
intermediate-term mortgage-backed securities. This strategy is
accretive to earnings.
 
 Financing activities consist primarily
of activity in deposit accounts and in Federal Home Loan Bank
advances.  We experienced a net increase in total deposits of $17.9
million and a net increase of $41.6 million for the years ended December 31,
2009 and 2008, respectively.  Deposit flows are affected by the
overall level of interest rates, the interest rates and products offered by us
and our local competitors and other factors.  We generally manage the
pricing of our deposits to be competitive and to increase core deposit
relationships.  Occasionally, we offer promotional rates on certain
deposit products in order to attract deposits.  We experienced a
decrease in borrowed funds of $164,000 for the year ended December 31,
2009.  Federal Home Loan Bank advances increase $34.0 million for the
year ended December 31, 2008.  The increase in 2008 was primarily due
to lending and investing activities.  We are subject to various
regulatory capital requirements administered by the Office of Thrift
Supervision, including a risk-based capital measure.  The risk-based
capital guidelines include both a definition of capital and a framework for
calculating risk-weighted assets by assigning balance sheet assets and
off-balance sheet items to broad risk categories.  At December 31,
2009, we exceeded all of our regulatory capital requirements.  We are
considered “well capitalized” under regulatory guidelines. See note 14 of the notes
to the financial statements in this Annual Report on Form 10-K.
 
 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, commercial letters of credit and
commitments to sell loans.  See note 16 of the notes to the financial
statements in this annual report.
 
 For the years ended December 31, 2009
and 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.
 
 Effect
of Inflation and Changing Prices
 
 We have prepared the financial
statements and related financial data presented in this report in accordance
with generally accepted accounting principles in the United States, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the change in the relative purchasing
power of money over time due to inflation.  The primary impact of
inflation on our operations is reflected in increased operating
costs.  Unlike most industrial companies, virtually all of our assets
and liabilities are monetary in nature.  As a result, interest rates
generally have a more significant impact on our performance than do general
levels of inflation.  Interest rates do not necessarily move in the
same direction or to the same extent as the prices of goods and
services.
  48
 Index
  ITEM7A.
              QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.
 
 The information required by this item
is incorporated herein by reference to part II, Item 7, “Management’s Discussion and
Analysis of Financial Condition and Results of Operations.”
 
 ITEM8.
              FINANCIAL
      STATEMENTS AND SUPPLEMENTAL DATA.
 
 The information regarding by this item
is included herein beginning on page F-1.
 
 ITEM9.
              CHANGE
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE.
 
 Not applicable.
 
 ITEM9A(T).
              CONTROLS
      AND PROCEDURES.
 
 (a)
              Disclosure
      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.
 
 (b)
              Internal
      Controls Over Financial Reporting
 
 Management’s
annual report on internal control over financial reporting is incorporated
herein by reference to the Company’s audited Consolidated Financial Statements
in this Annual Report on Form 10-K.
 
 This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management’s report in this annual report.
 
 (c)
              Changes
      to Internal Control Over Financial
Reporting
 
 There
were no changes in the Company’s internal control over financial reporting
during the three months ended December 31, 2009 that have materially affected,
or are reasonable likely to materially affect, the Company’s internal control
over financial reporting.
 
 ITEM9B.
              OTHER
      INFORMATION.
 
 Not applicable.
  49
 Index
  PART
III
 
 ITEM10.
              DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE.
 
 Directors
 
 For information concerning Naugatuck
Valley Financial’s directors, the information contained under the section
captioned “Item 1—Election of
Directors” in Naugatuck Valley Financial’s Proxy Statement for the 2010
Annual Meeting of Stockholders (the “Proxy Statement”) is incorporated herein by
reference.
 
 Executive
Officers
 
 For information relating to officers of
Naugatuck Valley Financial, the section captioned “Item 1—Election of
Directors” in the Proxy Statement, and Part I, Item 1, “Business—Executive Officers of the
Registrant” in this Annual Report on Form 10-K, are incorporated by
reference.
 
 Compliance
with Section 16(a) of the Exchange Act
 
 For information regarding compliance
with Section 16(a) of the Exchange Act, the information contained under the
section captioned “Section
16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement
is incorporated herein by reference.
 
 Disclosure
of Code of Ethics
 
 Naugatuck Valley Financial has adopted
a Code of Ethics and Business Conduct, a copy of which can be filed as an
exhibit to this Form 10-K.
 
 Corporate
Governance
 
 For information regarding the audit
committee and its composition and the audit committee financial expert, the
section captioned “Corporate
Governance and Board Matters” in the Proxy Statement is incorporated
herein by reference.
 
 ITEM11.
              EXECUTIVE
      COMPENSATION
 
 The information regarding executive
compensation is set forth under the section captioned “Executive Compensation” in
the Proxy Statement and is incorporated herein by reference.
 
 ITEM12.
              SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDERS MATTERS
 
 (a)
              Security
      Ownership of Certain Beneficial
Owners
 
 Information
required by this item is incorporated herein by reference to the section
captioned “Stock
Ownership” in the Proxy Statement.
 
 (b)
              Security
      Ownership of Management
 
 Information
required by this item is incorporated herein by reference to the section
captioned “Stock
Ownership” in the Proxy Statement.
 
 (c)
              Changes
      in Control
 
 Management
of Naugatuck Valley Financial knows of no arrangements, including any pledge by
any person or securities of Naugatuck Valley Financial, the operation of which
may at a subsequent date result in a change in control of the
registrant.
  50
 Index
  (d)
              Equity
      Compensation Plan Information
 
 The
following table sets forth information as of December 31, 2009 about Company
common stock that may be issued under the Naugatuck Valley Financial Corporation
2005 Equity Incentive Plan.  The plan was approved by the Company’s
stockholders.
 
 PLAN CATEGORY
              
              Number of securities
                to be issued upon
                the exercise of
                outstanding options,
                warrants and rights
              
              Weighted-average
                exercise price of
                outstanding options,
                warrants and rights
              
              Number of securities
                remaining available
                for future issuance under equity compensation
      plans (excluding securities reflected in the first
      column)Equity
      compensation plans approved by security holders
              
              353,430
              
              $11.13
              
              20,777Equity
      compensation plans not approved by security holders
              
              n/a
              
              n/a
              
              n/aTotal
              
              353,430
              
              $11.13
              
              20,777
 
 
 ITEM13.
              CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
      INDEPENDENCE
 
 The information relating to certain
relationships and related transactions and director independence is set forth
under the sections captioned “Transactions with Related
Persons” and “Corporate
Governance and Board Matters – Director Independence” in the Proxy
Statement and is incorporated herein by reference.
 
 ITEM14.
              PRINCIPAL
      ACCOUNTANT FEES AND SERVICES
 
 The information relating to the
principal accountant fees and services is set forth under the section captioned
“Ratification of the
Independent Registered Public Accounting Firm” in the Proxy Statement and
is incorporated herein by reference.
  51
 Index
  PART
IV
 
 ITEM15.
              EXHIBITS
      AND FINANCIAL STATEMENT SCHEDULES.
 
 (1)
              The
      financial statements required in response to this item are incorporated by
      reference from Item 8 of this
report.
 
 (2)
              All
      financial statement schedules are omitted because they are not required or
      applicable, or the required information is shown in the consolidated
      financial statements or the notes
thereto.
 
 (3)
              Exhibits
 
 Exhibit No.
              
              Description2.1
              
              Agreement
      and Plan of Merger, dated February 22, 2010, by and among Naugatuck Valley
      Financial Corporation, Newco (as defined therein) and Southern Connecticut
      Bancorp, Inc. (9)2.2
              
              Plan
      of Conversion and Reorganization, dated February 22, 2010
    (9)3.1
              
              Charter
      of Naugatuck Valley Financial Corporation (1)3.2
              
              Bylaws
      of Naugatuck Valley Financial Corporation (2)4.0
              
              Specimen
      Stock Certificate of Naugatuck Valley Financial Corporation
      (3)10.1
              
              Naugatuck
      Valley Financial Corporation and Naugatuck Valley Savings Employment
      Agreement with John C. Roman (4)*10.2
              
              Naugatuck
      Valley Savings Change in Control Agreement with Dominic J. Alegi, Jr. (4)
      *10.3
              
              Naugatuck
      Valley Financial Corporation and Naugatuck Valley Savings Deferred
      Compensation Plan for Directors (5)*10.4
              
              Form
      of Naugatuck Valley Savings Employee Severance Compensation Plan
      (3)*10.5
              
              Naugatuck
      Valley Savings Death Benefit Agreement with John C. Roman, as amended
      (3)*10.6
              
              Naugatuck
      Valley Savings Death Benefit Agreement with Dominic J. Alegi, Jr.
      (3)*10.7
              
              Naugatuck
      Valley Financial Corporation 2005 Equity Incentive Plan
    (6)*10.8
              
              Naugatuck
      Valley Savings Change in Control Agreement with Mark S. Graveline
      (7)*14.0
              
              Code
      of Ethics and Business Conduct (8)21.0
              
              List
      of Subsidiaries23.0
              
              Consent
      of Whittlesey & Hadley, P.C.31.1
              
              Rule
      13a-14(a)/15d-14(a) Certification of Chief Executive
    Officer31.2
              
              Rule
      13a-14(a)/15d-14(a) Certification of Chief Financial
    Officer32.0
              
              Section
      1350 Certification of Chief Executive Officer and Chief Financial
      Officer
 ______________________________
 *Management
contract or compensation plan arrangement
 (1)
              Incorporated
      by reference to Exhibit 3.1 to the Company’s Form 10-Q for the three
      months ended September 30, 2004.
 (2)
              Incorporated
      by reference to Exhibit 3 to the Company’s Current Report on Form 8-K
      filed with the SEC on October 18,
2007.
 (3)
              Incorporated
      by reference to the Company’s Registration Statement on Form S-1, as
      amended, initially filed on June 18,
2004.
 (4)
              Incorporated
      by reference to the Company’s Form 10-K for the fiscal year ended December
      31, 2007.
 (5)
              Incorporated
      by reference to Exhibit 10.1 to the Company’s Form 10-Q for the three
      months ended March 31, 2007, filed on May 15,
  2007.
 (6)
              Incorporated
      by reference to Appendix C to the Proxy Statement for the 2005 Annual
      Meeting of Stockholders filed on April 1,
2005.
 (7)
              Incorporated
      by reference to the Company’s Form 10-K for the fiscal year end December
      31, 2008.
 (8)
              Incorporated
      by reference to the Company’s Form 10-K for the fiscal year ended December
      31, 2004.
 (9)
              Incorporated
      by reference to the Exhibits filed to the Company’s Current Report on Form
      8-K filed February 23, 2010. The registrant has omitted schedules and
      similar attachments to the subject agreements pursuant to Item 601(b)(2)
      of Regulation S-K. The registrant will furnish a copy of any omitted
      schedule or similar attachment to the United States Securities and
      Exchange Commission upon
request.
   52
 Index
 
 Management’s
Report on Internal Control Over Financial Reporting
 
 The management of the Company is
responsible for establishing and maintaining adequate internal control over
financial reporting.  The internal control process has been designed
under our supervision to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of the Company’s financial statements
for external reporting purposes in accordance with accounting principles
generally accepted in the United States of America.
 
 Management conducted an assessment of
the effectiveness of the Company’s internal control over financial reporting as
of December 31, 2009, utilizing the framework established in Internal Control –
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).  Based on this assessment, management has
determined that the Company’s internal control over financial reporting as of
December 31, 2009 is effective.
 
 Our internal control over financial
reporting includes policies and procedures that pertain to the maintenance of
records that accurately and fairly reflect, in reasonable detail, transactions
and dispositions of assets; and provide reasonable assurances
that:  (1) transactions are recorded as necessary to permit
preparation of financial statements in accordance with accounting principles
generally accepted in the United States; (2) receipts and expenditures are being
made only in accordance with authorizations of management and the directors of
the Company; and (3) unauthorized acquisition, use, or disposition of the
Company’s assets that could have a material effect on the Company’s financial
statements are prevented or timely detected.
 
 All internal control systems, no matter
how well designed, have inherent limitations.  Therefore, even those
systems determined to be effective can provide only reasonable assurance with
respect to financial statement preparation and presentation.  Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.
 
 This annual report does not include an
attestation report of the Company’s registered public accounting firm regarding
internal control over financial reporting.  Management’s report was
not subject to attestation by the Company’s registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission that
permit the Company to provide only management’s report in this annual
report.
  53
 Index
  
 Report
of Independent Registered Public Accounting Firm
  
 To The
Board of Directors and Shareholders
 Naugatuck
Valley Financial Corporation
 
 
 We have
audited the accompanying consolidated statements of financial condition of
Naugatuck Valley Financial Corporation (the “Company”) and subsidiary as of
December 31, 2009 and 2008, and the related consolidated statements of income,
changes in stockholders' equity, and cash flows for each of the years ended
December 31, 2009, 2008 and 2007.  These consolidated financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Companies
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial
statements.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation.  We believe
that our audits provide a reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Naugatuck Valley Financial
Corporation and subsidiary at December 31, 2009 and 2008, and the results of its
operations and its cash flows for the each of the years ended December 31, 2009,
2008 and 2007, in conformity with accounting principles generally accepted in
the United States of America.
  
  Hartford,
Connecticut
 March 26,
2010
  F-1
  
  Consolidated
Statements of Financial Condition
 (Dollars
in thousands)
 December
      31,2009
              
              
              2008ASSETSCash
      and due from depository institutions
              
              $
              9,003
              
              
              $
              8,214Investment
      in federal funds
              
              
              3,143
              
              
              
              33Investment
      securities available-for-sale, at fair value
              
              
              37,623
              
              
              
              63,844Investment
      securities held-to-maturity, at amortized cost
              
              
              1,451
              
              
              
              -Loans
      receivable, net
              
              
              473,304
              
              
              
              431,976Accrued
      income receivable
              
              
              2,074
              
              
              
              2,099Foreclosed
      real estate, net
              
              
              140
              
              
              
              -Premises
      and equipment, net
              
              
              9,948
              
              
              
              10,565Bank
      owned life insurance
              
              
              8,920
              
              
              
              8,579Federal
      Home Loan Bank of Boston stock, at cost
              
              
              6,252
              
              
              
              6,252Other
      assets
              
              
              5,097
              
              
              
              3,824Total
      assets
              
              $
              556,955
              
              
              $
              535,386LIABILITIES
      AND STOCKHOLDERS' EQUITYLiabilitiesDeposits
              
              $
              380,931
              
              
              $
              363,026Borrowed
      funds
              
              
              118,984
              
              
              
              119,148Mortgagors'
      escrow accounts
              
              
              4,888
              
              
              
              4,562Other
      liabilities
              
              
              1,844
              
              
              
              3,061Total
      liabilities
              
              
              506,647
              
              
              
              489,797Commitments
      and contingenciesStockholders'
      equityPreferred
      stock, $.01 par value; 1,000,000 shares authorized;no shares
      issued or outstanding
              
              
              -
              
              
              
              -Common
      stock, $.01 par value; 25,000,000 shares authorized;7,604,375
      shares issued; shares outstanding - 7,022,866 at December 31, 2009;
      7,026,894 at December 31, 2008
              
              
              76
              
              
              
              76Paid-in
      capital
              
              
              33,756
              
              
              
              33,637Retained
      earnings
              
              
              24,849
              
              
              
              23,303Unearned
      ESOP shares (193,735 shares at December 31, 2009and 213,624 shares
      at December 31, 2008)
              
              
              (1,937
              )
              
              
              (2,136
              )Unearned
      stock awards (32,340 shares at December 31, 2009and 61,780 shares
      at December 31, 2008)
              
              
              (355
              )
              
              
              (680
              )Treasury
      Stock, at cost (583,342 shares at December 31, 2009and 579,314
      shares at December 31, 2008)
              
              
              (6,132
              )
              
              
              (6,107
              )Accumulated
      other comprehensive income (loss)
              
              
              51
              
              
              
              (2,504
              )Total
      stockholders' equity
              
              
              50,308
              
              
              
              45,589Total
      liabilities and stockholders' equity
              
              $
              556,955
              
              
              $
              535,386
  F-2





Consolidated
Statements of Income


(Dollars
in thousands, except earnings per share)


For
      the Years Ended December 31,2009
            
            
            2008
            
            
            2007Interest
      and dividend incomeInterest
      on loans
            
            $
            25,954
            
            
            $
            24,556
            
            
            $
            21,681Interest
      and dividends on investments and deposits
            
            
            2,337
            
            
            
            3,647
            
            
            
            3,349Total
      interest income
            
            
            28,291
            
            
            
            28,203
            
            
            
            25,030Interest
      expenseInterest
      on deposits
            
            
            8,477
            
            
            
            9,271
            
            
            
            9,750Interest
      on borrowed funds
            
            
            4,060
            
            
            
            4,633
            
            
            
            3,424Total
      interest expense
            
            
            12,537
            
            
            
            13,904
            
            
            
            13,174Net
      interest income
            
            
            15,754
            
            
            
            14,299
            
            
            
            11,856Provision
      for loan losses
            
            
            1,144
            
            
            
            675
            
            
            
            151Net
      interest income after provision for loan losses
            
            
            14,610
            
            
            
            13,624
            
            
            
            11,705Noninterest
      incomeFees
      for services related to deposit accounts
            
            
            1,060
            
            
            
            1,053
            
            
            
            955Fees
      for other services
            
            
            574
            
            
            
            529
            
            
            
            559Income
      from bank owned life insurance
            
            
            341
            
            
            
            315
            
            
            
            308Income
      from investment advisory services, net
            
            
            271
            
            
            
            299
            
            
            
            260Gain
      (loss) on investments
            
            
            388
            
            
            
            (3,398
            )
            
            
            65Other
      income
            
            
            108
            
            
            
            154
            
            
            
            207Total
      noninterest income (loss)
            
            
            2,742
            
            
            
            (1,048
            )
            
            
            2,354Noninterest
      expenseCompensation,
      taxes and benefits
            
            
            7,692
            
            
            
            7,521
            
            
            
            6,914Office
      occupancy
            
            
            2,151
            
            
            
            2,173
            
            
            
            1,966FDIC
      insurance premiums
            
            
            946
            
            
            
            132
            
            
            
            35Computer
      processing
            
            
            916
            
            
            
            861
            
            
            
            733Professional
      fees
            
            
            674
            
            
            
            518
            
            
            
            504Directors
      compensation
            
            
            560
            
            
            
            493
            
            
            
            494Advertising
            
            
            330
            
            
            
            534
            
            
            
            594Office
      supplies
            
            
            207
            
            
            
            195
            
            
            
            201Loss
      on foreclosed real estate, net
            
            
            36
            
            
            
            1
            
            
            
            -Other
      expenses
            
            
            1,029
            
            
            
            1,026
            
            
            
            981Total
      noninterest expense
            
            
            14,541
            
            
            
            13,454
            
            
            
            12,422Income
      (loss) before tax provision (benefit)
            
            
            2,811
            
            
            
            (878
            )
            
            
            1,637Income
      tax provision (benefit)
            
            
            818
            
            
            
            (566
            )
            
            
            217Net
      income (loss)
            
            $
            1,993
            
            
            $
            (312
            )
            
            $
            1,420Earnings
      (loss) per share - basic and diluted
            
            $
            0.29
            
            
            $
            (0.05
            )
            
            $
            0.20





F-3





Consolidated
Statements of Changes in Stockholders' Equity


(Dollars
in thousands)


Common
            
            
            Paid-inStock
            
            
            CapitalBalance
      at December 31, 2007
            
            $
            76
            
            
            $
            33,483ESOP
      shares released - 19,889 shares
            
            
            -
            
            
            
            (29
            )Dividends
      paid ($0.23 per common share)
            
            
            -
            
            
            
            -Stock
      based compensation -  1,000 shares awarded
            
            
            -
            
            
            
            -Stock
      based compensation - 29,246 shares vested
            
            
            -
            
            
            
            -Stock
      based compensation - options
            
            
            -
            
            
            
            183Treasury
      stock acquired - 241,840 shares
            
            
            -
            
            
            
            -Comprehensive
      income:Net
      income
            
            
            -
            
            
            
            -Net
      change in unrealized holding gain on available-for-sale securities, net of
      tax effect Comprehensive income
            
            
            -
            
            
            
            -Balance
      at December 31, 2008
            
            
            76
            
            
            
            33,637ESOP
      shares released - 19,889 shares
            
            
            -
            
            
            
            (87
            )Dividends
      paid ($0.17 per common share)
            
            
            -
            
            
            
            -Stock
      based compensation - 29,446 shares vested
            
            
            -
            
            
            
            -Stock
      based compensation - options
            
            
            -
            
            
            
            206Treasury
      stock acquired - 4,028 shares
            
            
            -
            
            
            
            -Comprehensive
      income:Net
      income
            
            
            -
            
            
            
            -Net
      change in unrealized holding gain on available-for-sale securities, net of
      tax effect Comprehensive income
            
            
            -
            
            
            
            -Balance
      at December 31, 2009
            
            $
            76
            
            
            $
            33,756





F-4





Retained
            
            
            Unearned
      ESOP
            
            
            Unearned
      Stock
            
            
            Treasury
            
            
            Accumulated
      Other ComprehensiveEarnings
            
            
            Shares
            
            
            Awards
            
            
            Stock
            
            
            Income
      (Loss)
            
            
            Total$
            24,233
            
            
            $
            (2,335
            )
            
            $
            (995
            )
            
            $
            (3,889
            )
            
            $
            (116
            )
            
            $
            50,457-
            
            
            
            199
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            170(614
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (614
            )(4
            )
            
            
            -
            
            
            
            (9
            )
            
            
            13
            
            
            
            -
            
            
            
            --
            
            
            
            -
            
            
            
            324
            
            
            
            -
            
            
            
            -
            
            
            
            324-
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            183-
            
            
            
            -
            
            
            
            -
            
            
            
            (2,231
            )
            
            
            -
            
            
            
            (2,231
            )(312
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -(2,388
            )
            
            
            --
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,700
            )23,303
            
            
            
            (2,136
            )
            
            
            (680
            )
            
            
            (6,107
            )
            
            
            (2,504
            )
            
            
            45,589-
            
            
            
            199
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            112(447
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (447
            )-
            
            
            
            -
            
            
            
            325
            
            
            
            -
            
            
            
            -
            
            
            
            325-
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            206-
            
            
            
            -
            
            
            
            -
            
            
            
            (25
            )
            
            
            -
            
            
            
            (25
            )1,993
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -2,555
            
            
            
            --
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4,548$
            24,849
            
            
            $
            (1,937
            )
            
            
            (355
            )
            
            $
            (6,132
            )
            
            $
            51
            
            
            $
            50,308





F-5





Consolidated
Statements of Cash Flows


(In
thousands)


For
      the Years Ended December 31,2009
            
            
            2008
            
            
            2007Cash
      flows from operating activitiesNet
      income (loss)
            
            $
            1,993
            
            
            $
            (312
            )
            
            $
            1,420Adjustments
      to reconcile net income (loss) to net cashprovided by operating
      activities:Provision
      for loan losses
            
            
            1,144
            
            
            
            675
            
            
            
            151Depreciation
      and amortization expense
            
            
            821
            
            
            
            835
            
            
            
            776Net
      amortization (accretion) from investments
            
            
            60
            
            
            
            51
            
            
            
            (21
            )Amortization
      of intangible assets
            
            
            34
            
            
            
            34
            
            
            
            34Provision
      for deferred tax (benefit)
            
            
            704
            
            
            
            (1,574
            )
            
            
            11Loss
      (gain) on investment securities
            
            
            (388
            )
            
            
            3,398
            
            
            
            (65
            )Stock-based
      compensation
            
            
            656
            
            
            
            813
            
            
            
            698Net
      change in:Accrued
      income receivable
            
            
            25
            
            
            
            (65
            )
            
            
            (130
            )Deferred
      loan fees
            
            
            (43
            )
            
            
            68
            
            
            
            51Cash
      surrender value of  life insurance
            
            
            (341
            )
            
            
            (315
            )
            
            
            (308
            )Other
      assets
            
            
            (2,291
            )
            
            
            (39
            )
            
            
            (35
            )Other
      liabilities
            
            
            222
            
            
            
            (110
            )
            
            
            98Net
      cash provided by operating activities
            
            
            2,596
            
            
            
            3,459
            
            
            
            2,680Cash
      flows from investing activitiesProceeds
      from maturities and repayments ofavailable-for-sale
      securities
            
            
            10,022
            
            
            
            7,501
            
            
            
            12,236Proceeds
      from sale of available-for-sale securities
            
            
            19,264
            
            
            
            13,171
            
            
            
            8,441Proceeds
      from sale of held-to-maturity securities
            
            
            110
            
            
            
            -
            
            
            
            -Proceeds
      from maturities of held-to-maturity securities
            
            
            -
            
            
            
            1,190
            
            
            
            1,390Purchase
      of available-for-sale securities
            
            
            -
            
            
            
            (25,017
            )
            
            
            (17,598
            )Purchase
      of held-to-maturity securities
            
            
            (1,566
            )
            
            
            -
            
            
            
            (250
            )Loan
      originations net of principal payments
            
            
            (42,570
            )
            
            
            (72,888
            )
            
            
            (51,656
            )Purchase
      of Federal Home Loan Bank of Boston stock
            
            
            -
            
            
            
            (1,619
            )
            
            
            (734
            )Purchase
      of property and equipment
            
            
            (212
            )
            
            
            (775
            )
            
            
            (325
            )Net
      cash used by investing activities
            
            
            (14,952
            )
            
            
            (78,437
            )
            
            
            (48,496
            )





F-6







For
      the Years Ended December 31,2009
            
            
            2008
            
            
            2007Cash
      flows from financing activitiesNet
      change in time deposits
            
            
            (3,859
            )
            
            
            33,353
            
            
            
            37,335Net
      change in other deposit accounts
            
            
            21,764
            
            
            
            8,275
            
            
            
            (5,135
            )Advances
      from Federal Home Loan Bank of Boston
            
            
            52,550
            
            
            
            55,915
            
            
            
            46,927Repayment
      of Advances from Federal HomeLoan Bank of
    Boston
            
            
            (58,418
            )
            
            
            (22,373
            )
            
            
            (30,538
            )Net
      change in mortgagors' escrow accounts
            
            
            327
            
            
            
            691
            
            
            
            376Change
      in short-term borrowings
            
            
            4,363
            
            
            
            1,839
            
            
            
            229Common
      stock repurchased
            
            
            (25
            )
            
            
            (2,231
            )
            
            
            (2,364
            )Cash
      dividends to common stockholders
            
            
            (447
            )
            
            
            (614
            )
            
            
            (589
            )Proceeds
      from exercise of options
            
            
            -
            
            
            
            -
            
            
            
            3Net
      cash provided by financing activities
            
            
            16,255
            
            
            
            74,855
            
            
            
            46,244Increase
      (decrease) in cash and cash equivalents
            
            
            3,899
            
            
            
            (123
            )
            
            
            428Cash
      and cash equivalents at beginning of year
            
            
            8,247
            
            
            
            8,370
            
            
            
            7,942Cash
      and cash equivalents at end of year
            
            $
            12,146
            
            
            $
            8,247
            
            
            $
            8,370Supplemental
      disclosuresNon-cash
      investing activities:Transfer
      of loans to foreclosed real estate
            
            $
            140
            
            
            $
            -
            
            
            $
            -Cash
      paid during the year for:Interest
            
            $
            12,283
            
            
            $
            13,950
            
            
            $
            13,130Income
      taxes
            
            
            286
            
            
            
            943
            
            
            
            296





F-7





Notes
to Consolidated Financial Statements


1.  Nature
of Operations




Naugatuck
Valley Financial Corporation (the “Company”) was organized as a federal
corporation at the direction of Naugatuck Valley Savings and Loan (the “Bank”)
in connection with the mutual holding company reorganization of Naugatuck Valley
Savings.  The reorganization and initial public offering of Naugatuck
Valley Financial was completed on September 30, 2004.  In the
offering, Naugatuck Valley Financial issued a majority of its outstanding shares
of common stock to Naugatuck Valley Mutual Holding Company (the “MHC”), the
mutual holding company parent of the Bank.





Originally
organized in 1922, the Bank is a federally chartered stock savings bank which is
headquartered in Naugatuck, Connecticut. The Bank provides a full range of
personal banking services to individual and small business customers located
primarily in the Naugatuck Valley and the immediate surrounding
vicinity.  It is subject to competition from other financial
institutions throughout the region.  The Bank is also subject to the
regulations of various federal agencies and undergoes periodic examinations by
those regulatory authorities.





The Bank
owns the Naugatuck Valley Mortgage Servicing Corporation, which qualifies and
operates as a Connecticut passive investment company pursuant to
legislation.




2.  Basis
of Presentation




The
consolidated financial statements include the accounts of the Company, the Bank
and the Bank’s wholly-owned subsidiary, Naugatuck Valley Mortgage Servicing
Corporation.  All significant intercompany accounts and transactions
have been eliminated in consolidation.





In
preparing the financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of the
date of the balance sheet, and income and expenses for the
period.  Actual results could differ from those
estimates.





Material
estimates that are particularly susceptible to significant change in the
near-term relate to the determination of the allowance for losses on loans and
the valuation of real estate acquired in connection with foreclosure or in
satisfaction of loans.  While management uses available information to
recognize losses on loans and foreclosed real estate, future additions to the
allowance may be necessary based on changes in economic conditions, particularly
in Connecticut.





Management
has evaluated subsequent events for potential recognition or disclosure in the
financial statements.  On February 23, 2010, the Company announced its
intention to acquire another bank. In addition, the MHC announced its intention
to sell its approximate 60% ownership interest in the Company to the
public.  See Note 18 to these financial statements for additional
disclosure regarding these events.





F-8








3.  Summary
of Significant Accounting Policies
  The
accounting and reporting policies of the Company and its subsidiary conform to
generally accepted accounting principles in the United States of America and to
general practices within the thrift industry. Such policies have been followed
on a consistent basis. The significant accounting policies of the Company are
summarized below.
 
  Investment
securities
  Investments
are accounted for in accordance with the intent of management at the time of
purchase.  If management has the intent and the Company has the
ability at the time of purchase to hold debt securities until maturity, they are
classified as held-to-maturity. These securities are carried at historical cost
adjusted for the amortization of premiums and accretion of discounts, which are
recognized as adjustments to interest income.
 
 Securities
to be held for indefinite periods of time are classified as available-for-sale
and are carried at fair value with unrealized gains and losses reported as a
separate component of capital net of estimated income
taxes.  Effective January 1, 2008, the Company adopted the new
valuation framework for fair value measurement and disclosure as specified by
generally accepted accounting principles. The framework specifies a hierarchy of
valuation techniques based on whether the inputs to those techniques are
observable or unobservable. Observable inputs reflect market data obtained from
independent sources, while unobservable inputs reflect the Company's own
assumptions.  See Note 17.
 
 The
Company has no securities held for trading.
 
 Gains or
losses on the sales of securities are recognized at trade date utilizing the
specific identification method. Unrealized losses on securities are charged to
noninterest income when the decline in fair value of a security is judged to be
other-than-temporary. In estimating other-than-temporary impairment losses,
management considers (1) the length of time and the extent to which the fair
value has been less than cost, (2) the financial condition and near-term
prospects of the issuer and (3) the intent and ability of the Bank to retain its
investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value.
  Loans receivable and
allowance for loan losses
  Loans
receivable are stated at unpaid principal balance less undistributed
construction loans, deferred loan fees, and allowances for loan
losses.
 
 Uncollected
interest on loans receivable is accrued as earned based on rates applied to
principal amounts outstanding.  Recognition of income on the accrual
basis is discontinued when there is sufficient question as to the collectibility
of the interest.  In these cases, the interest previously accrued to
income is reversed, and the loans are placed on the cash basis.
 
 Loan
origination fees and certain direct loan origination costs are being deferred
and the net amount amortized on a level-yield basis as an adjustment to the
related loan yield over its contractual life. Unamortized net fees are
recognized upon early repayment of the loans.
  F-9
 Notes
to Consolidated Financial Statements
  3.  Summary of Significant
Accounting Policies - (Continued)
 The
allowance for loan losses is established by a provision charged to earnings and
is maintained at a level considered adequate to provide for potential loan
losses based on management's evaluation of known and inherent risks in the loan
portfolio.  When a loan or portion of a loan is considered
uncollectible, it is charged against the allowance for loan
losses.  Recoveries of loans previously charged-off are credited to
the allowance when collected.
  Management
makes regular evaluations of the loan portfolio to determine the adequacy of the
level of the allowance for loan losses.  Numerous factors are
considered in the evaluation, including a review of certain borrowers' current
financial status and credit standing, available collateral, loss experience in
relation to outstanding loans, the overall loan portfolio quality, management's
judgment regarding prevailing and anticipated economic conditions, and other
relevant factors.
 
 In
addition, various regulatory agencies, as an integral part of their examination
process, periodically review the Bank's allowance for loan
losses.  Such agencies may require the Bank to recognize additions to
the allowance based on their judgments about information available to them at
the time of their examination.
  Loan sales and
mortgage-servicing rights
  Residential
mortgage loans originated and held for sale are classified separately in the
consolidated statement of financial condition and reported at the lower of
amortized cost or market value (based on secondary market
prices).  There were no loans held for sale at December 31, 2009 and
2008. Gains or losses on the sale of loans are determined using the specific
identification method.
 
 The Bank
sells residential mortgage loans with servicing rights retained. At the time of
the sale, the Bank determines the value of the retained servicing rights, which
represents the present value of the differential between the contractual
servicing fee and adequate compensation, defined as the fee a sub-servicer would
require to assume the role of servicer, after considering the estimated effects
of prepayments.  If material, a portion of the gain on the sale of the
loan is recognized as due to the value of the servicing rights, and a servicing
asset is recorded. The Bank has had no loan sales which have resulted in the
recording of a servicing asset, due to the immaterial differential between the
contractual servicing fee (25 basis points) and adequate compensation, as
described above.
  Foreclosed real
estate
  Real
estate properties acquired through loan foreclosure and other partial or total
satisfaction of problem loans are carried at the lower of fair value or the
related loan balance at the date of foreclosure.
 
 Valuations
are periodically performed by management and an allowance for losses is
established if the carrying value of a property subsequently exceeds its fair
value less estimated disposal costs.  Losses arising at the time of
acquisition of such properties are charged against the allowance for loan
losses. Subsequent write-downs in the carrying value and expenses incurred to
maintain the properties are charged to expense.
  F-10





Premises and
equipment




Premises
and equipment are stated at cost less accumulated depreciation computed on the
straight-line method at rates based on estimated useful lives.





Expenditures
for replacements or major improvements are capitalized.  Expenditures
for normal maintenance and repairs are charged to expense as
incurred.  Upon the sale or retirement of premises and equipment, the
cost and accumulated depreciation are removed from their respective accounts and
any gain or loss is included in income.




Bank owned life
insurance




The cash
surrender value of bank owned life insurance relates to policies on employees of
the Bank for which the Bank is the beneficiary.  Increases in cash
surrender value are included in noninterest income in the consolidated income
statements.




Income from investment
advisory services, net




In
conjunction with a third party, an employee of the Bank is licensed to sell
non-deposit investment products, including mutual funds, annuities and other
insurance products.  The Bank records, as noninterest income, revenues
earned from product sales in accordance with the terms of revenue sharing
agreements with the third party, net of certain marketing and other expenses
shared with the third party.  The Bank currently employs the
individual authorized to sell these products and pays most of the direct costs
related to the sales activities.  These costs are charged to expense
as incurred, and are classified primarily in compensation and benefits
expense.




Income
taxes




The
Company accounts for certain income and expense items differently for financial
reporting purposes than for income tax purposes.  Provisions for
deferred taxes are being made in recognition of these temporary differences. It
is the Company's policy to recognize interest and penalties related to
unrecognized tax liabilities within income tax expense in the consolidated
statements of income.




Earnings per
share




Basic
earnings per share is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period.




Accounting Standards
Update




In
December 2007, the FASB issued new authoritative guidance related to the
accounting for Business Combinations. The objective of the guidance is to
improve the relevance, representational faithfulness, and comparability of the
information that a reporting entity provides in its financial reports about a
business combination and its effects. The new standard applies prospectively to
business combinations for which the acquisition date is on or after December 31,
2008.





F-11


Notes
to Consolidated Financial Statements
 3.  Summary of Significant
Accounting Policies –(Continued)




Accounting Standards
Update –(Continued)





As
discussed in Notes 1 and 18, the Company has announced its intention to acquire
another bank which will be merged into the banking subsidiary of the
Company.  As a result of the new authoritative accounting guidance,
the transaction will be accounted for as a purchase, and all of the assets and
liabilities of the acquired bank will be remeasured and recorded at their
respective fair value as of the date of acquisition.





In June
2009, the Financial Accounting Standards Board (“FASB”) issued Accounting
Standards Update No. 2009-01 (“ASU 2009-01”), Topic 105 – Generally Accepted
Accounting Principles amendments based on Statement of Financial Accounting
Standards No. 168 – The FASB Accounting Standards Codification  and
the Hierarchy of Generally Accepted Accounting Principles.  ASU
2009-01 amends the FASB Accounting Standards Codification for the issuance of
FASB Statement No. 168 (“SFAS 168”), The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles. ASU 2009-1 includes SFAS 168 in its entirety, including the
accounting standards update instructions contained in Appendix B of the
Statement. The FASB Accounting Standards Codification (“Codification”) became
the source of authoritative U.S. generally accepted accounting principles
(“GAAP”) recognized by the FASB to be applied by nongovernmental entities. Rules
and interpretive releases of the Securities and Exchange Commission (“SEC”)
under authority of federal securities laws are also sources of authoritative
GAAP for SEC registrants. On the effective date of this Statement, the
Codification superseded all then-existing non-SEC accounting and reporting
standards. All other non-grandfathered non-SEC accounting literature not
included in the Codification became non-authoritative. This Statement is
effective for financial statements issued for interim and annual periods ending
after September 15, 2009.





Following
this Statement, the FASB will not issue new standards in the form of Statements,
FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, it will
issue Accounting Standards Updates. The FASB does not consider Accounting
Standards Updates as authoritative in their own right. Accounting Standards
Updates serve only to update the Codification, provide background information
about the guidance, and provide the bases for conclusions on the change(s) in
the Codification. FASB Statement No. 162, The Hierarchy of Generally Accepted
Accounting Principles, which became effective on November 13, 2008,
identified the sources of accounting principles and the framework for selecting
the principles used in preparing the financial statements of nongovernmental
entities that are presented in conformity with GAAP.  Statement 162
arranged these sources of GAAP in a hierarchy for users to apply
accordingly.  Upon becoming effective, all of the content of the
Codification carries the same level of authority, effectively superseding
Statement 162. In other words, the GAAP hierarchy has been modified to include
only two levels of GAAP: authoritative and non-authoritative.  As a
result, this Statement replaces Statement 162 to indicate this change to the
GAAP hierarchy. The adoption of the Codification and ASU 2009-01 did not have
any effect on the Company’s consolidated financial condition or results of
operations.





F-12











In August
2009, the FASB issued Accounting Standards Update No. 2009-05 (“ASU 2009-05”),
Fair Value Measurements and
Disclosures (Topic 820) – Measuring Liabilities at Fair
Value.  ASU 2009-05 applies to all entities that measure
liabilities at fair value within the scope of ASC Topic 820.  ASU
2009-05 provides clarification that in circumstances in which a quoted price in
an active market for the identical liability is not available, a reporting
entity is required to measure fair value using one or more of the following
techniques:




·
            A
      valuation technique that uses:




o
            The
      quoted price of the identical liability when traded as an
      asset.




o
            Quoted
      prices for similar liabilities or similar liabilities when traded as
      assets.




·
            Another
      valuation technique that is consistent with the principles of ASC Topic
      820. Two examples would be an income approach, such as a technique that is
      based on the amount at the measurement date that the reporting entity
      would pay to transfer the identical liability or would receive to enter
      into the identical liability.





The
amendments in ASU 2009-5 also clarify that when estimating the fair value of a
liability, a reporting entity is not required to include a separate input or
adjustment to other inputs relating to the existence of a restriction that
prevents the transfer of the liability.  It also clarifies that both a
quoted price in an active market for the identical liability at the measurement
date and the quoted price for the identical liability when traded as an asset in
an active market when no adjustments to the quoted price of the asset are
required are Level 1 fair value measurements.  The guidance provided
in ASU 2009-5 is effective for the first reporting period beginning after
issuance.  The adoption of ASU 2009-5 will not have a material effect
on the Company’s consolidated financial condition or results of
operations.




Reclassification




Certain
reclassifications have been made to the prior period financial statements to
conform to the December 31, 2009 reporting presentation. These reclassifications
only changed the reporting categories but did not affect the results of
operations or financial position.





4.  Investment
Securities




A summary
of investment securities at December 31, 2009 and 2008 follows:





2009
            
            
            2008Carrying
            
            
            Fair
            
            
            Carrying
            
            
            Fair(In
      thousands)
            
            Amount
            
            
            Value
            
            
            Amount
            
            
            ValueAvailable-for-sale
      securities
            
            $
            37,623
            
            
            $
            37,623
            
            
            $
            63,844
            
            
            $
            63,844Held-to-maturity
      securities
            
            
            1,451
            
            
            
            1,475
            
            
            
            -
            
            
            
            -Total
      investment securities
            
            $
            39,074
            
            
            $
            39,098
            
            
            $
            63,844
            
            
            $
            63,844





F-13


Notes
to Consolidated Financial Statements
 4.  Investment Securities– (Continued)




At
December 31, 2009, the composition of the investment portfolio was:





Amortized
            
            
            Gross
      Unrealized
            
            
            Fair(In
      thousands)
            
            Cost
      Basis
            
            
            Gains
            
            
            Losses
            
            
            ValueAvailable-for-sale
      securities:U.S.
      government and agency obligationsFrom
      one through five years
            
            $
            1,029
            
            
            $
            40
            
            
            $
            -
            
            
            $
            1,069From
      five through ten years
            
            
            500
            
            
            
            14
            
            
            
            -
            
            
            
            5141,529
            
            
            
            54
            
            
            
            -
            
            
            
            1,583Corporate
      bondsFrom
      one through five years
            
            
            1,000
            
            
            
            -
            
            
            
            (340
            )
            
            
            660Mortgage-backed
      securities
            
            
            23,561
            
            
            
            939
            
            
            
            -
            
            
            
            24,500Collateralized
      mortgage obligations
            
            
            3,091
            
            
            
            13
            
            
            
            (104
            )
            
            
            3,000Total
      debt securities
            
            
            29,181
            
            
            
            1,006
            
            
            
            (444
            )
            
            
            29,743Money
      market preferred stocks
            
            
            8,200
            
            
            
            -
            
            
            
            (320
            )
            
            
            7,880Total
      available-for-sale securities
            
            $
            37,381
            
            
            $
            1,006
            
            
            $
            (764
            )
            
            $
            37,623Amortized
            
            
            Gross
      Unrealized
            
            
            Fair(In
      thousands)
            
            Cost
      Basis
            
            
            Gains
            
            
            Losses
            
            
            ValueHeld-to-maturity
      securities:Mortgage-backed
      securities
            
            $
            1,451
            
            
            $
            24
            
            
            $
            -
            
            
            $
            1,475Total
      held-to-maturity securities
            
            $
            1,451
            
            
            $
            24
            
            
            $
            -
            
            
            $
            1,475





At
December 31, 2008, the composition of the investment portfolio was:





Amortized
            
            
            Gross
      Unrealized
            
            
            Fair(In
      thousands)
            
            Cost
      Basis
            
            
            Gains
            
            
            Losses
            
            
            ValueAvailable-for-sale
      securities:U.S.
      government and agency obligationsFrom
      one through five years
            
            $
            1,037
            
            
            $
            42
            
            
            $
            -
            
            
            $
            1,079From
      five through ten years
            
            
            500
            
            
            
            25
            
            
            
            -
            
            
            
            5251,537
            
            
            
            67
            
            
            
            -
            
            
            
            1,604Municipal
      obligationsFrom
      five through ten years
            
            
            2,904
            
            
            
            64
            
            
            
            -
            
            
            
            2,968After
      ten years
            
            
            5,984
            
            
            
            49
            
            
            
            (8
            )
            
            
            6,0258,888
            
            
            
            113
            
            
            
            (8
            )
            
            
            8,993Corporate
      bondsFrom
      five through ten years
            
            
            1,000
            
            
            
            -
            
            
            
            (710
            )
            
            
            290Mortgage-backed
      securities
            
            
            42,297
            
            
            
            804
            
            
            
            (71
            )
            
            
            43,030Collateralized
      mortgage obligations
            
            
            3,339
            
            
            
            -
            
            
            
            (156
            )
            
            
            3,183Total
      debt securities
            
            
            57,061
            
            
            
            984
            
            
            
            (945
            )
            
            
            57,100Money
      market preferred stocks
            
            
            9,273
            
            
            
            -
            
            
            
            (2,529
            )
            
            
            6,744Total
      available-for-sale securities
            
            $
            66,334
            
            
            $
            984
            
            
            $
            (3,474
            )
            
            $
            63,844





F-14











For the
year ended December 31, 2009, the Company realized gross gains of $425,637 and
gross losses of $37,203 compared with gross gains of $129,450 and gross losses
of $100,622 for the year ended December 31, 2008, and gross gains of $68,686 and
gross losses of $3,477 for the year ended December 31, 2007 on sales of
investment securities.  The 2009 gross gains included approximately
$9,600 of gains realized on the sale of Fannie Mae preferred
stock.  During 2008,  the Company realized an
other-than-temporary impairment loss on these shares of stock,  which
collateralized auction rate pass through certificates, in the amount of $3.4
million.





The
Company has identified other investment securities in which the fair value of
the security is less than the cost of the security.  This can be from
an increase in interest rates since the time of purchase or from deterioration
in credit quality of the issuer.  All investment securities which have
unrealized losses have undergone an internal impairment review.





Management’s
review for impairment generally entails identification and analysis of
individual investments that have fair values less than amortized cost, including
consideration of the length of time the investment has been in an unrealized
loss position and the expected recovery period; discussion of evidential matter,
including an evaluation of factors or triggers that could cause individual
investments to qualify as having other-than-temporary impairment and those that
would not support other-than-temporary impairment; and documentation of the
results of these analyses. As a result of the reviews, management has determined
that there has been no deterioration in credit quality subsequent to purchase,
and believes that these unrealized losses are temporary and are the result of
changes in market interest rates and market conditions over the past several
years.





At
December 31, 2009, these securities had an aggregate fair value of $3,392,000
which resulted in unrealized losses of $764,000 as compared with an aggregate
fair value of $16,705,000 and unrealized losses of $3,474,000 at December 31,
2008.





Unrealized
losses on investment securities at December 31, 2009





The
following is a summary of the fair values and related unrealized losses
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position:





Securities
      in Continuous UnrealizedLoss
      Position 12 or More Consecutive MonthsNumber
      of
            
            
            Market
            
            
            UnrealizedSecurities
            
            
            Value
            
            
            Loss(Dollars
      in thousands)Collateralized
      mortgage obligations
            
            
            2
            
            
            
            652
            
            
            
            (104
            )Corporate
      bonds
            
            
            1
            
            
            
            660
            
            
            
            (340
            )Money
      market preferred stocks
            
            
            2
            
            
            
            2,080
            
            
            
            (320
            )Total
      securities in unrealized loss position
            
            
            5
            
            
            $
            3,392
            
            
            $
            (764
            )





F-15


Notes
to Consolidated Financial Statements


4.  Investment Securities– (Continued)




Unrealized
losses on investment securities at December 31, 2008





The
following is a summary of the fair values and related unrealized losses
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position:





Securities
      in Continuous UnrealizedLoss
      Position Less Than 12 MonthsNumber
      of
            
            
            Market
            
            
            UnrealizedSecurities
            
            
            Value
            
            
            Loss(Dollars
      in thousands)Municipal
      obligations
            
            
            5
            
            
            $
            2,173
            
            
            $
            (8
            )Mortgage-backed
      securities
            
            
            5
            
            
            
            2,761
            
            
            
            (18
            )Collateralized
      mortgage obligations
            
            
            2
            
            
            
            792
            
            
            
            (114
            )Corporate
      bonds
            
            
            1
            
            
            
            290
            
            
            
            (710
            )Money
      market preferred stocks
            
            
            9
            
            
            
            6,744
            
            
            
            (2,529
            )Total
      securities in unrealized loss position
            
            
            22
            
            
            $
            12,760
            
            
            $
            (3,379
            )








Securities
      in Continuous UnrealizedLoss
      Position 12 or More Consecutive MonthsNumber
      of
            
            
            Market
            
            
            UnrealizedSecurities
            
            
            Value
            
            
            Loss(Dollars
      in thousands)Mortgage-backed
      securities
            
            
            3
            
            
            $
            1,554
            
            
            $
            (53
            )Collateralized
      mortgage obligations
            
            
            3
            
            
            
            2,391
            
            
            
            (42
            )Total
      securities in unrealized loss position
            
            
            6
            
            
            $
            3,945
            
            
            $
            (95
            )








At
December 31, 2009 and 2008, securities with  amortized cost of
$14,049,618 and $2,948,532, and fair values of $14,382,522 and $3,098,955,
respectively, were pledged as collateral to secure municipal deposits and
reverse repurchase agreements.





F-16











5.  Loans
Receivable




A summary
of loans receivable at December 31, 2009 and 2008 is as follows:





December
      31,(Dollars
      in thousands)
            
            2009
            
            
            2008Real
      estate loans:One-to-four
      family
            
            $
            229,693
            
            
            $
            216,201Construction
            
            
            46,298
            
            
            
            50,596Multi-family
      and commercial real estate
            
            
            134,931
            
            
            
            106,028Total
      real estate loans
            
            
            410,922
            
            
            
            372,825Commercial
      business loans
            
            
            31,325
            
            
            
            22,567Consumer
      loans:Savings
      accounts
            
            
            1,113
            
            
            
            1,093Personal
            
            
            256
            
            
            
            262Automobile
            
            
            230
            
            
            
            271Home
      equity
            
            
            37,276
            
            
            
            39,655Total
      consumer loans
            
            
            38,875
            
            
            
            41,281Totals
      loans
            
            
            481,122
            
            
            
            436,673Less:Allowance
      for loan losses
            
            
            3,996
            
            
            
            2,869Undisbursed
      construction loans
            
            
            3,336
            
            
            
            1,299Deferred
      loan origination fees
            
            
            486
            
            
            
            529Loans
      receivable, net
            
            $
            473,304
            
            
            $
            431,976Weighted
      average yield
            
            
            5.67
            %
            
            
            5.85
            %





F-17


Notes
to Consolidated Financial Statements


5.  Loans
Receivable–
(Continued)




The
Bank's lending activities are conducted principally in the Naugatuck Valley area
of Connecticut.  The Bank's investment in loans includes both
adjustable and fixed rate loans. At December 31, 2009 and 2008, the composition
of the Bank's investment in fixed rate loans was as follows:





Fixed RateTerm
      to Maturity
            
            2009
            
            
            2008(In
      thousands)Less
      than 1 year
            
            $
            3,611
            
            
            $
            1,3941 -
      3 years
            
            
            6,970
            
            
            
            4,3563 -
      5 years
            
            
            5,906
            
            
            
            4,7995 -
      10 years
            
            
            29,671
            
            
            
            30,45610
      - 20 years
            
            
            50,818
            
            
            
            48,759Over
      20 years
            
            
            159,940
            
            
            
            142,820Total
      loans at fixed rates
            
            $
            256,916
            
            
            $
            232,584





Adjustable
rate loans have interest rate adjustment limitations and are indexed to treasury
notes or FHLBB classic advances with similar repricing durations, or prime rate.
At December 31, 2009 and 2008, the Bank had the following adjustable rate
loans:





Adjustable RateRate
      Adjustment
            
            2009
            
            
            2008(In
      thousands)Less
      than 1 year
            
            $
            91,321
            
            
            $
            79,5251 -
      3 years
            
            
            36,986
            
            
            
            33,0003 -
      5 years
            
            
            55,058
            
            
            
            48,8835 -
      10 years
            
            
            40,841
            
            
            
            40,836Over
      10 years
            
            
            -
            
            
            
            1,845Total
      loans at adjustable rates
            
            $
            224,206
            
            
            $
            204,089





Nonperforming
loans totaled approximately $6.0 million and $2.7 million at December 31, 2009
and 2008, respectively.  These loans, primarily delinquent more than
90 days, were accounted for on a nonaccrual basis.  The amount of
income that was contractually due but not recognized on nonperforming loans
totaled $328,000, $140,000, and $45,000 in 2009, 2008 and 2007,
respectively.





F-18











At
December 31, 2009 the Bank had approximately $744,000 of loans which were
considered to be impaired with an allowance allocation of $98,000, compared with
$254,000 of loans without an allowance allocation at December 31,
2008.  These loans averaged $750,000 during 2009 and paid $23,000 in
interest, as compared with an average balance of $255,000 during 2008 on which
$11,000 of interest was received.





Transactions
in the allowance for loan losses account for the years ended December 31, 2009,
2008 and 2007 were as follows:





(In thousands)
            
            2009
            
            
            2008
            
            
            2007Balance
      at beginning of year
            
            $
            2,869
            
            
            $
            2,163
            
            
            $
            2,071Provision
      for loan losses
            
            
            1,144
            
            
            
            675
            
            
            
            151Loans
      written off
            
            
            (18
            )
            
            
            (7
            )
            
            
            (61
            )Recoveries
      of loans written off
            
            
            1
            
            
            
            38
            
            
            
            2Balance
      at end of year
            
            $
            3,996
            
            
            $
            2,869
            
            
            $
            2,163





As of
December 31, 2009 and 2008, loans to related parties totaled approximately
$3,976,000 and $3,845,000, respectively.  For the year ended December
31, 2009, new loans of approximately $1,123,000 were granted to these parties
and principal payments of approximately $992,000 were
received.    For the year ended December 31, 2008, new loans
of approximately $14,000 were granted to these parties and principal payments of
approximately $267,000 were received.  During 2008, loans in the
amount of $562,000 were removed from loans to related parties for individuals
whose related interests changed during the year.





Related
parties include directors and officers of the Bank, any respective affiliates in
which they have a controlling interest, and their immediate families. For the
years ended December 31, 2009 and 2008, all loans to related parties were
performing in accordance with the original terms.




The Bank
services loans for other financial institutions and agencies.  These
loans are originated by the Bank and then sold.  The Bank continues to
service these loans and remits the payments received to the purchasing
institution.  The amounts of these loans were approximately $7,256,000
and $8,693,000 at December 31, 2009 and 2008, respectively.





F-19





Notes
to Consolidated Financial Statements
 6.  Premises
and Equipment




Premises
and equipment at December 31, 2009 and 2008 are summarized as
follows:





(In thousands)
            
            2009
            
            
            2008Banking
      offices and branch buildings
            
            $
            8,469
            
            
            $
            8,469Furniture
      and equipment
            
            
            3,651
            
            
            
            3,553Land
            
            
            1,593
            
            
            
            1,593Leasehold
      improvements
            
            
            1,326
            
            
            
            1,32615,039
            
            
            
            14,941Accumulated
      depreciation and amortization
            
            
            (5,091
            )
            
            
            (4,376
            )Premises
      and equipment, net
            
            $
            9,948
            
            
            $
            10,565





Depreciation
and amortization expense is computed using the straight-line method over the
estimated useful life of an asset.  Estimated useful lives range from
three to ten years for furniture and equipment, 39 years for the banking
offices, and the initial lease term for leasehold improvements. Land is not
depreciated.  Depreciation and amortization expenses were $821,257 and
$834,473 and $775,978 for the years ended December 31, 2009, 2008 and 2007,
respectively.





The Bank
leases space for five of its branch offices.  The leases for the
branch offices have expiration dates ranging from 2011 through 2020, and are
accounted for as operating leases.  At December 31, 2009, future
minimum rental income and lease payment expense were expected to
be:





(In
      thousands)
            
            Income
            
            
            Expense2010
            
            $
            102
            
            
            $
            3202011
            
            
            98
            
            
            
            2812012
            
            
            72
            
            
            
            2542013
            
            
            67
            
            
            
            2052014
            
            
            -
            
            
            
            194Thereafter
            
            
            -
            
            
            
            852Total
      future minimum rents
            
            $
            339
            
            
            $
            2,106





F-20











7.  Deposits




Deposits
and weighted average rates at December 31, 2009 and 2008 are summarized as
follows:





2009
            
            
            2008Weighted
      Average Cost
            
            
            
            
            
            Weighted
      Average Cost(Dollars
      in thousands)
            
            Amount
            
            
            AmountCertificate
      accounts
            
            $
            231,905
            
            
            
            2.95
            %
            
            $
            235,764
            
            
            
            3.55
            %Regular
      savings accounts
            
            
            65,916
            
            
            
            0.58
            %
            
            
            48,427
            
            
            
            0.77
            %Checking
      and NOW accounts
            
            
            57,319
            
            
            
            0.09
            %
            
            
            52,537
            
            
            
            0.08
            %Money
      market savings accounts
            
            
            25,791
            
            
            
            0.90
            %
            
            
            26,298
            
            
            
            1.74
            %Total
      deposits
            
            $
            380,931
            
            
            
            1.97
            %
            
            $
            363,026
            
            
            
            2.55
            %





The
aggregate amount of individual certificate accounts of $100,000 or more at
December 31, 2009 and 2008 was $82,940,000 and $80,795,000 respectively. Under
the Emergency Economic Stabilization Act of 2008, deposits up to $250,000 are
federally insured through December 31, 2013.  In addition, federal law
provides up to $250,000 in deposit insurance coverage for self-directed
retirement accounts, such as Individual Retirement Accounts (IRAs).





The Bank
is also participating in the FDIC’s Temporary Liquidity Guaranty Program
(“TLGP”).  Under that program, all noninterest-bearing transaction
accounts are fully guaranteed by the FDIC for the entire balance in the account
until June 30, 2010.  Coverage under the TLGP is in addition to, and
separate from, the coverage available under the FDIC’s general deposit insurance
rules.





At
December 31, 2009 and 2008 the remaining maturities for certificate accounts
were:





(In thousands)
            
            2009
            
            
            2008Certificate
      accounts maturing in:Under
      12 months
            
            $
            115,648
            
            
            $
            119,52912
      to 24 months
            
            
            73,704
            
            
            
            22,66524
      to 36 months
            
            
            27,136
            
            
            
            62,716Over
      36 months
            
            
            15,417
            
            
            
            30,854Total
      certificate accounts
            
            $
            231,905
            
            
            $
            235,764





F-21


Notes
to Consolidated Financial Statements


8.  Borrowed
Funds




Borrowings
and advances, with calendar-year maturity dates and weighted average cost of
funds at December 31, 2009 and 2008, were as follows:





(Dollars in
      thousands)
            
            
            2009
            
            
            2008Weighted
      Average Cost
            
            
            
            
            
            Weighted
      Average CostAmount
            
            
            AmountDue
            
            
            DueShort-term
      borrowingsRepurchase
      agreements
            
            
            $
            6,431
            
            
            
            0.92
            %
            
            $
            727
            
            
            
            2.90
            %Long-term
      FHLBB advancesYear
      of maturity:2009
            
            
            
            -
            
            
            
            -
            
            
            
            58,418
            
            
            
            3.932010
            
            
            
            26,548
            
            
            
            3.30
            
            
            
            22,742
            
            
            
            3.742011
            
            
            
            26,629
            
            
            
            2.59
            
            
            
            16,262
            
            
            
            3.462012
            
            
            
            22,801
            
            
            
            2.88
            
            
            
            10,522
            
            
            
            4.122013
            
            
            
            19,187
            
            
            
            2.93
            
            
            
            6,789
            
            
            
            3.922014
            
            
            
            15,693
            
            
            
            2.96
            
            
            
            1,993
            
            
            
            3.702015
      - 2019
            
            
            
            978
            
            
            
            2.20
            
            
            
            978
            
            
            
            2.202020
      - 2024
            
            
            
            382
            
            
            
            0.18
            
            
            
            382
            
            
            
            0.182025
      - 2028
            
            
            
            335
            
            
            
            0.00
            
            
            
            335
            
            
            
            0.00Total
      long-term borrowings
            
            
            $
            112,553
            
            
            
            2.91
            
            
            $
            118,421
            
            
            
            3.80Total
      borrowed funds
            
            
            $
            118,984
            
            
            
            2.80
            
            
            $
            119,148
            
            
            
            3.79





The Bank
has an agreement with Federal Home Loan Bank of Boston (“FHLBB”) providing for
future credit availability of up to twenty times the amount of FHLBB stock held
by the Bank, not to exceed 30% of its total assets.  The Bank held
$6,251,700 in FHLBB stock at December 31, 2009.  In addition to the
outstanding advances, the Bank has a $2,540,000 line of credit available from
FHLBB, none of which was outstanding at December 31, 2009 or December 31, 2008.
The Bank also has a $3,500,000 line of credit available from another
correspondent bank, none of which was outstanding at December 31,
2009.  $1,340,000 was outstanding on this line at December 31,
2008.





FHLBB
advances are secured by a blanket lien on the Bank’s assets.  Included
in the amounts above are two long-term amortizing advances, which mature in 2023
and 2028 with interest rates of 0.27% and 0.00%, respectively, obtained under
the Affordable Housing Program offered by FHLBB.  These advances were
used to provide loans, at nominal cost to the borrower, for development of
low-cost housing in the Bank’s community.





Repurchase
agreements generally have terms of one day, and are secured by government agency
securities.





F-22











9.
Pension and Other Post-Retirement Benefits




Pension
Plan




Prior to
September 1, 2005, the Bank participated in a multi-employer defined benefit
pension plan covering all of its full time (as defined) employees who had been
employed by the Bank for more than six months and were at least twenty-one years
of age.  Benefits under this plan became fully vested after five years
of service.  The Bank's net pension cost for the period is the amount
of contributions due.  Total pension expense was $88,000 for the year
ended December 31, 2009 compared with $50,000 and $131,000 for 2008 and 2007,
respectively.  Current valuations of the Bank's allocation of the
plan's pooled assets are not available. Effective September 1, 2005, the Plan
was amended and as a result, is considered frozen, with no new participants
being accepted.  No future compensation will be considered for benefit
accruals, and there will be no future credited service, service accruals, or
additional accrued benefits.




Defined Contribution
Plan




The Bank
has a defined contribution 401(k) plan for eligible employees. The Bank provides
75% matching of employee contributions, with a maximum contribution on up to 6%
of the employee’s salary. The Bank’s contribution vests over a 6 year graded
vesting schedule.  The Bank’s contribution to the plan was $194,000,
$191,000 and $168,000 for the years ended December 31, 2009, 2008 and 2007,
respectively.




Directors Retirement
Plan




Through
December 27, 2006, the Bank sponsored a retirement and benefits plan for
non-employee directors.  All benefits earned were fully accrued based
on a fixed amount at December 31, 2006, and were paid to the participating
individuals in January, 2007.





Effective
December 27, 2006, for fees and compensation earned beginning January 1, 2007,
the Bank sponsors a deferred compensation plan under which non-employee
directors may elect to defer up to 100% of their compensation in the form of
either cash or stock-appreciation rights (“SARs”).  If a deferral is
made in SARs, then at the time of distribution an individual will receive in
cash the value of an equivalent number of shares of the Company’s stock that
could have been purchased at the time of the deferral.  The individual
will also receive in cash an amount equal to any dividends which would be paid
on the equivalent shares during the deferral period.  Under terms of
the plan, an election to defer compensation, including which form (cash or
SARs), must be made prior to December 31st of
the preceding year.  Each year the form of previous deferrals may be
converted to the other form at the option of the individual
participant.




Healthcare
Benefits




In
addition to providing pension benefits, the Bank provides certain health care
benefits to retired employees.  Substantially all of the Bank's
employees hired prior to February 2007 may become eligible for those benefits.
The Bank's policy is to accrue the expected cost of providing those benefits
during the years that the employee renders the necessary service.





F-23


Notes
to Consolidated Financial Statements
 
 9. Pension and Other
Post-Retirement Benefits–
(Continued)




Obligation and Funded
Status




The
following table summarizes the obligation and funded status, as well as the
amounts recognized in the consolidated statements of financial condition for the
Healthcare Benefits Plan as of December 31, 2009 and 2008:





Healthcare
      Benefit Plan(In
      thousands)
            
            2009
            
            
            2008Measurement
      date
            
            12/31/2009
            
            
            12/31/2008Projected
      benefit obligation
            
            $
            (361
            )
            
            $
            (334
            )Fair
      value of plan assets
            
            
            -
            
            
            
            -Funded
      status
            
            $
            (361
            )
            
            $
            (334
            )Accrued
      benefit cost recognized in the statement of financial
      condition
            
            $
            (361
            )
            
            $
            (334
            )




Net Periodic Benefit Cost
and Contributions




The
benefit costs and contributions related to the Healthcare Benefits plan for the
years ended December 31, 2009 and 2008 were:





Healthcare
      Benefit Plan(In
      thousands)
            
            2009
            
            
            2008Net
      periodic benefit cost
            
            $
            27
            
            
            $
            (32
            )Employer
      contributions
            
            
            18
            
            
            
            19Plan
      participants' contributions
            
            
            -
            
            
            
            -Benefits
      paid during the year
            
            
            18
            
            
            
            19





Due to
the unfunded status of the plan, the Bank expects to contribute the amount of
the estimated benefit payments for the next fiscal year, which is $15,068 for
the Healthcare Benefits Plan.





F-24











Assumptions and
Effects




The
actuarial assumptions used to determine the projected benefit obligations and
net periodic benefit cost for the years ended December 31, 2009 and 2008 were as
follows:





Healthcare
      Benefit PlanWeighted-average
      assumptions:
            
            2009
            
            
            2008Discount
      rate
            
            
            6.250
            %
            
            
            6.875
            %Rate
      of compensation increase
            
            
            -
            
            
            
            -Medical
      trend rate next year
            
            
            7.00
            %
            
            
            8.00
            %Ultimate
      medical trend rate
            
            
            5.00
            %
            
            
            5.00
            %Year
      ultimate trend rate is achieved
            
            
            2011
            
            
            
            2011





Assumed
health care cost trend rates have a significant effect on the amounts reported
for the Healthcare Benefits plan. At December 31, 2009, a one percentage-point
increase in the assumed health care trend rates would increase the projected
benefit obligation by $47,557 compared with a decrease of $40,727 if the assumed
health care trend rate were to decrease by one percentage-point.




10.  Employee
Stock Ownership Plan




During
2004 the Bank implemented the Naugatuck Valley Savings and Loan Employee Stock
Ownership Plan (the “ESOP”). On September 30, 2004, the ESOP purchased 298,091
shares of the common stock of the Company. To fund the purchase, the ESOP
borrowed $2,980,910 from the Company. The borrowing is at an interest rate of
4.75% and is to be repaid on a pro-rata basis in fifteen annual installments of
$282,520 commencing with the quarter ended December 31, 2004 through September
30, 2019. In addition, dividends paid on the unreleased shares are used to
reduce the principal balance of the loan. The collateral for the loan is the
common stock of the Company purchased by the ESOP. Contributions by the Bank to
the ESOP are discretionary, however, the Bank intends to make annual
contributions in an aggregate amount at least equal to the principal and
interest requirement on the debt.





The
shares of stock purchased by the ESOP are held in a suspense account until they
are released for allocation among participants. The shares will be released
annually from the suspense account and the released shares will be allocated
among the participants on the basis of each participant’s compensation for the
year of allocation. As shares are released from collateral, the Bank recognizes
compensation expense equal to the average market price of the shares during the
period and the shares will be outstanding for earning per share purposes. The
shares not released are reported as unearned ESOP shares in the capital accounts
of the consolidated statements of financial condition. ESOP expense for the
years ended December 31, 2009 and 2008 was $112,373 and $169,056 respectively.
At December 31, 2009 and 2008, there were 19,889 unallocated ESOP shares, and
193,735 and 213,624 unreleased ESOP shares respectively. At December 31, 2009
the unreleased shares had an aggregate fair value of $1,112,000.





F-25


Notes
to Consolidated Financial Statements


11.  Equity
Incentive Plan




In 2005,
stockholders of the Company approved the Naugatuck Valley Financial Corporation
2005 Equity Incentive Plan (the “Incentive Plan”).  Under the
Incentive Plan, the Company may grant up to 372,614 stock options and 149,045
shares of restricted stock to its employees, officers and directors for an
aggregate amount of up to 521,659 shares of the Company’s common stock for
issuance upon the grant or exercise of awards.  Both incentive stock
options and non-statutory stock options may be granted under the Incentive
Plan.  Through December 31, 2009, the following awards have been
made:





Grant
      DateJuly
      26,
            
            
            December
      18,
            
            
            March
      20,
            
            
            March
      21,
            
            
            July
      26,2008
            
            
            2007
            
            
            2007
            
            
            2006
            
            
            2005Option
      awardsAwarded
            
            
            1,000
            
            
            
            2,000
            
            
            
            7,500
            
            
            
            6,500
            
            
            
            354,580Exercise
      price
            
            $
            11.10
            
            
            $
            11.10
            
            
            $
            12.49
            
            
            $
            11.10
            
            
            $
            11.10Maximum
      term
            
            
            10
            
            
            
            10
            
            
            
            10
            
            
            
            10
            
            
            
            10Restricted
      stock awards Awarded
            
            
            1,000
            
            
            
            3,000
            
            
            
            2,000
            
            
            
            1,500
            
            
            
            139,712





Stock
option awards have been granted with an exercise price equal to the greater of
the market price of the Company’s stock at the date of grant, or $11.10, which
was the market price of the Company’s stock at the date stock option awards were
initially granted under the Incentive Plan.  Stock options and
restricted stock awards are considered common stock equivalents for the purpose
of computing earnings per share on a diluted basis.  A summary of the
status of outstanding stock options at December 31, 2009 and 2008 and changes
during the year, is as follows:





2009
            
            
            2008Weighted
            
            
            
            
            
            WeightedNumber
            
            
            Average
            
            
            Number
            
            
            Averageof
            
            
            Exercise
            
            
            of
            
            
            ExerciseShares
            
            
            Price
            
            
            Shares
            
            
            PriceOptions
      outstanding at beginning of year
            
            
            353,580
            
            
            $
            11.13
            
            
            
            359,460
            
            
            $
            11.13Granted
            
            
            -
            
            
            
            -
            
            
            
            1,000
            
            
            
            11.10Forfeited
            
            
            -
            
            
            
            -
            
            
            
            (2,830
            )
            
            
            11.10Exercised
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Expired
            
            
            (150
            )
            
            
            11.10
            
            
            
            (4,050
            )
            
            
            11.10Options
      outstanding at end of year
            
            
            353,430
            
            
            
            11.13
            
            
            
            353,580
            
            
            
            11.13Options
      exercisable at end of year
            
            
            278,548
            
            
            
            11.11
            
            
            
            202,504
            
            
            
            11.12Weighted-average
      fair value of optionsgranted during the year
            
            
            
            
            
            
            N/A
            
            
            
            
            
            
            $
            1.51





F-26











The
Company records share-based compensation expense related to outstanding stock
options and restricted stock awards based upon the fair value at the date of
grant over the vesting period of such awards on a straight-line
basis.  Both stock options and restricted stock awards vest at 20% per
year beginning on the first anniversary of the date of grant.





The fair
value of each restricted stock allocation, based on the market price at the date
of grant, is recorded to unearned stock awards.  Compensation expenses
related to unearned restricted shares are amortized to compensation, taxes and
benefits expense over the vesting period of the restricted stock
awards.





The fair
value of each stock option award is estimated on the date of grant using the
Black-Scholes option pricing method which includes several assumptions such as
volatility, expected dividends, expected term and risk-free rate for each stock
option award.





In
determining the expected term of the option awards, the Company has estimated
the expected term of the options as being equal to the average of the vesting
term plus the original contractual term. The Company estimated its volatility
using the historical volatility of other, similar companies during a period of
time equal to the expected life of the options. The risk-free rate for the
periods within the contractual life of the options is based upon the U.S.
Treasury yield curve in effect at the time of grant.





Assumptions
used to determine the weighted-average fair value of stock options granted were
as follows:





July
      26,
            
            
            December
      18,
            
            
            March
      20,
            
            
            March
      21,
            
            
            July
      26,Grant
      date
            
            2008
            
            
            2007
            
            
            2007
            
            
            2006
            
            
            2005Dividend
      yield
            
            
            2.74
            %
            
            
            2.20
            %
            
            
            1.60
            %
            
            
            1.89
            %
            
            
            1.44
            %Expected
      volatility
            
            
            13.40
            %
            
            
            11.00
            %
            
            
            10.49
            %
            
            
            11.20
            %
            
            
            11.47
            %Risk-free
      rate
            
            
            3.56
            %
            
            
            3.63
            %
            
            
            4.48
            %
            
            
            4.61
            %
            
            
            4.18
            %Expected
      life in years
            
            
            6.5
            
            
            
            6.5
            
            
            
            6.5
            
            
            
            6.5
            
            
            
            6.5Weighted
      average fair valueof options at grant date
            
            $
            1.51
            
            
            $
            1.18
            
            
            $
            2.55
            
            
            $
            2.25
            
            
            $
            2.47




The
Company recorded share-based compensation expense of $531,743, $507,557 and
$471,243 for the year ended December 31, 2009, 2008 and 2007, respectively, in
connection with the stock option and restricted stock awards.  At
December 31, 2009, the Company has approximately $146,923 of unrecorded option
expense to be recognized over the remaining vesting period of the
options.





F-27


Notes
to Consolidated Financial Statements


12.  Income
Taxes




The
Bank’s wholly-owned subsidiary, the Naugatuck Valley Mortgage Servicing
Corporation, qualifies and operates as a Connecticut passive investment company
pursuant to legislation.  Because the subsidiary earns income from
passive investments which is exempt from Connecticut Corporation Business Tax
and its dividends to the Bank are exempt from state tax, the Bank no longer
expects to incur state income tax expense.





Deferred
income taxes reflect the impact of "temporary differences" between the amount of
assets and liabilities for financial reporting purposes and such amounts as
measured by tax laws and regulations.  Principal items making up the
deferred income tax provision include impairment losses on investment securities
for which the Company expects to realize a future benefit,  a carry
forward of charitable contributions, the provision for loan losses, accelerated
tax depreciation and deferred mortgage fee income. The Company records a
valuation allowance against deferred tax assets if, based on the weight of
available evidence, it is more likely than not, that some or all of the deferred
tax assets will not be realized.  The Company believes that all
deferred tax assets will be realized in the future and that no valuation
allowance is necessary.





The
provision (benefit) for income taxes for the year ended December 31, 2009, 2008
and 2007 consisted of:





(In thousands)
            
            2009
            
            
            2008
            
            
            2007Current
      income tax expense
            
            $
            114
            
            
            $
            1,008
            
            
            $
            206Deferred
      income tax expense (benefit), due to:Impairment
      loss on investment securities
            
            
            1,165
            
            
            
            (1,165
            )
            
            
            -Reserve
      for loan losses
            
            
            (389
            )
            
            
            (236
            )
            
            
            (31
            )Deferred
      income
            
            
            (65
            )
            
            
            (151
            )
            
            
            (34
            )Charitable
      contributions
            
            
            36
            
            
            
            16
            
            
            
            88Post
      retirement benefits
            
            
            (9
            )
            
            
            11
            
            
            
            86Depreciation
            
            
            (36
            )
            
            
            (36
            )
            
            
            (73
            )Other
      items
            
            
            2
            
            
            
            (13
            )
            
            
            (25
            )Total
      deferred income tax expense (benefit)
            
            
            704
            
            
            
            (1,574
            )
            
            
            11Provision
      (benefit) for income taxes
            
            $
            818
            
            
            $
            (566
            )
            
            $
            217





F-28











A
reconciliation of the statutory federal income tax rate applied to income before
income taxes with the income tax provision is as follows:





Year
      Ended December 31,(Dollars in
      thousands)
            
            2009
            
            
            2008
            
            
            2007Income
      tax expense at statutory rate of 34%
            
            $
            956
            
            
            $
            (299
            )
            
            $
            557Increase
      (decrease) in income tax expense resulting from:Nondeductible
      compensation expense
            
            
            85
            
            
            
            100
            
            
            
            113Income
      exempt from income tax
            
            
            (225
            )
            
            
            (371
            )
            
            
            (456
            )Changes
      in tax bad debt base year reserves
            
            
            -
            
            
            
            -
            
            
            
            -Other
      items, net
            
            
            2
            
            
            
            4
            
            
            
            3Provision
      for income taxes
            
            $
            818
            
            
            $
            (566
            )
            
            $
            217Effective
      rate of income tax expense
            
            
            29.1
            %
            
            
            64.5
            %
            
            
            13.3
            %





Income
taxes receivable and payable included in the balance sheet at December 31, 2009
and 2008 were:





(In thousands)
            
            2009
            
            
            2008Current
      tax receivable
            
            $
            281
            
            
            $
            110Deferred
      tax receivableImpariment
      loss on investment secruities
            
            $
            -
            
            
            $
            1,165Reserve
      for loan losses
            
            
            1,360
            
            
            
            971Deferred
      income
            
            
            464
            
            
            
            399Charitable
      contributions carryforward
            
            
            261
            
            
            
            297Post-retirement
      benefits
            
            
            123
            
            
            
            114Total
      deferred tax receivable
            
            
            2,208
            
            
            
            2,946Deferred
      tax payableDepreciation
            
            $
            (65
            )
            
            $
            (101
            )Available-for-sale
      securities
            
            
            (191
            )
            
            
            (13
            )Other
      items
            
            
            -
            
            
            
            -Total
      deferred tax payable
            
            
            (256
            )
            
            
            (114
            )Net
      deferred tax receivable
            
            $
            1,952
            
            
            $
            2,832





F-29


Notes
to Consolidated Financial Statements


12.  Income
Taxes–
(Continued)




Retained
earnings at December 31, 2009 includes a contingency reserve for loan losses
of  $1,843,000, which represents the tax reserve balance existing at
December 31, 1987, and is maintained in accordance with provisions of the
Internal Revenue Code applicable to thrift institutions. It is not anticipated
that the Company will incur a federal income tax liability related to the
reduction of this reserve and accordingly, deferred income taxes of $627,000 has
not been recognized as of December 31, 2009





As of
December 31, 2009, the Company is subject to unexpired statutes of limitation
for examination of its tax returns for U.S. federal and Connecticut income taxes
for the years 2006-2009.





13.  Consolidated
Statements of Comprehensive Income




The
source of the Company’s other comprehensive income (loss) is the unrealized
gains and losses on its available for sale securities.





For
      the Years Ended December 31,(In thousands)
            
            2009
            
            
            2008
            
            
            2007Net
      income (loss)
            
            $
            1,993
            
            
            $
            (312
            )
            
            $
            1,420Other
      comprehensive income (loss):Unrealized
      gain (loss) on securities available-for-sale
            
            
            3,121
            
            
            
            (5,713
            )
            
            
            384Reclassification
      adjustment for losses (gains)realized in net income
            
            
            (388
            )
            
            
            3,398
            
            
            
            (65
            )Other
      comprehensive income (loss) before tax effect
            
            
            2,733
            
            
            
            (2,315
            )
            
            
            319Income
      tax expense related to items of other comprehensive income
      (loss)
            
            
            178
            
            
            
            73
            
            
            
            109Other
      comprehensive income (loss) net of tax effect
            
            
            2,555
            
            
            
            (2,388
            )
            
            
            210Total
      comprehensive income (loss)
            
            $
            4,548
            
            
            $
            (2,700
            )
            
            $
            1,630





At
December 31, 2008, the Company did not recognize approximately $714,000 of
income tax benefits related to its other comprehensive loss for the year due to
the uncertainty regarding its ability to realize a tax benefit from the
estimated unrealized losses.





F-30











14.  Regulatory
Capital




The
Company, as a federally chartered holding company, is not subject to regulatory
capital requirements. The Bank is subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Bank’s financial statements.





The
Office of Thrift Supervision (OTS) regulations require savings institutions to
maintain minimum levels of regulatory capital. Under the regulations in effect
at December 31, 2009, the Bank was required to maintain a minimum ratio of
tangible equity capital to total tangible assets of 1.5%; a minimum ratio of
Tier 1 (core) capital to total adjusted assets of 4.0%; a minimum ratio of Tier
I capital to risk-weighted assets of 4.0% and a minimum ratio of total (core and
supplementary) capital to risk-weighted assets of 8.0%. As of December 31, 2009
the Bank meets all capital requirements to which it is subject.





At
December 31, 2009 the Bank was considered “well capitalized” for regulatory
purposes. To be categorized as well capitalized, the Bank must maintain a
minimum ratio of tangible equity capital to total tangible assets of 2.0%; a
minimum ratio of Tier 1 (core) capital to adjusted total assets of 5.0%; a
minimum ratio of Tier I capital to risk-weighted assets of 6.0% and a minimum
ratio of total (core and supplementary) capital to risk-weighted assets of
10.0%. There have been no subsequent conditions or events which management
believes have changed the Bank’s status.





The
following is a summary of the Bank’s actual capital as computed under the
standards established by the OTS at December 31, 2009 and 2008,
respectively.





2009
            
            
            2008(Dollars
      in thousands)
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioTangible
      Equity Ratio (to Tangible Assets)
            
            $
            43,050
            
            
            
            7.76
            %
            
            $
            40,555
            
            
            
            7.58
            %Tier
      I (Core) Capital (to Adjusted Total Assets)
            
            
            43,050
            
            
            
            7.76
            %
            
            
            40,555
            
            
            
            7.58
            %Tier
      I Risk-Based Capital (to Risk-Weighted Assets)
            
            
            43,050
            
            
            
            10.16
            %
            
            
            40,555
            
            
            
            10.36
            %Total
      Risk-Based Capital (to Risk-Weighted Assets)
            
            
            47,046
            
            
            
            11.10
            %
            
            
            43,423
            
            
            
            11.09
            %





F-31


Notes
to Consolidated Financial Statements


14.  Regulatory
Capital–
(Continued)




The
ability of the Company to pay dividends depends, in part, on the ability of the
Bank to pay dividends to the Company. The Bank will not be able to declare or
pay a cash dividend on, or repurchase any of its common stock, if the effect
thereof would be to reduce the regulatory capital of the Bank to an amount below
amounts required under OTS rules and regulations.





The
measurement of the Bank’s capital as computed under regulatory standards differs
from its measurement under generally accepted accounting principles. A
reconcilement of the Bank’s capital follows:





December
      31,(In
      thousands)
            
            2009
            
            
            2008Total
      capital as calculated under generally accepted accounting principles (GAAP
      Capital)
            
            $
            43,171
            
            
            $
            38,197Adjustments
      to reconcile Total GAAP Capital to Regulatory Capital:Intangible
      assets
            
            
            (87
            )
            
            
            (121
            )Accumulated
      other comprehensive income from available-for-sale
    securities
            
            
            (34
            )
            
            
            2,479Tier
      I Risk-Based Capital
            
            
            43,050
            
            
            
            40,555Includible
      portion of allowance for loan losses
            
            
            3,996
            
            
            
            2,868Total
      Risk-Based Capital
            
            $
            47,046
            
            
            $
            43,423





F-32











15.  Earnings
per Share




Basic net
income per common share is calculated by dividing the net income available to
common stockholders by the weighted-average number of common shares outstanding
during the period. Diluted net income per common share is computed in a manner
similar to basic net income per common share except that the weighted-average
number of common shares outstanding is increased to include the incremental
common shares (as computed using the treasury stock method) that would have been
outstanding if all potentially dilutive common stock equivalents were issued
during the period. The Company's common stock equivalents relate solely to stock
option and restricted stock awards. Anti-dilutive shares are common stock
equivalents with weighted-average exercise prices in excess of the
weighted-average market value for the periods presented.  For the
years ended December 31, 2009 and December 31, 2008, anti-dilutive options
excluded from the calculations totaled 345,930 and 346,080 options, respectively
(with an exercise price of $11.10) and 7,500 options in both periods (with an
exercise price of $12.49).    Unallocated common shares held
by the ESOP are not included in the weighted-average number of common shares
outstanding for purposes of calculating either basic or diluted net income per
common share.





For
      the years ended December 31,2009
            
            
            2008Net
      income (loss) and income available to common stockholders
            
            $
            1,993,000
            
            
            $
            (312,000
            )Weighted-average
      shares outstanding during the periodBasic
            
            
            6,811,553
            
            
            
            6,859,383Effect
      of dilutive stock options and restrictive stock awards
            
            
            -
            
            
            
            -Diluted
            
            
            6,811,553
            
            
            
            6,859,383Net
      income (loss) per common share:Basic
      and Diluted Earnings per share
            
            $
            0.29
            
            
            $
            (0.05
            )




16.  Financial
Instruments




The
Company 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 and to
reduce its own exposure to fluctuations in interest rates.  These
financial instruments include commitments to extend credit.  Those
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the balance sheet.





F-33


Notes
to Consolidated Financial Statements


16.  Financial
Instruments–
(Continued)




The
following table summarizes these financial instruments and other commitments and
contingent liabilities as of December 31, 2009 and 2008:





(In thousands)
            
            2009
            
            
            2008Commitments
      to extend credit:Loan
      commitments
            
            $
            10,611
            
            
            $
            5,807Unused
      lines of credit
            
            
            21,142
            
            
            
            20,328Amounts
      due mortgagors on construction loans
            
            
            28,843
            
            
            
            25,855Amounts
      due on commercial  loans
            
            
            17,899
            
            
            
            15,384Commercial
      letters of credit
            
            
            4,332
            
            
            
            5,125





The
Company's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual notional amount of those
instruments.  The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
are principally collateralized by mortgages on real estate, generally have fixed
expiration dates or other termination clauses and may require payment of
fees.  Since some of the commitments may expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash
requirements.




17.  Fair
Value




The
following is a summary of the carrying value and estimated fair value of the
Company’s significant financial instruments as of December 31, 2009 and
2008:





December
      31,2009
            
            
            2008Carrying
            
            
            Estimated
            
            
            Carrying
            
            
            Estimated(In
      thousands)
            
            Amount
            
            
            Fair
      Value
            
            
            Amount
            
            
            Fair
      ValueFinancial
      AssetsCash
      and cash equivalents
            
            $
            12,146
            
            
            $
            12,146
            
            
            $
            8,247
            
            
            $
            8,247Investment
      securities
            
            
            39,074
            
            
            
            39,098
            
            
            
            63,844
            
            
            
            63,844Loans
      receivable, net
            
            
            473,304
            
            
            
            476,665
            
            
            
            431,976
            
            
            
            440,405Accrued
      income receivable
            
            
            2,074
            
            
            
            2,074
            
            
            
            2,099
            
            
            
            2,099Financial
      LiabilitiesDeposits
            
            $
            380,931
            
            
            $
            379,176
            
            
            $
            363,026
            
            
            $
            358,474Borrowed
      funds
            
            
            118,984
            
            
            
            120,719
            
            
            
            119,148
            
            
            
            120,811Mortgagors'
      escrow accounts
            
            
            4,888
            
            
            
            4,888
            
            
            
            4,562
            
            
            
            4,562





F-34











Effective
January 1, 2008, the Company adopted the new fair value measurement guidance,
which defines fair value and establishes a framework for measuring fair value in
generally accepted accounting principles. Fair value is defined as the exchange
price that would be received for an asset or paid to transfer a liability (exit
price) in the principal or most advantageous market for the asset or liability
in an orderly transaction between market participants on the measurement date.
The guidance specifies a fair value hierarchy which requires an entity to
maximize the use of observable inputs and minimize the use of unobservable
inputs when measuring fair value. The standards describe three levels of inputs
that may be used to measure fair values:




Level
      1 —
            Quoted
      prices for identical instruments in active
  markets.




Level
      2 —
            Quoted
      prices for similar instruments in active or non-active markets and
      model-derived valuations in which all significant inputs and value drivers
      are observable in active markets.




Level
      3 —
            Valuation
      derived from significant unobservable
inputs.





Valuation
techniques based on unobservable inputs are highly subjective and require
judgments regarding significant matters such as the amount and timing of future
cash flows and the selection of discount rates that may appropriately reflect
market and credit risks. Changes in these judgments often have a material impact
on the fair value estimates. In addition, since these estimates are as of a
specific point in time, they are susceptible to material near-term changes. The
fair values disclosed do not reflect any premium or discount that could result
from the sale of a large volume of a particular financial instrument, nor do
they reflect the possible tax ramifications or estimated transaction
costs.





The
Company uses fair value measurements to record certain assets at fair value on a
recurring basis. Additionally, the Company may be required to record at fair
value other assets on a nonrecurring basis. These nonrecurring fair value
adjustments typically involve the application of lower-of-cost-or market value
accounting or write-downs of individual assets.





The
Company used the following methods and significant assumptions to estimate the
fair value of its financial instruments which are carried at fair value on a
recurring basis in the financial statements:





Available-for-sale
securities:




Fair
value measurement is based upon quoted prices, if available.  If
quoted prices are not available, fair values are determined by matrix
pricing,  which is a mathematical technique widely used in the
industry to value debt securities without relying exclusively on quoted prices
for the specific securities but rather by relying on the securities’
relationship to other benchmark quoted securities.  The Company’s
available-for-sale securities that are traded on an active exchange, such as the
New York Stock Exchange, are classified as Level 1. Available-for-sale
securities valued using matrix pricing are classified as Level 2. During 2008,
the Company transferred seven auction-rate preferred securities in the
available-for-sale





F-35


Notes
to Consolidated Financial Statements


17.  Fair
Value–
(Continued)




portfolio
from Level 2 to Level 3.  Market prices of comparable instruments
became harder to identify due to inactive markets, which made it necessary for
the Company to make adjustments to the matrix prices to compensate for the
present value of expected cash flows, market liquidity, credit quality and
volatility. As a result, the Company utilized Level 3 inputs of greater
significance, which required the Company to move the valuation of these
securities from Level 2 to Level 3.  During 2009, two of the seven
securities were sold and one was called at par.  See also Note 4,
Investment
Securities.





Assets
measured at fair value are summarized below:





December
      31, 2009Carrying
      Value(In
      thousands)
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalAssets
      measured at fair value on a recurring basis:Available-for-sale
      investment securities
            
            $
            -
            
            
            $
            29,743
            
            
            $
            7,880
            
            
            $
            37,623Residential
      loans held for sale
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Assets
      measured at fair value on a non-recurring basis:Collateral
      dependent impaired loans
            
            $
            -
            
            
            $
            628
            
            
            $
            18
            
            
            $
            646Foreclosed
      real estate
            
            
            -
            
            
            
            -
            
            
            
            140
            
            
            
            140





Impaired
loans are carried at fair value. Collateral dependent loans are considered Level
2, as the fair value is based on an appraisal prepared using observable inputs.
Non-collateral dependent loans are measured using a discounted cash flow
technique and are considered to be Level 3 estimates.





The
following table shows a reconciliation of the beginning and ending balances for
Level 3 assets measured at fair value on a recurring basis:





(In
      thousands)Balance
      at December 31, 2008
            
            $
            6,744New
      purchases
            
            
            -Transfer
      to (from) level 3
            
            
            -Increase
      in fair value of securities included in accumulatedother
      comprehensive income
            
            
            2,219Impairment
      charges included in net income
            
            
            -Proceeds
      from sale of level 3 securities
            
            
            (83
            )Redemptions
      at par
            
            
            (1,000
            )Balance
      at December 31, 2009
            
            $
            7,880





F-36











The
following is a further description of the principal valuation methods used by
the Company to estimate the fair values of its financial
instruments.




Cash and cash
equivalents-
The carrying amounts reported in the statement of financial condition
approximate these assets' fair value.




Loans receivable - For
variable rate loans that reprice frequently and without significant change in
credit risk, fair values are based on carrying values.  The fair value
of other loans are estimated using discounted cash flow analyses using interest
rates currently being offered for loans with similar terms to borrowers of
similar credit quality.  The fair value of nonaccrual loans was
estimated using the estimated fair values of the underlying
collateral.




Accrued income receivable -
The carrying amounts reported in the statement of financial condition
approximate these assets' fair value.




Deposits liabilities - The
fair values of non-interest-bearing demand and savings deposits are, by
definition, equal to the amount payable on demand at the reporting date, i.e.,
their carrying amounts.  Fair values for time certificates of deposit
are estimated using a discounted cash flow technique that applies interest rates
currently being offered to a schedule of aggregated expected monthly maturities
on time deposits.




Borrowed Funds - Fair values
are estimated using discounted cash flow analyses based on the Bank's current
incremental borrowing rates for similar types of borrowing
arrangements.




Mortgagors’ escrow accounts –The carrying amounts reported in the statement of financialcondition approximate
the fair value of the mortgagors’ escrow accounts.




18.  Subsequent
Events




On
February 23, 2010, the Company announced it had entered into a definitive
agreement to acquire Southern Connecticut Bancorp, Inc (“SCBI”), the holding
company for The Bank of Southern Connecticut.  The Company also
announced its mutual holding company parent, Naugatuck Valley Mutual Holding
Company has adopted a Plan of Conversion and Reorganization to convert to a
stock holding company by selling to the public its approximate 60% ownership
interest in the Company in a transaction commonly referred to as a second step
conversion.  The completion of the acquisition of SCBI is contingent
on the completion of the second step conversion.  In addition to the
completion of the second step conversion, the acquisition is contingent on the
receipt of regulatory approvals, the approval of SCBI's stockholders and other
customary conditions. The acquisition is expected to be completed in the third
calendar quarter of 2010.





The
acquisition is expected to occur immediately following the completion of the
second step conversion.  Upon completion of the conversion, Naugatuck
Valley Savings and Loan will become the wholly-owned subsidiary of a new stock
holding company (“Newco”). It is expected that Newco will retain the name
“Naugatuck Valley Financial Corporation”.





F-37


Notes
to Consolidated Financial Statements


18.  Subsequent
Events–
(Continued)




As a
result of the acquisition, SCBI will merge with and into Newco, with Newco as
the surviving entity. SCBI shareholders will be able to elect to receive cash,
shares of Newco common stock, or a combination of cash and stock, subject to
proration, if necessary, to assure that 50% of SCBI's outstanding shares are
exchanged for Newco common stock and the remainder are exchanged for cash. The
exchange ratio for determining the number of shares of Newco common stock to be
exchanged for each share of SCBI common stock will equal $7.25 divided by the
initial offering price per share to be established for Newco's common stock in
the second step conversion offering. SCBI stockholders who elect to receive
stock are not expected to be subject to federal income tax on their receipt of
Newco common stock. As part of the transaction, The Bank of Southern Connecticut
will merge with and into Naugatuck Valley Savings and Loan, with Naugatuck
Savings and Loan as the surviving entity. Naugatuck Valley Savings and Loan
intends to continue to operate the four acquired banking offices of The Bank of
Southern Connecticut, which are located in New Haven (two offices), Branford and
North Haven, Connecticut, under the name "The Bank of Southern
Connecticut."





Information,
including details of the stock offering and detailed business and financial
information about Newco, NVFC and SCBI, will be provided in a prospectus and
proxy statement when the stock offering commences, which is expected to occur
late in the second or early in the third calendar quarter of 2010.




19.  Selected
Quarterly Consolidated Financial Information (unaudited)




The
following tables present quarterly consolidated information for the Company for
2009, 2008 and 2007.





For
      the Year Ended December 31, 2009Fourth
            
            
            Third
            
            
            Second
            
            
            First(In
      thousands)
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            QuarterInterest
      and dividend income
            
            $
            7,141
            
            
            $
            7,055
            
            
            $
            7,007
            
            
            $
            7,088Interest
      expense
            
            
            2,788
            
            
            
            3,068
            
            
            
            3,266
            
            
            
            3,415Net
      interest income
            
            
            4,353
            
            
            
            3,987
            
            
            
            3,741
            
            
            
            3,673Provision
      for loan losses
            
            
            285
            
            
            
            302
            
            
            
            272
            
            
            
            285Net
      interest income afterprovision for loan
    losses
            
            
            4,068
            
            
            
            3,685
            
            
            
            3,469
            
            
            
            3,388Noninterest
      income
            
            
            579
            
            
            
            812
            
            
            
            645
            
            
            
            706Noninterest
      expense
            
            
            3,664
            
            
            
            3,483
            
            
            
            3,796
            
            
            
            3,598Income
      before provision forincome tax
            
            
            983
            
            
            
            1,014
            
            
            
            318
            
            
            
            496Provision
      for income tax
            
            
            301
            
            
            
            311
            
            
            
            79
            
            
            
            127Net
      income
            
            $
            682
            
            
            $
            703
            
            
            $
            239
            
            
            $
            369





F-38





For
      the Year Ended December 31, 2008Fourth
            
            
            Third
            
            
            Second
            
            
            First(In
      thousands)
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            QuarterInterest
      and dividend income
            
            $
            7,256
            
            
            $
            7,224
            
            
            $
            6,877
            
            
            $
            6,846Interest
      expense
            
            
            3,516
            
            
            
            3,499
            
            
            
            3,343
            
            
            
            3,546Net
      interest income
            
            
            3,740
            
            
            
            3,725
            
            
            
            3,534
            
            
            
            3,300Provision
      for loan losses
            
            
            200
            
            
            
            200
            
            
            
            113
            
            
            
            162Net
      interest income afterprovision for loan
    losses
            
            
            3,540
            
            
            
            3,525
            
            
            
            3,421
            
            
            
            3,138Noninterest
      income
            
            
            300
            
            
            
            (2,636
            )
            
            
            661
            
            
            
            627Noninterest
      expense
            
            
            3,539
            
            
            
            3,453
            
            
            
            3,257
            
            
            
            3,205Income
      (loss) before provision forincome tax
    (benefit)
            
            
            301
            
            
            
            (2,564
            )
            
            
            825
            
            
            
            560Provision
      for income tax (benefit)
            
            
            (1,052
            )
            
            
            157
            
            
            
            223
            
            
            
            106Net
      income (loss)
            
            $
            1,353
            
            
            $
            (2,721
            )
            
            $
            602
            
            
            $
            454








For
      the Year Ended December 31, 2007Fourth
            
            
            Third
            
            
            Second
            
            
            First(In
      thousands)
            
            Quarter
            
            
            Quarter
            
            
            Quarter
            
            
            QuarterInterest
      and dividend income
            
            $
            6,632
            
            
            $
            6,384
            
            
            $
            6,030
            
            
            $
            5,984Interest
      expense
            
            
            3,494
            
            
            
            3,394
            
            
            
            3,189
            
            
            
            3,097Net
      interest income
            
            
            3,138
            
            
            
            2,990
            
            
            
            2,841
            
            
            
            2,887Provision
      for loan losses
            
            
            100
            
            
            
            -
            
            
            
            -
            
            
            
            51Net
      interest income afterprovision for loan
    losses
            
            
            3,038
            
            
            
            2,990
            
            
            
            2,841
            
            
            
            2,836Noninterest
      income
            
            
            647
            
            
            
            577
            
            
            
            606
            
            
            
            524Noninterest
      expense
            
            
            3,104
            
            
            
            3,158
            
            
            
            3,096
            
            
            
            3,064Income
      before provision forincome tax
            
            
            581
            
            
            
            409
            
            
            
            351
            
            
            
            296Provision
      for income tax
            
            
            101
            
            
            
            55
            
            
            
            39
            
            
            
            22Net
      income
            
            $
            480
            
            
            $
            354
            
            
            $
            312
            
            
            $
            274





F-39


Notes
to Consolidated Financial Statements


20.  Parent
Company Only Financial Statements




The
following financial statements are for the Company (Naugatuck Valley Financial
Corporation) only, and should be read in conjunction with the consolidated
financial statements of the Company.





Statements of Financial
Condition





December
      31,(In thousands)
            
            2009
            
            
            2008ASSETSCash
      on deposit with Naugatuck Valley Savings and Loan
            
            $
            2,434
            
            
            $
            1,872Investment
      in subsidiary, Naugatuck Valley Savings and Loan
            
            
            43,171
            
            
            
            38,197Investment
      securities
            
            
            1,624
            
            
            
            2,260Loan
      to ESOP
            
            
            2,163
            
            
            
            2,335Deferred
      income taxes
            
            
            252
            
            
            
            274Other
      assets
            
            
            671
            
            
            
            717Total
      assets
            
            $
            50,315
            
            
            $
            45,655LIABILITIES
      AND STOCKHOLDERS' EQUITYLiabilities
            
            $
            7
            
            
            $
            67Stockholders'
      equity
            
            
            50,308
            
            
            
            45,588Total
      liabilities and stockholders' equity
            
            $
            50,315
            
            
            $
            45,655








Statements of
Income





For the
Year Ended December 31, 2009, 2008 and 2007:





For
      the Years Ended December 31,(In
      thousands)
            
            2009
            
            
            2008
            
            
            2007Interest
      income
            
            $
            181
            
            
            $
            224
            
            
            $
            351Other
      income
            
            
            -
            
            
            
            1
            
            
            
            1Total
      income
            
            
            181
            
            
            
            225
            
            
            
            352Other
      expense
            
            
            577
            
            
            
            476
            
            
            
            313Income
      (loss) before income tax and equity in undistributed net income of
      subsidiary
            
            
            (396
            )
            
            
            (251
            )
            
            
            39Income
      tax (benefit)
            
            
            (134
            )
            
            
            (85
            )
            
            
            13Income
      (loss) before equity in undistributed net income of
    subsidiary
            
            
            (262
            )
            
            
            (166
            )
            
            
            26Equity
      in undistributed net income (loss) of subsidiary
            
            
            2,255
            
            
            
            (146
            )
            
            
            1,394Net
      income (loss)
            
            $
            1,993
            
            
            $
            (312
            )
            
            $
            1,420





F-40











Statements of Cash
flows





For the
Year Ended December 31, 2009, 2008 and 2007:





For
      the Years Ended December 31,(In
      thousands)
            
            2009
            
            
            2008
            
            
            2007Net
      cash provided by operating activities
            
            $
            61
            
            
            $
            240
            
            
            $
            438Cash
      flows from investing activitiesPurchase
      of available-for-sale securities
            
            
            -
            
            
            
            -
            
            
            
            (1,500
            )Paydowns
      and maturities of available-for-sale securities
            
            
            689
            
            
            
            497
            
            
            
            4,234Principal
      payments received from ESOP
            
            
            172
            
            
            
            163
            
            
            
            156Net
      cash provided by investing activities
            
            
            861
            
            
            
            660
            
            
            
            2,890Cash
      flows from financing activitiesCommon
      stock repurchased
            
            
            (25
            )
            
            
            (2,244
            )
            
            
            (2,430
            )Cash
      dividends to common shareholders
            
            
            (447
            )
            
            
            (614
            )
            
            
            (588
            )Release
      of ESOP shares
            
            
            112
            
            
            
            169
            
            
            
            227Net
      cash used by financing activities
            
            
            (360
            )
            
            
            (2,689
            )
            
            
            (2,791
            )Increase
      (decrease) in cash and cash equivalents
            
            
            562
            
            
            
            (1,789
            )
            
            
            537Cash
      and cash equivalents at beginning of year
            
            
            1,872
            
            
            
            3,661
            
            
            
            3,124Cash
      and cash equivalents at end of year
            
            $
            2,434
            
            
            $
            1,872
            
            
            $
            3,661Supplemental
      Disclosures:Cash
      paid during the year for:Interest
            
            $
            -
            
            
            $
            -
            
            
            $
            -Income
      taxes
            
            
            -
            
            
            
            -
            
            
            
            -




F-41





SIGNATURES





Pursuant to the requirements of Section
13 or 15(d) 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.





NAUGATUCK
      VALLEY FINANCIAL CORPORATIONDate:
      March 30, 2010
            By:
            /s/ John C. RomanJohn
      C. RomanPresident
      and Chief Executive Officer





Pursuant to the requirements of the
Exchange Act, this report has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates
indicated.





Name
            
            Title
            
            Date/s/ John C. Roman
            
            President,
      Chief Executive Officer
            
            March
      30, 2010John
      C. Roman
            
            and
      Director(principal
      executive officer)/s/ Lee R. Schlesinger
            
            Senior
      Vice President and Chief
            
            March
      30, 2010Lee
      R. Schlesinger
            
            Financial
      Officer(principal
      accounting andfinancial
      officer)/s/ Carlos S. Batista
            
            Director
            
            March
      30, 2010Carlos
      S. Batista/s/ Frederick A. Dlugokecki
            
            Director
            
            March
      30, 2010Frederick
      A. Dlugokecki/s/ Richard M. Famiglietti
            
            Director
            
            March
      30, 2010Richard
      M. Famiglietti/s/ James A. Mengacci
            
            Director
            
            March
      30, 2010James
      A. Mengacci/s/ Michael S. Plude
            
            Director
            
            March
      30, 2010Michael
      S. Plude/s/ Camilo P. Vieira
            
            Director
            
            March
      30, 2010Camilo
      P. Vieira/s/ Jane H. Walsh
            
            Director
            
            March
      30, 2010Jane
      H. Walsh