Exhibit 13.0





Annual Report to
Stockholders









Table
of Contents








PageLetters
      to Our Stockholders
                                          
                                          1Selected
      Consolidated Financial and Other Data
                                          
                                          3Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                          
                                          5Management’s
      Report on Internal Control Over Financial Reporting
                                          
                                          27Report
      of Independent Registered Public Accounting Firm
                                          
                                          28Consolidated
      Statements of Financial Condition
                                          
                                          29Consolidated
      Statements of Income
                                          
                                          30Consolidated
      Statements of Changes in Stockholders’ Equity
                                          
                                          31Consolidated
      Statements of Cash Flows
                                          
                                          32Notes
      to Consolidated Financial Statements
                                          
                                          34Directors
      and Officers
                                          
                                          67Investor
      and Corporate Information
                                          
                                          68Office
      Locations
                                          
                                          69














Naugatuck
Valley Financial Corporation





Naugatuck
Valley Financial Corporation, headquartered in Naugatuck, Connecticut, is the
holding company for Naugatuck Valley Savings and Loan.  A majority of
the outstanding shares of Naugatuck Valley Financial’s common stock is owned by
Naugatuck Valley Mutual Holding Company, the mutual holding company for
Naugatuck Valley Savings.  Naugatuck Valley Savings operates as a
community-oriented financial institution, dedicated to serving the financial
service needs of consumers and businesses with a variety of deposit and loan
products from its ten full-service banking offices in the Greater Naugatuck
Valley Region of southwestern Connecticut.


















Dear
Stockholders,





In the
face of significant global economic challenges we are pleased to report
continued strong core results for Naugatuck Valley Financial Corporation in
2008.





Throughout
the world decreasing asset values caused by the subprime mortgage crisis and the
resulting reduction in economic activity has negatively affected the operating
results and capital strength of many formerly highly regarded corporations. The
list of corporations affected include, but also go well beyond, the financial
services industry.





As the
economy expanded rapidly over the past decade, our adherence to conservative
banking standards has allowed us to maintain strong asset quality and grow core
earnings. This has enabled Naugatuck Valley Financial Corporation to remain well
capitalized. In turn our capital strength has allowed us to withstand a
write-down totaling $3.4 million in an investment in Fannie Mae without falling
below well capitalized standards.





During
2008 we grew assets by $73 million and loans increased $72 million. This
increase in loans was funded by a $42 million increase in deposits combined with
a $34 million increase in effectively priced borrowings. Operations in 2008
produced a net loss of $312,000 after the Fannie Mae write-down and related tax
effects. However core earnings before the Fannie Mae write-down increased 37% to
$2 million compared to $1.4 million in 2007. The progress we made in 2008 was a
result of the support of our loyal customers and the efforts of our dedicated
staff and Board.





We opened
a new branch office in 2008, taking advantage of a competitor’s branch closing
in the Heritage Village section of Southbury, CT.  We also increased
customer convenience by making significant upgrades to our internet banking
site, including new services that provide for online opening of deposit accounts
and loan applications.





I would
like to recognize the contributions of Ronald D. Lengyel as he retires from the
Board after 49 years of service to the Bank as President and CEO and Chairman of
the Board. Ron’s vision and skills have been an important ingredient in the
success of Naugatuck Valley Savings and Loan, and Naugatuck Valley Financial
Corporation. We look forward to Ron’s continued contributions as a Director
Emeritus.





We fully
expect economic challenges to continue in 2009 and beyond. However, we are
extremely confident that our capital, asset quality and strategic plan will
allow us to continue to face these challenges and take advantage of the
opportunities that lie ahead.





We value
the continued support of our stockholders.








Sincerely
Yours,








John C.
Roman


President
and CEO





















Dear
Stockholders,





As I
approach retirement from the Board of Directors, I would like to say that I have
been honored to have been associated with Naugatuck Valley Financial Corporation
and Naugatuck Valley Savings and Loan for the past 49 years.  I am
proud of the bank and my part in its success.





When I
joined the bank in 1960 assets totaled $7 million and we had 6
employees.  We operated out of an 1,100 square foot store front on
Maple street.  Our product offerings consisted of a savings passbook
and a fixed rate mortgage.  We were focused on providing a safe place
for people of ordinary means to save and obtain the financing needed to achieve
the dream of home ownership.





In 1970 I
became the managing officer of the bank.  At that time assets were $16
million and we employed 14 persons.  Three years later we opened our
first branch office on the east side of Naugatuck.  By 1999 we had
grown to $165 million in assets and 40 employees.  I retired in 1999
and became Chairman of the Board.





Over the
past 10 years we have continued to grow.  In 2004 we formed our Mutual
Holding Company and became partially publically owned.  We now operate
10 offices and our assets exceed $500 million.





The
success of the bank would not have been possible if not for the dedication of
the Directors, Officers and Staff of the Bank and I thank them
all.  Most of all I would like to thank my family, and especially my
wife Barbara for her patience throughout the years.





Having
built a solid foundation, the future is bright for Naugatuck Valley Savings and
Loan.  I look forward to continuing to provide guidance to the Board
and the Bank Officers as a Director Emeritus.








Sincerely,








Ronald D.
Lengyel


Chairman
of the Board










Selected
Consolidated Financial and Other 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.








At
      December 31,2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005
                  
                  
                  2004(In
      thousands)Financial
      Condition Data:Total
      assets
                  
                  $
                  535,386
                  
                  
                  $
                  462,527
                  
                  
                  $
                  413,855
                  
                  
                  $
                  355,346
                  
                  
                  $
                  265,449Securities
      held to maturity
                  
                  
                  -
                  
                  
                  
                  1,190
                  
                  
                  
                  2,531
                  
                  
                  
                  5,002
                  
                  
                  
                  5,168Securities
      available for sale
                  
                  
                  63,844
                  
                  
                  
                  65,264
                  
                  
                  
                  67,736
                  
                  
                  
                  58,047
                  
                  
                  
                  31,096Loans
      receivable, net
                  
                  
                  431,976
                  
                  
                  
                  359,831
                  
                  
                  
                  308,376
                  
                  
                  
                  259,427
                  
                  
                  
                  203,820Cash
      and cash equivalents
                  
                  
                  8,247
                  
                  
                  
                  8,370
                  
                  
                  
                  7,942
                  
                  
                  
                  8,951
                  
                  
                  
                  7,575Deposits
                  
                  
                  363,026
                  
                  
                  
                  321,398
                  
                  
                  
                  289,198
                  
                  
                  
                  240,846
                  
                  
                  
                  193,366Borrowed
      funds
                  
                  
                  119,148
                  
                  
                  
                  85,107
                  
                  
                  
                  68,488
                  
                  
                  
                  57,059
                  
                  
                  
                  15,826Total
      capital
                  
                  
                  45,589
                  
                  
                  
                  50,457
                  
                  
                  
                  51,084
                  
                  
                  
                  50,964
                  
                  
                  
                  51,571





Year
      Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005
                  
                  
                  2004(In
      thousands, except per share data)Operating
      Data:Interest
      and dividend income
                  
                  $
                  28,203
                  
                  
                  $
                  25,030
                  
                  
                  $
                  20,750
                  
                  
                  $
                  15,908
                  
                  
                  $
                  12,713Interest
      expense
                  
                  
                  13,904
                  
                  
                  
                  13,174
                  
                  
                  
                  9,350
                  
                  
                  
                  4,941
                  
                  
                  
                  3,559Net
      interest income
                  
                  
                  14,299
                  
                  
                  
                  11,856
                  
                  
                  
                  11,400
                  
                  
                  
                  10,967
                  
                  
                  
                  9,154Provision
      for loan losses
                  
                  
                  675
                  
                  
                  
                  151
                  
                  
                  
                  192
                  
                  
                  
                  32
                  
                  
                  
                  –Net
      interest income after provision for loan losses
                  
                  
                  13,624
                  
                  
                  
                  11,705
                  
                  
                  
                  11,208
                  
                  
                  
                  10,935
                  
                  
                  
                  9,154Noninterest
      income (loss)
                  
                  
                  (1,048
                  )
                  
                  
                  2,354
                  
                  
                  
                  1,948
                  
                  
                  
                  1,517
                  
                  
                  
                  1,078Noninterest
      expense
                  
                  
                  13,454
                  
                  
                  
                  12,422
                  
                  
                  
                  11,504
                  
                  
                  
                  10,097
                  
                  
                  
                  9,803Income
      (loss) before tax provision (benefit)
                  
                  
                  (878
                  )
                  
                  
                  1,637
                  
                  
                  
                  1,652
                  
                  
                  
                  2,355
                  
                  
                  
                  429Income
      tax provision (benefit)
                  
                  
                  (566
                  )
                  
                  
                  217
                  
                  
                  
                  204
                  
                  
                  
                  450
                  
                  
                  
                  14Net
      income (loss)
                  
                  $
                  (312
                  )
                  
                  $
                  1,420
                  
                  
                  $
                  1,448
                  
                  
                  $
                  1,905
                  
                  
                  $
                  415Earnings
      (loss) per share, basic and diluted
                  
                  $
                  (0.05
                  )
                  
                  $
                  0.20
                  
                  
                  $
                  0.20
                  
                  
                  $
                  0.26
                  
                  
                  $
                  0.07
                  (1)





(1)
            Net
      income per share is for the fourth quarter of 2004.  Before
      September 30, 2004, Naugatuck Valley Financial did not exist and Naugatuck
      Valley Savings operated as a mutual institution and, accordingly, had no
      per share data.





3




At
      or For the Year Ended December 31,2008
                
                
                2007
                
                
                2006
                
                
                2005
                
                
                2004Performance
      Ratios:Return
      (loss) on average assets
                
                
                (0.06
                )%
                
                
                0.33
                %
                
                
                0.38
                %
                
                
                0.62
                %
                
                
                0.16
                %Return
      (loss) on average equity
                
                
                (0.64
                )
                
                
                2.77
                
                
                
                2.79
                
                
                
                3.66
                
                
                
                1.42Interest
      rate spread (1)
                
                
                2.88
                
                
                
                2.76
                
                
                
                3.07
                
                
                
                3.68
                
                
                
                3.78Net
      interest margin (2)
                
                
                3.02
                
                
                
                2.95
                
                
                
                3.26
                
                
                
                3.87
                
                
                
                3.85Noninterest
      expense to average assets
                
                
                2.66
                
                
                
                2.86
                
                
                
                3.03
                
                
                
                3.27
                
                
                
                3.81Efficiency
      ratio (3)
                
                
                101.28
                
                
                
                87.18
                
                
                
                85.93
                
                
                
                80.61
                
                
                
                95.47Dividend
      payout ratio (4)
                
                
                N/M
                
                
                
                100.00
                
                
                
                100.00
                
                
                
                61.54
                
                
                
                –Average
      interest-earning assets to average interest-bearing
      liabilities
                
                
                104.46
                
                
                
                105.65
                
                
                
                107.18
                
                
                
                111.20
                
                
                
                104.98Average
      equity to average assets
                
                
                9.71
                
                
                
                11.80
                
                
                
                13.65
                
                
                
                16.87
                
                
                
                11.37Capital
      Ratios:Total
      capital to risk-weighted assets
                
                
                11.09
                %
                
                
                12.88
                %
                
                
                14.29
                %
                
                
                17.88
                %
                
                
                23.61
                %Tier
      1 capital to risk-weighted assets
                
                
                10.36
                
                
                
                12.22
                
                
                
                13.56
                
                
                
                17.07
                
                
                
                22.52Tier
      1 capital to adjusted total assets
                
                
                7.58
                
                
                
                8.81
                
                
                
                9.53
                
                
                
                11.42
                
                
                
                14.78Total
      equity to total assets
                
                
                8.52
                
                
                
                10.91
                
                
                
                12.34
                
                
                
                14.34
                
                
                
                19.43Asset
      Quality Ratios:Allowance
      for loan losses as a percent of total loans
                
                
                0.66
                %
                
                
                0.60
                %
                
                
                0.67
                %
                
                
                0.72
                %
                
                
                0.89
                %Allowance
      for loan losses as a percent of nonperforming loans
                
                
                107.13
                
                
                
                222.99
                
                
                
                103.03
                
                
                
                638.78
                
                
                
                306.88Net
      charge-offs (recoveries) to average loans outstanding during the
      period
                
                
                (0.01
                )
                
                
                0.02
                
                
                
                0.00
                
                
                
                0.01
                
                
                
                (0.01
                )Nonperforming
      loans as a percent of total loans
                
                
                0.62
                
                
                
                0.27
                
                
                
                0.65
                
                
                
                0.11
                
                
                
                0.29Nonperforming
      assets as a percent of total assets
                
                
                0.50
                
                
                
                0.21
                
                
                
                0.49
                
                
                
                0.10
                
                
                
                0.25Other
      Data:Number
      of:Deposit
      accounts
                
                
                30,721
                
                
                
                29,489
                
                
                
                27,385
                
                
                
                25,592
                
                
                
                22,599Full
      service customer service facilities
                
                
                10
                
                
                
                9
                
                
                
                9
                
                
                
                6
                
                
                
                5





(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.





4


Management’s
Discussion and Analysis of


Financial
Condition and Results of Operations





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.





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 2 and 4
of the notes to the financial statements included in this annual
report.





5




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 11 of the notes to the financial statements in this
annual report.





Operating
Strategy





The
subprime mortgage crisis and the current economic slowdown have caused us to
adjust but not significantly change our operating strategies.





Naugatuck
Valley Savings and Loan’s goal continues to be to increase shareholder value
by:





●
            maintaining
      strong capital levels,




●
            growing
      loans while maintaining strong credit
quality,




●
            growing
      deposits,




●
            controlling
      costs,




●
            expanding
      our market area, and




●
            utilizing
      capital market tools.




Maintaining
strong capital levels is imperative in this economic environment.  We
have maintained well capitalized levels despite write-downs totaling $3.4
million related to our holdings of auction rate securities backed by FNMA
preferred stock. After the write-downs, the carrying value of the auction rate
pass through certificates with Fannie Mae preferred stock as underlying
collateral have been written down to $73,000.  The credit quality of
our loan portfolios and our level of loan loss reserves also serves to protect
our capital levels.





During
2008 our loan balances increased over $72.1 million with most of the increase
seen in commercial loans. We expect loans to continue to grow in 2009 although
at a slower pace than 2008. We increased lending through the sales efforts of
our experienced loan officers and by offering competitive rates. We plan to
continue to utilize the effective underwriting standards we have maintained in
the past which have resulted in low delinquency levels and low
charge-offs.  We have also allocated funds to our loan loss reserve to
reflect the growth of our loan portfolios and the challenging economic
conditions in our market areas.





Deposit
levels increased by $41.6 million in 2008 as a result of competitive rates,
customer incentives and our superior customer service. We expect to continue to
increase deposits in 2009.  We maintain a competitive posture on
certificate of deposit rates and have offered incentives to customers who open
core savings and demand deposit accounts. In 2008 we offered $50 to new demand
deposit account customers plus a gas card for the added commitment of direct
deposit of payroll or social security payments. We plan to continue and increase
these incentives in 2009 in recognition of the value which core deposits bring
to the Bank. Recently we enhanced the capability of our internet banking system
by adding functions which enable customers to apply for loans and open deposit
accounts online. Our introduction of remote deposit capabilities has increased
convenience for our commercial checking account customers. We have also
successfully marketed our HSA Product (accounts designed to help individuals
save for future qualified medical and retiree health expenses on a tax free
basis) and have also increased  lower cost municipal deposits during
2008.





While we
grew assets by 15% in 2008, operating expense increases were limited to
8%.  Expenses related to our frozen defined benefit plan continue to
decrease and we have decreased advertising expenses by utilizing a more
efficient use of targeted media. We have also controlled the costs of health
insurance for our employees through the use of health reimbursement
accounts.





6




Net
interest income increased in 2008 as a result of our growth and improvement in
the yield curve. We continue to closely monitor our interest rate risk which has
been controlled through the offering of favorable rates on longer term
certificates of deposit and by borrowing from the Federal Home Loan Bank on
longer terms. At the same time we have grown shorter term assets such as
commercial loans.





In order
to decrease our reliance on net interest income for profitability we have also
built increasing amounts of non-interest income over the past few years. We earn
non-interest income primarily through the collection of checking account fees,
reverse mortgage fees, brokerage of mortgage loans and investment advisory
services.





During
2008 we opened a full service branch in the Heritage Village section of
Southbury, CT.  This branch has improved our access to and has
increased banking convenience for the residents of the Heritage Village
Condominium Development. Heritage Village is a 2,500 unit condominium project
which houses 4,000 residents. We continue to view our de novo branching strategy
as a way to increase loans and deposits and expand our market area. Overall we
have increased the number of customers and the number of products sold per
customer through effective utilization of our ten branches and through the sales
efforts of our employees.





We took
advantage of the reduced price of our stock in 2008 by repurchasing 241,840
shares of Naugatuck Valley Financial Corporation stock at an average price of
$9.22. Stock repurchases serve to increase value for the remaining minority
shareholders.





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, 2008, real estate
loans totaled $372.8 million, or 85.4% of total loans compared to $304.9
million, or 83.8% of total loans at December 31, 2007.  Real
estate loans have increased due to favorable interest rates together with
significant real estate development in our market area.





The
largest segment of our real estate loan portfolio is one- to four-family
residential loans.  At December 31, 2008, these loans totaled $216.2
million and represented 58.0% of real estate loans and 49.5% of total loans
compared to $193.8 million, which represented 63.6% of real estate loans and
53.2% of total loans, at December 31, 2007.  One- to four-family
residential loans increased $22.4 million, or 11.6%, from December 31, 2007 to
December 31, 2008, 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 $106.0 million and
represented 28.4% of real estate loans and 24.3% of total loans at December 31,
2008, compared to $70.0 million, which represented 23.0% of real estate loans
and 19.2% of total loans, at December 31, 2007.  Multi-family and
commercial real estate loans increased $36.0 million, or 51.4%, for the year
ended December 31, 2008 due to the efforts of our business development officers
to grow market share and attract new customers.





We also
originate construction loans secured by residential and commercial real
estate.  These loans were $50.6 million and represented 13.6% of real
estate loans and 11.6% of total loans at December 31, 2008, compared to $41.0
million, which represented 13.5% of real estate loans and 11.3% of total loans
at December 31, 2007.  Construction loans increased $9.6 million,
or 23.3%, for the year ended December 31, 2008 primarily due to increased 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 $22.6 million,
and represented 5.2% of total loans at December 31, 2008, compared to $16.7
million, representing 4.6% of total loans, at December 31,
2007.





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 $41.3 million and represented
9.4% of total loans at December 31, 2008, compared to $42.4 million, which
represented 11.6% of total loans at December 31, 2007.  The $1.1
million, or 2.7%, decrease for the year ended December 31, 2008 was due to
declining demand for this type of product.


7




The
following table sets forth the composition of our loan portfolio at the dates
indicated.




At
      December 31,2008
                        
                        
                        2007
                        
                        
                        2006
                        
                        
                        2005
                        
                        
                        2004Amount
                        
                        
                        Percent
                        
                        
                        Amount
                        
                        
                        Percent
                        
                        
                        Amount
                        
                        
                        Percent
                        
                        
                        Amount
                        
                        
                        Percent
                        
                        
                        Amount
                        
                        
                        Percent(Dollars
      in thousands)Real
      estate loans:One-
      to four-family
                        
                        $
                        216,201
                        
                        
                        
                        49.51
                        %
                        
                        $
                        193,787
                        
                        
                        
                        53.24
                        %
                        
                        $
                        179,374
                        
                        
                        
                        57.27
                        %
                        
                        $
                        156,900
                        
                        
                        
                        59.44
                        %
                        
                        $
                        134,785
                        
                        
                        
                        64.75
                        %Construction
                        
                        
                        50,596
                        
                        
                        
                        11.59
                        
                        
                        
                        41,041
                        
                        
                        
                        11.27
                        
                        
                        
                        30,124
                        
                        
                        
                        9.62
                        
                        
                        
                        24,943
                        
                        
                        
                        9.45
                        
                        
                        
                        17,486
                        
                        
                        
                        8.40Multi-family
      and commercial real estate
                        
                        
                        106,028
                        
                        
                        
                        24.28
                        
                        
                        
                        70,051
                        
                        
                        
                        19.25
                        
                        
                        
                        45,879
                        
                        
                        
                        14.65
                        
                        
                        
                        33,608
                        
                        
                        
                        12.73
                        
                        
                        
                        22,559
                        
                        
                        
                        10.84Total
      real estate loans
                        
                        
                        372,825
                        
                        
                        
                        85.38
                        
                        
                        
                        304,879
                        
                        
                        
                        83.76
                        
                        
                        
                        255,377
                        
                        
                        
                        81.54
                        
                        
                        
                        215,451
                        
                        
                        
                        81.62
                        
                        
                        
                        174,830
                        
                        
                        
                        83.99Commercial
      business loans
                        
                        
                        22,567
                        
                        
                        
                        5.17
                        
                        
                        
                        16,690
                        
                        
                        
                        4.59
                        
                        
                        
                        13,508
                        
                        
                        
                        4.31
                        
                        
                        
                        9,728
                        
                        
                        
                        3.69
                        
                        
                        
                        4,989
                        
                        
                        
                        2.40Consumer
      loans:Savings
      accounts
                        
                        
                        1,093
                        
                        
                        
                        0.25
                        
                        
                        
                        1,272
                        
                        
                        
                        0.35
                        
                        
                        
                        634
                        
                        
                        
                        0.20
                        
                        
                        
                        785
                        
                        
                        
                        0.30
                        
                        
                        
                        679
                        
                        
                        
                        0.33Personal
                        
                        
                        262
                        
                        
                        
                        0.06
                        
                        
                        
                        302
                        
                        
                        
                        0.08
                        
                        
                        
                        275
                        
                        
                        
                        0.09
                        
                        
                        
                        212
                        
                        
                        
                        0.08
                        
                        
                        
                        217
                        
                        
                        
                        0.10Automobile
                        
                        
                        271
                        
                        
                        
                        0.06
                        
                        
                        
                        327
                        
                        
                        
                        0.09
                        
                        
                        
                        186
                        
                        
                        
                        0.06
                        
                        
                        
                        160
                        
                        
                        
                        0.06
                        
                        
                        
                        98
                        
                        
                        
                        0.05Home
      equity
                        
                        
                        39,655
                        
                        
                        
                        9.08
                        
                        
                        
                        40,517
                        
                        
                        
                        11.13
                        
                        
                        
                        43,220
                        
                        
                        
                        13.80
                        
                        
                        
                        37,628
                        
                        
                        
                        14.25
                        
                        
                        
                        27,342
                        
                        
                        
                        13.13Total
      consumer loans
                        
                        
                        41,281
                        
                        
                        
                        9.45
                        
                        
                        
                        42,418
                        
                        
                        
                        11.65
                        
                        
                        
                        44,315
                        
                        
                        
                        14.15
                        
                        
                        
                        38,785
                        
                        
                        
                        14.69
                        
                        
                        
                        28,336
                        
                        
                        
                        13.61Total
      loans
                        
                        
                        436,673
                        
                        
                        
                        100.00
                        %
                        
                        
                        363,987
                        
                        
                        
                        100.00
                        %
                        
                        
                        313,200
                        
                        
                        
                        100.00
                        %
                        
                        
                        263,964
                        
                        
                        
                        100.00
                        %
                        
                        
                        208,155
                        
                        
                        
                        100.00
                        %Less:Allowance
      for loan losses
                        
                        
                        2,869
                        
                        
                        
                        
                        
                        
                        
                        2,163
                        
                        
                        
                        
                        
                        
                        
                        2,071
                        
                        
                        
                        
                        
                        
                        
                        1,878
                        
                        
                        
                        
                        
                        
                        
                        1,829Undisbursed
      construction loans
                        
                        
                        1,299
                        
                        
                        
                        
                        
                        
                        
                        1,532
                        
                        
                        
                        
                        
                        
                        
                        2,343
                        
                        
                        
                        
                        
                        
                        
                        2,258
                        
                        
                        
                        
                        
                        
                        
                        2,094Deferred
      loan origination fees
                        
                        
                        529
                        
                        
                        
                        
                        
                        
                        
                        461
                        
                        
                        
                        
                        
                        
                        
                        410
                        
                        
                        
                        
                        
                        
                        
                        401
                        
                        
                        
                        
                        
                        
                        
                        412Loans
      receivable, net
                        
                        $
                        431,976
                        
                        
                        
                        
                        
                        
                        $
                        359,831
                        
                        
                        
                        
                        
                        
                        $
                        308,376
                        
                        
                        
                        
                        
                        
                        $
                        259,427
                        
                        
                        
                        
                        
                        
                        $
                        203,820


8




The
following table sets forth certain information at December 31, 2008 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, 2008Real
      Estate
                    Loans
                  
                  
                  Commercial
                    Business
                    Loans
                  
                  
                  Consumer
                    Loans
                  
                  
                  Total
                    Loans(In
      thousands)One
      year or less
                  
                  $
                  48,478
                  
                  
                  $
                  12,304
                  
                  
                  $
                  20,137
                  
                  
                  $
                  80,919More
      than one year to five years
                  
                  
                  81,416
                  
                  
                  
                  6,963
                  
                  
                  
                  2,659
                  
                  
                  
                  91,038More
      than five years
                  
                  
                  242,931
                  
                  
                  
                  3,300
                  
                  
                  
                  18,485
                  
                  
                  
                  264,716Total
                  
                  $
                  372,825
                  
                  
                  $
                  22,567
                  
                  
                  $
                  41,281
                  
                  
                  $
                  436,673





The
following table sets forth the dollar amount of all loans at December 31, 2008
that are due after December 31, 2009 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
                  
                  $
                  193,760
                  
                  
                  $
                  27,767
                  
                  
                  $
                  221,527Construction
                  
                  
                  5,975
                  
                  
                  
                  591
                  
                  
                  
                  6,566Multi-family
      and commercial
                  
                  
                  6,013
                  
                  
                  
                  90,240
                  
                  
                  
                  96,253Commercial
      business loans
                  
                  
                  4,465
                  
                  
                  
                  5,798
                  
                  
                  
                  10,263Consumer
      loans
                  
                  
                  20,977
                  
                  
                  
                  168
                  
                  
                  
                  21,145Total
                  
                  $
                  231,190
                  
                  
                  $
                  124,564
                  
                  
                  $
                  355,754





The
following table shows loan origination activity during the periods indicated.





Year
      Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006(In
      thousands)Total
      loans at beginning of period
                  
                  $
                  363,987
                  
                  
                  $
                  313,200
                  
                  
                  $
                  263,964Loans
      originated:Real
      estate loans:One-
      to four-family
                  
                  
                  41,472
                  
                  
                  
                  30,172
                  
                  
                  
                  35,330Construction
                  
                  
                  34,459
                  
                  
                  
                  32,913
                  
                  
                  
                  27,288Multi-family
      and commercial
                  
                  
                  40,566
                  
                  
                  
                  30,009
                  
                  
                  
                  15,672Commercial
      business loans
                  
                  
                  15,597
                  
                  
                  
                  10,714
                  
                  
                  
                  8,172Consumer
      loans
                  
                  
                  13,235
                  
                  
                  
                  15,914
                  
                  
                  
                  22,651Total
      loans originated
                  
                  
                  145,329
                  
                  
                  
                  119,722
                  
                  
                  
                  109,113Deduct:Real
      estate loan principal repayments
                  
                  
                  (48,551
                  )
                  
                  
                  (43,595
                  )
                  
                  
                  (38,364
                  )Other
      repayments
                  
                  
                  (24,092
                  )
                  
                  
                  (25,340
                  )
                  
                  
                  (21,513
                  )Net
      loan activity
                  
                  
                  72,686
                  
                  
                  
                  50,787
                  
                  
                  
                  49,236Total
      loans at end of period
                  
                  $
                  436,673
                  
                  
                  $
                  363,987
                  
                  
                  $
                  313,200





The Bank
did not purchase or sell any loans during the periods presented in the table
above.





9




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 collectibility 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, 2008, our allowance for loan losses represented 0.66% of total
gross loans and 107.13% of nonperforming loans compared to 0.60% of total gross
loans and 222.99% of nonperforming loans at December 31, 2007.  The
allowance for loan losses increased $706,000 from $2.2 million at December 31,
2007 to $2.9 million at December 31, 2008.  The increase in the
allowance was largely the result of a $675,000 provision for loan losses made
during 2008.  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 2008 year.  Total nonperforming
loans increased from $970,000 at December 31, 2007, to $2.7 million at December
31, 2008 primarily due to the transfer of three commercial loans secured by real
estate to nonaccrual status during the period.





At
December 31, 2007, our allowance for loan losses represented 0.60% of total
gross loans and 222.99% of nonperforming loans.  The allowance for
loan losses increased $92,000 from December 31, 2006 to December 31,
2007.  The increase in the allowance was largely the result of a
$151,000 provision for loan losses made during 2007.





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 to increase our allowance for loan
losses.





10





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 31,2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005
                  
                  
                  2004(Dollars
      in thousands)Allowance
      at beginning of period
                  
                  $
                  2,163
                  
                  
                  $
                  2,071
                  
                  
                  $
                  1,878
                  
                  
                  $
                  1,829
                  
                  
                  $
                  1,810Provision
      for loan losses
                  
                  
                  675
                  
                  
                  
                  151
                  
                  
                  
                  192
                  
                  
                  
                  32
                  
                  
                  
                  —Less:  Charge
      offs:Real
      estate loans
                  
                  
                  —
                  
                  
                  
                  46
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Commercial
      business loans
                  
                  
                  —
                  
                  
                  
                  5
                  
                  
                  
                  —
                  
                  
                  
                  3
                  
                  
                  
                  51Consumer
      loans
                  
                  
                  7
                  
                  
                  
                  10
                  
                  
                  
                  2
                  
                  
                  
                  1
                  
                  
                  
                  5Total
      charge-offs
                  
                  
                  7
                  
                  
                  
                  61
                  
                  
                  
                  2
                  
                  
                  
                  4
                  
                  
                  
                  56Plus:  Recoveries:Real
      estate loans
                  
                  
                  38
                  
                  
                  
                  1
                  
                  
                  
                  3
                  
                  
                  
                  18
                  
                  
                  
                  43Commercial
      business loans
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  3
                  
                  
                  
                  —Consumer
      loans
                  
                  
                  —
                  
                  
                  
                  1
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  32Total
      recoveries
                  
                  
                  38
                  
                  
                  
                  2
                  
                  
                  
                  3
                  
                  
                  
                  21
                  
                  
                  
                  75Net
      charge-offs (recoveries)
                  
                  
                  (31
                  )
                  
                  
                  59
                  
                  
                  
                  (1
                  )
                  
                  
                  (17
                  )
                  
                  
                  (19
                  )Allowance
      at end of period
                  
                  $
                  2,869
                  
                  
                  $
                  2,163
                  
                  
                  $
                  2,071
                  
                  
                  $
                  1,878
                  
                  
                  $
                  1,829Allowance
      to nonperforming loans
                  
                  
                  107.13
                  %
                  
                  
                  222.99
                  %
                  
                  
                  103.03
                  %
                  
                  
                  638.78
                  %
                  
                  
                  306.88
                  %Allowance
      to total loans outstanding at the end of the period
                  
                  
                  0.66
                  %
                  
                  
                  0.60
                  %
                  
                  
                  0.67
                  %
                  
                  
                  0.72
                  %
                  
                  
                  0.89
                  %Net
      charge-offs (recoveries) to average loans outstanding during the
      period
                  
                  
                  (0.01
                  )%
                  
                  
                  0.02
                  %
                  
                  
                  0.00
                  %
                  
                  
                  (0.01
                  )%
                  
                  
                  (0.01
                  )%


11




The
following table sets forth the breakdown of the allowance for loan losses by
loan category at the dates indicated.





At
      December 31,2008
                          
                          
                          2007
                          
                          
                          2006Amount
                          
                          
                          %
      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
                          
                          $
                          762
                          
                          
                          
                          26.56
                          %
                          
                          
                          49.51
                          %
                          
                          $
                          661
                          
                          
                          
                          30.56
                          %
                          
                          
                          53.24
                          %
                          
                          $
                          718
                          
                          
                          
                          34.67
                          %
                          
                          
                          57.27
                          %Construction
                          
                          
                          621
                          
                          
                          
                          21.65
                          
                          
                          
                          11.59
                          
                          
                          
                          473
                          
                          
                          
                          21.87
                          
                          
                          
                          11.27
                          
                          
                          
                          464
                          
                          
                          
                          22.40
                          
                          
                          
                          9.62Multi-family
      and commercial real estate
                          
                          
                          903
                          
                          
                          
                          31.47
                          
                          
                          
                          24.28
                          
                          
                          
                          495
                          
                          
                          
                          22.88
                          
                          
                          
                          19.25
                          
                          
                          
                          347
                          
                          
                          
                          16.76
                          
                          
                          
                          14.65Commercial
      business
                          
                          
                          251
                          
                          
                          
                          8.75
                          
                          
                          
                          5.17
                          
                          
                          
                          185
                          
                          
                          
                          8.55
                          
                          
                          
                          4.59
                          
                          
                          
                          209
                          
                          
                          
                          10.09
                          
                          
                          
                          4.31Consumer
      loans
                          
                          
                          332
                          
                          
                          
                          11.57
                          
                          
                          
                          9.45
                          
                          
                          
                          349
                          
                          
                          
                          16.14
                          
                          
                          
                          11.65
                          
                          
                          
                          333
                          
                          
                          
                          16.08
                          
                          
                          
                          14.15Unallocated
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Total
      allowance for loan losses
                          
                          $
                          2,869
                          
                          
                          
                          100.00
                          %
                          
                          
                          100.00
                          %
                          
                          $
                          2,163
                          
                          
                          
                          100.00
                          %
                          
                          
                          100.00
                          %
                          
                          $
                          2,071
                          
                          
                          
                          100.00
                          %
                          
                          
                          100.00
                          %








At
      December 31,2005
                
                
                2004Amount
                
                
                %
      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
                
                $
                724
                
                
                
                38.55
                %
                
                
                59.44
                %
                
                $
                864
                
                
                
                47.25
                %
                
                
                64.75
                %Construction
                
                
                376
                
                
                
                20.02
                
                
                
                9.45
                
                
                
                142
                
                
                
                7.76
                
                
                
                8.40Multi-family
      and commercial real estate
                
                
                379
                
                
                
                20.18
                
                
                
                12.73
                
                
                
                374
                
                
                
                20.45
                
                
                
                10.84Commercial
      business
                
                
                113
                
                
                
                6.02
                
                
                
                3.69
                
                
                
                50
                
                
                
                2.73
                
                
                
                2.40Consumer
      loans
                
                
                283
                
                
                
                15.07
                
                
                
                14.69
                
                
                
                302
                
                
                
                16.51
                
                
                
                13.61Unallocated
                
                
                3
                
                
                
                0.16
                
                
                
                —
                
                
                
                97
                
                
                
                5.30
                
                
                
                —Total
      allowance for loan losses
                
                $
                1,878
                
                
                
                100.00
                %
                
                
                100.00
                %
                
                $
                1,829
                
                
                
                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 $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.








12




Nonperforming
assets totaled $970,000, or 0.21% of total assets, at December 31, 2007, which
was a decrease of $1.0 million, or 51.7%, from December 31,
2006.  Nonaccrual loans accounted for 100% of the total nonperforming
assets at December 31, 2007.





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 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,
2008, three 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 31,2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005
                  
                  
                  2004(Dollars
      in thousands)Nonaccrual
      loans:One-
      to four-family
                  
                  $
                  1,100
                  
                  
                  $
                  422
                  
                  
                  $
                  423
                  
                  
                  $
                  165
                  
                  
                  $
                  474Multi-family
      and commercial real estate
                  
                  
                  1,371
                  
                  
                  
                  356
                  
                  
                  
                  1,388
                  
                  
                  
                  120
                  
                  
                  
                  119Commercial
      business
                  
                  
                  142
                  
                  
                  
                  144
                  
                  
                  
                  142
                  
                  
                  
                  9
                  
                  
                  
                  3Consumer
                  
                  
                  65
                  
                  
                  
                  48
                  
                  
                  
                  57
                  
                  
                  
                  —
                  
                  
                  
                  —Total
                  
                  
                  2,678
                  
                  
                  
                  970
                  
                  
                  
                  2,010
                  
                  
                  
                  294
                  
                  
                  
                  596Foreclosed
      real estate
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  47
                  
                  
                  
                  68Total
      nonperforming assets
                  
                  $
                  2,678
                  
                  
                  $
                  970
                  
                  
                  $
                  2,010
                  
                  
                  $
                  341
                  
                  
                  $
                  664Total
      nonperforming loans to total loans
                  
                  
                  0.62
                  %
                  
                  
                  0.27
                  %
                  
                  
                  0.65
                  %
                  
                  
                  0.11
                  %
                  
                  
                  0.29
                  %Total
      nonperforming loans to total assets
                  
                  
                  0.50
                  %
                  
                  
                  0.21
                  %
                  
                  
                  0.49
                  %
                  
                  
                  0.08
                  %
                  
                  
                  0.22
                  %Total
      nonperforming assets to total assets
                  
                  
                  0.50
                  %
                  
                  
                  0.21
                  %
                  
                  
                  0.49
                  %
                  
                  
                  0.10
                  %
                  
                  
                  0.25
                  %





Other
than disclosed in the previous table, there are no other loans at December 31,
2008 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, 2008 and
December 31, 2007 had nonaccruing loans been current according to their
original terms amounted to $140,000 and $45,000, respectively.  Income
related to nonaccrual loans included in interest income for the years ended
December 31, 2008 and December 31, 2007 amounted to $11,000 and $7,000,
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.





13





The
following table shows the aggregate amounts of our classified assets at the
dates indicated.





At
      December 31,2008
                  
                  
                  2007(In
      thousands)Special
      mention assets
                  
                  $
                  30,268
                  
                  
                  $
                  15,408Substandard
      assets
                  
                  
                  10,274
                  
                  
                  
                  2,211Doubtful
      assets
                  
                  
                  4
                  
                  
                  
                  5Loss
      assets
                  
                  
                  —
                  
                  
                  
                  —Total
      classified assets
                  
                  $
                  40,546
                  
                  
                  $
                  17,624





Special
mention assets at December 31, 2008 and December 31, 2007 did not include
any nonaccrual loans. Substandard assets at December 31, 2008 and
December 31, 2007 included nonaccrual loans of $2.7 million and $970,000,
respectively.  Doubtful assets at December 31, 2008 and December 31,
2007 did not include any nonaccrual loans.  Theincrease in loans
classified as special mention in the 2008 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 31,2008
                  
                  
                  2007
                  
                  
                  200631-60
      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
                  
                  $
                  1,000
                  
                  
                  $
                  724
                  
                  
                  $
                  99
                  
                  
                  $
                  950
                  
                  
                  $
                  413
                  
                  
                  $
                  392Multi-family
      and commercial real estate
                  
                  
                  84
                  
                  
                  
                  --
                  
                  
                  
                  880
                  
                  
                  
                  678
                  
                  
                  
                  603
                  
                  
                  
                  664Commercial
      business
                  
                  
                  568
                  
                  
                  
                  7
                  
                  
                  
                  31
                  
                  
                  
                  25
                  
                  
                  
                  262
                  
                  
                  
                  310Consumer
      loans
                  
                  
                  2
                  
                  
                  
                  4
                  
                  
                  
                  11
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  5Total
                  
                  $
                  1,654
                  
                  
                  $
                  735
                  
                  
                  $
                  1,021
                  
                  
                  $
                  1,653
                  
                  
                  $
                  1,278
                  
                  
                  $
                  1,371





Securities.  Our
securities portfolio consists primarily of mortgage-backed securities and
collateralized mortgage obligations with maturities of 30 years or less,
municipal obligations with maturities of 15 years or less, money market
preferred obligations, as well as U.S. Government and agency
obligations.  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.





Securities
decreased by $3.8 million in the year ended December 31, 2007 primarily due to
principal payments received on mortgage-backed securities and investment sales
to meet liquidity needs.





14





The
following table sets forth the amortized costs and fair values of our securities
portfolio at the dates indicated.





At
      December 31,2008
                
                
                2007
                
                
                2006Amortized
                  Cost
                
                
                Fair
                  Value
                
                
                Amortized
                  Cost
                
                
                Fair
                  Value
                
                
                Amortized
                  Cost
                
                
                Fair
                  Value(In
      thousands)Available-for-sale
      securities:U.S.
      Government and agency obligations
                
                $
                1,537
                
                
                $
                1,604
                
                
                $
                2,749
                
                
                $
                2,744
                
                
                $
                8,495
                
                
                $
                8,415Mortgage-backed
      securities
                
                
                42,297
                
                
                
                43,030
                
                
                
                31,352
                
                
                
                31,261
                
                
                
                25,111
                
                
                
                24,782Collateralized
      mortgage obligations
                
                
                3,339
                
                
                
                3,183
                
                
                
                3,547
                
                
                
                3,494
                
                
                
                4,796
                
                
                
                4,694Municipal
      obligations
                
                
                8,888
                
                
                
                8,993
                
                
                
                14,092
                
                
                
                14,075
                
                
                
                15,177
                
                
                
                15,190Money
      market preferred obligations
                
                
                9,273
                
                
                
                6,744
                
                
                
                12,700
                
                
                
                12,700
                
                
                
                12,700
                
                
                
                12,700Corporate
      obligations
                
                
                1,000
                
                
                
                290
                
                
                
                1,000
                
                
                
                990
                
                
                
                1,951
                
                
                
                1,955Held-to-maturity
      securities:U.S.
      Government and agency obligations
                
                
                --
                
                
                
                --
                
                
                
                1,000
                
                
                
                998
                
                
                
                1,201
                
                
                
                1,192Interest-bearing
      balances
                
                
                --
                
                
                
                --
                
                
                
                190
                
                
                
                190
                
                
                
                1,330
                
                
                
                1,330Total
                
                $
                66,334
                
                
                $
                63,844
                
                
                $
                66,630
                
                
                $
                66,452
                
                
                $
                70,761
                
                
                $
                70,258





At
December 31, 2008, 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.





15





The
following table sets forth the final maturities and weighted average yields of
securities at December 31, 2008.  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, 2008,
mortgage-backed securities and collateralized mortgage obligations with
adjustable rates totaled $12.7 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
      Years
                        
                        
                        More
      than
                          Ten
      Years
                        
                        
                        TotalCarrying
                          Value
                        
                        
                        Weighted
                          Average
                          Yield
                        
                        
                        Carrying
                          Value
                        
                        
                        Weighted
                          Average
                          Yield
                        
                        
                        Carrying
                          Value
                        
                        
                        Weighted
                          Average
                          Yield
                        
                        
                        Carrying
                          Value
                        
                        
                        Weighted
                          Average
                          Yield
                        
                        
                        Carrying
                          Value
                        
                        
                        Weighted
                          Average
                          Yield(Dollars
      in thousands)Available-for-sale
      securities:U.S.
      Government and agency obligations
                        
                        $
                        --
                        
                        
                        %
                        
                        
                        $
                        1,079
                        
                        
                        
                        4.38
                        %
                        
                        $
                        525
                        
                        
                        
                        5.55
                        %
                        
                        $
                        --
                        
                        
                        
                        --
                        
                        
                        $
                        1,604
                        
                        
                        
                        4.76
                        %Mortgage-backed
      securities
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        1,164
                        
                        
                        
                        3.50
                        %
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        41,866
                        
                        
                        
                        5.25
                        %
                        
                        
                        43,030
                        
                        
                        
                        5.20
                        %Collateralized
      mortgage obligations
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        3,183
                        
                        
                        
                        3.43
                        %
                        
                        
                        3,183
                        
                        
                        
                        3.43
                        %Municipal
      obligations
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        2,968
                        
                        
                        
                        3.97
                        %
                        
                        
                        6,025
                        
                        
                        
                        4.06
                        %
                        
                        
                        8,993
                        
                        
                        
                        4.03
                        %Money
      market preferred obligations
                        
                        
                        6,744
                        
                        
                        
                        3.98
                        %
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        6,744
                        
                        
                        
                        3.98
                        %Corporate
      obligations
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        290
                        
                        
                        
                        6.00
                        %
                        
                        
                        --
                        
                        
                        
                        --
                        
                        
                        
                        290
                        
                        
                        
                        6.00
                        %Total
      available-for-sale securities
                        
                        $
                        6,744
                        
                        
                        
                        3.98
                        %
                        
                        $
                        2,243
                        
                        
                        
                        3.92
                        %
                        
                        $
                        3,783
                        
                        
                        
                        4.34
                        %
                        
                        $
                        51,074
                        
                        
                        
                        5.00
                        %
                        
                        $
                        63,844
                        
                        
                        
                        4.81
                        %


16




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, 2008, we had no brokered
deposits.  Total deposits increased $41.6 million or 13.0% in the year
ended December 31, 2008.  During that time period, certificate
accounts increased 16.5%, regular savings accounts increased by 16.7%, checking
and NOW accounts increased by 6.1% and money market savings accounts decreased
by 6.1%.  Theincreasein deposits was
primarily due to the opening of our 10th office
in the third quarter of 2008, combined with more aggressive
pricing.  The increase in regular savings accounts was primarily due
to the transfer of funds to other savings products with higher
rates.





The
following table sets forth the balances of our deposit products at the date
indicated.





At
      December 31,2008
                  
                  
                  2007
                  
                  
                  2006(In
      thousands)Certificate
      accounts
                  
                  $
                  235,764
                  
                  
                  $
                  202,411
                  
                  
                  $
                  165,076Regular
      savings accounts
                  
                  
                  48,427
                  
                  
                  
                  41,480
                  
                  
                  
                  46,156Checking
      and NOW accounts
                  
                  
                  52,537
                  
                  
                  
                  49,511
                  
                  
                  
                  57,301Money
      market savings accounts
                  
                  
                  26,298
                  
                  
                  
                  27,996
                  
                  
                  
                  20,665Total
                  
                  $
                  363,026
                  
                  
                  $
                  321,398
                  
                  
                  $
                  289,198





The
following table indicates the amount of jumbo certificate accounts by time
remaining until maturity at December 31, 2008.  Jumbo certificate
accounts require minimum deposits of $100,000.





Maturity Period
                    
                    Certificate
                      Accounts(In
      thousands)Three
      months or less
                    
                    $
                    16,559Over
      three through six months
                    
                    
                    13,778Over
      six through twelve months
                    
                    
                    9,298Over
      twelve months
                    
                    
                    41,160Total
                    
                    $
                    80,795





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, 2008, we had the ability to borrow a total of $3.5 million from a
correspondent bank, $1.3 million of which was borrowed at such
date.  We also use securities sold under agreements to repurchase as a
source of borrowings.





17





The
following table presents certain information regarding our Federal Home Loan
Bank advances during the periods and at the dates indicated.





Year
      Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006(Dollars
      in thousands)Maximum
      amount of advances outstanding at any month end during the
      period
                  
                  $
                  119,628
                  
                  
                  $
                  84,878
                  
                  
                  $
                  70,414Average
      advances outstanding during the period
                  
                  
                  107,182
                  
                  
                  
                  69,866
                  
                  
                  
                  59,423Weighted
      average interest rate during the period
                  
                  
                  4.31
                  %
                  
                  
                  4.89
                  %
                  
                  
                  4.69
                  %Balance
      outstanding at end of period
                  
                  $
                  118,421
                  
                  
                  $
                  84,878
                  
                  
                  $
                  68,488Weighted
      average interest rate at end of period
                  
                  
                  3.80
                  %
                  
                  
                  4.66
                  %
                  
                  
                  4.83
                  %





Equity.  Total
equity decreased by $4.9 million, or 9.6%, to $45.6 million at December 31, 2008
from $50.5 million at December 31, 2007.  The decrease in 2008
resulted from a net loss of $312,000, dividends of $614,000 paid to
stockholders, stock repurchases of $2.2 million, a net increase to the
unrealized loss on available for sale securities of $2.4 million and $676,000 in
capital adjustments related to the Company’s 2005 Equity Incentive
Plan.  Our average equity to average assets ratio was 9.71% at
December 31, 2008, compared to 11.72% at December 31, 2007.





Comparison
of Operating Results for the Years Ended December 31, 2008 and 2007





Overview.





2008
                          
                          2007
                          
                          %
      Change
                            2008/2007(Dollars
      in thousands)Net
      (loss) income
                          
                          $
                          (312
                          )
                          
                          $
                          1,420
                          
                          
                          
                          (121.97
                          )%Return
      (loss) on average assets
                          
                          
                          (0.06
                          )%
                          
                          
                          0.33
                          %
                          
                          
                          (118.18
                          )%Return
      (loss) on average equity
                          
                          
                          (0.64
                          )%
                          
                          
                          2.77
                          %
                          
                          
                          (123.10
                          )%





Net
income for the year ended December 31, 2008 decreased $1.7 million from net
income in 2007.  The decrease resulted primarily from an after tax
OTTI charge of $2.2 million on auction rate pass through certificates with
Fannie Mae preferred stock as underlying collateral.  Other than the
loss on investments, the Company experienced an increase of $524,000 in the
provision for loan losses, anincrease in noninterest
expense of $1.0 million, partially offset by a $2.4 million increase in net
interest income and a $25,000 increase in noninterest income.





Net
Interest Income.





Net
interest income for the year ended December 31, 2008, totaled $14.3 million
compared to $11.9 million for the year ended December 31, 2007, an increase of
$2.4 million or 20.6%.  Theincreasein 2008 was due to
anincreasein the average balance
of interest earning assets of 17.6%, partially offset by adecreasein the average rate
earned on these assets of 27 basis points.





The
increase in interest earning assets is attributed primarily to an increase in
the loan portfolio.  The average balances in the loan portfolio
increased by 19.6% in 2008.  The largest increases were in the
commercial mortgage portfolio followed by the residential mortgage
portfolio.





The
increase in interest income was partially offset by an increase in interest
expense.  Interest expense increased by $730,000, or 5.5% in 2008 due
to increases in the average balances of deposits and borrowings, partially
offset by falling rates on deposits and borrowings.  The average
balances of deposits increased by 11.3% in 2008, and the average balance of
borrowings





18





increased
by 53.7% due to increased loan demand.  We experienced adecrease of 40 basis
points in the average rate paid on deposits and borrowings during
2008.  The largest increases in deposits were in certificates of
deposit, followed by smaller increases in money market accounts and savings
accounts, partially offset by a decrease in checking accounts.  The
increasein
certificates of deposit was partially due to the opening of our 10th office
in the third quarter of 2008, combined with promotional rate
accounts.





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
2008, 2007 and 2006 periods, we held tax-exempt municipal securities with
average balances of $9.9 million, $15.0 million and $9.7 million, respectively,
and during the 2008, 2007 and 2006 periods we held preferred money market
securities with an average balance of $11.9 million, $12.7 million and $8.1
million respectively which recognize a dividends received
deduction.  The yields below do not reflect the tax benefits of these
securities.





19




2008
                                      
                                      
                                      2007
                                      
                                      
                                      2006Average
      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
                                      
                                      $
                                      396,524
                                      
                                      
                                      $
                                      24,556
                                      
                                      
                                      
                                      6.19
                                      %
                                      
                                      $
                                      331,490
                                      
                                      
                                      $
                                      21,681
                                      
                                      
                                      
                                      6.54
                                      %
                                      
                                      $
                                      277,789
                                      
                                      
                                      $
                                      17,506
                                      
                                      
                                      
                                      6.30
                                      %Fed
      Funds sold
                                      
                                      
                                      2,391
                                      
                                      
                                      
                                      57
                                      
                                      
                                      
                                      2.38
                                      
                                      
                                      
                                      2,599
                                      
                                      
                                      
                                      143
                                      
                                      
                                      
                                      5.50
                                      
                                      
                                      
                                      1,407
                                      
                                      
                                      
                                      77
                                      
                                      
                                      
                                      5.47Investment
      securities
                                      
                                      
                                      69,498
                                      
                                      
                                      
                                      3,391
                                      
                                      
                                      
                                      4.88
                                      
                                      
                                      
                                      64,290
                                      
                                      
                                      
                                      2,938
                                      
                                      
                                      
                                      4.57
                                      
                                      
                                      
                                      67,077
                                      
                                      
                                      
                                      2,976
                                      
                                      
                                      
                                      4.44Federal
      Home Loan Bank stock
                                      
                                      
                                      5,735
                                      
                                      
                                      
                                      199
                                      
                                      
                                      
                                      3.47
                                      
                                      
                                      
                                      4,179
                                      
                                      
                                      
                                      268
                                      
                                      
                                      
                                      6.41
                                      
                                      
                                      
                                      3,581
                                      
                                      
                                      
                                      191
                                      
                                      
                                      
                                      5.33Total
      interest-earningassets
                                      
                                      
                                      474,148
                                      
                                      
                                      
                                      28,203
                                      
                                      
                                      
                                      5.95
                                      
                                      
                                      
                                      402,558
                                      
                                      
                                      
                                      25,030
                                      
                                      
                                      
                                      6.22
                                      
                                      
                                      
                                      349,854
                                      
                                      
                                      
                                      20,750
                                      
                                      
                                      
                                      5.93Noninterest-earning
      assets
                                      
                                      
                                      30,910
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      31,629
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      30,084Total
      assets
                                      
                                      $
                                      505,058
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      $
                                      434,187
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      $
                                      379,938Interest-bearing
      liabilities:Certificate
      accounts
                                      
                                      $
                                      216,595
                                      
                                      
                                      $
                                      8,297
                                      
                                      
                                      
                                      3.83
                                      
                                      
                                      $
                                      183,172
                                      
                                      
                                      $
                                      8,414
                                      
                                      
                                      
                                      4.59
                                      
                                      
                                      $
                                      143,007
                                      
                                      
                                      $
                                      5,613
                                      
                                      
                                      
                                      3.92Regular
      savings accounts and escrow
                                      
                                      
                                      48,130
                                      
                                      
                                      
                                      288
                                      
                                      
                                      
                                      0.60
                                      
                                      
                                      
                                      46,093
                                      
                                      
                                      
                                      258
                                      
                                      
                                      
                                      0.56
                                      
                                      
                                      
                                      52,769
                                      
                                      
                                      
                                      418
                                      
                                      
                                      
                                      0.79Checking
      and NOW accounts
                                      
                                      
                                      53,732
                                      
                                      
                                      
                                      159
                                      
                                      
                                      
                                      0.30
                                      
                                      
                                      
                                      56,915
                                      
                                      
                                      
                                      487
                                      
                                      
                                      
                                      0.86
                                      
                                      
                                      
                                      52,682
                                      
                                      
                                      
                                      288
                                      
                                      
                                      
                                      0.55Money
      market savings accounts
                                      
                                      
                                      27,607
                                      
                                      
                                      
                                      527
                                      
                                      
                                      
                                      1.91
                                      
                                      
                                      
                                      24,709
                                      
                                      
                                      
                                      591
                                      
                                      
                                      
                                      2.39
                                      
                                      
                                      
                                      18,356
                                      
                                      
                                      
                                      232
                                      
                                      
                                      
                                      1.26Total
      interest-bearing deposits
                                      
                                      
                                      346,064
                                      
                                      
                                      
                                      9,271
                                      
                                      
                                      
                                      2.68
                                      
                                      
                                      
                                      310,889
                                      
                                      
                                      
                                      9,750
                                      
                                      
                                      
                                      3.14
                                      
                                      
                                      
                                      266,814
                                      
                                      
                                      
                                      6,551
                                      
                                      
                                      
                                      2.46FHLB
      advances
                                      
                                      
                                      107,182
                                      
                                      
                                      
                                      4,615
                                      
                                      
                                      
                                      4.31
                                      
                                      
                                      
                                      69,866
                                      
                                      
                                      
                                      3,414
                                      
                                      
                                      
                                      4.89
                                      
                                      
                                      
                                      59,423
                                      
                                      
                                      
                                      2,789
                                      
                                      
                                      
                                      4.69Other
      borrowings
                                      
                                      
                                      654
                                      
                                      
                                      
                                      18
                                      
                                      
                                      
                                      2.75
                                      
                                      
                                      
                                      290
                                      
                                      
                                      
                                      10
                                      
                                      
                                      
                                      3.45
                                      
                                      
                                      
                                      193
                                      
                                      
                                      
                                      10
                                      
                                      
                                      
                                      5.17Total
      interest-bearing liabilities
                                      
                                      
                                      453,900
                                      
                                      
                                      
                                      13,904
                                      
                                      
                                      
                                      3.06
                                      
                                      
                                      
                                      381,045
                                      
                                      
                                      
                                      13,174
                                      
                                      
                                      
                                      3.46
                                      
                                      
                                      
                                      326,431
                                      
                                      
                                      
                                      9,350
                                      
                                      
                                      
                                      2.86Noninterest-bearing
      liabilities
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      1,899
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      1,639Total
      liabilities
                                      
                                      
                                      2,138
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      382,944
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      328,070Stockholders’
      equity
                                      
                                      
                                      49,020
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      51,243
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      51,868Total
      liabilities and stockholders’ equity
                                      
                                      $
                                      505,058
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      $
                                      434,187
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      $
                                      379,938Net
      interest income
                                      
                                      
                                      
                                      
                                      
                                      $
                                      14,299
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      $
                                      11,856
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      $
                                      11,400Interest
      rate spread
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      2.88
                                      %
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      2.76
                                      %
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      3.07
                                      %Net
      interest margin
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      3.02
                                      %
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      2.95
                                      %
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      3.26
                                      %Average
      interest-earning assets to average interest-bearing
      liabilities
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      104.46
                                      %
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      105.65
                                      %
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      107.18
                                      %


20




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.





2008
      Compared to 2007
                  
                  
                  2007
      Compared to 2006Increase
      (Decrease)
                    Due
      to
                  
                  
                  Increase
      (Decrease)
                    Due
      toVolume
                  
                  
                  Rate
                  
                  
                  Net
                  
                  
                  Volume
                  
                  
                  Rate
                  
                  
                  Net(In
      thousands)Interest
      income:Loans
                  
                  $
                  3,943
                  
                  
                  $
                  (1,068
                  )
                  
                  $
                  2,875
                  
                  
                  $
                  3,491
                  
                  
                  $
                  684
                  
                  
                  $
                  4,175Fed
      Funds sold
                  
                  
                  (11
                  )
                  
                  
                  (75
                  )
                  
                  
                  (86
                  )
                  
                  
                  66
                  
                  
                  
                  -
                  
                  
                  
                  66Investment
      securities
                  
                  
                  247
                  
                  
                  
                  206
                  
                  
                  
                  453
                  
                  
                  
                  (137
                  )
                  
                  
                  99
                  
                  
                  
                  (38
                  )Federal
      Home Loan Bank stock
                  
                  
                  297
                  
                  
                  
                  (366
                  )
                  
                  
                  (69
                  )
                  
                  
                  35
                  
                  
                  
                  42
                  
                  
                  
                  77Total
      interest income
                  
                  
                  4,476
                  
                  
                  
                  (1,303
                  )
                  
                  
                  3,173
                  
                  
                  
                  3,455
                  
                  
                  
                  825
                  
                  
                  
                  4,280Interest
      expense:Certificate
      accounts
                  
                  
                  (1,302
                  )
                  
                  
                  1,185
                  
                  
                  
                  (117
                  )
                  
                  
                  1,744
                  
                  
                  
                  1,057
                  
                  
                  
                  2,801Regular
      savings accounts
                  
                  
                  12
                  
                  
                  
                  18
                  
                  
                  
                  30
                  
                  
                  
                  (48
                  )
                  
                  
                  (112
                  )
                  
                  
                  (160
                  )Checking
      and NOW accounts
                  
                  
                  (26
                  )
                  
                  
                  (302
                  )
                  
                  
                  (328
                  )
                  
                  
                  25
                  
                  
                  
                  174
                  
                  
                  
                  199Money
      market savings accounts
                  
                  
                  89
                  
                  
                  
                  (153
                  )
                  
                  
                  (64
                  )
                  
                  
                  100
                  
                  
                  
                  259
                  
                  
                  
                  359Total
      deposit expense
                  
                  
                  (1,227
                  )
                  
                  
                  748
                  
                  
                  
                  (479
                  )
                  
                  
                  1,821
                  
                  
                  
                  1,378
                  
                  
                  
                  3,199FHLB
      advances
                  
                  
                  1,545
                  
                  
                  
                  (344
                  )
                  
                  
                  1,201
                  
                  
                  
                  506
                  
                  
                  
                  119
                  
                  
                  
                  625Other
      borrowings
                  
                  
                  10
                  
                  
                  
                  (2
                  )
                  
                  
                  8
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
      interest expense
                  
                  
                  328
                  
                  
                  
                  402
                  
                  
                  
                  730
                  
                  
                  
                  2,327
                  
                  
                  
                  1,497
                  
                  
                  
                  3,824Net
      interest income
                  
                  $
                  4,148
                  
                  
                  $
                  (1,705
                  )
                  
                  $
                  2,443
                  
                  
                  $
                  1,128
                  
                  
                  $
                  (672
                  )
                  
                  $
                  456





Provision
for Loan Losses.





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.





During
the year ended December 31, 2007, a $151,000 provision was made to the allowance
for loan losses.  The provision was primarily due to the increasing
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 a
small adjustment to the factor used for general economic
conditions.





21





Noninterest
Income.  The
following table shows the components of noninterest income and the percentage
changes from 2008 to 2007.





2008
                      
                      
                      2007
                      
                      
                      % Change 2008/2007Fees
      for services related to deposit accounts
                      
                      $
                      1,053
                      
                      
                      $
                      955
                      
                      
                      
                      10.26
                      %Fees
      for other services
                      
                      
                      529
                      
                      
                      
                      559
                      
                      
                      
                      (5.37
                      )Income
      from bank owned life insurance
                      
                      
                      315
                      
                      
                      
                      308
                      
                      
                      
                      2.27Income
      from investment advisory services, net
                      
                      
                      299
                      
                      
                      
                      260
                      
                      
                      
                      15.00(Loss)
      gain on investments
                      
                      
                      (3,398
                      )
                      
                      
                      65
                      
                      
                      
                      (5,327.69
                      )Other
      income
                      
                      
                      154
                      
                      
                      
                      207
                      
                      
                      
                      (25.60
                      )Total
                      
                      $
                      (1,048
                      )
                      
                      $
                      2,354
                      
                      
                      
                      (144.52
                      )%





For the
year ended December 31, 2008, noninterest income decreased 144.5% to ($1.0)
million, compared to $2.4 million for 2007.  The largest decrease in
noninterest income was the loss on investments, primarily from an OTTI charge of
$3.4 million on auction rate pass through certificates with Fannie Mae preferred
stock as underlying collateral, which was partially offset by a small gain. The
largest increases in noninterest income were in income from investment advisory
services and fees related to deposit accounts, as a result of product growth in
these areas.





In late
February 2009, the Federal Home Loan Bank of Boston announced that it was
suspending dividends based on the results from the fourth quarter of
2008.  They also stated that, based on current information, dividend
payments in 2009 are unlikely.  As a result of this announcement, the
Bank may be subject to a reduction in non-interest income of approximately
$180,000 in 2009.





Noninterest
Expense.The
following table shows the components of noninterest expense and the percentage
changes from 2008 to 2007.





2008
                  
                  
                  2007
                  
                  
                  % Change 2008/2007Compensation,
      taxes and benefits
                  
                  $
                  7,521
                  
                  
                  $
                  6,914
                  
                  
                  
                  8.78
                  %Office
      occupancy
                  
                  
                  2,173
                  
                  
                  
                  1,966
                  
                  
                  
                  10.53Computer
      processing
                  
                  
                  861
                  
                  
                  
                  733
                  
                  
                  
                  17.46Advertising
                  
                  
                  534
                  
                  
                  
                  594
                  
                  
                  
                  (10.10
                  )Professional
      fees
                  
                  
                  518
                  
                  
                  
                  504
                  
                  
                  
                  2.78Directors
      compensation
                  
                  
                  493
                  
                  
                  
                  494
                  
                  
                  
                  (0.20
                  )Office
      supplies
                  
                  
                  195
                  
                  
                  
                  201
                  
                  
                  
                  (2.99
                  )Charitable
      contributions
                  
                  
                  47
                  
                  
                  
                  31
                  
                  
                  
                  51.61Loss
      on foreclosed real estate, net
                  
                  
                  1
                  
                  
                  
                  -
                  
                  
                  
                  N/AOther
      expenses (1)
                  
                  
                  1,111
                  
                  
                  
                  985
                  
                  
                  
                  12.79Total
                  
                  $
                  13,454
                  
                  
                  $
                  12,422
                  
                  
                  
                  8.31
                  %





(1)
            Other
      expenses for all periods include, among other items, insurance, postage
      and expenses related to checking
accounts.





Noninterest
expense was $13.5 million for the year ended December 31, 2008, compared to
$12.4 million for 2007.  The increase was primarily the result of
increases in compensation costs, computer processing costs and office occupancy
expenses over the 2007 period, all primarily resulting from the opening of a new
branch office in 2008.





22




Deposit
insurance expense is included in other expenses in the table above.On February
27, 2009, the Federal Deposit Insurance Corporation took action designed to
allow the Deposit Insurance Fund to withstand the problems facing the banking
industry.  The proposed action will impose a special emergency assessment
on all insured banks amounting up to 20 basis points on insured deposits as of
June 30, 2009 and payable on September 30, 2009.  As a result of this
action, the Bank may be subject to a potential special emergency assessment of
up to $775,000.  In addition, the Bank expects Federal Deposit Insurance
Corporation assessments to increase an additional $275,000 in 2009 as a result
of the across the board seven basis point increase adopted for
2009.





Income
Taxes





During
the year ended December 31, 2008, the Company recorded a tax benefit of $566,000
resulting primarily from the OTTI charge on auction rate pass through
certificates with Fannie Mae preferred stock as underlying
collateral.  Excluding the tax benefit for the OTTI charge, the
effective tax rate for 2008 was 23.5%, compared with 13.3% for
2007.  See note 11 to the financial statements in this annual
report.








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 our net
portfolio value at December 31, 2008 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.





23








Net
      Portfolio Value
                  
                  
                  Net
      Portfolio Value as % of
                    Present
      Value of AssetsBasis
      Point (“bp”)
                    Change
      in Rates
                  
                  $
      Amount
                  
                  
                  $
      Change
                  
                  
                  %
      Change
                  
                  
                  NPV
      Ratio
                  
                  
                  Change(Dollars
      in thousands)300
      bp
                  
                  $
                  31,211
                  
                  
                  $
                  (12,815
                  )
                  
                  
                  (29
                  )%
                  
                  
                  5.94
                  %
                  
                  
                  (1.98
                  )%200
                  
                  
                  38,299
                  
                  
                  
                  (5,727
                  )
                  
                  
                  (13
                  )
                  
                  
                  7.11
                  
                  
                  
                  (0.81
                  )100
                  
                  
                  43,041
                  
                  
                  
                  (985
                  )
                  
                  
                  (2
                  )
                  
                  
                  7.84
                  
                  
                  
                  (0.08
                  )50
                  
                  
                  43,809
                  
                  
                  
                  (217
                  )
                  
                  
                  -
                  
                  
                  
                  7.92
                  
                  
                  
                  -0
                  
                  
                  44,026
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  7.92
                  
                  
                  
                  -(50)
                  
                  
                  43,240
                  
                  
                  
                  (786
                  )
                  
                  
                  (2
                  )
                  
                  
                  7.74
                  
                  
                  
                  (0.18
                  )(100)
                  
                  
                  41,718
                  
                  
                  
                  (2,308
                  )
                  
                  
                  (5
                  )
                  
                  
                  7.45
                  
                  
                  
                  (0.47
                  )





The
Office of Thrift Supervision uses certain assumptions in assessing the interest
rate risk of savings associations.  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 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, 2008 and December 31, 2007, cash and cash
equivalents totaled approximately $8.2 million and $8.4 million respectively,
including federal funds of $33,000 and $497,000,
respectively.  Securities classified as available for sale, which
provide additional sources of liquidity, totaled $63.8 million and $65.3 million
at December 31, 2008 and December 31, 2007, respectively.  At December
31, 2008 and December 31, 2007, we had the ability to borrow a total of $152.0
million and $138.4 million, respectively, from the Federal Home Loan Bank of
Boston, of which $118.4 million and $84.9 million, was outstanding,
respectively.  At December 31, 2008 and December 31, 2007, 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, 2008 and December 31, 2007, we
had the ability to borrow $3.5 million from a correspondent bank for both
periods, of which $1.3 million was outstanding on this line at December 31,
2008, and zero outstanding at December 31, 2007.





At
December 31, 2008, we had $20.2 million in unused line availability on home
equity lines of credit, $15.4 million in unadvanced commercial lines, $1.6
million in mortgage commitments, $3.5 million in commercial mortgage loan
commitments, $25.9 million in unadvanced construction mortgage commitments, $5.1
million in letters of credit, $719,000 in commercial business loan commitments
and $98,000 in overdraft line of credit availability.  Certificates of
deposit due within one year of December 31, 2008 totaled $119.5 million, or
32.9% of total deposits.





24





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, 2008.  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.





Our
primary investing activities are the origination of loans and the purchase of
securities.  For the year ended December 31, 2008 we originated $145.3
million of loans and purchased $25.0 million of securities. For the year ended
December 31, 2007 we originated $119.7 million of loans and purchased $17.8
million of securities.  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.  During the year ended
December 31, 2007, these activities were funded primarily by an increase in
deposits of $32.2 million, net increase in borrowed funds of $16.6 million,
proceeds from sales and maturities of available-for-sale securities of $20.7
million and proceeds from held-to-maturity securities of $1.4
million.





Historically,
our investment portfolio had been funded by excess liquidity when deposit
inflows exceed loan demand.  During 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.  In December 2007, we implemented a leverage strategy with
the objective of enhancing earnings by borrowing $10.0 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. Both strategies are
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 $41.6 million and a net increase of $32.2 million for the years ended
December 31, 2008 and 2007, 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
an increase in borrowed funds of $34.0 million for the year ended December 31,
2008.  The increase in 2008 was primarily due to lending and investing
activities. Federal Home Loan Bank advances increased $16.6 million for the year
ended December 31, 2007.  The increase in 2007 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,
2008, we exceeded all of our regulatory capital requirements.  We are
considered “well capitalized” under regulatory guidelines. See note 13 of the notes
to the financial statements in this annual report.





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.





25





See note
15 of the notes to the financial statements in this annual report.





For the
years ended December 31, 2008 and 2007, 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.








26





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, 2008, 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, 2008 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.





27










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, 2008 and 2007, and the related consolidated statements of income,
changes in stockholders' equity, and cash flows for each of the years ended
December 31, 2008, 2007 and 2006.  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, 2008 and 2007, and the results of its
operations and its cash flows for the each of the years ended December 31, 2008,
2007 and 2006, in conformity with accounting principles generally accepted in
the United States of America.






/s/
WHITTLESEY & HADLEY, P.C.






Hartford,
Connecticut


March 20,
2009














28













Consolidated
Statements of Financial Condition


(Dollars
in thousands)


December
      31,2008
                                                    
                                                    2007ASSETSCash
      and due from depository institutions
                                                    
                                                    $
                                                    8,214
                                                    
                                                    
                                                    $
                                                    7,873Investment
      in federal funds
                                                    
                                                    
                                                    33
                                                    
                                                    
                                                    
                                                    497Investment
      securities
                                                    
                                                    
                                                    63,844
                                                    
                                                    
                                                    
                                                    66,454Loans
      receivable, net
                                                    
                                                    
                                                    431,976
                                                    
                                                    
                                                    
                                                    359,831Accrued
      income receivable
                                                    
                                                    
                                                    2,099
                                                    
                                                    
                                                    
                                                    2,033Premises
      and equipment, net
                                                    
                                                    
                                                    10,565
                                                    
                                                    
                                                    
                                                    10,624Bank
      owned life insurance
                                                    
                                                    
                                                    8,579
                                                    
                                                    
                                                    
                                                    8,264Federal
      Home Loan Bank of Boston stock
                                                    
                                                    
                                                    6,252
                                                    
                                                    
                                                    
                                                    4,632Other
      assets
                                                    
                                                    
                                                    3,824
                                                    
                                                    
                                                    
                                                    2,319Total
      assets
                                                    
                                                    $
                                                    535,386
                                                    
                                                    
                                                    $
                                                    462,527LIABILITIES
      AND STOCKHOLDERS' EQUITYLiabilitiesDeposits
                                                    
                                                    $
                                                    363,026
                                                    
                                                    
                                                    $
                                                    321,398Borrowed
      funds
                                                    
                                                    
                                                    119,148
                                                    
                                                    
                                                    
                                                    85,107Mortgagors'
      escrow accounts
                                                    
                                                    
                                                    4,562
                                                    
                                                    
                                                    
                                                    3,871Other
      liabilities
                                                    
                                                    
                                                    3,061
                                                    
                                                    
                                                    
                                                    1,694Total
      liabilities
                                                    
                                                    
                                                    489,797
                                                    
                                                    
                                                    
                                                    412,070Commitments
      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 - 7,026,894 atDecember
      31, 2008; 7,268,734 at December 31, 2007
                                                    
                                                    
                                                    76
                                                    
                                                    
                                                    
                                                    76Paid-in
      capital
                                                    
                                                    
                                                    33,637
                                                    
                                                    
                                                    
                                                    33,483Retained
      earnings
                                                    
                                                    
                                                    23,303
                                                    
                                                    
                                                    
                                                    24,233Unearned
      ESOP shares (213,624 shares at December 31, 2008and
      233,513 shares at December 31, 2007)
                                                    
                                                    
                                                    (2,136
                                                    )
                                                    
                                                    
                                                    (2,335
                                                    )Unearned
      stock awards (61,780 shares at December 31, 2008and
      90,026 shares at December 31, 2007)
                                                    
                                                    
                                                    (680
                                                    )
                                                    
                                                    
                                                    (995
                                                    )Treasury
      Stock, at cost (579,314 shares at December 31, 2008and
      338,474 shares at December 31, 2007)
                                                    
                                                    
                                                    (6,107
                                                    )
                                                    
                                                    
                                                    (3,889
                                                    )Accumulated
      other comprehensive loss
                                                    
                                                    
                                                    (2,504
                                                    )
                                                    
                                                    
                                                    (116
                                                    )Total
      stockholders' equity
                                                    
                                                    
                                                    45,589
                                                    
                                                    
                                                    
                                                    50,457Total
      liabilities and stockholders' equity
                                                    
                                                    $
                                                    535,386
                                                    
                                                    
                                                    $
                                                    462,527




See notes to
consolidated financial statements.





29













Consolidated
Statements of Income


(Dollars
in thousands, except earnings per share)


For
      the Years Ended December 31,2008
                                        
                                        
                                        2007
                                        
                                        
                                        2006Interest
      and dividend incomeInterest
      on loans
                                        
                                        $
                                        24,556
                                        
                                        
                                        $
                                        21,681
                                        
                                        
                                        $
                                        17,506Interest
      and dividends on investments and deposits
                                        
                                        
                                        3,647
                                        
                                        
                                        
                                        3,349
                                        
                                        
                                        
                                        3,244Total
      interest income
                                        
                                        
                                        28,203
                                        
                                        
                                        
                                        25,030
                                        
                                        
                                        
                                        20,750Interest
      expenseInterest
      on deposits
                                        
                                        
                                        9,271
                                        
                                        
                                        
                                        9,750
                                        
                                        
                                        
                                        6,551Interest
      on borrowed funds
                                        
                                        
                                        4,633
                                        
                                        
                                        
                                        3,424
                                        
                                        
                                        
                                        2,799Total
      interest expense
                                        
                                        
                                        13,904
                                        
                                        
                                        
                                        13,174
                                        
                                        
                                        
                                        9,350Net
      interest income
                                        
                                        
                                        14,299
                                        
                                        
                                        
                                        11,856
                                        
                                        
                                        
                                        11,400Provision
      for loan losses
                                        
                                        
                                        675
                                        
                                        
                                        
                                        151
                                        
                                        
                                        
                                        192Net
      interest income after provision for loan losses
                                        
                                        
                                        13,624
                                        
                                        
                                        
                                        11,705
                                        
                                        
                                        
                                        11,208Noninterest
      incomeFees
      for services related to deposit accounts
                                        
                                        
                                        1,053
                                        
                                        
                                        
                                        955
                                        
                                        
                                        
                                        873Fees
      for other services
                                        
                                        
                                        529
                                        
                                        
                                        
                                        559
                                        
                                        
                                        
                                        540Income
      from bank owned life insurance
                                        
                                        
                                        315
                                        
                                        
                                        
                                        308
                                        
                                        
                                        
                                        304Income
      from investment advisory services, net
                                        
                                        
                                        299
                                        
                                        
                                        
                                        260
                                        
                                        
                                        
                                        98Gain
      (loss) on investment securities
                                        
                                        
                                        (3,398
                                        )
                                        
                                        
                                        65
                                        
                                        
                                        
                                        6Other
      income
                                        
                                        
                                        154
                                        
                                        
                                        
                                        207
                                        
                                        
                                        
                                        127Total
      noninterest income (loss)
                                        
                                        
                                        (1,048
                                        )
                                        
                                        
                                        2,354
                                        
                                        
                                        
                                        1,948Noninterest
      expenseCompensation,
      taxes and benefits
                                        
                                        
                                        7,521
                                        
                                        
                                        
                                        6,914
                                        
                                        
                                        
                                        6,408Office
      occupancy
                                        
                                        
                                        2,173
                                        
                                        
                                        
                                        1,966
                                        
                                        
                                        
                                        1,757Computer
      processing
                                        
                                        
                                        861
                                        
                                        
                                        
                                        733
                                        
                                        
                                        
                                        606Advertising
                                        
                                        
                                        534
                                        
                                        
                                        
                                        594
                                        
                                        
                                        
                                        672Professional
      fees
                                        
                                        
                                        518
                                        
                                        
                                        
                                        504
                                        
                                        
                                        
                                        380Directors
      compensation
                                        
                                        
                                        493
                                        
                                        
                                        
                                        494
                                        
                                        
                                        
                                        516Office
      supplies
                                        
                                        
                                        195
                                        
                                        
                                        
                                        201
                                        
                                        
                                        
                                        193Contributions
                                        
                                        
                                        47
                                        
                                        
                                        
                                        31
                                        
                                        
                                        
                                        34Loss
      on foreclosed real estate, net
                                        
                                        
                                        1
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        16Other
      expenses
                                        
                                        
                                        1,111
                                        
                                        
                                        
                                        985
                                        
                                        
                                        
                                        922Total
      noninterest expense
                                        
                                        
                                        13,454
                                        
                                        
                                        
                                        12,422
                                        
                                        
                                        
                                        11,504Income
      (loss) before provision (benefit) for income taxes
                                        
                                        
                                        (878
                                        )
                                        
                                        
                                        1,637
                                        
                                        
                                        
                                        1,652Provision
      (benefit) for income taxes
                                        
                                        
                                        (566
                                        )
                                        
                                        
                                        217
                                        
                                        
                                        
                                        204Net
      income (loss)
                                        
                                        $
                                        (312
                                        )
                                        
                                        $
                                        1,420
                                        
                                        
                                        $
                                        1,448Earnings
      (loss) per share - basic and diluted
                                        
                                        $
                                        (0.05
                                        )
                                        
                                        $
                                        0.20
                                        
                                        
                                        $
                                        0.20










30













Consolidated
Statements of Changes in Stockholders' Equity


(Dollars
in thousands)


Common
                                                
                                                
                                                Paid-in
                                                
                                                
                                                Retained
                                                
                                                
                                                Unearned
                                                  ESOP
                                                
                                                
                                                Unearned
                                                  Stock
                                                
                                                
                                                Treasury
                                                
                                                
                                                Accumulated
                                                  Other
                                                  ComprehensiveStock
                                                
                                                
                                                Capital
                                                
                                                
                                                Earnings
                                                
                                                
                                                Shares
                                                
                                                
                                                Awards
                                                
                                                
                                                Stock
                                                
                                                
                                                Loss
                                                
                                                
                                                TotalBalance
      at December 31, 2006
                                                
                                                $
                                                76
                                                
                                                
                                                $
                                                33,302
                                                
                                                
                                                $
                                                23,415
                                                
                                                
                                                $
                                                (2,534
                                                )
                                                
                                                $
                                                (1,256
                                                )
                                                
                                                $
                                                (1,593
                                                )
                                                
                                                $
                                                (326
                                                )
                                                
                                                $
                                                51,084ESOP
      shares released - 19,889 shares
                                                
                                                
                                                -
                                                
                                                
                                                
                                                28
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                199
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                227Dividends
      paid ($0.20 per common share)
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (589
                                                )
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (589
                                                )Stock
      based compensation -  5,000 shares awarded
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (13
                                                )
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (52
                                                )
                                                
                                                
                                                65
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Stock
      based compensation - 28,242 shares vested
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                313
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                313Stock
      based compensation - options
                                                
                                                
                                                -
                                                
                                                
                                                
                                                153
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                3
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                156Treasury
      stock acquired - 204,731 shares
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (2,364
                                                )
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (2,364
                                                )Comprehensive
      income:Net
      income
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                1,420
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Net
      change in unrealized holding gain on available-for-sale
      securities, net of tax effect
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                210Comprehensive
      income
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                1,630Balance
      at December 31, 2007
                                                
                                                
                                                76
                                                
                                                
                                                
                                                33,483
                                                
                                                
                                                
                                                24,233
                                                
                                                
                                                
                                                (2,335
                                                )
                                                
                                                
                                                (995
                                                )
                                                
                                                
                                                (3,889
                                                )
                                                
                                                
                                                (116
                                                )
                                                
                                                
                                                50,457ESOP
      shares released - 19,889 shares
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (29
                                                )
                                                
                                                
                                                -
                                                
                                                
                                                
                                                199
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                170Dividends
      paid ($0.23 per common share)
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (614
                                                )
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (614
                                                )Stock
      based compensation -  1,000 shares awarded
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (4
                                                )
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (9
                                                )
                                                
                                                
                                                13
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Stock
      based compensation - 29,246 shares vested
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                324
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                324Stock
      based compensation - options
                                                
                                                
                                                -
                                                
                                                
                                                
                                                183
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                183Treasury
      stock acquired - 241,840 shares
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (2,231
                                                )
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (2,231
                                                )Comprehensive
      loss:Net
      loss
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (312
                                                )
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Net
      change in unrealized holding loss on available-for-sale
      securities, net of tax effect
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                (2,388
                                                )Comprehensive
      loss
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                (2,700
                                                )Balance
      at December 31, 2008
                                                
                                                $
                                                76
                                                
                                                
                                                $
                                                33,637
                                                
                                                
                                                $
                                                23,303
                                                
                                                
                                                $
                                                (2,136
                                                )
                                                
                                                $
                                                (680
                                                )
                                                
                                                $
                                                (6,107
                                                )
                                                
                                                $
                                                (2,504
                                                )
                                                
                                                $
                                                45,589










31













Consolidated
Statements of Cash Flows


(In
thousands)


For
      the Years Ended December 31,2008
                                
                                
                                2007
                                
                                
                                2006Cash
      flows from operating activitiesNet
      income (loss)
                                
                                $
                                (312
                                )
                                
                                $
                                1,420
                                
                                
                                $
                                1,448Adjustments
      to reconcile net income (loss) to net cashprovided
      by operating activities:Provision
      for loan losses
                                
                                
                                675
                                
                                
                                
                                151
                                
                                
                                
                                192Depreciation
      and amortization expense
                                
                                
                                835
                                
                                
                                
                                776
                                
                                
                                
                                655Net
      amortization (accretion) from investments
                                
                                
                                51
                                
                                
                                
                                (21
                                )
                                
                                
                                (35
                                )Amortization
      of intangible assets
                                
                                
                                34
                                
                                
                                
                                34
                                
                                
                                
                                34Provision
      for deferred tax (benefit)
                                
                                
                                (1,574
                                )
                                
                                
                                11
                                
                                
                                
                                (75
                                )Net
      gain on sale of real estate owned
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                (4
                                )Loss
      (gain) on investment securities
                                
                                
                                3,398
                                
                                
                                
                                (65
                                )
                                
                                
                                (6
                                )Loss
      on disposal of premises and equipment
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                1Stock-based
      compensation
                                
                                
                                813
                                
                                
                                
                                698
                                
                                
                                
                                657Net
      change in:Accrued
      income receivable
                                
                                
                                (65
                                )
                                
                                
                                (130
                                )
                                
                                
                                (379
                                )Deferred
      loan fees
                                
                                
                                68
                                
                                
                                
                                51
                                
                                
                                
                                9Cash
      surrender value of  life insurance
                                
                                
                                (315
                                )
                                
                                
                                (308
                                )
                                
                                
                                (304
                                )Other
      assets
                                
                                
                                (39
                                )
                                
                                
                                (35
                                )
                                
                                
                                107Other
      liabilities
                                
                                
                                (110
                                )
                                
                                
                                98
                                
                                
                                
                                228Net
      cash provided by operating activities
                                
                                
                                3,459
                                
                                
                                
                                2,680
                                
                                
                                
                                2,528Cash
      flows from investing activitiesProceeds
      from maturities and repayments ofavailable-for-sale
      securities
                                
                                
                                7,501
                                
                                
                                
                                12,236
                                
                                
                                
                                16,779Proceeds
      from sale of available-for-sale securities
                                
                                
                                13,171
                                
                                
                                
                                8,441
                                
                                
                                
                                5,163Proceeds
      from maturities of held-to-maturity securities
                                
                                
                                1,190
                                
                                
                                
                                1,390
                                
                                
                                
                                2,470Purchase
      of available-for-sale securities
                                
                                
                                (25,017
                                )
                                
                                
                                (17,598
                                )
                                
                                
                                (31,401
                                )Purchase
      of held-to-maturity securities
                                
                                
                                -
                                
                                
                                
                                (250
                                )
                                
                                
                                -Loan
      originations net of principal payments
                                
                                
                                (72,888
                                )
                                
                                
                                (51,656
                                )
                                
                                
                                (49,148
                                )Purchase
      of Federal Home Loan Bank of Boston stock
                                
                                
                                (1,619
                                )
                                
                                
                                (734
                                )
                                
                                
                                (739
                                )Proceeds
      from the sale of foreclosed real estate
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                50Proceeds
      from sale of property and equipment
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                2Purchase
      of property and equipment
                                
                                
                                (775
                                )
                                
                                
                                (325
                                )
                                
                                
                                (2,780
                                )Net
      cash used by investing activities
                                
                                
                                (78,437
                                )
                                
                                
                                (48,496
                                )
                                
                                
                                (59,604
                                )










32












Consolidated
Statements of Cash Flows (Continued)
 (In
thousands)


For
      the Years Ended December 31,2008
                                            
                                            
                                            2007
                                            
                                            
                                            2006Cash
      flows from financing activitiesNet
      change in time deposits
                                            
                                            
                                            33,353
                                            
                                            
                                            
                                            37,335
                                            
                                            
                                            
                                            42,645Net
      change in other deposit accounts
                                            
                                            
                                            8,275
                                            
                                            
                                            
                                            (5,135
                                            )
                                            
                                            
                                            5,707Advances
      from Federal Home Loan Bank of Boston
                                            
                                            
                                            55,915
                                            
                                            
                                            
                                            46,927
                                            
                                            
                                            
                                            51,250Repayment
      of Advances from Federal HomeLoan
      Bank of Boston
                                            
                                            
                                            (22,373
                                            )
                                            
                                            
                                            (30,538
                                            )
                                            
                                            
                                            (39,821
                                            )Net
      change in mortgagors' escrow accounts
                                            
                                            
                                            691
                                            
                                            
                                            
                                            376
                                            
                                            
                                            
                                            293Change
      in short-term borrowings
                                            
                                            
                                            1,839
                                            
                                            
                                            
                                            229
                                            
                                            
                                            
                                            (1,899
                                            )Common
      stock repurchased
                                            
                                            
                                            (2,231
                                            )
                                            
                                            
                                            (2,364
                                            )
                                            
                                            
                                            (1,491
                                            )Cash
      dividends to common stockholders
                                            
                                            
                                            (614
                                            )
                                            
                                            
                                            (589
                                            )
                                            
                                            
                                            (617
                                            )Proceeds
      from exercise of options
                                            
                                            
                                            -
                                            
                                            
                                            
                                            3
                                            
                                            
                                            
                                            -Net
      cash provided by financing activities
                                            
                                            
                                            74,855
                                            
                                            
                                            
                                            46,244
                                            
                                            
                                            
                                            56,067Increase
      (decrease) in cash and cash equivalents
                                            
                                            
                                            (123
                                            )
                                            
                                            
                                            428
                                            
                                            
                                            
                                            (1,009
                                            )Cash
      and cash equivalents at beginning of year
                                            
                                            
                                            8,370
                                            
                                            
                                            
                                            7,942
                                            
                                            
                                            
                                            8,951Cash
      and cash equivalents at end of year
                                            
                                            $
                                            8,247
                                            
                                            
                                            $
                                            8,370
                                            
                                            
                                            $
                                            7,942Supplemental
      disclosuresNon-cash
      investing activities:Transfer
      of loans to foreclosed real estate
                                            
                                            $
                                            -
                                            
                                            
                                            $
                                            -
                                            
                                            
                                            $
                                            -Cash
      paid during the year for:Interest
                                            
                                            $
                                            13,950
                                            
                                            
                                            $
                                            13,130
                                            
                                            
                                            $
                                            9,347Income
      taxes
                                            
                                            
                                            943
                                            
                                            
                                            
                                            296
                                            
                                            
                                            
                                            305







33












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 mutual holding
company parent of the Bank.  As long as Naugatuck Valley Mutual
exists, it will own at least a majority of Naugatuck Valley Financial
Corporation’s common stock.





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.  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.




Use of
estimates




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.




Principles of
consolidation




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.








34













Notes
to Consolidated Financial Statements




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, estimated fair value is determined
by applying the valuation framework specified in Statement of Financial
Accounting Standards No. 157 (“SFAS 157”), Fair Value
Measurements.  SFAS 157 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 Bank’s market
assumptions.  See Note 16.





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.





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.





35












Notes
to Consolidated Financial Statements




2.  Summary of Significant
Accounting Policies –(Continued)




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, 2008 and
2007. 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.





36













Notes
to Consolidated Financial Statements




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.




Recent Accounting
Pronouncements




In
September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS
157 defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair
value measurements. SFAS 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007 and interim periods within those
years. The Company has determined that adoption of SFAS 157 did not have a
material impact on its consolidated financial condition or results of
operations.





37












Notes
to Consolidated Financial Statements




2.  Summary of Significant
Accounting Policies –(Continued)




In June
2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes ("FIN 48"). FIN 48 clarifies when tax benefits should be recorded
in financial statements, requires certain disclosures of uncertain tax matters
and indicates how any tax reserves should be classified in a balance sheet. On
January 1, 2007, the Company adopted FIN 48. The Company has determined that
adoption of FIN 48 did not have any impact on its financial condition or results
of operations.





In
February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial
Assets and Liabilities. This Statement permits entities to measure many
financial instruments and certain other items at fair value. The objective is to
improve financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. This pronouncement is effective as of the beginning of an entity's
first fiscal year beginning after November 15, 2007. The Company has determined
that adoption of SFAS 159 did not have a material impact on its financial
position or results of operations.





In
December 2007, the FASB issued SFAS 141R, Business Combinations. SFAS
141R's objective 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. SFAS 141R
applies prospectively to business combinations for which the acquisition date is
on or after December 31, 2008. The Company does not expect the implementation of
SFAS 141R to have a material impact on its consolidated financial
statements.





In
December 2007, the FASB issued SFAS 160, Non-controlling Interests in
Consolidated Financial Statements. SFAS 160's objective is to improve the
relevance, comparability, and transparency of the financial information that a
reporting entity provides in its consolidated financial statements byestablishing accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS 160 is effective for fiscal years and interim periods within
those fiscal years, beginning on or after December 15, 2008. The Company does
not expect the implementation of SFAS 160 to have a material impact on its
consolidated financial statements.





In
October 2008, the FASB issued FASB Staff Position No. 157-3 (FSP 157-3), Determining the
Fair Value of a
Financial Asset When the Market for That Asset is Not Active. FSP 157-3
clarifies the application of SFAS 157 in a market that is not active and
provides an example to illustrate key considerations in determining fair value
of financial assets when the market for that financial asset is not active. FSP
157-3 applies to financial assets within the scope of accounting pronouncements
that require or permit fair value measurements in accordance with FAS 157. FSP
157-3 was effective upon issuance and included prior periods for which financial
statements had not been issued. The application of FSP 157-3 did not have a
material impact on the Company’s consolidated financial statements.




Reclassification




The
financial statements for the prior years have been reclassified to conform with
changes in the current financial statement presentation.





38













Notes
to Consolidated Financial Statements




3.  Investment
Securities




A summary
of investment securities at December 31, 2008 and 2007 follows:


2008
                                                                      
                                                                      
                                                                      2007Carrying
                                                                      
                                                                      
                                                                      Fair
                                                                      
                                                                      
                                                                      Carrying
                                                                      
                                                                      
                                                                      Fair(In
      thousands)
                                                                      
                                                                      Amount
                                                                      
                                                                      
                                                                      Value
                                                                      
                                                                      
                                                                      Amount
                                                                      
                                                                      
                                                                      ValueAvailable-for-sale
      securities
                                                                      
                                                                      $
                                                                      63,844
                                                                      
                                                                      
                                                                      $
                                                                      63,844
                                                                      
                                                                      
                                                                      $
                                                                      65,264
                                                                      
                                                                      
                                                                      $
                                                                      65,264Held-to-maturity
      securities
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      1,190
                                                                      
                                                                      
                                                                      
                                                                      1,188Total
      investment securities
                                                                      
                                                                      $
                                                                      63,844
                                                                      
                                                                      
                                                                      $
                                                                      63,844
                                                                      
                                                                      
                                                                      $
                                                                      66,454
                                                                      
                                                                      
                                                                      $
                                                                      66,452








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








39












Notes
to Consolidated Financial Statements




3.  Investment
Securities–(Continued)




At
December 31, 2007, 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 obligationsLess
      than one year
                                                      
                                                      $
                                                      1,749
                                                      
                                                      
                                                      $
                                                      1
                                                      
                                                      
                                                      $
                                                      (5
                                                      )
                                                      
                                                      $
                                                      1,745From
      five through ten years
                                                      
                                                      
                                                      1,000
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      (1
                                                      )
                                                      
                                                      
                                                      9992,749
                                                      
                                                      
                                                      
                                                      1
                                                      
                                                      
                                                      
                                                      (6
                                                      )
                                                      
                                                      
                                                      2,744Municipal
      obligationsFrom
      five through ten years
                                                      
                                                      
                                                      1,533
                                                      
                                                      
                                                      
                                                      22
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      1,555After
      ten years
                                                      
                                                      
                                                      12,559
                                                      
                                                      
                                                      
                                                      60
                                                      
                                                      
                                                      
                                                      (99
                                                      )
                                                      
                                                      
                                                      12,52014,092
                                                      
                                                      
                                                      
                                                      82
                                                      
                                                      
                                                      
                                                      (99
                                                      )
                                                      
                                                      
                                                      14,075Corporate
      bondsFrom
      five through ten years
                                                      
                                                      
                                                      1,000
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      (10
                                                      )
                                                      
                                                      
                                                      990Mortgage-backed
      securities
                                                      
                                                      
                                                      31,352
                                                      
                                                      
                                                      
                                                      67
                                                      
                                                      
                                                      
                                                      (158
                                                      )
                                                      
                                                      
                                                      31,261Collateralized
      mortgage obligations
                                                      
                                                      
                                                      3,547
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      (53
                                                      )
                                                      
                                                      
                                                      3,494Total
      debt securities
                                                      
                                                      
                                                      52,740
                                                      
                                                      
                                                      
                                                      150
                                                      
                                                      
                                                      
                                                      (326
                                                      )
                                                      
                                                      
                                                      52,564Money
      market preferred stocks
                                                      
                                                      
                                                      12,700
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      12,700Total
      available-for-sale securities
                                                      
                                                      $
                                                      65,440
                                                      
                                                      
                                                      $
                                                      150
                                                      
                                                      
                                                      $
                                                      (326
                                                      )
                                                      
                                                      $
                                                      65,264Amortized
                                                      
                                                      
                                                      Gross
      Unrealized
                                                      
                                                      
                                                      Fair(In
      thousands)
                                                      
                                                      Cost
      Basis
                                                      
                                                      
                                                      Gains
                                                      
                                                      
                                                      Losses
                                                      
                                                      
                                                      ValueHeld-to-maturity
      securities:U.S.
      government and agency obligationsLess
      than one year
                                                      
                                                      $
                                                      1,000
                                                      
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      (2
                                                      )
                                                      
                                                      $
                                                      998Interest
      bearing balancesLess
      than one year
                                                      
                                                      
                                                      190
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      190Total
      held-to-maturity securities
                                                      
                                                      $
                                                      1,190
                                                      
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      (2
                                                      )
                                                      
                                                      $
                                                      1,188











40













Notes
to Consolidated Financial Statements




For the
year ended December 31, 2008, the Company realized gross gains of
$129,450 and gross losses of $100,622 compared with gross gains of
$68,686 and gross losses of $3,477 for the year ended December 31, 2007, and
gross gains of $20,224 and gross losses of $14,436 for the year ended December
31, 2006 on sales of investment securities.  In addition, for the year
ended December 31, 2008, the Company realized an other-than-temporary impairment
loss on auction rate pass through certificates, with Fannie Mae preferred stock
as underlying collateral, 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, 2008, these securities had an aggregate fair value of $16,705,000
which resulted in unrealized losses of $3,474,000 as compared with an aggregate
fair value of $29,267,000 and unrealized losses of $328,000 at December 31,
2007.





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 as of December 31, 2008 and
2007.





41












Notes
to Consolidated Financial Statements




3.  Investment
Securities–(Continued)


Securities
      in Continuous UnrealizedLoss
      Position Less Than 12 MonthsNumber
      of
                                                            
                                                            
                                                            Market
                                                            
                                                            
                                                            Unrealized2008
                                                            
                                                            Securities
                                                            
                                                            
                                                            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
                                                            )


Securities
      in Continuous UnrealizedLoss
      Position Less Than 12 MonthsNumber
      of
                                            
                                            
                                            Market
                                            
                                            
                                            Unrealized2007
                                            
                                            Securities
                                            
                                            
                                            Value
                                            
                                            
                                            Loss(Dollars
      in thousands)U.S.
      government and agency obligations
                                            
                                            
                                            4
                                            
                                            
                                            $
                                            3,491
                                            
                                            
                                            $
                                            (7
                                            )Mortgage-backed
      securities
                                            
                                            
                                            11
                                            
                                            
                                            
                                            6,457
                                            
                                            
                                            
                                            (52
                                            )Collateralized
      mortgage obligations
                                            
                                            
                                            1
                                            
                                            
                                            
                                            737
                                            
                                            
                                            
                                            (1
                                            )Corporate
      bonds
                                            
                                            
                                            1
                                            
                                            
                                            
                                            990
                                            
                                            
                                            
                                            (10
                                            )Total
      securities in unrealized loss position
                                            
                                            
                                            17
                                            
                                            
                                            $
                                            11,675
                                            
                                            
                                            $
                                            (70
                                            )


42













Notes
to Consolidated Financial Statements


Securities
      in Continuous UnrealizedLoss
      Position 12 or More Consecutive MonthsNumber
      of
                                                  
                                                  
                                                  Market
                                                  
                                                  
                                                  UnrealizedSecurities
                                                  
                                                  
                                                  Value
                                                  
                                                  
                                                  Loss(Dollars
      in thousands)U.S.
      government and agency obligations
                                                  
                                                  
                                                  2
                                                  
                                                  
                                                  $
                                                  1,070
                                                  
                                                  
                                                  $
                                                  (47
                                                  )Mortgage-backed
      securities
                                                  
                                                  
                                                  22
                                                  
                                                  
                                                  
                                                  16,522
                                                  
                                                  
                                                  
                                                  (211
                                                  )Total
      securities in unrealized loss position
                                                  
                                                  24
                                                  
                                                  
                                                  $
                                                  17,592
                                                  
                                                  
                                                  $
                                                  (258
                                                  )




At
December 31, 2008 and 2007, securities with  amortized cost of
$2,948,532 and $2,250,000, and fair values of approximately $3,098,955 and
$2,264,181, respectively, were pledged as collateral to secure municipal
deposits.




4.  Loans
Receivable




A summary
of loans receivable at December 31, 2008 and 2007 is as
follows:


(Dollars
      in thousands)
                                            
                                            2008
                                            
                                            
                                            2007Residential
      real estate loansFixed
      rate mortgage loans
                                            
                                            $
                                            189,479
                                            
                                            
                                            $
                                            165,764Adjustable
      rate mortgage loans
                                            
                                            
                                            22,442
                                            
                                            
                                            
                                            24,834Construction
      loans
                                            
                                            
                                            6,566
                                            
                                            
                                            
                                            7,046Commercial
      mortgages and loans
                                            
                                            
                                            176,905
                                            
                                            
                                            
                                            123,925Loans
      on savings accounts
                                            
                                            
                                            1,093
                                            
                                            
                                            
                                            1,272Personal,
      auto and property improvement loans
                                            
                                            
                                            40,188
                                            
                                            
                                            
                                            41,146436,673
                                            
                                            
                                            
                                            363,987Less:    
        Allowance for loan losses
                                            
                                            
                                            2,869
                                            
                                            
                                            
                                            2,163Undisbursed
      construction loans
                                            
                                            
                                            1,299
                                            
                                            
                                            
                                            1,532Deferred
      loan origination fees
                                            
                                            
                                            529
                                            
                                            
                                            
                                            461Loans
      receivable, net
                                            
                                            $
                                            431,976
                                            
                                            
                                            $
                                            359,831Weighted
      average yield
                                            
                                            
                                            5.85
                                            %
                                            
                                            
                                            6.42
                                            %





43












Notes
to Consolidated Financial Statements




4.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, 2008 and 2007, the
composition of the Bank's investment in fixed rate loans was as
follows:




Fixed
      RateTerm
      to Maturity
                                                
                                                2008
                                                
                                                
                                                2007(In
      thousands)Less
      than 1 year
                                                
                                                $
                                                1,394
                                                
                                                
                                                $
                                                1,5791 -
      3 years
                                                
                                                
                                                4,356
                                                
                                                
                                                
                                                3,7803 -
      5 years
                                                
                                                
                                                4,799
                                                
                                                
                                                
                                                3,8015 -
      10 years
                                                
                                                
                                                30,456
                                                
                                                
                                                
                                                25,85210
      - 20 years
                                                
                                                
                                                48,759
                                                
                                                
                                                
                                                50,773Over
      20 years
                                                
                                                
                                                142,820
                                                
                                                
                                                
                                                124,767Total
      loans at fixed rates
                                                
                                                $
                                                232,584
                                                
                                                
                                                $
                                                210,552





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, 2008 and 2007, the Bank had the following adjustable rate
loans:





Adjustable
      RateRate
      Adjustment
                                          
                                          2008
                                          
                                          
                                          2007(In
      thousands)Less
      than 1 year
                                          
                                          $
                                          79,525
                                          
                                          
                                          $
                                          59,9551 -
      3 years
                                          
                                          
                                          33,000
                                          
                                          
                                          
                                          20,1333 -
      5 years
                                          
                                          
                                          48,883
                                          
                                          
                                          
                                          42,3835 -
      10 years
                                          
                                          
                                          40,836
                                          
                                          
                                          
                                          28,281Over
      10 years
                                          
                                          
                                          1,845
                                          
                                          
                                          
                                          2,683Total
      loans at adjustable rates
                                          
                                          $
                                          204,089
                                          
                                          
                                          $
                                          153,435





Nonperforming
loans totaled approximately $2.7 million and $970,000 at December 31, 2008 and
2007, 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
$140,000, $45,000, and $68,000 in 2008, 2007 and 2006,
respectively.





44













Notes
to Consolidated Financial Statements




At
December 31, 2008 the Bank had approximately $254,000 of loans which were
considered to be impaired without an allowance allocation, compared with
$107,600 of loans without an allowance allocation at December 31,
2007.  These loans averaged $255,000 during 2008 and paid $11,000
in interest, as compared with an average balance of $110,000 during 2007 on
which $7,000 of interest was received.





Transactions
in the allowance for loan losses account for the years ended December 31, 2008,
2007 and 2006 were as follows:


(In
      thousands)
                                        
                                        2008
                                        
                                        
                                        2007
                                        
                                        
                                        2006Balance
      at beginning of year
                                        
                                        $
                                        2,163
                                        
                                        
                                        $
                                        2,071
                                        
                                        
                                        $
                                        1,878Provision
      for loan losses
                                        
                                        
                                        675
                                        
                                        
                                        
                                        151
                                        
                                        
                                        
                                        192Loans
      written off
                                        
                                        
                                        (7
                                        )
                                        
                                        
                                        (61
                                        )
                                        
                                        
                                        (2
                                        )Recoveries
      of loans written off
                                        
                                        
                                        38
                                        
                                        
                                        
                                        2
                                        
                                        
                                        
                                        3Balance
      at end of year
                                        
                                        $
                                        2,869
                                        
                                        
                                        $
                                        2,163
                                        
                                        
                                        $
                                        2,071





As of
December 31, 2008 and 2007, loans to related parties totaled approximately
$3,845,000 and $4,660,000, respectively.  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.  For
the year ended December 31, 2007, new loans of approximately $160,000 were
granted to these parties and principal payments of approximately $123,000 were
received.  During 2007, an additional $912,000 in existing loans were
included in loans to related parties for an individual 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, 2008 and 2007, 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 $8,693,000
and $9,705,000 at December 31, 2008 and 2007, respectively.








45










Notes
to Consolidated Financial Statements




5.  Premises
and Equipment




Premises
and equipment at December 31, 2008 and 2007 are summarized as
follows:


(In
      thousands)
                                            
                                            2008
                                            
                                            
                                            2007Banking
      offices and branch buildings
                                            
                                            $
                                            8,469
                                            
                                            
                                            $
                                            8,390Furniture
      and equipment
                                            
                                            
                                            3,553
                                            
                                            
                                            
                                            3,321Land
                                            
                                            
                                            1,593
                                            
                                            
                                            
                                            1,596Leasehold
      improvements
                                            
                                            
                                            1,326
                                            
                                            
                                            
                                            1,22714,941
                                            
                                            
                                            
                                            14,534Accumulated
      depreciation and amortization
                                            
                                            
                                            (4,376
                                            )
                                            
                                            
                                            (3,910
                                            )Premises
      and equipment, net
                                            
                                            $
                                            10,565
                                            
                                            
                                            $
                                            10,624





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 $834,473 and
$775,978 and $655,607 for the years ended December 31, 2008, 2007 and 2006,
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, 2008, future
minimum rental income and lease payment expense were expected to
be:


(In
      thousands)
                                        
                                        Income
                                        
                                        
                                        Expense2009
                                        
                                        $
                                        100
                                        
                                        
                                        $
                                        3032010
                                        
                                        
                                        105
                                        
                                        
                                        
                                        3202011
                                        
                                        
                                        98
                                        
                                        
                                        
                                        2812012
                                        
                                        
                                        72
                                        
                                        
                                        
                                        2542013
                                        
                                        
                                        67
                                        
                                        
                                        
                                        205Thereafter
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,046Total
      future minimum rents
                                        
                                        $
                                        442
                                        
                                        
                                        $
                                        2,409











46













Notes
to Consolidated Financial Statements




6.  Deposits




Deposits
and weighted average rates at December 31, 2008 and 2007 are summarized as
follows:


2008
                                                                            
                                                                            2007Weighted
                                                                              Average
                                                                            
                                                                            
                                                                            
                                                                            
                                                                            Weighted
                                                                              Average(Dollars
      in thousands)
                                                                            
                                                                            Amount
                                                                            
                                                                            
                                                                            Cost
                                                                            
                                                                            Amount
                                                                            
                                                                            
                                                                            CostCertificate
      accounts
                                                                            
                                                                            $
                                                                            235,764
                                                                            
                                                                            
                                                                            
                                                                            3.55
                                                                            %
                                                                            
                                                                            $
                                                                            202,411
                                                                            
                                                                            
                                                                            
                                                                            4.47
                                                                            %Regular
      savings accounts
                                                                            
                                                                            
                                                                            48,427
                                                                            
                                                                            
                                                                            
                                                                            0.77
                                                                            %
                                                                            
                                                                            
                                                                            41,480
                                                                            
                                                                            
                                                                            
                                                                            0.58
                                                                            %Checking
      and NOW accounts
                                                                            
                                                                            
                                                                            52,537
                                                                            
                                                                            
                                                                            
                                                                            0.08
                                                                            %
                                                                            
                                                                            
                                                                            49,511
                                                                            
                                                                            
                                                                            
                                                                            0.15
                                                                            %Money
      market savings accounts
                                                                            
                                                                            
                                                                            26,298
                                                                            
                                                                            
                                                                            
                                                                            1.74
                                                                            %
                                                                            
                                                                            
                                                                            27,996
                                                                            
                                                                            
                                                                            
                                                                            2.64
                                                                            %Total
      deposits
                                                                            
                                                                            $
                                                                            363,026
                                                                            
                                                                            
                                                                            
                                                                            2.55
                                                                            %
                                                                            
                                                                            $
                                                                            321,398
                                                                            
                                                                            
                                                                            
                                                                            3.14
                                                                            %





The
aggregate amount of individual certificate accounts of $100,000 or more
at December 31, 2008 and 2007 was $80,795,000 and $67,250,000
respectively. Under the Emergency Economic Stabilization Act of 2008, deposits
up to $250,000 are federally insured through December 31, 2009.  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 December 31, 2009.  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, 2008 and 2007 the remaining maturities for certificate accounts
were:


(In
      thousands)
                                      
                                      2008
                                      
                                      
                                      2007Certificate
      accounts maturing in:Under
      12 months
                                      
                                      $
                                      119,529
                                      
                                      
                                      $
                                      184,72812
      to 24 months
                                      
                                      
                                      22,665
                                      
                                      
                                      
                                      8,96824
      to 36 months
                                      
                                      
                                      62,716
                                      
                                      
                                      
                                      5,177Over
      36 months
                                      
                                      
                                      30,854
                                      
                                      
                                      
                                      3,538Total
      certificate accounts
                                      
                                      $
                                      235,764
                                      
                                      
                                      $
                                      202,411








47










Notes
to Consolidated Financial Statements




7.  Borrowed
Funds




Borrowings
and advances, with calendar-year maturity dates and weighted average cost of
funds at December 31, 2008 and 2007, were as follows:





(Dollars
      in thousands)
                                                                                  
                                                                                  
                                                                                  2008
                                                                                  
                                                                                  2007Weighted
                                                                                  
                                                                                  
                                                                                  
                                                                                  
                                                                                  WeightedAmount
                                                                                  
                                                                                  
                                                                                  Average
                                                                                  
                                                                                  Amount
                                                                                  
                                                                                  
                                                                                  AverageDue
                                                                                  
                                                                                  
                                                                                  Cost
                                                                                  
                                                                                  Due
                                                                                  
                                                                                  
                                                                                  CostShort-term
      borrowingsRepurchase
      agreements
                                                                                  
                                                                                  
                                                                                  $
                                                                                  727
                                                                                  
                                                                                  
                                                                                  
                                                                                  2.90
                                                                                  %
                                                                                  
                                                                                  $
                                                                                  229
                                                                                  
                                                                                  
                                                                                  
                                                                                  2.75
                                                                                  %Long-term
      FHLBB advancesYear
      of maturity:2008
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  24,099
                                                                                  
                                                                                  
                                                                                  
                                                                                  4.782009
                                                                                  
                                                                                  
                                                                                  
                                                                                  58,418
                                                                                  
                                                                                  
                                                                                  
                                                                                  3.93
                                                                                  
                                                                                  
                                                                                  
                                                                                  45,981
                                                                                  
                                                                                  
                                                                                  
                                                                                  4.672010
                                                                                  
                                                                                  
                                                                                  
                                                                                  22,742
                                                                                  
                                                                                  
                                                                                  
                                                                                  3.74
                                                                                  
                                                                                  
                                                                                  
                                                                                  9,535
                                                                                  
                                                                                  
                                                                                  
                                                                                  4.542011
                                                                                  
                                                                                  
                                                                                  
                                                                                  16,262
                                                                                  
                                                                                  
                                                                                  
                                                                                  3.46
                                                                                  
                                                                                  
                                                                                  
                                                                                  3,990
                                                                                  
                                                                                  
                                                                                  
                                                                                  4.242012
                                                                                  
                                                                                  
                                                                                  
                                                                                  10,522
                                                                                  
                                                                                  
                                                                                  
                                                                                  4.12
                                                                                  
                                                                                  
                                                                                  
                                                                                  684
                                                                                  
                                                                                  
                                                                                  
                                                                                  4.092013
                                                                                  
                                                                                  
                                                                                  
                                                                                  6,789
                                                                                  
                                                                                  
                                                                                  
                                                                                  3.92
                                                                                  
                                                                                  
                                                                                  
                                                                                  579
                                                                                  
                                                                                  
                                                                                  
                                                                                  4.132014
      - 2018
                                                                                  
                                                                                  
                                                                                  
                                                                                  2,882
                                                                                  
                                                                                  
                                                                                  
                                                                                  3.30
                                                                                  
                                                                                  
                                                                                  
                                                                                  10
                                                                                  
                                                                                  
                                                                                  
                                                                                  3.942019
      - 2023
                                                                                  
                                                                                  
                                                                                  
                                                                                  446
                                                                                  
                                                                                  
                                                                                  
                                                                                  0.19
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -2024
      - 2028
                                                                                  
                                                                                  
                                                                                  
                                                                                  360
                                                                                  
                                                                                  
                                                                                  
                                                                                  0.00
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -Total
      long-term borrowings
                                                                                  
                                                                                  
                                                                                  
                                                                                  118,421
                                                                                  
                                                                                  
                                                                                  
                                                                                  3.80
                                                                                  
                                                                                  
                                                                                  
                                                                                  84,878
                                                                                  
                                                                                  
                                                                                  
                                                                                  4.66Total
      borrowed funds
                                                                                  
                                                                                  
                                                                                  $
                                                                                  119,148
                                                                                  
                                                                                  
                                                                                  
                                                                                  3.79
                                                                                  
                                                                                  
                                                                                  $
                                                                                  85,107
                                                                                  
                                                                                  
                                                                                  
                                                                                  4.65




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, 2008.  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, 2008, and a $3,500,000 line
of credit available from another correspondent bank, of which $1,340,000 was
outstanding at December 31, 2008.  The Bank had no amounts outstanding
under these lines of credit at December 31, 2007.





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.





48










Notes
to Consolidated Financial Statements




8.
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 $50,000 for the year
ended December 31, 2008 compared with $131,000 and $280,000 for 2007 and 2006,
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 $191,000, $168,000 and $136,000 for the years ended December 31, 2008,
2007 and 2006, respectively.




DirectorsRetirement
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.





49












Notes
to Consolidated Financial Statements




8. 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, 2008 and 2007:


Healthcare
      Benefits Plan(In
      thousands)
                                        
                                        2008
                                        
                                        
                                        2007Measurement
      date
                                        
                                        12/31/2008
                                        
                                        
                                        12/31/2007Projected
      benefit obligation
                                        
                                        $
                                        (334
                                        )
                                        
                                        $
                                        (366
                                        )Fair
      value of plan assets
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Funded
      status
                                        
                                        $
                                        (334
                                        )
                                        
                                        $
                                        (366
                                        )Accrued
      benefit cost recognized in thestatement
      of financial condition
                                        
                                        $
                                        (334
                                        )
                                        
                                        $
                                        (366
                                        )




Net Periodic Benefit Cost
and Contributions




The
benefit costs and contributions related to the Healthcare Benefits plan for the
years ended December 31, 2008 and 2007 were:


Healthcare
      Benefits Plan(In
      thousands)
                                  
                                  2008
                                  
                                  
                                  2007Net
      periodic benefit cost
                                  
                                  $
                                  (32
                                  )
                                  
                                  $
                                  (5
                                  )Employer
      contributions
                                  
                                  
                                  19
                                  
                                  
                                  
                                  20Plan
      participants' contributions
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Benefits
      paid during the year
                                  
                                  
                                  19
                                  
                                  
                                  
                                  20





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 $20,527 for
the Healthcare Benefits Plan.





50










Notes
to Consolidated Financial Statements




Assumptions and
Effects




The
actuarial assumptions used to determine the projected benefit obligations and
net periodic benefit cost for the years ended December 31, 2008 and 2007 were as
follows:


Healthcare
      Benefits PlanWeighted-average
      assumptions:
                                  
                                  2008
                                  
                                  2007Discount
      rate
                                  
                                  
                                  6.875
                                  %
                                  
                                  
                                  6.375
                                  %Rate
      of compensation increase
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Medical
      trend rate next year
                                  
                                  
                                  8.00
                                  %
                                  
                                  
                                  10.00
                                  %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, 2008, a one percentage-point
increase in the assumed health care trend rates would increase the projected
benefit obligation by $42,676 compared with a decrease of $36,718 if the assumed
health care trend rate were to decrease by one percentage-point.




9.  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, 2008 and 2007 was $169,056
and $226,735 respectively. At December 31, 2008 and 2007, there were 19,889
unallocated ESOP shares, and 213,624 and 233,513 unreleased ESOP shares
respectively. At December 31, 2008 the unreleased shares had an aggregate fair
value of $1,085,000.






51














Notes
to Consolidated Financial Statements




10.  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, 2008, 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 awardsAwarded
                                                                    
                                                                    
                                                                    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.  Both stock options and
restricted stock awards vest at 20% per year beginning on the first anniversary
of the date of grant.





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, 2008 and 2007 and
changes during the year, is as follows:





52














Notes
to Consolidated Financial Statements


2008
                                                      
                                                      
                                                      2007Weighted
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      WeightedNumber
                                                      
                                                      
                                                      Average
                                                      
                                                      
                                                      Number
                                                      
                                                      
                                                      Averageof
                                                      
                                                      
                                                      Exercise
                                                      
                                                      
                                                      of
                                                      
                                                      
                                                      ExerciseShares
                                                      
                                                      
                                                      Price
                                                      
                                                      
                                                      Shares
                                                      
                                                      
                                                      PriceOptions
      outstanding at beginning of year
                                                      
                                                      
                                                      359,460
                                                      
                                                      
                                                      $
                                                      11.13
                                                      
                                                      
                                                      
                                                      353,730
                                                      
                                                      
                                                      $
                                                      11.10Granted
                                                      
                                                      
                                                      1,000
                                                      
                                                      
                                                      
                                                      11.10
                                                      
                                                      
                                                      
                                                      9,500
                                                      
                                                      
                                                      
                                                      12.20Forfeited
                                                      
                                                      
                                                      (2,830
                                                      )
                                                      
                                                      
                                                      11.10
                                                      
                                                      
                                                      
                                                      (3,030
                                                      )
                                                      
                                                      
                                                      11.10Exercised
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      (240
                                                      )
                                                      
                                                      
                                                      11.10Expired
                                                      
                                                      
                                                      (4,050
                                                      )
                                                      
                                                      
                                                      11.10
                                                      
                                                      
                                                      
                                                      (500
                                                      )
                                                      
                                                      
                                                      11.10Options
      outstanding at end of year
                                                      
                                                      
                                                      353,580
                                                      
                                                      
                                                      
                                                      11.13
                                                      
                                                      
                                                      
                                                      359,460
                                                      
                                                      
                                                      
                                                      11.13Options
      exercisable at end of year
                                                      
                                                      
                                                      138,270
                                                      
                                                      
                                                      
                                                      11.12
                                                      
                                                      
                                                      
                                                      139,120
                                                      
                                                      
                                                      
                                                      11.10Weighted-average
      fair value of optionsgranted
      during the year
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      $
                                                      1.51
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      $
                                                      2.26





The
Company accounts for its share-based compensation in accordance with Financial
Accounting Standards Board’s SFAS No. 123(R), “Share Based
Payment”.  In accordance with Statement No. 123 (R), the Company
has recorded share-based compensation expense related to outstanding stock
option 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.





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 elected to
follow the simplified method as permitted by the SEC Staff Accounting Bulletin
107, which was issued to provide guidance on the implementation of
SFAS 123(R). Under this method, 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.





53












Notes
to Consolidated Financial Statements




10.Equity Incentive
Plan–
(Continued)




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 $507,557, $471,243 and
$435,860 for the year ended December 31, 2008, 2007 and 2006, respectively, in
connection with the stock option and restricted stock awards.  At
December 31, 2008, the Company has approximately $370,331 of unrecorded option
expense to be recognized over the remaining vesting period of the
options.




11.  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.





54












Notes
to Consolidated Financial Statements




Income
taxes receivable and payable included in the balance sheet at December 31, 2008
and 2007 were:


(In
      thousands)
                                    
                                    2008
                                    
                                    
                                    2007Current
      tax receivable
                                    
                                    $
                                    110
                                    
                                    
                                    $
                                    174Deferred
      tax receivableImpairment
      loss on investment securities
                                    
                                    $
                                    1,165
                                    
                                    
                                    $
                                    -Reserve
      for loan losses
                                    
                                    
                                    971
                                    
                                    
                                    
                                    735Deferred
      income
                                    
                                    
                                    399
                                    
                                    
                                    
                                    248Charitable
      contributions carryforward
                                    
                                    
                                    261
                                    
                                    
                                    
                                    277Post-retirement
      benefits
                                    
                                    
                                    114
                                    
                                    
                                    
                                    125Available-for-sale
      securities
                                    
                                    
                                    -
                                    
                                    
                                    
                                    60Total
      deferred tax receivable
                                    
                                    
                                    2,910
                                    
                                    
                                    
                                    1,445Deferred
      tax payableDepreciation
                                    
                                    $
                                    (65
                                    )
                                    
                                    $
                                    (101
                                    )Available-for-sale
      securities
                                    
                                    
                                    (13
                                    )
                                    
                                    
                                    -Other
      items
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (13
                                    )Total
      deferred tax payable
                                    
                                    
                                    (78
                                    )
                                    
                                    
                                    (114
                                    )Net
      deferred tax receivable
                                    
                                    $
                                    2,832
                                    
                                    
                                    $
                                    1,331





The
provision (benefit) for income taxes for the year ended December 31, 2008,
2007 and 2006 consisted of:


(In
      thousands)
                                  
                                  2008
                                  
                                  
                                  2007
                                  
                                  
                                  2006Current
      income tax expense
                                  
                                  $
                                  1,008
                                  
                                  
                                  $
                                  206
                                  
                                  
                                  $
                                  279Deferred
      income tax expense (benefit), due to:Impairment
      loss on investment securities
                                  
                                  
                                  (1,165
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Reserve
      for loan losses
                                  
                                  
                                  (236
                                  )
                                  
                                  
                                  (31
                                  )
                                  
                                  
                                  (152
                                  )Deferred
      income
                                  
                                  
                                  (151
                                  )
                                  
                                  
                                  (34
                                  )
                                  
                                  
                                  (76
                                  )Charitable
      contributions
                                  
                                  
                                  16
                                  
                                  
                                  
                                  88
                                  
                                  
                                  
                                  63Post
      retirement benefits
                                  
                                  
                                  11
                                  
                                  
                                  
                                  86
                                  
                                  
                                  
                                  2Depreciation
                                  
                                  
                                  (36
                                  )
                                  
                                  
                                  (73
                                  )
                                  
                                  
                                  71Other
      items
                                  
                                  
                                  (13
                                  )
                                  
                                  
                                  (25
                                  )
                                  
                                  
                                  17Total
      deferred income tax expense (benefit)
                                  
                                  
                                  (1,574
                                  )
                                  
                                  
                                  11
                                  
                                  
                                  
                                  (75
                                  )Provision
      (benefit) for income taxes
                                  
                                  $
                                  (566
                                  )
                                  
                                  $
                                  217
                                  
                                  
                                  $
                                  204





55










Notes
to Consolidated Financial Statements




11.Income Taxes–
(Continued)




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)
                                              
                                              2008
                                              
                                              
                                              2007
                                              
                                              
                                              2006Income
      tax expense (benefit) at statutory rate of 34%
                                              
                                              $
                                              (299
                                              )
                                              
                                              $
                                              557
                                              
                                              
                                              $
                                              562Increase
      (decrease) in income tax expense resulting from:Nondeductible
      compensation expense
                                              
                                              
                                              100
                                              
                                              
                                              
                                              113
                                              
                                              
                                              
                                              104Income
      exempt from income tax
                                              
                                              
                                              (371
                                              )
                                              
                                              
                                              (456
                                              )
                                              
                                              
                                              (321
                                              )Changes
      in tax bad debt base year reserves
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -
                                              
                                              
                                              
                                              (145
                                              )Other
      items, net
                                              
                                              
                                              4
                                              
                                              
                                              
                                              3
                                              
                                              
                                              
                                              4Provision
      for income taxes
                                              
                                              $
                                              (566
                                              )
                                              
                                              $
                                              217
                                              
                                              
                                              $
                                              204Effective
      rate of income tax expense
                                              
                                              
                                              64.5
                                              %
                                              
                                              
                                              13.3
                                              %
                                              
                                              
                                              12.3
                                              %





Retained
earnings at December 31, 2008 includes a contingency reserve for loan losses
of  $1,867,000, 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 $635,000 has
not been recognized as of December 31, 2008.





As of
December 31, 2008, 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 2005-2008.





56












Notes
to Consolidated Financial Statements


12.  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)
                                  
                                  2008
                                  
                                  
                                  2007
                                  
                                  
                                  2006Net
      income (loss)
                                  
                                  $
                                  (312
                                  )
                                  
                                  $
                                  1,420
                                  
                                  
                                  $
                                  1,448Other
      comprehensive income (loss):Unrealized
      gain (loss) on securities available-for-sale
                                  
                                  
                                  (5,713
                                  )
                                  
                                  
                                  384
                                  
                                  
                                  
                                  195Reclassification
      adjustment for losses (gains)realized
      in net income (loss)
                                  
                                  
                                  3,398
                                  
                                  
                                  
                                  (65
                                  )
                                  
                                  
                                  (6
                                  )Other
      comprehensive income (loss) before tax effect
                                  
                                  
                                  (2,315
                                  )
                                  
                                  
                                  319
                                  
                                  
                                  
                                  189Income
      tax expense related to items of othercomprehensive
      income (loss)
                                  
                                  
                                  73
                                  
                                  
                                  
                                  109
                                  
                                  
                                  
                                  64Other
      comprehensive income (loss) net of tax effect
                                  
                                  
                                  (2,388
                                  )
                                  
                                  
                                  210
                                  
                                  
                                  
                                  125Total
      comprehensive income (loss)
                                  
                                  $
                                  (2,700
                                  )
                                  
                                  $
                                  1,630
                                  
                                  
                                  $
                                  1,573





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.




13.  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, 2008, 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, 2008
the Bank meets all capital requirements to which it is subject.





At
December 31, 2008 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.





57










Notes
to Consolidated Financial Statements


13.Regulatory Capital–
(Continued)




The
following is a summary of the Bank’s actual capital as computed under the
standards established by the OTS at December 31, 2008 and 2007,
respectively.


2008
                                        
                                        
                                        2007(Dollars
      in thousands)
                                        
                                        Amount
                                        
                                        
                                        Ratio
                                        
                                        Amount
                                        
                                        
                                        RatioTangible
      Equity Ratio (to Tangible Assets)
                                        
                                        $
                                        40,555
                                        
                                        
                                        
                                        7.58
                                        %
                                        
                                        $
                                        40,484
                                        
                                        
                                        
                                        8.81
                                        %Tier
      I (Core) Capital (to Adjusted Total Assets)
                                        
                                        
                                        40,555
                                        
                                        
                                        
                                        7.58
                                        %
                                        
                                        
                                        40,484
                                        
                                        
                                        
                                        8.81
                                        %Tier
      I Risk-Based Capital (to Risk-Weighted Assets)
                                        
                                        
                                        40,555
                                        
                                        
                                        
                                        10.36
                                        %
                                        
                                        
                                        40,484
                                        
                                        
                                        
                                        12.22
                                        %Total
      Risk-Based Capital (to Risk-Weighted Assets)
                                        
                                        
                                        43,423
                                        
                                        
                                        
                                        11.09
                                        %
                                        
                                        
                                        42,647
                                        
                                        
                                        
                                        12.88
                                        %





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)
                                                      
                                                      2008
                                                      
                                                      
                                                      2007Total
      capital as calculated under generally acceptedaccounting
      principles (GAAP Capital)
                                                      
                                                      $
                                                      38,197
                                                      
                                                      
                                                      $
                                                      40,560Adjustments
      to reconcile Total GAAP Capital to Regulatory Capital:Intangible
      assets
                                                      
                                                      
                                                      (121
                                                      )
                                                      
                                                      
                                                      (155
                                                      )Accumulated
      other comprehensive incomefrom
      available-for-sale securities
                                                      
                                                      
                                                      2,479
                                                      
                                                      
                                                      
                                                      79Tier
      I Risk-Based Capital
                                                      
                                                      
                                                      40,555
                                                      
                                                      
                                                      
                                                      40,484Includible
      portion of allowance for loan losses
                                                      
                                                      
                                                      2,868
                                                      
                                                      
                                                      
                                                      2,163Total
      Risk-Based Capital
                                                      
                                                      $
                                                      43,423
                                                      
                                                      
                                                      $
                                                      42,647





On
October 3, 2008, the Troubled Asset Relief Program (“TARP”) was signed into law.
TARP gave the U.S. Department of the Treasury (“Treasury Department”) authority
to deploy up to $700 billion into the financial system with an objective of
improving liquidity in capital markets. On October 14, 2008, the Treasury
Department announced the Capital Purchase Program (“CPP”), which provides for
direct equity investment of perpetual preferred stock by the Treasury Department
in qualified financial institutions. The program is voluntary and requires an
institution to comply with a number of restrictions and provisions, including
limits on executive compensation, stock redemptions and declaration of
dividends. The CPP provides for the purchase by the Treasury Department of
perpetual senior preferred stock in an aggregate amount ranging from 1% to 3% of
a participant’s risk-weighted assets.





58













Notes
to Consolidated Financial Statements


The
senior preferred stock will pay cumulative dividends at a rate of 5% per
year, until the fifth anniversary of the Treasury Department investment, and at
a rate of 9% per year thereafter. The CPP also requires a participant to
issue to the Treasury Department warrants to purchase common stock equal to 15%
of the capital invested by the Treasury.





The terms
of the CPP could reduce investment returns to the Company’s shareholders by
restricting increases in dividends paid on the Company’s common stock without
the Treasury Department’s consent, diluting existing shareholders’ interests and
restricting capital management practices. Although the Company and the Bank meet
all applicable regulatory capital requirements and Naugatuck Valley Savings
remains well capitalized, the Company is evaluating whether to participate in
the CPP. Participation in the program is not automatic and is subject to
approval by the Treasury Department.





14.  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 year
ended December 31, 2008, anti-dilutive options excluded from the calculations
totaled 346,080 options (with an exercise price of $11.10) and 7,500 options
(with an exercise price of $12.49).  The Company had no anti-dilutive
common shares outstanding for the year ended December 31,
2007.  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 31,2008
                                  
                                  
                                  2007Net
      income (loss) available to common stockholders
                                  
                                  $
                                  (312,000
                                  )
                                  
                                  $
                                  1,420,000Weighted-average
      shares outstanding during the periodBasic
                                  
                                  
                                  6,859,383
                                  
                                  
                                  
                                  7,117,614Effect
      of dilutive stock options and restrictive stock awards
                                  
                                  
                                  -
                                  
                                  
                                  
                                  16,781Diluted
                                  
                                  
                                  6,859,383
                                  
                                  
                                  
                                  7,134,395Net
      income (loss) per common share:Basic
      and diluted earnings (loss) per share
                                  
                                  $
                                  (0.05
                                  )
                                  
                                  $
                                  0.20





59










Notes
to Consolidated Financial Statements




15.  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. The
following table summarizes these financial instruments and other commitments and
contingent liabilities as of December 31, 2008 and 2007:


(In
      thousands)
                          
                          2008
                          
                          
                          2007Commitments
      to extend credit:Loan
      commitments
                          
                          $
                          5,807
                          
                          
                          $
                          23,994Unused
      lines of credit
                          
                          
                          20,328
                          
                          
                          
                          22,067Amounts
      due mortgagors on construction loans
                          
                          
                          25,855
                          
                          
                          
                          22,783Amounts
      due on commercial  loans
                          
                          
                          15,384
                          
                          
                          
                          7,673Commercial
      letters of credit
                          
                          
                          5,125
                          
                          
                          
                          5,698





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.




16.  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, 2008 and
2007:


December
      31,2008
                                                        
                                                        
                                                        2007Carrying
                                                        
                                                        
                                                        Estimated
                                                        
                                                        
                                                        Carrying
                                                        
                                                        
                                                        Estimated(In
      thousands)
                                                        
                                                        Amount
                                                        
                                                        
                                                        Fair
      Value
                                                        
                                                        
                                                        Amount
                                                        
                                                        
                                                        Fair
      ValueFinancial
      AssetsCash
      and cash equivalents
                                                        
                                                        $
                                                        8,247
                                                        
                                                        
                                                        $
                                                        8,247
                                                        
                                                        
                                                        $
                                                        8,370
                                                        
                                                        
                                                        $
                                                        8,370Investment
      securities
                                                        
                                                        
                                                        63,844
                                                        
                                                        
                                                        
                                                        63,844
                                                        
                                                        
                                                        
                                                        66,454
                                                        
                                                        
                                                        
                                                        66,452Loans
      receivable, net
                                                        
                                                        
                                                        431,976
                                                        
                                                        
                                                        
                                                        440,405
                                                        
                                                        
                                                        
                                                        359,831
                                                        
                                                        
                                                        
                                                        362,249Accrued
      income receivable
                                                        
                                                        
                                                        2,099
                                                        
                                                        
                                                        
                                                        2,099
                                                        
                                                        
                                                        
                                                        2,033
                                                        
                                                        
                                                        
                                                        2,033Financial
      LiabilitiesDeposits
                                                        
                                                        $
                                                        363,026
                                                        
                                                        
                                                        $
                                                        358,474
                                                        
                                                        
                                                        $
                                                        321,398
                                                        
                                                        
                                                        $
                                                        308,226Borrowed
      funds
                                                        
                                                        
                                                        119,148
                                                        
                                                        
                                                        
                                                        120,811
                                                        
                                                        
                                                        
                                                        85,107
                                                        
                                                        
                                                        
                                                        85,640Mortgagors'
      escrow accounts
                                                        
                                                        
                                                        4,562
                                                        
                                                        
                                                        
                                                        4,562
                                                        
                                                        
                                                        
                                                        3,871
                                                        
                                                        
                                                        
                                                        3,871





60










Notes
to Consolidated Financial Statements


Effective
January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurement. SFAS
No. 157 defines fair value 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. In addition, SFAS 157 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 market assumptions. These two types of inputs have the following fair
value hierarchy:




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. In accordance with
Financial Accounting Standards Board (“FASB”) Staff Position No. 157-2,
Effective Date of FASB
Statement No. 157, the Company has delayed the application of SFAS 157
for nonfinancial assets, such as goodwill and real property held for sale,
and non-financial liabilities until January 1, 2009.





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:




Available-for-sale
securities are recorded at fair value on a recurring basis. 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. As of December 31, 2008, the Company transferred





61










Notes
to Consolidated Financial Statements




16.Fair Value–
(Continued)




seven
auction-rate preferred securities in the available-for-sale portfolio from Level
2 to Level 3. Market prices of comparable instruments have become harder to
identify due to inactive markets, which has 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 has
required the Company to move the valuation of these securities from Level 2 to
Level 3.





Assets
measured at fair value under SFAS No.157 are summarized below:


Carrying
      Value(In
      thousands)
                                        
                                        Level
      1
                                        
                                        
                                        Level
      2
                                        
                                        
                                        Level
      3
                                        
                                        
                                        TotalAssets
      measured at fair value on a recurring basis:Available-for-sale
      investment securities
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        57,100
                                        
                                        
                                        $
                                        6,744
                                        
                                        
                                        $
                                        63,844Assets
      measured at fair value on a non-recurring basis:Collateral
      dependent impaired loans
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        261,544
                                        
                                        
                                        $
                                        2,398
                                        
                                        
                                        $
                                        263,942





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 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.





62










Notes
to Consolidated Financial Statements




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.




17.  Selected
Quarterly Consolidated Financial Information (unaudited)




The
following tables present quarterly consolidated information for the Company for
2008, 2007 and 2006.





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 (loss)
                                  
                                  
                                  300
                                  
                                  
                                  
                                  (2,636
                                  )
                                  
                                  
                                  661
                                  
                                  
                                  
                                  627Noninterest
      expense
                                  
                                  
                                  3,539
                                  
                                  
                                  
                                  3,453
                                  
                                  
                                  
                                  3,257
                                  
                                  
                                  
                                  3,205Income
      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





63










Notes
to Consolidated Financial Statements




17. Selected
Quarterly Consolidated FinancialInformation(unaudited)– (Continued)







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


For
      the Year Ended December 31, 2006Fourth
                                    
                                    
                                    Third
                                    
                                    
                                    Second
                                    
                                    
                                    First(In
      thousands)
                                    
                                    Quarter
                                    
                                    
                                    Quarter
                                    
                                    
                                    Quarter
                                    
                                    
                                    QuarterInterest
      and dividend income
                                    
                                    $
                                    5,644
                                    
                                    
                                    $
                                    5,329
                                    
                                    
                                    $
                                    4,990
                                    
                                    
                                    $
                                    4,787Interest
      expense
                                    
                                    
                                    2,847
                                    
                                    
                                    
                                    2,490
                                    
                                    
                                    
                                    2,097
                                    
                                    
                                    
                                    1,916Net
      interest income
                                    
                                    
                                    2,797
                                    
                                    
                                    
                                    2,839
                                    
                                    
                                    
                                    2,893
                                    
                                    
                                    
                                    2,871Provision
      for loan losses
                                    
                                    
                                    62
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    68
                                    
                                    
                                    
                                    62Net
      interest income afterprovision
      for loan losses
                                    
                                    
                                    2,735
                                    
                                    
                                    
                                    2,839
                                    
                                    
                                    
                                    2,825
                                    
                                    
                                    
                                    2,809Noninterest
      income
                                    
                                    
                                    499
                                    
                                    
                                    
                                    522
                                    
                                    
                                    
                                    477
                                    
                                    
                                    
                                    450Noninterest
      expense
                                    
                                    
                                    3,029
                                    
                                    
                                    
                                    3,001
                                    
                                    
                                    
                                    2,819
                                    
                                    
                                    
                                    2,655Income
      before provision forincome
      tax (benefit)
                                    
                                    
                                    205
                                    
                                    
                                    
                                    360
                                    
                                    
                                    
                                    483
                                    
                                    
                                    
                                    604Provision
      for income tax (benefit)
                                    
                                    
                                    54
                                    
                                    
                                    
                                    (54
                                    )
                                    
                                    
                                    70
                                    
                                    
                                    
                                    134Net
      income
                                    
                                    $
                                    151
                                    
                                    
                                    $
                                    414
                                    
                                    
                                    $
                                    413
                                    
                                    
                                    $
                                    470





64










Notes
to Consolidated Financial Statements




18.  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)
                                            
                                            2008
                                            
                                            
                                            2007ASSETSCash
      on deposit with Naugatuck Valley Savings and Loan
                                            
                                            $
                                            1,872
                                            
                                            
                                            $
                                            3,661Investment
      in subsidiary, Naugatuck Valley Savings and Loan
                                            
                                            
                                            38,197
                                            
                                            
                                            
                                            40,560Investment
      securities
                                            
                                            
                                            2,260
                                            
                                            
                                            
                                            2,745Loan
      to ESOP
                                            
                                            
                                            2,335
                                            
                                            
                                            
                                            2,499Deferred
      income taxes
                                            
                                            
                                            274
                                            
                                            
                                            
                                            296Other
      assets
                                            
                                            
                                            717
                                            
                                            
                                            
                                            703Total
      assets
                                            
                                            $
                                            45,655
                                            
                                            
                                            $
                                            50,464LIABILITIES
      AND STOCKHOLDERS' EQUITYLiabilities
                                            
                                            $
                                            67
                                            
                                            
                                            $
                                            7Stockholders'
      equity
                                            
                                            
                                            45,588
                                            
                                            
                                            
                                            50,457Total
      liabilities and stockholders' equity
                                            
                                            $
                                            45,655
                                            
                                            
                                            $
                                            50,464





Statements of
Income





For the
Year Ended December 31, 2008, 2007 and 2006:





For
      the Years Ended December 31,(In
      thousands)
                                
                                2008
                                
                                
                                2007
                                
                                
                                2006Interest
      income
                                
                                $
                                224
                                
                                
                                $
                                351
                                
                                
                                $
                                441Other
      income
                                
                                
                                1
                                
                                
                                
                                1
                                
                                
                                
                                1Total
      income
                                
                                
                                225
                                
                                
                                
                                352
                                
                                
                                
                                442Other
      expense
                                
                                
                                476
                                
                                
                                
                                313
                                
                                
                                
                                309Income
      before income tax (benefit) and equity inundistributed
      net income (loss) of subsidiary
                                
                                
                                (251
                                )
                                
                                
                                39
                                
                                
                                
                                133Income
      tax (benefit)
                                
                                
                                (85
                                )
                                
                                
                                13
                                
                                
                                
                                47Income
      before equity in undistributednet
      income (loss) of subsidiary
                                
                                
                                (166
                                )
                                
                                
                                26
                                
                                
                                
                                86Equity
      in undistributed net income (loss) of subsidiary
                                
                                
                                (146
                                )
                                
                                
                                1,394
                                
                                
                                
                                1,362Net
      income (loss)
                                
                                $
                                (312
                                )
                                
                                $
                                1,420
                                
                                
                                $
                                1,448





65










Notes
to Consolidated Financial Statements




18.ParentCompany Only
Financial Statements– (Continued)




Statements of Cash
flows





For the
Year Ended December 31, 2008, 2007 and 2006:


For
      the Years Ended December 31,(In
      thousands)
                                  
                                  2008
                                  
                                  
                                  2007
                                  
                                  
                                  2006Net
      cash provided by operating activities
                                  
                                  $
                                  240
                                  
                                  
                                  $
                                  438
                                  
                                  
                                  $
                                  278Cash
      flows from investing activitiesPurchase
      of available-for-sale securities
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (1,500
                                  )
                                  
                                  
                                  -Paydowns
      and maturities of available-for-sale securities
                                  
                                  
                                  497
                                  
                                  
                                  
                                  4,234
                                  
                                  
                                  
                                  3,854Principal
      payments received from ESOP
                                  
                                  
                                  163
                                  
                                  
                                  
                                  156
                                  
                                  
                                  
                                  -Investment
      in subsidiary, Naugatuck Valley Savings and Loan
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  2,500Net
      cash provided by investing activities
                                  
                                  
                                  660
                                  
                                  
                                  
                                  2,890
                                  
                                  
                                  
                                  6,354Cash
      flows from financing activitiesPayment
      of borrowings from subsidiary
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (2,981
                                  )Common
      stock repurchased
                                  
                                  
                                  (2,244
                                  )
                                  
                                  
                                  (2,430
                                  )
                                  
                                  
                                  (1,491
                                  )Cash
      dividends to common shareholders
                                  
                                  
                                  (614
                                  )
                                  
                                  
                                  (588
                                  )
                                  
                                  
                                  (617
                                  )Release
      of ESOP shares
                                  
                                  
                                  169
                                  
                                  
                                  
                                  227
                                  
                                  
                                  
                                  -Cost
      of issuance of common stock
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Net
      cash used by financing activities
                                  
                                  
                                  (2,689
                                  )
                                  
                                  
                                  (2,791
                                  )
                                  
                                  
                                  (5,089
                                  )Increase
      (decrease) in cash and cash equivalents
                                  
                                  
                                  (1,789
                                  )
                                  
                                  
                                  537
                                  
                                  
                                  
                                  1,543Cash
      and cash equivalents at beginning of year
                                  
                                  
                                  3,661
                                  
                                  
                                  
                                  3,124
                                  
                                  
                                  
                                  1,581Cash
      and cash equivalents at end of year
                                  
                                  $
                                  1,872
                                  
                                  
                                  $
                                  3,661
                                  
                                  
                                  $
                                  3,124Supplemental
      Disclosures:Cash
      paid during the year for:Interest
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -Income
      taxes
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -





66









Directors
and Executive Officers





Directors
of Naugatuck Valley Financial Corporation,


Naugatuck
Valley Mutual Holding Company


and Naugatuck Valley Savings
and Loan








Carlos
      S. Batista
                Michael
      S. Plude, CPAVice
      President, Systems & Solutions
                Managing
      Partner – Kaskie, Plude & Company, LLC–
      Bristol, Inc. a division of Emerson Process ManagementRichard
      M. Famiglietti
                John
      C. RomanOwner
      – CM Property Management
                President
      and Chief Executive Officer – NaugatuckValley
      Financial Corporation, Naugatuck ValleyRonald
      D. Lengyel
                Mutual
      Holding Company and Naugatuck ValleyChairman
      of the Board – Naugatuck Valley
                Savings
      and LoanFinancial
      Corporation, Naugatuck Valley MutualHolding
      Company and Naugatuck Valley
                Camilo
      P. VieiraSavings
      and Loan
                Consultant
      – CM Property ManagementRetired
      – IBM CorporationJames
      A. MengacciOwner
      – James A. Mengacci Associates LLC
                Jane
      H. WalshRetired
      Senior Vice President – Naugatuck ValleyFinancial
      Corporation, Naugatuck Valley MutualHolding Company and Naugatuck
      Valley Savings and
      Loan








Executive
Officers of


Naugatuck
Valley Financial Corporation,


Naugatuck
Valley Mutual Holding Company


and Naugatuck Valley Savings
and Loan





John
      C. Roman
                William
      C. NimonsPresident
      and Chief Executive Officer
                Senior
      Vice PresidentDominic
      J. Alegi, Jr.
                Mark
      S. GravelineExecutive
      Vice President
                Senior
      Vice PresidentLee
      R. SchlesingerSenior
      Vice President and ChieFinancial
      Officer


67




Investor
and Corporate Information





Annual
Meeting





The
annual meeting of stockholders will be held at 10:30 a.m., local time, on May
13, 2009 in the Community Room at Naugatuck Valley Savings and Loan’s main
office at 333 Church Street, Naugatuck, Connecticut 06770.





Stock
Listing





Naugatuck
Valley Financial Corporation common stock is listed on the Nasdaq Global Market
under the symbol “NVSL.”





Price
Range of Common Stock





On
October 1, 2004, Naugatuck Valley Financial common stock commenced trading on
the Nasdaq National Market.  At March 25, 2009, there were 796 holders
of record of Naugatuck Valley Financial common stock.  The following
table sets forth the high and low sales prices of the common stock, as reported
on the Nasdaq National Market, and the dividend paid by Naugatuck Valley
Financial during each quarter since trading commenced.





High
                      
                      Low
                      
                      Dividends2007:First
      Quarter
                      
                      $12.95
                      
                      $12.00
                      
                      $0.05Second
      Quarter
                      
                      12.90
                      
                      10.05
                      
                      0.05Third
      Quarter
                      
                      11.90
                      
                      9.97
                      
                      0.05Fourth
      Quarter
                      
                      10.70
                      
                      8.75
                      
                      0.052008: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
                      
                      0.06





Stockholder
and General Inquiries





John C.
Roman


President
and Chief Executive Officer


Naugatuck
Valley Financial Corporation


333
Church Street


Naugatuck,
Connecticut 06770


(203)
720-5000





Annual
and Other Reports





A copy of
the Naugatuck Valley Financial Annual Report on Form 10-K, without exhibits, for
the year ended December 31, 2008, as filed with the Securities and Exchange
Commission, may be obtained without charge by contacting Bernadette A. Mole,
Corporate Secretary, Naugatuck Valley Financial Corporation, 333 Church Street,
Naugatuck, Connecticut 06770.





Independent
      Registered Public Accounting Firm
              Transfer
      AgentWhittlesey
      & Hadley, P.C.
              Registrar
      and Transfer Company147
      Charter Oak Avenue
              10
      Commerce DriveHartford,
      Connecticut  06106
              Cranford,
      New Jersey 07016





Corporate
Counsel





Kilpatrick
Stockton LLP


607
14th
Street, N.W.


Washington,
DC 20005





68





Office
Locations








Main Office333
      Church Street
                    Naugatuck,
      Connecticut  06770Branch Offices1009
      New Haven Road
                    Naugatuck,
      Connecticut  06770127
      South Main Street
                    Beacon
      Falls, Connecticut  064031699
      Highland Avenue
                    Cheshire,
      Connecticut  0641049
      Pershing Drive
                    Derby,
      Connecticut  06418249
      West Street
                    Seymour,
      Connecticut  06483504
      Bridgeport Avenue
                    Shelton,
      Connecticut  06484
                    
                    450
      Heritage Road, Suite 3C
                    Southbury,
      CT 064881570
      Southford Road
                    Southbury,
      Connecticut  064881030
      Hamilton Avenue
                    Waterbury,
      Connecticut  06706






69