**Table
      of Contents**





PageLetter
                to Our Shareholders
            1Selected
                Consolidated Financial and Other Data
            2Management's
                Discussion and Analysis of Financial Condition and Results of
                Operations
            4Report
                of Independent Registered Public Accounting Firm
            29Consolidated
                Statements of Financial Condition
            30Consolidated
                Statements of Income
            31Consolidated
                Statements of Changes in Stockholders’ Equity
            32Consolidated
                Statements of Cash Flows
            34Notes
                to Consolidated Financial Statements
            36Directors
                and Officers
            63Investor
                and Corporate Information
            64Office
                Locations
            66








**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 are 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 nine full-service banking offices in the Greater Naugatuck
      Valley Region of southwestern Connecticut.










Dear
      Stockholders,








During
      2006 Naugatuck Valley Financial Corporation continued to build value for its
      customers, employees and shareholders by taking initiatives to expand our
      franchise, providing superior service and developing meaningful customer
      relationships.





Assets
      grew 16.5% supported by deposit growth of 20.1%. These deposits funded loan
      growth of 18.9%. We brought our brand of community banking to three new
      communities by opening de novo branches in Southbury, Waterbury and Cheshire,
      Connecticut. We are pleased with the initial growth of these new branches and
      our acceptance in our new communities. Noninterest income increased 28.4% as
      new
      fee based programs such as reverse mortgages and an overdraft privilege program
      were delivered by our dedicated and experienced employees. Our loan
      delinquencies remained low due to our continued dedication to credit
      quality.





Earnings
      decreased in 2006 due to the challenging interest rate environment and as a
      result of the costs of our growth. We understand and remain focused on what
      it
      takes to build value within the Mutual Holding Company structure. The market
      rewarded our share holders with a 20% increase in our stock price and we built
      value through the repurchase of 131,150 shares or 34.5% of the total shares
      authorized to be repurchased under the announced program. We increased the
      amount of our quarterly dividend from $.04 to $.05 per share starting with
      the
      first quarterly dividend paid in 2006.





Finally,
      in 2006 the Naugatuck Valley Savings and Loan Foundation, the charitable
      foundation we established and funded with our common stock in connection with
      the 2004 stock offering, made grants in excess of $98,000 to support charitable
      and humanitarian needs in our community.





We
      thank
      you for your continued support as we strive for continued growth and
      success.








Sincerely
      Yours,




/s/
              Ronald D. Lengyel
            /s/
              John C. RomanRonald
                D. Lengyel
            John
                C. RomanChairman
                of the Board
            President
                and CEO










**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,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****(In
                thousands)****Financial
                Condition Data:**Total
                assets
            
            $
            413,855
            
            $
            355,346
            
            $
            265,449
            
            $
            243,956
            
            $
            227,998Securities
                held to maturity
            
            
            2,531
            
            
            5,002
            
            
            5,168
            
            
            1,561
            
            
            1,364Securities
                available for sale
            
            
            67,736
            
            
            58,047
            
            
            31,096
            
            
            37,166
            
            
            32,512Loans
                receivable, net
            
            
            308,376
            
            
            259,427
            
            
            203,820
            
            
            180,378
            
            
            166,046Cash
                and cash equivalents
            
            
            7,942
            
            
            8,951
            
            
            7,575
            
            
            9,775
            
            
            18,158Deposits
            
            
            289,198
            
            
            240,846
            
            
            193,366
            
            
            183,455
            
            
            173,231FHLB
                advances
            
            
            68,488
            
            
            57,059
            
            
            15,826
            
            
            34,990
            
            
            31,119Total
                capital
            
            
            51,084
            
            
            50,964
            
            
            51,571
            
            
            21,217
            
            
            19,850








**Year
                Ended December 31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****(In
                thousands, except per share data)****Operating
                Data:**Interest
                and dividend income
            
            $
            20,750
            
            $
            15,908
            
            $
            12,713
            
            $
            12,644
            
            $
            13,178Interest
                expense
            
            
            9,350
            
            
            4,941
            
            
            3,559
            
            
            4,241
            
            
            5,299Net
                interest income
            
            
            11,400
            
            
            10,967
            
            
            9,154
            
            
            8,403
            
            
            7,879Provision
                for loan losses
            
            
            192
            
            
            32
            
            
            -
            
            
            45
            
            
            231Net
                interest income after provision for loan losses
            
            
            11,208
            
            
            10,935
            
            
            9,154
            
            
            8,358
            
            
            7,648Noninterest
                income
            
            
            1,948
            
            
            1,517
            
            
            1,078
            
            
            1,115
            
            
            972Noninterest
                expense
            
            
            11,504
            
            
            10,097
            
            
            9,803
            
            
            6,845
            
            
            5,820Income
                before provision for income taxes
            
            
            1,652
            
            
            2,355
            
            
            429
            
            
            2,628
            
            
            2,800Provision
                for income taxes
            
            
            204
            
            
            450
            
            
            14
            
            
            822
            
            
            880Net
                income
            
            $
            1,448
            
            $
            1,905
            
            $
            415
            
            $
            1,806
            
            $
            1,920Earnings
                per share, basic and diluted
            
            $
            0.20
            
            $
            0.26
            
            $
            0.07
            (1)
            
            NA
            
            
            NA





(1)
            Net
                income per share is for the fourth quarter 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.




2





**At
                or For the Year Ended December 31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****Performance
                Ratios:**Return
                on average assets
            
            
            0.38
            %
            
            0.62
            %
            
            0.16
            %
            
            0.77
            %
            
            0.91
            %Return
                on average equity
            
            
            2.79
            
            
            3.66
            
            
            1.42
            
            
            8.59
            
            
            10.23Interest
                rate spread (1)
            
            
            3.07
            
            
            3.68
            
            
            3.78
            
            
            3.77
            
            
            3.77Net
                interest margin (2)
            
            
            3.26
            
            
            3.87
            
            
            3.85
            
            
            3.85
            
            
            3.90Noninterest
                expense to average assets
            
            
            3.03
            
            
            3.27
            
            
            3.81
            
            
            2.94
            
            
            2.75Efficiency
                ratio (3)
            
            
            85.93
            
            
            80.61
            
            
            95.47
            
            
            71.62
            
            
            65.20Dividend
                payout ratio (4)
            
            
            100.00
            
            
            61.54
            
            
            -
            
            
            -
            
            
            -Average
                interest-earning assets to average interest-bearing
                liabilities
            
            
            107.18
            
            
            111.20
            
            
            104.98
            
            
            103.69
            
            
            105.20Average
                equity to average assets
            
            
            13.65
            
            
            16.87
            
            
            11.37
            
            
            9.02
            
            
            8.86**Capital
                Ratios:**Total
                capital to risk-weighted assets
            
            
            14.29
            
            
            17.88
            %
            
            23.61
            %
            
            16.21
            %
            
            15.37
            %Tier
                1 capital to risk-weighted assets
            
            
            13.56
            
            
            17.07
            
            
            22.52
            
            
            14.96
            
            
            14.12Tier
                1 capital to adjusted total assets (5)
            
            
            9.53
            
            
            11.42
            
            
            14.78
            
            
            8.64
            
            
            8.30Total
                equity to total assets
            
            
            12.34
            
            
            14.34
            
            
            19.43
            
            
            8.70
            
            
            8.71**Asset
                Quality Ratios:**Allowance
                for loan losses as a percent of total loans
            
            
            0.67
            %
            
            0.72
            %
            
            0.89
            %
            
            0.99
            %
            
            1.19
            %Allowance
                for loan losses as a percent of nonperforming loans
            
            
            103.03
            
            
            638.78
            
            
            306.88
            
            
            199.78
            
            
            162.91Net
                charge-offs (recoveries) to average loans outstanding during the
                period
            
            
            0.00
            
            
            0.01
            
            
            (0.01
            )
            
            0.13
            
            
            0.05Nonperforming
                loans as a percent of total loans
            
            
            0.65
            
            
            0.11
            
            
            0.29
            
            
            0.50
            
            
            0.73Nonperforming
                assets as a percent of total assets
            
            
            0.49
            
            
            0.10
            
            
            0.25
            
            
            0.46
            
            
            0.58**Other
                Data:**Number
                of:Deposit
                accounts
            
            
            27,385
            
            
            25,592
            
            
            22,599
            
            
            22,447
            
            
            22,059Full
                service customer service facilities
            
            
            9
            
            
            6
            
            
            5
            
            
            5
            
            
            4





(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.


(5)
            Data
                for 2003 represents Tier 1 capital to average
                assets.





3





**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 collectibility
      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 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 its 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.





4





***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**





At
      Naugatuck Valley Financial Corporation we pursue a strategy which is focused
      on
      long-term growth by providing superior customer service and the profitable
      delivery of the products our customers want.





The
      successful pursuit of this strategy involves growth of deposits and loans,
      increases in non-interest income, maintenance of credit quality, branch
      improvement and expansion of our market area.





During
      2006, we grew deposits by competing aggressively on rate and marketing free
      checking products. We were also successful in building municipal deposits from
      towns and cities in our market area, through the creation of a competitively
      priced Municipal Deposit product.





We
      grew
      loans of all types by meeting rate competition and through the sales efforts
      of
      our experienced business development teams. We increased residential mortgage
      loans by offering competitive rates and superior customer service from the
      time
      of application through closing and servicing. Our 2006 Home Equity Loan and
      Line
      promotion successfully grew both fixed and variable rate consumer loans. We
      successfully increased commercial mortgages and residential development loans
      through the efforts of our business development officers who build relationships
      and understand our borrowers, businesses and the communities they operate
      in.





We
      strive
      to decrease reliance on net interest income by increasing our sources and the
      amount of non-interest income. We continue to build non-interest income by
      increasing income from overdraft protection services, reverse mortgages and
      brokerage income from the sale of mortgages that do not meet our underwriting
      standards. We expect non-interest income to continue to rise in the future
      through the lease of office and retail space available at our Seymour and
      Southbury offices and through increases in income from investment advisory
      services and sales of Savings Bank Life Insurance.





We
      continue to be dedicated to the maintenance of credit quality. We maintained
      strong credit standards as we grew loans in the first half of this decade and
      expect our loan portfolios to maintain their low delinquency levels. We are
      committed to the maintenance of adequate loan loss reserves and prudently
      increased our loan loss reserves in 2006.





During
      2006, we took advantage of opportunities to expand our geographic reach by
      opening de novo branches. Our Southbury office was constructed on bank owned
      property during the first half of 2006 and opened for business in August 2006.
      In the summer of 2006, we took advantage of opportunities to enter the Waterbury
      and Cheshire markets through the lease of bank offices recently abandoned by
      our
      competition due to bank consolidations. We will continue to upgrade our current
      branch facilities and pursue expansion of our branch system in future years
      through de novo branching and branch acquisitions.





Historically,
      we have pursued a strategy of maintaining a high loan-to-asset ratio. This
      strategy requires us to prudently deploy our sources of funds, primarily
      deposits, into new loans. As of December 31, 2006, our loan to asset ratio
      was
      75%, up from 73% as of December 31, 2005. In spite of the inverted yield curve,
      we increased our net interest income by successfully managing asset and
      liability growth. This was accomplished by growing deposits and investing the
      funds in high quality residential mortgages, consumer lines of credit and small
      business and development loans.





5





We
      utilize a number of tools to increase net interest income and decrease interest
      rate risk. These tools include the purchase of short-term investments and the
      pursuit of a leverage strategy under which we fund our investments with lower
      cost borrowings.




**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, 2006, real estate loans totaled
      $255.4 million, or 81.5% of total loans compared to $215.5 million, or 81.6%
      of
      total loans at December 31, 2005 and $174.8 million, or 84.0% of total
      loans at December 31, 2004. Real estate loans have increased due to the
      stable interest rates together with significant real estate development in
      our
      market area.





The
      largest segment of our real estate loans is one- to four-family residential
      loans. At December 31, 2006, these loans totaled $179.4 million and represented
      70.2% of real estate loans and 57.3% of total loans compared to $156.9 million,
      which represented 72.8% of real estate loans and 59.4% of total loans, at
      December 31, 2005. One- to four-family residential loans increased $22.5
      million, or 14.3%, from December 31, 2005 to December 31, 2006 and
      increased $22.1 million, or 16.4%, from December 31, 2004 to
      December 31, 2005, reflecting a 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. This portfolio was $45.9 million and represented 18.0%
      of
      real estate loans and 14.6% of total loans at December 31, 2006 compared to
      $33.6 million, which represented 15.6% of real estate loans and 12.7% of total
      loans, at December 31, 2005. Multi-family and commercial real estate loans
      increased $12.3 million, or 36.5%, for the year ended December 31, 2006 and
      $11.0 million, or 49.0%, in the year ended December 31, 2005 due to the
      efforts on the part 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.
      This portfolio was $30.1 million and represented 11.8% of real estate loans
      and
      9.6% of total loans at December 31, 2006 compared to $24.9 million, which
      represented 11.6% of real estate loans and 9.5% of total loans at
      December 31, 2005. Construction loans increased $5.2 million, or 20.8%, for
      the year ended December 31, 2006 and $7.4 million, or 42.6%, in the year ended
      December 31, 2005 primarily due to an increased demand by contractors for
      construction loans and an increase in demand for construction to permanent
      financing by commercial customers.





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 $13.5 million, and
      represented 4.3% of total loans at December 31, 2006, compared to $9.7 million,
      representing 3.7% of total loans, at December 31, 2005.




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 $44.3 million and represented 14.2% of total loans at
      December 31, 2006, compared to $38.8 million, which represented 14.7% of total
      loans at December 31, 2005. The $5.5 million, or 14.3%,
      increase **** for
      the
      year ended December 31, 2006 and the $10.5 million, or 36.9%, increase for
      the
      2005 fiscal year was due to an aggressive marketing campaign together with
      competitive pricing on our equity loan and equity line of credit
      products.





6


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





**At
                December 31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****Amount**
            
            **Percent**
            
            **Amount**
            
            **Percent**
            
            **Amount**
            
            **Percent**
            
            **Amount**
            
            **Percent**
            
            **Amount**
            
            **Percent****(Dollars
                in thousands)**Real
                estate loans:One-to
                four-family
            
            $
            179,374
            
            
            57.27
            %
            $
            156,900
            
            
            59.44
            %
            $
            134,785
            
            
            64.75
            %
            $
            131,353
            
            
            70.98
            %
            $
            132,134
            
            
            77.85
            %Construction
            
            
            30,124
            
            
            9.62
            
            
            24,943
            
            
            9.45
            
            
            17,486
            
            
            8.40
            
            
            14,094
            
            
            7.62
            
            
            6,888
            
            
            4.06Multi-family
                and commercial real estate
            
            
            45,879
            
            
            14.65
            
            
            33,608
            
            
            12.73
            
            
            22,559
            
            
            10.84
            
            
            14,273
            
            
            7.71
            
            
            10,285
            
            
            6.06Total
                real estate loans
            
            
            255,377
            
            
            81.54
            
            
            215,451
            
            
            81.62
            
            
            174,830
            
            
            83.99
            
            
            159,720
            
            
            86.31
            
            
            149,307
            
            
            87.97Commercial
                business loans
            
            
            13,508
            
            
            4.31
            
            
            9,728
            
            
            3.69
            
            
            4,989
            
            
            2.40
            
            
            4,240
            
            
            2.29
            
            
            1,693
            
            
            1.00Consumer
                loans:Savings
                accounts
            
            
            634
            
            
            0.20
            
            
            785
            
            
            0.30
            
            
            679
            
            
            0.33
            
            
            592
            
            
            0.32
            
            
            519
            
            
            0.31Personal
            
            
            275
            
            
            0.09
            
            
            212
            
            
            0.08
            
            
            217
            
            
            0.10
            
            
            139
            
            
            0.08
            
            
            153
            
            
            0.09Automobile
            
            
            186
            
            
            0.06
            
            
            160
            
            
            0.06
            
            
            98
            
            
            0.05
            
            
            143
            
            
            0.08
            
            
            181
            
            
            0.11Home
                equity
            
            
            43,220
            
            
            13.80
            
            
            37,628
            
            
            14.25
            
            
            27,342
            
            
            13.13
            
            
            20,212
            
            
            10.92
            
            
            17,873
            
            
            10.53Total
                consumer loans
            
            
            44,315
            
            
            14.15
            
            
            38,785
            
            
            14.69
            
            
            28,336
            
            
            13.61
            
            
            21,086
            
            
            11.40
            
            
            18,726
            
            
            11.03Total
                loans
            
            
            313,200
            
            
            100.00
            %
            
            263,964
            
            
            100.00
            %
            
            208,155
            
            
            100.00
            %
            
            185,046
            
            
            100.00
            %
            
            169,726
            
            
            100.00
            %Less:Allowance
                for loan losses
            
            
            2,071
            
            
            
            
            
            1,878
            
            
            
            
            
            1,829
            
            
            
            
            
            1,810
            
            
            
            
            
            1,994Undisbursed
                construction loans
            
            
            2,343
            
            
            
            
            
            2,258
            
            
            
            
            
            2,094
            
            
            
            
            
            2,519
            
            
            
            
            
            1,168Deferred
                loan origination fees
            
            
            410
            
            
            
            
            
            401
            
            
            
            
            
            412
            
            
            
            
            
            339
            
            
            
            
            
            518Loans
                receivable, net
            
            $
            308,376
            
            
            
            
            $
            259,427
            
            
            
            
            $
            203,820
            
            
            
            
            $
            180,378
            
            
            
            
            $
            166,046




7




The
      following table sets forth certain information at December 31, 2006 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, 2006****Real
                Estate**
              **Loans**
            
            **Commercial**
              **Business**
              **Loans**
            
            **Consumer**
              **Loans**
            
            **Total**
              **Loans****(In
                thousands)**One
                year or less
            
            $
            31,483
            
            $
            6,458
            
            $
            21,967
            
            $
            59,908More
                than one year to five years
            
            
            49,420
            
            
            5,241
            
            
            1,572
            
            
            56,233More
                than five years
            
            
            174,474
            
            
            1,809
            
            
            20,776
            
            
            197,059Total
            
            $
            255,377
            
            $
            13,508
            
            $
            44,315
            
            $
            313,200





The
      following table sets forth the dollar amount of all loans at December 31, 2006
      that are due after December 31, 2007 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
            
            $
            145,260
            
            $
            30,360
            
            $
            175,620Construction
            
            
            5,947
            
            
            1,013
            
            
            6,960Multi-family
                and commercial
            
            
            4,620
            
            
            36,694
            
            
            41,314Commercial
                business loans
            
            
            3,187
            
            
            3,863
            
            
            7,050Consumer
                loans
            
            
            22,282
            
            
            66
            
            
            22,348Total
            
            $
            181,296
            
            $
            71,996
            
            $
            253,292




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





**Year
                Ended December 31,****2006**
            
            **2005**
            
            **2004****(In
                thousands)**Total
                loans at beginning of period
            
            $
            263,964
            
            $
            208,155
            
            $
            185,046Loans
                originated:Real
                estate loans:One-
                to four-family
            
            
            35,330
            
            
            42,144
            
            
            30,002Construction
            
            
            27,288
            
            
            27,695
            
            
            20,598Multi-family
                and commercial
            
            
            15,672
            
            
            23,389
            
            
            10,865Commercial
                business loans
            
            
            8,172
            
            
            6,308
            
            
            3,962Consumer
                loans
            
            
            22,651
            
            
            24,664
            
            
            18,416Total
                loans originated
            
            
            109,113
            
            
            124,200
            
            
            83,843Loans
                purchased
            
            
            —
            
            
            —
            
            
            —Deduct:Real
                estate loan principal repayments
            
            
            (38,364
            )
            
            (52,607
            )
            
            (44,622
            )Loan
                sales
            
            
            —
            
            
            —
            
            
            (1,927
            )Other
                repayments
            
            
            (21,513
            )
            
            (15,784
            )
            
            (14,185
            )Net
                loan activity
            
            
            49,236
            
            
            55,809
            
            
            23,109Total
                loans at end of period
            
            $
            313,200
            
            $
            263,964
            
            $
            208,155




8





***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. Loss and risk factors are based on our
      historical loss experience and industry averages and may be adjusted for
      significant factors that in management’s judgment affect the collectibility of
      the portfolio as of the evaluation date. These significant factors may include
      changes in lending policies and procedures, changes in existing general economic
      and business conditions affecting our primary lending area, credit quality
      trends, collateral value, loan volumes and concentrations, seasoning of the
      loan
      portfolio, specific industry conditions within portfolio segments, recent loss
      experience in particular segments of the portfolio, duration of the current
      business cycle, and bank regulatory examination results.





Our
      methodology for assessing the appropriateness of the allowance for loan losses
      consists of the following procedures. The loan portfolio is segregated first
      between passed and classified assets.





***Passed
      Assets*** **.** Our
      assets designated as pass or bankable with care by our internal classification
      system are aggregated by loan category and an allowance percentage is assigned
      based on estimated inherent losses associated with each type of lending. Our
      passed and bankable with care assets are loans for which the borrower is
      established and represents a reasonable credit risk.





We
      retain
      a general loan loss allowance on loans classified as passed. This portion of
      our
      allowance is determined based on our historical loss experience, delinquency
      trends, and management’s evaluation of the loan portfolio and may be adjusted
      for significant factors that in management’s judgment affect the collectibility
      of the portfolio as of the evaluation date. These significant factors may
      include changes in general economic and business conditions affecting our
      primary lending areas, credit quality trends, collateral value, loan volumes
      and
      concentrations, seasoning of the loan portfolio, recent loss experience in
      particular segments of the portfolio, duration of the current business cycle
      and
      bank regulatory examination results. These factors are reviewed regularly to
      ensure their relevance in the prevailing business environment.





***Classified
      Assets*** **.** Our
      assets classified internally as special mention, substandard or doubtful (all
      regulatory classifications for problem assets) by our internal classification
      system are individually evaluated by management and an allowance percentage,
      increasing as the probability of loss increases, is assigned to each classified
      asset based on the collateral value and loan balance. The level of the allowance
      percentage is further dependent on whether the loan is secured by real estate,
      secured by assets other than real estate or unsecured. Loans classified as
      loss
      are charged off and, if the loan is secured by real estate collateral, the
      real
      estate is transferred to foreclosed real estate.





The
      loss
      factors allowance percentages which are presently used to determine the reserve
      level were updated in 2006 based on various risk factors such as type of loan,
      collateral and loss history. These factors are subject to ongoing evaluation
      to
      ensure their relevance to our loan portfolio in the current economic
      environment.





When
      we
      determine that a loan is troubled and where, based on current information and
      events, it is probable that we will not be able to collect all amounts due,
      the
      excess of the recorded investment in the loan over the fair market value of
      any
      collateral, net of estimated costs to sell the asset, is classified as loss,
      and
      we classify the remainder of the loan balance as substandard.





We
      identify loans which may require charge off as a loss by reviewing all
      delinquent loans, significant credits, loans classified as substandard,
      doubtful, loss, or special mention by our internal classification system, all
      classified loans, and other loans that management may have concerns about
      collectibility, such as loans to a specific industry. For individually reviewed
      loans, a borrower’s inability to service a credit according to the contractual
      terms based on the borrower’s cash flow and or a shortfall in collateral value
      would result in the recording of a charge off of the loan or the portion of
      the
      loan that was impaired.





9





Our
      banking regulators, as an integral part of their examination process,
      periodically review our allowance for loan losses. The examinations may require
      us to make additional provisions 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 classification of specific credits in the portfolio.





The
      following table sets forth the breakdown of the allowance for loan losses based
      on the components of our allowance at the dates indicated.





**At
                December 31, 2006**
            
            **At
                December 31, 2005****(In
                thousands)**Passed
                assets
            
            $
            1,711
            
            $
            1,425Classified
                assets
            
            
            360
            
            
            450Unallocated
            
            
            -
            
            
            3TotalTotal
            
            $
            2,071
            
            $
            1,878




At
      December 31, 2006, our allowance for loan losses represented 0.67% of total
      gross loans and 103.3% of nonperforming loans. The allowance for loan losses
      increased $193,000 from December 31, 2005 to December 31, 2006. The
      increase in the allowance was the result of net recoveries and provisions for
      loan losses.





At
      December 31, 2005, our allowance for loan losses represented 0.72% of total
      gross loans and 638.78% of nonperforming loans. The allowance for loan losses
      increased $49,000 from December 31, 2004 to December 31, 2005. The increase
      in
      the allowance was the result of net recoveries and provisions for loan
      losses.





Total
      nonperforming loans increased during the year ended December 31, 2006 due to
      the
      migration of a large relationship into nonaccrual. The Company recorded a
      provision for loan losses of $192,000 during the year ended December 31, 2006
      and a provision of $32,000 during the year ended December 31, 2005.





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. 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.




10





***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,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****(Dollars
                in thousands)**Allowance
                at beginning of period
            
            $
            1,878
            
            $
            1,829
            
            $
            1,810
            
            $
            1,994
            
            $
            1,856Provision
                for loan losses
            
            
            192
            
            
            32
            
            
            —
            
            
            45
            
            
            231Less:
                Charge offs:Real
                estate loans
            
            
            —
            
            
            —
            
            
            —
            
            
            265
            
            
            112Commercial
                business loans
            
            
            —
            
            
            3
            
            
            51
            
            
            —
            
            
            —Consumer
                loans
            
            
            2
            
            
            1
            
            
            5
            
            
            2
            
            
            5Total
                charge-offs
            
            
            2
            
            
            4
            
            
            56
            
            
            267
            
            
            117Plus:
                Recoveries:Real
                estate loans
            
            
            3
            
            
            18
            
            
            43
            
            
            38
            
            
            23Commercial
                business loans
            
            
            —
            
            
            3
            
            
            —
            
            
            —
            
            
            —Consumer
                loans
            
            
            —
            
            
            —
            
            
            32
            
            
            —
            
            
            1Total
                recoveries
            
            
            3
            
            
            21
            
            
            75
            
            
            38
            
            
            24Net
                charge-offs (recoveries)
            
            
            (1
            )
            
            (17
            )
            
            (19
            )
            
            229
            
            
            93Allowance
                at end of period
            
            $
            2,071
            
            $
            1,878
            
            $
            1,829
            
            $
            1,810
            
            $
            1,994Allowance
                to nonperforming loans
            
            
            103.03
            %
            
            638.78
            %
            
            306.88
            %
            
            199.78
            %
            
            162.91
            %Allowance
                to total loans outstanding at the end of the period
            
            
            0.67
            %
            
            0.72
            %
            
            0.89
            %
            
            0.99
            %
            
            1.19
            %Net
                charge-offs (recoveries) to average loans outstanding during the
                period
            
            
            0.00
            %
            
            0.01
            %
            
            (0.01
            )%
            
            0.13
            %
            
            0.05
            %





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


**At
                  December 31,****2006**
              
              **2005**
              
              **2004****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**
              
              **Amount**
              
              **%
                  of**
                **Allowance**
                **to
                  Total**
                **Allowance**
              
              **%
                  of**
                **Loans
                  in**
                **Category**
                **to
                  Total**
                **Loans****(Dollars
                  in thousands)**One-
                  to four-family
              
              $
              718
              
              
              34.67
              %
              
              57.27
              %
              $
              724
              
              
              38.55
              %
              
              59.44
              %
              $
              864
              
              
              47.25
              %
              
              64.75
              %Construction
              
              
              464
              
              
              22.40
              
              
              9.62
              
              
              376
              
              
              20.02
              
              
              9.45
              
              
              142
              
              
              7.76
              
              
              8.40Multi-family
                  and commercial real estate
              
              
              347
              
              
              16.76
              
              
              14.65
              
              
              379
              
              
              20.18
              
              
              12.73
              
              
              374
              
              
              20.45
              
              
              10.84Commercial
                  business
              
              
              209
              
              
              10.09
              
              
              4.31
              
              
              113
              
              
              6.02
              
              
              3.69
              
              
              50
              
              
              2.73
              
              
              2.40Consumer
                  loans
              
              
              333
              
              
              16.08
              
              
              14.15
              
              
              283
              
              
              15.07
              
              
              14.69
              
              
              302
              
              
              16.51
              
              
              13.61Unallocated
              
              
              —
              
              
              —
              
              
              —
              
              
              3
              
              
              0.16
              
              
              —
              
              
              97
              
              
              5.30
              
              
              —Total
                  allowance for loan losses
              
              $
              2,071
              
              
              100.00
              %
              
              100.00
              %
              $
              1,878
              
              
              100.00
              %
              
              100.00
              %
              $
              1,829
              
              
              100.00
              %
              
              100.00
              %




11





**At
                December 31,****2003**
            
            **2002****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
            
            $
            927
            
            
            51.22
            %
            
            70.98
            %
            $
            1,566
            
            
            78.54
            %
            
            77.85
            %Construction
            
            
            185
            
            
            10.22
            
            
            7.62
            
            
            100
            
            
            5.02
            
            
            4.06Multi-family
                and commercial real estate
            
            
            321
            
            
            17.73
            
            
            7.71
            
            
            148
            
            
            7.42
            
            
            6.06Commercial
                business
            
            
            92
            
            
            5.08
            
            
            2.29
            
            
            59
            
            
            2.96
            
            
            1.00Consumer
                loans
            
            
            232
            
            
            12.82
            
            
            11.40
            
            
            78
            
            
            3.91
            
            
            11.03Unallocated
            
            
            53
            
            
            2.93
            
            
            —
            
            
            43
            
            
            2.16
            
            
            —Total
                allowance for loan losses
            
            $
            1,810
            
            
            100.00
            %
            
            100.00
            %
            $
            1,994
            
            
            100.00
            %
            
            100.00
            %





***Nonperforming
      and Classified Assets*** **.** **** When
      a
      loan becomes 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 90 days or more 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 $2.0 million, or 0.49% of total assets, at December 31, 2006,
      which was an increase of $1.7 million, or 489.4%, from December 31, 2005.
      Nonaccrual loans accounted for 100% of the total nonperforming assets at
      December 31, 2006. At December 31, 2006, $106,000 of the allowance for loan
      losses was related to nonaccrual real estate loans.





Nonperforming
      assets totaled $341,000, or 0.10% of total assets, at December 31, 2005, which
      was a decrease of $323,000, or 48.6%, from December 31, 2004. Nonaccrual loans
      accounted for 86.2% of the total nonperforming assets at December 31, 2005.
      At
      December 31, 2005, $40,000 of the allowance for loan losses was related to
      nonaccrual real estate loans.





Under
      current accounting guidelines, a loan is defined as impaired when, based on
      current information and events, it is probable that the creditor will be unable
      to collect all amounts due under the contractual terms of the 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, 2006, two loans were considered impaired.




12





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,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****(Dollars
                in thousands)**Nonaccrual
                loans:One-
                to four-family
            
            $
            423
            
            $
            165
            
            $
            474
            
            $
            500
            
            $
            1,041Multi-family
                and commercial realestate
            
            
            1,388
            
            
            120
            
            
            119
            
            
            315
            
            
            117Commercial
                business
            
            
            142
            
            
            9
            
            
            3
            
            
            15
            
            
            —Consumer
            
            
            57
            
            
            —
            
            
            —
            
            
            76
            
            
            66Total
            
            
            2,010
            
            
            294
            
            
            596
            
            
            906
            
            
            1,224Foreclosed
                real estate
            
            
            —
            
            
            47
            
            
            68
            
            
            208
            
            
            108Total
                nonperforming assets
            
            $
            2,010
            
            $
            341
            
            $
            664
            
            $
            1,114
            
            $
            1,332Total
                nonperforming loans to total loans
            
            
            0.65
            %
            
            0.11
            %
            
            0.29
            %
            
            0.50
            %
            
            0.73
            %Total
                nonperforming loans to total assets
            
            
            0.49
            %
            
            0.08
            %
            
            0.22
            %
            
            0.37
            %
            
            0.54
            %Total
                nonperforming assets to total assets
            
            
            0.49
            %
            
            0.10
            %
            
            0.25
            %
            
            0.46
            %
            
            0.58
            %





Other
      than disclosed above, there are no other loans at December 31, 2006 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, 2006
      and
      December 31, 2005 had nonaccruing loans been current according to their
      original terms amounted to $68,200 and $20,900, respectively. Income related
      to
      nonaccrual loans included in interest income for the years ended December 31,
      2006 and December 31, 2005 amounted to $125,400 and $19,600,
      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. When we
      classify an asset as substandard or doubtful, we must establish a general
      allowance for loan losses. 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,****2006**
            
            **2005****(In
                thousands)**Special
                mention assets
            
            $
            6,899
            
            $
            5,197Substandard
                assets
            
            
            3,137
            
            
            1,360Doubtful
                assets
            
            
            4
            
            
            10Loss
                assets
            
            
            —
            
            
            —Total
                classified assets
            
            $
            10,040
            
            $
            6,567





Special
      mention assets at December 31, 2006 and December 31, 2005 did not include
      any nonaccrual loans. Substandard assets at December 31, 2006 and
      December 31, 2005 included nonaccrual loans of $2.0 million and $284,000,
      respectively. All doubtful assets at December 31, 2006 and December 31,
      2005 were nonaccrual loans and all loss assets at December 31, 2006 were
      nonaccrual loans.





***Delinquencies*** **.** The
      following table provides information about delinquencies in our loan portfolios
      at the dates indicated.





**At
                December 31,****2006**
            
            **2005**
            
            **2004****30-59
                Days**
              **Past
                Due**
            
            **60-89
                Days**
              **Past
                Due**
            
            **30-59
                Days**
              **Past
                Due**
            
            **60-89
                Days**
              **Past
                Due**
            
            **30-59
                Days**
              **Past
                Due**
            
            **60-89
                Days**
              **Past
                Due****(In
                thousands)**One-
                to four-family
            
            $
            413
            
            $
            392
            
            $
            792
            
            $
            498
            
            $
            2,017
            
            $
            581Multi-family
                and commercialreal
                estate
            
            
            603
            
            
            664
            
            
            —
            
            
            —
            
            
            510
            
            
            150Commercial
                business
            
            
            262
            
            
            310
            
            
            164
            
            
            —
            
            
            64
            
            
            15Consumer
                loans
            
            
            —
            
            
            5
            
            
            7
            
            
            —
            
            
            135
            
            
            12Total
            
            $
            1,278
            
            $
            1,371
            
            $
            963
            
            $
            498
            
            $
            2,726
            
            $
            758





***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 increased by $7.2 million in the year ended December 31, 2006
      primarily due to the purchase of securities funded through Federal Home Loan
      Bank advances and excess liquidity. Securities increased by $26.8 million in
      the
      year ended December 31, 2005 primarily due to the purchase of securities funded
      primarily through Federal Home Loan Bank advances. 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, to a lesser
      extent, corporate obligations and interest-bearing balances (certificates of
      deposits) at other institutions. The interest-bearing balances are all held
      to
      maturity and all mature within two years.




14





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





**At
                December 31,****2006**
            
            **2005**
            
            **2004****Amortized**
              **Cost**
            
            **Fair**
              **Value**
            
            **Amortized**
              **Cost**
            
            **Fair**
              **Value**
            
            **Amortized**
              **Cost**
            
            **Fair**
              **Value****(In
                thousands)**Available-for-sale
                securities:U.S.
                Government and agency obligations
            
            $
            8,495
            
            $
            8,415
            
            $
            15,344
            
            $
            15,175
            
            $
            15,072
            
            $
            15,210Mortgage-backed
                securities
            
            
            25,111
            
            
            24,782
            
            
            22,544
            
            
            22,082
            
            
            12,249
            
            
            12,092Collateralized
                mortgage obligations
            
            
            4,796
            
            
            4,694
            
            
            4,199
            
            
            4,098
            
            
            3,812
            
            
            3,794Municipal
                obligations
            
            
            15,177
            
            
            15,190
            
            
            8,715
            
            
            8,769
            
            
            —
            
            
            —Money
                market preferred obligations
            
            
            12,700
            
            
            12,700
            
            
            6,000
            
            
            6,000
            
            
            —
            
            
            —Corporate
                obligations
            
            
            1,951
            
            
            1,955
            
            
            1,928
            
            
            1,923
            
            
            —
            
            
            —Held-to-maturity
                securities:U.S.
                Government and agency obligations
            
            
            1,201
            
            
            1,192
            
            
            1,202
            
            
            1,189
            
            
            703
            
            
            708Interest-bearing
                balances
            
            
            1,330
            
            
            1,330
            
            
            3,800
            
            
            3,800
            
            
            4,465
            
            
            4,465Total
            
            $
            70,761
            
            $
            70,258
            
            $
            63,732
            
            $
            63,036
            
            $
            36,301
            
            $
            36,269





At
      December 31, 2006, 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, 2006. 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, 2006, mortgage-backed securities and collateralized
      mortgage obligations with adjustable rates totaled $19.3 million.





**Less
                Than**
              **One
                Year**
            
            **More
                than**
              **One
                Year to**
              **Five
                Years**
            
            **More
                than**
              **Five
                Years to**
              **Ten
                Years**
            
            **More
                than**
              **Ten
                Years**
            
            **Total****Carrying**
              **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
            
            $
            3,962
            
            
            3.77
            %
            $
            3,473
            
            
            4.56
            %
            $
            980
            
            
            5.80
            %
            $
            —
            
            
            —
            %
            $
            8,415
            
            
            4.33
            %Mortgage-backed
                securities
            
            
            —
            
            
            —
            
            
            1,533
            
            
            3.69
            
            
            —
            
            
            —
            
            
            23,249
            
            
            4.84
            
            
            24,782
            
            
            4.77Collateralized
                mortgage obligations
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            982
            
            
            5.28
            
            
            3,712
            
            
            4.27
            
            
            4,694
            
            
            4.48Municipal
                obligations
            
            
            999
            
            
            3.68
            
            
            —
            
            
            —
            
            
            830
            
            
            4.03
            
            
            13,361
            
            
            4.25
            
            
            15,190
            
            
            4.20Money
                market preferred obligations
            
            
            12,700
            
            
            4.42
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            12,700
            
            
            4.42Corporate
                obligations
            
            
            —
            
            
            —
            
            
            1,955
            
            
            5.21
            
            
            —
            
            
            
            
            
            —
            
            
            —
            
            
            1,955
            
            
            5.21Total
                available-for-sale securities
            
            
            17,661
            
            
            4.23
            
            
            6,961
            
            
            4.55
            
            
            2,792
            
            
            5.09
            
            
            40,322
            
            
            4.59
            
            
            67,736
            
            
            4.51Held-to-maturity
                securities:U.S.
                Government and agency obligations
            
            
            1,201
            
            
            4.10
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            1,201
            
            
            4.10Interest-bearing
                balances
            
            
            1,140
            
            
            3.06
            
            
            190
            
            
            3.75
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            1,330
            
            
            3.16Total
                held-to-maturity securities
            
            
            2,341
            
            
            3.59
            
            
            190
            
            
            3.75
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            2,531
            
            
            3.61Total
            
            $
            20,002
            
            
            4.16
            
            $
            7,151
            
            
            4.53
            
            $
            2,792
            
            
            5.09
            
            $
            40,322
            
            
            4.59
            
            $
            70,267
            
            
            4.48








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,
      2006,
      we had no brokered deposits. Total deposits increased $48.4 million or 20.1%
      in
      the year ended December 31, 2006. During that time period, certificate accounts
      increased 34.8%, regular savings accounts decreased by 10.2%, checking and
      NOW
      accounts increased by 22.4% and money market deposit accounts increased by
      2.2%.
      The increases in our deposit accounts were primarily due to increased
      advertising and more aggressive pricing, partially related to the opening of
      our
      three new branch offices in 2006. The decrease 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,****2006**
            
            **2005**
            
            **2004****(In
                thousands)**Certificate
                accounts
            
            $
            165,076
            
            $
            122,431
            
            $
            81,200Regular
                savings accounts
            
            
            46,156
            
            
            51,375
            
            
            43,941Checking
                and NOW accounts
            
            
            57,301
            
            
            46,825
            
            
            37,003Money
                market savings accounts
            
            
            20,665
            
            
            20,215
            
            
            31,222Total
            
            $
            289,198
            
            $
            240,846
            
            $
            193,366





The
      following table indicates the amount of jumbo certificate accounts by time
      remaining until maturity at December 31, 2006. Jumbo certificate accounts
      require minimum deposits of $100,000.





**Maturity
                Period**
            
            **Certificate**
              **Accounts****(In
                thousands)**Three
                months or less
            
            $
            9,042Over
                three through six months
            
            
            15,089Over
                six through twelve months
            
            
            19,490Over
                twelve months
            
            
            4,607Total
            
            $
            48,228





The
      following table sets forth the certificate accounts classified by rates at
      the
      dates indicated.





**At
                December 31,****2006**
            
            **2005**
            
            **2004****(In
                thousands)**0.00
                - 0.99%
            
            $
            805
            
            $
            2,416
            
            $
            13,0941.00
                - 1.99
            
            
            11,863
            
            
            17,633
            
            
            31,3712.00
                - 2.99
            
            
            3,138
            
            
            16,699
            
            
            14,7043.00
                - 3.99
            
            
            17,866
            
            
            50,729
            
            
            14,2284.00
                - 4.99
            
            
            60,207
            
            
            34,954
            
            
            6,8845.00
                - 5.99
            
            
            71,197
            
            
            —
            
            
            919Total
            
            $
            165,076
            
            $
            122,431
            
            $
            81,200





17





The
      following table sets forth the amount and maturities of certificate accounts
      at
      December 31, 2006.





**Amount
                Due****Less
                Than**
              **One
                Year**
            
            **More
                Than**
              **One
                Year to**
              **Two
                Years**
            
            **More
                Than**
              **Two
                Years to**
              **Three
                Years**
            
            **More
                Than**
              **Three
                to**
              **Four
                Years**
            
            **More
                Than**
              **Four
                Years**
            
            **Total**
            
            **Percent
                of Total Certificate Accounts****(Dollars
                in thousands)**0.00
                - 0.99%
            
            $
            805
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            805
            
            
            0.49
            %1.00
                - 1.99
            
            
            10,068
            
            
            1,573
            
            
            222
            
            
            —
            
            
            —
            
            
            11,863
            
            
            7.192.00
                - 2.99
            
            
            2,193
            
            
            604
            
            
            341
            
            
            —
            
            
            —
            
            
            3,138
            
            
            1.903.00
                - 3.99
            
            
            9,543
            
            
            5,824
            
            
            1,991
            
            
            508
            
            
            —
            
            
            17,866
            
            
            10.824.00
                - 4.99
            
            
            52,565
            
            
            3,705
            
            
            920
            
            
            2,863
            
            
            154
            
            
            60,207
            
            
            36.475.00
                - 5.99
            
            
            69,882
            
            
            1,315
            
            
            —
            
            
            —
            
            
            —
            
            
            71,197
            
            
            43.13Total
            
            $
            145,056
            
            $
            13,021
            
            $
            3,474
            
            $
            3,371
            
            $
            154
            
            $
            165,076
            
            
            100.00
            %





The
      following table sets forth the savings activity for the periods
      indicated.





**Year
                Ended December 31,****2006**
            
            **2005**
            
            **2004****(In
                thousands)**Beginning
                balance
            
            $
            240,846
            
            $
            193,366
            
            $
            183,455Increase
                before interest credited
            
            
            41,811
            
            
            44,086
            
            
            7,654Interest
                credited
            
            
            6,541
            
            
            3,394
            
            
            2,257Net
                increase in savings deposits
            
            
            48,352
            
            
            47,480
            
            
            9,911Ending
                balance
            
            $
            289,198
            
            $
            240,846
            
            $
            193,366




***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 2006 we also borrowed funds from the Federal
      Home Loan Bank of Boston to purchase securities. In addition, we occasionally
      borrow short-term from correspondent banks to cover temporary cash needs. At
      December 31, 2006, we had the ability to borrow a total of $3.5 million from
      a
      correspondent bank, none of which was borrowed at such date.





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,****2006**
            
            **2005**
            
            **2004****(Dollars
                in thousands)**Maximum
                amount of advances outstanding at any month end during the
                period
            
            $
            70,414
            
            $
            57,059
            
            $
            34,643Average
                advances outstanding during the period
            
            
            59,423
            
            
            38,530
            
            
            27,379Weighted
                average interest rate during the period
            
            
            4.69
            %
            
            3.93
            %
            
            4.59
            %Balance
                outstanding at end of period
            
            $
            68,488
            
            $
            57,059
            
            $
            15,826Weighted
                average interest rate at end of period
            
            
            4.83
            %
            
            4.20
            %
            
            4.42
            %




18





***Equity*** **.** Total
      equity increased by $120,000, or 0.24%, to $51.08 million at December 31, 2006
      from $50.96 million at December 31, 2005. The increase in 2006 was due to net
      income of $1.4 million for the twelve- month period, stock repurchases of $1.5
      million, year-to-date dividends of $617,000 paid to stockholders, a net decrease
      to the unrealized loss on available-for-sale securities of $125,000, $433,000
      in
      equity adjustments related to the Company’s 2005 Equity Incentive Plan and
      $221,000 in equity adjustments related to the release of 19,889 shares under
      the
      Company’s Employee Stock Ownership Plan. Total equity decreased by $607,000, or
      1.2%, to $51.0 million at December 31, 2005 from $51.6 million at December
      31,
      2004. The decrease in 2005 was due to net income of $1.9 million, $1.8 million
      in equity adjustments related to the Company’s 2005 Equity Incentive Plan,
      year-to-date dividends of $500,000 paid to stockholders, a net increase to
      the
      unrealized loss on available-for-sale securities of $427,000 and $218,000 in
      equity adjustments related to the release of 19,889 shares of our employee
      stock
      ownership plan. Our average equity to average assets ratio was 13.65% at
      December 31, 2006, compared to 16.87% at December 31, 2005, and 11.37% at
      December 31, 2004.





**Comparison
      of Operating Results for the Years Ended December 31, 2006, 2005 and
      2004**




***Overview.***


**2006**
            
            **2005**
            
            **2004**
            
            **%
                Change**
              **2006/2005**
            
            **%
                Change**
              **2005/2004****(Dollars
                in thousands)**Net
                income
            
            $
            1,448
            
            $
            1,905
            
            $
            415
            
            
            (23.99
            %)
            
            359.04
            %Return
                on average assets
            
            
            0.38
            %
            
            0.62
            %
            
            0.16
            %
            
            (38.71
            %)
            
            287.50
            %Return
                on average equity
            
            
            2.79
            %
            
            3.66
            %
            
            1.42
            %
            
            (23.77
            %)
            
            157.75
            %





***2006
      v. 2005*** **.** Net
      income decreased primarily due to an increase in interest expense as the cost
      of
      our interest-bearing liabilities continued to increase more rapidly than yields
      on our interest-earning assets, reflecting the inverted yield curve. The
      increase in interest expense was also the result of the marketing of
      competitively priced deposit products offered in conjunction with the opening
      of
      our three new branch offices in the third quarter of 2006. We also experienced
      an increase in non-interest expense due to branch expansion and an increase
      in
      the reserve for loan losses as our mix of loans changes.





***2005
      v. 2004.***  Net
      income increased primarily due to an increase in net interest income and
      non-interest income. These increases were partially offset by increases in
      non-interest expense and increases in tax and loan loss provisions.





***Net
      Interest Income.***





***2006
      v. 2005.*** Net
      interest income increased $433,000, or 3.9% to $11.4 million for 2006. The
      increase in net interest income for 2006 was the result of an increase in the
      average balances of interest earning assets combined with an increase in the
      average rate earned on these assets, partially offset by increases in interest
      expense.





Interest
      and dividend income for 2006 was $20.8 million, compared to $15.9 million for
      2005, an increase of $4.9 million or 30.4%. The increase was the result of
      an
      increase in the average balances of interest earning assets of 23.6%, combined
      with an increase in the average rate earned on these assets of 31 basis points
      over the 2005 rates. The increase in interest earning assets is attributed
      primarily to an increase in the loan and investment portfolios. The average
      balances in the loan portfolio increased by 23.0% to $277.8 million in 2006,
      up
      from $225.8 million in 2005, while the average balance of investments increased
      by 26.6% to $67.1 million in 2006 from $53.0 million in 2005.





Interest
      expense for 2006 was $9.3 million compared to $4.9 million for 2005, an increase
      of $4.4 million or 89.8%. This increase resulted from a 92 basis point increase
      in the rates paid on interest-bearing liabilities to 2.86% in 2006 from 1.94%
      in
      2005 due to rising market rates on deposits and borrowings along with increases
      in the average balances of deposits and borrowings of $71.9 million, or 28.2%,
      to $326.4 million in 2006 from $254.5




19
  million
        in 2005. The increase in the average interest-bearing liabilities was due
        to
        increases in certificates of deposit, advances from the Federal Home Loan
        Bank,
        checking and escrow, partially offset by a decrease in the average balance
        of
        money market savings accounts.




***2005
      v. 2004.*** Net
      interest income increased $1.8 million, or 19.8%, to $11.0 million for 2005.
      The
      increase in net interest income for 2005 was the result of an increase in the
      average balances of interest earning assets combined with an increase in the
      average rate earned on these assets, partially offset by higher cost of funds.





Interest
      and dividend income for 2005 was $15.9 million, compared to $12.7 million for
      2004, an increase of $3.2 million, or 25.1%. This increase was the result of
      an
      increase in the average balances of interest earning assets of 19.1% combined
      with an increase in the average rate earned on these assets of 27 basis points
      over the 2004 rates. The increase in interest earning assets is attributed
      primarily to an increase in the loan and investment portfolios. The average
      balances in the loan portfolio increased by 18.4% to $225.8 million in 2005,
      up
      from $190.7 million in 2004, while the average balance of investments increased
      by 59.1% to $53.0 million in 2005 from $33.3 million in 2004.





Interest
      expense for 2005 was $4.9 million compared to $3.6 million for 2004, an increase
      of $1.3 million or 38.8%. This increase resulted from a 37 basis point increase
      in the rates paid on interest-bearing liabilities to 1.94% in 2005 from 1.57%
      in
      2004 due to rising market rates on deposits and borrowings along with increases
      in the average balances of deposits and borrowings of $28.1 million, or 12.4%,
      to $254.5 million in 2005 from $226.4 in 2004. The increase in the average
      interest-bearing liabilities was due to increases in certificates of deposit,
      regular savings, checking and advances from the Federal Home Loan Bank,
      partially offset by a decrease in the average balance of money market savings
      accounts.




20





***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 2006 period, we held
      tax-exempt municipal securities with an average balance of $9.7 million and
      preferred money market securities with an average balance of $8.1 million which
      recognize a dividends received deduction. The yields below do not reflect the
      tax benefits of these securities.


**2006**
                      
                      **2005**
                      
                      **2004****Average
                          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
                      
                      $
                      277,789
                      
                      $
                      17,506
                      
                      
                      6.30
                      %
                      $
                      225,850
                      
                      $
                      13,642
                      
                      
                      6.04
                      %
                      $
                      190,713
                      
                      $
                      11,240
                      
                      
                      5.89
                      %Fed
                          Funds sold
                      
                      
                      1,407
                      
                      
                      77
                      
                      
                      5.47
                      
                      
                      1,756
                      
                      
                      56
                      
                      
                      3.19
                      
                      
                      11,726
                      
                      
                      174
                      
                      
                      1.48Investment
                          securities
                      
                      
                      67,077
                      
                      
                      2,976
                      
                      
                      4.44
                      
                      
                      52,987
                      
                      
                      2,102
                      
                      
                      3.97
                      
                      
                      33,307
                      
                      
                      1,245
                      
                      
                      3.74Federal
                          Home Loan Bank stock
                      
                      
                      3,581
                      
                      
                      191
                      
                      
                      5.33
                      
                      
                      2,481
                      
                      
                      108
                      
                      
                      4.35
                      
                      
                      1,950
                      
                      
                      54
                      
                      
                      2.77Total
                          interest-earning assets
                      
                      
                      349,854
                      
                      
                      20,750
                      
                      
                      5.93
                      
                      
                      283,074
                      
                      
                      15,908
                      
                      
                      5.62
                      
                      
                      237,696
                      
                      
                      12,713
                      
                      
                      5.35Noninterest-earning
                          assets
                      
                      
                      30,084
                      
                      
                      
                      
                      
                      
                      
                      
                      25,340
                      
                      
                      
                      
                      
                      
                      
                      
                      19,731Total
                          assets
                      
                      $
                      379,938
                      
                      
                      
                      
                      
                      
                      
                      $
                      308,414
                      
                      
                      
                      
                      
                      
                      
                      $
                      257,427Interest-bearing
                          liabilities:Certificate
                          accounts
                      
                      $
                      143,007
                      
                      $
                      5,613
                      
                      
                      3.92
                      
                      $
                      99,487
                      
                      $
                      2,772
                      
                      
                      2.79
                      
                      $
                      84,890
                      
                      $
                      1,784
                      
                      
                      2.10Regular
                          savings accounts and escrow
                      
                      
                      52,769
                      
                      
                      418
                      
                      
                      0.79
                      
                      
                      51,326
                      
                      
                      360
                      
                      
                      0.70
                      
                      
                      48,929
                      
                      
                      209
                      
                      
                      0.43Checking
                          and NOW accounts
                      
                      
                      52,682
                      
                      
                      288
                      
                      
                      0.55
                      
                      
                      39,857
                      
                      
                      46
                      
                      
                      0.12
                      
                      
                      37,620
                      
                      
                      49
                      
                      
                      0.13Money
                          market savings accounts
                      
                      
                      18,356
                      
                      
                      232
                      
                      
                      1.26
                      
                      
                      25,160
                      
                      
                      245
                      
                      
                      0.97
                      
                      
                      27,547
                      
                      
                      261
                      
                      
                      0.95Total
                          interest-bearing deposits
                      
                      
                      266,814
                      
                      
                      6,551
                      
                      
                      2.46
                      
                      
                      215,830
                      
                      
                      3,423
                      
                      
                      1.59
                      
                      
                      198,986
                      
                      
                      2,303
                      
                      
                      1.16FHLB
                          advances
                      
                      
                      59,423
                      
                      
                      2,789
                      
                      
                      4.69
                      
                      
                      38,530
                      
                      
                      1,512
                      
                      
                      3.92
                      
                      
                      27,379
                      
                      
                      1,256
                      
                      
                      4.59Other
                          borrowings
                      
                      
                      193
                      
                      
                      10
                      
                      
                      5.17
                      
                      
                      161
                      
                      
                      6
                      
                      
                      3.73
                      
                      
                      16
                      
                      
                      —Total
                          interest-bearing liabilities
                      
                      
                      326,431
                      
                      
                      9,350
                      
                      
                      2.86
                      
                      
                      254,521
                      
                      
                      4,941
                      
                      
                      1.94
                      
                      
                      226,381
                      
                      
                      3,559
                      
                      
                      1.57Noninterest-bearing
                          liabilities
                      
                      
                      1,639
                      
                      
                      
                      
                      
                      
                      
                      
                      1,869
                      
                      
                      
                      
                      
                      
                      
                      
                      1,767Total
                          liabilities
                      
                      
                      328,070
                      
                      
                      
                      
                      
                      
                      
                      
                      256,390
                      
                      
                      
                      
                      
                      
                      
                      
                      228,148Stockholders’
                          equity
                      
                      
                      51,868
                      
                      
                      
                      
                      
                      
                      
                      
                      52,024
                      
                      
                      
                      
                      
                      
                      
                      
                      29,279Total
                          liabilities and stockholders’ equity
                      
                      $
                      379,938
                      
                      
                      
                      
                      
                      
                      
                      $
                      308,414
                      
                      
                      
                      
                      
                      
                      
                      $
                      257,427Net
                          interest income
                      
                      
                      
                      
                      $
                      11,400
                      
                      
                      
                      
                      
                      
                      
                      $
                      10,967
                      
                      
                      
                      
                      
                      
                      
                      $
                      9,154Interest
                          rate spread
                      
                      
                      
                      
                      
                      
                      
                      
                      3.07
                      %
                      
                      
                      
                      
                      
                      
                      
                      3.68
                      %
                      
                      
                      
                      
                      
                      
                      
                      3.78
                      %Net
                          interest margin
                      
                      
                      
                      
                      
                      
                      
                      
                      3.26
                      %
                      
                      
                      
                      
                      
                      
                      
                      3.87
                      %
                      
                      
                      
                      
                      
                      
                      
                      3.85
                      %Average
                          interest-earning assets to average interest-bearing
                          liabilities
                      
                      
                      
                      
                      
                      
                      
                      
                      107.18
                      %
                      
                      
                      
                      
                      
                      
                      
                      111.20
                      %
                      
                      
                      
                      
                      
                      
                      
                      105.00
                      %
 21


***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.





**2006
                Compared to 2005**
            
            **2005
                Compared to 2004****Increase
                (Decrease)**
              **Due
                to**
            
            
            
            **Increase
                (Decrease)**
              **Due
                to****Volume**
            
            **Rate**
            
            **Net**
            
            **Volume**
            
            **Rate**
            
            **Net****(In
                thousands)**Interest
                income:Loans
            
            $
            3,254
            
            $
            610
            
            $
            3,864
            
            $
            2,114
            
            $
            288
            
            $
            2,402Fed
                Funds sold
            
            
            (8
            )
            
            29
            
            
            21
            
            
            340
            
            
            (458
            )
            
            (118
            )Investment
                securities
            
            
            605
            
            
            269
            
            
            874
            
            
            775
            
            
            82
            
            
            857Federal
                Home Loan Bank stock
            
            
            55
            
            
            28
            
            
            83
            
            
            17
            
            
            37
            
            
            54Total
                interest income
            
            
            3,906
            
            
            936
            
            
            4,842
            
            
            3,246
            
            
            (51
            )
            
            3,195Interest
                expense:Certificate
                accounts
            
            
            1,469
            
            
            1,372
            
            
            2,841
            
            
            341
            
            
            647
            
            
            988Regular
                savings accounts
            
            
            10
            
            
            48
            
            
            58
            
            
            11
            
            
            140
            
            
            151Checking
                and NOW accounts
            
            
            19
            
            
            223
            
            
            242
            
            
            3
            
            
            (6
            )
            
            (3
            )Money
                market savings accounts
            
            
            128
            
            
            (141
            )
            
            (13
            )
            
            (24
            )
            
            8
            
            
            (16
            )Total
                deposit expense
            
            
            1,626
            
            
            1,502
            
            
            3,128
            
            
            331
            
            
            789
            
            
            1,120FHLB
                advances
            
            
            938
            
            
            339
            
            
            1,277
            
            
            397
            
            
            (141
            )
            
            256Other
                borrowings
            
            
            1
            
            
            3
            
            
            4
            
            
            —
            
            
            6
            
            
            6Total
                interest expense
            
            
            2,565
            
            
            1,844
            
            
            4,409
            
            
            728
            
            
            654
            
            
            1,382Net
                interest income
            
            $
            1,341
            
            $
            (908
            )
            $
            433
            
            $
            2,518
            
            $
            (705
            )
            $
            1,813





***Provision
      for Loan Losses.***





***2006
      v. 2005.*** In
      2006,
      a $191,871 provision was made to the allowance for loan losses. This provision
      is due to the increasing size of the loan portfolio, specifically, the increase
      in commercial construction, commercial real estate and commercial business
      loan
      portfolios, as well as an increase in the mortgage loan portfolio. In addition,
      there was an increase in the loans which were classified requiring an increase
      to the reserve. In 2006, there was an increase in nonperforming loans and as
      a
      result there was a decrease in the ratio of the allowance to nonperforming
      loans
      and assets.





***2005
      v. 2004.*** In
      2005,
      a $32,000 provision was made to the allowance for loan losses. The provision
      in
      2005 is due to the increasing size of the loan portfolio, in particular, the
      increasing size of our construction, multi-family and commercial real estate
      and
      commercial business loan portfolios. In addition, there was an increase in
      the
      allowance due to net recoveries. During 2005 there was a decrease in
      nonperforming loans and assets. As a result there was an increase in the ratio
      of the allowance to nonperforming loans and assets.




22





***Noninterest
      Income*** **.** The
      following table shows the components of noninterest income and the percentage
      changes from 2006 to 2005 and from 2005 to 2004.





**2006**
            
            **2005**
            
            **2004**
            
            **%
                Change 2006/2005**
            
            **%
                Change**
              **2005/2004****(Dollars
                in thousands)**Fees
                for services related to deposit accounts
            
            $
            873
            
            $
            618
            
            $
            557
            
            
            41.26
            %
            
            10.95
            %Fees
                for other services
            
            
            540
            
            
            356
            
            
            315
            
            
            51.69
            
            
            13.02Income
                from bank owned life insurance
            
            
            304
            
            
            218
            
            
            201
            
            
            39.45
            
            
            8.46Income
                from investment advisory services, net
            
            
            98
            
            
            167
            
            
            93
            
            
            (41.32
            )
            
            79.57Gain
                (loss) on sale of investments
            
            
            6
            
            
            47
            
            
            (156
            )
            
            (87.23
            )
            
            130.13Gain
                on sale of mortgages
            
            
            —
            
            
            —
            
            
            5
            
            
            N/A
            
            
            (100.00
            )Other
                income
            
            
            127
            
            
            111
            
            
            63
            
            
            14.41
            
            
            76.19Total
            
            $
            1,948
            
            $
            1,517
            
            $
            1,078
            
            
            28.41
            %
            
            40.72
            %





***2006
      v. 2005.*** Income
      from fees for services related to deposit accounts increased $255,000, or 41.3%
      to $873,000 for the year ended December 31, 2006 compared to $618,000 for the
      year ended December 31, 2005 and income from fees for other services increased
      $184,000 or 51.7% over the same period due to increased volume in these areas
      including that from new products and services. An increase of 39.4% or $86,000
      in income earned from investments in bank-owned life insurance was also recorded
      in the 2006 period. Income from investment advisory services decreased $69,000,
      or 41.3% to $98,000 for the year ended December 31, 2006 due to decreased volume
      in this area. The 2006 period included a $6,000 gain on the sale of investments,
      while the 2005 period included a gain of $47,000.





***2005
      v. 2004.*** Income
      from investment advisory services increased $74,000, or 79.6%, to $167,000
      for
      the year ended December 31, 2005 compared to $93,000 for the year ended December
      31, 2004 due to increased volume in this area. Fees for services increased
      by
      $102,000 or 11.7% to $974,000 for the year ended December 31, 2005 up from
      $872,000 for the year ended December 31, 2004. The 2004 period included a net
      loss on sale of investments of $156,000, while the 2005 period included a gain
      of $47,000. An increase of $17,000, or 8.5%, in income earned from investments
      in bank-owned life insurance was also recorded in the 2005 period.





***Noninterest
      Expense*** **.** The
      following table shows the components of noninterest expense and the percentage
      changes from 2006 to 2005 and from 2005 to 2004.





**2006**
            
            **2005**
            
            **2004**
            
            **%
                Change 2006/2005**
            
            **%
                Change**
              **2005/2004****(Dollars
                in thousands)**Compensation,
                taxes and benefits
            
            $
            6,408
            
            $
            5,477
            
            $
            4,301
            
            
            17.05
            %
            
            27.34
            %Office
                occupancy
            
            
            1,757
            
            
            1,538
            
            
            1,191
            
            
            14.24
            
            
            29.14Advertising
            
            
            672
            
            
            523
            
            
            318
            
            
            28.49
            
            
            64.47Computer
                processing
            
            
            606
            
            
            624
            
            
            547
            
            
            (2.88
            )
            
            14.08Directors
                compensation
            
            
            516
            
            
            435
            
            
            335
            
            
            17.93
            
            
            29.85Professional
                fees
            
            
            380
            
            
            448
            
            
            272
            
            
            (15.18
            )
            
            64.71Office
                supplies
            
            
            193
            
            
            232
            
            
            190
            
            
            (16.81
            )
            
            22.11Charitable
                contributions
            
            
            34
            
            
            34
            
            
            1,587
            
            
            (0.00
            )
            
            (97.86
            )Loss
                (gain) on foreclosed real estate, net
            
            
            16
            
            
            (35
            )
            
            (57
            )
            
            145.71
            
            
            (38.60
            )Prepayment
                fee on Federal Home Loan Bank advances
            
            
            —
            
            
            —
            
            
            498
            
            
            N/A
            
            
            (100.00
            )Other
                expenses
            
            
            922
            
            
            821
            
            
            621
            
            
            12.30
            
            
            32.21Total
            
            $
            11,504
            
            $
            10,097
            
            $
            9,803
            
            
            13.93
            %
            
            3.00
            %





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





23





***2006
      v. 2005.*** Noninterest
      expense increased primarily due to increases in compensation costs, office
      occupancy and advertising expenditures in the 2006 period. Compensation costs
      for employees increased by $931,000, or 17.0% and compensation costs related
      to
      directors increased by $81,000, or 18.6%. Employee related compensation includes
      new employees hired to staff our three new branch offices opened in 2006. The
      increase in director related compensation includes costs associated with a
      change from a retirement plan to a deferred compensation plan. In both expense
      categories, the 2006 period includes a full year of expenses related to the
      awards made under the equity incentive plan, while the 2005 period included
      only
      five months of these expenses. The increases in office occupancy and advertising
      expenses can be attributed to the opening of three new branch offices in 2006.
      These increases were partially offset by nominal decreases in professional
      fees,
      office supplies and computer processing.





***2005
      v. 2004*** The
      increase in noninterest expense increase was primarily due to an increase of
      $1.3 million in compensation costs, an increase of $347,000 in office occupancy
      expenses, an increase of $205,000 in advertising expenditures, an increase
      of
      $176,000 in legal, accounting and consulting fees and an increase of $77,000
      in
      computer processing costs. The increase in advertising expense relates to more
      aggressive advertising for deposit products, while the increase in legal,
      accounting and consulting fees are the result of being a public company. The
      compensation costs in the 2005 period include expenses related to the adoption
      of the equity incentive plan previously approved by shareholders. Occupancy
      expenses increased in 2005 as a result of the opening of new branches in January
      and July 2005. The 2004 period included a charitable contribution of $1.5
      million to establish the Naugatuck Valley Savings and Loan Foundation and a
      prepayment charge of $498,000 on the early payoff of $9.6 million of FHLB
      borrowings.





***Income
      Taxes***





***2006
      v. 2005.*** Income
      taxes decreased due to a lower level of taxable income in the 2006 period.
      The
      Company continues to benefit from income exempt from income taxes including
      income from bank-owned life insurance, municipal securities and a portion of
      the
      income earned on preferred money market securities, along with deferred tax
      benefits related to tax bad debt reserves in the calculation of the effective
      tax rate. The effective tax rate for 2006 was 12.3% compared to 19.1% for
      2005.





***2005
      v. 2004.*** Income
      taxes increased due to a higher level of taxable income in the 2005 period.
      The
      2004 period included the charitable contribution resulting from the formation
      and funding of the Naugatuck Valley Savings and Loan Foundation. The Company
      continues to benefit from income exempt from income taxes including income
      from
      bank-owned life insurance and municipal securities, along with deferred tax
      benefits related to tax bad debt reserves in the calculation of the effective
      tax rate. The effective tax rate for 2005 was 19.1% compared to 3.3% for 2004.





**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 did not sell any loans in 2005 or 2006. 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.





24





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 a 100 to 300 basis point
      increase or a 100 to 200 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,
      2006
      that would occur in the event of an immediate change in interest rates based
      on
      Office of Thrift Supervision assumptions, with no effect given to any steps
      that
      we might take to counteract that change.




**Basis
                  Point (“bp”)**
              
              **Net
                  Portfolio Value**
              
              **Net
                  Portfolio Value as % of**
                **Present
                  Value of Assets****Change
                  in Rates**
              
              **$
                  Amount**
              
              **$
                  Change**
              
              **%
                  Change**
              
              **NPV
                  Ratio**
              
              **Change****(Dollars
                  in thousands)**300
                  bp
              
              $
              29,864
              
              $
              (21,889
              )
              
              (42
              )%
              
              7.61
              %
              
              (4.72
              )%200
              
              
              37,503
              
              
              (14,250
              )
              
              (28
              )
              
              9.34
              
              
              (2.99
              )100
              
              
              45,004
              
              
              (6,749
              )
              
              (13
              )
              
              10.95
              
              
              (1.38
              )0
              
              
              51,753
              
              
              —
              
              
              —
              
              
              12.33
              
              
              —(100)
              
              
              56,260
              
              
              4,507
              
              
              9
              
              
              13.20
              
              
              .87(200)
              
              
              57,498
              
              
              5,744
              
              
              11
              
              
              13.38
              
              
              1.05


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.





25





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, 2006, December 31, 2005
      and
      December 31, 2004, cash and cash equivalents totaled $7.9 million, $9.0
      million and $7.6 million, respectively, including Federal funds of $31,000,
      $29,000 and $23,000, respectively. Securities classified as available for sale,
      which provide additional sources of liquidity, totaled $67.7 million, $58.0
      million, and $31.1 million at December 31, 2006, December 31, 2005 and
      December 31, 2004, respectively. At December 31, 2006, December 31,
      2005 and December 31, 2004, we had the ability to borrow a total of $128.7
      million, $112.3 million and $95.9 million, respectively, from the Federal Home
      Loan Bank of Boston, of which $68.4 million, $57.1 million and $15.8 million
      was
      outstanding, respectively. At December 31, 2006, December 31, 2005 and
      December 31, 2004, we had arranged overnight lines of credit of $2.5
      million with the Federal Home Loan Bank of Boston for all periods. We had no
      overnight advances outstanding with the Federal Home Loan Bank of Boston on
      these dates. In addition, at December 31, 2006, December 31, 2005 and
      December 31, 2004, we had ability to borrow $3.5 million, $2.5 million and
      $2.0 million, respectively from a correspondent bank. There were no advances
      outstanding on this line at December 31, 2006 and $1.9 million was outstanding
      on this line at December 31, 2005. There were no advances outstanding of this
      line at December 31, 2004.





At
      December 31, 2006, we had $21.0 million in unused line availability on home
      equity lines of credit, $6.4 million in unadvanced commercial lines, $5.1
      million in mortgage commitments, $3.6 million in commercial mortgage loan
      commitments, $21.7 million in unadvanced construction mortgage commitments,
      $6.8
      million in letters of credit, $1.3 million in commercial business loan
      commitments and $91,000 in overdraft line of credit availability. Certificates
      of deposit due within one year of December 31, 2006 totaled $145.1 million,
      or
      50.2% of total deposits. If these deposits do not remain with us, we will be
      required to seek other sources of funds, including other certificates of deposit
      and lines of credit. Depending on market conditions, we may be required to
      pay
      higher rates on such deposits or other borrowings than we currently pay on
      the
      certificates of deposit due on or before December 31, 2007. 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, with our liquidity position increasing
      substantially over the past two fiscal years. 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.





The
      following table presents certain of our contractual obligations at December
      31,
      2006.





**Payments
                Due by Period****Contractual
                Obligations**
            
            **Total**
            
            **Less
                than**
              **1
                year**
            
            **1-3
                years**
            
            **3-5
                years**
            
            **More
                than 5 years****(In
                thousands)**Long-term
                debt obligations
            
            $
            68,488
            
            $
            30,465
            
            $
            33,890
            
            $
            2,860
            
            $
            1,273Operating
                lease obligations
            
            
            2,008
            
            
            200
            
            
            425
            
            
            428
            
            
            955Total
            
            $
            70,496
            
            $
            30,665
            
            $
            34,315
            
            $
            3,288
            
            $
            2,228





Our
      primary investing activities are the origination of loans and the purchase
      of
      securities. For the year ended December 31, 2006 we originated $109.1 million
      of
      loans and purchased $31.4 million of securities. In 2005, we originated $124.2
      million of loans and purchased $51.1 million of securities. In 2004, we
      originated $83.8 million of loans and purchased $24.4 million of securities.
      During the year ended December 31, 2006, these activities were funded primarily
      by an increase in deposits of $48.4 million, net advances from the Federal
      Home
      Loan Bank of Boston of $11.4 million, proceeds from sales and maturities of
      available-for-sale securities of $21.9 million and proceeds from
      held-to-maturity securities of $2.5 million. During the year ended December
      31,
      2005, these activities were funded primarily by an increase in deposits of
      $47.5
      million, net advances from the Federal Home Loan Bank of Boston of $41.2
      million, proceeds from sales and maturities of available-for-sale securities
      of




26
  $23.0
        million and proceeds from held-to-maturity securities of $665,000. During
        the
        year ended December 31, 2004, these activities were funded primarily by the
        net
        proceeds from the stock issuance of $31.6 million, proceeds from sales and
        maturities of available-for-sale securities of $26.2 million, an increase
        of
        deposits of $9.9 million and proceeds from the sale of loans of $1.9
        million.


Historically,
      our investment portfolio had been funded by excess liquidity when deposit
      inflows exceed loan demand. During 2006, we implemented a pre-purchase strategy
      with the objective of enhancing earnings by borrowing $6.5 million from the
      Federal Home Loan Bank of Boston on a short-term basis to fund the purchase
      of a
      like amount of long-term securities. These advances were paid down by subsequent
      investment maturities. This strategy was 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 $48.4
      million, $47.5 million and $9.9 million for the years ended December 31, 2006,
      2005 and 2004, 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 Federal Home Loan Bank advances of
      $11.4
      million for the year ended December 31, 2006. The increase in 2006 was primarily
      due to lending and investing activities. **** Federal
      Home Loan Bank advances increased $41.2 million for the year ended December
      31,
      2005, and decreased $19.1 million for the year ended December 31, 2004. The
      increase in advances in 2005 was primarily used for our lending and investing
      activities. During 2004, $9.6 million of advances with an average rate of 5.29%
      were prepaid in an effort to reduce the cost of funds.





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, 2006, 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.





27





**Off-Balance
      Sheet Arrangements**





In
      the
      normal course of operations, we engage in a variety of financial transactions
      that, in accordance with generally accepted accounting principles, are not
      recorded in our financial statements. These transactions involve, to varying
      degrees, elements of credit, interest rate, and liquidity risk. Such
      transactions are used primarily to manage customers’ requests for funding and
      take the form of loan commitments, unused lines of credit, amounts due
      mortgagors on construction loans, amounts due on commercial loans, commercial
      letters of credit and commitments to sell loans. See note 15 of the notes to
      the
      financial statements in this annual report.





For
      the
      years ended December 31, 2006, 2005 and 2004, 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.





28













**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, 2006 and 2005, and the related consolidated statements of income,
      changes in stockholders' equity, and cash flows for each of the years ended
      December 31, 2006, 2005 and 2004. 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, 2006 and 2005, and the results of
      its
      operations and its cash flows for the each of the years ended December 31,
      2006,
      2005 and 2004, in conformity with accounting principles generally accepted
      in
      the United States of America.








Hartford,
      Connecticut


March
      9,
      2007





29







**Consolidated
      Statements of Financial Condition**




*(Dollars
      in thousands)*


December
                31,2006
            
            2005**ASSETS**Cash
                and due from depository institutions
            
            $
            7,911
            
            $
            8,922Investment
                in federal funds
            
            
            31
            
            
            29Investment
                securities
            
            
            70,267
            
            
            63,049Loans
                receivable, net
            
            
            308,376
            
            
            259,427Accrued
                income receivable
            
            
            1,904
            
            
            1,525Premises
                and equipment, net
            
            
            11,209
            
            
            9,087Bank
                owned life insurance asset
            
            
            7,956
            
            
            7,652Federal
                Home Loan Bank of Boston stock
            
            
            3,898
            
            
            3,159Other
                assets
            
            
            2,303
            
            
            2,496**Total
                assets**
            
            $
            413,855
            
            $
            355,346**LIABILITIES
                AND STOCKHOLDERS' EQUITY**LiabilitiesDeposits
            
            $
            289,198
            
            $
            240,846Advances
                from Federal Home Loan Bank of Boston
            
            
            68,488
            
            
            57,059Mortgagors'
                escrow accounts
            
            
            3,495
            
            
            3,202Other
                liabilities
            
            
            1,590
            
            
            3,275Total
                liabilities
            
            
            362,771
            
            
            304,382Commitments
                and contingenciesStockholders'
                EquityCommon
                stock, $.01 par value; 25,000,000 shares authorized;7,604,375 shares
                issued; shares outstanding - 7,473,225 at December 31, 2006; 7,604,375
                at
                December 31, 2005
            
            
            76
            
            
            76Preferred
                stock, $.01 par value; 1,000,000 shares authorized; no shares issued
                or
                outstanding
            
            
            -
            
            
            -Paid-in
                capital
            
            
            33,302
            
            
            33,157Retained
                earnings
            
            
            23,415
            
            
            22,588Unearned
                ESOP shares (253,402 shares at December 31, 2006 and 273,291 shares
                at
                December 31, 2005)
            
            
            (2,534
            )
            
            (2,733
            )Unearned
                stock awards (113,266 shares at December 31, 2006 and 139,712 shares
                at
                December 31, 2005)
            
            
            (1,256
            )
            
            (1,551
            )Treasury
                Stock, at cost (138,983 shares at December 31, 2006 and 9,333 shares
                at
                December 31, 2005)
            
            
            (1,593
            )
            
            (122
            )Accumulated
                other comprehensive loss
            
            
            (326
            )
            
            (451
            )Total
                stockholders' equity
            
            
            51,084
            
            
            50,964**Total
                liabilities and stockholders' equity**
            
            $
            413,855
            
            $
            355,346





See
      notes
      to consolidated financial statements.




30







**Consolidated
      Statements of Income**




*(Dollars
      in thousands, except earnings per share)*


For
                  the Years Ended December 31,2006
              
              2005
              
              2004**Interest
                  and dividend income**Interest
                  on loans
              
              $
              17,506
              
              $
              13,642
              
              $
              11,240Interest
                  and dividends on investments and deposits
              
              
              3,244
              
              
              2,266
              
              
              1,473Total
                  interest income
              
              
              20,750
              
              
              15,908
              
              
              12,713**Interest
                  expense**Interest
                  on deposits
              
              
              6,551
              
              
              3,423
              
              
              2,303Interest
                  on borrowed funds
              
              
              2,799
              
              
              1,518
              
              
              1,256Total
                  interest expense
              
              
              9,350
              
              
              4,941
              
              
              3,559**Net
                  interest income**
              
              
              11,400
              
              
              10,967
              
              
              9,154**Provision
                  for loan losses**
              
              
              192
              
              
              32
              
              
              -**Net
                  interest income after provision for loan losses**
              
              
              11,208
              
              
              10,935
              
              
              9,154**Noninterest
                  income**Fees
                  for services related to deposit accounts
              
              
              873
              
              
              618
              
              
              557Fees
                  for other services
              
              
              540
              
              
              356
              
              
              315Income
                  from bank owned life insurance
              
              
              304
              
              
              218
              
              
              201Income
                  from investment advisory services, net
              
              
              98
              
              
              167
              
              
              93Gain
                  (loss) on sale of investments
              
              
              6
              
              
              47
              
              
              (156
              )Gain
                  on sale of mortgages
              
              
              -
              
              
              -
              
              
              5Other
                  income
              
              
              127
              
              
              111
              
              
              63Total
                  noninterest income
              
              
              1,948
              
              
              1,517
              
              
              1,078**Noninterest
                  expense**Compensation,
                  taxes and benefits
              
              
              6,408
              
              
              5,477
              
              
              4,301Office
                  occupancy
              
              
              1,757
              
              
              1,538
              
              
              1,191Advertising
              
              
              672
              
              
              523
              
              
              318Computer
                  processing
              
              
              606
              
              
              624
              
              
              547Directors
                  compensation
              
              
              516
              
              
              435
              
              
              335Professional
                  fees
              
              
              380
              
              
              448
              
              
              272Office
                  supplies
              
              
              193
              
              
              232
              
              
              190Contributions
              
              
              34
              
              
              34
              
              
              1,587Loss
                  (gain) on foreclosed real estate, net
              
              
              16
              
              
              (35
              )
              
              (57
              )Prepayment
                  fee on Federal Home Loan Bank of Boston advances
              
              
              -
              
              
              -
              
              
              498Other
                  expenses
              
              
              922
              
              
              821
              
              
              621Total
                  noninterest expense
              
              
              11,504
              
              
              10,097
              
              
              9,803**Income
                  before provision for income taxes**
              
              
              1,652
              
              
              2,355
              
              
              429**Provision
                  for income taxes**
              
              
              204
              
              
              450
              
              
              14**Net
                  income**
              
              $
              1,448
              
              $
              1,905
              
              $
              415**Earnings
                  per share - basic and diluted**
              
              $
              0.20
              
              $
              0.26
              
              
              N/M





See
      notes
      to consolidated financial statements.





31







**Consolidated
      Statements of Changes in Stockholders' Equity**




*(Dollars
      in thousands)*


Common
                                                        
                                                        Paid-in
                                                        
                                                        Retained
                                                        
                                                        Unearned
                                                          ESOPStock
                                                        
                                                        Capital
                                                        
                                                        Earnings
                                                        
                                                        Shares**Balance
                                                            at December 31, 2004**
                                                        
                                                        $
                                                        76
                                                        
                                                        $
                                                        33,089
                                                        
                                                        $
                                                        21,362
                                                        
                                                        $
                                                        (2,932
                                                        )ESOP
                                                            shares released - 19,889
                                                            shares
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        19
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        199Dividends
                                                            paid ($0.16 per common
                                                            share)
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        (500
                                                        )
                                                        
                                                        -Stock
                                                            acquired for future stock
                                                            awards - 9,333 shares
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -Stock
                                                            based compensation -
                                                            139,712 shares
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        49
                                                        
                                                        
                                                        (179
                                                        )
                                                        
                                                        -Comprehensive
                                                            income:Net
                                                            income
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        1,905
                                                        
                                                        
                                                        -Net
                                                            change in unrealized
                                                            holding gain on available-for-
                                                            sale
                                                          securities,
                                                            net of tax effect
                                                          Comprehensive
                                                            income
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -**Balance
                                                            at December 31, 2005**
                                                        
                                                        
                                                        76
                                                        
                                                        
                                                        33,157
                                                        
                                                        
                                                        22,588
                                                        
                                                        
                                                        (2,733
                                                        )ESOP
                                                            shares released - 19,889
                                                            shares
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        22
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        199Dividends
                                                            paid ($0.20 per common
                                                            share)
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        (617
                                                        )
                                                        
                                                        -Stock
                                                            based compensation
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        123
                                                        
                                                        
                                                        (4
                                                        )
                                                        
                                                        -Treasury
                                                            stock acquired - 131,150
                                                            shares
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -Comprehensive
                                                            income:Net
                                                            income
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        1,448
                                                        
                                                        
                                                        -Net
                                                            change in unrealized
                                                            holding gain on available-for-sale
                                                          securities,
                                                            net of tax effect
                                                          Comprehensive
                                                            income
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        -**Balance
                                                            at December 31, 2006**
                                                        
                                                        $
                                                        76
                                                        
                                                        $
                                                        33,302
                                                        
                                                        $
                                                        23,415
                                                        
                                                        $
                                                        (2,534
                                                        )





See
      notes
      to consolidated financial statements.




32






**Consolidated
        Statements of Changes in Stockholders' Equity (continued)**
  *(Dollars
          in thousands)*
 Unearned
                                                                Stock
                                                            
                                                            Treasury
                                                            Accumulated
                                                              Other
                                                              ComprehensiveAwards
                                                            
                                                            Stock
                                                            
                                                            Loss
                                                            
                                                            Total**Balance
                                                                at December 31, 2004**
                                                            
                                                            $
                                                            -
                                                            
                                                            $
                                                            -
                                                            
                                                            $
                                                            (24
                                                            )
                                                            $
                                                            51,571ESOP
                                                                shares released -
                                                                19,889 shares
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            218Dividends
                                                                paid ($0.16 per common
                                                                share)
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            (500
                                                            )Stock
                                                                acquired for future
                                                                stock awards - 9,333
                                                                shares
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            (122
                                                            )
                                                            
                                                            -
                                                            
                                                            
                                                            (122
                                                            )Stock
                                                                based compensation
                                                                - 139,712 shares
                                                            
                                                            
                                                            (1,551
                                                            )
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            (1,681
                                                            )Comprehensive
                                                                income:Net
                                                                income
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -Net
                                                                change in unrealized
                                                                holding gain on available-for-
                                                                sale
                                                              securities,
                                                                net of tax effect
                                                              Comprehensive
                                                                income
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            (427
                                                            )
                                                            
                                                            1,478**Balance
                                                                at December 31, 2005**
                                                            
                                                            
                                                            (1,551
                                                            )
                                                            
                                                            (122
                                                            )
                                                            
                                                            (451
                                                            )
                                                            
                                                            50,964ESOP
                                                                shares released -
                                                                19,889 shares
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            221Dividends
                                                                paid ($0.20 per common
                                                                share)
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            (617
                                                            )Stock
                                                                based compensation
                                                            
                                                            
                                                            295
                                                            
                                                            
                                                            20
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            434Treasury
                                                                stock acquired -
                                                                131,150 shares
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            (1,491
                                                            )
                                                            
                                                            -
                                                            
                                                            
                                                            (1,491
                                                            )Comprehensive
                                                                income:Net
                                                                income
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -Net
                                                                change in unrealized
                                                                holding gain on available-for-sale
                                                              securities,
                                                                net of tax effect
                                                              Comprehensive
                                                                income
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            125
                                                            
                                                            
                                                            1,573**Balance
                                                                at December 31, 2006**
                                                            
                                                            
                                                            (1,256
                                                            )
                                                            $
                                                            (1,593
                                                            )
                                                            $
                                                            (326
                                                            )
                                                            $
                                                            51,084






See notes to consolidated financial statements.




33







**Consolidated
      Statements of Cash Flows**




*(In
      thousands)*


For
                the Years Ended December 31,2006
            
            2005
            
            2004**Cash
                flows from operating activities**Net
                income
            
            $
            1,448
            
            $
            1,905
            
            $
            415Adjustments
                to reconcile net income to net cash provided by operating
                activities:Provision
                for loan losses
            
            
            192
            
            
            32
            
            
            -Contribution
                of common stock to charitable foundation
            
            
            -
            
            
            -
            
            
            1,519Depreciation
                and amortization expense
            
            
            654
            
            
            686
            
            
            642Provision
                for deferred tax (benefit)
            
            
            (75
            )
            
            (177
            )
            
            (464
            )Net
                gain on sale of real estate owned
            
            
            (4
            )
            
            (46
            )
            
            (68
            )Gain
                on sale of mortgages
            
            
            -
            
            
            -
            
            
            (5
            )Loans
                originated for sale
            
            
            -
            
            
            -
            
            
            (1,930
            )Proceeds
                from sale of loans
            
            
            -
            
            
            -
            
            
            1,935(Gain)
                loss on sale of investments
            
            
            (6
            )
            
            (47
            )
            
            156Loss
                on disposal of premises and equipment
            
            
            1
            
            
            14
            
            
            -Stock-based
                compensation
            
            
            657
            
            
            397
            
            
            53Increase
                in accrued income receivable
            
            
            (379
            )
            
            (448
            )
            
            (5
            )Increase
                (decrease) in deferred loan fees
            
            
            9
            
            
            (11
            )
            
            73Increase
                in cash surrender value of life insurance
            
            
            (304
            )
            
            (218
            )
            
            (201
            )Decrease
                (increase) in other assets
            
            
            107
            
            
            (319
            )
            
            2Increase
                (decrease) in other liabilities
            
            
            228
            
            
            (381
            )
            
            (33
            )**Net
                cash provided by operating activities**
            
            
            2,528
            
            
            1,387
            
            
            2,089**Cash
                flows from investing activities**Proceeds
                from maturities and repayments of available-for-sale
                securities
            
            
            16,779
            
            
            19,245
            
            
            9,222Proceeds
                from sale of available-for-sale securities
            
            
            5,163
            
            
            3,742
            
            
            16,982Proceeds
                from maturities of held-to-maturity securities
            
            
            2,470
            
            
            665
            
            
            -Purchase
                of available-for-sale securities
            
            
            (31,401
            )
            
            (50,593
            )
            
            (20,830
            )Purchase
                of held-to-maturity securities
            
            
            -
            
            
            (500
            )
            
            (3,610
            )Loan
                originations net of principal payments
            
            
            (49,148
            )
            
            (55,674
            )
            
            (23,582
            )Purchase
                of Federal Home Loan Bank of Boston stock
            
            
            (739
            )
            
            (980
            )
            
            (423
            )Proceeds
                from the sale of foreclosed real estate
            
            
            50
            
            
            113
            
            
            277Proceeds
                from sale of property and equipment
            
            
            2
            
            
            11
            
            
            -Purchase
                of property and equipment
            
            
            (2,780
            )
            
            (1,943
            )
            
            (2,157
            )Purchase
                of bank owned life insurance asset
            
            
            -
            
            
            (2,500
            )
            
            -**Net
                cash used by investing activities**
            
            
            (59,604
            )
            
            (88,414
            )
            
            (24,121
            )





See
      notes
      to consolidated financial statements.




34









For
                the Years Ended December 31,2006
            
            2005
            
            2004**Cash
                flows from financing activities**Net
                change in time deposits
            
            
            42,645
            
            
            41,231
            
            
            (4,992
            )Net
                change in other deposit accounts
            
            
            5,707
            
            
            6,249
            
            
            14,903Advances
                from Federal Home Loan Bank of Boston
            
            
            51,250
            
            
            62,193
            
            
            19,650Repayment
                of Advances from Federal Home Loan Bank of Boston
            
            
            (39,821
            )
            
            (20,960
            )
            
            (38,814
            )Net
                change in mortgagors' escrow accounts
            
            
            293
            
            
            143
            
            
            424Change
                in short-term borrowings
            
            
            (1,899
            )
            
            1,899
            
            
            -Common
                stock repurchased
            
            
            (1,491
            )
            
            (1,852
            )
            
            -Cash
                dividends to common stockholders
            
            
            (617
            )
            
            (500
            )
            
            -Proceeds
                from issuance of common stock
            
            
            -
            
            
            -
            
            
            32,601Cost
                of issuance of common stock
            
            
            -
            
            
            -
            
            
            (959
            )Payments
                to acquire common stock for ESOP
            
            
            -
            
            
            -
            
            
            (2,981
            )**Net
                cash provided by financing activities**
            
            
            56,067
            
            
            88,403
            
            
            19,832(Decrease)
                Increase in cash and cash equivalents
            
            
            (1,009
            )
            
            1,376
            
            
            (2,200
            )Cash
                and cash equivalents at beginning of year
            
            
            8,951
            
            
            7,575
            
            
            9,775**Cash
                and cash equivalents at end of year**
            
            $
            7,942
            
            $
            8,951
            
            $
            7,575***Supplemental
                disclosures***Non-cash
                investing activities:Transfer
                of loans to foreclosed real estate
            
            $
            -
            
            $
            47
            
            $
            67Cash
                paid during the year for:Interest
            
            $
            9,347
            
            $
            4,939
            
            $
            3,562Income
                taxes
            
            
            305
            
            
            683
            
            
            454





See
      notes
      to consolidated financial statements.





35









**Notes
      to Consolidated Financial Statements**




**1.  
      Nature of Operations**




Naugatuck
      Valley Financial Corporation (the “Company”) is a federally chartered holding
      company formed on September 30, 2004 for the purpose of acquiring all of the
      common stock of the Naugatuck Valley Savings and Loan (the “Bank”) concurrent
      with its reorganization from a mutual savings institution to the mutual holding
      company form of organization. The reorganization was consummated on September
      30, 2004. In connection with the reorganization, the Company sold 3,269,881
      shares of its common stock, par value $.01 per share, in a subscription offering
      and issued 4,182,407 shares to Naugatuck Valley Mutual Holding Company, raising
      approximately $31.7 million, net of costs. Approximately $15.9 million of the
      proceeds were contributed to the Bank. The Company is a majority owned
      subsidiary of Naugatuck Valley Mutual Holding Company, a federally chartered
      mutual holding company.





In
      addition, at the time of the reorganization, the Company contributed 152,087
      shares of its stock to the Naugatuck Valley Savings and Loan Foundation. The
      foundation is a 501(c)(3) organization formed by the Company to support
      charitable activities within its community.





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




36
  
  **Notes
        to Consolidated Financial Statements**
  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.




*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.





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.




*Loans
      receivable and allowance for loan losses*


Loans
      receivable are stated at unpaid principal balance 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.





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.





37







**Notes
      to Consolidated Financial Statements**




**2.  
      Summary of Significant Accounting Policies** ***-**
      (Continued)*




*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, 2006 and 2005. 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.




*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 asset*


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 non-interest 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




38
  
 **Notes
        to Consolidated Financial Statements**
  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.




*Earnings
      per share*


When
      presented, 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. Because the formation of the Company was completed on September
      30, 2004, per share earnings data is not meaningful for 2004.




*Computation
      of fair values*


The
      calculation of fair value estimates of financial instruments is dependent upon
      certain subjective assumptions and involves significant uncertainties. Changes
      in assumptions could significantly affect the estimates. These estimates do
      not
      reflect any possible tax ramifications, estimated transaction costs or any
      premium or discount that could result from offering the Company's entire
      holdings of a particular financial instrument.





The
      following methods and assumptions were utilized by the Company in estimating
      the
      fair values of its on-balance sheet financial instruments:





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





*Investment
      securities -* Fair
      values for investment securities are based on quoted market prices where
      available. If quoted market prices are not available, fair values are based
      on
      market prices for comparable instruments.




*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.




*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.




*Advances
      from Federal Home Loan Bank of Boston ("FHLBB")* - 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 financial condition approximate
      the fair value of the mortgagors’ escrow accounts.





39







**Notes
      to Consolidated Financial Statements**




**2.  
      Summary of Significant Accounting Policies** ***-**
      (Continued)*




*Recent
      Accounting Pronouncements*


In
      September, 2006 the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards No. 158,*Employers’
      Accounting for Defined Benefit Pension and Other Postretirement
      Plans,*which
      includes amendments to Statements 87, 106, and 132 (R).The
      Statement requires a company to fully recognize, as an asset or liability,
      the
      over-funded or under-funded status of its benefit plan in its 2006 year-end
      balance sheet. This will result in the immediate recognition (on the balance
      sheet) of amounts that would have been recognized in subsequent years
      (off-balance sheet). Unrecognized prior service costs and credits, any
      unrecognized net actuarial gains or losses and transition obligations and assets
      will be recorded as components of other comprehensive income (“OCI”). In
      subsequent periods, these amounts will be reclassified from OCI and recognized
      in income as components of net periodic benefit cost pursuant to Statements
      87,
      88 and 106. Statement 158 will not change how these amounts are recognized
      in
      the income statement.Implementation
      of the new standard had no effect on the financial statements, because the
      Company participates in a multi-employer plan. The accounting and disclosure
      requirements for multiemployer plans were unchanged by the new
      standard.





In
      July
      2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation No. 48, “Accounting for Uncertainty in Income Tax Positions.”
This Interpretation clarifies the application of SFAS. No. 109, “Accounting for
      Income Taxes,” by establishing a threshold condition that a tax position must
      meet for any part of the benefit of that position to be recognized in the
      financial statements. In addition to recognition, FASB Interpretation No. 48
      provides guidance concerning measurement, derecognition, classification, and
      disclosure of tax positions and is effective for fiscal years beginning after
      December 15, 2006. Adoption of this Interpretation is not expected to have
      a
      significant impact on the results of operations and financial condition.





In
      March
      2006, the Financial Accounting Standards Board issued Statement No. 156,
“Accounting for Servicing of Financial Assets.” Statement 156, which is an
      amendment to SFAS No. 140, simplifies the accounting for servicing assets and
      liabilities, such as those common with mortgage securitization activities.
      The
      new Standard clarifies when an obligation to service financial assets should
      be
      separately recognized as a servicing asset or a servicing liability; requires
      that a separately recognized servicing asset or servicing liability be initially
      measured at fair value, if practicable; and permits an entity with a separately
      recognized servicing asset or servicing liability to choose either the
      Amortization Method or Fair Value Method for subsequent measurement. Statement
      No. 156 is effective for separately recognized servicing assets and liabilities
      acquired or issued after the beginning of an entity's fiscal year that begins
      after September 15, 2006, with early adoption permitted. Adoption of this
      statement is not expected to have a material effect on results of operations
      or
      financial condition.




*Reclassification*


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




40







**Notes
      to Consolidated Financial Statements**




**3.  
      Investment Securities**




A
      summary
      of investment securities at December 31, 2006 and 2005 follows:





2006
            
            2005*(In
                thousands)*
            
            Carrying
              Amount
            
            Fair
              Value
            
            Carrying
              Amount
            
            Fair
              ValueAvailable-for-sale
                securities
            
            $
            67,736
            
            $
            67,736
            
            $
            58,047
            
            $
            58,047Held-to-maturity
                securities
            
            
            2,531
            
            
            2,522
            
            
            5,002
            
            
            4,989**Total
                investment securities**
            
            $
            70,267
            
            $
            70,258
            
            $
            63,049
            
            $
            63,036








At
      December 31, 2006, the composition of the investment portfolio
      was:


Amortized
            
            Gross
                Unrealized
            
            Fair*(In
                thousands)*
            
            Cost
                Basis
            
            Gains
            
            Losses
            
            Value**Available-for-sale
                securities:**U.S.
                government and agency obligationsLess
                than one year
            
            $
            4,000
            
            $
            -
            
            $
            (37
            )
            $
            3,963From
                one through five years
            
            
            3,495
            
            
            -
            
            
            (23
            )
            
            3,472From
                five through ten years
            
            
            1,000
            
            
            -
            
            
            (20
            )
            
            9808,495
            
            
            -
            
            
            (80
            )
            
            8,415Municipal
                obligationsLess
                than one year
            
            
            1,000
            
            
            -
            
            
            (1
            )
            
            999From
                five through ten years
            
            
            828
            
            
            2
            
            
            -
            
            
            830After
                ten years
            
            
            13,349
            
            
            49
            
            
            (37
            )
            
            13,36115,177
            
            
            51
            
            
            (38
            )
            
            15,190Corporate
                bondsFrom
                one through five years
            
            
            1,951
            
            
            8
            
            
            (4
            )
            
            1,955Mortgage-backed
                securities
            
            
            25,111
            
            
            60
            
            
            (389
            )
            
            24,782Collateralized
                mortgage obligations
            
            
            4,796
            
            
            6
            
            
            (108
            )
            
            4,694Total
                debt securities
            
            
            55,530
            
            
            125
            
            
            (619
            )
            
            55,036Money
                market preferred stocks
            
            
            12,700
            
            
            -
            
            
            -
            
            
            12,700**Total
                available-for-sale securities**
            
            $
            68,230
            
            $
            125
            
            $
            (619
            )
            $
            67,736




41







**Notes
      to Consolidated Financial Statements**




**3.  
      Investment Securities** ***-**
      (Continued)*


Amortized
            
            Gross
                Unrealized
            
            Fair*(In
                thousands)*
            
            Cost
                Basis
            
            Gains
            
            Losses
            
            Value**Held-to-maturity
                securities:**U.S.
                government and agency obligationsFrom
                one through five years
            
            $
            1,201
            
            $
            -
            
            $
            (9
            )
            $
            1,192Interest
                bearing balancesLess
                than one year
            
            
            1,140
            
            
            -
            
            
            -
            
            
            1,140From
                one through five years
            
            
            190
            
            
            -
            
            
            -
            
            
            190**Total
                held-to-maturity securities**
            
            $
            2,531
            
            $
            -
            
            $
            (9
            )
            $
            2,522





At
      December 31, 2005, the composition of the investment portfolio
      was:


Amortized
            
            Gross
                Unrealized
            
            Fair*(In
                thousands)*
            
            Cost
                Basis
            
            Gains
            
            Losses
            
            Value**Available-for-sale
                securities:**U.S.
                government and agency obligationsLess
                than one year
            
            $
            6,847
            
            $
            8
            
            $
            (49
            )
            $
            6,806From
                one through five years
            
            
            7,497
            
            
            2
            
            
            (95
            )
            
            7,404From
                five through ten years
            
            
            1,000
            
            
            -
            
            
            (35
            )
            
            96515,344
            
            
            10
            
            
            (179
            )
            
            15,175Municipal
                obligationsAfter
                ten years
            
            
            8,715
            
            
            61
            
            
            (7
            )
            
            8,769Corporate
                bondsFrom
                one through five years
            
            
            1,928
            
            
            -
            
            
            (5
            )
            
            1,923Mortgage-backed
                securities
            
            
            22,544
            
            
            1
            
            
            (463
            )
            
            22,082Collateralized
                mortgage obligations
            
            
            4,199
            
            
            -
            
            
            (101
            )
            
            4,098Total
                debt securities
            
            
            52,730
            
            
            72
            
            
            (755
            )
            
            52,047Money
                market preferred stocks
            
            
            6,000
            
            
            -
            
            
            -
            
            
            6,000**Total
                available-for-sale securities**
            
            $
            58,730
            
            $
            72
            
            $
            (755
            )
            $
            58,047**Held-to-maturity
                securities:**U.S.
                government and agency obligationsFrom
                one through five years
            
            $
            1,202
            
            $
            1
            
            $
            (14
            )
            $
            1,189Interest
                bearing balancesFrom
                one through five years
            
            
            3,800
            
            
            -
            
            
            -
            
            
            3,800**Total
                held-to-maturity securities**
            
            $
            5,002
            
            $
            1
            
            $
            (14
            )
            $
            4,989




42







**Notes
      to Consolidated Financial Statements**




The
      Company has certain investment securities in which the market value of the
      security is less than the cost of the security. Management believes that these
      unrealized losses are temporary and are the result of changes in market interest
      rates. In making this determination, management considered the period of time
      the securities have been in a loss position, the percentage decline in
      comparison to the securities’ amortized cost, the financial condition of the
      issuer and the Company’s ability and intent to hold these securities until their
      fair value recovers to their amortized cost. At December 31, 2006, these
      securities had an aggregate fair value of $38,170,000 which resulted in
      unrealized losses of $628,000.





The
      following is a summary of the fair value and related unrealized losses
      aggregated by investment category and length of time that individual securities
      have been in a continuous unrealized loss position at December 31,
      2006.


Securities
                in Continuous UnrealizedLoss
                Position Less Than 12 MonthsNumber
                of
            
            Market
            
            Unrealized*(Dollars
                in thousands)*
            
            Securities
            
            Value
            
            LossU.S.
                government and agency obligations
            
            
            3
            
            $
            999
            
            $
            (1
            )Municipal
                obligations
            
            
            9
            
            
            5,615
            
            
            (38
            )Corporate
                bonds
            
            
            1
            
            
            492
            
            
            (2
            )**Total
                securities in unrealized loss position**
            
            
            13
            
            $
            7,106
            
            $
            (41
            )




Securities
                in Continuous UnrealizedLoss
                Position 12 or More Consecutive MonthsNumber
                of
            
            Market
            
            Unrealized*(Dollars
                in thousands)*
            
            Securities
            
            Value
            
            LossU.S.
                government and agency obligations
            
            
            15
            
            $
            8,606
            
            $
            (88
            )Mortgage-backed
                securities
            
            
            24
            
            
            21,486
            
            
            (497
            )Corporate
                bonds
            
            
            1
            
            
            972
            
            
            (2
            )**Total
                securities in unrealized loss position**
            
            
            40
            
            $
            31,064
            
            $
            (587
            )





For
      the
      year ended December 31, 2006, the Company realized gross gains of $20,224 and
      gross losses of $14,436 compared with realized gross gains of $47,046 and no
      gross losses for the year ended December 31, 2005 and realized gross gains
      of
      $23,787 and gross losses of $179,952 for the year ended December 31, 2004 on
      sales of investment securities.





At
      December 31, 2006 and 2005, securities with a carrying value of $3,200,000
      and
      $1,200,000, and fair values of approximately $3,173,000 and $1,188,000,
      respectively, were pledged as collateral to secure municipal
      deposits.




43







**Notes
      to Consolidated Financial Statements**




**4.  
      Loans Receivable**




A
      summary
      of loans receivable at December 31, 2006 and 2005 is as
      follows:


*(Dollars
                in thousands)*
            
            2006
            
            2005Loans
                secured by first mortgages on real estate:Conventional:Fixed
                rate mortgage loans
            
            $
            148,357
            
            $
            127,924Adjustable
                rate mortgage loans
            
            
            29,364
            
            
            28,245Construction
                loans
            
            
            6,960
            
            
            6,063Commercial
                loans
            
            
            84,203
            
            
            62,946Loans
                on savings accounts
            
            
            634
            
            
            785Personal,
                auto and property improvement loans
            
            
            43,682
            
            
            38,001313,200
            
            
            263,964Less:Allowance
                for loan losses
            
            
            2,071
            
            
            1,878Undisbursed
                construction loans
            
            
            2,343
            
            
            2,258Deferred
                loan origination fees
            
            
            410
            
            
            401**Loans
                receivable, net**
            
            $
            308,376
            
            $
            259,427**Weighted
                average yield**
            
            
            6.32
            %
            
            6.07
            %





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, 2006 and 2005, the composition of the Bank's
      investment in fixed rate loans was as follows:




Fixed
                    RateTerm
                    to Maturity
                
                2006
                
                2005*(In
                    thousands)*Less
                    than 1 year
                
                $
                6,660
                
                $
                5,9071
                    -
                    3 years
                
                
                3,155
                
                
                1,6833
                    -
                    5 years
                
                
                2,581
                
                
                1,9705
                    -
                    10 years
                
                
                21,985
                
                
                19,22210
                    - 20 years
                
                
                54,486
                
                
                52,887Over
                    20 years
                
                
                99,089
                
                
                73,970**Total
                    loans at fixed rates**
                
                $
                187,956
                
                $
                155,639




44







**Notes
      to Consolidated Financial Statements**




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, 2006 and 2005, the Bank had the following adjustable rate
      loans:




Adjustable
                  RateRate
                  Adjustment
              
              2006
              
              2005*(In
                  thousands)*Less
                  than 1 year
              
              $
              53,248
              
              $
              53,4531
                  -
                  3 years
              
              
              13,388
              
              
              15,7923
                  -
                  5 years
              
              
              37,109
              
              
              21,2305
                  -
                  10 years
              
              
              20,736
              
              
              16,990Over
                  10 years
              
              
              763
              
              
              860**Total
                  loans at adjustable rates**
              
              $
              125,244
              
              $
              108,325








Nonperforming
      loans totaled approximately $2.0 million and $294,000 at December 31, 2006
      and
      2005, respectively. These loans, primarily delinquent 90 days or more, were
      accounted for on a nonaccrual basis. The amount of income that was contractually
      due but not recognized on nonperforming loans totaled $68,200, $20,900, and
      $44,600 in 2006, 2005 and 2004, respectively.





At
      December 31, 2006 the Bank had approximately $49,500 of loans with an allowance
      of $2,000 which were considered to be impaired. These loans averaged $51,000
      during 2006 and paid $2,400 in interest. There were no loans considered to
      be
      impaired by the Bank at December 31, 2005.





Transactions
      in the allowance for loan losses account for the years ended December 31, 2006,
      2005 and 2004 were as follows:





*(In
                thousands)*
            
            2006
            
            2005
            
            2004Balance
                at beginning of year
            
            $
            1,878
            
            $
            1,829
            
            $
            1,810Provision
                for loan losses
            
            
            192
            
            
            32
            
            
            -Loans
                written off
            
            
            (2
            )
            
            (4
            )
            
            (56
            )Recoveries
                of loans written off
            
            
            3
            
            
            21
            
            
            75**Balance
                at end of year**
            
            $
            2,071
            
            $
            1,878
            
            $
            1,829








As
      of
      December 31, 2006 and 2005, loans to related parties totaled approximately
      $3,711,000 and $3,269,000, respectively. For the year ended December 31, 2006,
      new loans of approximately $538,000 were granted to these parties and principal
      payments of approximately $180,000 were received. During 2006, an additional
      $84,000 in existing loans were included in loans to related parties for an
      individual who became a related party during the year. For the year ended
      December 31, 2005, new loans of approximately $375,000 were granted to these
      parties and principal payments of approximately $586,000





45







**Notes
      to Consolidated Financial Statements**




**4. 
       Loans Receivable** ***-**
      (Continued)*




were
      received. 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, 2006 and 2005, 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 $10,121,000 and $10,632,000 at December 31,
      2006
      and 2005, respectively.




**5.  
      Premises and Equipment**





Premises
      and equipment at December 31, 2006 and 2005 are summarized as
      follows:


*(In
                  thousands)*
              
              2006
              
              2005Banking
                  offices and branch buildings
              
              $
              8,489
              
              $
              6,819Furniture
                  and equipment
              
              
              3,241
              
              
              2,535Land
              
              
              1,551
              
              
              1,538Leasehold
                  improvements
              
              
              1,227
              
              
              1,06714,508
              
              
              11,959Accumulated
                  depreciation and amortization
              
              
              (3,299
              )
              
              (2,872
              )**Premises
                  and equipment, net**
              
              $
              11,209
              
              $
              9,087








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 $655,607 and $596,670 and $511,159
      for the years ended December 31, 2006, 2005 and 2004, respectively.





At
      December 31, 2006, future minimum rental income and lease payment expense were
      expected to be:


*(In
                thousands)*
            
            Income
            
            Expense2007
            
            $
            98
            
            $
            2002008
            
            
            98
            
            
            2082009
            
            
            100
            
            
            2172010
            
            
            102
            
            
            2332011
            
            
            98
            
            
            195Thereafter
            
            
            139
            
            
            955**Total
                future minimum rents**
            
            $
            635
            
            $
            2,008




46







**Notes
      to Consolidated Financial Statements**




**6.  
      Deposits**




Deposits
      and weighted average rates at December 31, 2006 and 2005 are summarized as
      follows:


2006
            
            2005*(Dollars
                in thousands)*
            
            Amount
            
            Weighted
                Average Cost
            
            Amount
            
            Weighted
                Average CostCertificate
                accounts
            
            $
            165,076
            
            
            4.43
            %
            $
            122,431
            
            
            3.38
            %Regular
                savings accounts
            
            
            46,156
            
            
            0.63
            %
            
            51,375
            
            
            0.85
            %Checking
                and NOW accounts
            
            
            57,301
            
            
            0.73
            %
            
            46,825
            
            
            0.10
            %Money
                market savings accounts
            
            
            20,665
            
            
            1.89
            %
            
            20,215
            
            
            0.88
            %**Total
                deposits**
            
            $
            289,198
            
            
            2.91
            %
            $
            240,846
            
            
            1.99
            %




The
      aggregate amount of individual certificate accounts of $100,000 or more at
      December 31, 2006 and 2005 was $48,228,000 and $32,001,000 respectively.
      Deposits up to $100,000 are federally insured. In addition, federal law provides
      up to $250,000 in deposit insurance coverage for self-directed retirement
      accounts, such as Individual Retirement Accounts (IRAs).





At
      December 31, 2006 and 2005 the remaining maturities for certificate accounts
      were:


*(In
                thousands)*
            
            2006
            
            2005Certificate
                accounts maturing in:Under
                12 months
            
            $
            145,056
            
            $
            63,19412
                to 24 months
            
            
            13,021
            
            
            37,06724
                to 36 months
            
            
            3,474
            
            
            13,564Over
                36 months
            
            
            3,525
            
            
            8,606**Total
                certificate accounts**
            
            $
            165,076
            
            $
            122,431




**7.  
      Advances from Federal Home Loan Bank of Boston**





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 $3,898,300
      in
      FHLBB stock at December 31, 2006. In additional to the outstanding advances,
      the
      Bank has a $2,540,000 line of credit available from FHLBB and a $3,500,000
      line
      of credit available from another correspondent bank, none of which was
      outstanding at December 31, 2006.





47







**Notes
      to Consolidated Financial Statements**




**7.  
      Advances from Federal Home Loan Bank of Boston** **-** *(Continued)*




FHLBB
      advances are secured by a blanket lien on the Bank’s assets. Outstanding
      advances with calendar-year maturity dates and weighted average cost of funds
      at
      December 31, 2006 and 2005 were as follows:


*(Dollars
                in thousands)*
            
            2006
            
            2005Year
                of Maturity
            
            Amount
              Due
            
            Weighted
                Average Cost
            
            Amount
              Due
            
            Weighted
                Average Cost2006
            
            $
            -
            
            
            0.00
            %
            $
            35,503
            
            
            4.27
            %2007
            
            
            30,465
            
            
            5.03
            
            
            5,034
            
            
            3.922008
            
            
            12,172
            
            
            4.60
            
            
            5,921
            
            
            4.062009
            
            
            21,718
            
            
            4.79
            
            
            6,468
            
            
            4.192010
            
            
            2,203
            
            
            4.32
            
            
            2,203
            
            
            4.322011
            
            
            657
            
            
            4.09
            
            
            657
            
            
            4.092012
            
            
            684
            
            
            4.09
            
            
            684
            
            
            4.092013
            
            
            579
            
            
            4.13
            
            
            579
            
            
            4.132014
            
            
            10
            
            
            3.94
            
            
            10
            
            
            3.94**Total
                advances**
            
            $
            68,488
            
            
            4.83
            
            $
            57,059
            
            
            4.20




During
      2004, the Bank prepaid $9,561,780 of FHLBB advances with a weighted-average
      rate
      of 5.29%. The Bank incurred a prepayment penalty of $498,000 as a part of the
      transaction.




**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 $280,000 for the year ended
      December 31, 2006 compared with $439,000 and $441,000 for 2005 and 2004,
      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 $136,000, $89,000 and
      $65,000 for the years ended December 31, 2006, 2005 and 2004,
      respectively.





48







**Notes
      to Consolidated Financial Statements**




*Directors
      Retirement Plan*


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





Effective
      December 27, 2006, for fees and compensation earned beginning January 1, 2007,
      the Bank is sponsoring 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, must be made prior to December
      31 st of the
      preceding year. Each year the form (cash or SARs) 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 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.





*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
      Directors Retirement Plan and the Healthcare Benefits plan as of December 31,
      2006 and 2005:


Directors
                Retirement Plan
            
            Healthcare
                Benefit Plan*(In
                thousands)*
            
            2006
            
            2005
            
            2006
            
            2005Measurement
                date
            
            12/31/2006
            
            12/31/2005
            
            12/31/2006
            
            12/31/2005Projected
                benefit obligation
            
            $
            (250
            )
            $
            (388
            )
            $
            (371
            )
            $
            (425
            )Fair
                value of plan assets
            
            
            -
            
            
            -
            
            
            -
            
            
            -Funded
                status
            
            $
            (250
            )
            $
            (388
            )
            $
            (371
            )
            $
            (425
            )Accrued
                benefit cost recognized in the statement of financial
                condition
            
            $
            (250
            )
            $
            (204
            )
            $
            (371
            )
            $
            (425
            )




49







**Notes
      to Consolidated Financial Statements**




**8.  
      Pension and Other Post-Retirement Benefits** ***-**
      (Continued)*




*Net
      Periodic Benefit Cost and Contributions*




The
      benefit costs and contributions the Directors Retirement Plan and the Healthcare
      Benefits plan for the years ended December 31, 2006 and 2005
      were:


Directors
                Retirement Plan
            
            Healthcare
                Benefit Plan*(In
                thousands)*
            
            2006
            
            2005
            
            2006
            
            2005Net
                periodic benefit cost
            
            $
            86
            
            $
            55
            
            $
            (54
            )
            $
            6Employer
                contributions
            
            
            -
            
            
            -
            
            
            -
            
            
            -Plan
                participants' contributions
            
            
            -
            
            
            -
            
            
            -
            
            
            -Benefits
                paid during the year
            
            
            39
            
            
            79
            
            
            19
            
            
            19





Due
      to
      the unfunded status of the plans, the Bank expects to contribute the amount
      of
      the estimated benefit payments for the next fiscal year, which is $19,765 for
      the Healthcare Benefits Plan. Because the Directors Retirement Plan terminated
      at December 31, 2006, the Bank expects to make no future contributions to that
      plan.





*Assumptions
      and Effects*




The
      actuarial assumptions used to determine the projected benefit obligations and
      net periodic benefit cost for the years ended December 31, 2006 and 2005 were
      as
      follows:


Directors
                Retirement Plan
            
            Healthcare
                Benefit Plan*Weighted-average
                assumptions:*
            
            2006
            
            2005
            
            2006
            
            2005Discount
                rate
            
            
            NA
            
            
            5.75
            %
            
            6.625
            %
            
            5.75
            %Rate
                of compensation increase
            
            
            NA
            
            
            2.00
            %
            
            -
            
            
            -Medical
                trend rate next year
            
            
            -
            
            
            -
            
            
            5.00
            %
            
            5.00
            %Ultimate
                medical trend rate
            
            
            -
            
            
            -
            
            
            5.00
            %
            
            5.00
            %Year
                ultimate trend rate is achieved
            
            
            -
            
            
            -
            
            
            2006
            
            
            2006





Assumed
      health care cost trend rates have a significant effect on the amounts reported
      for the Healthcare Benefits plan. At December 31, 2006, a one percentage-point
      increase in the assumed health care trend rates would increase the projected
      benefit obligation by $65,220 compared with a decrease of $53,265 if the assumed
      health care trend rate were to decrease by one percentage-point.




50







**Notes
      to Consolidated Financial Statements**




**9.  
      Employee Stock Ownership Plan**




On
      September 30, 2004, the date the reorganization was consummated, 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, 2006 and 2005 was $221,166 and $218,381 respectively.
      At December 31, 2006 and 2005, there were 19,889 and 19,889 unallocated ESOP
      shares and 253,402 and 273,291 unreleased ESOP shares respectively. At December
      31, 2006 the unreleased shares had an aggregate fair value of
      $3,117,000.





**10.  
      Equity Incentive Plan**




At
      the
      annual meeting of stockholders on May 5, 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.





On
      July
      26, 2005, the Company awarded 354,580 options to purchase the Company’s common
      stock and 139,712 shares of restricted stock. Stock option awards were granted
      with an exercise price equal to the market price of the Company’s stock at the
      date of grant ($11.10) with maximum term of ten years. On March 21, 2006, the
      Company awarded an additional 6,500 options to purchase the Company’s common
      stock and 1,500 shares of restricted stock. The additional stock awards were
      granted with an exercise price equal to those granted on July 26, 2005 ($11.10)
      with a maximum term of ten years. Both stock option and restricted stock awards
      vest at 20% per year beginning on the first anniversary of the date of
      grant.





51







**Notes
      to Consolidated Financial Statements**




**10.  
      Equity Incentive Plan** ***-**
      (Continued)*




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, 2006 and 2005 and
      changes during the year, is as follows:


2006
              
              2005Number
                of
                Shares
              
              Weighted
                Average
                Exercise
                Price
              
              Number
                of
                Shares
              
              Weighted
                Average
                Exercise
                PriceOptions
                  outstanding at beginning of year
              
              
              352,430
              
              $
              -
              
              
              -
              
              $
              -Granted
              
              
              6,500
              
              
              11.10
              
              
              354,580
              
              
              11.10Forfeited
              
              
              (5,100
              )
              
              11.10
              
              
              (2,150
              )
              
              11.10Exercised
              
              
              -
              
              
              -
              
              
              -
              
              
              -Expired
              
              
              (100
              )
              
              -
              
              
              -
              
              
              -Options
                  outstanding at end of year
              
              
              353,730
              
              
              11.10
              
              
              352,430
              
              
              11.10Options
                  exercisable at end of year
              
              
              69,526
              
              
              11.10
              
              
              -
              
              
              -Weighted-average
                  fair value of options granted during the year
              
              
              
              
              $
              2.25
              
              
              
              
              $
              2.47




The
      Company adopted Financial Accounting Standards Board’s SFAS No.123(R), “Share
      Based Payment”, during 2005, prior to the mandatory compliance date for the
      Company of January 1, 2006. 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.





52







**Notes
      to Consolidated Financial Statements**





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. 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:


**March
                21,**
            
            **July
                26,****Grant
                date**
            
            **2006**
            
            **2005**Dividend
                yield
            
            
            1.89
            %
            
            1.44
            %Expected
                volatility
            
            
            11.20
            %
            
            11.47
            %Risk-free
                rate
            
            
            4.61
            %
            
            4.18
            %Expected
                life in years
            
            
            6.5
            
            
            6.5Weighted
                average fair value of options at grant date
            
            $
            2.25
            
            $
            2.47




The
      Company recorded share-based compensation expense of $435,860 and $178,352
      for
      the year ended December 31, 2006 and 2005, respectively, in connection with
      the
      stock option and restricted stock awards. At December 31, 2006, the Company
      has
      approximately $685,000 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 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.





53







**Notes
      to Consolidated Financial Statements**




**11.  
      Income Taxes** ***-**
      (Continued)*




Income
      taxes receivable and payable included in the balance sheet at December 31,
      2006
      and 2005 were:


*(In
                thousands)*
            
            2006
            
            2005Current
                tax receivable
            
            $
            84
            
            $
            57Deferred
                tax receivableCharitable
                contributions carryforward
            
            $
            365
            
            $
            428Reserve
                for loan losses
            
            
            704
            
            
            552Post-retirement
                benefits
            
            
            212
            
            
            214Deferred
                income
            
            
            213
            
            
            138Available-for-sale
                securities
            
            
            168
            
            
            232Total
                deferred tax receivable
            
            
            1,662
            
            
            1,564Deferred
                tax payableDepreciation
            
            $
            (174
            )
            $
            (104
            )Other
                items
            
            
            (38
            )
            
            (21
            )Total
                deferred tax payable
            
            
            (212
            )
            
            (125
            )**Net
                deferred tax receivable**
            
            $
            1,450
            
            $
            1,439




The
      provision for income tax expense for the year ended December 31, 2006, 2005
      and
      2004 consisted of:


*(In
                thousands)*
            
            2006
            
            2005
            
            2004Current
                income tax expense
            
            $
            279
            
            $
            627
            
            $
            478Deferred
                income tax expense (benefit), due to:Charitable
                contributions
            
            
            63
            
            
            37
            
            
            (465
            )Reserve
                for loan losses
            
            
            (152
            )
            
            (170
            )
            
            (42
            )Deferred
                income
            
            
            (76
            )
            
            4
            
            
            (25
            )Post
                retirement benefits
            
            
            2
            
            
            6
            
            
            26Depreciation
            
            
            71
            
            
            (49
            )
            
            43Other
                items
            
            
            17
            
            
            (5
            )
            
            (1
            )Total
                deferred income tax expense (benefit)
            
            
            (75
            )
            
            (177
            )
            
            (464
            )**Provision
                for income taxes**
            
            $
            204
            
            $
            450
            
            $
            14




54







**Notes
      to Consolidated Financial Statements**




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)*
            
            2006
            
            2005
            
            2004Income
                tax expense at statutory rate of 34%
            
            $
            562
            
            $
            801
            
            $
            146Increase
                (decrease) in income tax expense resulting from:Nondeductible
                compensation expense
            
            
            104
            
            
            -
            
            
            -Income
                exempt from income tax
            
            
            (321
            )
            
            (193
            )
            
            (68
            )Changes
                in tax bad debt base year reserves
            
            
            (145
            )
            
            (160
            )
            
            (65
            )Other
                items, net
            
            
            4
            
            
            2
            
            
            1Provision
                for income taxes
            
            $
            204
            
            $
            450
            
            $
            14Effective
                rate of income tax expense
            
            
            12.3
            %
            
            19.1
            %
            
            3.3
            %





Retained
      earnings at December 31, 2006 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, 2006.




**12.  
      Consolidated Statement of Comprehensive Income**




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


For
                the Years Ended December 31,*(In
                thousands)*
            
            2006
            
            2005
            
            2004**Net
                income**
            
            $
            1,448
            
            $
            1,905
            
            $
            415**Other
                comprehensive loss:**Unrealized
                gain (loss) on securities available-for-sale
            
            
            195
            
            
            (600
            )
            
            (601
            )Reclassification
                adjustment for (gains) losses realized in net income
            
            
            (6
            )
            
            (47
            )
            
            156**Other
                comprehensive income (loss) before tax effect**
            
            
            189
            
            
            (647
            )
            
            (445
            )Income
                tax expense (benefit) related to items of other comprehensive income
                (loss)
            
            
            64
            
            
            (220
            )
            
            (151
            )Other
                comprehensive income (loss) net of tax effect
            
            
            125
            
            
            (427
            )
            
            (294
            )**Total
                comprehensive income**
            
            $
            1,573
            
            $
            1,478
            
            $
            121




55







**Notes
      to Consolidated Financial Statements**




**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, 2006, the Bank was required to maintain a minimum ratio of
      tangible capital to total adjusted 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,
      2005
      the Bank meets all capital requirements to which it is subject.





At
      December 31, 2006 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 2.00%;
      a
      minimum ratio of Tier 1 (core) capital to adjusted total assets of 5.00%; a
      minimum ratio of Tier I capital to risk-weighted assets of 6.00% and a minimum
      ratio of total (core and supplementary) capital to risk-weighted assets of
      10.00%. There have been no subsequent conditions or events which management
      believes have changed the Bank’s status.





The
      following is a summary of the Bank’s actual capital as computed under the
      standards established by the OTS at December 31, 2006 and 2005,
      respectively.


2006
            
            2005*(Dollars
                in thousands)*
            
            Amount
            
            Ratio
            
            Amount
            
            RatioTier
                I (Core) Capital (to Adjusted Total Assets)
            
            $
            38,904
            
            
            9.53
            %
            $
            39,885
            
            
            11.42
            %Tier
                I Risk-Based Capital (to Risk-Weighted Assets)
            
            
            38,904
            
            
            13.56
            %
            
            39,885
            
            
            17.07
            %Total
                Risk-Based Capital (to Risk-Weighted Assets)
            
            
            40,975
            
            
            14.29
            %
            
            41,763
            
            
            17.88
            %Tangible
                Equity Ratio (to Tangible Assets)
            
            
            38,904
            
            
            9.53
            %
            
            39,885
            
            
            11.42
            %





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. During 2006, the Bank received
      regulatory approval and paid a dividend of $2,500,000 to the
      Company.




56







**Notes
      to Consolidated Financial Statements**





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)*
            
            2006
            
            2005Total
                capital as calculated under generally accepted accounting principles
                (GAAP
                Capital)
            
            $
            38,850
            
            $
            39,795Adjustments
                to reconcile Total GAAP Capital to Regulatory Capital:Intangible
                assets
            
            
            (188
            )
            
            (222
            )Accumulated
                other comprehensive income from available-for-sale
                securities
            
            
            242
            
            
            312Tier
                I Risk-Based Capital
            
            
            38,904
            
            
            39,885Includible
                portion of allowance for loan losses
            
            
            2,071
            
            
            1,878**Total
                Risk-Based Capital**
            
            $
            40,975
            
            $
            41,763





**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. The Company had no
      anti-dilutive common shares outstanding for the year ended December 31, 2006.
      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 31,2006
            
            2005Net
                income and income available to common stockholders
            
            $
            1,448,000
            
            $
            1,905,000Weighted-average
                shares outstanding during the periodBasic
            
            
            7,275,718
            
            
            7,311,249Effect
                of dilutive stock options and restrictive stock awards
            
            
            5,864
            
            
            5,707Diluted
            
            
            7,281,582
            
            
            7,316,956Net
                income per common share:**Basic
                and Diluted Earnings per share**
            
            $
            0.20
            
            $
            0.26




57







**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, 2006 and 2005:


*(In
                thousands)*
            
            2006
            
            2005Commitments
                to extend credit:Loan
                commitments
            
            $
            9,933
            
            $
            7,578Unused
                lines of credit
            
            
            21,057
            
            
            18,363Amounts
                due mortgagors on construction loans
            
            
            21,713
            
            
            15,025Amounts
                due on commercial loans
            
            
            6,374
            
            
            3,434Commercial
                letters of credit
            
            
            6,758
            
            
            1,969




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.





The
      estimated fair value of the Company's financial instruments
      follows:


December
                31,2006
            
            2005*(In
                thousands)*
            
            Carrying
              Amount
            
            Estimated
              Fair
                Value
            
            Carrying
              Amount
            
            Estimated
              Fair
                ValueFinancial
                assetsCash
                and cash equivalents
            
            $
            7,942
            
            $
            7,942
            
            $
            8,951
            
            $
            8,951Investment
                securities
            
            
            70,267
            
            
            70,258
            
            
            63,049
            
            
            63,036Loans
                receivable, net
            
            
            308,376
            
            
            303,073
            
            
            259,427
            
            
            256,278Accrued
                income receivable
            
            
            1,904
            
            
            1,904
            
            
            1,525
            
            
            1,525Financial
                LiabilitiesDeposits
            
            $
            289,198
            
            $
            269,701
            
            $
            240,846
            
            $
            239,514Federal
                Home Loan Bank advances
            
            
            68,488
            
            
            67,847
            
            
            57,059
            
            
            56,449Mortgagors'
                escrow accounts
            
            
            3,495
            
            
            3,495
            
            
            3,202
            
            
            3,202




58







**Notes
      to Consolidated Financial Statements**




**16.  
      Selected Quarterly Consolidated Financial Information
      (unaudited)**




The
      following tables present quarterly consolidated information for the Company
      for
      2006, 2005 and 2004.





For
                the Year Ended December 31, 2006*(In
                thousands)*
            
            Fourth
              Quarter
            
            Third
              Quarter
            
            Second
              Quarter
            
            First
              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 after provision 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 for income tax (benefit)
            
            
            205
            
            
            360
            
            
            483
            
            
            604Provision
                for income tax (benefit)
            
            
            54
            
            
            (54
            )
            
            70
            
            
            134**Net
                income**
            
            $
            151
            
            $
            414
            
            $
            413
            
            $
            470






For
                the Year Ended December 31, 2005Fourth
            
            Third
            
            Second
            
            First*(In
                thousands)*
            
            Quarter
            
            Quarter
            
            Quarter
            
            QuarterInterest
                and dividend income
            
            $
            4,545
            
            $
            4,124
            
            $
            3,807
            
            $
            3,432Interest
                expense
            
            
            1,668
            
            
            1,367
            
            
            1,093
            
            
            813Net
                interest income
            
            
            2,877
            
            
            2,757
            
            
            2,714
            
            
            2,619Provision
                for loan losses
            
            
            -
            
            
            -
            
            
            17
            
            
            15Net
                interest income afterprovision
                for loan losses
            
            
            2,877
            
            
            2,757
            
            
            2,697
            
            
            2,604Noninterest
                income
            
            
            425
            
            
            372
            
            
            384
            
            
            336Noninterest
                expense
            
            
            2,604
            
            
            2,594
            
            
            2,523
            
            
            2,376Income
                before provision for income tax (benefit)
            
            
            698
            
            
            535
            
            
            558
            
            
            564Provision
                for income tax (benefit)
            
            
            151
            
            
            (2
            )
            
            140
            
            
            161**Net
                income**
            
            $
            547
            
            $
            537
            
            $
            418
            
            $
            403




59







**Notes
      to Consolidated Financial Statements**




**16.  
      Selected Quarterly Consolidated Financial Information
      (unaudited)** **-** *(Continued)*




For
                the Year Ended December 31, 2004Fourth
            
            Third
            
            Second
            
            First*(In
                thousands)*
            
            Quarter
            
            Quarter
            
            Quarter
            
            QuarterInterest
                and dividend income
            
            $
            3,365
            
            $
            3,265
            
            $
            3,057
            
            $
            3,026Interest
                expense
            
            
            765
            
            
            942
            
            
            916
            
            
            936Net
                interest income
            
            
            2,600
            
            
            2,323
            
            
            2,141
            
            
            2,090Provision
                for loan losses
            
            
            -
            
            
            -
            
            
            -
            
            
            -Net
                interest income after provision for loan losses
            
            
            2,600
            
            
            2,323
            
            
            2,141
            
            
            2,090Noninterest
                income
            
            
            290
            
            
            149
            
            
            306
            
            
            333Noninterest
                expense
            
            
            2,168
            
            
            3,891
            
            
            1,865
            
            
            1,879Income
                (loss) before provision (benefit) for income taxes
            
            
            722
            
            
            (1,419
            )
            
            582
            
            
            544Provision
                (benefit) for income taxes
            
            
            192
            
            
            (526
            )
            
            182
            
            
            166**Net
                income (loss)**
            
            $
            530
            
            $
            (893
            )
            $
            400
            
            $
            378




60







**Notes
      to Consolidated Financial Statements**




**17.  
      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)*
            
            2006
            
            2005**ASSETS**Cash
                on deposit with Naugatuck Valley Savings and Loan
            
            $
            3,124
            
            $
            1,581Investment
                in subsidiary, Naugatuck Valley Savings and Loan
            
            
            38,850
            
            
            39,794Investment
                securities
            
            
            5,416
            
            
            9,194Loan
                to ESOP
            
            
            2,655
            
            
            2,804Deferred
                income taxes
            
            
            408
            
            
            551Other
                assets
            
            
            642
            
            
            51**Total
                assets**
            
            $
            51,095
            
            $
            53,975**LIABILITIES
                AND STOCKHOLDERS' EQUITY**Liabilities
            
            $
            11
            
            $
            3,011Stockholders'
                equity
            
            
            51,084
            
            
            50,964**Total
                liabilities and stockholders' equity**
            
            $
            51,095
            
            $
            53,975




**Statements
      of Income**





For
      the
      Year Ended December 31, 2006 and 2005 and the Period From Inception (September
      30, 2004) through December 31, 2004


*(In
                thousands)*
            
            2006
            
            2005
            
            2004Interest
                income
            
            $
            442
            
            $
            506
            
            $
            90Other
                expenseCharitable
                contribution
            
            
            -
            
            
            -
            
            
            1,521Other
                expenses
            
            
            309
            
            
            444
            
            
            26Total
                other expense
            
            
            309
            
            
            444
            
            
            1,547Income
                (loss) before income tax (benefit) and equity in undistributed net
                income
                of subsidiary
            
            
            133
            
            
            62
            
            
            (1,457
            )Income
                tax (benefit)
            
            
            47
            
            
            21
            
            
            (495
            )Income
                (loss) before equity in undistributed net income of
                subsidiary
            
            
            86
            
            
            41
            
            
            (962
            )Equity
                in undistributed net income of subsidiary
            
            
            1,362
            
            
            1,864
            
            
            488**Net
                income (loss)**
            
            $
            1,448
            
            $
            1,905
            
            $
            (474
            )





61







**Notes
      to Consolidated Financial Statements**




**17.  
      Parent Company Only Financial Statements** ***-**
      (Continued)*




**Statements
      of Cash flows**





For
      the
      Year Ended December 31, 2006, 2005 and the Period From Inception (September
      30,
      2004) through December 31, 2004


For
                the Years Ended December 31,*(In
                thousands)*
            
            2006
            
            2005
            
            2004**Net
                cash provided (used) by operating activities**
            
            $
            278
            
            $
            243
            
            $
            (39
            )**Cash
                flows from investing activities**Purchase
                of available-for-sale securities
            
            
            -
            
            
            -
            
            
            (11,014
            )Paydowns
                and maturities of available-for-sale securities
            
            
            3,854
            
            
            1,591
            
            
            -Loan
                to ESOP
            
            
            -
            
            
            -
            
            
            (2,981
            )Principal
                payments received from ESOP
            
            
            -
            
            
            143
            
            
            -Investment
                in subsidiary, Naugatuck Valley Savings and Loan
            
            
            2,500
            
            
            -
            
            
            (15,870
            )**Net
                cash provided (used) by investing activities**
            
            
            6,354
            
            
            1,734
            
            
            (29,865
            )**Cash
                flows from financing activities**Payment
                of borrowings from subsidiary
            
            
            (2,981
            )
            
            -
            
            
            -Common
                stock repurchased
            
            
            (1,491
            )
            
            (1,851
            )
            
            -Cash
                dividends to common shareholders
            
            
            (617
            )
            
            (500
            )
            
            -Release
                of ESOP shares
            
            
            -
            
            
            217
            
            
            -Proceeds
                from issuance of common stock
            
            
            -
            
            
            -
            
            
            32,601Cost
                of issuance of common stock
            
            
            -
            
            
            -
            
            
            (959
            )**Net
                cash (used) provided by financing activities**
            
            
            (5,089
            )
            
            (2,134
            )
            
            31,642Increase
                (decrease) in cash and cash equivalents
            
            
            1,543
            
            
            (157
            )
            
            1,738Cash
                and cash equivalents at beginning of year
            
            
            1,581
            
            
            1,738
            
            
            -**Cash
                and cash equivalents at end of year**
            
            $
            3,124
            
            $
            1,581
            
            $
            1,738Supplemental
                Disclosures:Non-cash
                investing activities:Loan
                to acquire ESOP shares
            
            $
            -
            
            $
            -
            
            $
            2,981Capital
                contributed on acquisition of subsidiary
            
            
            -
            
            
            -
            
            
            22,010Cash
                paid during the year for:Interest
            
            $
            -
            
            $
            -
            
            $
            -Income
                taxes
            
            
            -
            
            
            -
            
            
            -






62




**Directors
        and Executive Officers**
  **Directors
        of Naugatuck Valley Financial Corporation,**
 **Naugatuck
        Valley Mutual Holding Company**
 **and
        Naugatuck Valley Savings and Loan**
 
 
 **Carlos
                  S. Batista**
                *Vice
                  President - Bristol, Inc. a division of Emerson Process Management*
              **Michael
                  S. Plude, CPA**
                *Managing
                  Partner - Kaskie, Plude & Pacowta, LLC***Richard
                  M. Famiglietti**
                *Owner
                  - CM Property Management*
                
                **Ronald
                  D. Lengyel**
                *Chairman
                  of the Board - Naugatuck Valley*
                *Financial
                  Corporation, Naugatuck Valley Mutual*
                *Holding
                  Company and Naugatuck Valley*
                *Savings
                  and Loan*
                
                *Director
                  - Connecticut Water Service, Inc.*
                
                **James
                  A. Mengacci**
                *Owner**-
                  James A. Mengacci Associates LLC*
              **John
                  C. Roman**
                *President
                  and Chief Executive Officer*-*Naugatuck
                  Valley Financial Corporation, Naugatuck Valley Mutual Holding Company
                  and
                  Naugatuck Valley Savings and Loan*
                
                **Camilo
                  P. Vieira**
                *Consultant*-*CM Property Management*
                
                **Jane
                  H. Walsh**
                *Senior
                  Vice President*-*Naugatuck
                  Valley*
                *Financial
                  Corporation, Naugatuck Valley Mutual*
                *Holding
                  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**
                *President
                  and Chief Executive Officer*
              **William
                  C. Nimons**
                *Senior
                  Vice President***Dominic
                  J. Alegi, Jr.**
                *Executive
                  Vice President*
              **Mark
                  S. Graveline**
                *Senior
                  Vice President***Jane
                  H. Walsh**
                *Senior
                  Vice President*
              **Lee
                  R. Schlesinger**
                *V**ice
                  President and Treasurer*
   63
 Investor
        and Corporate Information
 
 Annual
        Meeting


The
      annual meeting of stockholders will be held at 10:30 a.m., local time, on May
      3,
      2007 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 5, 2007, there were 842 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.
  **Dividends**
                    
                    **High**
                    
                    **Low**2005:First
                        Quarter
                    
                    $
                    0.04
                    
                    $
                    11.85
                    
                    $
                    10.32Second
                        Quarter
                    
                    
                    0.04
                    
                    
                    10.84
                    
                    
                    9.80Third
                        Quarter
                    
                    
                    0.04
                    
                    
                    13.09
                    
                    
                    10.45Fourth
                        Quarter
                    
                    $
                    0.04
                    
                    $
                    13.00
                    
                    $
                    10.202006:First
                        Quarter
                    
                    $
                    0.05
                    
                    $
                    10.95
                    
                    $
                    10.25Second
                        Quarter
                    
                    
                    0.05
                    
                    
                    11.80
                    
                    
                    10.17Third
                        Quarter
                    
                    
                    0.05
                    
                    
                    11.67
                    
                    
                    10.71Fourth
                        Quarter
                    
                    $
                    0.05
                    
                    $
                    12.65
                    
                    $
                    10.79
    64




**Stock
      Performance Graph**














***Period
                    Ending******Index***
                
                **10/01/04**
                **12/31/04**
                **06/30/05**
                **12/31/05**
                **06/30/06**
                **12/31/06**Naugatuck
                    Valley Financial
                100.00
                99.63
                99.36
                96.31
                104.30
                117.68NASDAQ
                    Composite
                100.00
                112.19
                106.44
                117.50
                116.23
                129.71SNL
                    MHC Thrift Index
                100.00
                107.69
                107.72
                110.64
                125.37
                151.52SNL
                    Thrift Index
                100.00
                106.57
                106.14
                110.33
                118.91
                128.61SNL
                    $250M-$500M Thrift Index
                100.00
                105.16
                94.62
                96.98
                103.07
                109.60




65





**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, 2006, 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
                  Agent**Whittlesey
                  & Hadley, P.C.
              Registrar
                  and Transfer Company147
                  Charter Oak Avenue
              10
                  Commerce DriveHartford,
                  Connecticut 06106
              Cranford,
                  New Jersey 07016





**Corporate
      Counsel**





Muldoon
      Murphy & Aguggia LLP


5101
      Wisconsin Avenue, NW


Washington,
      DC 20016








**Office
      Locations**


**Main
                Office**333
                Church Street
              Naugatuck,
                Connecticut 06770**Branch
                Offices**1009
                New Haven Road
              Naugatuck,
                Connecticut 06770
            249
                West Street
              Seymour,
                Connecticut 06483127
                South Main Street
              Beacon
                Falls, Connecticut 06403
            504
                Bridgeport Avenue
              Shelton,
                Connecticut 064841699
                Highland Avenue
              Cheshire,
                Connecticut 06410
            1570
                Southford Road
              Southbury,
                Connecticut 0648849
                Pershing Drive
              Derby,
                Connecticut 06418
            1030
                Hamilton Avenue
              Waterbury,
                Connecticut 06706


66