<PAGE>

                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS

     This document contains certain "forward-looking statements" which may be
identified by the use of words such as "believe," "expect," "anticipate,"
"should," "planned," "estimated" and "potential." Examples of forward-looking
statements include, but are not limited to, estimates with respect to our
financial condition, results of operations and business that are subject to
various factors which could cause actual results to differ materially from these
estimates and most other statements that are not historical in nature. These
factors include, but are not limited to, general and local economic conditions,
changes in interest rates, deposit flows, demand for mortgage and other loans,
real estate values, and competition; changes in accounting principles, policies,
or guidelines; changes in legislation or regulation; and other economic,
competitive, governmental, regulatory, and technological factors affecting our
operations, pricing products and services.

GENERAL

     First Federal Banc of the Southwest, Inc., a Delaware corporation, was
organized in 1998 for the purpose of becoming the savings and loan holding
company of First Federal Bank. First Federal Banc of the Southwest, Inc. is
referred to herein as First Federal. Originally chartered in 1920 as a mutual
savings association, First Federal Bank converted to the stock form of ownership
in 1979.

     First Federal Bank is headquartered in Roswell, New Mexico, and currently
serves the financial needs of communities in its trade area through its office
located at 300 N. Pennsylvania Ave., Roswell, New Mexico 88201, and 15 banking
offices located in Lincoln, Chaves, Eddy, McKinley, San Juan, Otero, Dona Ana
and Bernalillo Counties in New Mexico and El Paso County, Texas. First Federal's
business involves providing assistance in the management and coordination of the
financial resources of First Federal Bank and providing capital, business
development and long-range planning services to First Federal Bank.

     First Federal's revenues are derived principally from interest earned on
loans and, to a lesser extent, from interest earned on investments,
mortgage-backed and related securities. The operations of First Federal are
influenced significantly by general economic conditions and by policies of
financial institution regulatory agencies, including the Office of Thrift
Supervision, the Board of Governors of the Federal Reserve and the FDIC. First
Federal's cost of funds is influenced by interest rates on competing investments
and general market interest rates. Lending activities are affected by the demand
for financing of real estate and other types of loans, which in turn is affected
by the interest rates at which such financings may be offered.

     First Federal's net interest income is dependent primarily upon the
difference or spread between the average yield earned on loans receivable, net
and investments and the average rate paid on deposits and borrowings, as well as
the relative amounts of such assets and liabilities. First Federal is subject to
interest rate risk to the degree that its interest-bearing liabilities mature or
reprice at different times, or on a different basis, than its interest-earning
assets.

     Management's discussion and analysis of financial condition and results of
operations are intended to assist in understanding the financial condition and
results of operations of First Federal. The information contained in this
section should be read in conjunction with the financial statements and
accompanying notes contained elsewhere in this document.


                                        1

<PAGE>

MERGER AGREEMENT

     On October 10, 2006, First Federal and Washington Federal, Inc.
("Washington Federal"), the holding company for Washington Federal Savings and
Loan Association, entered into an Agreement and Plan of Reorganization (the
"Merger Agreement). Pursuant to the Merger Agreement, and subject to the terms
and conditions set forth therein, First Federal will merge with and into
Washington Federal, with Washington Federal being the surviving corporation of
such merger. Under the terms of the Merger Agreement, stockholders of First
Federal will receive $24.14 for each of their shares of First Federal common
stock. The transaction has a total indicated value of approximately $99 million.
Subject to regulatory and stockholder approvals, the transaction is expected to
close in the first quarter of 2007.

FINANCIAL CONDITION

SEPTEMBER 30, 2006 COMPARED TO SEPTEMBER 30, 2005.

     Total assets decreased approximately $2.5 million, or 0.5% from $549.9
million as of September 30, 2005 to $547.4 million as of September 30, 2005. The
overall decrease in total assets is insignificant. The most material change in
the total assets occurred as the investment portfolio was allowed to continue to
decline. The total investment portfolio declined nearly $20 million as of
September 30, 2006 as compared to September 30, 2005. The decrease in assets was
primarily re-allocated to the overnight deposit account maintained at the
Federal Home Loan Bank of Dallas and to a much lesser extent a small increase in
loans.

     Total gross loans increased $2.7 million, or 0.6% from $417.0 million as of
September 30, 2005 to $419.6 million as of September 30, 2006. The increase in
loans was primarily in commercial real estate loans and construction loans.
Commercial loans grew $16.2 million, or 12.5% from $129.1 million at September
30, 2005 to $145.3 million at September 30, 2006. Likewise, construction loans
grew $9.7 million from $30.8 million at September 30, 2005 to $40.5 million at
September 30, 2006. Most of the growth in these loan areas occurred in the
Albuquerque and Las Cruces markets. It primarily relates to residential housing
market in both the construction of new homes and the development of new
subdivisions. Most of this growth was funded by the decline in the residential
mortgage portfolio. The mortgage portfolio declined nearly $19.0 million between
fiscal year-end 2005 and 2006. First Federal Bank does not hold 30 year
mortgages because of the inherent interest rate risk. Due to the flat yield
curve, adjustable rate mortgage rates are nearly the same as 30 year mortgage
rates. Consequently, the demand for adjustable mortgages and other short-term
mortgages is very limited. Non-real estate related commercial loans also
declined $3.2 million or 9.0% between September 30, 2005 and 2006. Likewise
consumer loans decline slightly less than $1 million during the same period.

     Investment securities decreased $19.5 million, or 29.1%, from $67.0 million
as of September 30, 2005 to $47.5 million as of September 2006. The change was
across all types of investment categories as First Federal Bank did not make any
purchases of investment securities during the current fiscal year. This decision
was based upon the flattening of the yield curve which ultimately inverted in
the final months of the fiscal year. With overnight rates higher than long-term
bond rates, placing funds into investments with five-year terms was not deemed
prudent. Additionally, the Company was negotiating its sale and believed it was
advisable to keep the investment portfolio in short-term assets while rates were
declining. In addition to the normal repayments of principal and maturity of
securities, the bank sold two investments. These were the Capital Access
Strategies Fund ($600,000 book value) which was continuing to decline in value
and the common stock the Federal Home Loan Mortgage Corporation ("Freddie Mac")
($1.0 million book value). The Capital Access Strategies Fund was sold for a
small loss and the Freddie Mac was sold for a small gain. The funds generated by
the repayments and maturities of


                                        2

<PAGE>

investment securities were generally collected in the overnight funds account or
were used to fund new loans. The overnight funds account increased $12.7 million
or 48.6% to $38.9 million at September 30, 2006.

     Total deposits declined $300,000, or slightly less than 0.1% from $377.7
million as of September 30, 2005 to $377.4 million as of September 30, 2006.
While total deposits changed an immaterial amount the composition of deposits
did change significantly. Non-interest bearing accounts increased $2.7 million
from $62.1 million at September 30, 2005 to $64.8 million at September 30, 2006.
This change was the result of the commercial lending staff placing more emphasis
on obtaining deposit relationships with our commercial loan customers. The
balance of changes in deposits between fiscal year 2005 and 2006 were declines
in interest bearing checking from $62.8 million to $60.1 million, a decrease of
$2.7 million, savings deposits declined from $84.1 million to $61.7 million or
26.6%, certificates of deposit decreased from $144.9 million to $127.8 million,
or 11.8%. All of the declines in these interest bearing categories of deposits
were primarily offset by an increase in money market accounts from $23.7 million
to $62.9 million, or 165.4%. The decline in certificates of deposit was expected
as many of the time deposits owned by governmental entities acquired through the
Gallup Federal Savings acquisition in 2005 were allowed to mature without
matching the requested rates to maintain the deposits. As has been previously
discussed, the Company wishes to develop relationships with the customers, and
not just merely pay the highest rate to obtain the time deposit. While the
offering rates must remain competitive to attract and retain customers, the
Company has not aggressively gathered deposits. As the Federal Reserve Board has
continued raising short-term interest rates, depositors with funds in savings
accounts have begun to seek alternate investments. These changes in market
competition were best managed by offering a competitive money market product
that could attract and retain customer deposits while customers ponder the
long-term direction of interest rates. We believe this was an effective strategy
that minimized the interest rate risk to the Company and provided the best
platform to mange future changes in interest rates associated with our funding
sources. Our other significant source of funding is Federal Home Loan Bank
("FHLB") borrowings which decreased $6.9 million from $108.0 million as of
September 30, 2005 to $101.1 million as of September 30, 2006. First Federal
generally borrows through the FHLB only to fund certain long-term loans or will
use the borrowings when they are at a lower cost then deposits that can be
gathered.

     The allowance for loan losses decreased approximately $42,000. The decline
was the result of a $52,000 provision which was offset by net charge-offs of
$94,000 for the fiscal year ending September 30, 2006. As of September 30, 2006,
management deemed the allowance adequate to cover probable losses in the
portfolio.

     Stockholders' equity increased $4.6 million, or 9.3%, to approximately
$53.8 million as of September 30, 2006 compared to $49.2 million as of September
30, 2005. This net increase is primarily attributable to net income for the
fiscal year of approximately $5.4 million, and $243,000 in proceeds from the
exercise of stock-options. Those increases in equity were offset by cash
dividends declared and paid of approximately $1.1 million.


                                        3

<PAGE>

RESULT OF OPERATIONS

     First Federal's results of operations depend primarily upon the level of
net interest income, which is the difference between the interest income earned
on its interest-earning assets such as loans and investments, and the costs of
First Federal's interest-bearing liabilities, primarily deposits and borrowings.
Results of operations are also dependent upon the level of First Federal's
non-interest income including fee income and service charges, and affected by
the level of its non-interest expense, including its general and administrative
expenses. Net interest income depends upon the volume of interest-earning assets
and interest-bearing liabilities and the interest rate earned or paid on them,
respectively.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 2006 AND
SEPTEMBER 30, 2005

     NET INCOME. Net income increased by approximately $1.7 million, or 46.4%
from $3.7 million for the fiscal year ending September 30, 2005 to $5.4 million
for the fiscal year ending September 30, 2006. The increase was primarily due to
increases in net interest income of $7.1 million and non-interest income of
approximately $454,000. The increase in income was offset by an increase in
non-interest expenses of $4.6 million. Income tax expense increased $1.2 million
as a result of the higher pre-tax income which increased $2.9 million or 46.5%.

     NET INTEREST INCOME. Net interest income before loan loss provision
increased $7.1 million from $16.7 million for the fiscal year ending September
30, 2005 to $23.8 million for the fiscal year ending September 30, 2006, due to
a $12.4 million increase in interest income offset by an increase of $5.3
million in interest expense. The increase in interest income was primarily due
to the GFSB acquisition which took place on June 1, 2005. First Federal operated
as a combined entity for all of fiscal 2006, compared to four months of fiscal
2005. In addition to an increase in average earning assets of $121.6 million
between the two periods, the yield on average earning assets also increased
approximately 1.0%. Specific details regarding these increases are noted in the
"Yield and Cost Data" section that follows below. The increase in the rate
component is attributable to the actions of the Federal Reserve Bank as it
continued to increase short-term interest rates. Those increases directly impact
the yields on our overnight funds and the yields on floating rate loans that are
tied to indices such as "Wall Street Journal Prime". Another component of total
loan interest income is loan fees, which are either earned or accreted into
interest income. Loan fees for the fiscal year ending September 30, 2006
increased approximately $400,000, or approximately 23.5%, from the prior fiscal
year. This increase in loan fees is primarily related to fees on new loan
production related to the residential housing market. This segment of the market
generates fees from both the residential home construction loans and the
commercial real-estate loans that are used for the acquisition and development
of residential subdivisions. Generally, the residential home construction loans
are for a term of six to nine months and the loan fees are recognized during the
current year.

     Interest expense increased approximately $5.3 million from $7.2 million for
fiscal year 2005 to $12.5 million in fiscal year 2006. Much the same as interest
income, interest expense increased because of the larger average balance of
interest bearing liabilities associated with GFSB acquisition in 2005 and the
increase in higher average rates paid on interest-bearing liabilities. The
average rate paid on interest-bearing deposits increased from 1.5% for the
fiscal year ending September 30, 2005 to 2.4% for the fiscal year ending
September 30, 2006. Average deposits increased from $253.7 million to $316.7
million, or 24.8%. The average balance of borrowings increased $32.6 million, or
39.6% in fiscal year 2006 compared to fiscal 2005. However, due to the fixed
rate nature of these borrowings, the average interest rate paid remained
unchanged at 4.3%.


                                        4

<PAGE>

     PROVISION FOR LOAN LOSSES. Based on management's overall assessment of the
adequacy of the allowance for loan losses, the provision for loan loss increased
by $46,000 from a provision of $6,000 for fiscal 2005 to a $52,000 provision
expense for fiscal 2006. In determining the provision, management makes an
analysis of various factors, including the market value of the underlying
collateral, changes in the loan portfolio, the relationship of the allowance for
loan losses to outstanding loans, historical loss experience, delinquency trends
and prevailing and projected economic conditions. Although First Federal
maintains its allowance for loan losses at a level it considers adequate to
provide for future losses, there can be no assurance that such losses will not
exceed the estimated amounts or that additional substantial provisions for loan
losses will not be required in future periods. At September 30, 2006, the
allowance for loan losses totaled $3.8 million, representing 0.9% of net loans
and 407.6% of non-performing loans. Non-performing loans decreased approximately
$400,000 from $1.6 million as of September 30, 2005 to $1.2 million as of
September 30, 2006.

     OTHER INCOME. Other income increased approximately $0.5 million from $2.1
million in fiscal year 2005 to $2.6 million in fiscal year 2006, primarily due
to an increase in customer service fees of approximately $328,000 and increases
in ATM fees of approximately $133,000. The increase in revenue was partially
offset by a $57,000 decrease in gain on sale of residential mortgage loans. The
improvement in service charges and other fees was a result of fiscal year 2006
containing results of the combined entity for all twelve months as compared to
four months in fiscal year 2005 and continual adherence to charging and
collecting fees in accordance with established fee schedules.

     NON-INTEREST EXPENSE. Non interest expense increased $4.7 million from
approximately $12.6 million in fiscal year 2005 to approximately $17.3 million
in fiscal year 2006. The increase in non-interest expense was due to increases
in compensation and benefits of $2.9 million, data processing of $387,000,
depreciation and amortization of $489,000, occupancy expense of $217,000 and
other expenses of $276,000, which includes increases in legal expenses of
$111,000 and public company related expenses of approximately $50,000.

     Most of the specific referenced increases above relate to the impact of
twelve months of activities associated with the Gallup acquisition versus the
four months in fiscal year 2005. Most of the increases associated with the
public company related expenses were fees paid to the independent accounting
firm for review of public filings, and stock transfer fees. A majority of the
increase in legal fees relates to the activities associated with the sale of the
Company.

     INCOME TAX EXPENSE. Income tax expense increased $1.2 million as a result
of higher pre-tax income being $2.9 million larger for the fiscal year ended
September 30, 2006 as compared to September 30, 2005.


                                        5

<PAGE>

     YIELD AND COST DATA. The following table presents for the years indicated
the total dollar amount of interest income from average interest-earning assets
and the resultant yields, as well as the interest expense on average interest
bearing liabilities, expressed both in dollars and rates. All average balances
are daily average balances. Yields are reported on a tax equivalent basis.
Non-accruing loans have been included in the table as loans carrying a zero
yield. Also not included in interest income on loans are loan fees and other
charges on loans totaling $2.1 million, $1.7 million and $1.3 million for the
years ended September 30, 2006, 2005 and 2004, respectively.

<TABLE>
<CAPTION>
                                                                        YEARS ENDED SEPTEMBER 30,
                                     -------------------------------------------------------------------------------------------
                                                  2006                            2005                          2004
                                     -----------------------------  -----------------------------  -----------------------------
                                       AVERAGE                        AVERAGE                        AVERAGE
                                     OUTSTANDING            YIELD/  OUTSTANDING            YIELD/  OUTSTANDING            YIELD/
                                       BALANCE    INTEREST   RATE     BALANCE    INTEREST   RATE     BALANCE    INTEREST   RATE
                                     -----------  --------  ------  -----------  --------  ------  -----------  --------  ------
                                                                        (DOLLARS IN THOUSANDS)
<S>                                    <C>        <C>       <C>       <C>         <C>      <C>       <C>         <C>      <C>
INTEREST-EARNING ASSETS:
Loans................................  $417,280    $29,935    7.2%    $312,566    $19,822    6.3%    $254,508    $16,009    6.3%
Investment securities................    64,968      2,640    4.1%      56,323      1,690    3.0%      54,619      1,187    2.2%
Interest-earning deposits............    32,340      1,514    4.7%      24,078        614    2.6%      27,151        302    1.1%
                                       --------    -------  -----     --------    -------  -----     --------    -------  -----
   Total interest-earning assets.....   514,588     34,089    6.6%     392,957     22,126    5.6%     336,278     17,498    5.2%
Non-interest-earning assets..........    37,736                         61,981                         19,502
                                       --------                       --------                       --------
   Total assets......................  $552,324                       $454,948                       $355,780
                                       ========                       ========                       ========
INTEREST-BEARING LIABILITIES:
Passbook savings.....................  $ 69,336    $ 1,164    1.7%    $ 85,284    $   704    0.8%    $ 95,889    $   715    0.7%
NOW/Interest bearing checking........    63,873         96    0.2%      53,144         67    0.1%      45,787         65    0.1%
Money market.........................    47,361      1,462    3.1%      12,936         94    0.7%       8,166         28    0.3%
Certificates of deposit..............   136,126      4,891    3.6%     102,286      2,846    2.8%      81,522      2,166    2.7%
                                       --------    -------  -----     --------    -------  -----     --------    -------  -----
   Total deposits....................   316,696      7,613    2.4%     253,650      3,711    1.5%     231,364      2,974    1.3%
FHLB advances........................   104,570      4,306    4.1%      76,121      3,145    4.1%      59,757      2,707    4.5%
Long-term subordinated debt..........    10,310        601    5.8%       6,144        356    5.8%          --         --    0.0%
                                       --------    -------  -----     --------    -------  -----     --------    -------  -----
   Total borrowings..................   114,880      4,907    4.3%      82,265      3,501    4.3%      59,757      2,707    4.5%
Total interest-bearing liabilities...   431,576     12,520    2.9%     335,915      7,212    2.1%     291,121      5,681    2.0%
Non-interest-bearing liabilities.....    69,238                         77,205                         36,101
                                       --------                       --------                       --------
   Total liabilities.................   500,814                        413,120                        327,222
Stockholders' equity.................    51,510                         41,828                         28,558
                                       --------                       --------                       --------
   Total liabilities and
      stockholders' equity...........  $552,324                       $454,948                       $355,780
                                       ========                       ========                       ========
Net interest income..................              $21,569                        $14,914                        $11,817
                                                   =======                        =======                        =======
Net interest rate spread.............                         3.7%                           3.5%                           3.3%
Net interest-earning assets..........  $ 83,012                       $ 57,052                       $ 45,157
                                       ========                       ========                       ========
Net interest margin..................                         4.2%                           3.8%                           3.5%
Average interest-earning assets to
   interest-bearing liabilities......                       119.2%                         117.0%                         115.5%
</TABLE>


                                        6

<PAGE>

     The following table presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. It distinguishes between the changes related to
outstanding balances and those due to the changes in interest rates. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (i.e.,
changes in volume multiplied by old rate) and (ii) changes in rate (i.e.,
changes in rate multiplied by old volume). For purposes of this table, changes
attributable to both rate and volume, which cannot be segregated, have been
allocated proportionately to the change due to volume and the change due to
rate.

<TABLE>
<CAPTION>
                                                   YEARS ENDED SEPTEMBER 30,          YEARS ENDED SEPTEMBER 30,
                                                         2006 VS. 2005                      2005 VS. 2004
                                               --------------------------------   --------------------------------
                                               INCREASE (DECREASE)                INCREASE (DECREASE)
                                                      DUE TO                             DUE TO
                                               -------------------     TOTAL      -------------------      TOTAL
                                                                      INCREASE                           INCREASE
                                                VOLUME      RATE     (DECREASE)     VOLUME    RATE      (DECREASE)
                                               --------   --------   ----------   -------    --------   ----------
                                                                          (IN THOUSANDS)
<S>                                             <C>       <C>         <C>          <C>        <C>        <C>
INTEREST-EARNING ASSETS:
   Loans ...................................    $ 6,641   $ 3,472     $10,113      $ 3,652    $  161     $ 3,813
   Investment securities ...................        259       691         950           37       466         503
   Interest-earning deposits ...............        211       689         900          (34)      346         312
                                                -------   -------     -------      -------    ------     -------
      Total interest-earning assets ........      7,111     4,852      11,963        3,655       973       4,628
                                                -------   -------     -------      -------    ------     -------

INTEREST-BEARING LIABILITIES:
   Passbook savings ........................        132      (592)       (460)          79       (68)         11
   NOW/Interest bearing accounts ...........        (14)      (15)        (29)         (10)        8          (2)
   Money Market Accounts ...................       (250)   (1,118)     (1,368)         (17)      (49)        (66)
   Certificates of deposit .................       (942)   (1,103)     (2,045)        (552)     (128)       (680)
                                                -------   -------     -------      -------    ------     -------
      Total deposits .......................     (1,074)   (2,828)     (3,902)        (500)     (237)       (737)
   FHLB Advances ...........................     (1,175)       14      (1,161)        (741)      303        (438)
   Long-term subordinated debt .............       (241)       (4)       (245)        (356)       --        (356)
                                                -------   -------     -------      -------    ------     -------
      Total borrowings .....................     (1,416)       10      (1,406)      (1,097)      303        (794)
      Total interest-bearing liabilities ...     (2,490)   (2,818)     (5,308)      (1,597)       66      (1,531)
                                                -------   -------     -------      -------    ------     -------
Change in net interest income ..............    $ 4,621   $ 2,034     $ 6,655      $ 2,058    $1,039     $ 3,097
                                                =======   =======     =======      =======    ======     =======
</TABLE>

ASSET/LIABILITY MANAGEMENT AND MARKET RISK

     First Federal's profitability, like that of many financial institutions, is
dependent to a large extent upon its net interest income. When interest-bearing
liabilities mature or reprice more quickly (liability sensitive) than
interest-earning assets in a given period, a significant increase in market
rates of interest could adversely affect net interest income. Similarly, when
interest-earning assets mature or reprice more quickly (asset sensitive) than
interest-bearing liabilities, falling interest rates could result in a decrease
in net interest income. Finally, a flattening of the "yield curve" (i.e., a
decline in the difference between long- and short-term interest rates) could


                                       7

<PAGE>

adversely impact net interest income to the extent that First Federal's assets
have a longer average term than its liabilities.

     First Federal is also subject to interest rate risk to the extent that the
value of its net assets fluctuates with interest rates. In general, the value of
a portion of First Federal's assets will decline in the event of an increase in
interest rates. Historically, First Federal's lending activity consisted
primarily of one- to four-family mortgages with long terms and fixed rates.
These assets are interest rate sensitive and therefore decline in value during a
period of rising interest rates. Conversely, these assets can increase in value
during a period of decreasing interest rates to the extent they do not prepay.
As part of First Federal's business strategy and asset/liability management
policy, a primary focus of lending activity is the acquisition of variable rate
and/or shorter term loans thereby decreasing interest rate risk and fluctuations
in the value of First Federal's assets. At September 30, 2006, First Federal had
approximately $175.9 million in variable rate loans and $161.3 million at
September 30, 2005.

     First Federal has an asset/liability management policy. The principal goals
of this policy are to manage First Federal's net interest margin and interest
rate position. Nonetheless, First Federal's results of operations and the
economic value of its equity remain vulnerable to increases in interest rates
and declines in the difference between long- and short-term interest rates.

     Asset/liability management is monitored at the bank level by a committee
that is comprised of First Federal's president & chief executive officer, chief
financial officer, chief credit officer, senior vice presidents and the
controller of First Federal Bank. The committee meets periodically to review
First Federal's interest rate risk position and product mix and to make
recommendations for adjustments to First Federal's Board of Directors.
Management also monitors First Federal's interest rate risk position on a
monthly basis, reviews First Federal's portfolio, earnings, liquidity, asset
quality, formulates investment strategies and oversees the timing and
implementation of transactions to assure attainment of the Board's objectives in
a most effective manner.

     The principal elements of First Federal's asset/liability management policy
are as follows. First, First Federal requires that one-to-four family ARM loans
be indexed to changes in rates paid on U.S. Treasury securities or LIBOR and all
other adjustable rate loans be indexed to the Prime rate as published in the
Wall Street Journal. Management believes that U.S. Treasury securities, LIBOR
and the Prime rate are significantly more interest rate sensitive than other
indices and provides a better opportunity to manage interest rate risk in a
changing rate environment. Second, management intends to maintain significant
non-residential mortgage portfolios such as First Federal's commercial business,
consumer and commercial real estate loans, subject to market conditions. In
general, such loans carry shorter terms to maturity and/or repricing, and are
more interest rate sensitive than most of First Federal's other assets. Third,
management has used marketing and other initiatives to maintain First Federal's
transaction and other deposit accounts and believes that such accounts generally
carry lower interest costs and are less sensitive to interest rate shifts than
the certificates of deposit. First Federal also utilizes FHLB borrowings in
funding assets when the cost of these borrowings is more attractive than the
cost of deposits. There can be no assurance as to whether or when any or all of
the elements of the asset/liability management program will prove to be
successful over future periods of time.

     Economic Value of Equity ("EVE") analysis provides a quantitative measure
of interest rate risk. In essence, this approach calculates the difference
between the market value of assets and liabilities under different interest rate
environments. The degree of change between interest rate shock levels is a
measure of the volatility of value risk. The following table sets forth, as of


                                       8

<PAGE>

September 30, 2006, the estimated changes in First Federal Bank's EVE in the
event of the specified instantaneous changes in interest rates.

ECONOMIC VALUE OF EQUITY

                  Change in
                   Interest
                 Rates (Basis   Estimated   Amount of   Percent
                    Points)        EVE        Change     Change
                 ------------   ---------   ---------   -------
                            (Dollars in Thousands)
                     +300        $78,811     $(3,112)     -4%
                     +200         80,500      (1,423)     -2%
                     +100         81,562        (361)     --
                        0         81,923           0      --
                     -100         82,604         681       1%
                     -200         81,856         (67)     --

     Certain assumptions were employed in preparing the previous table. These
assumptions relate to interest rates, loan prepayment rates varied by categories
and rate environment, deposit decay rates varied by categories and rate
environment and the market values of certain assets under the various interest
rate scenarios. In addition, an intangible asset is created that approximates
the value of the deposits at $24.8 million as of September 30, 2006. It was also
assumed that delinquency rates will not change as a result of changes in
interest rates although there can be no assurance that this will be the case. In
the event that interest rates do change in the designated amounts, there can be
no assurance that First Federal's assets and liabilities would perform as set
forth above. In addition, a change in Treasury rates in the designated amounts
accompanied by a change in the shape of the Treasury yield curve would cause
significantly different changes to the EVE than indicated above.

LIQUIDITY AND CAPITAL RESOURCES

     First Federal's principal sources of funds are deposits and borrowings,
scheduled payments and prepayment of loan principal and mortgage-backed
securities, scheduled payments and maturities of investment securities and
operations. While scheduled loan repayments and maturing investments are
relatively predictable, deposit flows and early loan repayments are more
influenced by general interest rates, floors and caps on loan rates, general
economic conditions and competition. First Federal generally manages the pricing
of its deposits to be competitive and to increase core deposit relationships,
but has from time to time decided not to pay deposit rates that are as high as
those of its competitors and, when necessary, to supplement deposits with less
expensive alternative sources of funds, such as FHLB borrowings.

     The primary investing activities of First Federal are originating loans
and, to a much lesser extent, purchasing mortgage-backed and investment
securities. During the fiscal years ended September 30, 2006, 2005 and 2004,
First Federal had loan originations net of principal repayments of $2.8 million,
$25.1 million and $2.3 million, respectively. These amounts exclude the loans
acquired in conjunction with the GFSB acquisition on June 1, 2005. A substantial
portion of loan originations were funded by proceeds of loan repayments, the
maturity or sale of securities, deposits and FHLB advances.


                                       9

<PAGE>

     The primary financing activities of First Federal are deposits and
borrowings. For the fiscal years ended September 30, 2006, 2005 and 2004, First
Federal experienced a net change in deposits of ($400,000), ($6.1) million, and
($9.0) million, excluding the deposits acquired from GFSB at June 1, 2005.
Certificates of deposits as of September 30, 2006 and 2005 maturing within one
year totaled $71.3 million and $94.0 million, respectively. Management expects
most of these deposits to remain with the Bank. During the fiscal years ended
September 30, 2006, 2005 and 2004, First Federal's net financing activity
(proceeds less repayments) with the FHLB totaled ($6.5 million), $2.0 million,
and ($4.2) million, respectively, excluding the FHLB advances acquired with the
GFSB acquisition on June 1, 2005.

     First Federal's most liquid assets are cash and cash equivalents, which
consist of short-term highly liquid investments with original maturities of less
than one year that are readily convertible to known amounts of cash and include
interest-bearing deposits. The level of these assets is dependent on First
Federal's operating, financing and investing activities during any given period.
At September 30, 2006, cash and cash equivalents totaled $15.8 million and $11.8
million at September 30, 2005.

     Liquidity management is both a daily and long-term responsibility of
management. First Federal adjusts its investments in liquid assets based upon
management's assessment of (i) expected loan demand, (ii) expected deposit
flows, (iii) yields available on interest-earning deposits and investment
securities, and (iv) the objectives of its asset/liability management program.
Excess liquidity is invested generally in interest-earning overnight deposits
and short- and intermediate-term U.S. Government and agency obligations and
mortgage-backed securities of short duration. If First Federal requires funds
beyond its ability to generate them internally, the Bank has additional
borrowing capacity with the FHLB of Dallas which is, in the opinion of
management, adequate to provide any funds needed.

     First Federal anticipates that it will have sufficient funds available to
meet current loan commitments. At September 30, 2006, First Federal had unfunded
outstanding loan commitments totaling $70.5 million and $52.0 million at
September 30, 2005.

     First Federal Bank is required to maintain minimum levels of regulatory
capital. At September 30, 2006, First Federal Bank exceeded all of its capital
requirements.

OFF-BALANCE SHEET ARRANGEMENTS

     In the ordinary course of business, the Company has entered into
commitments to extend credit, including commitments under credit care
arrangements, commercial letters of credit, and standby letters of credit. Such
financial instruments are recorded when they are funded.

IMPACT OF NEW ACCOUNTING STANDARDS

     See Note 1 of the Notes to the Consolidated Financial Statements included
in this annual report for information regarding the effect of implementing new
accounting standards.

CRITICAL ACCOUNTING POLICIES

     The Management's Discussion and Analysis of Financial Condition and Results
of Operations, and disclosures included within this annual report, are based on
the First Federal's audited consolidated financial statements. These statements
have been prepared in accordance with the standards of the Public Company
Accounting Oversight Board (United States). The


                                       10

<PAGE>

financial information contained in these statements is, for the most part, based
on approximate measures of the financial effects of transactions and events that
have already occurred. However, the preparation of these statements requires
management to make certain estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses.

     First Federal's significant accounting policies are described in the Notes
to Consolidated Financial Statements. Based on its consideration of accounting
policies that involve the most complex and subjective estimates and judgments,
management has identified its most critical accounting policy to be that related
to the allowance for loan losses.

     The allowance for loan losses is established through a provision for loan
losses charged to expense. Loans are charged against the allowance for loan
losses when management believes that collectibility of the principal is
unlikely. First Federal has policies and procedures for evaluating the overall
credit quality of its loan portfolio including timely identification of
potential problem credits. On a quarterly basis, management reviews the
appropriate level for the allowance for loan losses incorporating a variety of
risk considerations, both quantitative and qualitative. Quantitative factors
include First Federal's historical loss experience, delinquency and charge-off
trends, collateral values, known information about individual loans and other
factors. Qualitative factors include the general economic environment in First
Federal's market areas and the expected trend of those economic conditions. To
the extent actual results differ from forecasts and management's judgment, the
allowance for loan losses may be greater or less than future charge-offs.

IMPACT OF INFLATION AND CHANGING PRICES

     First Federal's Consolidated Financial Statements and Notes have been
prepared in accordance with accounting principles generally accepted in the
United States of America, which require the measurement of financial position
and operating results in terms of historical dollars without consideration for
changes in the relative purchasing power of money over time due to inflation.
The impact of inflation can be found in the increased cost of First Federal's
operations. Nearly all the assets and liabilities of First Federal are
financial, unlike most industrial companies. As a result, First Federal's
performance is directly impacted by changes in interest rates, which are
indirectly influenced by inflationary expectations. Changes in interest rates do
not necessarily move to the same extent as changes in the price of goods and
services.

MARKET FOR COMMON STOCK

     Our common stock is traded on the Nasdaq Capital Market under the symbol
"FFSW." The approximate number of holders of record of First Federal's common
stock as of December 15, 2006 was 366. Certain shares of First Federal are held
in "nominee" or "street" name and accordingly, the number of beneficial owners
of such shares is not known or included in the foregoing number. The following
table presents quarterly market information for First Federal's common stock for
the fiscal year ended September 30, 2006. First Federal began trading on the
Nasdaq Capital Market on June 3, 2005. Accordingly, no information prior to this
date is available. The following information was provided by the Nasdaq Stock
Market.


                                       11

<PAGE>

                                                      HIGH      LOW    DIVIDENDS
                                                     ------   ------   ---------
Quarter ended June 30, 2005                          $20.00   $14.00   $0.00 (1)
Quarter ended September 30, 2005                      16.71    14.30    0.12 (1)
Quarter ended December 31, 2005                       15.51    15.01    0.07
Quarter ended March 31, 2006                          16.75    14.83    0.07
Quarter ended June 30, 2006                           16.00    14.95    0.07
Quarter ended September 30, 2006                      16.00    15.09    0.07

----------
(1)  First Federal, as a new public company, declared a cash dividend on July 1,
     2005, in the amount of $0.05 per share that represented earnings associated
     with the quarter ended June 30, 2005. On September 28, 2005, First Federal
     declared a $0.07 per share cash dividend that was associated with the
     earnings for the quarter ended September 30, 2005.

     Dividend payments by First Federal are dependent primarily on dividends it
receives from First Federal Bank, because First Federal has no source of income
other than dividends from First Federal Bank and earnings from the investment of
proceeds from the sale of shares of common stock retained by First Federal.

     Under the rules of the Office of Thrift Supervision, First Federal Bank is
not permitted to pay dividends on its capital stock to First Federal, its sole
stockholder, if First Federal Bank's stockholder's equity would be reduced below
the amount of the liquidation account established in connection with the
conversion. In addition, First Federal Bank is not permitted to make a capital
distribution if, after making such distribution, it would be undercapitalized.

     In addition to the foregoing, earnings of First Federal Bank appropriated
to bad debt reserves and deducted for federal income tax purposes are not
available for payment of cash dividends or other distributions to stockholders
without payment of taxes at the then-current tax rate by First Federal Bank on
the amount of earnings removed from the reserves for such distributions First
Federal intends to make full use of this favorable tax treatment and does not
contemplate any distribution by First Federal Bank in a manner that would create
federal tax liability.


                                       12


<PAGE>

                          INDEX TO FINANCIAL STATEMENTS

                    FIRST FEDERAL BANC OF THE SOUTHWEST, INC.

REPORTS OF INDEPENDENT REGISTERED ACCOUNTING FIRMS........................   F-2

CONSOLIDATED FINANCIAL STATEMENTS

   Statements of Financial Condition......................................   F-4

   Statements of Income...................................................   F-5

   Statements of Stockholders' Equity.....................................   F-6

   Statements of Cash Flows...............................................   F-7

   Notes to Financial Statements..........................................   F-9


                                       F-1

<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders
First Federal Banc of the Southwest, Inc.
Roswell, New Mexico


We have audited the accompanying consolidated statement of financial condition
of First Federal Banc of the Southwest, Inc. and subsidiary as of September 30,
2006 and 2005, and the related consolidated statements of income, stockholders'
equity and cash flows for the years then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the 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 consolidated financial position of First
Federal Banc of the Southwest, Inc. and subsidiary as of September 30, 2006 and
2005, and the results of their operations and cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States of America.



/s/ Eide Bailly LLP

Bismarck, North Dakota
December 22, 2006


                                      F-2

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

                                ($ in thousands)
ASSETS                                                     2006       2005
                                                         --------   --------
Cash and due from banks                                  $ 15,837   $ 11,777
Interest-bearing deposits with banks                       38,903     26,185
Held-to-maturity investments securities                         7      2,132
Available-for-sale investment securities                   47,472     64,902
Loans held for sale                                         2,615      2,892
Loans receivable, net                                     414,923    412,073
Accrued interest receivable                                 2,188      2,036
Federal Home Loan Bank stock, at cost, restricted           5,142      6,373
Property, equipment, and construction in progress, net     13,631     13,726
Identifiable Intangibles                                    3,225      3,645
Goodwill                                                    2,286      2,286
Investment in non-bank subsidiaries                           310        310
Other assets                                                  827      1,605
                                                         --------   --------
      TOTAL ASSETS                                       $547,366   $549,942
                                                         ========   ========
LIABILITIES AND STOCKHOLDERS' EQUITY
                                                           2006       2005
                                                         --------   --------
Liabilities
   Deposits
      Non-interest bearing                               $ 64,833   $ 62,106
      Interest bearing                                    312,578    315,609
   Advances from the Federal Home Loan Bank               101,136    107,991
   Escrows from borrowers for taxes and insurance           1,517      1,561
   Accrued and other liabilities                            3,202      3,156
   Long term subordinated debt                             10,310     10,310
                                                         --------   --------
      TOTAL LIABILITIES                                   493,576    500,733
                                                         --------   --------
Commitments and contingencies                                  --         --

Stockholders' Equity
   Preferred stock, $0.01 par value; 500,000 shares
      authorized; no shares issued and outstanding             --         --

   Common stock, $0.01 par value; 6,000,000
      shares authorized; 4,313,045 shares issued and
      3,992,453 shares outstanding at September 30, 2006;
      4,289,445 shares issued and 3,968,853 shares
      outstanding at September 30, 2005                        43         43

   Additional paid-in capital                              18,199     17,916
   Retained  earnings                                      38,579     34,345
   Accumulated other comprehensive income (loss)             (310)      (374)

Treasury stock, at cost, 320,592 shares in 2006 and
   2005  respectively                                      (2,721)    (2,721)
                                                         --------   --------
      TOTAL STOCKHOLDERS' EQUITY                           53,790     49,209
                                                         --------   --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY               $547,366   $549,942
                                                         ========   ========

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


                                       F-3

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF INCOME
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

<TABLE>
<CAPTION>
                                                                ($ in thousands, except
                                                                       per share)
                                                                   2006         2005
                                                                ----------   ----------
<S>                                                             <C>          <C>
INTEREST INCOME
   Interest and fees on loans                                   $   32,104   $   21,556
   Interest on investment securities                                 2,362        1,548
   Interest and dividends on other investments                       1,810          766
                                                                ----------   ----------
      TOTAL INTEREST INCOME                                         36,276       23,870
                                                                ----------   ----------
INTEREST EXPENSE
   Deposits                                                          7,614        3,711
   Borrowed funds                                                    4,908        3,501
                                                                ----------   ----------
      TOTAL INTEREST EXPENSE                                        12,522        7,212
                                                                ----------   ----------
         NET INTEREST INCOME BEFORE PROVISION FOR LOAN LOSSES       23,754       16,658
   Provision for loan losses                                           (52)          (6)
                                                                ----------   ----------
         NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES        23,702       16,652
                                                                ----------   ----------
OTHER INCOME
   Fees for services to customers                                    1,330        1,002
   Gain on sale of loans                                               501          558
   Gain on sale of available-for-sale investment securities              9           --
   Other                                                               752          578
                                                                ----------   ----------
         TOTAL OTHER INCOME                                          2,592        2,138
                                                                ----------   ----------
OTHER EXPENSES
   Compensation and related benefits                                10,253        7,337
   Occupancy                                                         1,223        1,006
   Data processing                                                   1,116          729
   Advertising                                                         178          178
   Telephone                                                           264          218
   Postage                                                             179          172
   Printing & supplies                                                 311          274
   Employee expenses                                                   326          263
   Depreciation and amortization                                     1,274          785
   Mortgage broker fees                                                117          231
   Loss  on  sale  of  available-for-sale investment
   securities                                                           59            -
   Professional fees                                                   493          330
   Other                                                             1,486        1,115
                                                                ----------   ----------
         TOTAL OTHER EXPENSES                                       17,279       12,638
                                                                ----------   ----------
         INCOME BEFORE INCOME TAXES                                  9,015        6,152
   Income tax expense                                                3,665        2,497
                                                                ----------   ----------
         NET INCOME                                             $    5,350   $    3,655
                                                                ==========   ==========
   Net income per average common share
         Basic                                                        1.34         1.07
         Diluted                                                      1.33         1.05
Average common shares - basic                                    3,982,191    3,427,582
Average common shares - diluted                                  4,033,608    3,491,582
</TABLE>

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


                                       F-4

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005
<TABLE>
<CAPTION>
                                                                                          ($ in thousands, except share data)
                                                                                                       Accumulated
                                         COMMON STOCK      Additional     TREASURY STOCK               Other Comp.
                                      ------------------     Paid-in    -----------------   Retained      Income
                                       Shares      Value     Capital     Shares     Cost    Earnings      (Loss)      Total
                                      --------   -------     -------    -------   -------   --------      ------      -----
<S>                                   <C>         <C>        <C>        <C>       <C>       <C>           <C>        <C>
BALANCE AT SEPTEMBER 30, 2004         3,507,680   $   35     $ 5,224    320,592   $(2,721)  $31,444       $  10      $33,992

   Stock issued for acquisition of
   GFSB Bancorp, Inc.                   720,765        7      12,229                                                  12,236

   Stock issued for stock options        61,000    0.610         463                                                     464

   Dividends - $0.2075 per share                                                               (754)                    (754)

   Comprehensive income:
      Change in unrealized gain on
      investment securities, net of
      taxes                                                                                                (384)

   Net income                                --       --          --         --        --     3,655          --           --
                              TOTAL                                                                                    3,271
                                      --------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2005         4,289,445   $   43     $17,916    320,592   $(2,721)  $34,345       $(374)     $49,209

   Compensation expense - stock
      compensation plan                                           40                                                      40

   Stock issued for stock options       23,600     0.236         243                                                     243

   Dividends - $0.28 per share                                                               (1,116)                  (1,116)

   Comprehensive income:
      Change in unrealized gain on
      investment securities, net of
      taxes                                                                                                  64

    Net income                               --       --          --         --        --     5,350          --           --
                              TOTAL                                                                                    5,414
                                      --------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2006         4,313,045   $   43     $18,199    320,592   $(2,721)  $38,579       $(310)     $53,790
                                      ======================================================================================
</TABLE>

                                                             For the years ended
Reconciliation of Other Comprehensive Income (Loss)             September 30,
                                                             -------------------
                                                                2006    2005
                                                             -------------------
Unrealized (losses) gains on securities:
   Unrealized holding (losses) gains arising during period      $ 57   $(639)

   Related taxes                                                 (23)    255

   Plus: Reclassification adjustments for net (gains) losses
   in net income                                                  50      --

   Related taxes                                                 (20)     --
                                                             -------------------
                   TOTAL OTHER COMPREHENSIVE INCOME (LOSS)      $ 64   $(384)
                                                             ===================

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


--------------------------------------------------------------------------------
                                       F-5

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

<TABLE>
<CAPTION>
                                                                2006       2005
                                                              --------   --------
<S>                                                           <C>        <C>
Cash Flows from Operating Activities
   Net income                                                 $  5,350   $  3,655
   Adjustments to reconcile net income to net
   cash provided by operating activities
      Depreciation & amortization of intangibles                 1,274        785
      Net loss (gain) on sale of REO                                (6)        29
      Loss (gain) on disposal of equipment                           -        (12)
      Net loss (gain) on sale of available-for-sale
          investment securities                                     50          -
      Compensation expense for stock option plan                    40          -
      Proceeds from sales of loans held for sale                37,590     33,650
      Origination of loans held for sale                       (36,812)   (34,207)
      Gain on sale of sold loans                                  (501)      (558)
      Provision (benefit) for loan losses                           52          6
      Amortization of investments, net                              83        208
      FHLB Stock dividend                                         (255)      (161)
      Change in accrued interest & dividend receivable            (153)        88
      Change in prepaid/other assets                               676     (1,276)
      Change in accounts payable & accrued liabilities              46        180
      Accretion of market-to-market, net                          (245)       (75)
      ARM fund share dividend                                     (444)         -
      Other, net                                                  (393)      (107)
                                                              --------   --------
         NET CASH PROVIDED BY OPERATING ACTIVITIES               6,352      2,205
                                                              --------   --------
Cash Flows from Investing Activities
   Change in deposits in banks                                 (12,718)     2,048
   Proceeds from maturity and principal paydowns
      of held-to-maturity securities                             2,105     20,935
   Principal payments on mortgage backed securities
      held-to-maturity                                              19         27
   Proceeds from sales, maturities and principal paydowns
      of available-for-sale securities                          11,846      6,575
   Purchases of available-for-sale securities                        -     (8,793)
   Principal payments on mortgage backed securities
      available-for-sale                                         6,002      3,148
   Loan origination and principal repayment on loans, net       (2,795)   (24,523)
   Proceeds from sale of foreclosed properties                     347        419
   Net cash paid for acquisition                                     -     (4,249)
   Purchase of TPS common equity                                     -       (310)
   Proceeds from sale of property and equipment                      -        143
   Redemption of FHLB stock                                      1,486          -
   Purchases of Building and Equipment                            (744)    (1,878)
                                                              --------   --------
         NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES        5,548     (6,458)
                                                              --------   --------
Cash Flows from Financing Activities
   Net increase (decrease) in transaction accounts, savings
          and now deposits                                        (391)    (6,067)
   Net increase (decrease) in mortgage escrow funds                (44)       555
   Proceeds from FHLB advances                                  11,596     18,220
   Repayments on FHLB Advances                                 (18,128)   (16,225)
   Dividends paid or to be paid in cash                         (1,116)      (754)
   Proceeds from exercise of stock options                         243        463
   Proceeds from sale of subordinated debentures                     -     10,310
                                                              --------   --------
         NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES       (7,840)     6,502
                                                              --------   --------
         NET CASH AND DUE FROM BANKS                          $  4,060   $  2,249
                                                              ========   ========
</TABLE>

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
                                       F-6

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

<TABLE>
<CAPTION>
                                                                  2006     2005
                                                                -------   ------
<S>                                                             <C>       <C>
Increase (decrease) in cash and due from banks                  $ 4,060    2,249
Cash and due from banks at beginning of year                     11,777    9,528
                                                                -------   ------
CASH AND DUE FROM BANKS AT END OF YEAR                          $15,837   11,777
                                                                =======   ======

SUPPLEMENTAL DISCLOSURES
Cash paid during the year for
   Interest on deposits and advances                            $11,939    6,473
   Income taxes                                                   3,493    2,661

Decrease (increase) in unrealized loss, net of deferred taxes
on available-for-sale securities -other comprehensive income         64     (384)
</TABLE>

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


--------------------------------------------------------------------------------
                                       F-7

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business Activity and History
First Federal Banc of the Southwest, Inc. (Company) was formed in April 1998 by
First Federal Bank (Bank or Subsidiary) to become the Bank's holding company.
The acquisition of the Bank was effective August 18, 1998, in connection with
the Bank's reorganization into a holding company structure.

The Bank's primary business is the origination of consumer, commercial and
mortgage loans and the solicitation of deposit accounts from the general public.
Since its original charter was granted in 1920, the Bank has promoted home
ownership through the granting of mortgage loans, primarily for the purchase,
construction or improvement of residential and non-residential real estate. This
has been, and continues to be, an important thrust of the Bank and is the focal
point of operations. The primary market area of the Bank includes Chaves, Eddy,
Lincoln, Dona Ana, Otero, and Bernalillo Counties in New Mexico, and El Paso
County in Texas.

The Bank was chartered in 1920 as a mutual savings and loan association. In July
1979, the Bank converted to a common stock association until February 1983, when
it became a federally chartered bank and changed its name to First Federal
Savings Bank of New Mexico, later First Federal Bank.

Principles of Consolidation
The 2006 and 2005 consolidated financial statements include the accounts of the
Company and the Bank. All significant inter-company accounts and transactions
have been eliminated in consolidation.

Interest-Bearing Deposits
Interest-bearing deposits with banks consists of a Federal Home Loan Bank (FHLB)
account, accounts with other financial institutions and certificates of deposit.
The Bank's policy is to maintain account balances, excluding balances with the
FHLB, with institutions which are federally insured by the U.S. Government.

The Bank is required by regulatory authorities to maintain certain cash balances
based on levels of customer deposits. The Bank was in compliance with the
required reserves at September 30, 2006 and 2005.

Investment Securities
Investment securities are comprised of U.S. government and federal agency
obligations, mortgage-backed securities, municipal and other bonds.

Premiums and discounts associated with investment securities are amortized using
the interest method over the remaining period to contractual maturity or call
date. Premiums and discounts associated with mortgage-backed securities are
amortized and recognized in interest income using the level-yield method.


--------------------------------------------------------------------------------
                                      F-8

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Investments in equity securities that have readily determinable fair values and
all investments in debt securities are to be classified in three categories and
accounted for as follows:

     o    Debt securities that the Bank has the positive intent and ability to
          hold to maturity are classified as held-to-maturity securities and
          reported at amortized cost.

     o    Debt and equity securities that are bought and held principally for
          the purpose of selling them in the near term are classified as trading
          securities and reported at fair value, with unrealized holding gains
          and losses included in earnings. The Bank does not have any securities
          identified as trading securities.

     o    Debt and equity securities not classified as either held-to-maturity
          securities or trading securities are classified as available-for-sale
          securities and reported at fair value, with unrealized holding gains
          and losses excluded from earnings and reported as a separate component
          of stockholder's equity, net of applicable deferred income taxes.

Declines in the fair value of held-to-maturity and available-for-sale securities
below their cost that are deemed to be other than temporary are reflected in
earnings as realized losses. In estimating other-than-temporary impairment
losses, management considers (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Company to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. Gains and losses on the sale of securities
are recorded on the trade date and are determined using the specific
identification method.

Investments in Nonbank Subsidiaries
The Company owns 100% of the outstanding common securities of First Federal NM
Trust I and II. The investments in First Federal NM Trust I and II is carried on
the equity basis of accounting. The equity basis results in the investment being
carried at cost plus equity in earnings since date of acquisition, less
dividends received from the subsidiaries.

Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. The allowance for losses on loans is based on
management's estimates. In connection with the determination of the value of
foreclosed real estate, management obtains independent appraisals for
significant properties.

While management uses available information to recognize losses on loans and
foreclosed real estate, future additions to the allowances may be necessary
based on changes in local economic conditions. In addition, regulatory agencies,
as an integral part of their examination


--------------------------------------------------------------------------------
                                      F-9

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

process, periodically review the Bank's allowances for losses on loans and
foreclosed real estate. Such agencies may require the Bank to recognize
additions to the allowances based on their judgments about information available
to them at the time of their examination. Because of these factors, it is
reasonably possible that the allowances for losses on loans and the valuation of
foreclosed real estate may change materially in the near term.

Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at
the lower of aggregate cost or fair value, as determined by aggregate
outstanding commitments from investors or current investor yield requirements.
Net unrealized losses are recognized through a valuation allowance by charges to
income. Gains or losses on sales of mortgage loans are recognized based on the
difference between the selling price and the carrying value of the related
mortgage loans sold.

Loans Receivable
Loans receivable are stated at unpaid principal balances, less the allowance for
loan losses, net deferred loan origination fees and unearned discounts and
interest. Interest income is accrued on the unpaid principal balance. Loan
origination fees, net of certain direct origination costs, are deferred and
recognized as an adjustment of the related loan yield using the interest method.

The accrual of interest on mortgage and commercial loans is discontinued at the
time the loan is 90 days past due unless the credit is well-secured and in
process of collection. Past due status is based on contractual terms of the
loan. In all cases, loans are placed on non-accrual or charged-off at an earlier
date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on non-accrual
or charged off is reversed against interest income. The interest on these loans
is accounted for on the cash-basis or cost-recovery method, until qualifying for
return to accrual. Loans are returned to accrual status when all the principal
and interest amounts contractually due are brought current and future payments
are reasonably assured.

Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loans losses
are charged against the allowance when management believes the uncollectibility
of a loan balance is confirmed. Subsequent recoveries, if any, are credited to
the allowance. The allowance for loan losses is evaluated on a regular basis by
management and is based upon management's periodic review of the collectibility
of the loans in light of historical experience, the nature and volume of the
loan portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available.

The allowance is maintained at a level determined adequate by management to
absorb future potential losses in the loan portfolio and outstanding commitments
to extend credit. The amount of the allowance is based on management's
evaluation of the collectibility of the loan portfolio, including the nature of
the portfolio, credit concentrations, trends in historical loss experience,
specific impaired loans, economic conditions and other risks inherent in the
portfolio.


--------------------------------------------------------------------------------
                                      F-10

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The allowance consists of specific and general components. The specific
component relates to loans that are classified as either doubtful, substandard
or special mention. For such loans that are also classified as impaired, an
allowance is established when the discounted cash flows (or collateral value or
observable market price) of the impaired loan is lower than the carrying value
of the loan. The general component covers non-classified loans and is based on
historical loss experience adjusted for qualitative factors. The qualitative
factors generally reflect concerns regarding certain geographic markets,
exposure to certain types of loans and economic conditions that may stress or
increase the risk to certain borrowers to fulfill their contractual obligations.

A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record, and the amount of
the shortfall in relation to the principal and interest owed. Impairment is
measured on a loan-by-loan basis for commercial and construction loans by either
the present value of expected future cash flows discounted at the loan's
effective interest rate, the loan's obtainable market price, or the fair value
of the collateral if the loan is collateral dependent.

Mortgage Servicing Rights
Servicing assets are recognized as separate assets when rights are acquired
through purchase or through sale of financial assets. Generally, purchase
servicing rights are capitalized at the cost to acquire the rights. For sales of
mortgage loans, a portion of the cost of the originating loan is allocated to
the servicing right based on relative fair value. Fair value is based on market
prices for comparable mortgage servicing contracts, when available, or
alternatively, is based on a valuation model that calculates the present value
of estimated future net servicing income. The valuation model incorporates
assumptions that market participants would use in estimating future net
servicing income, such as the cost to service, the discount rate, the custodial
earnings rate, an inflation rate, ancillary income, prepayment speeds and
default rates and losses. Capitalized servicing rights are reported in other
assets and are amortized into non-interest income in proportion to, and over the
period of, the estimated future net servicing income of the underlying financial
assets.

Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to the amortized cost. Impairment is determined by
stratifying rights into tranches based on predominant risk characteristics, such
as interest rate, loan type and investor type. Impairment is recognized through
a valuation allowance for an individual tranche, to the extent that fair value
is less than the capitalized amount for the tranche. If the Company later
determines that all or a portion of the impairment no longer exists for a
particular tranche, a reduction of the allowance may be recorded as an increase
to income.

Servicing fee income is recorded for fees earned for servicing loans. The fees
are based on contractual percentage of the outstanding principal; or a fixed
amount per loan and are recorded as income when earned. The amortization of
mortgage servicing rights is netted against loan servicing fee income.


--------------------------------------------------------------------------------
                                      F-11

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Advertising
The Bank's policy is to expense the cost of advertising in the period the
expenses are incurred.

Real Estate Owned and Real Estate Held for Investment
Assets acquired through, or in lieu of, loan foreclosure are held for sale and
are initially recorded at fair value at the date of foreclosure, establishing a
new cost basis. Subsequent to foreclosure, valuations are periodically performed
by management and the assets are carried at the lower of carrying amount or fair
value less cost to sell. Revenue and expenses from operations and changes in the
valuation allowance are included in net expenses from foreclosed assets.

Federal Home Loan Bank Stock (FHLB)
FHLB stock is stated at cost, based on the ultimate recoverability of its par
value. The FHLB stock represents a form of equity interest in the FHLB and can
be sold back only at par and only to the FHLB or to another institution. The
FHLB stock lacks a market and, accordingly, is a restricted investment security.
Membership in FHLB requires purchase of stock. Stock ownership is adjusted for
levels of activity with the FHLB.

Property and Equipment
Property and equipment is stated on the cost basis. Depreciation is generally
computed using the straight-line method over the following estimated useful
lives for buildings of 15 to 40 years and furniture, fixtures, and equipment of
3 to 20 years. The assets' actual useful lives could differ from the estimated
useful lives used for calculating depreciation. It is the Bank's policy to
capitalize project costs associated with the construction or remodeling of
facilities.

Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.

Net Income Per Common Share
Basic income per common share is calculated by dividing net income applicable to
common equity by the weighted average number of shares of common stock
outstanding for the period. Diluted income per common share is calculated by
adjusting the weighted average number of shares of common stock outstanding that
would be issued assuming the exercise of stock options during the period using
the treasury stock method. All share data has been adjusted to reflect the
effect of the May 20, 2005, 8:1 stock split.

Reclassifications
Certain reclassifications have been made to 2005 information to conform to 2006
presentation.

Intangible Assets and Goodwill
Goodwill is recorded when the purchase price is higher than the fair value of
net assets acquired in business combinations under the purchase method of
accounting. On July 1, 2002, the Company adopted FAS 142, "Goodwill and Other
Intangible Assets." FAS 142 eliminates


--------------------------------------------------------------------------------
                                      F-12

<PAGE>
FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005


amortization of goodwill from business combinations. Effective January 1, 2002,
all goodwill amortization was discontinued.

The Company assesses goodwill for impairment annually, and more frequently in
certain circumstances. Goodwill is assessed for impairment on a reporting unit
level by comparing the fair value of the reporting unit at its carry amount,
including goodwill. Impairment exists when the carrying amount of the goodwill
exceeds its implied fair value. Other intangible assets consist of costs
associated with acquisition, and the core deposit which is amortized using the
straight-line method over nine years. If certain factors become present that
could lead to impairment of intangible assets, testing will be performed at that
time.

Income Taxes
Deferred income tax assets and liabilities are determined using the liability
(or balance sheet) method. Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the temporary differences
between the book and tax bases of the various balance sheet assets and
liabilities and gives current recognition to changes in tax rates and laws.

Cash and Cash Equivalents
Cash and cash equivalents include currency on hand and due from banks.

Stock Options
The Company adopted Statement of Financial Accounting Standards No. 123R, Share
Based Payment, ("SFAS No. 123R") to account for stock-based compensation granted
through the existing stock option plans. Beginning January 1, 2006, compensation
expense is calculated based on the grant date fair value. This compensation
expense is recorded on a straight-line basis over the vesting period of the
stock options. The Company elected to use the modified prospective transition
method as permitted by SFAS No. 123R and, therefore, has not restated the
financial results for prior periods. Under this method, the provisions of SFAS
No. 123R are applied to new awards and to awards modified, repurchased, or
cancelled after January 1, 2006, (there were none). In addition, the Company
recognizes compensation expense for unvested awards outstanding at December 31,
2005.

Stock options are subject to various vesting schedules and terms, subject to
accelerated vesting upon death and disability or a change in control.
Compensation expense for the issuance of stock options is recognized over the
required service period based on the estimated fair value of the options on the
date of grant using a Black-Scholes valuation model. Included in the
determination of net income as reported for the year ending September 30, 2006
is compensation expense related to options of $40,000 (representing the expense
from January 1 to September 30, 2006 related to unvested awards). Prior to the
adoption of SFAS No. 123R, the Company accounted for stock-based compensation in
accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees. As a result, no compensation expense related to stock
options was reflected in net income for 2005, as all options granted under the
plans had an exercise price equal to or greater than the market value of the
underlying Common Stock on the date of grant. No stock options were granted
during the year ended September 30, 2005. Had compensation cost for the stock
options been determined as if the Company accounted for its stock-based
compensation plans consistent with the fair value method of SFAS No. 123R, the
Company's same period 2005 results would have been reduced by a similar
immaterial amount as reported in the 2006 period. See Note 12 for more
information on stock options.


--------------------------------------------------------------------------------
                                      F-13

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Fair Values of Financial Instruments
The fair value of a financial instrument is the current amount that would be
exchanged between willing parties, other than in a forced liquidation. Fair
value is best determined based upon quoted market prices. However, in many
instances, there are no quoted market prices for the Company's various financial
instruments. In cases where quoted market prices are not available, fair values
are based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. Accordingly, the fair value
estimates may not be realized in an immediate settlement of the instrument. SFAS
107 excludes certain financial instruments and all non-financial instruments
from its disclosure requirements. Accordingly, the aggregate fair value amounts
presented may not necessarily represent the underlying fair value of the
Company.

The following methods and assumptions were used by the Company in estimating the
fair values of its financial instruments:

o    CASH AND CASH EQUIVALENTS
     The carrying amounts reported in the Consolidated Statements of Financial
     Position for cash and short-term instruments approximate the fair values of
     those assets.

o    INTEREST-BEARING DEPOSITS IN BANKS
     The carrying amounts of interest-bearing deposits maturing within one year
     approximate their fair values.

o    INVESTMENT SECURITIES INCLUDING MORTGAGE-BACKED 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 quoted market prices of comparable instruments.

o    LOANS RECEIVABLE
     For variable-rate loans that re-price frequently and with no significant
     change in credit risk, fair values are based on carrying values. The fair
     values for certain mortgage loans (e.g., one-to-four family residential)
     and other consumer loans are based on quoted market prices of similar loans
     sold in conjunction with securitization transactions, adjusted for
     differences in loan characteristics.

     The fair values for other loans (e.g., commercial real estate and rental
     property mortgage loans and commercial 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
     carrying amount of accrued interest approximates its fair value.

o    LOANS HELD FOR SALE
     Fair values of mortgage loans held for sale are based on commitments on
     hand from investors or prevailing market prices.


--------------------------------------------------------------------------------
                                      F-14

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

o    FEDERAL HOME LOAN BANK STOCK
     The carrying value of Federal Home Loan Bank stock approximates fair value
     based on its redemptive provisions.

o    DEPOSIT LIABILITIES
     The fair values disclosed for demand deposits (e.g., interest-bearing and
     non interest-bearing checking, passbook savings, and certain types of money
     market accounts) are equal to the amount payable on demand at the reporting
     date (i.e., their carrying amounts). Fair values for fixed-rate
     certificates of deposit are estimated using a discounted cash flow
     calculation that applies interest rates currently being offered on
     certificates to a schedule of aggregated expected monthly maturities on
     time deposits.

o    FEDERAL HOME LOAN BANK ADVANCES
     The fair value of Federal Home Loan Bank advances is estimated based on
     interest rates for the same or similar debt offered to the Bank having the
     same or similar remaining maturities and collateral requirements.

o    LONG TERM SUBORDINATED DEBT
     The fair values of the Company's long-term borrowings are estimated using
     discounted cash flow analyses based on the Company's current borrowing
     rates for similar types of borrowings.

o    ACCRUED INTEREST
     The carrying amounts of accrued interest approximate fair value.

Off-Balance Sheet Credit Related Financial Instruments
In the ordinary course of business, the Company has entered into commitments to
extend credit, including commitments under credit care arrangements, commercial
letters of credit, and standby letters of credit. Such financial instruments are
recorded when they are funded.

Comprehensive Income
Accounting principles generally require that recognized revenue, expense, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income.

Recent Accounting Developments
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard No. 123R, Share-Base Payment. This
Statement revises SFAS Statement No. 123, Accounting for Stock-Based
Compensation, amends SFAS Statement No. 95, Statement of Cash Flows, and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. It
requires that all stock-based compensation now be measured at fair value and
recognized as expense in the income statement. This Statement also clarifies and
expands guidance on measuring fair value of stock compensation, requires
estimation of forfeitures when determining expense, and requires that excess tax
benefits be shown as financing cash inflows versus a reduction of taxes paid in
the statement of cash flows. Various other changes are also required. This
Statement is effective beginning January 1, 2006, for the Company as a result of
recent SEC actions.


--------------------------------------------------------------------------------
                                      F-15

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

Management believes the impact on the financial statements will be similar to
the disclosures made by footnote to the financial statements, showing the effect
on earnings and earnings per share of expensing the value of stock options
granted.

In November 2005, the FASB issued FASB Staff Position (FSP) FAS 115-1 and 124-1,
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments. The FASB addresses the determination of when an investment is
considered impaired, whether that impairment is other than temporary, and the
measurement of an impairment loss. The FSP also includes accounting
considerations subsequent to the recognition of an other-than-temporary
impairment and requires certain disclosures about unrealized losses that have
not been recognized as other-than-temporary impairments. The FSP amends FASB
Statement No. 115, Accounting for Certain Investments in Debt and Equity
Securities, FASB Statement No. 124, Accounting for Certain Investments Held by
Not-for-Profit Organizations and APB Opinion No. 18, The Equity Method of
Accounting for Investments in Common Stock. The FSP nullifies certain
requirements of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments and supersedes EITF
Abstracts, Topics D-44, Recognition of Other-Than-Temporary Impairment upon the
Planned Sale of a Security Whose Cost Exceeds Fair Value. The FSP is required to
be applied to reporting periods beginning after December 15, 2005. The Company
does not expect adoption to have a material impact on the consolidated financial
statements.

During this reporting period the FASB issued SFAS 155 and 156. SFAS 155,
Accounting for Certain Hybrid Financial Instruments, an amendment of FASB
Statements No. 133 and 140 was issued in February 2006. This Statement is
effective for all financial instruments acquired or issued after the beginning
of an entity's first fiscal year that begins after September 15, 2006. SFAS 156,
Accounting for Servicing of Financial Assets, an amendment of FASB Statement No.
140 was issued in March 2006. The effective date for this Statement is the
beginning of the first fiscal year that begins after September 15, 2006. For the
Company, the effective date for both of these Statements is the fiscal year
beginning October 1, 2006. At this time management does not believe either of
these Statements will have a material effect on the Company's results.

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 ("FIN
48"). This interpretation clarifies the accounting for uncertainity in income
taxes recognized in an enterprise's financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes. This interpretation prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to taken in a
tax return. This interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. This interpretation is effective for years beginning
after December 15, 2006. The adoption of this interpretation is not expected to
have a material impact on the Company's financial condition or operations.

In September 2006, the FASB issued SFAS 157, Fair Value Measurements. The
Statement defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles, and expands disclosures about fair
value measurements. This Statement does not require any new fair value
measurements. However, for some entities there maybe changes in the current
practice of determining fair value. The Statement is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years.


--------------------------------------------------------------------------------
                                      F-16

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

Adoption of this Statement is not expected to have a material impact on the
Company's financial condition or operations. Also in September 2006, the FASB
issued SFAS 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106 and
132(R). This Statement deals with the financial reporting of the overfunded or
underfunded status of defined benefit postretirement plans. Currently the
Company does not provide any defined benefit pension plans and therefore would
not be reporting under this Statement.

NOTE 2. INVESTMENT SECURITIES

The amortized costs and aggregate fair values of investment securities
classified as held-to-maturity were as follows at September 30:

                                                    2006
                              -----------------------------------------------
                                             GROSS        GROSS     AGGREGATE
HELD-TO-MATURITY              AMORTIZED   UNREALIZED   UNREALIZED     FAIR
INVESTMENT SECURITIES           COST         GAINS       LOSSES       VALUE
                              ---------   ----------   ----------   ---------
   Mortgage-backed securities
      FHLMC                       $7           -            -           7
                                 ---         ---          ---         ---
TOTAL INVESTMENT SECURITIES       $7           -            -           7
                                 ===         ===          ===         ===

<TABLE>
<CAPTION>
                                                         2005
                                   -----------------------------------------------
                                                  Gross        Gross     Aggregate
     HELD-TO-MATURITY              Amortized   Unrealized   Unrealized     Fair
     INVESTMENT SECURITIES           Cost         Gains       Losses       Value
                                   ---------   ----------   ----------   ---------
<S>                                  <C>           <C>          <C>        <C>
     U.S. Government and Federal
        agency obligations           $1,726         -           (3)        1,723
     Mortgage-backed securities
        FHLMC                            26         -            -            26
     Municipal and other bonds          380                      -           380
                                     ------       ---          ---         -----
     Total investment securities     $2,132         -           (3)        2,129
                                     ======       ===          ===         =====
</TABLE>

The amortized costs and aggregate fair values of investment securities
classified as available-for-sale were as follows at September 30:

<TABLE>
<CAPTION>
                                                         2006
                                   -----------------------------------------------
                                                  GROSS        GROSS     AGGREGATE
     AVAILABLE-FOR-SALE            AMORTIZED   UNREALIZED   UNREALIZED     FAIR
     INVESTMENT SECURITIES           COST         GAINS       LOSSES       VALUE
                                   ---------   ----------   ----------   ---------
<S>                                 <C>            <C>        <C>          <C>
     Federal agency obligations     $14,985         -         (246)        14,739
     Municipal securities             4,958        20          (14)         4,964
     SLMA asset-backed securities       463         -           (1)           462
     Mortgage-backed securities      17,003        14         (207)        16,810
     Common Stock                        10         -            -             10
     Mutual Funds                    10,569         -          (82)        10,487
                                    -------       ---         ----         ------
     TOTAL INVESTMENT SECURITIES    $47,988        34         (550)        47,472
                                    =======       ===         ====         ======
</TABLE>


--------------------------------------------------------------------------------
                                      F-17

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 2. INVESTMENT SECURITIES (CONTINUED)

                                                    2005
                              -----------------------------------------------
                                             Gross        Gross     Aggregate
   Available-for-sale         Amortized   Unrealized   Unrealized     Fair
  Investment Securities         Cost         Gains       Losses       Value
                              ---------   ----------   ----------   ---------
Federal agency obligations     $23,460         -          (315)      23,145
Municipal securities             5,647        48           (10)       5,685
SLMA asset-backed securities       787         -            (1)         786
Mortgage-backed securities      23,898        43          (174)      23,767
Common Stock                     1,006         -          (110)         896
Mutual Funds                    10,726         -          (103)      10,623
                               -------       ---          ----       ------
TOTAL INVESTMENT SECURITIES    $65,524        91          (713)      64,902
                               =======       ===          ====       ======

The amortized costs and fair value of all debt securities by contractual
maturity as of September 30, 2006 are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.

<TABLE>
<CAPTION>
                                     Available-for-Sale       Held-to-Maturity
                                   Amortized    Aggregate   Amortized    Aggregate
                                      Cost     Fair Value     Cost      Fair Value
                                   ---------   ----------   ---------   ----------
<S>                                 <C>           <C>         <C>         <C>
Due in one year or less             $ 6,823       6,756         -          -
Due after one through five years      8,594       8,411         -          -
Due after five through ten years        679         680         -          -
Due after ten years                   3,847       3,856         -          -
                                    -------      ------       ---        ---
                                     19,943      19,703         -          -
Mortgage-backed securities           17,466      17,272         7          7
                                    -------      ------       ---        ---
                                    $37,409      36,976         7          7
                                    =======      ======       ===        ===
</TABLE>


--------------------------------------------------------------------------------
                                      F-18

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

Mortgage-backed securities held by the Bank represent participation certificates
guaranteed by the Federal National Mortgage Association (FNMA) and Federal Home
Loan Mortgage Company (FHLMC), which are issued by qualified mortgage lenders
that pool qualifying loans.

The fair value of mortgage-backed securities and investments in U.S. Government
and Federal agency obligations pledged to state, city and county deposits was
$10,786 and $21,557 at September 30, 2006 and 2005, respectively.

The following table provides information pertaining to securities with gross
unrealized losses at September 30, 2006, aggregated by investment category and
length of time that individual securities have been in a continuous loss
position:

NOTE 2. INVESTMENT SECURITIES (CONTINUED)

<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE                   Less            12 months
INVESTMENT SECURITIES           than 12 months      or greater           TOTAL
                               ----------------   ---------------   ---------------
                                 Fair    Unreal    Fair    Unreal    Fair    Unreal
                                Value     Loss     Value    Loss    Value     Loss
                               -------   ------   ------   ------   ------   ------
<S>                             <C>       <C>     <C>       <C>     <C>       <C>
Federal agency obligations      $    -      -     14,739    (247)   14,739    (247)
Municipal securities                 -      -      1,289     (14)    1,289     (14)
SLMA asset-backed securities         -      -        462      (1)      462      (1)
Mortgage-backed securities       1,955     (4)    12,266    (202)   14,221    (206)
Mutual Funds                         -      -     10,569     (82)   10,569     (82)
                                ------    ---     ------    ----    ------    ----
   Total                        $1,955     (4)    39,325    (546)   41,280    (550)
</TABLE>

<TABLE>
<CAPTION>
HELD-TO-MATURITY                     Less            12 months
INVESTMENT SECURITIES           than 12 months      or greater           TOTAL
                               ----------------   ---------------   ---------------
                                 Fair    Unreal    Fair    Unreal    Fair    Unreal
                                Value     Loss     Value    Loss    Value     Loss
                               -------   ------   ------   ------   ------   ------
<S>                              <C>       <C>       <C>     <C>       <C>     <C>
Federal agency obligations       $ -        -        1        -        1        -
</TABLE>

Management evaluates securities for other-than-temporary impairment at least on
a quarterly basis, and more frequently when economic or market conditions
warrant such evaluation. Consideration is given to the length of time and amount
of the loss relative to cost, the nature and financial condition of the issuer
and the ability and intent of the Company to hold the investment for a time
sufficient to allow any anticipated recovery in fair value.


--------------------------------------------------------------------------------
                                      F-19

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

There were no securities with unrealized losses which management considers to be
other-than-temporary impairments at September 30, 2006. The contractual terms of
the Federal Agency obligations do not permit the issuer to settle the securities
at price less than face value. Because the Company has the ability and intent to
hold those investments until a recovery of fair value, which may be maturity,
the Company does not consider those investments to be other-than-temporarily
impaired at September 30, 2006.

The Company realized before tax $59 in losses and $9 in gains on sales of
investment securities available-for-sale in fiscal 2006 from gross proceeds of
$1,546. The Company realized no gains or losses on sales of investment
securities available-for-sale in fiscal 2005.

NOTE 3. LOANS RECEIVABLE

Loans receivable consisted of the following at September 30:

                                             2006       2005
                                           --------   --------
First mortgage loans:
      Conventional                         $168,012   $185,713
      Guaranteed - FHA and VA                 2,123      3,325
   Construction loans                        40,536     30,828
   Commercial real estate loans             145,343    129,133
   Commercial non-real estate loans          32,379     35,645
   Consumer loans                            31,243     32,329
                                           --------   --------
                                            419,636    416,973
                                           --------   --------
   Less:
      Net deferred loan origination fees       (955)    (1,100)
      Allowance for loan losses              (3,758)    (3,800)
                                           --------   --------
                                             (4,713)    (4,900)
                                           --------   --------
                                           $414,923   $412,073
                                           ========   ========

All first mortgage loans and construction loans are secured by a primary lien on
the mortgaged property.

Changes in allowance for loan losses were as follows for the years ended
September 30:

                                     2006     2005
                                    ------   ------
     Balance at beginning of year   $3,800   $2,253
     Acquisition of GFSB                 -    1,661
     Provision                          52        6
                                    ------   ------
                                     3,852    3,920
     Charge-offs, net                  (94)    (120)
                                    ------   ------
     Balance at end of year         $3,758   $3,800
                                    ======   ======

During the years ended September 30, 2006 and 2005, the Bank had recoveries
totaling $59 and $32, respectively.

The weighted average yield on all loans was 7.17% and 6.35% at September 30,
2006 and 2005, respectively.

The Bank's loan servicing portfolio is:

                                2006     2005
                              -------   -------
     Loans                    $15,098   $13,422
     Service fees                  15        18
     Custodial escrow funds        44        58




--------------------------------------------------------------------------------
                                      F-20

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005


NOTE 3. LOANS RECEIVABLE (CONTINUED)

Nonaccrual and renegotiated loans for which interest has been reduced totaled
$1,163 and $1,891 at September 30, 2006 and 2005, respectively. The Bank is not
committed to lend additional funds to debtors whose loans have been modified.

There was no material difference between interest income that would have been
recorded under the original terms of such loans and the interest income actually
recognized for the years ended September 30, 2006 and 2005.

An impaired loan can be valued based upon its fair value or the market value of
the underlying collateral if the loan is primarily collateral dependent. The
Bank assesses for impairment all loans delinquent more than 90 days.
Uncollectible interest on loans that are contractually past due is charged off,
based on management's periodic evaluation. There were no loans 90 days
delinquent and still accruing interest at September 30, 2006 and 2005. Interest
income is subsequently recognized only to the extent cash payments are received,
until, in management's judgment, the borrower's ability to make periodic
principal and interest payments is back to normal, in which case the loan is
returned to accrual status.

The average impaired loan balance for the years ended September 30, 2006 and
2005 were $3,528 and $2,113, respectively. All impaired loans at September 30,
2006 and 2005 have a related specific allowance associated with it.

                                                   2006     2005
                                                  ------   ------
Loans receivable that were evaluated for credit
losses in accordance with FASB Statement
No. 114, as amended                               $4,716   $2,967

Specific allowances for credit losses              1,492      771

Interest collected on impaired loans                 355      244

Of the Bank's total loans at September 30, 2006, approximately $175,900 and
$243,700 represent variable and fixed rate instruments, respectively. Of the
Bank's total loans at September 30, 2005, approximately $161,300 and $255,600
represent variable and fixed rate instruments, respectively.


--------------------------------------------------------------------------------
                                      F-21

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

An analysis of loans to directors, and executive officers follows below at
September 30:

                                      2006     2005
                                    -------   ------
     Balance at beginning of year   $ 1,446   $   43
     Acquisition of GFSB                  -    1,442
     New loans or advances              247      523
     Loan principal repayments       (1,057)    (562)
                                    -------   ------
     BALANCE AT END OF YEAR         $   636   $1,446
                                    =======   ======

None of the loans to directors and executive officers were on non-accrual, were
past due or were restructured during the years ended September 30, 2006 and
2005. All loans to directors and executive officers were made in the ordinary
course of business and were made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
third-party transactions.

NOTE 4. PROPERTY, EQUIPMENT AND CONSTRUCTION IN PROGRESS

Property and equipment, summarized by major classifications, was as follows at
September 30:

                                           2006       2005
                                         --------   --------
     Land                                $ 3,886    $ 3,666
     Buildings and improvements           12,202     11,207
     Furniture, fixtures and equipment     5,913      5,516
     Leasehold improvements                  629        629
     Construction in progress                 76        937
                                         -------     ------
                                          22,706     21,955
     Accumulated depreciation             (9,075)    (8,229)
                                         -------    -------
                                         $13,631     13,726
                                         =======    =======

The Bank leases equipment and buildings under agreements, which are classified
as operating leases. The Bank has two building leases and an in-store branch
lease. One building lease is a ten-year lease which expires in 2012, with
options to renew for additional five-year periods. The second building lease is
a ten-year lease which expires in 2007, with an option to purchase at term end
or renew for an additional 10-year period. The in-store branch lease will expire
on December 31, 2010, and allows for two 5-year extensions. Rent expense under
these operating lease agreements was $149 and $86 for the years ended September
30, 2006 and 2005, respectively.

As of September 30, 2006, future minimum lease payments under non-cancelable
operating leases are as follows:

     Years Ending       Lease
     September 30,   Commitments
     -------------   -----------
       2007             $189
       2008              124
       2009              116
       2010              118
       2011               89
       Thereafter         40
                        ----
                        $676
                        ====


--------------------------------------------------------------------------------
                                      F-22

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 5. SAVINGS, CERTIFICATES OF DEPOSIT AND DEMAND ACCOUNTS

Deposits consisted of the following at September 30:

                                                     2006       2005
                                                   --------   --------
          Non interest-bearing checking accounts   $ 64,833   $ 62,106
          Interest-bearing checking accounts         60,120     62,821
          Statement savings                          61,724     84,108
          Money market deposits                      62,894     23,762
          Certificates of deposit                   127,840    144,918
                                                   --------   --------
                                                   $377,411   $377,715
                                                   ========   ========

Interest expense incurred on the above deposits was as follows for the years
ended September 30:

                                                    2006      2005
                                                   ------   ------
             Interest-bearing checking accounts    $   96   $   67
             Statement savings                      1,164      704
             Money market deposits                  1,462       94
             Certificates of deposit                4,892    2,846
                                                   ------   ------
                                                   $7,614   $3,711
                                                   ======   ======

Certificates of deposit by remaining maturity are as follows:

       Years Ending
       September 30,                                Amount
       -------------                               --------
          2007                                     $ 71,339
          2008                                       24,987
          2009                                        8,566
          2010                                        9,680
          2011                                       12,764
          Thereafter                                    504
                                                   --------
                                                   $127,840
                                                   ========


--------------------------------------------------------------------------------
                                      F-23

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

The weighted average interest rate on deposits was 2.01% and 1.22% at September
30, 2006 and 2005, respectively.

The aggregate amount of time deposits with a minimum denomination of $100,000
was approximately $33,462 and $58,864 at September 30, 2006 and 2005,
respectively.

Deposit account balances of related parties at September 30, 2006 and 2005 were
approximately $2,376 and $2,378, respectively.

NOTE 6. INCOME TAXES

The Company and the Bank have elected to file a consolidated tax return.
Consolidated tax expense is allocated among the entities based on the proportion
of their taxable income to consolidated taxable income.

Consolidated income tax expense consists of the following at September 30:

                                        2006     2005
                                       ------   -----
     Current
        Federal                        $3,174   1,812
        State                             638     353
                                       ------   -----
                                        3,812   2,165
                                       ------   -----
     Deferred (benefit)
        Federal                          (120)    273
        State                             (27)     59
                                       ------   -----
                                         (147)    332
                                       ------   -----
                                       $3,665   2,497
                                       ======   =====

The differences between total tax expense and the amount computed by applying
the applicable statutory federal income tax rate of 34% to income before income
taxes at September 30 were:

                                        2006     2005
                                       ------   -----
     Computed "expected" tax expense   $3,065   2,092
     State income taxes, net              631     370
     Other                                (31)     35
                                       ------   -----
                                       $3,665   2,497
                                       ======   =====

Deferred taxes are attributable to temporary differences, such as the use of
accelerated depreciation methods for tax purposes, the excess of the allowance
for loan losses for financial reporting purposes over the amount for tax
purposes which arose after 1987, differences in FHLB stock basis, the
recognition of unrealized gains and losses on securities for tax purposes, and
the deduction of loan origination costs for tax purposes. Certain unrealized
gains and losses on available-for-sale securities, which are deferred for
financial statement reporting purposes, are recognized currently for income tax
purposes.


--------------------------------------------------------------------------------
                                      F-24

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

The Company's deferred tax liabilities and assets are as follows at
September 30:

                                      2006     2005
                                    -------   ------
     Deferred tax assets:
        Allowance for loan losses   $ 1,427    1,358
        GFSB ESOP                         -      226
        Other                           161      172
                                    -------   ------
                                      1,588    1,756
     Deferred tax liabilities:
        Depreciation                   (410)    (422)
        FHLB stock dividend            (634)    (847)
        Deductible goodwill             (94)     (88)
        Other                            (7)    (268)
                                    -------   ------
                                     (1,145)  (1,625)
                                    -------   ------
        NET DEFERRED TAX ASSET      $   443      131
                                    =======   ======

During the year ended September 30, 1997, the Bank changed its method of
computing its bad debt deduction for income tax purposes from the reserve method
to the specific charge-off method. For the year ending September 30, 2005, there
were no amounts remaining to be recaptured. At September 30, 2006, the Bank had
an accumulated bad debt reserve of approximately $5,467 for federal income tax
purposes that arose in tax years beginning before December 31, 1987, as a result
of deductions taken for tax purposes only. No deferred tax liability has been
recognized on this reserve. The reserve can only be used to absorb actual loan
losses and any use for other purposes may result in taxable income at current
rates to the Bank.


--------------------------------------------------------------------------------
                                      F-25

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 7. REGULATORY MATTERS

The Company and the Bank are subject to various regulatory capital requirements
administered by its primary federal regulator, the Office of Thrift Supervision
(OTS). The Bank's failure to meet the minimum regulatory capital requirements
can initiate certain mandatory, and possible additional discretionary actions by
regulators, that if undertaken, could have a direct material effect on the Bank
and the consolidated financial statements. Under the regulatory capital adequacy
guidelines and the regulatory framework for Prompt Corrective Action, the Bank
must meet specific capital guidelines involving quantitative measures of the
Bank's assets, liabilities, and certain off balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification under the Prompt Corrective Action guidelines are also subject to
qualitative judgments by the regulators about components, risk weighting, and
other factors. Prompt Corrective Action provisions are not applicable to bank
thrift companies.

Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of: total risk-based
capital and Tier I capital to risk-weighted assets (as defined in the
regulations), Tier I capital to adjusted total assets (as defined), and tangible
capital to adjusted total assets (as defined). As discussed in greater detail
below, as of September 30, 2006 and 2005, the Bank met all of the capital
adequacy requirements to which it is subject.

As of September 30, 2006 and 2005, the Bank was categorized as "well
capitalized" under the regulatory framework for Prompt Corrective Action. To
remain categorized as well capitalized, the Bank would have to maintain minimum
total risk-based, Tier I risk-based, and Tier I leverage ratios as disclosed in
the table below. There are no conditions or events since the most recent
notification that management believes have changed the Bank's Prompt Corrective
Action category.

<TABLE>
<CAPTION>
                                                                                                   To be Well
                                                                                                Capitalized for
                                                                        Minimum for Capital    Prompt Corrective
                                                          Actual         Adequacy Purposes      Action Provision
                                                      ---------------   -------------------   -------------------
                                                      Ratio    Amount    Ratio     Amount      Ratio      Amount
                                                      ---------------   -------------------   -------------------
                                                        (Dollars in         (Dollars in           (Dollars in
                                                         Thousands)          Thousands)            Thousands)
<S>                                                   <C>     <C>       <C>       <C>         <C>       <C>
As of September 30, 2006:
   Total Capital (to risk-weighted assets)            15.58%  $56,141   >=8.00%   >=$28,834   >=10.00%  >=$36,043

   Tier I (core) Capital (to risk-weighted assets)    14.53    52,383     4.00       14,417      6.00      21,626

   Tier I (core) Capital (to adjusted total assets)    9.67    52,383     3.00       16,249      5.00      27,081

   Tangible Capital (to adjusted total assets)         9.67    52,383     1.50        8,124         -           -

As of September 30, 2005:
   Total Capital (to risk-weighted assets)            15.40%  $55,674   >=8.00%   >=$28,916   >=10.00%  >=$36,145

   Tier I (core) Capital (to risk-weighted assets)    14.35    51,874     4.00       14,458      6.00      21,687

   Tier I (core) Capital (to adjusted total assets)    9.49    51,874     3.00       16,399      5.00      27,331

   Tangible Capital (to adjusted total assets)         9.49    51,874     1.50        8,199         -           -
</TABLE>


--------------------------------------------------------------------------------
                                      F-26

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 7. REGULATORY MATTERS (CONTINUED)

As an entity regulated by the OTS, the Bank has restrictions on capital
distributions. The Board may approve dividends up to the current year's net
income plus net retained earnings from the prior two years. For a distribution
within these limits, the Bank must notify the OTS 30 days before any such
distribution.

There are other restrictions that would apply to the Bank for distributions
above the amount outlined above. At present, management is not contemplating
distributions above this level. The restrictions that would apply are set forth
in 12 CFR section 563.143.

NOTE 8. EMPLOYEE RETIREMENT PLAN

The 401(k) Plan is available to all employees who have completed three months of
service and have attained the age of 21. The rate of annual vesting is based on
employees' credited years of service with the Bank. Employees are fully vested
when they have attained six years or more of credited service. Qualifying
employees may contribute up to 15% of their annual earnings, but not in excess
of the maximum amount allowed by the Internal Revenue Service. The Plan has a
mandatory match of 4% (assuming certain levels of contributions by the
participant) and also allows the Employer to make a discretionary match above
the mandatory levels. The Bank expects to contribute approximately $235 to the
401(k) Plan during the fiscal year 2007 for the 2006 plan year. During the
fiscal year ended September 30, 2006, the Bank contributed $158 to the 401(k)
Plan for the 2005 plan year.

NOTE 9. ADVANCES FROM THE FEDERAL HOME LOAN BANK

At September 30, 2006 and 2005, the Bank had $101,136 and $107,991,
respectively, of borrowed funds comprised of advances payable to the Federal
Home Loan Bank. The advances payable, bear interest at fixed interest rates
ranging from 2.36% to 6.97%. Interest is due monthly.

Principal payments and maturities for the advances are as follows:

      Years Ending
     September 30:      Amount
     -------------     --------
          2007         $ 21,642
          2008           10,879
          2009           19,663
          2010           17,233
          2011            2,986
          Thereafter     28,733
                       --------
                       $101,136
                       ========


--------------------------------------------------------------------------------
                                      F-27

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 9. ADVANCES FROM THE FEDERAL HOME LOAN BANK (CONTINUED)

The purpose of these advances is to finance mortgage and commercial real estate
loans with fixed interest rates maturing approximately at the same time as the
related loans. This provides the Bank with a constant interest rate spread. The
advances are scheduled to mature from October 2006 to November 2025. The blanket
lien status allows the Bank to borrow up to specific loan percentages of the
eligible collateral as determined by the Federal Home Loan Bank of Dallas
(FHLB), not to exceed 35% of the Bank's total assets without specifically
listing, segregating, or delivering collateral to the FHLB. Eligible collateral
under the blanket lien for Community Financial Institutions is as follows:
first-lien mortgages on one-to-four family and multifamily (up to 75%), small
farm/agriculture loans (up to 40%) and small business loans (up to 60%). The
collateral value is adjusted for credit deficiencies, delinquencies greater than
90 days, and other types of exceptions. Although no loans are specifically
pledged, substantially all loans are subject to the blanket lien and are deemed
to be pledged to FHLB. The blanket lien status pledge also requires the Bank to
pledge its demand deposit account (approximately $37 million and $24 million at
September 30, 2006 and 2005 respectively), the capital stock of the FHLB, and
other assets pursuant to the FHLB's Advances, Collateral Pledge and Security
Agreement.

NOTE 10. SIGNIFICANT GROUP CONCENTRATION OF CREDIT RISK

The Bank's loan business activity is with customers located within the state of
New Mexico and the El Paso, Texas area. Generally, the loans are secured by real
estate, however, the Bank also makes consumer loans and commercial loans. All
loans are expected to be repaid from cash flows of the borrowers. Credit losses
arising from lending transactions are affected by the economic conditions
surrounding the agribusiness, oil and gas, military, government and
manufacturing industries within the state of New Mexico and the El Paso area.

The Bank's collateral policy is to secure all real estate loans by mortgages,
place first liens on collateral to commercial loans and perfect liens on
consumer loan products.

At September 30, 2006 and 2005, the Bank had credit commitments of $145,961 and
$102,656, respectively. At September 30, 2006 and 2005, the Bank had $75,498 and
$50,674 outstanding against those lines, respectively. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Bank uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments.

At September 30, 2006 and 2005, the Bank had $693 and $1,001 outstanding under
standby letters of credit, respectively. Standby letters of credit are
conditional commitments issued by the Bank to guarantee the performance of a
customer to a third party. Standby letters of credit generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
The credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Collateral held varies
and is required in instances where the Bank deems necessary.


--------------------------------------------------------------------------------
                                      F-28

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 11. FAIR VALUE OF FINANCIAL INSTRUMENTS

The Bank has estimated the fair values of its financial instruments as follows
as of September 30:

                                           2006                  2005
                                   -------------------   -------------------
                                   CARRYING     FAIR     Carrying     Fair
                                     VALUE      VALUE      Value      Value
                                   -------------------   -------------------
Financial assets:
   Cash and due from bank          $ 15,837   $ 15,837   $ 11,777   $ 11,777
   Interest bearing deposits
      with banks                     38,903     38,903     26,185     26,185
   Held-to-maturity investment
      securities                          7          7      2,132      2,129
   Available-for-sale investment
      securities                     47,472     47,472     64,902     64,902
   Loans held for sale                2,615      2,615      2,892      2,892
   Loans receivable, net            414,923    417,403    412,073    414,876
   Accrued interest receivable        2,188      2,188      2,036      2,036
   Federal Home Loan Bank stock       5,142      5,142      6,373      6,373
Financial liabilities:
   Deposits                         377,411    377,051    377,715    376,662
   Advances from the Federal
      Home Loan Bank                101,136     99,481    107,991    108,376
   Long-term subordinated debt       10,310      9,962     10,310     10,489
   Accrued interest payable             756        756        803        803
Off-balance sheet items:
   Credit commitments                     -     70,463          -     51,982
   Letters of credit                      -        693          -      1,001

The carrying values in the preceding tables are included in the Consolidated
Statements of Financial Condition under the applicable captions.

NOTE 12. STOCK OPTION PLANS

The Company has two stock option plans with outstanding options during the
reporting period. These plans were implemented to promote the long-term interest
of the Company and its shareholders by providing an incentive to those key
employees who contribute to the operational success of the Company. The options
generally have been fully vested at the grant date and have a term of five
years. In March 2003, the Company's CEO was granted certain options that begin
to vest in October 2006 and serially vest through January 2012, and expire in
March 2012. That group represents all the unvested stock options.

Details of the plans are as follows:

1995 STOCK OPTION PLAN. The Bank established a nonqualified stock option plan,
which provided for the granting of stock options to directors, officers and key
employees on November 1, 1995 for a term of ten years. During fiscal 1998, upon
formation of the Company, the nonqualified stock option plan was transferred to
the Holding Company. A maximum of 327,080 shares (split adjusted for the 8-1
split) of stock may be issued under the plan, as amended. The option price,
number of shares and grant date are determined at the discretion of the
Company's Board of Directors. Grantees vest in the options at a rate determined
by the Board of Directors on the date of grant. The exercise price of each
option approximates the market price of the


--------------------------------------------------------------------------------
                                      F-29

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

Company's stock on the date of grant. Options granted under the plan are
exercisable for a period not to exceed five years from the options grant date.
Shares could be authorized from either unissued or treasury shares. This plan
expired on the tenth anniversary, November 1, 2005.

2002 STOCK OPTION AND INCENTIVE PLAN. The shareholders of the Company approved
the "2002 Stock Option and Incentive Plan", (the Plan) in January 2003. The Plan
designates that options granted to employees of the Company or its affiliates
will qualify as Incentive Stock Options. Options granted to persons who are not
employees will be Non-Qualified Stock Options. Under the Plan, awards may be
made up to a maximum of 240,000 shares(split-adjusted for the 8-1 split) subject
to adjustment as defined in Section 9 of the Plan. A Committee of the Board of
Directors will insure that the exercise price of any option shall not be less
than the market value per share at the date of grant of the option, the
expiration date shall not exceed ten years from the date of grant. Other terms
and conditions, including vesting schedules may be imposed upon each grant. The
terms and conditions need not be identical among Participants. Shares could be
authorized from either unissued or treasury shares. The Plan shall continue in
effect for a term of ten years unless sooner terminated under Section 16.

A summary of common stock option transactions during the year ended September
30, 2006 follows (amounts listed below are in actual dollars):

                                              Weighted Average
                                    Options    Exercise Price
                                    -------   ----------------
Outstanding at September 30, 2005   166,400        $ 9.87
Granted                              69,950         15.15
Exercised                           (23,600)        10.29
Forfeited                            (7,150)        11.45
                                    -------
Outstanding at September 30, 2006   205,600         11.57
                                    =======
Exercisable at September 30, 2006   125,600        $12.72
                                    =======

The following table summarizes vesting activity for the year ended September 30,
2006. The unrecognized compensation cost at September 30, 2006 is expected to be
recognized over the remaining contractual weighted average period of five years.

                                  Weighted      Weighted
                                   Average       Average      Unrecognized
                                 Grant Date     Remaining     Compensation
                        Shares   Fair Value   Term (Years)        Cost
                        ------   ----------   ------------    ------------
Non-vested options at
   January 1, 2006      80,000      $4.24          5.5            $339
Vested                       -          -            -               -
Forfeited                    -          -            -               -
                        ------      -----          ---            ----
Non-vested options at
   September 30, 2006   80,000      $4.24          5.0            $299
                        ======      =====          ===            ====

During the year ended September 30, 2006, the weighted average intrinsic value
of the stock options granted was $322. No stock options were granted during the
year ended September 30, 2005. The total intrinsic value of stock options
exercised during the years ended September 30,


--------------------------------------------------------------------------------
                                      F-30

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

2006 and 2005 was $100 and $145, respectively. The total cash received from the
exercise of stock options during the years ended September 30, 2006 and 2005 was
$243 and $463, respectively.

At September 30, 2006, there were 125,600 vested, exercisable stock options
outstanding with a weighted average exercise price of $12.72 each. The aggregate
intrinsic value of these stock options was $476, and has a weighted average
contractual remaining term of 37 months.

NOTE 13. INCOME PER COMMON SHARE

Basic income per common share is calculated by dividing net income applicable to
common equity by the weighted average number of shares of common stock
outstanding for the period. Diluted income per common share is calculated by
adjusting the weighted average number of shares of common stock outstanding that
would be issued assuming the exercise of stock options during the period using
the treasury stock method. All share data has been adjusted to reflect the
effect of the May 20, 2005, 8:1 stock split. The following reconciles amounts
reported in the financial statements:

<TABLE>
<CAPTION>
                                             FOR THE YEAR ENDED SEPTEMBER 30, 2006
                                            ---------------------------------------
                                               INCOME         SHARES      PER-SHARE
                                            (NUMERATOR)   (DENOMINATOR)     AMOUNT
<S>                                            <C>          <C>             <C>
Income available to common stockholders -
   basic income per share                      $5,350       3,982,191       $1.34

Effect of dilutive securities:
   Options                                          -          51,417
                                               ------       ---------
Income available to common stockholders -
   diluted income per common share             $5,350       4,033,608       $1.33
                                               ======       =========
</TABLE>

<TABLE>
<CAPTION>
                                             For the Year Ended September 30, 2005
                                            ---------------------------------------
                                               Income         Shares      Per-share
                                            (Numerator)   (Denominator)     Amount
<S>                                            <C>          <C>             <C>
Income available to common stockholders -
   basic income per share                      $3,655       3,427,582       $1.07

Effect of dilutive securities:
   Options                                          -          63,999
                                               ------       ---------
Income available to common stockholders -
   diluted income per common share             $3,655       3,491,581       $1.05
                                               ======       =========
</TABLE>


--------------------------------------------------------------------------------
                                      F-31

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 14. JUNIOR SUBORDINATED DEBT OWED TO UNCONSOLIDATED TRUSTS

The following table presents details on the junior subordinated debt owed to the
unconsolidated trusts as of September 30, 2006:

<TABLE>
<CAPTION>
                                                      First Federal NM    First Federal NM
                                                           Trust I             Trust II
                                                     ------------------   ----------------
<S>                                                  <C>                  <C>
Date of Issue                                         January 19, 2005      May 23, 2005
Amount of trust preferred securities issued          $       7,000,000    $    3,000,000
Rate on trust preferred securities                                 5.7%            6.145%
Maturity                                                March 15, 2035     June 15, 2035
Date of first redemption                                March 15, 2010     June 15, 2010
Common equity securities issued                      $         217,000    $       93,000
Junior subordinated deferrable interest debentures
   owed                                              $       7,217,000    $    3,093,000
Rate on junior subordinated deferrable interest
   debentures                                                      5.7%            6.145%
</TABLE>

In 2005, the Trusts, each being a Delaware statutory business trust, issued
trust preferred securities (the trust preferred securities) in the amounts and
at the rates indicated above. These securities represent preferred beneficial
interests in the assets of the Trusts. The trust preferred securities will
mature on the dates indicated, and are redeemable in whole or in part at the
option of the Company at any time after the date of first redemption indicated
above, and in whole at any time upon the occurrence of certain events affecting
their tax or regulatory capital treatment. The Trusts also issued common equity
securities to the Company in the amounts indicated above. The rates on the trust
preferred securities are fixed through the respective first redemption dates.
Subsequent to those dates, the interest rate will be equal to LIBOR plus 1.85%.
The Trusts used the proceeds of the offering of the trust preferred securities
to purchase junior subordinated deferrable interest debentures (the debentures)
issued by the Company, which have terms substantially similar to the trust
preferred securities. The Company has the right to defer payments of interest on
the debentures at any time or from time to time for a period of up to 20
consecutive quarterly periods with respect to each interest payment deferred.
Under the terms of the debentures, in the event that under certain circumstances
there is an event of default under the debentures, or the Company has elected to
defer interest on the debentures, the Company may not, with certain exceptions,
declare or pay any dividends or distributions on its capital stock or purchase
or acquire any of its capital stock. The Company used the proceeds from the sale
of the debentures, in part, to fund the cash portion of the acquisition of GFSB
Bancorp, Inc.

The Company owns all of the outstanding common securities of the Trusts. Each
Trust is considered a variable interest entity (VIE) under Financial Accounting
Standards Board Interpretation (FIN) No. 46, CONSOLIDATION OF VARIABLE INTEREST
ENTITIES, AN INTERPRETATION OF ACCOUNTING RESEARCH BULLETIN NO. 51, as revised.
Prior to FIN 46, VIEs were generally consolidated by an enterprise when the
enterprise had a controlling financial interest through ownership of a majority
of voting interest in the entity. Under FIN 46, a VIE should be consolidated by
its primary beneficiary. Because the Company is not the primary beneficiary of
the Trust, the financial statements of the Trust are not included in the
consolidated financial statements of the Company.


--------------------------------------------------------------------------------
                                      F-32

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE 14. JUNIOR SUBORDINATED DEBT OWED TO UNCONSOLIDATED TRUSTS (CONTINUED)

Payments of distributions on the trust preferred securities and payments on
redemption of the trust preferred securities are guaranteed by the Company on a
limited basis. The obligations of the Company under the junior subordinated
debentures, the related indentures, the trust agreements establishing the
Trusts, the guarantees and the agreements as to expenses and liabilities, in the
aggregate, constitute a full and unconditional guarantee by the Company of the
Trust's obligations under the trust preferred securities.

NOTE 15. ACQUISITION

After the close of business on May 31, 2005, the Company completed its
acquisition of GFSB Bancorp, Inc (GFSB). The results of GFSB's operations have
been included in the consolidated financial statements since June 1, 2005. The
following table depicts select balances of GFSB as of May 31, 2005:

  May 31, 2005 (1)                                    ($ amounts in thousands)

  Cash and due from banks                                     $  7,404
  Available for sale investment securities                      24,516
  Available for sale mortgage-backed securities                 23,285
  Loans receivable, net                                        139,604
  Other assets                                                   7,677
                                                              --------
     Total assets                                             $202,486
                                                              ========

  Demand deposits and NOW accounts                              32,727
  Savings and money market accounts                             22,834
  Time deposits                                                 73,915
  Advances from Federal Home Loan Bank                          48,154
  Other liabilities                                              5,250
                                                              --------
     Total liabilities                                         182,880

  Total stockholders' equity                                    19,606
                                                              --------
     Total liabilities and stockholders equity                $202,486
                                                              ========

  (1)  Amounts are book value.

The acquisition of GFSB increased the geographic footprint of the Company and
allowed shareholders an interest in a larger entity with access to the public
markets. The Company hopes to realize cost savings and efficiencies by combining
the respective operations. The value of the long-term nature of the customer
base contributed to a purchase price in excess of GFSB's book values.


--------------------------------------------------------------------------------
                                      F-33

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

Pursuant to the Merger Agreement, all shareholders of GFSB that properly elected
and surrendered their GFSB shares received in exchange for each of their shares
either $20 in cash, 1.17806 shares of the Company's common stock, or a
combination of the merger consideration (51% stock and 49% cash). Those
shareholders not properly electing pursuant to the Merger Agreement received
merger consideration for each of their shares of $6.0588 in cash and 0.821178789
shares of common stock. Additionally, all outstanding stock options for GFSB
officers and directors were cancelled by providing merger consideration for the
difference between the strike price of the option and $20.

The Merger Agreement stated the value of each share of common stock of the
Company was $16.977. The Company issued 720,765 shares of common stock at a
value of approximately $12.2 million. In addition, GFSB shareholders were paid
approximately $11.9 million in cash. Including certain costs to complete the
acquisition, the total cost was approximately $24.9 million. The acquisition was
accounted for under the purchase method of accounting in accordance with SFAS
No. 141. Under this method of accounting, the purchase price was allocated to
assets acquired and liabilities assumed based on their fair values at the
acquisition date.

As required by SFAS No. 141, the purchase method of accounting was used to
record the acquisition. This method requires that assets and liabilities be
recorded at the market value as of the acquisition date. As a result, certain
adjustments are necessary to transform the basis of some of the assets and
liabilities of the acquired entity to the new market values. The following table
reflects the significant adjustments made to the carrying values of certain GFSB
assets and liabilities to adjust them to there respective market values as of
the acquisition date and the related amortization periods:

     Category                                  Dr/(Cr)   Life (months)
     ---------------------------------------   -------   -------------

     Additional adjustment to AFS Securities    $(168)      various
     Loans                                        (43)      60
     Property (buildings)                         193       120
     Time Deposits                                122       14
     FHLB Advances                               (620)      23

NOTE 16. GOODWILL AND INTANGIBLE ASSETS

The change in the balance for goodwill during the years ended September 30, 2006
and 2005 as follows:

                                     2006     2005
                                    ------   ------
     Balance at beginning of year   $2,286   $  409
     Acquired goodwill                   -    1,877
                                    ------   ------
     End of year                    $2,286   $2,286
                                    ======   ======

Goodwill is tested annually for impairment as required under SFAS 142. The total
acquired goodwill is not deductible for tax purposed under current regulations.


--------------------------------------------------------------------------------
                                      F-34

<PAGE>

FIRST FEDERAL BANC OF THE SOUTHWEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, 2006 AND 2005

Intangible assets were as follows as of September 30:

                                         2006                      2005
                               -----------------------   -----------------------
                                 GROSS                     Gross
                               CARRYING    ACCUMULATED   Carrying    ACCUMULATED
                                AMOUNT    AMORTIZATION    Amount    AMORTIZATION
                               --------   ------------   --------   ------------
Amortized intangible assets:
   Core deposit intangibles     $3,015         447        $3,015         112
   Capitalized costs of
      GFSB acquisition             770         114           770          28
                                ------         ---        ------         ---
Total                           $3,785         561        $3,785         140
                                ======         ===        ======         ===

Aggregate amortization expense was $421 and $140 for the years ended September
30, 2006 and September 30, 2005, respectively.

Estimated amortization expense for each of the next five years is as follows:

      2007   $421
      2008    421
      2009    421
      2010    421
      2011    421

NOTE 17. SUBSEQUENT EVENTS

On October 10, 2006 the Company entered into a definitive agreement with
Washington Federal, Inc., ("Washington Federal") whereby Washington Federal
would acquire all of the outstanding common stock of the Company for $24.14
cash, per share. The merger agreement calls for the merger of the Company with
and into Washington Federal, followed by the merger of First Federal Bank into
Washington Federal's wholly owned subsidiary, Washington Federal Savings. The
aggregate consideration to be paid in connection with the merger is $99 million
for the shares of common stock and vested employee stock options outstanding
immediately prior to the effective time of the merger. The merger is expected to
close in the first calendar quarter of 2007, pending the receipt of all
requisite regulatory approvals and approval of the Company's shareholders.


--------------------------------------------------------------------------------
                                      F-35