** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-K**

** **
| **x**      | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     | ** ** | ** ** |
|------------|------------|------------------------------------------------------------------------------------------------|------------|------------|
| ** ** | ** ** | ** **                                                                                     | ** ** | ** ** |
| ** ** | ** ** | **For the  fiscal year ended December 31, 2006**                                               | ** ** | ** ** |
| ** ** | ** ** | ** **                                                                                     | ** ** | ** ** |
| ** ** | ** ** | **OR**                                                                                         | ** ** | ** ** |
| ** ** | ** ** | ** **                                                                                     | ** ** | ** ** |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** | ** ** | ** ** |

** **

**For the transition periodfrom                      to                     **

** **

**Commission File No.:*** *0-28312

** **

**First Federal Bancshares of Arkansas, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Texas**                          |   | **71-0785261**          |
|------------------------------------|--------|-------------------------|
| (State or other  jurisdiction      |   | (I.R.S. Employer        |
| of incorporation  or organization) |   | Identification  Number) |
|                               |   |                    |
| **1401  Highway 62-65 North**      |   |                    |
| **Harrison,  Arkansas**            |   | **72601**               |
| (Address)                          |   | (Zip Code)              |

 

Registrant’s telephone number, including area code:**  (870) 741-7641**

 

Securities registered pursuant to Section 12(b) of theAct:

 

| **Common Stock (par value $.01 per share)** |   | **The  Nasdaq Stock Market LLC** |
|---------------------------------------------|--------|----------------------------------|
| (Title of Class)                            |   | (Exchange on  which registered)  |

 

Securities registered pursuant to Section 12(g) of theAct

**None**

** **

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act. Yes o   No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act. Yes o   No x

Indicate by check markwhether the Registrant (1) has filed all reports required by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days. Yes x   No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer.

Large Accelerated Filer o         AcceleratedFiler x         Non-accelerated Filer o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12B-2 of theAct). Yes o   No x

As of June 30, 2006, theaggregate value of the 4,406,332 shares of Common Stock of the Registrantissued and outstanding on such date, which excludes 613,924 shares held bydirectors and officers of the Registrant as a group, was approximately $98.7million.  This figure is based on thelast sales price of $22.40 per share of the Registrant’s Common Stock on June30, 2006.

Number of shares of Common Stock outstanding as ofFebruary 23, 2007:  4,869,871

**DOCUMENTSINCORPORATED BY REFERENCE**

List hereunder thefollowing documents incorporated by reference and the Part of the Form 10-Kinto which the document is incorporated.

Portions of the definitive proxy statement for the2007 Annual Meeting of Stockholders are incorporated into Part III, Items 10through 14 of this Form 10-K.

 

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**FirstFederal Bancshares of Arkansas, Inc.**

**Form10-K**

**Forthe Year Ended December 31, 2006**
| **PART I.**   |   |                                                                                                               |   |   |   |
|---------------|--------|--------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| Item 1.       |   | Business                                                                                                           |   |   |   |
| Item  1A.     |   | Risk Factors                                                                                                       |   |   |   |
| Item 1B.      |   | Unresolved Staff Comments                                                                                          |   |   |   |
| Item 2.       |   | Properties                                                                                                         |   |   |   |
| Item  3.      |   | Legal Proceedings                                                                                                  |   |   |   |
| Item 4.       |   | Submission of Matters to a Vote of Security Holders                                                                |   |   |   |
|          |   |                                                                                                               |   |   |   |
| **PART II.**  |   |                                                                                                               |   |   |   |
| Item 5.       |   | Market for Registrant’s Common Equity, Related Stockholder  Matters and Issuer Purchases of Equity Securities |   |   |   |
| Item 6.       |   | Selected Financial Data                                                                                            |   |   |   |
| Item 7.       |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |   |   |   |
| Item 7A.      |   | Quantitative and Qualitative Disclosures About Market  Risk                                                        |   |   |   |
| Item 8.       |   | Financial Statements and Supplementary Data                                                                        |   |   |   |
| Item 9.       |   | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |   |   |   |
| Item 9A.      |   | Controls and Procedures                                                                                            |   |   |   |
| Item  9B.     |   | Other Information                                                                                                  |   |   |   |
|          |   |                                                                                                               |   |   |   |
| **PART III.** |   |                                                                                                               |   |   |   |
| Item 10.      |   | Directors, Executive Officers and Corporate Governance                                                             |   |   |   |
| Item 11.      |   | Executive Compensation                                                                                             |   |   |   |
| Item 12.      |   | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                    |   |   |   |
| Item 13.      |   | Certain Relationships and Related Transactions, and  Director Independence                                         |   |   |   |
| Item 14.      |   | Principal Accountant Fees and Services                                                                             |   |   |   |
|          |   |                                                                                                               |   |   |   |
| **PART IV.**  |   |                                                                                                               |   |   |   |
| Item 15.      |   | Exhibits and Financial Statement Schedules                                                                         |   |   |   |

 

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**PART I.**

**Item 1. Business**

**FirstFederal Bancshares of Arkansas, Inc. **FirstFederal Bancshares of Arkansas, Inc. (the “Company”) is a Texas corporationorganized in January 1996 by First Federal Bank (“First Federal” or the “Bank”)for the purpose of becoming a unitary holding company of the Bank.  The only significant assets of the Companyare the capital stock of the Bank and cash. The business and management of the Company consists of the business andmanagement of the Bank.  The Company doesnot presently own or lease any property, but instead uses the premises,equipment and furniture of the Bank.  Atthe present time, the Company does not employ any persons other than officersof the Bank, and the Company utilizes the support staff of the Bank from timeto time.  Additional employees will behired as appropriate to the extent the Company expands or changes its businessin the future.  At December 31, 2006, theCompany had $852.5 million in total assets, $652.3 million in total depositsand $75.6 million in stockholders’ equity.

The Company’s executiveoffice is located at the home office of the Bank at 1401 Highway 62-65 North,Harrison, Arkansas 72601, and its telephone number is (870) 741-7641.

**FirstFederal Bank. **The Bankis a federally chartered stock savings and loan association formed in1934.  First Federal conducts businessfrom its main office and seventeen full service branch offices, all of whichare located in a six county area in Northcentral and Northwest Arkansascomprised of Benton, Marion, Washington, Carroll, Baxter and Boonecounties.  First Federal’s deposits areinsured by the Deposit Insurance Fund (“DIF”), which is administered by theFederal Deposit Insurance Corporation (“FDIC”), to the maximum extent permittedby law.

The Bank is a community-oriented financial institution offering awide range of retail and business deposit accounts, including noninterestbearing and interest bearing checking, savings and money market accounts,certificates of deposit, and individual retirement accounts.  Loan products offered by the Bank includeresidential real estate, consumer, construction, lines of credit, commercialreal estate and commercial non-real estate. Other financial services include investment products offered throughFirst Federal Investment Services, Inc.; automated teller machines; 24-hourtelephone banking; internet banking, including account access, bill payment,e-statements and online loan applications; Bounce ProtectionTM overdraft service; debit cards; and safedeposit boxes.

The Bank is subject toexamination and comprehensive regulation by the Office of Thrift Supervision (“OTS”),which is the Bank’s chartering authority and primary regulator.  The Bank is also regulated by the FDIC, theadministrator of the DIF.  The Bank isalso subject to certain reserve requirements established by the Board ofGovernors of the Federal Reserve System (“FRB”) and is a member of the FederalHome Loan Bank (“FHLB”) of Dallas, which is one of the 12 regional bankscomprising the FHLB System.

This Form 10-K containscertain forward-looking statements and information relating to the Company thatare based on the beliefs of management as well as assumptions made by andinformation currently available to management. In addition, in those and other portions of this document, the words “anticipate,”“believe,” “estimate,” “expect,” “intend,” “should” and similar expressions, orthe negative thereof, as they relate to the Company or the Company’smanagement, are intended to identify forward-looking statements.  Such statements reflect the current views ofthe Company with respect to future looking events and are subject to certainrisks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize or shouldunderlying assumptions prove incorrect, actual results may vary materially fromthose described herein as anticipated, believed, estimated, expected orintended.  The Company does not intend toupdate these forward-looking statements.

**Employees**

The Bank had 279 full-timeemployees and 50 part-time employees at December 31, 2006, compared to 283full-time employees and 50 part-time employees at December 31, 2005.   None of these employees is represented by acollective bargaining agent, and the Bank believes that it enjoys goodrelations with its personnel.

**AvailableInformation**

The Company makesavailable free of charge its annual report on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K, and all amendments to such reportsfiled pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of1934, as soon as reasonably practicable on or through its website located atwww.ffbh.com after filing with the United States Securities and ExchangeCommission (“SEC”).

1

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**Competition**

The Bank facesstrong competition both in attracting deposits and making loans.  Its most direct competition for deposits hashistorically come from other savings associations, community banks, creditunions and commercial banks, including many large financial institutions thathave greater financial and marketing resources available to them.  In addition, the Bank has faced additionalsignificant competition for investors’ funds from short-term money marketsecurities, mutual funds and other corporate and government securities.  The ability of the Bank to attract and retainsavings and certificates of deposit depends on its ability to generally providea rate of return, liquidity and risk comparable to that offered by competinginvestment opportunities.  The Bank’sability to increase checking deposits depends on offering competitive checkingaccounts and promoting these products through effective channels.  Additionally, the Bank offers convenienthours, locations and online services to maintain and attract customers.

The Bank experiencesstrong competition for loans principally from savings associations, communitybanks, commercial banks and mortgage companies. New community banks as well as well-established financial institutionsare continuing to establish branches in the Washington-Benton county area,providing for increased competition. The Bank competes for loans principallythrough the interest rates and loan fees it charges and the efficiency andquality of services it provides borrowers.

**LendingActivities**

**General. **At December 31, 2006, theBank’s portfolio of net loans receivable amounted to $693.1 million or 81.3% ofthe Company’s total assets.  The Bank hastraditionally concentrated its lending activities on loans collateralized byreal estate.  Consistent with suchapproach, $625.2 million or 85.0% of the Bank’s total portfolio of loansreceivable (“total loan portfolio”) consisted of loans collateralized by firstmortgage loans at December 31, 2006.

In recent years, the Bankhas placed an increased emphasis on commercial real estate lending,construction lending, and commercial lending in order to diversify its loanportfolio, take advantage of market opportunities for these types of loans, andtransition to more of a full-service community bank.  The table below summarizes the changes in thecomposition of the loan portfolio between December 31, 2002, which is theearliest year presented in the loan composition table on page 3, and December31, 2006 (dollars in thousands):

 
| ** **               | ** ** | **2006 vs 2002**   | ** ** | **December 31,**         | ** ** |
|--------------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **               | ** ** | **Increase (Decrease)** | ** ** | **2006**                      | ** ** | **2002** | ** ** |
| ** **               | ** ** | **Amount**                   | ** ** | **Percentage  of Loans** | ** ** | **Amount** | ** ** | **Percentage  of Loans** | ** ** | **Amount** | ** ** | **Percentage  of Loans** | ** ** |
| ** **               | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Real estate  loans:      |       |                         |       |                          |       |   |   |   |   |   |   |   |   |
| 1-4 family residential   |       | $                            | (37,986    | )                             | (22.89     | )% | $ | 251,120 |   | 34.14 | % | $ | 289,106 |   | 57.03 | % |
| Multi-family residential |       | 6,079                        |       | 0.47                          |       | 11,900 |   | 1.62 |   | 5,821 |   | 1.15 |   |
| Commercial real estate   |       | 91,004                       |       | 7.76                          |       | 166,238 |   | 22.60 |   | 75,234 |   | 14.84 |   |
| Construction             |       | 146,758                      |       | 16.94                         |       | 195,902 |   | 26.63 |   | 49,144 |   | 9.69 |   |
| Total real estate loans  |       | 205,855                      |       | 2.28                          |       | 625,160 |   | 84.99 |   | 419,305 |   | 82.71 |   |
|                     |       |                         |       |                          |       |   |   |   |   |   |   |   |   |
| Commercial loans         |       | 16,806                       |       | 1.08                          |       | 36,407 |   | 4.95 |   | 19,601 |   | 3.87 |   |
|                     |       |                         |       |                          |       |   |   |   |   |   |   |   |   |
| Consumer loans           |       | 5,979                        |       | (3.36                         | )          | 74,026 |   | 10.06 |   | 68,047 |   | 13.42 |   |
|                     |       |                         |       |                          |       |   |   |   |   |   |   |   |   |
| Total (1)                |       | $                            | 228,640    |                          | 0.00       | % | $ | 735,593 |   | 100.00 | % | $ | 506,953 |   | 100.00 | % |
|                     |       |                         |       |                          |       |   |   |   |   |   |   |   |   |

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(1) Gross of undisbursedloan funds, unearned discounts and net deferred loan fees and the allowance forloan losses.

Commercial real estate,construction and commercial lending are generally considered to involve ahigher degree of risk than residential real estate lending due to therelatively larger loan amounts and the effect of general economic conditions onthe successful operation of the related business and/or income-producingproperties.  The Bank has attempted toreduce such risk by evaluating the credit history and past performance of theborrower, the quality of the borrower’s management, the debt service ratio, thequality and characteristics of the income stream generated by the business orthe property and appraisals supporting the property’s valuation asapplicable.  However, these types ofloans, and construction loans in particular, have largely been the reason forthe Bank’s significant increase in nonaccrual loans between 2005 and 2006.  See “Asset Quality.”

2

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**LoanComposition. **Thefollowing table sets forth certain data relating to the composition of the Bank’sloan portfolio by type of loan at the dates indicated.

 
| ** **                                             | ** ** | **December 31,**                | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                             | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                             | ** ** | **Amount**                           | ** ** | **Percentage  of Loans** | ** ** | **Amount** | ** ** | **Percentage  of Loans** | ** ** | **Amount** | ** ** | **Percentage  of Loans** | ** ** | **Amount** | ** ** | **Percentage  of Loans** | ** ** | **Amount** | ** ** | **Percentage  of Loans** | ** ** |
| ** **                                             | ** ** | **(Dollars in Thousands)** | ** ** |
| ** **                                             | ** ** | ** **                           | ** ** |
| Real estate loans:                                     |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 1-4 family residential                                 |       | $                                    | 251,120    |   | 34.14 | % | $ | 269,660 |   | 34.11 | % | $ | 282,144 |   | 40.35 | % | $ | 259,121 |   | 47.09 | % | $ | 289,106 |   | 57.03 | % |
| Multi-family residential                               |       | 11,900                               |       | 1.62 |   | 12,900 |   | 1.63 |   | 9,454 |   | 1.35 |   | 7,673 |   | 1.39 |   | 5,821 |   | 1.15 |   |
| Commercial real estate                                 |       | 166,238                              |       | 22.60 |   | 157,678 |   | 19.95 |   | 145,909 |   | 20.87 |   | 97,310 |   | 17.69 |   | 75,234 |   | 14.84 |   |
| Construction                                           |       | 195,902                              |       | 26.63 |   | 239,062 |   | 30.24 |   | 159,111 |   | 22.76 |   | 89,332 |   | 16.24 |   | 49,144 |   | 9.69 |   |
| Total first mortgage loans                             |       | 625,160                              |       | 84.99 |   | 679,300 |   | 85.93 |   | 596,618 |   | 85.33 |   | 453,436 |   | 82.41 |   | 419,305 |   | 82.71 |   |
|                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial loans                                       |       | 36,407                               |       | 4.95 |   | 32,693 |   | 4.14 |   | 27,545 |   | 3.94 |   | 21,491 |   | 3.91 |   | 19,601 |   | 3.87 |   |
|                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer loans:                                        |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Home equity and second mortgage loans                  |       | 48,665                               |       | 6.62 |   | 49,680 |   | 6.28 |   | 45,256 |   | 6.47 |   | 42,421 |   | 7.71 |   | 35,856 |   | 7.07 |   |
| Automobile                                             |       | 12,090                               |       | 1.64 |   | 15,748 |   | 1.99 |   | 19,101 |   | 2.73 |   | 22,087 |   | 4.01 |   | 22,570 |   | 4.45 |   |
| Other                                                  |       | 13,271                               |       | 1.80 |   | 13,149 |   | 1.66 |   | 10,685 |   | 1.53 |   | 10,780 |   | 1.96 |   | 9,621 |   | 1.90 |   |
| Total consumer loans                                   |       | 74,026                               |       | 10.06 |   | 78,577 |   | 9.93 |   | 75,042 |   | 10.73 |   | 75,288 |   | 13.68 |   | 68,047 |   | 13.42 |   |
|                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total loans receivable                                 |       | 735,593                              |       | 100.00 | % | 790,570 |   | 100.00 | % | 699,205 |   | 100.00 | % | 550,215 |   | 100.00 | % | 506,953 |   | 100.00 | % |
|                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Less:                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Undisbursed loan funds                                 |       | (40,069                              | )          |   |   | (69,086 | ) |   |   | (62,661 | ) |   |   | (35,181 | ) |   |   | (20,618 | ) |   |   |
| Unearned discounts and net deferred loan costs  (fees) |       | 143                                  |       |   |   | (156 | ) |   |   | (481 | ) |   |   | (657 | ) |   |   | (1,338 | ) |   |   |
| Allowance for loan losses                              |       | (2,572                               | )          |   |   | (2,114 | ) |   |   | (1,846 | ) |   |   | (1,621 | ) |   |   | (1,529 | ) |   |   |
| Total loans receivable, net                            |       | $                                    | 693,095    |   |   |   | $ | 719,214 |   |   |   | $ | 634,217 |   |   |   | $ | 512,756 |   |   |   | $ | 483,468 |   |   |   |
|                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

 

3

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**LoanMaturity and Interest Rates. **Thefollowing table sets forth certain information at December 31, 2006, regardingthe dollar amount of loans maturing in the Bank’s loan portfolio based on theircontractual terms to maturity.  Demandloans and loans having no stated schedule of repayments and no stated maturityare reported as due in one year or less. All other loans are included in theperiod in which the final contractual repayment is due.

 
| ** **               | ** ** | **Within  One Year** | ** ** | **One Year  Through Five  Years** | ** ** | **After Five  Years** | ** ** | **Total** | ** ** |
|--------------------------|------------|---------------------------|------------|---------------------------------------------|------------|----------------------------|------------|-----------|------------|
| ** **               | ** ** | **(In Thousands)**   | ** ** |
| ** **               | ** ** | ** **                | ** ** |
| Real estate loans:       |       |                      |       |                                        |       |                       |       |      |       |
| 1-4 family residential   |       | $                         | 4,100      |                                        | $          | 17,994                     |       | $         | 229,026    |   | $ | 251,120 |   |
| Multi-family residential |       | —                    |       | 6,697                                       |       | 5,203                      |       | 11,900    |       |
| Commercial real estate   |       | 46,600                    |       | 103,365                                     |       | 16,273                     |       | 166,238   |       |
| Construction             |       | 185,490                   |       | 10,412                                      |       | —                     |       | 195,902   |       |
| Commercial loans         |       | 23,233                    |       | 11,639                                      |       | 1,535                      |       | 36,407    |       |
| Consumer loans           |       | 35,989                    |       | 33,706                                      |       | 4,331                      |       | 74,026    |       |
| Total(1)                 |       | $                         | 295,412    |                                        | $          | 183,813                    |       | $         | 256,368    |   | $ | 735,593 |   |
|                     |       |                      |       |                                        |       |                       |       |      |       |

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(1)             Gross of undisbursed loan funds,unearned discounts and net deferred loan fees and the allowance for loanlosses.

The following table sets forth the dollar amount ofthe Bank’s loans at December 31, 2006, due after one year from such date whichhave fixed interest rates or which have floating or adjustable interest rates.
| ** **                | ** ** | **Fixed Rates**    | ** ** | **Floating or  Adjustable Rates** | ** ** | **Total** | ** ** |
|---------------------------|------------|-------------------------|------------|---------------------------------------------|------------|-----------|------------|
| ** **                | ** ** | **(In Thousands)** | ** ** |
| ** **                | ** ** | ** **              | ** ** |
| Real estate loans:        |       |                    |       |                                        |       |      |       |
| 1-4 family  residential   |       | $                       | 51,089     |                                        | $          | 195,931   |       | $ | 247,020 |   |
| Multi-family  residential |       | 8,952                   |       | 2,948                                       |       | 11,900    |       |
| Commercial real  estate   |       | 116,845                 |       | 2,793                                       |       | 119,638   |       |
| Construction              |       | 10,412                  |       | —                                      |       | 10,412    |       |
| Commercial loans          |       | 11,137                  |       | 2,037                                       |       | 13,174    |       |
| Consumer loans            |       | 31,412                  |       | 6,625                                       |       | 38,037    |       |
| Total                     |       | $                       | 229,847    |                                        | $          | 210,334   |       | $ | 440,181 |   |

 

Scheduled contractualmaturities of loans do not necessarily reflect the actual term of the Bank’sloan portfolio. The average life of mortgage loans is substantially less thantheir average contractual terms because of loan prepayments andrefinancing.  The average life ofmortgage loans tends to increase, however, when current mortgage loan ratessubstantially exceed rates on existing mortgage loans and, conversely, decreasewhen rates on existing mortgage loans substantially exceed current mortgageloan rates.

**Origination,Purchase and Sale of Loans.** The lending activities of the Bank are subject to the written,non-discriminatory underwriting standards and policies established by the Bank’sboard of directors and management.  Loanoriginations are obtained from a variety of sources, including realtorreferrals, walk-in customers to the Bank’s branch locations, solicitation byloan officers, radio, television and newspaper advertising, and to a lesserextent, through the Bank’s Internet website. The Bank continually emphasizes its community ties and its practice ofquick and efficient underwriting and loan approval processes, made possible inpart through the use of automated underwriting software.  The Bank believes it provides exceptionalpersonalized service to its customers. The Bank requires hazard insurance, title insurance, and to the extentapplicable, flood insurance on all secured real property.

Applications areinitially received by loan officers or from the Bank’s secure website.   Applications received over the Bank’swebsite are forwarded to loan officers. All loans exceeding individual officer’s approval authority are subjectto review by members of the appropriate loan committee. The Bank has three loancommittees (Senior Loan Committee, Executive Loan Committee, and Director LoanCommittee) which review and make a decision based upon type, size, andclassification.

During 2006, the Bankpurchased a commercial construction loan with a commitment amount of$100,000.  During 2005, the Bankpurchased a $397,000 participation in a commercial real estate loan.  During 2004, the Bank purchasedparticipations in five commercial construction loans with a total commitmentamount of $13.8 million as well as a $1.2 million participation in a commercialreal estate loan.  All participations purchasedwere current as of December 31, 2006.

4

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To minimize interest raterisk, fixed rate loans with terms of fifteen years or greater are typicallysold to specific investors in the secondary mortgage market.  The rights to service such loans aretypically sold with the loans. This allows the Bank to provide its customerscompetitive long-term fixed rate mortgage products, which are very popularfinancing products for home buyers in today’s market, while not exposing theBank to undue interest rate risk.  Theseloans are originated subject to Fannie Mae, Freddie Mac and the specificinvestor’s underwriting guidelines and are typically underwritten and validatedby a third party prior to loan closing. The Secondary Market Department of the Bank typically locks and confirmsthe purchase price of the loan on the day of the loan application, whichprotects the Bank from market price movements and ensures that the Bank willreceive a fair and reasonable price on the sale of the respective loan.  Due to the loans being underwritten by athird party, the repurchase risk associated with these loans is substantiallyassumed by the underwriter.  The Bankbelieves it has minimal risk of repurchase of these loans based upon thecontracts with the specific investors. This risk typically involves potential early prepayments of the mortgageor an early default of a loan.  In 2006,2005, and 2004, the Bank was not required to repurchase any loans.  In 2006, 2005, and 2004, the Bank’s secondarymarket loan sales amounted to $69.4 million, $55.4 million, and $45.8 million,respectively.  The Bank is not involvedin loan hedging or other speculative mortgage loan origination activities.

In addition to sales ofloans on the secondary market, the Bank periodically sells larger commercialloans or participations in such loans in order to comply with the Bank’s loansto one borrower limit or for credit concentration purposes.  In such situations the loans are typicallysold with servicing retained.  During theyears ended December 31, 2006, 2005, and 2004, such loans sold amounted toapproximately $3.4 million, $1.8 million, and $21.5 million, respectively.  At December 31, 2006, 2005, and 2004, thebalances of loans sold with servicing retained were approximately $22.2million, $19.6 million, and $18.9 million, respectively.   Loan servicing fee income for the yearsended December 31, 2006, 2005, and 2004, was approximately $121,000, $100,000,and $159,000, respectively.

The following table showsthe Bank’s originations, sales, purchases, and repayments of loans during the periodsindicated.

 
| ** **                               | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------|------------|--------------------------------------------|------------|
| ** **                               | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **(In Thousands)**                    | ** ** |
| ** **                               | ** ** | ** **                                 | ** ** |
| Loans receivable  at beginning of period |       | $                                          | 790,570    |   | $ | 699,205 |   | $ | 550,215 |   |
| Loan  originations:                      |       |                                       |       |   |   |   |   |
| Real estate:                             |       |                                       |       |   |   |   |   |
| 1-4 family residential                   |       | 119,859                                    |       | 121,270 |   | 135,584 |   |
| Multi-family residential                 |       | 3,034                                      |       | 6,341 |   | 11,303 |   |
| Commercial real estate                   |       | 54,953                                     |       | 69,115 |   | 94,508 |   |
| Construction                             |       | 93,557                                     |       | 195,784 |   | 158,929 |   |
| Commercial loans                         |       | 21,861                                     |       | 29,862 |   | 28,008 |   |
| Consumer:                                |       |                                       |       |   |   |   |   |
| Home equity and second mortgage loans    |       | 46,258                                     |       | 41,661 |   | 36,135 |   |
| Automobile                               |       | 7,678                                      |       | 9,537 |   | 12,467 |   |
| Other                                    |       | 13,008                                     |       | 11,710 |   | 9,851 |   |
| Total loan originations                  |       | 360,208                                    |       | 485,280 |   | 486,785 |   |
| Loan purchases                           |       | 100                                        |       | 397 |   | 15,000 |   |
| Repayments                               |       | (336,927                                   | )          | (336,427 | ) | (284,830 | ) |
| Loan sales                               |       | (72,857                                    | )          | (57,150 | ) | (67,301 | ) |
| Transfers to  real estate owned          |       | (6,284                                     | )          | (1,002 | ) | (894 | ) |
| Other                                    |       | 783                                        |       | 267 |   | 230 |   |
| Net loan  activity                       |       | (54,977                                    | )          | 91,365 |   | 148,990 |   |
| Loans receivable  at end of period(1)    |       | $                                          | 735,593    |   | $ | 790,570 |   | $ | 699,205 |   |
|                                     |       |                                       |       |   |   |   |   |

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(1)             Grossof undisbursed loan funds, unearned discounts and net loan fees and theallowance for loan losses.

**Loansto One Borrower. **Asavings institution generally may not make loans to one borrower and relatedentities in an amount which exceeds 15% of its unimpaired capital and surplus,although loans in an amount equal to an additional 10% of unimpaired capitaland surplus may be made to a borrower if the loans are fully secured by readilymarketable securities.  At December 31,2006, the Bank’s limit on loans to one borrower was approximately $11.5million.  At December 31, 2006, the Bank’slargest loan or group of loans to one borrower, including persons or entitiesrelated to the borrower, amounted to $10.8 million, including undisbursed loanfunds.  The Bank’s ten largest loans orgroups of loans to one borrower, including persons or entities related to theborrower, including unfunded commitments, totaled $92.7 million atDecember 31, 2006.  Two of theseloans, both related to one borrower, and totaling $7.4 million, includingundisbursed loan funds, were 90 days or more past due at December 31,2006.  The funded amount of these twoloans totaled $5.3 million at December 31, 2006.  See “Asset Quality” for a discussion of theseloans.

5

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**One-to Four-Family Residential Real Estate Loans. **The Bank has historically concentrated its lendingactivities on the origination of loans collateralized by first mortgage lienson existing one- to four-family residences. At December 31, 2006, $251.1 million or 34.1% of the Bank’s totalloan portfolio consisted of one- to four-family residential real estateloans.   Of the $251.1 million of suchloans at December 31, 2006, $195.9 million or 78.0% had adjustable ratesof interest (including $43.6 million of seven-year adjustable rate loans) and$55.2 million or 22.0% had fixed rates of interest.

The Bank currentlyoriginates both fixed rate and adjustable rate one- to four-family residentialmortgage loans.  The Bank’s fixed rateloans to be held in portfolio are typically originated with maximum terms of fifteenyears and are typically fully amortizing with monthly payments sufficient torepay the total amount of the loan with interest by the end of the loanterm.  The Bank does offer fixed rateloans with terms exceeding fifteen years and such loans are typically sold inthe secondary market.  The Bank’s one- tofour-family loans are typically originated under terms, conditions anddocumentation which permit them to be sold to U.S. Government-sponsoredagencies such as Fannie Mae or Freddie Mac. However, as stated above, such loans with terms of less than fifteenyears are generally originated for portfolio while substantially all of suchloans with terms of fifteen years or longer are sold in the secondarymarket.  The Bank’s fixed rate loanstypically include “due on sale” clauses.

The Bank’s adjustablerate mortgage loans that are held in the portfolio typically provide for aninterest rate which adjusts every one, three, five or seven years in accordancewith a designated index plus a margin. Such loans are typically based on a 15-, 20-, 25- or 30-yearamortization schedule.  The Bankgenerally does not offer below market rates, and the amount of any increase ordecrease in the interest rate per one- or three-year period is generallylimited to 2%, with a limit of 6% over the life of the loan.  The Bank’s five-year adjustable rate loansprovide that any increase or decrease in the interest rate per period islimited to 3%, with a limit of 6% over the life of the loan.  The Bank’s seven-year adjustable rate loansprovide that any increase or decrease in the interest rate per period islimited to 5%, with a limit of 5% over the life of the loan.  The Bank’s adjustable rate loans areassumable (generally without release of the initial borrower), do not containprepayment penalties and do not provide for negative amortization.  The Bank’s adjustable rate mortgage loanstypically include “due on sale” clauses. The Bank generally underwrites itsone- and three-year adjustable rate loans on the basis of the borrowers’ability to pay at the rate after the first interest rate adjustment.  Adjustable rate loans decrease the risksassociated with changes in interest rates but involve other risks, primarilybecause as interest rates rise, the payment by the borrower rises to the extentpermitted by the terms of the loan, thereby increasing the potential fordefault.  At the same time, themarketability of the underlying property may be adversely affected by higherinterest rates.

The Bank’s residentialmortgage loans generally do not exceed 80% of the appraised value of thesecured property. However, pursuant to the underwriting guidelines adopted bythe board of directors, the Bank may lend up to 100% of the appraised value ofthe property securing a one- to four-family residential loan with privatemortgage insurance to protect the portion of the loan that exceeds 80% of theappraised value.  The Bank may, onoccasion, extend a loan up to 90% of the appraised value of the secured propertywithout private mortgage insurance coverage. However, these exceptions are minimal and are only approved on loanswith exceptional credit scores, sizeable asset reserves, or other compensatingfactors.  At December 31, 2006, theBank had $3.0 million of nonaccrual one- to four-family residential loans.  See “Asset Quality.”

**Multi-FamilyResidential Real Estate Loans. **TheBank offers mortgage loans for the acquisition and refinancing of multi-familyresidential properties.  At December 31,2006, $11.9 million or 1.6% of the Bank’s total loan portfolio consisted ofloans collateralized by existing multi-family residential real estateproperties.

The Bank currentlyoriginates both fixed rate and adjustable rate multi-family loans.  Fixed rate loans are generally originatedwith amortization periods not to exceed 30 years, and typically have balloonperiods of three, five or seven years. Adjustable rate loans are typically amortized over terms up to 30 years,with interest rate adjustments every three to seven years.  Loan-to-value ratios on the Bank’smulti-family real estate loans are currently limited to 80%.  It is also the Bank’s general policy toobtain corporate or personal guarantees, as applicable, on its multi-familyresidential real estate loans from the principals of the borrower.

Multi-family real estatelending entails significant additional risks as compared with one- tofour-family residential property lending. Such loans typically involve large loan balances to single borrowers orgroups of related borrowers.  The paymentexperience on such loans is typically dependent on the successful operation ofthe real estate project.  The success ofsuch projects is sensitive to changes in supply and demand conditions in themarket for multi-family real estate as well as regional and economic conditionsgenerally.  At December 31, 2006, theBank did not have any nonaccrual multi-family real estate loans.  See “Asset Quality.”

**CommercialReal Estate Loans. **TheBank originates mortgage loans for the acquisition and refinancing of commercialreal estate properties.  At December 31,2006, $166.2 million or 22.6% of the Bank’s total loan portfolio consisted ofloans collateralized by existing commercial real estate properties anddeveloped as well as undeveloped land. In recent years, the Bank has placed anincreased emphasis on commercial real estate lending in order to transition toa more full-service community bank as well as to take advantage of the highdemand for this type of property in some of the markets we serve.

6

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Many of the Bank’scommercial real estate loans are collateralized by properties such as officebuildings, convenience stores, service stations, mini-storage facilities,motels, churches, small shopping malls, and strip centers.  The Bank has experienced an increase in thistype of lending over the last few years and underwrites commercial real estateloans specifically in relation to the type of property beingcollateralized.  Cash flows and occupancyrates are primary considerations when underwriting loans collateralized byoffice buildings, mini-storage facilities and motels.  Loans with borrowers that are corporations,limited liability companies, trusts, or other such legal entities are alsotypically personally guaranteed by the principals of the respectiveentity.  The financial strength of theindividuals who are personally guaranteeing the loan is also a primaryunderwriting factor.

Commercial real estateloans include loans for the acquisition of land.  This segment of the portfolio totaled $41.7million, $38.4 million, $30.9 million, $7.0 million, and $5.5 million, as ofDecember 31, 2006, 2005, 2004, 2003, and 2002, respectively.  The Bank has experienced an aggregateincrease in this loan portfolio during 2006, 2005 and 2004, primarily due toopportunities resulting from the growth and development of the Benton andWashington county areas discussed below. These loans are often made to borrowers with whom the Bank has hadprevious favorable experience and whose personal financial position is strong.  These loans include land purchased fordevelopment into single-family subdivision lots, condominium lots, andcommercial lots.  Generally, these loansare collateralized by properties in the Bank’s market areas.

The Bank’s policyrequires real estate appraisals of all properties securing commercial realestate loans by licensed real estate appraisers pursuant to state licensingrequirements.  The Bank considers thequality and location of the real estate, the creditworthiness of the borrower,the cash flow of the project, and the quality of management involved with theproperty.  The Bank’s commercial realestate loans are generally originated with amortization periods not to exceed25 years and typically have three-, five-, or seven-year balloon terms.  The Bank has originated some loans withvariable rate terms based upon Wall Street Journal Prime.  To a lesser degree, the Bank has in the pastoffered a limited number of fixed rate commercial real estate loans with termsnot to exceed fifteen years subject to then-current interest ratescenarios.  As part of the criteria forunderwriting multi-family and commercial real estate loans, the Bank generallyestimates a cash flow analysis that includes a vacancy rate projection,expenses for taxes, insurance, maintenance and repair reserves as well as debtcoverage ratios.  This information isalso estimated and included in commercial real estate appraisals.

Commercial real estatelending entails additional risks as compared to the Bank’s one- to four-familyresidential property loans. Commercial real estate loans generally involvelarger loan balances to single borrowers or groups of related borrowers.  The payment experience on such loans istypically dependent on the successful operation of the real estate project. Thesuccess of such projects is sensitive to changes in supply and demandconditions in the market for commercial real estate, as well as regional andeconomic conditions generally.  The Bankbelieves it has mitigated some of these additional risks by focusing itscommercial real estate lending activities in the economically strongWashington/Benton County, Arkansas market. This region is the home of the world’s largest retailer, Wal-Mart; aswell as the nation’s largest meat company, Tyson Foods; the trucking firm J. B.Hunt; and the University of Arkansas. Reports have ranked the region as one of the top performing economicareas in the country in the last few years. Population growth, job growth and low unemployment rates in this regionadd additional support to the Bank’s growth in the area of commercial realestate loans.    At December 31, 2006,the Bank had $1.8 million of nonaccrual commercial real estate loans. See “AssetQuality.”

**ConstructionLoans. **The Bankoriginates one- to four-family residential, multi-family, and commercial realestate construction loans.  However, theBank’s primary emphasis has been residential construction lending.  The Bank’s construction lending activitiesare typically limited to the Bank’s primary market areas.  At December 31, 2006, construction loansamounted to $195.9 million or 26.6% of the Bank’s total loan portfolio, ofwhich, $34.1 million consisted of one- to four-family residential constructionloans, $78.3 million consisted of speculative one- to four-family residentialconstruction loans, $47.5 million consisted of land development loans, $21.9million consisted of commercial real estate construction loans, and $14.1million consisted of multi-family residential construction loans.  As discussed above in the commercial realestate section, our market areas of Benton and Washington counties haveexperienced tremendous prosperity and growth and provided the Bank withincreased lending opportunities, which can be demonstrated by the significantgrowth in construction lending over the past few years.  However, beginning in late 2005, the Banklimited its construction loan origination activity compared to previous yearsdue to the oversupply of homes and lots in the Northwest Arkansas market andthe increased amount of nonperforming construction loans.

The Bank’s constructionloans generally have fixed interest rates or variable rates that float withWall Street Journal Prime and are typically issued for terms of six to eighteenmonths. However, the Bank is permitted to originate construction loans withterms up to two years under its loan policy. This practice is generally limited to larger projects that cannot becompleted in the typical six- to eighteen-month period.  Construction loans are typically made with amaximum loan-to-value ratio of 80% on an as-completed basis.

The majority of the Bank’sconstruction loans are made to individual homeowners and local builders anddevelopers for the purpose of constructing one- to four-family residences.  To a lesser but growing extent, constructionloans are also originated for multi-family and commercial properties.   The Bank typically requires that permanentfinancing with the Bank or some other lender be in place prior to closing anynon-speculative construction loan. Interest on construction/permanent loans is due upon completion of theconstruction phase of the loan.  At suchtime, the loan will convert to a permanent loan at the interest rateestablished at the initial closing of the construction/permanent loan.

7

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The Bank makesconstruction loans to local builders for the purpose of construction ofspeculative (or unsold) residential properties, and for the construction ofpre-sold one- to four-family homes. These loans are subject to credit review, analysis of personal and, ifapplicable, corporate financial statements, and an appraisal of the property tobe constructed. The Bank also reviews and inspects the project prior to thedisbursement of funds (draws) during the construction term.  Loan proceeds are disbursed after asatisfactory inspection of the project has been made based upon percentage ofcompletion.  Interest on theseconstruction loans is due upon maturity. The Bank may extend the term of a construction loan upon payment ofinterest accrued if the property has not been sold by the maturity date.  During 2006 the Bank began to experience anincrease in the incidence of builders who were unable to pay their interest atmaturity due to a softening of the housing market in Northwest Arkansas.  Although the economy in the NorthwestArkansas region continues to be strong as reflected in sustained job andpopulation growth, the supply of new residential lots and new speculative homesfor sale has outpaced demand.  Marketdata indicates an overall decrease in the number of home sales in Benton andWashington counties in 2006 compared to 2005. However, the data also indicates that average price of homes sold hasrisen steadily in Benton County and dipped temporarily but has begun to riseagain in Washington County.

Construction lending isgenerally considered to involve a higher level of risk as compared to one- tofour-family residential loans.  This isdue, in part, to the concentration of principal in a limited number of loansand borrowers, and the effects of general economic conditions on developers andbuilders.  In addition, constructionloans to a builder for construction of homes that are not pre-sold possess agreater potential risk to the Bank than construction loans to individuals ontheir personal residences or on houses that are pre-sold prior to the inceptionof the loan.  The Bank analyzes eachborrower involved in speculative building and limits the principal amount andnumber of unsold speculative homes at any one time with such borrower.  At December 31, 2006, the Bank hadnonaccrual construction loans totaling $11.3 million.  See “Asset Quality.”

**CommercialLoans. **The Bank alsooffers commercial loans which primarily consist of equipment and inventoryloans which are typically cross-collateralized by commercial real estate.  At December 31, 2006, such loansamounted to $36.4 million or 5.0% of the total loan portfolio.  At December 31, 2006, the Bank had nonaccrualcommercial loans totaling $1.6 million. See “Asset Quality.”

The Bank’s commercialloans are typically originated with fixed interest rates and call provisionsbetween one and five years.  These loansare typically based on a maximum fifteen-year amortization schedule.  The Bank also originates interest-onlycommercial loans and variable rate commercial loans.  The Bank’s commercial loans do not providefor negative amortization

**ConsumerLoans. **The Bank offersconsumer loans in order to provide a full range of financial services to itscustomers while increasing the yield on its overall loan portfolio anddecreasing its interest rate risk due to the relatively shorter-term nature ofconsumer loans. The consumer loans offered by the Bank primarily include homeequity and second mortgage loans, automobile loans, deposit account securedloans, and unsecured loans.  Consumerloans amounted to $74.0 million or 10.1% of the total loan portfolio atDecember 31, 2006, of which $48.7 million, $12.1 million and $13.2 millionconsisted of home equity and second mortgage loans, automobile loans, and otherconsumer loans, respectively.  The Bankintends to continue its emphasis on consumer loans in furtherance of its roleas a community-oriented financial institution.

The Bank’s home equityand second mortgage loans are fixed rate loans with fully amortized terms of upto fifteen years, variable rate interest-only loans with terms up to threeyears, or home equity lines of credit. The variable rate loans are typically tied to Wall Street Journal Prime,plus a margin commensurate with the risk as determined by the borrower’s creditscore.  Longer-term amortizing loanstypically have a balloon feature in five, seven, or ten years.  The home equity lines of credit are typicallyeither fixed rate for a term of no longer that one year or variable rate withterms typically up to three years. Although the Bank does not require that it hold the first mortgage onthe secured property, the Bank does hold the first mortgage on a significantnumber of its home equity loans.  TheBank generally limits the total loan-to-value on these mortgages to 90% of thevalue of the secured property.

The Bank’s automobileloans are typically originated for the purchase of new and used cars andtrucks.  Such loans are generallyoriginated with a maximum term of five years. The Bank does offer extended terms on automobile loans to some customersbased upon their creditworthiness.

Other consumer loansconsist primarily of deposit account loans and unsecured loans.  Loans secured by deposit accounts areoriginated for up to 95% of the deposit account balance, with a hold placed onthe account restricting the withdrawal of the deposit account balance.

Consumer loans entailgreater risk than do residential first mortgage loans, particularly in the caseof consumer loans which are unsecured or secured by rapidly depreciating assetssuch as automobiles.  In such cases, anyrepossessed collateral for a defaulted consumer loan may not provide anadequate source of repayment of the outstanding loan balance as a result of thegreater likelihood of damage, loss or depreciation.  In addition, consumer loan collections aredependent on the borrower’s continuing financial stability, and thus are morelikely to be adversely affected by job loss, divorce, illness or personalbankruptcy.  Furthermore, the applicationof various federal and state laws, including federal and state bankruptcy andinsolvency laws, may limit the amount which can be recovered on suchloans.  At December 31, 2006, theBank had $1.3 million of nonaccrual consumer loans.  See “Asset Quality.”

8

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**AssetQuality**

When a borrower fails tomake a required payment on a loan, the Bank attempts to cure the deficiency bycontacting the borrower and seeking the payment.  Depending upon the type of loan, late noticesare sent and/or personal contacts are made. In most cases, deficiencies arecured promptly.  While the Bank generallyprefers to work with borrowers to resolve such problems, when a mortgage loanbecomes 90 days delinquent, the Bank generally institutes foreclosure or otherproceedings, as necessary, to minimize any potential loss.

Loans are placed onnonaccrual status when, in the judgment of management, the probability ofcollection of interest is deemed to be insufficient to warrant furtheraccrual.  When a loan is placed onnonaccrual status, previously accrued but unpaid interest is deducted frominterest income.  The Bank generally doesnot accrue interest on loans past due 90 days or more.  Loans may be reinstated to accrual statuswhen payments are made to bring the loan under 90 days past due and, in theopinion of management, collection of the remaining balance can be reasonablyexpected.  The Bank may continue toaccrue interest on certain loans that are 90 days past due or more if suchloans are in the process of collection and collection is reasonably assured.

Real estate propertiesacquired through foreclosure are initially recorded at fair value lessestimated selling costs.  Valuations areperiodically performed by management and the real estate is carried at thelower of carrying amount or fair value less cost to sell.

**DelinquentLoans. **The followingtable sets forth information concerning delinquent loans at December 31,2006, in dollar amounts and as a percentage of the Bank’s total loanportfolio.  The amounts presentedrepresent the total outstanding principal balances of the related loans, ratherthan the actual payment amounts which are past due.

 

 
| ** **        | ** ** | **One- to Four-Family  Residential** | ** ** | **Construction**                     | ** ** | **Commercial  Real Estate** | ** ** | **Commercial**                       | ** ** | **Consumer** | ** ** |
|-------------------|------------|------------------------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|--------------|------------|
| ** **        | ** ** | **Amount**                                     | ** ** | **Percentage  of Total  Loans** | ** ** | **Amount**                       | ** ** | **Percentage  of Total  Loans** | ** ** | **Amount**   | ** ** | **Percentag  of Total  Loans** | ** ** | **Amount** | ** ** | **Percentage   of Total  Loans** | ** ** | **Amount** | ** ** | **Percentage  of Total  Loans** | ** ** |
| ** **        | ** ** | **(Dollars in Thousands)**           | ** ** |
| ** **        | ** ** | ** **                                     | ** ** |
| Loans delinquent: |       |                                           |       |                                 |       |                             |       |                                 |       |         |       |   |   |   |   |   |   |   |   |   |   |
|              |       |                                           |       |                                 |       |                             |       |                                 |       |         |       |   |   |   |   |   |   |   |   |   |   |
| 30-59 days        |       | $                                              | 3,480      |                                 | 0.47       | %                                | $          | 2,351                                |       | 0.32         | %          | $ | 2,221 |   | 0.30 | % | $ | 251 |   | 0.03 | % | $ | 782 |   | 0.11 | % |
|              |       |                                           |       |                                 |       |                             |       |                                 |       |         |       |   |   |   |   |   |   |   |   |   |   |
| 60-89 days        |       | 1,062                                          |       | 0.14                                 |       | 1,666                            |       | 0.23                                 |       | 469          |       | 0.06 |   | 113 |   | 0.02 |   | 264 |   | 0.04 |   |
|              |       |                                           |       |                                 |       |                             |       |                                 |       |         |       |   |   |   |   |   |   |   |   |   |   |
| 90 days and over  |       | 2,305                                          |       | 0.31                                 |       | 9,853                            |       | 1.34                                 |       | 709          |       | 0.10 |   | 771 |   | 0.10 |   | 1,009 |   | 0.14 |   |
|              |       |                                           |       |                                 |       |                             |       |                                 |       |         |       |   |   |   |   |   |   |   |   |   |   |
| Total             |       | $                                              | 6,847      |                                 |       |                             | $          | 13,870                               |       |         |       | $ | 3,399 |   |   |   | $ | 1,135 |   |   |   | $ | 2,055 |   |   |   |

 

Interest income thatwould have been recorded under the original terms of the Bank’s nonaccruingloans for the year ended December 31, 2006, amounted to $1.5 million, and theinterest recognized during this period amounted to $403,000.

9

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The following table sets forth the amounts and categories of the Bank’snonperforming assets at the dates indicated.

 
| ** **                                                                                                                   | ** ** | **December 31,**                | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                                   | ** ** | **(Dollars in Thousands)** | ** ** |
| ** **                                                                                                                   | ** ** | ** **                           | ** ** |
| Nonaccrual loans:                                                                                                            |       |                                 |       |   |   |   |   |   |   |   |   |
| One- to  four-family residential                                                                                             |       | $                                    | 2,980      |   | $ | 2,630 |   | $ | 2,619 |   | $ | 1,537 |   | $ | 2,184 |   |
| Multi-family  residential                                                                                                    |       | —                               |       | — |   | — |   | — |   | — |   |
| Construction  loans                                                                                                          |       | 11,320                               |       | 1,177 |   | 634 |   | — |   | — |   |
| Commercial real  estate                                                                                                      |       | 1,820                                |       | 707 |   | — |   | 99 |   | 124 |   |
| Commercial loans                                                                                                             |       | 1,561                                |       | 236 |   | 186 |   | 131 |   | 245 |   |
| Consumer loans                                                                                                               |       | 1,334                                |       | 556 |   | 723 |   | 564 |   | 175 |   |
| Total nonaccrual  loans                                                                                                      |       | 19,015                               |       | 5,306 |   | 4,162 |   | 2,331 |   | 2,728 |   |
|                                                                                                                         |       |                                 |       |   |   |   |   |   |   |   |   |
| Accruing loans 90 days  or more past due                                                                                     |       | 668                                  |       | 1,600 |   | — |   | — |   | — |   |
| Restructured loans                                                                                                           |       | —                               |       | 6,264 |   | 3,790 |   | 1,352 |   | 4,219 |   |
| Real estate owned                                                                                                            |       | 3,858                                |       | 892 |   | 563 |   | 822 |   | 320 |   |
|                                                                                                                         |       |                                 |       |   |   |   |   |   |   |   |   |
| Total  nonperforming assets                                                                                                  |       | $                                    | 23,541     |   | $ | 14,062 |   | $ | 8,515 |   | $ | 4,505 |   | $ | 7,267 |   |
|                                                                                                                         |       |                                 |       |   |   |   |   |   |   |   |   |
| Total nonaccrual,  accruing loans 90 days or more past due and restructured loans as a  percentage of total loans receivable |       | 2.68                                 | %          | 1.67 | % | 1.14 | % | 0.67 | % | 1.37 | % |
|                                                                                                                         |       |                                 |       |   |   |   |   |   |   |   |   |
| Total nonperforming  assets as a percentage of total assets                                                                  |       | 2.76                                 | %          | 1.65 | % | 1.13 | % | 0.65 | % | 1.07 | % |

 

The increase in nonaccrual loans is primarily related to an increasein nonaccrual construction, commercial real estate and commercial loans tocertain builders.  The Northwest Arkansasmarket has recently experienced an oversupply of lots and speculative homes.Certain of the Bank’s homebuilders are experiencing extended marketing timesfor the sale of their homes which has resulted in inadequate cash flow toservice the interest carry on their loans. The specific loan loss allowance related to these loans wasapproximately $325,000 at December 31, 2006.

The increase innonaccrual construction and commercial loans is attributable primarily to fourloan relationships.  Three of therelationships are either in foreclosure or are likely to end up inforeclosure.  The fourth is in a workoutplan and based on circumstances at this time we expect the loans to eventuallycome off the nonaccrual list.

The first relationshiptotaled $6.4 million at December 31, 2006, and is comprised of two subdivisionloans totaling $5.3 million, four complete speculative homes totalingapproximately $600,000, and the borrower’s primary residence totaling approximately$500,000.  At December 31, 2006, weanticipated that the four speculative homes would sell with no loss ofprincipal or interest to the Bank, and as a result, these loans were kept onaccrual status.  However, sinceDecember 31, 2006, foreclosure proceedings have begun on the subdivisionand the speculative homes.  Thesesubdivision loans as well as the primary residence loans were on nonaccrualstatus at December 31, 2006.  Thesubdivision loans represent two phases on the same subdivision located inLowell, Arkansas, one of which is complete and the other is approximately 10%complete.  We have estimated the costs tocomplete this phase of the subdivision and have compared the cost per lot ofthis phase as well as the completed phase to the estimated sales price of thelots, net of selling costs, and have estimated no loss on these loans as ofDecember 31, 2006.  However, due to thenature of these loans, difficulty in estimating costs to complete, and thepossibility of adverse changes in market conditions, we may incur materiallosses on these loans in the future.

The second relationshiptotaled $5.3 million at December 31, 2006, and is comprised of $1.0 million insingle family residential loans, most of which are rental properties, $3.0million in speculative single family construction loans, approximately $850,000of commercial real estate loans, and approximately $470,000 of commercialloans.  The speculative homes are invarious stages of completion ranging from approximately 60% to 100%.  The commercial loans consist of junior lienson the speculative single family properties. This relationship includes twoprincipals, one of which has filed for bankruptcy protection.  All of the properties in this relationshipare in foreclosure and bankruptcy litigation and all loans are on nonaccrualstatus.  The properties in thisrelationship are cross-collateralized and we have evaluated our loss exposureon a total relationship basis.  Based onestimated sales prices of the properties net of costs to sell, compared toprincipal balances plus estimated costs to complete, as appropriate, we haveestimated losses of approximately $150,000 at December 31, 2006.  However, based on factors such as thecomplexity of this relationship, difficulty in estimating completion costs,potential adverse changes in market conditions, and the decisions of thebankruptcy trustee, we may incur losses significantly in excess of the amountestimated.

10

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The third relationshiptotaled $1.5 million at December 31, 2006, and is comprised of $1.0 million inspeculative single family construction loans, approximately $300,000 ofcommercial real estate loans, and approximately $150,000 of commercialloans.  The speculative homes are invarious stages of completion ranging from approximately 75% to 100%. Thecommercial loans consist primarily of junior liens on the speculative singlefamily properties.  The commercial realestate loans are lot loans.  Thisborrower has filed for bankruptcy protection. We have estimated losses of $90,000 at December 31, 2006.  However, based on factors such as thedifficulty in estimating completion costs, potential adverse changes in marketconditions, and the decisions of the bankruptcy trustee, we may incur losses greaterthan the amount estimated.

The fourth relationshiptotaled $2.9 million at December 31, 2006, $1.8 million of which was onnonaccrual status.  The $1.8 millionconsisted of approximately $830,000 of speculative single family constructionloans on two properties, approximately $350,000 of commercial real estateloans, and approximately $650,000 of commercial loans.  One of the two speculative homes is undercontract and the other is listed for sale “as is”.  The commercial real estate loans are threeland and lot loans, one of which is under contract and the other two are listedfor sale.  The commercial loans consistof accounts receivable and unsecured loans totaling approximately $500,000,with an estimated reserve of $65,000, and junior liens on the lots andspeculative homes totaling approximately $150,000, with an estimated reserve of$10,000.  If the borrower’s workout plandoes not go as planned, if the properties do not sell in a timely manner, ifadverse changes in market conditions occur, or other such factors occur, we mayincur losses greater than the amount estimated.

The decrease in accruing loans 90 days or more past due and restructured loans was due to theremoval of two relationships totaling $3.8 million and $4.0 million,respectively.  These relationships havepaid current or performed for a sufficient period to time to warrant theirremoval from nonperforming assets.

The increase in realestate owned was due to the addition of seven speculative homes and twolots.  Three of the homes have been soldsince December 31, 2006, and one is under contract.  These homes were not complete at the time offoreclosure.  Construction costs areadded to the real estate balance to the extent that the resulting balance doesnot exceed the estimated fair value of the property less estimated sellingcosts.

**ClassifiedAssets. **Federalregulations require that each insured savings association classify its assetson a regular basis.  In addition, inconnection with examinations of insured institutions, federal examiners haveauthority to identify problem assets and, if appropriate, classify them.  There are three classifications for problemassets: “substandard,” “doubtful” and “loss.” Substandard assets have one or more defined weaknesses and arecharacterized by the distinct possibility that the insured institution willsustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses ofsubstandard assets with the additional characteristic that the weaknesses makecollection or liquidation in full on the basis of currently existing facts,conditions and values questionable, and there is a high possibility ofloss.  An asset classified loss isconsidered uncollectible and of such little value that continuance as an assetof the institution is not warranted.  AtDecember 31, 2006, the Bank had $25.4 million of classified assets, $24.8million of which were classified as substandard and $583,000 of which wereclassified as loss.  In addition, at suchdate, the Bank had $12.7 million of assets designated as special mention.  Special mention assets have potentialweaknesses that deserve management’s close attention.  If left uncorrected, these potentialweaknesses may result in deterioration of the repayment prospects for the assetor the institution’s credit position at some future date.

**Allowancefor Loan Losses.**  Theallowance for loan losses is established as losses are estimated to haveoccurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowancewhen management believes it is likely that a loan balance isuncollectible.  Subsequent recoveries, ifany, are credited to the allowance.

The allowance for loanlosses represents management’s estimate of incurred credit losses inherent inthe Company’s loan portfolio as of the balance sheet date.  The estimation of the allowance is based on avariety of factors, including past loan loss experience, the current creditprofile of the Company’s borrowers, adverse situations that have occurred thatmay affect the borrowers’ ability to repay, the estimated value of underlyingcollateral, and general economic conditions. Losses are recognized when available information indicates that it isprobable that a loss has been incurred and the amount of the loss can bereasonably estimated. This evaluation is inherently subjective as it requiresestimates that are susceptible to significant revision as more informationbecomes available or conditions change.

In determining theallowance for loan losses, the Company allocates a portion of the allowance toits various loan categories based on an analysis of individual loans and poolsof loans.  However, the entire allowanceis available to absorb credit losses inherent in the total loan portfolio as ofthe balance sheet date.

11

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A loan is consideredimpaired when, based on current information and events, it is probable that theBank will be unable to collect the scheduled payments of principal or interestwhen due according to the contractual terms of the loan agreement. Factorsconsidered by management in determining impairment include payment status,collateral value, and the probability of collecting scheduled principal andinterest payments when due. Loans that experience insignificant payment delaysand payment shortfalls generally are not classified as impaired. Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, the reasonsfor 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 ona loan by loan basis by either the present value of expected future cash flowsdiscounted at the loan’s effective interest rate, the loan’s obtainable marketprice, or the fair value of the collateral if the loan is collateraldependent.  Multi-family residential,commercial real estate, land and land development, and commercial loans thatare delinquent or where the borrower’s total loan relationship exceeds $1million are evaluated on a loan by loan basis at least annually.

Large groups of smallerbalance homogeneous loans are collectively evaluated for impairment.Accordingly, the Bank does not separately identify individual consumer andresidential loans for impairment disclosures. Homogeneous loans are those that are considered to have commoncharacteristics that provide for evaluation on an aggregate or pool basis. TheBank considers the characteristics of (1) one- to four-family residential firstmortgage loans; (2) unsecured consumer loans; and (3) collateralized consumerloans to permit consideration of the appropriateness of the allowance forlosses of each group of loans on a pool basis. The primary methodology used todetermine the appropriateness of the allowance for losses includes segregatingcertain specific, poorly performing loans based on their performancecharacteristics from the pools of loans as to type, valuing these loans, andthen applying a loss factor to the remaining pool balance based on severalfactors including past loss experience, inherent risks, and economic conditionsin the primary market areas.

In estimating the amount of credit losses inherent in our loan portfolio,various judgments and assumptions are made. For example, when assessing the condition of the overall economicenvironment, assumptions are made regarding future market conditions and theirimpact on the loan portfolio.  In theevent the national or local economy were to sustain a prolonged downturn, theloss factors applied to our portfolios may need to be revised, which maysignificantly impact the measurement of the allowance for loan losses.  For impaired loans that are collateraldependent, the estimated fair value of the collateral may deviate significantlyfrom the proceeds received when the collateral is sold in the event that theBank has to foreclose or repossess the collateral.

Although we consider the allowance for loan losses of approximately$2.6 million adequate to cover losses inherent in our loan portfolio atDecember 31, 2006, no assurance can be given that we will not sustain loanlosses that are significantly different from the amount recorded, or thatsubsequent evaluations of the loan portfolio, in light of factors thenprevailing, would not result in a significant change in the allowance for loanlosses.

12

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The following tablesummarizes changes in the allowance for loan losses and other selectedstatistics for the periods indicated.

 
| ** **                                                                             | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                             | ** ** | **(Dollars in Thousands)**       | ** ** |
| ** **                                                                             | ** ** | ** **                                 | ** ** |
| Total loans  outstanding at end of period                                              |       | $                                          | 735,593    |   | $ | 790,570 |   | $ | 699,205 |   | $ | 550,215 |   | $ | 506,953 |   |
| Average loans  outstanding                                                             |       | $                                          | 726,642    |   | $ | 687,373 |   | $ | 573,520 |   | $ | 492,492 |   | $ | 481,330 |   |
| Allowance at  beginning of period                                                      |       | $                                          | 2,114      |   | $ | 1,846 |   | $ | 1,621 |   | $ | 1,529 |   | $ | 923 |   |
| Charge-offs:                                                                           |       |                                       |       |   |   |   |   |   |   |   |   |
| One- to four-family residential                                                        |       | (25                                        | )          | (74 | ) | (152 | ) | (73 | ) | (54 | ) |
| Construction                                                                           |       | (239                                       | )          | (77 | ) | — |   | — |   | — |   |
| Commercial real estate                                                                 |       | —                                     |       | — |   | (71 | ) | — |   | (56 | ) |
| Commercial loans                                                                       |       | (234                                       | )          | (41 | ) | (184 | ) | (109 | ) | (415 | ) |
| Consumer loans (1)                                                                     |       | (697                                       | )          | (764 | ) | (491 | ) | (496 | ) | (461 | ) |
| Total charge-offs                                                                      |       | (1,195                                     | )          | (956 | ) | (898 | ) | (678 | ) | (986 | ) |
| Recoveries:                                                                            |       |                                       |       |   |   |   |   |   |   |   |   |
| One- to four-family residential                                                        |       | —                                     |       | — |   | 2 |   | 1 |   | 6 |   |
| Construction                                                                           |       | 7                                          |       | — |   | — |   | — |   | — |   |
| Commercial real estate                                                                 |       | —                                     |       | — |   | — |   | — |   | 2 |   |
| Commercial loans                                                                       |       | —                                     |       | 1 |   | 2 |   | — |   | — |   |
| Consumer loans (1)                                                                     |       | 164                                        |       | 122 |   | 99 |   | 79 |   | 84 |   |
| Total recoveries                                                                       |       | 171                                        |       | 123 |   | 103 |   | 80 |   | 92 |   |
| Net charge-offs                                                                        |       | (1,024                                     | )          | (833 | ) | (795 | ) | (598 | ) | (894 | ) |
| Total provisions  for losses                                                           |       | 1,482                                      |       | 1,101 |   | 1,020 |   | 690 |   | 1,500 |   |
| Allowance at end  of period                                                            |       | $                                          | 2,572      |   | $ | 2,114 |   | $ | 1,846 |   | $ | 1,621 |   | $ | 1,529 |   |
|                                                                                   |       |                                       |       |   |   |   |   |   |   |   |   |
| Allowance for  loan losses as a percentage of total loans outstanding at end of period |       | 0.35                                       | %          | 0.27 | % | 0.26 | % | 0.29 | % | 0.30 | % |
| Net loans  charged-off as a percentage of average loans outstanding                    |       | 0.14                                       | %          | 0.12 | % | 0.14 | % | 0.12 | % | 0.19 | % |
|                                                                                   |       |                                       |       |   |   |   |   |   |   |   |   |

----

(1)  Consumer loan charge-offs includeoverdraft charge-offs of  $600,000,$522,000, $323,000, $182,000 and $214,000 for the years ended December 31,2006, 2005, 2004, 2003, and 2002, respectively. Consumer loan recoveries include recoveries of overdraft charge-offs of$151,000, $114,000, $85,000, $50,000, and $53,000 for the years ended December 31,2006, 2005, 2004, 2003, and 2002, respectively.

13

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The following table presents the allocation of the Bank’s allowance forloan losses by the type of loan at each of the dates indicated.

** **
| ** **                  | ** ** | **December 31,**                | ** ** |
|-----------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                  | ** ** | **Amount**                           | ** ** | **Percentage of  Total Loans  by Category** | ** ** | **Amount** | ** ** | **Percentage of  Total Loans  by Category** | ** ** | **Amount** | ** ** | **Percentage of  Total Loans  by Category** | ** ** | **Amount** | ** ** | **Percentage of  Total Loans  by Category** | ** ** | **Amount** | ** ** | **Percentage of  Total Loans  by Category** | ** ** |
| ** **                  | ** ** | **(Dollars in Thousands)** | ** ** |
| ** **                  | ** ** | ** **                           | ** ** |
| 1-4 family residential      |       | $                                    | 223        |   | 34.14 | % | $ | 204 |   | 34.11 | % | $ | 318 |   | 40.35 | % | $ | 239 |   | 47.09 | % | $ | 128 |   | 57.03 | % |
| Multi-family residential    |       | 33                                   |       | 1.62 |   | 42 |   | 1.63 |   | 39 |   | 1.35 |   | 31 |   | 1.39 |   | 1 |   | 1.15 |   |
| Commercial real estate  (1) |       | 468                                  |       | 22.60 |   | 428 |   | 19.95 |   | 420 |   | 20.87 |   | 256 |   | 17.69 |   | 719 |   | 14.84 |   |
| Construction loans (2)      |       | 800                                  |       | 26.63 |   | 396 |   | 30.24 |   | — |   | 22.76 |   | — |   | 16.24 |   | — |   | 9.69 |   |
| Commercial loans (3)        |       | 500                                  |       | 4.95 |   | 371 |   | 4.14 |   | 509 |   | 3.94 |   | 404 |   | 3.91 |   | 209 |   | 3.87 |   |
| Consumer loans              |       | 548                                  |       | 10.06 |   | 573 |   | 9.93 |   | 508 |   | 10.73 |   | 628 |   | 13.68 |   | 463 |   | 13.42 |   |
| Unallocated                 |       | —                               |       | — |   | 100 |   | — |   | 52 |   | — |   | 63 |   | — |   | 9 |   | — |   |
| Total                       |       | $                                    | 2,572      |   | 100.00 | % | $ | 2,114 |   | 100.00 | % | $ | 1,846 |   | 100.00 | % | $ | 1,621 |   | 100.00 | % | $ | 1,529 |   | 100.00 | % |

----

(1)  The allowance allocated to commercialreal estate loans decreased between 2003 and 2002 primarily due to twofactors.  At December 31, 2002, there wasa valuation allowance on an impaired loan that was not recorded in 2003 and theloss experience factor was revised downward in 2003 due to a more establishedhistory of low levels of charge-offs.  The allowance increased in this categorybetween 2003 and 2004 due primarily to****loan growth.

(2)  The allowance allocated to constructionloans increased between 2006 and 2005 due to an increase in the loss experiencefactor applied to speculative 1-4 family residential construction loans andland development loans.  The increasebetween 2005 and 2004 was due to the allowance on speculative 1-4 familyresidential construction loans being included with other 1-4 family residentialloans in previous years.

(3)  The allowance allocated to commercialloans increased between 2006 and 2005 due to an increase in specific loan lossallowances in this category.

14

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## **Investment Activities**

**InvestmentSecurities. **Theinvestment policy of the Bank, as established by the board of directors, isdesigned primarily to provide and maintain liquidity, to provide collateral forpledging requirements, to complement the Bank’s interest rate risk strategy andto generate a favorable return on investments. The Bank’s investment policy is currently implemented by the Bank’sChief Executive Officer within the parameters set by the asset/liabilitymanagement committee and the board of directors.  The Bank is authorized to invest inobligations issued or fully guaranteed by the U.S. Government, certain federalagency obligations, certain time deposits, negotiable certificates of depositissued by commercial banks and other insured financial institutions, municipalsecurities, investment grade corporate debt securities and other specifiedinvestments.

Investment securitiesthat management has the positive intent and ability to hold to maturity areclassified as held to maturity and are reported at amortized cost.  Investment securities classified as availablefor sale are reported at fair value, with unrealized gains and losses excludedfrom earnings and reported net of tax in other comprehensive income.  At December 31, 2006, all of the Bank’sinvestment securities were classified as held to maturity.  At December 31, 2006, approximately$50.2 million of the Bank’s investment securities were pledged as collateralfor certain deposits in excess of $100,000. In addition, certain U.S. Government and agency securities were pledgedas collateral for FHLB advances under the FHLB’s blanket lien.  At December 31, 2006, investments in the debtand/or equity securities of any one issuer, other than those issued by U.S.Government agencies, did not exceed more than 10% of the Company’s stockholders’equity.

The following table setsforth the amount of investment securities held to maturity which contractuallymature during each of the periods indicated and the weighted average yields foreach range of maturities at December 31, 2006.  Weighted average yields for municipalobligations have not been adjusted to a tax-equivalent basis.  Expected maturities may differ from contractualmaturities because issuers may have the right to call or prepay the obligationwithout prepayment penalties.
| ** **                              | ** ** | **One to Five Years** | ** ** | **Five to Ten Years** | ** ** | **After Ten Years** | ** ** | **Total**  | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|-------------------------------|------------|------------|------------|
| ** **                              | ** ** | **Amount**                           | ** ** | **Yield**                            | ** ** | **Amount**                    | ** ** | **Yield**  | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
| ** **                              | ** ** | ** **                           | ** ** | ** **                           | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Municipal securities                    |       | $                                    | 630        |                                 | 3.55       | %                             | $          | 6,615      |       | 4.46 | % | $ | 9,644 |   | 4.50 | % | $ | 16,889 |   | 4.45 | % |
| U.S. Government and  agency obligations |       | 4,200                                |       | 4.93                                 | %          | 11,378                        |       | 4.51       | %          | 28,279 |   | 5.19 | % | 43,857 |   | 4.99 | % |
| Total                                   |       | $                                    | 4,830      |                                 | 4.75       | %                             | $          | 17,993     |       | 4.49 | % | $ | 37,923 |   | 5.01 | % | $ | 60,746 |   | 4.84 | % |

 

As of December 31, 2006,there were approximately $60.2 million of investment securities at an averageinterest rate of 4.85% with issuer call options, of which approximately $50.0million at an average interest rate of 4.94% are callable within one year.  In a rising interest rate environment, theCompany believes that the issuers would not call these investment securities.

The following table setsforth the carrying value of the Company’s investment securities classified asheld to maturity.  The Company held noinvestment securities as available for sale at the dates indicated.

 

|                                          | ** ** | **December 31,**   | ** ** |
|------------------------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **(In Thousands)** | ** ** |
| ** **                               | ** ** | ** **              | ** ** |
| Investment  securities held to maturity: |       |                    |       |   |   |   |   |
| Certificates of deposit                  |       | $                       | —     |   | $ | — |   | $ | 3,000 |   |
| Municipal securities                     |       | 16,889                  |       | 16,661 |   | 15,839 |   |
| U.S. Government and agency obligations   |       | 43,857                  |       | 40,034 |   | 37,821 |   |
| Total                                    |       | $                       | 60,746     |   | $ | 56,695 |   | $ | 56,660 |   |

 

As a member of the FHLBof Dallas, the Bank is required to maintain an investment in FHLB stock.  At December 31, 2006, the Bank’sinvestment in FHLB stock amounted to $7.1 million.  No ready market exists for such stock and ithas no quoted market value.

**Sourcesof Funds**

**General. **Deposits are the primarysource of the Bank’s funds for lending and other investment purposes.  In addition to deposits, the Bank derivesfunds from loan principal repayments and prepayments and interest payments,maturities and calls of investment securities and advances from the FHLB ofDallas.  Loan repayments are a relativelystable source of funds, while deposit inflows and outflows are significantlyinfluenced by general interest rates and money market conditions.  Borrowings are used when funds from depositsources are insufficient to meet funding needs. They may also be used on a longer-term basis for general businesspurposes.  FHLB advances are the primarysource of borrowings.

15

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**Deposits. **The Bank’s deposit productsinclude a broad selection of deposit instruments, including negotiable order ofwithdrawal (“NOW”) accounts, demand deposit accounts (“DDA”), money marketaccounts, regular savings accounts and term certificate accounts.  Deposit account terms vary, with theprincipal differences being the minimum balance required, the time period thefunds must remain on deposit, early withdrawal penalties and the interest rate.

The Bank considers itsprimary market area to be Northcentral and Northwest Arkansas.  The Bank utilizes traditional marketingmethods to attract new customers and savings deposits.  In the second quarter of 2004, the Bank begana direct mail campaign to solicit checking accounts.   The Bank willcontinue to focus much of its marketing resources on cross-selling checkingaccounts and developing new checking account relationships with the Bank.  The Bank does not advertise for depositsoutside of its primary market area and management believes that aninsignificant number of deposit accounts were held by non-residents of Arkansasat December 31, 2006.  Services ofdeposit brokers have been used on a limited basis  with less than 1% of certificates of depositat December 31, 2006, obtained through a broker.

The Bank has beencompetitive in the types of accounts and in interest rates it has offered onits deposit products but does not necessarily seek to match the highest ratespaid by competing institutions.  Althoughmarket demand generally dictates which deposit maturities and rates will beaccepted by the public, the Bank intends to continue to offer longer-termdeposits to the extent possible and consistent with its asset and liabilitymanagement goals.

The following table showsthe distribution of, and certain other information relating to, the Bank’sdeposits by type of deposit, as of the dates indicated.

 
| ** **                  | ** ** | **December 31,**                | ** ** |
|-----------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | **2006**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                  | ** ** | **Amount**                           | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(Dollars in Thousands)** | ** ** |
| ** **                  | ** ** | ** **                           | ** ** |
| Certificate  accounts:      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Less than 3.00%             |       | $                                    | 4,173      |   | 0.6 | % | $ | 62,689 |   | 10.2 | % | $ | 168,779 |   | 29.0 | % |
| 3.00% - 3.99%               |       | 98,932                               |       | 15.2 |   | 164,600 |   | 26.9 |   | 68,140 |   | 11.7 |   |
| 4.00% - 5.99%               |       | 327,311                              |       | 50.2 |   | 156,224 |   | 25.5 |   | 81,725 |   | 14.0 |   |
| 6.00% - 7.99%               |       | 3,826                                |       | 0.6 |   | 7,757 |   | 1.3 |   | 15,911 |   | 2.7 |   |
| 8.00% and over              |       | —                               |       | — |   | 458 |   | 0.1 |   | 423 |   | 0.1 |   |
| Total  certificate accounts |       | 434,242                              |       | 66.6 |   | 391,728 |   | 64.0 |   | 334,978 |   | 57.5 |   |
|                        |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Transaction  accounts:      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Savings                     |       | 26,824                               |       | 4.1 |   | 30,521 |   | 5.0 |   | 31,611 |   | 5.4 |   |
| Money market accounts       |       | 51,827                               |       | 7.9 |   | 64,021 |   | 10.5 |   | 106,063 |   | 18.2 |   |
| NOW accounts/DDA            |       | 139,372                              |       | 21.4 |   | 125,397 |   | 20.5 |   | 109,772 |   | 18.9 |   |
| Total transaction accounts  |       | 218,023                              |       | 33.4 |   | 219,939 |   | 36.0 |   | 247,446 |   | 42.5 |   |
| Total deposits              |       | $                                    | 652,265    |   | 100.0 | % | $ | 611,667 |   | 100.0 | % | $ | 582,424 |   | 100.0 | % |

 

During 2006 and 2005, duein large part to increases in short-term market interest rates, the Bankexperienced a shift in deposits from money market accounts and savings accountsto higher rate certificates of deposit. The increase in rates is also reflected in the shift between lower ratecertificates of deposit to higher rate certificates of deposit.

The following tablepresents the average balance of each type of deposit and the average rate paidon each type of deposit and/or total deposits for the periods indicated.

 
| ** **               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|
| ** **               | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **               | ** ** | **Average  Balance**                       | ** ** | **Average  Rate  Paid** | ** ** | **Average  Balance** | ** ** | **Average  Rate  Paid** | ** ** | **Average  Balance** | ** ** | **Average  Rate  Paid** | ** ** |
| ** **               | ** ** | **(Dollars in Thousands)**       | ** ** |
| ** **               | ** ** | ** **                                 | ** ** |
| Savings accounts         |       | $                                          | 29,018     |   | 0.59 | % | $ | 31,276 |   | 0.50 | % | $ | 31,096 |   | 0.41 | % |
| Money market  accounts   |       | 56,984                                     |       | 2.64 |   | 82,492 |   | 1.76 |   | 113,842 |   | 1.46 |   |
| NOW accounts             |       | 96,095                                     |       | 1.47 |   | 82,522 |   | 0.50 |   | 75,416 |   | 0.37 |   |
| Demand deposit  accounts |       | 36,133                                     |       | — |   | 35,387 |   | — |   | 29,263 |   | — |   |
| Certificates of  deposit |       | 412,000                                    |       | 4.31 |   | 359,076 |   | 3.54 |   | 331,662 |   | 3.20 |   |
| Total deposits           |       | $                                          | 630,230    |   | 3.28 | % | $ | 590,753 |   | 2.47 | % | $ | 581,279 |   | 2.18 | % |

 

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The followingtable presents, by various interest rate categories, certificates of deposit atDecember 31, 2006 and 2005, and the amounts at December 31, 2006,which mature during the periods indicated.

 
| ** **                  | ** ** | **December 31,**   | ** ** | **Amounts at December 31, 2006  Maturing in the 12 Months Ending December 31,** | ** ** |
|-----------------------------|------------|-------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                  | ** ** | **2006**                | ** ** | **2005**                                                                                                                               | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** |
| ** **                  | ** ** | **(In Thousands)** | ** ** |
| ** **                  | ** ** | ** **              | ** ** |
| Certificate accounts:       |       |                    |       |                                                                                                                                   |       |   |   |   |   |   |   |   |   |
| Less than 3.00%             |       | $                       | 4,173      |                                                                                                                                   | $          | 62,689 |   | $ | 3,977 |   | $ | 183 |   | $ | 13 |   | $ | — |   |
| 3.00% - 3.99%               |       | 98,932                  |       | 164,600                                                                                                                                |       | 60,397 |   | 36,094 |   | 946 |   | 1,495 |   |
| 4.00% - 5.99%               |       | 327,311                 |       | 156,224                                                                                                                                |       | 267,176 |   | 19,807 |   | 6,882 |   | 33,446 |   |
| 6.00% - 7.99%               |       | 3,826                   |       | 7,757                                                                                                                                  |       | — |   | 974 |   | 2,852 |   | — |   |
| 8.00% and over              |       | —                  |       | 458                                                                                                                                    |       | — |   | — |   | — |   | — |   |
| Total certificate  accounts |       | $                       | 434,242    |                                                                                                                                   | $          | 391,728 |   | $ | 331,550 |   | $ | 57,058 |   | $ | 10,693 |   | $ | 34,941 |   |

 

The following table sets forth maturities of the Bank’s certificates ofdeposit of $100,000 or more at December 31, 2006 by time remaining tomaturity.

 

|                                                                  | ** ** | **Amount**              | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                       | ** ** | **(In Thousands)** | ** ** |
| ** **                                                       | ** ** | ** **              | ** ** |
| Period Ending:                                              |       |                    |       |
| March 31, 2007                                                   |       | $                       | 42,268     |   |
| June 30, 2007                                                    |       | 36,349                  |       |
| September 30,  2007                                              |       | 16,952                  |       |
| December 31,  2007                                               |       | 11,831                  |       |
| After December  31, 2007                                         |       | 29,803                  |       |
| Total certificates of deposit with balances of  $100,000 or more |       | $                       | 137,203    |   |

 

**Borrowedfunds.**  The Bankutilizes FHLB advances in its normal operating and investing activities.  The Bank pledges as collateral for FHLBadvances its FHLB stock and FHLB demand deposit account and has entered into ablanket collateral agreement with the FHLB. Eligible collateral under the blanket lien includes First MortgageCollateral (as defined by FHLB), multi-family residential mortgages meeting therequirements for eligibility as First Mortgage Collateral, U.S. Government andAgency Securities (as defined by FHLB), privately issued mortgage-backedsecurities that qualify as eligible collateral under applicable regulations,FHLB Term Deposit Accounts, and other non-securitized real estate relatedcollateral.

Advances atDecember 31, 2006, have maturity dates and weighted average rates as follows:

 

| Year Ending  December 31, | ** ** | **Weighted  Average  Rate** | ** ** | **Amount**                           | ** ** |
|-------------------------------------|------------|-----------------------------|------------|--------------------------------------|------------|
| ** **                          | ** ** | ** **                  | ** ** | **(Dollars in Thousands)** | ** ** |
| 2007                                |       | 4.68                        | %          | $                                    | 59,818     |   |
| 2008                                |       | 4.50                        |       | 30,594                               |       |
| 2009                                |       | 4.48                        |       | 16,308                               |       |
| 2010                                |       | 4.36                        |       | 5,008                                |       |
| 2011                                |       | 4.49                        |       | 6,151                                |       |
| Thereafter                          |       | 4.36                        |       | 2,426                                |       |
| Total                               |       | 4.58                        | %          | $                                    | 120,305    |   |

 

The followingtable sets forth information with respect to the Company’s FHLB advances at andduring the periods indicated.

 

|                                  | ** ** | **At or For the Year Ended December 31,** | ** ** |
|----------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **2006**                                                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                       | ** ** | **(Dollars in Thousands)**                                         | ** ** |
| Maximum balance                  |       | $                                                                            | 171,375    |   | $ | 171,203 |   | $ | 89,756 |   |
|                             |       |                                                                         |       |   |   |   |   |
| Average balance                  |       | 154,186                                                                      |       | 135,636 |   | 53,299 |   |
|                             |       |                                                                         |       |   |   |   |   |
| Year end balance                 |       | 120,305                                                                      |       | 158,240 |   | 89,756 |   |
|                             |       |                                                                         |       |   |   |   |   |
| Weighted average  interest rate: |       |                                                                         |       |   |   |   |   |
|                             |       |                                                                         |       |   |   |   |   |
| At end of year                   |       | 4.58                                                                         | %          | 4.08 | % | 3.23 | % |
|                             |       |                                                                         |       |   |   |   |   |
| During the year                  |       | 4.50                                                                         | %          | 3.68 | % | 3.09 | % |
|                                  |            |                                                                              |            |  |  |  |  |  |  |  |

## **Subsidiaries**

The Bank is permitted toinvest up to 2% of its assets in the capital stock of, or secured or unsecuredloans to, subsidiary corporations, with an additional investment of 1% ofassets when such additional investment is utilized primarily for communitydevelopment purposes.  The Bank’s onlysubsidiary, First Harrison Service Corporation (the “Service Corporation”), wasformed in 1971.  At December 31, 2006,the Service Corporation was inactive.

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**REGULATION**

*Setforth below is a brief description of those laws and regulations which,together with the descriptions of laws and regulations contained elsewhereherein, are deemed material to an investor’s understanding of the extent towhich the Company and the Bank are regulated. The description of the laws and regulations hereunder, as well asdescriptions of laws and regulations contained elsewhere herein, does notpurport to be complete and is qualified in its entirety by reference toapplicable laws and regulations.*

**TheCompany**

**General.**  The Company, as a savings and loan holdingcompany within the meaning of the Home Owners’ Loan Act (“HOLA”), hasregistered with the OTS and is subject to OTS regulations, examinations,supervision and reporting requirements. As a subsidiary of a savings and loan holding company, the Bank issubject to certain restrictions in its dealings with the Company and affiliatesthereof.

**HoldingCompany Acquisitions.** Federal law generally prohibits a savings and loan holding company,without prior OTS approval, from acquiring the ownership or control of anyother savings institution or savings and loan holding company, or all, orsubstantially all, of the assets or more than 5% of the voting shares thereofwhich is not a subsidiary.  Theseprovisions also prohibit, among other things, any director or officer of asavings and loan holding company, or any individual who owns or controls morethan 25% of the voting shares of such holding company, from acquiring controlof any savings institution not a subsidiary of such savings and loan holdingcompany, unless the acquisition is approved by the OTS.

**HoldingCompany Activities.** There are generally no restrictions on the activities of a savings andloan holding company, such as the Company, which controlled only one subsidiarysavings association on or before May 4, 1999 (a “grandfathered holding company”).  However, if the Director of the OTSdetermines that there is reasonable cause to believe that the continuation by asavings and loan holding company of an activity constitutes a serious risk tothe financial safety, soundness or stability of its subsidiary savingsassociation, the Director may impose such restrictions as it deems necessary toaddress such risk, including limiting (i) payment of dividends by the savingsassociation; (ii) transactions between the savings association and itsaffiliates; and (iii) any activities of the savings association that mightcreate a serious risk that the liabilities of the holding company and itsaffiliates may be imposed on the savings association.  Notwithstanding the above rules as topermissible business activities of unitary savings and loan holding companies,if the savings association subsidiary of such a holding company fails to meet thequalified thrift lender (“QTL”) test, then such unitary holding company alsoshall become subject to the activities restrictions applicable to multiplesavings and loan holding companies and, unless the savings associationrequalifies as a QTL within one year thereafter, shall register as, and becomesubject to the restrictions applicable to, a bank holding company.

If a savings and loanholding company acquires control of a second savings association and holds itas a separate institution, the holding company becomes a multiple savings andloan holding company.  As a general rule,multiple savings and loan holding companies are subject to restrictions ontheir activities that are not imposed on a grandfathered holding company.  They are restricted to activitiestraditionally permitted to multiple savings and loan holding companies and tofinancial holding companies under provisions of the Bank Holding CompanyAct.  Multiple savings and loan holdingcompanies may:

·                  furnish or perform managementservices for a savings association subsidiary of a savings and loan holdingcompany;

·                  hold, manage or liquidate assetsowned or acquired from a savings association subsidiary of a savings and loanholding company;

·                  hold or manage properties used oroccupied by a savings association subsidiary of a savings and loan holdingcompany;

·                  engage in activities determined bythe Federal Reserve to be closely related to banking and a proper incidentthereto; and

·                  engagein services and activities previously determined by the Federal Home Loan BankBoard by regulation to be permissible for a multiple savings and loan holdingcompany as of March 5, 1987.

The activities financialholding companies may engage in include:

·                  lending, exchanging, transferring orinvesting for others, or safeguarding money or securities;

·                  insuring, guaranteeing orindemnifying others, issuing annuities, and acting as principal, agent orbroker for purposes of the foregoing;

·                  providing financial, investment oreconomic advisory services, including advising an investment company;

·                  issuing or selling interests inpooled assets that a bank could hold directly;

·                  underwriting, dealing in or making amarket in securities; and

·                  merchantbanking activities.

Every savings institutionsubsidiary of a savings and loan holding company is required to give the OTS atleast 30 days’ advance notice of any proposed dividends to be made on itsguaranteed, permanent or other non-withdrawable stock, or else such dividendwill be invalid.

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**Restrictionson Transactions with Affiliates.**   Transactions between a savings institutionand its “affiliates” are subject to quantitative and qualitative restrictionsunder Sections 23A and 23B of the Federal Reserve Act and OTS regulations.  Affiliates of a savings institution generallyinclude, among other entities, the savings institution’s holding company andcompanies that are controlled by or under common control with the savingsinstitution.  Generally, Section 23A (i)limits the extent to which the savings association or its subsidiaries mayengage in “covered transactions” with any one affiliate to an amount equal to10% of such association’s capital stock and surplus, and contain an aggregatelimit on all such transactions with all affiliates to an amount equal to 20% ofsuch capital stock and surplus.  Section23B applies to “covered transactions” as well as certain other transactions andrequires that all transactions be on terms substantially the same, or at leastfavorable, to the association or subsidiary as those provided to anon-affiliate.  The term “coveredtransaction” includes the making of loans to, purchase of assets from, issuanceof a guarantee to an affiliate and similar transactions.  Section 23B transactions also apply to theprovision of services and the sale of assets by a savings association to anaffiliate.  In addition to therestrictions imposed by Sections 23A and 23B, Section 11 of the HOLA prohibitsa savings association from (i) making a loan or other extension of credit to anaffiliate, except for any affiliate which engages only in certain activitieswhich are permissible for bank holding companies, or (ii) purchasing orinvesting in any stocks, bonds, debentures, notes or similar obligations of anyaffiliate, except for affiliates which are subsidiaries of the savingsassociation.

In addition, Sections22(g) and (h) of the Federal Reserve Act place restrictions on loans toexecutive officers, directors and principal stockholders.  Under Section 22(h), loans to a director, anexecutive officer and to a greater than 10% stockholder of a savingsinstitution (“a principal stockholder”), and certain affiliated interests ofeither, may not exceed, together with all other outstanding loans to suchperson and affiliated interests, the savings institution’s loans to oneborrower limit (generally equal to 15% of the institution’s unimpaired capitaland surplus).  Section 22(h) alsorequires that loans to directors, executive officers and principal stockholdersbe made on terms substantially the same as offered in comparable transactionsto other persons unless the loans are made pursuant to a benefit orcompensation program that (i) is widely available to employees of theinstitution and (ii) does not give preference to any director, executiveofficer or principal stockholder, or certain affiliated interests of either,over other employees of the savings institution.  Section 22(h) also requires prior boardapproval for certain loans.  In addition,the aggregate amount of extensions of credit by a savings institution to allinsiders cannot exceed the institution’s unimpaired capital and surplus.  Furthermore, Section 22(g) places additionalrestrictions on loans to executive officers. At December 31, 2006, the Bank was in compliance with the aboverestrictions.

**FederalSecurities Law.*** *The common stock of the Company isregistered with the SEC under the Securities Exchange Act of 1934, as amended.The Company is subject to the information, proxy solicitation, insider tradingrestrictions and other requirements of the SEC under the Securities ExchangeAct of 1934.

Company stock held bypersons who are affiliates of the Company may not be resold withoutregistration unless sold in accordance with certain resale restrictions.Affiliates are generally considered to be officers, directors and principalstockholders. If the Company meets specified current public informationrequirements, each affiliate of the Company will be able to sell in the publicmarket, without registration, a limited number of shares in any three-monthperiod.

The Sarbanes-Oxley Act of2002 (“Sarbanes-Oxley”), which was signed into law in July 2002, impacts allcompanies with securities registered under the Securities Exchange Act of 1934,including the Company. Sarbanes-Oxley created new requirements in the areas ofcorporate governance and financial disclosure including, among other things:

·                  increased responsibility for ChiefExecutive Officers and Chief Financial Officers with respect to the content offilings with the SEC;

·                  enhanced requirements for auditcommittees, including independence and disclosure of expertise;

·                  enhanced requirements for auditorindependence and the types of non-audit services that auditors can provide;

·                  enhanced requirements for controlsand procedures;

·                  accelerated filingrequirements for SEC reports;

·                  disclosure of a code of ethics; and

·                  increaseddisclosure and reporting obligations for companies, their directors and theirexecutive officers.

Certifications of theChief Executive Officer and the Chief Financial Officer as required bySarbanes-Oxley and the resulting SEC rules can be found in the “Exhibits”section of this Form 10-K.

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**The Bank**

**General.**  TheOTS has extensive authority over the operations of federally chartered savingsinstitutions.  As part of this authority,savings institutions are required to file periodic reports with the OTS and aresubject to periodic examinations by the OTS and the FDIC.  The last regulatory examination of the Bankby the OTS was completed in February 2006. The Bank was not required to make any material changes to its operationsas a result of such examination.  Theinvestment and lending authority of savings institutions are prescribed byfederal laws and regulations, and such institutions are prohibited fromengaging in any activities not permitted by such laws and regulations.

The OTS’ enforcementauthority over all savings institutions and their holding companies includes,among other things, the ability to assess civil money penalties, to issue ceaseand desist or removal orders and to initiate injunctive actions.  In general, these enforcement actions may beinitiated for violations of laws and regulations and unsafe or unsoundpractices.  Other actions or inactionsmay provide the basis for enforcement action, including misleading or untimelyreports filed with the OTS.

**Insuranceof Accounts.**  On February 8, 2006, President Bushsigned into law legislation that merges the Bank Insurance Fund (“BIF”) and theSavings Association Insurance Fund (“SAIF”), eliminates any disparities in bankand thrift risk-based premium assessments, reduces the administrative burden ofmaintaining and operating two separate funds and establishes certain newinsurance coverage limits and a mechanism for possible periodic increases.  The legislation also gives the FDIC greaterdiscretion to identify the relative risks all institutions present to thedeposit insurance fund and set risk-based premiums.

Major provisions in thelegislation include:  maintaining basicdeposit and municipal account insurance coverage at $100,000 but providing fora new basic insurance coverage for retirement accounts of $250,000; allowinginsurance coverage for basic deposit and retirement accounts to be increasedfor inflation every five years in $10,000 increments beginning in 2011;providing the FDIC with the ability to set the designated reserve ratio withina range of between 1.15% and 1.50%, rather than maintaining 1.25% at all timesregardless of prevailing economic conditions; providing a one-time assessmentcredit of $4.7 billion to banks and savings associations in existence onDecember 31, 1996, which may be used to offset future premiums with certainlimitations; requiring the payment of dividends of 100% of the amount that theinsurance fund exceeds 1.5% of the estimated insured deposits; requiring thepayment of dividends of 50% of the amount that the insurance fund exceeds 1.35%of the estimated insured deposits (when the reserve is greater than 1.35% butno more than 1.5%); and requiring that the merger of the SAIF and BIF occur nolater than July 1, 2006.

The FDIC merged the BIFand the SAIF to form the DIF on March 31, 2006 in accordance with the FederalDeposit Insurance Reform Act of 2005. The FDIC maintains the DIF by assessingdepository institutions an insurance premium. The FDIC Board approved a newrisk-based premium system in November 2006, effective January 1, 2007. The FDIC’snew regulations for risk-based deposit insurance assessments establish fourRisk Categories. Risk Category I, for well-capitalized institutions that arefinancially sound with only a few minor weaknesses, includes approximately 95%of FDIC-insured institutions. Risk Categories II, III, and IV presentprogressively greater risks to the deposit insurance fund. Effective January 1,2007, Risk Category I institutions pay quarterly assessments for depositinsurance at annual rates of five to seven basis points. The rates for RiskCategories II, III, and IV are seven, 28, and 43 basis points, respectively.Rates are subject to change with advance notice to insured institutions.

Within Risk Category I,the precise rate for an individual institution with less than $10 billion inassets is generally determined by a formula using CAMELS ratings which areassigned in regulatory examinations, and financial ratios. A different methodapplies for larger institutions. The rate for an individual institution isapplied to its assessment base, which is generally its deposit liabilitiessubject to certain adjustments. An institution insured by the FDIC on December31, 1996 which had previously paid assessments (or its successor) is eligiblefor certain credit against deposit insurance assessments. As a result of theBank’s credit, it anticipates no premium expense during calendar year 2007.

The Bank, like otherformer SAIF insured institutions and BIF insured institutions, is required topay a Financing Corporation (“FICO”) assessment in order to fund the intereston bonds issued to resolve thrift failures in the 1980s. For the first quarterof fiscal year 2007, the annual rate for this assessment is 1.24 basis pointsfor each $100 in domestic deposits. These assessments, which may be revisedbased upon the level of BIF and former SAIF classified insured institution’sdeposits, will continue until the bonds mature in 2017 through 2019.

The deposits of the Bankare insured to the maximum extent permitted by the DIF, which is administeredby the FDIC, and are backed by the full faith and credit of the U.S.Government.  As insurer, the FDIC isauthorized to conduct examinations of, and to require reporting by,FDIC-insured institutions.  It also mayprohibit any FDIC-insured institution from engaging in any activity the FDICdetermines by regulation or order to pose a serious threat to the FDIC.  The FDIC also has the authority to initiateenforcement actions against savings institutions, after giving the OTS anopportunity to take such action.

The FDIC may terminatethe deposit insurance of any insured depository institution, including theBank, if it determines after a hearing that the institution has engaged or isengaging in unsafe or unsound practices, is in an unsafe or unsound conditionto continue operations, or has violated any applicable law, regulation, orderor any condition imposed by an agreement with the FDIC.  It also may suspend deposit insurancetemporarily during the hearing process for the permanent termination ofinsurance, if the institution has no tangible capital.  If insurance of accounts is terminated, theaccounts at the institution at the time of the termination, less subsequentwithdrawals, shall continue to be insured for a period of six months 

20

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to two years, asdetermined by the FDIC.  Management isaware of no existing circumstances which would result in termination of theBank’s deposit insurance.

**RegulatoryCapital Requirements.** Federally insured savings institutions are required to maintain minimumlevels of regulatory capital.  The OTShas established capital standards applicable to all savings institutions.  These standards generally must be asstringent as the comparable capital requirements imposed on nationalbanks.  The OTS also is authorized toimpose capital requirements in excess of these standards on individualinstitutions on a case-by-case basis.

Current OTS capitalstandards require savings institutions to satisfy three different capitalrequirements.  Under these standards,savings institutions must maintain “tangible” capital equal to at least 1.5% ofadjusted total assets, “core” capital equal to at least 4.0% of adjusted totalassets and “total” capital (a combination of core and “supplementary” capital)equal to at least 8.0% of “risk-weighted” assets.  For purposes of the regulation, core capitalgenerally consists of common stockholders’ equity (including retainedearnings), noncumulative perpetual preferred stock and related surplus,minority interests in the equity accounts of fully consolidated subsidiaries,certain nonwithdrawable accounts and pledged deposits and “qualifyingsupervisory goodwill.”  Tangible capitalis given the same definition as core capital but does not include qualifyingsupervisory goodwill and is reduced by the amount of all the savingsinstitution’s intangible assets, with only a limited exception for purchasedmortgage servicing rights.  Both core andtangible capital are further reduced by an amount equal to a savingsinstitution’s debt and equity investments in subsidiaries engaged in activitiesnot permissible to national banks (other than subsidiaries engaged inactivities undertaken as agent for customers or in mortgage banking activitiesand subsidiary depository institutions or their holding companies).  These adjustments do not materially affectthe Bank’s regulatory capital.  AtDecember 31, 2006, the Bank exceeded its tangible, core and risk-based capitalrequirements.

In determining compliancewith the risk-based capital requirement, a savings institution is allowed toinclude both core capital and supplementary capital in its total capital,provided that the amount of supplementary capital included does not exceed thesavings institution’s core capital. Supplementary capital generally consists of hybrid capital instruments;perpetual preferred stock which is not eligible to be included as core capital;subordinated debt and intermediate-term preferred stock; and general allowancesfor loan losses up to a maximum of 1.25% of risk-weighted assets.  In determining the required amount ofrisk-based capital, total assets, including certain off-balance sheet items,are multiplied by a risk weight based on the risks inherent in the type ofassets.  The risk weights assigned by theOTS for principal categories of assets are (i) 0% for cash and securitiesissued by the U.S. Government or unconditionally backed by the full faith andcredit of the U.S. Government; (ii) 20% for securities (other than equitysecurities) issued by U.S. Government-sponsored agencies and mortgage-backedsecurities issued by, or fully guaranteed as to principal and interest by, theFNMA or the FHLMC, except for those classes with residual characteristics orstripped mortgage-related securities; (iii) 50% for prudently underwrittenpermanent one- to four-family first lien mortgage loans not more than 90days delinquent and having a loan-to-value ratio of not more than 90% atorigination unless insured to such ratio by an insurer approved by the FNMA orthe FHLMC, qualifying residential bridge loans made directly for theconstruction of one- to four-family residences and qualifying multi-familyresidential loans; and (iv) 100% for all other loans and investments, includingconsumer loans, commercial loans, and one- to four-familyresidential real estate loans more than 90 days delinquent, and for repossessedassets.

**QualifiedThrift Lender Test.** All savings institutions are required to meet a QTL test to avoidcertain restrictions on their operations.  A savings institution that doesnot meet the QTL test must either convert to a bank charter or comply with thefollowing restrictions on its operations: (i) the institution may not engage inany new activity or make any new investment, directly or indirectly, unlesssuch activity or investment is permissible for a national bank; (ii) thebranching powers of the institution shall be restricted to those of a national bank;and (iii) payment of dividends by the institution shall be subject to the rulesregarding payment of dividends by a national bank.  Upon the expiration ofthree years from the date the savings institution ceases to be a QTL, it mustcease any activity and not retain any investment not permissible for a nationalbank.

Currently, the QTL testrequires either (i) that a savings association qualifies as a domestic buildingand loan association as defined in Section 7701 (a)(19) of the Internal RevenueCode of 1986, as amended, (“Code”) or (ii) that 65% of an institution’s “portfolioassets” (as defined) consist of certain housing and consumer-relatedassets on a monthly average basis in nine out of every 12 months.  Assets that qualify without limit for inclusionas part of the 65% requirement are loans made to purchase, refinance,construct, improve or repair domestic residential housing and manufacturedhousing; home equity loans; educational loans; small business loans; loans madethrough credit cards or credit card accounts; mortgage-backed securities(where the mortgages are secured by domestic residential housing ormanufactured housing); stock issued by the FHLB of Dallas; and direct orindirect obligations of the FDIC.  Inaddition, the following assets, among others, may be included in meeting thetest subject to an overall limit of 20% of the savings institution’s portfolioassets: 50% of residential mortgage loans originated and sold within 90 days oforigination; investments in a service corporation that derives at least 80% ofits gross revenues from activities related to domestic or manufacturedresidential housing; 200% of the amount of loans and investments in “starterhomes”; 200% of the amount of certain loans in “credit-needy” areas; loans forthe purchase, construction, development, or improvements of “community servicefacilities” not in credit-needy areas; loans for personal, family, or householdpurchases (other than those in the includable without limit category); andstock issued by the FHLMC or the FNMA. Portfolio assets consist of total assets minus the sum of(i) goodwill and other intangible assets, (ii) property used by thesavings institution to conduct its business, and (iii) liquid assets up to20% of the institution’s total assets. At December 31, 2006, the qualified thrift investments of the Bankwere approximately 74.4% of its portfolio assets.

21

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**FederalHome Loan Bank System. **TheBank is a member of the FHLB of Dallas, which is one of 12 regional FHLBs thatadministers the home financing credit function of savings institutions.  Each FHLB serves as a reserve or central bankfor its members within its assigned region. It is funded primarily from proceeds derived from the sale ofconsolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policiesand procedures established by the board of directors of the FHLB.  At December 31, 2006, the Bank had $120.3million of outstanding FHLB advances.

As a member, the Bank isrequired to purchase and maintain stock in the FHLB of Dallas in an amountequal to the sum of 0.08% of total assets as of the previous December 31 and4.10% of outstanding advances.  AtDecember 31, 2006, the Bank had $7.1 million in FHLB stock, which was incompliance with this requirement.  Noready market exists for such stock and it has no quoted market value.

The FHLBs are required toprovide funds for the resolution of troubled savings institutions and tocontribute to affordable housing programs through direct loans or interestsubsidies on advances targeted for community investment and low- andmoderate-income housing projects.  Thesecontributions have adversely affected the level of FHLB dividends paid in thepast and could continue to do so in the future. These contributions also could have an adverse effect on the value ofFHLB stock in the future.

**FederalReserve System. **The FRBrequires all depository institutions to maintain reserves against theirtransaction accounts and non-personal time deposits.  As of December 31, 2006, no reserves wererequired to be maintained on the first $8.5 million of transaction accounts,reserves of 3% were required to be maintained against the next $37.3 million ofnet transaction accounts (with such dollar amounts subject to adjustment by theFRB), and a reserve of 10% against all remaining net transaction accounts.  Because required reserves must be maintainedin the form of vault cash or a noninterest bearing account at a Federal ReserveBank, the effect of this reserve requirement is to reduce an institution’searning assets.

**TAXATION**

**Federal Taxation**

**General. **The Company and the Bankare subject to the generally applicable corporate tax provisions of the Code,and the Bank is subject to certain additional provisions of the Code whichapply to thrift and other types of financial institutions.  The following discussion of federal taxationis intended only to summarize certain pertinent federal income tax mattersmaterial to the taxation of the Company and the Bank and is not a comprehensivediscussion of the tax rules applicable to the Company and Bank.

**Year. **The Bank files a federalincome tax return on the basis of a fiscal year ending on December 31.  The Company filed a consolidated federalincome tax return with both the Bank and the Service Corporation.

**Bad DebtReserves. **Prior to theenactment of the Small Business Jobs Protection Act (the “Act”), which wassigned into law on August 21, 1996, certain thrift institutions, such as theBank, were allowed deductions for bad debts under methods more favorable thanthose granted to other taxpayers. Qualified thrift institutions could compute deductions for bad debtsusing either the specific charge-off method of Section 166 of the Code or thereserve method of Section 593 of the Code.

Under Section 593, athrift institution annually could elect to deduct bad debts under either (i)the “percentage of taxable income” method applicable only to thriftinstitutions, or (ii) the “experience” method that also was available to smallbanks.  Under the percentage of taxableincome method, a thrift institution generally was allowed a deduction for anaddition to its bad debt reserve equal to 8% of its taxable income (determinedwithout regard to this deduction and with additional adjustments).  Under the experience method, a thriftinstitution was generally allowed a deduction for an addition to its bad debtreserve equal to the greater of (i) an amount based on its actual averageexperience for losses in the current and five preceding taxable years, or (ii)an amount necessary to restore the reserve to its balance as of the close ofthe base year.  A thrift institutioncould elect annually to compute its allowable addition to bad debt reserves forqualifying loans either under the experience method or the percentage oftaxable income method.

Section 1616(a) of theAct repealed the Section 593 reserve method of accounting for bad debts bythrift institutions, effective for taxable years beginning after 1995.  Thrift institutions that are treated as “smallbanks” are allowed to utilize the experience method applicable to suchinstitutions, while thrift institutions that are treated as “large banks” arerequired to use only the specific charge-off method.  The percentage of taxable income method ofaccounting for bad debts is no longer available for any financial institution.

A thrift institutionrequired to change its method of computing reserves for bad debts will treatsuch change as a change in the method of accounting, initiated by the taxpayerand having been made with the consent of the Secretary of the Treasury. Section481(a) of the Code requires certain amounts to be recaptured with respect tosuch change.  Generally, the amounts tobe recaptured will be determined solely with respect to the “applicable excessreserves” of the taxpayer.  The amount ofthe applicable excess reserves will be taken into account ratably over a periodof six taxable years, beginning with the first taxable year after 1995, subjectto the residential loan requirement described below.  In the case of a thrift institution that istreated as a large bank, the amount of the institution’s applicable excessreserves generally is the excess of (i) the balance of its reserve for losseson qualifying real property loans (generally loans secured by improved realestate) and its reserve for losses on nonqualifying loans (all other types ofloans) as of the close of its last taxable year beginning before January 1, 

22

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1996, over (ii) thebalances of such reserves as of the close of its last taxable year beginningbefore January 1, 1988 (i.e., the “pre-1988 reserves”).  In the case of a thrift institution that istreated as a small bank, the amount of the institution’s applicable excessreserves generally is the excess of (i) the balance of its reserve for losseson qualifying real property loans and its reserve for losses on nonqualifyingloans as of the close of its last taxable year beginning before January 1,1996, over (ii) the greater of the balance of (a) its pre-1988 reserves or, (b)what the thrift’s reserves would have been at the close of its last yearbeginning before January 1, 1996, had the thrift always used the experiencemethod.

For taxable years thatbegin after December 31, 1995, and before January 1, 1998, if a thrift meetsthe residential loan requirement for a tax year, the recapture of theapplicable excess reserves otherwise required to be taken into account as aCode Section 481(a) adjustment for the year will be suspended.  A thrift meets the residential loanrequirement if, for the tax year, the principal amount of residential loans madeby the thrift during the year is not less than its base amount.  The “base amount” generally is the average ofthe principal amounts of the residential loans made by the thrift during thesix most recent tax years beginning before January 1, 1996.  A residential loan is a loan as described inSection 7701(a) (19) (C) (v) (generally a loan secured by residential or churchproperty and certain mobile homes), but only to the extent that the loan ismade to the owner of the property.  TheBank’s applicable excess reserves were fully recaptured ratably over a periodof six taxable years, beginning with taxable year 1998 and concluding withtaxable year 2003.

The balance of thepre-1988 reserves is subject to the provisions of Section 593(e), as modifiedby the Act, which requires recapture in the case of certain excessivedistributions to shareholders.  Thepre-1988 reserves may not be utilized for payment of cash dividends or otherdistributions to a shareholder (including distributions in dissolution or liquidation)or for any other purpose (except to absorb bad debt losses).  Distribution of a cash dividend by a thriftinstitution to a shareholder is treated as made:  first, out of the institution’s post-1951accumulated earnings and profits; second, out of the pre-1988 reserves; andthird, out of such other accounts as may be proper.  To the extent a distribution by the Bank tothe Company is deemed paid out of its pre-1988 reserves under these rules, thepre-1988 reserves would be reduced and the Bank’s gross income for tax purposeswould be increased by the amount which, when reduced by the income tax, if any,attributable to the inclusion of such amount in its gross income, equals theamount deemed paid out of the pre-1988 reserves.  As of December 31, 2006, the Bank’spre-1988 reserves for tax purposes totaled approximately $4.2 million.

**MinimumTax. **The Code imposesan alternative minimum tax at a rate of 20%. The alternative minimum tax generally applies to a base of regulartaxable income plus certain tax preferences (“alternative minimum taxableincome” or “AMTI”) and is payable to the extent such AMTI is in excess of anexemption amount.  Items of taxpreference that constitute AMTI include (a) tax-exempt interest on newly issued(generally, issued on or after August 8, 1986) private activity bondsother than certain qualified bonds and (b) 75% of the excess (if any) of (i)adjusted current earnings as defined in the Code, over (ii) AMTI (determinedwithout regard to this preference and prior to reduction by net operatinglosses).

**NetOperating Loss Carryovers. **Afinancial institution may, for federal income tax purposes, carry back netoperating losses (“NOLs”) to the preceding two taxable years and forward to thesucceeding 20 taxable years.  Thisprovision applies to losses incurred in taxable years beginning after1997.  The Job Creation and WorkerAssistance Act of 2002 temporarily increased the general NOL carryback periodfrom two years to five years for NOLs arising in taxable years ending in 2001and 2002.  At December 31, 2006, the Bankhad no NOL carryforwards for federal income tax purposes.

**CapitalGains and Corporate Dividends-Received Deduction. **Corporate net capital gainsare taxed at a maximum rate of 35%.  Thecorporate dividends-received deduction is 80% in the case of dividends receivedfrom a “20-percent-owned corporation”, i.e., a corporation having at leasttwenty percent (but generally less than 80 percent) of its stock owned by therecipient corporation and corporations which own less than 20% of the stock ofa corporation distributing a dividend may deduct only 70% of dividends receivedor accrued on their behalf.  However, acorporation may deduct 100% of dividends from a member of the same affiliatedgroup of corporations.

**OtherMatters. **Federallegislation is introduced from time to time that would limit the ability ofindividuals to deduct interest paid on mortgage loans.  Individuals are currently not permitted todeduct interest on consumer loans. Significant increases in tax rates or further restrictions on thedeductibility of mortgage interest could adversely affect the Bank.

The Bank’s federal incometax returns for the tax years ended December 31, 2003 forward are open underthe statute of limitations and are subject to review by the IRS.

**StateTaxation**

The Bank is subject tothe Arkansas corporation income tax, which is a progressive rate up to amaximum of 6.5% of all taxable earnings.

The Company isincorporated under Texas law and, accordingly, is subject to Texas franchisetax in an amount equal to 4.5% of net income allocated to Texas pursuant toapportionments of gross receipts based upon where the Company conductsbusiness.

23

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**Item1A.  Risk Factors**

*In analyzing whether to make orto continue an investment in our securities, investors should consider, amongother factors, the following risk factors.*

**Our results of operations aresignificantly dependent on economic conditions and related uncertainties.**

Banking is affected,directly and indirectly, by domestic and international economic and politicalconditions and by governmental monetary and fiscal policies.  Conditions such as inflation, recession,unemployment, volatile interest rates, real estate values, government monetarypolicy, international conflicts, the actions of terrorists and other factors beyondour control may adversely affect our results of operations.  Changes in interest rates, in particular,could adversely affect our net interest income and have a number of otheradverse effects on our operations, as discussed in the immediately succeedingrisk factor.  Adverse economic conditionsalso could result in an increase in loan delinquencies, foreclosures andnonperforming assets and a decrease in the value of the property or othercollateral which secures our loans, all of which could adversely affect ourresults of operations.  We areparticularly sensitive to changes in economic conditions and relateduncertainties in Northcentral and Northwest Arkansas because we derivesubstantially all of our loans, deposits and other business from this area.  Accordingly, we remain subject to the risksassociated with prolonged declines in national or local economies.

**Changes in interest rates couldhave a material adverse effect on our operations.**

The operations offinancial institutions such as the Bank are dependent to a large extent on netinterest income, which is the difference between the interest income earned oninterest earning assets such as loans and investment securities and theinterest expense paid on interest bearing liabilities such as deposits andborrowings.  Changes in the general levelof interest rates can affect our net interest income by affecting thedifference between the weighted average yield earned on our interest earningassets and the weighted average rate paid on our interest bearing liabilities,or interest rate spread, and the average life of our interest earning assetsand interest bearing liabilities. Changes in interest rates also can affect our ability to originateloans; the value of our interest earning assets; our ability to obtain andretain deposits in competition with other available investment alternatives;and the ability of our borrowers to repay adjustable or variable rateloans.  Interest rates are highlysensitive to many factors, including governmental monetary policies, domesticand international economic and political conditions and other factors beyondour control.  Although we believe thatthe estimated maturities of our interest earning assets currently are fairly wellbalanced in relation to the estimated maturities of our interest bearingliabilities (which involves various estimates as to how changes in the generallevel of interest rates will impact these assets and liabilities), there can beno assurance that our profitability would not be adversely affected during anyperiod of changes in interest rates.

At December 31, 2006, theBank had $331.6 million of certificate accounts which will mature during theyear ending December 31, 2007.  Of suchamount, $4.0 million carry rates less than 3.0%, $60.4 million carry ratesbetween 3.00% and 3.99% and $267.2 million carry rates between 4.00% and5.99%.  In addition, of the $120.3million of FHLB advances at December 31, 2006, $59.8 million, with a weightedaverage rate of 4.68%, will mature during the year ending December 31,2007.  Conversely, $295.4 million of theBank’s loans are scheduled to contractually mature during the year endingDecember 31, 2007.  The repricing of suchliabilities and assets may substantially impact the Company’s interest ratespread and net interest margin.

The interest rate spreaddecreased from 3.64% for the year ended December 31, 2004 to 3.41% for 2005 and3.19% for 2006.  In addition, netinterest margin decreased from 3.75% for the year ended December 31, 2004 to 3.51%for 2005 and 3.29% for 2006.  Due to thecurrent interest rate environment, the flat yield curve, the interest sensitivenature of its interest bearing liabilities and the amount of such liabilitiesmaturing during 2007, the Company expects to experience continued pressure onits interest rate spread and net interest margin in 2007.

**There are increased risksinvolved with commercial real estate, construction, commercial business andconsumer lending activities.**

Our lending activitiesinclude loans secured by existing commercial real estate.  In addition, we originate loans for theconstruction of single-family residential real estate and land acquisition anddevelopment loans.  Commercial realestate and construction lending generally is considered to involve a higherdegree of risk than single-family residential lending due to a variety offactors, including generally larger loan balances, the dependency on successfulcompletion or operation of the project for repayment, the difficulties inestimating construction costs and loan terms which often do not require fullamortization of the loan over its term and, instead, provide for a balloonpayment at stated maturity.  Our lendingactivities also include commercial business loans to small- to medium-sizedbusinesses, which generally are secured by various equipment, machinery andother corporate assets, and a wide variety of consumer loans, including homeequity and second mortgage loans, automobile loans, deposit account securedloans and unsecured loans.  Although commercialbusiness loans and consumer loans generally have shorter terms and higherinterest rates than mortgage loans, they generally involve more risk thanmortgage loans because of the nature of, or in certain cases the absence of,the collateral which secures such loans.

24

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At December 31, 2006,total nonaccrual loans amounted to $19.0 million, a $13.7 million or 258.4%increase compared to nonaccrual loans of $5.3 million at December 31,2005.  Such increase was primarily due toa $10.1 million increase in nonaccrual construction loans and, to a lesserextent, a $1.3 million increase in nonaccrual commercial loans and a $1.1million increase in nonaccrual commercial real estate loans.  Such increases are primarily related to loansto local builders for the construction of speculative residential propertiesand for the construction of pre-sold one- to four family homes.  The Northwest Arkansas market has recentlyexperienced an oversupply of lots and speculative homes and certain of the Bank’sbuilders are experiencing extended marketing times for the sale of their homes,resulting in inadequate cash flow to service the interest carry on theirloan.  As a result, the Bank hassubstantially curtailed such lending.

The resolution of suchnonaccrual loans may substantially impact the Company’s provision for loanlosses and allowance for loan losses. Based on recent sales activity, the estimated value of the underlyingcollateral has remained relatively stable, however, a decrease in currentvalues or an adverse change in loss experience may require us to increase bothour provision for loan losses and our allowance for loan losses.

**Our allowance for losses on loansmay not be adequate to cover probable losses.**

We have established anallowance for loan losses which we believe is adequate to offset probablelosses on our existing loans.  There canbe no assurance that any future declines in real estate market conditions,general economic conditions or changes in regulatory policies will not requireus to increase our allowance for loan losses, which would adversely affect ourresults of operations.

**We aresubject to extensive regulation which could adversely affect our business andoperations.**

We are subject toextensive federal and state governmental supervision and regulation, which areintended primarily for the protection of depositors.  In addition, we are subject to changes infederal and state laws, as well as changes in regulations, governmentalpolicies and accounting principles.  Theeffects of any such potential changes cannot be predicted but could adverselyaffect our business and operations and that of our subsidiaries in the future.

**We facestrong competition which may adversely affect our profitability.**

We are subject tovigorous competition in all aspects and areas of our business from banks andother financial institutions, including savings and loan associations, savingsbanks, finance companies, credit unions and other providers of financialservices, such as money market mutual funds, brokerage firms, consumer financecompanies and insurance companies.  Wealso compete with non-financial institutions, including retail stores thatmaintain their own credit programs and governmental agencies that makeavailable low cost or guaranteed loans to certain borrowers.  Certain of our competitors are largerfinancial institutions with substantially greater resources, lending limits,larger branch systems and a wider array of banking services.  Competition from both bank and non-bankorganizations will continue.

**Ourability to successfully compete may be reduced if we are unable to maketechnological advances.**

The banking industry isexperiencing rapid changes in technology. In addition to improving customer services, effective use of technologyincreases efficiency and enables financial institutions to reduce costs.  As a result, our future success will dependin part on our ability to address our customers’ needs by usingtechnology.  We cannot assure that wewill be able to effectively develop new technology-driven products and servicesor be successful in marketing these products to our customers.  Many of our competitors have far greaterresources than we have to invest in technology.

**We andour banking subsidiary are subject to capital and other requirements whichrestrict our ability to pay dividends.**

Our ability to paydividends to our shareholders depends to a large extent upon the dividends wereceive from the Bank.  Dividends paid bythe Bank are subject to restrictions under the federal laws and regulations.  In addition, the Bank must maintain certaincapital levels, which may restrict the ability of the Bank to pay dividends tous and our ability to pay dividends to our shareholders.

**Holdersof our common stock have no preemptive rights and are subject to potentialdilution.**

Our certificate ofincorporation does not provide any shareholder with a preemptive right tosubscribe for additional shares of common stock upon any increase thereof.  Thus, upon the issuance of any additionalshares of common stock or other voting securities of the Company or securitiesconvertible into common stock or other voting securities, shareholders may beunable to maintain their pro rata voting or ownership interest in us.

**Item1B.  Unresolved Staff Comments**

None

25

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**Item2.  Properties.**

At December 31,2006, the Bank conducted its business from its executive office in Harrison,Arkansas, and seventeen full service offices, all of which are located inNorthcentral and Northwest Arkansas.

The followingtable sets forth information with respect to the offices and other propertiesof the Bank at December 31, 2006.

 
| **Description/Address**                         | ** ** | **Leased/  Owned** | ** ** | **Description/Address**                              | ** ** | **Leased/  Owned** |
|-------------------------------------------------|------------|--------------------|------------|------------------------------------------------------|------------|--------------------|
| ** **                                      | ** ** | ** **         | ** ** | ** **                                           | ** ** | ** **         |
| 1401 Highway 62-65 North  Harrison, AR 72601    |       | Owned              |       | 2501 E. Central Ave., Suite 2  Bentonville, AR 72712 |       | Leased(1)          |
|                                            |       |               |       |                                                 |       |               |
| 200 West Stephenson  Harrison, AR 72601         |       | Owned              |       | 3460 North College  Fayetteville, AR 72703           |       | Owned              |
|                                            |       |               |       |                                                 |       |               |
| Corner Central & Willow  Harrison, AR 72601 |       | Owned              |       | 1303 Hudson Road  Rogers, AR 72756                   |       | Owned              |
|                                            |       |               |       |                                                 |       |               |
| 324 Hwy. 62-65 Bypass  Harrison, AR 72601       |       | Owned              |       | 201 East Henri De Tonti Blvd.  Tontitown, AR 72764   |       | Owned              |
|                                            |       |               |       |                                                 |       |               |
| 210 South Main  Berryville, AR 72616            |       | Owned              |       | 2025 North Crossover Road  Fayetteville, AR 72703    |       | Owned              |
|                                            |       |               |       |                                                 |       |               |
| 668 Highway 62 East  Mountain Home, AR 72653    |       | Owned              |       | 249 West Main Street  Farmington, AR 72730           |       | Leased(2)          |
|                                            |       |               |       |                                                 |       |               |
| 1337 Highway 62 SW  Mountain Home, AR 72653     |       | Owned              |       | 2030 West Elm  Rogers, AR 72756                      |       | Owned              |
|                                            |       |               |       |                                                 |       |               |
| 301 Highway 62 West  Yellville, AR 72687        |       | Owned              |       | 1023 East Millsap Road  Fayetteville, AR 72703       |       | Owned              |
|                                            |       |               |       |                                                 |       |               |
| 307 North Walton Blvd.  Bentonville, AR 72712   |       | Owned              |       | 3027 Highway 62 East  Mountain Home, AR 72653        |       | Owned              |
|                                            |       |               |       |                                                 |       |               |
| 3300 West Sunset  Springdale, AR 72762          |       | Owned              |       | 1190 East Centerton Boulevard  Centerton, AR 72719   |       | Leased(3)          |
|                                            |       |               |       |                                                 |       |               |
|                                            |       |               |       | 191 West Main Street  Farmington, AR 72730           |       | Owned              |
|                                            |       |               |       |                                                 |       |               |

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(1)             Such property issubject to a five-year lease expiring August 1, 2008, with three five-yearrenewal options.

(2)             Such property issubject to a five-year lease expiring November 1, 2007, with one five-yearrenewal option.

(3)             Suchproperty is subject to a five-year lease expiring November 1, 2010, with threefive-year renewal options.

**Item3.  Legal Proceedings.**

Neither theCompany nor the Bank is involved in any pending legal proceedings other thannonmaterial legal proceedings occurring in the ordinary course of business.

**Item4.  Submission of Matters to Vote ofSecurity Holders.**

No matters weresubmitted to a vote of security holders during the fourth quarter of 2006.

**PARTII.**

**Item5.  Market for Registrant’s CommonEquity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.**

Shares of the Company’s common stock are traded under the symbol “FFBH”on the Nasdaq Global Market.  At February23, 2007, the Company had 4,869,871 shares of common stock outstanding and hadapproximately 1,883 beneficial holders of common stock.

26

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The following table sets forth the dividends declared and the reportedhigh and low end of day closing prices of a share of the Company’s common stockas reported by Nasdaq for the periods indicated.

 

| Quarter Ended | ** ** | **Year Ended**December 31, 2006 | ** ** | **Year Ended  December 31, 2005** | ** ** |
|--------------------|------------|------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **         | ** ** | **High**                                       | ** ** | **Low**                                          | ** ** | **Dividend** | ** ** | **High** | ** ** | **Low** | ** ** | **Dividend** | ** ** |
| ** **         | ** ** | ** **                                     | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **March 31**       |       | $                                              | 25.95      |                                             | $          | 23.02 |   | $ | 0.14 |   | $ | 25.55 |   | $ | 22.00 |   | $ | 0.12 |   |
| ** **         |       |                                           |       |                                             |       |   |   |   |   |   |   |   |   |
| **June 30**        |       | $                                              | 25.74      |                                             | $          | 22.10 |   | $ | 0.14 |   | $ | 25.95 |   | $ | 22.45 |   | $ | 0.12 |   |
| ** **         |       |                                           |       |                                             |       |   |   |   |   |   |   |   |   |
| **September 30**   |       | $                                              | 24.00      |                                             | $          | 22.00 |   | $ | 0.15 |   | $ | 25.59 |   | $ | 22.00 |   | $ | 0.13 |   |
| ** **         |       |                                           |       |                                             |       |   |   |   |   |   |   |   |   |
| **December  31**   |       | $                                              | 25.00      |                                             | $          | 22.86 |   | $ | 0.15 |   | $ | 25.50 |   | $ | 22.50 |   | $ | 0.13 |   |

** **

The followinggraph demonstrates comparison of the cumulative total returns for the commonstock of the Company, the SNL Securities $500 million to $1 Billion ThriftAsset Size Index, and the Nasdaq Stock Market Index since the close of tradingof the Company’s common stock on December 31, 2001.  The graph represents $100 invested in theCompany’s common stock at $11.50 per share, the closing price per share as ofDecember 31, 2001, adjusted for the December 31, 2003 two-for-one stocksplit.  The cumulative total returnsinclude the payment of dividends by the Company.

** **
| ** **                                  | ** ** | ***Period Ending*** | ** ** |
|---------------------------------------------|------------|--------------------------|------------|
| ***Index***                                 | ** ** | **12/31/01**             | ** ** | **12/31/02** | ** ** | **12/31/03** | ** ** | **12/31/04** | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** |
| First Federal  Bancshares of Arkansas, Inc. |       | 100.00                   |       | 112.78 |   | 185.97 |   | 208.39 |   | 229.48 |   | 235.27 |   |
| NASDAQ Composite                            |       | 100.00                   |       | 68.76 |   | 103.67 |   | 113.16 |   | 115.57 |   | 127.58 |   |
| SNL $500M-$1B Thrift  Index                 |       | 100.00                   |       | 140.09 |   | 199.47 |   | 220.65 |   | 209.70 |   | 256.94 |   |

 

**Source : SNLFinancial LC, Charlottesville, VA**

**© 2007**

27

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**ISSUER PURCHASESOF EQUITY SECURITIES**
| **Period**                       | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Number  of Shares that  May Yet Be Purchased  Under the Plans or  Programs** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | ** **                                           | ** ** | ** **                                       | ** ** | ** **                                                                                                                       | ** ** | ** **                                                                                                                          | ** ** |
| October 1 to October  31, 2006   |       | —                                               |       | —                                           |       | —                                                                                                                           |       | 297,518                                                                                                                             |       |
| November 1 to November  30, 2006 |       | 110,000                                              |       | $                                                | 23.06      |                                                                                                                             | 110,000    |                                                                                                                                | 187,518    |   |
| December 1 to December 31, 2006  |       | 55,366                                               |       | $                                                | 24.74      |                                                                                                                             | 55,366     |                                                                                                                                | 132,152    |   |

 

During the quarterended December 31, 2006, the Company completed its eighteenth announcedrepurchase program and began its nineteenth program.  The nineteenth announced repurchase programwas approved by the board of directors on July 25, 2006, and publicly announcedon November 8, 2006. Total shares approved to be purchased in this program are245,197, of which 113,045 had been purchased as of December 31, 2006.  All treasury stock purchases are made underpublicly announced repurchase programs.

 

**Item6.  Selected Financial Data.**

The selected consolidated financial and other data of the Company setforth below and on the following page is not complete and should be read inconjunction with, and is qualified in its entirety by, the more detailedinformation, including the Consolidated Financial Statements and related Notes,appearing elsewhere herein.

 
| ** **                                          | ** ** | **At or For the  Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                          | ** ** | **(In Thousands, Except Per Share Data)**       | ** ** |
| ** **                                          | ** ** | ** **                                                               | ** ** |
| **Selected  Financial Condition Data:**             |       |                                                                     |       |   |   |   |   |   |   |   |   |
| Total assets                                        |       | $                                                                        | 852,475    |   | $ | 852,411 |   | $ | 751,665 |   | $ | 690,653 |   | $ | 679,896 |   |
| Cash and cash equivalents                           |       | 35,518                                                                   |       | 21,109 |   | 16,003 |   | 56,201 |   | 44,493 |   |
| Investment securities                               |       | 60,746                                                                   |       | 56,695 |   | 56,660 |   | 80,379 |   | 114,471 |   |
| Loans receivable, net                               |       | 693,095                                                                  |       | 719,214 |   | 634,217 |   | 512,756 |   | 483,468 |   |
| Allowance for loan losses                           |       | 2,572                                                                    |       | 2,114 |   | 1,846 |   | 1,621 |   | 1,529 |   |
| Deposits                                            |       | 652,265                                                                  |       | 611,667 |   | 582,424 |   | 573,580 |   | 568,762 |   |
| Federal Home Loan Bank advances                     |       | 120,305                                                                  |       | 158,240 |   | 89,756 |   | 39,562 |   | 38,610 |   |
| Stockholders’ equity                           |       | 75,573                                                                   |       | 77,842 |   | 75,301 |   | 75,078 |   | 69,266 |   |
|                                                |       |                                                                     |       |   |   |   |   |   |   |   |   |
| **Selected  Operating Data:**                       |       |                                                                     |       |   |   |   |   |   |   |   |   |
| Interest income                                     |       | $                                                                        | 54,119     |   | $ | 46,085 |   | $ | 39,370 |   | $ | 38,745 |   | $ | 44,094 |   |
| Interest expense                                    |       | 27,576                                                                   |       | 19,604 |   | 14,338 |   | 15,986 |   | 21,633 |   |
| Net interest income                                 |       | 26,543                                                                   |       | 26,481 |   | 25,032 |   | 22,759 |   | 22,461 |   |
| Provision for loan losses                           |       | 1,482                                                                    |       | 1,101 |   | 1,020 |   | 690 |   | 1,500 |   |
| Net interest income after provision for loan losses |       | 25,061                                                                   |       | 25,380 |   | 24,012 |   | 22,069 |   | 20,961 |   |
| Noninterest income                                  |       | 8,335                                                                    |       | 6,961 |   | 6,274 |   | 6,989 |   | 5,346 |   |
| Noninterest expense                                 |       | 22,634                                                                   |       | 20,768 |   | 18,783 |   | 18,263 |   | 14,524 |   |
| Income before income taxes                          |       | 10,762                                                                   |       | 11,573 |   | 11,503 |   | 10,795 |   | 11,783 |   |
| Provision for income taxes                          |       | 3,379                                                                    |       | 3,723 |   | 3,698 |   | 3,339 |   | 4,005 |   |
| Net income                                          |       | $                                                                        | 7,383      |   | $ | 7,850 |   | $ | 7,805 |   | $ | 7,456 |   | $ | 7,778 |   |
|                                                |       |                                                                     |       |   |   |   |   |   |   |   |   |
| **Earnings  per Share (1):**                        |       |                                                                     |       |   |   |   |   |   |   |   |   |
| Basic                                               |       | $                                                                        | 1.48       |   | $ | 1.57 |   | $ | 1.54 |   | $ | 1.46 |   | $ | 1.44 |   |
| Diluted                                             |       | $                                                                        | 1.44       |   | $ | 1.50 |   | $ | 1.45 |   | $ | 1.38 |   | $ | 1.38 |   |
|                                                |       |                                                                     |       |   |   |   |   |   |   |   |   |
| **Cash  Dividends Declared per Share (1)**          |       | $                                                                        | 0.58       |   | $ | 0.50 |   | $ | 0.42 |   | $ | 0.34 |   | $ | 0.26 |   |
| ** **                                          |       |                                                                     |       |   |   |   |   |   |   |   |   |

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(1)             Per share amounts have been restatedfor the two-for-one stock split that was paid on December 31, 2003.

 

 

28

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| ** **                                                                  | ** ** | **At or For the Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2006**                                                                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                  | ** ** | ** **                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Selected Operating Ratios(1):**                                           |       |                                                                         |       |   |   |   |   |   |   |   |   |
| Return on average assets                                                    |       | 0.85                                                                         | %          | 0.97 | % | 1.09 | % | 1.08 | % | 1.14 | % |
| Return on average equity                                                    |       | 9.40                                                                         |       | 10.27 |   | 10.37 |   | 10.25 |   | 11.01 |   |
| Average equity to average assets                                            |       | 9.04                                                                         |       | 9.46 |   | 10.53 |   | 10.52 |   | 10.39 |   |
| Interest rate spread(2)                                                     |       | 3.19                                                                         |       | 3.41 |   | 3.64 |   | 3.40 |   | 3.30 |   |
| Net interest margin(2)                                                      |       | 3.29                                                                         |       | 3.51 |   | 3.75 |   | 3.52 |   | 3.50 |   |
| Net interest income after provision for loan losses to noninterest  expense |       | 110.72                                                                       |       | 122.21 |   | 127.84 |   | 120.84 |   | 144.32 |   |
| Noninterest expense to average assets                                       |       | 2.60                                                                         |       | 2.57 |   | 2.63 |   | 2.64 |   | 2.14 |   |
| Average interest earning assets to average interest bearing  liabilities    |       | 102.92                                                                       |       | 103.80 |   | 105.12 |   | 105.08 |   | 106.10 |   |
| Operating efficiency(3)                                                     |       | 64.89                                                                        |       | 62.10 |   | 60.00 |   | 61.39 |   | 52.23 |   |
|                                                                        |       |                                                                         |       |   |   |   |   |   |   |   |   |
| **Asset Quality Ratios(4):**                                                |       |                                                                         |       |   |   |   |   |   |   |   |   |
| Nonaccrual and restructured loans to total loans(5)                         |       | 2.68                                                                         |       | 1.67 |   | 1.14 |   | 0.67 |   | 1.37 |   |
| Nonperforming assets to total assets(5)                                     |       | 2.76                                                                         |       | 1.65 |   | 1.13 |   | 0.66 |   | 1.07 |   |
| Allowance for loan losses to non-performing loans(5)                        |       | 13.07                                                                        |       | 16.06 |   | 23.21 |   | 44.01 |   | 22.01 |   |
| Allowance for loan losses to total loans                                    |       | 0.35                                                                         |       | 0.27 |   | 0.26 |   | 0.29 |   | 0.30 |   |
|                                                                        |       |                                                                         |       |   |   |   |   |   |   |   |   |
| **Capital Ratios(6):**                                                      |       |                                                                         |       |   |   |   |   |   |   |   |   |
| Tangible capital to adjusted total assets                                   |       | 8.76                                                                         |       | 8.78 |   | 9.74 |   | 10.27 |   | 9.78 |   |
| Core capital to adjusted total assets                                       |       | 8.76                                                                         |       | 8.78 |   | 9.74 |   | 10.27 |   | 9.78 |   |
| Risk-based capital to risk-weighted assets                                  |       | 11.94                                                                        |       | 12.06 |   | 13.75 |   | 16.25 |   | 17.03 |   |
|                                                                        |       |                                                                         |       |   |   |   |   |   |   |   |   |
| **Other Data:**                                                             |       |                                                                         |       |   |   |   |   |   |   |   |   |
| Dividend payout ratio(7)                                                    |       | 39.26                                                                        | %          | 32.19 | % | 27.91 | % | 24.32 | % | 18.91 | % |
| Full service offices at end of period                                       |       | 18                                                                           |       | 16 |   | 15 |   | 15 |   | 14 |   |

----

(1)             Ratios are based on average dailybalances.

(2)             Interest rate spread represents thedifference between the weighted average yield on average interest earningassets and the weighted average cost of average interest bearing liabilities,and net interest margin represents net interest income as a percent of averageinterest earning assets.

(3)             Noninterest expense to net interestincome plus noninterest income.

(4)             Asset quality ratios are end of periodratios.

(5)             Nonperforming assets consist ofnonperforming loans and real estate owned (“REO”).  Nonperforming loans consist of nonaccrualloans, accruing loans 90 days or more, past due and restructured loans, whileREO consists of real estate owned.

(6)             Capitalratios are end of period ratios for First Federal Bank.

(7)          Dividend payout ratio isthe total dividends declared divided by net income.

29

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**Item7.  Management’s Discussions and Analysisof Financial Condition and Results of Operations.**

**GENERAL**

Management’s discussion and analysis of financial condition andresults of operations is intended to assist a reader inunderstanding the consolidated financialcondition and results of operations of the Company for the periods presented.  The information contained in this sectionshould be read in conjunction with the Consolidated Financial Statements andthe accompanying Notes to Consolidated Financial Statements and the othersections contained herein.

The Bank is a federally chartered stock savings and loan association whichwas formed in 1934.  First Federalconducts business from its main office and seventeen full-service branchoffices, all of which are located in a six county area in Northcentral andNorthwest Arkansas comprised of Benton, Marion, Washington, Carroll, Baxter andBoone counties. The Bank will continue to focus its growth and expansionefforts in this six county area, especially in Benton and Washington counties,one of the fastest growing areas of the state.    The Bank is a community-oriented financialinstitution offering a wide range of retail and commercial deposit accounts,including noninterest bearing and interest bearing checking, savings and moneymarket accounts, certificates of deposit, and individual retirementaccounts.  Loan products offered by theBank include residential real estate, consumer, construction, lines of credit,commercial real estate and commercial business loans. Other financial servicesinclude investment products offered through First Federal Investment Services,Inc.; automated teller machines; 24-hour telephone banking; internet banking,including account access, e-statements, bill payment and online loanapplications; Bounce ProtectionTM overdraft service; debit cards; and safedeposit boxes.

First Federal’s lending focus has traditionally been on permanentresidential real estate.  However, inrecent years, an increased emphasis has been placed on commercial real estatelending and construction lending. While our first mortgage real estateportfolio comprises a relatively steady 85.0% of our gross loan portfolio,commercial real estate loans and construction loans now comprise over half ofour first mortgage loans.  Beginning inlate 2005, we reduced our focus on construction lending due to an oversupply ofhomes and lots in Northwest Arkansas. While the oversupply issue does exist, the market in Northwest Arkansasis still strong, with rising average home prices, low unemployment, and strongpopulation growth.  Most of ourhistorical lending growth has occurred in the Washington and Benton countyareas, which are the headquarters of the state’s two largest employers,Wal-Mart and Tyson Foods.  These employersattract suppliers who establish offices in the area and create jobs, whichfosters demand for housing and office space. As of September 2006, unemployment in the Fayetteville/Springdale/Rogersmetro area was 3.3%, compared to the Arkansas rate of 5.2% and the U.S. rate of4.7%.  We expect loan growth to continuein Northwest Arkansas, although not necessarily at the level experienced in thepast.

Certificates of deposit and savings accounts continue to comprise themajority of our deposit accounts. However, in recent years, increased emphasis has been placed on growthin checking accounts   This emphasis willcontinue with plans to attract checking accounts through the utilization oftargeted direct mail throughout our market area and “thank you” gifts.   Checking accounts offer low interestdeposits, fee income potential, and the opportunity to cross-sell otherfinancial services.

The Company’s results of operations depend primarily on its netinterest income, which is the difference between interest income on interestearning assets, such as loans and investments, and interest expense on interestbearing liabilities, such as deposits and borrowings.  The Company’s results of operations are also affectedby the provision for loan losses, the level of its noninterest income andexpenses, and income tax expense.

Noninterest income is generated primarily through deposit account feeincome, profit on sale of loans, mortgage and installment lending fee income,and bank owned life insurance income.

Noninterest expense consists primarily of employee compensation andbenefits, office occupancy expense, data processing expense, and otheroperating expense.

Like most banks, First Federal Bank’s two greatest challenges aremanaging interest rate risk and asset quality. The Bank’s current interest rate risk position as measured by ourregulator, the OTS, is at a minimal level as defined by Thrift Bulletin13a.  The level of interest rate risk isimpacted by the movement of interest rates and the timing and magnitude ofassets repricing compared to liabilities repricing.  The Bank attempts to reduce the impact ofchanges in interest rates on its net interest income by managing the repricinggap as described in the “Asset and Liability Management” section.  We strive to maintain the asset quality ofour loan portfolio at acceptable levels through sound underwriting procedures,including the use of credit scoring; a thorough loan review function; activecollection procedures for delinquent loans; and, in the event of repossession,prompt and efficient liquidation of real estate, automobiles and other forms ofcollateral.  Both the board of directorsand senior management place a high priority on managing interest rate risk andasset quality.

30

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##  

**CRITICALACCOUNTING POLICIES**

Various elements of our accounting policies, by their nature, areinherently subject to estimation techniques, valuation assumptions and othersubjective assessments.  In particular,the methodology for the determination of our allowance for loan losses, due tothe judgments, estimates and assumptions inherent in that policy, is criticalto preparation of our financial statements. This policy and the judgments, estimates and assumptions are describedin greater detail in subsequent sections of Management’s Discussion andAnalysis and in the Notes to the Consolidated Financial Statements includedherein.  In particular, Note 1 to theConsolidated Financial Statements — “Summary of Significant Accounting Policies”describes generally our accounting policies. We believe that the judgments, estimates and assumptions used in thepreparation of our Consolidated Financial Statements are appropriate given thefactual circumstances at the time. However, given the sensitivity of our Consolidated Financial Statementsto this critical accounting policy, the use of other judgments, estimates andassumptions could result in material differences in our results of operationsor financial condition.

In estimating the amount of credit losses inherent in our loanportfolio, various judgments and assumptions are made.  For example, when assessing the condition ofthe overall economic environment, assumptions are made regarding future marketconditions and their impact on the loan portfolio.  In the event the economy were to sustain aprolonged downturn, the loss factors applied to our portfolios may need to berevised, which may significantly impact the measurement of the allowance forloan losses.  For impaired loans that arecollateral dependent, the estimated fair value of the collateral may deviatesignificantly from the proceeds received when the collateral is sold.

## **CHANGES IN FINANCIAL CONDITION**

Changes in financial condition betweenDecember 31, 2006 and 2005 are presented in the following table (dollars inthousands).  Material changes betweenperiods are discussed in the sections which follow the table.

 
| ** **                                     | ** ** | **December 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|------------------------------------------------|------------|-----------------------|------------|--------------|------------|----------------|------------|
| ** **                                     | ** ** | **2006**              | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                     | ** ** | ** **            | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
| **ASSETS**                                     |       |                  |       |         |       |           |       |   |   |
| Cash and cash equivalents                      |       | $                     | 35,518     |         | $          | 21,109         |       | $ | 14,409 |   | 68.3 | % |
| Investment securities held to maturity         |       | 60,746                |       | 56,695       |       | 4,051          |       | 7.1 |   |
| FHLB Stock                                     |       | 7,089                 |       | 8,412        |       | (1,323         | )          | (15.7 | ) |
| Loans receivable, net                          |       | 693,095               |       | 719,214      |       | (26,119        | )          | (3.6 | ) |
| Accrued interest receivable                    |       | 9,999                 |       | 7,490        |       | 2,509          |       | 33.5 |   |
| Real estate owned, net                         |       | 3,858                 |       | 892          |       | 2,966          |       | 332.5 |   |
| Office properties and equipment, net           |       | 20,384                |       | 18,522       |       | 1,862          |       | 10.1 |   |
| Prepaid expenses and other assets              |       | 21,786                |       | 20,077       |       | 1,709          |       | 8.5 |   |
|                                           |       |                  |       |         |       |           |       |   |   |
| TOTAL                                          |       | $                     | 852,475    |         | $          | 852,411        |       | $ | 64 |   | 0.0 | % |
|                                           |       |                  |       |         |       |           |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY** | ** ** | ** **            | ** ** | ** **   | ** ** |           | ** ** | ** ** | ** ** |
| LIABILITIES:                                   |       |                  |       |         |       |           |       |   |   |
| Deposits                                       |       | $                     | 652,265    |         | $          | 611,667        |       | $ | 40,598 |   | 6.6 | % |
| FHLB advances                                  |       | 120,305               |       | 158,240      |       | (37,935        | )          | (24.0 | ) |
| Other liabilities                              |       | 4,332                 |       | 4,662        |       | (330           | )          | (7.1 | ) |
| Total liabilities                              |       | 776,902               |       | 774,569      |       | 2,333          |       | 0.3 |   |
|                                           |       |                  |       |         |       |           |       |   |   |
| STOCKHOLDERS’  EQUITY                     |       | 75,573                |       | 77,842       |       | (2,269         | )          | (2.9 | ) |
| TOTAL                                          |       | $                     | 852,475    |         | $          | 852,411        |       | $ | 64 |   | 0.0 | % |
|                                           |       |                  |       |         |       |           |       |   |   |
| BOOK VALUE PER  SHARE                          |       | $                     | 15.62      |         | $          | 15.42          |       |   |   |   |   |
|                                           |       |                  |       |         |       |           |       |   |   |
| EQUITY TO ASSETS                               |       | 8.9                   | %          | 9.1          | %          |           |       |   |   |

 

31

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**Loans Receivable. **Changesin loan composition between December 31, 2006 and 2005 are presented in thefollowing table (dollars in thousands).

 
| ** **                                             | ** ** | **December 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|--------------|------------|----------------|------------|
| ** **                                             | ** ** | **2006**              | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                             | ** ** | ** **            | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
| One- to  four-family residences                        |       | $                     | 251,120    |         | $          | 269,660        |       | $ | (18,540 | ) | (6.9 | )% |
| Multi-family                                           |       | 11,900                |       | 12,900       |       | (1,000         | )          | (7.8 | ) |
| Commercial real  estate                                |       | 124,540               |       | 119,323      |       | 5,217          |       | 4.4 |   |
| Land                                                   |       | 41,698                |       | 38,355       |       | 3,343          |       | 8.7 |   |
| Construction:                                          |       |                  |       |         |       |           |       |   |   |
| One- to four-family residences                         |       | 34,112                |       | 51,579       |       | (17,467        | )          | (33.9 | ) |
| Speculative one- to four-family residences             |       | 78,335                |       | 104,001      |       | (25,666        | )          | (24.7 | ) |
| Multi-family                                           |       | 14,120                |       | 20,919       |       | (6,799         | )          | (32.5 | ) |
| Commercial real estate                                 |       | 21,896                |       | 22,331       |       | (435           | )          | (1.9 | ) |
| Land  development                                      |       | 47,439                |       | 40,232       |       | 7,207          |       | 17.9 |   |
| Total first mortgage loans                             |       | 625,160               |       | 679,300      |       | (54,140        | )          | (8.0 | ) |
|                                                   |       |                  |       |         |       |           |       |   |   |
| Commercial                                             |       | 36,407                |       | 32,693       |       | 3,714          |       | 11.4 |   |
|                                                   |       |                  |       |         |       |           |       |   |   |
| Home equity and  second mortgage                       |       | 48,665                |       | 49,680       |       | (1,015         | )          | (2.0 | ) |
| Automobile                                             |       | 12,090                |       | 15,748       |       | (3,658         | )          | (23.2 | ) |
| Other                                                  |       | 13,271                |       | 13,149       |       | 122            |       | 0.9 |   |
| Total consumer                                         |       | 74,026                |       | 78,577       |       | (4,551         | )          | (5.8 | ) |
|                                                   |       |                  |       |         |       |           |       |   |   |
| Total loans  receivable                                |       | 735,593               |       | 790,570      |       | (54,977        | )          | (7.0 | ) |
| Less:                                                  |       |                  |       |         |       |           |       |   |   |
| Undisbursed loan  funds                                |       | (40,069               | )          | (69,086      | )          | 29,017         |       | (42.0 | ) |
| Unearned  discounts and net deferred loan costs (fees) |       | 143                   |       | (156         | )          | 299            |       | (191.7 | ) |
| Allowance for  loan losses                             |       | (2,572                | )          | (2,114       | )          | (458           | )          | 21.7 |   |
|                                                   |       |                  |       |         |       |           |       |   |   |
| Loans receivable, net                                  |       | $                     | 693,095    |         | $          | 719,214        |       | $ | (26,119 | ) | (3.6 | )% |

 

The decrease in the Bank’sloan portfolio was primarily due to a softening of the housing market inNorthwest Arkansas.  Market dataindicates an overall decrease in home sales in Benton and Washington countiesin 2006 compared to 2005.   The Bank’sconstruction loan originations were down 52% for the year ended December 31,2006, compared to the same period in 2005. The decreases in one- to four-family, speculative and multi-familyconstruction loans were primarily the result of a general slowdown in housingfinance and the Bank’s decision to reduce its construction lending activity dueto the oversupply in the Northwest Arkansas market.  Although the economy in the NorthwestArkansas region continues to be strong as reflected in sustained job andpopulation growth, the supply of new residential lots and new speculative homesfor sale has outpaced demand during the year. The Bank also experienced a decline in one- to four-family residentialloans.  Originations for this loancategory were down slightly for 2006 compared to 2005.

Several years ago, theBank began to emphasize commercial real estate lending, construction lending,and commercial lending to diversify its loan portfolio, take advantage ofmarket opportunities in these types of loans, and help the Bank transition to amore full-service community bank, as well as to provide opportunities tocross-sell its other banking products.  Although the Bank plans to continue this emphasis, the volume of suchlending will continue to be subject to the economic and market conditionsdiscussed above and the availability of prudent lending opportunities.

**Allowance for Loan Losses**. Changes in the composition of the allowance for loan losses betweenDecember 31, 2006 and 2005 are presented in the following table (inthousands).

 

|             | ** ** | **December 31,** | ** ** | **Increase** | ** ** |
|-------------|------------|-----------------------|------------|--------------|------------|
| ** **  | ** ** | **2006**              | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** |
| General     |       | $                     | 1,966      |         | $          | 1,831 |   | $ | 135 |   |
| Specific    |       | 606                   |       | 183          |       | 423 |   |
| Unallocated |       | —                |       | 100          |       | (100 | ) |
|        |       | $                     | 2,572      |         | $          | 2,114 |   | $ | 458 |   |

 

32

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The general component ofthe allowance for loan losses increased due to an increase in the estimatedloss rate applied to speculative one- to four-family residential constructionloans and land development loans.  Suchloss rates were increased due to the increase in these loan balances and theinherently riskier nature of this category of loans.    The increase in the specificallowance for loan losses was primarily due to speculative one- to four-familyresidential construction loans.   In2006, we eliminated the unallocated category and included those factors in thevarious general loan pools.

**Investment Securities. **Changes in the composition of investment securities held to maturitybetween December 31, 2006 and 2005 are presented in the following table(in thousands).

 

|                                         | ** ** | **December 31,** | ** ** | **Increase** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|--------------|------------|
| ** **                              | ** ** | **2006**              | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** |
| U.S. Government  and agency obligations |       | 43,857                |       | 40,034       |       | 3,823 |   |
| Municipal  securities                   |       | 16,889                |       | 16,661       |       | 228 |   |
| Total                                   |       | $                     | 60,746     |         | $          | 56,695 |   | $ | 4,051 |   |
|                                         |            |                       |            |              |            |  |  |  |  |  |

 

During 2006, investment securities totaling approximately $7.5 millionwere purchased and $3.5 million matured or were called. The majority of thesepurchases and maturities were U.S. Government and agency obligations.

**Federal Home Loan Bank Stock. **FHLB stock decreased by approximately $1.3 million due to lowerbalance requirements related to the decrease in FHLB advances.

**Accrued Interest Receivable. **The increase in accrued interest receivable was due to an increase inthe number of days accrued, primarily related to construction loans, as well asan increase in the loan yield at December 31, 2006 compared to December 31,2005.

**Real Estate Owned, Net. **The increase in real estate owned was due to an increase in thenumber of foreclosures on speculative homes.

**OfficeProperties and Equipment, Net.  **The increase in office properties andequipment of $1.9 million was due primarily to the purchase of land for branchexpansion, construction costs for the new branches in Centerton and Springdaleand future branches in Farmington and Lowell, as well as renovation of certainexisting branch locations.

**Deposits. **Changes in the composition of depositsbetween December 31, 2006 and 2005 are presented in the following table (dollarsin thousands).

 

|                          | ** ** | **December 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|-----------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2006**              | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | ** **            | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
| DDA and NOW  accounts    |       | $                     | 139,372    |         | $          | 125,397        |       | $ | 13,975 |   | 11.1 | % |
| Money market  accounts   |       | 51,827                |       | 64,021       |       | (12,194        | )          | (19.0 | ) |
| Savings accounts         |       | 26,824                |       | 30,521       |       | (3,697         | )          | (12.1 | ) |
| Certificates of  deposit |       | 434,242               |       | 391,728      |       | 42,514         |       | 10.9 |   |
|                     |       |                  |       |         |       |           |       |   |   |
| Total deposits           |       | $                     | 652,265    |         | $          | 611,667        |       | $ | 40,598 |   | 6.6 | % |

 

Deposits increased during the year primarily due to anincrease in public unit accounts, focused marketing efforts to increasechecking accounts and the offering of certificate of deposit specials. During the year ended December 31, 2006, DDA and NOW account balancesincreased by $14.0 million, or 11.1%, and the number of such accounts increasedby 3.1%.  The Bank expanded its checkingaccount marketing efforts in the second quarter of 2005 by targeting small- andmedium-sized business accounts. The Bank continues to aggressively promotechecking accounts with its direct mail campaign and “thank you” gifts.  Checking accounts are an attractive source offunds for the Bank as they offer low interest deposits, fee income potential,and the opportunity to cross-sell other financial services.

The Bank also experienced a shift in the mix of deposits from moneymarket and savings accounts to certificates of deposit during the year.  Certificates of deposit balances increased asinterest rates began to rise.  Further,the Bank has advertised several CD products with special rates and termsranging from 7 to 40 months.  The averagecost of deposit funds increased from 2.47% for the year ended December 31, 2005to 3.28% for the year ended December 31, 2006.

33

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**FHLBAdvances.**  The Bankexperienced a $37.9 million or 24.0% decrease in FHLB of Dallas advances duringthe year.  The Bank was able to use fundsfrom deposit growth to repay FHLB of Dallas advances during 2006.  The balance of advances at December 31, 2006of $120.3 million consisted of $74.3 million of fixed rate advances with anaverage cost of 4.1% and $46.0 million of floating rate advances with anaverage cost of 5.4%.

**Stockholders’ Equity. **Stockholders’ equity decreasedapproximately $2.3 million from December 31, 2005 to December 31, 2006.  The decrease in stockholders’ equity wasprimarily due to the purchase of 354,266 shares of treasury stock totaling $8.6million in connection with the Company’s stock repurchase program and, to alesser extent, the payment of quarterly cash dividends in the amount of $2.9million.  Such decreases were partiallyoffset by net income in the amount of $7.4 million resulting from continuedprofitable operations, as well as the issuance of 140,566 shares of treasurystock totaling $954,000 as a result of the exercise of stock options.  See the Consolidated Statements ofStockholders’ Equity for the years ended December 31, 2006, 2005 and 2004contained herein for more detail.

 

34

----

 

**Average Balance Sheets**

The following table setsforth certain information relating to the Company’s average balance sheets andreflects the average yield on assets and average cost of liabilities for theperiods indicated.  Such yields and costsare derived by dividing interest income or interest expense by the averagebalance of assets or liabilities, respectively, for the periods presented.  Average balances are based on daily balancesduring the periods.

 
| ** **                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                        | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | **Average  Balance**                       | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/  Cost** | ** ** |
| ** **                                                        | ** ** | **(Dollars in Thousands)**       | ** ** |
| ** **                                                        | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest earning assets:                                          |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans receivable(1)                                               |       | $                                          | 726,642    |   | $ | 50,185 |   | 6.91 | % | $ | 687,373 |   | $ | 43,057 |   | 6.26 | % | $ | 573,520 |   | $ | 35,685 |   | 6.22 | % |
| Investment securities(2)                                          |       | 67,395                                     |       | 3,270 |   | 4.85 |   | 62,761 |   | 2,902 |   | 4.62 |   | 78,468 |   | 3,533 |   | 4.50 |   |
| Other interest earning assets                                     |       | 13,288                                     |       | 664 |   | 5.00 |   | 3,875 |   | 126 |   | 3.25 |   | 15,053 |   | 152 |   | 1.01 |   |
| Total interest earning assets                                     |       | 807,325                                    |       | 54,119 |   | 6.70 |   | 754,009 |   | 46,085 |   | 6.11 |   | 667,041 |   | 39,370 |   | 5.90 |   |
| Noninterest earning assets                                        |       | 61,841                                     |       |   |   |   |   | 54,388 |   |   |   |   |   | 47,793 |   |   |   |   |   |
| Total assets                                                      |       | $                                          | 869,166    |   |   |   |   |   | $ | 808,397 |   |   |   |   |   | $ | 714,834 |   |   |   |   |   |
| Interest bearing liabilities:                                     |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                          |       | $                                          | 630,230    |   | 20,643 |   | 3.28 |   | $ | 590,753 |   | 14,617 |   | 2.47 |   | $ | 581,279 |   | 12,690 |   | 2.18 |   |
| FHLB advances                                                     |       | 154,186                                    |       | 6,933 |   | 4.50 |   | 135,636 |   | 4,987 |   | 3.68 |   | 53,299 |   | 1,648 |   | 3.09 |   |
| Total interest bearing liabilities                                |       | 784,416                                    |       | 27,576 |   | 3.51 |   | 726,389 |   | 19,604 |   | 2.70 |   | 634,578 |   | 14,338 |   | 2.26 |   |
| Noninterest bearing liabilities                                   |       | 6,182                                      |       |   |   |   |   | 5,543 |   |   |   |   |   | 5,002 |   |   |   |   |   |
| Total liabilities                                                 |       | 790,598                                    |       |   |   |   |   | 731,932 |   |   |   |   |   | 639,580 |   |   |   |   |   |
| Stockholders’ equity                                         |       | 78,568                                     |       |   |   |   |   | 76,465 |   |   |   |   |   | 75,254 |   |   |   |   |   |
| Total liabilities and stockholders’ equity                   |       | $                                          | 869,166    |   |   |   |   |   | $ | 808,397 |   |   |   |   |   | $ | 714,834 |   |   |   |   |   |
|                                                              |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                               |       |                                       |       | $ | 26,543 |   |   |   |   |   | $ | 26,481 |   |   |   |   |   | $ | 25,032 |   |   |   |
| Net earning assets                                                |       | $                                          | 22,909     |   |   |   |   |   | $ | 27,620 |   |   |   |   |   | $ | 32,463 |   |   |   |   |   |
| Interest rate spread                                              |       |                                       |       |   |   | 3.19 | % |   |   |   |   | 3.41 | % |   |   |   |   | 3.64 | % |
| Net interest margin                                               |       |                                       |       |   |   | 3.29 | % |   |   |   |   | 3.51 | % |   |   |   |   | 3.75 | % |
| Ratio of interest earning assets to interest  bearing liabilities |       |                                       |       |   |   | 102.92 | % |   |   |   |   | 103.80 | % |   |   |   |   | 105.12 | % |

----

(1)  Includes nonaccrual loans.

(2)  Includes FHLB of Dallas stock.

35

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##  

## **Rate/VolumeAnalysis**

The table below setsforth certain information regarding changes in interest income and interestexpense of the Company for the periods indicated.  For each category of interest earning assetsand interest bearing liabilities, information is provided on changesattributable to (i) changes in volume (changes in average volume multiplied byprior rate); (ii) changes in rate (change in rate multiplied by prior averagevolume); (iii) changes in rate-volume (changes in rate multiplied by the changein average volume); and (iv) the net change.

 
| ** **                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|
| ** **                         | ** ** | **2006 vs. 2005**                | ** ** | **2005 vs. 2004** | ** ** |
| ** **                         | ** ** | **Increase (Decrease)  Due to**  | ** ** | **Total** | ** ** | **Increase (Decrease)  Due to** | ** ** | **Total** | ** ** |
| ** **                         | ** ** | **Volume**                                 | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Increase  (Decrease)** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Increase  (Decrease)** | ** ** |
| ** **                         | ** ** | **(In Thousands)**                    | ** ** |
| ** **                         | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income:                   |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans receivable                   |       | $                                          | 2,460      |   | $ | 4,416 |   | $ | 252 |   | $ | 7,128 |   | $ | 7,084 |   | $ | 240 |   | $ | 48 |   | $ | 7,372 |   |
| Investment securities              |       | 214                                        |       | 143 |   | 11 |   | 368 |   | (707 | ) | 95 |   | (19 | ) | (631 | ) |
| Other interest earning assets      |       | 306                                        |       | 68 |   | 164 |   | 538 |   | (113 | ) | 337 |   | (250 | ) | (26 | ) |
| Total interest earning assets      |       | 2,980                                      |       | 4,627 |   | 427 |   | 8,034 |   | 6,264 |   | 672 |   | (221 | ) | 6,715 |   |
|                               |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense:                  |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                           |       | 977                                        |       | 4,733 |   | 316 |   | 6,026 |   | 207 |   | 1,692 |   | 28 |   | 1,927 |   |
| FHLB advances                      |       | 682                                        |       | 1,112 |   | 152 |   | 1,946 |   | 2,546 |   | 312 |   | 481 |   | 3,339 |   |
| Total interest bearing liabilities |       | 1,659                                      |       | 5,845 |   | 468 |   | 7,792 |   | 2,753 |   | 2,004 |   | 509 |   | 5,266 |   |
| Net change in net interest income  |       | $                                          | 1,321      |   | $ | (1,218 | ) | $ | (41 | ) | $ | 62 |   | $ | 3,511 |   | $ | (1,332 | ) | $ | (730 | ) | $ | 1,449 |   |

 

36

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** **

** **

**CHANGES IN RESULTS OF OPERATIONS**

The table below presents a comparison of results of operations forthe years ended December 31, 2006, 2005, and 2004 (dollars in thousands).  Specific changes in captions will bediscussed below the table.
| ** **                                            | ** ** | **Year Ended December 31,** | ** ** | **Dollar Change** | ** ** | **Percentage Change** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                            | ** ** | **2006**                                   | ** ** | **2005**               | ** ** | **2004**                   | ** ** | **2006 vs 2005** | ** ** | **2005 vs 2004** | ** ** | **2006 vs 2005** | ** ** | **2005 vs 2004** | ** ** |
| Interest income:                                      |       |                                       |       |                   |       |                       |       |   |   |   |   |   |   |   |   |
| Loans  receivable                                     |       | $                                          | 50,185     |                   | $          | 43,057                     |       | $ | 35,685 |   | $ | 7,128 |   | $ | 7,372 |   | 16.6 | % | 20.7 | % |
| Investment  securities                                |       | 3,270                                      |       | 2,902                  |       | 3,533                      |       | 368 |   | (631 | ) | 12.7 |   | (17.9 | ) |
| Other                                                 |       | 664                                        |       | 126                    |       | 152                        |       | 538 |   | (26 | ) | 427.0 |   | (17.1 | ) |
| Total  interest income                                |       | 54,119                                     |       | 46,085                 |       | 39,370                     |       | 8,034 |   | 6,715 |   | 17.4 |   | 17.1 |   |
| Interest expense:                                     |       |                                       |       |                   |       |                       |       |   |   |   |   |   |   |   |   |
| Deposits                                              |       | 20,643                                     |       | 14,617                 |       | 12,690                     |       | 6,026 |   | 1,927 |   | 41.2 |   | 15.2 |   |
| FHLB  advances                                        |       | 6,933                                      |       | 4,987                  |       | 1,648                      |       | 1,946 |   | 3,339 |   | 39.0 |   | 202.6 |   |
| Total  interest expense                               |       | 27,576                                     |       | 19,604                 |       | 14,338                     |       | 7,972 |   | 5,266 |   | 40.7 |   | 36.7 |   |
| Net interest income  before provision for loan losses |       | 26,543                                     |       | 26,481                 |       | 25,032                     |       | 62 |   | 1,449 |   | 0.2 |   | 5.8 |   |
| Provision for loan  losses                            |       | 1,482                                      |       | 1,101                  |       | 1,020                      |       | 381 |   | 81 |   | 34.6 |   | 7.9 |   |
| Net interest income  after rovision for loan losses   |       | 25,061                                     |       | 25,380                 |       | 24,012                     |       | (319 | ) | 1,368 |   | (1.3 | ) | 5.7 |   |
| Noninterest income:                                   |       |                                       |       |                   |       |                       |       |   |   |   |   |   |   |   |   |
| Deposit  fee income                                   |       | 4,839                                      |       | 4,486                  |       | 3,674                      |       | 353 |   | 812 |   | 7.9 |   | 22.1 |   |
| Gain  on sale of loans                                |       | 924                                        |       | 764                    |       | 607                        |       | 160 |   | 157 |   | 20.9 |   | 25.9 |   |
| Other                                                 |       | 2,572                                      |       | 1,711                  |       | 1,993                      |       | 861 |   | (282 | ) | 50.3 |   | (14.1 | ) |
| Total  noninterest income                             |       | 8,335                                      |       | 6,961                  |       | 6,274                      |       | 1,374 |   | 687 |   | 19.7 |   | 11.0 |   |
| Noninterest expenses:                                 |       |                                       |       |                   |       |                       |       |   |   |   |   |   |   |   |   |
| Salaries  and employee benefits                       |       | 13,464                                     |       | 12,722                 |       | 11,094                     |       | 742 |   | 1,628 |   | 5.8 |   | 14.7 |   |
| Net  occupancy expense                                |       | 2,405                                      |       | 2,079                  |       | 2,009                      |       | 326 |   | 70 |   | 15.7 |   | 3.5 |   |
| Data  processing                                      |       | 1,474                                      |       | 1,546                  |       | 1,546                      |       | (72 | ) | 0 |   | (4.7 | ) | 0.0 |   |
| Advertising  and public relations                     |       | 1,338                                      |       | 1,137                  |       | 972                        |       | 201 |   | 165 |   | 17.7 |   | 17.0 |   |
| Other                                                 |       | 3,953                                      |       | 3,284                  |       | 3,162                      |       | 669 |   | 122 |   | 20.4 |   | 3.9 |   |
| Total  noninterest expenses                           |       | 22,634                                     |       | 20,768                 |       | 18,783                     |       | 1,866 |   | 1,985 |   | 9.0 |   | 10.6 |   |
| Income before provision  for income taxes             |       | 10,762                                     |       | 11,573                 |       | 11,503                     |       | (811 | ) | 70 |   | (7.0 | ) | 0.6 |   |
| Income tax provision                                  |       | 3,379                                      |       | 3,723                  |       | 3,698                      |       | (344 | ) | 25 |   | (9.2 | ) | 0.7 |   |
| Net income                                            |       | $                                          | 7,383      |                   | $          | 7,850                      |       | $ | 7,805 |   | $ | (467 | ) | $ | 45 |   | (5.9 | )% | 0.6 | % |
|                                                  |       |                                       |       |                   |       |                       |       |   |   |   |   |   |   |   |   |
| Basic earnings per share                              |       | $                                          | 1.48       |                   | $          | 1.57                       |       | $ | 1.54 |   | $ | (0.09 | ) | $ | 0.03 |   | (5.7 | )% | 1.9 | % |
| Diluted earnings per  share                           |       | $                                          | 1.44       |                   | $          | 1.50                       |       | $ | 1.45 |   | $ | (0.06 | ) | $ | 0.05 |   | (4.0 | )% | 3.5 | % |
|                                                  |       |                                       |       |                   |       |                       |       |   |   |   |   |   |   |   |   |
| Interest rate spread                                  |       | 3.19                                       | %          | 3.41                   | %          | 3.64                       | %          |   |   |   |   |   |   |   |   |
| Net interest margin                                   |       | 3.29                                       | %          | 3.51                   | %          | 3.75                       | %          |   |   |   |   |   |   |   |   |
|                                                  |       |                                       |       |                   |       |                       |       |   |   |   |   |   |   |   |   |
| Average full-time  equivalents                        |       | 306                                        |       | 270                    |       | 247                        |       |   |   |   |   |   |   |   |   |
| Full service offices                                  |       | 18                                         |       | 16                     |       | 15                         |       |   |   |   |   |   |   |   |   |

 

37

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**NetInterest Income. **Netinterest income is determined by the Company’s interest rate spread (i.e., thedifference between the yields earned on its interest earning assets and therates paid on its interest bearing liabilities) and the relative amounts ofinterest earning assets and interest bearing liabilities.

**InterestIncome and Interest Expense**

Dollar and percentagechanges in interest income and interest expense for the comparison periods arepresented in the rate/volume analysis table which appears on a previous page.

**InterestIncome.**  The increasein the 2006 vs. 2005 period was primarily due to an increase in the averagebalance of loans receivable, an increase in the average yield earned on loans,and an increase in the average balance of other interest-earning assets.  The increase in the average yield earned onloans was due to increased rates on new loans in conjunction with recentincreases in market interest rates.  Theaverage balance of loans increased primarily due to an increase in the averageprincipal balance of construction loans.  The average balance of other interest-earning assets increased due to anincrease in the average balance of our FHLB demand deposit account, whichoccurred primarily as a result of funds generated from the increase indeposits.

The increase in the 2005vs. 2004 period was primarily due to an increase in the average balance ofloans, an increase in the average yield earned on loans and an increase in theaverage yield earned on other interest earning assets, partially offset by adecrease in the average balance of investment securities and a decrease in theaverage balance of other interest earning assets.  The increase in the average yield earned onloans was due to increased rates on new loans, particularly construction loans,in conjunction with recent increases in market interest rates.  The average balance of loans increasedprimarily due to increased construction loan origination activity.  The average balance of investment securitiesdecreased due to calls and maturities.

**InterestExpense.**   The increasein the 2006 vs. 2005 period was primarily due to an increase in the averagerates paid on deposits and FHLB advances as well as an increase in the averagebalances of deposits and FHLB advances. The increase in the average rates paid on deposit accounts reflects boththe shift in deposits from money market accounts to higher rate certificates ofdeposit as well as increases in market interest rates.  The rates paid on FHLB advances increased dueto increases in market interest rates. The average balance of deposits increased due to growth in certificatesof deposit.  The average balance of FHLBadvances increased due to the use of advances to fund loan growth.

The increase in interestexpense in the 2005 vs. 2004 period was primarily due to increases in theaverage rates paid on deposit accounts and FHLB advances, as well as theincrease in the average balance of deposit accounts and FHLB advances.  The increase in FHLB advances was due to theuse of FHLB advances to fund the loan growth during the year.  The increase in the average rates paid ondeposit accounts reflects both the shift in deposits from money market accountsand savings accounts to higher rate certificates of deposit as well as therecent increases in market interest rates.

**Provisionfor Loan Losses.**  Theprovision for loan losses is determined by management as the amount to bringthe allowance for loan losses to a level that is considered adequate to absorbprobable losses inherent in the loan portfolio. Such provision and the adequacy of the allowance for loan losses isevaluated quarterly by management of the Bank based on the Bank’s past loanloss experience, known and inherent risks in the portfolio, adverse situationsthat may affect the borrower’s ability to repay, the estimated value of anyunderlying collateral and current economic conditions.

Factors influencingmanagement’s decision to increase the provision in the 2006 vs. 2005 periodinclude an increase in nonaccrual loans and conditions in the speculativesingle family real estate market in Northwest Arkansas.  Notwithstanding the sharp increase innonaccrual loans and the potential impact of such loans on our provisionanalysis, we have thoroughly evaluated the single family speculativeconstruction loan portfolio and believe we have identified all of the materialcredit concerns based on facts and circumstances existing at December 31,2006.  The speculative single familyconstruction market demonstrated weakness in late 2005 and we began reducingour exposure in this area.  During 2006,we incurred construction loan charge-offs of $239,000 compared to $77,000 forthe year ended December 31, 2005, and none for the year ended December 31,2004.  The losses on these loans in 2006related primarily to extraordinary costs in constructing these residences, someoverfunding to cover these costs, and some substandard construction, ratherthan deterioration of the value of the underlying collateral.  We have tightened our internal proceduresthat allowed the overfunding to occur as well as increased monitoring ofconstruction quality and do not expect future material losses based onoverfunding and construction quality issues, other than potential lossesassociated with the four relationships discussed in Asset Quality.  Further, based on a review of availablemarket data, we have not noted a decrease in home sale prices in the NorthwestArkansas market as of December 31, 2006. In light of these factors and our historically low charge-off history,we believe our provision for loan losses was adequate for the year endedDecember 31, 2006.

The increase in theprovision for loan losses for the 2005 vs. 2004 period was due primarily to anincrease in charge-offs on overdrafts.

38

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**NoninterestIncome. **Deposit feeincome increased as a result of the increase in the number of checkingaccounts.  The number of checkingaccounts increased approximately 3.1% from December 31, 2005 to December 31,2006 and increased 5.9% from December 31, 2004 to December 31, 2005.  The Bank plans to continue to aggressivelypromote checking accounts in 2007 through direct mail campaigns and offering “thankyou” gifts to further expand its checking accounts and increase deposit feeincome.

Gain on sale ofloans changed in relation to increases or decreases in originations of loansfor sale during the comparison periods. The activity in loans held for sale is summarized below (in thousands):
| ** **                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Loans held for  sale, beginning of period |       | $                                          | 2,641      |   | $ | 1,623 |   | $ | 1,687 |   |
| Originations of  loans held for sale      |       | 67,613                                     |       | 56,153 |   | 45,763 |   |
| Sales                                     |       | (69,155                                    | )          | (55,135 | ) | (45,827 | ) |
| Loans held for  sale, end of period       |       | $                                          | 1,099      |   | $ | 2,641 |   | $ | 1,623 |   |
|                                      |       |                                       |       |   |   |   |   |
| Gain on sale of loans                     |       | $                                          | 924        |   | $ | 764 |   | $ | 607 |   |

 

Other noninterest incomeincreased during the 2006 vs. 2005 period due to nonrecurring gains on thesales of two properties totaling $528,000. These properties represented excess land and a building adjacent to twoexisting branches.

Other noninterest incomedecreased during the 2005 vs. 2004 period primarily due to a decrease inloan-related fees and a decrease in gains on sales of office properties andequipment and real estate owned.  Thedecrease in loan-related fees was due to a reduction in the amount of feescollected due to competitive factors in the Bank’s market area.

**NoninterestExpense**

**Salariesand Employee Benefits. **Thechanges in the composition of this line item are presented below (inthousands):
| ** **                         | ** ** | **Year Ended December 31,** | ** ** | **Change** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|------------|------------|
| ** **                         | ** ** | **2006**                                   | ** ** | **2005**   | ** ** | **2004** | ** ** | **2006 vs 2005** | ** ** | **2005 vs 2004** | ** ** |
| Salaries                           |       | $                                          | 10,237     |       | $          | 8,516 |   | $ | 7,635 |   | $ | 1,721 |   | $ | 881 |   |
| Payroll taxes                      |       | 866                                        |       | 773        |       | 701 |   | 93 |   | 72 |   |
| Insurance                          |       | 696                                        |       | 630        |       | 572 |   | 66 |   | 58 |   |
| ESOP expense (1)                   |       | 508                                        |       | 1,965      |       | 1,661 |   | (1,457 | ) | 304 |   |
| 401(k)                             |       | 174                                        |       | —     |       | — |   | 174 |   | — |   |
| Stock compensation  (2)            |       | 81                                         |       | 27         |       | 27 |   | 54 |   | — |   |
| Defined benefit  plan contribution |       | 745                                        |       | 660        |       | 358 |   | 85 |   | 302 |   |
| Other                              |       | 157                                        |       | 151        |       | 140 |   | 6 |   | 11 |   |
| Total                              |       | $                                          | 13,464     |       | $          | 12,722 |   | $ | 11,094 |   | $ | 742 |   | $ | 1,628 |   |

----

(1)  Employee Stock Ownership Plan.

(2)  Includes stock options andManagement Recognition and Retention Plan (“MRP”) expense.

2006 vs. 2005

The increase in salarieswas primarily related to an increase in the number of employees and normalsalary and merit increases.  Payrolltaxes increased due to the increase in salaries.  The increase in insurance expense was due toan increase in the number of employees. The decrease in employee stock ownership plan expense was due to theplan shares becoming fully allocated as of March 31, 2006.  Defined benefit plan expense increased due toan increase in the required contribution to our multi-employer plan primarilyresulting from an increase in amortization cost.  The Company implemented a 401(k) Plan on June1, 2006.  The 401(k) expense aboverelates to employer matching of employee 401(k) contributions.

2005 vs. 2004

The increase in salarieswas due primarily to an increase in the number of employees and normal salaryand merit increases.  Payroll taxesincreased due to the increase in salaries. The increase in employee stock ownership plan expense was due to anincrease in the Company’s average stock price from $20.58 in 2004 to $23.93 in2005.  Defined benefit plan expenseincreased due to an increase in the required contribution to our multi-employerplan primarily resulting from an increase in amortization cost.

39

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**Netoccupancy expense. **Thechanges in the composition of this line item are presented below (inthousands):
| ** **                          | ** ** | **Year Ended December 31,** | ** ** | **Change** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|------------|------------|
| ** **                          | ** ** | **2006**                                   | ** ** | **2005**   | ** ** | **2004** | ** ** | **2006 vs 2005** | ** ** | **2005 vs 2004** | ** ** |
| Depreciation                        |       | $                                          | 1,224      |       | $          | 1,111 |   | $ | 1,103 |   | $ | 113 |   | $ | 8 |   |
| Furniture,  fixtures, and equipment |       | 261                                        |       | 235        |       | 183 |   | 26 |   | 52 |   |
| Utilities                           |       | 290                                        |       | 242        |       | 219 |   | 48 |   | 23 |   |
| Building repairs  and maintenance   |       | 313                                        |       | 237        |       | 258 |   | 76 |   | (21 | ) |
| Taxes and  insurance                |       | 220                                        |       | 187        |       | 179 |   | 33 |   | 8 |   |
| Rent                                |       | 97                                         |       | 67         |       | 67 |   | 30 |   | — |   |
| Total                               |       | $                                          | 2,405      |       | $          | 2,079 |   | $ | 2,009 |   | $ | 326 |   | $ | 70 |   |

 

2006 vs. 2005

The increases indepreciation, furniture, fixtures and equipment expense, and utilities were dueto two new branches that opened during the first quarter of 2006 as well asremodeling several existing branches during the year.  The increase in building repairs andmaintenance consisted of expenses related to new branches as well as anincrease in maintenance expenses for the corporate office.  

2005 vs. 2004

The increases infurniture, fixture, and equipment expense and utilities were due to the openingof one new full service branch office and remodeling several existing branchoffices, along with general utility cost increases.  The decrease in building repairs andmaintenance is due to one-time repairs in 2004.

**Advertisingand public relations.** Advertising and public relations increased for the years endedDecember 31, 2006 and December 31, 2005 compared to the relevant priorperiods primarily due to costs associated with the new checking account marketingprogram that began in 2005, including direct mail, “thank you” gifts, marketingbrochures, posters and billboards, and the start-up of the business accountmarketing program.  In 2006, the Bankalso had additional start up costs related to a new marketing firm andadvertising campaign.

**Otherexpenses.**  The changesin the composition of this line item are presented below (in thousands):
| ** **                      | ** ** | **Year Ended December 31,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|------------|------------|
| ** **                      | ** ** | **2006**                                   | ** ** | **2005**   | ** ** | **2004** | ** ** | **2006 vs 2005** | ** ** | **2005 vs 2004** | ** ** |
| Consultant and  management fees |       | $                                          | 196        |       | $          | 135 |   | $ | 234 |   | $ | 61 |   | $ | (99 | ) |
| Professional  fees              |       | 381                                        |       | 422        |       | 466 |   | (41 | ) | (44 | ) |
| Postage and  supplies           |       | 836                                        |       | 772        |       | 695 |   | 64 |   | 77 |   |
| Loan related  expenses          |       | 241                                        |       | 139        |       | 152 |   | 102 |   | (13 | ) |
| Real estate  owned expenses     |       | 305                                        |       | 83         |       | 109 |   | 222 |   | (26 | ) |
| Telephone                       |       | 261                                        |       | 242        |       | 214 |   | 19 |   | 28 |   |
| Other                           |       | 1,733                                      |       | 1,491      |       | 1,292 |   | 242 |   | 199 |   |
| Total                           |       | $                                          | 3,953      |       | $          | 3,284 |   | $ | 3,162 |   | $ | 669 |   | $ | 122 |   |

 

2006 vs. 2005

Loan relatedexpenses increased primarily due to the increase in loans sold in the secondarymortgage market during 2006.  Theincrease in real estate owned expenses was related to the increase in number ofproperties acquired during the year. Other expenses increased primarily due to travel and related trainingexpenses in connection with the Bank’s conversion to a new loan and depositsystem planned for March 2007.

2005 vs. 2004

The increase inpostage and supplies was due to replacing supplies during 2005 with the newcorporate logo and stocking new branch offices. Consultant and management fees decreased due to fees paid in 2004 tostart the new checking account marketing program.  Other expenses increased due primarily toincreases in employee training expenses and bank and Visa service fees.  Such fees increased during the year due toincreased customer use of the Visa cards as well as Visa raising their fees.

40

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**IncomeTaxes.**

2006 vs. 2005

The decrease inincome tax expense was primarily due to the decrease in taxable income.  The effective tax rate decreased slightly toapproximately 31%.

2005 vs. 2004

The increase inincome tax expense was primarily due to an increase in taxable income.  The effective tax rate remained relativelyconsistent at approximately 32%.

**OFF-BALANCE SHEET ARRANGEMENTS**

See Note 14 to the Consolidated Financial Statements.

### **CONTRACTUALOBLIGATIONS**

We arecontractually obligated to make future minimum payments as follows (inthousands):
| ** **                          | ** ** | **Less Than** | ** ** | ** **                     | ** ** | ** **                     | ** ** | **More Than** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|--------------------|------------|--------------------------------|------------|--------------------------------|------------|--------------------|------------|------------|------------|
| ** **                          | ** ** | **1 Year**    | ** ** | **1 - 3 Years** | ** ** | **3 - 5 Years** | ** ** | **5 Years**   | ** ** | **Total**  | ** ** |
|                                |       |               |       |                           |       |                           |       |               |       |       |       |
| Certificates of  deposit maturities |       | $                  | 331,550    |                           | $          | 67,751                         |       | $                  | 29,019     |       | $          | 5,922 |   | $ | 434,242 |   |
| FHLB advances  maturities           |       | $                  | 59,818     |                           | $          | 46,902                         |       | $                  | 11,159     |       | $          | 2,426 |   | $ | 120,305 |   |

 

### **LIQUIDITYAND CAPITAL RESOURCES**

The Bank’s liquidity, represented by cash and cash equivalents andeligible investment securities, is a product of its operating, investing andfinancing activities.  The Bank’s primarysources of funds are deposits, borrowings, payments on outstanding loans,maturities and calls of investment securities and other short-term investmentsand funds provided from operations. While scheduled loan amortization and maturing investment securities andshort-term investments are relatively predictable sources of funds, depositflows and loan prepayments are greatly influenced by general interest rates,economic conditions and competition.  TheBank manages the pricing of its deposits to maintain a steady depositbalance.  In addition, the Bank investsexcess funds in overnight deposits and other short-term interest earning assetswhich provide liquidity to meet lending requirements.  The Bank has generally been able to generateenough cash through the retail deposit market, its traditional funding source,to offset the cash utilized in investing activities.  As an additional source of funds, the Bankhas borrowed from the FHLB of Dallas. During 2006, the use of FHLB advances decreased due to the Bank usingfunds from deposit growth to repay FHLB of Dallas advances.  At December 31, 2006, available borrowingcapacity with the FHLB was approximately $186.5 million.  In addition, brokered deposits may be used toaugment the Bank’s primary funding sources. At December 31, 2006, the Bank had outstanding brokered deposits of $3.2million.

Liquidity management is both a daily and long-term function ofbusiness management.  Excess liquidity isgenerally invested in short-term investments such as overnight deposits andcertificates of deposit.  On alonger-term basis, the Bank maintains a strategy of investing in variouslending products.   The Bank uses itssources of funds primarily to meet its ongoing commitments, to pay maturingsavings certificates and savings withdrawals, to repay maturing FHLB of Dallasadvances, and to fund loan commitments.

In 2006 and 2005, the Company paid dividends of $0.58 and $0.50 pershare, respectively.  In 2006, thedividend per share was $0.14 in both the first and second quarters and $0.15 inboth the third and fourth quarters.  Thedetermination of future dividends on the Company’s common stock will depend onconditions existing at that time with consideration given to the Company’s earnings,capital, and liquidity needs.

As of December 31, 2006, the Bank’s regulatory capital was in excessof all applicable regulatory requirements. At December 31, 2006, the Bank’s tangible, core and risk-based capitalratios amounted to 8.76%, 8.76% and 11.94%, respectively, compared toregulatory requirements of 1.5%, 4.0% and 8.0%, respectively.

### **IMPACTOF INFLATION AND CHANGING PRICES**

The financial statementsand related financial data presented herein have been prepared in accordancewith generally accepted accounting principles, which require the measurement offinancial position and operating results in terms of historical dollars,without considering changes in relative purchasing power over time due toinflation.

Unlike most industrial companies, virtually all of the Bank’s assetsand liabilities are monetary in nature. As a result, interest rates generally have a more significant impact ona financial institution’s performance than does the effect of inflation.

### **IMPACTOF NEW ACCOUNTING STANDARDS**

See Note 1 to theConsolidated Financial Statements.

41

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**Item7A. Quantitative and Qualitative Disclosure about Market Risk.**

**ASSET AND LIABILITY MANAGEMENT**

The ability to maximize net interest income is largely dependent uponthe achievement of a positive interest rate spread that can be sustained duringfluctuations in prevailing interest rates. Interest rate sensitivity is a measure of the difference between amountsof interest earning assets and interest bearing liabilities that either repriceor mature within a given period of time. The difference, or the interest rate repricing “gap”, provides anindication of the extent to which an institution’s interest rate spread will beaffected by changes in interest rates.  Agap is considered positive when the amount of interest rate-sensitive assetsexceeds the amount of interest rate-sensitive liabilities, and is considerednegative when the amount of interest rate-sensitive liabilities exceeds theamount of interest rate-sensitive assets. Generally, during a period of rising interest rates, a negative gapwithin shorter maturities would adversely affect net interest income, while apositive gap within shorter maturities would result in an increase in netinterest income, and during a period of falling interest rates, a negative gapwithin shorter maturities would result in an increase in net interest incomewhile a positive gap within shorter maturities would have the oppositeeffect.  As of December 31, 2006, theBank estimates that the ratio of its one-year gap to total assets was a negative19.4%and its ratio of interest earning assets to interest bearing liabilitiesmaturing or repricing within one year was 68.2%.

The Bank focuses its residential lending activities for loans held inportfolio on the origination of one-, three-, five- and seven-year adjustablerate residential mortgage loans (“ARMs”). Although adjustable rate loans involve certain risks, includingincreased payments and the potential for default in an increasing interest rateenvironment, such loans decrease the risks associated with changes in interestrates.  As of December 31, 2006, $195.9million or 77.8% of the Bank’s portfolio of one- to four-family residentialmortgage loans consisted of ARMs, including $43.6 million in seven-year ARMs.  ARMs subject to contractual repricing withinone year totaled $27.6 million at December 31, 2006.

The Company’s investment portfolio, all of which is classified asheld to maturity, amounted to $60.7 million or 7.1% of the Company’s totalassets at December 31, 2006.  Ofsuch amount, none is contractually due within one year and $4.8 million or 8.0%is contractually due from one year to five years.  However, actual maturities can be shorterthan contractual maturities due to the ability of borrowers to call or prepaysuch obligations without call or prepayment penalties.  As of December 31, 2006, there wereapproximately $60.2 million of investment securities at an average interestrate of 4.85% with call options held by the issuer, of which approximately $50.0million, at an average interest rate of 4.94%, are callable within oneyear.  In a rising rate environment, theCompany believes the issuer will not call these investment securities.

Deposits are the Bank’s primary funding source and the Bank pricesits deposit accounts based upon competitive factors and the availability ofprudent lending and investment opportunities. The Bank seeks to lengthen the maturities of its deposits by offeringlonger-term certificates of deposit when market conditions have createdopportunities to attract such deposits. However, the Bank does not solicit highrate jumbo certificates of deposit and does not pursue an aggressive growthstrategy which would force the Bank to focus exclusively on competitors’ ratesrather than deposit affordability.  AtDecember 31, 2006, the Bank had $434.2 million in certificates of deposit ofwhich $331.6 million mature in one year or less.  At December 31, 2006, the Bank had $120.3million of FHLB advances of which $59.8 million is due in one year or less.

42

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### **Net Portfolio Value**

The value of the Bank’s loan and investment portfolio will change asinterest rates change.  As a result ofthe Bank’s negative interest rate repricing gap, rising interest rates willgenerally decrease the Bank’s net portfolio value (“NPV”), while fallinginterest rates will generally increase the value of that portfolio.  NPV is the difference between incoming andoutgoing discounted cash flows from assets, liabilities, and off-balance sheetcontracts.  The following tables setforth, quantitatively, as of December 31, 2006 and 2005, the OTS estimate ofthe projected changes in NPV in the event of a 100, 200 and 300 basis pointinstantaneous and permanent increase in market interest rates and a 100 and 200basis point instantaneous and permanent decrease in market interest rates as ofDecember 31, 2006 and 2005.  Due to thelow interest rate environments in 2006 and 2005, the changes in NPV are notestimated for a decrease in interest rates of 300 basis points in either year.
| **2006**                                                     | ** ** |
|--------------------------------------------------------------|------------|
| **Change in  Interest Rates  (basis points)** | ** ** | **Estimated NPV** | ** ** | **Estimated NPV as a  Percentage of  Present Value  of Assets** | ** ** | **Amount  of Change** | ** ** | **Percent  of Change** | ** ** |
| **(Dollars in Thousands)**                         | ** ** |
| +300                                                         |       | $ | 91,757 |   | 10.76 | % | $ | (15,438 | ) | (14 | )% |
| +200                                                         |       | 98,765 |   | 11.43 |   | (8,430 | ) | (8 | ) |
| +100                                                         |       | 104,404 |   | 11.95 |   | (2,791 | ) | (3 | ) |
|       0                             |       | 107,195 |   | 12.17 |   | — |   | — |   |
| –100                                                    |       | 108,537 |   | 12.24 |   | 1,342 |   | 1 |   |
| –200                                                    |       | 108,749 |   | 12.19 |   | 1,554 |   | 1 |   |
|                                                              |            |  |  |  |  |  |  |  |  |  |  |

 
| **2005**                                                     | ** ** |
|--------------------------------------------------------------|------------|
| **Change in  Interest Rates  (basis points)** | ** ** | **Estimated NPV** | ** ** | **Estimated NPV as a  Percentage of  Present Value  of Assets** | ** ** | **Amount  of Change** | ** ** | **Percent  of Change** | ** ** |
| **(Dollars in Thousands)**                         | ** ** |
| +300                                                         |       | $ | 86,342 |   | 10.24 | % | $ | (19,756 | ) | (19 | )% |
| +200                                                         |       | 94,255 |   | 11.01 |   | (11,843 | ) | (11 | ) |
| +100                                                         |       | 100,997 |   | 11.65 |   | (5,101 | ) | (5 | ) |
|       0                             |       | 106,098 |   | 12.09 |   | — |   | — |   |
| –100                                                    |       | 107,556 |   | 12.15 |   | 1,458 |   | 1 |   |
| –200                                                    |       | 106,166 |   | 11.93 |   | 68 |   | 0 |   |
|                                                              |            |  |  |  |  |  |  |  |  |  |  |

 

Computations of prospective effects of hypothetical interest ratechanges are calculated by the OTS from data provided by the Bank and are basedon numerous assumptions, including relative levels of market interest rates,loan repayments, and deposit runoffs, and should not be relied upon asindicative of actual results.  Further,the computations do not contemplate any actions the Bank may undertake inresponse to changes in interest rates.

Management cannot predict future interest rates or their effect onthe Bank’s NPV.  Certain shortcomings areinherent in the method of analysis presented in the computation of NPV.  For example, although certain assets andliabilities may have similar maturities or periods to repricing, they may reactin differing degrees to changes in market interest rates.  Additionally, certain assets, such asadjustable rate loans, have features that restrict changes in interest ratesduring the initial term and over the remaining life of the asset.  In addition, the proportion of adjustablerate loans in the Bank’s portfolio could decrease in future periods due torefinancing activity if market rates decrease. Further, in the event of a change in interest rates, prepayment andearly withdrawal levels could deviate significantly from those assumed in thetable.  Finally, the ability of manyborrowers to service their adjustable rate debt may decrease in the event of aninterest rate increase.

 

43

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** **

** **

**Item8.  Financial Statements andSupplementary Data.**

**MANAGEMENTREPORT ON INTERNAL CONTROL**

The management of FirstFederal Bancshares of Arkansas, Inc. and its subsidiary, First Federal Bank,(collectively referred to as the “Company”) is responsible for the preparation,integrity, and fair presentation of its published financial statements and allother information presented in this annual report.  The financial statements have been preparedin accordance with accounting principles generally accepted in the UnitedStates of America (“GAAP”) and, as such, include amounts based on informedjudgments and estimates made by management.

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting for financial presentations in conformity with GAAP. Pursuant to therules and regulations of the Securities and Exchange Commission, internalcontrol over financial reporting is a process designed by, or under thesupervision of, the company’s principal executive and principal financialofficers, or persons performing similar functions, and effected by the company’sboard of directors, management and other personnel, to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with GAAP andincludes those policies and procedures that:

Pertain to the maintenance of records that in reasonable detailaccurately and fairly reflect the transactions and dispositions of the assets ofthe Company;

Provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withGAAP, and that receipts and expenditures of the company are being made only inaccordance with authorizations of management and directors of the Company; and

Provide reasonable assurance regarding prevention or timely detectionof unauthorized acquisition, use or disposition of the Company’s assets thatcould have a material effect on the financial statements.

Management has evaluatedthe effectiveness of its internal control over financial reporting forfinancial presentations in conformity with GAAP as of December 31, 2006 basedon the control criteria established in a report entitled *Internal Control—Integrated Framework*,issued by the Committee of Sponsoring Organizations of the Treadway Commission.Based on such evaluation, we have concluded that the Company’s internal controlover financial reporting is effective as of December 31, 2006.

The independentregistered public accounting firm of Deloitte & Touche LLP, as auditors ofthe Company’s consolidated financial statements, has issued an attestationreport on management’s assessment of the Company’s internal control overfinancial reporting.
| Larry J. Brandt  President and Chief Executive Officer |   | Sherri R. Billings  Executive Vice President and  Chief Financial Officer |
|--------------------------------------------------------|--------|---------------------------------------------------------------------------|

 

44

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** **

** **

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directorsand Stockholders of First Federal Bancshares of Arkansas,Inc. Harrison, Arkansas

We have audited theaccompanying consolidated statements of financial condition of First Federal Bancshares of Arkansas, Inc.and subsidiaries (the “Company”) as of December 31, 2006 and 2005, andthe related consolidated statements of income, stockholders’ equity, and cashflows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’smanagement.  Our responsibility is to express an opinion on thesefinancial statements based on our audits.

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standards require that we plan and performthe audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includes assessing the accounting principlesused and significant estimates made by management, as well as evaluating theoverall financial statement presentation.  We believe that our auditsprovide a reasonable basis for our opinion.

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of First FederalBancshares of Arkansas, Inc. and subsidiaries**as of December 31, 2006 and 2005, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2006, in conformity with accounting principles generally acceptedin the United States of America.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2006, based on the criteria establishedin *Internal Control—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated February 27, 2007expressed an unqualified opinion on management’s assessment of theeffectiveness of the Company’s internal control over financial reporting and anunqualified opinion on the effectiveness of the Company’s internal control overfinancial reporting.

/s/ Deloitte & ToucheLLP

Little Rock,ArkansasFebruary 27, 2007

45

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** **

** **

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board ofDirectors and Stockholders ofFirst Federal Bancshares of Arkansas, Inc.Harrison, Arkansas

We have auditedmanagement’s assessment, included in the accompanying  Management Report on Internal Control, thatFirst Federal Bancshares of Arkansas, Inc. and its subsidiary (the “Company”)maintained effective internal control over financial reporting as of December31, 2006, based on criteria established in *InternalControl—Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission.  The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting.  Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States).  Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether effective internal controlover financial reporting was maintained in all material respects.  Ouraudit included obtaining an understanding of internal control over financialreporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing suchother procedures as we considered necessary in the circumstances.  Webelieve that our audit provides a reasonable basis for our opinions.

A company’s internalcontrol over financial reporting is a process designed by, or under thesupervision of, the company’s principal executive and principal financialofficers, or persons performing similar functions, and effected by the company’sboard of directors, management, and other personnel to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles.  A company’s internal control overfinancial reporting includes those policies and procedures that (1) pertain tothe maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2)provide reasonable assurance that transactions are recorded as necessary topermit preparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of the inherentlimitations of internal control over financial reporting, including thepossibility of collusion or improper management override of controls, materialmisstatements due to error or fraud may not be prevented or detected on atimely basis.  Also, projections of any evaluation of the effectiveness ofthe internal control over financial reporting to future periods are subject tothe risk that the controls may become inadequate because of changes inconditions, or that the degree of compliance with the policies or proceduresmay deteriorate.

In our opinion,management’s assessment that the Company maintained effective internal controlover financial reporting as of December 31, 2006, is fairly stated, in allmaterial respects, based on the criteria established in *Internal Control—Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31, 2006,based on the criteria established in *InternalControl—Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated financial statements as of and for the year ended December 31, 2006 of the Company and ourreport dated February 27, 2007 expressed an unqualified opinion on thosefinancial statements.

/s/ Deloitte & ToucheLLP

LittleRock, ArkansasFebruary 27, 2007

46

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**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**CONSOLIDATEDSTATEMENTS OF FINANCIAL CONDITION**

**DECEMBER31, 2006 AND 2005**

**(In thousands, except share data)**
| **ASSETS**                                                                                                                                                                          | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                                                                                                                                                |       |       |       |       |       |
| Cash and cash  equivalents:                                                                                                                                                         |       |       |       |       |       |
| Cash and  collection items                                                                                                                                                          |       | $          | 17,731     |       | $          | 16,907 |   |
| Interest bearing  deposits with banks                                                                                                                                               |       | 17,787     |       | 4,202      |       |
|                                                                                                                                                                                |       |       |       |       |       |
| Total cash and  cash equivalents                                                                                                                                                    |       | 35,518     |       | 21,109     |       |
|                                                                                                                                                                                |       |       |       |       |       |
| Investment securities—                                                                                                                                                         |       |       |       |       |       |
| Held to  maturity, at amortized cost (fair value at December 31, 2006 and 2005, of  $59,689 and $55,784, respectively)                                                              |       | 60,746     |       | 56,695     |       |
| Federal Home Loan Bank  stock—at cost                                                                                                                                          |       | 7,089      |       | 8,412      |       |
| Loans receivable, net  of allowance at December 31, 2006 and 2005, of $2,572 and $2,114,  respectively                                                                              |       | 693,095    |       | 719,214    |       |
| Accrued interest  receivable                                                                                                                                                        |       | 9,999      |       | 7,490      |       |
| Real estate owned—net                                                                                                                                                          |       | 3,858      |       | 892        |       |
| Office properties and  equipment—net                                                                                                                                           |       | 20,384     |       | 18,522     |       |
| Cash surrender value of  life insurance                                                                                                                                             |       | 19,396     |       | 18,654     |       |
| Prepaid expenses and  other assets                                                                                                                                                  |       | 2,390      |       | 1,423      |       |
|                                                                                                                                                                                |       |       |       |       |       |
| TOTAL                                                                                                                                                                               |       | $          | 852,475    |       | $          | 852,411 |   |
|                                                                                                                                                                                |       |       |       |       |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| LIABILITIES:                                                                                                                                                                        |       |       |       |       |       |
| Deposits:                                                                                                                                                                           |       |       |       |       |       |
| Interest bearing                                                                                                                                                                    |       | $          | 612,937    |       | $          | 574,772 |   |
| Noninterest  bearing                                                                                                                                                                |       | 39,328     |       | 36,895     |       |
|                                                                                                                                                                                |       |       |       |       |       |
| Total deposits                                                                                                                                                                      |       | 652,265    |       | 611,667    |       |
|                                                                                                                                                                                |       |       |       |       |       |
| Federal Home  Loan Bank advances                                                                                                                                                    |       | 120,305    |       | 158,240    |       |
| Advance payments  by borrowers for taxes and insurance                                                                                                                              |       | 666        |       | 847        |       |
| Other  liabilities                                                                                                                                                                  |       | 3,666      |       | 3,815      |       |
|                                                                                                                                                                                |       |       |       |       |       |
| Total  liabilities                                                                                                                                                                  |       | $          | 776,902    |       | $          | 774,569 |   |
|                                                                                                                                                                                |       |       |       |       |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                          |       |       |       |       |       |
| Preferred stock,  no par value—5,000,000 shares authorized, none issued                                                                                                        |       |       |       |       |       |
| Common stock,  $.01 par value—20,000,000 shares authorized; 10,307,502 shares issued;  4,838,962 and 5,048,662 shares outstanding at December 31, 2006 and 2005,  respectively |       | 103        |       | 103        |       |
| Additional  paid-in capital                                                                                                                                                         |       | 56,617     |       | 56,252     |       |
| Employee stock  benefit plans                                                                                                                                                       |       | (72        | )          | (140       | )          |
| Retained  earnings—substantially restricted                                                                                                                                    |       | 88,068     |       | 83,584     |       |
|                                                                                                                                                                                |       | 144,716    |       | 139,799    |       |
| Treasury  stock—at cost; 5,468,540 and 5,258,840 shares at December 31, 2006 and 2005,  respectively                                                                           |       | (69,143    | )          | (61,957    | )          |
|                                                                                                                                                                                |       |       |       |       |       |
| Total  stockholders’ equity                                                                                                                                                    |       | 75,573     |       | 77,842     |       |
|                                                                                                                                                                                |       |       |       |       |       |
| TOTAL                                                                                                                                                                               |       | $          | 852,475    |       | $          | 852,411 |   |

 

See notes to consolidated financial statements.

47

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** **

** **

**FIRST FEDERAL BANCSHARES OF ARKANSAS,INC**

 

**CONSOLIDATEDSTATEMENTS OF INCOME**

**YEARS ENDED DECEMBER 31, 2006, 2005,AND 2004**

**(Inthousands, except earnings per share)**
| ** **                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| INTEREST INCOME:                                     |       |     |       |     |       |     |       |
| Loans receivable                                     |       | $        | 50,185     |     | $          | 43,057   |       | $ | 35,685 |   |
| Investment  securities:                              |       |     |       |     |       |     |       |
| Taxable                                              |       | 2,526    |       | 2,181    |       | 2,837    |       |
| Nontaxable                                           |       | 744      |       | 721      |       | 696      |       |
| Other                                                |       | 664      |       | 126      |       | 152      |       |
| Total interest  income                               |       | 54,119   |       | 46,085   |       | 39,370   |       |
|                                                 |       |     |       |     |       |     |       |
| INTEREST EXPENSE:                                    |       |     |       |     |       |     |       |
| Deposits                                             |       | 20,643   |       | 14,617   |       | 12,690   |       |
| Federal Home  Loan Bank advances                     |       | 6,933    |       | 4,987    |       | 1,648    |       |
|                                                 |       |     |       |     |       |     |       |
| Total interest  expense                              |       | 27,576   |       | 19,604   |       | 14,338   |       |
|                                                 |       |     |       |     |       |     |       |
| NET INTEREST INCOME                                  |       | 26,543   |       | 26,481   |       | 25,032   |       |
|                                                 |       |     |       |     |       |     |       |
| PROVISION FOR LOAN  LOSSES                           |       | 1,482    |       | 1,101    |       | 1,020    |       |
|                                                 |       |     |       |     |       |     |       |
| NET INTEREST INCOME  AFTER PROVISION FOR LOAN LOSSES |       | 25,061   |       | 25,380   |       | 24,012   |       |
|                                                 |       |     |       |     |       |     |       |
| NONINTEREST INCOME:                                  |       |     |       |     |       |     |       |
| Deposit fee  income                                  |       | 4,839    |       | 4,486    |       | 3,674    |       |
| Earnings on life  insurance policies                 |       | 742      |       | 757      |       | 795      |       |
| Gain on sale of  loans                               |       | 924      |       | 764      |       | 607      |       |
| Other                                                |       | 1,830    |       | 954      |       | 1,198    |       |
|                                                 |       |     |       |     |       |     |       |
| Total noninterest  income                            |       | 8,335    |       | 6,961    |       | 6,274    |       |
|                                                 |       |     |       |     |       |     |       |
| NONINTEREST EXPENSES:                                |       |     |       |     |       |     |       |
| Salaries and  employee benefits                      |       | 13,464   |       | 12,722   |       | 11,094   |       |
| Net occupancy  expense                               |       | 2,405    |       | 2,079    |       | 2,009    |       |
| Data processing                                      |       | 1,474    |       | 1,546    |       | 1,546    |       |
| Professional  fees                                   |       | 381      |       | 422      |       | 466      |       |
| Advertising and  public relations                    |       | 1,338    |       | 1,137    |       | 972      |       |
| Postage and  supplies                                |       | 836      |       | 772      |       | 695      |       |
| Other                                                |       | 2,736    |       | 2,090    |       | 2,001    |       |
|                                                 |       |     |       |     |       |     |       |
| Total  noninterest expenses                          |       | 22,634   |       | 20,768   |       | 18,783   |       |
|                                                 |       |     |       |     |       |     |       |
| INCOME BEFORE INCOME  TAXES                          |       | 10,762   |       | 11,573   |       | 11,503   |       |
|                                                 |       |     |       |     |       |     |       |
| INCOME TAX PROVISION                                 |       | 3,379    |       | 3,723    |       | 3,698    |       |
|                                                 |       |     |       |     |       |     |       |
| NET INCOME                                           |       | $        | 7,383      |     | $          | 7,850    |       | $ | 7,805 |   |
|                                                 |       |     |       |     |       |     |       |
| EARNINGS PER SHARE:                                  |       |     |       |     |       |     |       |
| Basic                                                |       | $        | 1.48       |     | $          | 1.57     |       | $ | 1.54 |   |
|                                                 |       |     |       |     |       |     |       |
| Diluted                                              |       | $        | 1.44       |     | $          | 1.50     |       | $ | 1.45 |   |

 

See notes to consolidated financial statements.

48

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

 

## **CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

## **YEARS ENDED DECEMBER31, 2006, 2005, AND 2004**

**(Inthousands, except share data)**
| ** **                                 | ** ** | **Issued**            | ** ** | **Additional** | ** ** | **Employee** | ** ** | ** **             | ** ** | ** **              | ** ** | ** **             | ** ** | **Total**  | ** ** |
|--------------------------------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|------------|------------|
| ** **                                 | ** ** | **Common Stock** | ** ** | **Paid-In**    | ** ** | **Stock**    | ** ** | **Retained**           | ** ** | **Treasury Stock** | ** ** | **Stockholders’** | ** ** |
| ** **                                 | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Capital**  | ** ** | **Benefit Plans** | ** ** | **Earnings**            | ** ** | **Shares**             | ** ** | **Amount** | ** ** | **Equity** | ** ** |
|                                       |       |                  |       |           |       |         |       |                   |       |                    |       |                   |       |       |       |   |   |
| BALANCE — January 1,  2004            |       | 10,307,502            |       | $              | 103        |         | $          | 52,950                 |       | $                       | (1,025     | )                      | $          | 72,634     |       | 4,967,416 |   | $ | (49,584 | ) | $ | 75,078 |   |
|                                       |       |                  |       |           |       |         |       |                   |       |                    |       |                   |       |       |       |   |   |
| Net  income                                |       | —                |       | —         |       | —       |       | —                 |       | 7,805                   |       | —                 |       | —     |       | 7,805 |   |
| Release  of ESOP shares                    |       | —                |       | —         |       | 1,296        |       | 416                    |       | —                  |       | —                 |       | —     |       | 1,712 |   |
| Stock  compensation expense                |       | —                |       | —         |       | 14           |       | 27                     |       | —                  |       | (1,316                 | )          | 15         |       | 56 |   |
| Tax  effect of stock compensation plans    |       | —                |       | —         |       | 327          |       | —                 |       | —                  |       | —                 |       | —     |       | 327 |   |
| Purchase  of treasury stock — at cost |       | —                |       | —         |       | —       |       | —                 |       | —                  |       | 458,300                |       | (9,534     | )          | (9,534 | ) |
| Treasury  shares reissued                  |       | —                |       | —         |       | (160         | )          | —                 |       | —                  |       | (210,918               | )          | 2,195      |       | 2,035 |   |
| Dividends  paid ($0.42 per share)          |       | —                |       | —         |       | —       |       | —                 |       | (2,178                  | )          | —                 |       | —     |       | (2,178 | ) |
|                                       |       |                  |       |           |       |         |       |                   |       |                    |       |                   |       |       |       |   |   |
| BALANCE — December 31,  2004          |       | 10,307,502            |       | 103            |       | 54,427       |       | (582                   | )          | 78,261                  |       | 5,213,482              |       | (56,908    | )          | 75,301 |   |
|                                       |       |                  |       |           |       |         |       |                   |       |                    |       |                   |       |       |       |   |   |
| Net  income                                |       | —                |       | —-        |       | —       |       | —                 |       | 7,850                   |       | —                 |       | —     |       | 7,850 |   |
| Release  of ESOP shares                    |       | —                |       | —         |       | 1,575        |       | 416                    |       | —                  |       | —                 |       | —     |       | 1,991 |   |
| Stock  compensation expense                |       | —                |       | —         |       | —       |       | 26                     |       | —                  |       | —                 |       | —     |       | 26 |   |
| Tax  effect of stock compensation plans    |       | —                |       | —         |       | 625          |       | —                 |       | —                  |       | —                 |       | —     |       | 625 |   |
| Purchase  of treasury stock — at cost |       | —                |       | —         |       | —       |       | —                 |       | —                  |       | 307,887                |       | (7,630     | )          | (7,630 | ) |
| Treasury  shares reissued                  |       | —                |       | —         |       | (375         | )          | —                 |       | —                  |       | (262,529               | )          | 2,581      |       | 2,206 |   |
| Dividends  paid ($0.50 per share)          |       | —                |       | —         |       | —       |       | —                 |       | (2,527                  | )          | —                 |       | —     |       | (2,527 | ) |
|                                       |       |                  |       |           |       |         |       |                   |       |                    |       |                   |       |       |       |   |   |
| BALANCE — December 31,  2005          |       | 10,307,502            |       | 103            |       | 56,252       |       | (140                   | )          | 83,584                  |       | 5,258,840              |       | (61,957    | )          | 77,842 |   |
|                                       |       |                  |       |           |       |         |       |                   |       |                    |       |                   |       |       |       |   |   |
| Net  income                                |       | —                |       | —         |       | —       |       | —                 |       | 7,383                   |       | —                 |       | —     |       | 7,383 |   |
| Release  of ESOP shares                    |       | —                |       | —         |       | 408          |       | 104                    |       | —                  |       | —                 |       | —     |       | 512 |   |
| Stock  compensation expense                |       | —                |       | —         |       | 70           |       | (36                    | )          | —                  |       | (4,000                 | )          | 47         |       | 81 |   |
| Tax  effect of stock compensation plans    |       | —                |       | —         |       | 274          |       | —                 |       | —                  |       | —                 |       | —     |       | 274 |   |
| Purchase  of treasury stock — at cost |       | —                |       | —         |       | —       |       | —                 |       | —                  |       | 354,266                |       | (8,574     | )          | (8,574 | ) |
| Treasury  shares reissued                  |       | —                |       | —         |       | (387         | )          | —                 |       | —                  |       | (140,566               | )          | 1,341      |       | 954 |   |
| Dividends  paid ($0.58 per share)          |       | —                |       | —         |       | —       |       | —                 |       | (2,899                  | )          | —                 |       | —     |       | (2,899 | ) |
|                                       |       |                  |       |           |       |         |       |                   |       |                    |       |                   |       |       |       |   |   |
| BALANCE — December 31, 2006           |       | 10,307,502            |       | $              | 103        |         | $          | 56,617                 |       | $                       | (72        | )                      | $          | 88,068     |       | 5,468,540 |   | $ | (69,143 | ) | $ | 75,573 |   |

 

See notes to consolidated financial statements.

49

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** **

** **

**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YEARSENDED DECEMBER 31, 2006, 2005 AND 2004**

**(In thousands)**
| ** **                                                                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                               |       |     |       |     |       |     |       |
| OPERATING ACTIVITIES:                                                              |       |     |       |     |       |     |       |
| Net income                                                                         |       | $        | 7,383      |     | $          | 7,850    |       | $ | 7,805 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |     |       |     |       |     |       |
| Provision for  loan losses                                                         |       | 1,482    |       | 1,101    |       | 1,020    |       |
| Provision for  real estate losses                                                  |       | 92       |       | 29       |       | 45       |       |
| Deferred tax  provision (benefit)                                                  |       | 137      |       | (13      | )          | 350      |       |
| Accretion of  discounts on investment securities—net                          |       | (8       | )          | (2       | )          | (40      | )          |
| Federal Home  Loan Bank stock dividends                                            |       | (403     | )          | (251     | )          | (69      | )          |
| Loss (gain) on  disposition of fixed assets                                        |       | (522     | )          | 9        |       | (70      | )          |
| Gain on sale of  repossessed assets—net                                       |       | (51      | )          | (8       | )          | (42      | )          |
| Originations of  loans held for sale                                               |       | (67,642  | )          | (56,153  | )          | (63,041  | )          |
| Proceeds from  sales of loans originated to sell                                   |       | 70,108   |       | 55,899   |       | 63,712   |       |
| Gain on sale of  mortgage loans originated to sell                                 |       | (924     | )          | (764     | )          | (607     | )          |
| Depreciation                                                                       |       | 1,304    |       | 1,185    |       | 1,185    |       |
| Amortization of  deferred loan fees—net                                       |       | 280      |       | 167      |       | 91       |       |
| Release of ESOP  shares                                                            |       | 512      |       | 1,991    |       | 1,712    |       |
| Earnings on life  insurance policies                                               |       | (742     | )          | (757     | )          | (795     | )          |
| Stock  compensation expense                                                        |       | 81       |       | 26       |       | 56       |       |
| Changes in  operating assets and liabilities:                                      |       |     |       |     |       |     |       |
| Accrued interest  receivable                                                       |       | (2,509   | )          | (3,063   | )          | (338     | )          |
| Prepaid expenses  and other assets                                                 |       | (953     | )          | 304      |       | (427     | )          |
| Other  liabilities                                                                 |       | 283      |       | 1,921    |       | 351      |       |
|                                                                               |       |     |       |     |       |     |       |
| Net cash  provided by operating activities                                         |       | 7,908    |       | 9,471    |       | 10,898   |       |
|                                                                               |       |     |       |     |       |     |       |
| INVESTING ACTIVITIES:                                                              |       |     |       |     |       |     |       |
| Purchases of  investment securities—held to maturity                          |       | (7,533   | )          | (5,559   | )          | (87,039  | )          |
| Proceeds from  maturities of investment securities—held to maturity           |       | 3,490    |       | 4,626    |       | 111,798  |       |
| Purchase of  Federal Home Loan Bank stock                                          |       | —   |       | (3,285   | )          | (1,737   | )          |
| Federal Home  Loan Bank stock redeemed                                             |       | 1,726    |       | —   |       | 679      |       |
| Loan originations—net  of repayments                                          |       | 13,762   |       | (87,939  | )          | (121,946 | )          |
| Loan purchases                                                                     |       | (363     | )          | —   |       | (5,172   | )          |
| Loan  participations sold                                                          |       | 3,419    |       | 1,787    |       | 3,970    |       |
| Proceeds from  sales of repossessed assets                                         |       | 3,700    |       | 560      |       | 801      |       |
| Improvements to  real estate owned                                                 |       | (724     | )          | —   |       | —   |       |
| Proceeds from  sales of office properties and equipment                            |       | 251      |       | 4        |       | 632      |       |
| Purchases of  office properties and equipment                                      |       | (3,190   | )          | (4,425   | )          | (2,475   | )          |
|                                                                               |       |     |       |     |       |     |       |
| Net cash  provided by (used in) investing activities                               |       | 14,538   |       | (94,231  | )          | (100,489 | )          |
|                                                                                    |            |          |            |          |            |          |            |  |  |  |

 

(Continued)

50

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** **

** **

**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

** **

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YEARSENDED DECEMBER 31, 2006, 2005 AND 2004**

**(In thousands)**
| ** **                                                                        | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| FINANCING ACTIVITIES:                                                             |       |     |       |     |       |     |       |
| Net increase in  deposits                                                         |       | $        | 40,598     |     | $          | 29,243   |       | $ | 8,844 |   |
| Advances from  Federal Home Loan Bank                                             |       | 55,000   |       | 144,343  |       | 81,578   |       |
| Repayment of  advances from Federal Home Loan Bank                                |       | (92,935  | )          | (75,859  | )          | (31,384  | )          |
| Net increase  (decrease) in advance payments by borrowers for taxes and insurance |       | (181     | )          | 90       |       | 32       |       |
| Purchase of  treasury stock                                                       |       | (8,574   | )          | (7,630   | )          | (9,534   | )          |
| Dividends paid                                                                    |       | (2,899   | )          | (2,527   | )          | (2,178   | )          |
| Stock options  exercised                                                          |       | 954      |       | 2,206    |       | 2,035    |       |
|                                                                              |       |     |       |     |       |     |       |
| Net cash  provided by (used in) financing activities                              |       | (8,037   | )          | 89,866   |       | 49,393   |       |
|                                                                              |       |     |       |     |       |     |       |
| NET INCREASE (DECREASE)  IN CASH AND CASH EQUIVALENTS                             |       | 14,409   |       | 5,106    |       | (40,198  | )          |
|                                                                              |       |     |       |     |       |     |       |
| CASH AND CASH  EQUIVALENTS:                                                       |       |     |       |     |       |     |       |
| Beginning of  year                                                                |       | 21,109   |       | 16,003   |       | 56,201   |       |
|                                                                              |       |     |       |     |       |     |       |
| End of year                                                                       |       | $        | 35,518     |     | $          | 21,109   |       | $ | 16,003 |   |
|                                                                              |       |     |       |     |       |     |       |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION—                          |       |     |       |     |       |     |       |
| Cash paid for:                                                                    |       |     |       |     |       |     |       |
| Interest                                                                          |       | $        | 26,883     |     | $          | 19,034   |       | $ | 14,238 |   |
|                                                                              |       |     |       |     |       |     |       |
| Income taxes                                                                      |       | $        | 3,494      |     | $          | 2,914    |       | $ | 2,990 |   |
|                                                                              |       |     |       |     |       |     |       |
| SUPPLEMENTAL SCHEDULE  OF NONCASH INVESTING ACTIVITIES:                           |       |     |       |     |       |     |       |
| Real estate and  other assets acquired in settlement of loans                     |       | $        | 5,997      |     | $          | 935      |       | $ | 709 |   |
|                                                                              |       |     |       |     |       |     |       |
| Loans to  facilitate sales of real estate owned                                   |       | —   |       | $        | 30         |     | $          | 197 |   |
|                                                                              |       |     |       |     |       |     |       |
| Investment securities  purchased—not settled                                 |       | —   |       | $        | 100        |     | $          | 1,000 |   |

 

See notes to consolidated financial statements.                                                                                                             (Concluded)

51

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTSYEARS ENDED DECEMBER 31, 2006, 2005, AND 2004**

**1.**                      SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES

***Nature ofOperations and Principles of Consolidation—***First FederalBancshares of Arkansas, Inc. (the “Company”) is a unitary holding company whichowns all of the stock of First Federal Bank (the “Bank”). The Bank provides abroad line of financial products to individuals and small- to medium-sizedbusinesses. The consolidated financial statements also include the accounts ofthe Bank’s wholly owned subsidiary, First Harrison Service Corporation (“FHSC”),which is inactive. All material intercompany transactions have been eliminatedin consolidation.

***Use of Estimates—***Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimatesand such differences could be significant. The allowance for loan losses is amaterial estimate that is particularly susceptible to significant change in thenear term.

***Cash and CashEquivalents—***For the purpose of presentation in theconsolidated statements of cash flows, cash and cash equivalents includes cashon hand and amounts due from depository institutions, which includes interestbearing amounts available upon demand.

***InvestmentSecurities—***The Company classifies investment securitiesinto one of two categories: held to maturity or available for sale. The Companydoes not engage in trading activities. Debt securities that the Company has thepositive intent and ability to hold to maturity are classified as held tomaturity and recorded at cost, adjusted for the amortization of premiums andthe accretion of discounts.

Investment securities that the Company intends to holdfor indefinite periods of time are classified as available for sale and arerecorded at fair value. Unrealized holding gains and losses are excluded fromearnings and reported net of tax in other comprehensive income. Investmentsecurities in the available for sale portfolio may be used as part of theCompany’s asset and liability management practices and may be sold in responseto changes in interest rate risk, prepayment risk, or other economic factors.At December 31, 2006 and 2005, the Company did not own any investmentsecurities classified as available for sale.

Premiums are amortized into interest income using theinterest method to the earlier of maturity or call date. Discounts are accretedinto interest income using the interest method over the period to maturity. Thespecific identification method of accounting is used to compute gains or losseson the sales of investment securities.

Declines in the fair value of held to maturity andavailable for sale securities below their cost that are deemed to be other thantemporary are reflected in earnings as realized losses. In estimating otherthan temporary impairment losses, management considers independent pricequotations and the financial condition of the issuer.

***Loans Receivable—***The Bank originates and maintains loansreceivable which are substantially concentrated in its lending territory(primarily Northwest and Northcentral Arkansas). The majority of the Bank’sloans are residential mortgage loans, commercial real estate loans, andconstruction loans for residential property. The Bank’s policy calls forcollateral or other forms of repayment assurance to be received from theborrower at the time of loan origination. Such collateral or other form ofrepayment assurance is subject to changes in economic value due to variousfactors beyond the control of the Bank.

Loans receivable that management has the intent andability to hold for the foreseeable future or until maturity or pay-off arestated at unpaid principal balances adjusted for any charge-offs, the allowancefor loan losses, and any deferred loan fees or costs. Deferred loan fees orcosts and discounts on first mortgage loans are amortized or accreted to incomeusing the level-yield method over the remaining period to contractual maturity.

Mortgage loans originated and committed for sale inthe secondary market are carried at the lower of cost or estimated market valuein the aggregate. Such loans are generally carried at cost due to the shortperiod of time between funding and sale, generally two to three weeks.

52

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The accrual of interest on loans is generallydiscontinued when, in management’s opinion, the borrower may be unable to meetpayments as they become due or when the loan becomes 90 days past due,whichever occurs first. When interest accrual is discontinued, all unpaidaccrued interest is reversed against interest income. The interest on theseloans is accounted for on the cash basis until qualifying for return toaccrual. Loans are generally returned to accrual status when payments are madeto bring the loan under 90 days past due and, in the opinion of management,collection of the remaining balance can be reasonably expected.  The Company may continue to accrue intereston certain loans that are 90 days past due or more if such loans are in theprocess of collection and collection is reasonably assured.

***Allowance for LoanLosses—***The allowance for loan losses is established aslosses are estimated to have occurred through a provision for loan lossescharged to earnings. Loan losses are charged against the allowance whenmanagement believes it is likely that a loan balance is uncollectible.  Subsequent recoveries, if any, are creditedto the allowance.

The allowance for loan losses represents management’sestimate of incurred credit losses inherent in the Company’s loan portfolio asof the balance sheet date.  Theestimation of the allowance is based on a variety of factors, including pastloan loss experience, the current credit profile of the Company’s borrowers,adverse situations that have occurred that may affect the borrowers’ ability torepay, the estimated value of underlying collateral, and general economicconditions.  Losses are recognized whenavailable information indicates that it is probable that a loss has beenincurred and the amount of the loss can be reasonably estimated. Thisevaluation is inherently subjective as it requires estimates that aresusceptible to significant revision as more information becomes available orconditions change.

In determining the allowance for loan losses, theCompany allocates a portion of the allowance to its various loan categoriesbased on an analysis of individual loans and pools of loans.  However, the entire allowance is available toabsorb credit losses inherent in the total loan portfolio as of the balancesheet date.

A loan is considered impaired when, based on currentinformation and events, it is probable that the Bank will be unable to collectthe scheduled payments of principal or interest when due according to thecontractual terms of the loan agreement. Factors considered by management indetermining impairment include payment status, collateral value, and theprobability of collecting scheduled principal and interest payments when due.Loans that experience insignificant payment delays and payment shortfallsgenerally are not classified as impaired. Management determines thesignificance of payment delays and payment shortfalls on a case-by-case basis,taking into consideration all of the circumstances surrounding the loan and theborrower, including the length of the delay, the reasons for the delay, theborrower’s prior payment record, and the amount of the short fall in relationto the principal and interest owed. Impairment is measured on a loan by loanbasis by either the present value of expected future cash flows discounted atthe loan’s effective interest rate, the loan’s obtainable market price, or thefair value of the collateral if the loan is collateral dependent.  Multi-family residential, commercial realestate, land and land development, and commercial loans that are delinquent orwhere the borrower’s total loan relationship exceeds $1 million are evaluatedon a loan by loan basis at least annually.

Large groups of smaller balance homogeneous loans arecollectively evaluated for impairment. Accordingly, the Bank does notseparately identify individual consumer and residential loans for impairmentdisclosures.  Homogeneous loans are thosethat are considered to have common characteristics that provide for evaluationon an aggregate or pool basis. The Bank considers the characteristics of (1)one- to four-family residential first mortgage loans; (2) unsecured consumerloans; and (3) collateralized consumer loans to permit consideration of theappropriateness of the allowance for losses of each group of loans on a poolbasis. The primary methodology used to determine the appropriateness of theallowance for losses includes segregating certain specific, poorly performingloans based on their performance characteristics from the pools of loans as totype, valuing these loans, and then applying a loss factor to the remainingpool balance based on several factors including past loss experience, inherentrisks, and economic conditions in the primary market areas.

***Rate LockCommitments—***The Bank enters into commitments to originateloans whereby the interest rate on the loan is determined prior to funding(rate lock commitments). Rate lock commitments on mortgage loans that areintended to be sold are considered to be derivatives. Accordingly, suchcommitments, along with any related fees received from potential borrowers, arerecorded at fair value in derivative assets or liabilities, with changes infair value recorded in the net gain or loss on sale of mortgage loans. Fairvalue is based on fees currently charged to enter into similar agreements, andfor fixed rate commitments also considers the difference between current levelsof interest rates and the committed rates.

***Real Estate Owned,Net—***Real estate owned represents foreclosed assets heldfor sale and is initially recorded at estimated fair value less estimated coststo sell, establishing a new cost basis. Subsequent to foreclosure, valuationsare periodically performed by management and the assets are carried at thelower of carrying amount or fair value less costs to sell. Adjustments forestimated losses are charged to operations when any decline reduces the fairvalue to less than the carrying value. Costs and expenses related to major additions and improvements arecapitalized while maintenance and repairs which do not extend the lives of therespective assets are expensed.

53

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***Office Propertiesand Equipment, Net—***Land is carried at cost. Buildings andequipment are stated at cost less accumulated depreciation and amortization.The Company computes depreciation using the straight-line method over theestimated useful lives of the individual assets which range from 3 to 40 years.

***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 orliability is determined based on the tax effects of the temporary differencesbetween the book and tax bases of the various statement of financial conditionassets and liabilities and gives current recognition to changes in tax ratesand laws.

***Interest Rate Risk—***TheBank’s asset base is exposed to risk including the risk resulting from changesin interest rates and changes in the timing of cash flows. The Bank monitorsthe effect of such risks by considering the mismatch of the maturities of itsassets and liabilities in the current interest rate environment and thesensitivity of assets and liabilities to changes in interest rates. The Bank’smanagement has considered the effect of significant increases and decreases ininterest rates and believes such changes, if they occurred, would be manageableand would not affect the ability of the Bank to hold its assets as planned.However, the Bank is exposed to significant market risk in the event ofsignificant and prolonged interest rate changes.

***Employee StockOwnership Plan—***Compensation expense for the EmployeeStock Ownership Plan (“ESOP”) is determined based on the average fair value ofshares committed to be released during the period and is recognized as theshares are committed to be released. For the purpose of earnings per share,ESOP shares are included in weighted-average common shares outstanding as theshares are committed to be released.

***Earnings Per CommonShare—***Basic earnings per share represents incomeavailable to common stockholders divided by the weighted-average number ofcommon shares outstanding during the period. Diluted earnings per sharereflects additional common shares that would have been outstanding if dilutivepotential common shares had been issued, as well as any adjustment to incomethat would result from the assumed issuance. Potential common shares that maybe issued by the Company relate solely to outstanding stock options, and aredetermined using the treasury stock method.

***Recent AccountingPronouncements—***In May 2005, the Financial Accounting Standards Board (“FASB”) issued SFASNo. 154, *Accounting Changes and ErrorCorrections — A Replacement of APB Opinion No. 20 and FASB StatementNo. 3.*SFAS No. 154 requires the retrospective applicationto prior periods’ financial statements of changes in accounting principle,unless it is impracticable to determine either the period-specific effects orcumulative effect of the accounting change. SFAS No. 154 also requiresthat a change in depreciation, amortization, or depletion method for long-livednon-financial assets be accounted for as a change in accounting estimateaffected by a change in accounting principle. SFAS No. 154 is effectivefor accounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005.  Theadoption of this statement did not have a material effect on the financialstatements of the Company.

In February 2006, the FASB issued SFAS No. 155, *Accounting for Certain Hybrid Financial Instruments*.SFAS No. 155 amends SFAS No. 133, *Accountingfor Derivative Instruments and Hedging Activities* and SFAS No. 140, *Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities.* SFAS No. 155 permits fairvalue remeasurement for any hybrid financial instrument that contains anembedded derivative that would otherwise require bifurcation, if the holderirrevocably elects to account for the whole instrument on a fair value basis,and clarifies various aspects of SFAS No. 133 and SFAS No. 140 relating toderivative financial instruments and qualifying special-purpose entitiesholding derivative financial instruments. SFAS No. 155 is effective for all financialinstruments acquired or issued for fiscal years beginning after September 15,2006.  Based on our current activities,we estimate that the adoption of this statement will not have a material effecton the financial statements of the Company.

In March 2006, FASB issued SFAS No. 156, *Accounting for Servicing of Financial Assets*— an amendment of FASB Statement No. 140. SFAS No. 156 requires an entity torecognize a servicing asset or servicing liability each time it undertakes anobligation to service a financial asset by entering into a servicing contractas defined in the SFAS. It requires all separately recognized servicing assetsand servicing liabilities to be initially measured at fair value, ifpracticable, and allows an entity to choose between amortization or fair valuemeasurement methods for each class of separately recognized servicing assetsand servicing liabilities. It also permits a one-time reclassification ofavailable-for-sale securities to trading without tainting the investment portfolio,provided the available-for-sale securities are identified in some manner asoffsetting the entity’s exposure to changes in fair value of servicing assetsor servicing liabilities. SFAS No. 156 is effective for fiscal years beginningafter September 15, 2006.  Based on ourcurrent activities, we estimate that the adoption of this statement will nothave a material effect on the financial statements of the Company.

In July 2006, the FASB issued Financial Interpretation (FIN) No. 48,*Accounting for Uncertainty in Income Taxes* — an interpretation of FASBStatement No. 109, which is effective for fiscal years beginning after December15, 2006. FIN No. 48 provides guidance regarding the recognition, measurement,presentation and disclosure in the financial statements of tax positions takenor expected to be taken on a tax return, including the decision whether to fileor not file in a particular jurisdiction.  The cumulative effect of thechanges arising from the initial application of FIN 48 is required to bereported as an adjustment to the opening balance of retained earnings in theperiod of adoption.

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Based on our current activities, we estimate that theadoption of this statement will not have a material effect on the financialstatements of the Company.

In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*. SFAS No. 157defines fair value, establishes a framework for measuring fair value, andexpands disclosures regarding fair value measurements. The statement applieswhenever other standards require or permit that assets or liabilities bemeasured at fair value. The statement does not require new fair valuemeasurements, but rather provides a definition and framework for measuring fairvalue which will result in greater consistency and comparability amongfinancial statements prepared under accounting principles generally accepted inthe United States of America. The statement is effective for financialstatements issued for fiscal years beginning after November 15, 2007. The Companyhas not yet completed its assessment of the impact of SFAS No. 157.

In September 2006, the FASB issued SFAS No. 158, *Employer’s Accounting for Defined Benefit Pension andOther Postretirement Plans.* SFAS No. 158 requires balance sheetrecognition of the funded status of pension and other postretirement benefitswith the offset to accumulated other comprehensive income. Employers willrecognize actuarial gains and losses, prior service cost, and any remainingtransition amounts when recognizing a plan’s funded status. SFAS No. 158 iseffective for fiscal years ending after December 15, 2006. The adoption of thisstatement did not have a material effect on the financial statements of theCompany.

In September 2006, the SEC issued SAB No. 108, *Correcting the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*.SAB No. 108 provides interpretation of the SEC’s views regarding the process ofquantifying financial statement misstatements. SAB No. 108 requires registrantsto quantify misstatements using a balance sheet and income statement approachand evaluate materiality as it pertains to relevant qualitative andquantitative factors. The SEC believes registrants must quantify the impact ofcorrecting all misstatements on the current year financial statements. SAB No.108 is effective for fiscal years ending on or after November 15, 2006.  The adoption of SAB No. 108 did not have amaterial effect on the financial statements of the Company.

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities — Including an amendment of FASB Statement No. 115.*SFAS No. 159 permits entities to choose to measure many financial instrumentsand certain other items at fair value at specified election dates. SFAS No. 159is effective for fiscal years beginning after November 15, 2007.   The Company has not yet completed itsassessment of the impact of SFAS No. 159.

**2.**                      RESTRICTIONSON CASH AND AMOUNTS DUE FROM BANKS

The Bank is required to maintain average cash balanceson hand or with the Federal Reserve Bank. At December 31, 2006 and 2005,these reserve balances amounted to $508,000 and $485,000, respectively.

**3.**                      INVESTMENTSECURITIES

Investment securities consisted of the following atDecember 31 (in thousands):

|                                | ** ** | **2006**      | ** ** |
|--------------------------------|------------|---------------|------------|
| ** **                     | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Held To Maturity** | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                           |       |          |       |   |   |   |   |   |   |
| Municipal  securities          |       | $             | 16,889     |   | $ | 110 |   | $ | 76 |   | $ | 16,923 |   |
| U.S. Government  and           |       |          |       |   |   |   |   |   |   |
| Agency obligations             |       | 43,857        |       | — |   | 1,091 |   | 42,766 |   |
|                           |       |          |       |   |   |   |   |   |   |
| Total                          |       | $             | 60,746     |   | $ | 110 |   | $ | 1,167 |   | $ | 59,689 |   |

 

|                                | ** ** | **2005**      | ** ** |
|--------------------------------|------------|---------------|------------|
| ** **                     | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Held To Maturity** | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                           |       |          |       |   |   |   |   |   |   |
| Municipal  securities          |       | $             | 16,661     |   | $ | 144 |   | $ | 123 |   | $ | 16,682 |   |
| U.S. Government  and           |       |          |       |   |   |   |   |   |   |
| Agency obligations             |       | 40,034        |       | — |   | 932 |   | 39,102 |   |
|                           |       |          |       |   |   |   |   |   |   |
| Total                          |       | $             | 56,695     |   | $ | 144 |   | $ | 1,055 |   | $ | 55,784 |   |

 

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The following tables summarize the gross unrealizedlosses and fair value of the Company’s investments with unrealized losses thatare not deemed to be other-than-temporarily impaired (in thousands), aggregatedby investment category and length of time that individual securities have beenin a continuous unrealized loss position at December 31, 2006 and 2005:

|                                         | ** ** | **2006**                               | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                              | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **Fair**                               | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                              | ** ** | **Value**                              | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                                    |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Municipal securities                    |       | $                                      | 1,914      |   | $ | 19 |   | $ | 3,247 |   | $ | 57 |   | $ | 5,161 |   | $ | 76 |   |
| U.S. Government  and Agency obligations |       | 2,795                                  |       | 22 |   | 39,971 |   | 1,069 |   | 42,766 |   | 1,091 |   |
|                                         |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
|                                         |       | $                                      | 4,709      |   | $ | 41 |   | $ | 43,218 |   | $ | 1,126 |   | $ | 47,927 |   | $ | 1,167 |   |
| ** **                              | ** ** | **2005**                               | ** ** |
| ** **                              | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **Fair**                               | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                              | ** ** | **Value**                              | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                                    |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Municipal securities                    |       | $                                      | 4,489      |   | $ | 51 |   | $ | 1,973 |   | $ | 72 |   | $ | 6,462 |   | $ | 123 |   |
| U.S. Government  and Agency obligations |       | 13,930                                 |       | 192 |   | 25,172 |   | 740 |   | 39,102 |   | 932 |   |
|                                         |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
|                                         |       | $                                      | 18,419     |   | $ | 243 |   | $ | 27,145 |   | $ | 812 |   | $ | 45,564 |   | $ | 1,055 |   |

 

The unrealized losses are primarily a result of an increase in interestrates during the applicable periods.  Thecontractual terms of those investments do not permit the issuer to settle thesecurities at a price less than the amortized cost of the investment. Because the Company has the ability and intent to hold those investments untila recovery of fair value, which may be maturity, the Company does not considerthose investments to be other-than-temporarily impaired at December 31, 2006.

The Company has pledged investment securities held to maturity withcarrying values of approximately $50.2 million and $48.4 million atDecember 31, 2006 and 2005, respectively, as collateral for certaindeposits in excess of $100,000.

The scheduled maturities of debt securities atDecember 31, 2006, by contractual maturity are shown below (in thousands).Expected maturities may differ from contractual maturities because borrowersmay have the right to call or prepay obligations with or without call orprepayment penalties.

|                                   | ** ** | **2006**      | ** ** |
|-----------------------------------|------------|---------------|------------|
| ** **                        | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**      | ** ** | **Value** | ** ** |
|                              |       |          |       |   |   |
| Within one year                   |       | $             | —     |   | $ | — |   |
| Due from one  year to five years  |       | 4,830         |       | 4,762 |   |
| Due from five  years to ten years |       | 17,993        |       | 17,811 |   |
| Due after ten  years              |       | 37,923        |       | 37,116 |   |
|                              |       |          |       |   |   |
| Total                             |       | $             | 60,746     |   | $ | 59,689 |   |

 

As of December 31, 2006 and 2005, investmentswith carrying values of approximately $60.2 million and $55.5 million,respectively, have call options held by the issuer, of which approximately$50.0 million and $41.0 million, respectively, are callable within one year.

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**4.**                      LOANSRECEIVABLE

Loans receivable consisted of the following atDecember 31 (in thousands):

|                                     | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
|                                |       |     |       |     |       |
| First mortgage  loans:              |       |     |       |     |       |
| One- to four-family residences      |       | $        | 251,120    |     | $          | 269,660 |   |
| Commercial real estate              |       | 124,540  |       | 119,323  |       |
| Multi-family                        |       | 11,900   |       | 12,900   |       |
| Land                                |       | 41,698   |       | 38,355   |       |
| Construction                        |       | 195,902  |       | 239,062  |       |
|                                |       |     |       |     |       |
| Total first  mortgage loans         |       | 625,160  |       | 679,300  |       |
|                                |       |     |       |     |       |
| Commercial loans                    |       | 36,407   |       | 32,693   |       |
|                                |       |     |       |     |       |
| Consumer loans:                     |       |     |       |     |       |
| Home equity and second mortgage     |       | 48,665   |       | 49,680   |       |
| Automobile                          |       | 12,090   |       | 15,748   |       |
| Other                               |       | 13,271   |       | 13,149   |       |
|                                |       |     |       |     |       |
| Total consumer  and other loans     |       | 74,026   |       | 78,577   |       |
| Less:                               |       |     |       |     |       |
| Unearned discounts                  |       | (54      | )          | (81      | )          |
| Undisbursed loan funds              |       | (40,069  | )          | (69,086  | )          |
| Deferred loan costs (fees)—net |       | 197      |       | (75      | )          |
| Allowance for  loan losses          |       | (2,572   | )          | (2,114   | )          |
|                                |       |     |       |     |       |
| Loans receivable—net           |       | $        | 693,095    |     | $          | 719,214 |   |

 

At December 31, 2006 and 2005, loans receivableincluded loans committed to be sold with net book values of $1.1 million and$2.6 million, respectively.

Mortgage loans serviced for others are not included inthe accompanying consolidated statements of financial condition.  The unpaid principal balances of such loans atDecember 31, 2006 and 2005 were $22.2 million and $19.6 million,respectively.  Servicing loans for othersgenerally consists of collecting mortgage payments, maintaining escrowaccounts, disbursing payments to investors, and foreclosure processing.   Servicing income for the years endedDecember 31, 2006, 2005, and 2004 was $121,000, $100,000, and $159,000,respectively.

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The following is a summary of information pertainingto impaired and nonaccrual loans:

|                                                              | ** ** | **December 31** | ** ** |
|--------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                   | ** ** | **2006**             | ** ** | **2005** | ** ** |
|                                                         |       |                 |       |   |   |
| Impaired loans  without a valuation allowance                |       | $                    | 5,324      |   | $ | 3,846 |   |
| Impaired loans  with a valuation allowance                   |       | —               |       | — |   |
|                                                         |       |                 |       |   |   |
| Total impaired loans                                         |       | $                    | 5,324      |   | $ | 3,846 |   |
|                                                         |       |                 |       |   |   |
| Total nonaccrual  loans                                      |       | $                    | 19,015     |   | $ | 5,306 |   |
|                                                         |       |                 |       |   |   |
| Total loans past-due  ninety days or more and still accruing |       | $                    | 668        |   | $ | 1,600 |   |

 

|                                                               | ** ** | **Year Ended**  | ** ** |
|---------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                    | ** ** | **December 31** | ** ** |
| ** **                                                    | ** ** | **2006**             | ** ** | **2005** | ** ** |
|                                                          |       |                 |       |   |   |
| Average  investment in impaired loans                         |       | $                    | 3,188      |   | $ | 3,790 |   |
|                                                          |       |                 |       |   |   |
| Interest income  recognized on impaired loans                 |       | $                    | 135        |   | $ | 289 |   |
|                                                          |       |                 |       |   |   |
| Interest income  recognized on a cash basis on impaired loans |       | $                    | —     |   | $ | — |   |

 

Interest income recorded during the years ended December 31, 2006,2005, and 2004 for nonaccrual loans was $403,000, $35,000, and $85,000, respectively.  Under the original terms, these loans wouldhave reported approximately $1.5 million, $169,000, and $243,000, of interestincome for the years ended December 31, 2006, 2005, and 2004, respectively.

**5.**                      ACCRUEDINTEREST RECEIVABLE

Accrued interest receivable consisted of the followingat December 31 (in thousands):

|                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------|------------|----------|------------|----------|------------|
|                   |       |     |       |     |       |
| Loans                  |       | $        | 9,309      |     | $          | 6,875 |   |
| Investment  securities |       | 690      |       | 615      |       |
|                   |       |     |       |     |       |
| Total                  |       | $        | 9,999      |     | $          | 7,490 |   |

 

**6.**                      ALLOWANCESFOR LOAN AND REAL ESTATE LOSSES

A summary of the activity in the allowances for loanand real estate losses is as follows for the years ended December 31 (inthousands):

|                                 | ** ** | **2006**  | ** ** | **2005**         | ** ** | **2004**  | ** ** |
|---------------------------------|------------|-----------|------------|------------------|------------|-----------|------------|
| ** **                      | ** ** | **Loans** | ** ** | **Real  Estate** | ** ** | **Loans** | ** ** | **Real  Estate** | ** ** | **Loans** | ** ** | **Real  Estate** | ** ** |
|                            |       |      |       |             |       |      |       |   |   |   |   |   |   |
| Balance—beginning  of year |       | $         | 2,114      |             | $          | —    |       | $ | 1,846 |   | $ | — |   | $ | 1,621 |   | $ | — |   |
|                            |       |      |       |             |       |      |       |   |   |   |   |   |   |
| Provisions for estimated losses |       | 1,482     |       | 93               |       | 1,101     |       | 30 |   | 1,020 |   | 45 |   |
| Recoveries                      |       | 171       |       | —           |       | 123       |       | — |   | 103 |   | — |   |
| Losses charged off              |       | (1,195    | )          | (93              | )          | (956      | )          | (30 | ) | (898 | ) | (45 | ) |
|                            |       |      |       |             |       |      |       |   |   |   |   |   |   |
| Balance—end of year        |       | $         | 2,572      |             | $          | —    |       | $ | 2,114 |   | $ | — |   | $ | 1,846 |   | $ | — |   |

 

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**7.**                      OFFICEPROPERTIES AND EQUIPMENT

Office properties and equipment consisted of thefollowing at December 31 (in thousands):

|                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|
|                                     |       |     |       |     |       |
| Land and land  improvements              |       | $        | 4,993      |     | $          | 4,981 |   |
| Buildings and  improvements              |       | 15,436   |       | 13,649   |       |
| Furniture and equipment                  |       | 6,006    |       | 5,556    |       |
| Automobiles                              |       | 466      |       | 419      |       |
| Construction in  progress                |       | 1,344    |       | 985      |       |
|                                     |       |     |       |     |       |
| Total                                    |       | 28,245   |       | 25,590   |       |
|                                     |       |     |       |     |       |
| Accumulated  depreciation                |       | (7,861   | )          | (7,068   | )          |
|                                     |       |     |       |     |       |
| Office properties and equipment—net |       | $        | 20,384     |     | $          | 18,522 |   |

 

Depreciation expense for the years endedDecember 31, 2006, 2005, and 2004, amounted to approximately $1.3 million,$1.2 million and $1.2 million, respectively.

**8.**                      DEPOSITS

Deposits are summarized as follows at December 31(in thousands):

|                                                                                                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                    |       |     |       |     |       |
| Demand deposit  accounts, including noninterest bearing deposits of $39,328 and $36,895 in  2006 and 2005, respectively |       | $        | 139,372    |     | $          | 125,397 |   |
| Money market                                                                                                            |       | 51,827   |       | 64,021   |       |
| Regular savings                                                                                                         |       | 26,824   |       | 30,521   |       |
| Certificates of deposit                                                                                                 |       | 434,242  |       | 391,728  |       |
|                                                                                                                    |       |     |       |     |       |
| Total                                                                                                                   |       | $        | 652,265    |     | $          | 611,667 |   |

 

Overdrafts of demand deposit accounts of $425,000 and $312,000 atDecember 31, 2006 and 2005, respectively, have been reclassified for financialreporting and are reflected in net loans receivable on the consolidatedstatements of financial condition.

The aggregate amount of time deposits in denominations of $100 thousandor more was approximately $137.2 million and $118 million at December 31,2006 and 2005, respectively.

At December 31, 2006, scheduled maturities ofcertificates of deposit are as follows (in thousands):

| Year Ending December 31 | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|
| ** **                             | ** ** | ** ** | ** ** |
| 2007                                   |       | $          | 331,550    |       |
| 2008                                   |       | 57,058     |       |
| 2009                                   |       | 10,693     |       |
| 2010                                   |       | 17,748     |       |
| 2011                                   |       | 11,271     |       |
| 2012 and thereafter                    |       | 5,922      |       |
|                                   |       |       |       |
| Total                                  |       | $          | 434,242    |       |

 

Interest expense on deposits consisted of thefollowing (in thousands):

|                                           | ** ** | **Year Ended December 31** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                      |       |                                      |       |   |   |   |   |
| Interest bearing  checking accounts       |       | $                                         | 1,394      |   | $ | 412 |   | $ | 281 |   |
| Money market                              |       | 1,503                                     |       | 1,455 |   | 1,665 |   |
| Regular savings and  certificate accounts |       | 17,925                                    |       | 12,854 |   | 10,812 |   |
| Early withdrawal  penalties               |       | (179                                      | )          | (104 | ) | (68 | ) |
|                                      |       |                                      |       |   |   |   |   |
| Total                                     |       | $                                         | 20,643     |   | $ | 14,617 |   | $ | 12,690 |   |

 

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Eligible deposits of the Bank are insured up to $100 thousand by theDeposit Insurance Fund of the FDIC. Effective April 1, 2006, the FDIC increased the federal insurancecoverage limit to $250 thousand for retirement accounts.

**9.**                      FEDERAL HOMELOAN BANK STOCK AND ADVANCES

The Bank is a member of the Federal Home Loan BankSystem. As a member of this system, it is required to maintain an investment incapital stock of the FHLB in an amount equal to the sum of 0.08% of totalassets as of the previous December 31 and 4.10% of outstanding advances.No ready market exists for such stock and it has no quoted market value. Thecarrying value of the stock is its cost.

The Bank pledges eligible collateral for its FHLBadvances as defined in its blanket lien agreement with the FHLB as well as itsFHLB demand deposit account and FHLB stock. Eligible collateral under theblanket lien includes First Mortgage Collateral (as defined), multi-familyresidential mortgages meeting the requirements for eligibility as FirstMortgage Collateral, U.S. Government and Agency Securities (as defined), privatelyissued mortgage-backed securities that qualify as eligible collateral underapplicable regulations, Federal Home Loan Bank Term Deposit Accounts, and othernon-securitized real estate related collateral. Advances at December 31,2006 and 2005, consisted of the following (in thousands):

|                                                         | ** ** | **2006**     | ** ** | **2005**   | ** ** |
|---------------------------------------------------------|------------|--------------|------------|------------|------------|
| ** **                                              | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| **Amounts Maturing in Year Ending** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** |
| **December 31**                                    | ** ** | **Rate**     | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** |
|                                                    |       |         |       |       |       |   |   |   |   |
| 2006                                                    |       |         |       | $          | —     |   | 4.03 | % | $ | 60,766 |   |
| 2007                                                    |       | 4.68         | %          | 59,818     |       | 4.07 |   | 51,585 |   |
| 2008                                                    |       | 4.50         |       | 30,594     |       | 4.09 |   | 22,349 |   |
| 2009                                                    |       | 4.48         |       | 16,308     |       | 4.09 |   | 11,051 |   |
| 2010                                                    |       | 4.36         |       | 5,008      |       | 4.33 |   | 4,738 |   |
| 2011                                                    |       | 4.49         |       | 6,151      |       | 4.31 |   | 5,325 |   |
| Thereafter                                              |       | 4.36         |       | 2,426      |       | 4.36 |   | 2,426 |   |
|                                                    |       |         |       |       |       |   |   |   |   |
| Total                                                   |       | 4.58         | %          | $          | 120,305    |   | 4.08 | % | $ | 158,240 |   |

 

**10.**               INCOME TAXES

The provisions (benefits) for income taxes aresummarized as follows (in thousands):

|                                  | ** ** | **Year Ended December 31** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                             |       |                                      |       |   |   |   |   |
| Income tax provision  (benefit): |       |                                      |       |   |   |   |   |
| Current:                         |       |                                      |       |   |   |   |   |
| Federal                          |       | $                                         | 2,851      |   | $ | 3,275 |   | $ | 2,924 |   |
| State                            |       | 391                                       |       | 461 |   | 424 |   |
| Total current                    |       | 3,242                                     |       | 3,736 |   | 3,348 |   |
|                             |       |                                      |       |   |   |   |   |
| Deferred:                        |       |                                      |       |   |   |   |   |
| Federal                          |       | 102                                       |       | (69 | ) | 317 |   |
| State                            |       | 35                                        |       | 56 |   | 33 |   |
| Total deferred                   |       | 137                                       |       | (13 | ) | 350 |   |
|                             |       |                                      |       |   |   |   |   |
| Total                            |       | $                                         | 3,379      |   | $ | 3,723 |   | $ | 3,698 |   |

 

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The reasons for the differences between the statutoryfederal income tax rates and the effective tax rates are summarized as follows(in thousands):

|                                      | ** ** | **Year Ended December 31** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                 |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Taxes at statutory rate              |       | $                                         | 3,659      |   | 34.0 | % | $ | 3,935 |   | 34.0 | % | $ | 3,911 |   | 34.0 | % |
| Increase (decrease)  resulting from: |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| State income tax—net            |       | 260                                       |       | 2.4 |   | 269 |   | 2.3 |   | 287 |   | 2.5 |   |
| Earnings on life  insurance policies |       | (252                                      | )          | (2.3 | ) | (257 | ) | (2.2 | ) | (271 | ) | (2.4 | ) |
| Nontaxable investments               |       | (207                                      | )          | (1.9 | ) | (211 | ) | (1.8 | ) | (208 | ) | (1.8 | ) |
| Other—net                       |       | (81                                       | )          | (0.8 | ) | (13 | ) | (0.1 | ) | (21 | ) | (0.2 | ) |
|                                 |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Total                                |       | $                                         | 3,379      |   | 31.4 | % | $ | 3,723 |   | 32.2 | % | $ | 3,698 |   | 32.1 | % |

 

The Company’s net deferred tax liability account wascomprised of the following at December 31 (in thousands):

|                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
|                            |       |     |       |     |       |
| Deferred tax assets:            |       |     |       |     |       |
| Stock based  compensation       |       | $        | —     |     | $          | 18 |   |
| Allowance for  loan losses      |       | 985      |       | 810      |       |
| Real estate  owned              |       | 30       |       | —   |       |
|                            |       |     |       |     |       |
| Total deferred tax  assets      |       | 1,015    |       | 828      |       |
|                            |       |     |       |     |       |
| Deferred tax liabilities:       |       |     |       |     |       |
| Office  properties              |       | (854     | )          | (724     | )          |
| Federal Home  Loan Bank stock   |       | (692     | )          | (696     | )          |
| Pension plan  contribution      |       | (500     | )          | (327     | )          |
| Prepaid expenses                |       | (106     | )          | (81      | )          |
|                            |       |     |       |     |       |
| Total deferred tax  liabilities |       | (2,152   | )          | (1,828   | )          |
|                            |       |     |       |     |       |
| Net deferred tax liability      |       | $        | (1,137     | )        | $          | (1,000 | ) |

 

Specifically exempted from deferred tax recognitionrequirements are bad debt reserves for tax purposes of U.S. savings and loansin the institution’s base year, as defined. Base year reserves totaledapproximately $4.2 million. Consequently, a deferred tax liability ofapproximately $1.6 million related to such reserves was not provided for in theconsolidated statements of financial condition at December 31, 2006 and2005. Payment of dividends to shareholders out of retained earnings deemed tohave been made out of earnings previously set aside as bad debt reserves maycreate taxable income to the Bank. No provision has been made for income tax onsuch a distribution as the Bank does not anticipate making such distributions.

**11.**               STOCK BASEDCOMPENSATION

In December 2004, FASB issued SFAS No. 123(R), *Share-Based Payment*. SFAS No. 123(R)amended SFAS No. 123, *Accounting forStock-Based Compensation* and superseded Accounting PrinciplesBoard (“APB”) Opinion No. 25, *Accounting forStock Issued to Employees*. In March 2005, the SEC issued SAB No. 107to provide its guidance on the valuation of share-based payments forpublic companies. SFAS No. 123(R) requires companies to recognize allshare-based payments, which include stock options and restricted stock,in compensation expense over the service period of the share-basedpayment award. SFAS No. 123(R) establishes fair value as the measurementobjective in accounting for share-based payment arrangements and requires all entities to apply afair-value-based measurement method in accounting forshare-based payment transactions with employees, except for equityinstruments held by employee share ownership plans. At December 31, 2006, theCompany had a Stock Option Plan (the “SOP”) and a Management Recognition andRetention Plan (the “MRR Plan”).

The Company adopted SFAS No. 123(R) on January 1, 2006using the modified prospective method in which compensation cost is recognizedover the service period for all awards granted subsequent to the Company’sadoption of SFAS No. 123(R) as well as for the unvested portion of awardsoutstanding as of the Company’s adoption of SFAS No. 123(R). In accordance withthe modified prospective method, results for prior periods have not beenrestated.

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Compensation expense related to the amortization of MRR Plan awards wasrecognized in the income statement prior to the implementation of SFAS No.123(R). Compensation expense attributable to stock options during the yearended December 31, 2006 totaled approximately $16,000.  Prior to the adoption of SFAS No. 123(R), theCompany applied the recognition and measurement principles of APB No. 25, *Accounting for Stock Issued to Employees*as allowed by SFAS No. 123 and SFAS No. 148, *Accountingfor Stock-Based Compensation - Transition and Disclosure*.Accordingly, no stock based compensation was recognized in net income for stockoptions for the years ended December 31, 2005 and 2004 as all options grantedhad an exercise price equal to the market value of the underlying common stockon the date of the grant and the related number of options granted were fixedat that point in time.  Had compensationcost for the SOP been determined based on the fair value at the grant dates forawards under the SOP consistent with the methods of SFAS No. 123, the effect onthe Company’s pro forma net income and pro forma earnings per share would nothave been significant.

***Stock Option Plan***—TheStock Option Plan provides for a committee of the Company’s Board of Directorsto award incentive stock options, non-qualified or compensatory stock optionsand stock appreciation rights representing up to 1,030,750 shares of Companystock. One-fifth of the options granted vested immediately upon grant, with thebalance vesting in equal amounts on the four subsequent anniversary dates ofthe grant. Options granted vest immediately in the event of retirement,disability, or death. Stock options granted expire in ten years unless granteeterminates employment, in which case the award expires five years aftertermination date or ten years after grant date, whichever comes first.

Under the SOP, options have been granted to directorsand key employees to purchase common stock of the Company. The exercise pricein each case equals the fair market value of the Company’s stock at the date ofgrant. Options granted are summarized as follows:

|                       | ** ** | ** **                              | ** ** | **Options Outstanding**             | ** ** | **Options Exercisable**                        | ** ** |
|-----------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|-----------------------------------------------------|------------|
| **Year Granted** | ** ** | **Range of  Exercise Prices** | ** ** | **Number of  Options  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price Per  Share** | ** ** | **Number of  Options  Exercisable** | ** ** | **Weighted  Average  Exercise  Price Per  Share** | ** ** |
| 1997                  |       | $9.63                                   |       | 142,617                                  |       | 0.4  years                                          |       | $ | 9.63 |   | 142,617 |   | $ | 9.63 |   |
| 1998                  |       | 11.63                                   |       | 8,000                                    |       | 1.1  years                                          |       | 11.63 |   | 8,000 |   | 11.63 |   |
| 1999                  |       | 8.53  – 9.31                       |       | 2,800                                    |       | 0.9  years                                          |       | 8.98 |   | 2,800 |   | 8.98 |   |
| 2000                  |       | 9.13                                    |       | 950                                      |       | 3.7  years                                          |       | 9.13 |   | 950 |   | 9.13 |   |
| 2001                  |       | 9.34  – 11.35                      |       | 11,800                                   |       | 4.2  years                                          |       | 10.55 |   | 11,800 |   | 10.55 |   |
| 2002                  |       | 12.32                                   |       | 5,200                                    |       | 5.1  years                                          |       | 12.32 |   | 5,200 |   | 12.32 |   |
| 2003                  |       | 12.93  – 16.11                     |       | 2,412                                    |       | 6.3  years                                          |       | 14.84 |   | 1,112 |   | 15.57 |   |
| 2004                  |       | 19.25  – 21.50                     |       | 3,080                                    |       | 7.1  years                                          |       | 20.34 |   | 1,912 |   | 20.30 |   |
| 2005                  |       | 24.81                                   |       | 1,000                                    |       | 8.9  years                                          |       | 24.81 |   | 400 |   | 24.81 |   |
| 2006                  |       | 22.40  – 25.50                     |       | 1,500                                    |       | 9.2  years                                          |       | 24.47 |   | 300 |   | 24.47 |   |
|                  |       |                                    |       | 179,359                                  |       | 1.1 years                                           |       | $ | 10.30 |   | 175,091 |   | $ | 10.06 |   |

 

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A summary of the status of the Company’s SOP as ofDecember 31, 2006, 2005, and 2004, and changes during the years ending onthose dates are presented below:

|                                     | ** ** | ** ** | ** ** | **Weighted** | ** ** |
|-------------------------------------|------------|------------|------------|--------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Average**  | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Price**    | ** ** |
| ** **                          | ** ** | ** ** | ** ** | ** **   | ** ** |
| Outstanding—January 1,  2004   |       | 839,562    |       | $            | 9.74       |   |
|                                |       |       |       |         |       |
| Exercised                           |       | (210,918   | )          | 9.65         |       |
| Granted                             |       | 3,720      |       | 20.15        |       |
| Expired                             |       | (1,600     | )          | 11.63        |       |
| Forfeited                           |       | (1,040     | )          | 15.96        |       |
|                                |       |       |       |         |       |
| Outstanding—December  31, 2004 |       | 629,724    |       | $            | 9.82       |   |
|                                |       |       |       |         |       |
| Exercised                           |       | (283,456   | )          | 9.67         |       |
| Granted                             |       | 1,000      |       | 24.81        |       |
| Expired                             |       | (1,200     | )          | 9.63         |       |
| Forfeited                           |       | (800       | )          | 12.32        |       |
|                                |       |       |       |         |       |
| Outstanding—December  31, 2005 |       | 345,268    |       | $            | 9.98       |   |
|                                |       |       |       |         |       |
| Exercised                           |       | (166,997   | )          | 9.74         |       |
| Granted                             |       | 1,500      |       | 24.47        |       |
| Expired                             |       | —     |       | —       |       |
| Forfeited                           |       | (412       | )          | 14.66        |       |
|                                |       |       |       |         |       |
| Outstanding—December 31, 2006  |       | 179,359    |       | $            | 10.30      |   |

 

***ManagementRecognition and Retention Plan—***The MRR Plan provides fora committee of the Company’s Board of Directors to award restricted stock tokey officers as well as non-employee directors. The MRR Plan authorizes theCompany to grant up to 412,300 shares of the Company stock, of which 405,688shares have been granted through December 31, 2006. Compensation expensehas been recognized over the vesting period based on the fair market value ofthe shares on the grant date. Shares granted will be deemed vested in the eventof disability or death. Approximately $66,000, $27,000, and $27,000 incompensation expense was recognized during each of the years endedDecember 31, 2006, 2005 and 2004.

**12.**               EMPLOYEEBENEFIT PLANS

***ESOP—***TheCompany established an ESOP on May 3, 1996. During 1996, the ESOP borrowed $4.1million from the Company to purchase shares of Company stock.  The ESOP’s loan was paid in full on March 31,2006, and all shares in the ESOP were allocated to participant accounts as ofthat date.  The Company has determinedthat there will be no future Employer contributions to the ESOP and thateffective May 31, 2006, no employee shall become eligible to participate in theESOP.

Effective June 1, 2006, the Company adopted the FirstFederal Bancshares of Arkansas, Inc. Employees’ Savings & Profit SharingPlan and Trust (the “401(k) Plan”).  TheCompany merged the ESOP into the 401(k) Plan effective June 1, 2006.  Participant accounts under the ESOP will bemaintained as a separate source under the 401(k) Plan with ESOP provisionsconcerning matters such as vesting, withdrawals, loans, dividends, anddistributions remaining in effect. During the years ended December 31, 2006, 2005, and 2004, ESOPexpense was approximately $508,000, $2.0 million, and $1.7 million,respectively.

**401(k) Plan** — TheCompany has established a 401(k) Plan whereby substantially all employeesparticipate in the Plan.  Employees maycontribute up to 75% of their salary subject to certain limits based on federaltax laws.  The Company makes matchingcontributions equal to 100% of the first 3% plus 50% of contributions between 3and 5% of an employee’s compensation contributed to the Plan.  Matching contributions vest immediately tothe employee upon enrollment in the Plan. During the year ended December 31, 2006, 401(k) Plan expense wasapproximately $174,000.

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***OtherPostretirement Benefits—***The Bank is a participant in amulti-employer retirement plan and therefore separate information is notavailable. The plan is noncontributory and covers substantially all employees.The plan provides a retirement benefit and a death benefit. Retirement benefitsare payable in monthly installments for life and must begin not later than thefirst day of the month coincident with or the next month following theseventieth birthday or the participant may elect a lump-sum distribution. Deathbenefits are paid in a lump-sum distribution, the amount of which depends onyears of service. Net pension expense was approximately $745,000,  $660,000, and $358,000 for the years endedDecember 31, 2006, 2005, and 2004, respectively.

**13.**               EARNINGS PERSHARE

|                                                                                   | ** ** | **Year Ended December 31, 2006** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **Income**                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                        | ** ** | **(In Thousands)**                              | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                                        | ** ** | **(Numerator)**                                      | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic EPS—Income  available to common stockholders                           |       | $                                                    | 7,383      |   | 4,993,229 |   | $ | 1.48 |   |
|                                                                              |       |                                                 |       |   |   |   |   |
| Effect of dilutive  securities—Stock options                                 |       | —                                               |       | 118,553 |   |   |   |
|                                                                              |       |                                                 |       |   |   |   |   |
| Diluted EPS—Income available to common stockholders and assumed  conversions |       | $                                                    | 7,383      |   | 5,111,782 |   | $ | 1.44 |   |

 

|                                                                                   | ** ** | **Year Ended December 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **Income**                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                        | ** ** | **(In Thousands)**                              | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                                        | ** ** | **(Numerator)**                                      | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic EPS—Income  available to common stockholders                           |       | $                                                    | 7,850      |   | 4,989,041 |   | $ | 1.57 |   |
|                                                                              |       |                                                 |       |   |   |   |   |
| Effect of dilutive  securities—Stock options                                 |       | —                                               |       | 238,692 |   |   |   |
|                                                                              |       |                                                 |       |   |   |   |   |
| Diluted EPS—Income available to common stockholders and assumed  conversions |       | $                                                    | 7,850      |   | 5,227,733 |   | $ | 1.50 |   |

 

|                                                                                   | ** ** | **Year Ended December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **Income**                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                        | ** ** | **(In Thousands)**                              | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                                        | ** ** | **(Numerator)**                                      | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic EPS—Income  available to common stockholders                           |       | $                                                    | 7,805      |   | 5,066,682 |   | $ | 1.54 |   |
|                                                                              |       |                                                 |       |   |   |   |   |
| Effect of dilutive  securities—Stock options                                 |       | —                                               |       | 314,228 |   |   |   |
|                                                                              |       |                                                 |       |   |   |   |   |
| Diluted EPS—Income available to common stockholders and assumed  conversions |       | $                                                    | 7,805      |   | 5,380,910 |   | $ | 1.45 |   |

 

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**14.**               OFF-BALANCESHEET ARRANGEMENTS AND COMMITMENTS

The Bank is a party to financial instruments with off-balance sheetrisk in the normal course of business to meet the financing needs of itscustomers. These financial instruments include commitments to extend credit andstandby letters of credit. Those instruments involve, to varying degrees,elements of credit risk in excess of the amount recognized in the consolidatedstatements of financial condition.

The Bank does not use financial instruments with off-balance sheet riskas part of its asset/liability management program or for trading purposes. TheBank’s exposure to credit loss in the event of nonperformance by the otherparty to the financial instrument for commitments to extend credit and standbyletters of credit is represented by the contractual amounts of thoseinstruments. The Bank uses the same credit policies in making commitments andconditional obligations as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in the contract.Commitments generally have fixed expiration dates or other termination clauses.The Bank evaluates each customer’s creditworthiness on a case-by-case basis.The amount of collateral obtained, if deemed necessary by the Bank uponextension of credit, is based on management’s credit evaluation of thecounterparty. Such collateral consists primarily of residential properties.Standby letters of credit are conditional commitments issued by the Bank toguarantee the performance of a customer to a third party. The credit riskinvolved in issuing letters of credit is essentially the same as that involvedin extending loan facilities to customers.

The funding period for construction loans is generally six to eighteenmonths and commitments to originate mortgage loans are generally outstandingfor 60 days or less.

The Company, in the normal course of business, makes commitments to buyor sell assets or to incur or fund liabilities. Commitments include, but arenot limited to:

·                  theorigination, purchase or sale of loans;

·                  thefulfillment of commitments under letters of credit, extensions of credit onhome equity lines of credit, construction loans, and under predeterminedoverdraft protection limits; and

·                  thecommitment to fund withdrawals of certificates of deposit at maturity.

At December 31, 2006, the Bank’s off-balance sheet arrangementsprincipally included lending commitments, which are described below. AtDecember 31, 2006, the Company had no interests in non-consolidated specialpurpose entities.

At December 31, 2006, commitments included:

·                  totalapproved loan origination commitments outstanding amounting to $9.5 million,including $2.8 million of loans committed to sell;

·                  ratelock agreements with customers of $7.9 million, all of which have been lockedwith an investor;

·                  fundedmortgage loans committed to sell of $1.1 million;

·                  unadvancedportion of construction loans of $40.1 million;

·                  unusedlines of credit of $31.2 million;

·                  outstandingstandby letters of credit of $3.9 million;

·                  totalpredetermined overdraft protection limits of $11.6 million; and

·                  certificatesof deposit scheduled to mature in one year or less totaling $331.6 million.

Total unfunded commitments to originate loans for sale and the relatedcommitments to sell of $7.9 million meet the definition of a derivativefinancial instrument. The related asset and liability are considered immaterialat December 31, 2006.

Historically, a very small percentage of predetermined overdraft limitshave been used. At December 31, 2006, overdrafts of accounts with BounceProtectionä represented usageof 3.0% of the limit.

Based on historical experience, management believes that a significantportion of maturing deposits will remain with the Bank. Management anticipatesthat the Bank will continue to have sufficient funds, through repayments,deposits and borrowings, to meet our current commitments.

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**15.**               FAIR VALUEOF FINANCIAL INSTRUMENTS

The estimated fair value amounts have been determinedby the Company using available market information and appropriate valuationmethodologies. However, considerable judgment is required to interpret marketdata to develop the estimates of fair value. Accordingly, the estimatespresented herein are not necessarily indicative of the amounts the Companycould realize in a current market exchange. The use of different marketassumptions and/or estimation methodologies may have a material effect on theestimated fair value amounts. The estimated fair values of financialinstruments are as follows (in thousands):

|                                                        | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | ** **                      | ** ** | **Estimated**                   | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                             | ** ** | **Carrying**                    | ** ** | **Fair**                        | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                             | ** ** | **Value**                       | ** ** | **Value**                       | ** ** | **Value** | ** ** | **Value** | ** ** |
| ASSETS:                                                |       |                            |       |                            |       |   |   |   |   |
| Cash and cash equivalents                              |       | $                               | 35,518     |                            | $          | 35,518 |   | $ | 21,109 |   | $ | 21,109 |   |
| Investment securities—held to maturity            |       | 60,746                          |       | 59,689                          |       | 56,695 |   | 55,784 |   |
| Federal Home Loan Bank stock                           |       | 7,089                           |       | 7,089                           |       | 8,412 |   | 8,412 |   |
| Loans receivable—net                              |       | 693,095                         |       | 691,367                         |       | 719,214 |   | 711,479 |   |
| Cash surrender value of life insurance                 |       | 19,396                          |       | 19,396                          |       | 18,654 |   | 18,654 |   |
| Accrued interest receivable                            |       | 9,999                           |       | 9,999                           |       | 7,490 |   | 7,490 |   |
| Commitments                                            |       | 21                              |       | 21                              |       | 19 |   | 19 |   |
|                                                   |       |                            |       |                            |       |   |   |   |   |
| LIABILITIES:                                           |       |                            |       |                            |       |   |   |   |   |
| Deposits:                                              |       |                            |       |                            |       |   |   |   |   |
| Demand, NOW, money market and regular savings          |       | 218,023                         |       | 218,023                         |       | 219,939 |   | 219,939 |   |
| Certificates of deposit                                |       | 434,242                         |       | 433,211                         |       | 391,728 |   | 390,957 |   |
| Federal Home Loan Bank advances                        |       | 120,305                         |       | 119,803                         |       | 158,240 |   | 157,547 |   |
| Accrued interest payable                               |       |                            |       |                            |       | 914 |   | 914 |   |
| Advance payments by borrowers for taxes and  insurance |       | 666                             |       | 666                             |       | 847 |   | 847 |   |
| Commitments                                            |       | 21                              |       | 21                              |       | 19 |   | 19 |   |
|                                                        |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |

 

For cash and cash equivalents, Federal Home Loan Bank stock, cashsurrender value of life insurance and accrued interest receivable, the carryingvalue is a reasonable estimate of fair value, primarily because of theshort-term nature of the instruments or, as to Federal Home Loan Bank stock,the ability to sell the stock back to the Federal Home Loan Bank at cost. The fairvalue of investment securities is based on quoted market prices, dealer quotesand prices obtained from independent pricing services. The fair value ofvariable rate loans is based on repricing dates. Fixed rate loans were valuedusing discounted cash flows. The discount rates used to determine the presentvalue of these loans were based on interest rates currently being charged bythe Bank on comparable loans as to credit risk and term.

The fair value of demand deposit accounts, NOW accounts, savings accountsand money market deposits is the amount payable on demand at the reportingdate. The fair value of fixed-maturity certificates of deposit and Federal HomeLoan Bank advances is estimated using the rates currently offered for depositsof similar terms and advances of similar remaining maturities at the reportingdate. For advance payments by borrowers, for taxes and insurance and foraccrued interest payable the carrying value is a reasonable estimate of fairvalue, primarily because of the short-term nature of the instruments.

The fair value estimates presented herein are based on pertinentinformation available to management as of December 31, 2006 and 2005.Although management is not aware of any factors that would significantly affectthe estimated fair value amounts, such amounts have not been comprehensivelyrevalued for purposes of these financial statements since the reporting dateand, therefore, current estimates of fair value may differ significantly fromthe amounts presented herein.

**16.**               CONTINGENCIES

The Company is a defendant in certain claims and legalactions arising in the ordinary course of business. In the opinion ofmanagement, after consultation with legal counsel, the ultimate disposition ofthese matters is not expected to have a material adverse effect on theconsolidated financial statements of the Company.

**17.**               RETAINEDEARNINGS—SUBSTANTIALLY RESTRICTED

Upon conversion, the Company established a specialliquidation account for the benefit of eligible account holders and the supplementaleligible account holders in an amount equal to the net worth of the Bank as ofthe date of its latest statement of financial condition contained in the finaloffering circular used in connection with the conversion. The liquidationaccount will be maintained for the benefit of eligible account holders andsupplemental eligible account holders who continue to maintain their accountsin the Bank after conversion. In the event of a complete liquidation (and onlyin such event), each eligible and supplemental eligible account holder will beentitled to receive a liquidation distribution from the liquidation account inan amount proportionate to the current adjusted qualifying balances foraccounts then held.

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The Company may not declare or pay cash dividends onits shares of common stock if the effect thereof would cause the Company’sstockholders’ equity to be reduced below applicable regulatory capitalmaintenance requirements for insured institutions or below the specialliquidation account referred to above.

**18.**               REGULATORYMATTERS

The Bank is subject to various regulatory capitalrequirements administered by the OTS. Failure to meet minimum capitalrequirements can initiate certain mandatory—and possible additionaldiscretionary—actions by regulators that, if undertaken, could have a directand material effect on the Bank’s financial statements. Under capital adequacyguidelines and the regulatory framework for prompt corrective action, the Bankmust meet specific capital guidelines that involve quantitative measures of theBank’s assets, liabilities, and certain off-balance sheet items as calculatedunder regulatory accounting practices. The Bank’s capital amounts andclassification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

Quantitative measures established by regulation toensure capital adequacy require the Bank to maintain minimum amounts and ratios(set forth in the following table) of tangible capital (as defined) to tangibleassets (as defined) and core capital (as defined) to adjusted tangible assets(as defined), and of total risk-based capital (as defined) to risk-weightedassets (as defined). Management believes, as of December 31, 2006, thatthe Bank meets all capital adequacy requirements to which it is subject.

At December 31, 2006 and 2005, the most recentnotification from the OTS categorized the Bank as well capitalized under theregulatory framework for prompt corrective action. To be categorized as wellcapitalized the Bank must maintain minimum core (Tier I leverage), Tier Irisk-based, and total risk-based ratios as set forth in the table. There are noconditions or events since that notification that management believes havechanged the Bank’s category.

The Bank’s actual capital amounts (in thousands) andratios are also presented in the table:

|                                          | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To be Categorized** | ** ** |
|------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **as Well**                | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under**      | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                               | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                      | ** ** | **Ratio** | ** ** |
|                                     |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
| As of December  31, 2006:                |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
|                                     |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
| Tangible Capital to Tangible Assets      |       | $          | 74,625     |                       | 8.76       | %                          | $          | 12,779                     |       | 1.50                            | %          | N/A |   | N/A |   |
|                                     |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
| Core Capital to Adjusted Tangible Assets |       | 74,625     |       | 8.76                       | %          | 34,078                     |       | 4.00                       | %          | $                               | 42,597     |   | 5.00 | % |
|                                     |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
| Total Capital to Risk-Weighted Assets    |       | 76,500     |       | 11.94                      | %          | 51,235                     |       | 8.00                       | %          | 64,044                          |       | 10.00 | % |
|                                     |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
| Tier I Capital to Risk-Weighted Assets   |       | 74,625     |       | 11.65                      | %          | N/A                        |       | N/A                        |       | 38,426                          |       | 6.00 | % |
|                                     |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
| As of December  31, 2005:                |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
|                                     |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
| Tangible Capital to Tangible Assets      |       | $          | 74,857     |                       | 8.78       | %                          | $          | 12,784                     |       | 1.50                            | %          | N/A |   | N/A |   |
|                                     |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
| Core Capital to Adjusted Tangible Assets |       | 74,857     |       | 8.78                       | %          | 34,090                     |       | 4.00                       | %          | $                               | 42,612     |   | 5.00 | % |
|                                     |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
| Total Capital to Risk-Weighted Assets    |       | 76,718     |       | 12.06                      | %          | 50,872                     |       | 8.00                       | %          | 63,590                          |       | 10.00 | % |
|                                     |       |       |       |                       |       |                       |       |                       |       |                            |       |   |   |
| Tier I Capital to  Risk-Weighted Assets  |       | 74,857     |       | 11.77                      | %          | N/A                        |       | N/A                        |       | 38,154                          |       | 6.00 | % |

**19.**               RELATEDPARTY TRANSACTIONS

In the normal course of business, the Bank has madeloans to its directors, officers, and their related business interests. In theopinion of management, related party loans are made on substantially the sameterms, including interest rates and collateral, as those prevailing at the timefor comparable transactions with unrelated persons and do not involve more thanthe normal risk of collectibility. The aggregate dollar amount of loansoutstanding to directors, officers, and their related business interests wasapproximately $1.0 and $1.5 million at December 31, 2006 and 2005,respectively.

Deposits from related parties held by the Bank atDecember 31, 2006 and 2005 amounted to $5.2 million and $3.6 million,respectively.

67

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**20.**               PARENTCOMPANY ONLY FINANCIAL INFORMATION

The following condensed statements of financialcondition, as of December 31, 2006 and 2005, and condensed statements ofincome and of cash flows for each of the three years in the period endedDecember 31, 2006, for First Federal Bancshares of Arkansas, Inc. shouldbe read in conjunction with the consolidated financial statements and the notesherein.

**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

**(ParentCompany Only)**

 

**CONDENSEDSTATEMENTS OF FINANCIAL CONDITION**

**DECEMBER31, 2006 AND 2005**

**(Inthousands)**

| ASSETS                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Cash and cash  equivalents (deposits in Bank)  |       | $        | 23         |     | $          | 327 |   |
| Loan to Bank  subsidiary                       |       | 377      |       | 2,046    |       |
| Accrued interest  receivable                   |       | 7        |       | 5        |       |
| Investment in  Bank                            |       | 74,881   |       | 75,056   |       |
| Other assets                                   |       | 593      |       | 553      |       |
|                                           |       |     |       |     |       |
| TOTAL                                          |       | $        | 75,881     |     | $          | 77,987 |   |
|                                           |       |     |       |     |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY** |       |     |       |     |       |
|                                           |       |     |       |     |       |
| Accrued expenses  and other liabilities        |       | $        | 308        |     | $          | 145 |   |
| Stockholders’  equity                     |       | 75,573   |       | 77,842   |       |
|                                           |       |     |       |     |       |
| TOTAL                                          |       | $        | 75,881     |     | $          | 77,987 |   |

 

68

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** **

** **

**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

**(ParentCompany Only)**

 

**CONDENSEDSTATEMENTS OF INCOME**

**YEARSENDED DECEMBER 31, 2006, 2005, AND 2004**

**(Inthousands)**

|                                                                            | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| INCOME:                                                                    |       |       |       |       |       |       |       |
| Dividends from the Bank                                                    |       | $          | 8,000      |       | $          | 7,000      |       | $ | 6,000 |   |
| Interest income—loan to the Bank                                      |       | 52         |       | 45         |       | 22         |       |
|                                                                       |       |       |       |       |       |       |       |
| Total income                                                               |       | 8,052      |       | 7,045      |       | 6,022      |       |
|                                                                       |       |       |       |       |       |       |       |
| EXPENSES:                                                                  |       |       |       |       |       |       |       |
| Management fees                                                            |       | 66         |       | 66         |       | 66         |       |
| Other operating expenses                                                   |       | 259        |       | 230        |       | 234        |       |
|                                                                       |       |       |       |       |       |       |       |
| Total expenses                                                             |       | 325        |       | 296        |       | 300        |       |
|                                                                       |       |       |       |       |       |       |       |
| INCOME BEFORE  INCOME TAX                                                  |       |       |       |       |       |       |       |
| BENEFIT AND EQUITY IN UNDISTRIBUTED                                        |       |       |       |       |       |       |       |
| EARNINGS (LOSS) OF BANK SUBSIDIARY                                         |       | 7,727      |       | 6,749      |       | 5,722      |       |
|                                                                       |       |       |       |       |       |       |       |
| INCOME TAX  BENEFIT                                                        |       | 105        |       | 96         |       | 107        |       |
|                                                                       |       |       |       |       |       |       |       |
| INCOME BEFORE  EQUITY IN UNDISTRIBUTED EARNINGS (LOSS) OF  BANK SUBSIDIARY |       | 7,832      |       | 6,845      |       | 5,829      |       |
|                                                                       |       |       |       |       |       |       |       |
| EQUITY IN  UNDISTRIBUTED EARNINGS (LOSS) OF BANK SUBSIDIARY                |       | (449       | )          | 1,005      |       | 1,976      |       |
|                                                                       |       |       |       |       |       |       |       |
| NET INCOME                                                                 |       | $          | 7,383      |       | $          | 7,850      |       | $ | 7,805 |   |

 

69

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**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

**(ParentCompany Only)**

 

**CONDENSED STATEMENTS OF CASH FLOWS**

**YEARSENDED DECEMBER 31, 2006, 2005, AND 2004**

**(Inthousands)**

|                                                                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                               |       |     |       |     |       |     |       |
| OPERATING  ACTIVITIES:                                                             |       |     |       |     |       |     |       |
| Net income                                                                         |       | $        | 7,383      |     | $          | 7,850    |       | $ | 7,805 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |     |       |     |       |     |       |
| Equity in undistributed net loss (earnings) of Bank                                |       | 449      |       | (1,005   | )          | (1,976   | )          |
| Release of ESOP shares                                                             |       | 512      |       | 1,991    |       | 1,712    |       |
| Stock compensation expense                                                         |       | 81       |       | 26       |       | 56       |       |
| Changes in operating assets and liabilities:                                       |       |     |       |     |       |     |       |
| Accrued interest receivable                                                        |       | (2       | )          | (2       | )          | (1       | )          |
| Other assets                                                                       |       | (40      | )          | 149      |       | 235      |       |
| Accrued expenses and other liabilities                                             |       | 163      |       | 108      |       | (378     | )          |
|                                                                               |       |     |       |     |       |     |       |
| Net cash provided by operating activities                                          |       | 8,546    |       | 9,117    |       | 7,453    |       |
|                                                                               |       |     |       |     |       |     |       |
| INVESTING  ACTIVITIES—                                                        |       |     |       |     |       |     |       |
| Loan to bank, net of repayments                                                    |       | 1,669    |       | (1,045   | )          | 2,194    |       |
|                                                                               |       |     |       |     |       |     |       |
| Net cash provided by (used in) investing activities                                |       | 1,669    |       | (1,045   | )          | 2,194    |       |
|                                                                               |       |     |       |     |       |     |       |
| FINANCING  ACTIVITIES:                                                             |       |     |       |     |       |     |       |
| Purchase of treasury stock                                                         |       | (8,574   | )          | (7,630   | )          | (9,534   | )          |
| Dividends paid                                                                     |       | (2,899   | )          | (2,527   | )          | (2,178   | )          |
| Stock options exercised                                                            |       | 954      |       | 2,206    |       | 2,035    |       |
|                                                                               |       |     |       |     |       |     |       |
| Net cash used in financing activities                                              |       | (10,519  | )          | (7,951   | )          | (9,677   | )          |
|                                                                               |       |     |       |     |       |     |       |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                              |       | (304     | )          | 121      |       | (30      | )          |
|                                                                               |       |     |       |     |       |     |       |
| CASH AND CASH  EQUIVALENTS:                                                        |       |     |       |     |       |     |       |
| Beginning of period                                                                |       | 327      |       | 206      |       | 236      |       |
|                                                                               |       |     |       |     |       |     |       |
| End of period                                                                      |       | $        | 23         |     | $          | 327      |       | $ | 206 |   |

 

70

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**SELECTEDQUARTERLY OPERATING RESULTS (UNAUDITED)(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)**
| **YEAR ENDED DECEMBER 31, 2006** | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|
| Interest income                                      |       | $                   | 13,610     |               | $          | 13,681              |       | $                  | 13,737     |   | $ | 13,091 |   |
| Interest expense                                     |       | 7,377               |       | 7,307              |       | 6,704               |       | 6,188              |       |
| Net interest income                                  |       | 6,233               |       | 6,374              |       | 7,033               |       | 6,903              |       |
| Provision for loan losses                            |       | 354                 |       | 484                |       | 359                 |       | 285                |       |
| Net interest income after provision for loan losses  |       | 5,879               |       | 5,890              |       | 6,674               |       | 6,618              |       |
| Noninterest income                                   |       | 1,903               |       | 2,030              |       | 2,085               |       | 2,317              |       |
| Noninterest expense                                  |       | 5,768               |       | 5,466              |       | 5,378               |       | 6,022              |       |
| Income before income taxes                           |       | 2,014               |       | 2,454              |       | 3,381               |       | 2,913              |       |
| Provision for income taxes                           |       | 591                 |       | 754                |       | 1,106               |       | 928                |       |
| Net income                                           |       | $                   | 1,423      |               | $          | 1,700               |       | $                  | 2,275      |   | $ | 1,985 |   |
| Earnings per share(1):                               |       |                |       |               |       |                |       |               |       |
|  Basic                                          |       | $                   | 0.30       |               | $          | 0.34                |       | $                  | 0.45       |   | $ | 0.39 |   |
| Diluted                                              |       | $                   | 0.29       |               | $          | 0.33                |       | $                  | 0.44       |   | $ | 0.38 |   |
|                                                 |       |                |       |               |       |                |       |               |       |
| Selected Ratios (Annualized):                        |       |                |       |               |       |                |       |               |       |
| Net interest margin                                  |       | 3.14                | %          | 3.12               | %          | 3.46                | %          | 3.43               | %          |
| Return on average assets                             |       | 0.66                |       | 0.77               |       | 1.04                |       | 0.92               |       |
| Return on average equity                             |       | 7.29                |       | 8.54               |       | 11.57               |       | 10.19              |       |

 
| **YEAR ENDED DECEMBER 31, 2005** | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|
| Interest income                                      |       | $                   | 12,573     |               | $          | 11,916              |       | $                  | 11,001     |   | $ | 10,595 |   |
| Interest expense                                     |       | 5,754               |       | 5,135              |       | 4,588               |       | 4,127              |       |
| Net interest income                                  |       | 6,819               |       | 6,781              |       | 6,413               |       | 6,468              |       |
| Provision for loan losses                            |       | 280                 |       | 285                |       | 287                 |       | 249                |       |
| Net interest income after provision for loan losses  |       | 6,539               |       | 6,496              |       | 6,126               |       | 6,219              |       |
| Noninterest income                                   |       | 1,849               |       | 1,818              |       | 1,724               |       | 1,570              |       |
| Noninterest expense                                  |       | 5,580               |       | 5,313              |       | 4,979               |       | 4,896              |       |
| Income before income taxes                           |       | 2,808               |       | 3,001              |       | 2,871               |       | 2,893              |       |
| Provision for income taxes                           |       | 907                 |       | 965                |       | 922                 |       | 929                |       |
| Net income                                           |       | $                   | 1,901      |               | $          | 2,036               |       | $                  | 1,949      |   | $ | 1,964 |   |
|                                                 |       |                |       |               |       |                |       |               |       |
| Earnings per share(1):                               |       |                |       |               |       |                |       |               |       |
| Basic                                                |       | $                   | 0.38       |               | $          | 0.41                |       | $                  | 0.39       |   | $ | 0.39 |   |
| Diluted                                              |       | $                   | 0.37       |               | $          | 0.39                |       | $                  | 0.37       |   | $ | 0.37 |   |
|                                                 |       |                |       |               |       |                |       |               |       |
| Selected Ratios (Annualized):                        |       |                |       |               |       |                |       |               |       |
| Net interest margin                                  |       | 3.44                | %          | 3.55               | %          | 3.45                | %          | 3.61               | %          |
| Return on average assets                             |       | 0.89                |       | 1.00               |       | 0.98                |       | 1.01               |       |
| Return on average equity                             |       | 9.79                |       | 10.61              |       | 10.27               |       | 9.33               |       |

----

(1)  Basicand diluted shares outstanding are summarized below.
| ** **                        | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
|-----------------------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|
| YEAR ENDED DECEMBER 31, 2006      |       |                |       |               |       |                |       |               |       |
| Basic weighted - average shares   |       | 4,910,493           |       | 5,006,730          |       | 5,024,563           |       | 5,032,320          |       |
| Effect of dilutive securities     |       | 102,079             |       | 111,206            |       | 118,702             |       | 143,188            |       |
| Diluted weighted - average shares |       | 5,012,572           |       | 5,117,936          |       | 5,143,265           |       | 5,175,508          |       |
|                              |       |                |       |               |       |                |       |               |       |
| YEAR ENDED DECEMBER 31, 2005      |       |                |       |               |       |                |       |               |       |
| Basic weighted - average shares   |       | 5,002,779           |       | 4,990,081          |       | 4,975,893           |       | 4,987,228          |       |
| Effect of dilutive securities     |       | 201,359             |       | 222,985            |       | 250,552             |       | 280,357            |       |
| Diluted weighted - average shares |       | 5,204,138           |       | 5,213,066          |       | 5,226,445           |       | 5,267,585          |       |

 

71

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**Item9.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure.**

Not Applicable.

**Item9A.  Controls and Procedures.**

Our management evaluated,with the participation of our Chief Executive Officer and Chief FinancialOfficer, the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934) as of the end of the period covered by thisreport.  Based on such evaluation, ourChief Executive Officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures are designed to ensure that informationrequired to be disclosed by us in the reports that we file or submit under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and regulations and areoperating in an effective manner.

Management’s annualreport on internal control over financial reporting and the attestation reportof the Company’s independent registered public accounting firm are included inItem 8 under the headings “Management Report on Internal Control” and “Reportof Independent Registered Public Accounting Firm,” respectively, and areincorporated herein by reference.

No change in the Company’sinternal control over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) occurred during the fiscal quarter endedDecember 31, 2006 that has materially affected, or is reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

**Item9B.  Other Information.**

Not Applicable.

72

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**PARTIII.**

**Item10.  Directors, Executive Officers andCorporate Governance.**

The information regardingdirectors and executive officers is incorporated herein by reference from thesection entitled “Information with Respect to Nominees for Director, ContinuingDirectors and Executive Officers” in our definitive Proxy Statement (“2007Proxy Statement”) to be filed pursuant to Regulation 14A of the SecuritiesExchange Act of 1934, as amended, for our Annual Meeting of Stockholders to beheld on April 25, 2007. The 2007 Proxy Statement will be filed within 120 daysafter the end of our fiscal year ended December 31, 2006.

The information regardingcompliance with Section 16(a) of the Securities and Exchange Act of 1934 isincorporated herein by reference from the section entitled “Section 16(a)Beneficial Ownership Reporting Compliance” of our 2007 Proxy Statement.

The information regardingthe audit committee and audit committee financial experts is incorporated byreference herein from the subsection entitled “Committees and Meetings of theBoard of the Company and the Bank” in the section entitled “Information withRespect to Nominee for Director, Continuing Directors and Executive Officers”in our 2007 Proxy Statement.

The information regardingthe code of ethics applicable to our principal executive officer, principalfinancial officer and principal accounting officer is incorporated herein byreference from the subsection entitled—”Code of Ethics for Executive Officersand Financial Professionals” in the section entitled “Information with Respectto Nominees for Director, Continuing Directors and Executive Officers” in our2007 Proxy Statement.

**Item11.  Executive Compensation.**

Information regardingexecutive compensation is incorporated herein by reference from the sectionentitled “Executive Compensation” in our 2007 Proxy Statement.

**Item12.  Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters.**

Information regardingsecurity ownership of certain beneficial owners and management is incorporatedherein by reference from the section entitled “Beneficial Ownership of CommonStock By Certain Beneficial Owners and Management and Related StockholderMatters” and information regarding securities authorized for issuance underequity compensation plans is incorporated herein by reference from thesubsection entitled “Equity-Based Compensation Plans” in our 2007 ProxyStatement.

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**Item13.  Certain Relationships and RelatedTransactions, and Director Independence.**

Information regardingcertain relationships and related transactions is incorporated herein byreference from the section entitled “Transactions with Certain Related Persons”in our 2007 Proxy Statement.

Information regardingdirector independence is incorporated herein by reference from the subsectionentitled “Election of Directors” in the section entitled “Information withRespect to Nominees for Director, Continuing Directors and Executive Officers”in our 2007 Proxy Statement.

**Item14.  Principal Accountant Fees and Services.**

The information regardingprincipal auditor fees and services is incorporated herein by reference fromthe section entitled “Relationship with Independent Registered PublicAccounting Firm” in our 2007 Proxy Statement.

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**PARTIV.**

**Item15. Exhibits and Financial Statement Schedules.**

**(a)  Documents Filed as Part of this Report**

(1) Financialstatements have been included in Item 8.

(2) All schedulesfor which provision is made in the applicable accounting regulation of the SECare omitted because of the absence of conditions under which they are requiredor because the required information is included in the financial statements andrelated notes thereto.

**(b)Exhibit Index.**
| 2.1*     |   | Plan of Conversion                                                                                                                                          |
|----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1*     |   | Articles of Incorporation of First Federal  Bancshares of Arkansas, Inc.                                                                                    |
| 3.2*     |   | Bylaws of First Federal Bancshares of Arkansas, Inc.                                                                                                        |
| 4.0**    |   | Stock Certificate of First Federal Bancshares of  Arkansas, Inc.                                                                                            |
| 10.6     |   | Employment Agreement between the Company, the Bank  and Larry J. Brandt as amended                                                                          |
| 10.7***  |   | Employment Agreement between the Company, the Bank  and Tommy W. Richardson                                                                                 |
| 10.8***  |   | Employment Agreement between the Company, the Bank  and Sherri R. Billings                                                                                  |
| 10.9**** |   | Change in Control Severance Agreement between the  Company, the Bank and Jeffrey Brandt                                                                     |
| 10.10    |   | Change in Control Severance Agreement between the  Company, the Bank and Allen Ross Mallioux                                                                |
| 21.0     |   | Subsidiaries of  the Registrant - Reference is made to “Item 1 Business - Subsidiaries” for  the  required information                            |
| 23.0     |   | Consent of Deloitte & Touche LLP                                                                                                                        |
| 31.1     |   | Certification of  Chief Executive Officer pursuant to Rule 13a-14(a) of Exchange Act, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 31.2     |   | Certification of  Chief Financial Officer pursuant to Rule 13a-14(a) of Exchange Act, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32.1     |   | Section 906 Certification of the CEO                                                                                                                        |
| 32.2     |   | Section 906 Certification of the CFO                                                                                                                        |

----

(*)                    Incorporated herein by reference from the Company’sRegistration Statement on Form S-1 (File No. 333-612) filed with the SEC.

(**)             Incorporated herein by reference from the Company’sRegistration Statement on Form 8-A filed with the SEC.

(***)                        Incorporatedherein by reference from the Company’s Annual Report on Form 10-K for thefiscal year ended December 31, 2002 filed with the SEC.

(****)                 Incorporatedherein by reference from the Company’s Report on Form 10-Q for the quarterended March 31, 2006 filed with the SEC.

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** **

** **

**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
|    |   | FIRST FEDERAL BANCSHARES OF ARKANSAS, INC. |
|--------------|--------|--------------------------------------------|
|         |   |                                       |
|         |   |                                       |
|    |   | By:                                        |   | /s/ Larry J. Brandt |
|    |   |                                  |   | Larry J. Brandt |
|    |   |                                  |   | President and Chief Executive Officer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.
| /s/ Larry J. Brandt                                                                      |   | February 28, 2007 |
|------------------------------------------------------------------------------------------|--------|-------------------|
| Larry J. Brandt  President and Chief Executive Officer                                   |   |              |
|                                                                                     |   |              |
|                                                                                     |   |              |
| /s/ John P. Hammerschmidt                                                                |   | February 28, 2007 |
| John P. Hammerschmidt  Chairman                                                          |   |              |
|                                                                                     |   |              |
|                                                                                     |   |              |
| /s/ Jeff Brandt                                                                          |   | February 28, 2007 |
| Jeff Brandt  Director                                                                    |   |              |
|                                                                                     |   |              |
|                                                                                     |   |              |
| /s/ Kenneth C. Savells                                                                   |   | February 28, 2007 |
| Kenneth C. Savells  Director                                                             |   |              |
|                                                                                     |   |              |
|                                                                                     |   |              |
| /s/ Frank Conner                                                                         |   | February 28, 2007 |
| Frank Conner  Director                                                                   |   |              |
|                                                                                     |   |              |
|                                                                                     |   |              |
| /s/ Sherri R. Billings                                                                   |   | February 28, 2007 |
| Sherri R. Billings  Executive Vice President and  Chief Financial and Accounting Officer |   |              |

 

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