UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K





S
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the fiscal year ended December 31, 2007





OR





£
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the transition period from _________________________ to
_____________





Commission
File Number: 0-51856





NEWPORT
BANCORP, INC.


(Exact
name of registrant as specified in its charter)





UNITED
      STATES
            20-4465271(State
      or other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification No.)100
      Bellevue Avenue, Newport, Rhode Island
            02840(Address
      of principal executive offices)
            (Zip
      Code)





Securities
registered pursuant to Section 12(b) of the Act:




Title of each class
            
            Name of each exchange on which
      registeredCommon
      Stock, par value $0.01 per share
            
            The
      Nasdaq Stock Market LLC




Securities
registered pursuant to Section 12(g) of the Act:  None





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes  £      No  S





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.  Yes  £     No  S





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes  S       No  £





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. S





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “accelerated filer,” “large
accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.


(Check
      one):
            Large
      accelerated filer
            £
            Accelerated
      filer
            £Non-accelerated
      filer
            £
            Smaller
      reporting company
            S





Indicate
by check mark whether the registrant is a shell company (as defined by Rule
12b-2 of the Act).


Yes  £      No  S





The
aggregate market value of the voting and non-voting common equity held by
nonaffiliates as of June 29, 2007 was approximately
$41,246,211.







The
number of shares outstanding of the registrant’s common stock as of March 11,
2008 was 4,568,732.




DOCUMENTS
INCORPORATED BY REFERENCE:




Portions
of the Proxy Statement for the 2008 Annual Meeting of Stockholders are
incorporated by reference in Part III of this Form 10-K.









INDEX





Part
      IPageItem
      1.
            Business
            
            2-13Item
      1A.
            Risk Factors
            
            13-14Item
      1B.
            Unresolved Staff Comments
            
            14Item
      2.
            Properties
            
            14Item
      3.
            Legal Proceedings
            
            14-15Item
      4.
            Submission of Matters to a Vote of Security
      Holders
            
            15Part
      IIItem
      5.
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities
            
            15-16Item
      6.
            Selected Financial Data
            
            17Item
      7.
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operation
            
            17-39Item
      7A.
            Quantitative and Qualitative Disclosures About Market
      Risk
            
            39Item
      8.
            Financial Statements and Supplementary
    Data
            
            39Item
      9.
            Changes in and Disagreements With Accountants on Accounting
      and Financial Disclosure
            
            39Item
      9A(T).
            Controls and Procedures
            
            39-40Item
      9B.
            Other Information
            
            40Part
      IIIItem
      10.
            Directors, Executive Officers and Corporate
      Governance
            
            40Item
      11.
            Executive Compensation
            
            40Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters
            
            41Item
      13.
            Certain Relationships and Related Transactions, and
      Director Independence
            
            41Item
      14.
            Principal Accounting Fees and Services
            
            41Part
      IVItem
      15.
            Exhibits and Financial Statement
    Schedules
            
            42-43SIGNATURES
            
            
            44-45


Index





This
report contains certain “forward-looking statements” within the meaning of the
federal securities laws.  These statements are not historical facts;
rather, they are statements based on Newport Bancorp, Inc.’s current
expectations regarding its business strategies, intended results and future
performance.  Forward-looking statements are preceded by terms such as
“expects,” “believes,” “anticipates,” “intends” and similar
expressions.





Management’s
ability to predict results or the effect of future plans or strategies is
inherently uncertain.  Factors which could affect actual results
include interest rate trends, the general economic climate in the market area in
which Newport Bancorp, Inc. operates, as well as nationwide, Newport Bancorp,
Inc.’s ability to control costs and expenses, competitive products and pricing,
loan delinquency rates and changes in federal and state legislation and
regulation.  For further discussion of factors that may affect the
results, see “Item 1A. Risk Factors” in this Annual Report on Form 10-K (“Form
10-K”). These factors should be considered in evaluating the forward-looking
statements and undue reliance should not be placed on such
statements.  Newport Bancorp, Inc. assumes no obligation to update any
forward-looking statements.





PART
I





Item 1.
            BUSINESS





General





Newport
Bancorp, Inc. (“Newport Bancorp” or the “Company”) is a Maryland chartered
company established in March 2006 to become the holding company for Newport
Federal Savings Bank (“Newport Federal” or the “Bank”).  Newport
Bancorp’s business activity is the ownership of the outstanding capital stock of
Newport Federal.  Newport Bancorp does not own or lease any property
but instead uses the premises, equipment and other property of Newport Federal
with the payment of appropriate rental fees, as required by applicable law and
regulations, under the terms of an expense allocation agreement.  In
the future, Newport Bancorp may acquire or organize other operating
subsidiaries; however, there are no current plans, arrangements, agreements or
understandings, written or oral, to do so.





Newport
Federal is a federally chartered savings bank originally founded as a Rhode
Island institution in 1888.  In October 2005, Newport Federal merged
with Westerly Savings Bank, a Rhode Island mutual financial institution with two
branch locations in Westerly, Rhode Island. The Bank operates as a
community-oriented financial institution offering traditional financial services
to consumers and businesses in the Bank’s market area.  Newport
Federal attracts deposits from the general public and uses those funds to
originate one- to four-family residential loans, multi-family loans, commercial
real estate loans, construction loans and consumer loans.





Available
Information





The
Bank’s website address is www.newportfederal.com.  Information on this
website should not be considered a part of this Form 10-K.





Stock Conversion





On July
6, 2006, in accordance with a Plan of Conversion, Newport Federal, a federally
chartered mutual savings bank, was reorganized into a federally chartered stock
savings bank under the operation of a stock holding company, Newport Bancorp,
Inc.  In connection with the conversion, the Company issued an
aggregate of 4,878,349 shares of common stock, at an offering price of $10 per
share. The Company’s stock began trading on July 7, 2006, on the Nasdaq Stock
Market LLC, under the symbol “NFSB”.





In
connection with the conversion, the Company established and funded the
Newportfed Charitable Foundation (the “Foundation”) with shares of Company
common stock equal to 7.4% of the shares sold in the stock
offering.  The Foundation provides funding to support charitable
causes and community development activities in the communities served by the
Company.





2
 Index


Market
Area





Newport
Federal is headquartered in Newport, Rhode Island.  In addition to the
Bank’s main office in Newport, the Bank operates four other full-service branch
offices in Rhode Island:  one each in Middletown and in Wakefield and
two in Westerly.  We have also entered into a purchase and sale
agreement to acquire land for use as a new branch location in Portsmouth, Rhode
Island.  The purchase of the Portsmouth property became final on
January 10, 2008.  On November, 21, 2007, the Bank entered into a
twenty-year lease agreement for land in Stonington, Connecticut to construct a
new branch.  This agreement is subject to the Bank receiving the
necessary governmental approvals, among other conditions, to open the
branch.  The Bank considers Newport and Washington Counties, Rhode
Island to be its primary market area.  The economy in our market area
is primarily oriented to the retail and hospitality industries.





Competition





Newport
Federal faces significant competition for the attraction of deposits and
origination of loans.  The Bank’s most direct competition for deposits
has historically come from the several financial institutions operating in its
market area and, to a lesser extent, from other financial service companies such
as brokerage firms, credit unions and insurance companies.  Newport
Federal also faces competition for investors’ funds, from money market funds,
mutual funds and other corporate and government securities.  At June
30, 2007, which is the most recent date for which data is available from the
FDIC, the Bank held approximately 10.56% of the deposits in Newport County,
Rhode Island and approximately 3.47% of the deposits in Washington County, Rhode
Island.  In addition, banks owned by large holding companies such as
Bank of America Corporation, Citizens and Sovereign also operate in our market
area.  These institutions are significantly larger than the Bank and,
therefore, have significantly greater resources.





The
Bank’s competition for loans comes primarily from financial institutions in our
market area and, to a lesser extent, from other financial service providers,
such as mortgage companies, credit unions and mortgage
brokers.  Competition for loans also comes from the increasing number
of non-depository financial service companies entering the mortgage market, such
as insurance companies, securities companies and specialty finance
companies.





Newport
Federal expects competition to increase in the future as a result of
legislative, regulatory and technological changes and the continuing trend of
consolidation in the financial services industry.  Technological
advances, for example, have lowered barriers to entry, allowed banks to expand
their geographic reach by providing services over the Internet and made it
possible for non-depository institutions to offer products and services that
traditionally have been provided by banks.  Changes in federal law
permit affiliation among banks, securities firms and insurance companies, which
promotes a competitive environment in the financial services
industry.  Competition for deposits and the origination of loans could
limit our growth in the future.





Lending
Activities





General.  The
largest segment of the Bank’s loan portfolio is real estate mortgage loans,
primarily one- to four-family residential loans. The other significant segment
of the Bank’s loan portfolio is commercial real estate loans.  To a
lesser degree, Newport Federal also originates multi-family and construction
loans, as well as consumer loans.  The Bank originates loans for
investment purposes, although the Bank occasionally may sell a portion of one-
to four-family residential loans into the secondary market.





One- to
Four-Family Residential Loans.  The Bank’s
origination of mortgage loans enables borrowers to purchase or refinance
existing homes located in Rhode Island, Southeastern Connecticut and, to a
lesser extent, Southeastern Massachusetts, although our primary lending market
is Newport and Washington Counties, Rhode Island.





Newport
Federal’s residential lending policies and procedures conform to the secondary
market guidelines as we occasionally sell qualifying fixed-rate loans into the
secondary market.  The Bank offers fixed-rate mortgage loans with
terms of 10 to 30 years, and to a lesser extent, 40 years.  Newport
Federal also offers adjustable-rate mortgage loans.  Borrower demand
for adjustable-rate loans compared to fixed-rate loans is a function of the
level of interest rates, the expectations of changes in the level of interest
rates, and the difference between the interest rates and loan fees offered for
fixed-rate mortgage loans as compared to an initially discounted interest rate
and loan fees for multi-year adjustable-rate mortgages (“ARMs”).  The
relative amount of fixed-rate mortgage loans and adjustable-rate mortgage loans
that can be originated at any time is largely determined by the demand for each
in a competitive environment.  The loan fees, interest rates and other
provisions of mortgage loans are determined by us on the basis of our own
pricing criteria and competitive market conditions.


3
 Index




Interest
rates and payments on the Bank’s adjustable-rate mortgage loans generally adjust
annually after an initial fixed period that typically ranges from one to three
years.  Interest rates and payments on the Bank’s adjustable-rate
loans generally are adjusted to a rate typically equal to a percentage above the
one-year U.S. Treasury index.  The maximum amount by which the
interest rate may be increased or decreased is generally 2% per adjustment
period and the lifetime interest rate cap is generally 6% over the initial
interest rate of the loan.





While
one- to four-family residential real estate loans are normally originated with
up to 30-year terms, such loans typically remain outstanding for substantially
shorter periods because borrowers often prepay their loans in full either upon
sale of the property pledged as security or upon refinancing the original
loan.  Therefore, average loan maturity is a function of, among other
factors, the level of purchase and sale activity in the real estate market,
prevailing interest rates and the interest rates payable on outstanding
loans.  Newport Federal does not offer loans with negative
amortization and generally does not offer interest only loans.





The Bank
generally does not make conventional loans with loan-to-value ratios exceeding
95%.  Loans with loan-to-value ratios in excess of 80% generally
require private mortgage insurance.  Newport Federal requires all
properties securing first mortgage loans to be appraised by an independent
appraiser, who is approved by the Board of Directors.  The Bank
generally requires title insurance on all first mortgage
loans.  Borrowers must obtain hazard insurance, and flood insurance is
required for loans on properties located in a flood zone.





Multi-Family and
Commercial Real Estate Loans.  Newport Federal
offers fixed- and adjustable-rate mortgage loans secured by commercial and
multi-family real estate.  The Bank’s commercial and multi-family real
estate loans are generally secured by five to ten unit apartment buildings,
small office buildings, two to four unit mixed-use retail and residential
properties and hospitality establishments.  These properties are
primarily located in Newport and Washington Counties in Rhode Island, and to a
lesser extent other cities and towns in Rhode Island and New London County,
Connecticut.





Newport
Federal originates a variety of fixed- and adjustable-rate commercial real
estate and multi-family real estate loans generally for terms up to 10
years.  These adjustable-rate loans include loans that adjust based on
the five-year FHLB Classic Rate Advance Index, adjustable every five
years.  Loans are secured by first mortgages, and amounts generally do
not exceed 75% of the property’s appraised value.





As of
December 31, 2007, the Bank’s largest commercial loan was $1.9
million.  This loan is secured by a professional office
building.  This loan was performing in accordance with its original
terms at December 31, 2007.





Home Equity Loans
and Lines.Newport Federal offers home equity loans with a maximum
combined loan to value ratio of 80% or less.  Home equity lines of
credit have adjustable rates of interest that are indexed to the Prime Rate as
published by The Wall Street
Journal.  Home equity loans have fixed interest rates and terms
that typically range from five to 15 years, but may have terms as long as 20
years.





Construction
Loans.Newport Federal
originates construction loans for one- to four-family homes and commercial,
multi-family and other nonresidential purposes. The Bank’s residential
construction loans generally provide for the payment of only interest during the
construction phase, which is usually six to twelve months.  At the end
of the construction phase, the loan converts to a permanent mortgage loan. One- to four-family
residential construction loans are made with a maximum loan to value ratio of
80% of the market value of the real estate and
improvements.  Commercial, multi-family and other nonresidential loans
can be made with a maximum loan to value ratio of 75% of the upon completion
market value of the real estate and improvements.  At December 31,
2007, the largest construction loan was for $2.7 million, of which $1.3 million
was advanced.  This loan was performing according to its terms at
December 31, 2007.  Construction loans to individuals are generally
made on the same terms as Newport Federal’s one- to four-family mortgage
loans.


4
 Index




Consumer
Loans.  The Bank offers a
variety of consumer and other loans, including auto loans and loans secured by
passbook savings or certificate accounts.





The
procedures for underwriting consumer loans include an assessment of the
applicant’s payment history on other debts and ability to meet existing
obligations and payments on the proposed loan.  Although the
applicant’s creditworthiness is a primary consideration, the underwriting
process also includes a comparison of the value of the collateral, if any, to
the proposed loan amount.





Loan
Underwriting Risks.





Adjustable-Rate
Loans.  While Newport Federal anticipates that adjustable-rate
loans will better offset the adverse effects of an increase in interest rates as
compared to fixed-rate mortgages, an increased monthly mortgage payment required
of adjustable-rate loan borrowers in a rising interest rate environment could
cause an increase in delinquencies and defaults.  The marketability of
the underlying property also may be adversely affected in a high interest rate
environment.  In addition, although adjustable-rate mortgage loans
make our asset base more responsive to changes in interest rates, the extent of
this interest sensitivity is limited by the annual and lifetime interest rate
adjustment limits.





Multi-family and Commercial Real
Estate Loans.  Loans secured by multi-family and commercial
real estate generally have larger balances and involve a greater degree of risk
than one- to four-family residential mortgage loans.  Of primary
concern in multi-family and commercial real estate lending is the borrower’s
creditworthiness and the feasibility and cash flow potential of the
project.  Payments on loans secured by income properties often depend
on successful operation and management of the properties.  As a
result, repayment of such loans may be subject to a greater extent than
residential real estate loans, to adverse conditions in the real estate market
or the economy.  To monitor cash flows on income properties, the Bank
requires borrowers and loan guarantors, if any, to provide annual financial
statements on multi-family and commercial real estate loans.  In
reaching a decision on whether to make a multi-family or commercial real estate
loan, Newport Federal considers and reviews a global cash flow analysis of the
borrower and considers the net operating income of the property, the borrower’s
expertise, credit history and profitability and the value of the underlying
property.  The Bank has generally required that the properties
securing these real estate loans have debt service coverage ratios (the ratio of
earnings before debt service to debt service) of at least 1.25.  An
environmental survey or environmental risk insurance is obtained when the
possibility exists that hazardous materials may have existed on the site, or the
site may have been impacted by adjoining properties that handled hazardous
materials.





Construction
Loans.  Construction financing is generally considered to
involve a higher degree of risk of loss than long-term financing on improved,
occupied real estate.  Risk of loss on a construction loan depends
largely upon the accuracy of the initial estimate of the property’s value at
completion of construction and the estimated cost of
construction.  During the construction phase, a number of factors
could result in delays and/or cost overruns.  If the estimate of
construction costs proves to be inaccurate, the Bank may be required to advance
funds beyond the amount originally committed to permit completion of the
building.  Also, the Bank may be confronted, at or before the maturity
of the loan, with a building having a value that is insufficient to assure full
repayment.  If Newport Federal is forced to foreclose on such a
building before or at completion due to a default, there can be no assurance
that the Bank will be able to recover all of the unpaid balance of, and accrued
interest on, the loan as well as related foreclosure and holding
costs.





Consumer
Loans.  Consumer loans may entail greater risk than do
residential mortgage loans, particularly in the case of consumer loans that are
unsecured or secured by assets that depreciate rapidly, such as motor
vehicles.  In the latter case, repossessed collateral for a defaulted
consumer loan may not provide an adequate source of repayment for the
outstanding loan and a small remaining deficiency often does not warrant further
substantial collection efforts against the borrower.  Consumer loan
collections depend on the borrower’s continuing financial stability, and
therefore are likely to be adversely affected by various factors, including job
loss, divorce, illness or personal bankruptcy.  Furthermore, the
application of various federal and state laws, including federal and state
bankruptcy and insolvency laws, may limit the amount that can be recovered on
such loans.


5
 Index




Loan Originations, Purchases and
Sales.  Loan originations come from a number of
sources.  The primary source of loan originations are existing
customers, walk-in traffic, advertising and referrals from
customers.  Occasionally, Newport Federal sells loans that the Bank
has originated.  The decision to sell loans is based on prevailing
market interest rate conditions and interest rate management.  Newport
Federal did not sell any loans in 2007 and sold $886,000 of loans in
2006.





From time
to time, Newport Federal will purchase whole loans or participation loans to
supplement its lending portfolio.Whole loans purchased
totaled $1.1 million at December 31, 2007. The Bank performs its own
underwriting analysis on each loan purchased using the same standards used for
loans originated.  The Bank does not service purchased
loans.





Loan
participations, purchased and sold, totaled $2.8 million at December 31,
2007.  Loan participations are also subject to the same credit
analysis and loan approvals as loans Newport Federal originates. The Bank is
permitted to review all of the documentation relating to any loan in which
Newport Federal participates.  However, in a purchased participation
loan, the Bank does not service the loan and thus is subject to the policies and
practices of the lead lender with regard to monitoring delinquencies, pursuing
collections and instituting foreclosure proceedings.





Loan Approval Procedures and
Authority.  Newport Federal’s lending activities follow
written, non-discriminatory, underwriting standards and loan origination
procedures established by the Board of Directors and management.  The
President, Chief Lending Officer and Chief Operating Officer have authority to
approve secured loans in amounts up to $2.5 million and unsecured loans up to
$300,000.  Secured loans from $2.5 million to $3.0 million must be
approved by four of the following persons: recommending loan officer, Chief
Lending Officer, President, Chief Operating Officer and one non-employee member
of the Board of Directors.  Secured loans from $3.0 million to $3.5
million must be approved by a majority of the Executive Committee of the Board
of Directors.  Unsecured loans over $600,000 and secured loans greater
than $3.5 million up to the legal lending limit must be approved by a majority
vote of the entire Board of Directors.  Smaller loans may be approved
by individual loan officers; however, the Chief Lending Officer oversees the
origination of all loans.





Loans to One
Borrower.  The maximum amount the Bank may lend to one borrower
and the borrower’s related entities is limited, by regulation, to generally 15%
of its stated capital and reserves.  At December 31, 2007, Newport
Federal’s regulatory limit on loans to one borrower was $6.7
million.  At that date, the Bank’s largest lending relationship was
$2.7 million and was secured by a condominium-hotel property located in Newport,
Rhode Island.  This loan was performing in accordance with its
original terms at December 31, 2007.





Loan
Commitments.  The Bank issues commitments for fixed- and
adjustable-rate mortgage loans conditioned upon the occurrence of certain
events.  Commitments to originate mortgage loans are legally binding
agreements to lend to our customers.  Generally, these loan
commitments expire after 60 days.





Investment
Activities





Newport
Federal has legal authority to invest in various types of liquid assets,
including U.S. Treasury obligations, securities of various Government-sponsored
enterprises and of state and municipal governments, mortgage-backed securities
and certificates of deposit of federally insured institutions.  Within
certain regulatory limits, the Bank also may invest a portion of its assets in
corporate securities and mutual funds.  Newport Federal also is
required to maintain an investment in Federal Home Loan Bank of Boston
stock.





At
December 31, 2007, the Bank’s investment portfolio consisted of mortgage-backed
securities issued primarily by Fannie Mae and mutual funds, the underlying
assets of which consist of short-term agency securities and mortgage-backed
securities.





Newport
Federal’s investment objectives are to provide and maintain liquidity, to
establish an acceptable level of interest rate and credit risk, to provide an
alternate source of low-risk investments when demand for loans is weak and to
generate a favorable return.  The Bank’s Board of Directors has the
overall responsibility for the investment portfolio, including approval of the
investment policy.  The Chief Executive Officer and Chief Financial
Officer are responsible for implementation of the investment policy and
monitoring the Bank’s investment performance.The Board of Directors
of Newport Federal reviews the status of the investment portfolio on a quarterly
basis, or more frequently if warranted.


6
 Index




Deposit
Activities and Other Sources of Funds





General.  Deposits,
borrowings and loan repayments are the major sources of Newport Federal’s funds
for lending and other investment purposes.  Scheduled loan repayments
are a relatively stable source of funds, while deposit inflows and outflows and
loan prepayments are significantly influenced by general interest rates and
money market conditions.





Deposit
Accounts.  Substantially all
of the Bank’s depositors are residents of Rhode Island.  Deposits are
attracted from within our market area through the offering of a broad selection
of deposit instruments, including non-interest-bearing demand deposits (such as
checking accounts), interest-bearing demand accounts (such as NOW and money
market accounts), regular savings accounts and certificates of deposit. Deposit account terms
vary according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rate, among other factors.  In
determining the terms of Newport Federal’s deposit accounts, the Bank considers
the rates offered by the Bank’s competition, Newport Federal’s liquidity needs,
profitability to the Bank, matching deposit and loan products and customer
preferences and concerns.  Newport Federal generally reviews the
deposit mix and pricing weekly.  The Bank’s current strategy is to
offer competitive rates and to be in the middle of the market for rates on all
types of deposit products; however, the Bank selectively competes for various
certificates of deposit.





In
addition to accounts for individuals, Newport Federal also offers deposit
accounts designed for the businesses operating in our market
area.  The Bank’s business banking deposit products include commercial
checking accounts and money market accounts.





Borrowings.  Newport Federal
utilizes advances from the Federal Home Loan Bank of Boston to supplement the
Bank’s investable funds.  The Federal Home Loan Bank functions as a
central reserve bank providing credit for member financial
institutions.  As a member, the Bank is required to own capital stock
in the Federal Home Loan Bank and is authorized to apply for advances on the
security of such stock and certain of the Bank’s mortgage loans and other assets
(principally securities which are obligations of, or guaranteed by, the United
States), provided certain standards related to creditworthiness have been
met.  Advances are made under several different programs, each having
its own interest rate and range of maturities.  Depending on the
program, limitations on the amount of advances are based either on a fixed
percentage of an institution’s net worth or on the Federal Home Loan Bank’s
assessment of the institution’s creditworthiness.





Personnel





At
December 31, 2007, the Bank had 60 full-time employees and 13 part-time
employees, none of whom is represented by a collective bargaining
unit.  Newport Federal believes that its relationship with its
employees is good.





Subsidiaries





Newport
Bancorp conducts its principal business activities through its wholly-owned
subsidiary, Newport Federal Savings Bank.  Newport Bancorp has no
other subsidiaries.





REGULATION
AND SUPERVISION


General





As a
savings and loan holding company, the Company is required by federal law to
report to, and otherwise comply with the rules and regulations of, the Office of
Thrift Supervision.  The Bank is subject to extensive regulation,
examination and supervision by the Office of Thrift Supervision, as its primary
federal regulator, and the Federal Deposit Insurance Corporation, as the deposit
insurer.  The Bank is a member of the Federal Home Loan Bank System
and, with respect to deposit insurance, of the Deposit Insurance Fund managed by
the Federal Deposit Insurance Corporation.  The Bank must file reports
with the Office of Thrift Supervision and the Federal Deposit Insurance
Corporation concerning its activities and financial condition in addition to
obtaining regulatory approvals prior to entering into certain transactions such
as mergers with, or acquisitions of, other savings institutions.  The
Office of Thrift Supervision and/or the Federal Deposit Insurance Corporation
conduct periodic examinations to test the Bank’s safety and soundness and
compliance with various regulatory requirements.  This regulation and
supervision establishes a comprehensive framework of activities in which an
institution can engage and is intended primarily for the protection of the
insurance fund and depositors.  The regulatory structure also gives
the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes.  Any change in
such regulatory requirements and policies, whether by the Office of Thrift
Supervision, the Federal Deposit Insurance Corporation or Congress, could have a
material adverse impact on the Company, the Bank and their operations. Certain
regulatory requirements applicable to the Bank and to the Company are referred
to below or elsewhere herein.  The description of statutory provisions
and regulations applicable to savings institutions and their holding companies
set forth below and elsewhere in this document does not purport to be a complete
description of such statutes and regulations and their effects on the Bank and
the Company and is qualified in its entirety by reference to the actual laws and
regulations.


7
 Index




Holding
Company Regulation





The
Company is a non-diversified unitary savings and loan holding company within the
meaning of federal law.  Under prior law, a unitary savings and loan
holding company, such as the Company, was not generally restricted as to the
types of business activities in which it may engage, provided that the Bank
continued to be a qualified thrift lender.  See “Federal Savings Institution
Regulation - QTL Test.”  The Gramm-Leach-Bliley Act of 1999
provided that no company may acquire control of a savings institution after May
4, 1999 unless the company engages only in the financial activities permitted
for financial holding companies under law or for multiple savings and loan
holding companies as described below.  Further, the Gramm-Leach-Bliley
Act specified that existing savings and loan holding companies may only engage
in such activities.  The Gramm-Leach-Bliley Act, however,
grandfathered the unrestricted authority for activities with respect to unitary
savings and loan holding companies existing prior to May 4, 1999, so long as the
holding company’s savings institution subsidiary continues to comply with the
QTL Test.  The Company does not qualify for the
grandfathering.  Upon any non-supervisory acquisition by the Company
of another savings institution or savings bank that meets the qualified thrift
lender test and is deemed to be a savings institution by the Office of Thrift
Supervision, the Company would become a multiple savings and loan holding
company (if the acquired institution is held as a separate subsidiary) and would
generally be limited to activities permissible for bank holding companies under
Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval
of the Office of Thrift Supervision, and certain activities authorized by Office
of Thrift Supervision regulation.  However, the OTS has issued an
interpretation concluding that multiple savings and loan holding companies may
also engage in activities permitted for financial holding
companies.





A savings
and loan holding company is prohibited from, directly or indirectly, acquiring
more than 5% of the voting stock of another savings institution or savings and
loan holding company, without prior written approval of the Office of Thrift
Supervision and from acquiring or retaining control of a depository institution
that is not insured by the Federal Deposit Insurance Corporation.  In
evaluating applications by holding companies to acquire savings institutions,
the Office of Thrift Supervision considers factors such as the financial and
managerial resources and future prospects of the Company and institution
involved, the effect of the acquisition on the risk to the deposit insurance
funds, the convenience and needs of the community and competitive
effects.





The
Office of Thrift Supervision may not approve any acquisition that would result
in a multiple savings and loan holding company controlling savings institutions
in more than one state, subject to two exceptions:  (i) the approval
of interstate supervisory acquisitions by savings and loan holding companies;
and (ii) the acquisition of a savings institution in another state if the laws
of the state of the target savings institution specifically permit such
acquisitions.  The states vary in the extent to which they permit
interstate savings and loan holding company acquisitions.





Although
savings and loan holding companies are not currently subject to specific
regulatory capital requirements or specific restrictions on the payment of
dividends or other capital distributions, federal regulations do prescribe such
restrictions on subsidiary savings institutions.  The Bank must notify
the Office of Thrift Supervision thirty days before declaring any dividend to
the Company, and comply with the additional restrictions described
below.  In addition, the financial impact of a holding company on its
subsidiary institution is a matter that is evaluated by the Office of Thrift
Supervision and the agency has authority to order cessation of activities or
divestiture of subsidiaries deemed to pose a threat to the safety and soundness
of the institution.


8
 Index




Acquisition of
the Company.  Under the Federal Change in Control Act, a notice
must be submitted to the Office of Thrift Supervision if any person (including a
company), or group acting in concert, seeks to acquire “control” of a savings
and loan holding company or savings association.  Under certain
circumstances, a change of control may occur, and prior notice is required, upon
the acquisition of 10% or more of the Company’s outstanding voting stock, unless
the Office of Thrift Supervision has found that the acquisition will not result
in control of the Company.  Under the Change in Control Act, the
Office of Thrift Supervision generally has 60 days from the filing of a complete
notice to act, taking into consideration certain factors, including the
financial and managerial resources of the acquirer and the competitive effects
of the acquisition.  Any company that acquires control would then be
subject to regulation as a savings and loan holding company.





Federal
Savings Institution Regulation





Business
Activities.The activities of federal savings banks are governed by
federal laws and regulations.  Those laws and regulations delineate
the nature and extent of the business activities in which federal savings banks
may engage.  In particular, certain lending authority for federal
savings banks, e.g., commercial, non-residential real property loans and
consumer loans, is limited to a specified percentage of the institution’s
capital or assets.





Capital
Requirements.The Office of Thrift Supervision capital
regulations require savings institutions to meet three minimum capital
standards:  a 1.5% tangible capital to total assets ratio; a 4% tier 1
capital to total assets leverage ratio (3% for institutions receiving the
highest rating on the CAMELS examination rating system); and an 8% risk-based
capital ratio.  In addition, the prompt corrective action standards
discussed below also establish, in effect, a minimum 2% tangible capital
standard, a 4% leverage ratio (3% for institutions receiving the highest rating
on the CAMELS system) and, together with the risk-based capital standard itself,
a 4% Tier 1 risk-based capital standard.  The Office of Thrift
Supervision regulations also require that, in meeting the tangible, leverage and
risk-based capital standards, institutions must generally deduct investments in
and loans to subsidiaries engaged in activities as principal that are not
permissible for a national bank.





The
risk-based capital standard for savings institutions requires the maintenance of
Tier 1 (core) and total risk based capital (which is defined as core capital and
supplementary capital less certain specified deductions from total capital such
as reciprocal holdings of depository institution capital instruments and equity
investments), to risk-weighted assets of at least 4% and 8%,
respectively.  In determining the amount of risk-weighted assets, all
assets, including certain off-balance sheet activities, recourse obligations,
residual interests and direct credit substitutes, are multiplied by a
risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision
capital regulation based on the risks believed inherent in the type of
asset.  Core (Tier 1) capital is generally defined as common
stockholders’ equity (including retained earnings), certain non-cumulative
perpetual preferred stock and related surplus and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
mortgage servicing rights and credit card relationships.  The
components of supplementary capital (Tier 2 Capital) currently include
cumulative preferred stock, long-term perpetual preferred stock, mandatory
convertible debt securities, subordinated debt and intermediate preferred stock,
the allowance for loan and lease losses limited to a maximum of 1.25% of
risk-weighted assets, and up to 45% of unrealized gains on available-for-sale
equity securities with readily determinable fair market
values.  Overall, the amount of supplementary capital included as part
of total capital cannot exceed 100% of core capital.





The
Office of Thrift Supervision also has authority to establish individual minimum
capital requirements in appropriate cases upon a determination that an
institution’s capital level is or may become inadequate in light of the
particular circumstances.  At December 31, 2007, the Bank met each of
its capital requirements.





Prompt Corrective
Regulatory Action.The Office of Thrift Supervision is required to take
certain supervisory actions against undercapitalized institutions, the severity
of which depends upon the institution’s degree of
undercapitalization.  Generally, a savings institution that has a
ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier
1 (core) capital to risk-weighted assets of less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
highest examination rating) is considered to be “undercapitalized.”  A
savings institution that has a total risk-based capital ratio less than 6%, a
Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be “significantly undercapitalized” and a savings institution that
has a tangible capital to assets ratio equal to or less than 2% is deemed to be
“critically undercapitalized.”  Subject to a narrow exception, the
Office of Thrift Supervision is required to appoint a receiver or conservator
within specified time frames for an institution that is “critically
undercapitalized.”  The regulation also provides that a capital
restoration plan must be filed with the Office of Thrift Supervision within 45
days of the date a savings institution is deemed to have received notice that it
is “undercapitalized,” “significantly undercapitalized” or “critically
undercapitalized.”  Compliance with the plan must be guaranteed by any
parent holding company in the amount of up to the lesser of 5% of the savings
association’s total assets when it was deemed to be undercapitalized or the
amount necessary to achieve compliance with applicable capital
requirements.  In addition, numerous mandatory supervisory actions
become immediately applicable to an undercapitalized institution, including, but
not limited to, increased monitoring by regulators and restrictions on growth,
capital distributions and expansion.  The Office of Thrift Supervision
could also take any one of a number of discretionary supervisory actions,
including the issuance of a capital directive and the replacement of senior
executive officers and directors.  Significantly and critically
undercapitalized institutions are subject to additional mandatory and
discretionary measures.


9
 Index




Insurance of
Deposit Accounts.The Bank’s deposits are insured up to
applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance
Corporation.  The Federal Deposit Insurance Corporation amended its
risk-based assessment system for 2007 to implement authority granted by the
Federal Deposit Insurance Reform Act of 2005 (“Reform Act”).  Under
the revised system, insured institutions are assigned to one of four risk
categories based on supervisory evaluations, regulatory capital levels and
certain other factors.  An institution’s assessment rate depends upon
the category to which it is assigned.  Risk category I, which contains
the least risky depository institutions, is expected to include more than 90% of
all institutions.  Unlike the other categories, Risk Category I
contains further risk differentiation based on the Federal Deposit Insurance
Corporation’s analysis of financial ratios, examination component ratings and
other information.  Assessment rates are determined by the Federal
Deposit Insurance Corporation and currently range from five to seven basis
points for the healthiest institutions (Risk Category I) to 43 basis points of
assessable deposits for the riskiest (Risk Category IV).  The Federal
Deposit Insurance Corporation may adjust rates uniformly from one quarter to the
next, except that no single adjustment can exceed three basis
points.





The
Reform Act also provided for one-time credit for eligible institutions based on
their assessment base as of December 31, 1996.  Subject to certain
limitations, credits could be used to offset assessments beginning in
2007.  The Bank’s one-time credit was approximately $124,000, of which
$80,000 has been used to offset assessments and $44,000 remains available for
future use.  The Reform Act also provided for the possibility that the
Federal Deposit Insurance Corporation may pay dividends to insured institutions
once the Deposit Insurance Fund reserve ratio equals or exceeds 1.35% of
estimated insured deposits.





In
addition to the assessment for deposit insurance, institutions are required to
make payments on bonds issued in the late 1980s by the Financing Corporation to
recapitalize a predecessor deposit insurance fund.  That payment is
established quarterly and during the year ended December 31, 2007 averaged 1.18
basis points of assessable deposits.





The
Reform Act provided the Federal Deposit Insurance Corporation with authority to
adjust the Deposit Insurance Fund ratio to insured deposits within a range of
1.15% and 1.50%, in contrast to the prior statutorily fixed ratio of
1.25%.  The ratio, which is viewed by the Federal Deposit Insurance
Corporation as the level that the fund should achieve, has been established by
the agency at 1.25% for 2007.





The
Federal Deposit Insurance Corporation has authority to increase insurance
assessments.  A significant increase in insurance premiums would
likely have an adverse effect on the operating expenses and results of
operations of the Bank.  Management cannot predict what insurance
assessment rates will be in the future.





Insurance
of deposits may be terminated by the Federal Deposit Insurance Corporation upon
a finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the Federal
Deposit Insurance Corporation or the Office of Thrift
Supervision.  The management of the Bank does not know of any
practice, condition or violation that might lead to termination of deposit
insurance.


10
 Index




Loans to One
Borrower.Federal law provides that savings institutions are generally
subject to the limits on loans to one borrower applicable to national
banks.  Generally, subject to certain exceptions, a savings
institution may not make a loan or extend credit to a single or related group of
borrowers in excess of 15% of its unimpaired capital and surplus.  An
additional amount may be lent, equal to 10% of unimpaired capital and surplus,
if secured by specified readily-marketable collateral.





QTL Test.Federal law requires savings institutions to meet a qualified thrift
lender test.  Under the test, a savings association is required to
either qualify as a “domestic building and loan association” under the Internal
Revenue Code or maintain at least 65% of its “portfolio assets” (total assets
less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles,
including goodwill; and (iii) the value of property used to conduct business) in
certain “qualified thrift investments” (primarily residential mortgages and
related investments, including certain mortgage-backed securities, but also
including education, credit card and small business loans) in at least 9 months
out of each 12 month period.





A savings
institution that fails the qualified thrift lender test is subject to certain
operating restrictions and may be required to convert to a bank
charter.  At December 31, 2007, the Bank maintained 96.21% of its
portfolio assets in qualified thrift investments and, therefore, met the
qualified thrift lender test.





Limitation on
Capital Distributions.  Office of Thrift Supervision
regulations impose limitations upon all capital distributions by a savings
institution, including cash dividends, payments to repurchase its shares and
payments to shareholders of another institution in a cash-out
merger.  Under the regulations, an application to and prior approval
of the Office of Thrift Supervision is required prior to any capital
distribution if the institution does not meet the criteria for “expedited
treatment” of applications under Office of Thrift Supervision regulations (i.e.,
generally, examination and Community Reinvestment Act ratings in the two top
categories), the total capital distributions for the calendar year exceed net
income for that year plus the amount of retained net income for the preceding
two years, the institution would be undercapitalized following the distribution
or the distribution would otherwise be contrary to a statute, regulation or
agreement with the Office of Thrift Supervision.  If an application is
not required, the institution must still provide prior notice to the Office of
Thrift Supervision of the capital distribution if, like the Bank, it is a
subsidiary of a holding company.  In the event the Bank’s capital fell
below its regulatory requirements or the Office of Thrift Supervision notified
it that it was in need of increased supervision, the Bank’s ability to make
capital distributions could be restricted.  In addition, the Office of
Thrift Supervision could prohibit a proposed capital distribution by any
institution, which would otherwise be permitted by the regulation, if the Office
of Thrift Supervision determines that such distribution would constitute an
unsafe or unsound practice.





Standards for
Safety and Soundness.The federal banking agencies have adopted
Interagency Guidelines prescribing Standards for Safety and Soundness in various
areas such as internal controls and information systems, internal audit, loan
documentation and credit underwriting, interest rate exposure, asset growth and
quality, earnings and compensation, fees and benefits.  The guidelines
set forth the safety and soundness standards that the federal banking agencies
use to identify and address problems at insured depository institutions before
capital becomes impaired.  If the Office of Thrift Supervision
determines that a savings institution fails to meet any standard prescribed by
the guidelines, the Office of Thrift Supervision may require the institution to
submit an acceptable plan to achieve compliance with the standard.





Transactions with
Related Parties.The Bank’s authority to engage in transactions
with  “affiliates” (e.g., any entity that controls or is under common
control with an institution, including the Company and its other subsidiaries)
is limited by federal law.  The aggregate amount of covered
transactions with any individual affiliate is limited to 10% of the capital and
surplus of the savings institution.  The aggregate amount of covered
transactions with all affiliates is limited to 20% of the savings institution’s
capital and surplus.  Certain transactions with affiliates are
required to be secured by collateral in an amount and of a type specified by
federal law.  The purchase of low quality assets from affiliates is
generally prohibited.  Transactions with affiliates must generally be
on terms and under circumstances that are at least as favorable to the
institution as those prevailing at the time for comparable transactions with
non-affiliated companies.  In addition, savings institutions are
prohibited from lending to any affiliate that is engaged in activities that are
not permissible for bank holding companies and no savings institution may
purchase the securities of any affiliate other than a
subsidiary.


11
 Index




The
Sarbanes-Oxley Act of 2002 generally prohibits loans by the Company to its
executive officers and directors.  However,  the law
contains a specific exception for loans by the Bank to its executive officers
and directors in compliance with federal banking laws.  Under such
laws, the Bank’s authority to extend credit to executive officers, directors and
10% shareholders (“insiders”), as well as entities such persons control, is
limited.  The law limits both the individual and aggregate amount of
loans the Bank may make to insiders based, in part, on the Bank’s capital level
and requires that certain board approval procedures be followed.  Such
loans are required to be made on terms substantially the same as those offered
to unaffiliated individuals and not involve more than the normal risk of
repayment.  There is an exception for loans made pursuant to a benefit
or compensation program that is widely available to all employees of the
institution and does not give preference to insiders over other
employees.  Loans to executive officers are subject to additional
limitations based on the type of loan involved.  (See Note 13 “Related
Party Transactions” in the attached Financial Statement Schedules).





Enforcement.The Office of Thrift Supervision has primary enforcement responsibility
over savings institutions and has authority to bring actions against the
institution and all institution-affiliated parties, including stockholders, and
any attorneys, appraisers and accountants who knowingly or recklessly
participate in wrongful action likely to have an adverse effect on an insured
institution.  Formal enforcement action may range from the issuance of
a capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance.  Civil penalties cover a wide range of violations
and can amount to $25,000 per day, or even $1 million per day in especially
egregious cases.  The Federal Deposit Insurance Corporation has the
authority to recommend to the Director of the Office of Thrift Supervision that
enforcement action to be taken with respect to a particular savings
institution.  If action is not taken by the Director, the Federal
Deposit Insurance Corporation has authority to take such action under certain
circumstances.  Federal law also establishes criminal penalties for
certain violations.





Assessments.Savings institutions are required to pay assessments to the Office of
Thrift Supervision to fund the agency’s operations.  The general
assessments, paid on a semi-annual basis, are computed based upon the savings
institution’s (including consolidated subsidiaries) total assets, financial
condition and complexity of its portfolio.  The OTS assessments paid
by the Company for the year ended December 31, 2007 totaled
$92,000.





Federal
Home Loan Bank System





The Bank
is a member of the Federal Home Loan Bank System, which consists of (12)
regional Federal Home Loan Banks.  The Federal Home Loan Bank provides
a central credit facility primarily for member institutions.  The
Bank, as a member of the Federal Home Loan Bank, is required to acquire and hold
shares of capital stock in that Federal Home Loan Bank.  The Bank was
in compliance with this requirement with an investment in Federal Home Loan Bank
stock at December 31, 2007 of $4.2 million.





The
Federal Home Loan Banks are required to provide funds for certain purposes
including the resolution of insolvent thrifts in the late 1980s and to
contributing funds for affordable housing programs.  These
requirements could reduce the amount of dividends that the Federal Home Loan
Banks pay to their members and could also result in the Federal Home Loan Banks
imposing a higher rate of interest on advances to their members.  If
dividends were reduced, or interest on future Federal Home Loan Bank advances
increased, the Bank’s net interest income would likely also be
reduced.





Federal
Reserve System





The
Federal Reserve Board regulations require savings institutions to maintain
non-interest earning reserves against their transaction accounts (primarily
Negotiable Order of Withdrawal (NOW) and regular checking
accounts).  The regulations generally provide that reserves be
maintained against aggregate transaction accounts as follows:  a 3%
reserve ratio is assessed on net transaction accounts up to and including $43.9
million; a 10% reserve ratio is applied above $43.9 million.  The
first $9.3 million of otherwise reservable balances (subject to adjustments by
the Federal Reserve Board) are exempted from the reserve
requirements.  The amounts are adjusted annually.  The Bank
complies with the foregoing requirements.


12
 Index




Federal
Securities Laws





Newport
Bancorp’s common stock is registered with the Securities and Exchange Commission
under the Securities Exchange Act of 1934.  Newport Bancorp is subject
to the information, proxy solicitation, insider trading restrictions and other
requirements under the Securities Exchange Act of 1934.




ITEM 1A.
            RISK
      FACTORS





Changes
in interest rates may reduce our profits.





Short-term
market interest rates (which we use as a guide to price our deposits) have until
recently risen from historically low levels, while longer-term market interest
rates (which we use as a guide to price our longer-term loans) have
not.  This “flattening” of the market yield curve has had a negative
impact on our interest rate spread and net interest margin, which has reduced
our profitability.  For the years ended December 31, 2007 and 2006,
respectively, our interest rate spread was 2.69% and 2.97%.  If
short-term interest rates increase, and if rates on our deposits reprice upwards
faster than the rates on our long-term loans and investments, we would
experience compression of our interest rate spread and net interest margin,
which would have a negative effect on our profitability.  Recently,
however, the U.S. Federal Reserve decreased its target for the federal funds
rate from 5.25% to 4.25%.  Decreases in interest rates can result in
increased prepayments of loans and mortgage-related securities, as borrowers
refinance to reduce their borrowing costs.  Under these circumstances,
we are subject to reinvestment risk as we may have to redeploy such loan or
securities proceeds into lower-yielding assets, which might also negatively
impact our income.  For further discussion of how changes in interest
rates could impact us, see “Management’s Discussion and
Analysis of Financial Condition and Results of Operations—Risk
Management— Qualitative
Aspects of Market Risk” and “—Quantitative Aspects of Market
Risk.”





A
downturn in the local economy or a decline in real estate values could impact
our profits.





Nearly
all of Newport Federal’s loans are secured by real estate in the State of Rhode
Island.  As a result of this concentration, a downturn in the local
economy could cause significant increases in nonperforming loans, which would
impact the Bank’s profits.  In recent years, there has been a
significant increase in real estate values in Newport Federal’s market
area.  As a result of rising home prices, the Bank’s loans have been
well collateralized.  A decline in real estate values could cause some
of Newport Federal’s mortgage loans to become inadequately collateralized, which
would expose the Bank to a greater risk of loss.  Additionally, a
decline in real estate values could adversely impact the Bank’s portfolio of
commercial real estate loans and could result in a decline in the origination of
such loans.





Strong
competition within our market area could affect our profits and slow
growth.





Newport
Federal faces intense competition both in making loans and attracting
deposits.  This competition has made it more difficult for the Bank to
make new loans and attract deposits.  Price competition for loans and
deposits might result in the Bank earning less on the Bank’s loans and paying
more on the Bank’s deposits, which would reduce net interest
income.  Competition also makes it more difficult to grow loans and
deposits.  At June 30, 2007, which is the most recent date for which
data is available from the Federal Deposit Insurance Corporation (“FDIC”),
Newport Federal held approximately 10.56% of the deposits in Newport County,
Rhode Island and approximately 3.47% of the deposits in Washington County, Rhode
Island.  Some of the institutions with which the Bank competes have
substantially greater resources and lending limits than Newport Federal has and
may offer services that the Bank does not provide.  Newport Federal
expects competition to increase in the future as a result of legislative,
regulatory and technological changes and the continuing trend of consolidation
in the financial services industry.  The Bank’s profitability depends
upon our continued ability to compete successfully in our market
area.





Newport
Federal operates in a highly regulated environment and we may be adversely
affected by changes in laws and regulations.





The Bank
is subject to extensive regulation, supervision and examination by the Office of
Thrift Supervision, Newport Federal’s chartering authority, and by the Federal
Deposit Insurance Corporation, as insurer of the Bank’s
deposits.  Newport Bancorp and Newport Federal are all subject to
regulation and supervision by the Office of Thrift Supervision.  Such
regulation and supervision governs the activities in which an institution and
its holding company may engage, and are intended primarily for the protection of
the insurance fund and the depositors and borrowers of Newport Federal rather
than for holders of Newport Bancorp common stock.  Regulatory
authorities have extensive discretion in their supervisory and enforcement
activities, including the imposition of restrictions on the Bank’s operations
and the classification of the Bank’s assets.  Any change in such
regulation and oversight, whether in the form of regulatory policy, regulations,
legislation or supervisory action, may have a material impact on Newport
Federal’s operations.


13
 Index







Recent
Developments in the Housing Sector and Related Markets and the Economy May
Adversely Affect Our Business and Financial Results.





Throughout
the course of 2007, the housing market experienced a variety of worsening
economic conditions, due in large part to the collapse of the sub-prime mortgage
market. While we did not invest in sub-prime mortgages and related investments,
our lending business is tied, in large part, to the housing market. The housing
slump may result in reduced demand for the construction of new housing,
declining or flat home prices, and increased delinquencies on construction and
residential and commercial mortgage loans. These conditions may also cause a
reduction in loan demand, and an increase in our non-performing assets, net
charge-offs and provisions for loan losses. These negative economic conditions
could adversely impact our prospects for growth, asset and goodwill valuations
and our results of operations.








ITEM1B.
            UNRESOLVED
      STAFF COMMENTS





None.





ITEM 2.
            PROPERTIES





We
conduct our business through our main office and branch offices.  The
following table sets forth certain information relating to these facilities as
of December 31, 2007.





Location
            Year
              Opened
            
            Square
              Footage
            
            
            Date
      of
              Lease
              Expiration
            
            Owned/
              Leased
            
            Net
      Book Value(Dollars
      in thousands)Main
      Office:100
      Bellevue Avenue
              Newport,
      RI  02840
            1964
            
            
            12,000
            
            
            
            N/A
            
            Owned
            
            $
            2,208Branches:165
      East Main Road
              Middletown,
      RI  20842
            1978
            
            
            3,000
            
            
            05/30/2020
            
            Leased
            
            $
            477121
      Old Tower Hill Road
              Wakefield,
      RI  02879
            1996
            
            
            3,000
            
            
            05/14/2011
            
            Leased
            
            $
            1438
      Union Street
              Westerly,
      RI  02891
            1958
            
            
            5,000
            
            
            
            N/A
            
            Owned
            
            $
            7812
      Wilder Avenue
              Westerly,
      RI  02891
            2001
            
            
            1,200
            
            
            
            N/A
            
            Owned
            
            $
            520






ITEM 3.
            LEGAL
      PROCEEDINGS





Periodically,
there have been various claims and lawsuits against us, such as claims to
enforce liens, condemnation proceedings on properties in which we hold security
interests, claims involving the making and servicing of real property loans and
other issues incident to our business.  Newport Federal is not a party
to any pending legal proceedings that we believe would have a material adverse
effect on our financial condition, results of operations or cash
flows.




14
 Index





ITEM 4.
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS





None.





PART
II





ITEM5.
            MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES





Market
and Dividend Information.





The
Company’s common stock is listed on the Nasdaq Global Market (“NASDAQ”) under
the trading symbol “NFSB.”  The Company completed its initial public
offering on July 6, 2006 and commenced trading on July 7, 2006.  The
Company has not paid any dividends to its stockholders to date.  See
Item 1, “Business—Regulation
and Supervision—Limitation on Capital Distributions” for information
relating to restrictions on dividends.





The
following table sets forth the high and low sales prices of the Company’s common
stock since trading commenced, as reported by NASDAQ.





High
            
            
            Low
            
            
            Dividends
      Declared per Share2007:First
      Quarter
            
            $
            14.00
            
            
            $
            13.52
            
            
            $
            -Second
      Quarter
            
            $
            13.99
            
            
            $
            13.16
            
            
            
            -Third
      Quarter
            
            $
            13.54
            
            
            $
            11.61
            
            
            
            -Fourth
      Quarter
            
            $
            12.75
            
            
            $
            11.25
            
            
            
            -2006:Third
      Quarter
            
            $
            14.48
            
            
            $
            12.25
            
            
            $
            -Fourth
      Quarter
            
            $
            14.20
            
            
            $
            13.60
            
            
            
            -





Holders.





As of
March 11, 2008, there were approximately 632  holders of record of the
Company’s common stock.





Dividends.





The
payment of dividends will depend upon a number of factors, including capital
requirements, Newport Bancorp’s and Newport Federal Savings Bank’s financial
condition and results of operations, tax considerations, statutory and
regulatory limitations and general economic conditions.  No
assuarances can be given that any dividends will be paid or that, if paid, will
not be reduced or eliminated in the future.





Securities
Authorized for Issuance under Equity Compensation Plans.





See Part
III,  Item 12 (d) Equity Compensation Plan  Information, in
this Annual Report on Form 10-K, for the table providing
information as of December 31, 2007 about Company common stock that may be
issued upon the exercise of options under the Newport Bancorp, Inc. 2007 Equity
Incentive Plan.  The plan was approved by the Company’s shareholders
at the August 16, 2007 Annual meeting of Stockholders.


15
 Index




Recent
Sales of Unregistered Securities; Use of Proceeds from Registered
Securities.


Not
applicable.








Purchases of Equity Securities
      by the Issuer and Affiliated
Purchasers.





The
following table provides certain information with regard to shares repurchased
by the Company in the fourth quarter of 2007.





Period
            
            (a)
              Total
      number of Shares Purchased
            
            
            (b)
              Average
      Price Paid per Share
            
            
            (c)
              Total
      Number of Shares Purchased as Part of Publicly Announced Plans or
      Programs(1)
            
            
            (d)
              Maximum
      Number of Shares that May Yet Be Purchased Under the Plans or
      Programs(1)October
      1 - October 31
            
            
            1,400
            
            
            $
            12.53
            
            
            
            1,400
            
            
            
            108,857November
      1 - November 30
            
            
            18,400
            
            
            $
            12.39
            
            
            
            18,400
            
            
            
            90,457December
      1 - December 31
            
            
            60,200
            
            
            $
            12.18
            
            
            
            60,200
            
            
            
            30,257Total
            
            
            80,000
            
            
            
            
            
            
            
            80,000






(1)
            On
      July 16, 2007, Newport Bancorp, Inc. announced the commencement of a stock
      repurchase program to acquire up to 243,917 shares, or 5%, of the
      Company’s outstanding common stock.  Repurchases, which will be
      conducted through open market purchases or privately negotiated
      transactions, will be made from time to time depending on market
      conditions and other factors.  On January 30, 2008, the Company
      completed the aforementioned stock repurchase program.  The
      243,917 shares were acquired at an average price of approximately $12.35
      per share.





On
February 19, 2008, Newport Bancorp, Inc announced the commencement of another
stock repurchase program to acquire up to 231,721 shares, or 5%, of the
Company’s outstanding common stock.  Repurchases, which will be
conducted through open market purchases or privately negotiated transactions,
will be made from time to time depending on market conditions and other
factors.   As of March 11, 2008, the Company has purchased 65,700
shares under this stock repurchase program.


16
 Index




ITEM 6.
            SELECTED
      FINANCIAL DATA





At
      or For the Year Ended December 31,2007
            
            
            2006
            
            
            2005Performance
      Ratios:Return
      on average assets
            
            
            0.24
            %
            
            
            (0.59
            )%
            
            
            0.26
            %Return
      on average equity
            
            
            1.25
            
            
            
            (4.32
            )
            
            
            3.79Interest
      rate spread (1)
            
            
            2.68
            
            
            
            2.97
            
            
            
            3.18Net
      interest margin (2)
            
            
            3.55
            
            
            
            3.67
            
            
            
            3.60Non-interest
      expense to average assets
            
            
            3.46
            
            
            
            4.68
            
            
            
            3.46Efficiency
      ratio (3)
            
            
            85.90
            
            
            
            84.94
            
            
            
            84.39Average
      interest-earning assets to average interest-bearing
      liabilities
            
            
            132.77
            
            
            
            130.13
            
            
            
            119.72Average
      equity to average assets
            
            
            19.28
            
            
            
            13.56
            
            
            
            6.95Capital
      Ratios:Tangible
      capital
            
            
            16.32
            
            
            
            20.65
            
            
            
            6.85Core
      capital
            
            
            16.32
            
            
            
            20.65
            
            
            
            6.85Total
      risk-based capital
            
            
            25.14
            
            
            
            30.42
            
            
            
            11.21Asset
      Quality Ratios:Allowance
      for loan losses as a percent of total loans (4)
            
            
            0.81
            
            
            
            0.76
            
            
            
            0.79Allowance
      for loan losses as a percent of nonperforming loans
            
            
            264.21
            
            
            
            N/M
            
            
            
            N/MNet
      charge-offs (recoveries) to average outstanding loans during the
      period
            
            
            0.00
            
            
            
            0.00
            
            
            
            0.00Non-performing
      loans as a percent of total loans (4)
            
            
            0.31
            
            
            
            0.00
            
            
            
            0.00







(1)
            Represents
      the difference between the weighted average yield on average
      interest-earning assets and the weighted average cost of average
      interest-bearing liabilities.


(2)
            Represents
      net interest income as a percent of average interest-earning
      assets.


(3)
            Represents
      other operating expense minus the expense related to the contribution to
      the NewportFed Charitable Foundation divided by the sum of net interest
      income and other operating income.


(4)
            Loans
      are presented before the allowance for loan losses but include deferred
      costs/fees.  Construction loans are included net of loans in
      process.  Loans held for sale are
  included.


N/M
            Not
      meaningful because there are no nonperforming loans and, consequently, the
      denominator in the ratio was zero.




ITEM 7.
            MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATION





Overview





Income.Newport Federal’s
primary source of pre-tax income is net interest income.  Net interest
income is the difference between interest income, which is the income that we
earn on our loans and investments, and interest expense, which is the interest
that the Bank pays on deposits and borrowings.  Other significant
sources of pre-tax income are service charges (mostly from service charges on
deposit accounts and loan servicing fees).  In some years, Newport
Federal recognizes income from the sale of loans and
securities.


17
 Index




Allowance for
Loan Losses.  The allowance for
loan losses is a valuation allowance for probable losses inherent in the loan
portfolio.  The Bank evaluates the need to establish allowances
against losses on loans on a quarterly basis.  When additional
allowances are necessary, a provision for loan losses is charged to
earnings.





Expenses.  The
non-interest expenses Newport Federal incurs in operating the Bank’s business
consist of compensation and employee benefits expenses, occupancy expenses, data
processing expenses and other miscellaneous expenses.





Compensation
and employee benefits consist primarily of salaries and wages paid to the Bank’s
employees, stock-based compensation, payroll taxes, expenses for health
insurance, retirement plans, and other employee benefits.





Occupancy
expenses, which are the fixed and variable costs of buildings and equipment,
consist primarily of depreciation charges, furniture and equipment expenses,
maintenance, real estate taxes and costs of utilities. Depreciation of premises
and equipment is computed using the straight-line method based on the useful
lives of the related assets, which range from three to forty
years.  Leasehold improvements are amortized over the shorter of the
useful life of the asset or the expected term of the lease.  The
expected term includes lease option periods to the extent that the exercise of
such options is reasonably assured.





Data
processing expenses are the fees paid to third parties for processing customer
information, deposits and loans.





Other
expenses include expenses for professional services, advertising, office
supplies, postage, telephone, insurance, charitable contributions, regulatory
assessments and other miscellaneous operating expenses.





Critical
Accounting Policies





Newport
Bancorp considers accounting policies involving significant judgments and
assumptions by management that have, or could have, a material impact on the
carrying value of certain assets or on results of operations to be critical
accounting policies. The Company considers the allowance for loan losses and the
valuation of the net deferred tax asset to be our critical accounting
policies.





Allowance
for Loan Losses.





The
allowance for loan losses is the amount estimated by management as necessary to
cover losses inherent in the loan portfolio at the balance sheet date. The
allowance is established through the provision for loan losses, which is charged
to earnings. Loan losses are charged against the allowance when management
believes the uncollectibility of a loan balance is
confirmed.  Subsequent recoveries, if any, are credited to the
allowance.





Determining
the amount of the allowance for loan losses necessarily involves a high degree
of judgment. Management evaluates the level of the allowance at least quarterly
and establishes the provision for loan losses based upon a review of the
collectability of the loans in light of historical experience, the nature and
volume of the loan portfolio, adverse situations that may affect the borrower’s
ability to repay, estimated value of any underlying collateral, prevailing
economic conditions and other factors related to the collectability of the loan
portfolio. This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available. Although Newport Federal believes that the Bank uses the best
information available to establish the allowance for loan losses, future
adjustments to the allowance may be necessary if economic conditions differ
substantially from the assumptions used in making the evaluation. In addition,
the Office of Thrift Supervision, as an integral part of its examination
process, periodically reviews Newport Federal’s allowance for loan losses. Such
agency may require the Bank to recognize adjustments to the allowance based on
its judgments about information available to it at the time of its examination.
A large loss could deplete the allowance and require increased provisions to
replenish the allowance, which would adversely affect earnings.


18
 Index




The
allowance consists of general and unallocated loss components.  For
loans that are classified as impaired, an allowance is established when the
collateral value of the impaired loan is lower than the carrying value of that
loan.  The general component covers non-classified loans and is based
on historical loss experience adjusted for qualitative factors.  An
unallocated component is maintained to cover uncertainties that could affect
management’s estimate of probable losses.  The unallocated component
of the allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating the general losses in the
portfolio.





A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due.  Impairment is
measured on a loan by loan basis by the fair value of the
collateral.





Large
groups of smaller balance homogeneous loans are collectively evaluated for
impairment.  Accordingly, the Company does not separately identify
individual consumer and residential loans for impairment
disclosures.





Income
Taxes.





Management
considers accounting for income taxes as a critical accounting policy due to the
subjective nature of certain estimates that are involved in the
calculation.  Newport Federal uses the asset and liability method of
accounting for income taxes. Under this method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases.  A valuation allowance
related to deferred tax assets is established when, in the judgment of
management, it is more likely than not that all or a portion of such deferred
tax assets will not be realized.  The Bank assesses the realizability
of its deferred tax assets by (1) reviewing taxable income in allowable federal
carry-back periods, and (2) assessing the likelihood of the Bank generating
federal and state taxable income, as applicable, in future periods in amounts
sufficient to offset the deferred tax charges they are expected to
reverse.  Adjustments to increase or decrease the valuation allowance
are generally charged or credited, respectively, to income tax
expense.


Balance
Sheet Analysis





Overview.During
2007, the Company’s assets increased by $70.8 million, or 24.4%, to $361.3
million.  The majority of the asset growth was concentrated in net
loans which increased by $36.3 million, and securities held to maturity, which
increased by $29.0 million.  The asset growth was principally funded
by a $70.9 million, or 205.8%, increase in borrowings.




Loans.Newport Federal’s
primary lending activity is the origination of loans secured by real
estate.  The Bank originates one- to four-family residential loans,
commercial real estate and multi-family loans and home equity
loans.  To a lesser extent, Newport Federal originates construction
loans and consumer loans.  Net loans increased from $256.8 million at
December 31, 2006 to $293.1 million at December 31, 2007, or
14.1%.  Net loans represented 81.1% of total assets at December 31,
2007.




The
largest segment of the Bank’s loan portfolio is one- to four-family residential
loans, but the percentage of one- to four-family loans as a percentage of total
loans decreased in both 2007 and 2006 due to increases in other lending,
particularly, commercial real estate and home equity lending.


19
 Index




One- to
four-family loans totaled $169.2 million and represented 57.1% of total loans at
December 31, 2007, compared to $157.4 million, or 60.7% of total loans at
December 31, 2006.  The Bank offers fixed and adjustable rate one- to-
four family residential loans. At December 31, 2007, the Bank had $147.1 million
in fixed rate and $22.1 million in adjustable rate one- to four-family
loans.





Commercial
real estate loans totaled $76.9 million and represented 26.0% of total loans at
December 31, 2007, compared to $57.6 million, or 22.2% of total loans at
December 31, 2006.  The increase of $19.3 million, or 33.4%, was a
result of the Company’s concerted efforts to expand its commercial loan
portfolio.





Multi-family
loans totaled $9.5 million, or 3.2% of total loans at December 31, 2007,
compared to $9.4 million, or 3.6% of total loans at December 31,
2006.  Construction loans totaled $9.4 million, representing 3.2% of
total loans at December 31, 2007, compared to $4.7 million or 1.8% of total
loans at December 31, 2006.  The increase in construction loans is due
to the increase of commercial construction loans originated in 2007, as an
indirect result of the Company’s focus on commercial lending.





Home
equity loans and lines totaled $30.9 million at December 31, 2007, compared to
$29.3 million at December 31, 2006.  The growth was primarily due
to an increase of customers utilizing home equity loans to consolidate and
amortize consumer debt.





The Bank
also originates consumer loans secured by automobiles, passbook or certificate
accounts.  Consumer loans totaled $442,000 at December 31, 2007,
compared to $1.1 million at December 31, 2006.


20
 Index




The
following table sets forth the composition of the Bank’s loan portfolio at the
dates indicated.





At
      December 31,2007
              
              
              2006
              
              
              2005
              
              
              2004
              
              
              2003Amount
              
              
              Percent
              
              
              Amount
              
              
              Percent
              
              
              Amount
              
              
              Percent
              
              
              Amount
              
              
              Percent
              
              
              Amount
              
              
              Percent(Dollars
      in thousands)Real
      estate—mortgage:One-
      to four-family
              
              $
              169,179
              
              
              
              57.08
              %
              
              $
              157,448
              
              
              
              60.67
              %
              
              $
              152,385
              
              
              
              64.90
              %
              
              $
              137,790
              
              
              
              62.96
              %
              
              $
              121,423
              
              
              
              62.62
              %Multi-family
              
              
              9,494
              
              
              
              3.20
              
              
              
              9,360
              
              
              
              3.61
              
              
              
              6,726
              
              
              
              2.87
              
              
              
              5,809
              
              
              
              2.65
              
              
              
              3,884
              
              
              
              2.00Commercial
              
              
              76,919
              
              
              
              25.95
              
              
              
              57,650
              
              
              
              22.21
              
              
              
              47,742
              
              
              
              20.33
              
              
              
              46,406
              
              
              
              21.20
              
              
              
              43,034
              
              
              
              22.19Home
      equity loans and lines
              
              
              30,934
              
              
              
              10.44
              
              
              
              29,275
              
              
              
              11.28
              
              
              
              23,538
              
              
              
              10.02
              
              
              
              19,714
              
              
              
              9.01
              
              
              
              15,124
              
              
              
              7.80Total
      real estate—mortgage
              
              
              286,526
              
              
              
              96.67
              
              
              
              253,733
              
              
              
              97.77
              
              
              
              230,391
              
              
              
              98.12
              
              
              
              209,719
              
              
              
              95.82
              
              
              
              183,465
              
              
              
              94.61Construction
              
              
              9,427
              
              
              
              3.18
              
              
              
              4,685
              
              
              
              1.80
              
              
              
              3,151
              
              
              
              1.34
              
              
              
              7,712
              
              
              
              3.52
              
              
              
              9,142
              
              
              
              4.71Consumer
              
              
              442
              
              
              
              0.15
              
              
              
              1,112
              
              
              
              0.43
              
              
              
              1,263
              
              
              
              0.54
              
              
              
              1,437
              
              
              
              0.66
              
              
              
              1,318
              
              
              
              0.68Total
      loans
              
              
              296,395
              
              
              
              100.00
              %
              
              
              259,530
              
              
              
              100.00
              %
              
              
              234,805
              
              
              
              100.00
              %
              
              
              218,868
              
              
              
              100.00
              %
              
              
              193,925
              
              
              
              100.00
              %Allowance
      for losses
              
              
              (2,399
              )
              
              
              
              
              
              
              (1,973
              )
              
              
              
              
              
              
              (1,853
              )
              
              
              
              
              
              
              (1,655
              )
              
              
              
              
              
              
              (1,511
              )Deferred
      loan fees
              
              
              (912
              )
              
              
              
              
              
              
              (791
              )
              
              
              
              
              
              
              (626
              )
              
              
              
              
              
              
              (602
              )
              
              
              
              
              
              
              (508
              )Loans,
      net
              
              $
              293,084
              
              
              
              
              
              
              $
              256,766
              
              
              
              
              
              
              $
              232,326
              
              
              
              
              
              
              $
              216,611
              
              
              
              
              
              
              $
              191,906


21
 Index




The
following table sets forth certain information at December 31, 2007
regarding the dollar amount of loan principal repayments coming due during the
periods indicated.  The table does not include any estimate of
prepayments, which significantly shorten the average life of all loans and may
cause our actual repayment experience to differ from that shown
below.  Demand loans having no stated schedule of repayments and no
stated maturity are reported as due in one year or less.





One-
      to Four-Family Real Estate
              Loans
            
            
            Multi-
              Family
              Real
      Estate
              Loans
            
            
            Commercial
              Real
      Estate Loans
            
            
            Home
              Equity
      Loans &
              Lines(Dollars
      in thousands)Amounts
      due in:One
      year or less
            
            $
            46
            
            
            $
            96
            
            
            $
            1,748
            
            
            $
            151More
      than one year to five years
            
            
            2,008
            
            
            
            2,009
            
            
            
            7,707
            
            
            
            2,167More
      than five years to ten years
            
            
            11,725
            
            
            
            4,881
            
            
            
            55,457
            
            
            
            11,760More
      than ten years to twenty years
            
            
            40,125
            
            
            
            1,277
            
            
            
            12,007
            
            
            
            16,856More
      than twenty years
            
            
            115,275
            
            
            
            1,231
            
            
            
            -
            
            
            
            -Total
            
            $
            169,179
            
            
            $
            9,494
            
            
            $
            76,919
            
            
            $
            30,934





Construction
      Loans
            
            
            Consumer
      Loans
            
            
            Total
              Loans(Dollars
      in thousands)Amounts
      due in:One
      year or less
            
            $
            4,755
            
            
            $
            263
            
            
            $
            7,059More
      than one year to five years
            
            
            4,672
            
            
            
            179
            
            
            
            18,742More
      than five years to ten years
            
            
            -
            
            
            
            -
            
            
            
            83,823More
      than ten years to twenty years
            
            
            -
            
            
            
            -
            
            
            
            70,265More
      than twenty years
            
            
            -
            
            
            
            -
            
            
            
            116,506Total
            
            $
            9,427
            
            
            $
            442
            
            
            $
            296,395





The
following table sets forth the dollar amount of all loans at December 31,
2007 that are due after December 31, 2008 and have either fixed interest
rates or floating or adjustable interest rates.  The amounts shown
below exclude the allowance for loan losses and net deferred loan
fees.





Fixed
      Rates
            
            
            Floating
      or
              Adjustable
      Rates
            
            
            Total(Dollars
      in thousands)Real
      estate mortgage loans:One-
      to four-family
            
            $
            147,045
            
            
            $
            22,088
            
            
            $
            169,133Multi-family
            
            
            4,474
            
            
            
            4,924
            
            
            
            9,398Commercial
            
            
            31,789
            
            
            
            43,382
            
            
            
            75,171Home
      equity loans and lines
            
            
            18,889
            
            
            
            11,894
            
            
            
            30,783Construction
            
            
            -
            
            
            
            4,672
            
            
            
            4,672Consumer
            
            
            179
            
            
            
            -
            
            
            
            179Total
            
            $
            202,376
            
            
            $
            86,960
            
            
            $
            289,336


22
 Index




Securities.The securities portfolio
consists of mutual funds and mortgage-backed securities.





At
      December 31,2007
            
            
            2006
            
            
            2005Amortized
              Cost
            
            
            Fair
              Value
            
            
            Amortized
              Cost
            
            
            Fair
              Value
            
            
            Amortized
              Cost
            
            
            Fair
              Value(Dollars
      in thousands)Securities
      available for sale:Mutual
      funds
            
            $
            7,117
            
            
            $
            6,966
            
            
            $
            6,775
            
            
            $
            6,614
            
            
            $
            6,483
            
            
            $
            6,334Securities
      held to maturity:Mortgage-backed
      securities
            
            $
            30,886
            
            
            $
            30,751
            
            
            $
            1,922
            
            
            $
            1,869
            
            
            $
            2,292
            
            
            $
            2,191





Newport
Federal had no investments that had an aggregate book value in excess of 10% of
our equity at December 31, 2007.


23
 Index




The
following table sets forth the stated maturities and weighted average yields of
debt securities at December 31, 2007.





One
      Year
                or
      Less
              
              
              More
      than
                One
      Year to
                Five
      Years
              
              
              More
      than
                Five
      Years to
                Ten
      Years
              
              
              More
      than
                Ten
      Years
              
              
              TotalCarrying
                Value
              
              
              Weighted
      Average Yield
              
              
              Carrying
                Value
              
              
              Weighted
      Average Yield
              
              
              Carrying
                Value
              
              
              Weighted
      Average Yield
              
              
              Carrying
                Value
              
              
              Weighted
      Average Yield
              
              
              Carrying
                Value
              
              
              Weighted
      Average Yield(Dollars
      in thousands)Securities
      held to maturity:Mortgage-backed
      securities
              
              
              -
              
              
              
              -
              
              
              $
              1,606
              
              
              
              3.50
              %
              
              
              -
              
              
              
              -
              
              
              $
              29,280
              
              
              
              5.00
              %
              
              $
              30,886
              
              
              
              4.93
              %




24
 Index


Deposits.





Newport
Federal’s deposit base is comprised of demand deposits, money market and savings
accounts and time deposits.  The Bank considers demand deposits, money
market and savings accounts to be core deposits.  Deposits
increased$311,000,
or 0.2%, for the year ended December 31, 2007.   Deposit growth
was focused in money market accounts, which increased by $7.4 million, or 34.7%,
and NOW/Demand accounts, which increased $935,000, or 1.6%.  These
increases were substantially offset by a decrease in time deposit accounts of
$3.5 million, or 4.2%, and a decrease in savings accounts of $4.5 million, or
14.9%.





The
following table sets forth the balances of the Bank’s deposit products at the
dates indicated.





At
      December 31,2007
            
            
            2006
            
            
            2005(Dollars
      in thousands)Noninterest-bearing
      demand deposits
            
            $
            31,162
            
            
            $
            30,773
            
            
            $
            33,225Interest-bearing
      demand deposits
            
            
            28,061
            
            
            
            27,515
            
            
            
            27,298Money
      market deposit accounts
            
            
            28,763
            
            
            
            21,356
            
            
            
            24,004Regular
      savings
            
            
            25,963
            
            
            
            30,499
            
            
            
            36,805Certificates
      of deposit
            
            
            79,336
            
            
            
            82,831
            
            
            
            71,249Total
            
            $
            193,285
            
            
            $
            192,974
            
            
            $
            192,581





The
following table indicates the amount of jumbo certificates of deposit by time
remaining until maturity as of December 31, 2007.  Jumbo certificates
of deposit require minimum deposits of $100,000.  The Bank does not
offer special rates for jumbo certificates.





Maturity
      Period
              
              Certificates
      of Deposit(Dollars
      in thousands)Three
      months or less
              
              $
              12,495Over
      three through six months
              
              
              5,308Over
      six through twelve months
              
              
              5,399Over
      twelve months
              
              
              714Total
              
              $
              23,916





Borrowings.Newport Federal
utilizes borrowings from the Federal Home Loan Bank of Boston and repurchase
agreements to supplement the Bank’s supply of funds for loans and
investments.




Year
      Ended December 31,2007
              
              
              2006
              
              
              2005(Dollars
      in thousands)Maximum
      amount outstanding at any month end during the year
              
              $
              105,356
              
              
              $
              66,384
              
              
              $
              53,522Average
      balance outstanding
              
              $
              56,412
              
              
              $
              44,814
              
              
              $
              48,148Weighted
      average interest rate during the year
              
              
              4.97
              %
              
              
              5.23
              %
              
              
              5.32
              %Balance
      outstanding at end of period
              
              $
              105,356
              
              
              $
              34,450
              
              
              $
              50,123Weighted
      average interest rate at end of year
              
              
              4.14
              %
              
              
              5.05
              %
              
              
              5.22
              %




Federal
Home Loan Bank advancesincreased by $46.0
million to $80.4 million at December 31, 2007.  During 2007, the Bank
also borrowed $25.0 million using a repurchase agreement.  These
borrowings were used to help fund loan originations, to purchase securities held
to maturity and to purchase bank-owned life insurance during
2007.  The Bank had no securities sold under agreements to repurchase
in 2006 or 2005, and no other borrowings during the periods
indicated.


25
 Index




Results
of Operations for the Years Ended December 31, 2007 and 2006





Overview.




2007
            
            
            2006(Dollars
      in thousands)Net
      income (loss)
            
            $
            757
            
            
            $
            (1,656
            )Return
      on average assets
            
            
            0.24
            %
            
            
            (0.59
            )%Return
      on average equity
            
            
            1.25
            %
            
            
            (4.32
            )%Average
      equity to average assets
            
            
            19.28
            %
            
            
            13.56
            %





Net
income in 2007 was $757,000 compared to a loss of $1.7 million in 2006. The
increases in the Bank’s net interest income of $414,000 and non-interest income
of $868,000, along with the decrease in non-interest expenses of $2.4 million
contributed towards the net income in 2007.  The $414,000 increase in
net interest income was primarily the result of higher levels of
interest-earning assets, partially offset by expense from borrowings utilized to
fund the year’s asset growth and increased rates paid on interest-bearing
deposits.  The increase in non-interest income is attributable to FHLB
pre-payment penalties during 2006 of $367,000, which resulted in lower
non-interest income for the 2006 period compared to 2007.  Excluding
the debt pre-payment expense, the increase in non-interest income is primarily
due to the higher income earned on checking accounts and on bank-owned life
insurance.  Non-interest expense for 2007 decreased to $10.8 million
from $13.2 million in 2006, a decrease of 18.2%.  The higher
non-interest expense reported in the 2006 period is primarily due to the $3.6
million contribution to the NewportFed Charitable Foundation, made as part of
the Bank’s conversion to stock form.  Additionally, non-interest
expenses increased $1.2 million primarily due to increases in salaries and
employee benefits of $757,000, including an increase in ESOP and stock-based
compensation expense of $520,000.  Professional fees increased as a
result of costs associated with being a public company, including the Company’s
implementation of the provisions of Section 404 of the Sarbanes-Oxley Act of
2002.  Marketing costs increased as a result of a stronger marketing
focus for Newport Federal and its deposit products during
2007.  Effective tax rates were 44.1% and (18.3%) for 2007 and 2006,
respectively.




26
 Index




Average Balances
and Yields.The following
table presents information regarding average balances of assets and liabilities,
the total dollar amounts of interest income and dividends from average
interest-earning assets, the total dollar amounts of interest expense on average
interest-bearing liabilities, and the resulting annualized average yields and
costs.  The yields and costs for the periods indicated are derived by
dividing income or expense by the average balances of assets or liabilities,
respectively, for the periods presented.  For purposes of this table,
average balances have been calculated using month-end balances, and nonaccrual
loans are included in average balances only.  Management does not
believe that use of month-end balances instead of daily average balances has
caused any material differences in the information presented.  None of
the income reflected in the following table is tax-exempt income.





Year
      Ended December 31,2007
            
            
            2006
            
            
            2005Average
              Balance
            
            
            Interest
              and
              Dividends
            
            
            Yield/
              Cost
            
            
            Average
              Balance
            
            
            Interest
              and
              Dividends
            
            
            Yield/
              Cost
            
            
            Average
      Balance
            
            
            Interest
      and Dividends
            
            
            Yield/
      Cost(Dollars
      in thousands)Assets:Interest-earning
      assets:Loans
            
            $
            272,615
            
            
            $
            17,195
            
            
            
            6.31
            %
            
            $
            248,361
            
            
            $
            15,280
            
            
            
            6.15
            %
            
            $
            222,004
            
            
            $
            13,240
            
            
            
            5.96
            %Securities
            
            
            11,203
            
            
            
            567
            
            
            
            5.06
            
            
            
            8,543
            
            
            
            386
            
            
            
            4.52
            
            
            
            8,771
            
            
            
            321
            
            
            
            3.66Other
      interest-earning assets
            
            
            5,975
            
            
            
            226
            
            
            
            3.78
            
            
            
            12,640
            
            
            
            425
            
            
            
            3.36
            
            
            
            12,991
            
            
            
            321
            
            
            
            2.47Total
      interest-earning assets
            
            
            289,793
            
            
            
            17,988
            
            
            
            6.21
            
            
            
            269,544
            
            
            
            16,091
            
            
            
            5.97
            
            
            
            243,766
            
            
            
            13,882
            
            
            
            5.69Bank-owned
      life insurance
            
            
            9,024
            
            
            
            
            
            
            
            
            
            
            
            1,878
            
            
            
            
            
            
            
            
            
            
            
            1,981Noninterest-earning
      assets
            
            
            14,480
            
            
            
            
            
            
            
            
            
            
            
            11,335
            
            
            
            
            
            
            
            
            
            
            
            10,158Total
      assets
            
            $
            313,297
            
            
            
            
            
            
            
            
            
            
            $
            282,757
            
            
            
            
            
            
            
            
            
            
            $
            255,905Liabilities
      and equity:Interest-bearing
      liabilities:Interest-bearing
      demand deposits
            
            $
            26,011
            
            
            
            98
            
            
            
            0.38
            
            
            $
            26,404
            
            
            
            59
            
            
            
            0.22
            
            
            $
            28,346
            
            
            
            63
            
            
            
            0.22Savings
      accounts
            
            
            29,131
            
            
            
            94
            
            
            
            0.32
            
            
            
            33,774
            
            
            
            109
            
            
            
            0.32
            
            
            
            41,132
            
            
            
            192
            
            
            
            0.47Money
      market accounts
            
            
            23,123
            
            
            
            900
            
            
            
            3.89
            
            
            
            24,211
            
            
            
            630
            
            
            
            2.60
            
            
            
            25,819
            
            
            
            577
            
            
            
            2.23Certificates
      of deposit
            
            
            83,593
            
            
            
            3,796
            
            
            
            4.54
            
            
            
            77,927
            
            
            
            3,070
            
            
            
            3.94
            
            
            
            60,160
            
            
            
            1,724
            
            
            
            2.87Total
      interest-bearing deposits
            
            
            161,858
            
            
            
            4,888
            
            
            
            3.02
            
            
            
            162,316
            
            
            
            3,868
            
            
            
            2.38
            
            
            
            155,457
            
            
            
            2,556
            
            
            
            1.64Borrowings
            
            
            56,412
            
            
            
            2,806
            
            
            
            4.97
            
            
            
            44,814
            
            
            
            2,343
            
            
            
            5.23
            
            
            
            48,148
            
            
            
            2,562
            
            
            
            5.32Total
      interest-bearing liabilities
            
            
            218,270
            
            
            
            7,694
            
            
            
            3.52
            
            
            
            207,130
            
            
            
            6,211
            
            
            
            3.00
            
            
            
            203,605
            
            
            
            5,118
            
            
            
            2.51Demand
      deposits
            
            
            32,400
            
            
            
            
            
            
            
            
            
            
            
            35,601
            
            
            
            
            
            
            
            
            
            
            
            33,303Noninterest-bearing
      liabilities
            
            
            2,221
            
            
            
            
            
            
            
            
            
            
            
            1,674
            
            
            
            
            
            
            
            
            
            
            
            1,215Total
      liabilities
            
            
            252,891
            
            
            
            
            
            
            
            
            
            
            
            244,405
            
            
            
            
            
            
            
            
            
            
            
            238,123Equity
            
            
            60,406
            
            
            
            
            
            
            
            
            
            
            
            38,352
            
            
            
            
            
            
            
            
            
            
            
            17,782Total
      liabilities and equity
            
            $
            313,297
            
            
            
            
            
            
            
            
            
            
            $
            282,757
            
            
            
            
            
            
            
            
            
            
            $
            255,905Net
      interest income
            
            
            
            
            
            $
            10,294
            
            
            
            
            
            
            
            
            
            
            $
            9,880
            
            
            
            
            
            
            
            
            
            
            $
            8,764Interest
      rate spread
            
            
            
            
            
            
            
            
            
            
            2.69
            %
            
            
            
            
            
            
            
            
            
            
            2.97
            %
            
            
            
            
            
            
            
            
            
            
            3.18
            %Net
      interest margin
            
            
            
            
            
            
            
            
            
            
            3.55
            %
            
            
            
            
            
            
            
            
            
            
            3.67
            %
            
            
            
            
            
            
            
            
            
            
            3.60
            %Average
      interest-earning assets to average interest- bearing
      liabilities
            
            
            
            
            
            
            
            
            
            
            132.77
            %
            
            
            
            
            
            
            
            
            
            
            130.13
            %
            
            
            
            
            
            
            
            
            
            
            119.72
            %


27
 Index




Rate/Volume
Analysis.  The following
table sets forth the effects of changing rates and volumes on our net interest
income.  The rate column shows the effects attributable to changes in
rate (changes in rate multiplied by prior volume).  The volume column
shows the effects attributable to changes in volume (changes in volume
multiplied by prior rate).  The net column represents the sum of the
prior columns.  For purposes of this table, changes attributable to
changes in both rate and volume that cannot be segregated have been allocated
proportionately based on the changes due to rate and the changes due to
volume.





2007
      Compared to 2006Increase
      (Decrease)
                Due
      toVolume
              
              
              Rate
              
              
              Net(Dollars
      in thousands)Interest
      and dividend income:Loans
              
              $
              1,522
              
              
              $
              393
              
              
              $
              1,915Securities
              
              
              131
              
              
              
              50
              
              
              
              181Other
      interest-earning assets
              
              
              (261
              )
              
              
              62
              
              
              
              (199
              )Total
      interest-earning assets
              
              
              1,392
              
              
              
              505
              
              
              
              1,897Interest
      expense:Deposits
              
              
              11
              
              
              
              (1,031
              )
              
              
              (1,020
              )Borrowings
              
              
              (570
              )
              
              
              107
              
              
              
              (463
              )Total
      interest-bearing liabilities
              
              
              (559
              )
              
              
              (924
              )
              
              
              (1,483
              )Net
      change in interest income
              
              $
              833
              
              
              $
              (419
              )
              
              $
              414





Net Interest
Income.Net
interest income for the year ended December 31, 2007 was $10.3 million, compared
to $9.9 million for year December 31, 2006, an increase of 4.2%.  The
increase in net interest income is due to the increase in interest-earning
assets, partially offset by increased expense from borrowings utilized to fund
the year’s asset growth and increased rates paid on interest-bearing
deposits.  The yield on interest-earning assets increased to 6.21% in
2007 from 5.97% in 2006, an increase of 24 basis points.  The cost of
interest-bearing liabilities increased to 3.52% in 2007 from 3.00% in 2006, an
increase of 52 basis points.  The net interest margin decreased to
3.55% for 2007 from 3.67% in 2006, down 12 basis points.





Provision for
Loan Losses.The loan loss provision for the years ended
December 31, 2007 and December 31, 2006 was $426,000 and $120,000,
respectively.  The provision was increased primarily due to the growth
in the loan portfolio, changes in the composition of the loan portfolio
including the increase in commercial mortgages and changes in general economic
conditions including the slowing economy and falling housing
prices.





Non-Interest
Income.The following table shows the components of
non-interest income and the percentage changes from year to year.





Year
      Ended December 31,2007
            
            
            2006
            
            
            %
      Change(Dollars
      in thousands)Customer
      service fees
            
            $
            1,839
            
            
            $
            1,593
            
            
            
            15.4
            %FHLB
      pre-payment penalties
            
            
            -
            
            
            
            (367
            )
            
            
            -Bank-owned
      life insurance
            
            
            392
            
            
            
            75
            
            
            
            422.7Other
            
            
            88
            
            
            
            150
            
            
            
            (41.3
            )Total
            
            $
            2,319
            
            
            $
            1,451
            
            
            
            59.8
            %





Non-interest
income for 2007 totaled $2.3 million, an increase of $868,000, or 59.8%,
compared to 2006.  FHLB pre-payment penalties during 2006 resulted in
lower non-interest income for 2006 as compared to 2007.  Excluding the
debt pre-payment expense, the increase in non-interest income is primarily due
to the higher income earned on checking accounts and on bank-owned life
insurance.




28
 Index




Non-Interest
Expense.The following table shows the components of
non-interest expense and the percentage changes for the years
indicated.





2007
            
            
            2006
            
            
            %
      Change(Dollars
      in thousands)Salaries
      and employee benefits
            
            $
            6,171
            
            
            $
            5,414
            
            
            
            14.0
            %Occupancy
      and equipment, net
            
            
            1,282
            
            
            
            1,235
            
            
            
            3.8Data
      processing
            
            
            1,004
            
            
            
            1,022
            
            
            
            (1.8
            )Professional
      fees
            
            
            563
            
            
            
            387
            
            
            
            45.5Marketing
            
            
            1,085
            
            
            
            797
            
            
            
            36.1Contribution
      to NewportFed Charitable Foundation....
            
            
            -
            
            
            
            3,614
            
            
            
            (100.0
            )All
      other
            
            
            729
            
            
            
            769
            
            
            
            (5.2
            )Total
            
            $
            10,834
            
            
            $
            13,238
            
            
            
            (18.2
            )%Efficiency
      ratio (1)
            
            
            85.90
            %
            
            
            84.94
            %
            
            
            0.96
            %






(1)
            Computed
      as total non-interest expense minus the expense related to the
      contribution to the NewportFed Charitable Foundation divided by the sum of
      net interest income and non-interest
income.





Total
non-interest expenses for 2007 decreased to $10.8 million from $13.2 million for
2006, a decrease of 18.2%.  The higher non-interest expense reported
in the 2006 period is primarily due to the $3.6 million donation payment to the
NewportFed Charitable Foundation.  Additionally, non-interest expenses
increased due to increases in salaries and employee benefits, resulting from
ESOP and stock compensation expense, and professional fees due to increased
costs associated with being a public company and with the Company’s
implementation of the provisions of the Sarbanes-Oxley Act of
2002.  Marketing costs increased as a result of a stronger marketing
focus for the Bank and its deposit products during 2007.




Income Tax
Expense.The incometax expense for 2007
was $596,000 compared to an income tax benefit of $371,000 for
2006.  The effective tax rates were 44.1% and (18.3%) in 2007 and
2006, respectively.  The lower-than-expected tax benefit rate in 2006
relates to the limited deduction of the contribution of $3.6 million to the
charitable foundation.  The effective tax rate in 2007 includes the
non-deductible compensation expense recorded for a portion of the incentive
stock options, which was principally offset by non-taxable BOLI
income.





The
deferred tax assets applicable to loss carry forwards relating to the deduction
for the donation to the charitable foundation are recoverable, only to the
extent that 10% pre-tax of income exceeds the deduction during the five-year
carry forward period.  Newport Bancorp had previously recognized a
valuation allowance of $464,000 against the deferred tax asset related to this
loss carry forward at December 31, 2006. This valuation allowance is assessed
quarterly for recoverability.  Based upon management’s assessment, the
valuation allowance increased by $28,000 during the year ended December 31,
2007.





Risk
Management





Overview.  Managing risk is
an essential part of successfully managing a financial
institution.  Newport Bancorp’s most prominent risk exposures are
credit risk, interest rate risk and market risk.  Credit risk is the
risk of not collecting the interest and/or the principal balance of a loan or
investment when it is due.  Interest rate risk is the potential
reduction of interest income as a result of changes in interest
rates.  Market risk arises from fluctuations in interest rates that
may result in changes in the values of financial instruments, such as
available-for-sale securities that are accounted for on a mark-to-market
basis.  Other risks that the Company faces are operational risks,
liquidity risks and reputation risk.  Operational risks include risks
related to fraud, regulatory compliance, processing errors, technology and
disaster recovery.  Liquidity risk is the possible inability to fund
obligations to depositors, lenders or borrowers.  Reputation risk is
the risk that negative publicity or press, whether true or not, could cause a
decline in our customer base or revenue.


29
 Index




Credit Risk
Management.  Newport Federal’s
strategy for credit risk management focuses on having well-defined credit
policies and uniform underwriting criteria and providing prompt attention to
potential problem loans.





When a
borrower fails to make a required loan payment, the Bank takes a number of steps
to have the borrower cure the delinquency and restore the loan to current
status.  When the loan becomes 15 days past due a late notice is sent
to the borrower.  When the loan becomes 18 days past due, a more
formal letter is sent.  When a loan becomes 25 days past due, the
borrower is typically called.  After 30 days, we regard the borrower
as in default.  The borrower is promptly sent a letter from the Bank’s
attorney and the Bank may commence collection proceedings.  If a
foreclosure action is instituted and the loan is not brought current, paid in
full, or refinanced before the foreclosure sale, the real property securing the
loan generally is sold at foreclosure.  Generally, when a consumer
loan becomes 60 days past due, we institute collection proceedings and attempt
to repossess any personal property that secures the loan.  Management
informs the board of directors monthly of the amount of loans delinquent more
than 30 days, all loans in foreclosure and repossessed property that we
own.





Analysis of
Nonperforming and Classified Assets.  Newport Bancorp
considers repossessed assets and loans that are 90 days or more past due to be
nonperforming assets.  Loans are generally placed on nonaccrual status
when they become 90 days delinquent at which time the accrual of interest ceases
and the allowance for any uncollectible accrued interest is established and
charged against operations.  Typically, payments received on a
nonaccrual loan are applied to the outstanding principal and interest as
determined at the time of collection of the loan.





The
following table provides information with respect to the Bank’s nonperforming
assets at the dates indicated.





At
      December 31,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003(Dollars
      in thousands)Nonaccrual
      loans:Real
      estate—mortgage:One-
      to four-family
            
            $
            –
            
            
            $
            –
            
            
            $
            –
            
            
            $
            78
            
            
            $
            238Commercial
            
            
            908
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Total
            
            
            908
            
            
            
            –
            
            
            
            –
            
            
            
            78
            
            
            
            238Accruing
      loans past due 90 days or more
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Total
      nonperforming loans
            
            
            908
            
            
            
            –
            
            
            
            –
            
            
            
            78
            
            
            
            238Real
      estate owned
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            190Other
      nonperforming assets
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Total
      nonperforming assets
            
            $
            908
            
            
            $
            –
            
            
            $
            –
            
            
            $
            78
            
            
            $
            428Total
      nonperforming loans to total loans
            
            
            0.31
            %
            
            
            0.00
            %
            
            
            0.00
            %
            
            
            0.04
            %
            
            
            0.12
            %Total
      nonperforming loans to total assets
            
            
            0.25
            %
            
            
            0.00
            %
            
            
            0.00
            %
            
            
            0.03
            %
            
            
            0.10
            %Total
      nonperforming assets to total assets
            
            
            0.25
            %
            
            
            0.00
            %
            
            
            0.00
            %
            
            
            0.03
            %
            
            
            0.18
            %








Federal
regulations require the Newport Federal to review and classify the Bank’s assets
on a regular basis.  In addition, the Office of Thrift Supervision has
the authority to identify problem assets and, if appropriate, require them to be
classified.  There are three classifications for problem
assets:  substandard, doubtful and loss.  “Substandard
assets” must have one or more defined weaknesses and are characterized by the
distinct possibility that we will sustain some loss if the deficiencies are not
corrected.  “Doubtful assets” have the weaknesses of substandard
assets with the additional characteristic that the weaknesses make collection or
liquidation in full on the basis of currently existing facts, conditions and
values questionable, and there is a high possibility of loss.  An
asset classified “loss” is considered uncollectible and of such little value
that continuance as an asset of the institution is not warranted.  The
regulations also provide for a “special mention” category, described as assets
which do not currently expose us to a sufficient degree of risk to warrant
classification but do possess credit deficiencies or potential weaknesses
deserving our close attention.  When the Bank classifies an asset as
substandard or doubtful, the asset is assessed for impairment, and we establish
a specific allowance for loan losses when appropriate.  If Newport
Federal classifies an asset as loss, it is charged off at an amount equal to
100% of the portion of the asset-classified loss.


30
 Index





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





At
      December 31,2007
            
            
            2006
            
            
            2005(Dollars
      in thousands)Special
      mention assets
            
            $
            –
            
            
            $
            –
            
            
            $
            –Substandard
      assets
            
            
            908
            
            
            
            –
            
            
            
            –Doubtful
      assets
            
            
            –
            
            
            
            –
            
            
            
            –Loss
      assets
            
            
            –
            
            
            
            –
            
            
            
            –Total
      classified assets
            
            $
            908
            
            
            $
            –
            
            
            $
            –





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





At
      December 31,2007
            
            
            2006
            
            
            200530-59
              Days
              Past
      Due
            
            60-89
              Days
              Past
      Due
            
            
            30-59
              Days
              Past
      Due
            
            
            60-89
              Days
              Past
      Due
            
            
            30-59
              Days
              Past
      Due
            
            
            60-89
              Days
              Past
      Due(Dollars
      in thousands)Real
      estate – mortgage:One-
      to four-family
            
            $
            468
            
            
            $
            82
            
            
            $
            59
            
            
            $
            –
            
            
            $
            586
            
            
            $
            –Commercial
            
            
            –
            
            
            
            76
            
            
            
            295
            
            
            
            –
            
            
            
            –
            
            
            
            –Consumer
            
            
            –
            
            
            
            7
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Total
            
            $
            468
            
            
            $
            165
            
            
            $
            354
            
            
            $
            –
            
            
            $
            586
            
            
            $
            –Delinquent
      loans to total loans
            
            
            0.16
            %
            
            
            0.06
            %
            
            
            0.14
            %
            
            
            0.00
            %
            
            
            0.25
            %
            
            
            0.00
            %





Analysis and
Determination of the Allowance for Loan Losses.The allowance for loan
losses is a valuation allowance for probable losses inherent in the loan
portfolio.  Newport Federal evaluates the need to establish allowances
against losses on loans on a quarterly basis.  When additional
allowances are necessary, a provision for loan losses is charged to
earnings.





Our
methodology for assessing the appropriateness of the allowance for loan losses
consists of:  (1) a specific valuation allowance on identified
impaired loans; and (2) a general valuation allowance on the remainder of the
loan portfolio.  Although the Bank determines the amount of each
element of the allowance separately, the entire allowance for loan losses is
available to absorb losses in the loan portfolio.





Specific
Valuation Allowance on Identified Impaired Loans.  Newport
Federal identifies loans that may need to be charged off as a loss, or need a
specific reserve in accordance with SFAS 114, by reviewing all delinquent loans,
classified loans and other loans that management may have concerns about
collectability.  All identified impaired loans are reviewed to assess
the borrower’s inability to make payments under the terms of the loan and/or a
shortfall in collateral value that would result in charging off the loan or the
portion of the loan that was impaired.





General Valuation
Allowance on the Remainder of the Loan Portfolio.  Newport
Federal establishes a general allowance for loans that are not problem loans, to
recognize the inherent losses associated with lending
activities.  This general valuation allowance is determined by
segregating the loans by loan category and assigning allowance percentages to
each category.  The percentages are adjusted for significant changes
in factors that, in management’s judgment, affect the collectability of the
portfolio as of the evaluation date.  These significant factors may
include changes in lending policies and procedures, changes in existing general
economic and business conditions affecting our primary lending areas, credit
quality trends, collateral value, loan volumes and concentrations, seasoning of
the loan portfolio, recent loss experience in particular segments of the
portfolio, duration of the current business cycle and bank regulatory
examination results.  The applied loss factors are reevaluated
periodically to ensure their relevance in the current economic
environment.


31
 Index




The Bank
engages an independent third party to conduct an annual review of its commercial
real estate portfolio.  This loan review, which typically includes a
50% penetration of the commercial real estate portfolio, provide a credit
evaluation of individual loans to determine whether the risk ratings assigned
are appropriate.





The
Office of Thrift Supervision, as an integral part of its examination process,
periodically reviews our allowance for loan losses.  The Office of
Thrift Supervision may require the Bank to make additional provisions for loan
losses based on judgments different from ours.





The Bank
assigns percentages to eight qualitative loan portfolio risk factors to
determine the adequacy of the allowance for loan losses.





1.
            Levels/trends
      in delinquencies/impaired/classified
loans,


2.
            Levels/trends
      in charge-offs/recoveries,


3.
            Trends
      in volume and terms of loan,


4.
            Effects
      of changes in risk selection and underwriting standards and other changes
      in lending policies, procedures and
practices,


5.
            Experience/ability
      and depth of lending management and
staff,


6.
            National
      and local economic trends and
conditions,


7.
            Industry
      conditions, and


8.
            Effects
      of changes in credit concentration.





At
December 31, 2007, the allowance for loan losses represented 0.8% of total
loans.  No portion of the allowance was allocated to impaired loans at
December 31, 2007. The allowance for loan
losses increased from $1,973,000 at December 31, 2006, to $2,399,000 at December
31, 2007, or 21.6%.  At December 31, 2006, the allowance for loan
losses represented 0.76% of total loans.  The increase in 2007, was
primarily due to the growth, changes in the composition of the loan portfolio
and changes in general economic conditions. The increase in the allowance for
loan losses as a percentage of the loan portfolio was primarily due to an
increase in the proportion of commercial loans in the portfolio and the increase
in the percentage used to calculate the allowance on such loans due to general
economic conditions.


32
 Index




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





At
      December 31,2007
            
            
            2006Amount
            
            
            %
      of
              Allowance
              to
      Total
              Allowance
            
            
            %
      of
              Loans
      in
              Category
              to
      Total
              Loans
            
            
            Amount
            
            
            %
      of
              Allowance
              to
      Total
              Allowance
            
            
            %
      of
              Loans
      in
              Category
              to
      Total
              Loans(Dollars
      in thousands)Real
      estate—Mortgage:One-
      to four-family
            
            $
            835
            
            
            
            34.80
            %
            
            
            57.08
            %
            
            $
            787
            
            
            
            39.89
            %
            
            
            60.67
            %Multi-family
            
            
            137
            
            
            
            5.71
            
            
            
            3.20
            
            
            
            121
            
            
            
            6.13
            
            
            
            3.61Commercial
            
            
            1,115
            
            
            
            46.48
            
            
            
            25.95
            
            
            
            749
            
            
            
            37.96
            
            
            
            22.21Home
      equity loans and lines
            
            
            170
            
            
            
            7.09
            
            
            
            10.44
            
            
            
            241
            
            
            
            12.22
            
            
            
            11.28Construction
            
            
            136
            
            
            
            5.67
            
            
            
            3.18
            
            
            
            61
            
            
            
            3.09
            
            
            
            1.80Other
      consumer
            
            
            6
            
            
            
            0.25
            
            
            
            0.15
            
            
            
            14
            
            
            
            0.71
            
            
            
            0.43Total
      allowance for loan losses
            
            $
            2,399
            
            
            
            100.00
            %
            
            
            100.00
            %
            
            $
            1,973
            
            
            
            100.00
            %
            
            
            100.00
            %






At
      December 31,2005
              
              
              2004
              
              
              2003Amount
              
              
              %
      of
                Allowance
                to
      Total
                Allowance
              
              
              %
      of
                Loans
      in
                Category
                to
      Total
                Loans
              
              
              Amount
              
              
              %
      of
                Allowance
                to
      Total
                Allowance
              
              
              %
      of
                Loans
      in
                Category
                to
      Total
                Loans
              
              
              Amount
              
              
              %
      of
                Allowance
                to
      Total
                Allowance
              
              
              %
      of
                Loans
      in
                Category
                to
      Total
                LoansReal
      estate—Mortgage:
              
              (Dollars
      in thousands)One-
      to four-family
              
              $
              912
              
              
              
              49.22
              %
              
              
              64.90
              %
              
              $
              776
              
              
              
              46.89
              %
              
              
              62.96
              %
              
              $
              720
              
              
              
              47.65
              %
              
              
              62.61
              %Multi-family
              
              
              81
              
              
              
              4.37
              
              
              
              2.87
              
              
              
              65
              
              
              
              3.93
              
              
              
              2.65
              
              
              
              45
              
              
              
              2.98
              
              
              
              2.00Commercial
              
              
              573
              
              
              
              30.92
              
              
              
              20.33
              
              
              
              520
              
              
              
              31.42
              
              
              
              21.20
              
              
              
              506
              
              
              
              33.49
              
              
              
              22.19Home
      equity loans and lines
              
              
              234
              
              
              
              12.63
              
              
              
              10.02
              
              
              
              192
              
              
              
              11.60
              
              
              
              9.01
              
              
              
              153
              
              
              
              10.13
              
              
              
              7.80Construction
              
              
              38
              
              
              
              2.05
              
              
              
              1.34
              
              
              
              86
              
              
              
              5.19
              
              
              
              3.53
              
              
              
              72
              
              
              
              4.76
              
              
              
              4.72Other
      consumer
              
              
              15
              
              
              
              0.81
              
              
              
              0.54
              
              
              
              16
              
              
              
              0.97
              
              
              
              0.65
              
              
              
              15
              
              
              
              0.99
              
              
              
              0.68Total
      allowance for loan losses..
              
              $
              1,853
              
              
              
              100.00
              %
              
              
              100.00
              %
              
              $
              1,655
              
              
              
              100.00
              %
              
              
              100.00
              %
              
              $
              1,511
              
              
              
              100.00
              %
              
              
              100.00
              %





Although
Newport Federal believes the best information available was used to establish
the allowance for loan losses, future adjustments to the allowance for loan
losses may be necessary and our results of operations could be adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations.  Furthermore, while the Bank believes it
has established the allowance for loan losses in conformity with generally
accepted accounting principles, there can be no assurance that regulators, in
reviewing the loan portfolio, will not require an increase in the allowance for
loan losses.  In addition, because future events affecting borrowers
and collateral cannot be predicted with certainty, there can be no assurance
that the existing allowance for loan losses is adequate or that increases will
not be necessary should the quality of any loans deteriorate as a result of the
factors discussed above.  Any material increase in the allowance for
loan losses may adversely affect our financial condition and results of
operations.


33
 Index




Analysis of Loan
Loss Experience.  The following table sets forth an analysis of
the allowance for loan losses for the periods indicated.  Where
specific loan loss allowances have been established, any difference between the
loss allowance and the amount of loss realized has been charged or credited to
current income.





Year
      Ended December 31,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003(Dollar
      in thousands)Balance
      at beginning of period
            
            $
            1,973
            
            
            $
            1,853
            
            
            $
            1,655
            
            
            $
            1,511
            
            
            $
            1,482Provision
      for loan losses
            
            
            426
            
            
            
            120
            
            
            
            198
            
            
            
            144
            
            
            
            36Charge
      offs:Real
      estate–Mortgage:One-
      to four-family
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Non-residential
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Consumer
      loans
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            7Total
      charge-offs
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            7Recoveries:Real
      estate–mortgage:One-
      to four-family
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Non-residential
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Consumer
      loans
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Total
      recoveries
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Net
      charge-offs (recoveries)
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            7Balance
      at end of period
            
            $
            2,399
            
            
            $
            1,973
            
            
            $
            1,853
            
            
            $
            1,655
            
            
            $
            1,511Net
      charge-offs to average loans outstanding during the period
            
            
            0.00
            %
            
            
            0.00
            %
            
            
            0.00
            %
            
            
            0.00
            %
            
            
            0.00
            %





Qualitative Aspects of Market
Risk.The Company’s most significant form of market risk is
interest rate risk.  Newport Bancorp manages the interest rate
sensitivity of its interest-bearing liabilities and interest-earning assets in
an effort to minimize the adverse effects of changes in the interest rate
environment.  Deposit accounts typically react more quickly to changes
in market interest rates than mortgage loans because of the shorter maturities
of deposits.  As a result, sharp increases in interest rates may
adversely affect earnings while decreases in interest rates may beneficially
affect earnings.  To reduce the potential volatility of our earnings,
the Company has sought to improve the match between asset and liability
maturities and rates, while maintaining an acceptable interest rate
spread.  Newport Bancorp’s strategy for managing interest rate risk
emphasizes:  adjusting the maturities of borrowings; adjusting the
investment portfolio mix and duration; and periodically selling fixed-rate
mortgage loans and available-for-sale investment securities.





The
Company has an Asset Liability Management Committee to communicate, coordinate
and control all aspects involving asset/liability management. The committee
establishes and monitors the volume, maturities, pricing and mix of assets and
funding sources with the objective of managing assets and funding sources to
provide results that are consistent with liquidity, growth, risk limits and
profitability goals.





Quantitative Aspects of Market
Risk.The Company uses an interest rate sensitivity
analysis prepared by the Office of Thrift Supervision to review our level of
interest rate risk.  This analysis measures interest rate risk by
computing changes in net portfolio value of our cash flows from assets,
liabilities and off-balance sheet items in the event of a range of assumed
changes in market interest rates.  Net portfolio value represents the
market value of portfolio equity and is equal to the market value of assets
minus the market value of liabilities, with adjustments made for off-balance
sheet items.  This analysis assesses the risk of loss in market risk
sensitive instruments in the event of a sudden and sustained 100 to 300 basis
point increase or 100 to 200 basis point decrease in market interest rates with
no effect given to any steps that we might take to counter the effect of that
interest rate movement.  Newport Bancorp measures interest rate risk
by modeling the changes in net portfolio value over a variety of interest rate
scenarios.


34
 Index




The
following table presents the change in the net portfolio value at September 30,
2007 (the most current information available), that would occur in the event of
an immediate change in interest rates based on Office of Thrift Supervision
assumptions, with no effect given to any steps that we might take to counteract
that change. The Bank expects that its net portfolio value at December 31, 2007
is consistent with the table below.





Net
      Portfolio Value
              (Dollars
      in thousands)
            
            
            Net
      Portfolio Value as % of
              Portfolio
      Value of AssetsBasic
      Point (“bp”)
              Change
      in Rates
            
            
            Amount
            
            
            Change
            
            
            %
      Change
            
            
            NPV
      Ratio
            
            
            Change
      (bp)300
            
            
            $
            30,034
            
            
            $
            -17,765
            
            
            
            -37
            
            
            
            9.77
            %
            
            
            -472200
            
            
            
            35,922
            
            
            
            -11,877
            
            
            
            -25
            
            
            
            11.41
            %
            
            
            -308100
            
            
            
            42,062
            
            
            
            -5,737
            
            
            
            -12
            
            
            
            13.04
            %
            
            
            -14450
            
            
            
            45,047
            
            
            
            -2,752
            
            
            
            -6
            
            
            
            13.81
            %
            
            
            -680
            
            
            
            47,799
            
            
            
            0
            
            
            
            -
            
            
            
            14.49
            %
            
            
            -(50
            )
            
            
            50,172
            
            
            
            2,373
            
            
            
            5
            
            
            
            15.05
            %
            
            
            +56(100
            )
            
            
            52,059
            
            
            
            4,259
            
            
            
            9
            
            
            
            15.48
            %
            
            
            +99(200
            )
            
            
            54,212
            
            
            
            6,413
            
            
            
            13
            
            
            
            15.90
            %
            
            
            +141






The
Office of Thrift Supervision uses certain assumptions in assessing the interest
rate risk of savings associations.  These assumptions relate to
interest rates, loan prepayment rates, deposit decay rates, and the market
values of certain assets under differing interest rate scenarios, among
others.  As with any method of measuring interest rate risk, certain
shortcomings are inherent in the method of analysis presented in the foregoing
table.  For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates.  Also, the interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates.  Additionally, certain assets, such as
adjustable-rate mortgage loans, have features that restrict changes in interest
rates on a short-term basis and over the life of the asset.  Further,
in the event of a change in interest rates, expected rates of prepayments on
loans and early withdrawals from certificates could deviate significantly from
those assumed in calculating the table.





The
Committee also measures and evaluates interest rate risk using income simulation
analysis. This analysis considers the maturity and repricing characteristics of
assets and liabilities, as well as the relative sensitivities of these balance
sheet components over a range of interest rate scenarios. Interest rate
scenarios tested generally include instantaneous rate shocks, rate ramps over a
one-year period, and static (or flat) rates. The simulation analysis is used to
measure the exposure of net interest income to changes in interest rates over a
specified time horizon, usually a two-year period.





The table
below sets forth, as of November 30, 2007, the estimated changes in Newport
Bancorp’s net interest income that would result from the designated
instantaneous changes in the U.S. Treasury yield curve. Computations of
prospective effects of hypothetical interest rate changes are based on numerous
assumptions including relative levels of market interest rates, loan prepayments
and deposit decay, and should not be relied upon as indicative of actual
results. The Bank expects that it’s percentage change in estimated net interest
income over the next 12 months and from months 13-24 at December 31, 2007 is
consistent with the table below.


35
 Index




%
      Change in Estimated
            
            
            %
      Change in EstimatedNet
      Interest Income Over
            
            
            Net
      Interest Income Overthe
      Next 12 Months
            
            
            Months
      13-24200
      basis point increase in rates
            
            
            (0.1)%
            
            
            
            2.1%Flat
      interest rates
            
            
            0.0%
            
            
            
            1.0%200
      basis point decrease in rates
            
            
            (1.6)%
            
            
            
            (10.1)%





As
indicated in the table above, the result of an immediate 200 basis point
parallel increase in interest rates is estimated to decrease net interest income
by 0.1% over a 12-month horizon, and 2.1% for months 13-24, when compared to the
flat rate scenario, which assumes no increase in interest-bearing checking rates
except for high balance interest bearing checking which increase 75 basis points
(BP), an increase in savings rates of 50-75 (BP) and an increase in money market
rates of 150 basis points.  These assumptions are based on the
Bank’s past experience with the changes in rates paid on these non-maturity
deposits coincident with changes in market interest rates.  The
estimated change in net interest income from the flat rate scenario for a
200 basis point parallel decline in the level of interest rates is a
decrease of 1.6% over the 12 month horizon and 10.1% for months 13-24, which
assumes no decrease in interest-bearing checking rates, except for high balance
accounts which decrease 30-50 BP, savings rates decreasing 20-33 BP and a
decrease in money market rates of 100 basis points. These assumptions are
based on the Bank’s past experience with the changes in rates paid on these
non-maturity deposits coincident with changes in market interest
rates.





There are
inherent shortcomings in income simulation, given the number and variety of
assumptions that must be made in performing the analysis. The assumptions relied
upon in making these calculations of interest rate sensitivity include the level
of market interest rates, the shape of the yield curve, the degree to which
certain assets and liabilities with similar maturities or periods to repricing
react to changes in market interest rates, the degree to which non-maturity
deposits react to changes in market rates, the expected prepayment rates on
loans and mortgage-backed securities, the degree to which early withdrawals
occur on certificates of deposit and the volume of other deposit flows. As such,
although the analysis shown above provides an indication of Newport Bancorp’s
sensitivity to interest rate changes at a point in time, these estimates are not
intended to and do not provide a precise forecast of the effect of changes in
market interest rates on Newport Bancorp’s net interest income and will differ
from actual results.





The table
below shows Newport Bancorp’s interest sensitivity gap position at December 31,
2007, indicating the amount of interest-earning assets and interest-bearing
liabilities that are anticipated to mature or reprice in each of the future time
periods shown. Generally, these assets and liabilities are shown in the table
based on the earlier of the time remaining to repricing or contractual maturity.
However, savings, money market deposit and interest bearing deposit accounts are
assumed to have annual rates of withdrawal (decay rates) of 26%, 32% and 10%,
respectively.




36
 Index


Repricing
      Gap as of December 31, 2007More
      than
              
              
              More
      than
              
              
              More
      thanUp
      to
              
              
              One
      Year to
              
              
              Two
      Years
              
              
              Three
      Years
              
              
              More
      thanOne
      Year
              
              
              Two
      Years
              
              
              to
      Three Years
              
              
              to
      Five Years
              
              
              Five
      Years
              
              
              Total(Dollars
      in thousands)Interest-earning
      assets:Loans
              
              $
              28,732
              
              
              $
              17,579
              
              
              $
              14,979
              
              
              $
              24,746
              
              
              $
              210,359
              
              
              $
              296,395Securities
              
              
              6,966
              
              
              
              -
              
              
              
              -
              
              
              
              1,606
              
              
              
              29,280
              
              
              
              37,852Short-term
      investments
              
              
              59
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              59Total
      interest-earning assets
              
              
              35,757
              
              
              
              17,579
              
              
              
              14,979
              
              
              
              26,352
              
              
              
              239,639
              
              
              
              334,306Interest-bearing
      liabilities:Savings
      deposits
              
              
              5,193
              
              
              
              4,154
              
              
              
              3,323
              
              
              
              2,659
              
              
              
              10,634
              
              
              
              25,963Money
      market deposits
              
              
              5,753
              
              
              
              4,602
              
              
              
              3,682
              
              
              
              2,945
              
              
              
              11,781
              
              
              
              28,763Interest-bearing
      demand deposits
              
              
              5,612
              
              
              
              4,490
              
              
              
              3,592
              
              
              
              2,873
              
              
              
              11,494
              
              
              
              28,061Certificates
      of deposits
              
              
              76,058
              
              
              
              1,707
              
              
              
              1,189
              
              
              
              382
              
              
              
              -
              
              
              
              79,336Borrowings
              
              
              12,809
              
              
              
              11,642
              
              
              
              9,500
              
              
              
              4,290
              
              
              
              67,115
              
              
              
              105,356Total
      interest-bearing liabilities
              
              
              105,425
              
              
              
              26,595
              
              
              
              21,286
              
              
              
              13,149
              
              
              
              101,024
              
              
              
              267,479Interest
      rate sensitivity gap
              
              $
              (69,668
              )
              
              $
              (9,016
              )
              
              $
              (6,307
              )
              
              $
              13,203
              
              
              $
              138,615
              
              
              $
              66,827Interest
      rate sensitivity gap as of total assets
              
              
              (19.28
              %)
              
              
              (2.50
              %)
              
              
              (1.75
              %)
              
              
              3.65
              %
              
              
              38.37
              %Cum.
      interest rate sensitivity gap
              
              $
              (69,668
              )
              
              $
              (78,684
              )
              
              $
              (84,991
              )
              
              $
              (71,788
              )
              
              $
              66,827Cum.
      interest rate sensitivity gap as a % of total assets
              
              
              (19.28
              %)
              
              
              (21.78
              %)
              
              
              (23.53
              %)
              
              
              (19.87
              %)
              
              
              18.50
              %


Liquidity
Management.  Liquidity is the
ability to meet current and future financial obligations of a short-term nature.
The primary sources of funds consist of deposit inflows, loan repayments,
maturities and sales of investment securities and borrowings from the Federal
Home Loan Bank of Boston.  While maturities and scheduled amortization
of loans and securities are predictable sources of funds, deposit flows and
mortgage prepayments are greatly influenced by general interest rates, economic
conditions and competition.





The Bank
regularly adjusts our investments in liquid assets based upon our assessment of
(1) expected loan demand, (2) expected deposit flows, (3) yields available
on interest-earning deposits and securities and (4) the objectives of our
asset/liability management policy.





The most
liquid assets are cash and cash equivalents and interest-bearing
deposits.  The levels of these assets depend on the operating,
financing, lending and investing activities during any given
period.  At December


37
 Index


31, 2007,
cash and cash equivalents totaled $6.7 million.  Securities classified
as available for sale and whose market value exceeds their cost provide an
additional source of liquidity.   Securities classified as
available for sale totaled $7.0 million at December 31, 2007.  In
addition, at December 31, 2007, which is the most recent date for which
information is available, we had the ability to borrow a total of approximately
$26.0 million from the Federal Home Loan Bank of Boston.  On December
31, 2007, we had $80.4 million of advances outstanding.


At
December 31, 2007, the Bank had $27.0 million in loan commitments outstanding,
which consisted of $4.8 million of real estate loan commitments, $14.9 million
in unused home equity lines of credit, $4.5 million in construction loan
commitments and $2.8 million in commercial lines of credit
commitments.  Certificates of deposit due within one year of December
31, 2007 totaled $76.1 million, or 95.9% of certificates of
deposit.  The large percentage of certificates of deposit that mature
within one year reflects customer’s hesitancy to invest their funds for long
periods in the recent low interest rate environment.  If these
maturing deposits do not remain with us, we will be required to seek other
sources of funds, including other certificates of deposit and
borrowings.  Depending on market conditions, Newport Federal may be
required to pay higher rates on such deposits or other borrowings than we
currently pay on the certificates of deposit due on or before December 31,
2007.  The Bank believes, however, based on past experience, that a
significant portion of our certificates of deposit will remain with the
Bank.  Newport Federal has the ability to attract and retain deposits
by adjusting the interest rates offered.





The
Bank’s primary investing activities are the origination and purchase of loans
and the purchase of securities.  The primary financing activities
consist of activity in deposit accounts and Federal Home Loan Bank
advances.  Deposit flows are affected by the overall level of interest
rates, the interest rates and products offered by Newport Federal and our local
competitors and other factors.  The Bank generally manages the pricing
of our deposits to be competitive.  Occasionally, promotional rates
are offered on certain deposit products to attract deposits.





Capital
Resources.  The Bank is subject to various regulatory capital
requirements administered by the Office of Thrift Supervision, including a
risk-based capital measure.  The risk-based capital guidelines include
both a definition of capital and a framework for calculating risk-weighted
assets by assigning balance sheet assets and off-balance sheet items to broad
risk categories.  At December 31, 2007, we exceeded all of our
regulatory capital requirements.  We are considered “well capitalized”
under regulatory guidelines.





The
initial public stock offering increased the Company’s equity by approximately
$43.6 million, which significantly increased liquidity and capital
resources.  The financial condition and results of operations were
enhanced by the capital from the offering, resulting in increased net
interest-earning assets and net income.  However, the large increase
in equity resulting from the capital raised in the offering will, initially,
have an adverse impact on our return on equity.  The Company may use
capital management tools such as cash dividends and common share
repurchases.  However, under Office of Thrift Supervision regulations,
we are not allowed to repurchase any shares during the first year following our
initial stock offering, except: (1) in extraordinary circumstances, we may make
open market repurchases of up to 5% of our outstanding stock if we receive the
prior non-objection of the OTS of such repurchases; (2) repurchases of
qualifying shares of a director or if we conduct an OTS-approved offer to
repurchase made to all shareholders; (3) if we repurchase to fund a restricted
stock award plan that has been approved by shareholders; or (4) if we repurchase
stock to fund a tax-qualified employee stock benefit plan.  All
repurchases are prohibited, however, if the repurchase would reduce Newport
Federal’s regulatory capital below regulatory required levels.





Off-Balance Sheet
Arrangements.  In the normal
course of operations, Newport Federal engages in a variety of financial
transactions that, in accordance with generally accepted accounting principles,
are not recorded in our financial statements. These transactions involve, to
varying degrees, elements of credit, interest rate and liquidity risk. Such
transactions are used primarily to manage customers’ requests for funding and
take the form of loan commitments and lines of credit.  For
information about the Bank’s loan commitments and unused lines of credit, see
note 12 of the notes to the financial statements.





For the
year ended December 31, 2007, the Company did not engage in any off-balance
sheet transactions reasonably likely to have a material effect on our financial
condition, results of operations or cash flows.


38
 Index




Effect
of Inflation and Changing Prices





The
financial statements and related financial data presented in this Form 10-K have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the change in the relative purchasing
power of money over time due to inflation. The primary impact of inflation on
our operations is reflected in increased operating costs. Unlike most industrial
companies, virtually all the assets and liabilities of a financial institution
are monetary in nature.  As a result, interest rates generally have a
more significant impact on a financial institution’s performance than do general
levels of inflation.  Interest rates do not necessarily move in the
same direction or to the same extent as the prices of goods and
services.





ITEM 7A.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





The
information required by this item is incorporated herein by reference to Part
II, Item 7,  “Management’s Discussion and Analysis
of Financial Condition and Results of Operation.”





ITEM 8.
            FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA





The
Consolidated Financial Statements, including supplemental data, of Newport
Bancorp, Inc. begin on page F-1 of this Annual Report.





ITEM 9.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE





None.





ITEM 9A(T).
            CONTROLS
      AND PROCEDURES





Evaluation
of Disclosure Controls and Procedures.




The
Company’s President and Chief Executive Officer, its Chief Financial Officer,
and other members of its senior management team have evaluated the effectiveness
of the Company’s disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) or 15d-15(e)), as of December 31, 2007. Based on such
evaluation, the President and Chief Executive Officer and Chief Financial
Officer have concluded that the Company’s disclosure controls and procedures, as
of the end of the period covered by this report, were adequate and effective to
provide reasonable assurance that information required to be disclosed by the
NewportFed Bancorp, including Newport Federal Savings Bank, in reports that are
filed or submitted under the Exchange Act, is recorded, processed, summarized
and reported, within the time periods specified in the Commission’s rules and
forms.




Changes
in Internal Controls Over Financial Reporting.




There
have been no changes in the Company’s internal control over financial reporting
during the quarter ended December 31, 2007 that have materially affected, or are
reasonably likely to materially affect, the Company’s internal control over
financial reporting.





Management’s
Report on Internal Control Over Financial Reporting.





The
management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting. The internal control process
has been designed under our supervision to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of the
Company’s financial statements for external reporting purposes in accordance
with accounting principles generally accepted in the United States of
America.





Management
conducted an assessment of the effectiveness of the Company’s internal control
over financial reporting as of December 31, 2007, utilizing the framework
established in Internal
Control — Integrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Based on




39
 Index








Our
internal control over financial reporting includes policies and procedures that
pertain to the maintenance of records that accurately and fairly reflect, in
reasonable detail, transactions and dispositions of assets; and provide
reasonable assurances that: (1) transactions are recorded as necessary to
permit preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America; (2) receipts
and expenditures are being made only in accordance with authorizations of
management and the directors of the Company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the Company’s assets that could have a material effect on
the Company’s financial statements.




All
internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.





This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management’s report in this annual report.








ITEM 9B.
            OTHER
      INFORMATION





Not
applicable.





PART
III





ITEM 10.
            DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE





The
information relating to the directors and officers of the Company, information
regarding compliance with Section 16(a) of the Exchange Act and information
regarding the audit committee and audit committee financial expert is
incorporated herein by reference to the Company’s Proxy Statement for the 2008
Annual Meeting of Stockholders (the “Proxy Statement”).




The
Company has adopted a code of ethics that applies to its principal executive
officer, the principal financial officer and principal accounting
officer.  The Code of Ethics is posted on the Company’s Internet Web
site at www.newportfederal.com.




ITEM11.
            EXECUTIVE
      COMPENSATION





The
information regarding executive compensation, compensation committee interlocks
and insider participation is incorporated herein by reference to the Proxy
Statement.


40
 Index




ITEM 12.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDERS MATTERS





(a)
            Security
      Ownership of Certain Beneficial
Owners





Information
required by this item is incorporated herein by reference to the section
captioned “Stock Ownership” in the Proxy Statement.





(b)
            Security
      Ownership of Management





Information
required by this item is incorporated herein by reference to the section
captioned “Stock Ownership” in the Proxy Statement.





(c)
            Changes
      in Control





Management
of the Company knows of no arrangements, including any pledge by any person or
securities of the Company, the operation of which may at a subsequent date
result in a change in control of the registrant.





(d)
            Equity
      Compensation Plan Information





The
following table sets forth information as of December 31, 2007 about Company
common stock that may be issued upon the exercise of options under the Newport
Bancorp, Inc. 2007 Equity Incentive Plan.  The plan was approved by
the Company’s stockholders.




Plan
      Category
            
            Number
      of securities
              to
      be issued upon
              the
      exercise of
              outstanding
      options,
              warrants
      and rights
            
            
            Weighted-average
              exercise
      price of
              outstanding
      options,
              warrants
      and rights
            
            
            Number
      of securities
              remaining
      available
              for
      future issuance under equity compensation plans (excluding securities
      reflected in the first column)Equity
      compensation plans approved by security holders
            
            
            437,900
            
            
            $
            12.53
            
            
            
            49,934Equity
      compensation plans not approved by security holders
            
            
            N/A
            
            
            
            N/A
            
            
            
            N/ATotal







ITEM 13.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE





The
information relating to certain relationships and related transactions and
director independence is incorporated herein by reference to the Proxy
Statement.





ITEM 14.
            PRINCIPAL
      ACCOUNTING FEES AND SERVICES





The
information relating to the principal accounting fees and expenses is
incorporated herein by reference to the Proxy Statement.




41
 Index





PART
IV





ITEM 15.
            EXHIBITS
      AND FINANCIAL STATEMENT SCHEDULES





(1)
            The
      financial statements required in response to this item are incorporated by
      reference from Item 8 of this
report.





(2)
            All
      financial statement schedules are omitted because they are not required or
      applicable, or the required information is shown in the consolidated
      financial statements or the notes
thereto.





(3)
            Exhibits







3.1
              
              Articles
      of Incorporation of Newport Bancorp, Inc. (1)3.2
              
              Bylaws
      of Newport Bancorp, Inc. (2)4.1
              
              Specimen
      Stock Certificate of Newport Bancorp, Inc. (1)10.1
              
              Supplemental
      Executive Retirement Plan* (3)10.2
              
              Form
      of Newport Federal Savings Bank Supplemental Director Retirement
      Agreement, as Amended* (1)10.3
              
              Employment
      Agreement between Newport Federal Savings Bank and Kevin M. McCarthy and
      Proposed Amendment* (1)10.4
              
              Amendment
      to the Employment Agreement between Newport Federal Savings Bank and Kevin
      M. McCarthy* (3)10.5
              
              Employment
      Agreement between Newport Bancorp, Inc. and Kevin M. McCarthy*
      (3)10.6
              
              Employment
      Agreement between Newport Federal Savings Bank and Nino Moscardi and
      Proposed Amendment* (1)10.7
              
              Amendment
      to the Employment Agreement between Newport Federal Savings Bank and Nino
      Moscardi* (3)10.8
              
              Employment
      Agreement between Newport Bancorp, Inc. and Nino Moscardi*
    (3)10.9
              
              Employment
      Agreement between Newport Federal Savings Bank and Ray Gilmore and
      Proposed Amendment* (1)10.10
              
              Amendment
      to the Employment Agreement between Newport Federal Savings Bank and Ray
      Gilmore* (3)10.11
              
              Employment
      Agreement between Newport Bancorp, Inc. and Bruce A. Walsh*
      (3)10.12
              
              Change
      in Control Agreement between Newport Federal Savings Bank and Bruce A.
      Walsh* (3)10.13
              
              Change
      in Control Agreement between Newport Federal Savings Bank and Carol R.
      Silven* (3)10.14
              
              Change
      in Control Agreement between Newport Federal Savings Bank and Paul F.
      Nardone* (3)10.15
              
              Supplemental
      Executive Retirement Agreement between Newport Federal Savings Bank and
      Carol R. Silven, Kevin M. McCarthy, Nino Moscardi, Bruce A. Walsh and Ray
      D. Gilmore, II *(5)10.16
              
              Executive
      Split Dollar Life Insurance Agreements between Newport Federal Savings
      Bank and Kevin M. McCarthy, Nino Moscardi and Bruce A. Walsh
      *(5)10.17
              
              Supplemental
      Director Retirement Agreements between Newport Federal Savings Bank and
      Peter W. Rector, William R. Harvey, Donald N. Kaull, Robert S. Lazar,
      Michael S. Pinto, Michael J. Hayes, Barbara Saccucci Radebach, Alicia S.
      Quirk, Peter T. Crowley, John N. Conti, Arthur H. Lathrop, Arthur H.
      Macauley and Kathleen A. Nealon *(5)10.18
              
              Director
      Split Dollar Life Insurance Agreements between Newport Federal Savings
      Bank and Peter W. Rector, Donald N. Kaull, Robert S. Lazar, Michael S.
      Pinto, Michael J. Hayes, Barbara Saccucci Radebach, Alicia S. Quirk, Peter
      T. Crowley, Arthur H. Lathrop, Arthur H. Macauley and Kathleen A. Nealon
      *(5)21.0
              
              List
      of Subsidiaries (4)23.0
              
              Consent
      of Wolf & Company, P.C.31.1
              
              Rule
      13a-14(a)/15d-14(a) Certification of Chief Executive
    Officer31.2
              
              Rule
      13a-14(a)/15d-14(a) Certification of Chief Financial
    Officer
   42
 Index
  32.0
              
              Section
      1350 Certification of Chief Executive Officer and Chief Financial
      Officer


______________________________
 *
              Management
      contract or compensatory plan, contract or
  arrangement.
 (1)
              Incorporated
      by reference to the Company’s Registration Statement on Form S-1, as
      amended, initially filed with the SEC on March 20,
  2006.
 (2)
                Incorporated
      by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K
      filed with the SEC on for the quarter ended December 14,
    2007.
 (3)
                Incorporated
      by reference to the Company’s Quarterly Report on Form 10-Q for the
      quarter ended June 30, 2006.
 (4)
                Incorporated
      by reference to Exhibit 21.0 to the Company’s Annual Report on Form 10-K
      for the year ended December 31,
2006.
 (5)
                Incorporated
      by reference to the Company’s Quarterly Report on Form 10-Q for the
      quarter ended March 31,
2007.




43
 Index





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.





NEWPORT
      BANCORP, INC.By:
            /s/
      Kevin M. McCarthyDate:
      March 20, 2008
            
            Kevin
      M. McCarthyPresident
      and Chief Executive Officer





Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.





Name
            
            Title
            
            Date/s/
      Kevin M. McCarthy
            
            President,
      Chief Executive Officer,
            
            March
      24, 2008Kevin
      M. McCarthy
            
            and
      Director(principal
      executive officer)/s/
      Bruce A. Walsh
            
            Senior
      Vice President and Chief
            
            March
      24, 2008Bruce
      A. Walsh
            
            Financial
      Officer(principal
      accounting and financial officer)/s/
      John N. Conti
            
            Director
            
            March
      24, 2008John
      N. Conti/s/
      Peter T. Crowley
            
            Director
            
            March
      24, 2008Peter
      T. Crowley/s/
      William R. Harvey
            
            Director
            
            March
      24, 2008William
      R. Harvey/s/
      Michael J. Hayes
            
            Director
            
            March
      24, 2008Michael
      J. Hayes/s/
      Donald N. Kaull
            
            Director
            
            March
      24, 2008Donald
      N. Kaull/s/
      Arthur H. Lathrop
            
            Director
            
            March
      24, 2008Arthur
      H. Lathrop/s/
      Robert S. Lazar
            
            Director
            
            March
      24, 2008Robert
      S. Lazar




44
 Index




/s/
      Arthur P. Macauley
            
            Director
            
            March
      24, 2008Arthur
      P. Macauley/s/
      Nino Moscardi
            
            Director
            
            March
      24, 2008Nino
      Moscardi/s/
      Kathleen A. Nealon
            
            Director
            
            March
      24, 2008Kathleen
      A. Nealon/s/
      Michael S. Pinto
            
            Director
            
            March
      24, 2008Michael
      S. Pinto/s/
      Alicia S. Quirk
            
            Director
            
            March
      24, 2008Alicia
      S. Quirk/s/
      Peter W. Rector
            
            Director
            
            March
      24, 2008Peter
      W. Rector/s/
      Barbara Saccucci Radebach
            
            Director
            
            March
      24, 2008Barbara
      Saccucci Radebach


45
 Index


NEWPORT
BANCORP, INC.





CONSOLIDATED
FINANCIAL STATEMENTS


Years
Ended December 31, 2007 and 2006








INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS







PageReport
      of Independent Registered Public Accounting Firm
            
            F-2Consolidated
      Balance Sheets
            
            F-3Consolidated
      Statements of Operations
            
            F-4Consolidated
      Statements of Changes in Stockholders’ Equity
            
            F-5Consolidated
      Statements of Cash Flows
            
            F-6
      - F-7Notes
      to Consolidated Financial Statements
            
            F-8
      - F-42


F-1
 Index




Report
of Independent Registered Public Accounting Firm







The Board
of Directors


Newport
Bancorp, Inc.


Newport,
Rhode Island





We have
audited the accompanying consolidated balance sheets of Newport Bancorp, Inc.
and subsidiary as of December 31, 2007 and 2006, and the related
consolidated statements of operations, changes in stockholders’ equity and cash
flows for the years then ended.  These financial statements are the
responsibility of the Bank’s management.  Our responsibility is to
express an opinion on these financial statements based on our
audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Newport Bancorp, Inc. and
subsidiary as of December 31, 2007 and 2006, and the results of its
operations and its cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of
America.








Boston,
Massachusetts


March  20,
2008


F-2
 Index




NEWPORT
BANCORP, INC. AND SUBSIDIARY


CONSOLIDATED
BALANCE SHEETS


December 31,
2007 and 2006





ASSETS2007
              
              
              2006(In
      Thousands, Except Share Data)Cash
      and due from banks
              
              $
              6,646
              
              
              $
              3,705Short-term
      investments
              
              
              59
              
              
              
              3,567Cash
      and cash equivalents
              
              
              6,705
              
              
              
              7,272Securities
      available for sale, at fair value
              
              
              6,966
              
              
              
              6,614Securities
      held to maturity, at amortized cost
              
              
              30,886
              
              
              
              1,922Federal
      Home Loan Bank stock, at cost
              
              
              4,163
              
              
              
              2,390Loans
              
              
              295,483
              
              
              
              258,739Allowance
      for loan losses
              
              
              (2,399
              )
              
              
              (1,973
              )Loans,
      net
              
              
              293,084
              
              
              
              256,766Premises
      and equipment, net
              
              
              5,849
              
              
              
              6,099Accrued
      interest receivable
              
              
              1,269
              
              
              
              1,027Net
      deferred tax asset
              
              
              2,313
              
              
              
              1,851Bank-owned
      life insurance
              
              
              9,274
              
              
              
              5,382Other
      assets
              
              
              750
              
              
              
              1,121Total
      assets
              
              $
              361,259
              
              
              $
              290,444LIABILITIES
      AND STOCKHOLDERS' EQUITYDeposits
              
              $
              193,285
              
              
              $
              192,974Short-term
      borrowings
              
              
              5,809
              
              
              
              2,500Long-term
      borrowings
              
              
              99,547
              
              
              
              31,950Accrued
      expenses and other liabilities
              
              
              3,666
              
              
              
              3,040Total
      liabilities
              
              
              302,307
              
              
              
              230,464Commitments
      and contingencies (Notes 5, 11 and 12)Stockholders'
      equity:Preferred
      stock, $.01 par value; 1,000,000 sharesauthorized; none
      issued
              
              
              -
              
              
              
              -Common
      stock, $.01 par value; 19,000,000 sharesauthorized; 4,878,349
      shares issued
              
              
              49
              
              
              
              49Additional
      paid-in capital
              
              
              50,023
              
              
              
              47,258Retained
      earnings
              
              
              17,234
              
              
              
              16,477Unearned
      compensation (971,265 and 364,250 sharesat December 31, 2007 and
      2006, respectively)
              
              
              (5,548
              )
              
              
              (3,643
              )Treasury
      stock (213,660 shares at December 31, 2007)
              
              
              (2,655
              )
              
              
              -Accumulated
      other comprehensive loss
              
              
              (151
              )
              
              
              (161
              )Total
      stockholders' equity
              
              
              58,952
              
              
              
              59,980Total
      liabilities and stockholders' equity
              
              $
              361,259
              
              
              $
              290,444


See
accompanying notes to consolidated financial statements.


F-3
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF OPERATIONS


Years
Ended December 31, 2007 and 2006





2007
              
              
              2006(In
      Thousands, Except Per Share Data)Interest
      and dividend income:Loans
              
              $
              17,195
              
              
              $
              15,280Securities
              
              
              567
              
              
              
              386Federal
      Home Loan Bank stock
              
              
              177
              
              
              
              181Other
      interest-earning assets
              
              
              49
              
              
              
              244Total
      interest and dividend income
              
              
              17,988
              
              
              
              16,091Interest
      expense:Deposits
              
              
              4,888
              
              
              
              3,868Short-term
      borrowings
              
              
              349
              
              
              
              371Long-term
      borrowings
              
              
              2,457
              
              
              
              1,972Total
      interest expense
              
              
              7,694
              
              
              
              6,211Net
      interest income
              
              
              10,294
              
              
              
              9,880Provision
      for loan losses
              
              
              426
              
              
              
              120Net
      interest income, after provisionfor loan
    losses
              
              
              9,868
              
              
              
              9,760Non-interest
      income:Customer
      service fees
              
              
              1,839
              
              
              
              1,593Federal
      Home Loan Bank pre-payment penalties
              
              
              -
              
              
              
              (367
              )Bank-owned
      life insurance
              
              
              392
              
              
              
              75Miscellaneous
              
              
              88
              
              
              
              150Total
      non-interest income
              
              
              2,319
              
              
              
              1,451Non-interest
      expenses:Salaries
      and employee benefits
              
              
              6,171
              
              
              
              5,414Occupancy
      and equipment
              
              
              1,282
              
              
              
              1,235Data
      processing
              
              
              1,004
              
              
              
              1,022Professional
      fees
              
              
              563
              
              
              
              387Marketing
              
              
              1,085
              
              
              
              797Contribution
      to NewportFed Charitable Foundation
              
              
              -
              
              
              
              3,614Other
      general and administrative
              
              
              729
              
              
              
              769Total
      non-interest expenses
              
              
              10,834
              
              
              
              13,238Income
      (loss) before income taxes
              
              
              1,353
              
              
              
              (2,027
              )Provision
      (benefit) for income taxes
              
              
              596
              
              
              
              (371
              )Net
      income (loss)
              
              $
              757
              
              
              $
              (1,656
              )Weighted
      average shares outstanding:Basic
              
              
              4,481,203
              
              
              
              N/ADiluted
              
              
              4,481,203
              
              
              
              N/AEarnings
      per share:Basic
              
              $
              0.17
              
              
              
              N/ADiluted
              
              
              0.17
              
              
              
              N/A





See
accompanying notes to consolidated financial statements.


F-4
 Index




NEWPORT
BANCORP, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY


Years
Ended December 31, 2007 and 2006




Additional
                
                
                
                
                
                
                
                
                
                
                
                OtherCommon
      Stock
                
                
                Paid-in
                
                
                Retained
                
                
                Unearned
                
                
                Treasury
                
                
                ComprehensiveShares
                
                
                Amount
                
                
                Capital
                
                
                Earnings
                
                
                Compensation
                
                
                Stock
                
                
                Loss
                
                
                Total(Dollars
      in Thousands)Balance
      at December 31, 2005
                
                
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                18,133
                
                
                $
                -
                
                
                $
                -
                
                
                $
                (149
                )
                
                $
                17,984Comprehensive
      loss:Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,656
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,656
                )Net
      unrealized loss on securities available for sale
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (12
                )
                
                
                (12
                )Total
      comprehensive loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (1,668
                )Issuance
      of common stock for initial public stock offering, net of expenses of
      $1,573,000
                
                
                4,516,990
                
                
                
                45
                
                
                
                43,552
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                43,597Issuance
      of common stock to NewportFedCharitable
      Foundation
                
                
                361,359
                
                
                
                4
                
                
                
                3,610
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                3,614Common
      stock purchased by ESOP (390,268 shares)
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (3,903
                )
                
                
                -
                
                
                
                -
                
                
                
                (3,903
                )Release
      of ESOP shares (26,018 shares)
                
                
                -
                
                
                
                -
                
                
                
                96
                
                
                
                -
                
                
                
                260
                
                
                
                -
                
                
                
                -
                
                
                
                356Balance
      at December 31, 2006
                
                
                4,878,349
                
                
                
                49
                
                
                
                47,258
                
                
                
                16,477
                
                
                
                (3,643
                )
                
                
                -
                
                
                
                (161
                )
                
                $
                59,980Comprehensive
      income:Net
      income
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                757
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                757Net
      unrealized gain on securities available for sale
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                10
                
                
                
                10Total
      comprehensive income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                767Issuance
      of common stock in connection with equity incentive plan (437,900
      shares)
                
                
                -
                
                
                
                -
                
                
                
                2,445
                
                
                
                -
                
                
                
                (2,445
                )
                
                
                -
                
                
                
                -
                
                
                
                -Stock-based
      compensation - restricted stock (195,133 shares)
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                279
                
                
                
                -
                
                
                
                -
                
                
                
                279Stock-based
      compensation - options
                
                
                -
                
                
                
                -
                
                
                
                241
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                241Release
      of ESOP shares (26,018 shares)
                
                
                -
                
                
                
                -
                
                
                
                79
                
                
                
                -
                
                
                
                261
                
                
                
                -
                
                
                
                -
                
                
                
                340Purchase
      of treasury shares (213,660 shares)
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (2,655
                )
                
                
                -
                
                
                
                (2,655
                )Balance
      at December 31, 2007
                
                
                4,878,349
                
                
                $
                49
                
                
                $
                50,023
                
                
                $
                17,234
                
                
                $
                (5,548
                )
                
                $
                (2,655
                )
                
                $
                (151
                )
                
                $
                58,952







F-5
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CASH FLOWS


Years
Ended December 31, 2007 and 2006





2007
              
              
              2006(In
      Thousands)Cash
      flows from operating activities:Net
      income (loss)
              
              $
              757
              
              
              $
              (1,656
              )Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Provision
      for loan losses
              
              
              426
              
              
              
              120Accretion
      of securities
              
              
              (23
              )
              
              
              (17
              )Amortization
      of net deferred loan fees
              
              
              (159
              )
              
              
              (123
              )Depreciation
      and amortization of premises and equipment
              
              
              619
              
              
              
              619Stock-based
      compensation and ESOP allocation
              
              
              860
              
              
              
              356Deferred
      income tax benefit
              
              
              (462
              )
              
              
              (1,112
              )Income
      from bank-owned life insurance
              
              
              (392
              )
              
              
              (75
              )Contribution
      of common stock to NewportFed Charitable Foundation
              
              
              -
              
              
              
              3,614Net
      change in:Accrued
      interest receivable
              
              
              (242
              )
              
              
              (118
              )Other
      assets
              
              
              371
              
              
              
              55Accrued
      expenses and other liabilities
              
              
              626
              
              
              
              1,341Net
      cash provided by operating activities
              
              
              2,381
              
              
              
              3,004Cash
      flows from investing activities:Proceeds
      from maturities of certificates of deposit
              
              
              -
              
              
              
              3,000Purchase
      of held-to-maturity securities
              
              
              (29,421
              )
              
              
              -Reinvested
      dividends on mutual funds
              
              
              (342
              )
              
              
              (292
              )Principal
      payments received on securities held to maturity
              
              
              480
              
              
              
              387Purchase
      of bank-owned life insurance
              
              
              (3,500
              )
              
              
              (3,500
              )Redemption
      (purchase) of Federal Home Loan Bank stock
              
              
              (1,773
              )
              
              
              650Loan
      originations, net of principal payments
              
              
              (36,585
              )
              
              
              (24,587
              )Additions
      to premises and equipment
              
              
              (369
              )
              
              
              (718
              )


Net
      cash used by investing activities
              
              
              (71,510
              )
              
              
              (25,060
              )






(continued)




See
accompanying notes to consolidated financial statements.


F-6
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CASH FLOWS (Concluded)


Years
Ended December 31, 2007 and 2006




2007
              
              
              2006(In
      Thousands)Cash
      flows from financing activities:Net
      increase in deposits
              
              
              311
              
              
              
              393Net
      increase (decrease) in borrowings withmaturities of three months
      or less
              
              
              3,309
              
              
              
              (3,733
              )Proceeds
      from borrowings with maturities in excess of three months
              
              
              70,500
              
              
              
              -Repayment
      of borrowings with maturities in excess of three months
              
              
              (2,903
              )
              
              
              (11,940
              )Net
      proceeds from common stock offering
              
              
              -
              
              
              
              43,597Common
      stock purchased by ESOP
              
              
              -
              
              
              
              (3,903
              )Purchase
      of treasury stock
              
              
              (2,655
              )
              
              
              -Net
      cash provided by financing activities
              
              
              68,562
              
              
              
              24,414Net
      change in cash and cash equivalents
              
              
              (567
              )
              
              
              2,358Cash
      and cash equivalents at beginning of year
              
              
              7,272
              
              
              
              4,914Cash
      and cash equivalents at end of year
              
              $
              6,705
              
              
              $
              7,272Supplementary
      information:Interest
      paid on deposit accounts
              
              $
              4,943
              
              
              $
              3,048Interest
      paid on short-term borrowings
              
              
              339
              
              
              
              375Interest
      paid on long-term borrowings
              
              
              2,215
              
              
              
              2,037Income
      taxes paid, net of refunds
              
              
              954
              
              
              
              826




See
accompanying notes to consolidated financial statements.


F-7
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


Years
Ended December 31, 2007 and 2006





1.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES




Principles
of Consolidation




The
consolidated financial statements include the accounts of Newport Bancorp, Inc.
(the “Company”) and its wholly-owned subsidiary, Newport Federal Savings Bank
(the “Bank”).  All significant intercompany balances and transactions
have been eliminated in consolidation.




Nature
of Operations




The
Company provides a variety of financial services to individuals and small
businesses through its offices in Newport and Washington County, Rhode
Island.  Its primary deposit products are savings, checking and term
certificate accounts, and its primary lending products are residential and
commercial mortgage loans.




Stock
Conversion




On July
6, 2006, in accordance with a Plan of Conversion, Newport Federal Savings Bank
(the “Bank”), a federally chartered mutual savings bank, was reorganized into a
federally-chartered stock savings bank under the operation of a stock holding
company, Newport Bancorp, Inc. (the “Company”) which issued an aggregate of
4,878,349 shares of common stock, at an offering price of $10 per
share.  The net proceeds from the stock offering, net of offering
expenses of $1,573,000, amounted to $43,597,000.




In
connection with the Conversion, the Company established and funded the
NewportFed Charitable Foundation (the “Foundation”) with 361,359 shares of the
Company’s common stock resulting in recognition of expense in the third quarter
of 2006 based on the $10 per share offering price.  The Charitable
Foundation will make grants and donations to non-profit and community groups and
projects located within the Company’s market areas.




Also, in
connection with the conversion, the Bank established an employee stock ownership
plan (“ESOP”) which purchased 390,268 shares of the Company’s common stock at a
price of $10.00 per share.




Segment
Reporting




Management
evaluates the Company’s performance and allocates resources based on a single
segment concept.  Accordingly, there are no separately identified
operating segments for which discrete financial information is
available.  The Company does not derive revenues from, or have assets
located in, foreign countries, nor does it derive revenues from any single
customer that represents 10% or more of the Company’s total
revenues.


F-8
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Use
of Estimates




In
preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and reported amounts of revenues
and expenses during the reporting period.  Actual results could differ
from those estimates.  Material estimates that are particularly
susceptible to significant changes in the near term relate to the determination
of the allowance for loan losses and the valuation of deferred tax
assets.




Reclassification




Certain
amounts in the 2006 consolidated financial statements have been reclassified to
conform to the 2007 presentation.




Cash
and Cash Equivalents




Cash and
cash equivalents include cash and balances due from banks and short-term
investments consisting of federal funds and interest-bearing deposits, all of
which mature within ninety days.




Securities




Securities
available for sale are carried at fair value with unrealized gains and losses
excluded from earnings and reported as a separate component of comprehensive
income/loss.  Securities held to maturity are reflected at amortized
cost.




Purchase
premiums and discounts are amortized to earnings by the interest method over the
terms of the securities.  Declines in the value of securities that are
deemed to be other than temporary are reflected in earnings when
identified.  Gains and losses on disposition of securities are
recorded on the trade date and are computed by the specific identification
method.




Management
evaluates securities for other-than-temporary impairment at least on a quarterly
basis, and more frequently when economic or market concerns warrant such
evaluation.  Consideration is given to (1) the length of time and the
extent to which the fair value has been less than cost, (2) the financial
condition of the issuer, and (3) the intent and ability of the Company to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value.




F-9
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)


Loans




The Bank
grants mortgage, commercial and consumer loans to customers and a substantial
portion of the loan portfolio consists of mortgage loans in Newport and
Washington County, Rhode Island.  The ability of the Company’s debtors
to honor their contracts is dependent upon the economy in general and the real
estate and construction economic sectors.




Loans
that management has the intent and ability to hold for the foreseeable future or
until maturity or pay-off are reported at their outstanding unpaid principal
balances adjusted for charge-offs, the allowance for loan losses, and any
deferred fees or costs on originated loans.  Interest income is
accrued on the unpaid principal balance.  Loan origination fees, net
of certain direct origination costs, are deferred and recognized as an
adjustment of the related loan yield using the interest method over the
contractual terms of the loan.




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




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




Allowance
for Loan Losses




The
allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to
earnings.  Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is
confirmed.  Subsequent recoveries, if any, are credited to the
allowance.




The
allowance for loan losses is evaluated on a regular basis by management and is
based upon management’s periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower’s ability to repay, estimated
value of any underlying collateral and prevailing economic
conditions.  This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available.




F-10
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Allowance
for Loan Losses (concluded)




The
allowance consists of general and unallocated loss components.  For
loans that are classified as impaired, an allowance is established when the
collateral value of the impaired loan is lower than the carrying value of that
loan.  The general component covers non-classified loans and is based
on historical loss experience adjusted for qualitative factors.  An
unallocated component is maintained to cover uncertainties that could affect
management’s estimate of probable losses.  The unallocated component
of the allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating the general losses in the
portfolio.




A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due.  Impairment is
measured on a loan by loan basis by the fair value of the
collateral.




Large
groups of smaller balance homogeneous loans are collectively evaluated for
impairment.  Accordingly, the Company does not separately identify
individual consumer and residential loans for impairment
disclosures.




Transfers
of Financial Assets




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




Mortgage
Servicing Rights




The
Company sells loans in the secondary market both with servicing retained and
servicing released.  Servicing assets are not recognized as separate
assets when rights are acquired through the sale of loans as such assets are not
deemed to be material.  Servicing income is recorded on the cash
basis.




Bank-owned
Life Insurance




Bank-owned
life insurance policies are reflected on the consolidated balance sheets at cash
surrender value.  Changes in cash surrender value are reflected in
non-interest income on the consolidated statements of income.




F-11
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Premises
and Equipment




Land is
carried at cost.  Premises and equipment are stated at cost, less
accumulated depreciation and amortization, computed on a straight-line method
over the estimated useful lives of the assets or the expected terms of the
leases, if shorter.  Expected terms include lease option periods to
the extent that the exercise of such options is reasonably assured.




Marketing
Costs




Marketing
costs are expensed as incurred.




Pension
Plan




It is the
Company’s policy to fund pension costs in the year of accrual.




Stock
Compensation Plans




Effective
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
No. 123R, Share-Based
Payment (“SFAS 123R”) (revised 2004) which requires that the
compensation cost relating to share-based payment transactions be recognized in
financial statements.  That cost is measured based on the fair value
of the equity or liability instruments issued.  SFAS 123(R) covers a
wide range of share-based compensation arrangements including stock options,
restricted share plans, performance-based awards, share appreciation rights, and
employee share purchase plans.  The Statement requires the Company to
measure the cost of employee services received in exchange for stock options
based on the grant-date fair value of the award, and to recognize the cost over
the period the employee is required to provide services for the
award.  SFAS 123(R) permits the use of any option-pricing model that
meets the fair value objective in the Statement.




Income
Taxes




Deferred
tax assets and liabilities are reflected at currently enacted income tax rates
applicable to the period in which the deferred tax assets or liabilities are
expected to be realized or settled.  As changes in tax laws or rates
are enacted, deferred tax assets and liabilities are adjusted accordingly
through the provision for income taxes.  The Bank’s base amount of its
federal income tax reserve for loan losses is a permanent difference for which
there is no recognition of a deferred tax liability.  However, the
loan loss allowance maintained for financial reporting purposes is a temporary
difference with allowable recognition of a related deferred tax asset, if it is
deemed realizable.




A
valuation allowance related to deferred tax assets is established when, in the
judgment of management, it is more likely than not that all or a portion of such
deferred tax assets will not be realized.  (See Note
9.)


F-12
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Earnings
per Share




Basic
earnings per share (“EPS”) excludes dilution and is calculated by dividing net
income available to common stockholders by the weighted-average number of shares
of common stock outstanding during the period.  Diluted EPS is
computed in a manner similar to that of basic EPS except that the
weighted-average number of common shares outstanding is increased to include the
number of incremental common shares (computed using the treasury stock method)
that would have been outstanding if all potentially dilutive common stock
equivalents (such as stock options and unvested restricted stock) were issued
during the period.  Common stock equivalents that could potentially
dilute basic EPS in the future were not included in the computation of diluted
EPS because to do so would have been antidilutive for the year ended December
31, 2007.  Treasury shares and common shares held by the ESOP which
have not been released or committed to be released are shown as a reduction in
stockholders’ equity and are not included in the weighted-average number of
common shares outstanding for either basic or diluted earnings per share
calculations.




The
Company converted to a stock company on July 6, 2006, resulting in shares
outstanding for a period less than twelve months during the year ended December
31, 2006.  Earnings per share for the three-month period ended
December 31, 2006 can be found in Note 16 to the consolidated financial
statements.




Comprehensive
Income/Loss




Accounting
principles generally require that recognized revenue, expenses, gains and losses
be included in net income.  Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the retained earnings
section of the balance sheet, such items, along with net income, are components
of comprehensive income/loss.  There is no tax benefit available on
the unrealized losses on the securities available for sale as the losses
represent capital losses for which the Company has no capital gain history to
offset such losses.




Recent
Accounting Pronouncements




In March
2006, the Financial Accounting Standards Board (“FASB”) issued Statement
No. 156, “Accounting for Servicing of Financial Assets”, which amends FASB
Statement No. 140 and requires that all separately recognized servicing
rights be initially measured at fair value, if practicable.  This
Statement was adopted on January 1, 2007 and did not have an impact on the
Company’s consolidated financial statements.


F-13
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Recent
Accounting Pronouncements (continued)




In July
2006, the FASB issued Financial Accounting Standards Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes” (“FIN 48”) which clarifies the
accounting for uncertainty in income taxes recognized in an entity’s financial
statements in accordance with FASB Statement No. 109, “Accounting for Income
Taxes”.  FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return and provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosures and transitions.  The Company adopted FIN 48 on
January 1, 2007 and it did not have a material impact on the Company’s
consolidated financial statements.




In
September 2006, the FASB issued Statement No. 157, “Fair Value
Measurements.”  This Statement defines fair value, establishes a
framework for measuring fair value in accordance with generally accepted
accounting principles, and expands disclosures about fair value
measurements.  The definition of fair value retains the exchange price
notion in earlier definitions of fair value.  This Statement clarifies
that the exchange price is the price in an orderly transaction between market
participants to sell the asset or transfer the liability in the market in which
the reporting entity would transact for the asset or liability, that is, the
principal or most advantageous market for the asset or
liability.  Emphasis is placed on fair value being a market-based
measurement, not an entity-specific measurement, and therefore a fair value
measurement should be determined based on the assumptions that market
participants would use in pricing the asset or liability.  As a basis
for considering these market participant assumptions, a fair value hierarchy has
been established to distinguish between (1) market participant assumptions
developed based on market data obtained from sources independent of the
reporting entity (observable inputs) and (2) the reporting entity's own
assumptions about market participant assumptions developed based on the best
information available in the circumstances (unobservable
inputs).  This Statement is effective for the Company on January 1,
2008, with a general deferral for non-financial assets and liabilities to
January 1, 2009.  The Company is in the process of evaluating the
impact on the consolidated financial statements.




F-14
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Recent
Accounting Pronouncements (continued)




In
February 2007, the FASB issued Statement No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an amendment of FASB
Statement No. 115.”  This Statement permits entities to choose to
measure many financial instruments and certain other items at fair value, with
the objective of improving financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions, and is expected to expand the use of fair value
measurement.  An entity will report unrealized gains and losses on
items for which the fair value option has been elected in earnings at each
subsequent reporting date.  The fair value option may generally be
applied instrument by instrument and is irrevocable.  This Statement
is effective for the Company on January 1, 2008 and is not expected to have a
material impact on the Company’s consolidated financial statements.




In
September 2006, the FASB ratified EITF 06-4, “Accounting for Deferred
Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life
Insurance Arrangements” which addresses accounting for split-dollar life
insurance arrangements whereby the employer purchases a policy to insure the
life of an employee, and separately enters into an agreement to split the policy
benefits between the employer and the employee.  This EITF states that
an obligation arises as a result of a substantive agreement with an employee to
provide future postretirement benefits.  Under EITF 06-4, the
obligation is not settled upon entering into an insurance
arrangement.  Since the obligation is not settled, a liability should
be recognized in accordance with applicable authoritative
guidance.  This EITF was adopted on January 1, 2008, resulting in a
decrease to retained earnings in the amount of $61,000.




In
December 2007, the FASB issued Statement No. 141 (revised), “Business
Combinations” which replaces FASB Statement No. 141, and applies to all business
entities, including mutual entities that previously used the
pooling-of-interests method of accounting for certain business combinations.
This Statement makes significant amendments to other Statements and other
authoritative guidance, and applies prospectively to business combinations for
which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008.  An entity
may not apply it before that date.  This statement is not expected to
have a material impact on the Company’s consolidated financial
statements.




F-15
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (concluded)





Recent
Accounting Pronouncements (concluded)




In
December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51”  which
establishes accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary, and clarifies that
a noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements.  This Statement is effective for the Company’s
2009 fiscal year and is not expected to have a material impact on the Company’s
consolidated financial statements.




2.
            RESTRICTIONS ONCASHANDAMOUNTS DUE FROM
      BANKS




The Bank
is required to maintain average balances on hand or with the Federal Reserve
Bank.  At December 31, 2007 and 2006, these reserve balances
amounted to $2,904,000 and $3,624,000, respectively.




3.
            SECURITIES




The
amortized cost and estimated fair value of securities, with gross unrealized
gains and losses, follows:




Gross
              
              
              GrossAmortized
              
              
              Unrealized
              
              
              Unrealized
              
              
              FairCost
              
              
              Gains
              
              
              Losses
              
              
              Value(In
      Thousands)December 31,
      2007Securities Available
      for SaleMutual
      funds - bond funds
              
              $
              7,117
              
              
              $
              -
              
              
              $
              (151
              )
              
              $
              6,966Securities Held to
      MaturityMortgage-backed
      securities
              
              $
              30,886
              
              
              $
              3
              
              
              $
              (138
              )
              
              $
              30,751
  F-16
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)




SECURITIES (continued)




Gross
              
              
              GrossAmortized
              
              
              Unrealized
              
              
              Unrealized
              
              
              FairCost
              
              
              Gains
              
              
              Losses
              
              
              Value(In
      Thousands)December 31,
      2006Securities Available
      for SaleMutual
      funds - bond funds
              
              $
              6,775
              
              
              $
              -
              
              
              $
              (161
              )
              
              $
              6,614Securities Held to
      MaturityMortgage-backed
      securities
              
              $
              1,922
              
              
              $
              2
              
              
              $
              (55
              )
              
              $
              1,869




Mortgage-backed
securities consist of participation certificates guaranteed by
government-sponsored enterprises such as the Federal National Mortgage
Association and the Government National Mortgage Association.




At
December 31, 2007, mortgage-backed securities with a fair value of $29,124,000
were pledged to secure repurchase agreements (see Note 8).




There
were no sales of securities for the years ended December 31, 2007 and
2006.




Information
pertaining to securities with gross unrealized losses aggregated by investment
category and length of time that individual securities have been in a continuous
loss position, follows:




Less
      Than Twelve Months
              
              
              Over
      Twelve MonthsGross
              
              
              
              
              
              GrossUnrealized
              
              
              Fair
              
              
              Unrealized
              
              
              FairLosses
              
              
              Value
              
              
              Losses
              
              
              Value(In
      Thousands)December 31,
      2007Securities Available
      for SaleMutual
      funds - bond funds
              
              $
              -
              
              
              $
              -
              
              
              $
              151
              
              
              $
              6,966Securities Held to
      MaturityMortgage-backed
      securities
              
              
              105
              
              
              
              29,124
              
              
              
              33
              
              
              
              1,571Total
      temporarily impaired securities
              
              $
              105
              
              
              $
              29,124
              
              
              $
              184
              
              
              $
              8,537


F-17
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)




SECURITIES
(continued)




Less
      Than Twelve Months
              
              
              Over
      Twelve MonthsGross
              
              
              
              
              
              GrossUnrealized
              
              
              Fair
              
              
              Unrealized
              
              
              FairLosses
              
              
              Value
              
              
              Losses
              
              
              Value(In
      Thousands)December 31,
      2006Securities Available
      for SaleMutual
      funds - bond funds
              
              $
              -
              
              
              $
              -
              
              
              $
              161
              
              
              $
              6,614Securities Held to
      MaturityMortgage-backed
      securities
              
              
              -
              
              
              
              -
              
              
              
              55
              
              
              
              1,799Total
      temporarily impaired securities
              
              $
              -
              
              
              $
              -
              
              
              $
              216
              
              
              $
              8,413




At
December 31, 2007, three mutual funds and two mortgage-backed securities
had aggregate gross unrealized losses of 0.8% from the Company’s total amortized
cost.  Management evaluates securities for other-than-temporary
impairment on a quarterly basis.  The mutual funds with unrealized
losses for a period of greater than twelve months had aggregate depreciation of
less than 2.1% from the Company’s cost basis.  None of the funds have
been downgraded, and none of the funds have reduced or eliminated the dividend
payments.  The Company has determined that these unrealized losses
relate primarily to the changes in short-term interest rates and as short-term
interest rates decline, the value of the funds will increase.  The
Company has the intent and ability to hold the securities for a period of time
sufficient to allow for an anticipated recovery of the fair value, as short-term
rates decline in the future.  The effective duration of these funds
range from 0.7 years to 1.5 years.  Standard & Poor’s assigns
these funds a “AAA” credit quality rating (the highest credit rating
possible).  The Company has reviewed the financial condition of the
issuers and has determined that none of the declines are other than
temporary.




The
Company has the intent and ability to hold all of its mortgage-backed securities
until maturity, and no declines are deemed to be other than
temporary.




F-18
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





4.
            LOANS




A summary
of the balances of loans follows:




December
      31,2007
              
              
              2006(In
      Thousands)Mortgage
      loans:One-to-four
      family residential
              
              $
              169,179
              
              
              $
              157,448Multi-family
      residential
              
              
              9,494
              
              
              
              9,360Commercial
              
              
              76,919
              
              
              
              57,650Equity
      loans and lines of credit
              
              
              30,934
              
              
              
              29,275Construction
              
              
              9,427
              
              
              
              4,685295,953
              
              
              
              258,418Personal
      installment
              
              
              442
              
              
              
              1,112Total
      loans
              
              
              296,395
              
              
              
              259,530Less:  Allowance
      for loan losses
              
              
              (2,399
              )
              
              
              (1,973
              )Net
      deferred loan fees
              
              
              (912
              )
              
              
              (791
              )Loans,
      net
              
              $
              293,084
              
              
              $
              256,766




An
analysis of the allowance for loan losses follows:




Years
      Ended December 31,2007
              
              
              2006(In
      Thousands)Balance
      at beginning of year
              
              $
              1,973
              
              
              $
              1,853Provision
      for loan losses
              
              
              426
              
              
              
              120Balance
      at end of year
              
              $
              2,399
              
              
              $
              1,973




At
December 31, 2007, non-accrual and impaired loans amounted to $908,000 and
there was no valuation allowance allocated to impaired loans.  For the
year ended December 31, 2007, the average recorded investment in impaired
loans amounted to $326,000.  The Bank recognized no interest income on
impaired loans during the period that they were impaired.  There were
no non-accrual or impaired loans at or during the year ended December 31,
2006.  At December 31, 2007 and 2006, there were no loans greater than
ninety days past due and still accruing interest.




There
were no additional funds committed to be advanced in connection with impaired
loans.


F-19
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)







LOANS
(concluded)




Loans
sold and serviced for others amounted to $15,231,000 and $18,789,000 at
December 31, 2007 and 2006, respectively, which includes $5,072,000 and
$5,861,000 of loans sold with recourse provisions to the FHLB of
Boston.  When a realized loss on foreclosure occurs, losses will be
borne in priority order by the borrower, PMI insurance, FHLB of Boston and the
Bank.  At December 31, 2007 and 2006 and until the loans are paid
off, the maximum contingent liability to the Bank associated with these loans as
determined by the FHLB of Boston is $61,000.




5.
            PREMISES
      AND EQUIPMENT




A summary
of the cost and accumulated depreciation and amortization and estimated useful
lives of premises and equipment follows:




December
      31,
              
              
              Estimated2007
              
              
              2006
              
              
              Useful
      Life(In
      Thousands)Land
              
              $
              538
              
              
              $
              538
              
              
              -Building
      and improvements
              
              
              5,180
              
              
              
              5,169
              
              
              20-40
      yearsLeasehold
      improvements
              
              
              1,272
              
              
              
              1,267
              
              
              10-20
      yearsFurniture,
      fixtures and equipment
              
              
              2,977
              
              
              
              3,282
              
              
              3-10
      yearsConstruction
      in progress
              
              
              348
              
              
              
              25410,315
              
              
              
              10,510Less
      accumulated depreciation and amortization
              
              
              (4,466
              )
              
              
              (4,411
              )$
              5,849
              
              
              $
              6,099




Depreciation
and amortization expense for each of the years ended December 31, 2007 and
2006 amounted to $619,000.




Construction
in progress primarily represents costs incurred to date in connection with
proposed new branches in Portsmouth, RI, and Stonington, CT, and renovations to
the main office in Newport, RI.  On December 29, 2005, the Bank
entered into an agreement to purchase property for the Portsmouth branch in the
amount of $2,250,000, of which $80,000 has been paid as of December 31, 2007 and
$2,170,000 was paid in connection with the closing on January 10,
2008.




F-20
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





6.
            DEPOSITS




A summary
of deposit balances, by type, is as follows:




December
      31,2007
              
              
              2006(In
      Thousands)NOW
      and demand
              
              $
              59,223
              
              
              $
              58,288Money
      market deposits
              
              
              28,763
              
              
              
              21,356Regular
              
              
              25,963
              
              
              
              30,499Total
      non-certificate accounts
              
              
              113,949
              
              
              
              110,143Term
      deposit certificates
              
              
              79,336
              
              
              
              82,831Total
      deposits
              
              $
              193,285
              
              
              $
              192,974




The
aggregate amount of time deposit accounts with balances over $100,000 amounted
to $23,916,000 and $25,648,000 at December 31, 2007 and 2006,
respectively.




A summary
of certificate accounts is as follows:




December
      31, 2007
              
              
              December
      31, 2006Weighted
              
              
              
              
              
              WeightedAverage
              
              
              
              
              
              AverageAmount
              
              
              Rate
              
              
              Amount
              
              
              Rate(Dollars
      in Thousands)Maturing
      in:2007
              
              $
              -
              
              
              
              -
              %
              
              $
              77,603
              
              
              
              4.60
              %2008
              
              
              76,058
              
              
              
              4.41
              
              
              
              3,288
              
              
              
              2.912009
              
              
              1,707
              
              
              
              3.08
              
              
              
              960
              
              
              
              3.542010
              
              
              1,189
              
              
              
              4.17
              
              
              
              770
              
              
              
              4.782011
              
              
              183
              
              
              
              3.73
              
              
              
              210
              
              
              
              3.66Thereafter
              
              
              199
              
              
              
              3.20
              
              
              
              -
              
              
              
              -$
              79,336
              
              
              
              4.37
              %
              
              $
              82,831
              
              
              
              4.52
              %




7.
            SHORT-TERM
      BORROWINGS




Short-term
borrowings consist of Federal Home Loan Bank of Boston (“FHLB”) advances of
$5,809,000 and $2,500,000 maturing within one year at a weighted average rate of
4.41% and 5.58% at December 31, 2007 and 2006, respectively.




F-21
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





SHORT-TERM
BORROWINGS (concluded)




The Bank
also has an available line of credit with the FHLB at an interest rate that
adjusts daily.  Borrowings under the line are limited to 2% of the
Bank’s total assets.  At December 31, 2007 and 2006, this line of
credit amounted to $3,000,000, of which $1,809,000 was outstanding and is
included in short-term borrowings at December 31, 2007.  There were no
amounts outstanding at December 31, 2006.




8.
            LONG-TERM
      BORROWINGS




FHLB
Advances




Long-term
borrowings include the following FHLB advances:




December
      31, 2007
              
              
              December
      31, 2006Weighted
              
              
              
              
              
              WeightedAverage
              
              
              
              
              
              AverageAmount
              
              
              Rate
              
              
              Amount
              
              
              Rate(Dollars
      in Thousands)Fixed-rate
      advances maturing:2007
              
              $
              -
              
              
              
              -
              %
              
              $
              2,320
              
              
              
              4.64
              %2008
              
              
              7,000
              
              
              
              5.78
              
              
              
              7,000
              
              
              
              5.782009
              
              
              11,642
              
              
              
              4.96
              
              
              
              3,019
              
              
              
              3.792010
              
              
              9,500
              
              
              
              5.16
              
              
              
              2,500
              
              
              
              5.472011
              
              
              4,290
              
              
              
              5.53
              
              
              
              2,359
              
              
              
              5.692012
              
              
              14,615
              
              
              
              4.75
              
              
              
              5,752
              
              
              
              5.00Thereafter*
              
              
              27,500
              
              
              
              4.07
              
              
              
              9,000
              
              
              
              4.59$
              74,547
              
              
              
              4.72
              %
              
              $
              31,950
              
              
              
              5.00
              %




*
      Includes advances callable within one year aggregating $21,500,000 with a
      weighted average rate of 4.10% at December 31,
  2007.




All FHLB
borrowings are secured by a blanket lien on certain qualified collateral,
defined principally as 75% of the carrying value of first mortgage loans on
owner-occupied residential property.  At December 31, 2007 and 2006,
the carrying amount of assets qualifying as collateral for FHLB advances
amounted to $143,520,000 and $132,661,000, respectively.




F-22
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





LONG-TERM
BORROWINGS (concluded)




Repurchase
Agreement




During
2007, the Company entered into a repurchase agreement for $25,000,000 at a rate
of 3.36%, subject to downward adjustment if 3-month LIBOR is greater than
5.05%.  This agreement matures on November 29, 2012, and is callable
on February 29, 2008 and each quarter thereafter.  The agreement is
secured by government-sponsored enterprise obligations.  The amount of
securities collateralizing the agreements to repurchase remains in securities
and the obligation to repurchase securities sold is reflected as a liability in
the consolidated balance sheets.  Securities pledged to secure this
agreement have a carrying value of $29,804,000 and a fair market value of
$29,124,000 at December 31, 2007.




9.
            INCOME
      TAXES




Allocation
of federal and state income taxes between current and deferred portions is as
follows:




Years
      Ended December 31,2007
              
              
              2006(In
      Thousands)Current
      tax provision:Federal
              
              $
              821
              
              
              $
              575State
              
              
              237
              
              
              
              1661,058
              
              
              
              741Deferred
      tax benefit:Federal
              
              
              (389
              )
              
              
              (1,223
              )State
              
              
              (101
              )
              
              
              (353
              )(490
              )
              
              
              (1,576
              )Change
      in valuation allowance
              
              
              28
              
              
              
              464(462
              )
              
              
              (1,112
              )Total
      tax provision (benefit)
              
              $
              596
              
              
              $
              (371
              )


F-23
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





INCOME
TAXES (continued)




The
reasons for the differences between the statutory federal income tax rate and
the effective tax rates are summarized as follows:




Years
      Ended December 31,2007
              
              
              2006Statutory
      rate
              
              
              34.0
              %
              
              
              (34.0
              )%Increase
      (decrease) resulting from:State
      taxes, net of federal tax benefit
              
              
              6.7
              
              
              
              (5.9
              )Establishment
      of valuation allowance
              
              
              2.1
              
              
              
              22.9Officers'
      life insurance
              
              
              (9.7
              )
              
              
              (1.3
              )Stock-based
      compensation and ESOP Plan
              
              
              9.2
              
              
              
              -Other
              
              
              1.8
              
              
              
              -Effective
      tax rates
              
              
              44.1
              %
              
              
              (18.3
              )%




The
components of the net deferred tax asset are as follows:




December
      31,2007
              
              
              2006(In
      Thousands)Deferred
      tax asset:Federal
              
              $
              2,336
              
              
              $
              2,036State
              
              
              679
              
              
              
              5923,015
              
              
              
              2,628Deferred
      tax liability:Federal
              
              
              (164
              )
              
              
              (253
              )State
              
              
              (46
              )
              
              
              (60
              )(210
              )
              
              
              (313
              )Valuation
      allowance
              
              
              (492
              )
              
              
              (464
              )(702
              )
              
              
              (777
              )Net
      deferred tax asset
              
              $
              2,313
              
              
              $
              1,851


F-24
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





INCOME
TAXES (concluded)




The tax
effects of each item that gives rise to deferred taxes are as
follows:




December
      31,2007
              
              
              2006(In
      Thousands)Allowance
      for loan losses
              
              $
              804
              
              
              $
              634Depreciation
      and amortization
              
              
              (57
              )
              
              
              (160
              )Net
      deferred loan fees
              
              
              351
              
              
              
              300Charitable
      contribution carryover
              
              
              1,268
              
              
              
              1,364Stock
      options and awards
              
              
              177
              
              
              
              -Employee
      benefit plans
              
              
              246
              
              
              
              156Other,
      net
              
              
              16
              
              
              
              212,805
              
              
              
              2,315Valuation
      allowance
              
              
              (492
              )
              
              
              (464
              )Deferred
      tax asset
              
              $
              2,313
              
              
              $
              1,851




The
Company has a charitable contribution carryforward in the amount of $3,175,000
which will expire in 2011, if not fully utilized.  The Company reduces
deferred tax assets by a valuation allowance if, based on the weight of
available evidence, it is more likely than not that some portion or all of the
deferred tax assets will not be realized.  The Company assesses the
realizability of its deferred tax assets by (1) reviewing taxable income in
allowable federal carry-back periods, and (2) assessing the likelihood of the
Company generating federal and state taxable income, as applicable, in future
periods in amounts sufficient to offset the deferred tax charges in the periods
they are expected to reverse.  Based on this assessment, management
concluded that a valuation allowance of $492,000 and $464,000 was required for
the years ended December 31, 2007 and 2006, respectively, due to the possible
limitation of the charitable contribution.




The
federal income tax reserve for loan losses at the Bank’s base year amounted to
$1,032,000.  If any portion of the reserve is used for purposes other
than to absorb loan losses, approximately 150% of the amount actually used,
limited to the amount of the reserve, would be subject to taxation in the year
in which used.  As the Bank intends to use the reserve only to absorb
loan losses, a deferred income tax liability of $412,000 has not been
provided.




F-25
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





10.
            STOCKHLDERS’
      EQUITY




Minimum
Regulatory Capital Requirement




The Bank
is subject to various regulatory capital requirements administered by the Office
of Thrift Supervision.  Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank’s consolidated financial statements.  Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of
assets, liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices.  The capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.  Federal Savings and
Loan Holding Companies are not subject to any regulatory capital requirements or
to supervision by the Office of Thrift Supervision.




Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios of Tier 1 and tangible capital (as
defined) to adjusted total assets (as defined) and of total and Tier 1
capital to risk-weighted assets (as defined).  Management believes, as
of December 31, 2007 and 2006, that the Bank met all capital adequacy
requirements to which it was subject.




F-26
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





STOCKHLDERS’
EQUITY (continued)




Minimum
Regulatory Capital Requirement (concluded)




As of
December 31, 2007, the most recent notification from the Office of Thrift
Supervision categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action.  To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based,
Tier 1 leverage and tangible ratios as set forth in the following
table.  There are no conditions or events since that notification that
management believes have changed the Bank’s category.  The Bank’s
actual capital amounts and ratios as of December 31, 2007 and 2006 are also
presented in the table.




Minimum
              
              
              Capitalized
      UnderCapital
              
              
              Prompt
      CorrectiveActual
              
              
              Requirement
              
              
              Action
      ProvisionsAmount
              
              
              Ratio
              
              
              Amount
              
              
              Ratio
              
              
              Amount
              
              
              Ratio(Dollars
      in Thousands)December 31,
      2007Total
      capital to risk weighted assets
              
              $
              41,152
              
              
              
              16.9
              %
              
              $
              19,476
              
              
              
              8.0
              %
              
              $
              24,345
              
              
              
              10.0
              %Tier
      1 capital to risk weighted assets
              
              
              38,814
              
              
              
              15.9
              
              
              
              9,738
              
              
              
              4.0
              
              
              
              14,607
              
              
              
              6.0Tier
      1 capital to adjusted total assets
              
              
              38,814
              
              
              
              10.8
              
              
              
              10,814
              
              
              
              3.0
              
              
              
              18,024
              
              
              
              5.0Tangible
      capital to adjusted total assets
              
              
              38,814
              
              
              
              10.8
              
              
              
              5,407
              
              
              
              1.5
              
              
              
              N/A
              
              
              
              N/ADecember 31,
      2006Total
      capital to risk weighted assets
              
              $
              39,391
              
              
              
              19.5
              %
              
              $
              16,193
              
              
              
              8.0
              %
              
              $
              20,242
              
              
              
              10.0
              %Tier
      1 capital to risk weighted assets
              
              
              37,479
              
              
              
              18.5
              
              
              
              8,097
              
              
              
              4.0
              
              
              
              12,145
              
              
              
              6.0Tier
      1 capital to adjusted total assets
              
              
              37,479
              
              
              
              13.0
              
              
              
              8,682
              
              
              
              3.0
              
              
              
              14,471
              
              
              
              5.0Tangible
      capital to adjusted total assets
              
              
              37,479
              
              
              
              13.0
              
              
              
              4,341
              
              
              
              1.5
              
              
              
              N/A
              
              
              
              N/A


F-27
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





STOCKHLDERS’
EQUITY (concluded)




Other
Capital Restrictions




Federal
banking regulations place certain restrictions on dividends paid, stock
repurchases and other transactions charged to the capital accounts of the
Bank.  Capital distributions in the form of dividends paid to the
Bank’s stockholder for any one year may not exceed the Bank’s net income for the
year to date plus the Bank’s retained earnings for the preceding two years,
without regulatory approval.  Loans or advances are limited to 10
percent of the Bank’s capital stock and surplus on a secured basis.




At
December 31, 2007, the Bank’s retained net income available for the payment of
dividends was $2,039,000.  Accordingly, $36,774,000 of the Company’s
equity in the net assets of the Bank was restricted at December 31,
2007.  Funds available for loans or advances by the Bank to the
Company amounted to $2,022,000.  In addition, dividends paid would be
prohibited if the effect thereof would cause the Bank’s capital to be reduced
below applicable minimum capital requirements.




Liquidation
Account




As part
of the Conversion, the Bank established a liquidation account which was equal to
the net worth of the Bank as of the date of the latest consolidated balance
sheet appearing in the final prospectus distributed in connection with the
Conversion.  The liquidation account will be maintained for the
benefit of eligible account holders and supplemental eligible account holders
who maintain their accounts at the Bank after the Conversion.  The
liquidation account will be reduced annually to the extent that such account
holders have reduced their qualifying deposits as of each anniversary
date.  Subsequent increases will not restore an account holder’s
interest in the liquidation account.  In the event of a complete
liquidation, each eligible account holder will be entitled to receive balances
for accounts then held.  At December 31, 2007, the balance remaining
in the liquidation account amounted to $15,808,000.




Share
Repurchase Plan




On July
16, 2007, the Company announced the approval of its stock repurchase program to
acquire up to 243,917 shares, or 5%, of its outstanding common
stock.  At December 31, 2007, the Company had purchased 213,660 shares
under the stock repurchase program, leaving 30,257 shares available for possible
future repurchases. In addition, on February 19, 2008, the Company
announced the commencement of another stock repurchase program to acquire up to
231,721 shares, or 5% of the Company’s outstanding common
stock.  Repurchases, which will be conducted through open market
purchases or privately negotiated transactions, will be made from time to time
depending on market conditions and other factors.




F-28
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





11.
            EMPLOYEE
      BENEFIT PLANS




Defined
Benefit Plan




The Bank
is a participant in the defined benefit plan of the Financial Institutions
Retirement Fund.  The Plan is a multi-employer plan whereas the
contributions by each bank are not restricted to provide benefits to the
employees of the contributing bank.  Each employee reaching the age of
21 and having completed at least 1,000 hours of service in one consecutive
twelve-month period, beginning with such employee’s date of employment,
automatically becomes a participant in the Plan.  Participants become
vested after completion of five years of service measured from their date of
hire.  Pension expense under this Plan amounted to $318,000 and
$467,000 for the years ended December 31, 2007 and 2006,
respectively.




401(k)
Plan




The Bank
offers a 401(k) plan for eligible employees that provides for voluntary
contributions by participating employees up to fifty percent of their annual
compensation subject to certain limits based on federal tax
laws.  Each employee reaching the age of 21 and having completed at
least 500 hours of service in one six-month period beginning with such
employee’s date of employment, or anniversary thereof, becomes eligible to be a
participant in the plan.  The Bank matches the employees’ voluntary
contribution up to 3% of their compensation and will match one-half of the next
2%.  The Bank’s total contribution for the years ended
December 31, 2007 and 2006 amounted to $222,000 and $194,000,
respectively.




Incentive
Plan




The
Company has an Incentive Plan (the “Plan”) whereby officers and employees are
eligible to receive cash bonuses based upon Company performance against annual
established performance targets, including financial measures and other factors,
including individual performance.  The structure of the Plan is to be
reviewed on an annual basis by the Board of Directors and individual awards are
adjusted based on recommendations from the Compensation
Committee.  Incentive compensation expense for the years ended
December 31, 2007 and 2006 amounted to $322,000 and $304,000,
respectively.




Supplemental
Executive and Director Retirement Plans




The Bank
adopted a Supplemental Executive Retirement Plan, which provides for certain
executives of the Bank to receive monthly benefits upon retirement, subject to
certain limitations as set forth in the Plan.  The present value of
these future benefits is accrued over the executive’s term of service, taking
into consideration vesting provisions in these agreements.  The
related expense for the years ended December 31, 2007 and 2006 amounted to
$180,000 and $102,000, respectively.




F-29
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





EMPLOYEE
BENEFIT PLANS (continued)




Supplemental
Executive and Director Retirement Plans (concluded)




In
addition, the Bank adopted a Supplemental Director Retirement Plan, which
provides for certain directors to receive annual benefits upon retirement,
subject to certain limitations set forth in the Plan.  The present
value of these benefits is accrued over the directors’ required service periods,
and the expense for the years ended December 31, 2007 and 2006 amounted to
$45,000 and $26,000, respectively.




Endorsement
Split-Dollar Life Insurance Arrangements




The
Company is the sole owner of life insurance policies pertaining to certain
executives and directors of the Company.  The Company has entered into
agreements with these executives whereby the Company will pay to the executives’
estates or beneficiaries a portion of the death benefit that the Company will
receive as beneficiary of such policies.  No liability has been
recognized on the consolidated balance sheet for such death
benefits.  In September 2006, the Emerging Issues Task Force reached a
consensus on Issue No. 06-4, “Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements.”  As a result, effective January 1, 2008, the Company
will be required to recognize a liability for future death benefits, and may
choose to retroactively apply the accounting change to all periods presented, or
to cumulatively adjust the financial statements as of the beginning of the year
of adoption.  See Note 1 – Recent Accounting
Pronouncements.




Employee
Stock Ownership Plan




As part
of the Conversion, the Bank established an Employee Stock Ownership Plan
(“ESOP”) for the benefit of its eligible employees.  On July 6, 2006,
the Company provided a loan to the Newport Federal Savings Bank Employee Stock
Ownership Trust of $3,903,000, which was used to purchase 390,268 shares of the
Company’s common stock at a price of $10.00 per share.  The loan bears
interest equal to 8.25% and provides for annual payments of interest and
principal over the 15-year term of the loan.




F-30
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





EMPLOYEE
BENEFIT PLANS (continued)




Employee
Stock Ownership Plan (continued)




At
December 31, 2007, the remaining principal balance on the ESOP debt is payable
as follows:




Year
      EndingDecember
      31,
              
              Amount(In
      Thousands)2008
              
              $
              1592009
              
              
              1722010
              
              
              1862011
              
              
              2012012
              
              
              218Thereafter
              
              
              2,532$
              3,468




The Bank
has committed to make contributions to the ESOP sufficient to support the debt
service of the loan.  The loan is secured by the shares purchased,
which are held in a suspense account until released for allocation to
participants, as principal and interest payments are made by the ESOP to the
Company.




Shares
released are allocated to each eligible participant based on the ratio of each
such participant's compensation, as defined in the ESOP, to the total
compensation of all eligible plan participants.  Cash dividends paid
on allocated shares can be distributed, at the direction of the Bank, to
participants’ accounts or used to repay the principal and interest on the ESOP
loan used to acquire Company stock on which dividends were paid.  Cash
dividends on unallocated shares are used to repay the outstanding debt of the
ESOP.




The fair
value of unallocated ESOP shares at December 31, 2007 is
$3,991,000.




Shares
held by the ESOP include the following at December 31, 2007:




Years
      Ended December 31,2007
              
              
              2006Allocated
              
              
              26,018
              
              
              
              -Committed
      to be allocated
              
              
              26,018
              
              
              
              26,018Unallocated
              
              
              338,232
              
              
              
              364,250Ending
      balance
              
              
              390,268
              
              
              
              390,268


F-31
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





EMPLOYEE
BENEFIT PLANS (continued)





Employee
Stock Ownership Plan (concluded)




As ESOP
shares are earned by the participants, the Company recognizes compensation
expense equal to the fair value of the earned ESOP shares during the periods in
which they become committed to be released.  Total compensation
expense recognized in connection with the ESOP was $340,000 and $356,000 for the
years ended December 31, 2007 and 2006, respectively.




Stock
Compensation Plans




In
accordance with the Company’s 2007 Equity Incentive Plan (the “2007 Plan”),
approved by shareholders on August 16, 2007, the Company awarded 437,900 stock
options and 195,133 shares of restricted stock to eligible participants on
October 1, 2007.  The exercise price of the options and the fair value
of the stock at the date of grant was $12.53 per share.  The 2007 Plan
provides for total awards of 487,834 stock options and 195,133 shares of
restricted stock, leaving 49,934 stock options available for future
awards.  The exercise price of options granted under the plan is equal
to the fair market value of the underlying common stock on the date of
grant.  Options granted under the 2007 Plan vest over five years and
expire no later than ten years from the date of grant.  Upon a change
in control (as defined in the plan) or the death or disability of the individual
to whom options or shares were awarded, all options and restricted shares
awarded immediately vest.




The
Company estimates the fair value of stock options using the Black-Scholes
valuation model.  Key input assumptions used to estimate the fair
value of stock options include the exercise price of the award, the expected
option term, expected volatility of the Company’s stock over the option’s
expected term, the risk-free interest rate over the option’s expected term, and
the Company’s expected annual dividend yield.  The Company believes
that the valuation technique and the approach utilized to develop the underlying
assumptions are appropriate in calculating the fair values of the Company’s
stock options granted in the three months ended December 31,
2007.  Estimates of fair value are not intended to predict actual
future events or the value ultimately realized by persons who receive equity
awards.




The fair
value of the stock options granted was estimated on the date of grant using a
Black-Scholes option valuation model with the following weighted-average
assumptions:




Expected
      volatility (1)
              28%Expected
      option term (2)
              6.5
      yearsInterest
      rate (risk free) (3)
              4.31%Expected
      annual dividend yield (4)
              0%


F-32
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





EMPLOYEE
BENEFIT PLANS (continued)


Stock
Compensation Plans (continued)




(1)
            The
      expected volatility for each grant is determined based on the review of
      the experience of peer companies who are similar in size.  The
      volatility is calculated over the expected term of the
    grant.




(2)
            The
      expected term for each grant is determined using the average of the
      mathematical mean of the vesting period and the full term of the option
      rather than estimating based on historical
  experience.




(3)
            The
      risk-free interest rate for periods equal to the expected term of the
      share option is based on the U.S. Treasury yield curve in effect at the
      time of grant.




(4)
            The
      dividend yield assumption is based on the Company’s history and
      expectation of dividend payouts.




The
following table presents the activity for the 2007 Plan as of December 31,
2007:




Non-VestedStock
      Options Outstanding
              
              
              Restricted
      StockWeightedAverageWeighted
              
              
              Remaining
              
              
              
              
              
              
              
              
              WeightedAverage
              
              
              Contractual
              
              
              Aggregate
              
              
              
              
              
              AverageNumber
              
              
              Exercise
              
              
              Term
              
              
              Intrinsic
              
              
              Number
              
              
              Grant Dateof
      Shares
              
              
              Price
              
              
              (Years)
              
              
              Value
              
              
              of
      Shares
              
              
              Fair
      ValueBalance
      at December 31, 2006
              
              
              -
              
              
              $
              -
              
              
              
              -
              
              
              
              
              
              
              -
              
              
              $
              -Granted
              
              
              437,900
              
              
              
              12.53
              
              
              
              9.75
              
              
              
              
              
              
              195,133
              
              
              
              12.53Vesting
      of restricted stock Cancelled (forfeited and expired)
              
              
              -
              
              
              
              -
              
              
              
              
              
              
              
              
              
              
              -
              
              
              
              -Balance
      at December 31, 2007
              
              
              437,900
              
              
              $
              12.53
              
              
              
              9.75
              
              
              $
              -
              
              
              
              195,133
              
              
              $
              12.53Options
      vested or expected to vest at December 31, 2007
              
              
              437,900
              
              
              $
              12.53
              
              
              
              9.75
              
              
              
              -Options
      exercisable atDecember
      31, 2007
              
              
              -
              
              
              
              -
              
              
              
              9.75
              
              
              
              -




The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value, based on the Company’s closing stock price of $11.80 as of
December 31, 2007 which would have been received by the option holders had all
option holders exercised their options as of that date.  There were no
in-the-money options exercisable as of December 31, 2007.  The
weighted-average grant-date fair values of options granted during the year ended
December 31, 2007 was $4.82.


F-33
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)







EMPLOYEE
BENEFIT PLANS (concluded)




Stock
Compensation Plans (concluded)




The
shares of common stock underlying any awards that are forfeited, cancelled or
otherwise terminated (other than by exercise), shares that are tendered or
withheld in payment of the exercise price of any award, and shares that are
tendered or withheld for tax withholding obligations will be added back to the
shares of common stock with respect to which new awards may be granted under the
plan.




For the
year ended December 31, 2007, the Company recognized compensation cost of
$241,000 for stock options with a related tax benefit of $27,000, and $279,000
for restricted stock awards with a related tax benefit of
$111,000.  The Company is employing an accelerated method of expense
recognition for options and restricted stock awards.  The estimated
amount and timing of future compensation cost (pre-tax) to be recognized for
awards to date under the plan is as follows:




2008
              
              
              2009
              
              
              2010
              
              
              2011
              
              
              2012
              
              
              Total(In
      Thousands)Stock
      option
              
              $
              858
              
              
              $
              489
              
              
              $
              295
              
              
              $
              164
              
              
              $
              63
              
              
              $
              1,869Restricted
      stock
              
              
              994
              
              
              
              566
              
              
              
              342
              
              
              
              189
              
              
              
              73
              
              
              
              2,164$
              1,852
              
              
              $
              1,055
              
              
              $
              637
              
              
              $
              353
              
              
              $
              136
              
              
              $
              4,033




12.
            OTHER
      COMMITMENTS AND CONTINGENCIES




In the
normal course of business there are outstanding commitments and contingencies
which are not reflected in the accompanying financial statements.




Loan
Commitments




The Bank
is a party to financial instruments with off-balance-sheet risk in the normal
course of business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit.  Such commitments
involve, to varying degrees, elements of credit and interest rate risk in excess
of the amount recognized in the accompanying balance sheets.




F-34
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





OTHER
COMMITMENTS AND CONTINGENCIES (continued)


Loan
Commitments (concluded)




The
Bank’s exposure to credit loss is represented by the contractual amount of these
commitments.  The Bank uses the same credit policies in making
commitments as it does for on-balance-sheet instruments.




At
December 31, 2007 and 2006, the following financial instruments were
outstanding whose contract amounts represent credit risk:




2007
              
              
              2006(In
      Thousands)Commitments
      to grant loans
              
              $
              4,778
              
              
              $
              1,276Unadvanced
      funds on equity lines of credit
              
              
              14,934
              
              
              
              15,450Unadvanced
      funds on construction loans
              
              
              4,482
              
              
              
              2,466Unadvanced
      funds on commercial lines of credit
              
              
              2,771
              
              
              
              2,467





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee.  The commitments for lines of credit may
expire without being drawn upon.  Therefore, the total commitment
amounts do not necessarily represent future cash requirements.  The
Bank evaluates each customer’s credit worthiness on a case-by-case basis and the
commitments are collateralized by real estate.




Operating
Lease Commitments




Pursuant
to the terms of noncancelable lease agreements in effect pertaining to banking
premises, future minimum rent commitments are as follows:




Year
      EndingDecember
      31,
            
            Amount(In
      Thousands)2008
            
            $
            992009
            
            
            1022010
            
            
            1022011
            
            
            632012
            
            
            37Thereafter
            
            
            481$
            884


F-35
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





OTHER
COMMITMENTS AND CONTINGENCIES (concluded)


Operating
Lease Commitments (concluded)


The
leases contain options to extend for periods from five to fifty
years.  The cost of such rentals is not included
above.  Total rent expense for the years ended December 31, 2007
and 2006 amounted to $97,000 and $90,000, respectively.




Employment
and Change in Control Agreements




The
Company and the Bank have entered into employment agreements with certain
executive officers which provide for a specific salary and continuation of
benefits in the event the executive is terminated without
cause.  However, such employment may be terminated for cause, as
defined, without incurring any continuing obligations.  The agreements
also provide for a lump sum severance payment, subject to certain conditions,
following a “change in control” as defined in the agreement.  In
addition, the Bank has entered into change in control agreements with certain
other executive officers which provide for a lump sum severance payment, subject
to certain conditions.




Other
Contingencies




Various
legal claims also arise from time to time in the normal course of business
which, in the opinion of management, will have no material effect on the
Company’s financial position.




13.
            RELATED
      PARTY TRANSACTIONS




In the
ordinary course of business, the Bank has granted loans to its directors and
officers and affiliates.  Activity is as follows:




Years
      Ended December 31,2007
              
              
              2006(In
      Thousands)Balance
      at beginning of year
              
              $
              5,608
              
              
              $
              4,426Originations
              
              
              1,013
              
              
              
              2,133Payments
      and change in status
              
              
              (814
              )
              
              
              (951
              )Balance
      at end of year
              
              $
              5,807
              
              
              $
              5,608


F-36
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





14.
            FAIR
      VALUE OF FINANCIAL INSTRUMENTS




Statement
of Financial Accounting Standards (“SFAS”) No. 107, “Disclosures about Fair
Value of Financial Instruments,” requires disclosure of estimated fair values of
all financial instruments where it is practicable to estimate such
values.  In cases where quoted market prices are not available, fair
values are based on estimates using present value or other valuation
techniques.  Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows.  Accordingly, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could not
be realized in immediate settlement of the instrument.  SFAS
No. 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements.  Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
the Bank.




The
following methods and assumptions were used by the Bank in estimating fair value
disclosures for financial instruments:




Cash and cash
equivalents:  The carrying amounts of cash and cash equivalents
approximate fair values.




Securities:  Fair
values are based on quoted market prices.




FHLB
stock:  The carrying value of FHLB stock approximates fair
value based on the redemption provisions of the Federal Home Loan Bank of
Boston.




Loans:  For
variable rate loans that reprice frequently and with no significant change in
credit risk, fair values are based on carrying values.  Fair values
for other loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms, adjusted
for credit risk.




Accrued
interest:  The carrying amounts of accrued interest approximate
fair values.




Deposits:  The
fair values for non-certificate accounts are, by definition, equal to the amount
payable on demand at the reporting date which is the carrying
amount.  Fair values for certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates currently being
offered on certificates to a schedule of aggregated expected monthly maturities
on time deposits.




Short-term
borrowings:  The carrying amounts of short-term borrowings
approximate fair value.




F-37
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)







FAIR
VALUE OF FINANCIAL INSTRUMENTS (concluded)




Long-term
borrowings:  Fair values of long-term debt are estimated using
discounted cash flow analyses based on the Company’s current incremental
borrowing rates for similar types of borrowing arrangements.




Off-balance-sheet
instruments:  Fair values for off-balance-sheet lending
com-mitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counterparties’ credit standing.  The estimated fair values of
off-balance-sheet instruments are immaterial.




The
estimated fair values, and related carrying amounts, of the Bank’s financial
instruments at December 31, 2007 and 2006 are as follows:




2007
              
              
              2006Carrying
              
              
              Fair
              
              
              Carrying
              
              
              FairAmount
              
              
              Value
              
              
              Amount
              
              
              Value(In
      Thousands)Financial
      assets:Cash
      and cash equivalents
              
              $
              6,705
              
              
              $
              6,705
              
              
              $
              7,272
              
              
              $
              7,272Securities
      available for sale
              
              
              6,966
              
              
              
              6,966
              
              
              
              6,614
              
              
              
              6,614Securities
      held to maturity
              
              
              30,886
              
              
              
              30,751
              
              
              
              1,922
              
              
              
              1,869FHLB
      stock
              
              
              4,163
              
              
              
              4,163
              
              
              
              2,390
              
              
              
              2,390Loans,
      net
              
              
              293,084
              
              
              
              292,229
              
              
              
              256,766
              
              
              
              256,020Accrued
      interest receivable
              
              
              1,269
              
              
              
              1,269
              
              
              
              1,027
              
              
              
              1,027Financial
      liabilities:Deposits
              
              
              193,285
              
              
              
              194,078
              
              
              
              192,974
              
              
              
              193,802Short-term
      borrowings
              
              
              5,809
              
              
              
              5,809
              
              
              
              2,500
              
              
              
              2,500Long-term
      borrowings
              
              
              99,547
              
              
              
              99,896
              
              
              
              31,950
              
              
              
              31,662Accrued
      interest payable
              
              
              1,350
              
              
              
              1,350
              
              
              
              1,153
              
              
              
              1,153


F-38
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





15.
            CONDENSED
      FINANCIAL STATEMENTS OF PARENT
COMPANY




Financial
information pertaining only to Newport Bancorp, Inc. is as follows:




December
      31,BALANCE
      SHEETS
              
              2007
              
              
              2006(In
      Thousands)ASSETSCash
      and cash equivalents due from subsidiary
              
              $
              15,554
              
              
              $
              17,859Investment
      in common stock of subsidiary
              
              
              38,813
              
              
              
              37,478Loan
      to Newport Federal Savings Bank ESOP
              
              
              3,468
              
              
              
              3,614Net
      deferred tax asset
              
              
              776
              
              
              
              900Other
      assets
              
              
              429
              
              
              
              134Total
      assets
              
              $
              59,040
              
              
              $
              59,985LIABILITIES
      AND STOCKHOLDERS' EQUITYAccrued
      expenses and other liabilities
              
              $
              88
              
              
              $
              5Stockholders'
      equity
              
              
              58,952
              
              
              
              59,980Total
      liabilities and stockholders' equity
              
              $
              59,040
              
              
              $
              59,985
  F-39
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


CONDENSED
FINANCIAL STATEMENTS OF PARENT COMPANY (Continued)




For
      the
                
                
                July
      6, 2006Year
      Ended
                
                
                ThroughDecember
      31,
                
                
                December
      31,STATEMENTS OF
      OPERATIONS
                
                2007
                
                
                2006(In
      Thousands)Income:Interest
      and fees on loans
                
                $
                298
                
                
                $
                157Interest
      on cash and cash equivalents
                
                
                50
                
                
                
                -Total
      income
                
                
                348
                
                
                
                157Non-interest
      expenses:Salaries
      and employee benefits
                
                
                391
                
                
                
                225Professional
      fees
                
                
                194
                
                
                
                51Contribution
      to NewportFed Charitable Foundation
                
                
                -
                
                
                
                3,614Other
      general and administrative
                
                
                61
                
                
                
                4Total
      non-interest expenses
                
                
                646
                
                
                
                3,894Loss
      before income taxes and equity in undistributed netincome of
      subsidiary
                
                
                (298
                )
                
                
                (3,737
                )Applicable
      income tax benefit
                
                
                (69
                )
                
                
                (1,028
                )(229
                )
                
                
                (2,709
                )Equity
      in undistributed net income of subsidiary
                
                
                986
                
                
                
                1,053Net
      income (loss)
                
                $
                757
                
                
                $
                (1,656
                )
 F-40
 Index


NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


CONDENSED
FINANCIAL STATEMENTS OF PARENT COMPANY (Concluded)




For
      the
                
                
                July
      6, 2006Year
      Ended
                
                
                ThroughDecember
      31,
                
                
                December
      31,STATEMENT OF CASH
      FLOWS
                
                2007
                
                
                2006(In
      Thousands)Cash
      flows from operating activities:Net
      income (loss)
                
                $
                757
                
                
                $
                (1,656
                )Adjustments
      to reconcile net income (loss) to net cash provided (used) by operating
      activities:Equity
      in undistributed net income of subsidiary
                
                
                (986
                )
                
                
                (1,053
                )Contribution
      to NewportFed Charitable Foundation
                
                
                -
                
                
                
                3,614Loan
      to ESOP
                
                
                -
                
                
                
                (3,903
                )Repayment
      of ESOP loan
                
                
                146
                
                
                
                289Stock-based
      compensation
                
                
                28
                
                
                
                -Repayment
      of stock-based compensation by subsidiary
                
                
                493
                
                
                
                -Deferred
      income tax (benefit) provision
                
                
                124
                
                
                
                (900
                )Increase
      in other assets
                
                
                (295
                )
                
                
                (134
                )Increase
      in other liabilities
                
                
                83
                
                
                
                5Net
      cash provided (used) by operating activities
                
                
                350
                
                
                
                (3,738
                )Cash
      flows from investing activities:Investment
      in subsidiary
                
                
                -
                
                
                
                (22,000
                )Net
      cash used by investing activities
                
                
                -
                
                
                
                (22,000
                )Cash
      flows from financing activities:Proceeds
      from issuance of common stock
                
                
                -
                
                
                
                43,597Treasury
      stock purchased
                
                
                (2,655
                )
                
                
                -Net
      cash provided (used) by financing activities
                
                
                (2,655
                )
                
                
                43,597Net
      change in cash and cash equivalents
                
                
                (2,305
                )
                
                
                17,859Cash
      and cash equivalents at beginning of period
                
                
                17,859
                
                
                
                -Cash
      and cash equivalents at end of period
                
                $
                15,554
                
                
                $
                17,859


F-41
 Index





NEWPORT
BANCORP, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded)




16.
            QUARTERLY
      DATA (UNAUDITED)




Years
      Ended December 31,2007
                
                
                2006Fourth
                
                
                Third
                
                
                Second
                
                
                First
                
                
                Fourth
                
                
                Third
                
                
                Second
                
                
                FirstQuarter
                
                
                Quarter
                
                
                Quarter
                
                
                Quarter
                
                
                Quarter
                
                
                Quarter
                
                
                Quarter
                
                
                Quarter(In
      Thousands, Except Per Share Data)Interest
      and dividend income
                
                $
                4,864
                
                
                $
                4,536
                
                
                $
                4,367
                
                
                $
                4,221
                
                
                $
                4,182
                
                
                $
                4,245
                
                
                $
                3,998
                
                
                $
                3,666Interest
      expense
                
                
                2,203
                
                
                
                1,930
                
                
                
                1,896
                
                
                
                1,665
                
                
                
                1,514
                
                
                
                1,398
                
                
                
                1,767
                
                
                
                1,532Net
      interest income
                
                
                2,661
                
                
                
                2,606
                
                
                
                2,471
                
                
                
                2,556
                
                
                
                2,668
                
                
                
                2,847
                
                
                
                2,231
                
                
                
                2,134Provision
      for loan losses
                
                
                140
                
                
                
                126
                
                
                
                47
                
                
                
                113
                
                
                
                38
                
                
                
                50
                
                
                
                12
                
                
                
                20Net
      interest income, after provision for loan losses
                
                
                2,521
                
                
                
                2,480
                
                
                
                2,424
                
                
                
                2,443
                
                
                
                2,630
                
                
                
                2,797
                
                
                
                2,219
                
                
                
                2,114Non-interest
      income
                
                
                582
                
                
                
                584
                
                
                
                598
                
                
                
                555
                
                
                
                531
                
                
                
                125
                
                
                
                406
                
                
                
                389Non-interest
      expenses
                
                
                3,096
                
                
                
                2,627
                
                
                
                2,524
                
                
                
                2,587
                
                
                
                2,335
                
                
                
                6,123
                (1)
                
                
                2,312
                
                
                
                2,468Income
      (loss) before income taxes
                
                
                7
                
                
                
                437
                
                
                
                498
                
                
                
                411
                
                
                
                826
                
                
                
                (3,201
                
                
                
                313
                
                
                
                35Provision
      (benefit) for income taxes
                
                
                54
                
                
                
                176
                
                
                
                214
                
                
                
                152
                
                
                
                358
                
                
                
                (855
                
                
                
                116
                
                
                
                10Net
      income (loss)
                
                $
                (47
                )
                
                $
                261
                
                
                $
                284
                
                
                $
                259
                
                
                $
                468
                
                
                $
                (2,346
                
                
                $
                197
                
                
                $
                25Earnings
      (loss) per common share:Basic
      and diluted
                
                $
                (0.01
                )
                
                $
                0.06
                
                
                $
                0.06
                
                
                $
                0.06
                
                
                $
                0.10
                
                
                
                N/A
                
                
                
                N/A
                
                
                
                N/A
 (1)Includes $3,614 contribution to Newport Charitable
Foundation.
   F-42