**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, 2006**




**£**
            **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: 0-50801**





**SI
      FINANCIAL GROUP, INC.**


**(Exact
      name of registrant as specified in its charter)**





**United
                States**
            
            **84-1655232****(State
                or other jurisdiction of incorporation or
                organization)**
            
            **(I.R.S.
                Employer Identification
                No.)**




**803
                Main Street, Willimantic, Connecticut**
            
            **06226****(Address
                of principal executive offices)**
            
            **(Zip
                Code)**




**(860)
      423-4581**


**(Registrant’s
      telephone number, including area code)**





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





**Title
                of each class**
            **Name
                of Exchange on which registered**Common
                stock, par value $0.01 per share
            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 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. £





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




Large
                accelerated filer £
            Accelerated
                filer £
            Non-accelerated
                filer S




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act.) Yes £  No S





The
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates was $54.1 million, which was computed by reference to the closing
      price of $11.00, at which the common equity was sold as of June 30, 2006. Solely
      for the purposes of this calculation, the shares held by SI Bancorp, MHC and
      the
      directors and officers of the registrant are deemed to be
      affiliates.





As
      of
      March 13, 2007, there were 12,421,920 shares of the registrant’s common stock
      outstanding.





**DOCUMENTS
      INCORPORATED BY REFERENCE**





Portions
      of the Proxy Statement for the 2007 Annual Meeting of Stockholders are
      incorporated by reference in Part III of this Form 10-K.










*Table
            of Contents*





**SI
      FINANCIAL GROUP, INC.**


**TABLE
      OF CONTENTS**





**PART
                I.**
            
            **Page
                No.**Item
                1.
            Business
            1Item
                1A.
            Risk
                Factors
            35Item
                1B.
            Unresolved
                Staff Comments
            39Item
                2.
            Properties
            39Item
                3.
            Legal
                Proceedings
            41Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            41**PART
                II.**Item
                5.
            Market
                for the Registrant’s Common Equity, Related Stockholder
                Matters and Issuer Purchases of Equity Securities
            41Item
                6.
            Selected
                Financial Data
            43Item
                7.
            Management’s
                Discussion and Analysis of Financial Condition and
                Results of Operations
            45Item
                7A.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            58Item
                8.
            Financial
                Statements and Supplementary Data
            60Item
                9.
            Changes
                in and Disagreements with Accountants on Accounting and
                Financial Disclosure
            60Item
                9A.
            Controls
                and Procedures
            61Item
                9B.
            Other
                Information
            61**PART
                III.**Item
                10.
            Directors,
                Executive Officers and Corporate
                Governance
            61Item
                11.
            Executive
                Compensation
            62Item
                12.
            Security
                Ownership of Certain Beneficial Owners and Management
                and Related Stockholder Matters
            62Item
                13.
            Certain
                Relationships and Related Transactions and Director
                Independence
            62Item
                14.
            Principal
                Accountant Fees and Services
            63**PART
                IV.**Item
                15.
            Exhibits
                and Financial Statement Schedules
            63Signatures
            65





*Table
            of Contents*





***Forward-Looking
      Statements***


*This
      report contains forward-looking statements that are based on assumptions and
      may
      describe future plans, strategies and expectations of SI Financial Group, Inc.
      (the “Company”). These forward-looking statements are generally identified by
      the use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,”
“project” or similar expressions. The Company’s ability to predict results or
      the actual effect of future plans or strategies is inherently uncertain. Factors
      that could have a material adverse effect on the operations of the Company
      and
      its subsidiaries include, but are not limited to, changes in interest rates,
      national and regional economic conditions, legislative and regulatory changes,
      monetary and fiscal policies of the United States government, including policies
      of the United States Treasury and the Federal Reserve Board, the quality and
      composition of the loan or investment portfolios, demand for loan products,
      deposit flows, competition, demand for financial services in the Company’s
      market area, changes in real estate market values in the Company’s market area
      and changes in relevant accounting principles and guidelines. These risks and
      uncertainties should be considered in evaluating forward-looking statements
      and
      undue reliance should not be placed on such statements. Except as required
      by
      applicable law or regulation, the Company does not undertake, and specifically
      disclaims any obligation, to release publicly the result of any revisions that
      may be made to any forward-looking statements to reflect events or circumstances
      after the date of the statements or to reflect the occurrence of anticipated
      or
      unanticipated events.*





**PART
      I.**





**Item
      1. Business.**





**General**





*In
      certain instances where appropriate, the terms “we,” “us” and “our” refer to SI
      Financial Group, Inc. and Savings Institute Bank and Trust Company or
      both.*





SI
      Financial Group, Inc. was established on August 6, 2004 to become the parent
      holding company for Savings Institute Bank and Trust Company (the “Bank” or
“Savings Institute”) upon the conversion of the Bank’s former parent, SI
      Bancorp, Inc., from a state-chartered to a federally-chartered mutual holding
      company. At the same time, the Bank also converted from a state-chartered to
      a
      federally-chartered savings bank. The Bank is a wholly-owned subsidiary of
      the
      Company and management of the Company and the Bank are substantially similar.
      The Company neither owns nor leases any property, but instead uses the premises,
      equipment and other property of the Bank. Thus, the financial information and
      discussion contained herein primarily relates to the activities of the
      Bank.





The
      Bank
      was incorporated by an act of the Connecticut legislature in 1842 under the
      name
      Willimantic Savings Institute. It was shortened to Savings Institute in 1991
      to
      reflect the Bank’s expanded geographic territory. In 2000, the Bank converted to
      stock form and became the wholly-owned subsidiary of SI Bancorp, Inc., a
      Connecticut-chartered mutual holding company. On August 6, 2004, Savings
      Institute converted to a federal charter and now operates under the name Savings
      Institute Bank and Trust Company. At that time, SI Bancorp, Inc. converted
      to a
      federal charter operating under the name SI Bancorp, MHC and transferred all
      of
      the common stock of the Bank to SI Financial Group, Inc. On September 30, 2004,
      the Company completed its minority stock offering with the sale of 5,025,500
      shares of its common stock to the public, 251,275 shares contributed to SI
      Financial Group Foundation and 7,286,975 issued to SI Bancorp, MHC.





The
      Bank
      operates as a community-oriented financial institution offering a full range
      of
      financial services to consumers and businesses in its market area, including
      insurance, trust and investment services. The Bank attracts deposits from the
      general public and uses those funds to originate one- to four-family
      residential, multi-family and commercial real estate, commercial business and
      consumer loans, which it holds primarily for investment.





1
 *Table
            of Contents*





**Definitive
      Agreement Signed**





On
      September 5, 2006, the Bank signed a definitive agreement to purchase Fairfield
      Financial Mortgage Group, Inc. (“FFMG”). FFMG has branch offices in Texas,
      Massachusetts, New Hampshire, New Jersey, New York and Pennsylvania and is
      also
      a licensed mortgage banker in South Carolina, Florida, Georgia, Michigan, Rhode
      Island, Maryland, Delaware and California.





**Availability
      of Information**





The
      Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current
      reports on Form
      8-K
      and any amendments to such reports filed or furnished pursuant to Section 13(a)
      or 15(d) of the Securities Exchange Act of 1934, as amended, are made available
      free of charge on the Company’s website, ** *www.mysifi.com* ,
      as soon
      as reasonably practicable after the Company electronically files such material
      with, or furnishes it to, the Securities and Exchange Commission (the “SEC”).
      The information on the Company’s website shall not be considered as incorporated
      by reference into this Form 10-K.





**Market
      Area**





The
      Company is headquartered in Willimantic, Connecticut, which is located in
      eastern Connecticut approximately 30 miles east of Hartford. The Bank operates
      nineteen offices in Windham, New London, Tolland and Hartford Counties, which
      the Bank considers its primary market area. The economy in its market area
      is
      primarily oriented to the educational, service, entertainment, manufacturing
      and
      retail industries.





The
      major
      employers in the area include several institutions of higher education, the
      Mohegan Sun and Foxwoods casinos, General Dynamics Defense Systems and Pfizer,
      Inc. According to published statistics, Windham County’s population in 2006 was
      approximately 116,000 and consisted of 43,000 households. The population
      increased approximately 6.7% from 2000. Median household income in Windham
      County is $49,000, compared to $60,000 for Connecticut as a whole and $43,000
      nationally. The surrounding counties of Hartford, New London and Tolland
      Counties have median household incomes of $56,000, $55,000 and $65,000,
      respectively.





**Competition**





The
      Bank
      faces significant competition for the attraction of deposits and origination
      of
      loans. The most direct competition for deposits has historically come from
      the
      several financial institutions operating in the Bank’s market area and, to a
      lesser extent, from other financial service companies, such as brokerage firms,
      credit unions and insurance companies. The Bank also faces competition for
      investors’ funds from money market funds and other corporate and government
      securities. At June 30, 2006, which is the most recent date for which data
      is
      available from the Federal Deposit Insurance Corporation (“FDIC”), the Bank held
      approximately 18.95% of the deposits in Windham County, which is the largest
      market share out of 11 financial institutions with offices in this county.
      Also,
      at June 30, 2006, the Bank held approximately 0.97% of the deposits in Hartford,
      New London and Tolland Counties, which is the 15 th market
      share out of 36 financial institutions with offices in these counties. Banks
      owned by Bank of America Corp., Webster Bank Financial Corporation, TD Banknorth
      Group, Inc., Sovereign Bancorp., Inc. and Citizens Financial Group, Inc., all
      of
      which are large regional bank holding companies, also operate in the Bank’s
      market area. These institutions are significantly larger and, therefore, have
      significantly greater resources than the Bank does and may offer products and
      services that the Bank does not provide.





2
 *Table
            of Contents*





The
      Bank’s competition for loans comes primarily from financial institutions in its
      market area, and to a lesser extent from other financial service providers,
      such
      as mortgage companies 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.





The
      Bank
      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 the Company’s growth in the
      future.





**Lending
      Activities**





***General.*** The
      Bank’s loan portfolio consists primarily of one- to four-family residential
      mortgage loans, multi-family and commercial real estate loans and commercial
      business loans. To a much lesser extent, the loan portfolio includes
      construction and consumer loans. The Bank historically and currently originates
      loans primarily for investment purposes. At December 31, 2006, the Bank had
      $135,000 in loans that were held for sale.





The
      following table summarizes the composition of the Bank’s loan portfolio in
      dollar amounts and as a percentage of the respective portfolio at the dates
      indicated.





**At
                December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002**Amount
            
            Percent
              of
                Total
            
            Amount
            
            Percent
              of
                Total
            
            Amount
            
            Percent
              of
                Total
            
            Amount
            
            Percent
              of
                Total
            
            Amount
            
            Percent
              of
                Total**Real
                estate loans:**Residential
                - 1 to 4 family
            
            $
            309,695
            
            
            53.65
            %
            $
            266,739
            
            
            51.66
            %
            $
            252,180
            
            
            55.99
            %
            $
            226,881
            
            
            58.29
            %
            $
            213,831
            
            
            63.29
            %Multi-family
                and commercial
            
            
            118,600
            
            
            20.55
            
            
            100,926
            
            
            19.54
            
            
            82,213
            
            
            18.25
            
            
            73,428
            
            
            18.87
            
            
            61,214
            
            
            18.12Construction
            
            
            44,647
            
            
            7.73
            
            
            47,325
            
            
            9.16
            
            
            35,773
            
            
            7.94
            
            
            20,652
            
            
            5.30
            
            
            21,104
            
            
            6.25**Total
                real estate loans**
            
            
            472,942
            
            
            81.93
            
            
            414,990
            
            
            80.36
            
            
            370,166
            
            
            82.18
            
            
            320,961
            
            
            82.46
            
            
            296,149
            
            
            87.66**Consumer
                loans:**Home
                equity
            
            
            18,489
            
            
            3.20
            
            
            20,562
            
            
            3.98
            
            
            18,335
            
            
            4.07
            
            
            14,411
            
            
            3.70
            
            
            10,786
            
            
            3.19Other
            
            
            10,616
            
            
            1.84
            
            
            3,294
            
            
            0.64
            
            
            2,790
            
            
            0.62
            
            
            3,107
            
            
            0.80
            
            
            3,936
            
            
            1.16**Total
                consumer loans**
            
            
            29,105
            
            
            5.04
            
            
            23,856
            
            
            4.62
            
            
            21,125
            
            
            4.69
            
            
            17,518
            
            
            4.50
            
            
            14,722
            
            
            4.35**Commercial
                business loans**
            
            
            75,171
            
            
            13.03
            
            
            77,552
            
            
            15.02
            
            
            59,123
            
            
            13.13
            
            
            50,746
            
            
            13.04
            
            
            27,003
            
            
            7.99**Total
                loans**
            
            
            577,218
            
            
            100.00
            %
            
            516,398
            
            
            100.00
            %
            
            450,414
            
            
            100.00
            %
            
            389,225
            
            
            100.00
            %
            
            337,874
            
            
            100.00
            %Deferred
                loan origination costs, net of fees
            
            
            1,258
            
            
            
            
            
            1,048
            
            
            
            
            
            743
            
            
            
            
            
            387
            
            
            
            
            
            (209
            )Allowance
                for loan losses
            
            
            (4,365
            )
            
            
            
            
            (3,671
            )
            
            
            
            
            (3,200
            )
            
            
            
            
            (2,688
            )
            
            
            
            
            (3,067
            )**Loans
                receivable, net**
            
            $
            574,111
            
            
            
            
            $
            513,775
            
            
            
            
            $
            447,957
            
            
            
            
            $
            386,924
            
            
            
            
            $
            334,598





3
 *Table
            of Contents*





***One-
      to Four-Family Residential Loans*** **.** The
      Bank’s primary lending activity is the origination of mortgage loans to enable
      borrowers to purchase or refinance existing homes or to construct new
      residential dwellings in its market area. The Bank offers fixed-rate and
      adjustable-rate mortgage loans with terms up to 30 years. Borrower demand for
      adjustable-rate loans versus fixed-rate loans is a function of the level of
      interest rates, the expectations of changes in the level of interest rates,
      the
      difference between the interest rates and loan fees offered for fixed-rate
      mortgage loans and the initial period interest rates and loan fees for
      adjustable-rate loans. 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 and the effect
      each has on the Bank’s interest rate risk. The loan fees charged, interest rates
      and other provisions of mortgage loans are determined on the basis of the Bank’s
      own pricing criteria and competitive market conditions. Additionally, the Bank
      offers reverse mortgages to its customers, through a correspondent relationship
      with another institution, in response to increasing demand for this type of
      product.





The
      Bank
      offers fixed-rate loans with terms of 10, 15, 20 or 30 years. The Bank’s
      adjustable-rate mortgage loans are based on 15, 20 or 30 year amortization
      schedules. Interest rates and payments on adjustable-rate mortgage loans adjust
      annually after a one, three, five, seven or 10-year initial fixed period.
      Interest rates and payments on adjustable-rate loans are adjusted to a rate
      typically equal to 2.75% (2.875% for jumbo loans) above the one-year constant
      maturity 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
      the
      Bank anticipates that adjustable-rate loans will better offset the adverse
      effects of an increase in interest rates as compared to fixed-rate mortgages,
      the increased mortgage payments 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 help make the Bank’s 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.





Generally,
      the Bank does not originate conventional loans with loan-to-value ratios
      exceeding 95% and generally originates loans with a loan-to-value ratio in
      excess of 80% only when secured by first liens on owner-occupied one- to
      four-family residences. Loans with loan-to-value ratios in excess of 80%
      generally require private mortgage insurance or additional collateral. The
      Bank
      requires all properties securing mortgage loans to be appraised by a board
      approved independent licensed appraiser and requires title insurance on all
      first mortgage loans. Borrowers must obtain hazard insurance and flood insurance
      for loans on property located in a flood zone, before closing the
      loan.





In
      an
      effort to provide financing for moderate income and first-time buyers, the
      Bank
      offers Federal Housing Authority, Veterans Administration and Connecticut
      Housing Finance Agency loans and a first-time home buyers program. The Bank
      offers fixed-rate residential mortgage loans through these programs to qualified
      individuals and originates the loans using modified underwriting
      guidelines.





***Multi-Family
      and Commercial Real Estate Loans*** **.** The
      Bank
      offers fixed-rate and adjustable-rate mortgage loans secured by multi-family
      and
      commercial real estate. The Bank’s multi-family and commercial real estate loans
      are generally secured by condominiums, apartment buildings, single-family
      subdivisions as well as owner-occupied properties located in its market area
      and
      used for businesses. The Bank intends to continue to emphasize this segment
      of
      its loan portfolio.





4
 *Table
            of Contents*





The
      Bank
      originates adjustable-rate multi-family and commercial real estate loans for
      terms up to 25 years. Interest rates and payments on these loans typically
      adjust every five years after a five-year initial fixed-rate period. Interest
      rates and payments on adjustable-rate loans are adjusted to a rate typically 2.0-3.0%
      above the classic advance rates offered by the Federal Home Loan Bank of Boston
      (the “FHLB”). There are no adjustment period or lifetime interest rate caps.
      Loans are secured by first mortgages that generally do not exceed 75% of the
      property’s appraised value. At December 31, 2006, the largest outstanding
      multi-family or commercial real estate loan was $3.0 million. This loan is
      secured by office and retail space and was performing according to its terms
      at
      December 31, 2006.





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,
      consideration is given to the net operating income of the property, the
      borrower’s expertise, credit history and profitability and the value of the
      underlying property. In addition, with respect to commercial real estate rental
      properties, the Bank will also consider the term of the lease and the quality
      of
      the tenants. The Bank generally requires that the properties securing these
      real
      estate loans have debt service coverage ratios of at least 1.20. The debt
      service coverage ratio is equal to cash flows before interest, depreciation
      and
      required principal payments. Appropriate environmental assessments are generally
      required for commercial real estate loans over $100,000, based upon the
      environmental risk factors for the subject collateral property.





***Construction
      and Land Loans.*** The
      Bank
      originates loans to individuals, and to a lesser extent, builders, to finance
      the construction of residential dwellings. The Bank also originates construction
      loans for commercial development projects, including condominiums, apartment
      buildings, single-family subdivisions as well as owner-occupied properties
      used
      for businesses. Residential construction loans generally provide for the payment
      of interest only during the construction phase, which is usually twelve months.
      At the end of the construction phase, the loan generally converts to a permanent
      mortgage loan. Commercial construction loans generally provide for the payment
      of interest only during the construction phase which may range from three months
      to a maximum of twenty-four months as allowed by the Bank’s Loan Policy.
      Generally, commercial loans on owner-occupied properties would convert to a
      permanent mortgage as the construction loan is repaid from the sale of
      individual units or houses. Loans generally can be made with a maximum
      loan-to-value ratio of 90% on residential construction and 75% on commercial
      construction for nonresidential properties and 80% on commercial multi-family
      construction of the lower of appraised value or cost of the project, whichever
      is less. At December 31, 2006, the largest outstanding residential construction
      loan commitment was for $1.0 million, of which $392,000 was outstanding. At
      December 31, 2006, the largest outstanding commercial construction loan
      commitment was $7.3 million, of which $4.7 million was outstanding. These loans
      were performing according to their terms at December 31, 2006. Primarily all
      commitments to fund construction loans require an appraisal of the property
      by a
      board approved independent licensed appraiser. Also, inspections of the property
      are required before the disbursement of funds during the term of the
      construction loan.




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




5
 *Table
            of Contents*




accuracy
      of the initial estimate of the property’s value at completion of construction or
      development and the estimated cost, including interest, of construction. During
      the construction phase, a number of factors could result in delays and cost
      overruns. If the estimate of construction costs proves to be inaccurate, we
      may
      be required to advance funds beyond the amount originally committed to permit
      completion of the development. If the estimate of value proves to be inaccurate,
      the Bank may be confronted, at or before the maturity of the loan, with a
      project having a value which is insufficient to assure full repayment. As a
      result of the foregoing, construction lending often involves the disbursement
      of
      substantial funds with repayment dependent, in part, on the success of the
      ultimate project rather than the ability of the borrower or guarantor to repay
      principal and interest. If the Bank is forced to foreclose on a project 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.





The
      Bank
      also originates land loans to individuals and local contractors and developers
      only for the purpose of making improvements on approved building lots,
      subdivisions and condominium projects within two years of the date of the loan.
      Such loans to individuals generally are written with a maximum loan-to-value
      ratio based upon the appraised value or purchase price of the land. Maximum
      loan-to-value ratio on raw land is 50%, while the maximum loan-to-value ratio
      for land development loans involving approved projects is 65%. The Bank offers
      fixed-rate land loans and variable-rate land loans that adjust annually.
      Interest rates and payments on adjustable-rate land loans are adjusted to a
      rate
      typically equal to the then current *The
      Wall Street Journal* prime
      rate plus a 1.0 - 2.0% margin. The maximum amount by which the interest rate
      may
      be increased or decreased is generally 2% annually and the lifetime interest
      rate cap is generally 6% over the initial rate of the loan.





***Commercial
      Business Loans.*** The
      Bank
      originates commercial business loans to a variety of professionals, sole
      proprietorships and small businesses primarily in its market area. The Bank
      offers a variety of commercial lending products, the maximum amount of which
      is
      limited by the Bank’s in-house loans to one borrower limit. At December 31,
      2006, the largest commercial loan was a $1.5 million loan, which is secured
      by a
      business asset consisting of a waste processing system. This loan was performing
      according to its terms at December 31, 2006.





The
      Bank
      offers loans secured by business assets other than real estate, such as business
      equipment and inventory. These loans are originated with maximum loan-to-value
      ratios of 75% of the value of the personal property. The Bank originates lines
      of credit to finance the working capital needs of businesses to be repaid by
      seasonal cash flows or to provide a period of time during which the business
      can
      borrow funds for planned equipment purchases. These loans convert to a term
      loan
      at the expiration of a draw period, which is not to exceed twelve months and
      will be paid over a pre-defined amortization period. Additional products such
      as
      time notes, letters of credit and Small Business Administration guaranteed
      loans
      are offered.





When
      originating commercial business loans, the Bank considers the financial
      statements of the borrower, the borrower’s payment history of both corporate and
      personal debt, the debt service capabilities of the borrower, the projected
      cash
      flows of the business, viability of the industry in which the customer operates
      and the value of the collateral.





Unlike
      residential mortgage loans, which generally are made on the basis of the
      borrower’s ability to make repayment from his or her employment or other income,
      and which are secured by real property whose value tends to be more easily
      ascertainable, commercial loans are of higher risk and typically are made on
      the
      basis of the borrower’s ability to make repayment from the cash flow of the
      borrower’s business. As a result, the availability of funds for the repayment of
      commercial loans may depend


6
 *Table
            of Contents*




substantially
      on the success of the business itself. Further, any collateral securing such
      loans may depreciate over time, may be difficult to appraise and may fluctuate
      in value.




The
      Bank
      offers equipment lease financing to its commercial customers. Financing is
      available up to 100% of the leased equipment and amortized over a period of
      one
      to three years. All commercial leasing loans, totaling $1.3 million, were
      performing according to terms at December 31, 2006.





***Consumer
      Loans*** **.** The
      Bank
      offers a variety of consumer loans, primarily home equity lines of credit,
      and,
      to a lesser extent, loans secured by marketable securities, passbook or
      certificate accounts, motorcycles, automobiles and recreational vehicles as
      well
      as unsecured loans. Unsecured loans generally have a maximum borrowing limit
      of
      $15,000 and a maximum term of five years.





In
      February 2006, the Bank purchased a participation interest in a pool of
      automobile loans from UnitedOne Credit Union, which are serviced by Flatiron
      Financial Services, Inc. (formerly Centrix Financial, LLC), for a total purchase
      price of $10.3 million. These loans are secured by new and used automobiles.
      The
      indirect automobile loans have fixed interest rates and generally have terms
      up
      to seven years. Generally, the Bank offers automobile loans with a maximum
      loan-to-value ratio of 100% of the purchase price for new vehicles.





The
      procedures for underwriting consumer loans include an assessment of the
      applicant’s payment history on other debts and their ability to meet existing
      obligations and payments on the proposed loans. 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. Home equity lines of credit have adjustable rates of interest
      that
      are indexed to the prime rate as reported in *The
      Wall Street Journal* . The Bank
      will offer home equity loans with maximum combined loan-to-value ratios of
      100%,
      provided that loans in excess of 80% will be charged a higher rate of interest.
      A home equity line of credit may be drawn down by the borrower for an initial
      period of five years from the date of the loan agreement. During this period,
      the borrower has the option of paying, on a monthly basis, either principal
      and
      interest or only interest. If not renewed, the borrower has to pay back the
      amount outstanding under the line of credit over a term not to exceed ten years,
      beginning at the end of the five-year period.





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. In such cases, repossessed collateral for a defaulted
      consumer loan may not provide an adequate source of repayment for the
      outstanding loan and the remaining deficiency often does not warrant further
      substantial collection efforts against the borrower. In addition, consumer
      loan
      collections depend on the borrower’s continuing financial stability, and
      therefore, are more likely to be adversely affected by 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 which can be recovered on such loans.





***Loan
      Originations, Purchases, Sales and Servicing*** **.** Loan
      originations come from a number of sources. The primary source of loan
      originations are the Bank’s in-house loan originators, and to a lesser extent,
      local mortgage brokers, advertising and referrals from customers.





From
      time
      to time, the Bank will purchase whole participations in loans fully guaranteed
      by the United States Department of Agriculture and the Small Business
      Administration. The loans are primarily for commercial and agricultural
      properties located throughout the United States. The Bank purchased





7
 *Table
            of Contents*




$675,000
      and $22.2 million of these loans in fiscal 2006 and 2005, respectively.
      Additionally, the Bank purchased $10.3 million of indirect automobile loans
      during 2006.




The
      Bank
      generally originates loans for portfolio but from time to time will sell loans
      in the secondary market, primarily fixed-rate one- to four-family residential
      mortgage loans with servicing retained, based on prevailing market interest
      rate
      conditions, an analysis of the composition and risk of the loan portfolio,
      liquidity needs and interest rate risk management. Generally, loans are sold
      without recourse. The Bank utilizes the proceeds from these sales primarily
      to
      meet liquidity needs and manage interest rate risk. The Bank sold $11.0 million,
      $35.5 million and $15.5 million of loans in the years ended December 31, 2006,
      2005 and 2004, respectively.





At
      December 31, 2006, the Bank retained the servicing rights on $72.5 million
      of
      loans for others, consisting primarily of fixed-rate mortgage loans sold with
      or
      without recourse to third parties. Loan repurchase commitments are agreements
      to
      repurchase loans previously sold upon the occurrence of conditions established
      in the contract, including default by the underlying borrower. Loans sold with
      recourse totaled $59,000 at December 31, 2006. Loan servicing includes
      collecting and remitting loan payments, accounting for principal and interest,
      contacting delinquent mortgagors, processing insurance and tax payments on
      behalf of borrowers, assisting in foreclosures and property dispositions when
      necessary and general administration of loans. The gross servicing fee income
      from loans sold with servicing rights retained is typically 25.0 or 37.5 basis
      points of the total balance of serviced loans. The servicing rights related
      to
      these loans was $392,000 and $373,000 at December 31, 2006 and 2005,
      respectively. Amortization of mortgage servicing rights totaled $78,000, $64,000
      and $24,000 for the years ended December 31, 2006, 2005 and 2004,
      respectively.





The
      following table sets forth the Bank’s loan originations, loan purchases, loan
      sales, principal repayments, charge-offs and other reductions on loans for
      the
      years indicated.





**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004****Loans
                at beginning of year**
            
            $
            516,398
            
            $
            450,414
            
            $
            389,225**Originations:**Real
                estate loans
            
            
            144,533
            
            
            154,166
            
            
            147,899Commercial
                business loans
            
            
            11,094
            
            
            12,635
            
            
            14,465Consumer
                loans
            
            
            13,096
            
            
            17,011
            
            
            16,063**Total
                loan originations**
            
            
            168,723
            
            
            183,812
            
            
            178,427**Purchases**
            
            
            11,007
            
            
            22,211
            
            
            12,152**Deductions:**Principal
                loan repayments, prepayments and other, net
            
            
            107,672
            
            
            104,126
            
            
            113,766Loan
                sales
            
            
            11,039
            
            
            35,534
            
            
            15,549Loan
                charge-offs
            
            
            199
            
            
            29
            
            
            75Transfers
                to other real estate owned
            
            
            -
            
            
            350
            
            
            -**Total
                deductions**
            
            
            118,910
            
            
            140,039
            
            
            129,390**Net
                increase in loans**
            
            
            60,820
            
            
            65,984
            
            
            61,189**Loans
                at end of year**
            
            $
            577,218
            
            $
            516,398
            
            $
            450,414





8
 *Table
            of Contents*





***Loan
      Maturity.*** The
      following table shows the contractual maturity of the Bank’s loan portfolio at December
      31, 2006. The table does not reflect any estimate of prepayments, which
      significantly shortens the average life of all loans, and may cause actual
      repayment experience to differ from that shown below. Demand loans having no
      stated schedule of repayment and no stated maturity are reported as due in
      one
      year or less.





**Amounts
                Due In***(Dollars
                in Thousands)*
            
            One
                Year orLess
            
            More
                Than One Year
              toFive
                Years
            
            More
                ThanFive
                Years
            
            Total
                AmountDue**Real
                estate loans:**Residential
                - 1 to 4 family
            
            $
            49
            
            $
            5,209
            
            $
            304,437
            
            $
            309,695Multi-family
                and commercial
            
            
            714
            
            
            2,753
            
            
            115,133
            
            
            118,600Construction
            
            
            14,144
            
            
            1,146
            
            
            29,357
            
            
            44,647**Total
                real estate loans**
            
            
            14,907
            
            
            9,108
            
            
            448,927
            
            
            472,942**Commercial
                business loans**
            
            
            7,595
            
            
            6,897
            
            
            60,679
            
            
            75,171**Consumer
                loans**
            
            
            200
            
            
            9,135
            
            
            19,770
            
            
            29,105**Total
                loans**
            
            $
            22,702
            
            $
            25,140
            
            $
            529,376
            
            $
            577,218





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 upon the
      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, sale and refinancing activity in the real estate market,
      prevailing interest rates and the interest rates payable on outstanding
      loans.





The
      following table sets forth, at December 31, 2006, the dollar amount of gross
      loans receivable contractually due after December 31, 2007, and whether such
      loans have either fixed interest rates, floating or adjustable interest rates.
      The amounts shown below exclude deferred loan fees and costs and the allowance
      for loan losses and include $806,000 of nonperforming loans.





**Due
                After December 31, 2007***(Dollars
                in Thousands)*
            
            **Fixed**
              **Rates**
            
            **Floating
                or**
              **Adjustable****Rates**
            
            **Total****Real
                estate loans:**Residential
                - 1 to 4 family
            
            $
            199,744
            
            $
            109,902
            
            $
            309,646Multi-family
                and commercial
            
            
            8,842
            
            
            109,044
            
            
            117,886Construction
            
            
            21,976
            
            
            8,527
            
            
            30,503**Total
                real estate loans**
            
            
            230,562
            
            
            227,473
            
            
            458,035**Commercial
                business loans**
            
            
            38,043
            
            
            29,533
            
            
            67,576**Consumer
                loans**
            
            
            6,697
            
            
            22,208
            
            
            28,905**Total
                loans**
            
            $
            275,302
            
            $
            279,214
            
            $
            554,516





9
 *Table
            of Contents*





***Loan
      Approval Procedures and Authority*** **.** The
      Bank’s lending activities follow written, nondiscriminatory, underwriting
      standards and loan origination procedures established by the Board of Directors
      and management. All residential mortgages and consumer home equity lines of
      credit in excess of $6.0 million or all commercial loans and other consumer
      loans in excess of $2.0 million require the approval of the Board of Directors.
      The Loan Committee of the Board of Directors has the authority to approve:
      (1)
      residential mortgage loans and consumer home equity lines of credit of up to
      $6.0 million and (2) commercial and other consumer loans of up to $2.0 million.
      The President and the Senior Credit Officer have approval for: (1) residential
      mortgage loans that conform to Fannie Mae and Freddie Mac standards up to $2.0
      million or $417,000 for those that are non-conforming, (2) consumer and
      commercial loans up to $250,000 individually or $2.0 million jointly for
      consumer home equity lines of credit or $1.0 million jointly for commercial
      and
      other consumer loans. The Senior Commercial Real Estate Officer may approve
      home
      equity lines of credit and commercial loans of up to $250,000 individually
      or
      $500,000 with the additional approval of the President or Senior Credit Officer.
      Various bank personnel have been delegated authority to approve loans up to
      $417,000.





***Loans
      to One Borrower*** **.** The
      maximum amount that the Bank may lend to one borrower and the borrower’s related
      entities is limited, by regulation, to generally 15% of the Bank’s stated
      capital and reserves. At December 31, 2006, the Bank’s regulatory limit on loans
      to one borrower was approximately $9.0 million. At that date, the Bank’s largest
      lending relationship was $8.6 million, representing two commercial business
      loans and a commercial construction loan for the construction of a nursing
      home
      and rehabilitation facility, of which $5.0 million was outstanding and
      performing according to the original repayment terms at December 31,
      2006.





***Loan
      Commitments*** **.** The
      Bank
      issues commitments for fixed-rate and adjustable-rate mortgage loans conditioned
      upon the occurrence of certain events. Commitments to originate mortgage loans
      are legally binding agreements to lend to customers and generally expire in
      90
      days or less from the date of the application.





***Delinquencies*** **.** 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. The Bank makes initial contact with the borrower when the loan becomes
      15 days past due. If payment is not then received by the 30th day of
      delinquency, additional letters and phone calls generally are made. When the
      loan becomes 90 days past due, a letter is sent notifying the borrower that
      foreclosure proceedings will commence if the loan is not brought current within
      30 days. Generally, when the loan becomes 120 days past due, the Bank will
      commence foreclosure proceedings against any real property that secures the
      loan
      or attempts to repossess any personal property that secures a consumer or
      commercial loan. 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 is typically sold at foreclosure. The Bank
      may
      consider loan repayment arrangements with certain borrowers under certain
      circumstances.





On
      a
      monthly basis, management informs the Board of Directors of the amount of loans
      delinquent more than 30 days, all loans in foreclosure and all foreclosed and
      repossessed property.





10
 *Table
            of Contents*





The
      following table sets forth the delinquencies in the Bank’s loan portfolio as of
      the dates indicated.





**December
                31, 2006**
            
            **December
                31, 2005***(Dollars
                in Thousands)*
            
            **60
                - 89 Days**
            
            **90
                Days or More**
            
            **60
                - 89 Days**
            
            **90
                Days or More****Number****of
                Loans**
            
            **Principal
                Balance****of
                Loans**
            
            **Number****of
                Loans**
            
            **Principal
                Balance**
              **of
                Loans**
            
            **Number****of
                Loans**
            
            **Principal
                Balance****of
                Loans**
            
            **Number****of
                Loans**
            
            **Principal
                Balance****of
                Loans****Real
                estate loans:**Residential
                - 1 to 4 family
            
            
            2
            
            $
            256
            
            
            -
            
            $
            -
            
            
            -
            
            $
            -
            
            
            1
            
            $
            80Multi-family
                and commercial
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1
            
            
            74Construction
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -**Total
                real estate loans**
            
            
            2
            
            
            256
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2
            
            
            154**Consumer
                loans:**Home
                equity
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Other(1)
            
            
            15
            
            
            134
            
            
            99
            
            
            1,039
            
            
            -
            
            
            -
            
            
            2
            
            
            5**Total
                consumer loans**
            
            
            15
            
            
            134
            
            
            99
            
            
            1,039
            
            
            -
            
            
            -
            
            
            2
            
            
            5**Commercial
                business loans**
            
            
            1
            
            
            72
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -**Total
                delinquent loans**
            
            
            18
            
            $
            462
            
            
            99
            
            $
            1,039
            
            
            -
            
            $
            -
            
            
            4
            
            $
            159




(1)
            Includes
                110 indirect automobile loans totaling $1.2 million at December 31,
                2006.





***Classified
      Assets.*** Management
      of the Bank, including the Managed Asset Committee, consisting of a number
      of
      the Bank’s officers, review and classify the assets of the Bank on a monthly
      basis and the Board of Directors reviews the results of the reports on a
      quarterly basis. Federal regulations and the Bank’s internal policies require
      that management utilize an internal asset classification system to monitor
      and
      evaluate the credit risk inherent in its loan portfolio. The Bank currently
      classifies problem and potential problem assets as *“substandard,”
      “doubtful,”*  *“loss”* or
“ *special
      mention* .”
An
      asset is considered “substandard” if it is inadequately protected by the current
      net worth and paying capacity of the obligor or of the collateral pledged,
      if
      any. “Substandard” assets include those assets that are characterized by the
      distinct possibility that the Bank will sustain some loss if the deficiencies
      are not corrected. Assets characterized as “doubtful” have all the weaknesses
      inherent in those classified as “substandard” with the additional characteristic
      that the weaknesses present make collection or liquidation in full, on the
      basis
      of currently existing facts, conditions and values, questionable, and there
      is a
      high probability of loss. Assets classified as “loss” are those assets
      considered uncollectible and of such little value that their continuance as
      assets, without the establishment of a specific loss reserve, is not warranted.
      In addition, assets that do not currently expose the Bank to sufficient risk
      to
      warrant classification in one of the aforementioned categories but possess
      credit deficiencies or potential weaknesses are required to be designated
“special mention.” When an asset is classified as “substandard” or “doubtful,” a
      specific allowance for loan losses may be established. If an asset is classified
      as a “loss,” the Bank charges-off an amount equal to the portion of the asset
      classified as “loss.” All the loans mentioned above are included in the Bank’s
      Managed Asset Report. This report serves as an integral part in the evaluation
      of the adequacy of the Bank’s allowance for loan losses.





11
 *Table
            of Contents*





The
      following table sets forth the principal balance of the Bank’s classified loans
      as of December 31, 2006.





*(Dollars
                in Thousands)*
            
            **Loss**
            
            **Doubtful**
            
            **Substandard**
            
            **Special**
              **Mention****Real
                estate loans:**Residential
                - 1 to 4 family
            
            $
            -
            
            $
            -
            
            $
            780
            
            $
            736Multi-family
                and commercial
            
            
            -
            
            
            -
            
            
            3,723
            
            
            4,504Construction
            
            
            -
            
            
            -
            
            
            2,405
            
            
            3,848**Total
                real estate loans**
            
            
            -
            
            
            -
            
            
            6,908
            
            
            9,088**Consumer
                loans:**Home
                equity
            
            
            -
            
            
            -
            
            
            -
            
            
            -Other
            
            
            -
            
            
            64
            
            
            976
            
            
            35**Total
                consumer loans**
            
            
            -
            
            
            64
            
            
            976
            
            
            35**Commercial
                business loans**
            
            
            -
            
            
            -
            
            
            1,050
            
            
            651**Total
                classified loans**
            
            $
            -
            
            $
            64
            
            $
            8,934
            
            $
            9,774





At
      December 31, 2006, the Bank had no loss rated loans and ten indirect automobile
      loans rated as doubtful. Of the $8.9 million of substandard loans at December
      31, 2006, $1.4 million are considered nonperforming loans. The largest
      substandard loan is $2.9 million, which is not more than 30 days past due.
      Of
      the $9.8 million of special mention loans, only one loan totaling $150,000
      was
      more than 30 days past due at December 31, 2006.





At
      December 31, 2006, total classified loans related predominately to six
      commercial real estate and business loans totaling $11.7 million and indirect
      automobile loans totaling $1.0 million. The increase in classified loans for
      2006 was primarily the result of a slow-down in the local economy.





***Nonperforming
      Assets and Restructured Loans.*** When
      a
      loan becomes 90 days delinquent, the loan is placed on nonaccrual status 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 nonaccrual loans are applied to the outstanding
      principal and interest balance as determined at the time of collection of the
      loan.





The
      Bank
      considers repossessed assets and loans that are 90 days or more past due to
      be
      nonperforming assets. Real estate acquired as a result of foreclosure or by
      deed-in-lieu of foreclosure is classified as real estate owned until it is
      sold.
      When property is acquired it is recorded at the lower of its cost, which is
      the
      unpaid balance of the loan plus foreclosure costs or fair value at the date
      of
      the foreclosure. Holding costs and declines in fair value after acquisition
      of
      the property are charged against income as incurred.





12
 *Table
            of Contents*





The
      following table provides information with respect to the Bank’s nonperforming
      assets and troubled debt restructurings as of the dates indicated.





**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****Nonaccrual
                loans:**Real
                estate loans
            
            $
            392
            
            $
            224
            
            $
            943
            
            $
            1,295
            
            $
            1,347Commercial
                business loans
            
            
            71
            
            
            -
            
            
            -
            
            
            -
            
            
            418Consumer
                loans(1)
            
            
            929
            
            
            16
            
            
            1
            
            
            -
            
            
            72**Total
                nonaccrual loans**
            
            
            1,392
            
            
            240
            
            
            944
            
            
            1,295
            
            
            1,837**Accruing
                loans past due 90 days or more:**Real
                estate loans
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            5Commercial
                business loans
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Consumer
                loans
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -**Total
                accruing loans past due 90 days or more**
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            5**Total
                nonperforming loans**
            
            
            1,392
            
            
            240
            
            
            944
            
            
            1,295
            
            
            1,842Real
                estate owned, net(2)
            
            
            -
            
            
            325
            
            
            -
            
            
            328
            
            
            43**Total
                nonperforming assets**
            
            
            1,392
            
            
            565
            
            
            944
            
            
            1,623
            
            
            1,885Troubled
                debt restructurings
            
            
            72
            
            
            74
            
            
            76
            
            
            77
            
            
            78**Total
                nonperforming assets and troubled debt
                restructurings**
            
            $
            1,464
            
            $
            639
            
            $
            1,020
            
            $
            1,700
            
            $
            1,963***Ratios:***Total
                nonperforming loans to total loans
            
            
            0.24
            %
            
            0.05
            %
            
            0.21
            %
            
            0.33
            %
            
            0.55
            %Total
                nonperforming loans to total assets
            
            
            0.18
            
            
            0.03
            
            
            0.15
            
            
            0.25
            
            
            0.38Total
                nonperforming assets and troubled debt restructurings to total
                assets
            
            
            0.19
            
            
            0.09
            
            
            0.16
            
            
            0.33
            
            
            0.40


(1)
            Includes
                indirect automobile loans totaling $925,000 at December 31,
                2006.


(2)
            Real
                estate owned balances are shown net of related loss
                allowance.




In
      addition to the loans disclosed in the above table, at December 31, 2006, the
      Bank identified 116 loans totaling $8.9 million in which the borrowers had
      possible credit problems that caused management to have doubts about the ability
      of the borrowers to comply with the present loan repayment terms and that may
      result in the future inclusion of such loans in the table above. Indirect
      automobile loans totaling $972,000, representing 100 loans, are included in
      this
      amount. The aforementioned loans have been classified as substandard and are
      contained in the classified loan table on the previous page.





13
 *Table
            of Contents*





Interest
      income that would have been recorded for the year ended December 31, 2006 had
      nonaccruing loans and troubled debt restructurings been current in accordance
      with their original terms and had been outstanding throughout the period
      amounted to $110,000. The amount of interest related to nonaccrual loans and
      troubled debt restructurings included in interest income was $6,000 for the
      year
      ended December 31, 2006.





***Allowance
      for Loan Losses.*** The
      allowance for loan losses, a material estimate which could change significantly
      in the near-term, is established through a provision for loan losses charged
      to
      earnings to account for losses that are inherent in the loan portfolio and
      estimated to occur, and is maintained at a level that management considers
      adequate to absorb losses in the loan portfolio. Loans are charged against
      the
      allowance for loan losses when management believes that the uncollectibility
      of
      principal is confirmed. Subsequent recoveries, if any, are credited to the
      allowance for loan losses when received. The Bank evaluates the allowance for
      loan losses on a monthly basis.





The
      methodology for assessing the appropriateness of the allowance for loan losses
      consists of the following key elements:





—
            Specific
                allowances for identified problem loans, including certain impaired
                or
                collateral-dependent loans;


—
            General
                valuation allowance on certain identified problem loans;


—
            General
                valuation allowance on the remainder of the loan portfolio;
                and


—
            Unallocated
                component





*Specific
      Allowance on Identified Problem Loans.* The loan
      portfolio is segregated first between loans that are on the Bank’s “Managed
      Asset Report” and loans that are not. The Managed Asset Report includes: (1)
      loans that are 60 or more days delinquent, (2) loans with anticipated losses,
      (3) loans referred to attorneys for collection or in the process of foreclosure,
      (4) nonaccrual loans, (5) loans classified as “substandard,” “doubtful,” “loss”
or “special mention” by either the Bank’s internal classification system or by
      regulators during the course of their examination of the Bank and (6) troubled
      debt restructurings and other nonperforming loans.





The
      Managed Asset Committee, consisting of Bank officers, reviews each loan on
      the
      Managed Asset Report and may establish an individual reserve allocation on
      certain loans based on such factors as (1) the strength of the customer’s
      personal or business cash flow; (2) the availability of other sources of
      repayment; (3) the amount due or past due; (4) the type and value of collateral;
      (5) the strength of the borrower’s collateral position; (6) the estimated cost
      to sell the collateral; and (7) the borrower’s effort to cure the
      delinquency.





The
      Bank
      also reviews and establishes, as needed, a specific allowance for certain
      identified non-homogeneous problem loans. In accordance with the Statement
      of
      Financial Accounting Standards No. 114, “ *Accounting
      by Creditors for Impairment of a Loan”* as
      amended by Statement of Financial Accounting Standards No. 118, “ *Accounting
      by Creditors for Impairment of a Loan--an amendment of FASB Statement No.
      114* ,”
a
      loan
      is impaired when, based on current information and events, it is probable that
      a
      creditor will be unable to collect all amounts due under the contractual terms
      of the loan agreement. Measurement of the impairment is based on the present
      value of expected future cash flows or the fair value of the collateral, if
      the
      loan is collateral dependent. A specific allowance on impaired loans is
      established if the present value of the expected future cash flows, or fair
      value of the collateral for collateral dependent loans, is lower than the
      carrying value of the loan.





14
 *Table
            of Contents*





*General
      Valuation Allowance on Certain Identified Problem Loans.* The Bank
      establishes a general allowance for loans on the Managed Asset Report that
      do
      not have an individual allowance. The
      Bank
      segregates these loans by loan category and assigns allowance percentages to
      each category based on inherent losses associated with each type of lending
      and
      consideration that these loans, in the aggregate, represent an above-average
      credit risk and that more of these loans will prove to be uncollectible compared
      to loans in the general portfolio.





*General
      Valuation Allowance on the Remainder of the Loan Portfolio.* The Bank
      establishes another general allowance for loans that are not on the Managed
      Asset Report to recognize the probable losses associated with lending
      activities, but which, unlike specific allowances, has not been allocated to
      particular problem assets. This general valuation allowance is determined by
      segregating the loans by loan category and assigning allowance percentages
      based
      on the Bank’s historical loss experience and delinquency trends. The allowance
      may be adjusted for significant factors that, in management’s judgment, affect
      the collectibility of the portfolio as of the evaluation date. These significant
      factors may include changes in lending policies and procedures, changes in
      existing general economic and business conditions affecting the Bank’s primary
      lending areas, credit quality trends, collateral value, loan volumes and
      concentrations, seasoning of the loan portfolio, specific industry conditions
      within portfolio segments, recent loss experience in particular segments of
      the
      portfolio, duration of the current business cycle and bank regulatory
      examination results. The applied loss factors are re-evaluated annually to
      ensure their relevance in the current economic environment.





*Unallocated
      Component.* 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 specific and general losses
      in the portfolio.





Although
      management believes that it uses the best information available to establish
      the
      allowance for loan losses, future adjustments to the allowance for loan losses
      may be necessary and the Company’s results of operations could be adversely
      affected if circumstances differ substantially from the assumptions used in
      making the determinations. Furthermore, while management believes it has
      established its allowance for loan losses in conformity with generally accepted
      accounting principles, there can be no assurance that regulators, in reviewing
      the Bank’s loan portfolio, will not request the Bank to increase its 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 would
      adversely affect the Company’s financial condition and results of
      operations.





15
 *Table
            of Contents*





The
      following table sets forth an analysis of the allowance for loan losses for
      the
      years indicated.





**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****Allowance
                at beginning of year**
            
            $
            3,671
            
            $
            3,200
            
            $
            2,688
            
            $
            3,067
            
            $
            2,861Provision
                for loan losses
            
            
            881
            
            
            410
            
            
            550
            
            
            1,602
            
            
            537**Charge-offs:**Real
                estate loans
            
            
            -
            
            
            (17
            )
            
            -
            
            
            (1,523
            )
            
            (77
            )Commercial
                business loans
            
            
            -
            
            
            (1
            )
            
            (13
            )
            
            (374
            )
            
            (111
            )Consumer
                loans
            
            
            (199
            )
            
            (11
            )
            
            (62
            )
            
            (216
            )
            
            (218
            )**Total
                charge-offs**
            
            
            (199
            )
            
            (29
            )
            
            (75
            )
            
            (2,113
            )
            
            (406
            )**Recoveries:**Real
                estate loans
            
            
            4
            
            
            70
            
            
            19
            
            
            89
            
            
            35Commercial
                business loans
            
            
            2
            
            
            3
            
            
            6
            
            
            24
            
            
            32Consumer
                loans
            
            
            6
            
            
            17
            
            
            12
            
            
            19
            
            
            8**Total
                recoveries**
            
            
            12
            
            
            90
            
            
            37
            
            
            132
            
            
            75**Net
                (charge-offs) recoveries**
            
            
            (187
            )
            
            61
            
            
            (38
            )
            
            (1,981
            )
            
            (331
            )**Allowance
                at end of year**
            
            $
            4,365
            
            $
            3,671
            
            $
            3,200
            
            $
            2,688
            
            $
            3,067***Ratios:***Allowance
                to total loans outstanding at end of year
            
            
            0.76
            %
            
            0.71
            %
            
            0.71
            %
            
            0.69
            %
            
            0.91
            %Allowance
                to nonperforming loans
            
            
            313.58
            
            
            1529.58
            
            
            338.98
            
            
            207.57
            
            
            166.50Net
                (charge-offs) recoveries to average loans outstanding during the
                year
            
            
            (0.03
            )
            
            0.01
            
            
            (0.01
            )
            
            (0.55
            )
            
            (0.11
            )Recoveries
                to charge-offs
            
            
            6.03
            
            
            310.34
            
            
            49.30
            
            
            6.25
            
            
            18.47





The
      higher provision for 2006 reflects increases in the Bank’s classified and
      nonperforming loans, charge-offs and loan growth from the prior year-end.
      Charge-offs for 2003 included the charge-off of two commercial business loans
      and two commercial real estate loans that aggregated $1.8 million. The larger
      of
      the two commercial real estate loans, which at the time of charge-off had a
      principal balance of $1.6 million, was charged-off after the loan was
      nonperforming and the Bank determined that the value of the real estate
      underlying the loan was insufficient to cover the outstanding principal balance.
      Additionally, because we held a junior collateral position, the Bank determined
      that the likelihood of any recovery was remote. During the year ended December
      31, 2003, charge-offs exceeded the provision for loan losses as specific
      allowances of $237,000 were established in prior periods for a portion of the
      charged-off loans once it had been determined that collection or liquidation
      in
      full was unlikely.





16
 *Table
            of Contents*





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





**December
                31,****2006**
            
            **2005**
            
            **2004***(Dollars
                in Thousands)*
            
            **Amount**
            
            **%
                of Allowance in each Category to Total****Allowance**
            
            **%
                of Loans in each Category to Total****Loans**
            
            **Amount**
            
            **%
                of Allowance in each Category to Total****Allowance**
            
            **%
                of Loans in each Category to Total****Loans**
            
            **Amount**
            
            **%
                of Allowance in each Category to Total****Allowance**
            
            **%
                of Loans in each Category to Total****Loans**Real
                estate loans
            
            $
            3,244
            
            
            74.32
            %
            
            81.93
            %
            $
            2,639
            
            
            71.89
            %
            
            80.36
            %
            $
            2,403
            
            
            75.08
            %
            
            82.18
            %Commercial
                business
            
            
            783
            
            
            17.94
            
            
            13.03
            
            
            892
            
            
            24.29
            
            
            15.02
            
            
            641
            
            
            20.02
            
            
            13.13Consumer
                loans
            
            
            338
            
            
            7.74
            
            
            5.04
            
            
            140
            
            
            3.82
            
            
            4.62
            
            
            152
            
            
            4.74
            
            
            4.69Unallocated
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            4
            
            
            0.16
            
            
            -**Total
                allowance for loan losses**
            
            $
            4,365
            
            
            100.00
            %
            
            100.00
            %
            $
            3,671
            
            
            100.00
            %
            
            100.00
            %
            $
            3,200
            
            
            100.00
            %
            
            100.00
            %








**December
                31,****2003**
            
            **2002***(Dollars
                in Thousands)*
            
            **Amount**
            
            **%
                of Allowance in each Category to Total****Allowance**
            
            **%
                of**
              **Loans
                in each Category**
              **to
                Total****Loans**
            
            **Amount**
            
            **%
                of Allowance in each Category to Total****Allowance**
            
            **%
                of**
              **Loans
                in each Category**
              **to
                Total****Loans**Real
                estate loans
            
            $
            2,093
            
            
            77.86
            %
            
            82.46
            %
            $
            2,237
            
            
            72.94
            %
            
            87.66
            %Commercial
                business
            
            
            461
            
            
            17.15
            
            
            13.04
            
            
            488
            
            
            15.91
            
            
            7.99Consumer
                loans
            
            
            80
            
            
            2.98
            
            
            4.50
            
            
            318
            
            
            10.37
            
            
            4.35Unallocated
            
            
            54
            
            
            2.01
            
            
            -
            
            
            24
            
            
            0.78
            
            
            -**Total
                allowance for loan losses**
            
            $
            2,688
            
            
            100.00
            %
            
            100.00
            %
            $
            3,067
            
            
            100.00
            %
            
            100.00
            %





**Investment
      Activities**





The
      Company has legal authority to invest in various types of liquid assets,
      including U.S. Treasury obligations, securities of various federal agencies,
      government-sponsored enterprises, state and municipal governments,
      mortgage-backed securities and certificates of deposit of federally-insured
      institutions. Within certain regulatory limits, the Company also may invest
      a
      portion of its assets in corporate securities and mutual funds. The Company
      is
      also required to maintain an investment in FHLB stock. While the Company has
      the
      authority under applicable law and its investment policies to invest in
      derivative securities, the Company had no such investments at December 31,
      2006.




The
      Company’s primary source of income continues to be derived from its loan
      portfolio. The investment portfolio is mainly used to meet the cash flow needs
      of the Company, provide adequate liquidity for the protection of customer
      deposits and yield a favorable return on investments. The type of securities
      and
      the maturity periods are dependent on the composition of the loan portfolio,
      interest rate risk, liquidity position and tax strategies of the Company. The
      Company’s investment objectives are to provide and maintain liquidity, to
      maintain a balance of high quality, diversified investments to minimize risk,
      to
      provide collateral for pledging requirements, 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, to generate a favorable return and
      to
      assist in the financing needs of various local public entities, subject to
      credit quality review and liquidity concerns. The Company’s Board of Directors
      has the overall




17
 *Table
            of Contents*




responsibility
      for the investment portfolio, including approval of the Company’s Investment
      Policy and appointment of the Investment Committee. The Investment Committee
      is
      responsible for the approval of investment strategies and monitoring investment
      performance. The execution of specific investment initiatives and the day-to-day
      oversight of the Company’s investment portfolio is the responsibility of the
      Chief Executive Officer and the Chief Financial Officer. These officers, and
      others designated by the Board, are authorized to execute investment
      transactions up to specified limits based on the type of security without prior
      approval of the Investment Committee. Transactions exceeding these limitations
      require the approval of two of these officers, one of whom must be either the
      President and Chief Executive Officer or the Chief Financial Officer. Individual
      investment transactions are reviewed and approved by the Board of Directors
      on a
      monthly basis, while portfolio composition and performance are reviewed at
      least
      quarterly by the Investment Committee.





Statement
      of Financial Accounting Standards No. 115, *“Accounting
      for Certain Investments in Debt and Equity Securities”* (“SFAS
      No. 115”), requires that securities be categorized as either “held to maturity,”
“trading securities” or “available for sale” based on management’s intent as to
      the ultimate disposition of each security. Debt securities may be classified
      as
“held to maturity,” and reported in the financial statements at amortized cost,
      only if the Company has the positive intent and ability to hold those securities
      until maturity. Securities purchased and held principally for the purpose of
      trading in the near term are classified as “trading securities.” These
      securities are reported at fair value in the financial statements, with
      unrealized gains and losses recognized in earnings. Debt and equity securities
      not classified as either “held to maturity” or “trading securities” are
      classified as “available for sale securities.” These securities are reported at
      fair value with unrealized gains and losses excluded from earnings and reported
      in other comprehensive income, net of taxes.





At
      December 31, 2006, the Company’s investment portfolio, which consisted solely of
      available for sale securities, totaled $119.5 million and represented 15.8%
      of
      assets. The Company’s available for sale securities consisted primarily of
      government-sponsored enterprises with maturities of seven years or less,
      mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae
      with
      stated final maturities of 30 years or less, corporate debt securities, U.S.
      Government and agency securities and securities of state and municipal
      governments.





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




**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004****Amortized****Cost**
            
            **Fair**
              **Value**
            
            **Amortized****Cost**
            
            **Fair**
              **Value**
            
            **Amortized****Cost**
            
            **Fair**
              **Value**U.S.
                Government and agency securities
            
            $
            1,596
            
            $
            1,602
            
            $
            4,820
            
            $
            4,813
            
            $
            6,039
            
            $
            6,066Government-sponsored
                enterprises
            
            
            66,190
            
            
            65,263
            
            
            73,135
            
            
            71,490
            
            
            67,911
            
            
            67,610Mortgage-backed
                securities
            
            
            45,481
            
            
            44,815
            
            
            37,346
            
            
            36,538
            
            
            40,926
            
            
            40,594Corporate
                debt securities
            
            
            3,917
            
            
            3,903
            
            
            4,537
            
            
            4,528
            
            
            3,498
            
            
            3,563Obligations
                of state and political subdivisions
            
            
            2,000
            
            
            2,024
            
            
            1,499
            
            
            1,546
            
            
            1,499
            
            
            1,584Tax-exempt
            
            
            420
            
            
            420
            
            
            490
            
            
            490
            
            
            560
            
            
            560Other
                debt securities
            
            
            100
            
            
            99
            
            
            75
            
            
            74
            
            
            75
            
            
            75Total
                debt securities
            
            
            119,704
            
            
            118,126
            
            
            121,902
            
            
            119,479
            
            
            120,508
            
            
            120,052Marketable
                equity securities
            
            
            1,336
            
            
            1,382
            
            
            555
            
            
            540
            
            
            488
            
            
            505**Total
                available for sale securities**
            
            $
            121,040
            
            $
            119,508
            
            $
            122,457
            
            $
            120,019
            
            $
            120,996
            
            $
            120,557





18
 *Table
            of Contents*





The
      Company had no individual investments that had an aggregate book value in excess
      of 10% of its stockholders’ equity at December 31, 2006.





The
      following table sets forth the amortized cost, weighted average yields and
      contractual maturities of securities at December 31, 2006. Weighted average
      yields on tax-exempt securities are not presented on a tax equivalent basis
      because the impact would be insignificant. Certain mortgage-backed securities
      have adjustable interest rates and will reprice periodically within the various
      maturity ranges. These repricing schedules are not reflected in the table below.
      At December 31, 2006, the amortized cost of mortgage-backed securities with
      adjustable rates totaled $7.6 million.





**One
                Year or Less**
            
            **More
                than One Year****to Five Years**
            
            **More
                than Five****Years
                to Ten Years**
            
            **More
                than Ten Years**
            
            **Total***(Dollars
                in Thousands)*
            
            Amortized
              Cost
            
            Weighted
                AverageYield
            
            Amortized
              Cost
            
            Weighted
                AverageYield
            
            Amortized
              Cost
            
            Weighted
                AverageYield
            
            Amortized
              Cost
            
            Weighted
                AverageYield
            
            Amortized
              Cost
            
            Weighted
                AverageYieldU.S.
                Government and agency securities
            
            $
            -
            
            
            -
            %
            $
            16
            
            
            9.56
            %
            $
            452
            
            
            8.18
            %
            $
            1,128
            
            
            7.01
            %
            $
            1,596
            
            
            7.37
            %Government-sponsored
                enterprises
            
            
            17,775
            
            
            4.42
            
            
            48,043
            
            
            4.02
            
            
            372
            
            
            6.83
            
            
            -
            
            
            -
            
            
            66,190
            
            
            4.14Mortgage-backed
                securities
            
            
            8,127
            
            
            4.33
            
            
            2,765
            
            
            4.09
            
            
            7,243
            
            
            4.84
            
            
            27,346
            
            
            5.07
            
            
            45,481
            
            
            4.84Corporate
                debt securities
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            3,917
            
            
            6.18
            
            
            3,917
            
            
            6.18Obligations
                of state and political subdivisions
            
            
            -
            
            
            -
            
            
            1,000
            
            
            6.79
            
            
            -
            
            
            -
            
            
            1,000
            
            
            4.97
            
            
            2,000
            
            
            5.88Tax-exempt
                securities
            
            
            70
            
            
            3.87
            
            
            280
            
            
            3.87
            
            
            70
            
            
            3.88
            
            
            -
            
            
            -
            
            
            420
            
            
            3.87Other
                debt securities
            
            
            -
            
            
            -
            
            
            100
            
            
            5.29
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            100
            
            
            5.29Total
                debt securities
            
            
            25,972
            
            
            4.39
            
            
            52,204
            
            
            4.08
            
            
            8,137
            
            
            5.10
            
            
            33,391
            
            
            5.26
            
            
            119,704
            
            
            4.55Marketable
                equity securities
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,336
            
            
            6.43
            
            
            1,336
            
            
            6.43**Total
                available for sale securities**
            
            $
            25,972
            
            
            4.39
            
            $
            52,204
            
            
            4.08
            
            $
            8,137
            
            
            5.10
            
            $
            34,727
            
            
            5.31
            
            $
            121,040
            
            
            4.57





**Deposit
      Activities and Other Sources of Funds**





***General*** **.** Deposits
      and loan repayments are the major sources of the Company’s funds for lending and
      other investment purposes. 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 the State of Connecticut. Deposits
      are attracted from within the Bank’s market area through the offering of a broad
      selection of deposit instruments, including NOW, money market accounts, regular
      savings accounts and certificates of deposit. The Bank also utilizes brokered
      certificates of deposits, which at December 31, 2006 amounted to $7.1 million,
      as an alternate source of funds. Deposit account terms vary according to the
      minimum balance required, the time periods the funds must remain on deposit
      and
      the interest rates offered, among other factors. In determining the terms of
      the
      Bank’s deposit accounts, the Bank considers the rates offered by its
      competition, liquidity needs, profitability, matching deposit and loan products
      and customer preferences and concerns. The Bank generally reviews its deposit
      mix and pricing weekly. The Bank’s current strategy is to offer competitive
      rates, and even higher rates on long-term deposits, but not be the market leader
      in every account type and maturity.





The
      Bank
      also offers a variety of deposit accounts designed for the businesses operating
      in its market area. Business banking deposit products include a commercial
      checking account that provides an earnings credit to offset monthly service
      charges and a checking account specifically designed for small





19
 *Table
            of Contents*




business
      and nonprofit organizations. Additionally, sweep accounts and money market
      accounts are available for businesses. The Bank has sought to increase its
      commercial deposits through the offering of these products, particularly to
      its
      commercial borrowers and to local municipalities.




The
      following table sets forth the deposit activity for the years indicated,
      including mortgagors’ and investors’ escrow accounts and brokered
      deposits.





**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004****Beginning
                balance**
            
            $
            512,282
            
            $
            460,480
            
            $
            417,311Increase
                before interest credited
            
            
            16,483
            
            
            43,265
            
            
            36,833Interest
                credited
            
            
            13,157
            
            
            8,537
            
            
            6,336Net
                increase in deposits
            
            
            29,640
            
            
            51,802
            
            
            43,169**Ending
                balance****(1)**
            
            $
            541,922
            
            $
            512,282
            
            $
            460,480




(1)
            Includes
                mortgagors’ and investors’ escrow accounts in the amount of $3.2 million,
                $3.0 million and $2.7 million at December 31, 2006, 2005 and 2004,
                respectively. Includes brokered deposits of $7.1 million at December
                31,
                2006 and $5.0 million at December 31, 2005 and
                2004.





The
      following table sets forth the distribution of the Bank’s deposit accounts for
      the dates indicated.





**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004****Balance**
            
            **%
                of**
              **Total**
            
            **Balance**
            
            **%
                of**
              **Total**
            
            **Balance**
            
            **%
                of**
              **Total**Noninterest-bearing
                demand deposits
            
            $
            55,703
            
            
            10.28
            %
            $
            51,996
            
            
            10.15
            %
            $
            46,049
            
            
            10.00
            %NOW
                and money market accounts
            
            
            126,567
            
            
            23.36
            
            
            125,156
            
            
            24.43
            
            
            110,564
            
            
            24.01Savings
                accounts(1)
            
            
            81,020
            
            
            14.94
            
            
            90,879
            
            
            17.74
            
            
            95,310
            
            
            20.70Certificates
                of deposit(2)
            
            
            278,632
            
            
            51.42
            
            
            244,251
            
            
            47.68
            
            
            208,557
            
            
            45.29**Total
                deposits**
            
            $
            541,922
            
            
            100.00
            %
            $
            512,282
            
            
            100.00
            %
            $
            460,480
            
            
            100.00
            %




(1)
            Includes
                mortgagors’ and investors’ escrow accounts in the amount of $3.2 million,
                $3.0 million and $2.7 million at December 31, 2006, 2005 and 2004,
                respectively.


(2)
            Includes
                brokered deposits of $7.1 million at December 31, 2006 and $5.0 million
                at
                December 31, 2005 and 2004.





20
 *Table
            of Contents*





The
      Bank
      had $74.3 million of certificates of deposit of $100,000 or more outstanding
      as
      of December 31, 2006, maturing as follows:





*(Dollars
                in Thousands)*
            
            **Amount**
            
            **Weighted
                Average**
              **Rate*****Maturity
                Period:***Three
                months or less
            
            $
            12,895
            
            
            4.41
            %Over
                three through six months
            
            
            14,011
            
            
            4.48Over
                six through twelve months
            
            
            30,165
            
            
            4.94Over
                twelve months
            
            
            17,245
            
            
            4.80**Total**
            
            $
            74,316
            
            
            4.73
            %





The
      following table presents the amount of certificates of deposit accounts
      outstanding by the various rate categories, years to maturity and percent of
      total certificate accounts at December 31, 2006.





**Amount
                Due***(Dollars
                in Thousands)*
            
            **Less
                Than****One
                Year**
            
            **One
                to****Two
                Years**
            
            **Two
                to Three****Years**
            
            **Three
                to****Four
                Years**
            
            **More
                Than****Four
                Years**
            
            **Total**
            
            **Percent
                of Total Certificate****Accounts**0.51
                - 2.00%
            
            $
            13,513
            
            $
            18
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            13,531
            
            
            4.86
            %2.01
                - 3.00%
            
            
            21,830
            
            
            1,680
            
            
            277
            
            
            -
            
            
            -
            
            
            23,787
            
            
            8.543.01
                - 4.00%
            
            
            15,456
            
            
            10,240
            
            
            5,767
            
            
            1,343
            
            
            56
            
            
            32,862
            
            
            11.794.01
                - 5.00%
            
            
            92,282
            
            
            283
            
            
            3,510
            
            
            7,728
            
            
            1,337
            
            
            105,140
            
            
            37.735.01
                - 6.00%
            
            
            72,638
            
            
            20,305
            
            
            9,464
            
            
            -
            
            
            706
            
            
            103,113
            
            
            37.016.01
                - 6.78%
            
            
            83
            
            
            116
            
            
            -
            
            
            -
            
            
            -
            
            
            199
            
            
            0.07**Total**
            
            $
            215,802
            
            $
            32,642
            
            $
            19,018
            
            $
            9,071
            
            $
            2,099
            
            $
            278,632
            
            
            100.00
            %





***Borrowings*** **.** The
      Bank
      utilizes advances from the FHLB to supplement its supply of lendable funds
      and
      to meet deposit withdrawal requirements. The FHLB 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 FHLB and is authorized to apply for
      advances on the security of such stock and certain 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 FHLB’s assessment of the institution’s
      creditworthiness. Under its current credit policies, the FHLB generally limits
      advances to 25% of a member’s assets, and short-term borrowings of less than one
      year may not exceed 10% of the institution’s assets. The FHLB determines
      specific lines of credit for each member institution.





Advances
      from the FHLB increased $24.0 million, or 27.3%, for the year ended December
      31,
      2006 to $112.0 million. For 2006, new advances tended to be shorter in duration
      to provide the Company flexibility to repay the advances in the future because
      of their higher interest rates. The increased borrowings were used as a
      supplement to deposits to fund asset growth.





21
 *Table
            of Contents*





***Junior
      Subordinated Debt Owed to Unconsolidated Trusts.*** To a
      lesser extent, the Company has utilized the proceeds raised from the issuance
      of
      trust preferred securities. In 2002, SI Capital Trust I (the “Trust”), a
      business trust, issued $7.0 million of preferred securities in a private
      placement and issued approximately 217 shares of common stock at $1,000 par
      value to the Company. The Trust used the proceeds of these issuances to purchase
      $7.2 million of the Company’s floating rate junior subordinated deferrable
      interest debentures. The interest rate on the debentures and the trust preferred
      securities is variable and adjustable quarterly at 3.70% over the six-month
      LIBOR. The interest rate on these securities at December 31, 2006 was 9.09%.
      A
      rate cap of 11.00% is effective through April 22, 2007. The
      duration of the trust is 30 years; however, the Company intends to redeem the
      trust securities at par on or after April
      22,
      2007.





In
      2006,
      the Company formed a new subsidiary, SI Capital Trust II (“Trust II”), which
      issued $8.0 million of trust preferred securities through a pooled trust
      preferred securities offering. The Company owns all of the common securities
      of
      Trust II, which has no independent assets or operations. SI Capital Trust II
      was
      formed to issue trust preferred securities and invest the proceeds in an
      equivalent amount of junior subordinated debentures issued by the Company.
      The
      trust preferred securities mature in 30 years and bear interest at three-month
      LIBOR plus 1.70%. The interest rate on these securities at December 31, 2006
      was
      7.06%. The Company may redeem the trust preferred securities, in whole or in
      part, on or after September 15, 2011, or earlier under certain
      conditions.





The
      debentures are the sole assets of SI Capital Trust I and SI Capital Trust II
      and
      are subordinate to all of the Company’s existing and future obligations for
      borrowed money, its obligations under letters of credit and certain derivative
      contracts and any guarantees by the Company of any such obligations. The trust
      preferred securities generally rank equal to the trust common securities in
      priority of payment, but rank before the trust common securities if and so
      long
      as the Company fails to make principal or interest payments on the debentures.
      Concurrently with the issuance of the debentures and the trust preferred and
      common securities, the Company issued a guarantee related to the trust
      securities for the benefit of the holders. The Company’s obligations under the
      guarantee and the Company’s obligations under the debentures, the related
      indentures and the trust agreements relating to the trust securities, constitute
      a full and unconditional guarantee by the Company of the obligations of SI
      Capital Trust I and SI Capital Trust II under the trust preferred securities. If
      the
      Company defers interest payments on the junior subordinated debt securities,
      or
      otherwise is in default of the obligations, the Company would be prohibited
      from
      making dividend payments to its shareholders.





The
      debentures are also subject to redemption before April 22, 2007 and September
      15, 2011 for SI Capital Trust I and SI Capital Trust II, respectively, at a
      specified price after the occurrence of certain events that would either have
      a
      negative tax effect on SI Capital Trust I, SI Capital Trust II or the Company
      or
      would result in SI Capital Trust I or SI Capital Trust II being treated as
      investment companies that are required to be registered under the Investment
      Company Act of 1940. Upon repayment of the debentures at their stated maturity
      or following their redemption, the Trust and Trust II will use the proceeds
      of
      such repayment to redeem an equivalent amount of outstanding trust preferred
      securities and trust common securities.





Additionally,
      the Company occasionally utilizes collateralized borrowings, which represent
      loans sold that do not meet the criteria for derecognition, due primarily to
      recourse and other provisions that could not be measured at the date of
      transfer. Such borrowings are derecognized when all recourse and other
      provisions that could not be measured at the time of transfer either expire
      or
      become measurable. The Company had no collateralized borrowings at December
      31,
      2006.





22
 *Table
            of Contents*





The
      following table sets forth information regarding the Company’s borrowings at the
      dates or for the years indicated.





**At
                or For the Years Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004****Maximum
                amount of advances outstanding at any month-end during the
                year:**FHLB
                advances
            
            $
            117,982
            
            $
            93,190
            
            $
            72,674Subordinated
                debt
            
            
            15,465
            
            
            7,217
            
            
            7,217**Average
                balance outstanding during the year:**FHLB
                advances
            
            $
            101,902
            
            $
            79,596
            
            $
            65,154Subordinated
                debt
            
            
            9,522
            
            
            7,217
            
            
            7,217**Weighted
                average interest rate during the year:**FHLB
                advances
            
            
            4.27
            %
            
            3.90
            %
            
            4.12
            %Subordinated
                debt
            
            
            8.21
            
            
            6.86
            
            
            5.14**Balance
                outstanding at end of year:**FHLB
                advances
            
            $
            111,956
            
            $
            87,929
            
            $
            72,674Subordinated
                debt
            
            
            15,465
            
            
            7,217
            
            
            7,217**Weighted
                average interest rate at end of year:**FHLB
                advances
            
            
            4.44
            %
            
            3.97
            %
            
            3.80
            %Subordinated
                debt
            
            
            8.01
            
            
            8.15
            
            
            5.92





**Trust
      Services**





The
      Bank’s trust department provides fiduciary services, investment management and
      retirement services, to individuals, partnerships, corporations and
      institutions. Additionally, the Bank acts as guardian, conservator, executor
      or
      trustee under various trusts, wills and other agreements. The Bank has
      implemented comprehensive policies governing the practices and procedures of
      the
      trust department, including policies relating to investment of trust property,
      maintaining confidentiality of trust records, avoiding conflicts of interest
      and
      maintaining impartiality. Consistent with its operating strategy, the Bank
      will
      continue to emphasize the growth of its trust business in order to accumulate
      assets and increase fee-based income. At December 31, 2006, trust assets under
      administration were $149.3 million, consisting of 317 accounts, the largest
      of
      which totaled $10.6 million, or 7.1%, of the trust department’s total assets.
      The acquisition of SI Trust Servicing, in Rutland, Vermont, in November 2005
      represented an opportunity for significant growth of the Bank’s wealth
      management business. SI Trust Servicing offers third-party trust outsourcing
      services to other community banks located throughout the country. As of December
      31, 2006, SI Trust Servicing provided trust outsourcing services to 13 clients,
      consisting of 5,083 accounts totaling $5.40 billion in assets. For the years
      ended December 31, 2006, 2005 and 2004, total trust services revenue was $3.2
      million, $1.0 million and $631,000, respectively.





23
 *Table
            of Contents*





**Subsidiary
      Activities**





The
      Company has two subsidiaries other than Savings Institute Bank and Trust
      Company, SI Capital Trust I and SI Capital Trust II. SI Capital Trust I and
      SI
      Capital Trust II were established in 2002 and 2006, respectively, as statutory
      trusts under Delaware law to issue trust preferred securities. The trusts have
      no independent assets or operations. SI Capital Trust I issued trust preferred
      securities of $7.0 million in April 2002. SI Capital Trust II issued $8.0
      million of trust preferred securities in September 2006. All of the common
      securities of SI Capital Trust I and SI Capital Trust II are owned by the
      Company.





The
      following are descriptions of the Bank’s wholly-owned subsidiaries.





***803
      Financial Corp.*** 803
      Financial Corp. was established in 1995 as a Connecticut corporation to maintain
      an ownership interest in a third-party registered broker-dealer, Infinex
      Investments, Inc. Infinex operates offices at the Bank and offers customers
      a
      complete range of nondeposit investment products, including mutual funds, debt,
      equity and government securities, retirement accounts, insurance products and
      fixed and variable annuities. The Bank receives a portion of the commissions
      generated by Infinex from sales to customers. For the years ended December
      31,
      2004 and 2003, the Bank received fees of $184,000 and $121,000, respectively,
      through its relationship with Infinex .
      Due to
      a regulatory restriction on federally-chartered thrifts, on December 31, 2004,
      803 Financial Corp. sold its interest in Infinex which was subsequently
      purchased by the Company. As a result, 803 Financial Corp. had no other holdings
      or business activities.





***SI
      Realty Company, Inc.*** SI
      Realty
      Company, Inc., established in 1999 as a Connecticut corporation, holds real
      estate owned by the Bank, including foreclosure properties. At December 31,
      2006, SI Realty Company, Inc. had $204,000 in assets.





***SI
      Mortgage Company.*** In
      January 1999, the Bank formed SI Mortgage Company to manage and hold loans
      secured by real property. SI Mortgage Company qualifies as a “passive investment
      company,” which exempts it from Connecticut income tax under current law. Income
      tax savings to the Bank from the use of a passive investment company was
      approximately $188,000 and $245,000 for the years ended December 31, 2006 and
      2005, respectively.





**Personnel**





At
      December 31, 2006, the Company had 225 full-time employees and 33 part-time
      employees. None of the Company’s employees are represented by a collective
      bargaining unit. The Company believes its relationship with its employees is
      good.





**REGULATION
      AND SUPERVISION**





**General**





The
      Bank
      is subject to extensive regulation, examination and supervision by the Office
      of
      Thrift Supervision (“OTS”), as its primary federal regulator, and the FDIC, as
      its deposits insurer. The Bank is a member of the Federal Home Loan Bank System
      and its deposit accounts are insured up to applicable limits by the Deposit
      Insurance Fund managed by the FDIC. The Bank must file reports with the OTS
      and
      the FDIC concerning its activities and financial condition in addition to
      obtaining regulatory approvals before entering into certain transactions such
      as
      mergers with, or acquisitions of, other financial institutions. There are
      periodic examinations by the OTS and, under certain circumstances, the FDIC,
      to
      evaluate the Bank’s safety and soundness and compliance with various regulatory
      requirements.





24
 *Table
            of Contents*




This
      regulatory structure 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 policies, whether by the
      OTS, the FDIC or Congress, could have a material adverse impact on the Company,
      SI Bancorp, MHC and the Bank and their operations. The Company and SI Bancorp,
      MHC, as savings and loan holding companies, are required to file certain reports
      with, are subject to examination by, and otherwise must comply with the rules
      and regulations of the OTS. The Company is also subject to the rules and
      regulations of the Securities and Exchange Commission under the federal
      securities laws.




Certain
      of the regulatory requirements that are applicable to the Bank, the Company
      and
      SI Bancorp, MHC are described below. This description of statutes and
      regulations is not intended to be a complete explanation of such statutes and
      regulations and their effects on the Bank, the Company and SI Bancorp, MHC
      are
      qualified in their entirety by reference to the actual statutes and
      regulations.





**Regulation
      of Federal Savings Associations**





***Business
      Activities.*** Federal
      law and regulations, primarily the Home Owners’ Loan Act and the regulations of
      the OTS, govern the activities of federal savings banks, such as the Bank.
      These
      laws and regulations delineate the nature and extent of the 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
      OTS’s
      capital regulations require federal savings institutions to meet three minimum
      capital standards:





—
            a
                tangible capital ratio requirement of 1.5% of adjusted total
                assets;


—
            a
                leverage ratio of 4% of Tier 1 (core) capital to adjusted total assets
                (3%
                for institutions receiving the highest rating on the CAMELS examination
                rating system); and


—
            a
                risk-based capital ratio requirement of 8% of total capital (core
                and
                supplementary capital) to total risk-weighted assets of which at
                least
                half must be core capital





In
      addition, the prompt corrective action standards discussed below also
      established, in effect, a minimum 2% tangible capital standard, a 4% leverage
      ratio standard (3% for institutions receiving the highest rating on the CAMELS
      examination rating system) and, together with the risk-based capital standard
      itself, a 4% Tier 1 risk-based capital standard. The OTS 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.





In
      determining compliance with the risk-based capital requirement, savings
      institutions must compute its risk-weighted assets by multiplying its assets,
      including certain off-balance sheet assets, recourse obligations, residual
      interests and direct credit substitutes, by risk-weight factors ranging from
      0%
      for cash and obligations of the United States Government or its agencies to
      100%
      for consumer and commercial loans, as assigned by the OTS capital regulation
      based on the risks believed inherent in the type of asset.




Core
      (Tier 1) capital is defined as common stockholders’ equity (including retained
      earnings), certain noncumulative 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




25
 *Table
            of Contents*




relationships.
      The components of supplementary capital currently include cumulative preferred
      stock, long-term perpetual preferred stock, mandatory convertible 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
      OTS
      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,
      2006, the Bank exceeded each of these capital requirements.





***Prompt
      Corrective Regulatory Action.*** The
      OTS
      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 OTS is
      required to appoint a receiver or conservator within specified time frames
      for
      an institution that is “critically undercapitalized.” An institution must file a
      capital restoration plan with the OTS within 45 days of the date it receives
      notice that it is “undercapitalized,” “significantly undercapitalized” or
“critically undercapitalized.” Compliance with the plan must be guaranteed by
      any parent holding company. 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. “Significantly undercapitalized” and
“critically undercapitalized” institutions are subject to more extensive
      mandatory regulatory actions. The OTS 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.





***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, 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. *See
      Item 1. Business. “Lending Activities - Loans to One
      Borrower.”*





***Standards
      for Safety and Soundness.*** The
      federal banking agencies have adopted Interagency Guidelines, which 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 OTS determines that a savings institution fails to
      meet
      any standard prescribed by the guidelines, the OTS may require the institution
      to submit an acceptable plan to achieve compliance with the standard. The Bank
      has not received any notice from the OTS that it has failed to meet any standard
      prescribed by the guidelines.




***Limitation
      on Capital Distributions**.*OTS 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
      the prior approval of the OTS is required before any capital distribution if
      the
      institution does not meet the criteria for “expedited treatment” of applications
      under OTS regulations (*i.e.*, generally, examination and




26
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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 OTS. If
      an
      application is not required, the institution must still provide prior notice
      to
      the OTS of the capital distribution if, like the Bank, it is a subsidiary of
      a
      holding company. If the Bank’s capital were ever to fall below its regulatory
      requirements or the OTS notified it that it was in need of increased
      supervision, its ability to make capital distributions could be restricted.
      In
      addition, the OTS could prohibit a proposed capital distribution that would
      otherwise be permitted by the regulation, if the agency determines that such
      distribution would constitute an unsafe or unsound practice.





***Qualified
      Thrift Lender 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” in certain “qualified thrift investments”
(primarily residential mortgages and related investments, including certain
      mortgage-backed securities) in at least nine months out of each twelve-month
      period. “Portfolio assets” represent, in general, total assets less the sum
      of:





—
            specified
                liquid assets up to 20% of total assets;


—
            goodwill
                and other intangible assets; and


—
            the
                value of property used to conduct
                business





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. Recent
      legislation has expanded the extent to which education loans, credit card loans
      and small business loans may be considered “qualified thrift investments.” As of
      December 31, 2006, the Bank maintained 76.85% of its portfolio assets in
      qualified thrift investments and, therefore, met the qualified thrift lender
      test.





***Transactions
      with Related Parties.*** Federal
      law limits the Bank’s authority to lend to, and engage in certain other
      transactions with (collectively, “covered transactions”), “affiliates”
( *e.g* .,
      any
      company that controls or is under common control with an institution, including
      the Company, SI Bancorp, MHC and their non-savings institution subsidiaries).
      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. Loans and other specified
      transactions with affiliates are required to be secured by collateral in an
      amount and of a type described in federal law. The purchase of low quality
      assets from affiliates is generally prohibited. Transactions with affiliates
      must 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.





The
      Sarbanes-Oxley Act of 2002 generally prohibits a company from making loans
      to
      its executive officers and directors. However, that act contains a specific
      exception for loans by a depository institution 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 in which such persons control, is limited. The
      law restricts both the individual and aggregate amount of loans the Bank may
      make to insiders based, in part, on the Bank’s capital position and requires
      certain board approval procedures to be followed. Such loans must 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




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available
      to all employees of the institution and does not give preference to insiders
      over other employees. In addition, loans made to a director or executive officer
      in an amount that, when aggregated with the amount of all other loans to the
      person and his or her related interest, are in excess of the greater of $25,000,
      or 5% of the Bank’s capital and surplus, and in any event any loans totaling
      $500,000 or more, must be approved in advance by a majority of the disinterested
      members of the Board of Directors.




***Enforcement.*** The
      OTS
      has primary enforcement responsibility over federal savings institutions and
      has
      the 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 for 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 $1.0 million per day in especially egregious cases. The FDIC has authority
      to recommend to the Director of the OTS that enforcement action be taken with
      respect to a particular savings institution. If action is not taken by the
      Director, the FDIC has authority to take such action under certain
      circumstances. Federal law also establishes criminal penalties for certain
      violations.





***Assessments.*** Federal
      savings banks are required to pay assessments to the OTS to fund its operations.
      The general assessments, paid on a semi-annual basis, are based upon the savings
      institution’s total assets, including consolidated subsidiaries, as reported in
      the institution’s latest quarterly thrift financial report, financial condition
      and complexity of portfolio. The OTS assessments paid by the Bank for 2006
      were
      $158,000.





***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 Deposit Insurance Fund
      is
      the successor to the Bank Insurance Fund and the Savings Association Insurance
      Fund, which were merged in 2006. The Federal Deposit Insurance Corporation
      recently 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. No institution may pay a dividend if in default
      of
      the FDIC assessment.





The
      Reform Act also provided for a one-time credit for eligible institutions based
      on their assessment base as of December 31, 1996. Subject to certain limitations
      with respect to institutions that are exhibiting weaknesses, credits can be
      used
      to offset assessments until exhausted. The Bank’s one-time credit is expected to
      approximate $345,000. 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





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fund.
      This payment is established quarterly and during the calendar year ending
      December 31, 2006 averaged 1.28 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, was 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.





***Federal
      Home Loan Bank System.*** The
      Bank
      is a member of the Federal Home Loan Bank System, which consists of twelve
      regional Federal Home Loan Banks. The FHLB provides a central credit facility
      primarily for member institutions. The Bank, as a member of the FHLB, is
      required to acquire and hold shares of capital stock in FHLB. The Bank was
      in
      compliance with this requirement with an investment in FHLB at December 31,
      2006
      of $6.7 million.





The
      Federal Home Loan Banks are required to provide funds for the resolution of
      insolvent thrifts in the late 1980s and to contribute 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 FHLB advances
      increased, the Company’s net interest income would be negatively
      impacted.





***Community
      Reinvestment Act.*** Under
      the
      Community Reinvestment Act, as implemented by OTS regulations, a savings
      association has a continuing and affirmative obligation consistent with its
      safe
      and sound operation to help meet the credit needs of its entire community,
      including low and moderate income neighborhoods. The Community Reinvestment
      Act
      does not establish specific lending requirements or programs for financial
      institutions nor does it limit an institution’s discretion to develop the types
      of products and services that it believes are best suited to its particular
      community, consistent with the Community Reinvestment Act. The Community
      Reinvestment Act requires the OTS, in connection with its examination of a
      savings association, to assess the institution’s record of meeting the credit
      needs of its community and to take such record into account in its evaluation
      of
      certain applications by such institution.





The
      Community Reinvestment Act requires public disclosure of an institution’s rating
      and requires the OTS to provide a written evaluation of an association’s
      Community Reinvestment Act performance utilizing a four-tiered descriptive
      rating system.





The
      Bank
      received an “outstanding” rating, which is the highest possible rating, as a
      result of its most recent Community Reinvestment Act assessment.





29
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***Federal
      Reserve System.*** ** The
      Federal Reserve Board regulations require savings institutions to maintain
      noninterest 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 $45.8 million; a 10% reserve ratio
      is
      applied above $45.8 million. The first $8.5 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.





**Holding
      Company Regulation**





***General.*** The
      Company and SI Bancorp, MHC are savings and loan holding companies within the
      meaning of federal law. As such, they are registered with the OTS and are
      subject to OTS regulations, examinations, supervision, reporting requirements
      and regulations concerning corporate governance and activities. In addition,
      the
      OTS has enforcement authority over the Company, SI Bancorp, MHC and their
      non-savings institution subsidiaries. Among other things, this authority permits
      the OTS to restrict or prohibit activities that are determined to be a serious
      risk to the Bank.





***Restrictions
      Applicable to Mutual Holding Companies.*** According
      to federal law and OTS regulations, a mutual holding company, such as SI
      Bancorp, MHC, may generally engage in the following activities: (1) investing
      in
      the stock of a bank; (2) acquiring a mutual association through the merger
      of
      such association into a bank subsidiary of such holding company or an interim
      bank subsidiary of such holding company; (3) merging with or acquiring another
      holding company, one of whose subsidiaries is a bank; (4)
      investing in a corporation, the capital stock of which is available for purchase
      by a savings association under federal law or under the law of any state where
      the subsidiary savings association or associations share their home offices;
      (5)
      furnishing or performing management services for a savings association
      subsidiary of such company; (6) holding, managing or liquidating assets owned
      or
      acquired from a savings subsidiary of such company; (7) holding or managing
      properties used or occupied by a savings association subsidiary of such company
      properties used or occupied by a savings association subsidiary of such company;
      (8) acting as trustee under deeds of trust; (9) any other activity (A) that
      the
      Federal Reserve Board, by regulation, has determined to be permissible for
      bank
      holding companies under Section 4(c) of the Bank Holding Company Act, unless
      the
      OTS, by regulation, prohibits or limits any such activity for savings and loan
      holding companies; or (B) in which multiple savings and loan holding companies
      were authorized (by regulation) to directly engage on March 5, 1987; and (10)
      purchasing, holding or disposing of stock acquired in connection with a
      qualified stock issuance if the purchase of such stock by such savings and
      loan
      holding company is approved by the OTS.





The
      Gramm-Leach Bliley Act of 1999 was designed to modernize the regulation of
      the
      financial services industry by expanding the ability of bank holding companies
      to affiliate with other types of financial services companies such as insurance
      companies and investment banking companies. The legislation also expanded the
      activities permitted for mutual savings and loan holding companies to also
      include any activity permitted a “financial holding company” under the
      legislation, including a broad array of insurance and securities
      activities.





Federal
      law prohibits a savings and loan holding company, including a federal mutual
      holding company, from directly or indirectly, or through one or more
      subsidiaries, acquiring more than 5% of the voting stock of another savings
      institution, or its holding company, without prior written approval of the
      OTS.
      Federal law also prohibits a savings and loan holding company from acquiring
      more than 5% of a company engaged in activities other than those authorized
      for
      savings and loan holding companies by federal law; or acquiring or retaining
      control of a depository institution that is not insured by the FDIC. In
      evaluating applications by holding companies to acquire savings institutions,
      the OTS must consider the




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financial
      and managerial resources and future prospects of the company and institution
      involved, the effect of the acquisition on the risk to the insurance funds,
      the
      convenience and needs of the community and competitive factors.




The
      OTS
      is prohibited from approving any acquisition that would result in a multiple
      savings and loan holding company controlling savings institutions in more than
      one state, except: (1) the approval of interstate supervisory acquisitions
      by
      savings and loan holding companies, and (2) 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.





If
      the
      savings institution subsidiary of a savings and loan holding company fails
      to
      meet the qualified thrift lender test, the holding company must register with
      the Federal Reserve Board as a bank holding company within one year of the
      savings institution’s failure to so qualify.





Although
      savings and loan holding companies are not currently subject to 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 as described below. The Bank must notify
      the
      OTS 30 days before declaring any dividend. In addition, the financial impact
      of
      a holding company on its subsidiary institution is a matter that is evaluated
      by
      the OTS 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.





***Stock
      Holding Company Subsidiary Regulation.*** The
      OTS
      has adopted regulations governing the two-tier mutual holding company form
      of
      organization and subsidiary stock holding companies that are controlled by
      mutual holding companies. The Company has adopted this form of organization.
      The
      Company is the stock holding company subsidiary of SI Bancorp, MHC. The Company
      is permitted to engage in activities that are permitted for SI Bancorp, MHC
      subject to the same restrictions and conditions.





***Waivers
      of Dividends by SI Bancorp, MHC.*** OTS
      regulations require SI Bancorp, MHC to notify the OTS if it proposes to waive
      receipt of dividends from the Company. The OTS reviews dividend waiver notices
      on a case-by-case basis, and, in general, does not object to any such waiver
      if:
      (i) the waiver would not be detrimental to the safe and sound operating of
      the
      savings association subsidiary; and (ii) the mutual holding company’s Board of
      Directors determines that such waiver is consistent with such directors’
fiduciary duties to the mutual holding company’s members.





***Acquisition
      of Control.*** Under
      the
      federal Change in Bank Control Act, a notice must be submitted to the OTS 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. An
      acquisition of “control” can occur upon the acquisition of 10% or more of the
      voting stock of a savings and loan holding company or savings institution or
      as
      otherwise defined by the OTS. Under the Change in Bank Control Act, the OTS
      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 anti-trust effects of the acquisition. Any company that so
      acquires control would then be subject to regulation as a savings and loan
      holding company.





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**Sarbanes-Oxley
      Act of 2002**





The
      Sarbanes-Oxley Act of 2002 implemented legislative reforms intended to address
      corporate and accounting fraud. The Sarbanes-Oxley Act restricts the scope
      of
      services that may be provided by accounting firms to their public company audit
      clients and any non-audit services being provided to a public company audit
      client will require pre-approval by the company’s audit committee. In addition,
      the Sarbanes-Oxley Act requires chief executive officers and chief financial
      officers, or their equivalents, to certify to the accuracy of periodic reports
      filed with the Securities and Exchange Commission, subject to civil and criminal
      penalties if they knowingly or willingly violate this certification
      requirement.





Under
      the
      Sarbanes-Oxley Act, bonuses issued to top executives before restatement of
      a
      company’s financial statements are now subject to disgorgement if such
      restatement was due to corporate misconduct. Executives are also prohibited
      from
      insider trading during retirement plan “blackout” periods and loans to company
      executives (other than loans by financial institutions permitted by federal
      rules and regulations) are restricted. The legislation accelerates the time
      frame for disclosures by public companies of changes in ownership in a company’s
      securities by directors and executive officers.





The
      Sarbanes-Oxley Act also increases the oversight of, and codifies certain
      requirements relating to audit committees
      of public companies and how they interact with the company’s “registered public
      accounting firm.” Among other requirements, companies must disclose whether at
      least one member of the audit committee is a “financial expert” (as such term is
      defined by the Securities and Exchange Commission) and if not, why not. Although
      the Company anticipates that it will incur additional expense in complying
      with
      the provisions of the Sarbanes-Oxley Act and the resulting regulations,
      management does not expect that such compliance will have a material impact
      on
      the Company’s results of operations or financial condition.





**Privacy
      Requirements of the Gramm-Leach Bliley Act of 1999**





The
      Gramm-Leach-Bliley Act of 1999 (the “GLBA”) provided for sweeping financial
      modernization for commercial banks, savings banks, securities firms, insurance
      companies and other financial institutions operating in the United States.
      Among
      other provisions, the GLBA places limitations on the sharing of consumer
      financial information with unaffiliated third parties. Specifically, the GLBA
      requires all financial institutions offering financial products or services
      to
      retail customers to provide such customers with the financial institution’s
      privacy policy and provide such customers the opportunity to “opt out” of the
      sharing of personal financial information with unaffiliated third
      parties.





**Anti-Money
      Laundering and the USA Patriot Act**





The
      Uniting and Strengthening America by Providing Appropriate Tools Required to
      Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT
      Act”) significantly expands the responsibilities of financial institutions,
      including savings and loan associations, in preventing the use of the U.S.
      financial system to fund terrorist activities. Title III of the USA PATRIOT
      Act
      provides for a significant overhaul of the U.S. anti-money laundering regime.
      Among other provisions, it requires financial institutions operating in the
      United States to develop new anti-money laundering compliance programs, due
      diligence policies and controls to ensure the detection and reporting of money
      laundering. Such required compliance programs are intended to supplement
      existing compliance requirements, also applicable to financial institutions,
      under the Bank Secrecy Act and the Office of Foreign Assets Control
      Regulations.





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**Other
      Regulations**





Interest
      and other charges collected or contracted for by the Bank are subject to state
      usury laws and federal laws concerning interest rates. The Bank’s loan
      operations are also subject to federal laws applicable to credit transactions,
      such as the:





—
            Truth-In-Lending
                Act, governing disclosures of credit terms to consumer
                borrowers;


—
            Home
                Mortgage Disclosure Act of 1975, requiring financial institutions
                to
                provide information to enable the public and public officials to
                determine
                whether a financial institution is fulfilling its obligation to help
                meet
                the housing needs of the community it serves;


—
            Equal
                Credit Opportunity Act, prohibiting discrimination on the basis of
                race,
                creed or other prohibited factors in extending
                credit;


—
            Fair
                Credit Reporting Act of 1978, governing the use and provision of
                information to credit reporting
                agencies;


—
            Fair
                Debt Collection Act, governing the manner in which consumer debts
                may be
                collected by collection agencies;
                and


—
            Rules
                and regulations of the various federal agencies charged with the
                responsibility of implementing such federal laws.





The
      deposit operations of the Bank also are subject to the:





—
            Right
                to Financial Privacy Act, which imposes a duty to maintain confidentiality
                of consumers’ financial records and prescribes procedures for complying
                with administrative subpoenas of financial
                records;


—
            Electronic
                Funds Transfer Act and Regulation E promulgated thereunder, which
                governs
                automatic deposits to and withdrawals from deposit accounts and customers’
                rights and liabilities arising from the use of automated teller machines
                and other electronic banking services; and


—
            Check
                Clearing for the 21st Century Act (also known as “Check 21"), which gives
                “substitute checks,” such as digital check images and copies made from
                that image, the same legal standing as the original paper
                check.





**Federal
      Income Taxation**





***General.*** The
      Company reports its income on a calendar year basis using the accrual method
      of
      accounting. The federal income tax laws apply to the Company in the same manner
      as to other corporations with some exceptions, including particularly the Bank’s
      reserve for bad debts discussed below. The following discussion of tax matters
      is intended only as a summary and does not purport to be a comprehensive
      description of the tax rules applicable to the Company and its subsidiaries.
      The
      Company’s federal income tax returns have been either audited or closed under
      the statute of limitations through tax year 2002. The Company’s maximum federal
      income tax rate was 34% for 2006.





***Bad
      Debt Reserves.*** For
      fiscal years beginning before June 30, 1996, thrift institutions that qualified
      under certain definitional tests and other conditions of the Internal Revenue
      Code were permitted to use certain favorable provisions to calculate their
      deductions from taxable income for annual additions to their bad debt reserve.
      A
      reserve could be established for bad debts on qualifying real property loans,
      generally secured by interests in real property improved or to be improved,
      under the percentage of taxable income method or the experience method. The
      reserve for nonqualifying loans was computed using the experience method.
      Federal legislation enacted in 1996 repealed the reserve method of accounting
      for bad debts for institutions with assets in excess of $500.0 million and
      the
      percentage of taxable income method for all institutions for tax years beginning
      after 1995 and required savings institutions to recapture or take





33
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into
      income certain portions of their accumulated bad debt reserves. However, those
      tax bad debt reserves accumulated prior to 1988 (“Base Year Reserves”) were not
      required to be recaptured unless the institution failed certain tests.
      Approximately $3.7 million of the Bank’s accumulated tax-based bad debt reserves
      would not be recaptured into taxable income unless it makes a “non-dividend
      distribution” to the Company as described below.




***Distributions.*** If
      the
      Bank makes “non-dividend distributions” to the Company, the distributions will
      be considered to have been made from the Bank’s unrecaptured tax bad debt
      reserves, including the balance of its Base Year Reserves as of December 31,
      1987, to the extent of the “non-dividend distributions,” and then from the
      Bank’s supplemental reserve for losses on loans, to the extent of those
      reserves, and an amount based on the amount distributed, but not more than
      the
      amount of those reserves, will be included in the Bank’s taxable income.
      Non-dividend distributions include distributions in excess of the Bank’s current
      and accumulated earnings and profits as calculated for federal income tax
      purposes, distributions in redemption of stock and distributions in partial
      or
      complete liquidation. Dividends paid out of the Bank’s current or accumulated
      earnings and profits will not be so included in the Bank’s taxable income.





The
      amount of additional taxable income triggered by a non-dividend is an amount
      that, when reduced by the tax attributable to the income, is equal to the amount
      of the distribution. Therefore, if the Bank makes a non-dividend distribution
      to
      the Company, approximately one and one-half times the amount of the distribution
      not in excess of the amount of the reserves would be includable in income for
      federal income tax purposes, assuming a 34% federal corporate income tax rate.
      The Bank does not intend to pay non-dividend distributions that would result
      in
      a recapture of any portion of its bad debt reserves.





**State
      Income Taxation**





The
      Company and its subsidiaries are subject to the Connecticut corporation business
      tax. The Company and its subsidiaries are eligible to file a combined
      Connecticut income tax return and pay the regular corporation business tax.
      The
      Connecticut corporation business tax is based on the federal taxable income
      before net operating loss and special deductions of the Company and its
      subsidiaries and makes certain modifications to federal taxable income to arrive
      at Connecticut taxable income. Connecticut taxable income is multiplied by
      the
      state tax rate (7.5% for fiscal year 2006) to arrive at Connecticut income
      tax.





In
      May
      1998, the State of Connecticut enacted legislation permitting the formation
      of
      passive investment company subsidiaries by financial institutions. This
      legislation exempts qualifying passive investment companies from the Connecticut
      corporation business tax and excludes dividends paid from a passive investment
      company from the taxable income of the parent financial institution. The Bank’s
      formation of a passive investment company in January 1999 substantially
      eliminates the state income tax expense of the Company and its subsidiaries
      under current law. *See
      Item 1. Business. “Subsidiary Activities - SI Mortgage Company” for a discussion
      of the Bank’s passive investment company.*





34
 *Table
            of Contents*





**Executive
      Officers of the Registrant**





Certain
      executive officers of the Bank also serve as executive officers of the Company.
      The day-to-day management duties of the executive officers of the Company and
      the Bank relate primarily to their duties as to the Bank. The executive officers
      of the Company currently are as follows:





**Name**
            **Age****(1)**
            **Position**Rheo
                A. Brouillard
            52
            President
                and Chief Executive Officer of SI Financial Group, SI Bancorp, MHC
                and
                Savings Institute Bank and Trust CompanyBrian
                J. Hull
            46
            Executive
                Vice President, Chief Financial Officer and Treasurer of SI Financial
                Group, SI Bancorp, MHC and Savings Institute Bank and Trust
                CompanySonia
                M. Dudas
            56
            Senior
                Vice President and Senior Trust Officer of Savings Institute Bank
                and
                Trust CompanyMichael
                J. Moran
            58
            Senior
                Vice President and Senior Credit Officer of Savings Institute Bank
                and
                Trust CompanyWilliam
                E. Anderson, Jr.
            37
            Vice
                President and Retail Banking Officer of Savings Institute Bank and
                Trust
                CompanyLaurie
                L. Gervais
            42
            Vice
                President and Director of Human Resources of Savings Institute Bank
                and
                Trust Company





(1)
            Ages
                presented are as of December 31,
                2006.





***Biographical
      Information:***





***Rheo
      A. Brouillard*** **** has
      been
      the President and Chief Executive Officer of Savings Institute Bank and Trust
      Company, SI Bancorp, MHC and SI Financial Group since 1995, 2000 and 2004,
      respectively. Mr. Brouillard has been a director of the Company since
      1995.





***Brian
      J. Hull*** **** has
      been
      Executive Vice President since 2002 and Chief Financial Officer and Treasurer
      since he joined Savings Institute Bank and Trust Company in 1997. Mr. Hull
      has
      served as Chief Financial Officer and Treasurer of SI Bancorp, MHC and SI
      Financial Group since 2000 and 2004, respectively.





***Sonia
      M. Duda*** *s* has been
      Senior Vice President and Senior Trust Officer since 1999. Ms. Dudas oversees
      wealth management services, which includes trust, investment and insurance
      operations since she joined Savings Institute Bank and Trust Company in
      1992.





***Michael
      J. Moran*** has been
      Senior Vice President and Senior Credit Officer since 2001. Mr. Moran joined
      Savings Institute Bank and Trust Company in 1995.





***William
      E. Anderson, Jr.*** has been
      Vice President and Retail Banking Officer since 2002 and 2004, respectively.
      Mr.
      Anderson joined Savings Institute Bank and Trust Company in 1995.





***Laurie
      L. Gervais*** **** has
      been
      Vice President and Director of Human Resources since 2003 and 2001,
      respectively. Ms. Gervais joined Savings Institute Bank and Trust Company in
      1983.





**Item
      1A. Risk Factors.**





Prospective
      investors in the Company’s common stock should carefully consider the following
      factors.




—
            ***The
                Company’s increased emphasis on commercial lending may expose it to
                increased lending risks.*********At
                December 31, 2006, $193.8 million, or 33.6%, of the Company’s loan
                portfolio consisted




35
 *Table
            of Contents*





of
                commercial real estate and commercial business loans. The Company
                intends
                to continue to emphasize these types of lending. These types of loans
                generally expose a lender to greater risk of non-payment and loss
                than
                one- to four-family residential mortgage loans because repayment
                of the
                loans often depends on the successful operation of the property and
                the
                income stream of the borrowers. Such loans typically involve larger
                loan
                balances to single borrowers or groups of related borrowers compared
                to
                one- to four-family residential mortgage loans. Also, many of the
                Company’s commercial borrowers have more than one loan outstanding with
                the Company. Consequently, an adverse development with respect to
                one loan
                or one credit relationship can expose the Company to a significantly
                greater risk of loss compared to an adverse development with respect
                to a
                one- to four-family residential mortgage
                loan.





—
            ***The
                Company’s emphasis on automobile lending may expose it to increased
                lending risks.*******The
                Company****purchases
                automobile loans and, to a much lesser extent, originates automobile
                loans
                directly. At December 31, 2006, automobile loans constituted 1.3%
                of our
                loan portfolio. Automobile loans are generally considered to be riskier
                than residential mortgage loans because the collateral securing these
                loans depreciates over time. In many cases, repossessed collateral
                for a
                defaulted automobile loan will not provide an adequate source of
                repayment
                of the outstanding loan balance because of depreciation or improper
                repair
                and maintenance of the underlying security. In addition, automobile
                loan
                collections depend on the borrowers continuing financial stability,
                and
                thus are adversely affected by job loss, divorce, illness or personal
                bankruptcy.




—
            ***The
                Company’s inability to achieve profitability on new branches may
                negatively impact its earnings****.*****The
                Company considers its primary market area to consist of Hartford,
                New
                London, Tolland and Windham counties. However, the majority of the
                Company’s facilities are located in and a substantial portion of the
                Company’s business is derived from Windham county, which has a lower
                median household income and a higher unemployment rate than other
                counties
                in the Company’s market area and the rest of Connecticut. To address this,
                in recent years, the Company has expanded its presence throughout
                its
                market area and intends to pursue further expansion through the
                establishment of additional branches in Hartford, New London, Tolland
                and
                Middlesex counties, each of which has more favorable economic conditions
                than Windham County. The profitability of the Company’s expansion policy
                will depend on whether the income that it generates from the additional
                branches it establishes will offset the increased expenses resulting
                from
                operating new branches. The Company expects that it may take a period
                of
                time before new branches can become profitable, especially in areas
                in
                which it does not have an established presence. During this period,
                operating these new branches may negatively impact the Company’s net
                income.





—
            ***Rising
                interest rates may hurt the Company’s profits.*******Interest
                rates were recently at historically low levels. However, since June
                30,
                2005, the U.S. Federal Reserve has increased its target for the federal
                funds rate nine times, from 3.00% to 5.25%. While those short-term
                market
                interest rates (which the Bank uses as a guide to price its deposits)
                have
                increased, longer-term market interest rates (which the Bank uses
                as a
                guide to price its longer-term loans) have not. This “flattening” of the
                market yield curve has had a negative impact on the Company’s interest
                rate spread and net interest margin. If interest rates continue to
                rise,
                the Company’s net interest income and the value of its assets likely would
                be reduced if interest paid on interest-bearing liabilities, such
                as
                deposits and borrowings, increased more quickly than interest received
                on
                interest-earning assets, such as loans and investments, which would
                have a
                negative effect on the Company’s
                profitability.





36
 *Table
            of Contents*





—
            ***Strong
                competition within the Company’s market area could hurt the Company’s
                profits and slow growth.*******The
                Company faces intense competition both in making loans and attracting
                deposits. This competition has made it more difficult for the Company
                to
                make new loans and at times has forced the Company to offer higher
                deposit
                rates. Price competition for loans and deposits might result in the
                Company earning less on its loans and paying more on its deposits,
                which
                reduces net interest income. As of June 30, 2006, the Company held
                approximately 0.97% of the deposits in Hartford, New London, Tolland
                and
                Windham counties in Connecticut, which represented the 15thmarket share of deposits out of 36 financial institutions in these
                counties. Some of the institutions with which the Company competes
                have
                substantially greater resources and lending limits than the Company
                has
                and may offer services that the Company does not provide. The Company
                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 Company’s
                profitability depends upon its continued ability to compete successfully
                in its market area.





—
            ***The
                trading history of the Company’s common stock is characterized by low
                trading volume. The Company’s common stock may be subject to sudden
                decreases due to the volatility of the price of the Company’s common
                stock.*****The
                Company’s common stock trades on The Nasdaq Global Market. Over the past
                50 days, the average daily trading volume of its common stock was
                approximately 5,500 shares. The Company cannot predict whether a
                more
                active trading market in its common stock will occur or how liquid
                that
                market might become. A public trading market having the desired
                characteristics of depth, liquidity and orderliness depends upon
                the
                presence in the marketplace of willing buyers and sellers of its
                common
                stock at any given time, which presence is dependent upon the individual
                decisions of investors, over which we have no control.





The
      market price of the Company’s common stock may be highly volatile and subject to
      wide fluctuations in response to numerous factors, including, but not limited
      to, the factors discussed in other risk factors and the following:





—
            actual
                or anticipated fluctuations in the Company’s operating
                results;


—
            changes
                in interest rates;


—
            changes
                in the legal or regulatory environment in which the Company
                operates;


—
            press
                releases, announcements or publicity relating to the Company or the
                Company’s competitors or relating to trends in the Company’s
                industry;


—
            changes
                in expectations as to the Company’s future financial performance,
                including financial estimates or recommendations by securities analysts
                and investors;


—
            future
                sales of the Company’s common
                stock;


—
            changes
                in economic conditions in the Company’s marketplace, general conditions in
                the U.S. economy, financial markets or the banking industry;
                and


—
            other
                developments affecting the Company’s competitors or the Company.





These
      factors may adversely affect the trading price of the Company’s common stock,
      regardless of its actual operating performance, and could prevent you from
      selling your common stock at or above the price you desire. In addition, the
      stock markets, from time to time, experience extreme price and volume
      fluctuations that may be unrelated or disproportionate to the operating
      performance of companies. These broad fluctuations may adversely affect the
      market price of the Company’s common stock, regardless of its trading
      performance.




—
            ***Office
                of Thrift Supervision policy on remutualization transactions could
                prohibit acquisition of the Company, which may adversely affect its
                stock
                price.*******Current
                Office of Thrift Supervision regulations permit a mutual holding
                company
                to be acquired by a mutual institution in
                a




37
 *Table
            of Contents*




remutualization
                transaction. The possibility of a remutualization transaction has
                recently
                resulted in a degree of takeover speculation for mutual holding companies
                that is reflected in the per share price of mutual holding companies’
                common stock. However, the Office of Thrift Supervision has issued
                a
                policy statement indicating that it views remutualization transactions
                as
                raising significant issues concerning disparate treatment of minority
                stockholders and mutual members of the target entity and raising
                issues
                concerning the effect on the mutual members of the acquiring entity.
                Under
                certain circumstances, the Office of Thrift Supervision intends to
                give
                these issues special scrutiny and reject applications providing for
                the
                remutualization of a mutual holding company unless the applicant
                can
                clearly demonstrate that the Office of Thrift Supervision’s concerns are
                not warranted in the particular case. Should the Office of Thrift
                Supervision prohibit or otherwise restrict these transactions in
                the
                future, the Company’s per share stock price may be adversely
                affected.





—
            ***SI
                Bancorp, MHC’s majority control of the Company’s common stock enables it
                to exercise voting control over most matters put to a vote of
                shareholders, including preventing a sale, a merger or a second-step
                conversion transaction.*******SI
                Bancorp, MHC owns a majority of the Company’s common stock and, through
                its Board of Directors, is able to exercise voting control over most
                matters put to a vote of shareholders. The same directors and officers
                who
                manage the Company and the Bank also manage SI Bancorp, MHC. As a
                federally-chartered mutual holding company, the Board of Directors
                of SI
                Bancorp, MHC must ensure that the interests of depositors of the
                Bank are
                represented and considered in matters put to a vote of shareholders
                of the
                Company. Therefore, the votes cast by SI Bancorp, MHC may not be
                in your
                personal best interests as a shareholder. For example, SI Bancorp,
                MHC may
                exercise its voting control to prevent a sale or merger transaction
                in
                which shareholders could receive a premium for their shares or to
                defeat a
                shareholder nominee for election to the Board of Directors of the
                Company.
                In addition, SI Bancorp, MHC may exercise its voting control to prevent
                a
                second-step conversion transaction. Preventing a second-step conversion
                transaction may result in a lower value of the Company’s stock price than
                otherwise could be achieved as, historically, fully-converted institutions
                trade at higher multiples than mutual holding companies. The matters
                as to
                which shareholders, other than SI Bancorp, MHC, will be able to exercise
                voting control are limited.





—
            ***The
                Company operates in a highly regulated environment and it may be
                adversely
                affected by changes in laws and regulations.*******The
                Company is subject to extensive regulation, supervision and examination
                by
                the Office of Thrift Supervision, the Company’s chartering authority and
                the Federal Deposit Insurance Corporation, as insurer of the Bank’s
                deposits. SI Bancorp, MHC, the Company and the Bank 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 depositors. Regulatory authorities
                have extensive discretion in their supervisory and enforcement activities,
                including the imposition of restrictions on the Company’s operations, the
                classification of its assets and determination of the level of the
                Bank’s
                allowance for loan losses. 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 the Company’s
                operations.





—
            ***The
                Company is subject to security and operational risks relating to
                use of
                its technology that could damage its reputation and
                business.*******Security breaches in the Company’s internet banking activities could
                expose it to possible liability and damage its reputation. Any compromise
                of the Company’s security also could deter customers from using its
                internet banking services that involve the transmission of confidential
                information. The Company relies on standard internet security systems
                to
                provide the security and authentication necessary to effect
                secure





38
 *Table
            of Contents*




transmission
                of data. These precautions may not protect its systems from compromises
                or
                breaches of its security measures that could result in damage to
                its
                reputation and business. Additionally, the Company outsources its
                data
                processing to a third party. If the Company’s third party provider
                encounters difficulties or if the Company has difficulty in communicating
                with such third party, it will significantly affect the Company’s ability
                to adequately process and account for customer transactions, which
                would
                significantly affect its business
                operations.




**Item
      1B. Unresolved Staff Comments.**





None.





**Item
      2. Properties.**





The
      Bank
      conducts its business through its main office, branch offices and other
      properties. The following table sets forth certain information relating to
      these
      facilities as of December 31, 2006.




**Location**
              **Year**
                **Opened**
              **Square**
                **Footage**
              **Own/**
                **Lease**
              **Date
                  of**
                **Lease**
                **Expiration**
              **Net
                  Book**
                **Value
                  as of**
                **December
                  31,**
                **2006***(Dollars
                in thousands)****Main
                  Office:***803
                  Main Street
                Willimantic,
                  Connecticut 06226
              1870
              26,210
              Own
              -
              
              $
                  1,801***Branch
                  Offices:***115
                  Main Street
                Hebron,
                  Connecticut 06248
              1974
              2,400
              Own
              -
              
              521554
                  Exeter Road, Route 207
                Lebanon,
                  Connecticut 06249
              1978
              2,128
              Own
              -
              
              2349
                  Proulx Street
                Brooklyn,
                  Connecticut 06234
              1990
              1,538
              Lease
              2010
              
              19185
                  Freshwater Boulevard
                Enfield,
                  Connecticut 06082
              1992
              4,365
              Lease
              2012
              
              5596
                  Hartford Pike
                Dayville,
                  Connecticut 06241
              1996
              2,575
              Lease
              2006(1)
              
              629971
                  Poquonnock Road
                Groton,
                  Connecticut 06340
              1997
              3,373
              Lease
              2007(2)
              
              3Big
                  Y, 224 Salem Turnpike
                Norwich,
                  Connecticut 06360
              1998
              575
              Lease
              2008(2)
              
              -344
                  Prospect Street
                Moosup,
                  Connecticut 06354
              1998
              2,160
              Lease
              2008(2)
              
              240


39
 *Table
            of Contents*


Shaw’s,
                  60 Cantor Drive
                Willimantic,
                  Connecticut 06226
              1998
              421
              Lease
              2010(3)
              
              -180
                  Westminster Road, Route 14
                Canterbury,
                  Connecticut 06331
              1998
              1,781
              Lease
              2008(2)
              
              14Walmart,
                  474 Boston Post Road
                North
                  Windham, Connecticut 06256
              2000
              540
              Lease
              2010(3)
              
              47Walmart,
                  Lisbon Landing, 180 River Road
                Lisbon,
                  Connecticut 06351
              2001
              656
              Lease
              2011(3)
              
              81East
                  Brook Mall, 95 Storrs Road
                Mansfield,
                  Connecticut 06250
              2002
              2,325
              Lease
              2022(1)
              
              4771000
                  Sullivan Avenue
                South
                  Windsor, Connecticut 06074
              2005
              2,955
              Lease
              2025(2)
              
              21Mystic
                  Plaza, 80 Stonington Road
                Stonington,
                  Connecticut 06378
              2005
              3,436
              Lease
              2014(1)
              
              349200
                  Merrow Road, Route 195
                Tolland,
                  Connecticut 06084
              2005
              2,870
              Lease
              2015(2)
              
              253303
                  Flanders Road, Unit 8
                East
                  Lyme, Connecticut 06333
              2006
              3,075
              Lease
              2015(1)
              
              3202
                  Chapman Lane
                Gales
                  Ferry, Connecticut 06335
              2006
              2,575
              Lease
              2015(4)
              
              810***Other
                  Properties:***7
                  Ledgebrook Drive
                Mansfield,
                  Connecticut 06250
              1990
              4,554
              Lease(5)
              2007
              
              1779
                  Main Street
                Willimantic,
                  Connecticut 06226
              1999
              8,182
              Own(6)
              -
              
              203579
                  North Windham Road
                North
                  Windham, Connecticut 06256
              2005
              10,000
              Lease(7)
              2010(4)
              
              38780
                  West Street
                Rutland,
                  Vermont 05701
              2005
              7,496
              Lease(5)
              2011(3)
              
              -**Total:**
              
              
              
              
              
              $
                  6,587







(1)
            The
                Company has an option to renew this lease for four additional five-year
                periods.


(2)
            The
                Company has an option to renew this lease for two additional five-year
                periods.


(3)
            The
                Company has an option to renew this lease for one additional five-year
                period.


(4)
              The
                  Company has an option to renew this lease for three additional
                  five-year
                  periods.


40
 *Table
            of Contents*


(5)
              This
                  facility houses trust operations.
 (6)
              A
                  portion of this property includes a parking lot for the main office.
                  The
                  remainder of this property has been leased to a subtenant under
                  a lease
                  that expires in December 2007. The subtenant has an option to renew
                  this
                  lease for three additional five-year
                  periods.
 (7)
              A
                  portion of this facility is used for an employee training center.


**Item
      3. Legal Proceedings.**





At
      December 31, 2006, neither the Company nor the Bank was involved in any pending
      legal proceedings believed by management to be material to the Company’s
      financial condition or results of operations. 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 interest,
      claims involving the making and servicing of real property loans and other
      issues incident to our business. However, neither the Company nor the Bank
      is a
      party to any pending legal proceedings that management believes would have
      a
      material adverse effect on the Company’s financial condition, results of
      operations or cash flows.





**Item
      4. Submission of Matters to a Vote of Security
      Holders.**





None.





**PART
      II.**





**Item
      5. Market for the Registrant’s Common Equity, Related
      Stockholder Matters and Issuer Purchases of Equity
      Securities.**





The
      Company’s common stock is listed on the Nasdaq Global Market (“NASDAQ”) under
      the trading symbol “SIFI.” The following table sets forth the high and low sales
      prices of the common stock and the dividends declared per share of common stock
      for the periods indicated, as reported by NASDAQ.





**Price
                Range**
            
            **Dividends****Year
                Ended December 31, 2006:**
            
            **High**
            
            **Low**
            
            **Declared**First
                Quarter
            
            $
            11.75
            
            $
            10.35
            
            $
            0.04Second
                Quarter
            
            
            11.16
            
            
            10.72
            
            
            0.04Third
                Quarter
            
            
            11.99
            
            
            11.00
            
            
            0.04Fourth
                Quarter
            
            
            12.75
            
            
            11.31
            
            
            0.04





**Price
                Range**
            
            **Dividends****Year
                Ended December 31, 2005:**
            
            **High**
            
            **Low**
            
            **Declared**First
                Quarter
            
            $
            12.27
            
            $
            10.75
            
            $
            0.03Second
                Quarter
            
            
            11.76
            
            
            9.74
            
            
            0.03Third
                Quarter
            
            
            12.49
            
            
            11.22
            
            
            0.03Fourth
                Quarter
            
            
            12.26
            
            
            10.81
            
            
            0.03





The
      continued payment of dividends is dependent upon the Company’s debt and equity
      structure, earnings, financial condition, need for capital in connection with
      possible future acquisitions and other factors, including economic conditions,
      regulatory restrictions and tax considerations. The Company cannot guarantee
      that it will pay dividends or that, if paid, that it will not reduce or
      eliminate dividends in the future. *See
      Item 1. Business. “Regulation and Supervision - Limitation on Capital
      Distributions” and Note 17 in the Notes to the Consolidated Financial Statements
      for more information relating to restrictions on dividends.*





As
      of
      March 13, 2007, there were 12,421,920 shares of common stock outstanding, which
      were held by approximately 950 holders of record, including SI Bancorp,
      MHC.





41
 *Table
            of Contents*





The
      following table provides certain information with regard to shares repurchased
      by the Company in the fourth quarter of 2006.





**Period**
            
            **Total**
              **Number
                of**
              **Shares**
              **Purchased****(1)**
            
            **Average**
              **Price
                Paid**
              **Per
                Share**
            
            **Total
                Number**
              **of
                Shares**
              **Purchased
                as**
              **Part
                of Publicly**
              **Announced
                Plans****or
                Programs**
            
            **Maximum**
              **Number
                of Shares**
              **that
                May Yet be**
              **Purchased
                Under**
              **the
                Plans or****Programs**October
                1, 2006 through October 31, 2006
            
            
            -
            
            $
            -
            
            
            -
            
            
            486,170November
                1, 2006 through November 30, 2006
            
            
            -
            
            
            -
            
            
            -
            
            
            486,170December
                1, 2006 through December 31, 2006
            
            
            -
            
            
            -
            
            
            -
            
            
            486,170**Total**
            
            
            -
            
            $
            -
            
            
            -





(1)
            On
                November 23, 2005, the Company announced that the Board of Directors
                had
                approved a stock repurchase program authorizing the Company to repurchase
                up to 628,000 shares of the Company’s common stock. The repurchase program
                will continue until it is completed or terminated by the Board of
                Directors.





The
      following graph compares the cumulative total stockholder return on the
      Company’s common stock with the cumulative total return on the Nasdaq Index
      (U.S. Companies) and with the SNL $500M - $1B Thrift Index. Total return assumes
      the reinvestment of all dividends. The graph assumes $100 was invested at the
      close of business on October 1, 2004, the initial day of trading of the
      Company’s common stock.











**Period
                Ending****Index**
            
            **10/01/04**
            
            **12/31/04**
            
            **06/30/05**
            
            **12/31/05**
            
            **06/30/06**
            
            **12/31/06**SI
                Financial Group, Inc.
            
            
            100.00
            
            
            109.38
            
            
            104.40
            
            
            98.54
            
            
            99.63
            
            
            111.92NASDAQ
                Composite
            
            
            100.00
            
            
            112.19
            
            
            106.44
            
            
            117.50
            
            
            116.24
            
            
            129.71SNL
                $500M-$1B Thrift Index
            
            
            100.00
            
            
            107.90
            
            
            100.14
            
            
            102.54
            
            
            112.89
            
            
            125.64





42
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On
      September 22, 2006, the Company completed the sale of $8.0 million of trust
      preferred capital securities. The
      new
      trust preferred capital securities were issued by a statutory business trust
      formed by the Company and were sold to a pooled investment vehicle sponsored
      by
      FTN Financial Capital Markets in a private placement offering pursuant to an
      applicable exemption from registration under Section 4(2) of the Securities
      Act
      of 1933, as amended. The
      Company expects to utilize the net proceeds from the offering for general
      corporate purposes, including the expected redemption, in April 2007, of
      previously issued trust preferred securities, which carry significantly higher
      interest rates.





**Item
      6. Selected Financial Data.**





The
      Company has derived the following selected consolidated financial and other
      data
      in part from its Consolidated Financial Statements and Notes appearing elsewhere
      in this Form 10-K.





**Selected
                Financial Condition Data:**
            
            **At
                December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002**Total
                assets
            
            $
            757,037
            
            $
            691,868
            
            $
            624,649
            
            $
            518,141
            
            $
            484,944Cash
                and cash equivalents
            
            
            26,108
            
            
            25,946
            
            
            30,775
            
            
            29,577
            
            
            37,517Securities
                held to maturity
            
            
            -
            
            
            -
            
            
            -
            
            
            1,728
            
            
            9,463Securities
                available for sale
            
            
            119,508
            
            
            120,019
            
            
            120,557
            
            
            77,693
            
            
            87,914Loans
                receivable, net
            
            
            574,111
            
            
            513,775
            
            
            447,957
            
            
            386,924
            
            
            334,598Deposits(1)
            
            
            541,922
            
            
            512,282
            
            
            460,480
            
            
            417,311
            
            
            398,315Federal
                Home Loan Bank advances
            
            
            111,956
            
            
            87,929
            
            
            72,674
            
            
            57,168
            
            
            43,918Junior
                subordinated debt owed to unconsolidated trusts
            
            
            15,465
            
            
            7,217
            
            
            7,217
            
            
            7,217
            
            
            7,217Other
                borrowings
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,951Total
                stockholders’ equity
            
            
            82,386
            
            
            80,043
            
            
            80,809
            
            
            34,099
            
            
            31,408








**Selected
                Operating Data:**
            
            **Years
                Ended December 31,***(Dollars
                in Thousands, Except Per Share Data)*
            
            **2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002**Interest
                and dividend income
            
            $
            40,777
            
            $
            33,905
            
            $
            28,603
            
            $
            27,930
            
            $
            28,330Interest
                expense
            
            
            18,261
            
            
            12,131
            
            
            9,400
            
            
            9,346
            
            
            11,014Net
                interest income
            
            
            22,516
            
            
            21,774
            
            
            19,203
            
            
            18,584
            
            
            17,316Provision
                for loan losses
            
            
            881
            
            
            410
            
            
            550
            
            
            1,602
            
            
            537Net
                interest income after provision for loan losses
            
            
            21,635
            
            
            21,364
            
            
            18,653
            
            
            16,982
            
            
            16,779Noninterest
                income
            
            
            8,258
            
            
            6,310
            
            
            4,185
            
            
            4,722
            
            
            3,284Noninterest
                expenses
            
            
            25,959
            
            
            22,588
            
            
            21,031
            
            
            16,606
            
            
            15,394Income
                before income tax provision
            
            
            3,934
            
            
            5,086
            
            
            1,807
            
            
            5,098
            
            
            4,669Income
                tax provision
            
            
            1,156
            
            
            1,689
            
            
            519
            
            
            1,713
            
            
            1,587Net
                income
            
            $
            2,778
            
            $
            3,397
            
            $
            1,288
            
            $
            3,385
            
            $
            3,082Basic
                earnings per share
            
            $
            0.24
            
            $
            0.28
            
            
            N/A
            
            
            N/A
            
            
            N/ADiluted
                earnings per share
            
            $
            0.23
            
            $
            0.28
            
            
            N/A
            
            
            N/A
            
            
            N/A





43
 *Table
            of Contents*




**Selected
                Operating Ratios:**
            
            **At
                or For the Years Ended December 31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002***Performance
                Ratios:*Return
                on average assets
            
            
            0.38
            %
            
            0.52
            %
            
            0.23
            %
            
            0.67
            %
            
            0.68
            %Return
                on average equity
            
            
            3.44
            
            
            4.19
            
            
            2.77
            
            
            10.34
            
            
            10.46Interest
                rate spread(2)
            
            
            2.81
            
            
            3.19
            
            
            3.41
            
            
            3.81
            
            
            3.79Net
                interest margin(3)
            
            
            3.26
            
            
            3.56
            
            
            3.64
            
            
            3.98
            
            
            4.04Noninterest
                expense to average assets
            
            
            3.56
            
            
            3.47
            
            
            3.71(4
            )
            
            3.30
            
            
            3.39Dividend
                payout ratio(5)
            
            
            66.67
            
            
            42.86
            
            
            N/A
            
            
            N/A
            
            
            N/AEfficiency
                ratio(6)
            
            
            83.58
            
            
            80.60
            
            
            89.29
            
            
            71.62
            
            
            73.80Average
                interest-earning assets to average interest-bearing
                liabilities
            
            
            117.07
            
            
            118.38
            
            
            112.93
            
            
            108.70
            
            
            110.03Average
                equity to average assets
            
            
            11.07
            
            
            12.45
            
            
            8.21
            
            
            6.51
            
            
            6.49*Regulatory
                Capital Ratios:*Total
                risk-based capital ratio
            
            
            15.84
            
            
            16.79
            
            
            18.03
            
            
            12.45
            
            
            12.12Tier
                1 risk-based capital ratio
            
            
            14.86
            
            
            15.87
            
            
            17.12
            
            
            11.50
            
            
            11.00Tier
                1 capital ratio(7)
            
            
            8.97
            
            
            9.31
            
            
            9.99
            
            
            6.81
            
            
            6.46Tangible
                equity ratio
            
            
            8.97
            
            
            9.31
            
            
            9.99
            
            
            N/A
            
            
            N/A*Asset
                  Quality Ratios:*Allowance
                for loan losses as a percent of total loans
            
            
            0.76
            
            
            0.71
            
            
            0.71
            
            
            0.69
            
            
            0.91Allowance
                for loan losses as a percent of nonperforming loans
            
            
            313.58
            
            
            1529.58
            
            
            338.98
            
            
            207.57
            
            
            166.50Net
                (charge-offs) recoveries to average outstanding loans during the
                year
            
            
            (0.03
            )
            
            0.01
            
            
            0.01
            
            
            0.55
            
            
            0.11







(1)
            Includes
                mortgagors’ and investors’ escrow
                accounts.


(2)
            Represents
                the difference between the weighted average yield on average
                interest-earning assets and the weighted average cost of interest-bearing
                liabilities.


(3)
            Represents
                net interest income as a percent of average interest-earning
                assets.


(4)
            The
                noninterest expenses to average assets ratio, excluding the effect
                of the
                contribution expense to SI Financial Group Foundation, was 3.27%
                for the
                year ended December 31, 2004.


(5)
            Dividends
                declared per share divided by basic net income per common share.
                Dividends
                paid on shares held by SI Bancorp, MHC are waived and are excluded
                from
                this ratio. Comparable figures for 2004, 2003 and 2002 are not available
                since no dividends were paid during these
                periods.


(6)
            Represents
                noninterest expenses divided by the sum of net interest income and
                noninterest income, less any realized gains or losses on the sale
                of
                securities. The efficiency ratio, excluding the effect of the contribution
                to SI Financial Group Foundation, was 78.62% for the year ended December
                31, 2004.


(7)
            Represents
                Tier 1 capital to total assets as required by OTS regulations at
                December
                31, 2006, 2005 and 2004 and Tier 1 capital to total average assets
                at
                December 31, 2003 and 2002 as required by FDIC
                regulations.





44
 *Table
            of Contents*





**Item
      7. Management’s Discussion and Analysis of Financial Condition
      and Results of Operations.**





**General**





The
      Company’s results of operations are dependent primarily on net interest income,
      which is the difference between the interest income earned on the Company’s
      interest-earning assets, such as loans and investments, and the interest expense
      on its interest-bearing liabilities, such as deposits and borrowings. The
      Company also generates noninterest income such as gains on securities and loan
      sales, fees from deposit and trust and investment management services, insurance
      commissions and other fees. The Company’s noninterest expenses primarily consist
      of employee compensation and benefits, occupancy, computer services, furniture
      and equipment, outside professional services, electronic banking fees, marketing
      and other general and administrative expenses. The Company’s results of
      operations are also significantly affected by general economic and competitive
      conditions, particularly changes in market interest rates, governmental policies
      and actions of regulatory agencies.





The
      following analysis discusses changes in the financial condition as of December
      31, 2006 and 2005 and the results of operations for the years ended December
      31,
      2006, 2005 and 2004 and should be read in conjunction with the Company’s
      Consolidated Financial Statements and the Notes thereto, appearing in Part
      IV,
      Item 15 of this document.





**Management
      Strategy**





The
      Company’s mission is to operate and grow a profitable community-oriented
      financial institution. The Company plans to achieve this by continuing its
      strategy of:





—
            offering
                a full range of financial services;


—
            expanding
                the branch network into new market
                areas;


—
            pursuing
                opportunities to increase commercial lending in the Bank’s market
                area;


—
            applying
                conservative underwriting practices to maintain the high quality
                of the
                Bank’s loan portfolio;


—
            managing
                net interest margin and net interest spread by seeking to increase
                lending
                levels;


—
            managing
                investment and borrowing portfolios to provide liquidity, enhance
                income
                and manage interest rate risk; and


—
            increasing
                deposits by continuing to offer exceptional customer service and
                emphasizing the Bank’s commercial deposit
                offerings.





***Offering
      a full range of financial services.*** ** The
      Bank
      has a long tradition of focusing on the needs of consumers and small and
      medium-sized businesses in the community and being an active corporate citizen.
      The Bank delivers personalized service and responds with flexibility to
      customers needs. The Bank believes its community orientation is attractive
      to
      its customers and distinguishes it from the large regional banks that operate
      in
      its market area and it intends to maintain this focus as it grows. In this
      context, the Bank is striving to become a true financial services company
      offering its customers one-stop shopping for all of their financial needs
      through banking, investments, insurance and trust products and services. The
      Bank hopes that its broad array of product offerings will deepen its
      relationships with its current customers and entice new customers to begin
      banking with them, ultimately increasing fee income and
      profitability.





The
      Company’s purchase of the net assets of SI Trust Servicing in November 2005, a
      third-party provider of trust outsourcing services for community banks, expands
      the products offered by the Bank, and offers a trust service to other community
      banks, while presenting significant growth opportunities for the Company’s
      wealth management business and earnings.





45
 *Table
            of Contents*





***Expand
      branch network into new market areas.*** ** Since
      2000, the Bank has opened a new branch office in each of North Windham, Lisbon,
      Mansfield Center, Tolland and South Windsor, Connecticut. The Bank intends
      to
      continue to pursue expansion in Hartford, New London, Tolland and Windham
      Counties in future years, whether through de novo branching or acquisition.
      The
      Bank anticipates the opening of its 20 th office
      in East Hampton, Connecticut during the third quarter of 2007 and the relocation
      of its Norwich and Brooklyn, Connecticut offices in the fourth quarter of 2007
      and the first quarter of 2008, respectively.





***Pursue
      opportunities to increase commercial lending.*** ** Commercial
      real estate and commercial business loans increased $15.3 million and $37.1
      million for the years ended December 31, 2006 and 2005, respectively, and at
      December 31, 2006 comprised approximately 33.6% of total loans. There are many
      multi-family and commercial properties and businesses located in the Bank’s
      market area and the larger lending relationships associated with these
      commercial opportunities may be pursued, while continuing to originate any
      such
      loans in accordance with what the Bank believes are conservative underwriting
      guidelines. Toward this end, the Bank has hired additional seasoned commercial
      lenders and offered new products to increase the Bank’s ability to serve the
      market.





***Apply
      conservative underwriting practices and maintain high quality loan
      portfolio.*** ** The
      Bank
      believes that high asset quality is a key to long-term financial success. The
      Bank has sought to maintain a high level of asset quality and moderate credit
      risk by using underwriting standards which it believes are conservative, and
      by
      diligent monitoring and collection efforts. Despite the Bank’s conservative
      underwriting practices, nonperforming loans increased from $240,000 at December
      31, 2005 to $1.4 million at December 31, 2006. At December 31, 2006,
      nonperforming loans were 0.24% of total loan portfolio and 0.18% of total
      assets. Although the Bank intends to increase its multi-family and commercial
      real estate and commercial business lending, it intends to continue its
      philosophy of managing large loan exposures through a conservative approach
      to
      lending.





***Manage
      net interest margin and net interest spread.*** ** The
      Company intends to continue to manage its net interest margin and net interest
      spread by seeking to increase lending levels. Loans secured by multi-family
      and
      commercial real estate are generally larger and involve a greater degree of
      risk
      than one-to four-family residential mortgage loans. Consequently, multi-family
      and commercial real estate loans typically have higher yields, which increase
      the Company’s net interest margin and net interest spread.





***Manage
      investment and borrowing portfolios.*** ** The
      Company’s liquidity, income and interest rate risk are affected by the
      management of its investment and borrowing portfolios. The Company has and
      may
      continue to leverage the additional capital from the offering by borrowing
      funds
      from the Federal Home Loan Bank and investing the funds in loans and investment
      securities in a manner consistent with its current portfolio. This leverage
      strategy, if implemented and assuming favorable market conditions, will provide
      additional liquidity, enhance earnings and help to manage interest rate
      risk.





***Increase
      deposits.*** ** The
      Company’s primary source of funds is retail deposit accounts. Annually, deposits
      have continued to increase primarily due to competitive interest rates and
      the
      movement of customer funds out of riskier investments, including the stock
      market. The Company intends to continue to increase its deposits by continuing
      to offer exceptional customer service and by focusing on increasing its
      commercial deposits from small and medium-sized businesses through additional
      business banking products.





46
 *Table
            of Contents*





**Critical
      Accounting Policies**





The
      Company 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 income to be critical accounting
      policies. The Company considers the allowance for loan losses and the impairment
      of long-lived assets to be its critical accounting policies.





***Allowance
      for Loan Losses.*** Determining the amount of allowance for loan losses necessarily involves a
      high
      degree of judgment. Management reviews the level of the allowance on a monthly
      basis and establishes the provision for loan losses based on the size and the
      composition of the loan portfolio, delinquency levels, loss experience, economic
      conditions, and other factors related to the collectibility of the loan
      portfolio. The level of the allowance for loan losses fluctuates primarily
      due
      to changes in the size and composition of the loan portfolio and in the level
      of
      nonperforming loans, classified assets and charge-offs. A portion of the
      allowance is established by segregating the loans by loan category and assigning
      allocation percentages based on our historical loss experience and delinquency
      trends. The applied loss factors are re-evaluated annually to ensure their
      relevance in the current real estate environment. Accordingly, increases in
      the
      size of the loan portfolio and the increased emphasis on commercial real estate
      and commercial business loans, which carry a higher degree of risk of default
      and, thus, a higher allocation percentage, increases the allowance.
      Additionally, a portion of the allowance is established based on the level
      of
      specific nonperforming loans, classified assets or charged-off
      loans.





Although
      the Bank believes that it uses the best information available to establish
      the
      allowance for loan losses, future additions to the allowance may be necessary
      based on estimates that are susceptible to change as a result of changes in
      economic conditions and other factors. In addition, the OTS, as an integral
      part
      of its examination process, periodically reviews the 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. *See
      Part I. Item 1. Business. “Lending Activities - Allowance for Loan Losses” and
      Notes 1 and 4 in the Notes to the Consolidated Financial Statements for
      additional information.*





***Impairment
      of Long-Lived Assets.*** The
      Company is required to record certain assets it has acquired, including
      identifiable intangible assets such as core deposit intangibles, goodwill and
      certain liabilities that it assumed at fair value, which may involve making
      estimates based on third party valuations, such as appraisals, or internal
      valuations based on discounted cash flow analyses or other valuation techniques.
      Further, long-lived assets, including intangible assets and premises and
      equipment, that are held and used by us, are presumed to have a useful life.
      The
      determination of the useful lives of intangible assets is subjective, as is
      the
      appropriate amortization period for such intangible and long-lived assets.
      Additionally, long-lived assets are reviewed for impairment annually at a
      minimum or whenever events or changes in circumstances indicate that the
      carrying amount of the asset may not be recoverable. If impairment is indicated
      by that review, the asset is written down to its estimated fair value through
      a
      charge to noninterest expense. Testing for impairment is a subjective process,
      the application of which could result in different evaluations of impairment. *See
      Notes 1, 4, 6 and 7 in the Notes to the Consolidated Financial Statements for
      additional information.*





**Analysis
      of Net Interest Income**





***Average
      Balance Sheet.*** The
      following table presents information regarding average balances of assets and
      liabilities, the total dollar amounts of interest and dividend income from
      average interest-earning assets, the total dollar amounts of interest expense
      on
      average interest-bearing liabilities and the resulting average yields and costs.
      The yields and costs for the periods indicated are derived by dividing income
      or
      expense by the average balances of assets or liabilities, respectively, for
      the
      periods presented. For purposes of this table, average balances have been
      calculated using average daily balances.





47
 *Table
            of Contents*








**For
                the Years Ended December 31,****2006**
            
            **2005**
            
            **2004***(Dollars
                in Thousands)*
            
            **Average****Balance**
            
            **Interest
                &**
              **Dividends**
            
            **Average**
              **Yield/**
              **Rate**
            
            **Average****Balance**
            
            **Interest
                &**
              **Dividends**
            
            **Average**
              **Yield/**
              **Rate**
            
            **Average****Balance**
            
            **Interest
                &****Dividends**
            
            **Average**
              **Yield/**
              **Rate****ASSETS:****Interest-earning
                assets:**Loans(1)(2)
            
            $
            553,631
            
            $
            34,857
            
            
            6.30
            %
            $
            472,010
            
            $
            28,586
            
            
            6.06
            %
            $
            412,415
            
            $
            24,545
            
            
            5.95
            %Investment
                securities(3)
            
            
            130,121
            
            
            5,702
            
            
            4.38
            
            
            127,736
            
            
            5,018
            
            
            3.93
            
            
            97,021
            
            
            3,826
            
            
            3.94Other
                interest-earning assets
            
            
            7,966
            
            
            226
            
            
            2.84
            
            
            12,020
            
            
            308
            
            
            2.56
            
            
            18,309
            
            
            240
            
            
            1.31**Total
                interest-earning assets**
            
            
            691,718
            
            
            40,785
            
            
            5.90
            
            
            611,766
            
            
            33,912
            
            
            5.54
            
            
            527,745
            
            
            28,611
            
            
            5.42Noninterest-earning
                assets
            
            
            37,741
            
            
            
            
            
            
            
            
            39,242
            
            
            
            
            
            
            
            
            38,478**Total
                assets**
            
            $
            729,459
            
            
            
            
            
            
            
            $
            651,008
            
            
            
            
            
            
            
            $
            566,223**LIABILITIES
                AND EQUITY:****Interest-bearing
                liabilities:**Deposits:NOW
                and money market
            
            $
            124,136
            
            
            1,001
            
            
            0.81
            
            $
            118,858
            
            
            653
            
            
            0.55
            
            $
            108,678
            
            
            384
            
            
            0.35Savings(4)
            
            
            83,963
            
            
            961
            
            
            1.14
            
            
            92,999
            
            
            854
            
            
            0.92
            
            
            91,721
            
            
            625
            
            
            0.68Certificates
                of deposit
            
            
            271,352
            
            
            11,165
            
            
            4.11
            
            
            218,102
            
            
            7,021
            
            
            3.22
            
            
            194,569
            
            
            5,337
            
            
            2.74Total
                interest-bearing deposits
            
            
            479,451
            
            
            13,127
            
            
            2.74
            
            
            429,959
            
            
            8,528
            
            
            1.98
            
            
            394,968
            
            
            6,346
            
            
            1.61FHLB
                advances
            
            
            101,902
            
            
            4,352
            
            
            4.27
            
            
            79,596
            
            
            3,108
            
            
            3.90
            
            
            65,154
            
            
            2,683
            
            
            4.12Subordinated
                debt
            
            
            9,522
            
            
            782
            
            
            8.21
            
            
            7,217
            
            
            495
            
            
            6.86
            
            
            7,217
            
            
            371
            
            
            5.14Other
                borrowings
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -**Total
                interest-bearing liabilities**
            
            
            590,875
            
            
            18,261
            
            
            3.09
            
            
            516,772
            
            
            12,131
            
            
            2.35
            
            
            467,339
            
            
            9,400
            
            
            2.01Noninterest-bearing
                liabilities
            
            
            57,808
            
            
            
            
            
            
            
            
            53,192
            
            
            
            
            
            
            
            
            52,392**Total
                liabilities**
            
            
            648,683
            
            
            
            
            
            
            
            
            569,964
            
            
            
            
            
            
            
            
            519,731**Total
                stockholders’ equity**
            
            
            80,776
            
            
            
            
            
            
            
            
            81,044
            
            
            
            
            
            
            
            
            46,492**Total
                liabilities and stockholders’ equity**
            
            $
            729,459
            
            
            
            
            
            
            
            $
            651,008
            
            
            
            
            
            
            
            $
            566,223**Net
                interest-earning assets**
            
            $
            100,843
            
            
            
            
            
            
            
            $
            94,994
            
            
            
            
            
            
            
            $
            60,406**Tax
                equivalent net interest income****(3)**
            
            
            
            
            
            22,524
            
            
            
            
            
            
            
            
            21,781
            
            
            
            
            
            
            
            
            19,211**Tax
                equivalent interest rate spread****(5)**
            
            
            
            
            
            
            
            
            2.81
            %
            
            
            
            
            
            
            
            3.19
            %
            
            
            
            
            
            
            
            3.41
            %**Tax
                equivalent net interest margin as a percentage of interest-earning
                assets****(6)**
            
            
            
            
            
            
            
            
            3.26
            %
            
            
            
            
            
            
            
            3.56
            %
            
            
            
            
            
            
            
            3.64
            %**Average
                interest-earning assets to average interest-bearing
                liabilities**
            
            
            
            
            
            
            
            
            117.07
            %
            
            
            
            
            
            
            
            118.38
            %
            
            
            
            
            
            
            
            112.93
            %**Less:
                Tax equivalent adjustment****(3)**
            
            
            
            
            
            (8
            )
            
            
            
            
            
            
            
            (7
            )
            
            
            
            
            
            
            
            (8
            )**Net
                interest income**
            
            
            
            
            $
            22,516
            
            
            
            
            
            
            
            $
            21,774
            
            
            
            
            
            
            
            $
            19,203


48
 *Table
              of Contents*


(1)
            Amount
                is net of deferred loan origination fees and costs. Average balances
                include nonaccrual loans and loans held for
                sale.


(2)
            Loan
                fees are included in interest income and are
                immaterial.


(3)
            Municipal
                securities income and net interest income are presented on a tax
                equivalent basis using a tax rate of 34%. The tax equivalent adjustment
                is
                deducted from tax equivalent net interest income to agree to the
                amounts
                reported in the statements of
                income.


(4)
            Includes
                mortgagors’ and investors’ escrow
                accounts.


(5)
            Tax
                equivalent net interest rate spread represents the difference between
                the
                weighted-average yield on interest-earning assets and the weighted
                average
                cost of interest-bearing
                liabilities.


(6)
            Tax
                equivalent net interest margin represents tax equivalent net interest
                income divided by average interest-earning
                assets.




***Rate/Volume
      Analysis*** **.** The
      following table sets forth the extent to which changes in interest rates and
      changes in volume of interest-earning assets and interest-bearing liabilities
      have on the Company’s interest income and interest expense for the periods
      presented. 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 rate and volume columns. For
      purposes of this table, changes attributable to both changes in rate and volume
      that cannot be segregated have been allocated proportionately based on the
      changes due to rate and the changes due to volume.





**2006
                Compared to 2005**
            
            **2005
                Compared to 2004***(Dollars
                in Thousands)*
            
            **Increase
                (Decrease)**
              **Due
                To**
            
            
            
            **Increase
                (Decrease)**
              **Due
                To****Rate**
            
            **Volume**
            
            **Net**
            
            **Rate**
            
            **Volume**
            
            **Net****Interest-earning
                assets:***Interest
                and Dividend Income:*Loans(1)(2)
            
            $
            1,487
            
            $
            4,784
            
            $
            6,271
            
            $
            549
            
            $
            3,492
            
            $
            4,041Investment
                securities(3)
            
            
            592
            
            
            92
            
            
            684
            
            
            (15
            )
            
            1,207
            
            
            1,192Other
                interest-earning assets
            
            
            14
            
            
            (96
            )
            
            (82
            )
            
            129
            
            
            (61
            )
            
            68**Total
                interest-earning assets**
            
            
            2,093
            
            
            4,780
            
            
            6,873
            
            
            663
            
            
            4,638
            
            
            5,301**Interest-bearing
                liabilities:***Interest
                Expense:*Deposits(4)
            
            
            3,157
            
            
            1,442
            
            
            4,599
            
            
            1,540
            
            
            642
            
            
            2,182FHLB
                advances
            
            
            434
            
            
            810
            
            
            1,244
            
            
            (145
            )
            
            570
            
            
            425Subordinated
                debt
            
            
            148
            
            
            139
            
            
            287
            
            
            124
            
            
            -
            
            
            124**Total
                interest-bearing liabilities**
            
            
            3,739
            
            
            2,391
            
            
            6,130
            
            
            1,519
            
            
            1,212
            
            
            2,731**Change
                in net interest income****(5)**
            
            $
            (1,646
            )
            $
            2,389
            
            $
            743
            
            $
            (856
            )
            $
            3,426
            
            $
            2,570





(1)
            Amount
                is net of deferred loan origination fees and costs. Average balances
                include nonaccrual loans and loans held for
                sale.


(2)
            Loans
                fees are included in interest income and are
                immaterial.


(3)
            Municipal
                securities income and net interest income are presented on a tax
                equivalent basis using a tax rate of 34%. The tax equivalent adjustment
                is
                deducted from tax equivalent net interest income to agree to the
                amounts
                reported in the statements of
                income.


(4)
            Includes
                mortgagors’ and investors’ escrow
                accounts.


(5)
            Presented
                on a tax equivalent basis.








49
 *Table
            of Contents*




**Comparison
      of Financial Condition at December 31, 2006 and December 31,
      2005**




***Assets.*** **** Total
      assets increased $65.2 million, or 9.4%, to $757.0 million at December 31,
      2006,
      as compared to $691.9 million at December 31, 2005, primarily due to increases
      in net loans receivable, and to a lesser extent, premises and equipment and
      FHLB
      stock. Net loans receivable increased $60.3 million, or 11.7%, to $574.1 million
      at December 31, 2006. Residential and commercial mortgage loans contributed
      $43.0 million and $17.7 million, respectively. In 2006, loan originations for
      residential mortgage loans increased $3.8 million over 2005. Consumer and
      commercial mortgage and business loan originations decreased $3.9 million and
      $15.0 million, respectively, for 2006 as compared to 2005. Contributing to
      the
      increase in net loans receivable was the purchase of $10.3 million of indirect
      automobile loans during the first quarter of 2006. The increase in net loans
      receivable was offset by loan sales of $11.0 million of fixed-rate residential
      mortgage loans in an effort to manage interest rate risk. Premises and
      equipment, net, increased $1.7 million, or 18.9%, to $10.5 million as a result
      of branch expansion. FHLB stock increased $1.0 million to $6.7 million at
      December 31, 2006 to support a higher level of FHLB borrowings. Securities
      decreased $511,000, or 0.4%, from $120.0 million at December 31, 2005 to $119.5
      million at December 31, 2005 as the proceeds from the sale of securities during
      the second and third quarters of 2006 were reinvested into higher-yielding
      government-sponsored mortgage-backed securities.





***Liabilities.*** Total
      liabilities increased $62.8 million, or 10.3%, from December 31, 2005 to
      December 31, 2006 primarily as a result of increases in deposits and FHLB
      advances. Deposits, including mortgagors’ and investors’ escrow accounts,
      increased $29.6 million, or 5.8%, to $541.9 million at December 31, 2006. The
      Company experienced increases in interest-bearing accounts, such as certificates
      of deposit and, to a lesser extent, NOW and money market accounts. The increase
      of $34.4 million in certificates of deposit was predominately related to the
      increase in short-term certificates of deposit associated with new branch
      offices and attractive promotional rates offered to customers. In addition,
      noninterest-bearing deposits increased $3.7 million primarily as a result of
      business checking deposit volume. The increase in deposits was offset by a
      decrease of $9.1 million in passbook savings accounts during 2006. FHLB advances
      increased $24.0 million, or 27.3%, to $112.0 million at December 31, 2006.
      The
      increase in FHLB advances were primarily fixed-rate advances with terms of
      six
      months to seven years used to fund loan growth and to manage interest rate
      risk.
      Subordinated debt borrowings increased as a result of an $8.0 million trust
      preferred securities offering by a newly-formed subsidiary of the Company during
      the third quarter of 2006.





***Equity.*** Total
      stockholders’ equity increased $2.3 million from $80.0 million at December 31,
      2005 to $82.4 million at December 31, 2006. The increase in equity was primarily
      attributable to earnings of $2.8 million, amortization of equity awards of
      $765,000 and a decrease in net unrealized holding losses on available for sale
      securities aggregating $598,000 (net of taxes), offset by stock repurchases
      of
      129,266 shares at a cost of $1.4 million and dividends declared of $740,000.





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





***General.*** **** The
      Company recorded net income of $2.8 million for the year ended December 31,
      2006, a decrease of $619,000, compared to net income of $3.4 million for the
      year ended December 31, 2005. The decrease was primarily attributable to a
      $3.4
      million increase in noninterest expenses and a $471,000 increase in the
      provision for loan losses, offset by increases of $1.9 million in noninterest
      income and $742,000 in net interest income and a decrease of $533,000 in the
      provision for income taxes.





***Interest
      and Dividend Income.*** Total
      interest and dividend income increased
      $6.9 million, or 20.3%, for 2006. Average interest-earning assets increased
      $80.0 million, or 13.1%, to $691.7 million in 2006, mainly due to higher loan
      volume. Average loans increased $81.6 million and the rate earned on loans
      increased 24 basis points to 6.30% for 2006 from 6.06% for 2005. Increased
      volume on higher-yielding commercial





50
 *Table
            of Contents*




loans
      and
      rising interest rates contributed to the increase in interest earned on loans
      for 2006. Average securities rose $2.4 million, while the yield increased to
      4.38% in 2006 from 3.93% in 2005.




***Interest
      Expense.*** Interest expense increased $6.1 million, or 50.5%, to
      $18.3 million for 2006 compared to $12.1 million in 2005, primarily attributable
      to the rates paid and the average balance maintained for deposit accounts.
      The
      yield on deposit accounts increased 76 basis points due to rising market
      interest rates and average deposits rose $49.5 million in 2006. Certificates
      of
      deposit contributed the largest increase to interest expense, as customers
      shifted from savings accounts to certificates of deposit, with increases in
      the
      average balance of $53.3 million and the average yield of 89 basis points.
      Average FHLB advances increased $22.3 million, while the yield on FHLB
      borrowings rose 37 basis points to 4.27% for 2006. Rates on subordinated
      borrowings increased 135 basis points with an increase of $2.3 million in
      average borrowings.





***Provision
      for Loan Losses.*** The
      Company’s provision for loan losses increased $471,000 to $881,000 in 2006 from
      $410,000 in 2005. The higher provision reflects an increase in the Bank’s
      classified and nonperforming loans, charge-offs and loan growth from the prior
      year-end. At December 31, 2006, nonperforming loans totaled $1.4 million,
      compared to $240,000 at December 31, 2005. Additionally, the purchase of $10.3
      million of indirect automobile loans during the first quarter of 2006
      contributed to the increase in the provision for loan losses due to the
      increased risk of loss associated with this type of consumer lending. For the
      year ended December 31, 2006, net loan charge-offs totaled $187,000, compared
      to
      net loan recoveries of $61,000 for the year ended December 31, 2005.





***Noninterest
      Income.*** Total
      noninterest income increased $1.9 million, or 30.9%, to $8.3 million in 2006.
      The following table shows the components of noninterest income and the dollar
      and percentage changes from 2005 to 2006.





**Years
                Ended December 31,**
            
            **Change***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **Dollars**
            
            **Percent**Service
                fees
            
            $
            4,637
            
            $
            4,262
            
            $
            375
            
            
            8.8
            %Wealth
                management fees
            
            
            3,420
            
            
            1,301
            
            
            2,119
            
            
            162.9Increase
                in cash surrender value of BOLI
            
            
            279
            
            
            276
            
            
            3
            
            
            1.1Net
                (loss) gain on sale of securities
            
            
            (284
            )
            
            59
            
            
            (343
            )
            
            (581.4
            )Net
                gain on sale of loans
            
            
            104
            
            
            190
            
            
            (86
            )
            
            (45.3
            )Other
            
            
            102
            
            
            222
            
            
            (120
            )
            
            (54.1
            )**Total
                noninterest income**
            
            $
            8,258
            
            $
            6,310
            
            $
            1,948
            
            
            30.9
            %





Wealth
      management fees increased due primarily to the acquisition of SI Trust Servicing
      in November 2005 and an increase in the balance of assets under administration.
      The increase in noninterest income was offset by a decrease in the gain on
      the
      sale of loans. The net gain on the sale of loans reflects the sale of $11.0
      million of predominately fixed-rate residential mortgage loans in 2006 compared
      to $35.5 million in 2005. The increase in noninterest income for 2006 was also
      offset by the net loss on the sale of securities of $284,000, which primarily
      reflects the sale of government-sponsored enterprise securities in the second
      and third quarters of 2006, compared to a net gain on the sale of securities
      of
      $59,000 in 2005. The proceeds from the sale of securities during the second
      and
      third quarters of 2006 were reinvested into higher-yielding government-sponsored
      mortgage-backed securities.





51
 *Table
            of Contents*





***Noninterest
      Expenses*** **.** Noninterest expenses increased by $3.4 million, or 14.9%, for 2006 as compared
      to 2005. The following table shows the components of noninterest expenses and
      the dollar and percentage changes from 2005 to 2006.





**Years
                Ended December 31,**
            
            **Change***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **Dollar**
            
            **Percent**Salaries
                and employee benefits
            
            $
            14,277
            
            $
            12,102
            
            $
            2,175
            
            
            18.0
            %Occupancy
                and equipment
            
            
            4,825
            
            
            3,830
            
            
            995
            
            
            26.0Computer
                and electronic banking services
            
            
            2,458
            
            
            1,823
            
            
            635
            
            
            34.8Outside
                professional services
            
            
            967
            
            
            1,087
            
            
            (120
            )
            
            (11.0
            )Marketing
                and advertising
            
            
            783
            
            
            794
            
            
            (11
            )
            
            (1.4
            )Supplies
            
            
            527
            
            
            449
            
            
            78
            
            
            17.4Other
            
            
            2,122
            
            
            2,503
            
            
            (381
            )
            
            (15.2
            )**Total
                noninterest expenses**
            
            $
            25,959
            
            $
            22,588
            
            $
            3,371
            
            
            14.9
            %





The
      increase in noninterest expenses reflected an increase in operating costs
      associated with the opening of branch offices and the November 2005 acquisition
      of SI Trust Servicing. Compensation costs were higher in 2006 due to increased
      staffing levels and the amortization of share-based compensation arrangements,
      in accordance with Statement of Financial Accounting Standards No.
      123R, *“Accounting
      for Stock-Based Compensation”* (“SFAS
      123R”). Share-based compensation expense totaled $765,000 and $476,000 for the
      years ended December 31, 2006 and 2005, respectively. Occupancy and equipment
      expense increased primarily due to additional operating lease payments,
      depreciation expense and other occupancy-related expenses. Computer and
      electronic banking services were higher predominately as a result of costs
      associated with the SI Trust Servicing operation. Other noninterest expenses
      were lower in 2006 compared to the prior year mainly due to the implementation
      of the Bank’s remote branch capture system and the greater than anticipated
      losses on uncollectible items in 2005. Outside professional services expense
      was
      lower in 2006 versus 2005 as a result of reduced legal and auditing
      expenditures, offset by consulting costs associated with Sarbanes Oxley
      compliance.





***Income
      Tax Provision.*** The
      Company’s income tax provision decreased $533,000 to $1.2 million for 2006
      compared to $1.7 million for 2005 primarily resulting from a decrease in taxable
      income. The effective tax rate was 29.4% and 33.2% for 2006 and 2005,
      respectively.





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





***General.*** **** The
      Company recorded net income of $3.4 million for the year ended December 31,
      2005, an increase of $2.1 million, compared to $1.3 million for the year ended
      December 31, 2004. The increase was primarily attributable to a $2.6 million
      increase in net interest and dividend income, a $2.1 million increase in
      noninterest income and a $140,000 decrease in the provision for loan losses,
      offset by increases of $1.6 million in noninterest expenses and $1.2 million
      in
      the provision for income taxes. The increase in net interest and dividend income
      in 2005 resulted primarily from an increase in average earning assets, offset
      by
      increases in the rate paid on deposit accounts and the average balance of FHLB
      advances. For the year ended December 31, 2004, noninterest expenses included
      a
      $2.5 million contribution of common stock to SI Financial Group Foundation,
      resulting in a charge to earnings of approximately $1.7 million after taxes.





52
 *Table
            of Contents*





***Interest
      and Dividend Income.*** Total
      interest and dividend income increased
      $5.3 million, or 18.5%, for 2005. Average interest-earning assets increased
      $84.0 million, or 15.9%, to $611.8 million in 2005, mainly due to higher loan
      volume. Average loans increased $59.6 million and the rate earned on loans
      increased 11 basis points to 6.06% for 2005 from 5.95% for 2004. Increased
      volume on higher yielding commercial loans contributed to the rise in interest
      earned on loans for 2005. Average securities rose $30.7 million, while the
      yield
      nominally declined to 3.93% in 2005 from 3.94% in 2004.





***Interest
      Expense.*** Interest
      expense increased $2.7 million, or 29.1%, to $12.1 million for 2005 compared
      to
      $9.4 million in 2004, primarily as a result of the rate paid on deposits. The
      yield on deposit accounts increased 37 basis points due to rising market
      interest rates and average deposits rose $35.0 million in 2005. Although the
      average balance remained constant, the rate paid on subordinated debt borrowings
      increased 172 basis points from 5.14% to 6.86%. Average FHLB advances increased
      $14.4 million, while the yield on FHLB borrowings declined 22 basis points
      to
      3.90% for 2005.





***Provision
      for Loan Losses.*** The
      Company’s provision for loan losses decreased $140,000 to $410,000 in 2005 from
      $550,000 in 2004. The Company’s conservative underwriting standards as well as a
      favorable real estate market have contributed to the quality of the loan
      portfolio. The quality of the loan portfolio is evidenced by a reduction in
      nonperforming loans to $240,000 from $944,000, respectively, and net recoveries
      from loan losses of $61,000 compared to net charge-offs of $38,000 for the
      years
      ended December 31, 2005 and 2004, respectively. Despite improved asset quality,
      the Company continues to monitor the impact that the rise in short-term interest
      rates will have on variable-rate borrowers and their ability to repay higher
      monthly interest payments.





***Noninterest
      Income.*** Total
      noninterest income increased $2.1 million, or 50.8%, to $6.3 million in 2005.
      The following table shows the components of noninterest income and the dollar
      and percentage changes from 2004 to 2005.





**Years
                Ended December 31,**
            
            **Change***(Dollars
                in Thousands)*
            
            **2005**
            
            **2004**
            
            **Dollars**
            
            **Percent**Service
                fees
            
            $
            4,262
            
            $
            2,941
            
            $
            1,321
            
            
            44.9
            %Wealth
                management fees
            
            
            1,301
            
            
            942
            
            
            359
            
            
            38.1Increase
                in cash surrender value of BOLI
            
            
            276
            
            
            303
            
            
            (27
            )
            
            (8.9
            )Net
                gain (loss) on sale of securities
            
            
            59
            
            
            (166
            )
            
            225
            
            
            135.5Net
                gain on sale of loans
            
            
            190
            
            
            55
            
            
            135
            
            
            245.5Other
            
            
            222
            
            
            110
            
            
            112
            
            
            101.8**Total
                noninterest income**
            
            $
            6,310
            
            $
            4,185
            
            $
            2,125
            
            
            50.8
            %





Service
      fees increased primarily as a result of the Bank’s courtesy overdraft protection
      program offered to its deposit customers, which commenced in the first quarter
      of 2005 and as a result of customers’ escalating usage of the Bank’s electronic
      banking products. Wealth management fees, which include trust and investment
      services fees, rose in part due to the acquisition of SI Trust Servicing in
      November 2005 and a larger balance of assets under management. The Company
      realized net gains on the sale of securities sold in 2005 compared to realized
      net losses in 2004. The volume of securities sold was greater in 2005 versus
      2004. Net gains on the sale of loans reflect the sale of $35.5 million of loans
      in 2005 compared to $15.5 million in 2004. Increases in other noninterest income
      include a net gain of $40,000 on the sale of former branch locations and
      training center and a distribution of $107,000 in a small business investment
      corporation carried at cost.





53
 *Table
            of Contents*





***Noninterest
      Expenses*** **.** Noninterest expenses increased by $1.6 million, or 7.4%, for 2005 as compared
      to
      2004. The following table shows the components of noninterest expenses and
      the
      dollar and percentage changes from 2004 to 2005.





**Years
                Ended December 31,**
            
            **Change***(Dollars
                in Thousands)*
            
            **2005**
            
            **2004**
            
            **Dollar**
            
            **Percent**Salaries
                and employee benefits
            
            $
            12,102
            
            $
            9,835
            
            $
            2,267
            
            
            23.1
            %Occupancy
                and equipment
            
            
            3,830
            
            
            3,465
            
            
            365
            
            
            10.5Computer
                and electronic banking services
            
            
            1,823
            
            
            1,678
            
            
            145
            
            
            8.6Outside
                professional services
            
            
            1,087
            
            
            815
            
            
            272
            
            
            33.4Marketing
                and advertising
            
            
            794
            
            
            513
            
            
            281
            
            
            54.8Supplies
            
            
            449
            
            
            293
            
            
            156
            
            
            53.2Contribution
                to SI Financial Group Foundation
            
            
            -
            
            
            2,513
            
            
            (2,513
            )
            
            (100.0
            )Other
            
            
            2,503
            
            
            1,919
            
            
            584
            
            
            30.4**Total
                noninterest expenses**
            
            $
            22,588
            
            $
            21,031
            
            $
            1,557
            
            
            7.4
            %





Increases
      in salaries, benefits and taxes reflects higher staffing levels related to
      branch expansion as well as the amortization of share-based compensation awards
      granted in 2005. The adoption of SFAS 123R during the second quarter of 2005
      resulted in share-based compensation expense of $476,000, which represents
      the
      amortization of stock option and restricted stock awards over their requisite
      service period. In addition, the Company recorded compensation expense in
      connection with the employee stock ownership plan of $366,000 in 2005 compared
      to $93,000 in 2004. Additional facility leases, depreciation expense and other
      occupancy-related expenses associated with branch expansion resulted in the
      increase in occupancy and equipment expenses. In 2004, occupancy expense
      included a $337,000 impairment charge to reduce the carrying value of a former
      branch facility to its estimated net market value, which was ultimately sold
      in
      2005. Electronic banking fees continue to rise as a result of greater electronic
      banking transactions. Increases in outside professional services, which
      primarily include legal and auditing services, were attributable to higher
      costs
      associated with the Company’s public reporting requirements and consulting costs
      for assistance with Sarbanes Oxley compliance. Marketing and advertising
      expenses increased as a result of aggressive marketing campaigns for the Bank’s
      products and services and promotions related to new branch openings. Other
      expenses were higher in 2005 mainly due to the implementation of the Bank’s
      remote branch capture system and the greater than anticipated losses on
      uncollectible items. In 2004, noninterest expenses included a $2.5
      million contribution of the Company’s common stock to SI Financial Group
      Foundation in connection with the Company’s initial public offering during the
      third quarter of 2004 and a $51,000 impairment charge which was recorded to
      reduce the carrying value of the Company’s investment in a Small Business
      Investment Company (“SBIC”) limited partnership.





***Income
      Tax Provision.*** The
      Company’s income tax provision increased $1.2 million to $1.7 million for 2005
      compared to $519,000 in 2004 resulting from an increase in taxable income.
      The
      effective tax rate was 33.2% and 28.7% for 2005 and 2004, respectively. The
      lower 2004 effective tax rate reflects the Company’s contribution of stock to SI
      Financial Group Foundation.





54
 *Table
            of Contents*





**Liquidity
      and Capital Resources**





Liquidity
      is the ability to meet current and future financial obligations of a short-term
      nature. The Company’s primary sources of funds consist of deposit inflows, loan
      repayments and sales, maturities and sales of investment securities and
      borrowings from the FHLB. 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
      Company regularly adjusts its investment in liquid assets based upon its
      assessment of (1) expected loan demand, (2) expected deposit flows, (3)
      yields available on interest-earning deposits and securities and (4) the
      objectives of the Company’s asset/liability management, funds management and
      liquidity policies. The Company’s policy is to maintain liquid assets less
      short-term liabilities within a range of 12.5% to 20.0% of total assets. Excess
      liquid assets are generally invested in interest-earning deposits and short-
      and
      intermediate-term government-sponsored enterprises and mortgage-backed
      securities.





The
      Company’s most liquid assets are cash and cash equivalents. The levels of these
      assets depend on the Company’s operating, financing, lending and investing
      activities during any given period. At December
      31, 2006, cash and cash equivalents totaled $26.1 million, including
      interest-bearing deposits and federal funds sold of $11.1 million. Securities
      classified as available for sale, which provide additional sources of liquidity,
      totaled $119.5 million at December 31, 2006. In addition, at December 31, 2006,
      the Company had the ability to borrow a total of approximately $230.9 million
      from the FHLB, which includes overnight lines of credit of $6.2 million. On
      that
      date, the Company had FHLB advances outstanding of $112.0 million and no
      overnight advances outstanding. The Company believes that its most liquid assets
      combined with the available line from the FHLB provides adequate liquidity
      to
      meet its current financial obligations.





At
      December 31, 2006, the Bank had $70.9 million in loan commitments outstanding,
      which included $7.7 million in commitments to grant loans, $27.0 million in
      undisbursed construction loans, $21.6 million in unused home equity lines of
      credit, $12.1 million in commercial lines of credit, $1.4 million in overdraft
      protection lines and $1.2 million in standby letters of credit. Certificates
      of
      deposit due within one year of December 31, 2006 totaled $215.8 million, or
      39.8%, of total deposits (including mortgagors’ and investors’ escrow accounts).
      Management believes that the amount of deposits in shorter-term certificates
      of
      deposit reflects customers’ hesitancy to invest their funds in longer-term
      certificates of deposit in a rising interest rate environment. To compensate,
      the Bank has increased the duration of its borrowings with the FHLB. The Bank
      will be required to seek other sources of funds, including other certificates
      of
      deposit and lines of credit, if maturing certificates of deposit are not
      retained. Depending on market conditions, the Bank may be required to pay higher
      rates on such deposits or other borrowings than are currently paid on
      certificates of deposit. Additionally, a shorter duration in the securities
      portfolio may be necessary to provide liquidity to compensate for any deposit
      outflows. The Bank believes, however, based on past experience, a significant
      portion of its certificates of deposit will be retained. The Bank has the
      ability, if necessary, to adjust the interest rates offered to its customers
      in
      an effort to attract and retain deposits.





The
      Company’s primary investing activities are the origination of loans and the
      purchase of securities and loans. For the year ended December 31, 2006, the
      Bank
      originated $168.7 million of loans and purchased $31.7 million of securities.
      In
      fiscal 2005, the Bank originated $183.8 million of loans and purchased $27.0
      million of securities.




Financing
      activities consist primarily of activity in deposit accounts and in FHLB
      advances. Asset growth has outpaced deposit growth during the last three years.
      The increased liquidity needed to fund asset growth has been provided through
      increased FHLB borrowings, raising capital through the issuance of




55
 *Table
            of Contents*




trust
      preferred securities and proceeds from the initial public offering. The net
      increase in total deposits, including mortgagors’ and investors’ escrow accounts
      was $29.6 million, $51.8 million and $43.2 million for the years ended December
      31, 2006, 2005 and 2004, respectively. Deposit flows are affected by the overall
      level of interest rates, the interest rates and products offered by us and
      our
      local competitors and other factors. The Bank generally manages the pricing
      of
      its deposits to be competitive and to increase core deposit and commercial
      banking relationships. Occasionally, the Bank offers promotional rates on
      certain deposit products to attract deposits. The Bank experienced increases
      in
      FHLB advances of $24.0 million, $15.3 million and $15.5 million for the
      years ended December 31, 2006, 2005 and 2004, respectively.





During
      2005, the Company’s shareholders approved an equity compensation plan (the
“Equity Plan”). The Company utilized $2.9 million for the purchase of 246,249
      common shares to fund all restricted stock award grants during the year ended
      December 31, 2005. In November 2005, the Company’s Board of Directors approved a
      plan to repurchase approximately 628,000 shares of the Company’s common stock.
      In 2006, the Company repurchased 129,266 shares, at a cost of $1.4 million,
      under this plan.





The
      Bank
      is subject to various regulatory capital requirements administered by the OTS,
      including a risk-based capital measure. The risk-based capital guidelines
      include both a definition of capital and a framework for calculating
      risk-weighted assets by assigning balance sheet assets and off-balance sheet
      items to broad risk categories. At December 31, 2006, the Bank exceeded all
      of
      its regulatory capital requirements and is considered “well capitalized” under
      regulatory guidelines. As a savings and loan holding company regulated by the
      OTS, the Company is not subject to any separate regulatory capital requirements. *See
      Item 1. Business. “Regulation and Supervision - Regulation of Federal Savings
      Associations - Capital Requirements” and Note 14 in the Notes to the
      Consolidated Financial Statements for additional information relating to the
      Bank’s regulatory capital requirements.*





**Payments
      Due Under Contractual Obligations**





The
      following table presents information relating to the Company’s payments due
      under contractual obligations as of December 31, 2006.





**Payments
                Due by Period***(Dollars
                in Thousands)*
            
            **Less
                Than****One
                Year**
            
            **One
                to Three****Years**
            
            **Three
                to****Five
                Years**
            
            **More
                Than Five****Years**
            
            **Total**Long-term
                debt obligations(1)
            
            $
            26,329
            
            $
            40,627
            
            $
            31,000
            
            $
            14,000
            
            $
            111,956Operating
                lease obligations
            
            
            1,200
            
            
            2,526
            
            
            2,142
            
            
            10,446
            
            
            16,314Other
                long-term liabilities reflected on the balance sheet(2)
            
            
            -
            
            
            -
            
            
            -
            
            
            15,465
            
            
            15,465**Total
                contractual obligations**
            
            $
            27,529
            
            $
            43,153
            
            $
            33,142
            
            $
            39,911
            
            $
            143,735





(1)
            Represents
                Federal Home Loan Bank advances.


(2)
            Represents
                junior subordinated debt owed to unconsolidated
                trusts.




**Off-Balance
        Sheet Arrangements**
 
 In
        the
        normal course of operations, the Company engages in a variety of financial
        transactions that, in accordance with accounting principles generally accepted
        in the United States of America, are not recorded in its financial statements.
        These transactions involve, to varying degrees, elements of credit,


56
 *Table
            of Contents*




interest
      rate, and liquidity risk. Such transactions are used primarily to manage
      customers’ requests for funding and take the form of loan commitments, lines of
      credit and letters of credit.





The
      contractual amounts of commitments to extend credit represent the amounts of
      potential accounting loss should the contract be fully drawn upon, the customer
      defaults and the value of any existing collateral becomes worthless. The Company
      uses the same credit policies in making commitments and conditional obligations
      as it does for on-balance sheet instruments. Financial instruments whose
      contract amounts represent credit risk at December 31, 2006 and 2005 are as
      follows:





**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005***Commitments
                to extend credit:**(1)*Future
                loan commitments(2)
            
            $
            7,658
            
            $
            31,192Undisbursed
                construction loans
            
            
            27,010
            
            
            25,572Undisbursed
                home equity lines of credit
            
            
            21,554
            
            
            21,481Undisbursed
                commercial lines of credit
            
            
            12,070
            
            
            10,796Overdraft
                protection lines
            
            
            1,424
            
            
            1,277Standby
                letters of credit(3)
            
            
            1,178
            
            
            812**Total
                commitments**
            
            $
            70,894
            
            $
            91,130





(1)
            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
                may
                require payment of a fee and generally have fixed expiration dates
                or
                other termination clauses.


(2)
            Includes
                fixed-rate loan commitments of $2.6 million at interest rates ranging
                from
                5.125% to 8.000% and $5.5 million at interest rates ranging from
                4.875%
                to.8.000% at December 31, 2006 and 2005,
                respectively.


(3)
            Standby
                letters of credit are conditional commitments issued to guarantee
                the
                performance of a customer to a third
                party.





In
      1998,
      the Bank became a limited partner in a Small Business Investment Corporation
      (“SBIC”) and committed to a capital investment of $1.0 million in the limited
      partnership. At December 31, 2006 and 2005, the Bank’s remaining off-balance
      sheet commitment for capital investment was approximately $194,000. *See
      Note 12 in the Notes to the Consolidated Financial Statements.*





In
      2004,
      the Bank established an Employee Stock Ownership Plan for the benefit of its
      eligible employees. At December 31, 2006, the Bank had repaid principal payments
      on the loan to the ESOP of $527,000, allocated 38,963 shares and committed
      to
      release 32,295 shares held in suspense for allocation to participants in 2007.
      As of December 31, 2006, the amount of unallocated common shares held in
      suspense totaled 419,840, with a fair value of $5.2 million, which represents
      a
      potential commitment of the Bank to the ESOP. *See
      Note 11 in the Notes to the Consolidated Financial Statements.*





As
      of
      December 31, 2006, the Company did not engage in any off-balance sheet
      transactions reasonably likely to have a material effect on its financial
      condition, results of operations or cash flows.  *See
      Note 12 in the Notes to the Consolidated Financial Statements.*




**Impact
        of Inflation and Changes in Prices**
 
 The
        financial statements and financial data presented within this document have
        been
        prepared in accordance with accounting principles generally accepted in the
        United States of America, which require the measurement of financial position
        and operating results in terms of historical dollars without


57
 *Table
            of Contents*




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 the effects of 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.





**Impact
      of Recent Accounting Standards**





Please
      refer to *Note
      1 - Nature of Business and Summary of Significant Accounting Policies - Recent
      Accounting Pronouncements* in the
      notes to the Company’s consolidated financial statements for a detailed
      discussion of new accounting pronouncements and the impact on the Company’s
      consolidated financial statements.





**Item
      7A. Quantitative and Qualitative Disclosures About Market
      Risk.**





**Qualitative
      Aspects of Market Risk**





The
      primary market risk factor affecting the financial condition and operating
      results of the Company is interest
      rate risk. Interest rate risk is the exposure of current and future earnings
      and
      capital arising from movements in interest rates. This risk is managed by
      periodic evaluation of the interest rate risk inherent in interest-earning
      assets and interest-bearing liabilities 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
      earnings, the Company has sought to improve the match between asset and
      liability maturities and rates, while maintaining an acceptable interest rate
      spread. Pursuant to this strategy, the Company originates adjustable-rate
      mortgage loans for retention in its loan portfolio. However, the ability to
      originate adjustable-rate loans depends, to a great extent, on market interest
      rates and borrowers’ preferences. As an alternative to adjustable-rate mortgage
      loans, the Company offers fixed-rate mortgage loans with maturities of ten
      and
      fifteen years. These products enable the Company to compete in the fixed-rate
      mortgage market while maintaining a shorter maturity. Fixed-rate mortgage loans
      typically have an adverse effect on interest rate sensitivity compared to
      adjustable-rate loans. Accordingly, the Company continues to sell longer-term
      fixed-rate mortgage loans in the secondary market to manage interest rate risk.
      Recently, the Company has also used investment securities with terms of three
      years or less, shorter-term borrowings from the FHLB and brokered deposits
      to
      help manage interest rate risk. The Company currently does not participate
      in
      hedging programs, interest rate swaps or other activities involving the use
      of
      derivative financial instruments.





The
      Company has an Asset/Liability 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 analyzes its interest rate sensitivity position to manage the risk
      associated with interest rate movements through the use of interest income
      simulation. The matching of assets and liabilities may be analyzed by examining
      the extent to which such assets and liabilities are “interest rate sensitive.”
An asset or liability is said to be interest rate sensitive within a specific
      time period if it will mature or reprice within that time period. The Company’s
      goal is to manage asset and liability positions to moderate the effect of
      interest rate fluctuations on net interest income.





58
 *Table
            of Contents*





***Income
      Simulation Analysis.*** Interest
      income simulations are completed quarterly and presented to the Company’s
      Asset/Liability Committee. The simulations provide an estimate of the impact
      of
      changes in interest rates on net interest and dividend income under a range
      of
      assumptions. The numerous assumptions used in the simulation process are
      reviewed by the Asset/Liability Committee on a quarterly basis. Changes to
      these
      assumptions can significantly affect the results of the simulation. The
      simulation incorporates assumptions regarding the potential timing in the
      repricing of certain assets and liabilities when market rates change and the
      changes in spreads between different market rates. The simulation analysis
      incorporates management’s current assessment of the risk that pricing margins
      will change adversely over time due to competition or other factors.





Simulation
      analysis is only an estimate of the Company’s interest rate risk exposure at a
      particular point in time. The Company continually reviews the potential effect
      that changes in interest rates could have on the repayment of rate sensitive
      assets and funding requirements of rate sensitive liabilities.





The
      tables below set forth an approximation of the Company’s exposure as a
      percentage of estimated net interest income for the next twelve and
      twenty-four-month periods using interest income simulation. The simulation
      uses
      projected repricing of assets and liabilities at December 31, 2006 and at
      December 31, 2005 on the basis of contractual maturities, anticipated
      repayments and scheduled rate adjustments. Prepayment rates can have a
      significant impact on interest income simulation. Because of the Company’s large
      percentage of loans and mortgage-backed securities, rising or falling interest
      rates have a significant impact on the prepayment speeds of its earning assets
      that in turn affect the rate sensitivity position. The prepayment rates on
      investment securities are assumed to fluctuate between 8% and 15% in a flat
      interest rate environment, between 7% and 12% in an increasing interest rate
      environment and between 18% and 24% in a decreasing interest rate environment,
      depending on the type of security. Loan prepayment rates are assumed to
      fluctuate between 6% and 18% in a flat interest rate environment, between 6%
      and
      15% in a rising rate environment and between 6% and 36% in a falling rate
      environment, depending on the type of loan. As evidenced by these assumptions,
      when interest rates rise, prepayments tend to slow and when interest rates
      fall,
      prepayments tend to increase. The Company’s asset sensitivity would be reduced
      if prepayments slow and vice versa. Because prospective effects of hypothetical
      interest rate changes are based on a number of assumptions, these computations
      should not be relied upon as indicative of actual results. While the Company
      believes such assumptions to be reasonable, there can be no assurance that
      assumed prepayment rates will approximate actual future mortgage-backed
      securities, collateralized mortgage obligations and loan repayment activity.
      Further, the computations do not reflect any actions that management may
      undertake in response to changes in interest rates. Management periodically
      reviews its rate assumptions based on existing and projected economic
      conditions.





The
      Company’s management generally simulates changes to net interest income using
      three different interest rate scenarios. The first scenario anticipates the
      maximum foreseeable increase in rates over the next twelve months; management
      currently assumes this to be 200 and 300 basis points at December 31, 2006
      and
      2005, respectively. The second scenario anticipates management’s view of the
      most likely change in interest rates over the next twelve months; management’s
      current assumption is a 100 basis point increase in rates. The third scenario
      anticipates the maximum foreseeable decrease in rates over the next twelve
      months; management’s assumption was 200 basis points. The basis point change in
      each of the three scenarios is assumed to occur evenly over both the twelve
      and
      twenty-four months presented. As of December 31, 2006 and December 31, 2005,
      the
      Company’s estimated exposure as a percentage of estimated net interest income
      for the twelve-month and twenty-four-month periods is as follows:





59
 *Table
            of Contents*




**As
                of December 31, 2006:**
            
            **Percent
                Change in Estimated Net Interest Income Over****12
                Months**
            
            **24
                Months**200
                basis point increase in rates
            
            
            (4.88
            )%
            
            (9.69
            )%100
                basis point increase in rates
            
            
            (1.98
            )
            
            (3.67
            )200
                basis point decrease in rates
            
            
            0.50
            
            
            (0.87
            )





**As
                of December 31, 2005:**
            
            **Percent
                Change in Estimated Net Interest Income Over****12
                Months**
            
            **24
                Months**300
                basis point increase in rates
            
            
            (3.36
            )%
            
            (5.56
            )%100
                basis point increase in rates
            
            
            0.44
            
            
            1.54200
                basis point decrease in rates
            
            
            (4.28
            )
            
            (7.55
            )





As
      of
      December 31, 2006, based on the scenarios above, net interest income would
      be
      adversely affected in both the twelve and twenty-four-month periods if interest
      rates rose by 100 and 200 basis points or if interest rates decreased 200 basis
      points over the twenty-four-month period and favorably impacted by a 200 basis
      point decrease in rates over the twelve-month period. Using net interest income
      for the quarter ended December 31, 2006, for each percentage point change in
      net
      interest income, the effect on the Company’s annual net income would be
      $141,000, assuming a 34% income tax rate.





As
      of
      December 31, 2005, based on the scenarios above, net interest income would
      be
      adversely affected in both the twelve and twenty-four-month periods if interest
      rates rose by 300 basis points or if interest rates decreased 200 basis points
      and favorably impacted by a 100 basis point increase in rates. Using net
      interest income for the quarter ended December 31, 2005, for each percentage
      point change in net interest income, the effect on the Company’s annual net
      income would be $148,000 assuming a 34% income tax rate.





For
      both
      the twelve and twenty-four-month periods, the effect on net interest income
      has
      improved, in the event of a sudden and sustained decrease in prevailing market
      interest rates of 200 basis points at December 31, 2006 compared to December
      31,
      2005, as a result of the Company’s strategy to better position the balance sheet
      for an anticipated decline in market interest rates, which included shortening
      the duration of FHLB advances and slightly increasing the duration of earning
      assets. Net interest income declined in the event of a sudden and sustained
      increase in rates of 100 and 200 basis points at December 31, 2006 compared
      to
      December 31, 2005.





**Item
      8. Financial Statements and Supplementary
      Data.**





For
      the
      Company’s consolidated financial statements, see index on page 63.





**Item
      9. Changes in and Disagreements with Accountants on Accounting
      and Financial Disclosure.**





None.





60
 *Table
            of Contents*





**Item
      9A. Controls and Procedures.**





The
      Company’s management, including the Company’s principal executive officer and
      principal financial officer, have evaluated the effectiveness of the Company’s
“disclosure controls and procedures,” as such term is defined in Rule 13a-15(e)
      promulgated under the Securities Exchange Act of 1934, as amended, (the
“Exchange Act”). Based upon their evaluation, the principal executive officer
      and principal financial officer concluded that, as of the end of the period
      covered by this report, the Company’s disclosure controls and procedures were
      effective for the purpose of ensuring that the information required to be
      disclosed in the reports that the Company files or submits under the Exchange
      Act with the Securities and Exchange Commission (1) is recorded, processed,
      summarized and reported within the time periods specified in the SEC’s rules and
      forms and (2) is accumulated and communicated to the Company’s management,
      including its principal executive officer and principal financial officer,
      as
      appropriate to allow timely decisions regarding required disclosure.





**Item
      9B. Other Information.**





None.





**PART
      III.**





**Item
      10. Directors, Executive Officers and Corporate
      Governance.**





***Directors***


For
      information relating to the directors of the Company, the section captioned *“Proposal
      1 - Election of Directors”* in the
      Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders is
      incorporated by reference.





***Executive
      Officers***


For
      information relating to officers of the Company, see Part I, Item 1, *“Business
      — Executive Officers of the Registrant”* to this
      Annual Report on Form 10-K.





***Compliance
      with Section 16(a) of the Exchange Act***


For
      information regarding compliance with Section 16(a) of the Exchange Act, the
      cover page to this Annual Report on Form 10-K and the section captioned *“Section
      16(a) Beneficial Ownership Compliance”* in
      the
      Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders are
      incorporated by reference.





***Disclosure
      of Code of Ethics***


For
      information concerning the Company’s code of ethics, the information contained
      under the section captioned *“Corporate
      Governance - Code of Ethics and Business Conduct”* in the
      Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders is
      incorporated by reference. A copy of the code of ethics and business conduct
      is
      available to stockholders on the Governance Documents portion of the Investors
      Relations section on the Company’s website at *www.mysifi.com* .





***Corporate
      Governance***


For
      information regarding the audit committee and its composition and the audit
      committee financial expert, the section captioned *“Corporate
      Governance - Committees of the Board of Directors - Audit
      Committee”* in the
      Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders is
      incorporated by reference.





61
 *Table
            of Contents*





**Item
      11. Executive Compensation.**





***Executive
      Compensation***


For
      information regarding executive compensation, the sections captioned *“Compensation
      Disclosure and Analysis,” “Executive Compensation”* and *“Director
      Compensation”* in the
      Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders is
      incorporated by reference.





***Corporate
      Governance***


For
      information regarding the compensation committee report, the section captioned *“Compensation
      Committee Report”* in the
      Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders is
      incorporated by reference.





**Item
      12. Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters.**





The
      information relating to the security ownership of certain beneficial owners
      and
      management is incorporated herein by reference to the Company’s Proxy Statement
      for the 2007 Annual Meeting of Stockholders.





The
      following table sets forth information about the Company common stock that
      may
      be issued upon the exercise of stock options, warrants and rights under all
      of
      the Company’s equity compensation plans as of December 31, 2006.





**Plan
                category**
            
            **Number
                of securities****to
                be issued upon exercise of outstanding options,
                warrants**
              **and
                rights**
              **(a)**
            
            **Weighted-average****exercise
                price of****outstanding
                options,**
              **warrants
                and rights**
              **(b)**
            
            **Number
                of securities****remaining
                available for****future
                issuance under****equity
                compensation****plans
                (excluding securities reflected in column a))**
              ******(c)**Equity
                compensation plans approved by security holders
            
            
            467,500
            
            $
            10.13
            
            
            148,123Equity
                compensation plans not approved by security holders
            
            
            -
            
            
            -
            
            
            -**Total**
            
            
            467,500
            
            $
            10.13
            
            
            148,123





**Item
      13.Certain Relationships and Related Transactions and Director
      Independence.**





***Certain
      Relationships and Related Transactions***


For
      information regarding certain relationships and related transactions, the
      section captioned *“Transactions
      with Management”* in the
      Company ’s
      Proxy
      Statement for the 2007 Annual Meeting of Stockholders is incorporated by
      reference.





***Corporate
      Governance***


For
      information regarding director independence, the section captioned *“Proposal
      1 - Election of Directors”* in the
      Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders is
      incorporated by reference.





62
 *Table
            of Contents*





**Item
      14. Principal Accountant Fees and
      Services.**





The
      information relating to the principal accountant fees and expenses, the section
      captioned *“Proposal
      2 - Ratification of Independent Registered Public Accounting Firm - Audit and
      Non-Audit Fees”*  in
      the
      Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders is
      incorporated by reference.





**PART
      IV.**





**Item
      15. Exhibitsand Financial Statement
      Schedules.**





**(1)
      Financial Statements**


The
      following consolidated financial statements of the Company and its subsidiaries
      are filed as part of this report:


TM
            Report
                of Independent Registered Public Accounting Firm (Wolf & Company,
                P.C.)


TM
            Report
                of Independent Registered Public Accounting Firm (McGladrey & Pullen,
                LLP)


TM
            Consolidated
                Balance Sheets as of December 31, 2006 and
                2005


TM
            Consolidated
                Statements of Income for the Years Ended December 31, 2006, 2005
                and
                2004


TM
            Consolidated
                Statements of Changes in Stockholders’ Equity for the Years Ended December
                31, 2006, 2005 and 2004


TM
            Consolidated
                Statements of Cash Flows for the Years Ended December 31, 2006, 2005
                and
                2004


TM
            Notes
                to Consolidated Financial
                Statements





**(2)
      Financial Statement Schedules**


All
      financial statement schedules have been omitted because they are either not
      applicable or the required information is included in the consolidated financial
      statements or notes hereto.





**(3)
      Exhibits**





3.1
            
            Charter
                of SI Financial Group, Inc.(1)3.2
            
            Bylaws
                of SI Financial Group, Inc.4.0
            
            Specimen
                Stock Certificate of SI Financial Group, Inc.(1)10.1
            
            Employment
                Agreement by and among SI Financial Group, Inc. and Savings Institute
                Bank
                and Trust Company and Rheo A. Brouillard(2)10.2
            
            Employment
                Agreement by and among SI Financial Group, Inc. and Savings Institute
                Bank
                and Trust Company and Brian J. Hull(2)10.3
            
            Change
                in Control Agreement by and among SI Financial Group, Inc. and Savings
                Institute Bank and Trust Company and Michael J. Moran(2)10.4
            
            Form
                of Savings Institute Bank and Trust Company Employee Severance
                Compensation Plan(1)10.5
            
            Savings
                Institute Directors Retirement Plan(1)10.6
            
            Form
                of Amended and Restated Savings Institute Bank and Trust Company
                Supplemental Executive Retirement Plan10.7
            
            Savings
                Institute Group Term Replacement Plan(1)





63
 *Table
            of Contents*




10.8
            
            Form
                of Savings Institute Executive Supplemental Retirement Plan - Defined
                Benefit(1)10.9
            
            Form
                of Savings Institute Director Deferred Fee Agreement(1)10.10
            
            Form
                of Savings Institute Director Consultation Plan(1)10.11
            
            Change
                in Control Agreement by and among SI Financial Group, Inc., Savings
                Institute Bank and Trust Company and Sonia M. Dudas(2)10.12
            
            SI
                Financial Group, Inc. 2006 Equity Incentive Plan(3)10.13
            
            Change
                in Control Agreement by and among SI Financial Group, Inc., Savings
                Institute Bank and Trust Company and Laurie L. Gervais21.0
            
            List
                of Subsidiaries23.0
            
            Consent
                of McGladrey & Pullen, LLP23.1
            
            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
                Officer32.0
            
            Certification
                of Chief Executive Officer and Chief Financial Officer pursuant to
                18
                U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002




(1)
            Incorporated
                by reference into this document from the Exhibits filed with the
                Securities and Exchange Commission on the Registration Statement
                on Form
                S-1, and any amendments thereto, Registration No. 333-116381.


(2)
            Incorporated
                by reference into this document from the Exhibits filed with the
                Company’s
                Form 10-Q for the quarter ended September 30, 2004, filed with the
                Securities and Exchange Commission on November 15,
                2004.


(3)
            Incorporated
                by reference into this document from the Appendix to the Proxy Statement
                for the 2005 Annual Meeting of Stockholders filed with the Securities
                and
                Exchange Commission on April 6,
                2005.





64
 *Table
            of Contents*





**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.





SI
      Financial Group, Inc.





By:
            /s/
                Rheo A. Brouillard


Rheo
      A.
      Brouillard


President
      and Chief Executive Officer


March
      28,
      2007





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 in the
      capacities and on the dates indicated.





**Name**
            
            **Title**
            
            **Date**/s/
                Rheo A. Brouillard
            
            President
                and Chief Executive
            
            March
                28, 2007Rheo
                A. Brouillard
            
            Officer
                (principal executive officer)/s/
                Brian J. Hull
            
            Executive
                Vice President, Treasurer
            
            March
                28, 2007Brian
                J. Hull
            
            and
                Chief Financial Officer (principal accounting and financial
                officer)/s/
                Henry P. Hinckley
            
            Chairman
                of the Board
            
            March
                28, 2007Henry
                P. Hinckley/s/
                Robert C. Cushman, Sr.
            
            Director
            
            March
                28, 2007Robert
                C. Cushman, Sr./s/
                Donna M. Evan
            
            Director
            
            March
                28, 2007Donna
                M. Evan/s/
                Roger Engle
            
            Director
            
            March
                28, 2007Roger
                Engle/s/
                Robert O. Gillard
            
            Director
            
            March
                28, 2007Robert
                O. Gillard/s/
                Steven H. Townsend
            
            Director
            
            March
                28, 2007Steven
                H. Townsend/s/
                Mark D. Alliod
            
            Director
            
            March
                28, 2007Mark
                D. Alliod/s/
                Michael R. Garvey
            
            Director
            
            March
                28, 2007Michael
                R. Garvey





65
 *Table
          of Contents*




**SI
                  FINANCIAL GROUP, INC.**
                **I****NDEX
                  TO CONSOLIDATED FINANCIAL
                  STATEMENTS**


PageReport
                of Independent Registered Public Accounting Firm (Wolf
                & Company, P.C.)
            F-1Report
                of Independent Registered Public Accounting Firm
                (McGladrey & Pullen, LLP)
            F-2Consolidated
                Balance Sheets as of December 31, 2006 and
                2005
            F-3Consolidated
                Statements of Income for the Years Ended December
                31, 2006, 2005 and 2004
            F-4Consolidated
                Statements of Changes in Stockholders’ Equity for
                the Years Ended December 31, 2006, 2005 and 2004
            F-5Consolidated
                Statements of Cash Flows for the Years Ended
                December 31, 2006, 2005 and 2004
            F-6Notes
                to Consolidated Financial Statements
            F-8





*Table
            of Contents*






wolf  company, p.c.
              Certified
                  Public Accountants
                and
                  Business Consultants




The
                  Board of Directors and Stockholders ofSI
                  Financial Group, Inc.We
                  have audited the accompanying consolidated balance sheets of SI
                  Financial
                  Group, Inc. and subsidiaries (the “Company”) as of December 31, 2006
                  and 2005, and the related consolidated statements of income, changes
                  in
                  stockholders’ equity and cash flows for the years then
                  ended.  These consolidated financial statements are the
                  responsibility of the Company’s management.  Our responsibility
                  is to express an opinion on these consolidated 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 SI
                  Financial Group, Inc. and subsidiaries as of December 31, 2006 and
                  2005, and the results of their operations and their cash flows
                  for the
                  years then ended in conformity with accounting principles generally
                  accepted in the United States of America.WOLF  COMPANY, P.C.Boston,
                  MassachusettsMarch
                  26, 2007


99
      High Street  ● Boston,
      Massachusets 02110-2320  ● Phone
      617-439-9700  ● 
Fax
      617-542-0400


*1500
      Main Street  ● Suite
      1908  ● 
      Springfield, Massachusets  ● 
      01115   Phone 413-747-9042  ● 
Fax
      413-739-5149*


*www.wolfandco.com*




F
            -
            1
 *Table
            of Contents*









**REPORT
      OF INDEPENDENT REGISTERED**


**PUBLIC
      ACCOUNTING FIRM**











To
      the
      Board of Directors


SI
      Financial Group, Inc. and Subsidiary


Willimantic,
      Connecticut








We
      have
      audited the accompanying consolidated statements of income, changes in
      stockholders’ equity and cash flows of SI Financial Group, Inc. and Subsidiary
      (the “Company”) for
      the
      year ended December 31, 2004. These consolidated financial statements are the
      responsibility of the Company's management. Our responsibility is to express
      an
      opinion on these financial statements based on our audit.





We
      conducted our audit 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 audit provides a
      reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the results of operations and cash flows of SI
      Financial Group, Inc. and Subsidiary for the year ended December 31, 2004,
      in conformity with U.S. generally accepted accounting principles.




/
      s/
      McGladrey & Pullen, LLP




New
      Haven, Connecticut


February
      18, 2005





F
            -
            2
 *Table
            of Contents*




**SI
                FINANCIALGROUP, INC. AND
                SUBSIDIARIES**
              **CONSOLIDATED
                BALANCE SHEETS**
              *(Dollars
                in Thousands, Except Share
                Amounts)*




**December
                    31,****2006**
                
                
                **2005****ASSETS:**Cash
                    and due from banks:Noninterest-bearing
                
                $
                14,984
                
                
                $
                16,317Interest-bearing
                
                
                3,824
                
                
                
                6,829Federal
                    funds sold
                
                
                7,300
                
                
                
                2,800Total
                    cash and cash equivalents
                
                
                26,108
                
                
                
                25,946Available
                    for sale securities, at fair value
                
                
                119,508
                
                
                
                120,019Loans
                    held for sale
                
                
                135
                
                
                
                107Loans
                    receivable (net of allowance for loan losses of $4,365 at December
                    31,
                    2006 and $3,671 at December 31, 2005)
                
                
                574,111
                
                
                
                513,775Accrued
                    interest receivable
                
                
                3,824
                
                
                
                3,299Federal
                    Home Loan Bank stock, at cost
                
                
                6,660
                
                
                
                5,638Cash
                    surrender value of bank-owned life insurance
                
                
                8,116
                
                
                
                7,837Other
                    real estate owned
                
                
                -
                
                
                
                325Premises
                    and equipment, net
                
                
                10,512
                
                
                
                8,838Goodwill
                    and other intangibles
                
                
                741
                
                
                
                817Deferred
                    tax asset, net
                
                
                3,361
                
                
                
                2,804Other
                    assets
                
                
                3,961
                
                
                
                2,463**Total
                    assets**
                
                $
                757,037
                
                
                $
                691,868**LIABILITIES
                    AND STOCKHOLDERS’ EQUITY:****Liabilities:**Deposits:Noninterest-bearing
                
                $
                55,703
                
                
                $
                51,996Interest-bearing
                
                
                482,973
                
                
                
                457,301Total
                    deposits
                
                
                538,676
                
                
                
                509,297Mortgagors’
                    and investors’ escrow accounts
                
                
                3,246
                
                
                
                2,985Federal
                    Home Loan Bank advances
                
                
                111,956
                
                
                
                87,929Junior
                    subordinated debt owed to unconsolidated trusts
                
                
                15,465
                
                
                
                7,217Accrued
                    expenses and other liabilities
                
                
                5,308
                
                
                
                4,397**Total
                    liabilities**
                
                
                674,651
                
                
                
                611,825Commitments
                    and contingencies (notes 6, 11 and 12)**Stockholders’
                    Equity:**Preferred
                    stock ($.01 par value; 1,000,000 shares authorized; none
                    issued)
                
                
                -
                
                
                
                -Common
                    stock ($.01 par value; 75,000,000 shares authorized; 12,563,750
                    shares
                    issued; 12,421,920 shares outstanding at December 31, 2006 and
                    12,551,186
                    shares outstanding at December 31, 2005)
                
                
                126
                
                
                
                126Additional
                    paid-in capital
                
                
                51,481
                
                
                
                51,155Unallocated
                    common shares held by ESOP
                
                
                (4,199
                )
                
                
                (4,521
                )Unearned
                    restricted shares
                
                
                (1,679
                )
                
                
                (2,176
                )Retained
                    earnings
                
                
                39,254
                
                
                
                37,216Accumulated
                    other comprehensive loss
                
                
                (1,011
                )
                
                
                (1,609
                )Treasury
                    stock, at cost (141,830 shares at December 31, 2006 and 12,564
                    shares at
                    December 31, 2005)
                
                
                (1,586
                )
                
                
                (148
                )**Total
                    stockholders’ equity**
                
                
                82,386
                
                
                
                80,043**Total
                    liabilities and stockholders’ equity**
                
                $
                757,037
                
                
                $
                691,868





*See
      accompanying notes to consolidated financial statements.*





F
            -
            3
 *Table
            of Contents*


**SI
                      FINANCIALGROUP, INC. AND
                      SUBSIDIARIES**
                    **CONSOLIDATED
                      STATEMENTS OF INCOME**
                    *(Dollars
                      in Thousands, Except Share
                      Amounts)*


**Years
                Ended December 31,****2006**
            
            **2005**
            
            **2004****Interest
                and dividend income:**Loans,
                including fees
            
            $
            34,857
            
            $
            28,586
            
            $
            24,545Securities:Taxable
                interest
            
            
            5,260
            
            
            4,744
            
            
            3,658Tax-exempt
                interest
            
            
            24
            
            
            21
            
            
            24Dividends
            
            
            410
            
            
            246
            
            
            136Other
            
            
            226
            
            
            308
            
            
            240**Total
                interest and dividend income**
            
            
            40,777
            
            
            33,905
            
            
            28,603**Interest
                expense:**Deposits
            
            
            13,127
            
            
            8,528
            
            
            6,346Federal
                Home Loan Bank advances
            
            
            4,352
            
            
            3,108
            
            
            2,683Subordinated
                debt
            
            
            782
            
            
            495
            
            
            371**Total
                interest expense**
            
            
            18,261
            
            
            12,131
            
            
            9,400**Net
                interest income**
            
            
            22,516
            
            
            21,774
            
            
            19,203**Provision
                for loan losses**
            
            
            881
            
            
            410
            
            
            550**Net
                interest income after provision for loan losses**
            
            
            21,635
            
            
            21,364
            
            
            18,653**Noninterest
                income:**Service
                fees
            
            
            4,637
            
            
            4,262
            
            
            2,941Wealth
                management fees
            
            
            3,420
            
            
            1,301
            
            
            942Increase
                in cash surrender value of bank-owned life insurance
            
            
            279
            
            
            276
            
            
            303Net
                (loss) gain on sale of securities
            
            
            (284
            )
            
            59
            
            
            (166
            )Net
                gain on sale of loans
            
            
            104
            
            
            190
            
            
            55Other
            
            
            102
            
            
            222
            
            
            110**Total
                noninterest income**
            
            
            8,258
            
            
            6,310
            
            
            4,185**Noninterest
                expenses:**Salaries
                and employee benefits
            
            
            14,277
            
            
            12,102
            
            
            9,835Occupancy
                and equipment
            
            
            4,825
            
            
            3,830
            
            
            3,465Computer
                and electronic banking services
            
            
            2,458
            
            
            1,823
            
            
            1,678Outside
                professional services
            
            
            967
            
            
            1,087
            
            
            815Marketing
                and advertising
            
            
            783
            
            
            794
            
            
            513Supplies
            
            
            527
            
            
            449
            
            
            293Contribution
                to SI Financial Group Foundation
            
            
            -
            
            
            -
            
            
            2,513Other
            
            
            2,122
            
            
            2,503
            
            
            1,919**Total
                noninterest expenses**
            
            
            25,959
            
            
            22,588
            
            
            21,031**Income
                before income taxes**
            
            
            3,934
            
            
            5,086
            
            
            1,807**Income
                tax provision**
            
            
            1,156
            
            
            1,689
            
            
            519**Net
                income**
            
            $
            2,778
            
            $
            3,397
            
            $
            1,288**Net
                income per common share:**Basic
            
            $
            0.24
            
            $
            0.28
            
            
            N/ADiluted
            
            $
            0.23
            
            $
            0.28
            
            
            N/A





*See
      accompanying notes to consolidated financial statements.*





F
            -
            4
 *Table
            of Contents*




**SI
                FINANCIALGROUP, INC. AND
                SUBSIDIARIES**
              **CONSOLIDATED
                STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**
              **YEARS
                ENDED DECEMBER 31, 2006, 2005 AND 2004**
              *(Dollars
                in Thousands, Except Share
                Amounts)*




**Common
                Stock**
            
            **Additional**
              **Paid-in**
            
            **Unallocated
                Common Shares**
              **Held
                by**
            
            **Unearned**
              **Restricted**
            
            **Retained**
            
            **Accumulated
                Other Comprehensive**
            
            **Treasury**
            
            **Total**
              **Stockholders’****Shares**
            
            **Dollars**
            
            **Capital**
            
            **ESOP**
            
            **Shares**
            
            **Earnings**
            
            **Income
                (Loss)**
            
            **Stock**
            
            **Equity****BALANCE
                AT DECEMBER 31, 2003**
            
            
            **-**
            
            **$**
            **-**
            
            **$**
            **-**
            
            **$**
            **-**
            
            **$**
            **-**
            
            **$**
            **33,582**
            
            **$**
            **517**
            
            **$**
            **-**
            
            **$**
            **34,099**Issuance
                of common stock for initial public offering, net of expenses of $1.8
                million
            
            
            5,025,500
            
            
            50
            
            
            48,430
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            48,480Issuance
                of common stock to SI Bancorp, MHC
            
            
            7,286,975
            
            
            73
            
            
            (73
            )
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Issuance
                of common stock to SI Financial Group Foundation including additional
                tax
                benefit of $68 due to higher basis for tax purposes
            
            
            251,275
            
            
            3
            
            
            2,578
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,581Shares
                purchased for ESOP
            
            
            -
            
            
            -
            
            
            -
            
            
            (4,925
            )
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (4,925
            )Allocation
                of ESOP shares
            
            
            -
            
            
            -
            
            
            12
            
            
            81
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            93Comprehensive
                income:Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,288
            
            
            -
            
            
            -
            
            
            1,288Net
                unrealized loss on available for sale securities, net of reclassification
                adjustment and tax effects
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (807
            )
            
            -
            
            
            (807
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            481**BALANCE
                AT DECEMBER 31, 2004**
            
            
            **12,563,750**
            
            
            **126**
            
            
            **50,947**
            
            
            **(4,844**
            **)**
            
            **-**
            
            
            **34,870**
            
            
            **(290**
            **)**
            
            **-**
            
            
            **80,809**Cash
                dividends declared ($0.12 per share)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (590
            )
            
            -
            
            
            -
            
            
            (590
            )Restricted
                share grants and purchases
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (2,487
            )
            
            (461
            )
            
            -
            
            
            -
            
            
            (2,948
            )Equity
                incentive plan shares earned
            
            
            -
            
            
            -
            
            
            165
            
            
            -
            
            
            311
            
            
            -
            
            
            -
            
            
            -
            
            
            476Allocation
                of ESOP shares
            
            
            -
            
            
            -
            
            
            43
            
            
            323
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            366Treasury
                stock purchased (12,564 shares)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (148
            )
            
            (148
            )Comprehensive
                income:Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            3,397
            
            
            -
            
            
            -
            
            
            3,397Net
                unrealized loss on available for sale securities, net of reclassification
                adjustment and tax effects
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (1,319
            )
            
            -
            
            
            (1,319
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,078**BALANCE
                AT DECEMBER 31, 2005**
            
            
            **12,563,750**
            
            
            **126**
            
            
            **51,155**
            
            
            **(4,521**
            **)**
            
            **(2,176**
            **)**
            
            **37,216**
            
            
            **(1,609**
            **)**
            
            **(148**
            **)**
            
            **80,043**Cash
                dividends declared ($0.16 per share)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (740
            )
            
            -
            
            
            -
            
            
            (740
            )Equity
                incentive plan shares earned
            
            
            -
            
            
            -
            
            
            268
            
            
            -
            
            
            497
            
            
            -
            
            
            -
            
            
            -
            
            
            765Allocation
                of ESOP shares
            
            
            -
            
            
            -
            
            
            45
            
            
            322
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            367Excess
                tax benefit from share-based stock compensation
            
            
            -
            
            
            -
            
            
            13
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            13Treasury
                stock purchased (129,266 shares)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (1,438
            )
            
            (1,438
            )Comprehensive
                income:Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,778
            
            
            -
            
            
            -
            
            
            2,778Net
                unrealized gain on available for sale securities, net of reclassification
                adjustment and tax effects
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            598
            
            
            -
            
            
            598Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,376**BALANCE
                AT DECEMBER 31, 2006**
            
            
            **12,563,750**
            
            **$**
            **126**
            
            **$**
            **51,481**
            
            **$**
            **(4,199**
            **)**
            **$**
            **(1,679**
            **)**
            **$**
            **39,254**
            
            **$**
            **(1,011**
            **)**
            **$**
            **(1,586**
            **)**
            **$**
            **82,386**





*See
      accompanying notes to consolidated financial statements.*





F
            -
            5
 *Table
            of Contents*




**SI
                FINANCIALGROUP, INC. AND
                SUBSIDIARIES**
              **CONSOLIDATED
                STATEMENTS OF CASH FLOWS**
              *(Dollars
                in Thousands)*





**Years
                Ended December 31,****2006**
            
            **2005**
            
            **2004****Cash
                flows from operating activities:**Net
                income
            
            $
            2,778
            
            $
            3,397
            
            $
            1,288Adjustments
                to reconcile net income to net cash provided by operating
                activities:Provision
                for loan losses
            
            
            881
            
            
            410
            
            
            550Contribution
                of common stock to SI Financial Group Foundation
            
            
            -
            
            
            -
            
            
            2,513Employee
                stock ownership plan expense
            
            
            367
            
            
            366
            
            
            93Equity
                incentive plan expense
            
            
            765
            
            
            476
            
            
            -Excess
                tax benefit from share-based payment arrangements
            
            
            (13
            )
            
            -
            
            
            -Amortization
                (accretion) of investment premiums and discounts, net
            
            
            (126
            )
            
            53
            
            
            111Amortization
                of loan premiums and discounts, net
            
            
            972
            
            
            246
            
            
            285Depreciation
                and amortization of premises and equipment
            
            
            1,795
            
            
            1,359
            
            
            1,074Amortization
                of core deposit intangible
            
            
            97
            
            
            97
            
            
            97Amortization
                of deferred debt issuance costs
            
            
            79
            
            
            35
            
            
            35Amortization
                of mortgage servicing rights
            
            
            78
            
            
            64
            
            
            24Net
                loss (gain) on sales of securities
            
            
            284
            
            
            (59
            )
            
            166Deferred
                income tax benefit
            
            
            (865
            )
            
            (80
            )
            
            (959
            )Loans
                originated for sale
            
            
            (10,963
            )
            
            (7,760
            )
            
            (15,694
            )Proceeds
                from sale of loans held for sale
            
            
            11,039
            
            
            7,874
            
            
            15,549Net
                gain on sale of loans
            
            
            (104
            )
            
            (190
            )
            
            (55
            )Net
                loss (gain) on the sale of premises and equipment
            
            
            20
            
            
            (40
            )
            
            -Net
                loss on sale of other real estate owned
            
            
            11
            
            
            -
            
            
            -Write-down
                of other real estate owned
            
            
            -
            
            
            25
            
            
            60Increase
                in cash surrender value of bank-owned life insurance
            
            
            (279
            )
            
            (276
            )
            
            (303
            )Impairment
                charge - long-lived assets
            
            
            -
            
            
            -
            
            
            337Impairment
                charge - other assets
            
            
            -
            
            
            -
            
            
            51Change
                in operating assets and liabilities:Accrued
                interest receivable
            
            
            (525
            )
            
            (661
            )
            
            (400
            )Other
                assets
            
            
            (1,571
            )
            
            (820
            )
            
            36Accrued
                expenses and other liabilities
            
            
            877
            
            
            723
            
            
            1,123**Net
                cash provided by operating activities**
            
            
            5,597
            
            
            5,239
            
            
            5,981**Cash
                flows from investing activities:**Purchases
                of available for sale securities
            
            
            (31,713
            )
            
            (26,964
            )
            
            (90,693
            )Proceeds
                from sale of available for sale securities
            
            
            12,284
            
            
            159
            
            
            22,845Proceeds
                from maturities of and principal repayments on available for sale
                securities
            
            
            20,688
            
            
            25,350
            
            
            23,836Proceeds
                from sale of held to maturity securities
            
            
            -
            
            
            -
            
            
            1,253Proceeds
                from maturities of and principal repayments on held to maturity
                securities
            
            
            -
            
            
            -
            
            
            123Net
                increase in loans
            
            
            (62,189
            )
            
            (94,315
            )
            
            (61,868
            )Purchases
                of Federal Home Loan Bank stock
            
            
            (1,022
            )
            
            (1,325
            )
            
            (1,455
            )Purchase
                of trust subsidiary
            
            
            (21
            )
            
            (680
            )
            
            -Proceeds
                from sale of portfolio loans
            
            
            -
            
            
            27,660
            
            
            -Proceeds
                from sale of premises and equipment
            
            
            244
            
            
            571
            
            
            -Proceeds
                from sale of other real estate owned
            
            
            314
            
            
            -
            
            
            268Purchases
                of premises and equipment
            
            
            (3,733
            )
            
            (4,053
            )
            
            (1,322
            )**Net
                cash used in investing activities**
            
            
            (65,148
            )
            
            (73,597
            )
            
            (107,013
            )





F
            -
            6
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **CONSOLIDATED
                STATEMENTS OF CASH FLOWS - Concluded**
              *(Dollars
                in Thousands)*


**Years
                Ended December 31,****2006**
            
            **2005**
            
            **2004****Cash
                flows from financing activities:**Net
                increase in deposits
            
            
            29,379
            
            
            51,539
            
            
            42,668Net
                increase in mortgagors’ and investors’ escrow accounts
            
            
            261
            
            
            263
            
            
            501Proceeds
                from Federal Home Loan Bank advances
            
            
            195,513
            
            
            42,827
            
            
            36,370Repayments
                of Federal Home Loan Bank advances
            
            
            (171,486
            )
            
            (27,572
            )
            
            (20,864
            )Proceeds
                from subordinated debt borrowings
            
            
            8,248
            
            
            -
            
            
            -Net
                proceeds from common stock offering
            
            
            -
            
            
            -
            
            
            48,480Cash
                dividends paid on common stock
            
            
            (777
            )
            
            (432
            )
            
            -Purchase
                of common stock for equity incentive plan
            
            
            -
            
            
            (2,948
            )
            
            -Excess
                tax benefit from share-based payment arrangements
            
            
            13
            
            
            -
            
            
            -Treasury
                stock purchased
            
            
            (1,438
            )
            
            (148
            )
            
            -Acquisition
                of common stock by ESOP
            
            
            -
            
            
            -
            
            
            (4,925
            )**Net
                cash provided by financing activities**
            
            
            59,713
            
            
            63,529
            
            
            102,230**Net
                change in cash and cash equivalents**
            
            
            162
            
            
            (4,829
            )
            
            1,198**Cash
                and cash equivalents at beginning of year**
            
            
            25,946
            
            
            30,775
            
            
            29,577**Cash
                and cash equivalents at end of year**
            
            $
            26,108
            
            $
            25,946
            
            $
            30,775**SUPPLEMENTAL
                CASH FLOW INFORMATION:***Interest
                and Income Taxes Paid:*Interest
                paid on deposits and borrowed funds
            
            $
            17,998
            
            $
            12,016
            
            $
            9,367Income
                taxes paid, net
            
            
            1,727
            
            
            1,752
            
            
            1,296*Noncash
                Activities:*Unrealized
                gains (losses) on securities arising during the year
            
            
            906
            
            
            (1,999
            )
            
            (1,224
            )Transfer
                of loans to other real estate owned
            
            
            -
            
            
            350
            
            
            -Declared
                dividends
            
            
            740
            
            
            590
            
            
            -*Asset
                Purchase:*In
                conjunction with the asset purchase of SI Trust Servicing in November
                2005, the following net assets were acquired for a purchase price
                of
                $701,000:*Assets:*Fixed
                assets
            
            $
            -
            
            $
            89
            
            $
            -Goodwill
            
            
            21
            
            
            622
            
            
            -Other
                assets
            
            
            -
            
            
            16
            
            
            -**Total
                assets acquired**
            
            
            21
            
            
            727
            
            
            -*Liabilities:*Accrued
                expenses
            
            
            -
            
            
            2
            
            
            -Transaction
                costs
            
            
            -
            
            
            45
            
            
            -**Total
                liabilities assumed**
            
            
            -
            
            
            47
            
            
            -**Net
                assets acquired**
            
            $
            21
            
            $
            680
            
            $
            -





*See
      accompanying notes to consolidated financial statements.*





F
            -
            7
 *Table
            of Contents*




**SI
                FINANCIALGROUP, INC. AND
                SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




**NOTE
      1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
      POLICIES**





***Nature
      of Business***


SI
      Financial Group, Inc. (the “Company”) is the holding company for Savings
      Institute Bank and Trust Company (the “Bank”). Established in 1842, the Bank is
      a community-oriented financial institution headquartered in Willimantic,
      Connecticut. The Bank provides a variety of financial services to individuals,
      businesses and municipalities through its nineteen offices in eastern
      Connecticut. The primary products include savings, checking and certificate
      of
      deposit accounts, residential and commercial mortgage loans, commercial business
      loans and consumer loans. In addition, wealth management services, which include
      trust, financial planning, life insurance and investment services, are offered
      to individuals and businesses through the Bank’s Connecticut offices. The
      Company does not conduct any business other than owning all of the stock of
      the
      Bank and managing the proceeds it received from the stock offering in 2004.





On
      November 15, 2005, the Company acquired certain assets of two trust service
      businesses, Private Trust Services and Bank Trust Services (“SI Trust
      Servicing”), from the former Circle Trust Company headquartered in Darien,
      Connecticut. SI Trust Servicing, located in Rutland, Vermont, is a third-party
      provider of trust outsourcing services for other financial institutions. The
      acquisition was accounted for as an asset purchase transaction with total cash
      consideration funded through internal sources. The purchase price was allocated
      to the net assets acquired with the excess purchase price resulting in goodwill.





***Principles
      of Consolidation***


The
      accompanying consolidated financial statements include the accounts of the
      Company and its wholly-owned subsidiary, the Bank, and the Bank’s wholly-owned
      subsidiaries, 803 Financial Corp., SI Mortgage Company and SI Realty Company,
      Inc. All significant intercompany accounts and transactions have been
      eliminated.





***Basis
      of Financial Statement Presentation***


The
      consolidated financial statements have been prepared in accordance with
      accounting principles generally accepted in the United States of America and
      general practices within the banking industry. In preparing the consolidated
      financial statements, management is required to make estimates and assumptions
      that affect the reported amounts of assets and liabilities, and disclosures
      of
      contingent assets and liabilities, as of the date of the balance sheet and
      reported amounts of revenues and expenses for the years presented. Actual
      results could differ from those estimates. Material estimates that are
      particularly susceptible to significant change in the near term relate to the
      determination of the allowance for loan losses, impairment of long-lived assets
      and the valuation of deferred tax assets.





***Reclassifications***


Certain
      amounts in the Company’s 2005 and 2004 consolidated financial statements have
      been reclassified to conform to the 2006 presentation. Such reclassifications
      had no effect on net income.





***Significant
      Group Concentrations of Credit Risk***


Most
      of
      the Company’s activities are with customers located within eastern Connecticut.
      The Company does not have any significant concentrations in any one industry
      or
      customer. Refer to Notes 3 and 4, respectively, in the Notes to the Consolidated
      Financial Statements for details of the Company’s securities and types of
      lending activities.





F
            -
            8
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





***Cash
      and Cash Equivalents and Statements of Cash Flows***


Cash
      and
      due from banks, Federal funds sold and short-term investments with original
      maturities of less than 90 days are recognized as cash equivalents in the
      statements of cash flows. Federal funds sold generally mature in one day. For
      purposes of reporting cash flows, the Company considers all highly liquid debt
      instruments purchased with a maturity of three months or less to be cash
      equivalents. Cash flows from loans and deposits are reported net. The Company
      maintains amounts due from banks and Federal funds sold that, at times, may
      exceed federally insured limits. The Company has not experienced any losses
      from
      such concentrations.





***Investment
      in Debt and Marketable Equity Securities***


Management
      determines the appropriate classification of securities at the date individual
      securities are acquired, and the appropriateness of such classification is
      reassessed at each balance sheet date.





Debt
      securities that management has the positive intent and ability to hold to
      maturity are classified as “held to maturity” and recorded at amortized cost.
      Securities purchased and held principally for the purpose of trading in the
      near
      term are classified as “trading securities.” These securities are carried at
      fair value, with unrealized gains and losses recognized in earnings. Securities
      not classified as held to maturity or trading, including equity securities
      with
      readily determinable fair values, are classified as “available for sale” and
      recorded at fair value, with unrealized gains and losses excluded from earnings
      and reported in other comprehensive income (loss), net of taxes.





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





The
      sale
      of a held to maturity security within three months of its maturity date or
      after
      collection of at least 85% of the principal outstanding at the time the security
      was acquired is considered a maturity for purposes of classification and
      disclosure.





Transfers
      of debt securities into the held to maturity classification from the available
      for sale classification are made at fair value on the date of transfer. The
      unrealized holding gain or loss on the date of transfer is retained in
      accumulated other comprehensive income (loss) and in the carrying value of
      the
      held to maturity securities. Such amounts are amortized over the remaining
      contractual lives of the securities by the interest method.





Federal
      Home Loan Bank (“FHLB”) stock is recorded at cost.





F
            -
            9
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





***Loans
      Held for Sale***


Loans
      originated and intended for sale in the secondary market are carried at the
      lower of amortized cost or fair value, as determined by aggregate outstanding
      commitments from investors or current investor yield requirements. Net
      unrealized losses, if any, are recognized through a valuation allowance by
      charges to noninterest income.





Mortgage
      loans held for sale are generally sold with the mortgage servicing rights
      retained by the Company. The carrying value of mortgage loans sold is reduced
      by
      the value allocated to the associated mortgage servicing rights. Gains or losses
      on sales of mortgage loans are recognized based on the difference between the
      selling price and the carrying value of the related mortgage loans sold on
      the
      trade date.





***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 no condition
      both constrains the transferee from taking advantage of that right and provides
      more than a trivial benefit for the transferor and (3) the transferor does
      not
      maintain effective control over the transferred assets through either (a) an
      agreement that both entitles and obligates the transferor to repurchase or
      redeem the assets before maturity or (b) the ability to unilaterally cause
      the
      holder to return specific assets, other than through a cleanup
      call.





***Servicing***


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





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





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





F
            -
            10
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





***Loans
      Receivable***


Loans
      receivable are stated at current unpaid principal balances, net of the allowance
      for loan losses and deferred loan origination fees and costs. Management has
      the
      ability and intent to hold its loans receivable for the foreseeable future
      or
      until maturity or pay-off.





A
      loan is
      impaired when it is probable the Company will be unable to collect all
      contractual principal and interest payments due in accordance with the terms
      of
      the loan agreement. Impairment is measured on a loan by loan basis for
      residential and commercial mortgage loans and commercial business loans by
      either the present value of expected future cash flows discounted at the loan's
      effective interest rate or, as a practical expedient, at the loan's observable
      market price or the fair value of the collateral if the loan is collateral
      dependent. Large groups of smaller balance homogeneous loans are collectively
      evaluated for impairment. Accordingly, the Company does not separately identify
      individual consumer loans for impairment disclosures.





A
      loan is
      classified as a restructured loan when certain concessions have been made to
      the
      original contractual terms, such as reductions of interest rates or deferral
      of
      interest or principal payments, due to the borrowers' financial
      condition.





Management
      considers all nonaccrual loans and restructured loans to be impaired. In most
      cases, loan payments less than 90 days past due, are considered minor collection
      delays, and the related loans are generally not considered
      impaired.





***Allowance
      for Loan Losses***


The
      allowance for loan losses, a material estimate which could change significantly
      in the near-term, is established through a provision for loan losses charged
      to
      earnings to account for losses that are inherent in the loan portfolio and
      estimated to occur, and is maintained at a level that management considers
      adequate to absorb losses in the loan portfolio. Loans are charged against
      the
      allowance for loan losses when management believes that the uncollectibility
      of
      principal is confirmed. Subsequent recoveries, if any, are credited to the
      allowance for loan losses when received. In the determination of the allowance
      for loan losses, management may obtain independent appraisals for significant
      properties, if necessary.





Management's
      judgment in determining the adequacy of the allowance is inherently subjective
      as it requires estimates that are susceptible to significant revision as more
      information becomes available. The allowance for loan losses is evaluated on
      a
      monthly basis by management and is based on the evaluation of the known and
      inherent risk characteristics and size and composition of the loan portfolio,
      the assessment of current economic and real estate market conditions, adverse
      situations that may affect the borrower’s ability to repay, estimated value of
      any underlying collateral, historical loan loss experience and evaluations
      of
      loans and other relevant factors.





The
      allowance for loan losses consists of the following key elements:


—
            ***Specific
                allowance*******for
                identified impaired loans. For such loans that are classified as
                impaired,
                an allowance is established when the discounted cash flows (or collateral
                value or observable market price) of the impaired loan is lower than
                the
                carrying value of that loan.


—
            ***General
                valuation allowance***on
                certain identified problem loans which include loans on the Managed
                Asset
                Report that do not have an individual allowance. The Bank segregates
                these
                loans by loan category and assigns allowance percentages to each
                category
                based on inherent losses associated with each type of lending and
                consideration that these loans, in the aggregate, represent an
                above-average credit risk and that more of these loans will prove
                to be
                uncollectible compared to loans in the general
                portfolio.





F
            -
            11
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





—
            ***General
                valuation allowance***on
                the remainder of the loan portfolio covers non-classified loans and
                is
                based on historical loss experience adjusted for qualitative factors.


—
            ***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 specific and general losses in the
                portfolio.





The
      majority of the Company's loans are collateralized by real estate located in
      eastern Connecticut. Accordingly, the collateral value of a substantial portion
      of the Company's loan portfolio and real estate acquired through foreclosure
      is
      susceptible to changes in market conditions.





Management
      believes that the allowance for loan losses is adequate. While management uses
      available information to recognize losses on loans, future additions to the
      allowance or write-downs may be necessary based on changes in economic
      conditions, particularly in eastern Connecticut. In addition, the Office of
      Thrift Supervision, as an integral part of its examination process, periodically
      reviews the Company's allowance for loan losses. Such agency has the authority
      to require the Company to recognize additions to the allowance or write-downs
      based on the agency’s judgments about information available to it at the time of
      its examination.





***Derivative
      Financial Instruments***


***Derivative
      Loan Commitments.*** **** Mortgage
      loan commitments are referred to as derivative loan commitments if the loan
      that
      will result from exercise of the commitment will be held for sale upon funding.
      Loan commitments that are derivatives are recognized at fair value on the
      consolidated balance sheet in other assets and other liabilities with changes
      in
      their fair values recorded in other noninterest income, if
      material.





The
      Company records a zero value for the loan commitment at inception (at the time
      the commitment is issued to a borrower (“the time of rate lock”)) and does not
      recognize the value of the expected normal servicing rights until the underlying
      loan is sold. Subsequent to inception, changes in the fair value of the loan
      commitment are recognized based on changes in the fair value of the underlying
      mortgage loan due to interest rate changes, changes in the probability the
      derivative loan commitment will be exercised and the passage of time. In
      estimating fair value, the Company assigns a probability to a loan commitment
      based on an expectation that it will be exercised and the loan will be
      funded.





***Forward
      Loan Sale Commitments.*** To
      protect against the price risk inherent in derivative loan commitments, the
      Company utilizes both “mandatory delivery” and “best efforts” forward loan sale
      commitments to mitigate the risk of potential decreases in the values of loans
      that would result from the exercise of the derivative loan commitments.
      Mandatory delivery contracts are accounted for as derivative instruments.
      Generally, the Company’s best efforts contracts meet the definition of
      derivative instruments when the loans to the underlying borrowers close, and
      are
      accounted for as derivative instruments at that time. Accordingly, forward
      loan
      sale commitments are recognized at fair value on the consolidated balance sheet
      in other assets and other liabilities with changes in their fair value recorded
      in other noninterest income, if material.





The
      Company estimates the fair value of its forward loan sales commitments using
      methodology similar to that used for derivative loan commitments.





F
            -
            12
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





***Interest
      and Fees on Loans***


Interest
      on loans is accrued and included in operating income based on contractual rates
      applied to principal amounts outstanding. Accrual of interest is discontinued
      when loan payments are 90 days or more past due, based on contractual terms,
      or
      when, in the judgment of management, collectibility of the loan or loan interest
      becomes uncertain. Subsequent recognition of income occurs only to the extent
      payment is received subject to management's assessment of the collectibility
      of
      the remaining interest and principal. A nonaccrual loan is restored to accrual
      status when it is no longer delinquent and collectibility of interest and
      principal is no longer in doubt. Interest collected on nonaccrual loans and
      impaired loans is recognized only to the extent cash payments are received,
      and
      may be recorded as a reduction to principal if the collectibility of the
      principal balance of the loan is unlikely.





Loan
      origination fees and direct loan origination costs are deferred, and the net
      amount is recognized as an adjustment of the related loan's yield utilizing
      the
      interest method over the contractual life of the loan.





***Other
      Real Estate Owned***


Other
      real estate owned consists of properties acquired through, or in lieu of, loan
      foreclosure or other proceedings and is initially recorded at the lower of
      the
      related loan balances less any specific allowance for loss or fair value at
      the
      date of foreclosure, which establishes a new cost basis. Subsequent to
      foreclosure, the properties are held for sale and are carried at the lower
      of
      cost or fair value less estimated costs of disposal. Any write-down to fair
      value at the time of acquisition is charged to the allowance for loan losses.
      Properties are evaluated regularly to ensure the recorded amounts are supported
      by current fair values, and a charge to operations is recorded as necessary
      to
      reduce the carrying amount to fair value less estimated costs to dispose.
      Revenue and expense from the operation of other real estate owned and the
      provision to establish and adjust valuation allowances are included in
      operations. Costs relating to the development and improvement of the property
      are capitalized, subject to the limit of fair value of the collateral. Gains
      or
      losses are included in operations upon disposal.





***Income
      Taxes***


The
      Company recognizes income taxes under the asset and liability method. 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. Deferred tax assets and liabilities are measured using enacted tax rates
      expected to apply to taxable income in the years in which those temporary
      differences are expected to be realized or settled. The effect on deferred
      tax
      assets and liabilities of a change in tax rates is recognized in income in
      the
      period that includes the enactment date. Deferred tax assets are reduced by
      a
      valuation allowance when, in the opinion of management, it is more likely than
      not that all or some portion of the deferred tax assets will not be
      realized.





The
      Company had transactions in which the related tax effect was recorded directly
      to stockholders’ equity instead of operations. Transactions in which the tax
      effect was recorded directly to stockholders’ equity included the tax effects of
      unrealized gains and losses on available for sale securities, the tax benefit
      for the difference between the book and tax basis of the contribution to SI
      Financial Group Foundation and the excess tax benefit from share-based payment
      arrangements. At December 31, 2006, the Company had a net deferred tax asset
      of
      $521,000 for unrealized losses on available for sale securities and a deferred
      tax asset of $68,000 related to the difference between the book and tax basis
      of
      the SI Financial Group Foundation contribution.





F
            -
            13
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





***Premises
      and Equipment***


Land
      is
      carried at cost. Premises and equipment are stated at cost, net of accumulated
      depreciation and amortization. Depreciation is charged to operations using
      the
      straight-line method over the estimated useful lives of the related assets.
      Leasehold improvements are amortized over the shorter of the estimated economic
      lives of the improvements or the expected lease terms. Expected terms include
      lease option periods to the extent that the exercise of such options is
      reasonably assured. The estimated useful lives of the assets are as
      follows:





**Classification**
            
            **Estimated
                Useful Lives**Buildings
            
            
            5
                to 40 yearsFurniture
                and equipment
            
            
            3
                to 10 yearsLeasehold
                improvements
            
            
            3
                to 20 years





Gains
      and
      losses on dispositions are recognized upon realization. Maintenance and repairs
      are expensed as incurred and improvements are capitalized.





***Impairment
      of Long-lived Assets***


Long-lived
      assets, including premises and equipment and certain identifiable intangible
      assets that are held and used by the Company, are reviewed for impairment
      whenever events or changes in circumstances indicate that the carrying amount
      of
      an asset may not be recoverable. If impairment is indicated by that review,
      the
      asset is written down to its estimated fair value through a charge to
      noninterest expense.





***Goodwill
      and Other Intangibles***


Goodwill
      and other intangibles are evaluated for impairment on an annual basis. The
      Company records goodwill as the excess purchase price over the fair value of
      net
      identifiable assets acquired. The Company follows the guidance provided in
      the
      Statement of Financial Accounting Standards No. 142, *“Goodwill
      and Other Intangible Assets”* (“SFAS
      142”), which prescribes a two-step process to test and measure the impairment of
      goodwill.





In
      connection with branch acquisitions that do not represent business combinations,
      the excess of deposit liabilities assumed from other banks over assets acquired
      is recorded as a core deposit intangible and amortized over the expected life
      of
      the asset.





***Other
      Investment***


The
      Company’s investment in a Small Business Investment Company (“SBIC”) is recorded
      at cost and is evaluated annually for impairment. Impairment that is considered
      by management to be other-than-temporary, results in a write-down of the
      investment which is recognized as a realized loss in earnings. The Company
      recognized write-downs on this investment of $51,000 during the year ended
      December 31, 2004. The Company did not recognize write-downs on this investment
      during the years ended December
      31, 2006 and 2005. This investment, with a net book value of $585,000 at
      December 31, 2006 and 2005 is included in other assets. The SBIC is licensed
      by
      the Small Business Administration. It provides mezzanine financing and private
      equity investments to small companies which may not otherwise qualify for
      standard bank financing.





F
            -
            14
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





***Trust
      Assets***


Trust
      assets held in a fiduciary or agency capacity, other than trust cash on deposit
      at the Bank, are not included in these consolidated financial statements because
      they are not assets of the Company. Trust fees are recognized on the accrual
      basis of accounting.





***Related
      Party Transactions***


Directors,
      officers and affiliates of the Company and the Bank have been customers of
      and
      have had transactions with the Bank, and it is expected that such persons will
      continue to have such transactions in the future. Management believes that
      all
      deposit accounts, loans, services and commitments comprising such transactions
      were made in the ordinary course of business, on substantially the same terms,
      including interest rates and collateral, as those prevailing at the time for
      comparable transactions with other customers who were not directors, officers
      or
      affiliates. In the opinion of management, the transactions with related parties
      did not involve more than normal risk of collectibility, favored treatment
      or
      terms or present other unfavorable features. *See
      Note 13 for details regarding related party transactions.*





***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 capital section on the balance sheet,
      such items, along with net income, are components of comprehensive income
      (loss). *See
      Note 15 for components of other comprehensive income (loss) and related tax
      effects.*





***Earnings
      Per Share***


Basic
      net
      income per common share is calculated by dividing the net income available
      to
      common stockholders by the weighted-average number of common shares outstanding
      during the period. Diluted net income per common share is computed in a manner
      similar to basic net income per common share except that the weighted-average
      number of common shares outstanding is increased to include the incremental
      common shares (as computed using the treasury stock method) that would have
      been
      outstanding if all potentially dilutive common stock equivalents were issued
      during the period. The Company’s common stock equivalents relate solely to stock
      option and restricted stock awards. Anti-dilutive shares are common stock
      equivalents with weighted-average exercise prices in excess of the
      weighted-average market value for the periods presented. The Company had
      anti-dilutive common shares outstanding of approximately 468,000 and 292,000
      for
      the years ended December 31, 2006 and 2005, respectively. Treasury shares and
      unallocated common shares held by the ESOP are not included in the
      weighted-average number of common shares outstanding for purposes of calculating
      both basic and diluted net income per common share. Unvested restricted shares
      are only included in dilutive net income per common share
      computations.





**Years
                Ended December 31,***(Dollars
                in Thousands, Except Share Amounts)*
            
            **2006**
            
            **2005**
            
            **2004****Net
                income**
            
            $
            2,778
            
            $
            3,397
            
            $
            1,288**Weighted-average
                common shares outstanding:**Basic
            
            
            11,798,711
            
            
            12,016,800
            
            
            N/AEffect
                of dilutive stock option and restricted stock awards
            
            
            44,570
            
            
            24,516
            
            
            N/ADiluted
            
            
            11,843,281
            
            
            12,041,316
            
            
            N/A**Net
                income per common share:**Basic
            
            $
            0.24
            
            $
            0.28
            
            
            N/ADiluted
            
            $
            0.23
            
            $
            0.28
            
            
            N/A




F
            -
            15
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            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





Per
      common share data is not considered meaningful and, is therefore, not presented
      for the year ended December 31, 2004, as the Company had no shares outstanding
      prior to the Company’s initial public offering on September 30,
      2004.





***Bank-owned
      Life Insurance***


Bank-owned
      life insurance policies are presented on the consolidated balance sheet at
      cash
      surrender value. Changes in cash surrender value are reflected in noninterest
      income on the consolidated statement of income. *See
      Note 11 for additional discussion.*





***Employee
      Stock Ownership Plan***


The
      Company accounts for its Employee Stock Ownership Plan (“ESOP”) in accordance
      with Statement of Position 93-6, *“Employers’
      Accounting for Employee Stock Ownership Plans”* (“SOP
      93-6”). The value of unearned shares to be allocated to ESOP participants for
      future services not yet performed is recognized as a reduction to stockholders’
equity in the Company’s balance sheet. Unallocated ESOP shares are not
      considered outstanding for the purpose of calculating net income per common
      share. Dividends paid on allocated ESOP shares are charged to retained earnings
      and dividends paid on unallocated ESOP shares are used to satisfy debt service.
      The loan to the ESOP is repaid principally from the Bank’s contributions to the
      ESOP and dividends payable on common stock held by the ESOP over a period of
      15
      years. Compensation expense is recognized as ESOP shares are committed to be
      released.





***Equity
      Incentive Plan***


Statement
      of Financial Accounting Standards No. 123R, “ *Accounting
      for Stock-Based Compensation”* (“SFAS
      123R”) requires all entities to follow the same accounting standard and
      recognize the cost of share-based payment transactions in their financial
      statements. In accordance with SFAS 123R, the Company has recorded share-based
      compensation expense related to outstanding stock option and restricted stock
      awards based upon the fair value at the date of grant over the vesting period
      of
      such awards on a straight-line basis. The fair value of each restricted stock
      allocation, equal to the market price at the date of grant, was recorded to
      unearned restricted shares. Unearned restricted shares are amortized to salaries
      and employee benefits expense over the vesting period of the restricted stock
      awards. The fair value of each stock option award was estimated on the date
      of
      grant using the Black-Scholes option pricing model, which includes several
      assumptions such as expected volatility, dividends, term and risk-free rate
      for
      each stock option award. *See
      Note 11 for additional discussion.*





***Business
      Segment Reporting***


In
      June
      1997, the Financial Accounting Standards Board (“FASB”) issued Statement of
      Financial Accounting Standards No. 131, *“Disclosures
      about Segments of an Enterprise and Related Information.”* This
      Statement requires public companies to report (i) certain financial and
      descriptive information about “reportable operating segments,” as defined, and
      (ii) certain enterprise-wide financial information about products and services,
      geographic areas and major customers. An operating segment is a component of
      a
      business for which separate financial information is available and evaluated
      regularly by the chief operating decision-maker in deciding how to allocate
      resources and evaluate performance. The Company’s operations are limited to
      financial services provided within the framework of a community bank, and
      decisions are generally based on specific market areas and or product offerings.
      Accordingly, based on the financial information presently evaluated by the
      Company’s chief operating decision-maker, the Company’s operations are
      aggregated in one reportable operating segment.





***Advertising
      Costs***


Advertising
      costs are expensed as incurred.





F
            -
            16
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





***Recent
      Accounting Pronouncements***


In
      March
      2006, the Financial Accounting Standards Board issued Financial Accounting
      Standards No. 156, *“Accounting
      for Servicing of Financial Assets* ,”
which
      amends Financial Accounting Standards No. 140, *“Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities,”* with
      respect to the accounting for the servicing of financial assets. This Statement
      requires that all separately recognized servicing rights be initially measured
      at fair value, if practicable. For each class of separately recognized servicing
      assets and liabilities, this Statement permits an entity to choose either of
      the
      following subsequent measurement methods: (1) amortize servicing assets or
      liabilities in proportion to and over the period of estimated net servicing
      income or net servicing loss; or (2) report servicing assets or liabilities
      at
      fair value at each reporting date and report changes in fair value in earnings
      in the period in which the changes occur. This Statement also requires
      additional disclosures for all separately recognized servicing rights and is
      effective for new transactions occurring and for subsequent measurement at
      the
      beginning of an entity’s first fiscal year that begins after September 15, 2006.
      This Statement is not expected to have a material impact on the Company’s
      consolidated financial statements.





In
      June
      2006, the FASB issued FASB Interpretation No. 48, *“Accounting
      for Uncertainty in Income Taxes,”* which is
      an interpretation of FASB Statement No. 109, *“Accounting
      for Income Taxes.”* This
      Interpretation clarifies the accounting for uncertainty in income taxes
      recognized in a Company’s financial statements, prescribes a recognition
      threshold and measurement attribute for the financial statement recognition
      and
      measurement of a tax position in the tax return and provides guidance on
      derecognition, classification, interest and penalties, accounting in interim
      periods, disclosures and transition. The effective date of this Interpretation
      is for fiscal years beginning after December 15, 2006. This Interpretation
      is
      not expected to have a material impact on the Company’s consolidated financial
      statements.





In
      September 2006, the FASB issued Financial Accounting Standards No. 157,
“ *Fair
      Value Measurement* ”
(“SFAS
      157”) which defines fair value, establishes a framework for measuring fair value
      in generally accepted accounting principles and expands the disclosures about
      fair value measurement. This Statement was developed to provide guidance for
      consistency and comparability in fair value measurements and disclosures and
      applies under other accounting pronouncements that require or permit fair value
      measurements. This Statement is effective for financial statements issued for
      fiscal years beginning after November 15, 2007 and interim periods within those
      fiscal years. This Statement is not expected to have a material impact on the
      Company’s consolidated financial statements.





In
      September 2006, the FASB issued Financial Accounting Standards No. 158,
“ *Employers’
      Accounting for Defined Benefit Pension and Other Postretirement Plans - an
      amendment of FASB Statements No. 87, 88, 106 and 132(R)* .”
This
      Statement improves financial reporting by requiring employers to recognize
      the
      overfunded or underfunded status of a defined benefit postretirement plan as
      an
      asset or liability in its statement of financial position and to recognize
      changes in that funded status in the year in which the changes occur through
      comprehensive income for a business entity or changes in unrestricted net assets
      of a not-for-profit organization. An employer with publicly traded equity
      securities is required to initially recognize the funded status of a defined
      benefit postretirement plan and to provide the required disclosures as of the
      end of the fiscal year ending after December 15, 2006. This Statement does
      not
      have a material impact on the Company’s consolidated financial
      statements.





In
      September 2006, the FASB ratified the Emerging Task Force (“EITF”) consensus on
      Issue No. 06-4, *“Accounting
      for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
      Split-Dollar Life Insurance Arrangements”* (“EITF
      06-4). This issue 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





F
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            17
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




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. EITF 06-4
      is
      effective for fiscal years beginning after December 15, 2007. The Company is
      in
      the process of evaluating the potential impacts of adopting EITF 06-4 on its
      consolidated financial statements.




In
      September 2006, the Securities and Exchange Commission (the “SEC”) issued Staff
      Accounting Bulletin No. 108, *“Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements”* (“SAB
      108”). This Bulletin provides interpretive guidance on how the effects of the
      carry-over or reversal of prior year misstatements should be considered in
      a
      quantifying a current year misstatement. The SEC staff believes that registrants
      should quantify errors using both a balance sheet and an income statement
      approach and evaluate whether either approach results in a quantifying
      misstatement that, when all relevant quantitative and qualitative factors are
      considered, is material. SAB 108 is effective for years ending on or after
      November 15, 2006. SAB 108 does not have a material impact on the Company’s
      consolidated financial statements.





In
      February 2007, the FASB issued Statement of Financial Accounting Standards
      No.
      159, *“The
      Fair Value Option for Financial Assets and Financial
      Liabilities”* (“SFAS
      159”). ** This
      Statement provides companies with an option to report selected financial assets
      and liabilities at fair value. The Standard’s objective is to reduce both the
      complexity in accounting for financial instruments and the volatility in
      earnings caused by measuring related assets and liabilities differently. SFAS
      159 also establishes presentation and disclosure requirements designed to
      facilitate comparisons between companies that choose different measurement
      attributes for similar types of assets and liabilities. This Statement is
      effective as of the beginning of an entity’s first fiscal year beginning after
      November 15, 2007. Early adoption is permitted if the Company makes the choice
      in the first 120 days of that fiscal year and also elects to apply the
      provisions of SFAS 157. The Company does not expect SFAS 159 to have a material
      impact on its consolidated financial statements.





**NOTE
      2. RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANKS**





The
      Bank
      is required to maintain cash reserve balances against its respective transaction
      accounts and non-personal time deposits. At December 31, 2006 and 2005, the
      Bank
      maintained cash and liquid asset reserves of approximately $753,000, and
      maintained $3.0 million in the Federal Reserve Bank for clearing purposes to
      satisfy such reserve requirements.







F
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            18
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




**NOTE
      3. SECURITIES**




The
      amortized cost and approximate fair values of securities at December 31, 2006
      and 2005 are as follows:





**December
                31, 2006***(Dollars
                in Thousands)*
            
            **Amortized**
              **Cost**
            
            **Gross**
              **Unrealized**
              **Gains**
            
            **Gross**
              **Unrealized**
              **Losses**
            
            **Fair**
              **Value***Debt
                securities:*U.S.
                Government and agency obligations
            
            $
            1,596
            
            $
            21
            
            $
            (15
            )
            $
            1,602Government-sponsored
                enterprises
            
            
            66,190
            
            
            64
            
            
            (991
            )
            
            65,263Mortgage-backed
                securities
            
            
            45,481
            
            
            109
            
            
            (775
            )
            
            44,815Corporate
                debt securities
            
            
            3,917
            
            
            5
            
            
            (19
            )
            
            3,903Obligations
                of state and political subdivisions
            
            
            2,000
            
            
            24
            
            
            -
            
            
            2,024Tax-exempt
                securities
            
            
            420
            
            
            -
            
            
            -
            
            
            420Foreign
                government securities
            
            
            100
            
            
            -
            
            
            (1
            )
            
            99**Total
                debt securities**
            
            
            119,704
            
            
            223
            
            
            (1,801
            )
            
            118,126*Equity
                securities:*Marketable
                equity securities
            
            
            1,336
            
            
            46
            
            
            -
            
            
            1,382**Total
                available for sale securities**
            
            $
            121,040
            
            $
            269
            
            $
            (1,801
            )
            $
            119,508








**December
                31, 2005***(Dollars
                in Thousands)*
            
            **Amortized**
              **Cost**
            
            **Gross**
              **Unrealized**
              **Gains**
            
            **Gross**
              **Unrealized**
              **Losses**
            
            **Fair**
              **Value***Debt
                securities:*U.S.
                Government and agency obligations
            
            $
            4,820
            
            $
            58
            
            $
            (65
            )
            $
            4,813Government-sponsored
                enterprises
            
            
            73,135
            
            
            -
            
            
            (1,645
            )
            
            71,490Mortgage-backed
                securities
            
            
            37,346
            
            
            28
            
            
            (836
            )
            
            36,538Corporate
                debt securities
            
            
            4,537
            
            
            3
            
            
            (12
            )
            
            4,528Obligations
                of state and political subdivisions
            
            
            1,499
            
            
            47
            
            
            -
            
            
            1,546Tax-exempt
                securities
            
            
            490
            
            
            -
            
            
            -
            
            
            490Foreign
                government securities
            
            
            75
            
            
            -
            
            
            (1
            )
            
            74**Total
                debt securities**
            
            
            121,902
            
            
            136
            
            
            (2,559
            )
            
            119,479*Equity
                securities:*Marketable
                equity securities
            
            
            555
            
            
            -
            
            
            (15
            )
            
            540**Total
                available for sale securities**
            
            $
            122,457
            
            $
            136
            
            $
            (2,574
            )
            $
            120,019





F
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            19
 *Table
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**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





The
      following tables present information pertaining to securities with gross
      unrealized losses at December 31, 2006 and 2005, aggregated by investment
      category and length of time the individual securities have been in a continuous
      unrealized loss position.





**December
                31, 2006:**
            
            **Less
                Than 12 Months**
            
            **12
                Months Or More**
            
            **Total***(Dollars
                in Thousands)*
            
            **Fair**
              **Value**
            
            **Unrealized**
              **Loss**
            
            **Fair**
              **Value**
            
            **Unrealized**
              **Loss**
            
            **Fair**
              **Value**
            
            **Unrealized**
              **Loss**U.S.
                Government and agency obligations
            
            $
            -
            
            $
            -
            
            $
            981
            
            $
            15
            
            $
            981
            
            $
            15Government-sponsored
                enterprises
            
            
            -
            
            
            -
            
            
            53,063
            
            
            991
            
            
            53,063
            
            
            991Mortgage-backed
                securities
            
            
            5,770
            
            
            26
            
            
            23,255
            
            
            749
            
            
            29,025
            
            
            775Corporate
                debt securities
            
            
            1,408
            
            
            2
            
            
            990
            
            
            17
            
            
            2,398
            
            
            19Foreign
                government securities
            
            
            -
            
            
            -
            
            
            24
            
            
            1
            
            
            24
            
            
            1**Total**
            
            $
            7,178
            
            $
            29
            
            $
            78,313
            
            $
            1,772
            
            $
            85,491
            
            $
            1,801




**December
                31, 2005:**
            
            **Less
                Than 12 Months**
            
            **12
                Months Or More**
            
            **Total***(Dollars
                in Thousands)*
            
            **Fair**
              **Value**
            
            **Unrealized**
              **Loss**
            
            **Fair**
              **Value**
            
            **Unrealized**
              **Loss**
            
            **Fair**
              **Value**
            
            **Unrealized**
              **Loss**U.S.
                Government and agency obligations
            
            $
            -
            
            $
            -
            
            $
            3,270
            
            $
            65
            
            $
            3,270
            
            $
            65Government-sponsored
                enterprises
            
            
            23,998
            
            
            314
            
            
            47,492
            
            
            1,331
            
            
            71,490
            
            
            1,645Mortgage-backed
                securities
            
            
            6,163
            
            
            152
            
            
            22,787
            
            
            684
            
            
            28,950
            
            
            836Corporate
                debt securities
            
            
            1,003
            
            
            12
            
            
            -
            
            
            -
            
            
            1,003
            
            
            12Foreign
                government securities
            
            
            -
            
            
            -
            
            
            24
            
            
            1
            
            
            24
            
            
            1Marketable
                equity securities
            
            
            85
            
            
            15
            
            
            -
            
            
            -
            
            
            85
            
            
            15**Total**
            
            $
            31,249
            
            $
            493
            
            $
            73,573
            
            $
            2,081
            
            $
            104,822
            
            $
            2,574





Management
      evaluates securities for other-than-temporary impairment at least on a quarterly
      basis and more frequently when economic or market conditions warrant such
      evaluation.





At
      December 31, 2006, 76 debt securities with gross unrealized losses have
      aggregate depreciation of approximately 2% of the Company’s amortized cost
      basis. Management believes that none of the unrealized losses on these
      securities are other-than-temporary because primarily all of the unrealized
      losses relate to debt and mortgage-backed securities issued by government
      agencies or government-sponsored enterprises and private issuers that maintain
      investment grade ratings, which the Company has both the intent and the ability
      to hold until maturity or until the fair value fully recovers. In addition,
      management considers the issuers of the securities to be financially sound
      and
      believes the Company will receive all contractual principal and interest related
      to these investments.





F
            -
            20
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





The
      amortized cost and fair value of debt securities at December 31, 2006 by
      contractual maturities are presented below. Actual maturities of mortgage-backed
      securities may differ from contractual maturities because the mortgages
      underlying the securities may be called or repaid without any penalties. Because
      mortgage-backed securities are not due at a single maturity date, they are
      not
      included in the maturity categories in the following maturity
      summary.





*(Dollars
                in Thousands)*
            
            **Amortized**
              **Cost**
            
            **Fair**
              **Value*****Maturity:***Within
                1 year
            
            $
            17,845
            
            $
            17,789After
                1 but within 5 years
            
            
            49,439
            
            
            48,567After
                5 but within 10 years
            
            
            894
            
            
            926After
                10 years
            
            
            6,045
            
            
            6,02974,223
            
            
            73,311Mortgage-backed
                securities
            
            
            45,481
            
            
            44,815**Total
                debt securities**
            
            $
            119,704
            
            $
            118,126





At
      December 31, 2006 and 2005, government-sponsored enterprise securities with
      an
      amortized cost of $4.0 million and a fair value of $3.9 million were pledged
      to
      secure U.S. Treasury tax and loan payments and public deposits.





Proceeds
      from the sales of available for sale securities during the years ended December
      31, 2006, 2005 and 2004 amounted to $12.3 million, $159,000 and $22.8 million,
      respectively.





The
      following is a summary of realized gains and losses on the sale of securities
      for the years ended December 31, 2006, 2005 and 2004:





**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004**Gross
                gains on sales
            
            $
            98
            
            $
            59
            
            $
            689Gross
                losses on sales
            
            
            (382
            )
            
            -
            
            
            (855
            )**Net
                (loss) gain on sale of securities**
            
            $
            (284
            )
            $
            59
            
            $
            (166
            )





F
            -
            21
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





**NOTE
      4. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES**





***Loan
      Portfolio***


The
      composition of the Company's loan portfolio at December 31, 2006 and 2005 is
      as
      follows:




**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005****Real
                estate loans:**Residential
                - 1 to 4 family
            
            $
            309,695
            
            $
            266,739Multi-family
                and commercial
            
            
            118,600
            
            
            100,926Construction
            
            
            44,647
            
            
            47,325**Total
                real estate loans**
            
            
            472,942
            
            
            414,990**Commercial
                business loans**
            
            
            75,171
            
            
            77,552**Consumer
                loans**
            
            
            29,105
            
            
            23,856**Total
                loans**
            
            
            577,218
            
            
            516,398Deferred
                loan origination costs, net of deferred fees
            
            
            1,258
            
            
            1,048Allowance
                for loan losses
            
            
            (4,365
            )
            
            (3,671
            )**Loans,
                net**
            
            $
            574,111
            
            $
            513,775





***Impaired
      and Nonaccrual Loans***


The
      following is a summary of information pertaining to impaired loans, which
      include all nonaccrual and restructured loans.





**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**Impaired
                loans without valuation allowance
            
            $
            6,078
            
            $
            298Impaired
                loans with valuation allowance
            
            
            64
            
            
            16Total
                impaired loans
            
            $
            6,142
            
            $
            314Valuation
                allowance related to impaired loans
            
            $
            14
            
            $
            9Nonaccrual
                loans
            
            $
            1,392
            
            $
            240Total
                loans past due 90 days or more and still accruing
            
            $
            -
            
            $
            -





F
            -
            22
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





Additional
      information related to impaired loans is as follows:





**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004**Average
                recorded investment in impaired loans
            
            $
            3,189
            
            $
            663
            
            $
            1,487Interest
                income recognized on impaired loans
            
            $
            6
            
            $
            5
            
            $
            9Cash
                interest received on impaired loans
            
            $
            18
            
            $
            9
            
            $
            12





No
      additional funds are committed to be advanced to those borrowers whose loans
      are
      impaired.





Interest
      income that would have been recorded had nonaccrual loans been performing in
      accordance with
      their original terms totaled approximately $110,000, $15,000 and $56,000 for
      the
      years ended December
      31, 2006, 2005 and 2004, respectively.





***Allowance
      for Loan Losses***


Changes
      in the allowance for loan losses for the years ended December 31, 2006, 2005
      and
      2004 are as follows:





**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004****Balance
                at beginning of year**
            
            $
            3,671
            
            $
            3,200
            
            $
            2,688Provision
                for loan losses
            
            
            881
            
            
            410
            
            
            550Loans
                charged-off
            
            
            (199
            )
            
            (29
            )
            
            (75
            )Recoveries
                of loans previously charged-off
            
            
            12
            
            
            90
            
            
            37**Balance
                at end of year**
            
            $
            4,365
            
            $
            3,671
            
            $
            3,200





***Related
      Party Loans***


Reference
      Note 13 for a discussion of related party transactions, including loans with
      related parties.





***Loans
      Held for Sale***


At
      December 31, 2006 and 2005, total loans held for sale were $135,000 and
      $107,000, respectively, consisting of fixed-rate residential mortgage
      loans.





***Mortgage
      Servicing Rights***


The
      Company services certain loans that it has sold with and without recourse to
      third parties and other loans for which the Company acquired the servicing
      rights. Loans serviced for others are not included in the Company’s consolidated
      balance sheets. The aggregate of loans serviced for others approximated $72.5
      million and $71.7 million at December 31, 2006 and 2005, respectively. As of
      December 31, 2006 and 2005, the Company was liable under recourse provisions
      for
      loans sold by the Company of approximately $59,000 and $66,000,
      respectively.





At
      December 31, 2006 and 2005, the balance of capitalized servicing rights included
      in other assets was $392,000 and $373,000, respectively. The fair value of
      the
      capitalized mortgage servicing rights approximated its carrying value for the
      periods presented. No impairment charges related to servicing rights were
      recognized during the years ended December 31, 2006, 2005 and 2004.





F
            -
            23
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





A
      summary
      of the activity in the balances of capitalized mortgage servicing rights is
      as
      follows:





**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004****Balance
                at beginning of year**
            
            $
            373
            
            $
            165
            
            $
            124Additions
            
            
            97
            
            
            272
            
            
            65Amortization
            
            
            (78
            )
            
            (64
            )
            
            (24
            )**Balance
                at end of year**
            
            $
            392
            
            $
            373
            
            $
            165





**NOTE
      5. OTHER REAL ESTATE OWNED**





Other
      real estate owned is presented at net realizable value. A summary of expenses
      applicable to other real estate operations for the years ended December 31,
      2006, 2005 and 2004, is as follows:





**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004**Net
                loss from sales or write-downs of other real estate owned,
                net
            
            $
            11
            
            $
            25
            
            $
            60Rental
                expense (income) of holding other real estate, net
            
            
            12
            
            
            55
            
            
            (49
            )**Expense
                from other real estate operations, net**
            
            $
            23
            
            $
            80
            
            $
            11





**NOTE
      6. PREMISES AND EQUIPMENT**





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





**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**Land
            
            $
            145
            
            $
            198Buildings
            
            
            5,455
            
            
            5,785Leasehold
                improvements
            
            
            5,225
            
            
            3,666Furniture
                and equipment
            
            
            9,166
            
            
            7,674Construction
                in process
            
            
            418
            
            
            54620,409
            
            
            17,869Accumulated
                depreciation and amortization
            
            
            (9,897
            )
            
            (9,031
            )**Premises
                and equipment, net**
            
            $
            10,512
            
            $
            8,838





F
            -
            24
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





At
      December 31, 2006, construction in process primarily relates to design and
      site
      costs associated with new branch locations and other incidental branch
      improvements. At December 31, 2005, construction in process related to
      construction costs associated with two new branch locations that opened during
      2006. Outstanding commitments relative to the construction of new branches
      in
      the aggregate totaled approximately $0 and $870,000 at December 31, 2006 and
      2005, respectively.





Depreciation
      and amortization expense for the years ended December 31, 2006, 2005 and 2004
      was $1.8 million, $1.4 million and $1.1 million, respectively.





*Reference
      Note 12 for a schedule of future minimum rental commitments pursuant to the
      terms of noncancelable lease agreements in effect at December 31, 2006 relating
      to premises and equipment.*





**NOTE
      7. GOODWILL AND OTHER INTANGIBLES**





***Goodwill***


In
      November 2005, the Bank acquired net assets of SI Trust Servicing, with a fair
      value of $58,000, for a purchase price of $701,000, resulting in goodwill of
      $643,000. In accordance with Statement of Financial Accounting Standards No.
      142, *“Goodwill
      and Other Intangible Assets,”* goodwill
      is not amortized for financial reporting purposes but rather evaluated for
      impairment. No impairment charges relating to goodwill were recognized during
      the years ended December 31, 2006 and 2005.





***Core
      Deposit Intangible***


In
      1998,
      the Bank acquired certain assets and assumed certain deposit liabilities of
      the
      Canterbury, Connecticut branch of Chelsea Groton Savings Bank. In consideration
      of the assumption of approximately $8.1 million of deposit liabilities, the
      Bank
      received approximately $7.1 million in cash and other assets. The resulting
      core
      deposit premium intangible is being amortized over 10 years using the
      straight-line method. The net book value of this asset at December 31, 2006
      and
      2005 is as follows:




**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**Core
                deposit intangible
            
            $
            973
            
            $
            973Accumulated
                amortization
            
            
            (875
            )
            
            (778
            )**Core
                deposit intangible, net**
            
            $
            98
            
            $
            195





Amortization
      expense, relating solely to the core deposit intangible, was $97,000 for each
      of
      the years ended December 31, 2006, 2005 and 2004. The balance of $98,000 at
      December 31, 2006 will be amortized during the year ending December 31,
      2007.





F
            -
            25
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





**NOTE
      8. DEPOSITS**





A
      summary
      of deposit balances, by type, at December 31, 2006 and 2005 is as
      follows:





**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005****Noninterest-bearing
                demand deposits**
            
            $
            55,703
            
            $
            51,996***Interest-bearing
                accounts:***NOW
                and money market accounts
            
            
            126,567
            
            
            125,156Savings
                accounts
            
            
            77,774
            
            
            87,894Certificates
                of deposit(1)
            
            
            278,632
            
            
            244,251**Total
                interest-bearing accounts**
            
            
            482,973
            
            
            457,301**Total
                deposits**
            
            $
            538,676
            
            $
            509,297





(1)
            Includes
                brokered deposits of $7.1 million and $5.0 million at December 31,
                2006
                and 2005, respectively.





Certificates
      of deposit in denominations of $100,000 or more were approximately $74.3 million
      and $65.0 million at December 31, 2006 and 2005, respectively. With the
      exception of self-directed retirement accounts which are insured up to $250,000,
      deposits in excess of $100,000 are not federally insured.





Contractual
      maturities of certificates of deposit as of December 31, 2006 and 2005 are
      summarized below.





**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**Within
                one year
            
            $
            215,802
            
            $
            129,869After
                one year to two years
            
            
            32,642
            
            
            70,342After
                two years to three years
            
            
            19,018
            
            
            27,295After
                three years to four years
            
            
            9,071
            
            
            8,003Over
                four years
            
            
            2,099
            
            
            8,742**Total
                certificates of deposit**
            
            $
            278,632
            
            $
            244,251










F
            -
            26
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




A
      summary
      of interest expense by account type for the years ended December 31, 2006,
      2005
      and 2004 is as follows:




**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004**NOW
                and money market accounts
            
            $
            1,001
            
            $
            653
            
            $
            384Savings
                accounts(1)
            
            
            961
            
            
            854
            
            
            625Certificates
                of deposit(2)
            
            
            11,165
            
            
            7,021
            
            
            5,337**Total**
            
            $
            13,127
            
            $
            8,528
            
            $
            6,346





(1)
            Includes
                interest expense on mortgagors’ and investors’ escrow
                accounts.


(2)
            Includes
                interest expense on brokered
                deposits.





***Related
      Party Deposits***


Reference
      Note 13 for a discussion of related party transactions, including deposits
      from
      related parties.





**NOTE
      9.  BORROWINGS**





***Federal
      Home Loan Bank Advances***


The
      Bank
      is a member of the Federal Home Loan Bank of Boston. At December 31, 2006
      and 2005, the Bank had access to a pre-approved secured line of credit with
      the
      FHLB of $6.2 million and the capacity to obtain additional advances up to a
      certain percentage of the value of its qualified collateral, as defined in
      the
      FHLB Statement of Credit Policy. In accordance with an agreement with the FHLB,
      the qualified collateral must be free and clear of liens, pledges and
      encumbrances. At December 31, 2006 and 2005, there were no advances outstanding
      under the line of credit. Other outstanding advances from the FHLB aggregated
      $112.0 million and $87.9 million at December 31, 2006 and 2005, respectively,
      at
      interest rates ranging from 2.34% to 5.85% and 1.87% to 5.84%, respectively.





FHLB
      advances are secured by the Company’s investment in FHLB stock, which is based
      on a percentage of its outstanding residential first mortgage loans. The
      carrying value of Federal Home Loan Bank stock approximates fair value based
      on
      the redemption provisions of the FHLB.





***Junior
      Subordinated Debt Owed to Unconsolidated Trusts***


SI
      Capital Trust I (the “Trust ”), a wholly-owned subsidiary of the Company, was
      formed on March 25, 2002. The Trust has no independent assets or operations,
      and
      was formed to issue $7.0 million of trust securities and invest the proceeds
      thereof in an equivalent amount of junior subordinated debentures issued by
      the
      Company. The junior subordinated debentures bear interest at six-month LIBOR
      plus 3.70%. The duration of the trust is 30 years; however, the trust securities
      are redeemable at par on or after April 22, 2007 and semi-annually
      thereafter.





On
      August
      31, 2006, the Company formed a new subsidiary, SI Capital Trust II (“Trust II”),
      and issued $8.0 million of trust preferred securities through a pooled trust
      preferred securities offering. The Company owns all of the common securities
      of
      Trust II, which has no independent assets or operations. SI Capital Trust II
      was
      formed to issue trust preferred securities and invest the proceeds in an
      equivalent amount of junior subordinated debentures issued by the Company.
      The
      trust preferred securities mature in 30 years and bear interest at three-month
      LIBOR plus 1.70%. The Company may redeem the trust-preferred securities, in
      whole or in part, on or after September 15, 2011, or earlier under certain
      conditions.





F
            -
            27
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





The
      subordinated debt securities are unsecured obligations of the Company and are
      subordinate and junior in right of payment to all present and future senior
      indebtedness of the Company. The Company has entered into a guarantee, which
      together with its obligations under the subordinated debt securities and the
      declaration of trust governing Trust and Trust II, including its obligations
      to
      pay costs, expenses, debts and liabilities, other than trust securities,
      provides a full and unconditional guarantee of amounts on the capital
      securities. If the Company defers interest payments on the junior subordinated
      debt securities, or otherwise is in default of the obligations, the Company
      would be prohibited from making dividend payments to its
      shareholders.





The
      contractual maturities of borrowings, by year, at December 31, 2006 are as
      follows:





*(Dollars
                in Thousands)*
            
            **FHLB
                Advances**(1)(2)(3)
            
            **Subordinated
                Debt**
            
            **Total**2007(3)
            
            $
            26,329
            
            $
            -
            
            $
            26,3292008(2)
            
            
            24,127
            
            
            -
            
            
            24,1272009
            
            
            16,500
            
            
            -
            
            
            16,5002010(2)
            
            
            19,000
            
            
            -
            
            
            19,0002011(2)
            
            
            12,000
            
            
            -
            
            
            12,000Thereafter
            
            
            14,000
            
            
            15,465
            
            
            29,465**Total
                long-term debt**
            
            $
            111,956
            
            $
            15,465
            
            $
            127,421**Weighted-average
                rate**
            
            
            4.44
            %
            
            8.01
            %
            
            4.87
            %




(1)
            Interest
                rates on the FHLB advances are primarily fixed. A variable rate advance
                of
                $2.0 million matures in 2008.


(2)
            Includes
                FHLB advances that are callable in the aggregate of $5.0 million
                during
                2007. These advances are reported based on their scheduled maturity
                in the
                summary table presented above.


(3)
            Includes
                amortizing advances requiring monthly principal and interest
                payments.





**NOTE
      10. INCOME TAXES**





The
      components of the income tax provision for the years ended December 31, 2006,
      2005 and 2004 are as follows:





**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004***Current
                tax provision:*Federal
            
            $
            2,020
            
            $
            1,767
            
            $
            1,477State
            
            
            1
            
            
            2
            
            
            1**Total
                current tax provision**
            
            
            2,021
            
            
            1,769
            
            
            1,478*Deferred
                tax benefit:*Federal
            
            
            (865
            )
            
            (80
            )
            
            (959
            )**Total
                deferred tax benefit**
            
            
            (865
            )
            
            (80
            )
            
            (959
            )**Total
                provision for income taxes**
            
            $
            1,156
            
            $
            1,689
            
            $
            519




F
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            28
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            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





A
      reconciliation of the anticipated income tax provision, based on the statutory
      tax rate of 34.0%, to the provision for income taxes as reported in the
      statements of income is as follows:





**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004**Provision
                for income tax at statutory rate
            
            $
            1,338
            
            $
            1,729
            
            $
            614Increase
                (decrease) resulting from:Dividends
                received deduction
            
            
            (13
            )
            
            (6
            )
            
            (7
            )Bank-owned
                life insurance
            
            
            (95
            )
            
            (94
            )
            
            (103
            )Tax-exempt
                income
            
            
            (12
            )
            
            (10
            )
            
            (6
            )Employee
                benefit plans
            
            
            70
            
            
            58
            
            
            -Nondeductible
                expenses
            
            
            6
            
            
            6
            
            
            6Other
            
            
            (138
            )
            
            6
            
            
            15**Total
                provision for income taxes**
            
            $
            1,156
            
            $
            1,689
            
            $
            519**Effective
                tax rate**
            
            
            29.4
            %
            
            33.2
            %
            
            28.7
            %





The
      tax
      effects of temporary differences that give rise to significant components of
      the
      deferred tax assets and deferred tax liabilities at December 31, 2006 and 2005
      are presented below:




**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005***Deferred
                tax assets:*Allowance
                for loan losses
            
            $
            1,517
            
            $
            1,259Goodwill
                and other intangibles
            
            
            104
            
            
            112Unrealized
                losses on available for sale securities
            
            
            612
            
            
            875Depreciation
                of premises and equipment
            
            
            434
            
            
            47Investment
                write-downs
            
            
            67
            
            
            67Charitable
                contribution carry-forward
            
            
            408
            
            
            569Deferred
                compensation
            
            
            646
            
            
            388Employee
                benefit plans
            
            
            227
            
            
            162Capital
                loss carry-forward
            
            
            160
            
            
            160Other
            
            
            255
            
            
            1**Total
                deferred assets**
            
            
            4,430
            
            
            3,640*Deferred
                tax liabilities:*Unrealized
                gains on available for sale securities
            
            
            91
            
            
            46Deferred
                loan costs
            
            
            845
            
            
            786Mortgage
                servicing asset
            
            
            133
            
            
            -Other
            
            
            -
            
            
            4**Total
                deferred liabilities**
            
            
            1,069
            
            
            836**Deferred
                tax asset, net**
            
            $
            3,361
            
            $
            2,804




At
      December 31, 2006, the charitable contribution carry-forward, primarily related
      to the contribution of the Company’s common stock to SI Financial Group
      Foundation, Inc. in 2004, was approximately $1.7 million. The utilization of
      charitable contributions for any tax year is limited to 10% of taxable income





F
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            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





without
      regard to charitable contributions, net operating losses and dividend received
      deductions. An organization is permitted to carry over contributions that exceed
      the annual 10% limitation as a deduction to the five succeeding tax years
      provided the organization has sufficient earnings. The Company estimates that
      the deferred tax asset related to this contribution carry-forward will be
      realized prior to its expiration in 2009 and therefore, no valuation allowance
      has been established.





Retained
      earnings at December 31, 2006 and 2005 includes a contingency reserve for loan
      losses of approximately $3.7 million, which represents the tax reserve balance
      existing at December 31, 1987, and is maintained in accordance with provisions
      of the Internal Revenue Code applicable to mutual savings banks. Amounts
      transferred to the reserve have been claimed as deductions from taxable income,
      and, if the reserve is used for purposes other than to absorb losses on loans,
      a
      federal income tax liability could be incurred. It is not anticipated that
      the
      Company will incur a federal income tax liability relating to this reserve
      balance, and accordingly, deferred income taxes of approximately $1.3 million
      at
      December 31, 2006 and 2005 have not been recognized.





Effective
      for taxable years commencing after December 31, 1998, financial services
      companies doing business in Connecticut are permitted to establish a “passive
      investment company” (“PIC”) to hold and manage loans secured by real property.
      PICs are exempt from Connecticut corporation business tax, and dividends
      received by the financial services companies from PICs are not taxable. In
      January 1999, the Bank established a PIC, as a wholly-owned subsidiary, and
      in
      June 2000, began to transfer a portion of its residential and commercial
      mortgage loan portfolios from the Bank to the PIC. A substantial portion of
      the
      Company’s interest income is now derived from the PIC, an entity whose net
      income is exempt from State of Connecticut taxes, and accordingly, state income
      taxes represent minimum state tax amounts.





The
      Bank’s ability to continue to realize the tax benefits of the PIC is subject to
      the PIC continuing to comply with all statutory requirements related to the
      operations of the PIC.





**NOTE
      11. BENEFIT PLANS**





***Profit
      Sharing and 401(k) Savings Plan***


The
      Bank’s Profit Sharing and 401(k) Savings Plan (the “Plan”) is a tax-qualified
      defined contribution plan for the benefit of its eligible employees. The Bank’s
      profit sharing contribution to the Plan is a discretionary amount authorized
      by
      the Board of Directors, based on the financial results of the Bank. An
      employee’s share of the profit sharing contribution represents the ratio of the
      employee’s salary to the total salary expense of the Bank. Contributions to the
      profit sharing plan were approximately $227,000 for the year ended December
      31,
      2004. There were no profit sharing contributions for the years ended December
      31, 2006 and 2005.





The
      Bank’s Plan also includes a 401(k) feature. Eligible participants may make
      salary deferral contributions of up to 100% of earnings subject to Internal
      Revenue Services limitations. The Bank makes matching contributions equal to
      50%
      of the first 6% of the participant’s contributions to the Plan. Participants are
      immediately vested in the Bank’s matching contributions. Bank contributions were
      approximately $222,000, $200,000 and $169,000 for the years ended December
      31,
      2006, 2005 and 2004, respectively.




***Group
        Term Replacement Plan***
 The
        Bank
        maintains the Group Term Replacement Plan to provide a death benefit to
        executives designated by the Compensation Committee of the Board of Directors.
        The death benefits are funded


F
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**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





through
      certain insurance policies that are owned by the Bank on the lives of the
      participating executives. The Bank pays the life insurance premiums, which
      fund
      the death benefits from its general assets and is the beneficiary of any death
      benefits exceeding any executive’s maximum dollar amount specified in his or her
      split dollar endorsement policy. The maximum dollar amount of each executive’s
      split dollar death benefit equals three times the executive’s annual
      compensation less $50,000 pre-retirement and three times final annual
      compensation post-retirement not to exceed a specified dollar amount. For
      purposes of the plan, annual compensation includes an executive’s base
      compensation, plus commissions and cash bonuses earned under the Bank’s bonus
      plan. Participation in the plan ceases if an executive is terminated for cause
      or the executive terminates employment for reasons other than death, disability
      or retirement. If the Bank wishes to maintain the insurance after a
      participant’s termination in the plan, the Bank will be the direct beneficiary
      of the entire death proceeds of the insurance policies.





No
      liability has been recognized on the consolidated balance sheet for such death
      benefits. In September 2006, the EITF reached a consensus on EITF 06-4, *“Accounting
      for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
      Split-Dollar Life Insurance Arrangements.”* As a
      result, effective for fiscal years beginning after December 15, 2007, 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. Management is in the process of evaluating
      the impact of EITF 06-4 on the Company’s consolidated financial statements. *See
      Note 1 - Recent Accounting Pronouncements.*





***Executive
      Supplemental Retirement Agreements - Defined
      Benefit***


The
      Bank
      maintains unfunded supplemental defined-benefit retirement agreements with
      its
      directors and members of senior management. These agreements provide for
      supplemental retirement benefits to certain executives based upon average annual
      compensation and years of service. Entitlement of benefits commence upon the
      earlier of executive’s termination of employment (other than for cause), at or
      after attaining age 65 or, depending on the executive, on the date when the
      executive’s years of service and age total 80 or 78. Total expenses incurred
      under these agreements for the years ended December 31, 2006, 2005 and 2004
      were
      $740,000, $541,000 and $282,000, respectively.





***Performance-Based
      Incentive Plan***


The
      Bank
      has an incentive plan whereby all management and staff members are eligible
      to
      receive a bonus tied to both Company and individual performance. Discretionary
      contributions to the plan require the approval of the Board of Directors’
Compensation Committee. Total expense recognized was $352,000, $369,000 and
      $400,000 for the years ended December 31, 2006, 2005 and 2004.





***Supplemental
      Executive Retirement Plan***


The
      Bank
      maintains the Supplemental Executive Retirement Plan to provide restorative
      payments to executives, designated by the Board of Directors, who are prevented
      from receiving the full benefits of the Bank’s Profit Sharing and 401(k) Savings
      Plan and Employee Stock Ownership Plan. The supplemental executive retirement
      plan also provides supplemental benefits to participants upon a change in
      control prior to the complete scheduled repayment of the ESOP loan. For the
      years ended December 31, 2006 and 2005, the President and Chief Executive
      Officer was designated by the Board of Directors to participate in the plan.
      Total expense incurred under this plan was $6,000, $0 and $3,000 for the years
      ended December 31, 2006, 2005 and 2004.




***Employee
      Stock Ownership Plan***


In
      September 2004, the Bank established an Employee Stock Ownership Plan for the
      benefit of its eligible employees. The Company provided a loan to the Savings
      Institute Bank and Trust Company Employee


F
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            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




Stock
      Ownership Plan of $4.9 million which was used to purchase 492,499 shares of
      the
      Company’s outstanding stock. The loan bears interest equal to 4.75% and provides
      for annual payments of interest and principal over the 15-year term of the
      loan.




At
      December 31, 2006, the remaining principal balance on the ESOP debt is payable
      as follows:





*(Dollars
                in Thousands)*
            
            **December
                31, 2006**2007
            
            $
            2522008
            
            
            2642009
            
            
            2772010
            
            
            2902011
            
            
            304Thereafter
            
            
            3,011**Total**
            
            $
            4,398





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 for allocation among participants as the loan is repaid.
      Cash dividends paid on allocated shares are distributed to participants and
      cash
      dividends paid on unallocated shares are used to repay the outstanding debt
      of
      the ESOP.





Shares
      held by the ESOP include the following at December 31, 2006 and
      2005:





**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**Allocated
            
            
            38,963
            
            
            7,675Committed
                to be Allocated
            
            
            32,295
            
            
            32,295Unallocated
            
            
            419,840
            
            
            452,135**Total
                shares**
            
            
            491,098
            
            
            492,105**Fair
                value of unallocated shares**
            
            $
            5,151
            
            $
            4,951





The
      Company accounts for these ESOP shares in accordance with Statement of Position
      93-6, *“Employers’
      Accounting for Employee Stock Ownership Plans”* (“SOP
      93-6”). Under SOP 93-6, unearned ESOP shares are not considered outstanding for
      calculating net income per common share and are presented as unallocated common
      shares held by ESOP, as a reduction in shareholders’ equity, on the balance
      sheet. As ESOP shares are committed to be released to participants, the Company
      recognizes compensation expense equal to the fair value of the earned ESOP
      shares. Total compensation expense recognized in connection with the ESOP was
      approximately $367,000, $366,000 and $93,000 for the years ended December 31,
      2006, 2005 and 2004, respectively.





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            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





**Equity
      Incentive Plan**


The
      2005
      Equity Incentive Plan (the “Incentive Plan”) allows the Company to grant up to
      615,623 stock options and 246,249 shares of restricted stock to its employees,
      officers, directors and directors emeritus. Both incentive stock options and
      non-statutory stock options may be granted under the plan. Stock option and
      restricted stock awards vest at 20% per year beginning on the first anniversary
      of the date of grant. All
      restricted stock awards under the Company’s Incentive Plan were granted in May
      2005. At
      December 31, 2006, a total of 148,123 stock options were available for future
      grants.





In
      June
      2005, the Board of Directors authorized an independent trustee to purchase
      up to
      1.96%, or 246,249 shares, of the Company’s common stock in the open market to
      fund the 2005 Equity Incentive Plan. In fiscal 2005, the trustee purchased
      246,249 shares at a cost of approximately $2.9 million under this program.





In
      2005,
      the Company adopted the provisions of FASB’s Statement of Financial Accounting
      Standards No. 123, *“Accounting
      for Stock-Based Compensation”* for
      recognizing the cost of employee services received in share-based payment
      arrangements. In accordance with SFAS 123R, the Company records share-based
      compensation expense related to outstanding stock option and restricted stock
      awards based upon the fair value at the date of grant over the vesting period
      of
      such awards on a straight-line basis. The fair value of the restricted stock
      awards, which is equal to the market price at the date of grant, was recorded
      as
      unearned restricted shares.





The
      Company recorded share-based compensation expense of approximately $765,000
      and
      $476,000 related to the stock option and restricted stock awards for the years
      ended December 31, 2006 and 2005, respectively.





The
      fair
      value of each option is determined at the grant date using the Black-Scholes
      option pricing model with the following weighted-average
      assumptions:





**December
                31,****2006**
            
            **2005**Expected
                term (years)
            
            
            10.0
            
            
            10.0Expected
                dividend yield
            
            
            1.50
            %
            
            1.50
            %Expected
                volatility
            
            
            20.02
            
            
            17.00Risk-free
                interest rate
            
            
            4.57
            
            
            4.32Fair
                value of options granted
            
            $
            3.64
            
            $
            2.89





The
      expected volatility is based on a combination of the Company’s historical
      volatility and the volatility of comparable peer institutions due to the limited
      trading history for the Company. The risk-free interest rates are based on
      the
      implied yields of U.S. Treasury zero-coupon issues for periods within the
      contractual life of the awards in effect at the time of the stock option grants.
      The expected life is based on the estimated life of the stock options. The
      dividend yield assumption is based on the Company’s historical and expected
      dividend pay-outs.





F
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 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





The
      following is a summary of activity for the Company’s stock options for the years
      ended December 31, 2006 and 2005:





**December
                  31, 2006**
              
              **December
                  31, 2005****Shares**
              
              **Weighted-**
                **Average
                  Exercise Price**
              
              **Shares**
              
              **Weighted-**
                **Average
                  Exercise Price****Options
                  outstanding at beginning of year**
              
              
              463,500
              
              $
              10.10
              
              
              -
              
              $
              -Options
                  granted
              
              
              10,000
              
              
              11.39
              
              
              467,000
              
              
              10.10Options
                  forfeited/cancelled
              
              
              (6,000
              )
              
              10.10
              
              
              (3,500
              )
              
              10.10**Options
                  outstanding at end of year**
              
              
              467,500
              
              $
              10.13
              
              
              463,500
              
              $
              10.10**Options
                  exercisable at end of year**
              
              
              91,500
              
              $
              10.10
              
              
              -
              
              $
              -





The
      following table summarizes information relating to stock options outstanding
      and
      exercisable at December 31, 2006:




**Exercise**
              **Prices**
            
            **Options**
              **Outstanding**
            
            **Weighted-**
              **Average
                Remaining Contractual Life**
              **(in
                years)**
            
            **Weighted-**
              **Average**
              **Exercise
                Price**
            
            **Options**
              **Exercisable**$
            10.10
            
            
            457,500
            
            
            8.38
            
            $
            10.10
            
            
            91,50011.39
            
            
            10,000
            
            
            9.15
            
            
            11.39
            
            
            -467,500
            
            
            8.40
            
            $
            10.13
            
            
            91,500





***Bank-Owned
      Life Insurance***


The
      Company has an investment in, and is the beneficiary of, life insurance policies
      on the lives of certain officers. The purpose of these life insurance
      investments is to provide income through the appreciation in cash surrender
      value of the policies, which is used to offset the costs of various benefit
      and
      retirement plans. These policies had aggregate cash surrender values of
      approximately $8.1 million and $7.8 million at December 31, 2006 and 2005,
      respectively. Income earned on these life insurance policies aggregated
      $279,000, $276,000 and $303,000 for the years ended December 31, 2006, 2005
      and
      2004, respectively.





**NOTE
      12. OTHER COMMITMENTS AND CONTINGENCIES**





In
      the
      normal course of business, there are outstanding commitments and contingencies
      that are not reflected in the accompanying consolidated financial statements.
      The Company is a party to financial instruments with off-balance sheet risk
      to
      meet the financing needs of its customers. These financial instruments include
      commitments to extend credit and standby letters of credit and involve, to
      varying degrees, elements of credit and interest rate risk in excess of the
      amounts recognized on the balance sheets. The contractual amounts of those
      instruments reflect the extent of involvement the Company has in particular
      classes of financial instruments.




***Loan
        Commitments and Letters of Credit***
 The
        contractual amounts of commitments to extend credit represent the amounts
        of
        potential loss should the contract be fully drawn upon, the customer defaults
        and the value of any existing collateral be


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            -
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**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




determined
      as worthless. The Company uses the same credit policies in making commitments
      and conditional obligations as it does for on-balance sheet instruments.
      Financial instruments whose contract amounts represent credit risk at December
      31, 2006 and 2005 were as follows:





**December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005***Commitments
                to extend credit:*Future
                loan commitments(1)
            
            $
            7,658
            
            $
            31,192Undisbursed
                construction loans
            
            
            27,010
            
            
            25,572Undisbursed
                home equity lines of credit
            
            
            21,554
            
            
            21,481Undisbursed
                commercial lines of credit
            
            
            12,070
            
            
            10,796Overdraft
                protection lines
            
            
            1,424
            
            
            1,277Standby
                letters of credit
            
            
            1,178
            
            
            812**Total**
            
            $
            70,894
            
            $
            91,130





(1)
            Includes
                fixed rate loan commitments of $2.6 million at interest rates ranging
                from
                5.125% to
                8.000% and $5.5 million at interest rates ranging from 4.875% to
                8.000% at
                December 31, 2006 and 2005,
                respectively.





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 Company evaluates each customer's creditworthiness on a
      case-by-case basis. The amount of collateral obtained, if deemed necessary
      by
      the Company upon extension of credit, is based on management's credit evaluation
      of the counterparty. Collateral held varies but may include residential and
      commercial property, accounts receivable, inventory, property, plant and
      equipment, deposits and securities.





Undisbursed
      commitments under construction, home equity or commercial lines of credit are
      commitments for future extensions of credit to existing customers. Total
      undisbursed amounts on lines of credit may expire without being fully drawn
      upon
      and therefore, do not necessarily represent future cash
      requirements.





Standby
      letters of credit are conditional commitments issued by the Company to guarantee
      the performance of a customer to a third party. Letters of credit are primarily
      issued to support public or private borrowing arrangements. Essentially all
      letters of credit issued have expiration dates within one year.





The
      Company adopted the provisions of Statement of Financial Accounting Standards
      No. 149, “ *Amendment
      of Statement 133 on Derivative Instruments and Hedging
      Activities,”* effective July 1, 2003, which includes the Company’s commitments to fund loans
      held for sale. Newly issued or modified guarantees that are not derivative
      contracts, are required to be recorded on the Company’s consolidated balance
      sheet at their fair value at the date of inception. There was no liability
      related to such guarantees at December 31, 2006 and 2005.








F
            -
            35
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            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




***Loans
      Sold with Recourse***


At
      December 31, 2006 and 2005, the outstanding balance of loans sold with recourse
      was approximately $59,000 and $66,000, respectively. Loan repurchase commitments
      are agreements to repurchase loans previously sold upon the occurrence of
      conditions established in the contract, including default by the underlying
      borrower. The Company determined that losses relating to loans sold with
      recourse were not probable and therefore, a liability was not recorded on the
      Company’s balance sheets at December 31, 2006 and 2005.





***Operating
      Lease Commitments***


The
      Company leases certain of its branch offices and equipment under operating
      lease
      agreements that expire at various dates through
      2027. In addition
      to rental payments, the branch leases require payments for property taxes in
      excess of base year taxes.





Future
      minimum rental commitments pursuant to the terms of noncancelable lease
      agreements, by year and in the aggregate, at December 31, 2006, are as
      follows:





*(Dollars
                in Thousands)*
            
            **December
                31,**
              **2006**2007
            
            $
            1,2002008
            
            
            1,2802009
            
            
            1,2462010
            
            
            1,1512011
            
            
            991Thereafter
            
            
            10,446**Total**
            
            $
            16,314





Rental
      expense charged to operations for cancelable and noncancelable operating leases
      approximated $1.1 million, $842,000 and $589,000 for the years ended December
      31, 2006, 2005 and 2004, respectively.





***Rental
      Income Under Subleases***


The
      Company subleased excess office space to one tenant under a noncancelable
      operating lease with a remaining term of one year. Future minimum lease payments
      receivable for the noncancelable lease at December 31, 2006, is
      $13,000.





Rental
      income under noncancelable leases approximated $13,000, $47,000 and $51,000
      for
      the years ended December 31, 2006, 2005 and 2004, respectively.





***Legal
      Matters***


The
      Company is involved in various legal proceedings that occur in the normal course
      of business. Management believes that resolution of these matters will not
      have
      a material effect on the Company’s financial condition or results of
      operations.


***Investment
        Commitments***
 In
        1998,
        the Bank became a limited partner in a Small Business Investment Corporation
        and
        made a commitment to make a capital investment of $1.0 million in the limited
        partnership. At December 31,


F
            -
            36
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




2006
      and
      2005, the Bank’s remaining off-balance sheet commitment for the capital
      investment was approximately $194,000.





***Other***


Also,
      the
      Bank has entered into agreements with certain customers whereby the Bank, on
      a
      nightly basis, transfers to a third party a portion of the customers’ demand
      deposit account balance above a certain level. The balance of the amounts so
      transferred of approximately $14.1 million and $17.0 million at December 31,
      2006 and 2005, respectively, has been derecognized and is not reflected on
      the
      accompanying balance sheets.





**NOTE
      13. RELATED PARTY TRANSACTIONS**





***Loans
      Receivable***


In
      the
      normal course of business, the Bank grants loans to related parties. Related
      parties include directors and certain officers of the Company and its
      subsidiaries and their immediate family members and respective affiliates in
      which they have a controlling interest. These loans were made on substantially
      the same terms, including interest rates and collateral, as those prevailing
      at
      the time for comparable transactions with customers, and did not involve more
      than the normal risk of collectibility. At December 31, 2006 and 2005, all
      related party loans were performing.





Changes
      in loans outstanding to such related parties during the years ended December
      31,
      2006 and 2005 are as follows:




**Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005****Balance
                at beginning of year**
            
            $
            1,743
            
            $
            1,743Additions
            
            
            1,731
            
            
            1,604Repayments
            
            
            (1,575
            )
            
            (1,604
            )**Balance
                at end of year**
            
            $
            1,899
            
            $
            1,743





***Deposits***


Deposit
      accounts of directors, certain officers and other related parties aggregated
      approximately $1.7 million and $621,000 at December 31, 2006 and 2005,
      respectively.





***Operating
      Expenses***


During
      the years ended December 31, 2006, 2005 and 2004, the Company paid approximately
      $24,000, $22,000 and $27,000, respectively, for insurance, supplies and
      advertising, to companies related to directors of the Company.





***Other
      Income***


The
      Company entered into an agreement to sublease real property to a company
      affiliated with one of the Company’s directors. The sublease agreement
      terminated in 2005 upon the sale of the property to an unrelated party. For
      the
      years ended December 31, 2005 and 2004, the Company received rental income
      of
      approximately $15,000 and $6,000, respectively.








F
            -
            37
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




***SI
      Bancorp, MHC - Mutual Holding Company Parent***


SI
      Bancorp, MHC owns a majority of the Company’s common stock and, through its
      Board of Directors, exercise voting control over most matters put to a vote
      of
      shareholders. The same directors and officers who manage the Company and the
      Bank also manage SI Bancorp, MHC. As a federally-chartered mutual holding
      company, the Board of Directors of SI Bancorp, MHC must ensure that the
      interests of depositors of the Bank are represented and considered in matters
      put to a vote of shareholders of the Company. Therefore, the votes cast by
      SI
      Bancorp, MHC may not be in the best interest of all shareholders. For example,
      SI Bancorp, MHC may exercise its voting control to prevent a sale or merger
      transaction, a second-step conversion transaction or defeat a shareholder
      nominee for election to the Board of Directors of the Company. The matters
      as to
      which shareholders, other than SI Bancorp, MHC, will be able to exercise voting
      control are limited and include any proposal to implement a stock-based
      incentive plan.





**NOTE
      14. REGULATORY CAPITAL**





The
      Bank
      is subject to various regulatory capital requirements administered by the
      federal banking agencies. Failure to meet minimum capital requirements can
      initiate certain mandatory, and possibly additional discretionary, actions
      by
      regulators that, if undertaken, could have a direct material effect on the
      Company'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 the Bank’s
      assets, liabilities and certain off-balance sheet items, as calculated under
      regulatory accounting practices. The Bank’s capital amounts and classification
      are also subject to qualitative judgments by the regulators about components,
      risk weightings and other factors.





Quantitative
      measures established by regulation to ensure capital adequacy require the Bank
      to maintain minimum amounts and ratios (set forth in the table below) of total
      and Tier I capital (as defined in the regulations) to risk-weighted assets
      (as
      defined) and of Tier I capital (as defined) to total assets (as defined). As
      of
      December 31, 2006 and 2005, the Bank met the conditions to be classified as
      “well capitalized” under the regulatory framework for prompt corrective action.
      As a savings and loan holding company regulated by the Office of Thrift
      Supervision, the Company is not subject to any separate regulatory capital
      requirements.





The
      Bank's actual capital amounts and ratios at December 31, 2006 and 2005
      were:





**December
                    31, 2006:**
                
                **Actual**
                
                **For
                    Capital**
                  **Adequacy**
                  **Purposes**
                
                **To
                    Be Well Capitalized Under Prompt Corrective****Action
                    Provisions***(Dollars
                    in Thousands)*
                
                **Amount**
                
                **Ratio**
                
                **Amount**
                
                **Ratio**
                
                **Amount**
                
                **Ratio**Total
                    Risk-based Capital Ratio
                
                $
                70,127
                
                
                15.84
                %
                $
                35,418
                
                
                8.00
                %
                $
                44,272
                
                
                10.00
                %Tier
                    I Risk-based Capital Ratio
                
                
                65,776
                
                
                14.86
                
                
                17,706
                
                
                4.00
                
                
                26,558
                
                
                6.00Tier
                    I Capital Ratio
                
                
                65,776
                
                
                8.97
                
                
                29,332
                
                
                4.00
                
                
                36,664
                
                
                5.00




**December
                    31, 2005:**
                
                **Actual**
                
                **For
                    Capital**
                  **Adequacy**
                  **Purposes**
                
                **To
                    Be Well Capitalized Under Prompt Corrective****Action
                    Provisions***(Dollars
                    in Thousands)*
                
                **Amount**
                
                **Ratio**
                
                **Amount**
                
                **Ratio**
                
                **Amount**
                
                **Ratio**Total
                    Risk-based Capital Ratio
                
                $
                66,274
                
                
                16.79
                %
                $
                31,578
                
                
                8.00
                %
                $
                39,472
                
                
                10.00
                %Tier
                    I Risk-based Capital Ratio
                
                
                62,612
                
                
                15.87
                
                
                15,781
                
                
                4.00
                
                
                23,672
                
                
                6.00Tier
                    I Capital Ratio
                
                
                62,612
                
                
                9.31
                
                
                26,901
                
                
                4.00
                
                
                33,626
                
                
                5.00





F
            -
            38
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





A
      reconciliation of the Company’s total capital to the Bank’s regulatory capital
      is as follows:





**December
                            31,***(Dollars
                            in Thousands)*
                        
                        **2006**
                        
                        **2005****Total
                            capital per consolidated financial statements**
                        
                        $
                        82,386
                        
                        $
                        80,043Holding
                            company equity not available for regulatory capital
                        
                        
                        (16,767
                        )
                        
                        (18,097
                        )Accumulated
                            losses on available for sale securities
                        
                        
                        898
                        
                        
                        1,482Intangible
                            assets
                        
                        
                        (741
                        )
                        
                        (816
                        )**Total
                            tier 1 capital**
                        
                        
                        65,776
                        
                        
                        62,612*Adjustments
                            for total capital:*Allowance
                            for loan losses
                        
                        
                        4,351
                        
                        
                        3,662**Total
                            capital per regulatory reporting**
                        
                        $
                        70,127
                        
                        $
                        66,274





**NOTE
      15. OTHER COMPREHENSIVE INCOME (LOSS)**





Other
      comprehensive income (loss), which is comprised solely of the change in
      unrealized gains and losses on available for sale securities, for the years
      ended December 31, 2006 and 2005 is as follows:





**December
                                      31, 2006***(Dollars
                                      in Thousands)*
                                  
                                  **Before
                                      Tax**
                                    **Amount**
                                  
                                  
                                  **Tax**
                                    **Effects**
                                  
                                  
                                  **Net
                                      of Tax**
                                    **Amount**Unrealized
                                      holding gains on available for sale securities
                                  
                                  $
                                  622
                                  
                                  
                                  $
                                  (211
                                  )
                                  
                                  $
                                  411Reclassification
                                      adjustment for losses recognized in net income
                                  
                                  
                                  284
                                  
                                  
                                  
                                  (97
                                  )
                                  
                                  
                                  187**Unrealized
                                      holding gains on available for sale securities,
                                      net of
                                      taxes**
                                  
                                  $
                                  906
                                  
                                  
                                  $
                                  (308
                                  )
                                  
                                  $
                                  598





F
            -
            39
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





**December
                31, 2005***(Dollars
                in Thousands)*
            
            **Before
                Tax**
              **Amount**
            
            **Tax**
              **Effects**
            
            **Net
                of Tax**
              **Amount**Unrealized
                holding losses on available for salesecurities
            
            $
            (1,940
            )
            $
            660
            
            $
            (1,280
            )Reclassification
                adjustment for gains recognized in net income
            
            
            (59
            )
            
            20
            
            
            (39
            )**Unrealized
                holding losses on available for sale securities, net of
                taxes**
            
            $
            (1,999
            )
            $
            680
            
            $
            (1,319
            )




**December
                31, 2004***(Dollars
                in Thousands)*
            
            **Before
                Tax**
              **Amount**
            
            **Tax**
              **Effects**
            
            **Net
                of Tax**
              **Amount**Unrealized
                holding losses on available for sale securities
            
            $
            (1,390
            )
            $
            473
            
            $
            (917
            )Reclassification
                adjustment for losses recognized in net income
            
            
            166
            
            
            (56
            )
            
            110**Unrealized
                holding losses on available for sale securities, net of
                taxes**
            
            $
            (1,224
            )
            $
            417
            
            $
            (807
            )




**NOTE
      16.  FAIR VALUE OF FINANCIAL INSTRUMENTS AND INTEREST RATE
      RISK**





Financial
      Accounting Standards Board Statement No. 107, *"Disclosures
      About Fair Value of Financial Instruments"* (“FAS
      107”), requires disclosure of fair value information about financial
      instruments, whether or not recognized on the balance sheets, for which it
      is
      practicable to estimate that value. 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 rates and estimates of future cash
      flows. In that regard, the derived fair value estimates cannot be substantiated
      by comparisons to independent markets and, in many cases, could not be realized
      in immediate settlement of the instrument. FAS 107 excludes certain financial
      instruments from its disclosure requirements. Accordingly, the aggregate fair
      value amounts presented do not represent the underlying value of the
      Company.




The
        following methods and assumptions were used by the Company in estimating
        fair
        value disclosures of its financial instruments:
  —
              *Cash
                  and cash equivalents.*******The
                  carrying amounts of these instruments approximate the fair
                  values.


F
            -
            40
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




—
            *Securities.*Fair
                values, excluding restricted Federal Home Loan Bank stock, are based
                on
                quoted market prices or dealer quotes, if available. If a quoted
                market
                price is not available, fair value is estimated using quoted market
                prices
                for similar securities. The carrying value of FHLB stock approximates
                fair
                value based on the redemption provisions of the Federal Home Loan
                Bank.




—
            *Loans
                held for sale.*The
                fair value of loans held for sale is estimated using quoted market
                prices.




—
            *Loans
                receivable.*For variable rate loans which reprice frequently and have no significant
                change in credit risk, fair values are based on carrying values.
                The fair
                value of fixed-rate loans are estimated by discounting the future
                cash
                flows using the year-end rates at which similar loans would be made
                to
                borrowers with similar credit ratings and for the same remaining
                maturities.




—
            *Accrued
                interest receivable.*The carrying amount of accrued interest approximates fair
                value.




—
            *Deposits.*The fair value of demand deposits, negotiable orders of withdrawal,
                regular savings, certain money market deposits and mortgagors’ and
                investors’ escrow accounts is the amount payable on demand at the
                reporting date. The fair value of certificates of deposit and other
                time
                deposits is estimated using a discounted cash flow calculation that
                applies interest rates currently being offered for deposits of similar
                remaining maturities to a schedule of aggregated expected maturities
                on
                such deposits.




—
            *Federal
                Home Loan Bank advances.*The fair value of the advances is estimated using a discounted cash
                flow
                calculation that applies current FHLB interest rates for advances
                of
                similar maturity to a schedule of maturities of such
                advances.




—
            *Junior
                subordinated debt owed to unconsolidated trust.*Based on the floating rate characteristic of these instruments, the
                carrying value is considered to approximate fair
                value.




—
            *Off-balance
                sheet instruments.*Fair values for off-balance sheet lending commitments are based on
                fees
                currently charged to enter into similar agreements, taking into account
                the remaining terms of the agreements and the counterparties' credit
                standings.




Management
      uses its best judgment in estimating the fair value of the Company's financial
      instruments; however, there are inherent weaknesses in any estimation technique.
      Therefore, for substantially all financial instruments, the fair value estimates
      presented herein are not necessarily indicative of the amounts the Company
      could
      have realized in a sales transaction at December 31, 2006 or 2005. The estimated
      fair value amounts for 2006 and 2005 have been measured as of their respective
      year-ends, and have not been re-evaluated or updated for purposes of these
      consolidated financial statements subsequent to those respective dates. As
      such,
      the estimated fair values of these financial instruments subsequent to the
      respective reporting dates may be different than the amounts reported at each
      year-end.





The
      information presented should not be interpreted as an estimate of the fair
      value
      of the entire Company since a fair value calculation is only required for a
      limited portion of the Company's assets. Due to the wide range of valuation
      techniques and the degree of subjectivity used in making the estimate,
      comparisons between the Company's disclosures and those of other banks may
      not
      be meaningful.





F
            -
            41
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





As
      of
      December 31, 2006 and 2005, the recorded carrying amounts and estimated fair
      values of the Company's financial instruments are as follows:





**2006**
            
            **2005***(Dollars
                in Thousands)*
            
            **Carrying**
              **Amount**
            
            **Fair**
              **Value**
            
            **Carrying**
              **Amount**
            
            **Fair**
              **Value*****Financial
                Assets:***Noninterest-bearing
                deposits
            
            $
            14,984
            
            $
            14,984
            
            $
            16,317
            
            $
            16,317Interest-bearing
                deposits
            
            
            3,824
            
            
            3,824
            
            
            6,829
            
            
            6,829Federal
                funds sold
            
            
            7,300
            
            
            7,300
            
            
            2,800
            
            
            2,800Available
                for sale securities
            
            
            119,508
            
            
            119,508
            
            
            120,019
            
            
            120,019Loans
                held for sale
            
            
            135
            
            
            135
            
            
            107
            
            
            107Loans
                receivable, net
            
            
            574,111
            
            
            566,421
            
            
            513,775
            
            
            508,820Federal
                Home Loan Bank stock
            
            
            6,660
            
            
            6,660
            
            
            5,638
            
            
            5,638Accrued
                interest receivable
            
            
            3,824
            
            
            3,824
            
            
            3,299
            
            
            3,299***Financial
                Liabilities:***Savings
                deposits
            
            
            77,774
            
            
            77,774
            
            
            87,894
            
            
            87,894Demand
                deposits, negotiable orders of withdrawal and money market
                accounts
            
            
            182,270
            
            
            182,270
            
            
            177,152
            
            
            177,152Certificates
                of deposit
            
            
            278,632
            
            
            280,212
            
            
            244,251
            
            
            245,466Mortgagors’
                and investors’ escrow accounts
            
            
            3,246
            
            
            3,246
            
            
            2,985
            
            
            2,985Federal
                Home Loan Bank advances
            
            
            111,956
            
            
            109,867
            
            
            87,929
            
            
            85,890Junior
                subordinated debt owed to unconsolidated trust
            
            
            15,465
            
            
            15,465
            
            
            7,217
            
            
            7,217





***Off-Balance
      Sheet Instruments***


Loan
      commitments on which the committed interest rate is less than the current market
      rate are insignificant at December 31, 2006 and 2005.





The
      Company assumes interest rate risk, which represents the risk that general
      interest rate levels will change, as a result of its normal operations. As
      a
      result, the fair values of the Company's financial instruments will change
      when
      interest rate levels change and that change may be either favorable or
      unfavorable to the Company. Management attempts to match maturities of assets
      and liabilities to the extent believed necessary to minimize interest rate
      risk.
      However, borrowers with fixed-rate obligations are less likely to prepay in
      a
      rising rate environment and more likely to prepay in a falling rate environment.
      Conversely, depositors who are receiving fixed rates are more likely to withdraw
      funds before maturity in a rising rate environment and less likely to do so
      in a
      falling rate environment. Management monitors rates and maturities of assets
      and
      liabilities and attempts to minimize interest rate risk by adjusting terms
      of
      new loans and deposits and by investing in securities with terms that mitigate
      the Company's overall interest rate risk.








F
            -
            42
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




**NOTE
      17.  RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES**




Federal
      regulations place certain restrictions on dividends paid and loans or advances
      made by the Bank to the Company. The total amount of dividends which may be
      declared in a given calendar year is generally limited to the net income of
      the
      Bank for that year plus retained net income for the preceding two
      years.





At
      December 31, 2006 and 2005, the Bank’s retained earnings available for payment
      of dividends was $8.3 million and $8.8 million, respectively. Accordingly,
      $57.3
      million and $53.2 million of the Company’s equity in the net assets of the Bank
      was restricted at December 31, 2006 and 2005, respectively.





In
      addition, the Company is further restricted, under its junior subordinated
      debt
      obligation, from paying dividends to its shareholders if the Company has
      deferred interest payments or has otherwise defaulted on its junior subordinated
      debt obligations.





Under
      federal regulation, the Bank is also limited to the amount it may loan to the
      Company, unless such loans are collateralized by specific obligations. Loans
      or
      advances to the Company by the Bank are limited to 10% of the Bank’s capital
      stock and surplus on a secured basis. In addition, dividends paid by the Bank
      to
      the Company would be prohibited if the effect there of, would cause the Bank’s
      capital to be reduced below applicable minimum capital
      requirements.





At
      December 31, 2006, SI Bancorp, MHC owned 7.3 million shares of the Company’s
      common stock, representing 58% of the total number of the Company’s outstanding
      shares. Upon regulatory approval, SI Bancorp, MHC may seek to waive receipt
      of
      future dividends declared by the Company. For the years ended December 31,
      2006
      and 2005, SI Bancorp, MHC waived receipt of all dividends declared by the
      Company.





**NOTE
      18.  COMMON STOCK REPURCHASE PROGRAM**





In
      November 2005, the Board of Directors approved a plan to repurchase up to 5%,
      or
      approximately 628,000 shares, of the Company’s common stock through open market
      purchases or privately negotiated transactions. Stock repurchases under the
      program are accounted for as treasury stock, carried at cost, and reflected
      as a
      reduction in stockholders’ equity. As of December 31, 2006, the Company
      repurchased 141,830 shares at a cost of approximately $1.6 million under this
      plan.







F
            -
            43
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**




**NOTE
        19.  CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY**
 
 Condensed
        financial information pertaining only to the parent company, SI Financial
        Group,
        Inc., is as follows:




**Condensed
                Balance Sheets**
            
            **December
                31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005****Assets:**Cash
                and cash equivalents
            
            $
            6,973
            
            $
            6,660Available
                for sale securities
            
            
            17,748
            
            
            12,050Investment
                in Savings Institute Bank and Trust Company
            
            
            65,619
            
            
            61,946Other
                assets
            
            
            8,404
            
            
            6,743**Total
                assets**
            
            $
            98,744
            
            $
            87,399**Liabilities
                and Stockholders’ Equity:**Liabilities
            
            $
            16,358
            
            $
            7,356Stockholders’
                equity
            
            
            82,386
            
            
            80,043**Total
                liabilities and stockholders’ equity**
            
            $
            98,744
            
            $
            87,399




**Condensed
                Statements of Income**
            
            **Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004**Interest
                and dividends on investments
            
            $
            605
            
            $
            462
            
            $
            141Other
                income
            
            
            387
            
            
            444
            
            
            139**Total
                income**
            
            
            992
            
            
            906
            
            
            280Operating
                expenses(1)
            
            
            1,188
            
            
            937
            
            
            2,957**Loss
                before income taxes and equity in undistributed income of
                subsidiary**
            
            
            (196
            )
            
            (31
            )
            
            (2,677
            )Income
                tax benefit
            
            
            166
            
            
            11
            
            
            909(30
            )
            
            (20
            )
            
            (1,768
            )Equity
                in undistributed income of subsidiary
            
            
            2,808
            
            
            3,417
            
            
            3,056**Net
                income**
            
            $
            2,778
            
            $
            3,397
            
            $
            1,288




(1)
            Operating
                expenses for 2004 include a $2.5 million charitable contribution
                to SI
                Financial Group Foundation.





F
            -
            44
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





**Condensed
                Statements of Cash Flows**
            
            **Years
                Ended December 31,***(Dollars
                in Thousands)*
            
            **2006**
            
            **2005**
            
            **2004****Cash
                flows from operating activities:**Net
                income
            
            $
            2,778
            
            $
            3,397
            
            $
            1,288Adjustments
                to reconcile net income to net cash used in operating
                activities:Equity
                in undistributed income of subsidiary
            
            
            (2,808
            )
            
            (3,417
            )
            
            (3,056
            )Excess
                tax benefit from share-based payment arrangements
            
            
            (13
            )
            
            -
            
            
            -Other,
                net
            
            
            (60
            )
            
            (14
            )
            
            1,562**Cash
                used in operating activities**
            
            
            (103
            )
            
            (34
            )
            
            (206
            )**Cash
                flows from investing activities:**Purchase
                of available for sale securities
            
            
            (5,763
            )
            
            (4,847
            )
            
            (9,503
            )Proceeds
                from maturities of available for sale securities
            
            
            131
            
            
            3,000
            
            
            1,000Proceeds
                from sale of available for sale securities
            
            
            -
            
            
            111
            
            
            -Investment
                in subsidiary
            
            
            2
            
            
            1,080
            
            
            (32,108
            )**Cash
                used in investing activities**
            
            
            (5,630
            )
            
            (656
            )
            
            (40,611
            )**Cash
                flows from financing activities:**Treasury
                stock purchased
            
            
            (1,438
            )
            
            (148
            )
            
            -Cash
                dividends paid on common stock
            
            
            (777
            )
            
            (432
            )
            
            -Excess
                tax benefit from share-based payment arrangements
            
            
            13
            
            
            -
            
            
            -Proceeds
                from subordinated debt borrowings
            
            
            8,248
            
            
            -
            
            
            -Purchase
                of common stock for equity incentive plan
            
            
            -
            
            
            (2,948
            )
            
            -Proceeds
                from common stock offering
            
            
            -
            
            
            -
            
            
            48,480**Cash
                provided by (used in) financing activities**
            
            
            6,046
            
            
            (3,528
            )
            
            48,480**Net
                change in cash and cash equivalents**
            
            
            313
            
            
            (4,218
            )
            
            7,663**Cash
                and cash equivalents at beginning of year**
            
            
            6,660
            
            
            10,878
            
            
            3,215**Cash
                and cash equivalents at end of year**
            
            $
            6,973
            
            $
            6,660
            
            $
            10,878**SUPPLEMENTAL
                CASH FLOW INFORMATION:**Declared
                dividends
            
            $
            740
            
            $
            590
            
            $
            -




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 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





**NOTE
      20. QUARTERLY DATA (UNAUDITED)**





Quarterly
      results of operations for the years ended December 31, 2006 and 2005 are as
      follows:




**Year
                        Ended December 31, 2006**
                    
                    **Year
                        Ended December 31, 2005***(Dollars
                        in Thousands, Except Share Amounts)*
                    
                    **Fourth**
                      **Quarter**
                    
                    **Third**
                      **Quarter**
                    
                    **Second**
                      **Quarter**
                    
                    **First**
                      **Quarter**
                    
                    **Fourth**
                      **Quarter**
                    
                    **Third**
                      **Quarter**
                    
                    **Second**
                      **Quarter**
                    
                    **First**
                      **Quarter**Interest
                        and dividend income
                    
                    $
                    10,550
                    
                    $
                    10,308
                    
                    $
                    10,389
                    
                    $
                    9,530
                    
                    $
                    9,110
                    
                    $
                    8,711
                    
                    $
                    8,192
                    
                    $
                    7,892Interest
                          expense
                    
                    
                    5,196
                    
                    
                    4,796
                    
                    
                    4,373
                    
                    
                    3,896
                    
                    
                    3,509
                    
                    
                    3,206
                    
                    
                    2,824
                    
                    
                    2,592**Net
                        interest and dividend income**
                    
                    
                    5,354
                    
                    
                    5,512
                    
                    
                    6,016
                    
                    
                    5,634
                    
                    
                    5,601
                    
                    
                    5,505
                    
                    
                    5,368
                    
                    
                    5,300Provision
                        for loan losses
                    
                    
                    335
                    
                    
                    141
                    
                    
                    120
                    
                    
                    285
                    
                    
                    100
                    
                    
                    75
                    
                    
                    130
                    
                    
                    105**Net
                        interest and dividend income after provision for loan
                        losses**
                    
                    
                    5,019
                    
                    
                    5,371
                    
                    
                    5,896
                    
                    
                    5,349
                    
                    
                    5,501
                    
                    
                    5,430
                    
                    
                    5,238
                    
                    
                    5,195Noninterest
                        income
                    
                    
                    2,157
                    
                    
                    1,972
                    
                    
                    2,005
                    
                    
                    2,124
                    
                    
                    1,929
                    
                    
                    1,425
                    
                    
                    1,629
                    
                    
                    1,327Noninterest
                        expenses
                    
                    
                    6,343
                    
                    
                    6,557
                    
                    
                    6,779
                    
                    
                    6,280
                    
                    
                    6,145
                    
                    
                    5,638
                    
                    
                    5,611
                    
                    
                    5,194**Income
                        before income taxes**
                    
                    
                    833
                    
                    
                    786
                    
                    
                    1,122
                    
                    
                    1,193
                    
                    
                    1,285
                    
                    
                    1,217
                    
                    
                    1,256
                    
                    
                    1,328Provision
                        for income taxes
                    
                    
                    164
                    
                    
                    229
                    
                    
                    365
                    
                    
                    398
                    
                    
                    447
                    
                    
                    405
                    
                    
                    411
                    
                    
                    426**Net
                        income**
                    
                    $
                    669
                    
                    $
                    557
                    
                    $
                    757
                    
                    $
                    795
                    
                    $
                    838
                    
                    $
                    812
                    
                    $
                    845
                    
                    $
                    902**Net
                        income per common share:**Basic
                    
                    $
                    0.06
                    
                    $
                    0.05
                    
                    $
                    0.06
                    
                    $
                    0.07
                    
                    $
                    0.07
                    
                    $
                    0.07
                    
                    $
                    0.07
                    
                    $
                    0.07Diluted
                    
                    $
                    0.06
                    
                    $
                    0.05
                    
                    $
                    0.06
                    
                    $
                    0.07
                    
                    $
                    0.07
                    
                    $
                    0.07
                    
                    $
                    0.07
                    
                    $
                    0.07




Quarterly
      data may not add to annual data due to rounding.





F
            -
            46
 *Table
            of Contents*




**SI
                FINANCIAL GROUP, INC. AND SUBSIDIARIES**
              **NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31, 2006, 2005 AND 2004**





**NOTE
      21. DEFINITIVE AGREEMENT SIGNED TO BUY MORTGAGE COMPANY**





On
      September 5, 2006, the Company announced that the Bank had signed a definitive
      agreement to purchase Fairfield Financial Mortgage Group, Inc. (“FFMG”). FFMG
      has branch offices in Texas, Massachusetts, New Hampshire, New Jersey, New
      York
      and Pennsylvania and is also a licensed mortgage banker in South Carolina,
      Florida, Georgia, Michigan, Rhode Island, Maryland, Delaware and California.






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