UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
DC 20549


____________





FORM
10-Q


(Mark
One)





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





For the
quarterly period ended March 31, 2008





OR





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





For the
transition period from ______________ to _____________




Commission
file number:   0-50876







NAUGATUCK
VALLEY FINANCIAL
CORPORATION


(Exact
name of registrant as specified in its charter)





UNITED
      STATES
            65-1233977(State
      or other jurisdiction of incorporation or
            (I.R.S.
      Employer Identification No.)organization)333
      CHURCH STREET, NAUGATUCK,
      CONNECTICUT
            06770(Address
      of principal executive offices)
            (Zip
      Code)








(203)
720-5000


(Registrant’s
telephone number, including area code)





N/A


(Former
name, former address and former fiscal year, if changed since last
report)





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 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 ý                    No
o





Large
      Accelerated Filer o
            Accelerated
      Filer oNon-accelerated
      Filer o
            Smaller
      Reporting Company  ý(Do
      not check if a smaller reporting company)








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


Yes o                    No  ý





As of May 8, 2008, there were 7,048,594
shares of the registrant’s common stock outstanding.





NAUGATUCK
VALLEY FINANCIAL CORPORATION





Table
of Contents





Part I.  Financial Information
            Page
      No.Item 1.
            Financial Statements (Unaudited)Condensed Consolidated Statements of Financial Condition at
      March 31, 2008 and December 31, 2007
            3Consolidated Statements of Income for the three months ended
      March 31, 2008 and 2007
            4Consolidated Statements of Cash Flows for the three months
      ended March 31, 2008 and 2007
            5Notes to Unaudited Consolidated Financial
      Statements
            6Item 2.
            Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
            11Liquidity and Capital Resources
            15Item 3.
            Quantitative and Qualitative Disclosures About Market
      Risk
            17Item 4.
            Controls and Procedures
            18Part II.  Other InformationItem 1.
            Legal Proceedings
            19Item 1A.
            Risk Factors
            19Item 2.
            Unregistered Sales of Equity Securities and Use of
      Proceeds
            19Item 3.
            Defaults Upon Senior Securities
            19Item 4.
            Submission of Matters to a Vote of Security
      Holders
            19Item 5.
            Other Information
            19Item 6.
            Exhibits
            19SignaturesExhibits


Table of Contents


Part
I - FINANCIAL INFORMATION








Item 1.  Financial Statements (Unaudited).











2
 Table of Contents







Condensed
Consolidated Statements of Financial Condition


(In
thousands, except share data)




March
      31,
              
              
              December
      31,2008
              
              
              2007(Unaudited)ASSETSCash
      and due from depository institutions
              
              $
              9,293
              
              
              $
              7,873Investment
      in federal funds
              
              
              4,203
              
              
              
              497Investment
      securities
              
              
              73,154
              
              
              
              66,454Loans
      receivable, net
              
              
              377,036
              
              
              
              359,831Deferred
      income taxes
              
              
              1,071
              
              
              
              1,332Other
      assets
              
              
              27,441
              
              
              
              26,540Total
      assets
              
              $
              492,198
              
              
              $
              462,527LIABILITIES
      AND STOCKHOLDERS' EQUITYLiabilitiesDeposits
              
              $
              334,367
              
              
              $
              325,269Borrowed
      funds
              
              
              105,901
              
              
              
              85,107Other
      liabilities
              
              
              1,638
              
              
              
              1,694Total
      liabilities
              
              
              441,906
              
              
              
              412,070Commitments
      and contingenciesStockholders'
      equityCommon
      stock, $.01 par value; 25,000,000 shares authorized;7,604,375
      shares issued, 7,158,594 shares outstanding at March31,
      2008 and 7,268,734 shares outstanding at December 31, 2007
              
              
              76
              
              
              
              76Preferred
      stock, $.01 par value; 1,000,000 shares authorized;no
      shares issued or outstanding
              
              
              -
              
              
              
              -Paid-in
      capital
              
              
              33,530
              
              
              
              33,483Retained
      earnings
              
              
              24,544
              
              
              
              24,233Unearned
      ESOP shares (233,513 shares at March 31, 2008and
      December 31, 2007)
              
              
              (2,335
              )
              
              
              (2,335
              )Unearned
      stock awards (89,320 shares at March 31, 2008and
      90,020 shares at December 31, 2007)
              
              
              (987
              )
              
              
              (995
              )Treasury
      stock, at cost (448,614 shares at March 31, 2008and
      338,474 shares at December 31, 2007)
              
              
              (4,926
              )
              
              
              (3,889
              )Accumulated
      other comprehensive income (loss)
              
              
              390
              
              
              
              (116
              )Total
      stockholders' equity
              
              
              50,292
              
              
              
              50,457Total
      liabilities and stockholders' equity
              
              $
              492,198
              
              
              $
              462,527




See notes
to consolidated financial statements.


3
 Table of Contents







Consolidated
Statements of Income


(In
thousands, except per share data)





Three
      Months EndedMarch
      31,2008
              
              2007(Unaudited)Interest
      incomeInterest
      on loans
              
              $
              5,918
              
              
              $
              5,123Interest
      and dividends on investments and deposits
              
              
              928
              
              
              
              861Total
      interest income
              
              
              6,846
              
              
              
              5,984Interest
      expenseInterest
      on deposits
              
              
              2,481
              
              
              
              2,254Interest
      on borrowed funds
              
              
              1,065
              
              
              
              843Total
      interest expense
              
              
              3,546
              
              
              
              3,097Net
      interest income
              
              
              3,300
              
              
              
              2,887Provision
      for loan losses
              
              
              162
              
              
              
              51Net
      interest income after provision for loan losses
              
              
              3,138
              
              
              
              2,836Noninterest
      incomeFees
      for services related to deposit accounts
              
              
              244
              
              
              
              209Fees
      for other services
              
              
              117
              
              
              
              119Income
      from investment advisory services, net
              
              
              82
              
              
              
              63Income
      from bank owned life insurance
              
              
              75
              
              
              
              76Gain
      on sale of investments
              
              
              59
              
              
              
              6Other
      income
              
              
              50
              
              
              
              51Total
      noninterest income
              
              
              627
              
              
              
              524Noninterest
      expenseCompensation,
      taxes and benefits
              
              
              1,808
              
              
              
              1,741Office
      occupancy
              
              
              523
              
              
              
              513Computer
      processing
              
              
              195
              
              
              
              179Directors
      compensation
              
              
              183
              
              
              
              170Advertising
              
              
              81
              
              
              
              96Loss
      on foreclosed real estate, net
              
              
              3
              
              
              
              -Other
      expenses
              
              
              412
              
              
              
              365Total
      noninterest expense
              
              
              3,205
              
              
              
              3,064Income
      before provisionfor
      income taxes
              
              
              560
              
              
              
              296Provision
      for income taxes
              
              
              106
              
              
              
              22Net
      Income
              
              $
              454
              
              
              $
              274Earnings
      per common share - Basic and Diluted
              
              $
              0.06
              
              
              $
              0.04





See notes
to consolidated financial statements.


4
 Table of Contents










Consolidated
Statements of Cash Flows


(In
thousands)




Three
      Months EndedMarch
      31,2008
              
              
              2007Cash
      flows from operating activities
              
              (Unaudited)Net
      income
              
              $
              454
              
              
              $
              274Adjustments
      to reconcile net income to cash provided by operating
      activities:Provision
      for loan losses
              
              
              162
              
              
              
              51Depreciation
      and amortization expense
              
              
              197
              
              
              
              193Net
      amortization (accretion) from investments
              
              
              18
              
              
              
              (9
              )Amortization
      of intangible assets
              
              
              8
              
              
              
              8Stock-based
      compensation
              
              
              173
              
              
              
              179Gain
      on sale of investments
              
              
              (59
              )
              
              
              (6
              )Net
      change in:Accrued
      income receivable
              
              
              (40
              )
              
              
              91Deferred
      loan fees
              
              
              71
              
              
              
              (2
              )Cash
      surrender value of life insurance
              
              
              (75
              )
              
              
              (76
              )Other
      assets
              
              
              216
              
              
              
              108Other
      liabilities
              
              
              (244
              )
              
              
              (99
              )Net
      cash provided by operating activities
              
              
              881
              
              
              
              712Cash
      flows from investing activitiesProceeds
      from maturities and repayments of available-for-sale
      securities
              
              
              2,630
              
              
              
              2,037Proceeds
      from sale of available-for-sale securities
              
              
              6,134
              
              
              
              979Proceeds
      from maturities of held-to-maturity securities
              
              
              190
              
              
              
              95Purchase
      of available-for-sale securities
              
              
              (14,846
              )
              
              
              (484
              )Purchase
      of held-to-maturity securities
              
              
              -
              
              
              
              (250
              )Purchase
      of Federal Home Loan Bank stock
              
              
              (938
              )
              
              
              (159
              )Loan
      originations net of principal payments
              
              
              (17,439
              )
              
              
              (6,789
              )Purchase
      of property and equipment
              
              
              (201
              )
              
              
              (52
              )Net
      cash used by investing activities
              
              
              (24,470
              )
              
              
              (4,623
              )Cash
      flows from financing activitiesNet
      change in time deposits
              
              
              (1,118
              )
              
              
              9,076Net
      change in other deposit accounts
              
              
              11,958
              
              
              
              6,764Net
      change in mortgagors' escrow deposits
              
              
              (1,742
              )
              
              
              (1,536
              )Advances
      from Federal Home Loan Bank
              
              
              26,415
              
              
              
              1,000Repayment
      of advances from Federal Home Loan Bank
              
              
              (5,668
              )
              
              
              (4,461
              )Net
      change in repurchase agreements
              
              
              48
              
              
              
              112Treasury
      stock acquired
              
              
              (1,036
              )
              
              
              (832
              )Dividends
      paid to stockholders
              
              
              (142
              )
              
              
              (151
              )Net
      cash provided by financing activities
              
              
              28,715
              
              
              
              9,972Increase
      in cash and cash equivalents
              
              
              5,126
              
              
              
              6,061Cash
      and cash equivalents at beginning of period
              
              
              8,370
              
              
              
              7,942Cash
      and cash equivalents at end of period
              
              $
              13,496
              
              
              $
              14,003Cash
      paid during the period for:Interest
              
              $
              9,635
              
              
              $
              3,097Income
      taxes
              
              
              221
              
              
              
              -





See notes
to consolidated financial statements.


5
 Table of Contents





Notes
to Consolidated Financial Statements





NOTE
1 – NATURE OF OPERATIONS





Naugatuck
Valley Financial Corporation (the “Company”) was organized as a federal
corporation at the direction of Naugatuck Valley Savings and Loan (the “Bank”)
in connection with the mutual holding company reorganization of Naugatuck Valley
Savings.  The reorganization and initial public offering of Naugatuck
Valley Financial was completed on September 30, 2004.  In the
offering, Naugatuck Valley Financial issued a majority of its outstanding shares
of common stock to Naugatuck Valley Mutual Holding Company, the mutual holding
company parent of the Bank.  As long as Naugatuck Valley Mutual
exists, it will own at least a majority of Naugatuck Valley Financial
Corporation’s common stock.





Originally
organized in 1922, the Bank is a federally chartered stock savings bank which is
headquartered in Naugatuck, Connecticut. The Bank provides a full range of
personal banking services to individual and small business customers located
primarily in the Naugatuck Valley and the immediate surrounding
vicinity.  It is subject to competition from other financial
institutions throughout the region.  The Bank is also subject to the
regulations of various federal agencies and undergoes periodic examinations by
those regulatory authorities.





The Bank
owns the Naugatuck Valley Mortgage Servicing Corporation, which qualifies and
operates as a Connecticut passive investment company pursuant to
legislation.





NOTE
2 - BASIS OF PRESENTATION





The
accompanying condensed consolidated interim financial statements are unaudited
and include the accounts of the Company, the Bank, and the Bank’s wholly
owned subsidiary, Naugatuck Valley Mortgage Servicing Corporation. The
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
(“GAAP”) for interim financial information and with the instructions to SEC Form
10-Q.  Accordingly, they do not include all the information and
footnotes required by GAAP for complete financial statements.  All
significant intercompany accounts and transactions have been eliminated in the
consolidation. These financial statements reflect, in the opinion of management,
all adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of the Company’s financial position and the results of its
operations and its cash flows for the periods presented.





In
preparing the financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of the
date of the balance sheet, and income and expenses for the
period.  Actual results could differ from those
estimates.  Material estimates that are particularly susceptible to
significant change in the near-term relate to the determination of the allowance
for losses on loans and the valuation of real estate acquired in connection with
foreclosure or in satisfaction of loans.  While management uses
available information to recognize losses on loans and foreclosed real estate,
future additions to the allowance may be necessary based on changes in economic
conditions, particularly in Connecticut.





Operating
results for the three months ended March 31, 2008 are not necessarily indicative
of the results that may be expected for the year ending December 31,
2008.





These
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company’s Annual Report
on Form 10-K for the year ended December 31, 2007.  The year-end
condensed balance sheet data was derived from audited financial statements, but
does not include all disclosures required by GAAP.





NOTE
3 - 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.  For the
three months ended March 31, 2008, anti-dilutive options excluded from the
calculations totaled 351,030 options (with an exercise price of $11.10) and
7,500 options (with an exercise price of $12.49).  The Company had no
anti-dilutive common shares outstanding for the three months ended March 31,
2007.  Unallocated common shares held by the ESOP are not included in
the weighted-average number of common shares outstanding for purposes of
calculating either basic or diluted net income per common
share.


6
 Table of Contents







Three
      Months EndedMarch
      31,2008
              
              2007(Dollars
      in thousands, except share data)Net
      income
              
              $
              454
              
              
              $
              274Weighted-average
      common shares outstanding:Basic
              
              
              6,993,902
              
              
              
              7,184,811Effect
      of dilutive stock optionsand
      restrictive stock awards
              
              
              -
              
              
              
              40,250Diluted
              
              
              6,993,902
              
              
              
              7,225,061Net
      income per common share:Basic
              
              $
              0.06
              
              
              $
              0.04Diluted
              
              $
              0.06
              
              $
              0.04


NOTE
4 - COMPREHENSIVE INCOME





Statement
of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income," establishes standards for disclosure of comprehensive income, which
includes net income and any changes in equity from non-owner sources that are
not recorded in the income statement (such as changes in the net unrealized
gain/loss on available-for-sale securities). The purpose of reporting
comprehensive income is to provide a measure of all changes in equity that
result from recognized transactions and other economic events of the period
other than transactions with owners in their capacity as owners. The Company’s
sole source of other comprehensive income is the net unrealized gain on its
available-for-sale securities.





Three
      Months EndedMarch
      31,2008
              
              2007(In
      thousands)Net
      income
              
              $
              454
              
              
              $
              274Net
      unrealized gain onsecurities
      available for saleduring
      the period, net of tax
              
              
              506
              
              
              
              82Total
      Comprehensive Income
              $
              960
              
              $
              356





7
 Table of Contents





NOTE
5 - 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 following to be critical
accounting policies:  allowance for loan losses and deferred income
taxes.





Allowance for
Loan Losses.  Determining the
amount of the allowance for loan losses necessarily involves a high degree of
judgment.  Management reviews the level of the allowance on a
quarterly basis, at a minimum, and establishes the provision for loan losses
based on the composition of the loan portfolio, delinquency levels, loss
experience, economic conditions, and other factors related to the collectibility
of the loan portfolio.





Although
the Company 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.  The Company engages
an independent review of its commercial loan portfolio annually and adjusts its
loan ratings based upon this review.  In addition, the Company’s
regulatory authorities, as an integral part of their examination process,
periodically review the Company’s allowance for loan losses.  Such an
agency may require the Company to recognize adjustments to the allowance based
on its judgments about information available to it at the time of its
examination.





Deferred Income
Taxes.  The Company
accounts for certain income and expense items differently for financial
reporting purposes than for income tax purposes.  Provisions for
deferred taxes are being made in recognition of these temporary differences. It
is the Company's policy to recognize interest and penalties related to
unrecognized tax liabilities within income tax expense in the consolidated
statements of income.





NOTE
6 - EQUITY INCENTIVE PLAN





At the
annual meeting of stockholders on May 5, 2005, stockholders of the Company
approved the Naugatuck Valley Financial Corporation 2005 Equity Incentive Plan
(the “Incentive Plan”).  Under the Incentive Plan, the Company may
grant up to 372,614 stock options and 149,045 shares of restricted stock to its
employees, officers and directors for an aggregate amount of up to 521,659
shares of the Company’s common stock for issuance upon the grant or exercise of
awards.  Both incentive stock options and non-statutory stock options
may be granted under the Incentive Plan.





The
amounts and terms of the awards granted under the Incentive Plan are summarized
in the following table.


Grant
      dateDecember
      18,
              
              
              March
      20,
              
              
              March
      21,
              
              
              July
      26,2007
              
              
              2007
              
              
              2006
              
              
              2005Option
      awardsAwarded
              
              
              2,000
              
              
              
              7,500
              
              
              
              6,500
              
              
              
              354,580Exercise
      price
              
              $
              11.10
              
              
              $
              12.49
              
              
              $
              11.10
              
              
              $
              11.10Maximum
      term
              
              
              10
              
              
              
              10
              
              
              
              10
              
              
              
              10Restricted
      stock awardsAwarded
              
              3,000
              
              
              
              2,000
              
              
              
              1,500
              
              
              
              139,712





Stock
option awards were granted with an exercise price equal to the market price of
the Company’s stock at the date of grant with the exception of those granted on
March 21, 2006 and December 18, 2007, which have an exercise price equal to
those granted on July 26, 2005 ($11.10, which was higher than the market price
of $10.56 on March 21, 2006 and $9.09 on December 18, 2007).  Both
stock options and restricted stock awards vest at 20% per year beginning on the
first anniversary of the date of grant.


8
 Table of Contents


Stock
options and restricted stock awards are considered common stock equivalents for
the purpose of computing earnings per share on a diluted basis.





The
Company adopted Financial Accounting Standards Board’s SFAS No.123(R), “Share
Based Payment”, during 2005.  In accordance with Statement No.123 (R),
the Company is recording share-based compensation expense related to outstanding
stock option and restricted stock awards based upon the fair value at the date
of grant over the vesting period of such awards on a straight-line
basis.  The fair value of each restricted stock allocation, based on
the market price at the date of grant, is recorded to unearned stock
awards.  Compensation expenses related to unearned restricted shares
are amortized to compensation, taxes and benefits expense over the vesting
period of the restricted stock awards.  The fair value of each stock
option award is estimated on the date of grant using the Black-Scholes option
pricing method as described below.  The Company recorded share-based
compensation expense of $127,097 for the three months ended March 31, 2008,
compared with $116,487 for the three months ended March 31, 2007, in connection
with the stock option and restricted stock awards.





The fair
value of each stock option award is estimated on the date of grant using the
Black-Scholes option pricing method which includes several assumptions such as
volatility, expected dividends, expected term and risk-free rate for each stock
option award.  In determining the expected term of the option awards,
the Company elected to follow the simplified method as permitted by the SEC
Staff Accounting Bulletin 107, which was issued to provide guidance on the
implementation of SFAS 123(R). Under this method, the Company has estimated the
expected term of the options as being equal to the average of the vesting term
plus the original contractual term. The Company estimated its volatility using
the historical volatility of other, similar companies during a period of time
equal to the expected life of the options. The risk-free rate for the periods
within the contractual life of the options is based upon the U.S. Treasury yield
curve in effect at the time of grant.  Assumptions used to determine
the weighted-average fair value of stock options granted were as
follows:


December
      18,
              
              March
      20,
              
              March
      21,
              
              July
      26,Grant
      date
              
              2007
              
              2007
              
              2006
              
              2005Dividend
      yield
              
              
              2.20
              %
              
              
              1.60
              %
              
              
              1.89
              %
              
              
              1.44
              %Expected
      volatility
              
              
              11.00
              %
              
              
              10.49
              %
              
              
              11.20
              %
              
              
              11.47
              %Risk-free
      rate
              
              
              3.63
              %
              
              
              4.48
              %
              
              
              4.61
              %
              
              
              4.18
              %Expected
      life in years
              
              
              6.5
              
              
              
              6.5
              
              
              
              6.5
              
              
              
              6.5Weighted
      average fair value of options at grant date
              
              $
              1.18
              
              
              $
              2.55
              
              
              $
              2.25
              
              
              $
              2.47





NOTE
7 - DIVIDENDS





On
January 15, 2008, the Company's Board of Directors declared a cash dividend of
$0.05 per outstanding common share, which was paid on April 1, 2008, to
stockholders of record as of the close of business on February 4,
2008.





Naugatuck
Valley Mutual Holding Company, the Company's mutual holding company and majority
stock holder, waived receipt of its dividend upon non-objection from the Office
of Thrift Supervision ("OTS").





NOTE
8 – RECENT ACCOUNTING PRONOUNCEMENTS





In
September of 2006, the FASB issued Statement No. 157 (SFAS No. 157),
“Fair Value Measurements.” This statement defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. The standard establishes
a fair value hierarchy about the assumptions used to measure fair value and
clarifies assumptions about risk and the effect of a restriction on the sale or
use of an asset. SFAS No. 157 became effective for the Company on
January 1, 2008. See Note 9 to the consolidated financial statements for
additional information.





In
February 2008, the FASB issued FASB Staff Position No. 157-2. The
staff position delays the effective date of SFAS No. 157 for nonfinancial
assets and nonfinancial liabilities, except for items that are recognized or
disclosed at fair value in the financial statements on a recurring basis. The
delay is intended to allow additional time to consider the effect of various
implementation issues with regard to the application of SFAS No. 157. The
new staff position defers the effective date of SFAS No. 157 to
January 1, 2009 for items within the scope of the staff position. The
Company is currently evaluating the impact of FSP SFAS No. 157-2 on the
consolidated financial statements.


9
 Table of Contents




In
February of 2007, the FASB issued Statement No. 159 (SFAS No. 159),
“The Fair Value Option for Financial Assets and Financial Liabilities –
Including an amendment of FASB Statement No. 115.” This statement permits
the measurement of many financial instruments and certain other assets and
liabilities at fair value on an instrument-by-instrument, irrevocable basis. On
January 1, 2008, the date this pronouncement became effective, the Company
elected the fair value option on newly originated residential mortgage loans
held for sale on a prospective basis. See Note 9 to the consolidated financial
statements for additional information.





In
December 2007, the FASB issued Statement No. 141(R) – Business Combinations. This
statement replaces FASB Statement No. 141 – Business Combinations. SFAS
No. 141(R) establishes principles and requirements for how an acquiring
company (1) recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed and any noncontrolling
interest in the acquiree, (2) recognizes and measures the goodwill acquired
in the business combination or a gain from a bargain purchase, and
(3) determines what information to disclose to enable users of the
financial statements to evaluate the nature and financial effects of the
business combination. The new standard is effective for the Company on
January 1, 2009. The Company is currently evaluating the impact of adopting
SFAS No. 141(R) on the consolidated financial statements.





NOTE
9 – FAIR VALUE





Effective
January 1, 2008, the Company adopted SFAS No. 157 and SFAS
No. 159. Both standards address aspects of the expanding application of
fair value accounting.





SFAS
No. 157 defines fair value as the exchange price that would be received for
an asset or paid to transfer a liability (exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. SFAS No. 157 also establishes a
fair value hierarchy which requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value.
The standard describes three levels of inputs that may be used to measure fair
values:





Level 1 —
Quoted prices (unadjusted) for identical assets or liabilities in active
markets that the entity has the ability to access as of the measurement
date.


Level 2 —
Significant other observable inputs other than Level 1 prices such as quoted
prices for similar assets or liabilities; quoted prices in markets that are not
active; or other inputs that are observable or can be corroborated by observable
market data.


Level 3 —
Significant unobservable inputs that reflect a company’s own assumptions about
the assumptions that market participants would use in pricing an asset or
liability.





The
Company used the following methods and significant assumptions to estimate the
fair value of each type of financial instrument:





Investment
securities: The fair values for investment securities are determined by
quoted market prices, if available (Level 1). For securities where quoted prices
are not available, fair values are calculated based on market prices of similar
securities (Level 2).





Residential loans held for
sale: The fair value of loans held for sale is determined using quoted
prices for a similar asset, adjusted for specific attributes of that loan (Level
2).





10
 Table of Contents


Assets
and liabilities measured at fair value under SFAS No. 157 on a recurring
basis, including financial assets and liabilities for which the Company has
elected the fair value option, are summarized below:





Fair
      Value Measurements at March 31, 2008 Using:SignificantQuoted
      Prices in
              
              
              Other
              
              
              SignificantActive
      Markets for
              
              Observable
              
              
              UnobservableCarrying
              
              
              Identical
      Assets
              
              
              Inputs
              
              
              Inputs(In
      thousands)
              
              Amount
              
              
              (Level
      1)
              
              
              (Level
      2)
              
              
              (Level
      3)Financial
      AssetsInvestment
      securities available for sale
              
              $
              72,074
              
              
              $
              -
              
              
              $
              72,074
              
              
              $
              -Residential
      loans held for sale
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -





Financial
instruments recorded using SFAS No. 159


Under
SFAS No. 159, the Company may elect to report most financial instruments
and certain other items at fair value on an instrument-by-instrument basis with
changes in fair value reported in net income. After the initial adoption, the
election is made at the acquisition of an eligible financial asset, financial
liability or firm commitment or when certain specified reconsideration events
occur. The fair value election may not be revoked once an election is
made.





Additionally,
the transaction provisions of SFAS No. 159 permit a one-time election for
existing positions at the adoption date with a cumulative-effect adjustment
included in beginning retained earnings and future changes in fair value
reported in net income. The Company did not elect the fair value option for any
existing position at January 1, 2008.





The
Company did elect the fair value option under SFAS No. 159 prospectively
for residential loans held for sale.




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





This
discussion should be read in conjunction with the Company’s Consolidated
Financial Statements for the year ended December 31, 2007 included in the
Company’s Annual Report on Form 10-K.





Forward-Looking
Statements





This
report contains forward-looking statements that are based on assumptions and may
describe future plans, strategies and expectations of the
Company.  These forward-looking statements are generally identified by
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 which 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 U.S. government,
including policies of the U.S. 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.  Additional factors are discussed in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2007 under “Item 1A - Risk
Factors”.  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.





11
 Table of Contents





Comparison
of Financial Condition at March 31, 2008 and December 31, 2007





Total
assets increased by $29.7 million, or 6.4%, to $492.2 million during the period
from December 31, 2007 to March 31, 2008, primarily due to an increase of $17.2
million in loans, an increase in investment securities of $6.7 million and an
increase in federal funds of $3.7 million.  The increase in loans
primarily reflects an increase in our commercial real estate loans and
one-to-four family mortgages, while consumer loans remained relatively
flat.  The increases are due in part to an additional lender who was
hired in 2007 with a strong commercial background.  These increases
were primarily funded by increases in deposits and borrowings.





Total
liabilities were $441.9 million at March 31, 2008 compared to $412.1 million at
December 31, 2007.  Deposits at March 31, 2008 increased $9.1 million,
or 2.8%, over December 31, 2007 primarily due to more aggressive pricing on
promotional accounts.  Borrowed funds, including advances from the
Federal Home Loan Bank of Boston and reverse repurchase agreements, increased
$20.8 million, from $85.1 million to $105.9 million.  The increases in
deposits and borrowings were used primarily to fund the growth in loans and
investments.  In late January 2008 and early February 2008, the
Company initiated a leverage strategy to take advantage of the favorable rate
environment and increase earnings.





Total
stockholders’ equity decreased $165,000, from $50.5 million at December 31, 2007
to $50.3 million at March 31, 2008.  The decrease in equity was
primarily due to stock repurchases of $1.0 million and dividends of $142,000
paid to stockholders, partially offset by net income of $454,000 for the
three-month period, $54,000 in capital adjustments related to the Company’s 2005
Equity Incentive Plan, and a net decrease to the unrealized loss on
available-for-sale securities of $506,000.





Comparison
of Operating Results For the Three Months Ended March 31, 2008 and
2007





General.     For
the three months ended March 31, 2008, the Company had net income of $454,000
compared to $274,000 for the three months ended March 31, 2007, an increase of
$180,000.  The increase was primarily due to increases in net interest
income and noninterest income, partially offset by increases in noninterest
expense, the provision for loan losses and the provision for income
taxes.





Net Interest
Income.Net interest income
increased $413,000, or 14.3%, to $3.3 million for the three months ended March
31, 2008.  The increase in net interest income for the period resulted
from a $862,000, or 14.4%, increase in total interest income, partially offset
by a $449,000, or 14.5%, increase in interest expense.  The Company
experienced an increase in the average balances of interest earning assets of
14.4%, while the average rate earned on these assets remained constant over the
period.  Although rates on short-term, adjustable rate loans decreased
during the period as prime rate decreased, this decrease is rates was offset by
higher rates on longer term fixed-rate loans.  The increase in
interest earning assets for the three-month period is attributed primarily to an
increase in the loan portfolio.  The average balance in the loan
portfolio increased by 17.9% in the three month period, primarily in the
commercial mortgage and residential mortgage portfolios. The increase in
interest expense is attributed to a 10.5% increase in the average balance of
interest bearing deposits combined with an increase of 35.0% in the average
balance of borrowings over the period.  The largest increases in
deposits were in certificates of deposit, followed by smaller increases in money
market accounts, partially offset by decreases in checking accounts and savings
accounts.  The average rate paid on deposits and borrowings decreased
by 2 basis points over this period.











12
 Table of Contents





The
following table summarizes changes in interest income and interest expense for
the three months ended March 31, 2008 and 2007.




Three
      MonthsEnded
      March 31,2008
                
                
                2007
                
                
                %
      change(Dollars
      in thousands)Interest
      income:Loans
                
                $
                5,918
                
                
                $
                5,123
                
                
                
                15.52
                %Fed
      Funds sold
                
                
                28
                
                
                
                36
                
                
                
                -22.22
                %Investment
      securities
                
                
                833
                
                
                
                759
                
                
                
                9.75
                %Federal
      Home Loan Bank stock
                
                
                67
                
                
                
                66
                
                
                
                1.52
                %Total
      interest income
                
                
                6,846
                
                
                
                5,984
                
                
                
                14.41
                %Interest
      expense:Certificate
      accounts
                
                
                2,192
                
                
                
                1,887
                
                
                
                16.16
                %Regular
      savings accounts
                
                
                64
                
                
                
                73
                
                
                
                -12.33
                %Checking
      and NOW accounts
                
                
                72
                
                
                
                189
                
                
                
                -61.90
                %Money
      market savings accounts
                
                
                153
                
                
                
                105
                
                
                
                45.71
                %Total
      interest-bearing deposits
                
                
                2,481
                
                
                
                2,254
                
                
                
                10.07
                %FHLB
      advances
                
                
                1,063
                
                
                
                841
                
                
                
                26.40
                %Other
      borrowings
                
                
                2
                
                
                
                2
                
                
                
                0.00
                %Total
      interest expense
                
                
                3,546
                
                
                
                3,097
                
                
                
                14.50
                %Net
      interest income
                
                $
                3,300
                
                
                $
                2,887
                
                
                
                14.31
                %




The
following table summarizes average balances and average yields and costs for the
three months ended March 31, 2008 and 2007.





Three
      Months Ended March 31,2008
              
              
              2007Average
              
              
              Yield/
              
              
              Average
              
              
              Yield/Balance
              
              
              Cost
              
              
              Balance
              
              
              Cost(Dollars
      in thousands)Interest-earning
      assetsLoans
              
              $
              369,931
              
              
              
              6.40
              %
              
              $
              313,742
              
              
              
              6.53
              %Fed
      Funds sold
              
              
              2,866
              
              
              
              3.91
              %
              
              
              2,500
              
              
              
              5.76
              %Investment
      securities
              
              
              67,314
              
              
              
              4.95
              %
              
              
              69,019
              
              
              
              4.40
              %Federal
      Home Loan Bank stock
              
              
              5,073
              
              
              
              5.28
              %
              
              
              4,006
              
              
              
              6.59
              %Total
      interest-earning assets
              
              $
              445,184
              
              
              
              6.15
              %
              
              $
              389,267
              
              
              
              6.15
              %Interest-bearing
      liabilitiesCertificate
      accounts
              
              $
              202,738
              
              
              
              4.32
              %
              
              $
              167,935
              
              
              
              4.49
              %Regular
      savings accounts & escrow
              
              
              43,997
              
              
              
              0.58
              %
              
              
              47,325
              
              
              
              0.62
              %Checking
      and NOW accounts
              
              
              55,098
              
              
              
              0.52
              %
              
              
              61,659
              
              
              
              1.23
              %Money
      market savings accounts
              
              
              27,724
              
              
              
              2.21
              %
              
              
              21,316
              
              
              
              1.97
              %Total
      interest-bearing deposits
              
              
              329,557
              
              
              
              3.01
              %
              
              
              298,235
              
              
              
              3.02
              %FHLB
      advances
              
              
              93,772
              
              
              
              4.53
              %
              
              
              69,468
              
              
              
              4.84
              %Other
      borrowings
              
              
              218
              
              
              
              3.67
              %
              
              
              174
              
              
              
              4.60
              %Total
      interest-bearing liabilities
              
              $
              423,547
              
              
              
              3.35
              %
              
              $
              367,877
              
              
              
              3.37
              %


13
 Table of Contents





Interest
income increased $862,000, or 14.4%, for the three months ended March 31, 2008
as a result of a 14.4% increase in the average balance of interest-earning
assets to $445.2 million from $389.3 million. The average yield on
interest-earning assets remained constant at 6.15% in both periods.





Interest
expense increased by $449,000 for the three months ended March 31, 2008, due to
an increase of $31.3 million in the average balance of interest-bearing deposits
and an increase in the average balance of Federal Home Loan Bank advances of
$24.3 million, partially offset by a 31 basis point decrease in the average cost
of advances from 4.84% to 4.53%.




Provision for
Loan Losses.  The
following table summarizes the activity in the allowance for loan losses and
provision for loan losses for the three months ended March 31, 2008 and
2007.





Three
      Months EndedMarch
      31,2008
              
              
              2007(In
      thousands)Allowance
      at beginning of period
              
              $
              2,163
              
              
              $
              2,071Provision
      for loan losses
              
              
              162
              
              
              
              51Charge-offs
              
              
              -
              
              
              
              (51
              )Recoveries
              
              
              -
              
              
              
              1Net
      recoveries (charge-offs)
              
              
              -
              
              
              
              (50
              )Allowance
      at end of period
              
              $
              2,325
              
              
              $
              2,072




The
Company recorded a provision for loan losses of $162,000 for the three month
period ended March 31, 2008, compared to a provision of $51,000 in the 2007
period.  The increase in the provision in 2008 is due primarily to the
increasing size of the loan portfolio and a change in the mix of the portfolio
towards commercial loans which are generally riskier than one-to-four family
loans, along with general economic conditions.  The charge-off in the
2007 period was due to one home equity loan and two personal loans.




The
following table provides information with respect to the Company’s nonperforming
assets at the dates indicated.  The Company did not have any troubled
debt restructurings or any accruing loans past due 90 days or more at the dates
presented.





At
      March 31,
              
              
              At
      December 31,2008
              
              
              2007
              
              
              %
      change(Dollars
      in thousands)Nonaccrual
      loans
              
              $
              997
              
              
              $
              970
              
              
              
              2.78
              %Total
      nonperforming assets
              
              $
              997
              
              
              $
              970
              
              
              
              2.78
              %Total
      nonperforming loans to total loans
              
              
              0.26
              %
              
              
              0.27
              %
              
              
              -3.70
              %Total
      nonperforming loans to total assets
              
              
              0.20
              %
              
              
              0.21
              %
              
              
              -4.76
              %Total
      nonperforming assets to total assets
              
              
              0.20
              %
              
              
              0.21
              %
              
              
              -4.76
              %





The
Company has not experienced any significant change in loan delinquencies over
this period.


14
 Table of Contents


Noninterest
Income.The following
table summarizes noninterest income for the three months ended March 31, 2008
and 2007.




Three
      MonthsEnded
      March 31,2008
              
              
              2007
              
              
              %
      Change(Dollars
      in thousands)Fees
      for services related to deposit accounts
              
              $
              244
              
              
              $
              209
              
              
              
              16.75
              %Fees
      for other services
              
              
              117
              
              
              
              119
              
              
              
              -1.68
              %Income
      from investment advisory services, net
              
              
              82
              
              
              
              63
              
              
              
              30.16
              %Income
      from bank owned life insurance
              
              
              75
              
              
              
              76
              
              
              
              -1.32
              %Gain
      on sale of investments
              
              
              59
              
              
              
              6
              
              
              
              883.33
              %Other
      income
              
              
              50
              
              
              
              51
              
              
              
              -1.96
              %Total
              
              $
              627
              
              
              $
              524
              
              
              
              19.66
              %


Noninterest
income increased $103,000 or 19.7% for the three months ended March 31, 2008
over the same 2007 period primarily as a result of an increase in gain on the
sale of investments.  The Company also experienced an increase in fees
for services related to deposit accounts due to product growth and an increase
in income earned from investment advisory services due to a higher level of
referrals from branch employees and a general increase in activity.




Noninterest
Expense.  The following
table summarizes noninterest expense for the three months ended March 31, 2008
and 2007.





Three
      MonthsEnded
      March 31,2008
              
              
              2007
              
              
              %
      Change(Dollars
      in thousands)Compensation,
      taxes and benefits
              
              $
              1,808
              
              
              $
              1,741
              
              
              
              3.85
              %Office
      occupancy
              
              
              523
              
              
              
              513
              
              
              
              1.95
              %Computer
      processing
              
              
              195
              
              
              
              179
              
              
              
              8.94
              %Directors
      compensation
              
              
              183
              
              
              
              170
              
              
              
              7.65
              %Advertising
              
              
              81
              
              
              
              96
              
              
              
              -15.63
              %Loss
      on foreclosed real estate, net
              
              
              3
              
              
              
              -
              
              
              
              N/AOther
      expenses
              
              
              412
              
              
              
              365
              
              
              
              12.88
              %Total
              
              $
              3,205
              
              
              $
              3,064
              
              
              
              4.60
              %




Noninterest
expense increased for the three months ended March 31, 2008 primarily as a
result of an increase in compensation costs, office occupancy costs and computer
processing costs over the 2007 period.  The increases in compensation
costs were largely related to normal salary increases for existing
staff.  The primary reason for the increase in computer processing
costs was additional product offerings.





Liquidity
and Capital Resources





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


15
 Table of Contents





Each
quarter the Company projects liquidity availability and demands on this
liquidity for the next 90 days.  The Company regularly adjusts its
investments 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 our
asset/liability management program.  Excess liquid assets are invested
generally in interest-earning deposits, federal funds, short- and
intermediate-term U.S. Government agency obligations and to a lesser extent,
municipal securities and auction pass-through certificates.





The
Company’s most liquid assets are cash and cash equivalents and interest-bearing
deposits.  The levels of these assets depend on our operating,
financing, lending and investing activities during any given
period.  At March 31, 2008, cash and cash equivalents totaled $13.5
million, including federal funds of $4.2 million.  Securities
classified as available-for-sale, which provide additional sources of liquidity,
totaled $72.1 million at March 31, 2008.  At March 31, 2008, the
Company had the ability to borrow a total of $141.4 million from the Federal
Home Loan Bank of Boston, of which $105.6 million in borrowings was outstanding,
along with $276,000 in repurchase agreements.  At March 31, 2008, the
Company had arranged overnight lines of credit of $2.5 million with the Federal
Home Loan Bank of Boston.  The Company had no overnight advances
outstanding with the Federal Home Loan Bank of Boston as of that
date.  In addition, at March 31, 2008, the Company had the ability to
borrow $3.5 million from a correspondent bank.  The Company had no
advances outstanding on this line at March 31, 2008.





At March
31, 2008, the Company had commitments of $24.8 million in unadvanced
construction mortgages, $21.6 million in unused home equity lines of credit,
$1.5 million in mortgage commitments, $9.8 million in commercial loan
commitments, $6.9 million in unadvanced commercial lines, $5.1 million in
letters of credit, $2.3 million in unadvanced commitments on other loans, and
$93,000 in overdraft line of credit availability.  Certificates of
deposit due within one year of March 31, 2008 totaled $174.4 million, or 52.2%
of total deposits.  If these deposits do not remain with us, the
Company will be required to seek other sources of funds, including other
certificates of deposit and our available lines of credit.  Depending
on market conditions, the Company may be required to pay higher rates on such
deposits or other borrowings than are currently paid on the certificates of
deposit due on or before March 31, 2009.  Based on past experience,
however, the Company believes that a significant portion of our certificates of
deposit will remain with us.  The Company has the ability to attract
and retain deposits by adjusting the interest rates offered.





Historically,
the Company has remained highly liquid.  The Company is not aware of
any trends and/or demands, commitments, events or uncertainties that could
result in a material decrease in liquidity.  The Company expects that
all of our liquidity needs, including the contractual commitments stated above,
the estimated costs of our branch expansion plans and increases in loan demand
can be met by our currently available liquid assets and cash
flows.  In the event loan demand was to increase at a pace greater
than expected, or any unforeseen demand or commitment were to occur, we could
access our borrowing capacity with the Federal Home Loan Bank of
Boston.  The Company expects that our currently available liquid
assets and our ability to borrow from the Federal Home Loan Bank of Boston would
be sufficient to satisfy our liquidity needs without any material adverse effect
on our liquidity.





The
Company’s primary investing activities are the origination of loans and the
purchase of securities.  For the three months ended March 31, 2008,
the Company originated $21.8 million of loans, including renewals and
refinances, and purchased $14.8 million of securities.  These
activities were funded primarily by the proceeds from sales and maturities of
available-for-sale and held-to-maturity securities of $8.9 million and an
increase of deposits of $9.1 million.





Financing
activities consist primarily of activity in deposit accounts and in Federal Home
Loan Bank advances.  The Company experienced a net increase in total
deposits of $9.1 million for the three months ended March 31,
2008.  Deposit flows are affected by the overall level of interest
rates, the interest rates and products offered by us and its local competitors
and other factors.  The Company generally manages the pricing of
deposits to be competitive and to increase core deposit
relationships.  Occasionally, the Company offers promotional rates on
certain deposit products in order to attract deposits.  The Company
experienced a net increase in Federal Home Loan Bank advances and repurchase
agreements of $20.8 million for the three months ended March 31,
2008.  The increases in deposit accounts and borrowings primarily
funded our lending and investing activities.





The
Company is not subject to separate regulatory capital
requirements.  At March 31, 2008, the Bank was subject to the
regulatory capital requirements of the Office of Thrift Supervision (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 March 31, 2008, the Bank exceeded
all of its regulatory capital requirements.  The Bank is considered
“well capitalized” under regulatory guidelines.


16
 Table of Contents







The
following table is a summary of the Bank’s actual capital as computed under the
standards established by the OTS at March 31, 2008.





(Dollars
      in Thousands)
              
              Amount
              
              
              RatioTier
      I  Capital (to Adjusted Total Assets)
              
              $
              41,022
              
              
              
              8.40
              %Total
      Risk-Based Capital (to Risk-Weighted Assets)
              
              
              43,347
              
              
              
              12.45
              %Tier
      I Risk-Based Capital (to Risk-Weighted Assets)
              
              
              41,022
              
              
              
              11.78
              %Tangible
      Equity Capital (to Tangible Assets)
              
              
              41,022
              
              
              
              8.40
              %




Off-Balance
Sheet Arrangements





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





For the
three months ended March 31, 2008, 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.





Item
3. Quantitative and Qualitative Disclosures About Market
Risk.





Qualitative Aspects of Market
Risk.The
Company’s most significant form of market risk is interest rate
risk.  The Company manages the interest rate sensitivity of its
interest-bearing liabilities and interest-earning assets in an effort to
minimize the adverse effects of changes in the interest rate
environment.  Deposit accounts typically react more quickly to changes
in market interest rates than mortgage loans because of the shorter maturities
of deposits.  As a result, sharp increases in interest rates may
adversely affect the Company’s earnings while decreases in interest rates may
beneficially affect the Company’s earnings.  To reduce the potential
volatility of the Company’s earnings, the Company has sought to improve the
match between assets and liability maturities (or rate adjustment periods),
while maintaining an acceptable interest rate spread, by originating
adjustable-rate mortgage loans for retention in the loan portfolio,
variable-rate home equity lines and variable-rate commercial loans and by
purchasing variable-rate investments and investments with expected maturities of
less than 10 years.  The Company currently does not participate in
hedging programs, interest rate swaps or other activities involving the use of
off-balance sheet derivative financial instruments.





The
Bank’s Asset/Liability Committee communicates, coordinates and controls all
aspects of asset/liability management.  The committee establishes and
monitors the volume and mix of assets and funding sources with the objective of
managing assets and funding sources.





Quantitative
Aspects of Market Risk.  The Bank uses an interest rate
sensitivity analysis prepared by the Office of Thrift Supervision to review its
level of interest rate risk.  This analysis measures interest rate
risk by computing changes in net portfolio value of the Bank’s cash flows from
assets, liabilities and off-balance sheet items in the event of a range of
assumed changes in market interest rates.  Net portfolio value
represents the market value of portfolio equity and is equal to the market value
of assets minus the market value of liabilities, with adjustments made for
off-balance sheet items.  This analysis assesses the risk of loss in
market risk sensitive instruments in the event of a sudden and sustained 100 to
300 basis point increase or 100 to 200 basis point decrease in market interest
rates with no effect given to any steps that we might take to counter the effect
of that interest rate movement.  The Bank measures interest rate risk
by modeling the changes in net portfolio value over a variety of interest rate
scenarios.  The following table, which is based on information that
the Bank provides to the Office of Thrift Supervision, presents the change in
the Bank’s net portfolio value at December 31, 2007 (the most current
information available) that would occur in the event of an immediate change in
interest rates based on Office of Thrift Supervision assumptions, with no effect
given to any steps that the Bank might take to counteract that
change.  The Bank expects that its net portfolio value at March 31,
2008 is consistent with the table below.


17
 Table of Contents




Net
      Portfolio Value as % ofBasis
      Point ("bp")
              
              Net
      Portfolio Value
              
              
              
              
              
              Present
      Value of AssetsChange
      in Rates
              
              $
      Amount
              
              
              $
      Change
              
              
              %
      Change
              
              NPV
      Ratio
              
              Change(Dollars
      in thousands)300
              bp
              
              $
              24,814
              
              
              $
              (25,516
              )
              
              
              -51
              %
              
              
              5.64
              %
              
              
              -5.04
              %200
              
              
              
              33,916
              
              
              
              (16,414
              )
              
              
              -33
              %
              
              
              7.52
              %
              
              
              -3.16
              %100
              
              
              
              42,710
              
              
              
              (7,620
              )
              
              
              -15
              %
              
              
              9.25
              %
              
              
              -1.43
              %0
              
              
              
              50,330
              
              
              
              -
              
              
              
              -
              
              
              
              10.68
              %
              
              
              -(100
              )
              
              
              54,817
              
              
              
              4,487
              
              
              
              9
              %
              
              
              11.48
              %
              
              
              0.80
              %(200
              )
              
              
              57,368
              
              
              
              7,038
              
              
              
              14
              %
              
              
              11.89
              %
              
              
              1.21
              %


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





Item
4. 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 that 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 (the “SEC”) (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 and principal financial officers,
as appropriate to allow timely decisions regarding required
disclosure.





Except as
indicated herein, there were no changes in the Company’s internal control over
financial reporting during the three months ended March 31, 2008 that have
materially affected, or are reasonable likely to materially affect, the
Company’s internal control over financial reporting.








18
 Table of Contents


Part
II - OTHER INFORMATION





Item 1. - Legal Proceedings.





The
Company is not involved in any pending legal proceedings.  The Bank is
not involved in any pending legal proceedings other than routine legal
proceedings occurring in the ordinary course of business. Such routine legal
proceedings, in the aggregate, are believed by management to be immaterial to
its financial condition and results of operations.





Item
1A. – RiskFactors.





In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in Part I, “Item 1.A. Risk Factors” in our Annual
Report on Form 10-K for the year ended December 31, 2007, which could materially
affect our business, financial condition or future results. The risks described
in our Annual Report on Form 10-K are not the only risks that we face.
Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially adversely affect our
business, financial condition and/or operating results.





Item 2. – Unregistered Sales of Equity Securities and Use of
Proceeds.





During
the three month period ended March 31, 2008, the Company repurchased 110,000
shares of common stock for $1,035,000, at an average cost of $9.41 per share as
detailed in the following table:





Total
      Number of
              
              Maximum
      NumberShares
      Purchased as
              
              of
      Shares that MayTotal
      Number
              
              
              Average
      Price
              
              
              Part
      of Publicly
              
              Yet
      Be Purchasedof
      Shares
              
              
              Paid
              
              
              Announced
      Plans
              
              Under
      the PlansPeriod
              
              Purchased
              
              
              per
      Share
              
              
              or
      Programs
              
              or
      ProgramsJanuary
              
              
              -
              
              
              $
              -
              
              
              
              -
              
              
              
              44,337February
              
              
              110,000
              
              
              $
              9.41
              
              
              
              110,000
              
              
              
              295,544March
              
              
              -
              
              
              $
              -
              
              
              
              -
              
              
              
              295,544Total
              
              
              110,000
              
              
              $
              9.41
              
              
              
              110,000
              
              
              
              295,544




Following
the successful completion of our first stock repurchase program, the Company
announced on February 19, 2008, that the Board of Directors authorized the
Company to repurchase up to 361,207 shares, or approximately 5%, of the
outstanding shares including shares held by Naugatuck Valley Mutual Holding
Company.  The repurchases will be conducted through open-market
purchases or privately negotiated transactions and will be made from time to
time depending on market conditions and other factors.  No time limit
was placed on the duration of the share repurchase program.  Any
repurchased shares will be held as treasury stock and will be available for
general corporate purposes.





Item 3. – Defaults
Upon Senior Securities.  Not applicable





Item 4. – Submission
of Matters to a Vote of Security Holders.Not
applicable





Item 5. – Other
Information.  Not applicable





Item
6. – Exhibits.





Exhibits
      –3.1
            Charter
      of Naugatuck Valley Financial Corporation (1)3.2
            Bylaws
      of Naugatuck Valley Financial Corporation
(2)





19
 Table of Contents





4.1
            Specimen
      Stock Certificate of Naugatuck Valley Financial Corporation
      (3)31.1
            Rule
      13a-14(a)/15d-14(a) Certification.31.2
            Rule
      13a-14(a)/15d-14(a) Certification.32
            Section
      1350 Certifications.


____________________


(1)  Incorporated
by reference to the Exhibits to the Company’s Form 10-Q for the three months
ended September 30, 2004.





(2)  Incorporated
herein by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K
filed on October 18, 2007.





(3)  Incorporated
herein by reference to the Exhibits to the Company’s Registration Statement on
Form S-1, as amended, initially filed on June 18, 2004.





20
 Table of Contents





SIGNATURES





Pursuant
to the requirements 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.





Naugatuck
Valley Financial Corporation








Date:
            May
      8, 2008
            
            by:
            /s/
      John C. RomanJohn
      C. RomanPresident
      and Chief Executive Officer(principal
      executive officer)Date:
            May
      8, 2008
            
            by:
            /s/
      Lee R. SchlesingerLee
      R. SchlesingerSenior
      Vice President and Chief Financial Officer(principal
      financial officer)









21