UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
DC 20549


____________





FORM
10-Q


(Mark
One)





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





For the
quarterly period ended September 30, 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 x             No
o





Large
      Accelerated Filer  o
            Accelerated
      Filer  oNon-accelerated
      Filer  o
            Smaller
      Reporting Company  x(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
x





As of November 7, 2008, there were
7,026,894 shares of the registrant’s common stock outstanding.





NAUGATUCK
VALLEY FINANCIAL CORPORATION





Table
ofContents





Part I.  Financial Information
            Page
      No.Item 1.
            Financial Statements (Unaudited)Consolidated Statements of Financial Condition at September 30,
      2008 and December 31, 2007
            3Consolidated Statements of Income for the three and nine months
      ended September 30, 2008 and 2007
            4Consolidated Statements of Cash Flows for the nine months ended
      September 30, 2008 and 2007
            5Notes to Unaudited Consolidated Financial
      Statements
            6Item 2.
            Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
            14Liquidity and Capital Resources
            19Item 3.
            Quantitative and Qualitative Disclosures About Market
      Risk
            21Item 4.
            Controls and Procedures
            22Part II.  Other InformationItem 1.
            Legal Proceedings
            23Item 1A.
            Risk Factors
            23Item 2.
            Unregistered Sales of Equity Securities and Use of
      Proceeds
            23Item 3.
            Defaults Upon Senior Securities
            24Item 4.
            Submission of Matters to a Vote of Security
      Holders
            24Item 5.
            Other Information
            24Item 6.
            Exhibits
            24SignaturesExhibits


Table of Contents


Part
I - FINANCIAL INFORMATION








Item 1.  Financial Statements (Unaudited)





2
 Table of Contents





Consolidated Statements of Financial Condition




(In
thousands, except share data)


September
      30,
              
              
              December
      31,2008
              
              
              2007(Unaudited)ASSETSCash
      and due from depository institutions
              
              $
              7,058
              
              
              $
              7,873Investment
      in federal funds
              
              
              33
              
              
              
              497Investment
      securities
              
              
              64,352
              
              
              
              66,454Loans
      receivable, net
              
              
              415,390
              
              
              
              359,831Accrued
      income receivable
              
              
              2,083
              
              
              
              2,033Premises
      and equipment, net
              
              
              10,736
              
              
              
              10,624Bank
      owned life insurance
              
              
              8,494
              
              
              
              8,264Federal
      Home Loan Bank stock
              
              
              5,965
              
              
              
              4,632Other
      assets
              
              
              3,166
              
              
              
              2,319Total
      assets
              
              $
              517,277
              
              
              $
              462,527LIABILITIES
      AND STOCKHOLDERS' EQUITYLiabilitiesDeposits
              
              $
              359,001
              
              
              $
              321,398Borrowed
      funds
              
              
              110,640
              
              
              
              85,107Mortgagors'
      escrow accounts
              
              
              2,172
              
              
              
              3,871Other
      liabilities
              
              
              1,803
              
              
              
              1,694Total
      liabilities
              
              
              473,616
              
              
              
              412,070Commitments
      and contingenciesStockholders'
      equityCommon
      stock, $.01 par value; 25,000,000 shares authorized;7,604,375
      shares issued, 7,026,894 shares outstanding at September30,
      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
              
              
              33,621
              
              
              
              33,483Retained
      earnings
              
              
              22,105
              
              
              
              24,233Unearned
      ESOP shares (233,513 shares at September 30, 2008and
      December 31, 2007)
              
              
              (2,335
              )
              
              
              (2,335
              )Unearned
      stock awards (62,380 shares at September 30, 2008and
      90,020 shares at December 31, 2007)
              
              
              (686
              )
              
              
              (995
              )Treasury
      stock, at cost (579,314 shares at September 30, 2008and
      338,474 shares at December 31, 2007)
              
              
              (6,107
              )
              
              
              (3,889
              )Accumulated
      other comprehensive loss
              
              
              (3,013
              )
              
              
              (116
              )Total
      stockholders' equity
              
              
              43,661
              
              
              
              50,457Total
      liabilities and stockholders' equity
              
              $
              517,277
              
              $
              462,527





See notes
to consolidated financial statements.


3
 Table of Contents





Consolidated
Statements ofIncome




(In
thousands, except per share data)


Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,2008
              
              2007
              
              
              2008
              
              2007(Unaudited)Interest
      incomeInterest
      on loans
              
              $
              6,287
              
              
              $
              5,568
              
              
              $
              18,163
              
              
              $
              15,891Interest
      and dividends on investments and deposits
              
              
              937
              
              
              
              816
              
              
              
              2,785
              
              
              
              2,507Total
      interest income
              
              
              7,224
              
              
              
              6,384
              
              
              
              20,948
              
              
              
              18,398Interest
      expenseInterest
      on deposits
              
              
              2,303
              
              
              
              2,494
              
              
              
              6,949
              
              
              
              7,147Interest
      on borrowed funds
              
              
              1,196
              
              
              
              900
              
              
              
              3,440
              
              
              
              2,532Total
      interest expense
              
              
              3,499
              
              
              
              3,394
              
              
              
              10,389
              
              
              
              9,679Net
      interest income
              
              
              3,725
              
              
              
              2,990
              
              
              
              10,559
              
              
              
              8,719Provision
      for loan losses
              
              
              200
              
              
              
              -
              
              
              
              475
              
              
              
              51Net
      interest income after provision for loan losses
              
              
              3,525
              
              
              
              2,990
              
              
              
              10,084
              
              
              
              8,668Noninterest
      income (loss)Fees
      for services related to deposit accounts
              
              
              273
              
              
              
              244
              
              
              
              790
              
              
              
              685Fees
      for other services
              
              
              144
              
              
              
              163
              
              
              
              393
              
              
              
              422Income
      from bank owned life insurance
              
              
              78
              
              
              
              78
              
              
              
              230
              
              
              
              231Income
      from investment advisory services, net
              
              
              48
              
              
              
              25
              
              
              
              222
              
              
              
              173(Loss)
      gain on investments
              
              
              (3,216
              )
              
              
              9
              
              
              
              (3,111
              )
              
              
              36Other
      income
              
              
              37
              
              
              
              58
              
              
              
              126
              
              
              
              160Total
      noninterest income (loss)
              
              
              (2,636
              )
              
              
              577
              
              
              
              (1,350
              )
              
              
              1,707Noninterest
      expenseCompensation,
      taxes and benefits
              
              
              1,897
              
              
              
              1,745
              
              
              
              5,580
              
              
              
              5,229Office
      occupancy
              
              
              583
              
              
              
              492
              
              
              
              1,660
              
              
              
              1,479Computer
      processing
              
              
              232
              
              
              
              182
              
              
              
              630
              
              
              
              541Advertising
              
              
              162
              
              
              
              171
              
              
              
              361
              
              
              
              426Directors
      compensation
              
              
              111
              
              
              
              87
              
              
              
              397
              
              
              
              371Loss
      (gain) on foreclosed real estate, net
              
              
              -
              
              
              
              -
              
              
              
              3
              
              
              
              (1
              )Other
      expenses
              
              
              468
              
              
              
              481
              
              
              
              1,283
              
              
              
              1,274Total
      noninterest expense
              
              
              3,453
              
              
              
              3,158
              
              
              
              9,914
              
              
              
              9,319Income
      (loss) before provisionfor
      income taxes
              
              
              (2,564
              )
              
              
              409
              
              
              
              (1,180
              )
              
              
              1,056Provision
      for income taxes
              
              
              157
              
              
              
              55
              
              
              
              486
              
              
              
              115Net
      income (loss)
              
              $
              (2,721
              )
              
              $
              354
              
              
              $
              (1,666
              )
              
              $
              941Earnings
      (loss) per common share - Basic and Diluted
              
              $
              (0.40
              )
              
              $
              0.05
              
              
              $
              (0.24
              )
              
              $
              0.13





See notes
to consolidated financial statements.


4
 Table of Contents








Consolidated Statements ofCash Flows(In
thousands)


Nine
      Months EndedSeptember
      30,2008
              
              
              2007Cash
      flows from operating activities
              
              (Unaudited)Net
      (loss) income
              
              $
              (1,666
              )
              
              $
              941Adjustments
      to reconcile net income (loss) to cash provided by operating
      activities:Provision
      for loan losses
              
              
              475
              
              
              
              51Depreciation
      and amortization expense
              
              
              620
              
              
              
              580Net
      amortization (accretion) from investments
              
              
              42
              
              
              
              (17
              )Amortization
      of intangible assets
              
              
              25
              
              
              
              25Stock-based
      compensation
              
              
              702
              
              
              
              529Gain
      on sale of investments
              
              
              (106
              )
              
              
              (36
              )Other
      than temporary impariment charge
              
              
              3,216
              
              
              
              -Net
      change in:Accrued
      income receivable
              
              
              (49
              )
              
              
              (82
              )Deferred
      loan fees
              
              
              52
              
              
              
              32Cash
      surrender value of life insurance
              
              
              (230
              )
              
              
              (231
              )Other
      assets
              
              
              (518
              )
              
              
              321Other
      liabilities
              
              
              (136
              )
              
              
              (309
              )Net
      cash provided by operating activities
              
              
              2,427
              
              
              
              1,804Cash
      flows from investing activitiesProceeds
      from maturities and repayments of available-for-sale
      securities
              
              
              6,521
              
              
              
              6,039Proceeds
      from sale of available-for-sale securities
              
              
              12,631
              
              
              
              6,370Proceeds
      from maturities of held-to-maturity securities
              
              
              1,190
              
              
              
              1,010Purchase
      of available-for-sale securities
              
              
              (24,621
              )
              
              
              (3,156
              )Purchase
      of held-to-maturity securities
              
              
              -
              
              
              
              (250
              )Purchase
      of Federal Home Loan Bank stock
              
              
              (1,333
              )
              
              
              (492
              )Loan
      originations net of principal payments
              
              
              (56,087
              )
              
              
              (37,022
              )Purchase
      of property and equipment
              
              
              (756
              )
              
              
              (192
              )Net
      cash used by investing activities
              
              
              (62,455
              )
              
              
              (27,693
              )Cash
      flows from financing activitiesNet
      change in time deposits
              
              
              27,453
              
              
              
              32,937Net
      change in other deposit accounts
              
              
              10,150
              
              
              
              1,077Net
      change in mortgagors' escrow deposits
              
              
              (1,699
              )
              
              
              (1,631
              )Advances
      from Federal Home Loan Bank
              
              
              42,465
              
              
              
              25,927Repayment
      of advances from Federal Home Loan Bank
              
              
              (17,508
              )
              
              
              (26,822
              )Net
      change in repurchase agreements
              
              
              576
              
              
              
              230Treasury
      stock acquired
              
              
              (2,231
              )
              
              
              (1,897
              )Dividends
      paid to stockholders
              
              
              (457
              )
              
              
              (445
              )Options
      exercised
              
              
              -
              
              
              
              3Net
      cash provided by financing activities
              
              
              58,749
              
              
              
              29,379Net
      change in cash and cash equivalents
              
              
              (1,279
              )
              
              
              3,490Cash
      and cash equivalents at beginning of period
              
              
              8,370
              
              
              
              7,942Cash
      and cash equivalents at end of period
              
              $
              7,091
              
              
              $
              11,432Cash
      paid during the period for:Interest
              
              $
              10,427
              
              
              $
              9,635Income
      taxes
              
              
              818
              
              
              
              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 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, the valuation of real estate acquired in connection with
foreclosure or in satisfaction of loans, and the valuation of certain investment
securities.  While management uses available information to recognize
losses and properly value these assets, future adjustments may be necessary
based on changes in economic conditions both in Connecticut and
nationally.





Operating
results for the nine months ended September 30, 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.





6
 Table of Contents


NOTE
3 - 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:  other-than-temporary impairment, allowance for
loan losses and deferred income taxes.





Other-than-temporary
impairment. Each quarter, the Company reviews its investment portfolio to
determine whether unrealized losses are temporary, based on an evaluation of the
creditworthiness of the issuers/guarantors as well as the underlying collateral,
if applicable, as well as the continuing performance of the
securities.  Management also evaluates other facts and circumstances
that may be indicative of an other-than-temporary impairment
condition.  This includes, but is not limited to, an evaluation of the
type of security and length of time and extent to which the fair value has been
less than cost as well as certain collateral related
characteristics.





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 collectability
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
4 – 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 5 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.




In
October 2008, the FASB issued FASB Staff Position No. 157-3 (FSP 157-3),
“Determining the Fair Value of a Financial Asset When the Market for That Asset
is Not Active.” FSP 157-3 clarifies the application of SFAS 157 in a market that
is not active and provides an example to illustrate key considerations in
determining fair value of financial assets when the market for that financial
asset is not active. FSP 157-3 applies to financial assets within the scope of
accounting pronouncements that require or permit fair value measurements in
accordance with FAS 157.


7
 Table of Contents


FSP 157-3
was effective upon issuance and included prior periods for which financial
statements had not been issued. The application of FSP 157-3 did not have a
material impact on the Company’s consolidated financial statements.








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 5 to the consolidated financial
statements for additional information.








NOTE
5 – 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:





Available-for-sale
securities:Available-for-sale
securities are recorded at fair value on a recurring basis. Fair value
measurement is based upon quoted prices, if available. If quoted prices are not
available, fair values are determined by matrix pricing, which is a mathematical
technique widely used in the industry to value debt securities without relying
exclusively on quoted prices for the specific securities but rather by relying
on the securities’ relationship to other benchmark quoted securities. The
Company’s available-for-sale securities that are traded on an active exchange,
such as the New York Stock Exchange, are classified as Level 1.
Available-for-sale securities valued using matrix pricing are classified as
Level 2. As of September 30, 2008, the Company transferred two auction-rate
preferred securities in the available-for-sale portfolio from Level 2 to Level
3. Market prices of comparable instruments have become harder to identify due to
inactive markets, which has made it necessary for the Company to make
adjustments to the matrix prices to compensate for the present value of expected
cash flows, market liquidity, credit quality and volatility. As a result, the
Company utilized Level 3 inputs of greater significance, which has required the
Company to move the valuation of these securities from Level 2 to Level
3.





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).





8
 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 September 30, 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
              
              $
              64,352
              
              
              $
              -
              
              
              $
              61,291
              
              
              $
              3,061Residential
      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.








NOTE
6 – INVESTMENT SECURITIES





At
September 30, 2008, the composition of the investment portfolio
was:





Amortized
              
              
              Gross
      Unrealized
              
              
              Fair(In
      thousands)
              
              Cost
      Basis
              
              
              Gains
              
              
              Losses
              
              
              ValueAvailable-for-sale
      securities:U.S.
      government and agency obligations
              
              $
              1,539
              
              
              $
              -
              
              
              $
              (25
              )
              
              $
              1,514Municipal
      obligations
              
              
              9,112
              
              
              
              3
              
              
              
              (284
              )
              
              
              8,831Corporate
      bonds
              
              
              1,000
              
              
              
              -
              
              
              
              (700
              )
              
              
              300Mortgage-backed
      securities
              
              
              43,243
              
              
              
              52
              
              
              
              (91
              )
              
              
              43,204Collateralized
      mortgage obligations
              
              
              3,378
              
              
              
              -
              
              
              
              (106
              )
              
              
              3,272Total
      debt securities
              
              
              58,272
              
              
              
              55
              
              
              
              (1,206
              )
              
              
              57,121Auction
      rate preferred securities
              
              
              9,484
              
              
              
              -
              
              
              
              (2,253
              )
              
              
              7,231Total
      available-for-sale securities
              
              $
              67,756
              
              
              $
              55
              
              
              $
              (3,459
              )
              
              $
              64,352





The
Company had no securities classified as held-to-maturity at September 30,
2008.


9
 Table of Contents


At
December 31, 2007, the composition of the investment portfolio was:





Amortized
              
              
              Gross
      Unrealized
              
              
              Fair(In
      thousands)
              
              Cost
      Basis
              
              
              Gains
              
              
              Losses
              
              
              ValueAvailable-for-sale
      securities:U.S.
      government and agency obligations
              
              $
              2,749
              
              
              $
              1
              
              
              $
              (6
              )
              
              $
              2,744Municipal
      obligations
              
              
              14,092
              
              
              
              82
              
              
              
              (99
              )
              
              
              14,075Corporate
      bonds
              
              
              1,000
              
              
              
              -
              
              
              
              (10
              )
              
              
              990Mortgage-backed
      securities
              
              
              31,352
              
              
              
              67
              
              
              
              (158
              )
              
              
              31,261Collateralized
      mortgage obligations
              
              
              3,547
              
              
              
              -
              
              
              
              (53
              )
              
              
              3,494Total
      debt securities
              
              
              52,740
              
              
              
              150
              
              
              
              (326
              )
              
              
              52,564Auction
      rate preferred securities
              
              
              12,700
              
              
              
              -
              
              
              
              -
              
              
              
              12,700Total
      available-for-sale securities
              
              $
              65,440
              
              
              $
              150
              
              
              $
              (326
              )
              
              $
              65,264Amortized
              
              
              Gross
      Unrealized
              
              
              Fair(In
      thousands)
              
              Cost
      Basis
              
              
              Gains
              
              
              Losses
              
              
              ValueHeld-to-maturity
      securities:U.S.
      government and agency obligations
              
              $
              1,000
              
              
              $
              -
              
              
              $
              (2
              )
              
              $
              998Interest
      bearing balances
              
              
              190
              
              
              
              -
              
              
              
              -
              
              
              
              190Total
      held-to-maturity securities
              
              $
              1,190
              
              
              $
              -
              
              
              $
              (2
              )
              
              $
              1,188





In the
third quarter of 2008, as a result of actions taken in September 2008 by the
United States Treasury Department (“Treasury Department”) and the Federal
Housing Finance Agency with respect to Fannie Mae and Freddie Mac, the Company
recorded an Other Than Temporary Impairment (“OTTI”) on its investment in
auction-rate pass-through certificates collateralized by Fannie Mae perpetual
preferred stock of $3.2 million. See also Subsequent Events discussed
in Note 8, Earnings Per Share.





The
unrealized losses in all other Company investments is primarily caused by the
movement of interest rates, as well as current market
conditions.  Based upon a review of the credit quality of these
securities, the ability and intent to hold these securities for a period of time
sufficient for recovery of costs, which may be maturity, and the volatility of
their market price, the impairments related to these securities were determined
to be temporary. The ability and intent of the Company is demonstrated by the
fact that the Company is well capitalized and has no need to sell these
securities.  At September 30, 2008, these securities had an aggregate
fair value of $48,382,000 which resulted in an unrealized loss of $3,529,000 as
compared with securities with an aggregate fair value of $29,267,000 with an
unrealized loss of $328,000 at December 31, 2007.







10
 Table of Contents


NOTE
7 – LOANS RECEIVABLE





A summary
of loans receivable at September 30, 2008 and December 31, 2007 is as
follows:





September
      30,
              
              
              December
      31,(Dollars
      in thousands)
              
              2008
              
              
              2007Loans
      secured by first mortgages on real estate:Conventional:Fixed
      rate mortgage loans
              
              $
              185,582
              
              
              $
              165,764Adjustable
      rate mortgage loans
              
              
              23,187
              
              
              
              24,834Construction
      loans
              
              
              5,413
              
              
              
              7,046Commercial
      loans
              
              
              164,178
              
              
              
              123,925Loans
      on savings accounts
              
              
              1,131
              
              
              
              1,272Personal,
      auto and property improvement loans
              
              
              40,515
              
              
              
              41,146420,006
              
              
              
              363,987Less:   Allowance
      for loan losses
              
              
              2,669
              
              
              
              2,163Undisbursed
      construction loans
              
              
              1,434
              
              
              
              1,532Deferred
      loan origination fees
              
              
              513
              
              
              
              461Loans
      receivable, net
              
              $
              415,390
              
              
              $
              359,831





Non
performing loans totaled approximately $2.2 million at September 30, 2008 and
approximately $970,000 at December 31, 2007.  These loans, primarily
delinquent 90 days or more, were accounted for on a nonaccrual
basis.  The amount of income that was contractually due but not
recognized on nonperforming loans totaled $111,000 at September 30, 2008 and
$45,000 at December 31, 2007.





At
September 30, 2008, the Bank had approximately $160,000 of loans which were
considered to be impaired with an allocated allowance of $26,667 compared with
approximately $107,600 of such loans at December 31, 2007 with no allocated
allowance.  The increase is primarily due to one residential mortgage
which was modified during the period.  This mortgage has been
performing under the new terms since the modification.





Transactions
in the allowance for loan losses account were as follows for the periods
indicated:




September
      30,
              
              
              December
      31,(In
      thousands)
              
              2008
              
              
              2007Balance
      at beginning of year
              
              $
              2,163
              
              
              $
              2,071Provision
      for loan losses
              
              
              475
              
              
              
              151Loans
      written off
              
              
              (7
              )
              
              
              (61
              )Recoveries
      of loans written off
              
              
              38
              
              
              
              2Balance
      at end of period
              
              $
              2,669
              
              
              $
              2,163





NOTE
8 - 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 and nine months ended September 30, 2008, anti-dilutive options excluded
from the calculations totaled 348,450 options (with an exercise price of
$11.10)


11
 Table of Contents


and 7,500
options (with an exercise price of $12.49).  For the three months
ended September 30, 2007, anti-dilutive options excluded from the calculations
totaled 350,780 options (with an exercise price of $11.10).  For the
three and nine months ended September 30, 2007, 7,500 options (with an exercise
price of $12.49) were excluded from the calculations.  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.





Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007Net
      income (loss)
              
              $
              (2,721,000
              )
              
              $
              354,000
              
              
              $
              (1,666,000
              )
              
              $
              941,000Weighted-average
      common shares outstanding:Basic
              
              
              6,801,792
              
              
              
              7,101,126
              
              
              
              6,881,565
              
              
              
              7,143,940Effect
      of dilutive stock optionsand
      restrictive stock awards
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              22,375Diluted
              
              
              6,801,792
              
              
              
              7,101,126
              
              
              
              6,881,565
              
              
              
              7,166,315Net
      income (loss) per common share:Basic
              
              $
              (0.40
              )
              
              $
              0.05
              
              
              $
              (0.24
              )
              
              $
              0.13Diluted
              
              $
              (0.40
              )
              
              $
              0.05
              
              
              $
              (0.24
              )
              
              $
              0.13








Subsequent
event





Following
the U.S. Government’s action of placing Fannie Mae into conservatorship in
September 2008, the Company recorded an OTTI charge of $3.2 million on the
Company’s auction rate pass-through certificates backed by Fannie Mae preferred
stock.  Section 301 of the Emergency Economic Stabilization Act of
2008 (“EESA”), enacted on October 3, 2008, provides tax relief by treating these
losses as ordinary losses rather than capital losses for federal income tax
purposes.  Under Statement of Financial Accounting Standards No. 109,
a company can not record the effect of changes in tax laws until the period in
which the law is enacted.  As a result, the Company will record a
deferred tax benefit of $1.1 million related to the OTTI loss in the fourth
quarter of 2008 and not in the third quarter of 2008.  The following
table shows the earnings per share calculations if the tax benefit was allowed
to be recorded in the third quarter of 2008.





Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007Net income (loss)(as reported on Statement of
      Operations)
              
              $
              (2,721,000
              )
              
              $
              354,000
              
              
              $
              (1,666,000
              )
              
              $
              941,000Tax
      benefit from OTTI charge
              
              
              1,093,000
              
              
              
              -
              
              
              
              1,093,000
              
              
              
              -Net income (loss) (adjusted)
              
              $
              (1,628,000
              )
              
              $
              354,000
              
              
              $
              (573,000
              )
              
              $
              941,000Weighted-average
      common shares outstanding:Basic
              
              
              6,801,792
              
              
              
              7,101,126
              
              
              
              6,881,565
              
              
              
              7,143,940Effect
      of dilutive stock optionsand
      restrictive stock awards
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              22,375Diluted
              
              
              6,801,792
              
              
              
              7,101,126
              
              
              
              6,881,565
              
              
              
              7,166,315Net
      income (loss) per common share:Basic
              
              $
              (0.24
              )
              
              $
              0.05
              
              
              $
              (0.08
              )
              
              $
              0.13Diluted
              
              $
              (0.24
              )
              
              $
              0.05
              
              
              $
              (0.08
              )
              
              $
              0.13








12
 Table of Contents


NOTE
9 - COMPREHENSIVE INCOME





Comprehensive
income is the net income of a company adjusted for 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
(loss) on its available-for-sale securities.





Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              September
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007(In
      thousands)Net
      income (loss)
              
              $
              (2,721
              )
              
              $
              354
              
              
              $
              (1,666
              )
              
              $
              941Net
      unrealized gain (loss) onsecurities
      available for saleduring
      the period, net of tax
              
              
              (2,441
              )
              
              
              446
              
              
              
              (2,897
              )
              
              
              84Total
      Comprehensive Income (Loss)
              
              $
              (5,162
              )
              
              $
              800
              
              
              $
              (4,563
              )
              
              $
              1,025








NOTE
10 - EQUITY INCENTIVE PLAN





Under the
Naugatuck Valley Financial Corporation 2005 Equity Incentive Plan (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
      dateJuly
      26,
              
              
              December
      18,
              
              
              March
      20,
              
              
              March
      21,
              
              
              July
      26,2008
              
              
              2007
              
              
              2007
              
              
              2006
              
              
              2005Option
      awardsAwarded
              
              
              1,000
              
              
              
              2,000
              
              
              
              7,500
              
              
              
              6,500
              
              
              
              354,580Exercise
      price
              
              $
              11.10
              
              
              $
              11.10
              
              
              $
              12.49
              
              
              $
              11.10
              
              
              $
              11.10Maximum
      term
              
              
              10
              
              
              
              10
              
              
              
              10
              
              
              
              10
              
              
              
              10Restricted
      stock awardsAwarded
              
              
              1,000
              
              
              
              3,000
              
              
              
              2,000
              
              
              
              1,500
              
              
              
              139,712





To date,
stock option awards have been granted with an exercise price equal to the higher
of the market price of the Company’s stock at the date of grant or $11.10, which
was the market price of the Company’s stock at the date stock option awards were
initially granted under the Incentive Plan.  Both stock options and
restricted stock awards vest at 20% per year beginning on the first anniversary
of the date of grant.





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 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


13
 Table of Contents


described
below.  The Company recorded share-based compensation expense of
$126,760 and $380,954 for the three and nine months ended September 30, 2008,
respectively, compared to $118,164 and $352,402 for the three and nine months
ended September 30, 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:





July
      26,
              
              
              December
      18,
              
              
              March
      20,
              
              
              March
      21,
              
              
              July
      26,Grant
      date
              
              2008
              
              
              2007
              
              
              2007
              
              
              2006
              
              
              2005Dividend
      yield
              
              
              2.74
              %
              
              
              2.20
              %
              
              
              1.60
              %
              
              
              1.89
              %
              
              
              1.44
              %Expected
      volatility
              
              
              13.40
              %
              
              
              11.00
              %
              
              
              10.49
              %
              
              
              11.20
              %
              
              
              11.47
              %Risk-free
      rate
              
              
              3.56
              %
              
              
              3.63
              %
              
              
              4.48
              %
              
              
              4.61
              %
              
              
              4.18
              %Expected
      life in years
              
              
              6.5
              
              
              
              6.5
              
              
              
              6.5
              
              
              
              6.5
              
              
              
              6.5Weighted
      average fair valueof
      options at grant date
              
              $
              1.51
              
              
              $
              1.18
              
              
              $
              2.55
              
              
              $
              2.25
              
              
              $
              2.47








NOTE
11 - DIVIDENDS





On July
15, 2008, the Company's Board of Directors declared a cash dividend of $0.06 per
outstanding common share, which was paid on September 2, 2008, to stockholders
of record as of the close of business on August 4, 2008.





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







Item
2. Management’sDiscussion 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”.


14
 Table of Contents


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.








Non-GAAP
Financial Measures





This
report contains certain non-GAAP financial measures in addition to results
presented in accordance with GAAP.  These measures include net income,
noninterest income and earnings per share adjusted for the tax benefit on the
OTTI charge.  These measures should not be construed as a substitute
for GAAP measures; they should be read and used in conjunction with the
Company’s GAAP financial information.  A reconciliation of the
included non-GAAP financial measures to GAAP measures is included elsewhere in
this report.








Comparison
of Financial Condition at September 30, 2008 and December 31, 2007





Total
assets increased by $54.8 million, or 11.8%, to $517.3 million during the period
from December 31, 2007 to September 30, 2008, primarily due to an increase of
$55.6 million in loans, partially offset by a decrease in investment
securities.  The increase in loans primarily reflects increases of
$40.3 million in our commercial real estate loans and $18.2 million in
one-to-four family mortgages, partially offset by a decrease in construction
loans.  The increase in commercial loans is 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 $473.6 million at September 30, 2008 compared to $412.1 million
at December 31, 2007.  Deposits at September 30, 2008 increased $37.6
million, or 11.7%, 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 $25.5 million, from $85.1 million to $110.6 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 $6.8 million, from $50.5 million at December 31,
2007 to $43.7 million at September 30, 2008.  The decrease in equity
was primarily due to a net increase to the unrealized loss on available-for-sale
securities of $2.9 million, stock repurchases of $2.2 million, a net loss of
$1.7 million for the nine months and dividends of $458,000 paid to stockholders,
partially offset by $456,000 in capital adjustments related to the Company’s
2005 Equity Incentive Plan.








Comparison
of Operating Results For the Three and Nine Months Ended September 30, 2008 and
2007





General.     For
the three months ended September 30, 2008, the Company experienced a net loss of
$2.7 million compared to net income of $354,000 for the three months ended
September 30, 2007.  For the nine months ended September 30, 2008, the
Company experienced a net loss of $1.7 million, compared to net income of
$941,000 for the nine months ended September 30, 2007.  The net loss
in both the three and nine month periods was due to an OTTI charge on auction
rate pass-through certificates secured by Fannie Mae preferred stock as the
underlying collateral.  Absent the OTTI charge, net income would have
been $495,000 and $1.5 million for the three and nine months ended September 30,
2008, respectively, as shown in the following table.


15
 Table of Contents


SELECTED
      OPERATIONS DATAThree
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30, 2008
              
              
              September
      30, 2008Before
              
              
              OTTI
              
              
              After
              
              
              Before
              
              
              OTTI
              
              
              AfterOTTI
              
              
              Charge
              
              
              OTTI
              
              
              OTTI
              
              
              Charge
              
              
              OTTI(Unaudited)(In
      thousands, except per share data)Total
      interest income
              
              $
              7,224
              
              
              
              
              
              $
              7,224
              
              
              $
              20,948
              
              
              
              
              
              $
              20,948Total
      interest expense
              
              
              3,499
              
              
              
              
              
              
              3,499
              
              
              
              10,389
              
              
              
              
              
              
              10,389Net
      interest income
              
              
              3,725
              
              
              
              
              
              
              3,725
              
              
              
              10,559
              
              
              
              
              
              
              10,559Provision
      for loan losses
              
              
              200
              
              
              
              
              
              
              200
              
              
              
              475
              
              
              
              
              
              
              475Net
      interest income after provision for loan losses
              
              
              3,525
              
              
              
              
              
              
              3,525
              
              
              
              10,084
              
              
              
              
              
              
              10,084Noninterest
      income (loss)
              
              
              580
              
              
              
              (3,216
              )
              
              
              (2,636
              )
              
              
              1,866
              
              
              
              (3,216
              )
              
              
              (1,350
              )Noninterest
      expense
              
              
              3,453
              
              
              
              
              
              
              
              3,453
              
              
              
              9,914
              
              
              
              
              
              
              
              9,914Income
      (loss) before provisionfor
      income taxes
              
              
              652
              
              
              
              
              
              
              
              (2,564
              )
              
              
              2,036
              
              
              
              
              
              
              
              (1,180
              )Provision
      for income taxes
              
              
              157
              
              
              
              
              
              
              
              157
              
              
              
              486
              
              
              
              
              
              
              
              486Net
      income (loss)
              
              $
              495
              
              
              
              
              
              
              $
              (2,721
              )
              
              $
              1,550
              
              
              
              
              
              
              $
              (1,666
              )Earnings
      (loss) per common share - basic and diluted
              
              $
              0.07
              
              
              
              
              
              
              $
              (0.40
              )
              
              $
              0.22
              
              
              
              
              
              
              $
              (0.24
              )





Net Interest
Income.Net interest income
increased $735,000, or 24.6%, to $3.7 million for the three months ended
September 30, 2008 and increased by $1.8 million, or 21.1%, to $10.6 million for
the nine months ended September 30, 2008.  The increase in net
interest income for the three month period resulted from a $840,000, or 13.2%,
increase in total interest income, partially offset by a $105,000, or 3.1%,
increase in interest expense.  For the nine month period ended
September 30, 2008, total interest income increased $2.5 million, or 13.9%,
partially offset by an increase of $710,000, or 7.3%, in total interest
expense.  The Company experienced an increase in the average balances
of interest earning assets of 19.9% in the three month period and an increase of
17.3% for the nine month period, while the average rate earned on these assets
decreased by 35 basis points and 19 basis points over the same
periods.  The increase in interest earning assets for both periods is
attributed primarily to an increase in the loan portfolio.  The
average balance in the loan portfolio increased by 20.6% in the three month
period, and by 19.6% in the nine month period, primarily in the commercial
mortgage and residential mortgage portfolios.





Interest
expense increased by $105,000, or 3.1% for the three months ended September 30,
2008, due to an increase of $82.9 million in the average balance of
interest-bearing liabilities partially offset by a decrease in the average cost
of these liabilities from 3.52% to 2.99%.  The average balance of
borrowed funds increased by $38.8 million over this period and the average
balance of interest-bearing deposits increased by 14.1%.  Interest
expense also increased in the nine month period ended September 30, 2008 by
$710,000, or 7.3%, again as a result of an increase in the average balance of
interest-bearing liabilities of $69.9 million, or 18.7%.  The average
cost decreased by 33 basis points from 3.44% to 3.11% over this
period.










16
 Table of Contents





The
following table summarizes changes in interest income and interest expense for
the three and nine months ended September 30, 2008 and 2007.





Three
      Months
              
              
              
              
              
              Nine
      MonthsEnded
      September 30,
              
              
              
              
              
              Ended
      September 30,2008
              
              
              2007
              
              
              %
      change
              
              
              2008
              
              
              2007
              
              
              %
      change(Dollars
      in thousands)Interest
      income:Loans
              
              $
              6,287
              
              
              $
              5,568
              
              
              
              12.91
              %
              
              $
              18,163
              
              
              $
              15,891
              
              
              
              14.30
              %Fed
      Funds sold
              
              
              22
              
              
              
              43
              
              
              
              -48.84
              %
              
              
              56
              
              
              
              114
              
              
              
              -50.88
              %Investment
      securities
              
              
              871
              
              
              
              707
              
              
              
              23.20
              %
              
              
              2,568
              
              
              
              2,194
              
              
              
              17.05
              %Federal
      Home Loan Bank stock
              
              
              44
              
              
              
              66
              
              
              
              -33.33
              %
              
              
              161
              
              
              
              199
              
              
              
              -19.10
              %Total
      interest income
              
              
              7,224
              
              
              
              6,384
              
              
              
              13.16
              %
              
              
              20,948
              
              
              
              18,398
              
              
              
              13.86
              %Interest
      expense:Certificate
      accounts
              
              
              2,071
              
              
              
              2,175
              
              
              
              -4.78
              %
              
              
              6,197
              
              
              
              6,110
              
              
              
              1.42
              %Regular
      savings accounts
              
              
              72
              
              
              
              59
              
              
              
              22.03
              %
              
              
              204
              
              
              
              199
              
              
              
              2.51
              %Checking
      and NOW accounts
              
              
              37
              
              
              
              93
              
              
              
              -60.22
              %
              
              
              142
              
              
              
              434
              
              
              
              -67.28
              %Money
      market savings accounts
              
              
              123
              
              
              
              167
              
              
              
              -26.35
              %
              
              
              406
              
              
              
              404
              
              
              
              0.50
              %Total
      interest-bearing deposits
              
              
              2,303
              
              
              
              2,494
              
              
              
              -7.66
              %
              
              
              6,949
              
              
              
              7,147
              
              
              
              -2.77
              %FHLB
      advances
              
              
              1,190
              
              
              
              898
              
              
              
              32.52
              %
              
              
              3,428
              
              
              
              2,525
              
              
              
              35.76
              %Other
      borrowings
              
              
              6
              
              
              
              2
              
              
              
              200.00
              %
              
              
              12
              
              
              
              7
              
              
              
              71.43
              %Total
      interest expense
              
              
              3,499
              
              
              
              3,394
              
              
              
              3.09
              %
              
              
              10,389
              
              
              
              9,679
              
              
              
              7.34
              %Net
      interest income
              
              $
              3,725
              
              
              $
              2,990
              
              
              
              24.58
              %
              
              $
              10,559
              
              
              $
              8,719
              
              
              
              21.10
              %








The
following table summarizes average balances and average yields and costs for the
three and nine months ended September 30, 2008 and 2007.





Three
      Months Ended September 30,
              
              
              Nine
      Months Ended September 30,2008
              
              
              2007
              
              
              2008
              
              
              2007Average
              
              
              Yield/
              
              
              Average
              
              
              Yield/
              
              
              Average
              
              
              Yield/
              
              
              Average
              
              
              Yield/Balance
              
              
              Cost
              
              
              Balance
              
              
              Cost
              
              
              Balance
              
              
              Cost
              
              
              Balance
              
              
              Cost(Dollars
      in thousands)Interest-earning
      assetsLoans
              
              $
              407,075
              
              
              
              6.18
              %
              
              $
              337,421
              
              
              
              6.60
              %
              
              $
              387,338
              
              
              
              6.25
              %
              
              $
              323,964
              
              
              
              6.54
              %Fed
      Funds sold
              
              
              4,218
              
              
              
              2.09
              %
              
              
              3,179
              
              
              
              5.41
              %
              
              
              2,769
              
              
              
              2.70
              %
              
              
              2,716
              
              
              
              5.60
              %Investment
      securities
              
              
              71,378
              
              
              
              4.88
              %
              
              
              62,886
              
              
              
              4.50
              %
              
              
              70,284
              
              
              
              4.87
              %
              
              
              66,421
              
              
              
              4.40
              %Federal
      Home Loan Bank stock
              
              
              5,965
              
              
              
              2.95
              %
              
              
              4,209
              
              
              
              6.27
              %
              
              
              5,605
              
              
              
              3.83
              %
              
              
              4,092
              
              
              
              6.48
              %Total
      interest-earning assets
              
              $
              488,636
              
              
              
              5.91
              %
              
              $
              407,695
              
              
              
              6.26
              %
              
              $
              465,996
              
              
              
              5.99
              %
              
              $
              397,193
              
              
              
              6.18
              %Interest-bearing
      liabilitiesCertificate
      accounts
              
              $
              226,701
              
              
              
              3.65
              %
              
              $
              187,494
              
              
              
              4.64
              %
              
              $
              211,154
              
              
              
              3.91
              %
              
              $
              177,314
              
              
              
              4.59
              %Regular
      savings accounts & escrow
              
              
              48,091
              
              
              
              0.60
              %
              
              
              44,794
              
              
              
              0.53
              %
              
              
              47,277
              
              
              
              0.58
              %
              
              
              46,589
              
              
              
              0.57
              %Checking
      and NOW accounts
              
              
              54,915
              
              
              
              0.27
              %
              
              
              54,486
              
              
              
              0.68
              %
              
              
              53,935
              
              
              
              0.35
              %
              
              
              58,445
              
              
              
              0.99
              %Money
      market savings accounts
              
              
              27,324
              
              
              
              1.80
              %
              
              
              26,190
              
              
              
              2.55
              %
              
              
              27,859
              
              
              
              1.94
              %
              
              
              23,645
              
              
              
              2.28
              %Total
      interest-bearing deposits
              
              
              357,031
              
              
              
              2.58
              %
              
              
              312,964
              
              
              
              3.19
              %
              
              
              340,225
              
              
              
              2.72
              %
              
              
              305,993
              
              
              
              3.11
              %FHLB
      advances
              
              
              110,570
              
              
              
              4.30
              %
              
              
              72,309
              
              
              
              4.97
              %
              
              
              104,173
              
              
              
              4.39
              %
              
              
              68,787
              
              
              
              4.89
              %Other
      borrowings
              
              
              867
              
              
              
              2.77
              %
              
              
              279
              
              
              
              2.87
              %
              
              
              581
              
              
              
              2.75
              %
              
              
              264
              
              
              
              3.54
              %Total
      interest-bearing liabilities
              
              $
              468,468
              
              
              
              2.99
              %
              
              $
              385,552
              
              
              
              3.52
              %
              
              $
              444,979
              
              
              
              3.11
              %
              
              $
              375,044
              
              
              
              3.44
              %


17
 Table of Contents


Provision for
Loan Losses.  The
following table summarizes the activity in the allowance for loan losses and
provision for loan losses for the three and nine months ended September 30, 2008
and 2007.





Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007(In
      thousands)Allowance
      at beginning of period
              
              $
              2,469
              
              
              $
              2,073
              
              
              $
              2,163
              
              
              $
              2,071Provision
      for loan losses
              
              
              200
              
              
              
              -
              
              
              
              475
              
              
              
              51Charge-offs
              
              
              -
              
              
              
              (2
              )
              
              
              (7
              )
              
              
              (53
              )Recoveries
              
              
              -
              
              
              
              -
              
              
              
              38
              
              
              
              2Net
      recoveries (charge-offs)
              
              
              -
              
              
              
              (2
              )
              
              
              31
              
              
              
              (51
              )Allowance
      at end of period
              
              $
              2,669
              
              
              $
              2,071
              
              
              $
              2,669
              
              
              $
              2,071





The
Company recorded a provision for loan losses of $200,000 for the three month
period ended September 30, 2008, compared to no provision in the 2007
period.  Provisions of $475,000 and $51,000 were recorded for the nine
months ended September 30, 2008 and 2007, respectively.  The increase
in the provisions in the 2008 periods 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 an
increase in nonperforming loans and general economic conditions.  The
charge-offs in the 2008 period were due to two unsecured personal loans and the
charge-offs in the 2007 period were 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 modified the terms of one residential mortgage during the quarter ended
June 30, 2008 in the amount of $115,000.  This mortgage has been
performing under the new terms since the modification.  The Company
did not have any accruing loans past due 90 days or more at the dates
presented.





At
      September 30,
              
              
              At
      December 31,2008
              
              
              2007
              
              
              %
      change(Dollars
      in thousands)Nonaccrual
      loans
              
              $
              2,215
              
              
              $
              970
              
              
              
              128.35
              %Total
      nonperforming assets
              
              $
              2,215
              
              
              $
              970
              
              
              
              128.35
              %Total
      nonperforming loans to total loans
              
              
              0.53
              %
              
              
              0.27
              %
              
              
              96.30
              %Total
      nonperforming loans to total assets
              
              
              0.43
              %
              
              
              0.21
              %
              
              
              104.76
              %Total
      nonperforming assets to total assets
              
              
              0.43
              %
              
              
              0.21
              %
              
              
              104.76
              %








Noninterest
Income.The following
table summarizes noninterest income for the three and nine months ended
September 30, 2008 and 2007.




Three
      Months
              
              
              
              
              
              Nine
      MonthsEnded
      September 30,
              
              
              
              
              
              Ended
      September 30,2008
              
              
              2007
              
              
              %
      Change
              
              
              2008
              
              
              2007
              
              
              %
      Change(Dollars
      in thousands)Fees
      for services related to deposit accounts
              
              $
              273
              
              
              $
              244
              
              
              
              11.89
              %
              
              $
              790
              
              
              $
              685
              
              
              
              15.33
              %Fees
      for other services
              
              
              144
              
              
              
              163
              
              
              
              -11.66
              %
              
              
              393
              
              
              
              422
              
              
              
              -6.87
              %Income
      from bank owned life insurance
              
              
              78
              
              
              
              78
              
              
              
              0.00
              %
              
              
              230
              
              
              
              231
              
              
              
              -0.43
              %Income
      from investment advisory services, net
              
              
              48
              
              
              
              25
              
              
              
              92.00
              %
              
              
              222
              
              
              
              173
              
              
              
              28.32
              %(Loss)
      gain on  investments
              
              
              (3,216
              )
              
              
              9
              
              
              
              -35,833.33
              %
              
              
              (3,111
              )
              
              
              36
              
              
              
              -8,741.67
              %Other
      income
              
              
              37
              
              
              
              58
              
              
              
              -36.21
              %
              
              
              126
              
              
              
              160
              
              
              
              -21.25
              %Total
              
              $
              (2,636
              )
              
              $
              577
              
              
              
              -556.85
              %
              
              $
              (1,350
              )
              
              $
              1,707
              
              
              
              -179.09
              %





18
 Table of Contents


Noninterest
income, net of the OTTI charge, was a loss of $2.6 million and $1.4 million for
the three and nine months ended September 30, 2008.  Excluding the
$3.2 million OTTI charge, noninterest income was $580,000 and $1.9 million for
the three and nine month periods ended September 30, 2008, versus $577,000 and
$1.7 million for the three and nine months ended September 30, 2007, an increase
of 0.5% and 9.3%, respectively.  The increases in both periods were
primarily as a result of increases in the fees for services related to deposit
accounts and income from investment advisory services, partially offset by
decreases in fees for other services.  The increases in fees for
services related to deposit accounts is due to product growth and the increase
in income earned from investment advisory services is 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 and nine months ended
September 30, 2008 and 2007.





Three
      Months
              
              
              
              
              
              Nine
      MonthsEnded
      September 30,
              
              
              
              
              
              Ended
      September 30,2008
              
              
              2007
              
              
              %
      Change
              
              
              2008
              
              
              2007
              
              
              %
      Change(Dollars
      in thousands)Compensation,
      taxes and benefits
              
              $
              1,897
              
              
              $
              1,745
              
              
              
              8.71
              %
              
              $
              5,580
              
              
              $
              5,229
              
              
              
              6.71
              %Office
      occupancy
              
              
              583
              
              
              
              492
              
              
              
              18.50
              %
              
              
              1,660
              
              
              
              1,479
              
              
              
              12.24
              %Computer
      processing
              
              
              232
              
              
              
              182
              
              
              
              27.47
              %
              
              
              630
              
              
              
              541
              
              
              
              16.45
              %Advertising
              
              
              162
              
              
              
              171
              
              
              
              -5.26
              %
              
              
              361
              
              
              
              426
              
              
              
              -15.26
              %Directors
      compensation
              
              
              111
              
              
              
              87
              
              
              
              27.59
              %
              
              
              397
              
              
              
              371
              
              
              
              7.01
              %Loss
      (gain) on foreclosed real estate, net
              
              
              -
              
              
              
              -
              
              
              
              N/A
              
              
              
              3
              
              
              
              (1
              )
              
              
              -400.00
              %Other
      expenses
              
              
              468
              
              
              
              481
              
              
              
              -2.70
              %
              
              
              1,283
              
              
              
              1,274
              
              
              
              0.71
              %Total
              
              $
              3,453
              
              
              $
              3,158
              
              
              
              9.34
              %
              
              $
              9,914
              
              
              $
              9,319
              
              
              
              6.38
              %








Noninterest
expense increased in the three and nine months ended September 30, 2008
primarily as a result of an increase in compensation costs, office occupancy
costs and computer processing costs over the 2007 periods.  The
increases in compensation costs were largely related to normal salary increases
for existing staff and the opening of our tenth office in July
2008.  Rental expense, increases in property taxes and general repairs
and maintenance are the reasons for the increases in office occupancy, partially
due to the opening of our tenth office.  The primary reason for the
increase in computer processing costs was additional product
offerings.  The increases were partially offset by decreases in
advertising expenses.








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.





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 federal funds, short- and intermediate-term U.S. Government agency
obligations and to a lesser extent, municipal securities.





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 September 30, 2008, cash and cash equivalents totaled $7.1
million, including federal funds of $33,000.  Securities classified as
available-for-sale, which provide additional sources of liquidity, totaled $64.4
million at September 30, 2008.  At September 30, 2008, the Company had
the ability to borrow a total of $150.3 million from the Federal Home
Loan


19
 Table of Contents


Bank of
Boston, of which $109.8 million in borrowings was outstanding, along with
$805,000 in repurchase agreements.  At September 30, 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 September 30, 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 September 30, 2008.





The
following table summarizes the commitments and contingent liabilities as of the
dates indicated:





September
      30,
              
              
              December
      31,(In
      thousands)
              
              2008
              
              2007Commitments
      to extend credit:Loan
      commitments
              
              $
              22,777
              
              
              $
              23,994Unused
      lines of credit
              
              
              20,127
              
              
              
              22,067Amounts
      due mortgagors on construction loans
              
              
              27,869
              
              
              
              22,783Amounts
      due on commercial  loans
              
              
              15,244
              
              
              
              7,673Commercial
      letters of credit
              
              
              5,070
              
              
              
              5,698





Certificates
of deposit due within one year of September 30, 2008 totaled $113.5 million, or
31.6% 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 September 30, 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 nine months ended September 30, 2008,
the Company originated $83.0 million of loans, including renewals and
refinances, and purchased $24.6 million of securities.  These
activities were funded primarily by an increase of $37.6 million in deposits, an
increase of $25.5 million in borrowings, and the proceeds from sales and
maturities of available-for-sale and held-to-maturity securities of $20.3
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 $37.6 million for the nine months ended September 30,
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 $25.5 million for the nine months ended September 30,
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 September 30, 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 September 30, 2008, the Bank
exceeded all of its regulatory capital requirements.  The Bank is
considered “well capitalized” under regulatory guidelines.


20
 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 September 30, 2008.





Naugatuck
      ValleyOTS
      Regulation
              
              
              Savings
      and LoanAdequately
              
              
              Well(Dollars
      in thousands)
              
              Capitalized
              
              
              Capitalized
              
              
              Amount
              
              
              RatioTier
      I  Capital (to Adjusted Total Assets)
              
              
              4.00
              %
              
              
              5.00
              %
              
              $
              40,145
              
              
              
              7.74
              %Total
      Risk-Based Capital (to Risk-Weighted Assets)
              
              
              8.00
              %
              
              
              10.00
              %
              
              
              42,814
              
              
              
              11.30
              %Tier
      I Risk-Based Capital (to Risk-Weighted Assets)
              
              
              4.00
              %
              
              
              6.00
              %
              
              
              40,145
              
              
              
              10.59
              %Tangible
      Equity Capital (to Tangible Assets)
              
              
              4.00
              %
              
              
              5.00
              %
              
              
              40,145
              
              
              
              7.74
              %








In early
September 2008, the U.S. Government placed Fannie Mae into conservatorship,
resulting in an OTTI charge of $3.2 million on the Company’s auction rate
pass-through certificates backed by Fannie Mae preferred
stock.  Section 301 of the EESA, enacted on October 3, 2008, provides
tax relief by treating these losses as ordinary losses rather than capital
losses for federal income tax purposes.  Under Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes, a company can not
record the effect of changes in tax laws until the period in which the law is
enacted.  For purposes of the third quarter 2008 regulatory capital
calculations, the federal banking agencies are allowing banking organizations to
adjust the tax effects associated with the losses on Fannie Mae preferred stock
as if Section 301 of EESA had been enacted in the third quarter
2008.  The $1.1 million tax benefit related to the OTTI loss on Fannie
Mae auction rate pass-through certificates that will not be recorded for GAAP
purposes in the Company’s financial statements until the quarter ending December
31, 2008 is included in the September 30, 2008 regulatory capital numbers in the
table presented above.








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
nine months ended September 30, 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


21
 Table of Contents


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 OTS 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 50 to 300 basis point increase or 50 to 100 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 OTS, presents the change in the Bank’s
net portfolio value at June 30, 2008 (the most current information available)
that would occur in the event of an immediate change in interest rates based on
OTS assumptions, with no effect given to any steps that the Bank might take to
counteract that change.





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
              
              $
              28,868
              
              
              $
              (20,620
              )
              
              
              -42
              %
              
              
              5.99
              %
              
              
              -3.64
              %200
              
              
              
              35,962
              
              
              
              (13,526
              )
              
              
              -27
              %
              
              
              7.30
              %
              
              
              -2.33
              %100
              
              
              
              42,936
              
              
              
              (6,552
              )
              
              
              -13
              %
              
              
              8.53
              %
              
              
              -1.10
              %50
              
              
              
              46,325
              
              
              
              (3,163
              )
              
              
              -6
              %
              
              
              9.11
              %
              
              
              -0.52
              %0
              
              
              
              49,488
              
              
              
              -
              
              
              
              -
              
              
              
              9.63
              %
              
              
              -(50
              )
              
              
              51,831
              
              
              
              2,343
              
              
              
              5
              %
              
              
              10.00
              %
              
              
              0.37
              %(100
              )
              
              
              53,201
              
              
              
              3,713
              
              
              
              8
              %
              
              
              10.20
              %
              
              
              0.57
              %




The OTS
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.


22
 Table of Contents




There
were no changes in the Company’s internal control over financial reporting
during the three months ended September 30, 2008 that have materially affected,
or are reasonable likely to materially affect, the Company’s internal control
over financial reporting.








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. – Risk Factors.





In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in Part I, “Item 1A. 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 September 30, 2008, the Company repurchased 16,700
shares of common stock for $147,625, at an average cost of $8.84 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
      ProgramsJuly
              
              
              4,200
              
              
              $
              8.75
              
              
              
              4,200
              
              
              
              176,204August
              
              
              7,500
              
              
              $
              8.75
              
              
              
              7,500
              
              
              
              168,704September
              
              
              5,000
              
              
              $
              9.05
              
              
              
              5,000
              
              
              
              163,704Total
              
              
              16,700
              
              
              $
              8.84
              
              
              
              16,700
              
              
              
              163,704





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.








23
 Table of Contents


Item 3. – Defaults
Upon Senior Securities.  Not applicable





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





Item 5. – OtherInformation.  Not applicable





Item
6. – Exhibits.





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





24
 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:
      November 12,
      2008
            by:
            /s/
      John C. RomanJohn
      C. RomanPresident
      and Chief Executive Officer(principal
      executive officer)Date:
      November 12,
      2008
            by:
            /s/
      Lee R. SchlesingerLee
      R. SchlesingerSenior
      Vice President and Chief Financial Officer(principal
      financial officer)


25