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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-KSB



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Annual Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the fiscal year ended June 30, 2006

Commission File No.: 0-24479



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AF Financial Group

(Exact name of small business issuer as
specified in its charter)



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|                       |  |                    
|---------------------- |  | -------------------
|Federally Chartered    |  | 56-2098545         
|State of Incorporation |  | IRS Employer Number

21 East Ashe Street

West Jefferson, North Carolina 28694-0026

(Address of Principal
Executive Offices)

Issuers telephone, including area code: (336) 246-4344

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

Common Stock, par value $0.01 per share

Title of Class



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

Indicate by check mark if there is no disclosure of delinquent filers
pursuant to Item 405 of Regulation S-B contained herein and no disclosure will be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in part III of this Form 10-KSB, or
any amendment to this Form 10-KSB.  x

Indicate by check mark whether the registrant is a
shell company (as defined in Rule 126-2 of the Exchange Act.)    Yes ̈No  x

The revenues for the issuers fiscal year ended June 30, 2006 are $18,097,948.

The issuer had 1,050,804 shares of common stock outstanding as of August 31, 2006. The aggregate value of the voting stock held by non-affiliates of
the issuer, computed by reference to the price at which the common stock was sold on August 31, 2006 was $8,104,659.

Documents
Incorporated by Reference.

Portions of the Proxy Statement for the 2006 Annual Meeting of Stockholders are incorporated by reference
into Part III of this Form 10-KSB.

Transitional Small Business Disclosure Format.    Yes ̈No  x



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##### Table of Contents

TABLE OF CONTENTS



|           |  |                                                                                                                 |  |      
|---------- |  | --------------------------------------------------------------------------------------------------------------- |  | -----
|PART I     |  |                                                                                                                 |  |      
|Item 1.    |  | Description of Business                                                                                         |  | 1-27 
|Item 2.    |  | Description of Property                                                                                         |  | 28   
|Item 3.    |  | Legal Proceedings                                                                                               |  | 29   
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                             |  | 29   
|           |  |                                                                                                                
|PART II    |  |                                                                                                                 |  |      
|Item 5.    |  | Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities  |  | 29   
|Item 6.    |  | Managements Discussion and Analysis or Plan of Operation                                                       |  | 30-42
|Item 7.    |  | Financial Statements                                                                                            |  | 43-74
|Item 8.    |  | Changes in and Disagreement with Accountants on Accounting and Financial Disclosure                             |  | 75   
|Item 8A.   |  | Controls and Procedures                                                                                         |  | 75   
|Item 8B.   |  | Other Information                                                                                               |  | 75   
|           |  |                                                                                                                
|PART III   |  |                                                                                                                 |  |      
|Item 9.    |  | Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act |  | 75   
|Item 10.   |  | Executive Compensation                                                                                          |  | 75   
|Item 11.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                  |  | 76   
|Item 12.   |  | Certain Relationships and Related Transactions                                                                  |  | 76   
|Item 13.   |  | Exhibits                                                                                                        |  | 76-77
|Item 14.   |  | Principal Accountant Fees and Services                                                                          |  | 77   
|           | 
|SIGNATURES |  | 78                                                                                                             



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PART I

ITEM1. DESCRIPTION OF BUSINESS

General

AF Financial Group (the Company) is a federally chartered thrift holding company which owns 100% of the common
stock of AF Bank (the Bank), AF Insurance Services, Inc. (an independent insurance agency) and AF Capital Trust I (a Delaware business trust). The Company has no operations and conducts no business of its own other than ownership of its
subsidiaries. The Bank is a federally chartered stock savings bank which was chartered in 1939 and the historical operations of AF Bank have been to provide fixed rate loans for the residents of Ashe County, North Carolina. Over the past several
years, we have expanded our market area to include Alleghany, Caldwell, Surry, Watauga and Wilkes counties and have diversified our product lines by engaging in non-residential mortgage and non-mortgage lending and offering insurance and uninsured
investment products. In July 1997, we started offering traditional property and casualty, life and health insurance products through AF Insurance Services, Inc., headquartered in West Jefferson, North Carolina and operating in Boone, Elkin,
Jefferson, Lenoir, Sparta, West Jefferson and Wilkesboro, North Carolina. AF Bank operates 7 branches throughout its expanded market area.

During the fourth quarter of the 2005 fiscal year, AF Financial Group dissolved the broker/dealer subsidiary, AF Brokerage, Inc. We continue to offer the same level of service through a third party relationship that AF Bank has entered into
with LaSalle Street Securities. This structure allows us to offer a full array of investment products, including fixed-rate and variable annuities and mutual funds while reducing expenses associated with maintaining an independent broker/dealer
registration. This third party relationship operates as a division of AF Bank under the name AF Investments.

At June 30, 2006, we had
total assets of $229.4 million, net loans of $193.9 million, deposits of $177.0 million and stockholders equity of $14.0 million. We realized net income of $1,020,823 for the year ended June 30, 2006 compared to net income of $648,777 for
the year ended June 30, 2005. The Companys operating results are primarily dependent upon net interest income, fees and charges and insurance commissions. Net interest income is the difference between interest earned on loans, investments
and interest-earning deposits at other financial institutions, and the cost of interest-bearing savings deposits and other borrowings. The primary interest-earning asset of the Company is its mortgage loan portfolio, representing 85.2% of gross
loans with approximately 53.3% of portfolio mortgage loans at fixed rates as of June 30, 2006. The net interest income of the Company is affected by changes in economic conditions that influence market interest rates and to a large extent by
the monetary actions by the Federal Reserve Board (FRB). This exposure to changes in interest rates contributes to a moderate degree of interest rate risk because of the negative impact of changing rates to the Banks earnings and
to the new market value of its assets and liabilities. Historically, mortgage lenders have made loans and funded those loans with core and short-term deposits, exposing the lender to a higher level of interest rate risk in a rising rate scenario. We
have reduced our exposure to rising rates by limiting the term or the time to reprice of loans that we retain in our portfolio. Generally, the Bank sells mortgage loans with terms exceeding 15 years unless the loan documents permit us to re-price
the loan at an interval of ten years or less. Non-mortgage loans have rates that allow for adjustment as the prime rate changes, where possible, and where non-mortgage loans are made with fixed terms, the terms typically do not exceed five years.

We also offer consumer loans, including automobile and home improvement loans. At June 30, 2006, consumer loans constituted
approximately 5.0% of portfolio loans. In addition, we offer commercial loans to businesses in Ashe, Alleghany and Watauga counties and to areas adjacent to those counties. Commercial loans generally have rates based on the prime rate of interest
that more closely reflects prevailing market interest rates than do fixed rate products or other rate indices. Consumer and commercial loans also generally have shorter terms and greater interest rate sensitivity than mortgage loans. Funding for
loan originations has been provided by marketing savings and checking accounts, competitively pricing certificates of deposit, and borrowing from the Federal Home Loan Bank of Atlanta (FHLB). Deposits increased $13.0 million as the
result of normal business activities and FHLB advances increased $497,720 during the year ended June 30, 2006.

In addition to loans,
the Bank invests in federal agency securities, certificates of deposit of insured banks, overnight deposits with the FHLB, equity securities in the Federal Home Loan Mortgage Corporation (FHLMC), municipal bonds, and mortgage-backed securities
issued by the Government National Mortgage Association



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##### Table of Contents

(GNMA) and Federal National Mortgage Association (FNMA). We do not engage in the practice of trading securities. Rather,
the Banks investment portfolio consists primarily of securities designated as available for sale. We intend to maintain investment securities to meet liquidity needs, as a supplement to our lending activities, and as a means to reduce the
interest rate risk and credit risk of our asset base in exchange for lower rates of return than would typically be available with other lending activities.

The Company receives fee income primarily from loan origination fees; late loan payments fees; commissions from the sale of credit life; accident and health insurance; deposit transaction fees; insurance commissions
generated from AF Insurance Services, Inc.; commission income generated from AF Investments, a division of AF Bank through our third party relationship with a broker/dealer; and from payment for other services provided to customers by the Company.

Major non-interest costs to the Company include compensation and benefits; occupancy and equipment; information technology costs; and
provision for loan losses. Other external factors that affect the operating results of the Company include changes in government and accounting regulations and changes in the competitive dynamics within the Companys market area.

Our executive offices are located at 21 East Ashe Street, West Jefferson, North Carolina 28694-0026. Our telephone number is (336) 246-4344. We
maintain a website at www.afgrp.com on which we will post all reports we file with the SEC under Section 13(a) and Section 16 of the Securities Exchange Act of 1934. You can review these reports free of charge by clicking on About AF
Financial on the homepage of AF Financial Group, proceeding to Investor Relations and then to reports filed with the SEC. We also post on this site our key corporate governance documents, including our board committee
charters and our code of ethics. Information on our website is not, however, a part of this report.

Market Area and Competition

Our market area for deposit gathering and lending is concentrated in Alleghany, Ashe and Watauga Counties, North Carolina and to areas adjacent to those
counties. Headquartered in West Jefferson, North Carolina, AF Insurance Services, Inc., has branches in Boone, Elkin, Jefferson, Lenoir, Sparta, West Jefferson, and North Wilkesboro, North Carolina. AF Investments, a division of AF Bank, serves
Ashe, Alleghany, Wilkes and Watauga counties in North Carolina.

The Company has substantial competition for each of the deposits it
accepts, the loans it makes and for insurance and investment services. In the Banks three county market area (Alleghany, Ashe and Watauga) there are 15 banks and thrifts, including the four largest banks in North Carolina. AF Bank has the
fourth largest deposit base in its combined three county market area with a 12.4% market share. In our home market of Ashe County, we have a 26.9% market share. We compete for deposits by offering a variety of customer services and deposit accounts
at competitive interest rates. Insurance and investment sales are service oriented as well as price sensitive. We, like our competitors, are affected by general economic conditions, particularly changes in market interest rates, real estate market
values, government policies and regulatory authorities actions. Changes in the ratio of demand for loans relative to the availability of credit may attract additional competition from financial institutions which may have greater resources
than our Company, but which have not generally engaged in lending activities in our market area in the past and from credit unions that can expand into our market area and compete for customers without the level of taxation experienced by the
Company. Competition may also increase as a result of the lifting of restrictions on the interstate operations of financial institutions. SeeRegulation.



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##### Table of Contents

Lending Activities

Loan Portfolio Composition. The Companys loan portfolio consists primarily of mortgage loans. The Company also makes consumer and commercial loans.

The types of loans that the Company may originate are subject to federal and state laws and regulations. Interest rates charged by the Bank on loans are
affected by the demand for such loans, the supply of money available for lending purposes and the rates offered by competitors. These factors are in turn affected by, among other things, economic conditions, monetary policies of the federal
government, including the FRB, and legislative tax policies.

The following table sets forth the composition of the Companys mortgage
and other loan portfolios in dollar amounts and percentages at the dates indicated.



|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|--------------------------------------------- |  | ---------------------- | ------- | ---------- | ------ | - | ------ | ---- | ---------- |  | ------ | ------ |  | ---------- | ------- |  | ------ | - | ---------- | - | ------- | ------ | ------ | ---------- |  | - | ------- |  | ------ | -
|                                              |  | At June 30,            |        
|                                              |  | 2006                   |         |            | 2005   |   |        | 2004 |            |  | 2003   |        |  | 2002       |        
|                                              |  | Amount                 |         | % of Total |        |   | Amount |      | % of Total |  |        | Amount |  | % of Total |         |  | Amount |   | % of Total |   |         | Amount |        | % of Total | 
|                                              |  | (Dollars in thousands) |        
|Mortgage loans:                               |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|One-to four-family                            |  | $                      | 100,198 |            | 51.68  | % |        | $    | 96,368     |  | 53.17  | %      |  | $          | 94,691  |  | 52.56  | % |            | $ | 88,725  |        | 56.78  | %          |  | $ | 80,952  |  | 56.38  | %
|Multi-family                                  |  |                        | 4,179   |            | 2.15   | % |        |      | 4,171      |  | 2.30   | %      |  |            | 5,728   |  | 3.18   | % |            |   | 6,226   |        | 3.98   | %          |  |   | 6,142   |  | 4.28   | %
|Non-residential                               |  |                        | 29,779  |            | 15.35  | % |        |      | 27,154     |  | 14.98  | %      |  |            | 28,958  |  | 16.07  | % |            |   | 18,873  |        | 12.08  | %          |  |   | 15,196  |  | 10.59  | %
|Land                                          |  |                        | 17,929  |            | 9.24   | % |        |      | 17,155     |  | 9.47   | %      |  |            | 13,906  |  | 7.72   | % |            |   | 7,961   |        | 5.11   | %          |  |   | 8,008   |  | 5.58   | %
|Construction                                  |  |                        | 14,660  |            | 7.56   | % |        |      | 11,416     |  | 6.30   | %      |  |            | 14,203  |  | 7.88   | % |            |   | 9,383   |        | 6.00   | %          |  |   | 10,329  |  | 7.20   | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Total mortgage loans                          |  | $                      | 166,745 |            | 85.98  | % |        | $    | 156,264    |  | 86.22  | %      |  | $          | 157,486 |  | 87.41  | % |            | $ | 131,168 |        | 83.95  | %          |  | $ | 120,627 |  | 84.03  | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Other loans:                                  |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Commercial                                    |  | $                      | 19,221  |            | 9.91   | % |        | $    | 15,972     |  | 8.82   | %      |  | $          | 12,626  |  | 7.01   | % |            | $ | 15,186  |        | 9.72   | %          |  | $ | 10,784  |  | 7.51   | %
|Consumer loans                                |  |                        | 9,782   |            | 5.04   | % |        |      | 10,611     |  | 5.85   | %      |  |            | 11,512  |  | 6.39   | % |            |   | 11,227  |        | 7.18   | %          |  |   | 13,512  |  | 9.41   | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Total other loans                             |  | $                      | 29,003  |            | 14.95  | % |        | $    | 26,583     |  | 14.67  | %      |  | $          | 24,138  |  | 13.40  | % |            | $ | 26,413  |        | 16.90  | %          |  |   | 24,296  |  | 16.92  | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Gross loans                                   |  | $                      | 195,748 |            | 100.93 | % |        | $    | 182,847    |  | 100.89 | %      |  | $          | 181,624 |  | 100.81 | % |            | $ | 157,581 |        | 100.85 | %          |  | $ | 144,923 |  | 100.95 | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Less:                                         |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Undisbursed loan funds                        |  |                        |        |            |       | % |        |      |           |  |       | %      |  |            |        |  |       | % |            |   |        |        |       | %          |  |   |        |  |       | %
|Unearned discounts and net deferred loan fees |  | $                      | 241     |            | 0.12   | % |        | $    | 220        |  | 0.13   | %      |  | $          | 223     |  | 0.12   | % |            | $ | 212     |        | 0.14   | %          |  | $ | 239     |  | 0.17   | %
|Allowance for loan losses                     |  |                        | 1,568   |            | 0.81   | % |        |      | 1,385      |  | 0.76   | %      |  |            | 1,245   |  | 0.69   | % |            |   | 1,111   |        | 0.71   | %          |  |   | 1,131   |  | 0.78   | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|                                              |  |                        | 1,809   |            | 0.93   | % |        |      | 1,605      |  | 0.89   | %      |  |            | 1,468   |  | 0.81   | % |            |   | 1,323   |        | 0.85   | %          |  |   | 1,370   |  | 0.95   | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Loans, net                                    |  | $                      | 193,939 |            | 100.00 | % |        | $    | 181,242    |  | 100.00 | %      |  | $          | 180,156 |  | 100.00 | % |            | $ | 156,258 |        | 100.00 | %          |  | $ | 143,553 |  | 100.00 | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  



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##### Table of Contents

Loan Maturity.The following table shows the maturity or period to repricing of the Companys
loan portfolio at June 30, 2006. Loans that have adjustable rates are shown using scheduled principal amortization. The table does not consider estimated prepayments of principal.



|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|------------------------------------- |  | ---------------------- | ------- | ------------ | - | ---------------- |  | ------ | ------ | ------------ | - | ---------------- |  | -------------- | ------ | ----- | - | ------ |  | - | ----- |  | - | ------- |  | ------ | -
|                                      |  | At June 30, 2006       |        
|                                      |  | Mortgage Loans         |         |              |   |                  |  |        |        |              |  
|                                      |  | One- to Four- Family   |         | Multi-Family |   | Non- Residential |  | Land   |        | Construction |   | Commercial Loans |  | Consumer Loans |        | Total |  
|                                      |  |                        |         |              |   |                  |  | Amount |        | %            |  
|                                      |  | (Dollars in thousands) |        
|Fixed rate loans:                     |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|                                      |  |                        |         |              |   |                  |  |        |       
|Amount due or repricing:              |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|                                      |  |                        |         |              |   |                  |  |        |       
|One year or less                      |  | $                      | 4,866   |              |   |                 |  |        | 897    |              |   | 299              |  |                | 0      |       |   | 50     |  |   | 770   |  | $ | 6,882   |  | 3.52   | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|One to three years                    |  |                        | 13,407  |              |   | 413              |  |        | 3,249  |              |   | 1,134            |  |                | 92     |       |   | 444    |  |   | 2,964 |  |   | 21,703  |  | 11.09  | %
|More than three years to five years   |  |                        | 16,374  |              |   | 293              |  |        | 8,354  |              |   | 1,852            |  |                |       |       |   | 2,579  |  |   | 3,123 |  |   | 32,575  |  | 16.64  | %
|More than five years to fifteen years |  |                        | 28,515  |              |   | 912              |  |        | 4,230  |              |   | 5,179            |  |                |       |       |   | 1,344  |  |   | 1,038 |  |   | 41,218  |  | 21.06  | %
|Over fifteen years                    |  |                        | 1,857   |              |   |                 |  |        |       |              |   |                 |  |                |       |       |   |       |  |   | 83    |  |   | 1,940   |  | 0.99   | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|Total due or repricing after one year |  |                        | 60,153  |              |   | 1,618            |  |        | 15,833 |              |   | 8,165            |  |                | 92     |       |   | 4,367  |  |   | 7,208 |  |   | 97,436  |  | 49.78  | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|Total amounts due or repricing, gross |  | $                      | 65,019  |              | $ | 1,618            |  | $      | 16,730 |              | $ | 8,464            |  | $              | 92     |       | $ | 4,417  |  | $ | 7,978 |  | $ | 104,318 |  | 53.29  | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|Variable rate loans:                  |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|                                      |  |                        |         |              |   |                  |  |        |       
|Amount due or repricing:              |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|                                      |  |                        |         |              |   |                  |  |        |       
|One year or less                      |  | $                      | 35,179  |              |   | 2,561            |  |        | 13,049 |              |   | 9,465            |  |                | 14,568 |       |   | 14,804 |  |   | 1,804 |  | $ | 91,430  |  | 46.71  | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|One to three years                    |  |                        |        |              |   |                 |  |        |       |              |   |                 |  |                |       |       |   |       |  |   |      |  |   |        |  | 0.00   | %
|More than three years to five years   |  |                        |        |              |   |                 |  |        |       |              |   |                 |  |                |       |       |   |       |  |   |      |  |   |        |  | 0.00   | %
|More than five years to fifteen years |  |                        |        |              |   |                 |  |        |       |              |   |                 |  |                |       |       |   |       |  |   |      |  |   |        |  | 0.00   | %
|Over fifteen years                    |  |                        |        |              |   |                 |  |        |       |              |   |                 |  |                |       |       |   |       |  |   |      |  |   |        |  | 0.00   | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|Total due or repricing after one year |  |                        |        |              |   |                 |  |        |       |              |   |                 |  |                |       |       |   |       |  |   |      |  |   |        |  | 0.00   | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|Total amounts due or repricing, gross |  | $                      | 35,179  |              | $ | 2,561            |  | $      | 13,049 |              | $ | 9,465            |  | $              | 14,568 |       | $ | 14,804 |  | $ | 1,804 |  | $ | 91,430  |  | 46.71  | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|Total loans:                          |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|                                      |  |                        |         |              |   |                  |  |        |       
|Amount due or repricing:              |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|                                      |  |                        |         |              |   |                  |  |        |       
|One year or less                      |  | $                      | 40,045  |              | $ | 2,561            |  | $      | 13,946 |              | $ | 9,764            |  | $              | 14,568 |       | $ | 14,854 |  | $ | 2,574 |  | $ | 98,312  |  | 50.22  | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|One to three years                    |  |                        | 13,407  |              |   | 413              |  |        | 3,249  |              |   | 1,134            |  |                | 92     |       |   | 444    |  |   | 2,964 |  |   | 21,703  |  | 11.09  | %
|More than three years to five years   |  |                        | 16,374  |              |   | 293              |  |        | 8,354  |              |   | 1,852            |  |                |       |       |   | 2,579  |  |   | 3,123 |  |   | 32,575  |  | 16.64  | %
|More than five years to fifteen years |  |                        | 28,515  |              |   | 912              |  |        | 4,230  |              |   | 5,179            |  |                |       |       |   | 1,344  |  |   | 1,038 |  |   | 41,218  |  | 21.06  | %
|Over fifteen years                    |  |                        | 1,857   |              |   |                 |  |        |       |              |   |                 |  |                |       |       |   |       |  |   | 83    |  |   | 1,940   |  | 0.99   | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|Total due or repricing after one year |  |                        | 60,153  |              |   | 1,618            |  |        | 15,833 |              |   | 8,165            |  |                | 92     |       |   | 4,367  |  |   | 7,208 |  |   | 97,436  |  | 49.78  | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  
|Total amounts due or repricing, gross |  | $                      | 100,198 |              | $ | 4,179            |  | $      | 29,779 |              | $ | 17,929           |  | $              | 14,660 |       | $ | 19,221 |  | $ | 9,782 |  | $ | 195,748 |  | 100.00 | %
|                                      |  |                        |         |              |   |                  |  |        |        |              |   |                  |  |                |        |       |   |        |  |   |       |  |   |         |  |        |  



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##### Table of Contents

Origination, Purchase, Sale and Servicing of Loans. The Banks lending activities are
conducted through its branches in Ashe, Alleghany and Watauga counties, North Carolina. The Bank originates both adjustable-rate loans and fixed-rate mortgage loans for portfolio and for sale in the secondary market. The Bank retains in its
portfolio adjustable-rate mortgage loans and fixed-rate mortgage loans that carry maximum maturities of 30 years and 15 years, respectively. Fixed-rate loans originated for sale in the secondary market have maximum maturities of 30 years. The Bank
sells qualified fixed-rate loans to FNMA, but retains the servicing rights. The determination to sell loans is based upon managements efforts to reduce interest rate risk. At June 30, 2006, the Bank serviced approximately $68.9 million of
loans for FNMA.

One-to-Four-Family Mortgage Lending. The Bank offers both fixed-rate and adjustable-rate mortgage loans, with
maturities up to 30 years, which are secured by one-to-four-family residences, which generally are owner-occupied. Fixed-rate loans held in the Banks portfolio generally have higher interest rates and shorter terms than those loans sold to
FNMA. Most are secured by property located in Ashe, Alleghany and Watauga counties, North Carolina. Loan originations are generally obtained from existing or past customers and members of the local communities.

The Bank offers three to five year call loans, which are either called or modified based on the Banks interest rates currently in effect at the
call date. These loans are similar to adjustable rate loans in that the loans generally amortize over terms of up to 30 years but are not indexed to any widely recognized rate, such as the one year U.S. Treasury securities rate, and do not have
interest rate caps or floors. Instead, the majority of such loans are modified at the call date and the rate is adjusted to the Banks current rate offered for similar loans being originated on such dates. For purposes of the tabular
presentations included throughout this document, such loans are considered to be adjustable.

In view of its operating strategy, the Bank
adheres to its Board-approved underwriting guidelines for loan originations, which, though prudent in approach to credit risk and evaluation of collateral, allow management flexibility with respect to documentation of certain matters, such as loan
amount and certain credit requirements. The Banks loans are typically originated under terms, conditions and documentation which permit them to be sold to U.S. government sponsored agencies such as FNMA. The Banks policy is to originate
one-to-four-family residential mortgage loans in amounts up to 80% of the lower of the appraised value or the selling price of the property securing the loan. The Bank offers products with a higher loan-to-value ratio in conjunction with private
mortgage insurance. Mortgage loans originated by the Bank generally include due-on-sale clauses which provide the Bank with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the
property without the Banks consent. Due-on-sale clauses are an important means of adjusting the rates on the Banks fixed-rate mortgage loan portfolio and the Bank has generally exercised its rights under these clauses.

Construction Lending. The Bank originates construction loans primarily to finance construction of one-to- four-family homes to the individuals who
will be the owners and occupants upon completion of construction in the Banks market area. At June 30, 2006, the Banks portfolio contained construction loans with balances of approximately $14.7 million, or 7.5%, of total loans. The
Banks policy is to disburse loan proceeds as construction progresses and as periodic inspections warrant. These loans are made primarily to the individuals who will ultimately occupy the home, and are structured to guarantee the permanent
financing to the Bank. Thus construction loans typically roll into permanent financing. Construction loans are normally made for a maximum of 12 months, by which time permanent financing generally is obtained. From time to time the Bank
makes construction loans to a select group of builders for speculative purposes. The Bank imposes limits on the number of speculative units that each builder has unsold at any time. The Bank is selective on the builders that qualify for speculative
construction loans.

Construction lending is generally considered to involve a higher degree of credit risk than long-term financing of
residential properties. The Banks risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the propertys value at completion of construction or development and the estimated cost of
construction. If the estimated construction cost proves to be inaccurate, the Bank may be compelled to advance additional funds to complete construction.



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##### Table of Contents

Non-Residential Mortgage Lending. The Bank originates real estate mortgage loans that are
generally secured by various properties used for business purposes and retail facilities, such as small office buildings and church loans. The Banks underwriting procedures provide that non-residential mortgage loans may be made based on debt
service coverage and in amounts up to the lesser of (i) 80% of the lesser of the appraised value or purchase price of the property or (ii) the Banks current loans-to-one-borrower limit. These loans are generally originated as three
to five year call loans with amortization periods of up to 15 years. The Bank considers factors such as the borrowers business expertise, credit history, profitability, cash flow and the value of the collateral while underwriting these loans.
At June 30, 2006 the Banks non-residential mortgage loan portfolio was $29.8 million, or 15.2% of total loans outstanding. The largest non-residential mortgage loan in the Banks portfolio at June 30, 2006 was approximately
$940,000 and is secured by a commercial property.

Mortgage loans secured by non-residential properties can be larger and therefore may
involve a greater degree of credit risk than one-to-four-family residential mortgage loans. This risk is attributable to the uncertain realization of projected income-producing cash flows which are affected by vacancy rates, the ability to maintain
rent levels against competitively-priced properties and the ability to collect rent from tenants on a timely basis. Because payments on loans secured by non-residential properties are often dependent on the successful operation or management of the
properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting standards, which require such loans to be
qualified on the basis of the propertys income and debt service ratio.

Other Mortgage Lending. The Bank also offers loans
secured by land and multi-family residences. Land loans generally consist of residential building lots for which the borrower intends to ultimately construct residential properties, but may also include tracts purchased for agricultural use and a
minor amount purchased for speculative purposes. Multi-family loans generally consist of residential properties with more than four units, typically small apartment complexes. At June 30, 2006, the Banks total land loan portfolio was
$17.9 million or 9.2% of total loans and its multi-family loan portfolio was $4.2 million or 2.1% of total loans.

The Bank originates
multi-family residential loans with both fixed and adjustable interest rates which vary as to maturity. Such loans are typically income-producing investment loans. Loan to value ratios on the Banks multi-family residential loans are generally
limited to 80%. As part of the criteria for underwriting these loans, the Banks general policy is to require principals of corporate borrowers to become co-borrowers or to obtain personal guarantees from the principals of corporate borrowers.

Multi-family residential lending generally entails significant additional risks as compared with single-family residential property
lending. Such loans typically involve large loan balances to single borrowers or groups of related borrowers. The payment experience on such loans is typically dependent on the successful operation of the real estate project. The success of such
projects is sensitive to changes in supply and demand, conditions in the market for multi-family residential properties as well as to regional and economic conditions.

Appraisals for most mortgage loans are performed by independent appraisers designated by the Bank. The appraisals of such properties are then reviewed by the Banks management. The independent appraisers used by
the Bank are reviewed annually by management and the Board of Directors. Experienced loan officers may rely on tax records for smaller mortgage loans where the loan to value ratios are high, such as home equity or second mortgages, especially where
the Bank holds the first mortgage.

Consumer Loans. Subject to the restrictions contained in federal laws and regulations, the Bank
is also authorized to make loans for a wide variety of personal or consumer purposes. As of June 30, 2006, $9.8 million, or 5.0%, of the Banks total loan portfolio consisted of consumer loans. The primary component of the Banks
consumer loan portfolio was $5.3 million of auto loans. Consumer loans are available at fixed or variable interest rates.

The Bank also
offers loans secured by savings accounts at the Bank. Interest rates charged on such loans are tied to the prime rate and are available in amounts up to 90% of the value of the account. Savings account loans are reviewed and approved in conformity
with standards approved by the Banks Board of Directors. At June 30, 2006, the Banks savings account loan portfolio totaled $770,549.



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Consumer loans generally involve more credit risk than mortgage loans because of the type and nature of
the collateral. In addition, consumer lending collections are dependent on the borrowers continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, and personal bankruptcy. In some cases,
any repossessed collateral resulting from a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation and improper repair and maintenance of the underlying security.

As of June 30, 2006, the Bank did not have any non-performing consumer loans (loans 90 days or more delinquent). Charge-offs for consumer loans
totaled $47,100 and $117,600 for the years ended June 30, 2006 and 2005, respectively.

Commercial Business Loans. The Bank
offers commercial business loans that are generally provided to various types of closely held businesses located in the Banks primary market area. Commercial business loans generally have terms of five years or less and interest rates which
float in accordance with the prime rate although the Bank occasionally originates commercial business loans with fixed rates of interest. The Bank performs a cash flow analysis in underwriting these loans. The Banks commercial loans generally
are secured by equipment, machinery or other corporate assets including receivables. The Bank requires principals of corporate borrowers to become co-borrowers or obtains personal guarantees from the principals of the borrowers with respect to all
commercial business loans.

Commercial business lending generally entails greater credit risk than mortgage lending. The repayment of
commercial business loans typically is dependent on the successful operations and income of the borrower. Such risks can be significantly affected by economic conditions. In addition, commercial business lending generally requires substantially
greater oversight efforts compared to residential real estate lending. As of June 30, 2006, the Bank had no non-performing commercial business loans. Charge-offs for commercial business loans totaled $41,402 for the year ended June 30,
2006 and we did not charge-off any commercial business loans during the year ended June 30, 2005.

Loan Approval Procedures and
Authority. The Board of Directors establishes the lending policies of the Bank. The Board of Directors has established the following lending authority: the Banks Chief Executive Officer, Chief Lending Officer, Chief Credit Officer and
Retail Bank Executive may individually combine with any lending officer to approve lending relationships up to $750,000. In addition, the Bank Loan Committee comprised of three voting members which may include the Chief Executive Officer, Chief
Lending Officer, Chief Credit Officer or the Retail Bank Executive can approve lending relationships up to $1,500,000. The Loan Committee of the Board of Directors may approve loans up to the Banks legal lending limit. The foregoing lending
limits are reviewed annually and, as needed, revised by the Board of Directors. The Board ratifies all loans on a monthly basis.

For all
loans originated by the Bank, upon receipt of a completed loan application from a prospective borrower, a credit report is obtained and certain other information supporting the borrowers ability to repay is required. An appraisal performed by
a Bank approved independent appraiser is generally required for all real property intended to secure a proposed loan when the amount of the loan proceeds will exceed $100,000. The Board annually approves the independent appraisers used by the Bank
and approves the Banks appraisal policy. It is the Banks policy to obtain title insurance on all real estate loans of $25,000 or more and hazard insurance on all improved real estate loans. In connection with a borrowers request
for a renewal of a mortgage loan, the Bank evaluates both the borrowers ability to service the renewed loan applying an interest rate that reflects prevailing market conditions and the customers payment history, as well as the value of
the underlying collateral property.

Asset Quality

Non-Performing Loans. Loans are considered non-performing if they are in foreclosure or are 90 or more days delinquent. The Banks level of non-performing loans increased to $218,700, or 0.10% of total
assets, at June 30, 2006 compared to $185,000, or 0.09% of total assets, at June 30, 2005. We stop accruing interest on loans when they are classified as non-performing. The Bank established reserves for uncollectible interest, or interest
accrued prior to the non-performing classification, totaling $2,802 and $2,161 at June 30, 2006 and 2005, respectively. The effect of not recognizing interest income on non-performing loans in accordance with original terms totaled
approximately $12,243 and $11,630 during the years ended June 30, 2006 and 2005, respectively. Management and



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##### Table of Contents

the Board of Directors perform a monthly review of all delinquent loans. The actions taken by the Bank with respect to
delinquencies vary depending on the nature of the loan and period of delinquency. The Banks policies generally provide that delinquent mortgage loans be reviewed and that a written late charge notice be mailed no later than the 17th day of
delinquency. The Banks policies provide that telephone contact and further written notification will be attempted to ascertain the reasons for delinquency and the prospects of repayment. When contact is made with the borrower at any time prior
to foreclosure, the Bank attempts to obtain full payment or work out a repayment schedule with the borrower to avoid foreclosure. It is the Banks general policy to reserve all accrued interest due on all loans that are 90 days or more past
due.

Real Estate Owned. Property acquired by the Bank as a result of foreclosure on a mortgage loan is classified as real estate
owned (REO). At June 30, 2006, the Bank held REO totaling $908,611, while non-performing loans, defined as loans that are 90 days or more delinquent, totaled $218,700. The REO is commercial property that the bank received as a
result of deed in lieu of foreclosure. The Banks REO is initially recorded at the fair value of the related assets at the date of foreclosure. Thereafter, if there is a further deterioration in value, the Bank provides an REO valuation
allowance and charges operations for the diminution in value less cost to sell. It is the policy of the Bank to obtain an appraisal on all real estate acquired through foreclosure as soon as practicable after it determines that foreclosure is
imminent. The Bank generally reassesses the value of REO at least annually thereafter. The policy for loans is to establish loss reserves in accordance with the Banks asset classification process, based on Generally Accepted Accounting
Principles (GAAP).



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Non-performing Assets. The following table sets forth information regarding the Banks
non-performing assets at the dates indicated.



|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|----------------------------------------------------------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ---- | ---- |  | - | ---- | - |  | ---- | ---- | - |  | - | ---- | -
|                                                                                          |  | At June 30,            |      
|                                                                                          |  | 2006                   |       |   | 2005 |   |      | 2004 |  |   | 2003 |   |  | 2002 |     
|                                                                                          |  | (Dollars in thousands) |      
|Non-accrual mortgage loans:                                                               |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|One-to four-family                                                                        |  | $                      | 219   |   |      | $ | 185  |      |  | $ | 232  |   |  | $    | 321  |   |  | $ | 305  |  
|Multi-family                                                                              |  |                        |      |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Non-residential                                                                           |  |                        |      |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Land                                                                                      |  |                        |      |   |      |   |     |      |  |   |     |   |  |      | 22   |   |  |   |     |  
|Construction                                                                              |  |                        |       |   |      |   |     |      |  |   | 249  |   |  |      |     |   |  |   |     |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total mortgage loans                                                                      |  |                        | 219   |   |      |   | 185  |      |  |   | 481  |   |  |      | 343  |   |  |   | 305  |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Commercial                                                                                |  |                        |      |   |      |   |     |      |  |   |     |   |  |      | 33   |   |  |   |     |  
|Consumer Loans                                                                            |  |                        |      |   |      |   |     |      |  |   | 38   |   |  |      | 67   |   |  |   | 155  |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total non-accruing loans                                                                  |  | $                      | 219   |   |      | $ | 185  |      |  | $ | 519  |   |  | $    | 443  |   |  | $ | 460  |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Loans delinquent 90 or more days for which interest is fully reserved and still accruing: |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|One-to four-family                                                                        |  | $                      |      |   |      | $ |     |      |  | $ |     |   |  | $    |     |   |  | $ |     |  
|Multi-family                                                                              |  |                        |      |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Non-residential                                                                           |  |                        |      |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Land                                                                                      |  |                        |      |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Construction                                                                              |  |                        |      |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total mortgage loans                                                                      |  |                        |      |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Commercial                                                                                |  |                        |      |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Consumer Loans                                                                            |  |                        |      |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total loans delinquent 90 or more days for which interest has been fully reserved         |  |                        |      |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total non-performing loans                                                                |  | $                      | 219   |   |      | $ | 185  |      |  | $ | 519  |   |  | $    | 443  |   |  | $ | 460  |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total real estate owned                                                                   |  |                        | 909   |   |      |   |     |      |  |   |     |   |  |      | 43   |   |  |   | 263  |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total non-performing assets                                                               |  | $                      | 1,128 |   |      | $ | 185  |      |  | $ | 519  |   |  | $    | 486  |   |  | $ | 723  |  
|                                                                                          |  |                        |       |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total non-performing loans to loans, gross                                                |  |                        | 0.11  | % |      |   | 0.10 | %    |  |   | 0.29 | % |  |      | 0.28 | % |  |   | 0.32 | %
|Total non-performing assets to total assets                                               |  |                        | 0.49  | % |      |   | 0.09 | %    |  |   | 0.25 | % |  |      | 0.25 | % |  |   | 0.41 | %

Classified Assets. Federal regulations and the Banks Classification of Assets Policy
require the Bank to use an internal asset classification system as a means of reporting problem and potential problem assets. The Bank has incorporated the Office of Thrift Supervisions (OTS) internal asset classifications as a
part of its credit monitoring system. The Bank currently classifies problem and potential problem assets as Special Mention, Substandard, Doubtful or Loss assets. Additionally, the Bank places assets
on an internal Watch List when those assets demonstrate characteristics that if not corrected or that if deteriorated further would lead to a more severe classification. An asset is considered Substandard if it is
inadequately protected by the current equity and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all of the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses
present make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Assets classified as Loss are those considered
uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses are required to be designated Special Mention.

The Banks management reviews and classifies the Banks assets and reports the results to the Banks Board of Directors on a monthly basis. The Bank classifies assets in accordance with the management guidelines described
above. At June 30, 2006, the Bank had $1.3 million of assets classified as Substandard, $2.8 million of assets designated as Special Mention, no assets classified as Loss and no assets classified as Doubtful.



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Allowance for Loan Losses. The Allowance for Loan Losses (ALL) is established through
a provision for loan losses based on managements evaluation of the risks inherent in the Banks loan portfolio, prior loss history and the general economy. The ALL is maintained at an amount we consider adequate to cover loan losses which
are deemed probable and estimable. The allowance is based upon a number of factors, including asset classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, our assessment
of the credit risk inherent in the portfolio, historical loan loss experience, and the Banks underwriting policies. At June 30, 2006, the Banks ALL was $1.6 million, or 0.80% of total loans, as compared to $1.4 million or 0.76% of
total loans at June 30, 2005. The Bank had non-performing loans of $218,700 and $185,000 at June 30, 2006 and June 30, 2005, respectively. Allowance for loan losses to total non-performing assets at the end of the period decreased to
139.1% at June 30, 2006 compared to 748.9% at June 30, 2005. This decrease is primarily the result of the increase of non-performing loans, mentioned above and the $908,611 REO that was held as of June 30, 2006. The increase in
nonperforming assets is the result of three borrowers that had changes in their financial condition and were unable to make the required payments on their one- to four residential loans. All nonperforming loans were in the process of foreclosures at
June 30, 2006 and no loss is expected. The REO is commercial property that the bank received as a result of a deed in lieu of foreclosure and it is currently on the market for sale. The Bank will continue to monitor and modify its ALL as
conditions dictate. While the Bank believes it has established its existing allowances for loan losses in accordance with GAAP, various regulatory agencies, as an integral part of their examination processes, periodically review the Banks ALL.
These agencies may require the Bank to establish additional valuation allowances, based on their judgments of the information available at the time of the examination, and thereby negatively affect the Banks financial condition and earnings.
In addition, there can be no assurance that increases in the Banks allowance for loan losses will not occur in the future.



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The following table sets forth activity in the Banks ALL at or for the dates indicated.



|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------------------------------------------------------- |  | --------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                                      |  | At or For the Year Ended June 30, |        
|                                                                                      |  | 2006                              |         |   | 2005 |   |         | 2004 |  |   | 2003    |   |  | 2002 |        
|                                                                                      |  | (Dollars in thousands)            |        
|Balance at beginning of year                                                          |  | $                                 | 1,385   |   |      | $ | 1,245   |      |  | $ | 1,111   |   |  | $    | 1,131   |   |  | $ | 1,022   |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Provision for loan losses                                                             |  |                                   | 265     |   |      |   | (79     | )    |  |   | 668     |   |  |      | 243     |   |  |   | 420     |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                                      |  |                                   |         |   |     
|Charge-offs:                                                                          |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|One- to four-family residential                                                       |  |                                   | (28     | ) |      |   | (97     | )    |  |   | (73     | ) |  |      | (39     | ) |  |   | (123    | )
|Multi-family residential                                                              |  |                                   |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Non-residential and land                                                              |  |                                   |        |   |      |   |        |      |  |   | (19     | ) |  |      | (3      | ) |  |   | (11     | )
|Construction                                                                          |  |                                   |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Commercial                                                                            |  |                                   | (41     | ) |      |   |        |      |  |   | (399    | ) |  |      | (69     | ) |  |   | (11     | )
|Consumer loans                                                                        |  |                                   | (47     | ) |      |   | (117    | )    |  |   | (112    | ) |  |      | (306    | ) |  |   | (282    | )
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total charge-offs                                                                     |  |                                   | (116    | ) |      |   | (214    | )    |  |   | (603    | ) |  |      | (417    | ) |  |   | (427    | )
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Recoveries                                                                            |  |                                   | 34      |   |      |   | 433     |      |  |   | 69      |   |  |      | 154     |   |  |   | 116     |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Balance at end of year                                                                |  | $                                 | 1,568   |   |      | $ | 1,385   |      |  | $ | 1,245   |   |  | $    | 1,111   |   |  | $ | 1,131   |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total loans outstanding at end of period                                              |  | $                                 | 195,748 |   |      | $ | 182,847 |      |  | $ | 181,624 |   |  | $    | 157,581 |   |  | $ | 144,923 |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Average total loans outstanding                                                       |  | $                                 | 188,389 |   |      | $ | 185,623 |      |  | $ | 169,549 |   |  | $    | 154,586 |   |  | $ | 136,621 |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for loan losses to total loans at end of period                             |  |                                   | 0.80    | % |      |   | 0.76    | %    |  |   | 0.69    | % |  |      | 0.71    | % |  |   | 0.78    | %
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for loan losses to total non-performing assets at end of period             |  |                                   | 139.09  | % |      |   | 748.87  | %    |  |   | 239.98  | % |  |      | 228.60  | % |  |   | 156.43  | %
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for loan losses to total non-performing loans at end of period              |  |                                   | 716.98  | % |      |   | 748.87  | %    |  |   | 239.98  | % |  |      | 250.79  | % |  |   | 245.87  | %
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Ratio of net charge-offs during the period to average loans outstanding during period |  |                                   | 0.04    | % |      |   | 0.12    | %    |  |   | 0.31    | % |  |      | 0.17    | % |  |   | 0.23    | %
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  



- 11 -



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##### Table of Contents

The following table sets forth the Banks ALL allocated by loan category and the percent of loans in
each category to total loans at the dates indicated.



|                         |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                         |  |        |                                                  |  |        |                  |  |                                         |       |  |                                                  |   |  |        |  
|------------------------ |  | ---------------------- | ----- | --------------------------------------- | ------ | - | ------------------------------------------------ | ------ | - | ---------------- | - | --------------------------------------- |  | ------ | ------------------------------------------------ |  | ------ | ---------------- |  | --------------------------------------- | ----- |  | ------------------------------------------------ | - |  | ------ | -
|                         |  | At June 30,            |      
|                         |  | 2006                   |       |                                         | 2005   |   |                                                  | 2004   |  
|                         |  | Allowance Amount       |       | Percent of Allowance to Total Allowance |        |   | Percent of Loans in Each Category to Total Loans |        |   | Allowance Amount |   | Percent of Allowance to Total Allowance |  |        | Percent of Loans in Each Category to Total Loans |  |        | Allowance Amount |  | Percent of Allowance to Total Allowance |       |  | Percent of Loans in Each Category to Total Loans |  
|                         |  | (Dollars in thousands) |      
|Mortgage Loans:          |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                         |  |        |                                                  |  |        |                  |  |                                         |       |  |                                                  |   |  |        |  
|One-to four family       |  | $                      | 765   |                                         | 48.78  | % |                                                  | 51.21  | % |                  | $ | 685                                     |  | 49.46  | %                                                |  | 52.70  | %                |  | $                                       | 651   |  | 52.29                                            | % |  | 52.14  | %
|Multi-family             |  |                        | 28    |                                         | 1.79   | % |                                                  | 2.13   | % |                  |   | 24                                      |  | 1.73   | %                                                |  | 2.28   | %                |  |                                         | 20    |  | 1.61                                             | % |  | 3.15   | %
|Non-residential and land |  |                        | 170   |                                         | 10.84  | % |                                                  | 24.36  | % |                  |   | 148                                     |  | 10.69  | %                                                |  | 24.24  | %                |  |                                         | 93    |  | 7.47                                             | % |  | 23.60  | %
|Construction             |  |                        | 90    |                                         | 5.74   | % |                                                  | 7.49   | % |                  |   | 78                                      |  | 5.63   | %                                                |  | 6.24   | %                |  |                                         | 45    |  | 3.61                                             | % |  | 7.82   | %
|Other:                   |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                         |  |        |                                                  |  |        |                  |  |                                         |       |  |                                                  |   |  |        |  
|Consumer                 |  |                        | 185   |                                         | 11.80  | % |                                                  | 4.99   | % |                  |   | 170                                     |  | 12.27  | %                                                |  | 5.80   | %                |  |                                         | 160   |  | 12.85                                            | % |  | 6.34   | %
|Commercial               |  |                        | 330   |                                         | 21.05  | % |                                                  | 9.82   | % |                  |   | 280                                     |  | 20.22  | %                                                |  | 8.74   | %                |  |                                         | 276   |  | 22.17                                            | % |  | 6.95   | %
|                         |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                         |  |        |                                                  |  |        |                  |  |                                         |       |  |                                                  |   |  |        |  
|Total                    |  | $                      | 1,568 |                                         | 100.00 | % |                                                  | 100.00 | % |                  | $ | 1,385                                   |  | 100.00 | %                                                |  | 100.00 | %                |  | $                                       | 1,245 |  | 100.00                                           | % |  | 100.00 | %
|                         |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                         |  |        |                                                  |  |        |                  |  |                                         |       |  |                                                  |   |  |        |  



|                         |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                         |  |        |                                                  |  |        |  
|------------------------ |  | ---------------------- | ----- | --------------------------------------- | ------ | - | ------------------------------------------------ | ------ | - | ---------------- | - | --------------------------------------- |  | ------ | ------------------------------------------------ |  | ------ | -
|                         |  | At June 30,            |      
|                         |  | 2003                   |       |                                         | 2002   |  
|                         |  | Allowance Amount       |       | Percent of Allowance to Total Allowance |        |   | Percent of Loans in Each Category to Total Loans |        |   | Allowance Amount |   | Percent of Allowance to Total Allowance |  |        | Percent of Loans in Each Category to Total Loans | 
|                         |  | (Dollars in thousands) |      
|Mortgage Loans:          |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                         |  |        |                                                  |  |        |  
|One-to four family       |  | $                      | 646   |                                         | 58.15  | % |                                                  | 56.30  | % |                  | $ | 606                                     |  | 53.58  | %                                                |  | 55.92  | %
|Multi-family             |  |                        | 20    |                                         | 1.80   | % |                                                  | 3.95   | % |                  |   | 20                                      |  | 1.77   | %                                                |  | 4.23   | %
|Non-residential and land |  |                        | 80    |                                         | 7.20   | % |                                                  | 17.03  | % |                  |   | 75                                      |  | 6.63   | %                                                |  | 16.03  | %
|Construction             |  |                        | 25    |                                         | 2.25   | % |                                                  | 5.95   | % |                  |   | 25                                      |  | 2.21   | %                                                |  | 7.11   | %
|Other:                   |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                         |  |        |                                                  |  |        |  
|Consumer                 |  |                        | 150   |                                         | 13.50  | % |                                                  | 9.64   | % |                  |   | 310                                     |  | 27.41  | %                                                |  | 9.29   | %
|Commercial               |  |                        | 190   |                                         | 17.10  | % |                                                  | 7.13   | % |                  |   | 95                                      |  | 8.40   | %                                                |  | 7.42   | %
|                         |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                         |  |        |                                                  |  |        |  
|Total                    |  | $                      | 1,111 |                                         | 100.00 | % |                                                  | 100.00 | % |                  | $ | 1,131                                   |  | 100.00 | %                                                |  | 100.00 | %
|                         |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                         |  |        |                                                  |  |        |  



- 12 -



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##### Table of Contents

Investment Activities

The Banks investment policy permits it to invest in U.S. government obligations, certain securities of various government-sponsored agencies and municipal obligations, including mortgage-backed securities
issued/guaranteed by FNMA, FHLMC and GNMA, certificates of deposit of insured banks, federal funds, mutual funds and FHLB stock. At June 30, 2006, the Company held $5.2 million in investment securities.

The following table sets forth activity in the Companys investment securities portfolio for the periods indicated:



|                                                   |  |                            |       |   |      |   |       |      |  |   |        |  
|-------------------------------------------------- |  | -------------------------- | ----- | - | ---- | - | ----- | ---- |  | - | ------ | -
|                                                   |  | For the Year Ended June 30 |      
|                                                   |  | 2006                       |       |   | 2005 |   |       | 2004 | 
|                                                   |  | (In thousands)             |      
|Amortized cost at beginning of period              |  | $                          | 5,684 |   |      | $ | 6,484 |      |  | $ | 8,658  |  
|Proceeds, net                                      |  |                            | (68   | ) |      |   | (227  | )    |  |   | (907   | )
|Principal payments from mortgage backed securities |  |                            | (334  | ) |      |   | (556  | )    |  |   | (1,221 | )
|Premium and discount amortization, net             |  |                            | (7    | ) |      |   | (17   | )    |  |   | (46    | )
|                                                   |  |                            |       |   |      |   |       |      |  |   |        |  
|Amortized cost at end of period                    |  |                            | 5,275 |   |      |   | 5,684 |      |  |   | 6,484  |  
|Net unrealized gain (loss) (1)                     |  |                            | (26   | ) |      |   | 66    |      |  |   | 17     |  
|                                                   |  |                            |       |   |      |   |       |      |  |   |        |  
|Total securities, net                              |  | $                          | 5,249 |   |      | $ | 5,750 |      |  | $ | 6,501  |  
|                                                   |  |                            |       |   |      |   |       |      |  |   |        |  

---

|(1) | The net unrealized gain (loss) at June 30, 2006, 2005 and 2004 relates to available for sale securities in accordance with Statement of Financial Accounting Standards
(SFAS) No. 115. The net unrealized gain (loss) is presented in order to reconcile the Amortized Cost of the Companys securities portfolio to the Carrying Cost, as reflected in the Statements of
Financial Condition.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The following table sets forth the amortized cost and fair value of the Companys securities at
the dates indicated.



|                              |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|----------------------------- |  | -------------- | ----- | ---- | ---------- | ---- | -------------- |  | ---------- | ----- | -------------- | - | ---------- |  | - | ----- |  | - | -----
|                              |  | At June 30,   
|                              |  | 2006           |       | 2005 |            | 2004
|                              |  | Amortized Cost |       |      | Fair Value |      | Amortized Cost |  | Fair Value |       | Amortized Cost |   | Fair Value
|                              |  | (In thousands)
|Mortgage-backed securities:   |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Fannie Mae and GNMA           |  | $              | 795   |      |            | $    | 780            |  | $          | 1,137 |                | $ | 1,149      |  | $ | 1,711 |  | $ | 1,706
|                              |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Other debt securities:        |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|U.S. Treasury and Agency      |  |                | 2,400 |      |            |      | 2,358          |  |            | 1,400 |                |   | 1,391      |  |   | 1,400 |  |   | 1,400
|Other                         |  |                | 288   |      |            |      | 302            |  |            | 287   |                |   | 304        |  |   | 286   |  |   | 300  
|                              |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Total debt securities         |  |                | 2,688 |      |            |      | 2,660          |  |            | 1,687 |                |   | 1,695      |  |   | 1,686 |  |   | 1,700
|                              |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Equity securities(1)          |  |                |      |      |            |      | 17             |  |            | 1,001 |                |   | 1,047      |  |   | 1,001 |  |   | 1,009
|FHLB Stock                    |  |                | 1,792 |      |            |      | 1,792          |  |            | 1,705 |                |   | 1,705      |  |   | 1,657 |  |   | 1,657
|Certificates of Deposit       |  |                |      |      |            |      |               |  |            | 154   |                |   | 154        |  |   | 429   |  |   | 429  
|Net unrealized gain (loss)(2) |  |                | (26   | )    |            |      |               |  |            | 66    |                |   |           |  |   | 17    |  |   |     
|                              |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Total securities, net         |  | $              | 5,249 |      |            | $    | 5,249          |  | $          | 5,750 |                | $ | 5,750      |  | $ | 6,501 |  | $ | 6,501
|                              |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      

---

|(1) | Equity securities consist of FHLMC common stock and mutual fund securities.
|--- | ---------------------------------------------------------------------------

|(2) | The net unrealized gain (loss) at June 30, 2006, 2005 and 2004 relates to available for sale securities in accordance with SFAS No. 115. The net unrealized gain (loss) is
presented in order to reconcile the Amortized Cost of the Companys securities portfolio in the Carrying Cost, as reflected in the Statements of Financial Condition.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



- 13 -



---

##### Table of Contents

The following table sets forth the amortized cost and fair value of the Companys securities, by
accounting classification and by type of security, at the dates indicated.



|                               |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|------------------------------ |  | -------------- | ----- | ---- | ---------- | ---- | -------------- |  | ---------- | ----- | -------------- | - | ---------- |  | - | ----- |  | - | -----
|                               |  | At June 30,   
|                               |  | 2006           |       | 2005 |            | 2004
|                               |  | Amortized Cost |       |      | Fair Value |      | Amortized Cost |  | Fair Value |       | Amortized Cost |   | Fair Value
|                               |  | (In thousands)
|Held-to-Maturity               |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Other debt securities          |  | $              |      |      |            | $    |               |  | $          |      |                | $ |           |  | $ | 100   |  | $ | 100  
|Certificates of deposit        |  |                |      |      |            |      |               |  |            | 154   |                |   | 154        |  |   | 429   |  |   | 429  
|                               |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Total held-to-maturity         |  |                |      |      |            |      |               |  |            | 154   |                |   | 154        |  |   | 529   |  |   | 529  
|                               |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Available-for-Sale:            |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Mortgage-backed securities     |  |                | 795   |      |            |      | 780            |  |            | 1,137 |                |   | 1,149      |  |   | 1,711 |  |   | 1,706
|Other debt securities          |  |                | 2,688 |      |            |      | 2,660          |  |            | 1,687 |                |   | 1,695      |  |   | 1,586 |  |   | 1,600
|Equity securities:             |  |                |      |      |            |      | 17             |  |            | 1,001 |                |   | 1,047      |  |   | 1,001 |  |   | 1,009
|                               |  |                |       |      |            |     
|Net unrealized gain (loss) (1) |  |                | (26   | )    |            |      |               |  |            | 66    |                |   |           |  |   | 17    |  |   |     
|                               |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Total available-for-sale       |  |                | 3,457 |      |            |      | 3,457          |  |            | 3,891 |                |   | 3,891      |  |   | 4,315 |  |   | 4,315
|                               |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|FHLB Stock                     |  |                | 1,792 |      |            |      | 1,792          |  |            | 1,705 |                |   | 1,705      |  |   | 1,657 |  |   | 1,657
|                               |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      
|Total securities, net          |  | $              | 5,249 |      |            | $    | 5,249          |  | $          | 5,750 |                | $ | 5,750      |  | $ | 6,501 |  | $ | 6,501
|                               |  |                |       |      |            |      |                |  |            |       |                |   |            |  |   |       |  |   |      

---

|(1) | The net unrealized gain (loss) at June 30, 2006, 2005 and 2004 relate to available for sale securities in accordance with SFAS No. 115. The net unrealized gain is
presented in order to reconcile the Amortized Cost of the Companys securities portfolio to the Carrying Cost, as reflected in the Statements of Financial Condition.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



- 14 -



---

##### Table of Contents

The following table sets forth certain information regarding the amortized cost, fair value and weighted
average yield of the Companys investment securities at June 30, 2006, by remaining period to contractual maturity. With respect to mortgage-backed securities, the entire amount is reflected in the maturity period that includes the final
security payment date and, accordingly, no effect has been given to periodic repayments or possible prepayments. The weighted average yields on investments available-for-sale are based on amortized cost.



|                                      |  |                        |       |            |   |                        |  |      |  
|------------------------------------- |  | ---------------------- | ----- | ---------- | - | ---------------------- |  | ---- | -
|                                      |  | At June 30, 2006       |      
|                                      |  | Available-for-Sale     |      
|                                      |  | Amortized Cost         |       | Fair Value |   | Weighted Average Yield | 
|                                      |  | (Dollars in thousands) |      
|Debt Securities                       |  |                        |       |            |   |                        |  |      |  
|Mortgaged-backed securities:          |  |                        |       |            |   |                        |  |      |  
|Due within 1 year                     |  | $                      |      |            | $ |                       |  |     | %
|Due after 1 year but within 5 years   |  |                        |      |            |   |                       |  |     |  
|Due after 5 years but within 10 years |  |                        | 302   |            |   | 292                    |  | 4.82 |  
|Due after 10 years                    |  |                        | 493   |            |   | 489                    |  | 5.37 |  
|                                      |  |                        |       |            |   |                        |  |      |  
|Total                                 |  |                        | 795   |            |   | 781                    |  | 5.16 |  
|                                      |  |                        |       |            |   |                        |  |      |  
|U.S. Treasury and Agency:             |  |                        |       |            |   |                        |  |      |  
|Due within 1 year                     |  |                        |      |            |   |                       |  |     |  
|Due after 1 year but within 5 years   |  |                        | 2,100 |            |   | 2,069                  |  | 4.49 |  
|Due after 5 years but within 10 years |  |                        | 300   |            |   | 289                    |  | 4.00 |  
|Due after 10 years                    |  |                        |      |            |   |                       |  |     |  
|                                      |  |                        |       |            |   |                        |  |      |  
|Total                                 |  |                        | 2,400 |            |   | 2,358                  |  | 4.43 |  
|                                      |  |                        |       |            |   |                        |  |      |  
|Corporate & Other:                    |  |                        |       |            |   |                        |  |      |  
|Due within 1 year                     |  |                        |      |            |   |                       |  |     |  
|Due after 1 year but within 5 years   |  |                        |      |            |   |                       |  |     |  
|Due after 5 years but within 10 years |  |                        |      |            |   |                       |  |     |  
|Due after 10 years                    |  |                        | 288   |            |   | 301                    |  | 4.79 |  
|                                      |  |                        |       |            |   |                        |  |      |  
|Total                                 |  |                        | 288   |            |   | 301                    |  | 4.79 |  
|                                      |  |                        |       |            |   |                        |  |      |  
|Equity Securities:                    |  |                        |      |            |   | 17                     |  |     |  
|                                      |  |                        |       |            |   |                        |  |      |  
|Total:                                |  |                        |       |            |   |                        |  |      |  
|Due within 1 year                     |  |                        |      |            |   |                       |  |     |  
|Due after 1 year but within 5 years   |  |                        | 2,100 |            |   | 2,069                  |  | 4.49 |  
|Due after 5 years but within 10 years |  |                        | 602   |            |   | 581                    |  | 4.41 |  
|Due after 10 years                    |  |                        | 781   |            |   | 790                    |  | 5.16 |  
|Equity Securities                     |  |                        |      |            |   | 17                     |  |     |  
|Federal Home Loan Bank Stock          |  |                        | 1,792 |            |   | 1,792                  |  |      |  
|                                      |  |                        |       |            |   |                        |  |      |  
|Total                                 |  | $                      | 5,275 |            | $ | 5,249                  |  | 4.62 | %
|                                      |  |                        |       |            |   |                        |  |      |  



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##### Table of Contents

Sources of Funds

General. Deposits, loan and security repayments and prepayments, proceeds of refinanced loans sold to FNMA and cash flows generated from operations are the primary sources of the Banks funds for use in
lending and for other general purposes.

Deposits. The Bank offers a variety of deposit accounts with a range of interest rates and
terms. The Banks deposits consist of savings accounts, checking accounts, money market deposit accounts, IRAs and certificates of deposit. At June 30, 2006, the Banks core deposits (which the Bank considers to consist of checking
accounts and savings accounts) constituted 48.5% of total deposits. The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. The Banks deposits
are obtained predominantly from Ashe, Alleghany and Watauga counties. The Bank relies primarily on customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered
by competing financial institutions significantly affect the Banks ability to attract and retain deposits.

The following table
presents the deposit activity of the Bank for the periods indicated.



|                                                                  |  |                             |         |      |   |         |  |   |        
|----------------------------------------------------------------- |  | --------------------------- | ------- | ---- | - | ------- |  | - | -------
|                                                                  |  | For the Year Ended June 30,
|                                                                  |  | 2006                        |         | 2005 |   | 2004   
|                                                                  |  | (In thousands)             
|Total deposits at beginning of period, including accrued interest |  | $                           | 163,977 |      | $ | 157,434 |  | $ | 149,571
|Net increase before interest credited                             |  |                             | 3,893   |      |   | 3,668   |  |   | 5,156  
|Interest credited                                                 |  |                             | 9,143   |      |   | 2,875   |  |   | 2,707  
|                                                                  |  |                             |         |      |   |         |  |   |        
|Total deposits at end of period                                   |  | $                           | 177,013 |      | $ | 163,977 |  | $ | 157,434
|                                                                  |  |                             |         |      |   |         |  |   |        

At June 30, 2006, the Bank had approximately $27.9 million in jumbo certificates
of deposit (accounts in amounts over $100,000) maturing as follows:



|                                  |  |                |        |                       |      |  
|--------------------------------- |  | -------------- | ------ | --------------------- | ---- | -
|                                  |  | Amount         |        | Weighted Average Rate |     
|                                  |  | (In thousands) |       
|Maturity Period                   |  |                |        |                       |      |  
|Within three months               |  | $              | 5,171  |                       | 4.04 | %
|After three but within six months |  |                | 6,852  |                       | 4.10 | %
|After six but within 12 months    |  |                | 9,807  |                       | 4.58 | %
|After 12 months                   |  |                | 6,094  |                       | 4.38 | %
|                                  |  |                |        |                       |      |  
|Total                             |  | $              | 27,924 |                       | 4.32 | %
|                                  |  |                |        |                       |      |  



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##### Table of Contents

The following table sets forth the distribution of the Banks deposit accounts and the related
weighted average interest rates at the dates indicated.



|                                      |  |                        |         |                           |        |   |                       |      |   |        |   |                           |  |        |                       |  |      |        |  |                           |         |  |                       |   |  |      |  
|------------------------------------- |  | ---------------------- | ------- | ------------------------- | ------ | - | --------------------- | ---- | - | ------ | - | ------------------------- |  | ------ | --------------------- |  | ---- | ------ |  | ------------------------- | ------- |  | --------------------- | - |  | ---- | -
|                                      |  | At June 30,            |        
|                                      |  | 2006                   |         |                           | 2005   |   |                       | 2004 |  
|                                      |  | Amount                 |         | Percent of Total Deposits |        |   | Weighted Average Rate |      |   | Amount |   | Percent of Total Deposits |  |        | Weighted Average Rate |  |      | Amount |  | Percent of Total Deposits |         |  | Weighted Average Rate |  
|                                      |  | (Dollars in thousands) |        
|Noninterest bearing checking accounts |  | $                      | 24,053  |                           | 13.59  | % |                       | 0.00 | % |        | $ | 18,007                    |  | 10.98  | %                     |  | 0.00 | %      |  | $                         | 13,793  |  | 8.76                  | % |  | 0.00 | %
|Interest bearing checking accounts    |  |                        | 25,406  |                           | 14.35  | % |                       | 1.00 | % |        |   | 23,771                    |  | 14.50  | %                     |  | 0.65 | %      |  |                           | 22,724  |  | 14.43                 | % |  | 0.49 | %
|Money Market accounts                 |  |                        | 13,679  |                           | 7.73   | % |                       | 3.28 | % |        |   | 1,017                     |  | 0.62   | %                     |  | 0.49 | %      |  |                           | 1,646   |  | 1.05                  | % |  | 0.48 | %
|Savings                               |  |                        | 22,741  |                           | 12.85  | % |                       | 1.21 | % |        |   | 39,499                    |  | 24.08  | %                     |  | 1.43 | %      |  |                           | 42,495  |  | 26.99                 | % |  | 1.12 | %
|Certificates of deposit               |  |                        | 90,797  |                           | 51.29  | % |                       | 4.13 | % |        |   | 81,427                    |  | 49.66  | %                     |  | 3.05 | %      |  |                           | 76,436  |  | 48.55                 | % |  | 2.55 | %
|Accrued interest                      |  |                        | 337     |                           | 0.19   | % |                       | 0.00 | % |        |   | 256                       |  | 0.16   | %                     |  | 0.00 | %      |  |                           | 340     |  | 0.22                  | % |  | 0.00 | %
|                                      |  |                        |         |                           |        |   |                       |      |   |        |   |                           |  |        |                       |  |      |        |  |                           |         |  |                       |   |  |      |  
|Totals                                |  | $                      | 177,013 |                           | 100.00 | % |                       | 2.68 | % |        | $ | 163,977                   |  | 100.00 | %                     |  | 1.95 | %      |  | $                         | 157,434 |  | 100.00                | % |  | 1.62 | %
|                                      |  |                        |         |                           |        |   |                       |      |   |        |   |                           |  |        |                       |  |      |        |  |                           |         |  |                       |   |  |      |  



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##### Table of Contents

The following table presents, by interest rate ranges and the period to maturity, the amount of
certificate of deposit accounts outstanding at June 30, 2006.



|                    |  |                                     |        |                    |   |                      |  |       |       |  |   |       
|------------------- |  | ----------------------------------- | ------ | ------------------ | - | -------------------- |  | ----- | ----- |  | - | ------
|                    |  | Period to Maturity at June 30, 2006
|Interest Rate Range |  | Less than One Year                  |        | One to Three years |   | Four Years and After |  | Total
|                    |  | (In thousands)                     
|1.50% to 4.99%      |  | $                                   | 65,612 |                    | $ | 13,973               |  | $     | 1,713 |  | $ | 81,298
|5.00% to 5.75%      |  |                                     | 8,196  |                    |   | 1,303                |  |       |      |  |   | 9,499 
|                    |  |                                     |        |                    |   |                      |  |       |       |  |   |       
|Total               |  | $                                   | 73,808 |                    | $ | 15,276               |  | $     | 1,713 |  | $ | 90,797
|                    |  |                                     |        |                    |   |                      |  |       |       |  |   |       

In addition to traditional savings deposits, AF Bank has an agreement with Promontory
Interfinancial Network which allows us to provide FDIC insurance coverage beyond the normal limits by using its network. The agreement allows us to maintain large deposit relationships when the customer desires FDIC coverage on all deposit balances.
As of June 30, 2006, we had $3.2 million placed in the Promontory Interfinancial Network which is included in the certificate of deposit account totals in the tables above.

Borrowings. The Bank may obtain advances from the FHLB as an alternative to retail deposit funds and may do so in the future as part of its
operating strategy. These advances would be collateralized primarily by certain of the Banks mortgage loans and secondarily by the Banks investment in capital stock of the FHLB. See RegulationRegulation of Federal Savings
BanksFederal Home Loan Bank System. Such advances may be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The maximum amount that the FHLB will advance to member
institutions, including the Bank, fluctuates from time to time in accordance with the policies of the OTS and the FHLB. The Bank had advances of $28.6 million at June 30, 2006 from the FHLB. Interest is payable at rates ranging from 3.50% to
6.87%. These advances are listed on the balance sheet as either short-term or long-term borrowings depending on the remaining maturity of the advance as of the balance sheet date. FHLB advances consist of the following:



|                                                             |  |      |            |   |      |   |            |      |  |   |            |  
|------------------------------------------------------------ |  | ---- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                             |  | 2006 |            |   | 2005 |   |            | 2004 | 
|Balance outstanding                                          |  | $    | 28,639,385 |   |      | $ | 28,141,664 |      |  | $ | 33,143,754 |  
|Interest rate range                                          |  |      | 3.50%-6.87 | % |      |   | 2.51%-6.87 | %    |  |   | 1.03%-6.87 | %
|Weighted average interest rate at June 30                    |  |      | 5.07       | % |      |   | 4.50       | %    |  |   | 3.76       | %
|Maximum amount outstanding at any month end                  |  |      | 28,639,385 |   |      |   | 42,143,248 |      |  |   | 33,143,754 |  
|Average amount outstanding                                   |  |      | 26,181,873 |   |      |   | 35,059,129 |      |  |   | 23,345,330 |  
|Interest expense                                             |  |      | 1,258,301  |   |      |   | 1,367,744  |      |  |   | 1,129,778  |  
|Weighted average interest rate during the year ended June 30 |  |      | 4.73       | % |      |   | 3.88       | %    |  |   | 4.53       | %

The Company may also obtain additional borrowings from other financial institutions or related
parties to fund cash flow needs or to provide additional capital. The borrowings are listed on the balance sheet as either short-term or long-term borrowings depending on the remaining maturity of the advance as of the balance sheet date.

Short-term and long-term borrowings are due in future years as follows:



|                     |  |        |           
|-------------------- |  | ------ | ----------
|Year ending June 30, |  | Amount
|2007                 |  | $      | 5,155,918 
|2008                 |  |        | 231,112   
|2009                 |  |        | 176,701   
|2010                 |  |        | 78,954    
|2011                 |  |        | 16,000,000
|Thereafter           |  |        | 13,155,000
|                     |  |        |           
|                     |  | $      | 34,797,685
|                     |  |        |           

In addition, the Bank has a $1.5 million letter of credit from the FHLB used to collateralize
public deposits.



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##### Table of Contents

Subsidiary Activities

AF Insurance Services, Inc., a wholly owned subsidiary of the Company, was formed in July 1997 upon the purchase of two independent insurance agencies for the sole purpose of selling traditional property and casualty,
life and health insurance. From 1999 through 2004 AF Insurance Services purchased additional insurance agencies. It offers these services in a segregated location at the Companys offices and branch locations in, Boone, Sparta, Lenoir,
Jefferson, North Wilkesboro, West Jefferson and Elkin, North Carolina. The operating results of AF Insurance Services are not material to the operating results of the Company.

On July 16, 2001, AF Capital Trust I, a Delaware business trust, was formed by the Company and completed the sale of $5.0 million of 10.25% Capital
Securities (liquidation amount of $1,000 per security) in a private placement as part of a pooled capital securities transaction. The Trust also issued common securities to the Company and used the net proceeds from the offering to purchase a like
amount of 10.25% Junior Subordinated Deferrable Interest Debentures (the Subordinated Debentures) of the Company. The Company participated in a new $5.0 million trust preferred issuance during the first quarter of the 2007 fiscal year.
At approximately the same time this new issuance settled, the Company paid off the existing $5.0 million trust preferred issuance. The Company paid an early redemption cost of $384,375. This amount was expensed during the first quarter of the 2007
fiscal year. The new issuance was priced at a floating rate of LIBOR plus 150 basis points compared to the current issuance which is at a fixed rate of 10.25%.

Personnel

As of June 30, 2006, the Company had 111 full-time employees. The employees are not represented by a
collective bargaining unit and the Company considers its relationship with its employees to be good. See Executive Compensation for a description of certain compensation and benefit programs offered to the Companys employees.

REGULATION

General

The Company and AsheCo, MHC, the mutual holding company (MHC) that owns 51.22% of the Companys common stock, are regulated as savings
and loan holding companies by the OTS. The Bank, as a federal stock savings bank, is subject to regulation, examination and supervision by the OTS. The Bank must file reports with the OTS concerning its activities and financial condition. The
Company and the MHC are also required to file reports with, and otherwise comply with the rules and regulations of the OTS. The Company is also required to file reports with, and otherwise comply with, the rules and regulations of the SEC under the
federal securities laws.

Federal Banking Regulation

Activity Powers. The Bank derives its lending and investment powers from the Home Owners Loan Act (HOLA), as amended, and the regulations of the OTS. Under these laws and regulations, the Bank
may invest in mortgage loans secured by residential and commercial real estate; commercial and consumer loans; certain types of debt securities; and certain other assets. The Bank may also establish service corporations that may engage in activities
not otherwise permissible for the Bank, including certain real estate equity investments and securities and insurance brokerage. The Banks authority to invest in certain types of loans or other investments is limited by federal law.

Loans-to-One-Borrower Limitations. The Bank is generally subject to the same limits on loans to one borrower as a national bank.
With specified exceptions, the Banks total loans or extensions of credit to a single borrower cannot exceed 15% of the Banks unimpaired capital and surplus which does not include accumulated other comprehensive income. The Bank may lend
additional amounts up to 10% of its unimpaired capital and surplus, if the loans or extensions of credit are fully-secured by readily-marketable collateral. The Bank currently complies with applicable loans-to-one-borrower limitations.

QTL Test. Under federal law, the Bank must comply with the qualified thrift lender, or QTL test. Under the QTL test, the Bank is
required to maintain at least 65% of its portfolio assets in certain qualified thrift investments in at least nine months of the most recent 12-month period. Portfolio assets means, in general, the Banks
total assets less the sum of:



| |  |  | specified liquid assets up to 20% of total assets;
| | - |  | --------------------------------------------------



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##### Table of Contents

| |  |  | goodwill and other intangible assets; and
| | - |  | -----------------------------------------



| |  |  | the value of property used to conduct the Banks business.
| | - |  | ----------------------------------------------------------

The Bank may also satisfy the QTL test by qualifying as a domestic building and loan association as defined in the Internal Revenue Code of 1986. The Bank met the QTL test at June 30, 2006, and in each of the prior 12
months, and, therefore, qualifies as a thrift lender. For purposes of calculating compliance with the QTL test, we use the cost basis of our investment in our FHLMC common stock, rather than the current market value of the stock.

If the Bank fails the QTL test it must either operate under certain restrictions on its activities or convert to a bank charter.

Capital Requirements. OTS regulations require the Bank to meet three minimum capital standards:

(1) a tangible capital ratio requirement of 1.5% of total assets, as adjusted under the OTS regulations;

(2) a leverage ratio requirement of 3% of core capital to such adjusted total assets, if a savings association has been assigned the highest composite
rating of 1 under the Uniform Financial Institutions Ratings System; and

(3) a risk-based capital ratio requirement of 8% of core and
supplementary capital to total risk- weighted assets.

The minimum leverage capital ratio for any other depository institution that does
not have a composite rating of 1 will be 4%, unless a higher leverage capital ratio is warranted by the particular circumstances or risk profile of the depository institution. In determining compliance with the risk-based capital requirement, the
Bank must compute its risk-weighted assets by multiplying its assets and certain off-balance sheet items by risk-weights, which range from 0% for cash and obligations issued by the United States government or its agencies to 100% for consumer and
commercial loans, as assigned by the OTS capital regulation based on the risks that the OTS believes are inherent in the type of asset.

Tangible capital is defined, generally, as common stockholders equity (including retained earnings), certain non-cumulative perpetual preferred stock and related earnings and minority interests in equity accounts of fully consolidated
subsidiaries, less intangibles (other than certain mortgage servicing rights) and investments in and loans to subsidiaries engaged in activities not permissible for a national bank. Core capital is defined similarly to tangible capital, but core
capital also includes certain qualifying supervisory goodwill and certain purchased credit card relationships. Supplementary capital currently includes cumulative and other perpetual preferred stock, mandatory convertible securities, subordinated
debt and intermediate preferred stock and the allowance for loan and lease losses, as defined in the OTS regulations. In addition, up to 45% of unrealized gains on available-for-sale equity securities with a readily determinable fair value may be
included in tier 2 capital. The allowance for loan and lease losses is includable in tier 2 capital to a maximum of 1.25% of risk-weighted assets, and the amount of supplementary capital that may be included as total capital cannot exceed the amount
of core capital. At June 30, 2006, the Bank met each of its capital requirements.

Community Reinvestment Act. Under the
Community Reinvestment Act (CRA), as implemented by OTS regulations, the Bank has a continuing and affirmative obligation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA
does not establish specific lending requirements or programs for the Bank nor does it limit its discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA
requires the OTS, in connection with its examination of the Bank, to assess the Banks record of meeting the credit needs of its community and to take the record into account in its evaluation of certain applications by the Bank. The CRA also
requires all institutions to make public disclosure of their CRA ratings. The Bank received a Satisfactory CRA rating in its most recent examination.



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##### Table of Contents

CRA regulations rate an institution based on its actual performance in meeting community needs. In
particular, the system focuses on three tests:



| |  |  | a lending test, to evaluate the institutions record of making loans in its assessment areas;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | an investment test, to evaluate the institutions record of investing in community development projects, affordable housing, and programs benefiting low or moderate income
individuals and businesses; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a service test, to evaluate the institutions delivery of services through its branches, ATMs and other offices.
| | - |  | ----------------------------------------------------------------------------------------------------------------

Transactions with Related Parties. The Banks authority to engage in transactions with its affiliates is limited by the OTS
regulations and by Sections 23A and 23B of the Federal Reserve Act (the FRA). In general, these transactions must be on terms which are as favorable to the Bank as comparable transactions with non-affiliates. In addition, certain types
of these transactions are restricted to an aggregate percentage of the Banks capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the Bank. In addition, the OTS regulations prohibit a
savings association from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.

Effective April 1, 2003, the FRB rescinded its interpretations of Sections 23A and 23B of the FRA and replaced these interpretations with Regulation
W (Regulation W expands the definition of what constitutes an affiliate subject to Sections 23A and 23B).

The Banks authority to
extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the FRB. Among other
things, these provisions require that extensions of credit to insiders (a) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable
transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features and (b) not exceed certain limitations on the amount of credit extended to such persons, individually
and in the aggregate, which limits are based, in part, on the amount of the Banks capital. The regulations allow small discounts on fees on residential mortgages for directors, officers and employees. In addition, extensions of credit in
excess of certain limits must be approved by the Banks Board of Directors.

Section 402 of the Sarbanes-Oxley Act of 2002,
(Sarbanes-Oxley) prohibits the extension of personal loans to directors and executive officers of issuers (as defined in Sarbanes-Oxley). The prohibition, however, does not apply to mortgages advanced by an insured depository
institution, such as the Bank, which are subject to the insider lending restrictions of Section 22(h) of the FRA.

Enforcement.
The OTS has primary enforcement responsibility over savings associations, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove
directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and to unsafe or unsound practices.

Standards For Safety And Soundness. Under federal law, the OTS has adopted a set of guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal
controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings standards, and compensation, fees and benefits. In general, the guidelines require
appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines.

In addition, the OTS adopted
regulations that authorize, but do not require, the OTS to order an institution that has been given notice that it is not satisfying these safety and soundness standards to submit a compliance plan. If, after being notified, an institution fails to
submit an acceptable plan or fails in any material respect to implement an accepted plan, the OTS must issue an order directing action to correct the deficiency and may issue an order directing corrective actions and may issue an order directing
other actions of the types to which an undercapitalized association is subject under the prompt corrective action provisions of federal law. If an institution fails to comply with such an order, the OTS may seek to enforce such order in
judicial proceedings and to impose civil money penalties.



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##### Table of Contents

Limitation on Capital Distributions. The OTS imposes various restrictions or requirements on the
Banks ability to make capital distributions, including cash dividends. A savings institution that is the subsidiary of a savings and loan holding company must file a notice with the OTS at least 30 days before making a capital distribution.
The Bank must file an application for prior approval if the total amount of its capital distributions, including the proposed distribution, for the applicable calendar year would exceed an amount equal to the Banks net income for that year
plus the Banks retained net income for the previous two years.

The OTS may disapprove a notice or application if:



| |  |  | the Bank would be undercapitalized following the distribution;
| | - |  | --------------------------------------------------------------



| |  |  | the proposed capital distribution raises safety and soundness concerns; or
| | - |  | --------------------------------------------------------------------------



| |  |  | the capital distribution would violate a prohibition contained in any statute, regulation or agreement.
| | - |  | -------------------------------------------------------------------------------------------------------

Liquidity. The Bank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.

Prompt Corrective Action Regulations. Under the OTS prompt corrective action regulations, the OTS is required to take certain, and is authorized
to take other, supervisory actions against undercapitalized savings associations. For this purpose, a savings association would be placed in one of the following four categories based on the associations capital:



| |  |  | well-capitalized;
| | - |  | -----------------



| |  |  | adequately capitalized;
| | - |  | -----------------------



| |  |  | undercapitalized; and
| | - |  | ---------------------



| |  |  | critically undercapitalized.
| | - |  | ----------------------------

At June 30, 2006, the
Bank met the criteria for being considered well-capitalized.

When appropriate, the OTS can require corrective action by a
savings association holding company under the prompt corrective action provisions of federal law.

Insurance of Deposit
Accounts. The Bank is a member of the Savings Association Insurance Fund (SAIF), and the Bank pays its deposit insurance assessments to the SAIF. The FDIC also maintains another insurance fund, the Bank Insurance Fund
(BIF), which primarily insures the deposits of banks and state chartered savings banks.

Under federal law, the FDIC
established a risk-based assessment system for determining the deposit insurance assessments to be paid by insured depository institutions. Under the assessment system, the FDIC assigns an institution to one of three capital categories based on the
institutions financial information as of its most recent quarterly financial report filed with the applicable bank regulatory agency prior to commencement of the assessment period. An institutions assessment rate depends on the capital
category and supervisory sub-category to which it is assigned. Under the regulation, there are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied.
Assessment rates currently range from 0.0% of deposits for an institution in the highest category (i.e., well-capitalized and financially sound, with no more than a few minor weaknesses) to 0.27% of deposits for an institution in the lowest category
(i.e., undercapitalized and substantial supervisory concern). The FDIC is authorized to raise the assessment rates as necessary to maintain the required reserve ratio of 1.25%.

In addition, all FDIC insured institutions are required to pay assessments to the FDIC at an annual rate of approximately .0134% of insured deposits to
fund interest payment on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the SAIF. These assessments will continue until the Financing Corporation bonds mature in 2017.



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##### Table of Contents

Federal Home Loan Bank System. The Bank is a member of the FHLB of Atlanta, which is one of the
regional FHLBs making up the FHLB System. Pursuant to regulations promulgated by the Federal Housing Finance Board, as required by the Gramm-Leach-Bliley Act (the GLB ACT), the FHLB of Atlanta adopted a new capital plan on
December 17, 2004. Under the new capital plan, each member of the FHLB of Atlanta has to maintain a minimum investment in FHLB of Atlanta stock in an amount estimated to be the sum of (i) an amount (up to a maximum of $25 million) equal to
approximately 0.20% of the members total assets and (ii) 4.5% of the members outstanding advances, plus 4.5% of the outstanding assets purchased from the member and held by the FHLB under master commitments, plus 8% of any
Affordable Multi-Family Participation Program loans purchased from the member. Any advances from a FHLB must be secured by specified types of collateral, and all long-term advances may be obtained only for the purpose of providing funds for
residential housing finance.

FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for
affordable housing programs. These requirements could reduce the amount of earnings that the FHLBs can pay as dividends to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. If dividends
were reduced, or interest on future FHLB advances increased, the Banks net interest income would be affected.

Prohibitions
Against Tying Arrangements. Federal savings banks are subject to the prohibitions of 12 U.S.C. § 1972 on certain tying arrangements. A depository institution is prohibited, subject to some exceptions, from extending credit to or offering
any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the
institution.

Federal Reserve System

Under regulations of the FRB, the Bank is required to maintain noninterest-earning reserves against its transaction accounts. FRB regulations generally require that reserves of 3% must be maintained against aggregate transaction accounts of
$48.3 million or less, subject to adjustment by FRB, and a reserve 10% of that portion of total transaction accounts in excess of $48.3 million. The first $7.8 million of otherwise reservable balances, subject to adjustments by FRB, are exempted
from the reserve requirements. The Bank is in compliance with these requirements. Because required reserves must be maintained in the form of either vault cash, a noninterest-bearing account at a Federal Reserve Bank or a pass-through account as
defined by FRB, the effect of this reserve requirement is to reduce the Banks interest-earning assets, to the extent the requirement exceeds vault cash.

Holding Company Regulation

The Company and the MHC are savings and loan holding companies regulated by the OTS. As such,
the Company and the MHC are registered with and are subject to OTS examination and supervision, as well as certain reporting requirements. In addition, the OTS has enforcement authority over the Company and the MHC and any of their non-savings
institution subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness or stability of a subsidiary savings institution. Unlike bank
holding companies, federal savings and loan holding companies are not subject to any regulatory capital requirements or to supervision by the FRB.

Restrictions Applicable to the Company. Because the Company was organized before May 4, 1999, under the GLB Act, it is grandfathered under the GLB Act and generally has no restriction on its business activities.

Restrictions Applicable to Activities of Mutual Holding Companies. Under federal law, a mutual holding company may engage only in
the following activities:



| |  |  | investing in the stock of a savings institution;
| | - |  | ------------------------------------------------



| |  |  | acquiring a mutual association through the merger of such association into a savings institution subsidiary of such holding company or an interim savings institution subsidiary of
such holding company;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | merging with or acquiring another holding company, one of whose subsidiaries is a savings institution;
| | - |  | ------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | investing in a corporation the capital stock of which is available for purchase by a savings institution under federal law or under the law of any state where the subsidiary savings
institution or association is located; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the permissible activities described above for non-grandfathered savings and loan holding companies.
| | - |  | ----------------------------------------------------------------------------------------------------

If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company resulting from such
merger or acquisition may only invest in assets and engage in activities listed above, and it has a period of two years to cease any non-conforming activities and divest any non-conforming investments.

Restrictions Applicable to All Savings and Loan Holding Companies. Federal law prohibits a savings and loan holding company, including the Company
and the MHC, directly or indirectly, from acquiring:



| |  |  | control (as defined under HOLA) of another savings institution (or a holding company parent) without prior OTS approval;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | through merger, consolidation, or purchase of assets, another savings institution or a holding company thereof, or acquiring all or substantially all of the assets of such
institution (or a holding company) without prior OTS approval; or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | control of any depository institution not insured by the FDIC (except through a merger with and into the holding companys savings institution subsidiary that is approved by
the OTS).
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A savings and loan holding company may not acquire as a separate subsidiary an insured institution that has a
principal office outside of the state where the principal office of its subsidiary institution is located, except: in the case of certain emergency acquisitions approved by the FDIC;



| |  |  | if such holding company controls a savings institution subsidiary that operated a home or branch office in such additional state as of March 5, 1987; or
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if the laws of the state in which the savings institution to be acquired is located specifically authorize a savings institution chartered by that state to be acquired by a savings
institution chartered by the state where the acquiring savings institution or savings and loan holding company is located or by a holding company that controls such a state chartered association.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If the savings institution subsidiary of a federal mutual holding company fails to meet the QTL test set forth in Section 10(m) of the HOLA and
regulations of the OTS, the holding company must register with the FRB as a bank holding company under the Bank Holding Company Act within one year of the savings institutions failure to so qualify.

Federal Securities Law.Our common stock is registered with the SEC under Section 12(g) of the Securities Exchange Act of 1934, as amended
(the Exchange Act). We are subject to information, proxy solicitation, insider trading restrictions, and other requirements under the Exchange Act.

Sarbanes-Oxley Act of 2002

On July 30, 2002, Sarbanes-Oxley was signed into law and became some of the most sweeping
federal legislation addressing accounting, corporate governance and disclosure issues. The impact of Sarbanes-Oxley is wide-ranging as it applies to all public companies and imposes significant new requirements for public company governance and
disclosure requirements. Some of the provisions of Sarbanes-Oxley became effective immediately while others are still in the process of being implemented.

In general, Sarbanes-Oxley mandates important new corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies reported financial results. It
establishes new responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process and creates a new regulatory body to oversee auditors of public companies. It backs these
requirements with new SEC enforcement tools, increases criminal penalties for federal mail, wire and securities fraud, and creates new criminal penalties for document and record destruction in connection with federal



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##### Table of Contents

investigations. It also increases the opportunity for more private litigation by lengthening the statute of limitations
for securities fraud claims and providing new federal corporate whistleblower protection. The economic and operational effects of this new legislation on public companies, including us, have been and will continue to be significant in terms of the
time, resources and costs associated with complying with the new law.

USA Patriot Act of 2001

The USA Patriot Act of 2001 was enacted in response to the terrorist attacks that occurred in New York, Pennsylvania and Washington, D.C. on
September 11, 2001. The Act is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Act on financial institutions of
all kinds is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws and has resulted in numerous regulations, including standards for verifying customer identification at account opening, and
rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

Gramm-Leach-Bliley Act

The GLB Act dramatically changed various federal laws governing the banking,
securities and insurance industries. The GLB Act has expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. However, this expanded
authority also may present us with new challenges as our larger competitors are able to expand their services and products into areas that are not feasible for smaller, community oriented financial institutions. The GLB Act likely will have a
significant economic impact on the banking industry and on competitive conditions in the financial services industry.

Fair and Accurate Credit
Transactions (FACT) Act

AF Bank will follow all applicable guidelines covered in the Fair and Accurate Credit Transactions Act of 2003
(FACT Act) requiring protection for the victims of identity theft, the providing of information to consumers about credit reports and credit scoring, the limits of information sharing between affiliates, and the protection of
consumers medical and other information. Some of the provisions of the FACT Act became effective immediately while others are still in the process of being implemented.

FEDERAL AND STATE TAXATION

Federal Taxation

General. The following discussion is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable
to the Bank, the MHC or the Company. The Bank has not been audited by the Internal Revenue Service for the last eight years.

For federal
income tax purposes, the Company reports its income on the basis of a taxable year ending June 30, using the accrual method of accounting, and is subject to federal income taxation in the same manner as other corporations with some exceptions,
including particularly the Banks tax reserve for bad debts, discussed below. The Bank, AF Insurance Services, Inc., and the Company constitute an affiliated group of corporations and, therefore, are eligible to report their income on a
consolidated basis. Because the MHC owns less than 80% of the Common Stock, it is not be a member of such affiliated group and reports its income on a separate return.

Bad Debt Reserves. The Bank, as a small bank (one with assets having an adjusted tax basis of $500 million or less), is permitted to maintain a reserve for bad debts with respect to qualifying
loans, which, in general, are loans secured by certain interests in real property, and to make, within specified formula limits, annual additions to the reserve which are deductible for purposes of computing the Banks taxable income.
Pursuant to the Small Business Job Protection Act of 1996, the Bank is now recapturing (taking into income) over a multi-year period a portion of the balance of its bad debt reserve as of June 30, 1996. Since the Bank has already provided a
deferred tax liability equal to the amount of such recapture, the recapture will not adversely impact the Banks financial condition or results of operations.



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##### Table of Contents

Distributions. To the extent that the Bank makes non-dividend distributions to
shareholders, such distributions will be considered to result in distributions from the Banks base year reserve, to the extent thereof and then from its supplemental reserve for losses on loans, and an amount based on the amount
distributed will be included in the Banks taxable income. Non-dividend distributions include distributions in excess of the Banks current and accumulated earnings and profits, distributions in redemption of stock and distributions in
partial or complete liquidation. However, dividends paid out of the Banks current or accumulated earnings and profits, as calculated for federal income tax purposes, will not constitute non-dividend distributions and, therefore, will not be
included in the Banks income.

The amount of additional taxable income created from a non-dividend distribution is equal to the
lesser of the Banks base year reserve and supplemental reserve for losses on loans; or an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, in certain situations approximately
one and one-half times the non-dividend distribution would be includable in gross income for federal income tax purposes, assuming a 35% federal corporate income tax rate.

Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended (the Code), imposes a tax (AMT) on
alternative minimum taxable income (AMTI) at a rate of 20%. Only 90% of AMTI can be offset by net operating loss carryovers. AMTI is also adjusted by determining the tax treatment of certain items in a manner that negates the deferral of
income resulting from the regular tax treatment of those items. Thus, the Banks AMTI is increased by an amount equal to 75% of the amount by which the Banks adjusted current earnings exceeds its AMTI (determined without regard to this
adjustment and prior to reduction for net operating losses).

Elimination of Dividends; Dividends Received Deduction. The Company
may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. Because the MHC is not a member of such affiliated group, it does not qualify for such 100% dividends exclusion, but will
be entitled to deduct 70% of the dividends it receives from the Company so long as it owns more than 20% of the common stock.

State Taxation

Under North Carolina law, the corporate income tax is 6.9% of federal taxable income as computed under the Code, subject to certain
prescribed adjustments. An annual state franchise tax is imposed at a rate of 0.0015 applied to the greatest of the institutions (i) capital stock, surplus and undivided profits, (ii) investment in tangible property in North Carolina
or (iii) 55% of the appraised valuation of property in North Carolina.

Risk Factors

Concentration of Operations

The Banks
operations are concentrated in the western region of North Carolina. As a result of this geographic concentration, the Banks results may correlate to the economic conditions in these areas. A deterioration in economic conditions in any of
these market areas, particularly in the industries on which these geographic areas depend, may adversely affect the quality of the Banks loan portfolio and the demand for the Banks products and services, and accordingly, its results of
operations.

Risks Associated with Loans

A significant source of risk for the Bank arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Bank has underwriting
and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking
loan performance and diversifying the Banks loan portfolio. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect results of operations.

Competition with Larger Financial Institutions

The
banking and financial services business in the Banks market area continues to be a competitive field and is becoming more competitive as a result of:



| |  |  | changes in regulations;
| | - |  | -----------------------



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##### Table of Contents

| |  |  | changes in technology and product delivery systems; and
| | - |  | -------------------------------------------------------



| |  |  | the accelerating pace of consolidation among financial services providers.
| | - |  | --------------------------------------------------------------------------

It may be difficult to compete effectively in the Banks market, and results of operations could be adversely affected by the nature or pace of change in competition. The Bank competes for loans, deposits and
customers with various bank and non-bank financial services providers, many of which are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services.

Trading Volume

The trading volume in AF
Financials common stock on the OTC Bulletin Board has been comparable to other similarly sized banks and companies trading on the OTC Bulletin Board. Nevertheless, this trading is relatively low when compared with more seasoned companies
listed on the Nasdaq Capital Market, the Nasdaq Global Select Market, the Nasdaq Global Market, the New York Stock Exchange or other consolidated reporting systems or stock exchanges. The market in the Companys common stock may be limited in
scope relative to other companies. AF Financial cannot guarantee that a more active and liquid trading market for its common stock will develop in the future.

Technological Advances

The banking industry is undergoing technological changes with frequent introductions of new
technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. The Banks future success will depend, in part, on its
ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in the Banks operations. Many of our competitors
have substantially greater resources than the Company and the Bank to invest in technological improvements.

Government Regulations

Current and future legislation and the policies established by federal and state regulatory authorities will affect the Companys and the Banks
operations. The Bank is subject the supervision of and examination by the OTS and for some purposes by the FRB. AF Financial is also subject to the supervision and regulation of the OTS. OTS regulations, designed primarily for the protection of
depositors, may limit the Companys and the Banks growth and the return to our shareholders by restricting certain of AF Financials and the Banks activities, such as:



| |  |  | the payment of dividends to the Companys shareholders;
| | - |  | -------------------------------------------------------



| |  |  | possible mergers with or acquisitions of or by other institutions;
| | - |  | ------------------------------------------------------------------



| |  |  | investment policies;
| | - |  | --------------------



| |  |  | loans and interest rates on loans;
| | - |  | ----------------------------------



| |  |  | interest rates paid on deposits;
| | - |  | --------------------------------



| |  |  | expansion of branch offices; and/or
| | - |  | -----------------------------------



| |  |  | the possibility to provide or expand securities or trust services.
| | - |  | ------------------------------------------------------------------

AF Financial cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that any changes may have on future business and earnings prospects. The cost of
compliance with regulatory requirements may adversely affect the Companys and the Banks ability to operate profitably.



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##### Table of Contents

ITEM2. DESCRIPTION OF PROPERTY

The Company
conducts its business through its main office, located in West Jefferson, North Carolina, and its branches located in Boone, Elkin, Jefferson, Lenoir, Sparta, Warrensville, North Wilkesboro and West Jefferson, North Carolina. The Company owns the
main office and corporate offices located in West Jefferson, the Mt. Jefferson Financial Center Office, the Lenoir branch, the Jefferson branch and the Boone branch. Management believes that the Companys current facilities are adequate to meet
the present and immediately foreseeable needs of the Company.



|                                                                                  |  |                |  |                        |  |                      |     |  |                               |          
|--------------------------------------------------------------------------------- |  | -------------- |  | ---------------------- |  | -------------------- | --- |  | ----------------------------- | ---------
|                                                                                  |  | Leased orOwned |  | Date Leasedor Acquired |  | LeaseExpiration Date |     |  | Net BookValue atJune 30, 2006
|Corporate Offices 21 East Ashe Street West Jefferson, NC 28694                    |  | Owned          |  | 06/15/2000             |  |                     |     |  | $                             | 1,420,161
|                                                                                  |  |                |  |                       
|Insurance and Investment Offices 206 S. Jefferson Avenue West Jefferson, NC 28694 |  | Owned          |  | 06/30/1997             |  |                     |     |  | $                             | 115,619  
|                                                                                  |  |                |  |                       
|AF Bank 205 S. Jefferson Avenue West Jefferson, NC 28694                          |  | Owned          |  | 06/30/1963             |  |                     |     |  | $                             | 72,255   
|                                                                                  |  |                |  |                       
|AF Bank 840 E. Main Street Jefferson, NC 28640                                    |  | Owned          |  | 05/18/1994             |  |                     |     |  | $                             | 429,296  
|                                                                                  |  |                |  |                       
|AF Bank 4951 NC Hwy. 88 West Warrensville, NC 28693                               |  | Leased         |  | 08/01/1995             |  | 07/31/2010           | **  |  |                               |         
|                                                                                  |  |                |  |                       
|AF Bank 381 South Main Street Sparta, NC 28675                                    |  | Leased         |  | 01/09/1998             |  | 10/04/2008           |     |  |                               |         
|                                                                                  |  |                |  |                       
|AF Financial Center 1675 Blowing Rock Road Boone, NC 28607                        |  | Owned          |  | 10/04/2005             |  |                     |     |  | $                             | 7,742,897
|                                                                                  |  |                |  |                       
|AF Insurance Services, Inc. 315 Main Street North Wilkesboro, NC 28659            |  | Leased         |  | 06/01/2000             |  | 05/31/2007           | *** |  |                               |         
|                                                                                  |  |                |  |                       
|AF Insurance Services, Inc. 324 Morganton Blvd., SW Lenoir, NC 28645              |  | Owned          |  | 07/03/2000             |  |                     |     |  | $                             | 102,902  
|                                                                                  |  |                |  |                       
|AF Insurance Services, Inc. 948 Johnson Ridge Road Elkin, NC 28621                |  | Leased         |  | 01/01/2002             |  | 12/30/2009           |     |  |                               |         
|                                                                                  |  |                |  |                       
|AF Insurance Services, Inc. 400 Shadowline Drive Boone, NC 28607                  |  | Leased         |  | 12/01/2000             |  | 09/30/2007           |     |  |                               |         
|                                                                                  |  |                |  |                       
|AF Financial Center 1441 Mt. Jefferson Road West Jefferson, NC 28694              |  | Owned          |  | 04/10/2001             |  |                     |     |  | $                             | 1,263,070
|                                                                                  |  |                |  |                       
|AF Bank 1489 Mt. Jefferson Road West Jefferson, NC 28694                          |  | Leased         |  | 01/05/2001             |  | 01/08/2011           | *   |  |                               |         

---

|* | Option to renew for an additional five-year period.
|- | ---------------------------------------------------

|** | Option to renew for two additional five-year periods.
|-- | -----------------------------------------------------

|*** | Option to renew for three additional one-year periods.
|--- | ------------------------------------------------------



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##### Table of Contents

ITEM3. LEGAL PROCEEDINGS

At June 30, 2006, the Company
is not a party to, and its property is not the subject of, any pending legal proceedings at the present time other than routine litigation that is incidental to the business.

ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

ITEM5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES

There is no established market for the Companys common stock, excluding occasional quotations, although the Companys common stock is quoted on the OTC Bulletin Board. The table below reflects the stock
trading and dividend payment frequency of the Company for the years ended June 30, 2006 and 2005. Stock prices reflect bid prices between broker/dealer, prior to any markups, markdowns or commissions, is based upon information provided to
management of the Company by certain securities firms effecting transactions in the Companys stock on an ongoing basis, and may not necessarily represent actual transactions.



|               |  |           |      |             |   |       |  |   |      
|-------------- |  | --------- | ---- | ----------- | - | ----- |  | - | -----
|               |  |           |      | Stock Price
|2006           |  | Dividends |      | High        |   | Low  
|First quarter  |  | $         | 0.05 |             | $ | 21.50 |  | $ | 18.25
|Second quarter |  |           | 0.05 |             |   | 21.50 |  |   | 19.10
|Third quarter  |  |           | 0.05 |             |   | 21.50 |  |   | 20.25
|Fourth quarter |  |           | 0.05 |             |   | 21.20 |  |   | 18.30



|               |  |           |      |             |   |       |  |   |      
|-------------- |  | --------- | ---- | ----------- | - | ----- |  | - | -----
|               |  |           |      | Stock Price
|2005           |  | Dividends |      | High        |   | Low  
|First quarter  |  | $         | 0.05 |             | $ | 19.15 |  | $ | 16.30
|Second quarter |  |           | 0.05 |             |   | 23.00 |  |   | 18.50
|Third quarter  |  |           | 0.05 |             |   | 22.00 |  |   | 19.00
|Fourth quarter |  |           | 0.05 |             |   | 19.00 |  |   | 14.90

A dividend declared by the Board of Directors of the Bank is considered a capital distribution
from the Bank to the stockholders, including the MHC. The MHC waived the right to receive any dividend to be paid on the common stock of the Company during the next two calendar quarters beginning with the September 2006 quarter and ending with the
December 2006 quarter.

Under the requirements of the OTS, there are certain restrictions on the ability of the Bank to pay a capital
distribution. See Regulation  Limitation on Capital Distributions.

The Company paid cash dividends totaling $.20 per
share during each of the years ended June 30, 2006 and 2005. When the Company pays dividends to its stockholders, it is required to pay dividends to the MHC, unless the MHC elects to waive dividends. The MHC waived dividends paid by the Company
during each of the four quarters of the year ended June 30, 2006. Any decision to waive dividends will be subject to regulatory approval.

As of June 30, 2006, the Company had approximately 359 shareholders of record.

See Item 11 for information related to
Equity Compensation Plans.



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##### Table of Contents

ITEM6. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION

This discussion contains certain forward-looking statements consisting of estimates with respect to the financial
condition, results of operations and other business of the Company, that are subject to various factors which could cause actual results to differ materially from the estimates. These factors include: changes in general, economic and market
conditions; the development of an interest rate environment that adversely affects the interest rate spread or other income anticipated from the Companys operations and investments; our ability to offer new products and increase lower cost
core deposits; and depositor and borrower preferences. The Company disclaims any obligation to publicly announce future events or developments that may affect the forward-looking statements contained herein. The information in this section should be
read in conjunction with the Consolidated Financial Statements, the accompanying Notes to the Consolidated Financial Statements and the other sections contained in this document.

The following table sets forth certain information concerning the consolidated financial position and results of operation of the Company at the dates
and for the year end as indicated. The selected consolidated financial condition and operating data were derived from the audited consolidated financial statements of the Company. The information should be read in conjunction with the consolidated
financial statements of the Company and notes contained in Item 7 of this Form 10-KSB.



|                                                    |  |                                       |         |      |   |         |      |  |   |         |   |      |   |         |  |   |        
|--------------------------------------------------- |  | ------------------------------------- | ------- | ---- | - | ------- | ---- |  | - | ------- | - | ---- | - | ------- |  | - | -------
|                                                    |  | June 30,                             
|                                                    |  | 2006                                  |         | 2005 |   |         | 2004 |  |   | 2003    |   | 2002
|                                                    |  | (In thousands, except per share data)
|Selected Financial Condition Data:                  |  |                                       |         |      |   |         |      |  |   |         |   |      |   |         |  |   |        
|Total assets                                        |  | $                                     | 229,355 |      | $ | 214,101 |      |  | $ | 211,619 |   |      | $ | 191,973 |  | $ | 176,684
|Loans receivable, net1                              |  |                                       | 193,939 |      |   | 181,242 |      |  |   | 180,156 |   |      |   | 156,258 |  |   | 143,553
|Investment securities2                              |  |                                       | 5,249   |      |   | 5,750   |      |  |   | 6,501   |   |      |   | 8,754   |  |   | 11,422 
|Cash and cash equivalents3                          |  |                                       | 11,009  |      |   | 8,809   |      |  |   | 7,674   |   |      |   | 14,072  |  |   | 11,220 
|Savings deposits                                    |  |                                       | 177,013 |      |   | 163,977 |      |  |   | 157,434 |   |      |   | 149,571 |  |   | 136,769
|FHLB advances                                       |  |                                       | 28,639  |      |   | 28,142  |      |  |   | 33,144  |   |      |   | 21,146  |  |   | 18,910 
|Equity                                              |  |                                       | 14,002  |      |   | 13,039  |      |  |   | 12,474  |   |      |   | 12,960  |  |   | 12,777 
|Book value per share                                |  |                                       | 13.32   |      |   | 12.42   |      |  |   | 11.88   |   |      |   | 12.35   |  |   | 12.17  
|                                                    |  |                                       |         |      |  
|Selected Operating Data:                            |  |                                       |         |      |   |         |      |  |   |         |   |      |   |         |  |   |        
|Interest income and dividends                       |  | $                                     | 13,676  |      | $ | 11,995  |      |  | $ | 10,684  |   |      | $ | 11,011  |  | $ | 11,191 
|Interest expense                                    |  |                                       | 5,808   |      |   | 4,733   |      |  |   | 4,405   |   |      |   | 5,085   |  |   | 5,801  
|                                                    |  |                                       |         |      |   |         |      |  |   |         |   |      |   |         |  |   |        
|Net interest income                                 |  |                                       | 7,868   |      |   | 7,262   |      |  |   | 6,279   |   |      |   | 5,926   |  |   | 5,390  
|Provision for loan losses                           |  |                                       | 265     |      |   | (79     | )    |  |   | 668     |   |      |   | 243     |  |   | 420    
|                                                    |  |                                       |         |      |   |         |      |  |   |         |   |      |   |         |  |   |        
|Net interest income after provision for loan losses |  |                                       | 7,603   |      |   | 7,341   |      |  |   | 5,611   |   |      |   | 5,683   |  |   | 4,970  
|Non-interest income                                 |  |                                       | 4,422   |      |   | 3,966   |      |  |   | 3,744   |   |      |   | 3,604   |  |   | 3,120  
|Non-interest expense                                |  |                                       | 10,340  |      |   | 10,165  |      |  |   | 9,786   |   |      |   | 8,656   |  |   | 7,998  
|                                                    |  |                                       |         |      |   |         |      |  |   |         |   |      |   |         |  |   |        
|Income (loss) before income tax expense             |  |                                       | 1,685   |      |   | 1,142   |      |  |   | (431    | ) |      |   | 631     |  |   | 92     
|Income tax expense (benefit)                        |  |                                       | 664     |      |   | 493     |      |  |   | (123    | ) |      |   | 256     |  |   | 56     
|                                                    |  |                                       |         |      |   |         |      |  |   |         |   |      |   |         |  |   |        
|Net income (loss)                                   |  | $                                     | 1,020   |      | $ | 649     |      |  | $ | (308    | ) |      | $ | 375     |  | $ | 36     
|                                                    |  |                                       |         |      |   |         |      |  |   |         |   |      |   |         |  |   |        
|Selected Ratios                                     |  |                                       |         |      |   |         |      |  |   |         |   |      |   |         |  |   |        
|                                                    |  |                                       |         |      |  
|Basic earnings (loss) per share4                    |  | $                                     | 0.97    |      | $ | 0.62    |      |  | $ | (0.30   | ) |      | $ | 0.36    |  | $ | 0.03   
|Diluted earnings (loss) per share4                  |  |                                       | 0.97    |      |   | 0.62    |      |  |   | (0.30   | ) |      |   | 0.36    |  |   | 0.03   
|Dividends per share                                 |  |                                       | 0.20    |      |   | 0.20    |      |  |   | 0.20    |   |      |   | 0.20    |  |   | 0.20   

---

|1. | Loans receivable, net is comprised of total loans less allowance for loan losses, loans sold, undisbursed loan funds, and deferred loan fees.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------

|2. | Includes FHLB stock, certificates of deposit and investment securities.
|-- | -----------------------------------------------------------------------

|3. | Includes interest-earning deposit balances of $2.1 million, $2.7 million, $2.5 million, $6.2 million, and $4.2 million at June 30, 2006, 2005, 2004, 2003, and 2002,
respectively.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. | Earnings per share has been calculated in accordance with the Statement of Financial Accounting Standards No. 128, Earnings Per Share, and is based on net income for the
year, divided by the weighted average number of shares outstanding for the year. In accordance with the AICPAs SOP 93-6, unallocated ESOP shares were deducted from outstanding shares used in the computation of earnings per share. Diluted
earnings per share includes the effect of dilutive common stock equivalents in the weighted average number of shares outstanding.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|                                                                         |  |             |   |  |        |   |  |        |    |  |        |   |  |        |  
|------------------------------------------------------------------------ |  | ----------- | - |  | ------ | - |  | ------ | -- |  | ------ | - |  | ------ | -
|                                                                         |  | At June 30, |  
|                                                                         |  | 2006        |   |  | 2005   |   |  | 2004   |    |  | 2003   |   |  | 2002   |  
|Selected Financial Ratios and Other Data:                                |  |             |   |  |        |   |  |        |    |  |        |   |  |        |  
|Performance Ratios:1                                                     |  |             |   |  |        |   |  |        |    |  |        |   |  |        |  
|Return on average assets                                                 |  | 0.46        | % |  | 0.30   | % |  | (0.15  | )% |  | 0.20   | % |  | 0.02   | %
|Return on average equity                                                 |  | 7.58        | % |  | 5.13   | % |  | (2.46  | )% |  | 2.90   | % |  | 0.28   | %
|Average equity to average assets                                         |  | 6.12        | % |  | 5.78   | % |  | 6.25   | %  |  | 6.90   | % |  | 7.51   | %
|Equity to total assets at end of period                                  |  | 6.10        | % |  | 6.09   | % |  | 5.89   | %  |  | 6.75   | % |  | 7.23   | %
|Interest rate spread2                                                    |  | 3.80        | % |  | 3.73   | % |  | 3.38   | %  |  | 3.41   | % |  | 3.36   | %
|Average interest-earnings assets to average interest-bearing liabilities |  | 106.96      | % |  | 100.30 | % |  | 105.12 | %  |  | 104.35 | % |  | 106.35 | %
|Net interest margin3                                                     |  | 4.01        | % |  | 3.74   | % |  | 3.51   | %  |  | 3.54   | % |  | 3.52   | %
|Non-interest expense to average assets                                   |  | 4.70        | % |  | 4.65   | % |  | 4.89   | %  |  | 4.62   | % |  | 4.70   | %
|Efficiency ratio4                                                        |  | 84.13       | % |  | 90.53  | % |  | 97.64  | %  |  | 90.83  | % |  | 93.98  | %
|Dividend payout ratio5                                                   |  | 20.62       | % |  | 32.26  | % |  | (66.67 | )% |  | 55.56  | % |  | 666.67 | %
|                                                                         |  |             |   |  |       
|Regulatory Capital Ratios: 6                                             |  |             |   |  |        |   |  |        |    |  |        |   |  |        |  
|Tangible capital                                                         |  | 8.14        | % |  | 8.42   | % |  | 8.11   | %  |  | 8.92   | % |  | 9.51   | %
|Core capital                                                             |  | 8.14        | % |  | 8.42   | % |  | 8.11   | %  |  | 8.92   | % |  | 9.51   | %
|Total risk based capital                                                 |  | 11.11       | % |  | 11.36  | % |  | 10.89  | %  |  | 12.89  | % |  | 13.00  | %
|                                                                         |  |             |   |  |       
|Asset Quality Ratios and Other Data:                                     |  |             |   |  |        |   |  |        |    |  |        |   |  |        |  
|Ratios:                                                                  |  |             |   |  |        |   |  |        |    |  |        |   |  |        |  
|Nonperforming loans to total loans                                       |  | 0.11        | % |  | 0.10   | % |  | 0.29   | %  |  | 0.28   | % |  | 0.32   | %
|Nonperforming loans and real estate owned to total assets                |  | 0.49        | % |  | 0.09   | % |  | 0.25   | %  |  | 0.25   | % |  | 0.41   | %
|Allowance for loan losses to:                                            |  |             |   |  |        |   |  |        |    |  |        |   |  |        |  
|Nonperforming loans                                                      |  | 716.98      | % |  | 748.87 | % |  | 239.98 | %  |  | 250.79 | % |  | 245.92 | %
|Total loans                                                              |  | 0.80        | % |  | 0.76   | % |  | 0.69   | %  |  | 0.71   | % |  | 0.78   | %
|Number of full service Bank branches                                     |  | 7           |   |  | 7      |   |  | 7      |    |  | 7      |   |  | 7      |  

---

|1. | With the exception of end of period ratios, all ratios are based on average monthly or quarterly balances during the indicated periods, and are annualized where appropriate. Asset
Quality and Regulatory Capital Ratios are end of period ratios.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2. | The interest rate spread represents the difference between the weighted-average yield on interest-bearing assets and the weighted-average cost of interest-bearing liabilities.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. | The net interest margin represents net interest income as a percent of average interest-earning assets.
|-- | -------------------------------------------------------------------------------------------------------

|4. | The efficiency ratio represents non-interest expense as a percentage of the sum of net interest income and non-interest income.
|-- | -------------------------------------------------------------------------------------------------------------------------------

|5. | The dividend payout ratio represents dividends per share as a percentage of basic earnings per share. Earnings per share has been calculated in accordance with the Statement of
Financial Accounting Standards No. 128, Earnings Per Share, and is based on net income for the year, divided by the weighted average number of shares outstanding for the year. In accordance with the AICPAs SOP 93-6, unallocated
ESOP shares were deducted from outstanding shares used in the computation of earnings per share.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. | For definitions and further information relating to the Banks regulatory capital requirements, see Note 8 of Notes to the Consolidated Financial Statements.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Critical Accounting Policies

We believe that our policies with respect to the methodology for our determination of the allowance for loan losses, the fair value of mortgage servicing assets and asset impairment judgments, including the
recoverability of goodwill, involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions
or estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors. We consider the following accounting policies to be most
critical in their potential effect on our financial position or results of operations:

Allowance for Loan Losses

The Allowance for Loan Losses (ALL) is established through a provision for loan losses based on our evaluation of the risks inherent in AF
Banks loan portfolio, prior loss history and the general economy. The ALL is maintained at an amount we consider adequate to cover loan losses which are deemed probable and estimable. The allowance is based upon a number of factors, including
asset classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, our assessment of the credit risk inherent in the portfolio, historical loan loss experience, and AF
Banks underwriting policies.

All loans in the portfolio are assigned an allowance percentage requirement based on the type of
underlying collateral and payment terms. Furthermore, loans are evaluated individually and are assigned a credit grade using such factors as the borrowers cash flow, the value of the collateral and the strength of any guarantee. Loans
identified as having weaknesses, or adverse credit grades, are assigned a higher allowance percentage requirement than loans where no weaknesses are identified. We routinely monitor our loan portfolio to determine if a loan is deteriorating,
therefore requiring a higher allowance requirement. Factors we consider are payment status, collateral value and the probability of collecting scheduled principal and interest payment when due.

The allowance percentage requirement changes from period to period as a result of a number of factors, including: changes in the mix of types of loans;
changes in credit grades within the portfolio, which arise from a deterioration or an improvement in the performance of the borrower; changes in the historical loss percentages and delinquency trends; current charge-offs and recoveries; and changes
in the amounts of loans outstanding.

Although we believe that we have established and maintained the allowance for loan losses at adequate
levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment. We will continue to monitor and modify our ALL as conditions dictate.

Mortgage Servicing Assets

Mortgage servicing assets
represent the present value of the future net servicing fees from servicing mortgage loans sold to the secondary market. The most critical accounting policy associated with mortgage servicing is the methodology used to determine the fair value of
mortgage servicing assets, which requires the development of a number of assumptions, including anticipated loan principal amortization and prepayments of principal. The value of mortgage servicing rights is significantly affected by mortgage
interest rates available in the marketplace that influence the speed of mortgage loan prepayments. During periods of declining interest rates, the value of mortgage servicing assets generally declines due to increasing prepayments attributable to
increased mortgage refinance activity. Conversely, during periods of rising interest rates, the value of servicing assets generally increases due to reduced refinance activity. We amortize mortgage servicing assets over the estimated period that
servicing income is expected to be received based on estimates of the amount and timing of future cash flows. The amount and timing of servicing asset amortization is adjusted quarterly based on actual results and updated projections.



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##### Table of Contents

Goodwill

On July 1, 2002, we adopted the provisions of Financial Accounting Standards Board Statement 142, Goodwill and Other Intangible Assets. Under the provisions of the Statement, on July 1, 2002, we ceased to amortize goodwill. We
will reevaluate the carrying value of goodwill annually by comparing the market value of each reporting segment to the respective total equity at that level. Impairment would then be determined if the equity exceeds the fair value of the reporting
unit. This evaluation is subjective as it requires material estimates that may be susceptible to significant change.

Management Strategy

As mentioned above, AF Financial Group is a financial services company that provides banking, insurance and investment services to
residents in the northwest corner of North Carolina. We are committed to the long-term profitability and success of the Company. Management and the board of directors placed major emphasis upon improving the Companys net earnings and return on
equity in 2006 and will continue to emphasize net earnings and return on equity in 2007 and beyond. This has and will continue to be accomplished by increasing the overall productivity of the Company and its operating subsidiaries, controlling
costs, and reducing or eliminating unprofitable activities whenever and wherever possible.

There are a number of positive factors and
recent events which reflect our progress toward our goals during the year ended June 30, 2006:



| |  |  | An increase in net loans of $12.7 million or 7.0%;
| | - |  | --------------------------------------------------



| |  |  | An increase in savings deposits of $13.0 million or 8.0%
| | - |  | --------------------------------------------------------



| |  |  | Asset growth of $15.3 million or 7.1%;
| | - |  | --------------------------------------



| |  |  | An increase in stockholders equity of $962,647, or 7.4%;
| | - |  | ---------------------------------------------------------



| |  |  | An increase in net income of $372,046, or 57.3%, during the year ended June 30, 2006 as compared to the year ended June 30, 2005 and;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  |  | An increase in noninterest income of $456,600, or 11.5%, during the year ended June 30, 2006 as compared to the year ended June 30, 2005.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------

Net income increased $372,046, or 57.4%, to net income of $1,020,823 for the year ended June 30, 2006, compared to net income of $648,777 for the
year ended June 30, 2005. This change is primarily due to an increase in interest income due to the 200 basis point interest rate hike by the FRB during the 12 months ended June 30, 2006 and an increase in insurance commissions. At
June 30, 2006 we had approximately $70.5 million in loans priced at prime or a margin thereto which provides for adjusting rates immediately when market rates change. In the rising rate environment that existed during the twelve months ended
June 30, 2006, our ability to make immediate rate adjustments on our loans priced at prime and our ability to move our deposit mix to less interest rate sensitive products has allowed us to increase our net interest margin. We believe that the
stabilization of interest rates by the Federal Reserve will have a more positive impact on our net income than continued rate hike adjustments.

Another important initiative that management and the board of directors believe is a focal point of our continued success is to develop methods and products to better serve our customers in order to maintain a loyal customer base. To
accomplish this we are developing products and services that help create a unique financial experience to make banking easier and more convenient for our customers. We started the process of improving customer service during the 2006 fiscal year by
listening to our customers and learning what is important to them. Below are just a few of the changes that we implemented during the 2006 fiscal year that we believe will provide our customers with a more convenient and enjoyable financial services
experience.



| |  |  | Expanded hours;
| | - |  | ---------------



| |  |  | Expanded ATM network;
| | - |  | ---------------------



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##### Table of Contents

| |  |  | Reserved parking for expectant parents;
| | - |  | ---------------------------------------



| |  |  | Branch remodeling projects;
| | - |  | ---------------------------



| |  |  | Coffee service in each branch location;
| | - |  | ---------------------------------------



| |  |  | Computer kiosks in branch lobby and;
| | - |  | ------------------------------------



| |  |  | Express drive-thru lane.
| | - |  | ------------------------

More ideas will be implemented
in fiscal year 2007. We are excited about these changes and will continue to look for ways to provide unique and convenient financial services to our customers and potential customers.

Comparison of Financial Condition at June 30, 2006 and 2005

Total assets increased by $15.3
million or 7.1% to $229.4 million at June 30, 2006 from $214.1 million at June 30, 2005. The increase in assets was primarily the result of an increase of $12.7 million, or 7.0%, in net loans receivable from June 30, 2005 to
June 30, 2006. The increase in net loans receivable was partially offset by a decrease of $434,704, or 11.2%, in securities available for sale from June 30, 2005 to June 30, 2006. The decrease in securities available for sale was used
to partially fund the increase in loans discussed above. The increase in net loans receivable is typical for the Bank, which operates in lending markets that have had sustained loan demand over the last several years.

As mentioned above, securities available for sale decreased $434,704, or 11.1%, to $3.5 million at June 30, 2006 from $3.9 million at June 30,
2005. This decrease was due to mutual fund sales and principal reductions on mortgage-backed securities. At June 30, 2006, the Companys investment portfolio had $26,224 in net unrealized losses as compared to net unrealized gains of
$65,978 at June 30, 2005.

The Banks savings deposits increased by $13.0 million, or 8.0%, from $164.0 million at June 30,
2005 to $177.0 million at June 30, 2006. We believe the increase in deposits is attributable to our continuing marketing efforts directed towards increasing balances in savings and transaction accounts and in smaller, stable certificates of
deposit. We intend to further focus our marketing efforts and to offer new products to increase lower cost core deposits.

Short-term
borrowings increased $2.4 million, or 92.2%, from $2.6 million at June 30, 2005 to $4.9 million at June 30, 2006. Long-term borrowings decreased $2.1 million, or 6.6%, from $32.0 million at June 30, 2005 to $29.9 million at
June 30, 2006. The net increase in short-term and long-term borrowings was used to help fund the $12.7 million increase in net loans.

The Banks level of non-performing loans, defined as loans past due 90 days or more, increased to $218,700, or 0.10% of total assets, at June 30, 2006 compared to $185,000, or 0.09% of total assets, at June 30, 2005. The Bank
recognized total charge-offs of $116,524 during the year ended June 30, 2006 compared to total charge-offs of $214,125 during the year ended June 30, 2005. Total recoveries during June 30, 2006 decreased to $34,100 for the year ended
June 30, 2006 from $433,441 for the year ended June 30, 2005. The decrease in recoveries is primarily due to a $309,080 recovery on a previously charged off commercial line of credit that was received during the year ended June 30,
2005. The Bank recognized net charge-offs of approximately $82,424 during the year ended June 30, 2006 compared to net recoveries of $219,316 for the year ended June 30, 2005.



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##### Table of Contents

Comparison of Operating Results for the Fiscal Years Ended June 30, 2006 and 2005

The Company had net income for the year ended June 30, 2006 of $1,020,823 compared to net income of $648,777 for the year ended June 30, 2005.
Changes in net income during the comparable twelve-month period were attributable to: an increase in interest income and noninterest income partially offset by an increase in noninterest expense and provision for loan losses during the year ended
June 30, 2006, which is explained below. In our opinion, there has not been a material change in interest rate risk from the end of the Companys most recent fiscal year.

Interest Income. Interest income increased by $1,680,722 or 14.0% from $11,995,109 for the year ended June 30, 2005 to $13,675,831 for the
year ended June 30, 2005. Interest income from loans increased $1,544,604 or 13.2% from $11,693,803 for the year ended June 30, 2005 to $13,238,407 for the year ended June 30, 2006. The increase in interest income from loans for the
year ended June 30, 2006 was attributable to an increase in the weighted average rate on portfolio loans and an increase in the outstanding loan balances. The weighted average rate on portfolio loans increased .50% from 6.39% during
June 30, 2005 to 6.89% during June 30, 2006, primarily due to the 200 basis point interest rate hike by the FRB during the 12 months ended June 30, 2006. Net loans increased $12.7 million from $181.2 million at June 30, 2005 to
$193.9 million at June 30, 2006.

Table 1.

The
following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table distinguishes between (i) changes attributable to volume
(changes in volume multiplied by the prior periods rate) (ii) changes attributable to rate (changes in rate multiplied by the prior periods volume) and (iii) mixed changes (changes in volume multiplied by changes in rate).
Rate/volume variances are allocated to the rate/volume column.



|                                   |  |                                                    |      |   |                                                    |   |             |  |   |     |   |  |        |       |   |      |   |       |             |  |   |      |   |  |   |     |   |  |   |       |  
|---------------------------------- |  | -------------------------------------------------- | ---- | - | -------------------------------------------------- | - | ----------- |  | - | --- | - |  | ------ | ----- | - | ---- | - | ----- | ----------- |  | - | ---- | - |  | - | --- | - |  | - | ----- | -
|                                   |  | Year ended June 30, 2006 compared to June 30,
2005 |      |   | Year ended June 30, 2005 compared to June 30,
2004 |  
|                                   |  | Increase/(Decrease) Due to                         |      |   | Increase/(Decrease) Due to                         |  
|                                   |  | Volume                                             |      |   | Rate                                               |   | Rate/Volume |  |   | Net |   |  | Volume |       |   | Rate |   |       | Rate/Volume |  |   | Net  |  
|                                   |  | (In thousands)                                     |     
|Assets:                            |  |                                                    |      |   |                                                    |   |             |  |   |     |   |  |        |       |   |      |   |       |             |  |   |      |   |  |   |     |   |  |   |       |  
|Interest-earning assets:           |  |                                                    |      |   |                                                    |   |             |  |   |     |   |  |        |       |   |      |   |       |             |  |   |      |   |  |   |     |   |  |   |       |  
|Interest-bearing deposits          |  | $                                                  | 62   |   |                                                    | $ | 20          |  | $ | 17  |   |  | $      | 99    |   |      | $ | (12   | )           |  | $ | 56   |   |  | $ | (15 | ) |  | $ | 29    |  
|Investment securities              |  |                                                    | (28  | ) |                                                    |   | 73          |  |   | (9  | ) |  |        | 36    |   |      |   | (28   | )           |  |   | 17   |   |  |   | (2  | ) |  |   | (13   | )
|Loans receivable                   |  |                                                    | 67   |   |                                                    |   | 1,465       |  |   | 9   |   |  |        | 1,541 |   |      |   | 1,039 |             |  |   | 234  |   |  |   | 24  |   |  |   | 1,297 |  
|                                   |  |                                                    |      |   |                                                    |   |             |  |   |     |   |  |        |       |   |      |   |       |             |  |   |      |   |  |   |     |   |  |   |       |  
|Total                              |  |                                                    | 101  |   |                                                    |   | 1,558       |  |   | 17  |   |  |        | 1,676 |   |      |   | 999   |             |  |   | 307  |   |  |   | 6   |   |  |   | 1,313 |  
|                                   |  |                                                    |      |   |                                                    |   |             |  |   |     |   |  |        |       |   |      |   |       |             |  |   |      |   |  |   |     |   |  |   |       |  
|Liabilities:                       |  |                                                    |      |   |                                                    |   |             |  |   |     |   |  |        |       |   |      |   |       |             |  |   |      |   |  |   |     |   |  |   |       |  
|Interest-bearing liabilities:      |  |                                                    |      |   |                                                    |   |             |  |   |     |   |  |        |       |   |      |   |       |             |  |   |      |   |  |   |     |   |  |   |       |  
|Interest-bearing checking accounts |  |                                                    | 23   |   |                                                    |   | 314         |  |   | 54  |   |  |        | 391   |   |      |   | 42    |             |  |   | (23  | ) |  |   | (8  | ) |  |   | 11    |  
|Savings                            |  |                                                    | (170 | ) |                                                    |   | 17          |  |   | (5  | ) |  |        | (158  | ) |      |   | (10   | )           |  |   | (13  | ) |  |   |    |   |  |   | (23   | )
|Certificates of deposit            |  |                                                    | 197  |   |                                                    |   | 681         |  |   | 62  |   |  |        | 940   |   |      |   | 176   |             |  |   | (81  | ) |  |   | (6  | ) |  |   | 89    |  
|Borrowed funds                     |  |                                                    | (424 | ) |                                                    |   | 401         |  |   | (88 | ) |  |        | (111  | ) |      |   | 527   |             |  |   | (220 | ) |  |   | (68 | ) |  |   | 239   |  
|                                   |  |                                                    |      |   |                                                    |   |             |  |   |     |   |  |        |       |   |      |   |       |             |  |   |      |   |  |   |     |   |  |   |       |  
|Total                              |  |                                                    | (374 | ) |                                                    |   | 1,413       |  |   | 23  |   |  |        | 1,062 |   |      |   | 735   |             |  |   | (337 | ) |  |   | (82 | ) |  |   | 316   |  
|                                   |  |                                                    |      |   |                                                    |   |             |  |   |     |   |  |        |       |   |      |   |       |             |  |   |      |   |  |   |     |   |  |   |       |  
|Net interest income                |  | $                                                  | 475  |   |                                                    | $ | 145         |  | $ | (6  | ) |  | $      | 614   |   |      | $ | 264   |             |  | $ | 644  |   |  | $ | 88  |   |  | $ | 997   |  
|                                   |  |                                                    |      |   |                                                    |   |             |  |   |     |   |  |        |       |   |      |   |       |             |  |   |      |   |  |   |     |   |  |   |       |  



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##### Table of Contents

Table 2.

The
following table provides information concerning the Banks yields on interest-earning assets and cost of funds on interest-bearing liabilities over the years ended June 30, 2006 and 2005.



|                                                                 |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|---------------------------------------------------------------- |  | ---------------------- | ------- | ------------------- | ------ | - | --------------------------- | ---- | -------- |  | ------------------- | ------ |  | --------------- | - | -------- | - | ------------------- |  | - | --------------- |  | -------- | - | ------------------- | - | ------- |  | - | ------ |  | ------ | -
|                                                                 |  |                        |         |                     |        |   | For the year ended June 30, |     
|                                                                 |  | At June 30, 2006       |         |                     | 2006   |   |                             | 2005 |          |  | 2004                |       
|                                                                 |  | Actual Balance         |         | Average Yield/ Rate |        |   | Average Balance             |      | Interest |  | Average Yield/ Rate |        |  | Average Balance |   | Interest |   | Average Yield/ Rate |  |   | Average Balance |  | Interest |   | Average Yield/ Rate |  
|                                                                 |  | (Dollars in thousands) |         |                     |        |   |                            
|Assets:                                                          |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Interest-earnings assets:                                        |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Interest-bearing deposits                                        |  | $                      | 2,102   |                     | 4.10   | % |                             | $    | 4,064    |  | $                   | 171    |  | 4.21            | % |          | $ | 2,187               |  | $ | 72              |  | 3.29     | % |                     | $ | 3,010   |  | $ | 43     |  | 1.43   | %
|Investment securities                                            |  |                        | 5,249   |                     | 4.54   | % |                             |      | 5,564    |  |                     | 266    |  | 4.78            | % |          |   | 6,331               |  |   | 229             |  | 3.62     | % |                     |   | 7,162   |  |   | 242    |  | 3.38   | %
|Loans receivable, net (1)                                        |  |                        | 193,939 |                     | 6.89   | % |                             |      | 186,698  |  |                     | 13,238 |  | 7.09            | % |          |   | 185,623             |  |   | 11,694          |  | 6.30     | % |                     |   | 168,738 |  |   | 10,399 |  | 6.16   | %
|                                                                 |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Total interest-earning assets                                    |  |                        | 201,290 |                     | 6.80   | % |                             |      | 196,326  |  |                     | 13,675 |  | 6.97            | % |          |   | 194,141             |  |   | 11,995          |  | 6.18     | % |                     |   | 178,910 |  |   | 10,684 |  | 5.97   | %
|Non-interest-earning assets                                      |  |                        | 28,065  |                     |        |   |                             |      | 23,694   |  |                     |        |  |                 |   |          |   | 24,665              |  |   |                 |  |          |   |                     |   | 21,276  |  |   |        |  |        |  
|                                                                 |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Total assets                                                     |  | $                      | 229,355 |                     |        |   |                             | $    | 220,020  |  |                     |        |  |                 |   |          | $ | 218,806             |  |   |                 |  |          |   |                     | $ | 200,186 |  |   |        |  |        |  
|                                                                 |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Liabilities and equity:                                          |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Interest-bearing liabilities:                                    |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Interest-bearing checking accounts                               |  | $                      | 39,085  |                     | 1.40   | % |                             | $    | 36,550   |  |                     | 526    |  | 1.44            | % |          | $ | 31,138              |  |   | 134             |  | 0.43     | % |                     | $ | 23,085  |  |   | 122    |  | 0.53   | %
|Savings                                                          |  |                        | 22,741  |                     | 1.33   | % |                             |      | 28,137   |  |                     | 364    |  | 1.29            | % |          |   | 41,753              |  |   | 521             |  | 1.25     | % |                     |   | 42,497  |  |   | 543    |  | 1.28   | %
|Certificates of deposit                                          |  |                        | 90,797  |                     | 3.58   | % |                             |      | 86,395   |  |                     | 3,084  |  | 3.57            | % |          |   | 79,138              |  |   | 2,136           |  | 2.70     | % |                     |   | 72,878  |  |   | 2,037  |  | 2.80   | %
|Borrowed funds                                                   |  |                        | 34,798  |                     | 5.62   | % |                             |      | 32,463   |  |                     | 1,835  |  | 5.65            | % |          |   | 41,536              |  |   | 1,942           |  | 4.68     | % |                     |   | 31,738  |  |   | 1,703  |  | 5.37   | %
|                                                                 |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Total interest-bearing liabilities                               |  |                        | 187,421 |                     | 3.23   | % |                             |      | 183,545  |  |                     | 5,809  |  | 3.16            | % |          |   | 193,565             |  |   | 4,733           |  | 2.45     | % |                     |   | 170,198 |  |   | 4,405  |  | 2.59   | %
|                                                                 |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Other non-interest-bearing liabilities                           |  |                        | 27,932  |                     |        |   |                             |      | 23,007   |  |                     |        |  |                 |   |          |   | 12,587              |  |   |                 |  |          |   |                     |   | 17,471  |  |   |        |  |        |  
|Equity                                                           |  |                        | 14,002  |                     |        |   |                             |      | 13,468   |  |                     |        |  |                 |   |          |   | 12,654              |  |   |                 |  |          |   |                     |   | 12,517  |  |   |        |  |        |  
|                                                                 |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Total liabilities and equity                                     |  | $                      | 229,355 |                     |        |   |                             | $    | 220,020  |  |                     |        |  |                 |   |          | $ | 218,806             |  |   |                 |  |          |   |                     | $ | 200,186 |  |   |        |  |        |  
|                                                                 |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Net interest income and interest rate spread (2)                 |  |                        |         |                     | 3.57   | % |                             |      |          |  | $                   | 7,866  |  | 3.80            | % |          |   |                     |  | $ | 7,262           |  | 3.73     | % |                     |   |         |  | $ | 6,279  |  | 3.38   | %
|                                                                 |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Net interest-earning assets and net interest margin (3)          |  | $                      | 13,869  |                     |        |   |                             | $    | 12,781   |  |                     |        |  | 4.01            | % |          | $ | 576                 |  |   |                 |  | 3.74     | % |                     | $ | 8,712   |  |   |        |  | 3.51   | %
|                                                                 |  |                        |         |                     |        |   |                             |      |          |  |                     |        |  |                 |   |          |   |                     |  |   |                 |  |          |   |                     |   |         |  |   |        |  |        |  
|Ratio of interest-earning assets to interest-bearing liabilities |  |                        |         |                     | 107.40 | % |                             |      |          |  |                     |        |  | 106.96          | % |          |   |                     |  |   |                 |  | 100.30   | % |                     |   |         |  |   |        |  | 105.12 | %

---

|(1) | Balance is net of deferred loan fees and loans in process. Non-accrual loans are included in the balances.
|--- | ----------------------------------------------------------------------------------------------------------

|(2) | Average interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Net interest margin represents net interest income divided by average total interest-earning assets. With the exception of end of period ratios, all ratios are based on monthly or
quarterly balances during the indicated years. Management does not believe that the use of month and quarter end balances instead of daily balances has caused a material difference in the information presented.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Interest Expense. Interest expense increased by $1,074,947 or 22.7% to $5,808,159 for the year
ended June 30, 2006 from $4,733,212 for the year ended June 30, 2005. Interest expense on savings deposits increased by $1,181,989 or 42.3% to $3,973,383 for the year ended June 30, 2006 from $2,791,394 for the year ended
June 30, 2005. The increase in interest expense on savings deposits is the result of the 0.73% increase in the institutions weighted average rate of deposits during the year ended June 30, 2006 and the $13.0 million increase in
savings deposits. Interest expense on short-term borrowings decreased $98,976 to $39,065 for the year ended June 30, 2006 from $138,041 for the year ended June 30, 2005. Interest expense on long-term borrowings decreased $8,066 to
$1,795,711 for the year ended June 30, 2006 from $1,803,777 for the year ended June 30, 2005

Net Interest Income. Net
interest income increased by $605,775, or 8.3%, from $7,261,897 for the year ended June 30, 2005 to $7,867,672 for the year ended June 30, 2006. The increase in net interest income is the result of the increase in outstanding loan balances
and the increase in the weighted average interest rate earned on the loan portfolio, partially offset by the increase in interest expense as discussed above. We do not believe that there has been a material change in interest rate risk from the end
of our most recent fiscal year.

Provision for Loan Losses. The provision for loan losses charged to earnings is an amount
sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb probable losses on existing loans that may become uncollectible. Loans are charged off against the allowance when we believe collection is
unlikely. The allowance for loan losses changes from period to period as a result of a number of factors, including: changes in the mix of types of loans; changes in credit grades within the portfolio, which arise from a deterioration or an
improvement in the performance of the borrower; changes in the historical loss percentages and delinquency trends; current charge offs and recoveries; and changes in the amounts of loans outstanding. The net change in all of the components results
in the provision for loan losses. We had no significant changes in any of the factors mentioned above during the year ended June 30, 2006.

All loans in the portfolio are assigned an allowance percentage requirement based on the type of underlying collateral and payment terms. Furthermore, loans are evaluated individually and are assigned a credit grade using such factors as
the borrowers cash flow, the value of the collateral and the strength of any guarantee. Loans identified as having weaknesses, or adverse credit grades, are assigned a higher allowance percentage requirement than loans where no weaknesses are
identified. We routinely monitor our loan portfolio to determine if a loan is deteriorating, therefore requiring a higher allowance requirement. Factors we consider are payment status, collateral value and the probability of collecting scheduled
principal and interest payment when due. Although we believe that we have established and maintained the allowance for loan losses at adequate levels, future adjustments may be necessary if economic, real estate and other conditions differ
substantially from the current operating environment.

We made provisions of $265,000 to the allowance for loan losses during the year
ended June 30, 2006, compared to a reversal of provision for loan losses of $78,922 made during the year ended June 30, 2005.

During the year ended June 30, 2006 we had net charge-offs of $82,424 compared to net recoveries of $219,316 during the year ended June 30, 2005 primarily due to a $309,080 recovery from a commercial loan that was previously
charged off. We made additional provisions for loan loss allowances during the year ended June 30, 2006 based upon an analysis of the quality of our loan portfolio. While future loan loss provision requirements are uncertain, management
believes that similar charge-offs are likely. At June 30, 2006, our level of allowance for loan losses amounted to $1,567,988, or 0.80% of total loans, as compared to $1,385,412 of allowance for loan losses, or 0.76% of total loans at
June 30, 2005, which we believe is adequate to absorb any probable losses inherent in our loan portfolio. We increased our allowance for loan losses as a percentage of total loans during the year ended June 30, 2006 as compared to
June 30, 2005 due the changes and mix of our loan portfolio. We do not maintain an allowance for undisbursed loan commitments.

Non-Interest Income. Non-interest income increased by $456,600 or 11.5% from $3,965,517 for the year ended June 30, 2005 to $4,422,117 for the year ended June 30, 2006. The increase in non-interest income during the year
ended June 30, 2006 was primarily attributable to an increase in revenue generated from insurance commissions, the increase in rental income and the increase in transaction fees on deposit account. The increase in insurance commissions is
primarily due to an increase in contingency income received from the insurance companies we represent as compared to the same time period in 2005. The increase in contingency income is due to an improved claims ratio and the increased volume of
business we place with the carriers we represent. These trends are expected to continue to produce growth in non-interest income. Insurance commissions increased by $234,560, or 9.3%, from $2,533,852 for the year ended June 30, 2005 to
$2,768,412 for the year ended June 30, 2006. The



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increase in rental income is due to the leasing of the available office space in the Boone Financial Center during the
fiscal year ended June 30, 2006. The leases have terms ranging from three to five years. The increase in transaction fees on deposit accounts is primarily attributable to an increase in the number of transaction accounts and an increase in the
amount of transaction fees charged for services on deposit accounts

Non-Interest Expense. Non-interest expense increased by
$175,324 or 1.7% from $10,164,413 for the year ended June 30, 2005 to $10,339,737 for the year ended June 30, 2006. The increase in non-interest expense for the year ended June 30, 2006 is primarily attributable to an increase in
compensation costs and computer processing charges. Compensation and employee benefits increased $140,636, or 2.5% from $5,739,162 at June 30, 2005 to $5,879,798 at June 30, 2006. The increase in compensation expense is primarily due to an
increase in commissions paid to employees whose pay is based on a percentage of insurance commissions that the Company earns and an increase in benefit expenses. Computer processing charges increased $67,565 from $673,244 for the year ended
June 30, 2005 to $740,809 for the year ended June 30, 2006. These increases are due to expenses associated with the Banks core data processing conversion that occurred during the third quarter of the 2006 fiscal year. The conversion
related expenses are not recurring expenses and we expect to see significant cost savings on computer processing charges in future years as a result of the conversion.

Income Taxes.Income taxes resulted from applying normal, expected tax rates on income earned during the years ended June 30, 2006 and 2005. The income tax expense was $664,229 for the year ended
June 30, 2006 and the income tax expense was $493,146 for the year ended June 30, 2005. The effective tax rate was higher than expected tax rates for 2006 and 2005, resulting primarily from the fact that North Carolina corporations may not
file consolidated income tax returns. This had the effect of taxing all income in a particular member of a consolidated group without permitting an offsetting benefit for losses incurred in another member of the same group, creating a higher than
expected overall state income tax expense.

Capital Resources and Liquidity

The term liquidity generally refers to an organizations ability to generate adequate amounts of funds to meet its needs for cash. More
specifically, for financial institutions, liquidity ensures that adequate funds are available to meet deposit withdrawals, fund loan demand and capital expenditure commitments, maintain reserve requirements, pay operating expenses, and provide funds
for debt service, dividends to stockholders, and other institutional commitments. The Companys primary sources of funds consist of deposits, borrowings, repayment and prepayment of loans, sales and participations of loans, maturities of
securities and interest-bearing deposits, and funds provided from operations. While scheduled repayments of loans and maturities of securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the general
level of interest rates, economic conditions, and competition. The Company uses its liquid resources primarily to fund existing and future loan commitments, to fund net deposit outflows, to invest in other interest-earning assets, to maintain
liquidity, and to meet operating expenses. For additional information about cash flows from the Companys operating, financing and investing activities, see Condensed Consolidated Statements of Cash Flow.

Liquidity management is both a daily and long-term function of management. If we require funds beyond our ability to generate them internally, we believe
we could borrow additional funds from the FHLB and use the wholesale deposit markets. At June 30, 2006, we had borrowings of $28.6 million from the FHLB. The Bank also maintains borrowing agreements with the FRB of Richmond, Virginia.

The Company anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificates of
deposit scheduled to mature in less than one year totaled $73.8 million at June 30, 2006. Based upon historical experience, we believe that a significant portion of such deposits will remain with the Bank.

As of June 30, 2006, cash and cash equivalents, a significant source of liquidity, totaled $11.0 million. The OTS regulations require the Company to
maintain sufficient liquidity to ensure its safe and sound operation. Given our level of liquidity and our ability to borrow from the FHLB, we believe that we will have sufficient funds available to meet anticipated future loan commitments,
unexpected deposit withdrawals, and other cash requirements. We do not anticipate any financial or insurance acquisitions at this time.

Capital management is another important daily and long-term function of management. While we currently meet all regulatory capital levels, we monitor this level on an ongoing basis. Our principal goals related to capital management are to
provide an adequate return to shareholders while retaining a sufficient foundation from which to support future growth and to comply with all regulatory guidelines.



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Asset/Liability Management

The Companys asset/liability management is focused primarily on evaluating and managing the Companys net interest income in relation to various risk criteria. Factors beyond the Companys control,
such as the effects of changes in market interest rates and competition, may also have an impact on the management of interest rate risk.

In the absence of other factors, the Companys overall yield on interest-earning assets will increase, as will its cost of funds on its interest-bearing liabilities, when market rates increase over an extended period of time.
Inversely, the Companys yields and cost of funds will decrease when market rates decline. We are able to manage these fluctuations to some extent by attempting to control the maturity or rate adjustments of our interest-earning assets and
interest-bearing liabilities over given periods of time. One of our tools for monitoring interest rate risk is the measurement of the sensitivity of the net portfolio value to changes in interest rates.

In order to minimize the potential effects of adverse material and prolonged increases in market interest rates on the Companys operations, we have
implemented an asset/liability program designed to improve the Companys interest rate risk exposure. The program emphasizes the originations of three-and five-year fixed-rate balloon mortgages, adjustable-rate mortgages, selling long term
fixed-rate loans to the secondary market, shorter term consumer and commercial loans, the investment of excess cash in short or intermediate term interest-earning assets and the solicitation of deposit accounts that can be repriced rapidly in high
rate scenarios and longer repricing terms in low rate environments.

Although the Companys asset/liability management program has
generally helped to decrease the exposure of our earnings to interest rate increases, the residual effect of reducing the Companys historical exposure to interest rate increases is a heightened exposure to interest rate decreases.
Additionally, a decline in rates for earning assets may occur more rapidly than a decline in funding costs. Certificates of deposit typically have terms ranging from three to 36 months. Consequently, the rates paid for these deposits cannot be
adjusted until the maturity date. Loans priced at prime or a margin thereto provide for adjusting rates immediately when market rates change. In a rising rate environment, the ability to make immediate upward rate adjustments with adjustable-rate
loans serves to protect the net interest margin against increases in rates at a more rapid speed than the increase in funding. In a declining rate environment, the rates on prime rate based loans decrease immediately while certificate rates lag
causing the interest margin to decline until the certificates mature offering an opportunity for repricing.

We believe the Companys
asset/liability management program continues to function as a useful financial management tool, adequately providing for the safe, sound and prudent management of the Companys exposure to changes in interest rates.

Net Portfolio Value

All federally regulated
financial institutions are required to measure the exposure to changes in interest rates. Institutions with assets of less than $500 million may rely on outside sources of measurement such as those provided by the OTS. The purpose is to determine
how changes in interest rates affect the estimated value or Net Portfolio Value (NPV) of the insured institutions statement of financial condition under several immediate or shock changes in market rates.

Since the timing of repricing opportunities for interest-earning assets and interest-bearing liabilities are different, the impact of shock changes will
have a negative, neutral or positive impact on the NPV of the bank based upon the structure of the banks assets and liabilities. Thus, NPV is the difference between incoming and outgoing discounted cash flows from assets, liabilities and
off-balance sheet contracts.

Our banking subsidiary, AF Bank, has historically been a mortgage lender, which means that it generally has
longer terms before repricing its assets than it does repricing its interest bearing liabilities or deposit accounts. Therefore, a rising rate environment will have the most negative impact on the NPV of the typical mortgage lender. The following
table presents the Companys NPV at June 30, 2006, as calculated by the OTS, based on information provided to the OTS by the Company.



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Table 3. Interest Rate Sensitivity of Net Portfolio Value (NPV)



|                    |  |                       |                              |             |   |  |             |    |  |           |   |  |           
|------------------- |  | --------------------- | ---------------------------- | ----------- | - |  | ----------- | -- |  | --------- | - |  | ----------
|Net Portfolio
Value |  |                       | NPV as % of PV (5) of Assets
|Change in Rates     |  | $ Amount in Thousands |                              | $ Change(1) |   |  | % Change(2) |    |  | Ratio (3) |   |  | Change (4)
|+300 bp             |  | 20,590                |                              | (7,007      | ) |  | (25         | )% |  | 9.03      | % |  | -268 bp   
|+200 bp             |  | 23,120                |                              | (4,477      | ) |  | (16         | )% |  | 10.02     | % |  | -170 bp   
|+100 bp             |  | 25,491                |                              | (2,107      | ) |  | (8          | )% |  | 10.92     | % |  | -79 bp    
|0 bp                |  | 27,597                |                              |            |   |  |            |    |  | 11.71     | % |  |          
|-100  bp            |  | 29,489                |                              | 1,892       |   |  | 7           | %  |  | 12.42     | % |  | 71 bp     
|-200  bp            |  | 30,970                |                              | 3,372       |   |  | 12          | %  |  | 12.99     | % |  | 127 bp    

---

|(1) | Represents the change in NPV from the base (zero change in rates) assuming the indicated change in interest rates.
|--- | ------------------------------------------------------------------------------------------------------------------

|(2) | Calculated as the percentage of change in the estimated NPV compared to the base scenario.
|--- | ------------------------------------------------------------------------------------------

|(3) | Calculated as the estimated NPV divided by average total assets.
|--- | ----------------------------------------------------------------

|(4) | Represents the change, expressed in basis points (bp), in the ratio of NPV to Assets in each scenario compared to the base.
|--- | -----------------------------------------------------------------------------------------------------------------------------

|(5) | PV means present value.
|--- | -----------------------

At June 30, 2006, the
estimated NPV decreased by 25% in a 300 basis point rising interest rate shock scenario compared to an increase of 7% in a 100 basis point falling rate scenario. This compares to a decrease of 23% under a similar rise and an increase of 4% in a
similar decline one year earlier. The interest rate risk is further measured by the basis point decline in the ratio of NPV to PV of assets, defined as the Sensitivity Measure by the OTS.

At June 30, 2006, the decline of the Sensitivity Measure was 170 basis points with a 200 basis point shock decrease in rates compared to a decrease
of 162 basis points under a 200 basis point shock at June 30, 2005.

The following table provided by the OTS reflects further measures
of the Companys interest rate risk.

Table 4. Risk Measures: 200 bp Rate Shock



|                     |  |                            |  |              |   |  |              |  
|-------------------- |  | -------------------------- |  | ------------ | - |  | ------------ | -
|                     |  |                            |  | June 30,2006 |   |  | June 30,2005 |  
|Pre-shock NPV Ratio: |  | NPV as a % of PV of Assets |  | 11.71        | % |  | 12.62        | %
|Exposure Measure:    |  | Post Shock NPV Ratio       |  | 10.02        | % |  | 11.00        | %
|Sensitivity Measure: |  | Change in NPV              |  | 170 bp       |   |  | 162 bp       |  

Certain shortcomings are inherent in the methodology used in the above table. Modeling changes in
NPV require making certain assumptions that may tend to oversimplify the manner in which actual yields and costs respond to changes in market interest rates. First, the models assume that the composition of the Banks interest sensitive assets
and liabilities existing at the beginning of a period remains constant over the period being measured. Second, the models assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to
maturity of the repricing of specific assets and liabilities. Accordingly, although the NPV measurements do provide an indication of the Companys interest rate risk exposure at a particular point in time, such measurements are not intended to
provide a precise forecast of the effect of changes in market interest rates on the Companys net interest income. Furthermore, in times of decreasing interest rates, the value of fixed-rate assets could increase in value and the lag in
repricing of interest rate sensitive assets could be expected to have a negative effect on the Company because of the timing differences in the repricing opportunities for its interest earning assets and its interest bearing deposits. Interest
sensitive assets could be expected to have a positive effect on the Company when interest rates are increasing.

We believe the NPV method
of assessing the Companys exposure to interest risk and potential reductions in net interest income is a useful tool for measuring risk. The strategies that are currently in place to reduce the level of interest rate risk under an increasing
rate assumption will reduce the impact of rising rates as long term mortgages are sold and replaced with shorter term mortgages and non-mortgage loans with rates that can be adjusted to more closely simulate market rates of interest.



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Future Reporting Requirements

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instrumentsan amendment of FASB Statements No. 133 and 140. This Statement amends SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Statement resolves issues addressed in
SFAS No. 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of
an entitys first fiscal year that begins after September 15, 2006. We do not believe that the adoption of SFAS No. 155 will have a material impact on our financial position, results of operations and cash flows.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assetsan amendment of FASB Statement
No. 140. This Statement amends FASB No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing
assets and servicing liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract; requires all
separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; permits an entity to choose its subsequent measurement methods for each class of separately recognized servicing assets and
servicing liabilities; at its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other
available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entitys exposure to changes in fair value of servicing assets or servicing liabilities that a
servicer elects to subsequently measure at fair value; and requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all
separately recognized servicing assets and servicing liabilities. An entity should adopt SFAS No. 156 as of the beginning of its first fiscal year that begins after September 15, 2006. We do not believe the adoption of SFAS No. 156
will have a material impact on our financial position, results of operations and cash flows.

In December 2004, the FASB issued SFAS
No. 123(R), Accounting for Stock-Based Compensation (SFAS No. 123(R)). SFAS No. 123(R) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This
Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires that the fair value of such equity instruments be recognized as an expense in
the historical financial statements as services are performed. Prior to SFAS No. 123(R), only certain pro forma disclosures of fair value were required. The provisions of this Statement are effective for the first interim reporting period of
the first fiscal year that begins on or after December 15, 2005. Accordingly, we will adopt SFAS No. 123(R) commencing with the quarter ending September 30, 2006. Since all options granted were fully vested on December 8, 2001
there would be no cost of employee stock option compensation in our consolidated financial statements for the years months ended June 30, 2006 and 2005. Accordingly, the adoption of SFAS No. 123(R) is not expected to have a material effect
on our consolidated financial statements.

In April 2005, the Securities and Exchange Commissions Office of the Chief Accountant and
its Division of Corporation Finance issued Staff Accounting Bulletin (SAB) No.107 to provide guidance regarding the application of SFAS No.123(R). SAB No. 107 provides interpretive guidance related to the interaction between SFAS
No.123(R) and certain SEC rules and regulations, as well as the staffs views regarding the valuation of share-based payment arrangements for public companies. SAB No. 107 also reminds public companies of the importance of including
disclosures within filings made with the SEC relating to the accounting for share-based payment transactions, particularly during the transition to SFAS No.123(R). This SAB is effective concurrently with SFAS 123(R).

In May 2005, the FASB issued SFAS No. 154,Accounting Changes and Error Corrections  a replacement of APB Opinion No. 20 and
FASB Statement No. 3. SFAS No. 154 establishes retrospective application as the required method for reporting a change in accounting principle, unless it is impracticable, in which case the changes should be applied to the latest
practicable date presented. SFAS No. 154 also requires that a correction of an error be reported as a prior period adjustment by restating prior period financial statements. SFAS No. 154 is effective for accounting changes and corrections
of errors made in fiscal years beginning after December 15, 2005.



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In June 2006, the FASB issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty
in Income Taxes,an interpretation of FASB Statement No. 109. FIN 48 addresses the recognition and measurement of certain tax positions taken in the financial statements of a business enterprise. It also includes certain financial
statement disclosures around uncertain tax positions. FIN 48 is effective for fiscal years beginning after December 15, 2006. We have not yet evaluated the impact of FIN 48 on our consolidated financial statements.

Impact of Inflation and Changing Prices

The
financial statements and accompanying footnotes have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative
purchasing power of money over time due to inflation. The assets and liabilities of the Company are primarily monetary in nature and changes in market interest rates have a greater impact on the Companys performance than do the effects of
inflation.

Off-Balance Sheet Arrangements

Information about our off-balance sheet risk exposure is presented in Note 17 to the consolidated financial statements. As part of our on-going business, we do not participate in transactions that generate relationships with unconsolidated
entities or financial partnerships, such as entities referred to as special purpose entities (SPEs), which generally are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
See Note 17 Commitments and Contingencies in the Notes to Consolidated Financial Statements provided under Item 7.



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##### Table of Contents

ITEM7 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors

AF Financial Group and Subsidiaries

West Jefferson, North Carolina

We have audited the accompanying consolidated statements of financial condition of AF Financial Group and subsidiaries as of June 30, 2006 and 2005, and the related
consolidated statements of income, stockholders equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the
Companys internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AF
Financial Group and subsidiaries as of June 30, 2006 and 2005, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

LOGO

Charlotte, North Carolina

September 14, 2006



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##### Table of Contents

Consolidated Statements of Financial Condition

Years ended June 30, 2006 and 2005



|                                                                                                                                                                                                                             |  |      |             |   |      |   |             |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                                                                                                                                                                             |  | 2006 |             |   | 2005 |  
|Assets                                                                                                                                                                                                                       |  |      |             |   |      |   |             |  
|                                                                                                                                                                                                                             |  |     
|Cash and cash equivalents:                                                                                                                                                                                                   |  |      |             |   |      |   |             |  
|Interest-bearing deposits                                                                                                                                                                                                    |  | $    | 2,102,087   |   |      | $ | 2,657,931   |  
|Noninterest-bearing deposits                                                                                                                                                                                                 |  |      | 8,906,573   |   |      |   | 6,150,597   |  
|Securities held to maturity (fair value $153,787 in 2005)                                                                                                                                                                    |  |      |            |   |      |   | 153,787     |  
|Securities available for sale                                                                                                                                                                                                |  |      | 3,457,007   |   |      |   | 3,891,711   |  
|Federal Home Loan Bank stock                                                                                                                                                                                                 |  |      | 1,791,600   |   |      |   | 1,704,800   |  
|                                                                                                                                                                                                                             |  |     
|Loans                                                                                                                                                                                                                        |  |      | 195,506,996 |   |      |   | 182,627,642 |  
|Less allowance for loan losses                                                                                                                                                                                               |  |      | (1,567,988  | ) |      |   | (1,385,412  | )
|                                                                                                                                                                                                                             |  |      |             |   |      |   |             |  
|Loans receivable, net                                                                                                                                                                                                        |  |      | 193,939,008 |   |      |   | 181,242,230 |  
|Loans held for sale                                                                                                                                                                                                          |  |      | 885,000     |   |      |   | 1,226,750   |  
|Real estate owned                                                                                                                                                                                                            |  |      | 908,611     |   |      |   |            |  
|Office properties and equipment, net                                                                                                                                                                                         |  |      | 13,105,187  |   |      |   | 12,756,375  |  
|Accrued interest receivable on loans                                                                                                                                                                                         |  |      | 1,026,816   |   |      |   | 886,813     |  
|Accrued interest receivable on investment securities                                                                                                                                                                         |  |      | 53,654      |   |      |   | 62,373      |  
|Prepaid expenses and other assets                                                                                                                                                                                            |  |      | 1,451,134   |   |      |   | 1,719,280   |  
|Deferred income taxes, net                                                                                                                                                                                                   |  |      | 79,692      |   |      |   |            |  
|Goodwill                                                                                                                                                                                                                     |  |      | 1,648,468   |   |      |   | 1,648,468   |  
|                                                                                                                                                                                                                             |  |      |             |   |      |   |             |  
|Total assets                                                                                                                                                                                                                 |  | $    | 229,354,837 |   |      | $ | 214,101,115 |  
|                                                                                                                                                                                                                             |  |      |             |   |      |   |             |  
|Liabilities and Stockholders Equity                                                                                                                                                                                         |  |      |             |   |      |   |             |  
|                                                                                                                                                                                                                             |  |     
|Liabilities:                                                                                                                                                                                                                 |  |      |             |   |      |   |             |  
|Savings deposits                                                                                                                                                                                                             |  | $    | 177,012,652 |   |      | $ | 163,976,928 |  
|Short-term borrowings                                                                                                                                                                                                        |  |      | 4,939,385   |   |      |   | 2,570,544   |  
|Long-term borrowings                                                                                                                                                                                                         |  |      | 29,858,300  |   |      |   | 31,968,407  |  
|Accounts payable and other liabilities                                                                                                                                                                                       |  |      | 2,939,216   |   |      |   | 1,853,628   |  
|Deferred income taxes, net                                                                                                                                                                                                   |  |      |            |   |      |   | 76,373      |  
|Redeemable common stock held by the Employee Stock Ownership Plan (ESOP), net of unearned ESOP shares                                                                                                                        |  |      | 603,668     |   |      |   | 616,266     |  
|                                                                                                                                                                                                                             |  |      |             |   |      |   |             |  
|Total liabilities                                                                                                                                                                                                            |  |      | 215,353,221 |   |      |   | 201,062,146 |  
|                                                                                                                                                                                                                             |  |      |             |   |      |   |             |  
|Commitments and contingencies                                                                                                                                                                                                |  |      |             |   |      |   |             |  
|                                                                                                                                                                                                                             |  |     
|Stockholders equity:                                                                                                                                                                                                        |  |      |             |   |      |   |             |  
|Common stock, par value $.01 per share; authorized 5,000,000 shares; 1,054,644 shares issued and 1,050,804 shares outstanding at June 30,
2006 and 1,053,675 shares issued and 1,049,835 shares outstanding at June 30, 2005 |  |      | 10,546      |   |      |   | 10,537      |  
|Additional paid-in capital                                                                                                                                                                                                   |  |      | 4,743,174   |   |      |   | 4,687,955   |  
|Retained earnings, substantially restricted                                                                                                                                                                                  |  |      | 9,338,743   |   |      |   | 8,375,186   |  
|Accumulated other comprehensive income (loss)                                                                                                                                                                                |  |      | (15,967     | ) |      |   | 40,171      |  
|                                                                                                                                                                                                                             |  |      |             |   |      |   |             |  
|                                                                                                                                                                                                                             |  |      | 14,076,496  |   |      |   | 13,113,849  |  
|Less cost of 3,840 shares of treasury stock                                                                                                                                                                                  |  |      | (74,880     | ) |      |   | (74,880     | )
|                                                                                                                                                                                                                             |  |      |             |   |      |   |             |  
|Total stockholders equity                                                                                                                                                                                                   |  |      | 14,001,616  |   |      |   | 13,038,969  |  
|                                                                                                                                                                                                                             |  |      |             |   |      |   |             |  
|Total liabilities and stockholders equity                                                                                                                                                                                   |  | $    | 229,354,837 |   |      | $ | 214,101,115 |  
|                                                                                                                                                                                                                             |  |      |             |   |      |   |             |  

See Notes to Consolidated Financial Statements



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##### Table of Contents

Consolidated Statements of Income

Years ended June 30, 2006 and 2005



|                                                    |  |      |            |      |   |            |  
|--------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | -
|                                                    |  | 2006 |            | 2005 |  
|Interest and dividend income:                       |  |      |            |      |   |            |  
|Loans                                               |  | $    | 13,238,407 |      | $ | 11,693,803 |  
|Investment securities                               |  |      | 265,987    |      |   | 229,336    |  
|Interest-bearing deposits                           |  |      | 171,437    |      |   | 71,970     |  
|                                                    |  |      |            |      |   |            |  
|Total interest and dividend income                  |  |      | 13,675,831 |      |   | 11,995,109 |  
|                                                    |  |      |            |      |   |            |  
|Interest expense:                                   |  |      |            |      |   |            |  
|Savings deposits                                    |  |      | 3,973,383  |      |   | 2,791,394  |  
|Short-term borrowings                               |  |      | 39,065     |      |   | 138,041    |  
|Long-term borrowings                                |  |      | 1,795,711  |      |   | 1,803,777  |  
|                                                    |  |      |            |      |   |            |  
|Total interest expense                              |  |      | 5,808,159  |      |   | 4,733,212  |  
|                                                    |  |      |            |      |   |            |  
|Net interest income                                 |  |      | 7,867,672  |      |   | 7,261,897  |  
|                                                    |  |     
|Provision for loan losses:                          |  |      | 265,000    |      |   | (78,922    | )
|                                                    |  |      |            |      |   |            |  
|Net interest income after provision for loan losses |  |      | 7,602,672  |      |   | 7,340,819  |  
|                                                    |  |      |            |      |   |            |  
|Noninterest income:                                 |  |      |            |      |   |            |  
|Insurance commissions                               |  |      | 2,768,412  |      |   | 2,533,852  |  
|Other                                               |  |      | 1,653,705  |      |   | 1,431,665  |  
|                                                    |  |      |            |      |   |            |  
|Total noninterest income                            |  |      | 4,422,117  |      |   | 3,965,517  |  
|                                                    |  |      |            |      |   |            |  
|Noninterest expense:                                |  |      |            |      |   |            |  
|Compensation and employee benefits                  |  |      | 5,879,798  |      |   | 5,739,162  |  
|Occupancy and equipment                             |  |      | 1,346,416  |      |   | 1,342,966  |  
|Computer processing charges                         |  |      | 740,809    |      |   | 673,244    |  
|Other                                               |  |      | 2,372,714  |      |   | 2,409,041  |  
|                                                    |  |      |            |      |   |            |  
|Total noninterest expense                           |  |      | 10,339,737 |      |   | 10,164,413 |  
|                                                    |  |      |            |      |   |            |  
|Income before income taxes                          |  |      | 1,685,052  |      |   | 1,141,923  |  
|                                                    |  |     
|Income taxes:                                       |  |      | 664,229    |      |   | 493,146    |  
|                                                    |  |      |            |      |   |            |  
|Net income                                          |  | $    | 1,020,823  |      | $ | 648,777    |  
|                                                    |  |      |            |      |   |            |  
|Basic earnings per share                            |  | $    | 0.97       |      | $ | 0.62       |  
|                                                    |  |      |            |      |   |            |  
|Diluted earnings per share                          |  | $    | 0.97       |      | $ | 0.62       |  
|                                                    |  |      |            |      |   |            |  
|Basic weighted average shares outstanding           |  |      | 1,049,157  |      |   | 1,044,791  |  
|                                                    |  |      |            |      |   |            |  
|Diluted weighted average shares outstanding         |  |      | 1,050,395  |      |   | 1,045,185  |  
|                                                    |  |      |            |      |   |            |  

See Notes to Consolidated Financial Statements



- 45 -



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##### Table of Contents

Consolidated Statements of Stockholders Equity

Years ended June 30, 2006 and 2005



|                                                                               |  |             |        |                          |   |                  |  |   |                                     |   |  |               |         |   |                          |   |         |   |  |   |            |  
|------------------------------------------------------------------------------ |  | ----------- | ------ | ------------------------ | - | ---------------- |  | - | ----------------------------------- | - |  | ------------- | ------- | - | ------------------------ | - | ------- | - |  | - | ---------- | -
|                                                                               |  | CommonStock |        | AdditionalPaid-inCapital |   | RetainedEarnings |  |   | AccumulatedOtherComprehensiveIncome |   |  | TreasuryStock |         |   | TotalStockholdersEquity |  
|Balance, June 30, 2004                                                         |  | $           | 10,537 |                          | $ | 4,653,933        |  | $ | 7,874,017                           |   |  | $             | 10,389  |   |                          | $ | (74,880 | ) |  | $ | 12,473,996 |  
|                                                                               |  |             |        |                          |   |                 
|Transfer to redeemable common stock net of unearned ESOP shares                |  |             |       |                          |   |                 |  |   | (81,516                             | ) |  |               |        |   |                          |   |        |   |  |   | (81,516    | )
|ESOP contribution                                                              |  |             |       |                          |   | 34,022           |  |   | 36,999                              |   |  |               |        |   |                          |   |        |   |  |   | 71,021     |  
|Cash dividend, $.20 per share                                                  |  |             |       |                          |   |                 |  |   | (103,091                            | ) |  |               |        |   |                          |   |        |   |  |   | (103,091   | )
|Net income                                                                     |  |             |       |                          |   |                 |  |   | 648,777                             |   |  |               |        |   |                          |   |        |   |  |   | 648,777    |  
|Other comprehensive income, net of tax:                                        |  |             |        |                          |   |                  |  |   |                                     |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Unrealized holding income arising during period, net of tax benefit of $19,132 |  |             |       |                          |   |                 |  |   |                                    |   |  |               | 29,782  |   |                          |   |        |   |  |   | 29,782     |  
|                                                                               |  |             |        |                          |   |                  |  |   |                                     |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Comprehensive income                                                           |  |             |        |                          |   |                  |  |   |                                     |   |  |               |         |   |                          |   |         |   |  |   | 678,559    |  
|                                                                               |  |             |        |                          |   |                  |  |   |                                     |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Balance, June 30, 2005                                                         |  | $           | 10,537 |                          | $ | 4,687,955        |  | $ | 8,375,186                           |   |  | $             | 40,171  |   |                          | $ | (74,880 | ) |  | $ | 13,038,969 |  
|                                                                               |  |             |        |                          |   |                 
|Transfer from redeemable common stock net of unearned ESOP shares              |  |             |       |                          |   |                 |  |   | 12,598                              |   |  |               |        |   |                          |   |        |   |  |   | 12,598     |  
|ESOP contribution                                                              |  |             |       |                          |   | 36,274           |  |   | 33,421                              |   |  |               |        |   |                          |   |        |   |  |   | 69,695     |  
|Cash dividend, $.20 per share                                                  |  |             |       |                          |   |                 |  |   | (103,285                            | ) |  |               |        |   |                          |   |        |   |  |   | (103,285   | )
|Net income                                                                     |  |             |       |                          |   |                 |  |   | 1,020,823                           |   |  |               |        |   |                          |   |        |   |  |   | 1,020,823  |  
|Common stock issued in connection with stock option exercise                   |  |             | 9      |                          |   | 18,945           |  |   |                                    |   |  |               |        |   |                          |   |        |   |  |   | 18,954     |  
|Other comprehensive loss, net of tax:                                          |  |             |        |                          |   |                  |  |   |                                     |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Unrealized holding loss arising during period, net of tax of $36,064           |  |             |       |                          |   |                 |  |   |                                    |   |  |               | (56,138 | ) |                          |   |        |   |  |   | (56,138    | )
|                                                                               |  |             |        |                          |   |                  |  |   |                                     |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Comprehensive income                                                           |  |             |        |                          |   |                  |  |   |                                     |   |  |               |         |   |                          |   |         |   |  |   | 964,685    |  
|                                                                               |  |             |        |                          |   |                  |  |   |                                     |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Balance, June 30, 2006                                                         |  | $           | 10,546 |                          | $ | 4,743,174        |  | $ | 9,338,743                           |   |  | $             | (15,967 | ) |                          | $ | (74,880 | ) |  | $ | 14,001,616 |  
|                                                                               |  |             |        |                          |   |                  |  |   |                                     |   |  |               |         |   |                          |   |         |   |  |   |            |  

See Notes to Consolidated Financial Statements



- 46 -



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##### Table of Contents

Consolidated Statements of Cash Flows

Years ended June 30, 2006 and 2005



|                                                                                  |  |      |             |   |      |   |             |  
|--------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                                  |  | 2006 |             |   | 2005 |  
|Cash flows from operating activities                                              |  |      |             |   |      |   |             |  
|Net income                                                                        |  | $    | 1,020,823   |   |      | $ | 648,777     |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |             |   |      |   |             |  
|Provision for loan losses                                                         |  |      | 265,000     |   |      |   | (78,922     | )
|Depreciation and amortization                                                     |  |      | 1,176,653   |   |      |   | 995,950     |  
|Loss on disposal of fixed assets                                                  |  |      | 42,498      |   |      |   | 88,177      |  
|Loss on sale of securities available for sale                                     |  |      | 4,388       |   |      |   |            |  
|Gain on loans held for sale                                                       |  |      | (32,235     | ) |      |   | (75,606     | )
|Proceeds from loans held for sale                                                 |  |      | 16,342,305  |   |      |   | 17,574,106  |  
|Originations of loans held for sale                                               |  |      | (15,968,320 | ) |      |   | (17,391,650 | )
|Amortization of deferred loan fees                                                |  |      | (132,171    | ) |      |   | (135,184    | )
|ESOP expense                                                                      |  |      | 69,695      |   |      |   | 71,021      |  
|Deferred income taxes                                                             |  |      | (120,001    | ) |      |   |            |  
|Change in operating assets and liabilities:                                       |  |      |             |   |      |   |             |  
|Accrued interest receivable                                                       |  |      | (131,284    | ) |      |   | (27,376     | )
|Accrued interest payable                                                          |  |      | 105,880     |   |      |   | (79,729     | )
|Prepaid expenses and other assets                                                 |  |      | 38,459      |   |      |   | 13,727      |  
|Accounts payable and other liabilities                                            |  |      | 1,060,232   |   |      |   | 523,108     |  
|                                                                                  |  |      |             |   |      |   |             |  
|Net cash provided by operating activities                                         |  |      | 3,741,922   |   |      |   | 2,126,399   |  
|                                                                                  |  |      |             |   |      |   |             |  
|Cash flows from investing activities                                              |  |      |             |   |      |   |             |  
|Purchases of Federal Home Loan Bank stock                                         |  |      | (86,800     | ) |      |   | (47,600     | )
|Purchases of investments held to maturity                                         |  |      |            |   |      |   | (438,787    | )
|Proceeds from maturities of investments held to maturity                          |  |      | 153,787     |   |      |   | 814,000     |  
|Purchases of securities available for sale                                        |  |      | (1,000,000  | ) |      |   | (1,900,000  | )
|Proceeds from principal repayment and maturities of securities available for sale |  |      | 334,645     |   |      |   | 2,355,753   |  
|Proceeds from sale of investments available for sale                              |  |      | 996,479     |   |      |   |            |  
|Net originations of loans receivable                                              |  |      | (13,738,218 | ) |      |   | (1,352,377  | )
|Recovery in insurance agency assets                                               |  |      |            |   |      |   | 27,978      |  
|Purchases of office properties and equipment                                      |  |      | (1,331,286  | ) |      |   | (2,267,192  | )
|Proceeds from sale of real estate owned                                           |  |      |            |   |      |   | 320,000     |  
|                                                                                  |  |      |             |   |      |   |             |  
|Net cash used in investing activities                                             |  |      | (14,671,393 | ) |      |   | (2,488,225  | )
|                                                                                  |  |      |             |   |      |   |             |  
|Cash flows from financing activities                                              |  |      |             |   |      |   |             |  
|Net increase in savings deposits                                                  |  |      | 12,955,200  |   |      |   | 6,627,422   |  
|Short-term borrowings (repayments), net                                           |  |      | 2,368,841   |   |      |   | (2,927,274  | )
|Long-term borrowings (repayments), net                                            |  |      | (2,110,107  | ) |      |   | (2,100,755  | )
|Net proceeds from common stock issued                                             |  |      | 17,927      |   |      |   |            |  
|Tax benefit from exercise of stock options                                        |  |      | 1,027       |   |      |   |            |  
|Dividends paid                                                                    |  |      | (103,285    | ) |      |   | (103,091    | )
|                                                                                  |  |      |             |   |      |   |             |  
|Net cash provided by financing activities                                         |  |      | 13,129,603  |   |      |   | 1,496,302   |  
|                                                                                  |  |      |             |   |      |   |             |  
|Net increase in cash and cash equivalents                                         |  |      | 2,200,132   |   |      |   | 1,134,476   |  
|                                                                                  |  |     
|Cash and cash equivalents                                                         |  |      |             |   |      |   |             |  
|Beginning                                                                         |  |      | 8,808,528   |   |      |   | 7,674,052   |  
|                                                                                  |  |      |             |   |      |   |             |  
|Ending                                                                            |  | $    | 11,008,660  |   |      | $ | 8,808,528   |  
|                                                                                  |  |      |             |   |      |   |             |  

See Notes to Consolidated Financial Statements



- 47 -



---

##### Table of Contents

Consolidated Statements of Cash Flows

Years ended June 30, 2006 and 2005



|                                                                                  |  |      |           |   |      |   |           |  
|--------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                                                                                  |  | 2006 |           |   | 2005 |  
|Supplemental disclosures of cash flow information                                 |  |      |           |   |      |   |           |  
|Cash payments for:                                                                |  |      |           |   |      |   |           |  
|Interest                                                                          |  | $    | 5,702,278 |   |      | $ | 4,812,941 |  
|Income taxes                                                                      |  |      | 132,383   |   |      |   | 48,540    |  
|                                                                                  |  |     
|Supplemental disclosure of noncash investing and financing activities             |  |      |           |   |      |   |           |  
|Net change in unrealized gain (loss) on securities available for sale, net of tax |  | $    | (56,138   | ) |      | $ | 29,782    |  
|Transfer from loans receivable to real estate owned                               |  |      | 908,611   |   |      |   | 479,812   |  
|Fair value of ESOP shares in excess of unearned ESOP shares                       |  |      | 46,018    |   |      |   | (44,516   | )
|Transfer from (to) retained earnings to ESOP redeemable common stock              |  |      | 12,598    |   |      |   | (81,516   | )

See Notes to Consolidated Financial Statements



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies

Principles of consolidation

The accompanying consolidated financial statements include the accounts of AF
Financial Group and its wholly owned subsidiaries, AF Bank and AF Insurance Services, Inc., together referred to as the Company. All significant intercompany transactions and balances have been eliminated in consolidation.

Business segments

The Company reports its activities in
various business segments. In determining appropriate segment definition, the Company considers the materiality of potential segments and components of the business about which financial information is available and regularly evaluated, relative to
resource allocation and performance assessment.

Use of estimates

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. In preparing the
financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported
revenues and expenses for the period. Actual results could differ from those estimates. Material estimates that are particularly sensitive to significant change relate to the determination of the allowance for loan losses, mortgage servicing assets
and goodwill.

Cash and cash equivalents

For
purposes of reporting the statement of cash flows, the Company includes cash on hand and demand deposits at other financial institutions with terms less than 90 days as cash and cash equivalents. Cash flows from loans and deposits are reported net.
The Company maintains amounts due from banks which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts.

Investment securities

The Company has investments in debt and equity securities. Debt securities consist primarily of U.S.
Government agency securities, Federal Home Loan Bank (FHLB) bonds, Fannie Mae and Government National Mortgage Association securities and certificates of deposit. Equity securities consist of Federal Home Loan Mortgage Corporation
(FHLMC) stock and mutual funds.

Management classifies all debt securities and certain equity securities as trading, available for sale, or held to
maturity as individual investment securities are acquired, and thereafter the appropriateness of such classification is reassessed at each statement of financial condition date. Because the Company does not buy investment securities in anticipation
of short-term fluctuations in market prices, none of the investment securities are classified as trading in accordance with Statement of Financial Accounting Standards (SFAS) No. 115. All securities have been classified as either
available for sale or held to maturity.

Declines in the fair value of individual securities classified as either available for sale or held to maturity
below their amortized cost, that are determined to be other than temporary, result in write-downs of the individual securities to their fair value with the resulting write-downs included in current earnings as realized losses. In estimating other
than temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and
ability of the Company to retain its investment in the issuer of a period of time sufficient to allow for any anticipated recovery in fair value.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies, continued

Securities available for sale

Securities classified as available for sale are those securities that the
Company intends to hold for an indefinite period of time but, in the case of debt securities, not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant
movements in interest rates, changes in the maturity mix of the Companys assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available for sale are carried at fair value. Premiums
and discounts are amortized using the interest method over the securities contractual lives. Unrealized gains or losses are reported as increases or decreases in equity, net of the related deferred tax effect. Realized gains or losses,
determined on the basis of the cost of specific securities sold, are included in income.

Securities held to maturity

Securities classified as held to maturity are those securities for which the Company has both the intent and ability to hold to maturity regardless of changes in market
conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for amortization of premium and accretion of discount, computed by the interest method over their contractual lives. Based on the
Companys financial position and liquidity, management believes the Company has the ability to hold these securities to maturity.

Investment in
Federal Home Loan Bank stock

The Company, as a member of the FHLB system, is required to maintain an investment in capital stock of the FHLB. No
ready market exists for the FHLB stock, it has no quoted market value and it is carried at cost. The FHLB stock also collateralizes the Companys borrowings from the FHLB. Due to the redemption provisions of the FHLB, the Company estimated that
the fair value equals cost and that this investment was not impaired at June 30, 2006.

Loans receivable

The Company grants mortgage, commercial and consumer loans to customers. The Companys loan portfolio consists principally of mortgage loans collateralized by first
trust deeds on single family residences, other residential property, commercial property and land. The ability of the Banks debtors to honor their contracts is dependent upon the real estate and general economic conditions in the market area.

Loans receivable are stated at unpaid principal balances, less the allowance for loan losses, the loans sold and net deferred loan-origination fees and
costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

The accrual of interest on loans is discontinued at the time the loan is 90 days past due or impaired. Past due status is based on contractual terms of the loan. In all
cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful according to internal evaluation policies.

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



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies, continued

Loans held for sale

Mortgage loans originated and intended for sale in the secondary market are carried at
the lower of aggregate cost or fair value as determined by aggregate outstanding commitments from investors. Market values on mortgage loans originated and intended for sale in the secondary market are determined by discounting future cash flows at
current market rates. Mortgage loans held for sale are sold with servicing rights retained. Gains or losses on sales of mortgage loans are recognized based upon the difference between the selling price and the carrying value of the related mortgage
loans sold. The terms of the loans are set by the secondary investors and are transferred to them at par within several days of the Company initially funding the loan. The Company receives origination fees from borrowers. Between the initial funding
of the loans by the Company and the subsequent reimbursement by the investors, the Company carries the loans on its statement of financial condition at cost. The Company has no recourse obligation on loans sold.

Rate lock commitments

Loan commitments related to the
origination or acquisition of mortgage loans that will be held for sale must be accounted for as derivative instruments. The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding
(rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Fair value is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments also
considers the difference between current levels of interest rates and the committed rates. It has been determined that the value of these commitments is not significant and has not been recognized in these consolidated financial statements.

Allowance for loan losses

The allowance for
loan losses is increased by charges to income and decreased by charge-offs (net of recoveries) based on the Companys evaluation of the potential and inherent risk of losses in its loan portfolio. The allowance for loan losses is evaluated on a
regular basis by management and is based upon periodic review of the Companys past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrowers ability to repay, the estimated value of
any underlying collateral, and current economic conditions. While management uses the best information available to make evaluations, future adjustments may be necessary if economic or other conditions differ or change substantially from the
assumptions used.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as
doubtful, substandard or special mention. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect
managements estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the
portfolio.

Impaired loans

SFAS No. 114,
Accounting by Creditors for Impairment of a Loan,as amended, requires that the Company establish a specific loan allowance on an impaired loan if the present value of the future cash flows discounted using the loans effective interest
rate is less than the carrying value of the loan. An impaired loan can also be valued based upon its fair value or the market value of the underlying collateral if the loan is primarily collateral dependent. The Company considers all loans
delinquent more than 90 days to be impaired. See Note 3 for further information.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies, continued

Interest income

SFAS No. 118, Accounting by Creditors for Impairment of a Loan  Income
Recognition and Disclosures, which amended SFAS No. 114, requires disclosure of the Companys method of accounting for interest income on impaired loans. The Company does not accrue interest on impaired loans or loans delinquent 90
days or more. In addition, interest accrued up to 90 days is reversed by the establishment of a reserve for uncollectible interest if in the opinion of management collectibility is uncertain. Such interest, if ultimately collected, is credited to
income in the period received.

Loan origination fees and related costs

Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method over the contractual life of the loans, adjusted
for actual prepayments.

Real estate owned

Real
estate owned is initially recorded at the estimated fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations of the property are periodically performed by management and the real estate is carried
at the lower of cost or fair value minus estimated costs to sell. Costs relating to improvement of the property are capitalized, while holding costs of the property are charged to expense in the period incurred.

Office properties and equipment

Land is carried at cost.
Office premises and equipment are stated at cost less accumulated depreciation. Depreciation of premises and equipment is recorded on a straight-line basis over the estimated useful lives of the related assets. Expenditures for maintenance and
repairs are charged to expense as incurred, while those for improvements are capitalized. The costs and accumulated depreciation relating to premises and equipment retired or otherwise disposed of are eliminated from the accounts and any resulting
gains or losses are credited or charged to income.

Goodwill

Goodwill is the cost of the investment by AF Insurance Services, Inc. in excess of the fair value of net tangible assets acquired at the date of purchase. On July 1, 2002, the Company adopted the provisions of
Financial Accounting Standards Board (FASB) Statement 142, Goodwill and Other Intangible Assets. Under the provisions of the Statement, on July 1, 2002, the Company eliminated the amortization of goodwill. During the 2006
fiscal year a goodwill impairment test was performed and the Company had no impairment of goodwill.

Mortgage servicing rights

When mortgage loans are sold, the proceeds are allocated between the related loans and the retained mortgage servicing rights based on their relative fair value.
Servicing assets are amortized over the average period of estimated net servicing income. The Company recorded amortization of mortgage servicing rights of $60,743 during the year ended June 30, 2006.

All servicing assets are assessed for impairment based on their fair value. The Company recognized no impairment during the year ended June 30, 2006.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies, continued

Employee benefit plans

The Company has deferred compensation and retirement plan agreements for the benefit
of the Board of Directors and a key officer. These plans are unfunded and the liabilities are being accrued over the terms of active service. The Company also has an ESOP which covers substantially all of its employees. Contributions to the plan are
based on amounts necessary to fund the amortization requirements of the ESOPs debt to an unrelated third party financial institution, subject to compensation limitations, and are expensed based on the AICPAs Statement of Position 93-6,
Employers Accounting for Employee Stock Ownership Plans.

Additionally, the Company has implemented a qualified stock option plan authorizing
the grant of up to 14,573 stock options to certain officers and directors, either in the form of incentive stock options or non-incentive stock options. As permitted under the generally accepted accounting principles, grants under the plan are
accounted for following the provisions of Accounting Principles Board (APB) Opinion No. 25 and its related interpretations. Accordingly, no compensation cost has been recognized for grants made to date. All options were fully vested
on December 8, 2001.

Advance payments by borrowers for taxes and insurance

Certain borrowers make monthly payments, in addition to principal and interest, in order to accumulate funds from which the Bank can pay the borrowers property
taxes and insurance premiums.

Income taxes

Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards, and deferred tax liabilities are recognized for
taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is
more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

Off-balance sheet credit related financial instruments

The
Bank is a party to financial instruments with off-statement of financial condition risk such as commitments to extend credit and home equity lines of credit. Management assesses the risk related to these instruments for potential losses on an
ongoing basis. Such financial instruments are recorded when they are funded. Management has determined that no allowance for loan losses is provided against these off-balance sheet commitments.

Earnings per share

SFAS No. 128, Earnings Per
Share, requires the presentation of earnings per share by all entities that have common stock or potential common stock, such as options, warrants and convertible securities outstanding that trade in a public market. Basic per-share amounts are
computed by dividing net income or loss (the numerator) by the weighted-average number of common shares outstanding (the denominator). Diluted per-share amounts assume the conversion, exercise or issuance of all potential common stock instruments
unless the effect is to reduce the loss or increase the income per common share from continuing operations. For both computations, the number of shares of common stock purchased by the Companys employee stock ownership plan which have not been
allocated to participant accounts are not assumed to be outstanding.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies, continued

Comprehensive income

SFAS No. 130, Reporting Comprehensive Income, established standards for
reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This statement requires that all items that are recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Accumulated other comprehensive income in the Companys financial statements relates solely to
unrealized gains and losses on available-for-sale securities.

Insurance income

Insurance commissions from agency bill policies, or polices where we bill the customer directly, are earned when due as determined by the respective policy. Commissions from direct bill insurance policies, or policies
where the insurance companies we represent bill our customers directly, are recorded when received.

Brokerage income

Brokerage commissions are recognized in income on a trade-date basis.

Fair value of financial instruments

The estimated fair values required under SFAS No. 107,
Disclosures About Fair Value of Financial Instruments, have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to develop the estimates of fair
value. Accordingly, the estimates presented for the fair value of the Companys financial instruments are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions
or estimation methodologies may have a material effect on the estimated fair market value amounts.

Note 2. Debt and Equity Securities

Debt and equity securities have been classified in the statements of financial condition according to managements intent. The carrying amount of securities and
approximate fair values as of June 30 were as follows:



|                                  |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|--------------------------------- |  | ------------- | --------- | --------------------- | - | ---------------------- |  | - | ---------- | - |  | - | ---------
|                                  |  | 2006         
|                                  |  | AmortizedCost |           | Gross UnrealizedGains |   | Gross UnrealizedLosses |  |   | Fair Value
|Available for sale securities:    |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Debt securities:                  |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|U.S. Government agency securities |  | $             | 2,400,000 |                       | $ |                       |  | $ | (42,190    | ) |  | $ | 2,357,810
|Fannie Mae and Government         |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|National Mortgage Association     |  |               | 795,127   |                       |   | 2,198                  |  |   | (16,722    | ) |  |   | 780,603  
|Municipals                        |  |               | 287,854   |                       |   | 13,637                 |  |   |           |   |  |   | 301,491  
|Equity securities:                |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Federal Home Loan Mortgage        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Corporation common stock          |  |               | 250       |                       |   | 16,853                 |  |   |           |   |  |   | 17,103   
|                                  |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|                                  |  | $             | 3,483,231 |                       | $ | 32,688                 |  | $ | (58,912    | ) |  | $ | 3,457,007
|                                  |  |               |           |                       |   |                        |  |   |            |   |  |   |          



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 2. Debt and Equity Securities, continued



|                                  |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|--------------------------------- |  | -------------- | --------- | ---------------------- | - | ---------------------- |  | - | ---------- | - |  | - | ---------
|                                  |  | 2005          
|                                  |  | Amortized Cost |           | Gross Unrealized Gains |   | Gross UnrealizedLosses |  |   | Fair Value
|Available for sale securities:    |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|Debt securities:                  |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|U.S. Government agency securities |  | $              | 1,400,000 |                        | $ |                       |  | $ | (8,121     | ) |  | $ | 1,391,879
|Fannie Mae and Government         |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|National Mortgage Association     |  |                | 1,137,488 |                        |   | 14,776                 |  |   | (3,518     | ) |  |   | 1,148,746
|Municipals                        |  |                | 287,128   |                        |   | 16,934                 |  |   |           |   |  |   | 304,062  
|Equity securities:                |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|Mutual funds                      |  |                | 1,000,000 |                        |   | 11,297                 |  |   | (51,681    | ) |  |   | 959,616  
|Federal Home Loan Mortgage        |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|Corporation common stock          |  |                | 1,117     |                        |   | 86,291                 |  |   |           |   |  |   | 87,408   
|                                  |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|                                  |  | $              | 3,825,733 |                        | $ | 129,298                |  | $ | (63,320    | ) |  | $ | 3,891,711
|                                  |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|Held to maturity securities:      |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|Debt securities:                  |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|Certificates of deposit           |  |                | 153,787   |                        |   |                       |  |   |           |   |  |   | 153,787  
|                                  |  |                |           |                        |   |                        |  |   |            |   |  |   |          
|                                  |  | $              | 153,787   |                        | $ |                       |  | $ |           |   |  | $ | 153,787  
|                                  |  |                |           |                        |   |                        |  |   |            |   |  |   |          

The following tables show investments gross unrealized losses and fair value, aggregated by investment
category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2006 and 2005. These unrealized losses on investment securities are a result of volatility in the market. The unrealized
losses on investment securities during 2006 relate to six federal agency securities and nine mortgage-back securities. The unrealized losses on investment securities during 2005 relate to four federal agency securities, one mortgage-back security,
and two mutual funds. All unrealized losses on investment securities are considered by management to be temporary given the credit ratings on these investment securities and the short duration of the unrealized loss.



|                                                        |  |                     |           |                   |   |            |  |                   |           |            |   |                   |  |   |           |  |   |       
|------------------------------------------------------- |  | ------------------- | --------- | ----------------- | - | ---------- |  | ----------------- | --------- | ---------- | - | ----------------- |  | - | --------- |  | - | ------
|                                                        |  | 2006               
|                                                        |  | Less Than 12 Months |           | 12 Months or More |   | Total     
|                                                        |  | Fair Value          |           | Unrealized Losses |   | Fair Value |  | Unrealized Losses |           | Fair Value |   | Unrealized Losses
|Securities available for sale:                          |  |                     |           |                   |   |            |  |                   |           |            |   |                   |  |   |           |  |   |       
|U.S. government agencies                                |  | $                   | 988,280   |                   | $ | 11,720     |  | $                 | 1,369,530 |            | $ | 30,470            |  | $ | 2,357,810 |  | $ | 42,190
|                                                        |  |                     |           |                   |   |           
|Fannie Mae and Government National Mortgage Association |  |                     | 298,166   |                   |   | 5,024      |  |                   | 319,880   |            |   | 11,698            |  |   | 618,046   |  |   | 16,722
|                                                        |  |                     |           |                   |   |            |  |                   |           |            |   |                   |  |   |           |  |   |       
|Total temporarily impaired securities                   |  | $                   | 1,286,446 |                   | $ | 16,744     |  | $                 | 1,689,410 |            | $ | 42,168            |  | $ | 2,975,856 |  | $ | 58,912
|                                                        |  |                     |           |                   |   |            |  |                   |           |            |   |                   |  |   |           |  |   |       



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 2. Debt and Equity Securities, continued



|                                                        |  |                     |           |                   |   |            |  |                   |           |            |   |                  |  |   |           |  |   |       
|------------------------------------------------------- |  | ------------------- | --------- | ----------------- | - | ---------- |  | ----------------- | --------- | ---------- | - | ---------------- |  | - | --------- |  | - | ------
|                                                        |  | 2005               
|                                                        |  | Less Than 12 Months |           | 12 Months or More |   | Total     
|                                                        |  | Fair Value          |           | Unrealized Losses |   | Fair Value |  | Unrealized Losses |           | Fair Value |   | UnrealizedLosses
|Securities available for sale:                          |  |                     |           |                   |   |            |  |                   |           |            |   |                  |  |   |           |  |   |       
|U.S. government agencies                                |  | $                   | 599,250   |                   | $ | 750        |  | $                 | 792,629   |            | $ | 7,371            |  | $ | 1,391,879 |  | $ | 8,121 
|Fannie Mae and Government National Mortgage Association |  |                     | 293,226   |                   |   | 3,518      |  |                   |          |            |   |                 |  |   | 293,226   |  |   | 3,518 
|Mutual funds                                            |  |                     | 199,779   |                   |   | 221        |  |                   | 548,540   |            |   | 51,460           |  |   | 748,319   |  |   | 51,681
|                                                        |  |                     |           |                   |   |            |  |                   |           |            |   |                  |  |   |           |  |   |       
|Total temporarily impaired securities                   |  | $                   | 1,092,255 |                   | $ | 4,489      |  | $                 | 1,341,169 |            | $ | 58,831           |  | $ | 2,433,424 |  | $ | 63,320
|                                                        |  |                     |           |                   |   |            |  |                   |           |            |   |                  |  |   |           |  |   |       

The amortized cost and estimated fair value of debt securities at June 30, 2006, by contractual maturity are
shown below. Fannie Mae and Government National Mortgage Association securities are not included in the maturity categories because they do not have a single maturity date. Additionally, equity securities and mutual funds are not included in the
maturity categories because they do not have contractual maturities.



|                                                                        |  |                                |            |            |   |          
|----------------------------------------------------------------------- |  | ------------------------------ | ---------- | ---------- | - | ---------
|                                                                        |  | Available for sale securities:
|                                                                        |  | Amortized Cost                 |            | Fair Value
|Due within one year                                                     |  | $                              |           |            | $ |         
|Due from one year to five years                                         |  |                                | 2,100,000  |            |   | 2,068,967
|Due from five to ten years                                              |  |                                | 300,000    |            |   | 288,843  
|Due after ten years                                                     |  |                                | 287,854    |            |   | 301,491  
|Fannie Mae and Government National Mortgage Association debt securities |  |                                | 795,127    |            |   | 780,603  
|Equity securities                                                       |  |                                | 250        |            |   | 17,103   
|                                                                        |  |                                |            |            |   |          
|                                                                        |  |                                | $3,483,231 |            | $ | 3,457,007
|                                                                        |  |                                |            |            |   |          



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 3. Loans Receivable

Loans receivable at June 30, 2006 and 2005 consist of the following: (Dollars in thousands)



|                          |  |      |         |      |   |        
|------------------------- |  | ---- | ------- | ---- | - | -------
|                          |  | 2006 |         | 2005
|One to four-family        |  | $    | 100,198 |      | $ | 96,368 
|Multifamily               |  |      | 4,179   |      |   | 4,171  
|Non-residential           |  |      | 29,779  |      |   | 27,154 
|Land                      |  |      | 17,929  |      |   | 17,155 
|Construction loans        |  |      | 14,660  |      |   | 11,416 
|Commercial loans          |  |      | 19,221  |      |   | 15,972 
|Consumer loans            |  |      | 9,782   |      |   | 10,611 
|                          |  |      |         |      |   |        
|                          |  |      | 195,748 |      |   | 182,847
|                          |  |     
|Less:                     |  |      |         |      |   |        
|Deferred loan fees        |  |      | 241     |      |   | 220    
|Allowance for loan losses |  |      | 1,568   |      |   | 1,385  
|                          |  |      |         |      |   |        
|                          |  | $    | 193,939 |      | $ | 181,242
|                          |  |      |         |      |   |        

There were $885,000 outstanding commitments to sell loans as of June 30, 2006.

The following is an analysis of the allowance for loan losses for the years ended June 30:



|                           |  |      |           |   |      |   |           |  
|-------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                           |  | 2006 |           |   | 2005 |  
|Balance, beginning         |  | $    | 1,385,412 |   |      | $ | 1,245,018 |  
|Provisions for loan losses |  |      | 265,000   |   |      |   | (78,922   | )
|Charge-offs                |  |      | (116,524  | ) |      |   | (214,125  | )
|Recoveries                 |  |      | 34,100    |   |      |   | 433,441   |  
|                           |  |      |           |   |      |   |           |  
|Balance, ending            |  | $    | 1,567,988 |   |      | $ | 1,385,412 |  
|                           |  |      |           |   |      |   |           |  

SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118,
Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure, requires that the Company establish a specific allowance on impaired loans and disclosure of the Banks method of accounting for interest income on
impaired loans. The Company considers all loans delinquent more than 90 days to be impaired and such loans amounted to approximately $218,700 and $185,000 at June 30, 2006 and 2005, respectively. These loans are primarily collateral dependent
and management has determined that the underlying collateral value is in excess of the carrying amounts. As a result, the Company has determined that specific allowances on these loans are not required. The Company established reserves for
uncollectible interest totaling $2,802 and $2,161 at June 30, 2006 and 2005, respectively.

The effect of not recognizing interest income on non
accrual loans in accordance with the original terms totaled approximately $13,775 and $25,724 during the years ended June 30, 2006 and 2005, respectively. Interest income actually recognized on a cash basis on impaired loans during the years
ended June 30, 2006 and 2005 was $1,532 and $14,094, respectively.

The Company may renegotiate the terms of certain loans to provide a reduction of
interest or principal because of deterioration on the financial position of the borrower. These loans are considered troubled debt restructuring. As of June 30, 2006 and 2005, troubled debt restructured loans totaled $375,966 and $1,526,293,
respectively.



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Notes to Consolidated Financial Statements



Note 4. Loan Servicing

Mortgage loans
serviced for others consist of loans sold to Fannie Mae and are not included in the accompanying statements of financial condition. Mortgage loan portfolios serviced for Fannie Mae were $68,937,333 and $63,589,523 at June 2006 and 2005,
respectively.

Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payment to investors
and foreclosure processing. The carrying value of mortgage servicing rights is included as other assets in the Consolidated Balance Sheets. At June 30, 2006 and 2005 the mortgage servicing assets were carried at $364,989 and $307,660,
respectively. At June 30, 2006 and 2005 the fair value of mortgage servicing assets was $499,799 and 307,660, respectively.

Mortgage servicing rights
are amortized into non-interest income in proportion to and over the period of estimated future net servicing income of the underlying financial assets. The amortization is adjusted prospectively in response to changes in estimated projections of
future cash flows. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms.
Fair value is determined using prices for similar assets with similar characteristics. Impairment is recognized to the extent that the capitalized amount for the stratum exceeds their fair value. The following summarizes mortgage servicing rights
activity for the years ended June 30, 2006 and 2005:



|                                            |  |      |         |   |      |   |         |  
|------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                            |  | 2006 |         |   | 2005 |  
|Mortgage servicing asset, beginning of year |  | $    | 307,660 |   |      | $ | 203,734 |  
|Capitalized                                 |  |      | 118,072 |   |      |   | 167,435 |  
|Amortization                                |  |      | (60,743 | ) |      |   | (41,138 | )
|Other than temporary impairment             |  |      |        |   |      |   | (22,371 | )
|                                            |  |      |         |   |      |   |         |  
|Mortgage servicing assets, end of year      |  | $    | 364,989 |   |      | $ | 307,660 |  
|                                            |  |      |         |   |      |   |         |  

Note 5. Office Properties and Equipment

Office properties and equipment at June 30 consist of the following:



|                                               |  |      |            |   |      |   |            |  
|---------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                               |  | 2006 |            |   | 2005 |  
|Land and land improvements                     |  | $    | 2,448,444  |   |      | $ | 2,448,444  |  
|Buildings                                      |  |      | 10,805,390 |   |      |   | 10,200,583 |  
|Furniture, fixtures, equipment and automobiles |  |      | 4,318,700  |   |      |   | 3,948,007  |  
|Leasehold improvements                         |  |      | 498,496    |   |      |   | 498,496    |  
|                                               |  |      |            |   |      |   |            |  
|                                               |  |      | 18,071,030 |   |      |   | 17,095,530 |  
|Accumulated depreciation                       |  |      | (4,965,843 | ) |      |   | (4,339,155 | )
|                                               |  |      |            |   |      |   |            |  
|                                               |  | $    | 13,105,187 |   |      | $ | 12,756,375 |  
|                                               |  |      |            |   |      |   |            |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 6. Savings Deposits

Savings deposits at June 30 consist of the following:



|                                                                               |  |      |             |   |      |   |             |  
|------------------------------------------------------------------------------ |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                               |  | 2006 |             |   | 2005 |  
|Interest bearing checking accounts at 1.00% (2006) and 0.65% (2005)            |  | $    | 25,405,795  |   |      | $ | 23,770,734  |  
|Noninterest bearing checking accounts                                          |  |      | 24,053,477  |   |      |   | 18,007,299  |  
|Savings accounts at 1.21% (2006) and 1.43% (2005)                              |  |      | 22,740,649  |   |      |   | 39,498,735  |  
|Money market demand accounts at 3.28% (2006) and 0.49% (2005)                  |  |      | 13,679,521  |   |      |   | 1,017,283   |  
|Certificates of deposit weighted average rate of 4.13% (2006) and 3.05% (2005) |  |      | 90,796,526  |   |      |   | 81,426,717  |  
|                                                                               |  |      |             |   |      |   |             |  
|                                                                               |  |      | 176,675,968 |   |      |   | 163,720,768 |  
|                                                                               |  |      |             |   |      |   |             |  
|Accrued interest payable                                                       |  |      | 336,684     |   |      |   | 256,160     |  
|                                                                               |  |      |             |   |      |   |             |  
|                                                                               |  | $    | 177,012,652 |   |      | $ | 163,976,928 |  
|                                                                               |  |      |             |   |      |   |             |  
|Weighted average cost of savings deposits                                      |  |      | 2.68        | % |      |   | 1.95        | %
|                                                                               |  |      |             |   |      |   |             |  

At June 30, 2006, scheduled maturities of certificates of deposit are as follows:



|               |  |      |            |      |   |            |  |      |         |       |   |           |  |   |         |  |   |           
|-------------- |  | ---- | ---------- | ---- | - | ---------- |  | ---- | ------- | ----- | - | --------- |  | - | ------- |  | - | ----------
|               |  | 2007 |            | 2008 |   | 2009       |  | 2010 |         | After |   | Total    
|1.50% to 4.99% |  | $    | 65,612,497 |      | $ | 13,442,097 |  | $    | 531,384 |       | $ | 1,534,949 |  | $ | 177,322 |  | $ | 81,298,249
|5.00% to 5.75% |  |      | 8,195,591  |      |   | 1,279,670  |  |      | 23,016  |       |   |          |  |   |        |  |   | 9,498,277 
|               |  |      |            |      |   |            |  |      |         |       |   |           |  |   |         |  |   |           
|               |  | $    | 73,808,088 |      | $ | 14,721,767 |  | $    | 554,400 |       | $ | 1,534,949 |  | $ | 177,322 |  | $ | 90,796,526
|               |  |      |            |      |   |            |  |      |         |       |   |           |  |   |         |  |   |           

The aggregate amount of jumbo certificates of deposit with a denomination of greater than $100,000 was $27,924,078
and $23,493,607 at June 30, 2006 and 2005, respectively. At June 30, 2006, scheduled maturities of jumbo certificates of deposit are as follows:



|                          |  |        |            |                       |      |  
|------------------------- |  | ------ | ---------- | --------------------- | ---- | -
|                          |  | Amount |            | Weighted Average Rate |     
|Maturity period:          |  |        |            |                       |      |  
|Within three months       |  | $      | 5,170,869  |                       | 4.04 | %
|Three through six months  |  |        | 6,851,500  |                       | 4.10 |  
|Six through twelve months |  |        | 9,807,375  |                       | 4.58 |  
|Over twelve months        |  |        | 6,094,334  |                       | 4.38 |  
|                          |  |        |            |                       |      |  
|                          |  | $      | 27,924,078 |                       | 4.32 | %
|                          |  |        |            |                       |      |  

Eligible deposits are insured up to $100,000 by the Savings Association Insurance Fund (SAIF) which is
administered by the FDIC. At June 30, 2006 the Company had $33,629,284 in uninsured deposits.

Interest expense on savings deposits consists of the
following for the years ended June 30:



|                                   |  |      |           |      |   |          
|---------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                   |  | 2006 |           | 2005
|Interest-bearing checking accounts |  | $    | 525,743   |      | $ | 134,116  
|Savings accounts                   |  |      | 363,690   |      |   | 520,977  
|Certificate accounts               |  |      | 3,083,950 |      |   | 2,136,301
|                                   |  |      |           |      |   |          
|                                   |  | $    | 3,973,383 |      | $ | 2,791,394
|                                   |  |      |           |      |   |          



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 7. Short-term and Long-term Borrowings

Short-term borrowings consist of the following at June 30:



|                                                                                                                                                                                                                                                    |  |      |            |      |   |           
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | - | ----------
|                                                                                                                                                                                                                                                    |  | 2006 |            | 2005
|Note payable to AsheCo, M.H.C. at the FHLB overnight rate at 5.57% (3.63% at June 30, 2005).                                                                                                                                                        |  | $    | 300,000    |      | $ | 300,000   
|Note payable, due in monthly installments of $7,808 including interest at the banks prime rate of 8.25% (6.25% at June 30, 2005)
with a balloon payment due November 6, 2005. Collateralized by insurance expirations and the right to renew them. |  |      | _          |      |   | 270,544   
|FHLB advances at 5.61% (3.63% at June 30, 2005)                                                                                                                                                                                                     |  |      | 4,639,385  |      |   | 2,000,000 
|                                                                                                                                                                                                                                                    |  |      |            |      |   |           
|                                                                                                                                                                                                                                                    |  | $    | 4,939,385  |      | $ | 2,570,544 
|                                                                                                                                                                                                                                                    |  |      |            |      |   |           
|Long-term borrowings consist of the following at June 30:                                                                                                                                                                                           |  |      |            |      |   |           
|                                                                                                                                                                                                                                                    |  |     
|                                                                                                                                                                                                                                                    |  | 2006 |            | 2005
|FHLB advances at weighted average interest rate of 4.97% (4.57% at June 30, 2005)                                                                                                                                                                   |  | $    | 24,000,000 |      | $ | 26,141,664
|ESOP note payable, interest due quarterly and principal payments due annually at the banks prime rate of 8.25% at June 30, 2006
Collateralized by stock owned by the ESOP.                                                                         |  |      |           |      |   | 33,420    
|Capital securities at rate of 10.25% at June 30, 2006 and 2005                                                                                                                                                                                      |  |      | 5,155,000  |      |   | 5,155,000 
|Note payable, due in monthly installments of $7,808 including interest at the banks prime rate of 8.25% Collateralized by insurance
expirations and the right to renew them.                                                                       |  |      | 193,528    |      |   |          
|Notes payable, unsecured, due in quarterly interest only installments at 5.50% through December 1, 2004, at which time repayments of
principal and interest commenced over a period of 60 months with first payment due on January 1, 2005.         |  |      | 509,772    |      |   | 638,322   
|                                                                                                                                                                                                                                                    |  |      |            |      |   |           
|                                                                                                                                                                                                                                                    |  | $    | 29,858,300 |      | $ | 31,968,406
|                                                                                                                                                                                                                                                    |  |      |            |      |   |           

As of June 30, 2006, the Company had a $1,500,000 outstanding letter of credit from the FHLB used to
collateralize public deposits.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 8. Related Party Transactions

AF
Bank has had, and expects to have in the future, banking transactions in the ordinary course of business with directors, officers and their associates (Related Parties), on substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with others. Loan activity to officers and directors of the Company during the years ended June 30, 2006 and 2005 is summarized as follows:



|                   |  |      |            |   |      |   |            |  
|------------------ |  | ---- | ---------- | - | ---- | - | ---------- | -
|                   |  | 2006 |            |   | 2005 |  
|Balance, beginning |  | $    | 2,861,662  |   |      | $ | 3,993,172  |  
|Disbursements      |  |      | 259,043    |   |      |   | 601,550    |  
|Payments received  |  |      | (1,039,062 | ) |      |   | (1,733,060 | )
|                   |  |      |            |   |      |   |            |  
|Balance, ending    |  | $    | 2,081,643  |   |      | $ | 2,861,662  |  
|                   |  |      |            |   |      |   |            |  

Deposits of directors and officers have terms consistent with those offered to other customers. At June 30,
2006 and 2005, outstanding deposits of directors and officers totaled $2.3 million.

Note 9. Capital Securities

On July 16, 2001, AF Capital Trust I (the Trust), a Delaware business trust formed by the Company, completed the sale of $5.0 million of 10.25% Capital
Securities (liquidation amount of $1,000 per security) (the Capital Securities) in a private placement as part of a pooled capital securities transaction. The Trust also issued common securities to the Company and used the net proceeds
from the offering to purchase a like amount of 10.25% Junior Subordinated Deferrable Interest Debentures (the Subordinated Debentures) of the Company.

The Capital Securities accrue and pay distributions semi-annually on January 25thand
July 25thof each year, commencing on January 25, 2002 at a fixed annual rate of 10.25% of the stated
liquidation amount of $1,000 per Capital Security. The Company has fully and unconditionally guaranteed all of the obligations of the Trust, including the semi-annual distributions and payments on liquidation or redemption of the Capital Securities.

The Capital Securities are mandatorily redeemable upon the maturing of the Subordinated Debentures on July 25, 2031 or upon earlier redemption as
provided in the Indenture. The Company has the right to redeem the Subordinated Debentures, in whole or in part, on any January 25thor July 25thon or after July 25, 2006 at the liquidation amount, plus any
accrued but unpaid interest to the redemption date.

On December 31, 2004, the Company adopted FIN 46R which resulted in the deconsolidation of the
Companys trust preferred subsidiary, AF Capital Trust I (the Trust). Upon deconsolidation, the junior subordinated debentures issued by the Company to the trust were included in borrowings (instead of trust preferred securities)
and the Companys equity interests in the trust were included in other assets. As a result, other assets and borrowings increased by $155,000. Except for accounting treatment, the relationship between the Company and the Trust has not changed.
AF Capital Trust I continues to be a wholly owned trust preferred subsidiary of the Company and the full and unconditional guarantee of the Company for the repayment of the trust preferred securities remains in effect.

The Company participated in a $5.0 million trust preferred issuance during the first quarter of the 2007 fiscal year. At approximately the same time this new issuance
settled, the Company paid off the existing $5.0 million trust preferred issuance. The Company paid an early redemption cost of $384,375. This amount was expensed during the first quarter of the 2007 fiscal year. The new issuance was priced at a
floating rate of LIBOR plus 150 basis points.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 10. Stockholders Equity

The
Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory  and possibly additional discretionary 
actions by regulators that, if undertaken, could have a direct material effect on the Company and the Banks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the
Bank must meet specific capital guidelines that involve quantitative regulatory accounting practices. The Company and the Banks capital amounts and classifications are also subject to qualitative judgments by the regulators about components,
risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

The Bank has established a
liquidation account in an amount equal to its net worth as reflected in its latest statement of financial condition used in its final offering circular. The liquidation account will be maintained for the benefit of eligible deposit account holders
and supplemental eligible deposit account holders who continue to maintain their deposit accounts in the Bank after the reorganization. Only in the event of a complete liquidation will eligible deposit account holders and supplemental eligible
deposit account holders be entitled to receive a liquidation distribution from the liquidation account in the amount of the then current adjusted sub account balance for deposit accounts then held before any liquidation distribution may be made with
respect to common stock. Dividends paid by the Bank subsequent to the reorganization cannot be paid from this liquidation account.

The Bank may not
declare or pay a cash dividend on its common stock if its stockholders equity would thereby be reduced below either the aggregate amount required for the liquidation account or the minimum regulatory capital requirements imposed by federal
regulations.

The Office of Thrift Supervision (OTS) regulations require institutions to maintain amounts and ratios of total and Tier 1 capital to
risk-weighted assets and Tier 1 capital to average assets. At June 30, 2006 and 2005, the Company and the Bank exceeded all of the capital requirements.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 10. Stockholders Equity, continued

As of June 30, 2006, the most recent notification from the OTS categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum
total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since that notification that management believes have changed the Banks category.



|                                        |  |                        |        |       |                             |   |        |                                                                          |        |  |     |        |  |       |        |  |      |  
|--------------------------------------- |  | ---------------------- | ------ | ----- | --------------------------- | - | ------ | ------------------------------------------------------------------------ | ------ |  | --- | ------ |  | ----- | ------ |  | ---- | -
|                                        |  | Actual                 |        |       | Minimum Capital Requirement |   |        | Minimum to be well Capitalized Under Prompt Corrective Action Provisions |       
|                                        |  | Amount                 |        | Ratio |                             |   | Amount |                                                                          | Ratio  |  |     | Amount |  | Ratio |       
|                                        |  | (Dollars in Thousands) |       
|June 30, 2006:                          |  |                        |        |       |                             |   |        |                                                                          |        |  |     |        |  |       |        |  |      |  
|Total Capital to Risk Weighted Assets:  |  |                        |        |       |                             |   |        |                                                                          |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 19,067 |       | 10.4                        | % |        | $                                                                        | 14,610 |  | 8.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 20,079 |       | 11.1                        | % |        | $                                                                        | 14,459 |  | 8.0 | %      |  | $     | 18,074 |  | 10.0 | %
|                                        |  |                        |        |       |                             |  
|Tier 1 Capital to Risk Weighted Assets: |  |                        |        |       |                             |   |        |                                                                          |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 16,459 |       | 9.0                         | % |        | $                                                                        | 7,305  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 18,503 |       | 10.2                        | % |        | $                                                                        | 7,230  |  | 4.0 | %      |  | $     | 10,845 |  | 6.0  | %
|                                        |  |                        |        |       |                             |  
|Tier 1 Capital to Average Assets:       |  |                        |        |       |                             |   |        |                                                                          |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 16,459 |       | 7.5                         | % |        | $                                                                        | 8,798  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 18,503 |       | 8.5                         | % |        | $                                                                        | 8,709  |  | 4.0 | %      |  | $     | 10,887 |  | 5.0  | %
|                                        |  |                        |        |       |                             |  
|June 30, 2005:                          |  |                        |        |       |                             |   |        |                                                                          |        |  |     |        |  |       |        |  |      |  
|                                        |  |                        |        |       |                             |  
|Total Capital to Risk Weighted Assets:  |  |                        |        |       |                             |   |        |                                                                          |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 17,774 |       | 10.5                        | % |        | $                                                                        | 13,587 |  | 8.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 19,255 |       | 11.4                        | % |        | $                                                                        | 13,560 |  | 8.0 | %      |  | $     | 16,950 |  | 10.0 | %
|                                        |  |                        |        |       |                             |  
|Tier 1 Capital to Risk Weighted Assets: |  |                        |        |       |                             |   |        |                                                                          |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 15,134 |       | 8.9                         | % |        | $                                                                        | 6,794  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 17,832 |       | 10.5                        | % |        | $                                                                        | 6,780  |  | 4.0 | %      |  | $     | 10,170 |  | 6.0  | %
|                                        |  |                        |        |       |                             |  
|Tier 1 Capital to Average Assets:       |  |                        |        |       |                             |   |        |                                                                          |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 15,134 |       | 6.9                         | % |        | $                                                                        | 8,732  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 17,832 |       | 8.3                         | % |        | $                                                                        | 8,636  |  | 4.0 | %      |  | $     | 10,794 |  | 5.0  | %

Under the conversion regulations the Bank may not declare or pay a cash dividend on any of its stock if the effect
thereof would cause the Banks equity to be reduced below (1) the amount required for the liquidation account; or (2) the net worth requirements imposed by the OTS.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 11. Employee Pension and Incentive Plans

The Company has profit-sharing plans for the benefit of substantially all employees. Contributions are discretionary and totaled $72,082 and $48,424 for the years ended June 30, 2006 and 2005, respectively.

In addition, the Company has 401(k) retirement plans which contain provisions for specified matching contributions by the Company. The Company funds contributions as
they accrue and 401(k) plan expense amounted to $109,354 and $111,992 for the years ended June 30, 2006 and 2005, respectively.

Note 12. Employee
Stock Ownership Plan

As part of the reorganization, the Company established an ESOP to benefit substantially all employees. The ESOP purchased 36,942
shares of common stock with the proceeds from a loan from a third party financial institution. The note required annual principal payments of $28,845 plus quarterly interest at the lending institutions prime rate (8.25% at June 30, 2006).
The Company made quarterly contributions to the ESOP in amounts sufficient to allow the ESOP to make its scheduled principal and interest payments on the note. The ESOP shares were pledged as collateral for the debt. The debt was repaid in June 2006
and the shares were released from collateral and allocated to active employees. All shares held by the ESOP have been allocated to employees.

Excluding
interest, expense of $69,695 and $71,021 during 2006 and 2005, respectively, has been incurred in connection with the ESOP. The expense includes, in addition to the cash contribution necessary to fund the ESOP, $36,275 in 2006 and $34,022 in 2005,
which represents the difference between the fair value of the shares which have been released or committed to be released to participants, and the cost of these shares to the ESOP. The Company has credited this amount to paid-in capital in
accordance with the provisions of AICPA Statement of Position 93-6.

At June 30, 2006 and 2005, 36,942 and 33,600 shares, respectively, held by the
ESOP have been released or committed to be released to the plans participants for purposes of computing earnings per share. No unallocated shares were held as of June 30, 2006. The fair value of the unallocated shares amounted to
approximately $63,500 at June 30, 2005.

In accordance with the ESOP, the Company is expected to honor the rights of certain participants to diversify
their account balances or to liquidate their ownership of the common stock in the event of termination. The purchase price of the common stock would be based on the fair market value of the Companys common stock as of the valuation date. Since
the redemption of common stock is outside the control of the Company, the Companys maximum cash obligation based on the approximate market process of common stock as of the reporting date has been presented outside of stockholders
equity. The amount presented as redeemable common stock held by the ESOP in the consolidated balance sheet represents the Companys maximum cash obligation and has been reflected as a reduction of retained earnings. As of June 30, 2006 and
2005, the shares held by the ESOP, fair value and maximum cash obligation were as follows:



|                                                                  |  |      |         |      |   |        
|----------------------------------------------------------------- |  | ---- | ------- | ---- | - | -------
|                                                                  |  | 2006 |         | 2005
|Shares held by the ESOP, net of unallocated or distributed shares |  |      | 31,772  |      |   | 30,852 
|                                                                  |  |      |         |      |   |        
|Fair value per share                                              |  | $    | 19.00   |      | $ | 19.00  
|                                                                  |  |      |         |      |   |        
|Maximum cash obligation                                           |  | $    | 603,668 |      | $ | 616,266
|                                                                  |  |      |         |      |   |        



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 13. Deferred Compensation and Retirement Plan Agreements

The Bank has an unfunded deferred compensation agreement providing retirement, disability, and death benefits for directors. Vested benefits under the agreements are payable in monthly installments over a ten-year
period upon the directors death, disability or retirement. The Bank also has a retirement plan for members of the Board of Directors. The Plan states that outside directors with at least ten years of service will receive an amount equal to
their annual retainer for ten years after their retirement from the Board. The liability for the benefits is being accrued over the terms of active service of the directors. The amount charged to expense under these plans amounted to $100,496 and
$47,895 for the years ended June 30, 2006 and 2005, respectively. The related liability recorded for these plans was $654,339 and $614,924 for the years ended June 30, 2006 and 2005, respectively.

The Company has entered into a salary continuation agreement with the Chief Financial Officer. Under this agreement, the executive will be paid monthly amounts of
$5,532, after retirement for a period of forty-three years. This agreement also provides for benefits upon death, disability, a change of control and early retirement. The amount charged to expense under this plan amounted to $90,720 and $39,994 for
the years ended June 30, 2006 and 2005, respectively. The related liability record for these plans was $244,831 and $159,112 for the years ended June 30, 2006 and 2005, respectively.

Note 14. Stock Option Plan

The Companys stockholders approved
the Banks Stock Option Plan (the Plan) on December 8, 1997. The stock option plan provides for the issuance of up to 21,707 stock options to certain officers and directors in the form of incentive stock options or
non-incentive stock options. The exercise price of the stock options may not be less than the fair market value of the Companys common stock at the date of grant.

At June 30, 2006, 13,604 options have been granted at an exercise price of $18.50, of which 13,604 options are fully vested and therefore currently exercisable. During the year ended June 30, 2006 969
options were exercised.

Note 15. Income Tax Matters

Deferred taxes have been provided for certain increases in the Banks tax bad debt reserves subsequent to 1987 which are in excess of additions to recorded loan loss allowances. At June 30, 2006, retained earnings contain certain
historical additions to bad debt reserves for income tax purposes of approximately $870,000, the balance at June 30, 1987, for which no deferred taxes have been provided because the Bank does not intend to use these reserves for purposes other
than to absorb losses. If amounts which qualified as bad debt deductions are used for purposes other than to absorb bad debt losses or adjustments arising from the carryback of net operating losses, income taxes may be imposed at the then existing
rates. The approximate amount of unrecorded deferred tax liability associated with these historical additions is approximately $340,000. In the future, if the Bank does not meet the income tax requirements necessary to permit the deduction of an
allowance for bad debts, the Banks effective tax rate would increase to the maximum percent under existing law.



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Notes to Consolidated Financial Statements



Note 15. Income Tax Matters, continued

The following provides the tax effects of temporary differences that gave rise to significant portions of the net deferred tax asset as of June 30:



|                                                     |  |      |           |   |      |   |         |  
|---------------------------------------------------- |  | ---- | --------- | - | ---- | - | ------- | -
|                                                     |  | 2006 |           |   | 2005 |  
|Deferred tax assets                                  |  |      |           |   |      |   |         |  
|Reserve for loan losses                              |  | $    | 551,745   |   |      | $ | 449,576 |  
|Reserve for uncollected interest                     |  |      | 10,184    |   |      |   | 13,612  |  
|Deferred compensation                                |  |      | 346,666   |   |      |   | 298,422 |  
|Deferred loan fees                                   |  |      | 92,871    |   |      |   | 84,987  |  
|Other                                                |  |      | 48,829    |   |      |   | 53,836  |  
|Net unrealized loss on securities available for sale |  |      | 10,257    |   |      |   |        |  
|State net economic loss carryforwards                |  |      |          |   |      |   | 14,767  |  
|                                                     |  |      |           |   |      |   |         |  
|                                                     |  |      | 1,060,552 |   |      |   | 915,200 |  
|Less valuation allowance                             |  |      | (10,483   | ) |      |   | (14,767 | )
|                                                     |  |      |           |   |      |   |         |  
|                                                     |  |      | 1,050,069 |   |      |   | 900,433 |  
|                                                     |  |      |           |   |      |   |         |  
|Deferred tax liabilities                             |  |      |           |   |      |   |         |  
|Net unrealized gain on securities available for sale |  |      |          |   |      |   | 25,807  |  
|Depreciation                                         |  |      | 426,560   |   |      |   | 439,483 |  
|FHLB stock dividends                                 |  |      | 60,067    |   |      |   | 60,067  |  
|Prepaid expenses                                     |  |      | 58,851    |   |      |   | 57,008  |  
|Deferred loan fees                                   |  |      | 424,899   |   |      |   | 394,441 |  
|                                                     |  |      |           |   |      |   |         |  
|                                                     |  |      | 970,377   |   |      |   | 976,806 |  
|                                                     |  |      |           |   |      |   |         |  
|Net deferred tax asset (liability)                   |  | $    | 79,692    |   |      | $ | (76,373 | )
|                                                     |  |      |           |   |      |   |         |  

During the year ended June 30, 2006, the Company recorded a decrease in the valuation allowance of $4,284 on
the deferred tax assets to reduce the total to an amount that management believes will ultimately be realized. Realization of deferred tax assets is dependent upon sufficient future taxable income during the period that deductible temporary
differences and carryforwards are expected to be available to reduce taxable income.

The provision for income taxes charged to operations for the years
ended June 30, 2006 and 2005 consists of the following:



|                   |  |      |          |   |      |   |         |  
|------------------ |  | ---- | -------- | - | ---- | - | ------- | -
|                   |  | 2006 |          |   | 2005 |  
|Current            |  |      |          |   |      |   |         |  
|Federal            |  | $    | 640,094  |   |      | $ | 398,672 |  
|State              |  |      | 144,136  |   |      |   | 94,474  |  
|                   |  |      |          |   |      |   |         |  
|Total              |  |      | 784,230  |   |      |   | 493,146 |  
|Deferred           |  |      |          |   |      |   |         |  
|Federal            |  |      | (110,674 | ) |      |   | (34,725 | )
|State              |  |      | (9,327   | ) |      |   | 34,725  |  
|                   |  |      |          |   |      |   |         |  
|Total              |  |      | (120,001 | ) |      |   |        |  
|                   |  |      |          |   |      |   |         |  
|Income tax expense |  | $    | 664,229  |   |      | $ | 493,146 |  
|                   |  |      |          |   |      |   |         |  



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Notes to Consolidated Financial Statements



Note 15. Income Tax Matters, continued

A reconciliation of income taxes computed at the statutory federal income tax rate to the income tax provision follows:



|                                  |  |        |         |   |         |      |   |        |   |         |         |  |      |  
|--------------------------------- |  | ------ | ------- | - | ------- | ---- | - | ------ | - | ------- | ------- |  | ---- | -
|                                  |  | 2006   |         |   | 2005    |     
|                                  |  | Amount |         |   | Percent |      |   | Amount |   |         | Percent | 
|Tax at statutory rate             |  | $      | 572,917 |   |         | 34.0 | % |        | $ | 388,254 |         |  | 34.0 | %
|State tax, net of federal benefit |  |        | 88,974  |   |         | 5.3  |   |        |   | 85,272  |         |  | 7.5  |  
|Municipal interest income         |  |        | (11,928 | ) |         | (0.8 | ) |        |   | (21,330 | )       |  | (1.9 | )
|Nondeductible employee benefits   |  |        | 19,910  |   |         | 1.2  |   |        |   | 31,006  |         |  | 2.7  |  
|Other                             |  |        | (5,644  | ) |         | (0.3 | ) |        |   | 9,944   |         |  | 0.9  |  
|                                  |  |        |         |   |         |      |   |        |   |         |         |  |      |  
|Total                             |  | $      | 664,229 |   |         | 39.4 | % |        | $ | 493,146 |         |  | 43.2 | %
|                                  |  |        |         |   |         |      |   |        |   |         |         |  |      |  

Note 16. Other Noninterest Income and Expense

The major components of other noninterest income for the years ended June 30, 2006 and 2005 are as follows:



|                                        |  |      |           |      |   |          
|--------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                        |  | 2006 |           | 2005
|Service charges on deposit accounts     |  | $    | 685,792   |      | $ | 537,516  
|Cardholder and merchant services income |  |      | 182,906   |      |   | 126,269  
|Brokerage fees and commissions          |  |      | 295,055   |      |   | 326,809  
|Mortgage income                         |  |      | 185,307   |      |   | 205,230  
|Rental income                           |  |      | 126,067   |      |   | 17,721   
|Other                                   |  |      | 178,578   |      |   | 218,120  
|                                        |  |      |           |      |   |          
|Total                                   |  | $    | 1,653,705 |      | $ | 1,431,665
|                                        |  |      |           |      |   |          

The major components of other noninterest expense for the years ended
June 30, 2006 and 2005 are as follows:



|                                          |  |      |           |      |   |          
|----------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                          |  | 2006 |           | 2005
|Cleaning, postage and office supplies     |  | $    | 324,882   |      | $ | 341,431  
|Advertising and promotion                 |  |      | 168,865   |      |   | 150,581  
|Travel, meals, dues and subscriptions     |  |      | 210,079   |      |   | 246,225  
|Telephone and utilities                   |  |      | 251,902   |      |   | 267,648  
|Training                                  |  |      | 41,232    |      |   | 51,839   
|Fees and charges                          |  |      | 64,547    |      |   | 59,809   
|Professional fees and contracted services |  |      | 453,920   |      |   | 555,443  
|REO expense                               |  |      | 14,580    |      |   | 165,398  
|Loss on sale of investments               |  |      | 4,388     |      |   |         
|Other                                     |  |      | 838,319   |      |   | 570,667  
|                                          |  |      |           |      |   |          
|Total                                     |  | $    | 2,372,714 |      | $ | 2,409,041
|                                          |  |      |           |      |   |          



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Notes to Consolidated Financial Statements



Note 17. Commitments and Contingencies

The Bank is a party to financial instruments with off-statement of financial condition risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and
equity lines of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the statement of financial condition. The contract or notional amounts of those instruments
reflect the extent of involvement the Bank has in particular classes of financial instruments.

A summary of the contract amount of the Banks
exposure to off-statement of financial condition risk, except for undisbursed construction loan funds, is as follows at June 30, 2006:



|                                                                    |  |                |           
|------------------------------------------------------------------- |  | -------------- | ----------
|                                                                    |  | NotionalAmount
|Financial instruments whose contract amounts represent credit risk: |  |                |           
|Undisbursed home equity lines of credit                             |  | $              | 13,948,065
|Undisbursed construction lines of credit                            |  |                | 8,141,876 
|Undisbursed consumer lines of credit                                |  |                | 3,798,349 
|Undisbursed commercial lines of credit                              |  |                | 4,504,865 
|Letters of credit                                                   |  |                | 315,000   
|Commitments outstanding to originate loans                          |  |                | 818,871   

The Bank evaluates each customers credit worthiness on a case-by-case basis. Commitments to extend credit
are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Home equity lines of credit have variable rates based on the prime rate of interest. Home equity lines are reassessed every five
years. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The collateral obtained by the Bank upon extension of credit is based on
managements credit evaluation of the customer. The collateral held is the underlying real estate. Commercial lines of credit have variable rates tied to prime and are reassessed on an annual basis. Prime at June 30, 2006 was 8.25%.

The Company has entered into operating leases for AF Bank branch locations in Warrensville and Sparta, North Carolina, and also a branch inside Wal-Mart
in West Jefferson, North Carolina, and for AF Insurance branches located in Boone, Elkin and Wilkesboro, North Carolina. These leases generally contain renewal options for periods ranging from one to five years and require the Company to pay all
executory costs such as maintenance and insurance. Rental expense for operating leases was $152,763 and $152,868 during 2006 and 2005.

Future minimum lease payments under noncancelable operating leases as of June 30, 2006 are:



|                             |  |   |        
|---------------------------- |  | - | -------
|Year Ending June 30:         |  |   |        
|2007                         |  | $ | 134,987
|2008                         |  |   | 86,646 
|2009                         |  |   | 60,900 
|2010                         |  |   | 42,300 
|2011                         |  |   | 18,925 
|After 2012                   |  |   | 6,000  
|                             |  |   |        
|Total minimum lease payments |  | $ | 349,758
|                             |  |   |        



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Notes to Consolidated Financial Statements



Note 18. Dividends Declared

On
June 23, 2006, the Board of Directors of the Company declared a dividend of $0.05 a share for stockholders of record as of July 7, 2006 and payable on July 21, 2006. The dividends declared were accrued and reported in accounts payable
and other liabilities in the June 30, 2006. Consolidated Statement of Financial Condition. AsheCo, MHC elected to waive the receipt of dividends declared.

Note 19. Fair Value of Financial Instruments

The following table reflects a comparison of carrying amounts and the fair values of the
financial instruments as of June 30, 2006 and 2005:



|                             |  |                |             |            |   |                |  |            |             |  |   |            
|---------------------------- |  | -------------- | ----------- | ---------- | - | -------------- |  | ---------- | ----------- |  | - | -----------
|                             |  | 2006           |             | 2005      
|                             |  | Carrying Value |             | Fair Value |   | Carrying Value |  | Fair Value
|Financial assets:            |  |                |             |            |   |                |  |            |             |  |   |            
|Cash                         |  |                |             |            |   |                |  |            |             |  |   |            
|Interest-bearing             |  | $              | 2,102,087   |            | $ | 2,102,087      |  | $          | 2,657,931   |  | $ | 2,657,931  
|Noninterest-bearing deposits |  |                | 8,906,573   |            |   | 8,906,573      |  |            | 6,150,597   |  |   | 6,150,597  
|Investments                  |  |                | 3,457,007   |            |   | 3,457,007      |  |            | 4,045,498   |  |   | 4,045,498  
|Loans receivable, net        |  |                | 193,939,008 |            |   | 193,864,808    |  |            | 181,242,230 |  |   | 181,964,592
|Loans held for sale          |  |                | 885,000     |            |   | 885,000        |  |            | 1,226,750   |  |   | 1,226,750  
|Accrued interest receivable  |  |                | 1,080,470   |            |   | 1,080,470      |  |            | 949,186     |  |   | 949,186    
|FHLB stock                   |  |                | 1,791,600   |            |   | 1,791,600      |  |            | 1,704,800   |  |   | 1,704,800  
|                             |  |                |             |           
|Financial liabilities:       |  |                |             |            |   |                |  |            |             |  |   |            
|Deposits                     |  |                | 177,012,652 |            |   | 176,884,893    |  |            | 163,976,928 |  |   | 163,779,345
|Borrowings                   |  |                | 34,797,685  |            |   | 34,757,368     |  |            | 34,538,951  |  |   | 34,826,767 

The fair values utilized in the table were derived using the information described below for the group of
instruments listed. It should be noted that the fair values disclosed in this table do not represent market values of all assets and liabilities of the Company and, thus, should not be interpreted to represent the market or liquidation value of the
Company.

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Cash and certificates of deposits: The carrying amounts for cash and short-term instruments approximate their fair values.

Investment securities: Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are
based on quoted market prices of similar securities.

Loans receivable: The fair value of loans receivable is estimated by discounting the future
cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Certain prepayment assumptions have also been made depending upon the original contractual lives
of the loans.

Loans held for sale: The carrying amounts for loans held for sale approximate their fair values.

Accrued interest receivable and accrued interest payable: The fair value of accrued interest receivable and payable is the amount receivable or
payable on demand at the statement of financial condition date.

FHLB stock: The fair value of FHLB stock is the
stated value by the FHLB.



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Notes to Consolidated Financial Statements



Note 19. Fair Value of Financial Instruments, continued

Deposits: The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the statement of financial condition date. The fair value of fixed maturity
certificates of deposit are estimated based upon the discounted value of contractual cash flows using rates currently offered for deposits with similar remaining maturities.

Borrowings: The fair value of borrowings is estimated based on present values using the current rates at which similar borrowings would be made to borrowers with similar credit ratings and for the same
remaining maturities.

Off-statement of financial condition instruments: Fair values for the Companys off-statement of financial condition
instruments (loan commitments) are based on fees currently charged for similar agreements, taking into account the remaining terms of the agreements and the counterparties credit standings. The fair value for such commitments is nominal.

Note 20. Mid-Tier Holding Company and Mutual Holding Company Data

The following are the condensed financial statements of AF Financial Group as of and for the years ended June 30, 2006 and 2005:

AF Financial Group

Condensed Balance Sheets

June 30, 2006 and 2005



|                                                                                                      |  |      |            |   |      |   |            |  
|----------------------------------------------------------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                                                                                      |  | 2006 |            |   | 2005 |  
|Assets                                                                                                |  |      |            |   |      |   |            |  
|Cash and cash equivalents:                                                                            |  |      |            |   |      |   |            |  
|Interest-bearing deposits                                                                             |  | $    |           |   |      | $ | 11,787     |  
|Non interest-bearing deposits                                                                         |  |      | 434,575    |   |      |   | 68,276     |  
|Investment in AF Bank                                                                                 |  |      | 18,521,301 |   |      |   | 17,903,244 |  
|Investment in AF Insurance Services, Inc.                                                             |  |      | 962,102    |   |      |   | 810,997    |  
|Investment in AF Capital Trust I                                                                      |  |      | 155,000    |   |      |   | 155,000    |  
|Prepaid financing costs, net                                                                          |  |      |           |   |      |   | 168,944    |  
|Deferred income taxes                                                                                 |  |      | 51,653     |   |      |   |           |  
|Other assets                                                                                          |  |      | 214,385    |   |      |   | 310,985    |  
|                                                                                                      |  |      |            |   |      |   |            |  
|Total assets                                                                                          |  | $    | 20,339,016 |   |      | $ | 19,429,233 |  
|                                                                                                      |  |      |            |   |      |   |            |  
|Liabilities and Stockholders Equity                                                                  |  |      |            |   |      |   |            |  
|Liabilities                                                                                           |  |      |            |   |      |   |            |  
|Accounts payable                                                                                      |  | $    | 278,731    |   |      | $ | 282,720    |  
|Short-term borrowings                                                                                 |  |      | 300,000    |   |      |   | 300,000    |  
|Long-term borrowings                                                                                  |  |      | 5,155,000  |   |      |   | 5,188,420  |  
|Deferred income taxes                                                                                 |  |      |           |   |      |   | 2,857      |  
|Redeemable common stock held by the Employee Stock Ownership Plan (ESOP), net of unearned ESOP shares |  |      | 603,668    |   |      |   | 616,266    |  
|                                                                                                      |  |      |            |   |      |   |            |  
|Total liabilities                                                                                     |  |      | 6,337,399  |   |      |   | 6,390,263  |  
|                                                                                                      |  |      |            |   |      |   |            |  
|Stockholders equity                                                                                   |  |      |            |   |      |   |            |  
|Common stock                                                                                          |  |      | 10,546     |   |      |   | 10,537     |  
|Additional paid-in capital                                                                            |  |      | 12,022,869 |   |      |   | 11,967,650 |  
|Retained earnings                                                                                     |  |      | 2,059,049  |   |      |   | 1,095,492  |  
|Accumulated other comprehensive income (loss)                                                         |  |      | (15,967    | ) |      |   | 40,171     |  
|                                                                                                      |  |      |            |   |      |   |            |  
|                                                                                                      |  |      | 14,076,497 |   |      |   | 13,113,850 |  
|Less cost of 3,840 shares of treasury stock                                                           |  |      | (74,880    | ) |      |   | (74,880    | )
|                                                                                                      |  |      |            |   |      |   |            |  
|Total stockholders equity                                                                            |  |      | 14,001,617 |   |      |   | 13,038,970 |  
|                                                                                                      |  |      |            |   |      |   |            |  
|Total liabilities and stockholders equity                                                            |  | $    | 20,339,016 |   |      | $ | 19,429,233 |  
|                                                                                                      |  |      |            |   |      |   |            |  



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Notes to Consolidated Financial Statements



Note 20. Mid-Tier Holding Company and Mutual Holding Company Data, continued

AF Financial Group

Condensed Statements of Income

Years ended June 30, 2006 and 2005



|                                   |  |      |           |   |      |   |           |  
|---------------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                                   |  | 2006 |           |   | 2005 |  
|Equity in earnings of subsidiaries |  | $    | 1,575,301 |   |      | $ | 1,218,623 |  
|Interest income                    |  |      | 51        |   |      |   |          |  
|Income tax credit                  |  |      | 266,778   |   |      |   | 275,908   |  
|Professional fees                  |  |      | (68,000   | ) |      |   | (238,005  | )
|Interest expense                   |  |      | (525,471  | ) |      |   | (519,411  | )
|Other expense                      |  |      | (227,836  | ) |      |   | (88,338   | )
|                                   |  |      |           |   |      |   |           |  
|Net income                         |  | $    | 1,020,823 |   |      | $ | 648,777   |  
|                                   |  |      |           |   |      |   |           |  

AF Financial Group

Condensed Statements of Cash Flows

Years ended June 30, 2006 and 2005



|                                                    |  |      |            |   |      |   |            |  
|--------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                                    |  | 2006 |            |   | 2005 |  
|Cash Flows from Operating Activities:               |  |      |            |   |      |   |            |  
|Net income                                          |  | $    | 1,020,823  |   |      | $ | 648,777    |  
|ESOP expense                                        |  |      | 69,695     |   |      |   | 71,022     |  
|Deferred income taxes                               |  |      | (54,510    | ) |      |   | (3,084     | )
|Depreciation and amortization                       |  |      | 168,944    |   |      |   | 9,827      |  
|Loss on disposal of office properties and equipment |  |      |           |   |      |   | 11,338     |  
|Change in assets and liabilities:                   |  |      |            |   |      |   |            |  
|Equity in earnings of subsidiaries                  |  |      | (1,575,301 | ) |      |   | (1,218,623 | )
|Decrease in other assets                            |  |      | 96,600     |   |      |   | 55,616     |  
|Increase in accounts payable and other liabilities  |  |      | (3,988     | ) |      |   | 2,243      |  
|                                                    |  |      |            |   |      |   |            |  
|Net cash used in operating activities               |  |      | (277,737   | ) |      |   | (422,884   | )
|                                                    |  |      |            |   |      |   |            |  
|Cash Flows from Investing Activities:               |  |      |            |   |      |   |            |  
|Dividends received from subsidiaries                |  |      | 750,000    |   |      |   | 484,797    |  
|                                                    |  |      |            |   |      |   |            |  
|Net cash provided by investing activities           |  |      | 750,000    |   |      |   | 484,797    |  
|                                                    |  |      |            |   |      |   |            |  
|Cash Flows from Financing Activities:               |  |      |            |   |      |   |            |  
|Short-term borrowings, net                          |  |      |           |   |      |   | 150,000    |  
|Long-term borrowings (repayments), net              |  |      | (33,420    | ) |      |   | (37,000    | )
|Net proceeds from common stock issued               |  |      | 17,927     |   |      |   |           |  
|Tax benefit from exercise of stock option           |  |      | 1,027      |   |      |   |           |  
|Cash dividends paid                                 |  |      | (103,285   | ) |      |   | (103,091   | )
|                                                    |  |      |            |   |      |   |            |  
|Net cash provided by (used in) financing activities |  |      | (117,751   | ) |      |   | 9,909      |  
|                                                    |  |      |            |   |      |   |            |  
|Net increase in cash                                |  |      | 354,512    |   |      |   | 71,822     |  
|                                                    |  |     
|Cash, beginning                                     |  |      | 80,063     |   |      |   | 8,241      |  
|                                                    |  |      |            |   |      |   |            |  
|Cash, ending                                        |  | $    | 434,575    |   |      | $ | 80,063     |  
|                                                    |  |      |            |   |      |   |            |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 20. Mid-Tier Holding Company and Mutual Holding Company Data, continued

The following are the condensed financial statements of the mutual holding company, AsheCo, M.H.C., as of and for the years ended June 30, 2006 and 2005:

AsheCo, M.H.C.

Condensed Balance
Sheets

June 30, 2006 and 2005



|                                              |  |      |           |   |      |   |          
|--------------------------------------------- |  | ---- | --------- | - | ---- | - | ---------
|                                              |  | 2006 |           |   | 2005
|Assets                                        |  |      |           |   |      |   |          
|Interest-bearing deposits                     |  | $    | 197,823   |   |      | $ | 217,701  
|Investment in AF Financial Group              |  |      | 7,171,628 |   |      |   | 6,685,080
|Other assets                                  |  |      | 340,803   |   |      |   | 328,720  
|                                              |  |      |           |   |      |   |          
|Total assets                                  |  | $    | 7,710,254 |   |      | $ | 7,231,501
|                                              |  |      |           |   |      |   |          
|Liabilities and Shareholders Equity          |  |      |           |   |      |   |          
|Liabilities                                   |  |      |           |   |      |   |          
|Accounts payable and other liabilities        |  | $    | 14,040    |   |      | $ | 7,020    
|                                              |  |      |           |   |      |   |          
|Stockholders equity                          |  |      |           |   |      |   |          
|Additional paid-in capital                    |  |      | 5,709,548 |   |      |   | 5,717,328
|Retained earnings                             |  |      | 1,994,845 |   |      |   | 1,486,557
|Accumulated other comprehensive income (loss) |  |      | (8,179    | ) |      |   | 20,596   
|                                              |  |      |           |   |      |   |          
|Total shareholders equity                    |  |      | 7,696,214 |   |      |   | 7,224,481
|                                              |  |      |           |   |      |   |          
|Total liabilities and shareholders equity    |  | $    | 7,710,254 |   |      | $ | 7,231,501
|                                              |  |      |           |   |      |   |          

AsheCo, M.H.C.

Condensed Statements of Income

Years ended June 30, 2006 and 2005



|                                   |  |      |         |   |      |   |          |  
|---------------------------------- |  | ---- | ------- | - | ---- | - | -------- | -
|                                   |  | 2006 |         |   | 2005 |  
|Interest income                    |  | $    | 15,461  |   |      | $ | 7,883    |  
|Equity in earnings of subsidiaries |  |      | 523,103 |   |      |   | 354,392  |  
|Loss on sale of subsidiary         |  |      |        |   |      |   | (133,068 | )
|Other expense                      |  |      | (30,276 | ) |      |   | (32,006  | )
|                                   |  |      |         |   |      |   |          |  
|Net income                         |  | $    | 508,288 |   |      | $ | 197,201  |  
|                                   |  |      |         |   |      |   |          |  



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Notes to Consolidated Financial Statements



Note 20. Mid-Tier Holding Company and Mutual Holding Company Data, continued

AsheCo, M.H.C.

Condensed Statements of Cash Flows

Years ended June 30, 2006 and 2005



|                                          |  |      |          |   |      |   |          |  
|----------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | -
|                                          |  | 2006 |          |   | 2005 |  
|Cash Flows from Operating Activities:     |  |      |          |   |      |   |          |  
|Net income                                |  | $    | 508,288  |   |      | $ | 197,201  |  
|Equity in earnings of subsidiaries        |  |      | (523,103 | ) |      |   | (354,392 | )
|Change in assets and liabilities:         |  |      |          |   |      |   |          |  
|Loss on sale of subsidiary                |  |      |         |   |      |   | 133,068  |  
|Increase in other assets                  |  |      | (12,083  | ) |      |   | (95,478  | )
|Increase (decrease) in accounts payable   |  |      | 7,020    |   |      |   | (3,000   | )
|                                          |  |      |          |   |      |   |          |  
|Net cash used in operating activities     |  |      | (19,878  | ) |      |   | (122,601 | )
|                                          |  |     
|Cash Flows from Investing Activities:     |  |      |          |   |      |   |          |  
|Dividends from AF Financial Group         |  |      |         |   |      |   | 26,912   |  
|Proceeds from sale of subsidiary          |  |      |         |   |      |   | 150,000  |  
|                                          |  |      |          |   |      |   |          |  
|Net cash provided by investing activities |  |      |         |   |      |   | 176,912  |  
|                                          |  |     
|Net increase (decrease) in cash           |  |      | (19,878  | ) |      |   | 54,311   |  
|Cash, beginning                           |  |      | 217,701  |   |      |   | 163,390  |  
|                                          |  |      |          |   |      |   |          |  
|Cash, ending                              |  | $    | 197,823  |   |      | $ | 217,701  |  
|                                          |  |      |          |   |      |   |          |  

Note 21. Segment Reporting

The Company had additional reportable segments: AF Bank, AF Brokerage, Inc. and AF Insurance Services, Inc. As of June 24, 2005, AF Brokerage, Inc. was dissolved as a separate entity and as of June 30, 2005,
operated as AF Investments, a subsidiary of AF Bank. The information below includes the operating results of AF Brokerage, Inc. during the 2005 fiscal year prior to the dissolution. AF Bank is a federally chartered stock savings bank. The principal
activities of the Bank consist of obtaining savings deposits and providing credit to customers in its primary market area. AF Insurance Services, Inc. provides insurance services. Information about reportable segments, and reconciliation of such
information to the consolidated financial statements as of and for the year ended June 30, 2006 and June 30, 2005 is as follows (dollars in thousands):



|                                    |  |                  |      |   |         |   |                           |  |   |                          |   |  |                    |      |   |  |   |        
|----------------------------------- |  | ---------------- | ---- | - | ------- | - | ------------------------- |  | - | ------------------------ | - |  | ------------------ | ---- | - |  | - | -------
|June 30, 2006                       |  | AFFinancialGroup |      |   | AF Bank |   | AFInsuranceServices, Inc. |  |   | Inter-segmentElimination |   |  | ConsolidatedTotals
|Interest income                     |  | $                |     |   |         | $ | 13,682                    |  | $ |                         |   |  | $                  | (6   | ) |  | $ | 13,676 
|Interest expense                    |  |                  | 525  |   |         |   | 5,234                     |  |   | 55                       |   |  |                    | (6   | ) |  |   | 5,808  
|                                    |  |                  |      |   |         |   |                           |  |   |                          |   |  |                    |      |   |  |   |        
|Net interest income                 |  |                  | (525 | ) |         |   | 8,448                     |  |   | (55                      | ) |  |                    |     |   |  |   | 7,868  
|Provision for loan losses           |  |                  |     |   |         |   | 265                       |  |   |                         |   |  |                    |     |   |  |   | 265    
|                                    |  |                  |      |   |         |   |                           |  |   |                          |   |  |                    |      |   |  |   |        
|Net interest income after provision |  |                  | (525 | ) |         |   | 8,183                     |  |   | (55                      | ) |  |                    |     |   |  |   | 7,603  
|Non-interest income                 |  |                  |     |   |         |   | 1,765                     |  |   | 2,820                    |   |  |                    | (163 | ) |  |   | 4,422  
|Non-interest expense                |  |                  | 296  |   |         |   | 7,914                     |  |   | 2,293                    |   |  |                    | (163 | ) |  |   | 10,340 
|                                    |  |                  |      |   |         |   |                           |  |   |                          |   |  |                    |      |   |  |   |        
|Income (loss) before income taxes   |  |                  | (821 | ) |         |   | 2,034                     |  |   | 472                      |   |  |                    |     |   |  |   | 1,685  
|Income taxes                        |  |                  | (267 | ) |         |   | 760                       |  |   | 171                      |   |  |                    |     |   |  |   | 664    
|                                    |  |                  |      |   |         |   |                           |  |   |                          |   |  |                    |      |   |  |   |        
|Net income (loss)                   |  | $                | (554 | ) |         | $ | 1,274                     |  | $ | 301                      |   |  | $                  |     |   |  | $ | 1,021  
|                                    |  |                  |      |   |         |   |                           |  |   |                          |   |  |                    |      |   |  |   |        
|Assets                              |  | $                | 642  |   |         | $ | 227,395                   |  | $ | 2,244                    |   |  | $                  | (926 | ) |  | $ | 229,355
|                                    |  |                  |      |   |         |   |                           |  |   |                          |   |  |                    |      |   |  |   |        



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Notes to Consolidated Financial Statements



Note 21. Segment Reporting, continued



|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|----------------------------------- |  | ---------------- | ---- | - | ------- | - | ------- | ------------------------- |  | - | --------------- | - |  | ------------------------ | --- | - | ------------------ | - | ---- | - |  | - | ------- | -
|June 30, 2005                       |  | AFFinancialGroup |      |   | AF Bank |   |         | AFInsuranceServices, Inc. |  |   | AFBrokerageInc. |   |  | Inter-segmentElimination |     |   | ConsolidatedTotals |  
|Interest income                     |  | $                |     |   |         | $ | 12,001  |                           |  | $ |                |   |  | $                        | 1   |   |                    | $ | (7   | ) |  | $ | 11,995  |  
|Interest expense                    |  |                  | 519  |   |         |   | 4,163   |                           |  |   | 58              |   |  |                          |    |   |                    |   | (7   | ) |  |   | 4,733   |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net interest income                 |  |                  | (519 | ) |         |   | 7,838   |                           |  |   | (58             | ) |  |                          | 1   |   |                    |   |     |   |  |   | 7,262   |  
|Provision for loan losses           |  |                  |     |   |         |   | (79     | )                         |  |   |                |   |  |                          |    |   |                    |   |     |   |  |   | (79     | )
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net interest income after provision |  |                  | (519 | ) |         |   | 7,917   |                           |  |   | (58             | ) |  |                          | 1   |   |                    |   |     |   |  |   | 7,341   |  
|Non-interest income                 |  |                  |     |   |         |   | 1,388   |                           |  |   | 2,593           |   |  |                          | 322 |   |                    |   | (338 | ) |  |   | 3,965   |  
|Non-interest expense                |  |                  | 326  |   |         |   | 7,367   |                           |  |   | 2,426           |   |  |                          | 383 |   |                    |   | (338 | ) |  |   | 10,164  |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Income (loss) before income taxes   |  |                  | (845 | ) |         |   | 1,938   |                           |  |   | 109             |   |  |                          | (60 | ) |                    |   |     |   |  |   | 1,142   |  
|Income taxes                        |  |                  | (275 | ) |         |   | 748     |                           |  |   | 37              |   |  |                          | (17 | ) |                    |   |     |   |  |   | 493     |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net income (loss)                   |  | $                | (570 | ) |         | $ | 1,190   |                           |  | $ | 72              |   |  | $                        | (43 | ) |                    | $ |     |   |  | $ | 649     |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Assets                              |  | $                | 429  |   |         | $ | 211,781 |                           |  | $ | 2,377           |   |  | $                        |    |   |                    | $ | (486 | ) |  | $ | 214,101 |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  



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ITEM8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE

Not applicable.

ITEM8A. CONTROLS AND PROCEDURES

The Company
maintains a system of internal controls and procedures designed to provide reasonable assurance as to the reliability of our published financial statements and other disclosures included in this report. The Companys Board of Directors,
operating through its Audit Committee, which is composed entirely of independent outside directors, provides oversight of the Companys financial reporting process.

Management, including the Companys President and Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, the President and Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and
procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.

There have been no changes in the Companys internal control over financial reporting identified in connection with the evaluation
that occurred during the Companys last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, the Companys internal control over financial reporting.

ITEM8B. OTHER INFORMATION

None

PART III

ITEM9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT

The information required by this Item regarding (i) directors of the Company is set forth under the section captioned Proposal 1  Election of Directors; (ii) Company executive officers is
set forth under the section Proposal 1  Election of Directors  Executive Officers; (iii) Section 16(a) compliance is set forth under the section captioned Section 16(a) Beneficial Ownership Reporting
Compliance in the Companys Proxy Statement for the Annual Meeting of Stockholders to be held November 6, 2006, all of which are incorporated herein by this reference.

The Company has adopted a written Code of Ethics for its principal executive officer and senior financial officer as required by Sarbanes-Oxley and
applicable SEC Rules. A copy of our Code of Ethics policy is available on our website at www.afgrp.com.

ITEM10. EXECUTIVE COMPENSATION

The information requested
by this Item is set forth under the section captioned Proposal 1  Election of Directors  Directors Compensation and Executive Compensation in the Companys Proxy Statement for the Annual Meeting of
Stockholders to be held on November 6, 2006 both of which are incorporated herein by reference.



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ITEM11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS

The information relating to security
ownership of certain beneficial owners and management is incorporated herein by reference to the section captioned Security Ownership  Certain Beneficial Owners and Management in the Companys Proxy Statement for the Annual
Meeting of Stockholders to be held on November 6, 2006.

The following table sets forth the aggregate information with respect to the
Companys equity compensation plans as in effect as of June 30, 2006.



|                                                           |  |                                                                                           |  |                                                                            |       |                                                                                                                                           |  
|---------------------------------------------------------- |  | ----------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------- | ----- | ----------------------------------------------------------------------------------------------------------------------------------------- | -
|                                                           |  | Equity Compensation Plan Information                                                     
|Plan category                                              |  | Number of securitiesto be issued upon exercise ofoutstanding options, warrants and rights |  | Weighted-averageexercise price of outstanding options, warrants
and rights |       | Number of securitiesremaining available for future issuance under equity compensation plans (excluding securitiesreflected in column (a))
|                                                           |  | (a)                                                                                       |  | (b)                                                                        |       | (c)                                                                                                                                      
|Equity compensation plans approved by security holders     |  | 13,604                                                                                    |  | $                                                                          | 18.50 |                                                                                                                                           | 
|                                                           |  |                                                                                           |  |                                                                            |       |                                                                                                                                           |  
|Equity compensation plans not approved by security holders |  |                                                                                          |  |                                                                            |      |                                                                                                                                           | 
|                                                           |  |                                                                                           |  |                                                                            |       |                                                                                                                                           |  
|Total                                                      |  | 13,604                                                                                    |  | $                                                                          | 18.50 |                                                                                                                                           | 
|                                                           |  |                                                                                           |  |                                                                            |       |                                                                                                                                           |  

ITEM12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information relating to certain relationships and related transactions is incorporated herein by reference to the section captioned Proposal 1
 Election of Directors  Transactions with Certain Related Persons in the Companys Proxy Statement for the Annual Meeting of Stockholders to be held on November 6, 2006.

Item 13. Exhibits



|    |  |          |  |                                                                                                                                                                                                                                                                                               
|--- |  | -------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Exhibits |  |                                                                                                                                                                                                                                                                                               
|    |  | 2.1      |  | Agreement and Plan of Reorganization dated September 15, 1997 by and among Ashe Federal Bank, AF Bankshares, Inc. and Ashe Interim Savings Bank (Incorporated by reference to Exhibit 2.1 of
the Registration Statement on Form 8-A, as filed with the SEC on June 16, 1998 (the Form 8-A)).
|    |  |         
|    |  | 3.1      |  | Federal Stock Charter of the Company (Incorporated by reference to Exhibit 3.1 of the Form 8-A).                                                                                                                                                                                              
|    |  |         
|    |  | 3.2      |  | Bylaws of the Company (Incorporated by reference to Exhibit 3.2 of the Form 8-A).                                                                                                                                                                                                             
|    |  |         
|    |  | 4.1      |  | Common Stock Certificate of the Company (Incorporated by reference to Exhibit 4.3 of the Form 8-A).                                                                                                                                                                                           
|    |  |         
|    |  | 4.2      |  | Indenture dated July 16, 2001 by and between AF Bankshares, Inc. and The Bank of New York (Incorporated by reference to Exhibit 4.2 of the Annual Report on Form 10-KSB, as filed with the SEC
on September 29, 2003 (the 2003 Form 10-KSB)).                                               
|    |  |         
|    |  | 4.3      |  | Guarantee Agreement of AF Bankshares, Inc. dated July 16, 2001 (Incorporated by reference to Exhibit 4.3 of the 2003 Form 10-KSB).                                                                                                                                                            



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| |  |      |  |                                                                                                                                                                                
| |  | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |     
| |  | 10.1 |  | Employee Stock Ownership Plan of Ashe Federal Bank (Incorporated by reference to Exhibit 10.4 of the 1998 Form 10-KSB).                                                        
| |  |     
| |  | 10.2 |  | Amendment No. 1 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.5 of the 2003 Form 10-KSB).                                           
| |  |     
| |  | 10.3 |  | Amendment No. 2 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.6 of the 2003 Form 10-KSB).                                           
| |  |     
| |  | 10.4 |  | Amendment No. 3 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.7 of the 2003 Form 10-KSB).                                           
| |  |     
| |  | 10.5 |  | Amendment No. 4 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.7 of the 2003 Form 10-KSB).                                           
| |  |     
| |  | 10.6 |  | Salary Continuation Agreement between AF Bankshares, Inc. and Melanie Paisley Miller dated April 15, 2002 (Incorporated by reference to Exhibit 10.10 of the 2003 Form 10-KSB).
| |  |     
| |  | 31.1 |  | Rule 13a-14(a)/15d-14(a) Certifications                                                                                                                                        
| |  |     
| |  | 32.1 |  | Section 1350 Certifications                                                                                                                                                    

ITEM14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information relating to the principal accountant fees and services is incorporated herein by reference to the section captioned Proposal 1 
Election of Directors  Principal Accountant Fees and Services and Pre-Approval of Audit and Permissible Non-Audit Services in the Companys Proxy Statement for the Annual Meeting of Stockholders to be held on
November 6, 2006.



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SIGNATURES

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



|                         |  |     |  |                                      
|------------------------ |  | --- |  | -------------------------------------
|                         |  |     |  | AF Financial Group                   
|                         |  |     |  | (Registrant)                         
|                         |  |    
|Date: September 22, 2005 |  | By: |  | /s/ Robert E. Washburn               
|                         |  |     |  | Robert E. Washburn                   
|                         |  |     |  | President and Chief Executive Officer

In accordance with the Exchange Act, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.



|                                                |  |                   
|----------------------------------------------- |  | ------------------
|                                                |  | Date              
|/s/ Robert E. Washburn                          |  | September 22, 2006
|Robert E. Washburn                              |  |                   
|President, Chief Executive Officer and Director |  |                   
|                                                | 
|/s/ Wayne R. Burgess                            |  | September 22, 2006
|Wayne R. Burgess - Director                     |  |                   
|                                                | 
|/s/ Jan R. Caddell                              |  | September 22, 2006
|Jan R. Caddell - Director                       |  |                   
|                                                | 
|/s/ Kenneth R. Greene                           |  | September 22, 2006
|Kenneth R. Greene  Director                    |  |                   
|                                                | 
|/s/ Claudia L. Kelley                           |  | September 22, 2006
|Claudia L. Kelley  Director                    |  |                   
|                                                | 
|/s/ Donald R. Moore                             |  | September 22, 2006
|Donald R. Moore - Director                      |  |                   
|                                                | 
|/s/ Jimmy D. Reeves                             |  | September 22, 2006
|Jimmy D. Reeves  Director                      |  |                   
|                                                | 
|/s/ Jerry L. Roten                              |  | September 22, 2006
|Jerry L. Roten - Director                       |  |                   
|                                                | 
|/s/ Michael M. Sherman                          |  | September 22, 2006
|Michael M. Sherman  Director                   |  |                   



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