Exhibit 13 SFSB, INC. 2006 ANNUAL REPORT  PageLetter to Stockholders





1Selected Consolidated Financial and Other Data





2Managements Discussion and Analysis of Financial Condition and Results of Operations





4Consolidated Financial Statements





20Directors and Officers





22Investor and Corporate Information





23




---

SFSB, INC. 1614 Churchville Road Bel Air, Maryland 21015 (443) 265-5570 Dear Fellow Stockholder, Our companys financial results for the year ending December 31, 2006 are detailed on the pages that follow. The closing of the Edgewood branch, the continued impact of our placement of a non-performing commercial land acquisition and development participation loan on non accrual status and increasing the provision for loan loss reserves by 100% of the loan balances of two commercial non-real estate loans had a major impact on the results. In November 2005, we received regulatory approval to close the Edgewood branch. In the first quarter of 2006, we incurred $101,000 in expenses in connection with closing the branch on February 24, 2006 primarily due to the acceleration of depreciation on the leasehold improvements. Long term, we will cease to incur some of the costs associated with branch operations, yet retain in our portfolio the loans that were originated from the branch. The Edgewood branch personnel have remained with us and were reassigned to positions at the Bel Air branch and Corporate Headquarters. During the third quarter of 2006, we classified two commercial non-real estate loans as impaired. One of these commercial loans is a business line of credit to a company that ceased operations as of July 31, 2006 and the other is an unsecured term loan to the principal of the same company. In anticipation of a minimal recovery of principal on these loans, we have increased our allowance for loan losses by $260,000 or 100% of the balance of the loans. We continue to implement strategies formed during a Strategic Planning Meeting of the board of directors and the companys officers held in the second quarter 2006. In our continued efforts to boost the yield on our interest earning assets during a period of net interest margin compression, management decided to sell a larger percentage of the companys residential loan originations to facilitate our goal of increasing and diversifying the mix of commercial loans to residential loans in our portfolio. This strategy, if successful, should enable us to increase our fee income on loans sold. In February 2007, we also hired an experienced
commercial loan originator to further our goal of increasing the average outstanding balance of our commercial loan portfolio. In addition, we have intensified our marketing strategy by offering incentives to attract new checking accounts in an effort to attain our goal of decreasing the yield on our interest bearing liabilities. Additionally, we have begun to pay off Federal Home Loan Bank Advances, a step many banks have taken nationwide to improve profitability in a difficult banking environment. As in 2006, our focus for 2007 will be profitability. For the year ended December 31, 2006, we were able to decrease non-interest expense by $218,000 compared to the year ended December 31, 2005. Our directors, officers, management and staff remain committed in a unified effort to improve the banks profitability. Our efforts to control costs will be on-going. In closing, on behalf of our directors, officers, management and staff, I thank you for your support and confidence. Both are greatly appreciated. Sincerely, /s/ Philip E. Logan Philip E. Logan President, Chief Executive Officer and Chairman of the Board


1

---

SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA The summary information presented below at or for each of the periods presented is derived in part from our consolidated financial statements. The information at and for the year ended December 31, 2006, 2005 and 2004 is derived from the audited consolidated financial statements of SFSB, Inc. The following information is only a summary, and should be read together with Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the related notes included elsewhere in this annual report. Results for past periods are not necessarily indicative of results that may
be expected for any future period.  At December 31,2006

          

          2005

          

          2004(In Thousands)Selected Financial Condition Data:Total assets

          

          $

          174,225

          

          

          $

          171,067

          

          

          $

          160,433Cash and cash equivalents

          

          

          2,851

          

          

          

          1,342

          

          

          

          15,597Loans receivable(1)

          

          

          147,118

          

          

          

          144,609

          

          

          

          117,900Investment securities

          

          

          15,726

          

          

          

          16,676

          

          

          

          18,958Deposits

          

          

          111,823

          

          

          

          109,623

          

          

          

          109,711Borrowings

          

          

          39,000

          

          

          

          36,000

          

          

          

          26,500Equity

          

          

          22,365

          

          

          

          22,805

          

          

          

          22,620
  (1)

          Net of loans in process, allowance for loan losses and deferred loan fees.  Years Ended December 31,2006

          

          2005

          

          2004(In Thousands, Except for Per Share Data)Selected Operating Data:Total interest income

          

          $

          9,091

          

          

          $

          7,720

          

          

          $

          6,517Total interest expense

          

          

          5,467

          

          

          

          3,795

          

          

          

          3,075Net interest income

          

          

          3,624

          

          

          

          3,925

          

          

          

          3,442Provision for loan losses

          

          

          376

          

          

          

          58

          

          

          

          50Net interest income after provision for loan losses

          

          

          3,248

          

          

          

          3,867

          

          

          

          3,392Other income

          

          

          277

          

          

          

          234

          

          

          

          78Non-interest expense

          

          

          3,482

          

          

          

          3,700

          

          

          

          3,008Income taxes

          

          

          25

          

          

          

          162

          

          

          

          192Net income

          

          $

          18

          

          

          $

          239

          

          

          $

          270Basic Earnings per Share

          

          $

          0.01

          

          

          $

          0.08

          

          

          

          N/ADiluted Earnings per Share

          

          $

          0.01

          

          

          $

          0.08

          

          

          

          N/A


2

---

At or for the Years Ended December 31,2006

          

          2005

          

          2004Selected Financial Ratios and Other Data:Performance Ratios:Return on average assets(1)

          

          

          0.01 %

          

          

          

          0.15 %

          

          

          

          0.20 %Return on average equity

          

          

          0.08

          

          

          

          1.05

          

          

          

          2.25Net loans to total assets

          

          

          84.44

          

          

          

          84.53

          

          

          

          73.49Net yield on average interest-earning assets

          

          

          5.43

          

          

          

          5.05

          

          

          

          4.89Net cost of average interest bearing liabilities

          

          

          3.68

          

          

          

          2.83

          

          

          

          2.43Net interest rate spread(2)

          

          

          1.75

          

          

          

          2.22

          

          

          

          2.46Net interest margin(3)

          

          

          2.17

          

          

          

          2.57

          

          

          

          2.58Average interest-earning assets to average interest bearing liabilities

          

          

          1.13 x

          

          

          

          1.14 x

          

          

          

          1.06 xNon-interest expense to average assets

          

          

          2.00

          %

          

          

          2.31

          %

          

          

          2.14

          %Average equity to average assets

          

          

          12.93

          

          

          

          14.22

          

          

          

          8.53Efficiency ratio(4)

          

          

          89.26

          

          

          

          88.96

          

          

          

          85.46Capital Ratios:Tangible ratio

          

          

          9.62 %

          

          

          

          9.70 %

          

          

          

          9.72 %Tier 1 core ratio

          

          

          9.62

          

          

          

          9.70

          

          

          

          9.72Total risk-based capital ratio

          

          

          17.79

          

          

          

          18.26

          

          

          

          19.45Asset Quality Ratios:Net charge-offs (recoveries) to average nonperforming assets

          

          

          %

          

          

          

          %

          

          

          

          %Net charge-offs (recoveries) to average loans outstanding

          

          

          

          

          

          

          

          

          

          

          Allowance for loan losses to gross loans outstanding

          

          

          0.57

          

          

          

          0.32

          

          

          

          0.35Non-performing loans to total assets

          

          

          0.85

          

          

          

          0.73

          

          

          

          0.23Non-performing assets to total assets

          

          

          0.85

          

          

          

          0.73

          

          

          

          0.23Non-performing loans to total loans

          

          

          1.01

          

          

          

          0.86

          

          

          

          0.31Other Data:Number of full-service offices(5)

          

          

          2

          

          

          

          3

          

          

          

          3
  (1)

          Ratio of net income to average total assets. (2)

          The difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities. (3)

          Net interest income divided by average interest-earning assets. (4)

          The efficiency ratio represents the ratio of non-interest expenses divided by the sum of net interest income and non-interest income. (5)

          We closed our Edgewood branch on February 24, 2006.


3

---

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS SFSB, Inc. is a federal corporation, which was organized in 2004 as part of the mutual holding company reorganization of Slavie Federal Savings Bank. Our principal asset is our investment in Slavie Federal Savings Bank. We are a majority owned subsidiary of Slavie Bancorp, MHC, a federally chartered mutual holding company. In connection with the reorganization, we sold 1,339,031 shares of our common stock and issued 1,636,594 shares to our mutual holding company parent. The net proceeds from our stock offering totaled $12,710,000. At December 31, 2006, we had consolidated assets of $174,225,000, deposits of $111,823,000 and shareholders' equity of
$22,365,000. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements, including the related footnotes to the consolidated financial statements, included elsewhere in this annual report. Overview Earnings declined to $18,000 in 2006 as compared to $239,000 in 2005 primarily due to our increasing the provision for loan loss reserves by 100% of the loan balances of two commercial non-real estate loans due to a default on those loans, in accordance with regulatory requirements. The decrease also resulted from the acceleration of depreciation on the leasehold improvements of the Edgewood branch in connection with closing the branch and the impact of our placement of a non-performing commercial land acquisition and development participation loan on non-accrual status, therefore, not accruing interest on that loan. Interest income increased
$1,371,000, or 17.76%, and non-interest income increased $43,000, or 18.38%. These improvements were offset by a $1,672,000, or 44.06%, increase in interest expenses and an increase of $318,000, or 548.28% in the provision for loan losses. Assets increased to $174,225,000 in 2006 as compared to $171,067,000 in 2005 primarily because we increased our loan portfolio by $2,509,000, or 1.74%, to $147,118,000 at December 31, 2006 from $144,609,000 at December 31, 2005. The increase is also a result of an increase in investment securities available for sale of $373,000, or 4.58%, to $8,526,000 at December 31, 2006 from $8,153,000 at December 31, 2005 and an increase in Federal Home Loan Bank stock of $143,000, or 7.31%, to $2,098,000 at December 31, 2006 from $1,955,000 at December 31, 2005. These increases were offset by a decrease in mortgage backed securities held to maturity of
$1,325,000, or 29.28%, to $3,200,000 at December 31, 2006 from $4,525,000 at December 31, 2005. We hold a 19% participation (approximately $1,083,000 unpaid principal balance) in an acquisition and development loan. This loan became delinquent in late 2004 and was placed on non-accrual status in late 2005. A national homebuilder had contracted to purchase the property and pay off the subject loan upon the borrower developing it to the record plat stage. This was to occur in late 2005. To date, the borrower has been unable to do so. In November 2005, the national homebuilder released the borrower from their contract, and the participating lenders entered into a forbearance agreement with the borrower so that the borrower could
attempt to sell the property. In February 2006, the national homebuilder agreed to purchase the property as is subject to a feasibility study, which uncovered road access and storm water management issues. As of the date of this report, the borrower has been unable to resolve these issues with the controlling municipality preventing the sale of the property to the national homebuilder. In May 2006, upon the expiration of the forbearance agreement, the participating banks sent a notice of default to the borrower. In addition, the collateral property has been docketed for foreclosure. The principal of the borrower filed for personal (Chapter 11) bankruptcy in September 2006, and a meeting of creditors was held on November 8, 2006. Later that same day, the entity that owns the collateral property filed for Chapter 11 bankruptcy, which caused the cancellation of the foreclosure auction that had been scheduled for November 9, 2006. On February 9, 2007, the participating
lenders counsel filed a motion with the bankruptcy judge to lift stay so that the lenders could proceed to sell the property at foreclosure. A hearing on this matter, scheduled for March 16, 2007, was postponed and rescheduled for April 19, 2007. As of the date of this filing, the loan continues to be on non-accrual status. We continue to believe the property is viable and that our collateral position is adequate. Ultimately, we believe we will receive all interest and principal on this loan, although there can be no assurance that this will be the case.


4

---

In addition to the non-accrual acquisition and development loan mentioned above, we classified two commercial non-real estate loans as impaired in 2006. One of these commercial loans is a business line of credit to a company that ceased operations as of July 31, 2006; the other is an unsecured term loan to the principal of the same company. The company filed for Chapter 7 bankruptcy on September 26, 2006. In anticipation of a minimal recovery of principal on these loans, we have increased our allowance for loan losses by $260,000, or 100% of the balance of the loans. Opened in November 2001, our Edgewood branch had been an active part of the community it served, but it had been unable to generate the business necessary to keep it a viable part of our strategic plan. In November 2005, we received regulatory approval to close our Edgewood location and we closed the branch on February 24, 2006. We incurred $101,000 in expenses in the first quarter of 2006 in connection with the closing the branch, primarily due to the acceleration of depreciation on the leasehold improvements. Long term, we will cease to incur some of the costs associated with branch operations, yet retain in our portfolio the loans that were
originated from the branch. The Edgewood branch personnel have remained with us and were reassigned to positions at the Bel Air branch and corporate headquarters. As a gesture of our commitment to our customers and neighbors, the Bank celebrated Customer Appreciation Days at each of its two branch locations in 2006, promoting its newest products. To remain competitive and offer even more choices to our customers, in the third quarter of 2006, we developed a money market account with what we believe is an attractive tri-tiered interest rate level option, a business checking account with an earnings credit feature to counterbalance the typical service fees charged, and a premium rate personal checking account, requiring higher balances but paying a very competitive interest rate without the standard service
fees. We also began offering a service that automatically pulls funds from a customers savings account to cover checking account overdrafts to compliment our Check Assurance Overdraft Protection Line of Credit product. We continue to offer a seven month certificate of deposit with what we believe is an attractive interest rate. In addition to the variety of products we offer and the new ones mentioned above, our product development and review committee expects to implement a health savings account for health care expenses, a Coverdale individual retirement account for educational needs and a business sweep checking account for accountholders who maintain high balances and are looking for an alternative way to increase earnings on their excess available funds. We expect to develop and offer these services in 2007. We continue to implement strategies formed during a strategic planning meeting of the Board of Directors and the Companys officers held in the second quarter of 2006. In our continued efforts to boost the yield of our interest earning assets during a period of net interest margin compression, management decided to sell a larger percentage of the Companys residential loan originations to facilitate our goal of increasing and diversifying the mix of commercial loans to residential loans in our portfolio. This strategy, if successful, should enable us to increase our fee income on loans sold. In February 2007, we also hired an experienced
commercial loan originator to further our goal of increasing the average outstanding balance of our commercial loan portfolio. In addition, we have intensified our marketing strategy by offering incentives to attract new checking accounts in an effort to attain our goal of decreasing the yield on our interest bearing liabilities. Our directors, officers, management and staff remain committed in a unified effort to improve the Banks profitability. Key measurements and events for year ended December 31, 2006 include the following: 

          Total assets at December 31, 2006 increased by 1.85% to $174,225,000 as compared to $171,067,000 as of December 31, 2005. 

          Net loans outstanding increased by 1.74% from $144,609,000 as of December 31, 2005 to $147,118,000 as of December 31, 2006. 

          Nonperforming loans at December 31, 2006 totaled $1,486,000. We believe an appropriate allowance for loan losses continues to be maintained. 

          Deposits at December 31, 2006 were $111,823,000, an increase of $2,200,000 or 2.01% from December 31, 2005. 

          We realized net income of $18,000 for the year ended December 31, 2006, compared to net income of $239,000 for the year ended December 31, 2005.


5

---



          Net interest income, our main source of income, was $3,624,000 during the year ended December 31, 2006 compared to $3,925,000 for the year ended December 31, 2005. 

          Non-interest income increased by $43,000 or 18.38% for the year ended December 31, 2006 as compared to the year ended December 31, 2005, from $234,000 to $277,000. 

          Non-interest expense decreased by $218,000 or 5.89% for the year ended December 31, 2006 as compared to the year ended December 31, 2005, from $3,700,000 to $3,482,000. A detailed discussion of the factors leading to these changes can be found in the discussion below. General Our profitability depends primarily on our net interest income, which is the difference between interest and dividend income on interest-earning assets, primarily loans, investment securities, mortgage-backed securities and other interest-earning assets (primarily federal funds sold), and interest expense on interest-bearing liabilities, consisting primarily of deposit accounts and borrowings. Net interest income is dependent upon the level of interest rates and the extent and degree of changes to such rates. Our profitability also depends on our non-interest expenses and, to a lesser extent, on our provision for loan losses, non-interest income and
income taxes. Our profitability also may be affected significantly by changes in market interest rates, applicable statutes and regulations, general and local economic and competitive conditions, as well as other factors beyond our control. Our non-interest income, which currently consists primarily of rental income, gain on sale of loans and other miscellaneous income, historically nominal, has improved over the past few years . One of our continued strategies going forward is to build our sources of non-interest income. See Business Strategy. Non-interest expense currently consists primarily of compensation and related expenses, occupancy expense, deposit insurance premiums, advertising expense, data processing expense, furniture, fixture and equipment expenses, telephone, postage and delivery expenses and other general and administrative expenses. We have made strides in our efforts to control our non-interest expenses by negotiating lower electrical rates for utilities expenses, centralizing the office supplies ordering, and bringing some printing projects in-house. These are all examples of cost cutting measures we have taken in 2006. Critical Accounting Policies The Companys consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America or GAAP, and follow general practices within the industry in which we operate. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions,
and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation allowance to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. The most significant accounting policies followed by the Company are presented in Note 1 to the financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses as the accounting area that requires the
most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.


6

---

The allowance for loan losses represents managements best estimate of losses known and inherent in the loan portfolio that are both probable and reasonable to estimate, based on, among other factors, historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any underlying collateral, and prevailing economic conditions (particularly as such conditions relate to our market area). Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant estimates,
assumptions and judgment. The loan portfolio also represents the largest asset type on our balance sheet. We have developed a methodology for evaluating the adequacy of the allowance for loan losses that distinguishes betweenspecific allowances for identified problem loans (watch list loans), a general valuation allowance on certain identified problem loans (but for which we dont expect to take a loss based on the individual circumstances of the loan, for example, collateral that we believe is sufficient to cover the full amount of the loan) and a general valuation allowance for the remainder of the loan portfolio. Two of our officers review the watch list loans and establish an individual allowance allocation on certain loans based on
such factors as: (1) the strength of the customers personal or business cash flow; (2) the availability of other sources of repayment; (3) the amount due or past due; (4) the type and value of collateral; (5) the strength of our collateral position; (6) the estimated cost to sell the collateral; and (7) the borrowers effort to cure the delinquency. We also establish a general allowance for watch list loans that do not have an individual allowance. We segregate these loans by loan category and assign allowance percentages to each category based on inherent losses associated with each type of lending and consideration that these loans, in the aggregate, represent an above-average credit risk and that more of these loans will prove to be uncollectible compared to loans in the general portfolio. Finally, we establish another general allowance for loans that are not on the watch list to recognize the inherent losses associated with lending activities, but which, unlike specific
allowances, has not been allocated to particular problem assets. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience and delinquency trends. The allowance may be adjusted for significant factors that, in managements judgment, affect the collectibility of the portfolio as of the evaluation date. The applied loss factors are reevaluated annually to ensure their relevance in the current environment. Management has significant discretion in making the judgments inherent in the determination of the provision and allowance for loan losses, including in connection with the valuation of collateral and the financial condition of the borrower. The establishment of allowance factors is a continuing exercise and allowance factors may change over time, resulting in an increase or decrease in the amount of the provision or allowance based upon the same volume and classification of loans. Changes in allowance factors or in managements interpretation of those factors will have a direct impact on the amount of the provision, and a corresponding effect
on income and assets. Also, errors in managements perception and assessment of the allowance factors could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs, which would adversely affect income and capital. For additional information regarding the allowance for loan losses, see Results of Operations for the Years Ended December 31, 2006 and 2005 - Provision for Loan Losses and Analysis of Allowance for Loan Losses. On January 1, 2005, the Company adopted SFAS 123R using the modified-prospective transition method as more fully described in Note 1 of the Consolidated Financial Statement. The compensation expense recognized in 2006 pertaining to the stock-based compensation plans was $161,000 and the related tax benefit was $30,000. As of December 31, 2006, there was $428,000 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the plans. This cost is expected to be recognized over a weighted average period of 3.4 years. In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. FASB Statement No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. We are currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 157 on our consolidated financial position,
results of operations and cash flows.


7

---

Business Strategy Our business strategy is to operate and grow a profitable community-oriented financial institution serving primarily retail customers in our market area. The following strategic initiatives form the foundation of our strategy: Our business strategy is to grow and improve our profitability by: 

          Leveraging excess equity to improve earnings; 

          Increasing loan diversification with an emphasis on commercial lending; 

          Increasing residential loan originations to sell on the secondary market; 

          Increasing customer access through enhanced electronic delivery systems; 

          Building sources of fee revenue to increase non-interest income; and 

          Maintaining a high quality loan portfolio through prudent underwriting practices. Leveraging excess equity to improve earnings. Leveraging excess equity means that we have sufficient regulatory capital to increase our deposits and other borrowings to finance a greater amount of interest earning assets. Our borrowings increased $3,000,000 during 2006 and $9,500,000 during 2005. Increasing loan diversification, particularly with respect to commercial business and commercial real estate loans. We believe that increasing loan diversification has increased our competitive profile and improved earnings through higher yields. Established in April 2004, our commercial loan department added an experienced commercial lender in February 2007. We focus our commercial lending activities on small to mid-size businesses in our market area. We seek to distinguish ourselves by providing responsive personal service and local decision making. Our goal is to grow the commercial business and commercial real estate loan portfolio to 30%
of totalloans over the next four years. During 2006, our commercial mortgage loans increased from $5,402,000 to $5,752,000, or 3.88% of our loan portfolio and our commercial business loans increased from $1,481,000 to $2,800,000, or 1.89% of our loan portfolio. We have also expanded our consumer lending activities by cross-selling to a larger base of transaction accounts. Increasing residential loan originations. During 2006, we continued to originate our residential mortgage loans within our market area and, to facilitate the loan volume activity, we hired a residential loan officer in October 2005. As of December 31, 2006 and December 31, 2005, $117,755,000 and $122,262,000, respectively, or 79.48% and 83.74%, respectively, of our total loan portfolio consisted of one- to four-family residential loans. During the years ended December 31, 2006 and December 31, 2005, we originated $14,400,000 and $27,444,000, respectively, of one- to four-family residential mortgage loans. Our growth strategy contemplates that we will only retain for our portfolio those loans meeting our interest rate risk and balance sheet composition targets and will sell the remaining loans in the secondary market on a servicing released basis and without recourse. Our goal continues to be to increasethe number of fixed rate loans that we sell in the secondary market. Over time, we may evaluate selling loans on a servicing retained basis. To date, our secondary market activities continue to improve. During 2006, we sold twenty-one residential mortgage loans with a total principal balance of $3,739,000. Decisions to sell loans are based on prevailing
market interest rate conditions and interest rate risk management and not on the anticipated collectibility of the loan sold. We believe enhanced residential mortgage loan origination volume should (1) increase opportunities for non-interest income and (2) enhance the customer base for cross-selling purposes. Increasing customer access through enhanced electronic delivery systems. We believe that our electronic delivery systems will increase transaction accounts, emphasize cross-selling, increase non-interest income and raise our profile. We have affiliated with an ATM network, allowing our customers to use the ATM machines of another larger financial institution without charge. Also, we continue to offer free ServiceFirst Internet Banking and Simplicity Bill Pay to our customers, allowing them to view their account information online, transfer balances among Slavie accounts and pay their bills electronically at any time. In 2006, we added Business
Bill Pay for the convenience of our commercial account holders.


8

---

Building sources of fee income. We increased our fee income by, among other things, intensifying the marketing of transaction accounts and business checking accounts and broadening the financial products and services we offer. In the second half of 2006, we began to offer a money market account with what we believe is an attractive tri-tiered interest rate level option, a business checking account with an earnings credit feature to counterbalance the typical service fees charged, and a premium rate personal checking account, requiring higher balances but paying a very competitive interest rate without the standard service fees. We currently
have a contractual arrangement with a broker-dealer to provide financial planning related services to our customers and potential customers and we plan to hire one or two individuals to provide financial planning services in 2007. Our activities to date in this area have achieved moderate success. Fee income, other than a non-recurring item, increased by $10,000 during 2006 compared to 2005. Maintaining a high quality loan portfolio through prudent underwriting practices. We believe that high asset quality is a key to long-term success. We have sought to maintain a high level of asset quality and moderate credit risk by focusing on residential mortgage lending and by using conservative underwriting standards. At December 31, 2006, our nonperforming loans (loans that were 90 days or more past due) were 1.01% of our total loan portfolio and 0.85% of total assets. Although we intend to continue to increase our commercial mortgage and commercial business lending, which have greater credit risk than residential mortgage loans, we will
continue to use conservative underwriting standards. Comparison of Financial Condition at December 31, 2006 and 2005 Assets. Our total assets increased by $3,158,000, or 1.85%, to $174,225,000 at December 31, 2006, from $171,067,000 at December 31, 2005. The increase in total assets resulted primarily from a $2,509,000, or 1.74% increase in net loans receivable, from $144,609,000 at December 31, 2005 to $147,118,000 at December 31, 2006 and a $1,509,000, or 112.44% increase in cash and cash equivalents from $1,342,000 at December 31, 2005 to $2,851,000 at December 31, 2006. These increases were partially offset by a $1,325,000, or 29.28% decrease in mortgage-backed securities, from $4,525,000 at December 31, 2005 to $3,200,000 at December 31, 2006. Approximately 54.09% of the $2,509,000 increase in net loans receivable was the result of additional one-to-four family residential loan originations, consistent with our intended growth strategy in this area. In general, the decrease in mortgage-backed securities resulted from scheduled repayments and payoffs and our use of the received funds to originate loans. Cash and cash equivalents increased primarily due to increased deposits. As we are not continuing to purchase mortgage-backed securities, we expect continued decreases in this asset both in amount and as a percentage of our assets. Liabilities. Total liabilities increased by $3,598,000, or 2.43%, to $151,860,000 at December 31, 2006, from $148,262,000 at December 31, 2005. The increase in total liabilities resulted from a $2,200,000, or 2.01% increase in deposits, from $109,623,000 at December 31, 2005 to $111,823,000 at December 31, 2006 and a $3,000,000, or 8.33% increase in borrowings, from $36,000,000 at December 31, 2005 to $39,000,000 at December 31, 2006. These increases were partially offset by a decrease of $1,535,000, or 79.99%, in checks outstanding in excess of bank balance, from $1,919,000 at December 31, 2005 to $384,000 at December 31, 2006 and a $45,000,
or 12.93% decrease in other liabilities, from $348,000 at December 31, 2005 to $303,000 at December 31, 2006. The increase in borrowings was consistent with our strategy of leveraging excess equity and utilizing the borrowings for loan originations. The other liabilities consist primarily of accrued federal and state income taxes and accrued interest on Federal Loan Home Bank borrowings. Stockholders Equity. Total equity decreased by $440,000, or 1.93% to $22,365,000 at December 31, 2006, compared to $22,805,000 at December 31, 2005 as a result of the purchase of $665,000 in additional Treasury stock. The decrease in equity also reflects a $10,000 increase in accumulated other comprehensive loss (resulting from unrealized losses on investments available for sale, net of tax), partially offset by net income of $18,000 and stock based compensation of $217,000. We are considered well capitalized under the risk-based capital guidelines applicable to us.


9

---

Average Balances, Net Interest Income, Yields Earned and Rates Paid The following table presents for the periods indicated the total dollar amount of interest income from average interest earning assets and the resultant yields, as well as the interest expense on average interest bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made and no income was exempt from federal income taxes. All average balances are monthly average balances. We do not believe that the monthly averages differ materially from what the daily averages would have been. Non-accruing loans have been included in the table as loans carrying a zero yield. The amortization of loan fees is included in
computing interest income, however, such fees are not material.  At December 31,

          

          Years Ended December 30,2006

          

          2006

          

          2005

          

          2004Outstanding Balance

          

          Yield/Rate

          

          Average Outstanding Balance

          

          Interest Earned/Paid

          

          Yield/Rate

          

          Average Outstanding Balance

          

          Interest Earned/Paid

          

          Yield/Rate

          

          Average Outstanding Balance

          

          Interest Earned/Paid

          

          Yield/Rate(Dollars in Thousands)Interest-earning assets:Loans receivable(1)

          

          $

          147,118

          

          

          

          5.86

          %

          

          $

          147,238

          

          

          $

          8,165

          

          

          

          5.55

          %

          

          $

          129,169

          

          

          $

          6,875

          

          

          

          5.32

          %

          

          $

          107,580

          

          

          $

          5,785

          

          

          

          5.38

          %Mortgage-backed securities

          

          

          3,200

          

          

          

          4.89

          

          

          

          3,773

          

          

          

          157

          

          

          

          4.16

          

          

          

          5,662

          

          

          

          204

          

          

          

          3.60

          

          

          

          8,438

          

          

          

          288

          

          

          

          3.41Investment securities (available for sale)

          

          

          8,526

          

          

          

          5.22

          

          

          

          8,339

          

          

          

          390

          

          

          

          4.68

          

          

          

          8,059

          

          

          

          279

          

          

          

          3.46

          

          

          

          7,912

          

          

          

          188

          

          

          

          2.38Investment securities (held to maturity)

          

          

          4,000

          

          

          

          3.74

          

          

          

          4,000

          

          

          

          151

          

          

          

          3.78

          

          

          

          3,997

          

          

          

          153

          

          

          

          3.83

          

          

          

          3,994

          

          

          

          152

          

          

          

          3.81Other interest-earning assets

          

          

          4,268

          

          

          

          5.59

          

          

          

          3,931

          

          

          

          228

          

          

          

          5.80

          

          

          

          6,062

          

          

          

          209

          

          

          

          3.45

          

          

          

          5,412

          

          

          

          104

          

          

          

          1.92Total interest-earning assets

          

          

          167,112

          

          

          

          5.75 %

          

          

          

          167,281

          

          

          

          9,091

          

          

          

          5.43 %

          

          

          

          152,949

          

          

          

          7,720

          

          

          

          5.05 %

          

          

          

          133,336

          

          

          

          6,517

          

          

          

          4.89 %Non-interest earning assets

          

          

          7,113

          

          

          

          

          

          

          

          7,074

          

          

          

          

          

          

          

          

          

          

          

          7,232

          

          

          

          

          

          

          

          

          

          

          

          7,413Total assets

          

          $

          174,225

          

          

          

          

          

          

          $

          174,355

          

          

          

          

          

          

          

          

          

          

          $

          160,181

          

          

          

          

          

          

          

          

          

          

          $

          140,749Interest-bearing liabilities:Savings deposits

          

          $

          18,015

          

          

          

          1.11 %

          

          

          $

          23,132

          

          

          

          288

          

          

          

          1.25 %

          

          

          $

          33,595

          

          

          

          436

          

          

          

          1.30 %

          

          

          $

          32,562

          

          

          

          324

          

          

          

          1.00 %Demand and NOW accounts

          

          

          6,456

          

          

          

          2.45

          

          

          

          4,055

          

          

          

          68

          

          

          

          1.68

          

          

          

          2,339

          

          

          

          15

          

          

          

          0.56

          

          

          

          2,176

          

          

          

          13

          

          

          

          0.60Certificates of deposit

          

          

          85,996

          

          

          

          4.84

          

          

          

          82,037

          

          

          

          3,497

          

          

          

          4.26

          

          

          

          72,124

          

          

          

          2,537

          

          

          

          3.52

          

          

          

          67,647

          

          

          

          2,190

          

          

          

          3.24Escrows

          

          

          2

          

          

          

          

          

          

          

          11

          

          

          

          

          

          

          

          

          

          

          

          15

          

          

          

          

          

          

          

          

          

          

          

          16

          

          

          

          

          

          

          

          Borrowings

          

          

          39,000

          

          

          

          4.35

          

          

          

          39,250

          

          

          

          1,614

          

          

          

          4.11

          

          

          

          26,250

          

          

          

          807

          

          

          

          3.07

          

          

          

          23,917

          

          

          

          548

          

          

          

          2.29Total interest-bearing liabilities

          

          

          149,469

          

          

          

          4.16 %

          

          

          

          148,485

          

          

          

          5,467

          

          

          

          3.68 %

          

          

          

          134,323

          

          

          

          3,795

          

          

          

          2.83 %

          

          

          

          126,318

          

          

          

          3,075

          

          

          

          2.43 %Non-interest-bearing liabilities

          

          

          2,391

          

          

          

          

          

          

          

          3,330

          

          

          

          

          

          

          

          

          

          

          

          3,077

          

          

          

          

          

          

          

          

          

          

          

          2,429Total liabilities

          

          

          151,860

          

          

          

          

          

          

          

          151,815

          

          

          

          

          

          

          

          

          

          

          

          137,400

          

          

          

          

          

          

          

          

          

          

          

          128,747Total equity(2)

          

          

          22,365

          

          

          

          

          

          

          

          22,540

          

          

          

          

          

          

          

          

          

          

          

          22,781

          

          

          

          

          

          

          

          

          

          

          

          12,002Total liabilities and equity

          

          $

          174,225

          

          

          

          

          

          

          $

          174,355

          

          

          

          

          

          

          

          

          

          

          $

          160,181

          

          

          

          

          

          

          

          

          

          

          $

          140,749Net interest income

          

          

          

          

          

          

          

          

          

          

          

          

          

          $

          3,624

          

          

          

          

          

          

          

          

          

          

          $

          3,925

          

          

          

          

          

          

          

          

          

          

          $

          3,442Interest rate spread(3)

          

          

          

          

          

          

          1.59 %

          

          

          

          

          

          

          

          

          

          

          

          1.75 %

          

          

          

          

          

          

          

          

          

          

          

          2.22 %

          

          

          

          

          

          

          

          

          

          

          

          2.46 %Net interest-earning assets

          

          $

          17,643

          

          

          

          

          

          

          $

          18,796

          

          

          

          

          

          

          

          

          

          

          $

          18,626

          

          

          

          

          

          

          

          

          

          

          $

          7,018Net interest margin(4)

          

          

          

          

          

          

          2.17 %

          

          

          

          

          

          

          

          

          

          

          

          2.17 %

          

          

          

          

          

          

          

          

          

          

          

          2.57 %

          

          

          

          

          

          

          

          

          

          

          

          2.58 %Ratio of interest earning assets to interest bearing liabilities

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          1.11x

          

          

          

          

          

          

          

          

          

          

          

          1.14x

          

          

          

          

          

          

          

          

          

          

          

          1.06x
  (1)

          Loans receivable are net of the allowance for loan losses. (2)

          Total equity includes retained earnings and accumulated other comprehensive income (loss). (3)

          Net interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities. (4)

          Net interest margin represents net interest income as a percentage of average interest earning assets.


10

---

Rate/Volume Analysis The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to changes in outstanding balances and those due to the changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume (i.e., changes in volume multiplied by old rate), (2) changes in rate (i.e., changes in rate multiplied by old volume), and (3) total changes in rate and volume. For purposes of this table, changes
attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.  Years Ended December 31,

          

          Years Ended December 31,2006 vs. 2005

          

          2005 vs. 2004Increase/(Decrease) Due to

          

          Total Increase (Decrease)

          

          Increase/(Decrease) Due to

          

          Total Increase (Decrease)Volume

          

          Rate

          

          Volume

          

          Rate(Dollars in Thousands)Interest income:Loans receivable

          

          $

          985

          

          

          $

          305

          

          

          $

          1,290

          

          

          $

          1,154

          

          

          $

          (64

          )

          

          $

          1,090Mortgage-backed securities

          

          

          (75

          )

          

          

          28

          

          

          

          (47

          )

          

          

          (99

          )

          

          

          15

          

          

          

          (84

          )Investment securities (available for sale)

          

          

          10

          

          

          

          101

          

          

          

          111

          

          

          

          4

          

          

          

          87

          

          

          

          91Investment securities (held to maturity)

          

          

          0

          

          

          

          (2

          )

          

          

          (2

          )

          

          

          0

          

          

          

          1

          

          

          

          1Other interest-earnings assets

          

          

          (91

          )

          

          

          110

          

          

          

          19

          

          

          

          14

          

          

          

          91

          

          

          

          105Total interest income

          

          

          829

          

          

          

          542

          

          

          

          1,371

          

          

          

          1,073

          

          

          

          130

          

          

          

          1,203Interest expense:Savings deposits

          

          

          (132

          )

          

          

          (16

          )

          

          

          (148

          )

          

          

          11

          

          

          

          101

          

          

          

          112Demand and NOW deposits

          

          

          15

          

          

          

          38

          

          

          

          53

          

          

          

          0

          

          

          

          2

          

          

          

          2Certificates of deposits

          

          

          379

          

          

          

          581

          

          

          

          960

          

          

          

          151

          

          

          

          196

          

          

          

          347Escrow

          

          

          0

          

          

          

          0

          

          

          

          0

          

          

          

          0

          

          

          

          0

          

          

          

          0Borrowings

          

          

          479

          

          

          

          328

          

          

          

          807

          

          

          

          58

          

          

          

          201

          

          

          

          259Total interest expense

          

          

          741

          

          

          

          931

          

          

          

          1,672

          

          

          

          220

          

          

          

          500

          

          

          

          720Net interest income

          

          $

          88

          

          

          

          ($389

          )

          

          $

          (301

          )

          

          $

          853

          

          

          $

          (370

          )

          

          $

          483
 Comparison of Operating Results for the Years Ended December 31, 2006 and 2005 Net Income. Net income decreased by $221,000, or 92.47%, to $18,000 for the year ended December 31, 2006, from $239,000 for the year ended December 31, 2005. The decrease was due primarily to a $1,672,000 increase in interest expense, and a $318,000 increase in provision for loan losses, offset by a $1,371,000 increase in interest income and a $218,000 decrease in non-interest expenses. Net Interest Income. Net interest income decreased $301,000, or 7.67%, to $3,624,000 for the year ended December 31, 2006, from $3,925,000 for the year ended December 31, 2005. The decrease was due primarily to an increase of $15,146,000, or 11.28%, in average interest bearing liabilities to $149,469,000 from $134,323,000 and an 85 basis point increase in the cost of average interest bearing liabilities. These increases were partially offset by an increase of $14,332,000, or 9.37%, in average interest earning assets to $167,281,000 from $152,949,000 and a 38 basis point increase in the yield on average interest earning assets. Our interest rate spread decreased to 1.75% from 2.22%, reflecting the more rapid increase in the cost of our average interest bearing liabilities as compared to the increase in the yield of our average interest earning assets. Our net interest margin decreased to 2.17% from 2.57% because the growth in average interest earning assets was not enough to offset the increase in the cost of interest bearing liabilities. The ratio of interest earning assets to interest bearing liabilities remained relatively steady at 1.11 times for the year ended December 31, 2006 from 1.14 times for the year ended December 31, 2005.


11

---

Interest Income. Interest income increased by $1,371,000, or 17.76%, to $9,091,000 for the year ended December 31, 2006, from $7,720,000 for the year ended December 31, 2005. The increase in interest income resulted primarily from an increase of $1,290,000, or 18.76%, in interest and fee income from loans, $109,000, or 25.23%, in interest income from investment securities and $19,000, or 9.09%, in interest income from other interest earning assets (primarily consisting of interest earned on federal funds sold and Federal Home Loan Bank stock), partially offset by a decrease of $47,000, or 23.047% in interest income from mortgage-backed
securities. The increase in interest income reflected a $14,332,000, or 9.37% increase in the average balance of interest earning assets to $167,281,000 from $152,949,000, and a 38 basis point increase in the yield on average interest earning assets to 5.43% for the year ended December 31, 2006 from 5.05% for the year ended December 31, 2005, reflecting an increase in market interest rates. The increase in interest income and fees on loans was due to an $18,069,000, or 13.99% increase in average net loans receivable, from $129,169,000 to $147,238,000 and a 23 basis point increase in the average yield on net loans receivable. The increase in interest income from investment securities was primarily reflective of a 122 basis point increase in the average yield and a $280,000 or 3.47% increase in the average balance of available for sale investment securities. The decrease in interest income from mortgage-backed securities was primarily the result of a $1,889,000, or 33.36% decline in average mortgage-backed securities, which was partially offset by a 56 basis point increase in the yield on these securities. Interest Expense. Interest expense, which consists of interest paid on deposits and borrowings, increased by $1,672,000, or 44.06% to $5,467,000 for the year ended December 31, 2006, from $3,795,000 for the year ended December 31, 2005. The increase in interest expense resulted from an increase in the average balance and average cost of interest bearing liabilities. The average balance of interest bearing deposits increased to $109,224,000 from $108,058,000 and the average cost of deposits increased by 79 basis points as a result of a rising interest rate market. The average balance of borrowings increased to $39,250,000 from $26,250,000 and
the average cost of borrowings increased by 104 basis points as a result of borrowings at higher interest rates. Provision for Loan Losses. We establish provisions for loan losses, which are charged to operations, at a level estimated as necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management considers, among other things, historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of any underlying collateral, and prevailing economic conditions (particularly as such conditions relate to
our market area). We charge losses on loans against the allowance when we believe that collection of loan principal is unlikely. Recoveries on loans previously charged off are added back to the allowance. Based on our evaluation of these factors, management made a provision of $376,000 and $58,000 for the years ended December 31, 2006 and December 31, 2005, respectively. There was one overdraft protection line of credit loan charge-off during the year ended December 31, 2006, which was less than $1,000. As discussed below under General Valuation Allowance on the Remainder of the Loan Portfolio, we fully reserved for two commercial non-real estate loans in the allowance for loan losses. These loans were not charged-off during the period ended December 31, 2006 because the final disposition of this matter is still pending a resolution of the
bankruptcy proceedings. We had an automobile loan charge-off of $2,000 during the year ended December 31, 2005. We used the same methodology and generally similar assumptions in assessing the allowance for both periods.


12

---

The provision for 2006 reflects part of the $423,000 allowance that we have allocated to the non-performing acquisition and development loan described above and two impaired non-real estate commercial loans discussed below, the increase of $350,000 in commercial mortgage loans and $1,319,000 in commercial non-mortgage loans during the year ended December 31, 2006. Non-performing loans increased to $1,486,000 from $1,245,000, or 19.36% for the period. Non-performing loans were 1.01% and 0.86% of total loans at December 31, 2006 and 2005. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revisions as more information becomes available or as future events change. The level of the allowance is based on estimates, and the ultimate losses may vary from these estimates. The allowance for loan losses totaled $850,000, or 0.57%, of gross loans outstanding of $148,160,000 at December 31, 2006, compared to an allowance for loan losses of $474,000, or 0.32% of gross loans outstanding of $146,008,000 at December 31, 2005. The increase to the loan loss reserve is due to the increase of our loans receivable balance and the addition of $260,000, or 100% of the loan balances of two commercial non-real estate loans that are classified as impaired. As of December 31, 2006, pursuant to regulatory requirements, we made the additional provision of $260,000 to the allowance for loan losses because we believe there is a substantial
likelihood that we will not collect the total amount of the outstanding principal balance on these loans. In mid-July 2006, a corporate commercial loan borrower informed the Bank that it was contemplating ceasing business operations, which it did as of July 31, 2006. The principal of this company also borrowed additional funds from the Bank directly. Both of these loans were cross-guaranteed, cross-defaulted and cross-collateralized. Once the company ceased operations, the borrower and guarantor were in non-financial default on these loans, even though the loans were current as of that date. On September 11, 2006, the Bank gave written notice to the borrower and the guarantor that they had defaulted on their loan agreements. Subsequently, the company filed for Chapter 7 bankruptcy on September 26, 2006. The borrower has made a partial settlement offer, to which the Bank made a counter offer. Final disposition of this matter is still pending as of the date of this report. Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically reviews our allowance for loan losses. The Office of Thrift Supervision may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. Other Income. Historically, our non-interest income has been relatively modest and one of our strategic initiatives is to increase our non-interest income. Non-interest income increased $43,000 or 18.38%, to $277,000 for the year ended December 31, 2006, as compared to $234,000 for the year ended December 31, 2005. The primary reason for the increase in non-interest income is a $39,000 increase in gain on sale of loans to $40,000 for the year ended December 31, 2006 as compared to $1,000 for the year ended December 31, 2005. Rental income from our headquarters building increased $12,000, or 8.63%, to $151,000 for the year ended December 31,
2006 as compared to $139,000 for the year ended December 31, 2005. The increase in rental income is a result of our headquarters building being 88% leased to non-affiliated tenants at the end of 2006 as compared to 81% at the end of 2005. Our other income (generally, fees from deposit accounts, late charges from delinquent loan products and ATM fees) decreased by $8,000, or 8.51%, to $86,000 for the year ended December 31, 2006, as compared to $94,000 for the year ended December 31, 2005. The decrease is primarily due to the additional $18,000 received during the 2005 period in connection with the adjustment to the purchase price of the sale of our ground rents in 2004. The ground rent portfolio was sold to a company controlled by director J. Benson Brown. Ground rents are relatively unique to the Baltimore area. They represent obligations on the part of a homeowner to pay semi-annual rents to the holder of their ground lease. The ground lease typically is for a term of 99 years, automatically renewable forever and is freely transferable. The only obligation of the homeowner is to pay the ground rent to the holder of the ground lease for as long as the homeowner owns the real property. The holder of the ground lease has no right to take possession of the real property as long as the ground rent is paid.


13

---

Under Maryland law, the owner of the real property has a right to redeem the ground lease based upon a statutory formula. The resale price of a ground lease is typically substantially less than the redemption price. During the first part of 2004, we made a strategic decision to sell our ground rent portfolio because this type of investment was not consistent with our long range plans in light of the servicing and collection burden associated with a large group of small balances. Non-interest Expense. Non-interest expense was $3,482,000 for the year ended December 31, 2006 as compared to $3,700,000 for the year ended December 31, 2005, a decrease of $218,000, or 5.89%. The decrease was due primarily to a $154,000 decrease in other expenses (consisting primarily of office supplies and printing expenses, network support expenses, professional services expenses, dues and subscriptions expenses, and professional fees associated with being a public company). The decrease in other non-interest expenses resulted primarily from a $68,000 decrease in professional legal fees, a $29,000 decrease in printing expenses, a $17,000 decrease in office supplies, a $14,000 decrease in franchise taxes, a $13,000 decrease in stock transfer agent fees and a $13,000 decrease in other operating expenses. Income Tax Expense. The provision for income taxes decreased to $25,000 for the year ended December 31, 2006 from $162,000 for the year ended December 31, 2005, representing a decrease of $137,000, or 84.57%. The decrease in the provision for income taxes was due to a lower level of income before taxes. The effective tax rate was 58.14% and 40.48% for 2006 and 2005, respectively. Management of Market Risk General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting of deposits and borrowings. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, we have an asset/liability management committee, which consists of senior management and one outside director operating under a policy adopted by the board of directors. The
committee is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors. Senior management monitors the level of interest rate risk on a regular basis and the asset/liability management committee meets at least quarterly to review our asset/liability policies and interest rate risk position. Net Portfolio Value and Interest Rate Risk. In past years, many savings institutions have measured interest rate sensitivity by computing the gap between the assets and liabilities which are expected to mature or reprice within certain time periods, based on assumptions regarding loan prepayment and deposit decay rates formerly provided by the Office of Thrift Supervision. However, the Office of Thrift Supervision now requires the computation of amounts by which the net present value of an institutions cash flow from assets, liabilities and off -balance sheet items (the institutions net portfolio value or
NPV) would change in the event of a range of assumed changes in market interest rates. The Office of Thrift Supervision provides all institutions that file a Consolidated Maturity/Rate Schedule as a part of their quarterly Thrift Financial Report with an interest rate sensitivity report of net portfolio value. The Office of Thrift Supervision simulation model uses a discounted cash flow analysis and an option-based pricing approach to measuring the interest rate sensitivity of net portfolio value. Historically, the Office of Thrift Supervision model estimated the economic value of each type of asset, liability and off-balance sheet contract under the assumption that the United States Treasury yield curve increases or decreases instantaneously on any given day by 100 to 300 basis points in 100 basis point increments. However, given the current low level of market interest rates, we did not receive a NPV calculation for an interest rate decrease of greater than 200 basis
points. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the Change in Interest Rates column below. The Office of Thrift Supervision provides us the results of the interest rate sensitivity model, which is based on information we provide to the Office of Thrift Supervision to estimate the sensitivity of our net portfolio value.


14

---

The table below sets forth, as of December 31, 2006, the estimated changes in our net portfolio value that would result from the designated instantaneous changes in the United States Treasury yield curve.  Change in Interest Rates (basis points)

          

          Net Portfolio Value

          

          Net Portfolio Value as a % of Present Value of AssetsEstimated NPV

          

          Amount of Change

          

          Percent of Change

          

          NPV Ratio

          

          Change in Basis Points(Dollars in Thousands)+300

          

          $

          5,417

          

          

          $

          (10,743

          )

          

          

          (66

          )%

          

          

          3.42

          %

          

          

          (588) basis points+200

          

          

          9,231

          

          

          

          (6,296

          )

          

          

          (43

          )

          

          

          5.64

          

          

          

          (366) basis points+100

          

          

          12,875

          

          

          

          (3,285

          )

          

          

          (20

          )

          

          

          7.63

          

          

          

          (168) basis points0

          

          

          16,160

          

          

          

          

          

          

          

          

          

          

          

          9.30

          

          

          

           basis points-100

          

          

          18,517

          

          

          

          2,357

          

          

          

          15

          

          

          

          10.40

          

          

          

          110 basis points-200

          

          

          19,343

          

          

          

          3,183

          

          

          

          20

          

          

          

          10.68

          

          

          

          138 basis points
 The table above indicates that at December 31, 2006, in the event of a 100 basis point increase in interest rates, we would experience a 20% decrease in net portfolio value. In the event of a 200 basis point increase in interest rates, we would experience a 43% decrease in net portfolio value. Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in net portfolio value require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net portfolio value table presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of
specific assets and liabilities. Accordingly, although the net portfolio value table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results. As indicated above, our ability to maintain a positive spread between the interest earned on assets and the interest paid on deposits and borrowings is affected by changes in interest rates. Our fixed-rate loans generally are profitable if interest rates are stable or declining since these loans have yields that exceed our cost of funds. If interest rates increase, however, we would have to pay more on our deposits and new borrowings, which would adversely affect the interest rate spread. In order to offset the potential effects of dramatic increases in market rates of interest, we have, among other things, implemented or will implement a
number of strategies designed to assist in managing interest rate risk, including the following: 

          Pursuing greater diversification into other types of lending, particularly commercial real estate and commercial business loans, which typically have shorter terms and higher interest rates than single family residential mortgage loans; 

          Offering a variety of adjustable rate loan products, including one-to-five-year adjustable rate mortgage loans, construction loans and home equity lines of credit; 

          Reducing the interest rate sensitivity of interest-bearing liabilities through utilizing fixed rate FHLB advances with terms of more than one year; 

          Placing a greater emphasis on building sources of non-interest income through expanded offerings of products and services and selling mortgage loans on the secondary market; and 

          Emphasizing growth of less interest rate sensitive and lower cost core deposits in the form of transaction accounts, including commercial deposit accounts.


15

---

Liquidity Management Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, borrowings from the Federal Home Loan Bank of Atlanta, scheduled amortization and prepayment of loans and mortgage-backed securities, maturities and calls of held to maturity investment securities and earnings and funds provided from operations. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows, calls of securities and loan prepayments are greatly influenced by market interest rates, economic conditions, and
rates offered by our competition. We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management policy. Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At December 31, 2006, cash and cash equivalents totaled $2,851,000. Securities classified as available-for-sale, which can provide additional sources of liquidity, totaled $8,526,000 at December 31, 2006. However, because all of these securities were in an unrealized loss position at December 31, 2006,and because management has the intent and ability to hold these securities until recovery or maturity, management does not consider these securities as a source of liquidity at
December 31, 2006. Also, at December 31, 2006, we had advances outstanding of $39,000,000 from the Federal Home Loan Bank of Atlanta. On that date, we had the ability to borrow an additional $13,268,000. At December 31, 2006, we had outstanding commitments to originate loans of $830,000 (excluding the undisbursed portions of loans). These commitments do not necessarily represent future cash requirements since certain of these instruments may expire without being funded. We also extend lines of credit to customers, primarily home equity lines of credit. The borrower is able to draw on these lines as needed, thus the funding is generally unpredictable. Unused home equity lines of credit amounted to $5,335,000 at December 31, 2006 and unused commercial lines of credit amounted to $1,210,000 at December 31, 2006. Since the majority of unused lines of
credit expire without being funded, it is anticipated that our obligation to fund the above commitment amount will be substantially less than the amounts reported. Certificates of deposit accounts scheduled to mature within one year totaled $51,914,000, or 46.43%, of total deposits at December 31, 2006. Management believes that the large percentage of deposits in shorter-term certificates of deposit reflects customers hesitancy to invest their funds in long-term certificates of deposit in the current interest rate environment. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and/or additional borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we
currently pay on the certificates of deposit due on or before December 31, 2007. We believe, however, that, based on past experience, a significant portion of our certificates of deposit will remain with us. We believe we have the ability to attract and retain deposits by adjusting the interest rates offered. The following table presents certain of our contractual obligations as of December 31, 2006.  Contractual Obligations

          

          Total

          

          Less than One Year

          

          One to Three Years

          

          Three to Five Years

          

          More than Five Years(Dollars in thousands)Long and short-term debt obligations

          

          $

          39,000

          

          

          $

          12,500

          

          

          $

          1,500

          

          

          $

          

          

          

          $

          25,000Certificate of deposit maturities

          

          

          85,996

          

          

          

          51,914

          

          

          

          19,511

          

          

          

          14,571

          

          

          

          Leases

          

          

          9

          

          

          

          9

          

          

          

          

          

          

          

          

          

          

          

          Total

          

          $

          124,996

          

          

          $

          64,414

          

          

          $

          21,011

          

          

          $

          14,571

          

          

          $

          25,000


16

---

Our borrowings are with the Federal Home Loan Bank of Atlanta and are secured by Federal Home Loan Bank of Atlanta stock that we own and a blanket lien on mortgages. Borrowings at December 31, 2006 consisted of $12,500,000 short term fixed rate FHLB advances bearing interest at rates ranging from 5.28% to 5.36% and $26,500,000 long term convertible rate FHLB advances with fixed interest rates ranging from 3.63% to 4.90%. If not repaid or converted to a different product, the convertible rate advances will convert from a fixed to a floating rate after the initial borrowing periods ranging from one to five years. Borrowings at December 31, 2005
consisted of $5,000,000 short term fixed rate FHLB advances bearing interest at 2.83%, and $26,500,000 long term fixed rate FHLB advances with interest rates ranging from 3.08% to 4.90%. The following table represents information regarding short term FHLB borrowings during the years ended December 31, 2006 and 2005.  December 31, 2006

          

          December 31, 2005(Dollars in thousands)Total outstanding at period-end

          

          $

          12,500

          

          

          $

          9,500Average interest rate at period-end

          

          

          5.33

          %

          

          

          3.59

          %Average balance during the period

          

          $

          12,667

          

          

          $

          8,750Average interest rate during the period

          

          

          4.49

          %

          

          

          2.75

          %Maximum balance during the period

          

          $

          9,500

          

          

          $

          15,000
 Our primary investing activity is the origination of loans, primarily one- to four-family residential mortgage loans, commercial loans, and the purchase of securities. Our primary financing activity consists of activity in deposit accounts and Federal Home Loan Bank of Atlanta advances. Asset growth has outpaced deposit growth over the past 30-36 months and the increased liquidity needed to fund the asset growth has been provided through increased Federal Home Loan Bank borrowings. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally
manage the pricing of our deposits to be competitive. Occasionally, we offer promotional rates on certain deposit products to attract deposits. The following table presents our primary investing and financing activities during the periods indicated.  Year Ended December 31,2006

          

          2005(Dollars in Thousands)Investing Activities:One- to four-family loan originations

          

          $

          14,400

          

          

          $

          27,444Other loan originations

          

          

          12,222

          

          

          

          11,806Financing Activities:Increase (Decrease) in deposits

          

          

          2,190

          

          

          

          (85

          )Increase in FHLB advances

          

          

          3,000

          

          

          

          9,500
 The foregoing was consistent with our expectations and the pricing policies we implemented. All of our deposit products other than savings deposits increased during 2006. Specifically, certificates of deposit increased by $9,096,000, non-interest bearing deposits increased by $538,000, NOW and money market demand deposits increased by $251,000 while savings deposits decreased by $7,695,000. Deposits decreased slightly in 2005 due to a declinein savings and money market deposits, offset by an increase in certificates of deposits, a result of normal business fluctuations. We are not aware of any known trends, events or uncertainties that will have or are reasonably likely to have a material effect on our liquidity, capital or operations, nor are we aware of any current recommendation by regulatory authorities, which if implemented, would have a material effect on liquidity, capital or operations.


17

---

Capital Management We are subject to various regulatory capital requirements administered by the Office of Thrift Supervision, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2006, we exceeded all of our regulatory capital requirements. We are considered well capitalized under regulatory guidelines. See note 14 of the notes to the consolidated financial statements. Off-Balance Sheet Arrangements In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers requests for funding and take the form of loan commitments and lines of credit. Our exposure to credit loss from non-performance by the other party to the above-mentioned financial instruments is represented by the contractual amount of those instruments. We use the same credit policies in
making commitments and conditional obligations as we do for on-balance sheet instruments. In general, we do not require collateral or other security to support financial instruments with off-balance sheet credit risk.  Financial Instruments Whose Contract Amount Represents Credit Risk

          

          Contract Amount atDecember 31, 2006

          

          December 31, 2005Lines of credit  commercial

          

          $

          1,210

          

          

          $

          1,018Lines of credit  home equity

          

          

          5,335

          

          

          

          5,073Lines of credit  overdraft checking

          

          

          118

          

          

          

          95Mortgage loan commitments

          

          

          830

          

          

          

          2,425
 Commercial lines of credit are generally secured by a blanket lien on assets of the borrower. Revolving Lines of Credit (RLOC) are typically used for short term working capital needs and are based most heavily on the accounts receivable and inventory components of the borrowers balance sheet. RLOC have terms of one year, are subject to annual reaffirmation and carry variable rates of interest. We generally receive a one percent fee, based on the commitment amount. Equipment lines of credit are secured by equipment being purchased and sometimes by a blanket lien on assets of the borrower as well. Each advance is repaid over a three to five year period and carries a variable or prevailing fixed rate of interest. We will generally advance up to 80% of the cost of the new or used equipment. These credit facilities are revolving in nature and the commitment is subject to annual reaffirmation. For both types of credit facilities listed above, we evaluate each customers credit worthiness on a case-by-case basis. Home equity lines of credit are secured by second deeds of trust on residential real estate. They have fixed expiration dates as long as there is no violation of any condition established in the contract. We evaluate each customers credit worthiness on a case-by-case basis. Overdraft lines of credit on checking accounts are unsecured. Linked to any Slavie Federal personal checking account, the line will automatically make a deposit to the customers checking account if the balance falls below the amount needed to pay an item presented for payment. Our outstanding commitments to make mortgages are at fixed rates ranging from 5.625% to 7.125% and 5.00% to 6.00% at December 31, 2006 and December 31, 2005, respectively. Loan commitments expire 60 days from the date of the commitment. For the years ended December 31, 2006 and December 31, 2005, we engaged in no off-balance-sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.


18

---

Impact of Inflation and Changing Prices The financial statements and related notes of Slavie Federal Savings Bank have been prepared in accordance with GAAP. GAAP generally 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 impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all of our assets and liabilities are primarily monetary in nature. As a result, interest rates generally have a more significant impact on our performance than does the effect of inflation.
Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates. For a discussion of the possible effect of changes in interest rates on our operations, see   Management of Market Risk. Forward Looking Statements In addition to the historical information contained herein, this Annual Report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including with respect to our future business plans and strategy. Forward-looking statements often use words such as believe, expect, plan, may, will, should, project, contemplate, anticipate, forecast, intend or other words of similar meaning. You can also
identify them by the fact that they do not relate strictly to historical or current facts. These forward-looking statements include statements regarding profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk and financial and other goals. These forward-looking statements are based on our beliefs, assumptions and on information available to us as of the date of this Annual Report, and involve risks and uncertainties. These risks and uncertainties include, among others: the effect of rising interest rates on our profits and asset values; risks related to our intended increased focus on commercial real estate and commercial business loans; our limited recognition and reputation in our markets; adverse economic conditions in our market area; the dependence on key personnel; competitive factors within our market area; the effect of developments in technology on our business; adverse
changes in the overall national economy as well as adverse economic conditions in our specific market area; adequacy of the allowance for loan losses; expenses as a result of our stock benefit plans; our ability to successfully utilize the proceeds from our recent stock offering and changes in regulatory requirements. Our actual results and the actual outcome of our expectations and strategies could differ materially from those described in this Annual Report. Because of these risks and uncertainties, you should not put undue reliance on any forward-looking statements. All forward-looking statements speak only as of the date of this filing, and we undertake no obligation to make any revisions to the forward-looking statements to reflect events or circumstances after the date of this filing or to reflect the occurrence of unanticipated events.


19

---

TABLE OF CONTENTS  Page No.Consolidated Financial StatementsReport of Independent Registered Public Accounting Firm





F-1Consolidated Statements of Financial Condition





F-2Consolidated Statements of Operations





F-3Consolidated Statements of Stockholders Equity





F-4Consolidated Statements of Cash Flows





F-5Notes to Consolidated Financial Statements





F-6  F-25


20

---

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders SFSB, Inc. Bel Air, Maryland We have audited the accompanying consolidated statements of financial condition of SFSB, Inc. and Subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, 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 consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits 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 consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated 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 SFSB, Inc. and Subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ Beard Miller Company LLP Beard Miller Company LLP Baltimore, Maryland March 23, 2007


F-1

---

SFSB, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION  December 31,2006

          

          2005(Dollars in Thousands, Except for Per Share Data)ASSETSCash and due from banks

          

          

          $881

          

          

          $

          710Federal funds sold

          

          

          1,970

          

          

          

          632Cash and cash equivalents

          

          

          2,851

          

          

          

          1,342Investment securities  available for sale

          

          

          8,526

          

          

          

          8,153Investment securities  held to maturity

          

          

          4,000

          

          

          

          3,998Mortgage backed securities  held to maturity

          

          

          3,200

          

          

          

          4,525Loans receivable  net of allowance for loan losses of 2006 $850; 2005 $474

          

          

          147,118

          

          

          

          144,609Federal Home Loan Bank of Atlanta stock at cost

          

          

          2,098

          

          

          

          1,955Premises and equipment, at cost, less accumulated depreciation

          

          

          5,265

          

          

          

          5,612Accrued interest receivable

          

          

          560

          

          

          

          487Other assets

          

          

          607

          

          

          

          386Total assets

          

          

          $174,225

          

          

          $

          171,067LIABILITIES AND STOCKHOLDERS EQUITYLiabilitiesDeposits

          

          

          $111,823

          

          

          $

          109,623Checks outstanding in excess of bank balance

          

          

          384

          

          

          

          1,919Borrowings

          

          

          39,000

          

          

          

          36,000Advance payments by borrowers for taxes and insurance

          

          

          350

          

          

          

          372Other liabilities

          

          

          303

          

          

          

          348Total liabilities

          

          

          151,860

          

          

          

          148,262Commitments and contingenciesStockholders EquityPreferred stock, no par value, 1,000,000 shares authorized, none issued and outstanding

          

          

          

          

          

          

          Common stock, par value $.01, 9,000,000 shares authorized, 2,975,625 shares issued at December 31, 2006 and 2005, and 2,907,759 and 2,975,625 shares outstanding at December 31, 2006 and 2005, respectively

          

          

          30

          

          

          

          30Additional paid-in capital

          

          

          12,788

          

          

          

          12,730Retained earnings (substantially restricted)

          

          

          11,393

          

          

          

          11,375Unearned Employee Stock Ownership Plan shares

          

          

          (1,050)

          

          

          

          (1,108

          )Treasury stock at cost, 2006, 67,866 shares and 2005, 10,000 shares

          

          

          (660)

          

          

          

          (96

          )Accumulated other comprehensive loss

          

          

          (136)

          

          

          

          (126

          )Total stockholders equity

          

          

          22,365

          

          

          

          22,805Total liabilities and stockholders equity

          

          

          $174,225

          

          

          $

          171,067
 See notes to consolidated financial statements.


F-2

---

SFSB. INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS  Years Ended December 31,2006

          

          2005(Dollars in Thousands, Except for Per Share Data)Interest and fees on loans

          

          

          $8,165

          

          

          $

          6,875Interest and dividends on investment securities

          

          

          541

          

          

          

          432Interest on mortgage backed securities

          

          

          157

          

          

          

          204Other interest income

          

          

          228

          

          

          

          209Total interest income

          

          

          9,091

          

          

          

          7,720Interest on deposits

          

          

          3,853

          

          

          

          2,988Interest on short-term borrowings

          

          

          466

          

          

          

          119Interest on long-term borrowings

          

          

          1,148

          

          

          

          688Total interest expense

          

          

          5,467

          

          

          

          3,795Net interest income

          

          

          3,624

          

          

          

          3,925Provision for loan losses

          

          

          376

          

          

          

          58Net interest income after provision for loan losses

          

          

          3,248

          

          

          

          3,867Other IncomeRental income

          

          

          151

          

          

          

          139Other income

          

          

          86

          

          

          

          94Gain on sale of loans

          

          

          40

          

          

          

          1Total other income

          

          

          277

          

          

          

          234Non-Interest ExpensesCompensation and other related expenses

          

          

          1,746

          

          

          

          1,777Occupancy expense

          

          

          471

          

          

          

          472Advertising expense

          

          

          172

          

          

          

          179Service bureau expense

          

          

          162

          

          

          

          155Furniture, fixtures and equipment

          

          

          204

          

          

          

          230Telephone, postage and delivery

          

          

          82

          

          

          

          88Other expenses

          

          

          645

          

          

          

          799Total non-interest expenses

          

          

          3,482

          

          

          

          3,700Income before income tax provision

          

          

          43

          

          

          

          401Income tax provision

          

          

          25

          

          

          

          162Net income

          

          

          $18

          

          

          $

          239Basic Earnings per Share

          

          

          $0.01

          

          

          $

          0.08Diluted Earnings Per Share

          

          

          $0.01

          

          

          $

          0.08
 See notes to consolidated financial statements.


F-3

---

SFSB. INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY YEARS ENDED DECEMBER 31, 2006 AND DECEMBER 31, 2005  Common Stock

          

          Additional Paid-In Capital

          

          Retained Earnings

          

          Unearned Employee Stock Ownership Plan Shares

          

          Treasury Stock

          

          Accumulated Other Comprehensive (Loss)

          

          Total(Dollars in Thousands)BALANCE   JANUARY 1, 2005

          

          $

          30

          

          

          $

          12,680

          

          

          $

          11,136

          

          

          $

          (1,166

          )

          

          $

          -

          

          

          $

          (60

          )

          

          $

          22,620Comprehensive income:Net income

          

          

          

          

          

          

          

          

          

          

          239

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          239Net unrealized loss on securities available for sale, net of taxes of $41

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          (66

          )

          

          

          (66

          )Total Comprehensive Income

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          173Compensation under stock based benefit plans

          

          

          

          

          

          

          50

          

          

          

          

          

          

          

          58

          

          

          

          

          

          

          

          

          

          

          

          108Purchase of treasury stock (10,000 shares)

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          (96

          )

          

          

          

          

          

          

          (96

          )BALANCE   DECEMBER 31, 2005

          

          

          30

          

          

          

          12,730

          

          

          

          11,375

          

          

          

          (1,108

          )

          

          

          (96

          )

          

          

          (126

          )

          

          

          22,805Comprehensive income:Net income

          

          

          

          

          

          

          

          

          

          

          18

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          18Net unrealized loss on securities available for sale, net of taxes of $6

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          (10)

          

          

          

          (10)Total Comprehensive Income

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          8Compensation under stock based benefit plans

          

          

          

          

          

          

          58

          

          

          

          

          

          

          

          58

          

          

          

          101

          

          

          

          

          

          

          

          217Purchase of treasury stock (68,361 shares)

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          (665)

          

          

          

          

          

          

          

          (665)BALANCE   DECEMBER 31, 2006

          

          

          $30

          

          

          

          $12,788

          

          

          

          $11,393

          

          

          

          $(1,050)

          

          

          

          $(660)

          

          

          

          $(136)

          

          

          

          $22,365
 See notes to consolidated financial statements.


F-4

---

SFSB, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS  Years Ended December 31,2006

          

          2005(Dollars in Thousands)Cash Flows From Operating ActivitiesNet income

          

          $

          18

          

          

          $

          239Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:Non-cash compensation under stock based compensation plans and Employee Stock Ownership Plan

          

          

          217

          

          

          

          108Net amortization of premiums and discounts of investment securities

          

          

          15

          

          

          

          26Amortization of deferred loan fees

          

          

          (54)

          

          

          

          (72

          )Provision for loan losses

          

          

          376

          

          

          

          58Gain on sale of loans

          

          

          (40)

          

          

          

          (1

          )Loans originated for sale

          

          

          (3,739)

          

          

          

          (155

          )Proceeds from loans sold

          

          

          3,779

          

          

          

          156Provision for depreciation

          

          

          410

          

          

          

          373Increase in accrued interest receivable and other assets

          

          

          (287)

          

          

          

          (142

          )Increase in accrued interest payable

          

          

          11

          

          

          

          31Decrease in other liabilities

          

          

          (57)

          

          

          

          (332

          )Net Cash Provided by Operating Activities

          

          

          649

          

          

          

          289Cash Flows from Investing ActivitiesPurchase of available for sale securities

          

          

          (390)

          

          

          

          (278

          )Net increase in loans

          

          

          (2,831)

          

          

          

          (26,693

          )Principal collected on mortgage backed securities

          

          

          1,309

          

          

          

          2,426Purchase of Federal Home Loan Bank of Atlanta stock

          

          

          (278)

          

          

          

          (735

          )Redemption of Federal Home Loan Bank of Atlanta Stock

          

          

          135

          

          

          

          226Purchases of premises and equipment

          

          

          (63)

          

          

          

          (143

          )Net Cash Used in Investing Activities

          

          

          (2,118)

          

          

          

          (25,197

          )Cash Flows from Financing ActivitiesNet increase (decrease) in deposits

          

          

          2,200

          

          

          

          (85

          )(Decrease) increase in checks outstanding in excess of bank balance

          

          

          (1,535)

          

          

          

          1,291Proceeds from long term borrowings

          

          

          6,500

          

          

          

          25,000Repayment of long term borrowings

          

          

          (11,500)

          

          

          

          (15,000

          )Net change of short term borrowings

          

          

          8,000

          

          

          

          (500

          )(Decrease) increase in advance payments by borrowers for taxes and insurance

          

          

          (22)

          

          

          

          43Purchase of treasury stock

          

          

          (665)

          

          

          

          (96

          )Net Cash Provided by Financing Activities

          

          

          2,978

          

          

          

          10,653Increase (decrease) in cash and cash equivalents

          

          

          1,509

          

          

          

          (14,255

          )Cash and cash equivalents at beginning of year

          

          

          1,342

          

          

          

          15,597Cash and cash equivalents at end of year

          

          

          $2,851

          

          

          $

          1,342Supplemental Disclosures of Cash Flows Information:Cash paid during the year for:Income taxes

          

          

          $295

          

          

          $

          202Interest expense

          

          

          $5,446

          

          

          $

          3,764
 See notes to consolidated financial statements.


F-5

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of SFSB, Inc. (the Company), its wholly-owned subsidiaries, Slavie Federal Savings Bank (the Bank) and the Banks wholly-owned subsidiary, Slavie Holdings, LLC (Holdings). The accompanying consolidated financial statements include the accounts and transactions of these companies on a consolidated basis since inception. All intercompany accounts and transactions have been eliminated in the consolidated financial statements. Slavie Bancorp, MHC, a mutual holding company whose activity is not included in the accompanying consolidated financial statements, owns 56.3% of the outstanding common stock of the Company as of December 31, 2006. Business The Companys primary business is the ownership and operation of the Bank. The Banks primary business activity is the acceptance of deposits from the general public and the use of the proceeds for investments and loan originations. The Bank is subject to competition from other financial institutions. The Bank is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities. Holdings, formed on August 18, 1999 as a Maryland limited liability company, was created to acquire and manage certain real property located at 1614 Churchville Road, Bel Air, Maryland. This property includes the main office and corporate headquarters of the Bank. In addition, the property houses mixed use office space, which is available for lease. Significant Group Concentrations of Credit Risk Most of the Banks activities are with customers located within the greater Baltimore metropolitan area. The Bank does not have any significant concentrations to any one industry or customer. Estimates The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenues and expenses for the period. Actual results could differ significantly from those estimates. The material estimate that is particularly susceptible to significant change in the near-term relates to the determination of the allowance for loan losses and the evaluation of other than
temporary impairment of investment securities. Investments and Mortgage Backed Securities Available for sale investment securities consist of an investment in Adjustable Rate Mortgage Portfolio Mutual Funds. Securities available for sale are carried at fair value. Unrealized gains and losses, net of tax, on available for sale securities are reported as accumulated other comprehensive income (loss) until realized. Realized gains and losses on sales, determined using the specific identification method, are included in earnings. Investments and mortgage-backed securities held to maturity are carried at amortized cost since management has the ability and intention to hold them to maturity. Amortization of related premiums and discounts are computed using the level yield method over the terms of the securities. The Company evaluates securities for other-than-temporary impairment on a quarterly basis. Consideration is given to (1) the length of time and the extent to which the fair value has been less than the cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for an anticipated recovery in fair value. In evaluating an issuers financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and
industry analysts reports.


F-6

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Summary of Significant Accounting Policies   (continued) Loans Receivable Loans receivable that management has the intent and ability to hold until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees and costs. Interest income is accrued on the unpaid principal balance. Loan origination fees and certain direct loan origination costs are deferred and recognized by the level yield method over the contractual life of the related loan as an adjustment of yield. The accrual of interest is generally discontinued when contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on nonaccrual loans generally is either applied against
principal or reported as interest income, according to managements judgment as to the collectibility of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. Allowance for Loan Losses An allowance for loan losses is provided through charges to income in an amount that management believes necessary for known and inherent losses in the loan portfolio that are both probable and estimable, based on evaluations of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay. Determining the amount of the allowance for loan losses requires the use of estimates and assumptions, which is
permitted under accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates. While management uses available information to estimate losses on loans, future additions to the allowances may be necessary based on changes in economic conditions, particularly in the State of Maryland. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks allowances for losses on loans. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Statement of Financial Accounting Standards (SFAS) No. 114, as amended by SFAS No. 118 addresses the accounting by creditors for impairment of certain loans. It is generally applicable for all loans except large groups of smaller balance homogeneous loans that are evaluated collectively for
impairment, including residential mortgage loans and consumer installment loans. It also applies to all loans that are restructured in a troubled debt restructuring involving a modification of terms. SFAS No. 114 requires that the impaired loans be measured on the present value of expected future cash flows discounted at the loans effective interest rate, or at the loans observable market price or the fair value of the collateral if the loan is collateral dependent. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans are reviewed for impairment on a monthly basis. The Companys methodology for assessing the adequacy of the allowance for loan losses consists of three key elements: (i) specific allowances for identified problem loans, including certain impaired or collateral-dependent loans; (ii) a general
valuation allowance on certain identified problem loans; and (iii) a general valuation allowance on the remainder of the loan portfolio. Specific Allowance on Identified Problem Loans.  The loan portfolio is segregated first between loans that are on the watch list and loans that are not. Each loan on the watch list is reviewed and an individual reserve allocation is established on certain loans based on such factors as: (i) the strength of the customers personal or business cash flow; (ii) the availability of other sources of repayment; (iii) the amount due or past due; (iv) the


F-7

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Summary of Significant Accounting Policies   (continued) type and value of collateral; (v) the strength of the collateral position; (vi) the estimated cost to sell the collateral; and (vii) the borrowers effort to cure the delinquency. If necessary, an allowance for certain impaired loans is established for the amounts by which the discounted cash flows (or collateral value or observable market price) are lower than the carrying value of the loan. General Valuation Allowance on Certain Identified Problem Loans.  A general allowance is established for watch list loans that do not have an individual allowance. These loans are segregated by loan category and allowance percentages are assigned to each category based on inherent losses associated with each type of lending and consideration that these loans, in the aggregate, represent an above-average credit risk and that more of these loans will prove to be uncollectible compared to loans in the general portfolio. General Valuation Allowance on the Remainder of the Loan Portfolio.  A general allowance is established for loans that are not on the watch list to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, has not been allocated to particular problem assets. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on the historical loss experience and delinquency trends. The allowance may be adjusted for significant factors that, in managements judgment, affect the collectibility of the portfolio as of the
evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting primary lending areas, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience in a particular segment of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are reevaluated regularly to ensure their relevance in the current environment. Premises and Equipment Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation. Depreciation is computed on the straight-line method, based on the useful lives of the respective assets. Income Taxes Deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities based on enacted tax rates expected to be in effect when such amounts are realized or settled. Deferred tax assets are recognized only to the extent that is more likely than not that such amounts will be realized based on consideration of available evidence. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Advertising Costs Advertising costs are expensed as incurred. Cash and Cash Equivalents For the statement of cash flows, cash and cash equivalents include cash on hand, cash in banks, Federal Home Loan Bank overnight deposits and federal funds sold. Generally, federal funds are sold for one day periods. Off-Balance Sheet Financial Instruments In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit. Such financial instruments are recorded in the balance sheet when they are funded.


F-8

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Summary of Significant Accounting Policies   (continued) Comprehensive Income Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on securities available for sale, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. Reclassification Certain amounts in the 2005 consolidated financial statements have been reclassified to conform to the 2006 presentation. Earnings Per Share Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding for the appropriate period. Unearned Employee Stock Ownership Plan (ESOP) shares are not included in outstanding shares. Diluted earnings per share is computed by dividing net income by the weighted average shares outstanding as adjusted for the dilutive effect of outstanding stock options and unvested stock awards. Potential common shares related to stock options and unvested stock awards are determined based on the treasury stock method. Information related to the calculation of earnings per share is
summarized for the years ended December 31, 2006 and 2005, as follows:  Year ended December 31, 2006Basic

          

          Diluted(In Thousands,Except Per Share Data)Net income

          

          $

          18

          

          

          $

          18Weighted average common shares outstanding

          

          

          2,815

          

          

          

          2,815Diluted securities:Stock options

          

          

          

          

          

          

          5Unvested Stock Awards

          

          

          

          

          

          

          1Adjusted weighted average shares

          

          

          2,815

          

          

          

          2,821Per share amount

          

          $

          0.01

          

          

          $

          0.01
  Year ended December 31, 2005Basic

          

          Diluted(In Thousands,Except Per Share Data)Net income

          

          $

          239

          

          

          $

          239Weighted average common shares outstanding

          

          

          2,853

          

          

          

          2,853Diluted securities:Stock options

          

          

          

          

          

          

          1Unvested Stock Awards

          

          

          

          

          

          

          Adjusted weighted average shares

          

          

          2,853

          

          

          

          2,854Per share amount

          

          $

          0.08

          

          

          $

          0.08


F-9

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Summary of Significant Accounting Policies   (continued) Share Based Compensation Effective January 1, 2005, the Company adopted SFAS 123R using the modified-prospective transition method. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense in the statement of income at fair value. In addition to recognizing expense for options granted or modified subsequent to the adoption date, under the modified-prospective transition method, the Company will recognize expense over the remaining required service period for any stock options granted prior to January 1, 2005 for the portion of those grants for which the requisite service has not yet been
rendered. Prior to the adoption of SFAS 123R, the Company did not recognize expense for stock options as it followed APB Opinion No. 25 and the exercise price of the options was not less than the share price at the date of grant. Employee Stock Ownership Plan The Company accounts for its employee stock ownership plan (ESOP) in accordance with American Institute of Certified Public Accountants (AICPA) Statement of Position 93-6. The cost of shares issued to the ESOP but not yet allocated to participants is presented in the consolidated balance sheet as a reduction of stockholders equity. Compensation expense is recorded based on the market price of the shares as they are committed to be released for allocation to participant accounts. The difference between the market price and the cost of shares committed to be released is recorded as an adjustment to additional paid-in capital.
Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are reflected as a reduction of debt. Shares are considered outstanding for earnings per share calculations when they are committed to be released; unallocated shares are not considered outstanding. Note 2 - Investment Securities  Available for Sale The amortized cost and fair value of available for sale investment securities are as follows:  Amortized Cost

          

          Gross Unrealized Gains

          

          Gross Unrealized Losses

          

          Fair Value(Dollars in Thousands)December 31, 2006:Adjustable Rate MortgagePortfolio Mutual Funds

          

          

          $8,747

          

          

          

          $

          

          

          

          $221

          

          

          

          $8,526December 31, 2005:Adjustable Rate MortgagePortfolio Mutual Funds

          

          $

          8,358

          

          

          $

          

          

          

          $

          205

          

          

          $

          8,153
 No gains or losses were realized for the years ended December 31, 2006 and 2005. The mutual funds have no stated maturity date.


F-10

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 3 - Investment Securities  Held to Maturity The amortized cost and fair value of held to maturity investment securities are as follows:  Amortized Cost

          

          Gross Unrealized Gains

          

          Gross Unrealized Losses

          

          Fair Value(Dollars in Thousands)December 31, 2006:FNMA Note

          

          

          $1,000

          

          

          

          $

          

          

          

          $31

          

          

          

          $969FHLB Notes

          

          

          2,000

          

          

          

          

          

          

          

          46

          

          

          

          1,954FFCB Note

          

          

          1,000

          

          

          

          

          

          

          

          13

          

          

          

          987Total

          

          

          $4,000

          

          

          

          $

          

          

          

          $90

          

          

          

          $3,910December 31, 2005:FNMA Note

          

          $

          998

          

          

          $

          

          

          

          $

          40

          

          

          $

          958FHLB Notes

          

          

          2,000

          

          

          

          

          

          

          

          48

          

          

          

          1,952FFCB Note

          

          

          1,000

          

          

          

          

          

          

          

          26

          

          

          

          974Total

          

          $

          3,998

          

          

          $

          

          

          

          $

          114

          

          

          $

          3,884
 The scheduled maturities of held to maturity investment securities at December 31, 2006 are shown below:  Amortized Cost

          

          Fair Value(Dollars in Thousands)Due within one year

          

          

          $1,000

          

          

          

          $987Due after one year through five years

          

          

          2,000

          

          

          

          1,943Due after ten years

          

          

          1,000

          

          

          

          980Total

          

          

          $4,000

          

          

          

          $3,910
 Note 4 - Mortgage Backed Securities  Held to Maturity The amortized cost and fair value of mortgage backed securities  held to maturity are as follows:  Amortized Cost

          

          Gross Unrealized Gains

          

          Gross Unrealized Losses

          

          Fair Value(Dollars in Thousands)December 31, 2006:FHLMC

          

          

          $1,731

          

          

          

          $

          

          

          

          $61

          

          

          

          $1,670GNMA

          

          

          1,246

          

          

          

          1

          

          

          

          6

          

          

          

          1,241FNMA

          

          

          223

          

          

          

          

          

          

          

          

          

          

          

          223$3,200

          

          

          

          $1

          

          

          

          $67

          

          

          

          $3,134December 31, 2005FHLMC

          

          $

          2,175

          

          

          $

          

          

          

          $

          79

          

          

          $

          2,096GNMA

          

          

          2,054

          

          

          

          1

          

          

          

          19

          

          

          

          2,036FNMA

          

          

          296

          

          

          

          2

          

          

          

          

          

          

          

          298$

          4,525

          

          

          $

          3

          

          

          $

          98

          

          

          $

          4,430


F-11

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5 - Gross Unrealized Losses of Investment Securities Below are schedules of securities with unrealized losses as of December 31, 2006 and 2005. The Companys unrealized losses are the result of interest rate levels differing from those existing at the time of the purchase of the securities and, as to mortgage backed securities, actual and estimated prepayment speeds. These unrealized losses are considered temporary as they reflect fair values on December 31, 2006 and are subject to change daily as interest rates fluctuate. The Company has the ability and intent to hold the securities until the earlier of recovery or maturity. At December 31, 2006 the Companys mutual fund equity securities
have unrealized loss depreciation of 2.53% from the Companys cost basis. No credit risk issues have been identified that cause management to believe the declines in fair value are other than temporary. In analyzing the issuers financial condition, management considers industry analysts reports, financial performance and projected target prices of investment analysts. No securities are deemed to be other than temporarily impaired. The following table shows the Companys gross unrealized losses and fair value of investments at December 31, 2006 and 2005:  Continuous Unrealized LossesFor Less Than 12 Months

          

          For More Than 12 Months

          

          TotalFair Value

          

          Unrealized Losses

          

          Fair Value

          

          Unrealized Losses

          

          Fair Value

          

          Unrealized Losses(Dollars in Thousands)December 31, 2006Available for Sale SecuritiesAdjustable Rate MortgagePortfolio Mutual Funds

          

          

          $

          

          

          

          $

          

          

          

          $8,526

          

          

          

          $221

          

          

          

          $8,526

          

          

          

          $221Held to Maturity SecuritiesFNMA Note  1 security

          

          

          

          

          

          

          

          

          

          

          969

          

          

          

          31

          

          

          

          969

          

          

          

          31FHLB Note  2 securities

          

          

          

          

          

          

          

          

          

          

          1,954

          

          

          

          46

          

          

          

          1,954

          

          

          

          46FFCB Note  1 security

          

          

          

          

          

          

          

          

          

          

          987

          

          

          

          13

          

          

          

          987

          

          

          

          13Mortgage Backed SecuritiesFHLMC  3 securities

          

          

          

          

          

          

          

          

          

          

          1,659

          

          

          

          61

          

          

          

          1,659

          

          

          

          61GNMA  2 securities

          

          

          

          

          

          

          

          

          

          

          1,128

          

          

          

          6

          

          

          

          1,128

          

          

          

          6Total temporarily impaired securities

          

          

          $

          

          

          

          $

          

          

          

          $15,223

          

          

          

          $378

          

          

          

          $15,223

          

          

          

          $378
  Continuous Unrealized LossesFor Less Than 12 Months

          

          For More Than 12 Months

          

          TotalFair Value

          

          Unrealized Losses

          

          Fair Value

          

          Unrealized Losses

          

          Fair Value

          

          Unrealized Losses(Dollars in Thousands)December 31, 2005Available for Sale SecuritiesAdjustable Rate MortgagePortfolio Mutual Funds

          

          $

          

          

          

          $

          

          

          

          $

          8,153

          

          

          $

          205

          

          

          $

          8,153

          

          

          $

          205Held to Maturity SecuritiesFNMA Note  1 security

          

          

          

          

          

          

          

          

          

          

          958

          

          

          

          40

          

          

          

          958

          

          

          

          40FHLB Notes  2 securities

          

          

          

          

          

          

          

          

          

          

          1,952

          

          

          

          48

          

          

          

          1,952

          

          

          

          48FFCB Note  1 security

          

          

          

          

          

          

          

          

          

          

          974

          

          

          

          26

          

          

          

          974

          

          

          

          26Mortgage Backed SecuritiesFHLMC  3 securities

          

          

          

          

          

          

          

          

          

          

          2,078

          

          

          

          79

          

          

          

          2,078

          

          

          

          79GNMA  2 securities

          

          

          715

          

          

          

          5

          

          

          

          1,127

          

          

          

          14

          

          

          

          1,842

          

          

          

          19Total temporarily impaired securities

          

          $

          715

          

          

          $

          5

          

          

          $

          15,242

          

          

          $

          412

          

          

          $

          15,957

          

          

          $

          417


F-12

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6 - Loans Receivable Loans receivable consist of the following:  December 31,2006

          

          2005(Dollars in Thousands)Mortgage loans 1  4 family residential

          

          

          $117,755

          

          

          $

          122,262Construction loans

          

          

          300

          

          

          

          1,515Commercial mortgage loans

          

          

          5,752

          

          

          

          5,402Commercial non-mortgage loans

          

          

          2,800

          

          

          

          1,481Home equity loans

          

          

          16,857

          

          

          

          10,439Land loans

          

          

          4,160

          

          

          

          4,299Home improvement loans

          

          

          116

          

          

          

          203Consumer loans

          

          

          420

          

          

          

          407Total Gross Loans Receivable

          

          

          148,160

          

          

          

          146,008Allowance for loan losses

          

          

          (850)

          

          

          

          (474

          )Deferred loan fees

          

          

          (132)

          

          

          

          (125

          )Loans in process

          

          

          (60)

          

          

          

          (800

          )Total Loans Receivable  Net

          

          

          $147,118

          

          

          $

          144,609
 Directors and officers of the Company are permitted to borrow from the Bank to the extent permitted by applicable laws and regulations. The following table shows the activity in these related party loans:  (Dollars in Thousands)Beginning balance

          

          

          $1,093Loans made

          

          

          203Principal repayments

          

          

          (54)Ending balance

          

          

          $1,242
 Residential lending is generally considered to involve less risk than other forms of lending, although payment experience on these loans is dependent to some extent on economic and market conditions in the Banks lending area. Construction loan repayments are generally dependent on the operations of the related properties or the financial condition of its borrower or guarantor. Accordingly, repayment of such loans can be more susceptible to adverse conditions in the real estate market and the regional economy. Activity in the Banks allowance for loan losses for the periods indicated is as follows:  Years EndedDecember 31,2006

          

          2005(Dollars in Thousands)Balance at beginning of period

          

          

          $474

          

          

          $

          413Provision for loan losses

          

          

          376

          

          

          

          58Charge-offs

          

          

          

          

          

          

          (2

          )Recoveries

          

          

          

          

          

          

          5Balance at end of period

          

          

          $850

          

          

          $

          474


F-13

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6 - Loans Receivable   (continued) The following tables show a summary of information pertaining to impaired and non-accrual loans:  Years EndedDecember 31,2006

          

          2005(Dollars in Thousands)Impaired loans without a valuation allowance

          

          

          $

          

          

          $

          Impaired loans with a valuation allowance

          

          

          1,343

          

          

          

          1,080Total impaired loans

          

          

          $1,343

          

          

          $

          1,080Valuation allowance related to impaired loans

          

          

          $423

          

          

          $

          108Total non-accrual loans

          

          

          $1,486

          

          

          $

          1,245Total loans past-due ninety days or more and still accruing

          

          

          $

          

          

          $

          
  Years EndedDecember 31,2006

          

          2005(Dollars in Thousands)Average investment in impaired loans

          

          

          $1,326

          

          

          $

          1,080Interest income recognized on impaired loans

          

          

          $29

          

          

          $

          Interest income recognized on a cash basis on impaired loans

          

          

          $29

          

          

          $

          
 No additional funds are committed to be advanced in connection with impaired loans. The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers. The financial instruments are limited to commitments to extend credit and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of financial position. The contract amounts of these instruments express the extent of involvement the Bank has in each class of financial instruments. The Banks exposure to credit loss from non-performance by the other party to the above-mentioned financial instruments is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Unless otherwise noted, the Bank does not require collateral or other security to support financial instruments with off-balance-sheet credit risk.  Financial Instruments Whose Contract Amount Represents Credit Risk

          

          Contract Amount atDecember 31, 2006

          

          December 31, 2005(Dollars in Thousands)Lines of credit  commercial

          

          

          $1,210

          

          

          $

          1,018Lines of credit  home equity

          

          

          5,335

          

          

          

          5,073Lines of credit  overdraft checking

          

          

          118

          

          

          

          95Mortgage loan commitments

          

          

          830

          

          

          

          2,425
 Commercial lines of credit are generally secured by a blanket lien on assets of the borrower. Revolving Lines of Credit (RLOC) are typically used for short term working capital needs and are based most heavily on the accounts receivable and inventory components of the borrowers balance sheet. RLOC have terms of one year, are subject to annual reaffirmation and carry variable rates of interest. The Bank generally receives a one percent fee, based on the commitment amount.


F-14

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6 - Loans Receivable   (continued) Equipment lines of credit are secured by equipment being purchased and sometimes by a blanket lien on assets of the borrower as well. Each advance is repaid over a three to five years term and carries a variable or prevailing fixed rate of interest. The Bank will generally advance up to 80% of the cost of the new or used equipment. These credit facilities are revolving in nature and the commitment is subject to annual reaffirmation. For both types of credit facilities listed above, the Bank evaluates each customers credit worthiness on a case-by-case basis. Home equity lines of credit are secured by second deeds of trust on residential real estate. They have fixed expiration dates as long as there is no violation of any condition established in the contract. The Bank evaluates each customers credit worthiness on a case-by-case basis. Overdraft lines of credit on checking accounts are unsecured. Linked to any Slavie Federal personal checking account, the line will automatically make a deposit to the customers checking account if the balance falls below the amount needed to pay an item presented for payment. The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. The Banks outstanding commitments to make mortgages are at fixed rates ranging from 5.625% to 7.125% and 5.00% to 6.00% at December 31, 2006 and December 31, 2005 respectively. Note 7 - Investment in Federal Home Loan Bank of Atlanta Stock The Bank is required to maintain an investment in the stock of the Federal Home Loan Bank of Atlanta (FHLB). On December 17, 2004, the FHLB adopted a new capital plan under which member institutions are required to maintain capital stock based upon two components. The first component is a stock requirement equal to 0.20% of the members total assets as of the preceding year end. The second component is a stock requirement equal to 4.50% of the members outstanding advances. Purchases and sales of stock are made directly with the FHLB at par value. This restricted stock is carried at cost. Note 8 - Premises and Equipment Premises and equipment are summarized by major classification as follows:  December 31,

          

          Useful Life in Years2006

          

          2005(Dollars in Thousands)Land

          

          

          $1,128

          

          

          $

          1,128

          

          

          

          Office building

          

          

          4,639

          

          

          

          5,141

          

          

          

          40Furniture, fixtures and equipment

          

          

          1,211

          

          

          

          1,337

          

          

          

          3  106,978

          

          

          

          7,606Accumulated depreciation

          

          

          1,713

          

          

          

          1,994$5,265

          

          

          $

          5,612
 The provision for depreciation charged to operations for the years ended December 31, 2006 and 2005 amounted to $410,000 and $373,000, respectively. Holdings has negotiated and rented office space to non-bank tenants in the Churchville Road property under various noncancellable operating leases. Credit is extended based on an evaluation of the lessees financial condition and, generally, collateral is not required. These leases included no commitments to provide for various tenant-finishing costs at December 31, 2006.


F-15

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 8 - Premises and Equipment   (continued) The cost and accumulated depreciation of the property, which is included in premises and equipment of the Company, was $5,420,000and $647,000, respectively, at December 31, 2006. Future minimum rentals to be received from non-Company tenants under noncancellable operating leases in effect at December 31, 2006, and in the aggregate, are as follows:  (Dollars in Thousands)2007

          

          

          $1442008

          

          

          1492009

          

          

          832010

          

          

          662011

          

          

          49Thereafter

          

          

          122$613
 Note 9 - Deposits The Bank has the following deposits:  December 31,2006

          

          2005(Dollars in Thousands)Non-interest bearing demand deposits

          

          

          $1,356

          

          

          $

          818NOW and money market demand deposits

          

          

          15,368

          

          

          

          15,117Savings deposits

          

          

          9,092

          

          

          

          16,787Certificates of deposit

          

          

          85,996

          

          

          

          76,900111,812

          

          

          

          109,622Accrued interest on deposits

          

          

          11

          

          

          

          1$111,823

          

          

          $

          109,623
 The aggregate amount of certificates of deposit accounts with a minimum denomination of $100,000 was $26,547,000 and $20,442,000 as of December 31, 2006 and 2005, respectively. Deposits in excess of $100,000 are not federally insured. Scheduled maturities of certificates of deposit are as follows:  December 31, 2006Maturing Within

          

          (Dollars in thousands)One year

          

          

          $51,914Two years

          

          

          11,956Three years

          

          

          7,555Four years

          

          

          8,808Five years

          

          

          5,763Total

          

          

          $85,996


F-16

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 9 - Deposits   (continued)  Years Ended December 31,2006

          

          2005Interest Expense on Deposits

          

          (In Thousands)NOW and money market demand deposits

          

          

          $149

          

          

          $

          120Savings deposits

          

          

          207

          

          

          

          331Certificates of deposit

          

          

          3,497

          

          

          

          2,537$3,853

          

          

          $

          2,988
 Note 10 - Borrowings The Bank has a line of credit from the Federal Home Loan Bank of Atlanta (FHLB). The line is secured by the FHLB stock and a blanket lien on mortgages. There is no set limit. Each borrowing is evaluated on a case-by-case basis by the lender. The Bank also has a $1 million unsecured line of credit with its correspondent bank, M & T Bank, however no advances have been made on this line. At December 31, 2006 and 2005, outstanding borrowings with the FHLB were $39 million and $36 million respectively. Borrowings at December 31, 2006 consisted of $12.5 million short term fixed rate FHLB advances bearing interest rates ranging from 5.28% to 5.36% and $26.5 million long term fixed rate FHLB advances with interest rates ranging from 3.63% to 4.90% as of December 31, 2006. Borrowings at December 31, 2005 consisted of $5 million short term fixed rate FHLB advances bearing interest at 2.83% and $26.5 million long term fixed rate FHLB advances with interest rates ranging from 3.08% to 4.90%. There is also $4.5 million short term daily rate
FHLB advances bearing an interest rate of 4.44% as of December 31, 2005. The maturities of advances outstanding as of December 31, 2006 are as follows:  Due Within

          

          (Dollars in Thousands)One year

          

          

          $12,500Two years

          

          

          1,500Beyond five years

          

          

          25,000$39,000
 Note 11 - 401(k) Plan and Deferred Compensation Agreement The Bank has a 401(k) plan. Employees could contribute up to $15,000 in 2006, with those over fifty years old allowed an additional $5,000 catch-up contribution. The Bank will match 25% of the employees contribution up to the amount as permitted by law. The Banks cost was $12,000 and $13,000, respectively, for the years ended December 31, 2006 and 2005. The Bank also entered into a deferred compensation agreement with one of its former officers. The liability under this agreement was accrued by charges to operating expense during prior periods. The liability balances were $44,000 and $55,000 at December 31, 2006 and 2005. Note 12  Stock Grants and Stock Option Plans On January 1, 2005, the Company adopted SFAS 123R using the modified-prospective transition method as more fully described in Note 1. The compensation expense recognized pertaining to the stock-based compensation plans was $161,000 and $54,000 for the years ended December 31, 2006 and 2005. The related tax benefit was $30,000 and $15,000 for the years ended December 31, 2006 and 2005. As of December 31, 2006, there was $428,000 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the plans. This cost is expected to be recognized over a weighted average period of 3.4 years.


F-17

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 12  Stock Grants and Stock Option Plans   (continued) Under the 2005 Stock Option Incentive Plan (the Plan), the directors and certain employees of the Company are eligible to receive options to purchase shares of common stock with an exercise price equal to the fair market value of a share of common stock on the grant date. Shares that may be issued under the Stock Option Plan shall not exceed in the aggregate 102,061 shares. Unless otherwise authorized by the Board of Directors, each grant shall vest over a five-year period and will expire no later than ten years from the date of the grant. Information regarding the Companys stock option plan as of and for the year ended December 31, 2006 is as follows:  Shares

          

          Weighted Average Price

          

          Weighted Average Remaining Life

          

          Aggregate Intrinsic ValueOptions outstanding, beginning of year

          

          

          102,061

          

          

          $

          9.15

          

          

          

          9.6Options granted

          

          

          

          

          

          

          

          

          

          

          Options exercised

          

          

          

          

          

          

          

          

          

          

          Options forfeited

          

          

          

          

          

          

          

          

          

          

          Options outstanding, end of year

          

          

          102,061

          

          

          $

          9.15

          

          

          

          8.6

          

          

          

          45,927Options exercisable, end of year

          

          

          26,244

          

          

          $

          9.15

          

          

          

          8.6

          

          

          

          11,810
 The weighted average grant-date fair value of each optiongranted in 2005 was computed to be$2.53. The fair value of the options awarded under the option plan is estimated on the date of grant using the Black-Scholes valuation model, which is dependent upon certain assumptions as presented below:  2005Expected life (in years)

          

          

          7Risk-free interest rate

          

          

          4.22

          %Expected volatility

          

          

          11.42

          %Expected dividend yield

          

          

          0.00

          %
 The expected life of the options is estimated using the average vesting period of the options granted and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the grant date. Volatility of the Companys stock price is based on historical volatility. Dividend yield is based on historical dividends divided by the average market price for that period. Under the 2005 Recognition and Retention Stock Award Plan (the Award Plan), the directors and certain employees of the Company are eligible to receive shares of restricted stock. If a participant terminates employment for reasons other than death, disability, normal retirement following a change of control, he or she forfeits all right to the unvested shares. The awards vest over a five-year period and, therefore, the fair value of such awards are accrued ratably over a five-year period as compensation expense.


F-18

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 12  Stock Grants and Stock Option Plans   (continued) Information regarding the Companys recognition and retention stock award plan as of and for the year ended December 31, 2006 is as follows:  Shares

          

          Weighted Average Grant Date Fair ValueNonvested shares outstanding, beginning of year

          

          

          38,102

          

          

          $

          9.40Shares granted

          

          

          

          

          

          

          Shares vested

          

          

          (10,495

          )

          

          $

          9.40Shares forfeited

          

          

          

          

          

          

          Nonvested shares, end of year

          

          

          27,607

          

          

          $

          9.40
 Note 13 - Common Stock In December 2006, the Company repurchased 68,361 shares of its stock at an average price of $9.72 per share. In December 2005, the Company repurchased 10,000 shares of its stock at $9.60 per share. Treasury Stock is recorded at cost and is shown as a reduction of stockholders equity. In 2004, the Bank reorganized to a federally chartered stock savings bank and it established an Employee Stock Ownership Plan (ESOP) for its employees. The ESOP acquired 116,630 shares of the Companys common stock with funds provided by a loan from the Company, to be repaid principally from the Banks contributions to the ESOP with twenty equal annual installments through 2024, bearing interest at the Wall Street Journal prime rate adjusted monthly. Shares are released to participants proportionately as the loan is repaid. The Bank recognizes compensation expense as shares are committed for release from collateral at their
current market price. Dividends on allocated shares are recorded as a reduction of retained earnings and dividends on unallocated shares are recorded as a reduction of debt. The compensation cost for the years ended December 31, 2006 and 2005 was $56,000 and $54,000, respectively. The ESOP holds the common stock in a trust for allocation among participating employees, in trust or allocated to the participants accounts; and an annual contribution from the Bank to the ESOP; and earnings thereon. There were 104,968 shares of unearned ESOP shares at December 31, 2006. The fair value of unearned ESOP shares at December 31, 2006 is $1,008,000. All employees of the Bank who attain the age of 21 and complete one year of service with the Bank will be eligible to participate in the ESOP. Each participants vested interest under the ESOP is determined according to the following schedule: 0% for less than 5 years of service with the Company and 100% for more than 5 years of service. For vesting purposes, a year of service means any plan year in which an employee completes at least 1,000 hours of service (whether before or after the ESOPs January 1, 2004 effective date). Vesting accelerates to 100% upon a participants attainment of normal retirement age 65, death or disability. Note 14  Regulatory Requirements The Bank is required to maintain cash reserve balances in vault cash or with the Federal Reserve Bank. The total of these reserve balances at December 31, 2006 was approximately $150,000. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Banks financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Banks assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting principles. The
Banks capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as


F-19

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 14  Regulatory Requirements   (continued) defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2006, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 2006, the most recent notification from the Office of Thrift Supervision has 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 I risk-based and Tier I leverage ratios as set forth in the table. There have been no conditions or events since that notification that management believes have changed the Banks category. The following table summarizes the Banks regulatory capital position at December 31, 2006.  Actual

          

          For Capital Adequacy Purposes

          

          To Be Well Capitalized Under Prompt Corrective Action ProvisionsAmount

          

          %

          

          Amount

          

          %

          

          Amount

          

          %(Dollars in Thousands)December 31, 2006Tangible(1)

          

          

          $16,775

          

          

          

          9.62 %

          

          

          

          $2,617

          

          

          

          1.50

          %

          

          

          N/A

          

          

          

          N/ATier I risk-based(2)

          

          

          16,775

          

          

          

          16.93 %

          

          

          

          N/A

          

          

          

          N/A

          

          

          

          $5,944

          

          

          

          6.00%Core (leverage)(1)

          

          

          16,775

          

          

          

          9.62 %

          

          

          

          6,978

          

          

          

          4.00%

          

          

          

          8,723

          

          

          

          5.00%Total risk-based(2)

          

          

          17,625

          

          

          

          17.79 %

          

          

          

          7,926

          

          

          

          8.00%

          

          

          

          9,907

          

          

          

          10.00%December 31, 2005Tangible(1)

          

          $

          16,651

          

          

          

          9.70

          %

          

          $

          2,574

          

          

          

          1.50

          %

          

          

          N/A

          

          

          

          N/ATier I risk-based(2)

          

          

          16,651

          

          

          

          17.76

          %

          

          

          N/A

          

          

          

          N/A

          

          

          $

          5,627

          

          

          

          6.00

          %Core (leverage)(1)

          

          

          16,651

          

          

          

          9.70

          %

          

          

          6,864

          

          

          

          4.00

          %

          

          

          8,580

          

          

          

          5.00

          %Total risk-based(2)

          

          

          17,125

          

          

          

          18.26

          %

          

          

          7,502

          

          

          

          8.00

          %

          

          

          9,378

          

          

          

          10.00

          %
  (1)

          To adjusted total assets. (2)

          To risk-weighted assets. The following table provides a reconciliation of total equity per the consolidated financial statements to capital amounts reflected in the above table:  December 31,2006

          

          2005(Dollars in Thousands)Total equity

          

          

          $22,365

          

          

          $

          22,805Adjustment for accumulated other comprehensive loss

          

          

          136

          

          

          

          126Adjustment for intangible assets

          

          

          (17)

          

          

          

          (35

          )Adjustment for parent company equity

          

          

          (5,709)

          

          

          

          (6,245

          )Tangible, Tier 1 and Core capital

          

          

          16,775

          

          

          

          16,651Allowance for loan losses

          

          

          850

          

          

          

          474Total risk-based capital

          

          

          $17,625

          

          

          $

          17,125


F-20

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 14  Regulatory Requirements   (continued) The Bank was allowed a special bad debt deduction at various percentages of otherwise taxable income for various years effectively through December 31, 1987. If the amounts, which qualified as deductions for federal income tax purposes prior to December 31, 1987, are later used for purposes other than to absorb loan losses, including distributions in liquidations, they will be subject to federal income tax at the then current corporate rate and mortgage loans must be maintained at the December 31, 1987 level to receive current tax deductions for loan losses. Retained earnings at December 31, 2006 and 2005 include $1,580,000, for which no provision
for federal income tax has been provided. The unrecorded deferred income tax liability on the above amount was approximately $610,000. Note 15 - Income Taxes The income tax provision consists of the following for the years ended December 31, 2006 and 2005.  December 31,2006

          

          2005(Dollars in Thousands)CurrentFederal

          

          $

          173

          

          

          $

          201State

          

          

          30

          

          

          

          31203

          

          

          

          232DeferredFederal

          

          

          (146

          )

          

          

          (59

          )State

          

          

          (32

          )

          

          

          (11

          )(178

          )

          

          

          (70

          )$

          25

          

          

          $

          162
 The amounts computed by applying the statutory federal income tax rate to the income before taxes is less than the taxes provided for the following reasons:  Years Ended December 31,2006

          

          2005Amount

          

          Percent of Pretax Income

          

          Amount

          

          Percent of Pretax Income(Dollars in Thousands)Federal tax at statutory rate

          

          

          $15

          

          

          

          34.00%

          

          

          $

          136

          

          

          

          34.00

          %Increases (Decreases) in TaxesState tax, net of federal income tax benefit

          

          

          $(2)

          

          

          

          (3.91)

          

          

          

          13

          

          

          

          3.24Other

          

          

          12

          

          

          

          28.05

          

          

          

          13

          

          

          

          3.24$25

          

          

          

          58.14%

          

          

          $

          162

          

          

          

          40.48

          %


F-21

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15 - Income Taxes   (continued) The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2006 and 2005 are presented below:  December 31,2006

          

          2005(Dollars in Thousands)Deferred Tax Assets:Allowance for loan losses

          

          

          $328

          

          

          $

          183Deferred compensation

          

          

          17

          

          

          

          21Reserve  uncollected interest

          

          

          1

          

          

          

          3Market value adjustment on available for sale securities

          

          

          85

          

          

          

          79Stock-based compensation

          

          

          46

          

          

          

          12Other

          

          

          

          

          

          

          5Total gross deferred tax assets

          

          

          477

          

          

          

          303Deferred Tax Liabilities:Federal Home Loan Bank of Atlanta stock dividends

          

          

          (100)

          

          

          

          (100

          )Depreciation

          

          

          (52)

          

          

          

          (62

          )Total gross deferred tax liabilities

          

          

          (152)

          

          

          

          (162

          )Net deferred tax assets

          

          

          $325

          

          

          $

          141
 Note 16 - Disclosures about Fair Value of Financial Instruments The estimated fair values of the Companys financial instruments are summarized below. The fair values of a significant portion of these financial instruments are estimates derived using present value techniques prescribed by the FASB and may not be indicative of the net realizable or liquidation values. Also, the calculation of estimated fair values is based on market conditions at a specific point in time and may not reflect current or future fair values. The carrying amount is a reasonable estimate of fair value for cash, federal funds, accrued interest receivable and accrued interest payable due to the short-term nature of these investments. Fair value is based upon market prices quoted by dealers for investment securities and mortgage backed securities. The carrying amount of Federal Home Loan Bank of Atlanta stock is a reasonable estimate of fair value. Loans receivable were discounted using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. These rates were used for each aggregated category of loans as reported on
the Office of Thrift Supervision Quarterly Report. The fair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered on deposits of similar remaining maturities. The fair value of borrowings is estimated using discounted cash flow analyses, based on rates currently available to the Bank for borrowings with similar terms and remaining maturities. The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account market interest rates, the remaining terms and present credit worthiness of the counterparties.


F-22

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 16 - Disclosures about Fair Value of Financial Instruments   (continued) The estimated fair values of the Companys financial instruments are as follows:  December 31,2006

          

          2005Carrying Value

          

          Fair Value

          

          Carrying Value

          

          Fair Value(Dollars in Thousands)Financial AssetsCash and due from banks

          

          

          $2,851

          

          

          

          $2,851

          

          

          $

          1,342

          

          

          $

          1,342Investment securities available for sale

          

          

          8,526

          

          

          

          8,526

          

          

          

          8,153

          

          

          

          8,153Investment securities held to maturity

          

          

          4,000

          

          

          

          3,910

          

          

          

          3,998

          

          

          

          3,884Mortgage backed securities held to maturity

          

          

          3,200

          

          

          

          3,134

          

          

          

          4,525

          

          

          

          4,430Federal Home Loan Bank stock

          

          

          2,098

          

          

          

          2,098

          

          

          

          1,955

          

          

          

          1,955Loans receivable  net

          

          

          147,118

          

          

          

          141,590

          

          

          

          144,609

          

          

          

          141,103Accrued interest receivable

          

          

          560

          

          

          

          560

          

          

          

          487

          

          

          

          487Financial LiabilitiesDeposits

          

          

          $111,823

          

          

          

          $112,091

          

          

          $

          109,623

          

          

          $

          109,655Borrowings

          

          

          39,000

          

          

          

          38,653

          

          

          

          36,000

          

          

          

          35,665Accrued interest payable

          

          

          102

          

          

          

          102

          

          

          

          91

          

          

          

          91Financial Instruments  Off-Balance SheetLoan commitments

          

          

          $

          

          

          

          $

          

          

          $

          

          

          

          $

          Lines of credit

          

          

          

          

          

          

          

          

          

          

          

          

          

          

          
 Note 17 - Recent Accounting Pronouncements In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS No 155). SFAS No. 155 amends FASB Statement No. 133 and FASB Statement No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting that eliminates exemptions and provides a means to simplify the accounting for these instruments. Specifically, SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole
instrument on a fair value basis. 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. SFSB, Inc. is required to adopt the provisions of SFAS No. 155, as applicable, beginning in fiscal year 2007. Management does not believe the adoption of SFAS No. 155 will have a material impact on SFSB, Inc.s financial position and results of operations. In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets  An Amendment of FASB Statement No. 140 (SFAS 156). SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The statement permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. SFAS No. 156 is effective as of the beginning of an entitys first fiscal year that begins after September 15, 2006, which for SFSB, Inc. will be as of the beginning of fiscal 2007. We do not believe that the adoption of SFAS 156 will have a significant effect on our financial statements.


F-23

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17 - Recent Accounting Pronouncements   (continued) In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes. The interpretation clarifies the accounting for uncertainty in income taxes recognized in a companys financial statements in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Specifically, the pronouncement prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the related de-recognition,
classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The interpretation is effective for fiscal years beginning after December 15, 2006. The Company is evaluating the impact of this new pronouncement on its consolidated financial statements. In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. FASB Statement No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. We are currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 157 on our consolidated financial position,
results of operations and cash flows. On September 13, 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, companies might evaluate the materiality of financial-statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of
misstatement present in a companys balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. The Company has analyzed SAB 108 and determined that upon adoption it will have no impact on the reported results of operations or financial conditions. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. The effective date for the Bank will be January 1, 2008. Management is currently analyzing the effect, if any, on consolidated financial position or results of operations. Note 18 - Related Party Transactions Since August 2003, Mr. James Benson Brown, a Director of the Bank, has provided the Bank with real estate consulting services. For the years ended December 31, 2006 and 2005, Slavie Federal Savings Bank paid Mr. Brown $3,000 and $4,000, respectively, for these services. Mr. Thomas L. Drechsler, a director of the Company, currently serves as the Banks general counsel through Kearney, Drechsler & Awalt, LLC, of which Mr. Drechsler is a 33% owner. Through other firms, Mr. Drechsler has served as Slavie Federal Savings Banks general counsel since 2000. For the years ended December 31, 2006 and 2005, Slavie Federal Savings Bank paid law firms that Mr. Drechsler was associated with $10,000 and $6,000, respectively, for legal services. Through Universal Title, LLC, Mr. Drechsler also provides settlement related services to the Banks borrowers in connection with loans originated by the Bank. In those
circumstances, Universal Title, LLC is compensated by the borrower. For the years ended December 31, 2006 and 2005, borrowers paid Universal Title, LLC $73,000 and $145,000, respectively, for those services.


F-24

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 19  Condensed Financial Information (Parent Company Only)  December 31,2006

          

          2005(Dollars in Thousands)Statements of Financial ConditionASSETSCash and cash equivalents

          

          

          $4,684

          

          

          $

          5,136Note receivable  ESOP

          

          

          1,050

          

          

          

          1,108Investment in subsidiary

          

          

          16,656

          

          

          

          16,560Other assets

          

          

          

          

          

          

          9Total assets

          

          

          $22,390

          

          

          $

          22,813LIABILITIES AND STOCKHOLDERS EQUITYLiabilitiesOther liabilities

          

          

          $25

          

          

          $

          8Total liabilities

          

          

          25

          

          

          

          8Total stockholders equity

          

          

          22,365

          

          

          

          22,805Total liabilities and stockholders equity

          

          

          $22,390

          

          

          $

          22,813
  December 31,2006

          

          2005(Dollars in Thousands)Statements of IncomeTotal Revenue

          

          

          $89

          

          

          $

          73Non-interest Expense

          

          

          38

          

          

          

          97Income (Loss) before equity in undistributed net income of subsidiary and income taxes

          

          

          51

          

          

          

          (24

          )Undistributed net (loss) income of subsidiary

          

          

          (13)

          

          

          

          254Income before income tax provision

          

          

          38

          

          

          

          230Income tax provision (benefit)

          

          

          20

          

          

          

          (9

          )Net income

          

          

          $18

          

          

          $

          239


F-25

---

SFSB, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 19  Condensed Financial Information (Parent Company Only)   (continued)  Years Ended December 31,2006

          

          2005(Dollars in Thousands)Statements of Cash FlowsOperating activitiesNet income

          

          

          $18

          

          

          $

          239Adjustments to reconcile net income to net cash provided by operating activities:Non-cash compensation under stock based compensation plans And Employee Stock Ownership Plan

          

          

          101

          

          

          

          Equity in undistributed net loss (income) of subsidiary

          

          

          13

          

          

          

          (254

          )Decrease in note receivable - ESOP

          

          

          58

          

          

          

          58Decrease in intercompany payable

          

          

          

          

          

          

          (7,035

          )Decrease (increase) in other assets

          

          

          6

          

          

          

          (9

          )Increase in other liabilities

          

          

          17

          

          

          

          9Net Cash Provided by (Used in) Operating Activities

          

          

          213

          

          

          

          (6,992

          )Financial activitiesPurchase of treasury stock

          

          

          (665)

          

          

          

          (96

          )Net Cash Used in Financial Activities

          

          

          (665)

          

          

          

          (96

          )Decrease in cash and cash equivalents

          

          

          (452)

          

          

          

          (7,088

          )Cash and cash equivalents at beginning of year

          

          

          5,136

          

          

          

          12,224Cash and cash equivalents at end of year

          

          

          $4,684

          

          

          $

          5,136


F-26

---

DIRECTORS AND OFFICERS Directors of SFSB, Inc. and Slavie Federal Savings Bank  J. Benson Brown Real estate consulting, JB Brown Associates

          

          James D. Wise Financial and investment consulting, Ronald Blue & Co., LLC
  Thomas J. Drechsler Practicing attorney, Kearney, Drechsler  Awalt, LLC

          

          Philip E. Logan President, Chief Executive Officer and Chairman
  Robert M. Stahl IV Practicing attorney and a Certified Public Accountant, Law Offices of Robert M. Stahl

          

          Charles E. Wagner, Jr. Executive Vice President, Chief Lending Officerand Secretary
 Officers of SFSB, Inc.  Philip E. Logan President and Chief Executive Officer

          

          Sophie T. Wittelsberger Vice President and Chief Financial Officer
  Charles E. Wagner, Jr. Executive Vice President, Chief Lending Officer and Secretary
 Officers of Slavie Federal Savings Bank  Philip E. Logan President and Chief Executive Officer

          

          Gary E. Barnoff Vice President  Branch Operations
  Charles E. Wagner, Jr. Executive Vice President, Chief Lending Officerand Secretary

          

          Sophie T. Wittelsberger Vice President and Chief Financial Officer
  Michael Tagg Vice President  Commercial Lending


22

---

INVESTOR AND CORPORATE INFORMATION Annual Meeting The annual meeting of stockholders will be held at 4:00 p.m. on May 17, 2007 at the Slavie Federal Savings Bank Community Room located at 1614 Churchville Road, Bel Air, Maryland. Stock Listing and Market Information SFSB, Inc.s common stock is traded on the Over the Counter Bulletin Board (OTCBB) under the symbol SFBI.OB. As of March27, 2007, the number of holders of record of SFSB, Inc.s common stock was approximately 149. SFSB, Inc. first issued shares of common stock on December 30, 2004 and trading began on the OTCBB on December 31, 2004. The following table represents the Companys common stock, based on high and low sales information as reported on the OTCBB. This information reflects inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions.  High

          

          LowDecember 31, 2004

          

          $

          11.00

          

          

          $

          10.75March 31, 2005

          

          

          10.95

          

          

          

          9.00June 30, 2005

          

          

          9.35

          

          

          

          8.40September 30, 2005

          

          

          9.40

          

          

          

          8.95December 31, 2005

          

          

          9.90

          

          

          

          9.10March 31, 2006

          

          

          9.80

          

          

          

          9.10June 30, 2006

          

          

          10.05

          

          

          

          9.55September 30, 2006

          

          

          9.75

          

          

          

          9.60December 31, 2006

          

          

          9.95

          

          

          

          9.60
 SFSB, Inc. has not paid any cash dividends.  **Stockholder and General
        Inquiries**


      **Transfer Agent** SFSB, Inc.

          Illinois Stock Transfer Company 1614 Churchville Road

          209 West Jackson Boulevard, Suite 903 Bel Air, Maryland 21015

          Chicago, Illinois 60606-6905 (443) 265-5570

          (312) 427-2953 Attention: Charles E. Wagner, Jr. Executive Vice President Please contact our transfer agent directly for assistance in changing your address, elimination of duplicate mailing, transferring stock, or replacing lost, stolen or destroyed stock certificates. Annual Reports A copy of the SFSB, Inc. Annual Report on Form 10-KSB without exhibits for the year ended December 31, 2006 as filed with the Securities and Exchange Commission, may be obtained without charge by contacting Charles E. Wagner, Jr., Executive Vice President, SFSB, Inc., 1614 Churchville Road, Bel Air, Maryland 21015.  **Independent Registered
        Public Accounting Firm**


      **Special Counsel** Beard Miller Company LLP

          Ober, Kaler, Grimes & Shriver Suite 404

          A Professional Corporation 100 West Road

          120 E. Baltimore Street Baltimore, Maryland 21204

          Baltimore, Maryland 21202 Slavie Federal Savings Banks Office Locations Main Office

          Branch Office 1614 Churchville Road

          3700 East Northern Pkwy Bel Air, MD 21015

          Baltimore, MD 21206


23

---